L2-8

• Audit risk


  The risk of inappropriate opinion due to materially misstated financial statements
• Materiality


  Judged by its influence on economic decisions and can be quantitative or qualitative
• Materiality assessment


  Occurs at planning, entire financial statements, and account balance levels
• Tolerable error


  The minimum misstatement permitted
• Understanding the client's business

  • Helps assess risks, controls, and plan the audit efficiently
• Phases of an audit


  Knowing the client, planning, performing procedures, and reporting findings
• Audit strategy


  A broad plan setting the scope, timing, and direction of the audit aligned with identified risks
• Audit plan


  Detailed plan addressing audit strategy matters, tailored based on size, complexity, team experience, and changes during the audit period
• Auditor independence


  • Not allowing prejudice, no biased/personal gain from auditing from the company, no conflict of interest
• Auditor independence


  A requirement - implies honestly and openness
• The greater the auditor independence


  The more credible the opinion is on the financial statements as they are able to work without bias and evaluate with more rigor
• Materiality


  If its omission or misstatement is significant enough to influence the economic decision of users
• Factors affecting materiality


  • Size of misstatement
  • Nature of misstatement
  • Circumstances
• Audit risk


  Audit risk = inherent risk X control risk X detection risk
• If inherit or control risks are high


  More extensive testing is needed to reduce detection risk
• Audit documentation


  • Crucial for audit success and required by ISAs
• Contents of audit documentation

  • Audit strategy
  • Procedures
  • Evidence
  • Conclusions
• Internal controls


  • Designed by management to prevent and detect material misstatements
• Responsibility for internal controls


  • Lies with management or governance
• 5 key components of internal controls


  • Control environment
  • Risk assessment process
  • Information system and communication
  • Control activities
  • Monitoring of controls
• Importance of internal controls to auditors

  • Auditors need to ensure reliability of financial statements by understanding system reliability and effectiveness of controls
• Identifying internal controls


  Through management enquiry, observation, and documentation
• Testing effectiveness of internal controls


  Inquiry, observation, walk-through, and inspection of relevant documents
• Manual systems


  • Prone to errors; auditors work with the assumption that controls prevent or correct mistakes
• IT systems


  • Automate controls, assuming things go right unless a specific threat arises
• Assertions for revenue


  • Occurrence
  • Completeness
  • Cut off
• Assertions for purchases


  • Authorisation
  • Accuracy
• Assertions for inventory


  • Existence
  • Completeness
• Examples of transaction cycle controls

  • Payroll transactions: Cut off, Classification, Authorisation
• Capital Expenditure


  • Acquisition
  • Disposal
  • Depreciation
  • Leasing
• Assertions for PP&E


  • Existence
  • Completeness
  • Authorization
  • Rights & obligations
  • Accuracy
  • Valuation
  • Cut-off
  • Classification
• Assets purchased not authorised by the board

  Risk
• Long Term Debt


  Assurance on debt amounts and recognition of interest expense
• Portion of long-term debt due next year isn't reclassified as a short term liability

  Risk
• Main Transactions for Equity

  • Issuance of shares
  • Repurchase of shares
  • Payment of dividends
• Cash dividends declared but not paid are not shown as liabilities

  Risk
• Representation of cash in FS

  • Cash
  • Cash equivalents
• Cash received or paid near the year end is recorded in the wrong period

  Risk
• Limitations & Weaknesses


  • Cost vs benefits
  • Management override
  • Errors or mistakes
  • Collusion
  • Breakdowns
• Effects of Weak Controls

  • Adjusting risk levels
  • Conducting further audit procedures
  • Performing more substantive procedures