QUESTION 16.

MILLA CO: [AUDIT RISK]

a) Explain audit risk and components of audit risk:

Audit risk is the risk of the auditor giving an inappropriate opinion on the financial
statements. The auditor must obtain sufficient audit evidence in order to be certain that the
correct audit opinion is given about the financial statements.

Audit risk is made up of inherent risk, control risk, and detection risk. All these together
should be reduced to an adequate level in order to guarantee the evidence obtained makes
up for the risk.

Inherent risk: the risk that comes along which might not be controlled by the internal
controls in time.

Control risk: risk that the internal controls are not working fully and therefore, internal
system such as sales systems would lack management.

Detection risk: the risk that the auditor does not detect the material misstatements.

b) Describe 7 audit risk, and give auditors response:

AUDIT RISK AUDIT RESPONSE
The expenditure of $5mil on updating, repairing and The auditor should request an asset register and
replacing significant amount of machinery. obtain supporting documents on all the additions
made to the machinery.
This creates the risk of overstating assets from the
additional capitalisation of the assets. As per IAS 16, PPE, Update the depreciation policy if needed and agree
short-term expenses such as training costs and repair any disposals for the year.
costs should not be capitalized as part of the asset.
The company has increased its warehouses and we are It might be important to observe a physical count
not told more employees were added for the inventory to ensure that the same procedures are done and
counts. that the work done has not decreased.

There is a greater detection risk placed on inventory due The auditor would also obtain rent invoices from
to the spread of more warehouses. the 3rd parties and confirm that the additional
warehouses were indeed needed.
New accounting ledger was introduced and only tested The auditor should add more resilience on the
for 2 months. opening balances tests to ensure that the balances
match up with the year before. Following that, the
Slight balances that might provide little errors in 2 auditor can also request sample of supplier
months could be material in the long run. statements to confirm the balances agree.
The trade receivables allowance was released fully. The auditor should perform analytical procedures
There is a control risk due to the fact that the finance on the trade receivables to make sure it did not
director solely deciding that the trade receivables increase from last year. Also, the auditor has to
allowance can be fully released. discuss with management the possibility of
reducing a part of the allowance and not all, unless
all the customers have a superb credit risk score.
There was a problem in the mixing of raw materials and The auditor will have to obtain a sample of goods
some of the products were sold. despatched notes and goods returned notes, and
agree the values with the sales ledger.
There is the risk of overstating revenue because some of
the goods would have been returned back. There is also The auditor should send a confirmation request to
a greater detection risk because the problem was not the customers that have returned the product to
caught on early and has resulted in products being confirm that the correct balance is issued.
produced and sold.
The inventory has not been adjusted and is therefore The Auditor must obtain an inventory list and
overstated. This should be accounted for as per IAS 2, discuss with management the need to adjust the
inventory using the lower of cost and Net Realisable inventory at the net realisable value.
Value Method.
The inventory should be calculated again and
The risk of overstating inventory is present due to the evaluate any significant differences.
fact that the management did not adjust it.
Even more risk is present as we are told that a significant The auditor should ensure that assets are tested
annual bonus is based on value of year-end total assets. carefully and given the importance they deserve.

There is the risk of overstating the assets for a greater The auditor should inspect the asset register and
bonus. This could be done by buying machinery that add any amortization/depreciation schedule.
would not be of benefit to the company, or not replacing The auditor will also confirm the cash balance
asset until fully depreciated. Cash and inventory might agrees to the cashbook and that inventory agrees
also be overstated for the added bonus to the inventory list. Additional procedures could
be to compare the figures with prior periods, and
to evaluate the need to observe the physical count.

c) What should be included in audit strategy document for Mila, and provide an
example:

Description: Example
1. identify the main characteristics of the engagement which define its If the accounts have been
scope prepared in accordance with IFRS
2. The document should understand the reporting objective  Location of Inventory counts
 timings of the audit team
meetings and review of work
performed
3. The document should show the factors directing the audit team's effort  Materiality levels
4. It should consider the knowledge from prelim planning & other areas  Results of previous audits and
any tests of internal controls

d) Explain difference between interim and final audit:

Interim audit is done in throughout the year to help the final audit. It consists of audit work
done to gather information and audit evidence to facilitate the collection of all the evidence
easily at the end of the financial year.

e) Interim audit would consist of evaluating the monthly inventory counts, while the
final audit would consider if enough evidence was collected to state that no material
misstatements are present in the financial statements.

Question 18:

a) Factors when considering third party valuations:

Rossi & Co should consider any information that is crucial to understand the value
difference and how reliable it is to ascertain audit evidence.

- The date of the valuation

- The reputation of the valuer, COMPETANCE, AND CAPABILITY OF EXPERT.
o ASSESS INDEPENDENCE
o ASSESS WHETHER RELEVANT EXPERTISE OF PROPERTIES
- EVALUATE ASSUMPTIONS

b) Substantive procedures on land and buildings: