Week 3

Week 3 07/08/2023 Risk Assessment I The Audit Process - 3 Distinct Stages The textbook Chapter 2 shows it like this: The textbook Chapter 3 shows it like this: Risk then Response then Report An understanding of the client is gained in the early stages of each audit and that knowledge drives the planning of the audit. It informs the choice of where to focus most attention throughout the audit (1) Risk - Assess the audit risk (2) Response - Respond to these risks with audit procedures (3) Report - Report based on evidence gathered (form an opinion on the truth and fairness of the financial report) Key terms: - Risk of material misstatement (RoMM) - Significance/Material - Error vs. Fraud Risk Assessment Process During the risk assessment phase of an audit an auditor will gain an understanding of their client - Their client's internal controls - Their client's information technology - Their client's corporate governance environment - Their client's closing procedures - Identify any relates parties - Factors that may affect their client's going concern status - Significant accounts and classes of transactions that will require close audit attention to gauge the risk of material misstatement Specific consideration of fraud After signing engagement letter No signed engagement letter
Gaining an Understanding of the Client Assessing RoMM starts high level Entity - Industry - Economy - Th nature of the client's business (Customers, Suppliers, Products/Services, Pricing structures, Business model) - The industry in which the client operates - The level of competition within that industry - The client's customers and suppliers - The regulatory environment in which the client operates Considering FRAUD When assessing fraud risk an auditor will adopt an attitude of professional scepticism to ensure that any indicator of a potential fraud is properly investigated DEFINITION : Fraud is an intentional act to obtain an unjust or illegal advantage through the use of deception (ASA 240, para. 11; IAS 240, para. 11) Red flags include: - A high turnover of key employees - Key finance personnel refusing to take leave - Overly dominant management - Poor compensation practices - Inadequate training programs - A complex business structure - No (or ineffective) internal auditing staff - A high turnover of auditors - Unusual transactions Examples of frauds: Financial reporting frauds: - Improper asset valuations - Unrecorded liabilities - Timing differences - bringing forward the recognition of revenues and delaying the recognition of expenses - Recording fictitious sales - Understanding expenses - Inappropriate application of accounting principles Misappropriation of assets frauds: - Using a company credit card for personal use - Employees remaining on the payroll after ceasing employment - Unauthorised discounts or refunds to customers
- Theft of stock by employees or customers - Using a company car for unauthorised personal use A crime requires 3 things: means, motive and opportunity Consider Incentives and Pressures Faced by Client Staff INCENTIVE and OPPORTUNITY Examples of incentives and pressures that increase the risk of fraud include: - The client operates in a highly competitive industry - A significant decline in demand for the client's products or services - Falling profits - A threat of takeover - A threat of bankruptcy - Ongoing losses - Rapid growth - Poor cash flows combined with high earnings - Pressure to meet market expectations - Planning to list on a stock exchange - Planning to raise debt or renegotiate a loan - About to enter into a significant new contract - A significant proportion of remuneration, which is tied to earnings (that is, bonuses, options) Examples of opportunities that increase the risk that a fraud may have been perpetuated include: - Accounts that rely on estimates and judgement - A high volume of transactions close to year-end - Significant adjusting entries and reversals after year-end - Significant related party transactions - Poor corporate governance mechanisms - Poor internal controls - A high turnover of staff - Reliance on complex transactions - Transactions out of character for a business (for example, if a client leases its motor vehicles they should not have car registration expenses) The FRAUD Triangle Going Concern Will the client remain as a going concern (ASA 570, ISA 570)? Meaning - will the business remain trading "for the foreseeable future"? (12 months) The financial statements are prepared on the going concern ASSUMPTION i.e. assets are valued on the basis that they will continue to be used for the purposes of conducting a business and liabilities are recorded and classified as current and non-current on the basis that the client will pay its debts as they fall due in the years to come It is management's responsibility to assess going concern. It is the responsibility of the auditor to obtain sufficient appropriate evidence to assess the validity of the going concern assumption made by the client CONCEPT: 'Risk factor' - the event, circumstance, process or policy that leads the auditor to believe there may be a risk. Examples? Always distinguish between the RISK and the RISK FACTOR Always distinguish between the RISK and the RISK FACTOR
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