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ISA 315, Identifying and Assessing the Risks of Material Misstatement Through
Understanding the Entity and Its Environment identifies the following assertions:
? Assertions about classes of transactions and events for the period under
audit – occurrence completeness, accuracy, cut off and classification.
? Assertions about account balances at the period end – existence, rights
and obligations completeness, and valuation and allocation.
? Assertions about presentation and disclosure – occurrence and rights
and obligations, completeness, classification and understandability, and
accuracy and valuation.
In addition, a risk can relate to a practical problem the audit team may face,
such as attendance at inventory counts where the company has multiple sites
holding simultaneous inventory counts, or if the company has had significant
changes in their finance department and so the risk of fraud and error has
increased.
The common mistake is for candidates to identify a relevant issue from the
scenario and then consider the risk to the company rather than to the auditor,
linking into the related assertion.
Therefore, using Question 3b from the June 2011 exam: ‘The travel agents are
given a 90-day credit period to pay Donald Co; however, due to difficult trading
conditions, a number of the receivables are struggling to pay.’ The audit risk
related to this point is that if receivables are struggling to pay, then they may
be overstated and, hence, valuation of receivables is the relevant risk.
The business faces the risk of slow cash flows and so there is a business risk
related to the liquidity of Donald Co. While going concern is an audit risk, the
above point from the scenario is not sufficient on its own to indicate going
concern risk.
In addition, Question 1a from the June 2010 exam told candidates: ‘Purchase
orders for overseas paint are made six months in advance and goods can be in
transit for up to two months.’ The explanation of the audit risk would be to
ascertain that the cut-off of inventory is appropriate at the year end. However,
many candidates explained that the company may encounter problems with
stock-outs of goods, which is focused more on operational business risk rather
than on the risks to the financial statements.
Other examples of audit risks include:
? treatment of capital and revenue expenditure – the risk here could relate
to existence of property plant and equipment if revenue expenditure has
been capitalised rather than charged as an expense in the income
statement
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? valuation of inventory – when, for example, there are considerable levels
of aged inventory
? completeness of liabilities – this could arise if provisions have been
incorrectly treated as contingent liabilities
? completeness of revenue – this could be relevant where the entity being
audited has significant cash sales.
Responses to audit risks
Having identified the audit risk candidates are often required to identify the
relevant response to these risks. A common mistake made by candidates is to
provide a response that management would adopt rather than the auditor.
From Question 3b June 2011, in relation to the risk of valuation of receivables,
as Donald Co had a number of receivables who were struggling to pay, many
candidates suggested that management needed to chase these outstanding
customers. This is not a response that the auditor would adopt, as they would
be focused on testing valuation through after date cash receipts or reviewing
the aged receivables ledger.
Auditor’s responses should focus on how the team will obtain evidence to
reduce the risks identified to an acceptable level. Their objective is confirming
whether the financial statement assertions have been adhered to, and whether
the financial statements are true and fair.
Responses are not as detailed as audit procedures; instead they relate to the
approach the auditor will adopt to confirm whether the transactions or
balances are materially misstated. Therefore, in relation to the risk of going
concern, the response is to focus on performing additional going concern
procedures, such as reviews of cash flow forecasts.
Also, auditor responses should not be too vague such as ‘increase substantive
testing’ without making it clear how, or in what area, this would be addressed.
In addition, candidates’ must ensure that they do not provide impractical
responses. A common example of this is to request directly from the
company’s bank as to whether the bank will provide a loan or renew a bank
overdraft. The bank is not going to provide this type of information to the
auditor, especially if they have not yet informed the company, and therefore
this response will not generate any marks.
Limited range of risks identified
In order to score well in risk questions it is advisable to aim to identify a
breadth of points from the question scenario. If the question asks for a specific
number of audit risks, such as five, then it is not sufficient to identify just one
or two risks. In addition, a common mistake is to identify a risk such as going
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concern and then give this answer over and over again. In Question 3b of the
June 2011 exam, there was only a maximum of one mark available for the
description of going concern risk.
Each scenario will have a variety of audit risks and candidates should, as part
of their planning, aim to identify as many as possible. They should then decide
which of the identified risks they will explain/describe in their answer. If the
question asks for five risks, candidates should aim to identify six or seven
points during their initial reading of the question. Candidates should then
review their list and pick the five risks and responses that they feel they can
expand on the most when writing up their answer.
Conclusion
Audit risk is, and will continue to be, an important element of the Paper F8
syllabus. Candidates must understand the syllabus outcomes, understand what
the question requirements involve and practise risk questions prior to the
exam.
Pami Bahl is the examiner for Paper F8
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