PART B: PLANNING AND RISK

ASSESSMENT
CHAPTER 5: FRAUD AND ERROR
Definition:
Fraud – Intentional act to obtain an unjust or illegal advantage.
Error – Unintentional misstatement in financial statements.

D21 Responsibility for Prevention and Detection of Fraud

– FIRM are responsible for obtaining reasonable assurance that the financial
statements taken as a whole are free from material misstatement, whether
caused by fraud or error.
– FIRM is required to identify and assess the risks of material misstatement of
the financial statements due to fraud. (AUDIT RISKS)
– The auditor needs to obtain sufficient appropriate audit evidence regarding the
assessed risks of material misstatement due to fraud, through designing and
implementing appropriate responses.
– FIRM must respond appropriately to fraud or suspected fraud identified during
the audit, for example, the fraud regarding the purchase of assets for personal
use identified by CLIENT. (AUDITOR’s RESPONSES)
– When obtaining reasonable assurance, FIRM is responsible for maintaining
professional skepticism throughout the audit, considering the potential for
management override of controls and recognizing the fact that audit procedures
which are effective in detecting error may not be effective in detecting fraud.
– To ensure that the whole engagement team is aware of the risks and
responsibilities for fraud and error, ISAs require that a discussion is held within
the team.
– FIRM must report any actual or suspected fraud to appropriate parties.
 CHAPTER 6: MATERIALITY

J19 Materiality

Materiality is defined as Misstatements, including omissions, are considered to

be material if they, individually or in the aggregate, could reasonably be
expected to influence the economic decisions of users taken on the basis of the
financial statements.

A misstatement may be considered material due to its size (quantitative) and/or

due to its nature (qualitative) or a combination of both. The quantitative nature
of a misstatement refers to its relative size. The qualitative nature of a
misstatement refers to an amount which might be low in value but due to its
prominence and relevance could influence the user’s decision.

Materiality is often calculated using benchmarks such as 5% of profit before tax

or 0.5% of total revenue or 1% of total assets. Even so, the assessment of what
is material is based on the auditor’s professional judgement.

In assessing materiality, the auditor must consider that a number of errors each
with a low value may, when aggregated, amount to a material misstatement.

The auditor sets performance materiality at an amount which is lower than

the materiality level for the financial statements as a whole. Performance
materiality is used to reduce the risk that the aggregate of uncorrected and
undetected
misstatements exceeds materiality for the financial statements as a whole to an
acceptable level
 CHAPTER 7: ANALYTICAL PROCEDURES
Analytical Procedures:
- Definition: AP consist of the analysis of significant ratios and trends,
including the resulting investigations of fluctuations and relationships that
are inconsistent

S22 / D18 3 Stages of Analytical Procedures

Analytical Procedures identify three particular stages are as follows:

During the planning stage, analytical procedures must be used as risk

assessment procedures in order to help the auditor to obtain an understanding
of the entity, assess the risk of material misstatement and identify unexpected
fluctuations or unusual relationships.

During the final audit, analytical procedures can be used to obtain sufficient
appropriate evidence which substantive procedures can either be tests of detail
or substantive analytical procedures.

At the final review stage, the auditor must design and perform analytical
procedures which corroborate the overall conclusion formed as to whether the
financial statements are consistent with the auditor’s understanding of the
entity.

CHAPTER 8: AUDIT RISKS

D21 /J17 / J16 Definition and Components of Audit Risk

Audit risk is the risk that the auditor expresses an inappropriate audit opinion
when the financial statements are materially misstated. Audit risk is form of two
main components which are risk of material misstatement and detection risk.
Risk of material misstatement is made up of a further two components, inherent
risk and control risk.

Inherent risk is the susceptibility of an assertion about a class of transaction,

account balance or disclosure to a misstatement which could be material, before
consideration of any related controls (the risk that an item will be misstated due
to the characteristics of that item)

Control risk is the susceptibility of an assertion about a class of transaction,

account balance or disclosure and which could be material, will not be
prevented, or detected and corrected, on a timely basis by the entity’s internal
control (the risk that CLIENT’s internal controls will not prevent or detect
misstatement)

Detection risk is the risk that the procedures performed by the auditor to reduce
audit risk to an acceptably low level will not detect a misstatement. Detection
risk is affected by sampling and non-sampling risk (the risk that the auditor's
substantive procedures will not detect material misstatements)
D15 Sources of information to gain understanding

Prior year financial statements: Provides information in relation to the size of

CLIENT as well as the key accounting policies, disclosure notes and whether the
audit opinion was modified or not.

Discussions with the previous auditors: Provides information on key issues

identified during the prior year audit as well as the audit approach adopted.

Prior year report to management: If this can be obtained from the previous
auditors or from management, it can provide information on the internal control
deficiencies noted last year. If these have not been rectified by management,
then they could arise in the current year audit as well and may impact the audit
approach.

CLIENT’s accounting systems notes/procedural manuals: Provides information on

how each of the key accounting systems operates and this will be used to
identify areas of potential control risk and help determine the audit approach.

Discussions with management: Provides information in relation to the business,

any important issues which have arisen or changes to accounting policies from
the prior year.

Review of board minutes: Provides an overview of key issues which have arisen
during the year and how those charged with governance have addressed them.

Current year budgets and management accounts: Provides relevant financial

information for the year to date. It will help the auditor during the planning
stage for preliminary analytical review and risk identification.

CLIENT’s website: Recent press releases from the company may provide
background on the business during the year as this will help in identifying the
key audit risks.

Financial statements of competitors: This will provide information about

CLIENT’s competitors, in relation to their financial results and their accounting
policies. This will be important in assessing CLIENT’s performance in the year
and also when undertaking the going concern review.
 CHAPTER 9: AUDIT PLANNING
Audit Strategy Audit Plan
- Scope, timing and direction of the - Specific audit work based on the
audit audit strategy

D20 / S16 Benefits of Audit Planning

− Helping the auditor to devote appropriate attention to important areas of the

audit.
− Helping the auditor to identify and resolve potential problems on a timely
basis.
− Helping the auditor to properly organize and manage the audit engagement
so that it is performed in an effective and efficient manner.
− Assisting in the selection of engagement team members with appropriate
levels of capabilities and competence to respond to anticipated risks and the
proper assignment of work to them.
− Facilitating the direction and supervision of engagement team members and
the review of their work.
− Assisting, where applicable, in coordination of work done by experts.

J14 Interim Audit VS Final Audit

Interim audit
The interim audit is that part of the audit which takes place before the year end.
The auditor uses the interim audit to carry out procedures which would be
difficult to perform at the year end because of time pressure. There is no
requirement to undertake an interim audit.

Typical procedures undertaken during the interim audit include consideration of

inherent risks, documenting and testing of internal controls, testing of profit and
loss transactions for the year to date and identification of potential problems
which may affect the final audit work.

Final audit
The final audit will take place after the year end. The auditor uses final audit to
form and express an opinion on the financial statements for the whole year
subject to audit.

Typical work carried out at the final audit includes follow up of items noted at
the inventory count, obtaining confirmations from third parties, analytical
reviews of figures in the financial statements, substantive procedures of account
balances and transactions, review of events after the reporting period and going
concern review.
J14 Benefits of Documenting Audit Work

– Provides evidence of the auditor’s basis for a conclusion about the

achievement of the overall objective of the audit.
– Provides evidence that the audit was planned and performed in accordance
with ISAs and applicable legal and regulatory requirements.
– Assists the engagement team to plan and perform the audit.
– Assists members of the engagement team responsible for supervision to
direct, supervise and review the audit work.
– Enables the engagement team to be accountable for its work.
– Retains a record of matters of continuing significance to future audits.

D17 Main Areas Included in Audit Strategy

The audit strategy sets out the scope, timing and direction of the audit and
helps the development of the audit plan.

[ S ] Main characteristics of the engagement

The audit strategy should consider the main characteristics of the engagement,
which define its scope. The following are examples of things which should be
included:
– Whether the financial information to be audited has been prepared in
accordance with the relevant financial reporting framework.
– Whether computer-assisted audit techniques will be used and the effect of IT
on audit procedures.
– The availability of key personnel at Prancer Construction Co.

[ T ] Reporting objectives, timing and nature of communication

It should ascertain the reporting objectives of the engagement to plan the
timing of the audit and the nature of the communications required, such as:
– The audit timetable for reporting including the timing of interim and final
stages.
– Organization of meetings with Prancer Construction Co’s management to
discuss any audit issues arising.
– Any discussions with management regarding the reports to be issued.
– The timings of the audit team meetings and review of work performed.

[ D ] Significant factors affecting the audit

The strategy should consider the factors which, in the auditor’s professional
judgement, are significant in directing Prancer Construction Co’s audit team’s
efforts, such as:
– The determination of materiality for the audit.
– The need to maintain a questioning mind and to exercise professional
skepticism in gathering and evaluating audit evidence.
 CHAPTER 11: EXPERT and SERVICE ORGANISATION
J16 Service Organization

– The audit team should gain an understanding of the services being provided
by SO, including the materiality of payroll and the basis of the outsourcing
contract.
– They will need to assess the design and implementation of internal controls
over CLIENT’s payroll at SO.
– The team may wish to visit SO and undertake tests of controls to confirm the
operating effectiveness of the controls.
– If this is not possible, FIRM should contact SO’s auditors to request either a
type 1 (report on description and design of controls) or type 2 report (on
description, design and operating effectiveness of controls).
– FIRM is responsible for obtaining sufficient and appropriate evidence;
therefore, no reference may be made in the audit report regarding the use of
information from SO’s auditors.
– The use of information from service organization is not referenced in the
auditor’s responses.

* Can be asked in audit risks and auditor’s responses

S16 Placing Reliance on the work of Expert

ISA requires auditors to evaluate the competence, capabilities including

expertise and objectivity of a management expert. This would include
consideration of the qualifications of the valuer and assessment of whether they
were members of any professional body or industry association. The expert’s
independence should be ascertained, with potential threats such as undue
reliance on CLIENT or a self-interest threat such as share ownership considered.

In addition, FIRM should meet with the expert and discuss with them their
relevant expertise, in particular whether they have valued similar land and
buildings to those of CLIENT in the past. FIRM should also consider whether the
valuer understands the accounting requirements of accounting standard in
relation to valuations. The valuation should then be evaluated.

The assumptions used should be carefully reviewed and compared to previous

revaluations at CLIENT. These assumptions should be discussed with both
management and the valuer to understand the basis of any valuations.