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Copy of F8 Audit Risk

ACCA
by

Dorota McKay

on 27 May 2013

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Transcript of Copy of F8 Audit Risk

100 = 10 x 10 x 1 Audit Risk Control Risk Controls do not prevent or detect misstatement on a timely basis

- Deficiencies in internal control not addressed by management
- Lack of personnel with accounting qualifications
- Change in key personnel
- Changes in IT environment
- New IT equipment Inherent Risk The risk that is out there.

- Type of industry
- Changes in industry
- High degree of regulation
- New product or services
- New locations
- Complex transactions
- Pending litigation Detection Risk Auditors won't spot material misstatements Audit Risk Model Audit Risk = Inherent Risk x Control Risk x
Detection Risk Financial Statements Statement of
Profit or loss Statement of
Financial
Position ISA's ISA 200
Overall
Objectives [3] The purpose of an audit is to enhance the degree of confidence of intended users in the financial statements. This is achieved by the expression of an opinion by the auditor on whether the financial statements are prepared, in all material aspects, in accordance with and applicable financial reporting framework [13 (c)] Audit Risk- The risk that the auditor
expresses an inappropriate audit opinion when the financial statements are materially misstated. Audit risk is a function of the
risks of material misstatement and detection risk. [13 (e)] Detection Risk- The risk that
the procedures performed by the
auditor to reduce audit risk to an
acceptably low level will not detect a
misstatement that exists and that
could be material, either individually
or when aggregated with other
misstatements. [13 (n)] Risk of material misstatement – The risk that the financial statements are materially misstated prior to audit. This consists of two components, described as follows at the assertion level:

(i) Inherent risk – The susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be material, either individually or when aggregated with other misstatements, before consideration of any related controls.

(ii) Control risk – The risk that a misstatement that could occur in an assertion about a class of transaction, account balance or disclosure and that could be material, either individually or when aggregated with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control. Knowledge
of business? Past Exam Papers ISA 315
Identifying
& Assessing
the Risks ... [4b] Business risk – A risk resulting
from significant conditions, events,
circumstances, actions or inactions
that could adversely affect an
entity’s ability to achieve its
objectives and execute its
strategies, or from the setting of
inappropriate objectives and
strategies. December 2012

3 (b) Using the information provided,
describe FIVE audit risks and explain the auditor’s response to each risk in
planning the audit of Sunflower Stores Co.

(10 marks) June 2012 December 2011

3 (a) Explain the components of audit risk and, for each component, state an example of a factor which can result in increased audit risk.
(6marks)

(b) Using the information provided, identify and describe FIVE audit risks and explain the auditor’s response to each risk in planning the audit of Abrahams Co.
(10 marks) June 2011

3 (b) Using the information provided,
describe FIVE audit risks and explain
the auditor’s response to each risk in
planning the audit of Donald Co.
(10 marks) December 2010

3 (b) Using the information above:
(i) Calculate FIVE ratios, for BOTH years,
which would assist the audit senior in
planning the audit; and (5 marks)

(ii) From a review of the above information
and the ratios calculated, explain the
audit risks that arise and describe the appropriate response to these risks.
(10 marks) June 2010

1 a) Identify and explain the audit
risks identified at the planning
stage of the audit of Smoothbrush
Paints Co.

(10 marks) Comments from the
examiner Common mistakes made include:

providing definitions of the audit risk model, even though this was not part of the question requirement

a lack of understanding of what audit risk is and providing business risks instead

not providing an adequate response to the risk. This needs to be from the perspective of the auditor and not from management’s perspective

a limited range of risks identified, often just focusing on one area such as going concern. Objectives 1. To ensure we can explain audit risk and
it's components and be able to explain audit risks in the financial statements and the auditor's response to each risk.

2. To ensure that we know the difference between audit risk and business risk.

3. To ensure we know how to approach F8 exam questions. Sunflower Stores Co (Sunflower) operates 25 food supermarkets. The company’s year end is 31 December 2012. The audit manager and partner recently attended a planning meeting with the finance director and have provided you with the planning notes below. Sunflower has spent $1•6 million in refurbishing all of its supermarkets; as part of this refurbishment programme their central warehouse has been extended and a smaller warehouse, which was only occasionally
used, has been disposed of at a profit. In order to finance this refurbishment, a sum of $1•5 million was borrowed from the bank. This is due to be repaid over five years. The company will be performing a year-end inventory count at the central warehouse
as well as at all 25 supermarkets on 31 December. Inventory is valued at selling
price less an average profit margin as the finance director believes that this is a close approximation to cost. Prior to 2012, each of the supermarkets maintained their own financial records and submitted returns monthly to head office. During 2012 all accounting records have been centralised within head office. Therefore at the beginning of the year, each supermarket’s opening balances were transferred into head office’s accounting records. The increased
workload at head office has led to some changes in the finance department and in November 2012 the financial controller left. His replacement will start in late December. Business Risk Audit Risk Purchase orders for overseas paints are
made six month in advance and goods can
be in transit for up to two months

As there is a long period of time between ordering and delivery there is a risk of stock out. This may result in losing customer goodwill thereby reducing not only current sales but also future sales

The company should establish a predetermined order level system to reduce the risk of
stock outs The Examiner Audit Risk v Business Risk The travel agents are given a 90- day credit period to pay Donald & co: However due to difficult trading conditions, a number of receivables are struggling to pay. June 2011 The travel agents who sell tickets on behalf
of the airline are struggling to pay their outstanding balances to Donald Co.

This could result in irrecoverable debts and receivables being overvalued The audit team should plan to extend post-year end cash receipts testing and carefully review the aged receivables ledger to assess
valuation The travel agents who sell tickets on behalf
of the airline are struggling to pay their outstanding balances to Donald Co.

This could result in a liquidity risk as Donald Co. may not receive all of the outstanding balances and experience an unexpected shortage of cash.

Donald & Co should consider employing a debt factoring company to help them recover the
outstanding balances Purchase orders for overseas paints are made six month in advance and goods can be in transit for up to two months June 2010 Purchase orders for overseas paints are made six month in advance and goods can be in transit for up to two months

As only goods that have been received in the warehouse should be included in the inventory there is a risk that cut-off of purchases and inventory may not be accurate.

The audit team should plan to perform detailed cut- off testing on goods received prior to year end and post year end In order to fund the expansion
Donald co has applied for a
loan of $25m.
It has yet to hear from the
bank whether it will lend
them the money June 2011 In order to fund the expansion Donald
co has applied for a loan of $25m. It has
yet to hear from the bank whether it will
lend them the money

Donald has already ordered $20m of planes. if it does not receive the loan they may struggle to pay for for the planes resulting in going concern problems. There is a risk that the financial statements are prepared on the wrong basis or inadequate disclosures have been made

Discuss with the management the status of
the loan application, Perform a detailed Going concern review In order to fund the expansion Donald
co has applied for a loan of $25m. It has
yet to hear from the bank whether it will
lend them the money

Donald has already ordered $20m of planes. if it does not receive the loan they may struggle to pay for for the planes resulting in going concern problems.

Donald should investigate alternative financing if the loan application is rejected. A common mistake is to identify a risk such as going concern and
give this answer over and over
again. In question 3(b) of the June 2011 exam, there was only a maximum of one mark available for the description of going concern risk Multi-
location?

Returns
from
all
branches? Capital or
Revenue?

Breakdown
of costs Profit or loss
calc correct?

No longer in NCA's?

Review NCA
register

recalculate? Disclosed Properly
CL v NCL?
interest?
Review agreement/payment
CL/NCl split Can the auditor visit all 25 stores?
Controls important?
select a sample of stores to visit Seems weird. Normally lower of cost or NRV. Allowed by IAS 2 for close
approximation to cost.
Detailed testing of cost & NRV
Compare cost to selling price less average profit margin 25 stores- data
transfer-
erorrs?!

What was the
process

CAATS? No FC Nov/Dec
Errors??
Who do we ask questions to? Audit Risk Auditor's Response Identification of the issue on it's own is not enough!


You need to explain how it gives rise to an audit risk and specifically how it may lead to a misstatement in the financial statements 5 Different Issues Describe Explain Must Link to Audit risk

Think- what evidence do you want to collect to address the risk

Less detailed than an audit procedure but do not be vague Issues

1. Multi- location
2. First Year on the audit
3. Refurbishment of stores
4. Smaller warehouse sold
5. £1.5m borrowed from the bank
6. Inventory valuation
7. Year-end inventory count- 25 stores
8. Accounting records centralised
9. Financial Controller left Audit Risk Auditor's Response 1. Sunflower has spent $1.6m on refurbishing
its 25 supermarkets. There is a risk that some expenditure that should have been expensed has been capitalised (i.e. repairs and maintenance) or vice versa. There is a risk that non current assets and expenditure in the income statement is mistated Review a breakdown of the costs and agree
to invoices to assess the nature of expenditure.

If capital expenditure ensure it has been
included in the non current asset register.
If it is revenue expenditure agree to the income statement. Audit Risk Auditor's Response 2. During the year a small warehouse has been
disposed of at a profit. There is a risk that non current assets over overstated if it has not been correctly removed from Property, plant and Equipment. There is a risk that profit on disposal has not been calculated properly and profit is therefore misstated in the income statement. Review the non current asset register to ensure that the assets has been removed.

Recalculate the profit and loss on disposal and ensure it agrees with the figure disclosed in the income statement.

. Audit Risk Auditor's Response 4. Sunflower will be performing a year end
inventory count in its central warehouse and
25 supermarkets all on 31st December 2012 It is unlikely that the auditor will be able to attend inventory counts at all locations. There is risk that inventory is misstated if not all inventory counts are accurate. The audit team should select a sample of supermarkets to attend the year end inventory count.

The sample chosen will be based on those stores
with material inventory balances or a history of inventory count issues. Audit Risk Auditor's Response 3. Sunflower's inventory valuation policy is
selling price less average profit margin IAS 2 allows this method for retailers as long
as it is an approximation of cost and is applied
on a line by line basis.

If it is not applied on a line by line basis there is
a risk that inventory is misstated in the
financial statements
Discuss with management how they calculate the average profit margin and agree as reasonable.

Valuation testing should be undertaken
to compare the cost of inventory to the selling price less average profit margin on a line by line basis. Audit Risk Auditor's Response 5. There has been an increased workload for the
finance department and the financial controller
has left, with a replacement not due until late
December There is an increased risk of their being errors
in the financial statements as employees try
to fit more work into their schedules

The new financial controller may not be experienced enough to produce the financial statements for Sunflower The audit team should remain alert throughout
the audit for errors made by the finance department.

Enquire of the financial director if he can provide assistance to the team for any issues the new financial controllor is unable to resolve AR = IR x CR x DR Sampling Risk Non-sampling Risk Inadequate Planning
Inappropriate staff
Failing to apply professional scepticism Incorrect sampling techniques
Incorrect sample sizes Professional skepticism – An attitude
that includes a questioning mind,
being alert to conditions which may
indicate possible misstatement
due to error or fraud, and a
critical assessment of audit evidence. The risk assessment procedures shall include the following:

(a) Inquiries of management, and of others within the entity who in the auditor’s judgment may
have information that is likely to assist in identifying risks of material misstatement due to fraud or error.

(b) Analytical procedures.

(c) Observation and inspection. Cashflow
Problems? You are the audit senior, and this is your first year on this audit. In order to familiarise yourself with Sunflower, the audit manager has asked you to undertake some research in order to gain an understanding of Sunflower, so that you are able to assist in the planning process. He has then asked that you identify relevant audit risks from the notes
below and also consider how the team should respond to these risks. Issues

1. Refurbishment of stores
2. Smaller warehouse sold
3. Inventory valuation
4. Year-end inventory count- 25 stores
5. Extra workload/Financial Controller left IR CR DR Client 1 AR = IR x CR x DR CR DR Client 2 IR 100 = 2 x 2 x 25 AR = IR x CR x DR
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