Tutorial letter 102
Lesson 1.2: Regulation of the auditor
1.2.1: APA
Sections often tested of the APA below:
Section 37 and 38 dealing with the registration procedures for
individuals and firms as registered auditors
Section 41 dealing with conduct and liability of registered auditors
relating to public practice
Section 44 dealing with duties in relation to an audit
Section 45 dealing with the duty to report on irregularities
Section 46 dealing with the limitation of the auditors liability
Section 52 dealing with reportable irregularities and false statements in
connection with audits
Lesson 1.3: King IV
Lesson 2.1: The preliminary audit engagement stage
The activities to consider in the preliminary audit engagement stage
1. Establish whether the pre-conditions for the audit are present to
determine whether the new client should be accepted or whether
the firm should continue its relationship with an existing client
2. Investigate prospective or existing clients to determine whether the
client should be accepted, or whether the firm should continue its
relationship with an existing client
3. Determine skills, competence and resources to establish whether
the firm can perform the audit in compliance with standards
4. Consider ethical and statutory requirements to establish if there are
any reasons not to perform the audit
5. Establish the terms of the engagement and formalise the agreement
in an audit engagement letter
Lesson 3: Planning an audit
The phases of the planning stage of an audit
Lesson 3.3: identifying and assessing risk
Risk of material misstatement (ISA 200 and ISA 315) this is the risk that
the financial statements are materiality misstated prior to the audit and
consists of two components at assertion level, namely, inherent and
control risk
- Inherent risk (ISA 315 para 04)
This is 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 any related controls are considered
- Control risk (ISA 315 para 04)
This involves the risk that a material misstatement could occur in an
assertion about a class of transaction, account balance or disclosure
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 controls
Detection risk (ISA 200 para 13(e))
This involves the risk that the procedures that the auditor performs to
reduce audit risk to an acceptably low level will not detect a misstatement
that could be material, either individually or when aggregated with other
misstatements
Audit risk (ISA 200 para 13(c))
Audit risk is the risk that the auditor can express an inappropriate audit
opinion when the financial statements are materially misstated. Audit risk
can be expressed as a function of the risk of material misstatement (which
consists of inherent risk and control risk and detection risk).
3.3.4: Risk of material misstatement at financial statement level
Study ISA 315 para 28(a), 30, A193 – A198, appendix 2
When auditors identify and assess risk of material misstatement at
financial statement level, they specifically determine which risks will affect
the financial statements as a whole. These risks typically affect many
assertions. An example would be that management will override controls,
it will effect the financial statements as a whole and thus many assertions.
Inherent risk factors:
Risk of material misstatement at assertion level
Study ISA 315 para 28(b), 29, 31, A186 – A191, A201 – A203, A205 – A214
Risks of material misstatement at assertion level are risks that do not only
relate to the financial statements as a whole, but also to individual
assertions and classes of transactions, account balances and disclosures.
To determine whether this is the case, the auditor needs to use and refer
to assertions listed in ISA 315 para A190 and consider if any potential
misstatements may occur for any of the.
Activity 3.3.1
Identify risks at financial statement level
Inherent risks include
- There is complexity and the AFS may be materially misstated due to
error, as Connect Imports cell phones and the accounting treatment
of importing and hedging is complex and certain costs may or may
not be included according to the accounting standards, for example
VAT, transport costs, import duties and so forth
o The likelihood is low as staff seem to be competent and
experience
o The magnitude is medium/high as all Connects products are
imported and therefore may have a huge impact on the AFS
o Conclusion on the spectrum of inherent risk is set to medium
- There is subjectivity/uncertainty and the AFS may therefore be
materially misstated due to error, as Connect imports cell phones
and the accounting treatment is subjective as staff may be
uncertain and has a choice of what spot/conversion rates and which
dates to use
- There is a possibility of change as the AFS may be materially
misstated due to error as the entity needs to adhere to international
laws and regulations which might result in penalties or closure of the
business. The incorrect financial reporting framework may therefore
be used as the going concern assumption might not be properly
accounted for and/or disclosed
Control risks
- The AFS is not likely to be misstated due to error, as the off-the shelf
system seems to be well-developed and tried and tested
Lesson 3.6: Materiality
Calculation of planning materiality
Step 1: Determine which figures to use
- Use the unaudited figures of the current year if they are available
- If the unaudited figures of the current year cannot be used because
they are not available, consider using the budgeted figures if they
are available
o Use budgeted figures if there were not material deviations
from them
- If both the unaudited and budgeted figures are not available, use
figures from the previous year
Step 2: Consider the indicators
Step 3: Determine which indicators are appropriate for the calculation of
planning materiality when planning an audit
The following factors should be considered:
- Profit before tax is usually used for entities that are profit oriented.
However, f the profit before tax from continuing operations seem to
be volatile (meaning changing rapidly or being unpredictable),
indicators from gross profit or turnover should be considered
- If a company made a loss, the indicator of net profit before tax
cannot be used
- Expected issues with an indicator can be determined by performing
analytical procedures
- The inherent characteristics of a company should be considered for
an entity that is capital intensive, for example, as a manufacturer
you are likely to use total assets for your materiality, or for the
instance of an entity that renders services, it is likely that this entity
is not capital intensive and therefore total assets will not be an
appropriate indicator to use
- The stability of the figures is important
o If the turnover figure for the year under review fluctuates
dramatically from the previous year to the next, the turnover
indicator cannot be used
o If the turnover for the year under review increases
dramatically, but the accounts receivable figure reflects a
dramatic decrease, it could be an indication of fraud or an
error in either one of these balances. Consequently, the
turnover indicator cannot be used.
Step4: Calculate the materiality interval for each of the suitable indicators
- Calculate both the lowest and the highest limits of the intervals for
each suitable indicator
Step 5: Decide on a materiality figure to use when planning an audit
- There is an inverse relationship between materiality and risk of
material misstatement
Lesson 3.8: The overall audit strategy
Scope
Refers to the range of activities the auditor must perform
For example, if the company is governed by industry specific regulations,
the auditors should familiarise themselves with such requirements and
make sure that the reporting complies with these requirements
Note that this is only one example and that there are many more.
Timing
Refers to the timing, that is, when audit procedures should be performed:
The auditors can perform procedures at one of the following times:
- Before year end (interim)
- At year end or after year end
- Early verification, just prior to year end, and rolling forward at year
end
- Both at interim stage and at year end
Direction
Refers to the areas of focus
The auditors should consider significant factors and should direct their
attention to the areas of focus
For example, if the risk assessment procedures determined that the
company experienced going concern issued, the auditor should direct his
or her efforts to this specific area.
Lesson 3.9: The audit plan
ISA 300
Nature
Refers to the type of audit approach and the purpose and type of audit
procedures to be performed (ISA 300 para A4 and A5)
The auditor can decide to follow one of the following approaches:
1. He or she can follow a combined approach, according to which both
tests of controls and substantive procedures should be performed.
This approach is followed when the auditor intends to rely on the
operating effectiveness of internal controls or when substantive
procedures alone cannot provide sufficient appropriate audit
evidence
2. He or she can follow a substantive procedure approach, according to
which both tests of detail and analytical procedures should be
performed. This approach is followed when the risk assessment
procedures have not identified appropriate and sufficient controls
relevant to the assertion or because controls would be inefficient
Timing
Same as above
Extent
Refers to how many tests or audit procedures you will perform and in how
much detail (ISA 330 para A7)
This refers to the number of tests of detail and/or analytical procedures
you will perform. For example, if the audit client has a strong control
environment, you will perform tests of controls with fewer tests of detail
and more analytical procedures
