What is the link between audit risk and engagement risk? How does the audit risk model allow the auditor to deal with these risks in the most cost effective manner? Audit risk is the risk that the auditor gives the wrong opinion -? this can either be stating errors when there are none or when there are errors stating that there are none. This risk cannot be eliminated as auditors can only provide a reasonable assurance and not absolute, but instead this can only be managed and reduced to a minimum.
Engagement risk is the risk of the consequences of giving a wrong opinion to occur. Consequences include legal action against the auditor and loss of reputation of the auditor and lower fees charged. The link between these two risks is that the lower the audit risk, the lower the engagement risk. If the risk of giving a wrong opinion is minimal, so is the risk of facing consent ounces Of making the error. Reducing audit risk requires more resources to conduct better audits. Auditor must design an audit strategy so that the benefits of reduced engagement risk outweigh additional costs of more auditing.
Generally, the risk based auditing approach is used – concentrate on the parts f the financial statements that require more work. SQ. Discuss the procedures that should be followed and the matters that should be considered when accepting new audit engagement The basic audit process Decide whether to accept or decline the process Decline if: Too risky -? or charge higher fees Auditor audits clients competitor – might disclose sensitive information The auditor might not have enough staff Auditor does not have expertise in the clients industry The fee is too low – auditor will lose money through the engagement. Impasses sometimes use the auditor’s brand name Engagement letter Assess the risk of the client Collect sufficient appropriate audit evidence Form and issue an audit opinion SQ. What would you include in an engagement letter? What should be included in an engagement letter is what is mentioned in AS 210 Agreeing the terms of Audit Engagements which are: The objective and scope of the audit of the financial report Agreement fees The responsibilities of the auditor “audit in accordance to an applicable framework” The responsibilities of management TO provide the auditors with enough access with evidence Preparation of financial statements SQ.
What is the key account and key audit assertion that is affected by each of the following accounting issues: excessive bad debts, accounts receivable, valuation and allocation must be appropriate valued at the collectible amount or allowance for doubtful debts – completeness inventory purchased in foreign currencies, Inventory, valuation and allocation Is it in the appropriate currency? Unusual lengthening of the useful lives of assets, Depreciation expense, accuracy More direct than accumulated depreciation capitalization of research and development expenditure on failed projects R, existence
R expense understated, completeness complex payroll calculations, wages expense, accuracy customers canceling sales orders, sales, occurrence sales are overstated since orders are cancelled prepayment of insurance prep mums, insurance prepayment, completeness Insurance expense, occurrence changes in the fair value of shares held for investment purposes, asset, valuation and allocation SQ. During the course of an audit engagement, an independent must address the concept of materiality.
This concept is inherent in the work of the independent auditor and is important for planning, evidence gathering, error valuation and the audit opinion-forming process. 1 . Briefly describe what is meant by the independent auditor’s concept of materiality 2. Outline the relevance of materiality during each of the following stages of the audit process: a. Planning b. Evaluation of the results of audit testing c. Forming and audit opinion 3. Discuss the process of setting the planning materiality for an audit 4.
Explain the concept of performance materiality 1 Materiality is the concept of whether the errors or misstatements are significant enough to be considered as an error. It is material if it affects the seer’s decisions. In general, the larger the error, the more material. There are items that are always material regardless of dollar amount, usually statutory requirements 2. A. In the planning Stage, the maximum error threshold is decided b. Based on the threshold, measure whether it is material or not c. Sing materiality to determine whether the accumulated errors, are they large enough to justify an opinion 3. SAAB 1031 materiality. Planning materiality and performance materiality – are only for auditors. Planning materiality – one base for the whole statement. For public companies – net profit since people are more focused on that only if it is stable, if not pick total revenue or total assets. Used for financial statements as a whole. 4.
Performance materiality is set lower than planning materiality. Used for testing individual items. Gives a buffer. I. E. Inventory – cannot audit everything, so this lowers the chance of not picking material items. SQ. EX. Ltd is a publicly listed company which has suffered from major sales declines, due to increased foreign completion, and has made a succession of losses over the past three years. During the year, its CEO resigned and was replaced by Chief Operating Officer (COO).
The trial balance reveals that sales were $1 and the company made a loss of $500,000. At what level would you set planning materiality? Justify your answer. Planning materiality coos of $500,000 Set planning materiality of 5-10% or loss $25000 or $50000 Riskier then closer to $25000 Pick 330000 as Tutorial notes Risk based auditing Determine which parts of the F/S are at most risk of material error and concentrate audit effort in those areas Reducing audio risk is a trade off (cost benefit approach)
Reducing audit risk lowers engagement risk but audits are costly 4 main stages Accept/reject client Planning Assessment of business risk Assessment of internal controls Evidence gathering and assessment Tests of controls Us obstinate procedures Form and issue audit opinion Business risk high internal controls weak high residual audit risk Reduce audit risk through appropriate audit procedures If risk is low, don’t concentrate on those accounts Assertions: Transactions (P/L accounts) Account balances (B/S accounts) Disclosures (footnotes) Coco Renee Is it overstated? Existence
Is it real? Occurrence and rights and obligations Rights and obligation Does the company own the asset? Or a legitimate liability? Completeness Understated? Is cometh ins missing? Understated? Accuracy Is the right dollar value ascribed to it? Valuation and allocation Is it the right dollar value?