AA - ACCA - Edison Stanely

Audit risk & response

How to identify audit risk
 Accounting standard/ transaction - Always a risk of using improper means of
recognition or disclosure.
 Internal control deficiency which can impact FS.
 Transfer of data
 New key employees /third parties / internal control – Inexperience, deficiency
 Detection – Auditor’s inability to detect.
 Intentional manipulation – Management/directors/owner should have a motive.

Exam format - Example

Risk Response
Pancer Construction Co is a new client for cupid Cupid & Co should ensure they have suitably
& Co. experience team and adequate time is
As the team is not familiar with the accounting allocated to obtain understanding of entity. A
policies, transactions and balances of company, detailed team briefing should be prepared.
there will be an increase detection risk on the
audit.

Things to remember
 Risk – “risk word – DOUM” is mandatory. Use misstatement only if you can’t clearly identify
whether it is overstatement or understatement.” This is illustrated in ‘Peony Co’ from the
‘Sample March/June 2019 Questions’ where inventory records showed higher levels of
inventory than the physical counts. In this instance the risk was one of overstatement.
Candidates who stated that inventory could be misstated would not have been awarded
credit. A scattergun approach is not recommended.” - M20
 Specify account – “Candidates must state the specific area of the financial statements
impacted, as opposed to a general statement. For example, following on from the inventory
risk above, no credit was awarded for candidates stating ‘therefore current assets could be
overstated’. An appropriate explanation in this instance would be ‘inventory could be
overstated’.” – M20
 Risks from previous years are not significant. For eg, assume current year is 2020, Client
listed its shares during 2016. Then, “listed client risk – intentional manipulation” is not that
significant. Similarly, for any assets purchased in 2016, the initial recognition won’t be
significant unless otherwise specified. However, subsequent measurement shall be
discussed.
 Response - Do not write objectives instead of action. Eg, If it is a new client, Action is
discussed in above example where as objective is “Auditor should have enough
understanding of client.”
 Response – “AUDITOR’S” response. It was noted that some candidates focussed on what
management should do rather than the auditor, and/or, gave responses that were
inappropriate to the scenario. For example, in this session a scenario stated that ‘no
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supplier statement reconciliations had been performed due to staff shortages at the client’.
The scenario also stated that ‘the financial controller had agreed that that no supplier
statement reconciliations needed to be prepared at the year-end as there was not enough
time’. Some candidates recommended as a response that ‘management should be asked to
perform supplier statement reconciliations.’ -D20
 Analytical procedures – “Do not calculate more than the required number of ratios as this
wastes time. Do not provide the formula for ratios, as no credit is available.” – D20
 Opening & closing paragraph – “A point to note however is that there may be risk factors at
the beginning of the scenario in the opening paragraph and also in the closing paragraph.
Candidates are often missing these.” – J19

List of threats & safeguards

Sl.no Risks Response
1 New client Cupid & Co should ensure they have
Prancer Construction Co is a new client for cupid suitably experience team and adequate
& Co. time is allocated to obtain understanding
of entity. A detailed team briefing should
As the team is not familiar with the accounting be prepared.
policies, transactions and balances of company,
there will be an increase detection risk on the
audit.
WIP Auditor should discuss with management
Aquamarine hold work in progress of the controls implemented to determine
approximately 950,000 in its inventory correct cut off and assumption used to
determine WIP and auditor should assess
The cut off of work in progress is difficult to its rationale
determine as production is not ceasing. In Auditor should attend inventory count to
addition the assumptions made to value WIP can value the work in progress at that point of
go wrong. Therefore, there is a risk that inventory time
could over or under valued
PPE – incomplete transfer Discuss with management whether they
Aquamarine placed an order for PPE which have received the remaining ppe before
amount to 720,000. 1/3rd of this PPE is expected the year end. If they have received
to arrive on late July or early August physically inspect it to confirm the same.

PPE should be recognised only if it physically exit

with the entity. There is a risk that management
might recognise the whole ppe without receiving
it leading to overstated ppe (assets)

In addition depreciation could overstated if

management recognised it along with the
overstated PPE
Patent Auditor should inspect patent acquisition
Aquamarine purchased a patent which can be document to verify the cost of 1.3m & UEL
used for 5 years of 5 years. Auditor should recalculate
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ammortisation expense & compare it with

Intangible asset should be ammortised over its managements calculation to ensure
useful economic life. There is a risk that arithmetic accuracy
management might not ammortise patent
appropriately leading to oversated patents
(intrangible assets) & understated ammortisation
expense
Loan Auditor should inspect loan agreement to
Aquamarine borrowed loan of 1.2 which is to be confirm the principle amount, loan period
repaid over 5 years & other terms & conditions
Auditor should recaulacate cl & ncl and
There should be a proper split between current compare it with manageemnets calculation
liability & non current liability in FS. There is a risk to verify appropriate split
that management might not adequately split the
loan leading to misstatement in CL & non current
liability disclosure
Loan - FC Recalculate FC to ensure arithmetric
In addition, there could be misstatement in accuracy
cacluating interest expense leading to missateted
FC.

There is risk that attached covenants mightnot be Auditor should inspect Loan agreement
disclosed leading to misstated FS and trace loan covenants attached to
disclosures in FS
Transfer of data Auditor should discuss with the
Coral company (SP) transfer the payroll records to management about the controls placed to
aquamarine. mitigate the risk & assess the rationale of it
Auditor should obtain a sample data from
There is risk of inaccurate or incomplete transfer aquamarine and compare it with coral
or even technical issues in the medium which can respective information to ensure the
lead to misstatement in payroll expense & related accuracy of transfer
liability
Service org -detection Auditor should perform increase test of
In addition, it might be difficult for the auditor to control in coral and try to assess control
obtain sufficient appropriate audit evidence for documets of the entity
coral company (SP) resulting in increased
detection risk.
Revaluation Discuss with management the rational of
revaluation and obtain supporting if any
Management has revalued all land & buildings If required auditor shall user independent
expert to revalue the assets
Revaluation is judgemental process and involve
lots of assumption. There is a risk revaluation
might not be as per the relecant accounting
standards leading to overstated assets
Increased receivable Discuss with management whether the
have increased the allowance in ,ine with
increased receaivabe.
Receivable has increased significantly compared
to previous year. Auditor should perform receivable age
analysis & post cash receipt testing to asses
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Increased receivable requires recognistion of the allowance required.

allowance for bad & doubt debts. There is a risk
that management might not recognise adequate
allowance leading to oversated recevables
(Assets) & understated expense
Redandancy provsion Auditor should discuss with management
whether they have announced it before
Company is planning to make approximately 65 the year end and obtain the supporting of
employees redundant from the organisation announcement to verify the date.

If the announcement happens prior to the year, If announcement before the year, then
then there is present obligation which requires a auditor should recaulate the provision and
probable outflow of economic benefits which can assess the reasonableness of assumption
be reliably estimated and redundancy provison used in valuing provision to verify accuarcy
should be recognised.
There is risk of inadequate provision recognised
leading to undersated provision expense &
liabiluity
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Substantive procedures
Common substantive procedures
NB: This is not a comprehensive list

Accounts 0ccurance/Existence Completeness Accuracy & valuation Rights &

obligation
Receivable  Obtain verifyation from  For a sample of GDN  Review post year end bank  Inspect sales
s sample customers to & trace it to Invoice statement for to identify invoice to
ensure existence and journal to receipt amount from identify
 For a sample of ensure completeness customers to ensure valuation address of
receivables, inspect  Inspect aged analysis  Inspect aged receivables report client to
signed GDN to verify report & trace the to identify long outstanding verify rights &
existence provision to FS to receivables that requires obligation
 Review post year end verify … provision.
bank statement to  Re-perform  If no provision, Enquire
identify receipt from Receivables ledger & management the reasons of
customers to ensure trace to trial balance same and assess its
existence & FS to verify .. reasonableness
 Reperform provision and
compare with management to
verify accuracy
Inventory  For a sample of  For a sample of  Inspect purchase invoice for  Inspect
inventory recorded, physical inventory, evidence of cost of inventory purchase
physically verify to trace to journals and  Inspect post year end sales invoice to
confirm existence ledger to verify … invoice for evidence of NRV identify
 For inventory held with  Recalculate  Physically verify inventory to address of
3rd party obtain inventory ledger and assess the condition for client to
confirmation from 3rd trace to trial balance evidence of any damaged verify rights &
part to verify existence & FS to verify… inventory obligation
 Reperform inventory days and  For inventory
compare with management to held with 3rd
assess the need for write off party obtain
confirmation
from 3rd part
to verify
rights
Payables  Perform creditors  Reconcile suppliers  Reconcile suppliers statement  For a sample
circularisation to verify statement to to relevant suppliers ledger for of payables,
existence relevant suppliers any difference to confirm inspect GRN &
 For a sample of ledger to verify valuation purchase
payables, inspect GRN completeness  For any disputes with suppliers invoice to
& purchase invoice to  For a sample of GRN inspect correspondence to verify
verify existence trace to purchase assess the value obligations
 Review post year end invoice & journals to 
bank statement to verify …
identify payments to  Recalculate payables
suppliers to ensure ledger and trace it to
existence trial balance & FS to
confirm
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completeness
Cash &  For cash balance,  Recalculate cash & For cash balance, Physically 
Bank Physically verify cash in bank ledger and verify cash in hand to verify
hand to verify trace it to Trial value
existence balance & ledger to  Reperform bank reconciliation
 Inspect bank verify completeness statement to verify arithemetic
confirmation to verify aaccuracy
existence of bank
balance
Tangible  For NCA, Physically  Recalculate NCA OP b/s – inspect PY  Inspect tittles
NCA verify it to confirm ledger and trace it to Add – inspect purchase invoice deeds for
existence Trial balance & Disposal – sales invoice address of
ledger to verify Depreciation – reperform client to
completeness Inspect valuers report ensure rights
Intangibles  Inspect ownership  Recalculate OP b/s – inspect PY  Inspect
documents to ensure intangible ledger and Add – inspect purchase invoice ownership
existence trace it to Trial Disposal – sales invoice document for
balance & ledger to  Ammortisation – reperform address of
verify compl  Inspect valuers report client to
verify rights

Tips to look for :

1. 3rd party – confirmation

2. Calculation – Recalculate
3. Cashflows – B/S
4. Estimate – mngt rep
5. Recurring account – AP
6. Tangible assets – Physical verification