Assurance

Professional Stage: Knowledge level

Process of Assurance- Planning the Assignment (Chapter- 03)

1. Define audit strategy and audit plan.

Audit Strategy
Audit strategy is the formulation of the general strategy for the audit, which stets the scope,
timing and direction of the audit and guides the development of the audit plan.

Audit plan
An audit plan shows the overall implementation of the audit strategy, being detailed than audit
strategy and sets out the nature, timing and extent of the audit procedures to obtain sufficient
appropriate audit evidence.

2. Identify the key contents of an audit plan or how audits are planned?

Audits are planned to:

 Ensure appropriate attention is devoted to important areas of the audit;
 Identify the potential problems are resolved on a timely basis;
 Ensure that the audit is properly organized and managed;
 Assign work to engagement team members properly;
 Facilitate direction to supervision of engagement team members; and
 Facilitate review of work.

3. What are the key contents of an overall audit strategy?

a) Understanding the entity’s environment

 General economic factors and industry conditions; and
 Important characteristics of the client.

b) Understanding the accounting and internal control system

 The accounting policies and charges in those police;
 The effect of new accounting or auditing pronouncements; and
 The auditor’s cumulative knowledge of the accounting and internal control systems.

c) Risk and materiality

 The expected assessments of risks of fraud or error;
 The setting of materiality for audit planning purposes;
 The possibility of material misstatements.
 The identification of complex accounting areas including those involving estimates.

d) Consequent nature, timing and extent of procedures

 Possible change of emphasis on specific audit areas; and
 The effect of information technology on the audit.

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 e) Coordination, direction, supervision and review
 The number of locations;
 Staffing requirements; and
 Need to attend client premises for inventory count or other year-end procedures.

f) Other matters
 The possibility that the going concern basis may be subject to question;
 Conditions requiring special attention;
 The terms of the engagement and any statutory responsibilities; and
 The nature and timing of reports.

4. What are the appropriate procedures used by the auditor in obtaining an

understanding of the entity?

Understanding the entity

BSA 315, followed for obtaining an understanding of the entity and its environment and
assessing the risks of material misstatements states that, “the auditor should obtain an
understanding of the entity and its environment, including its internal control, sufficient to
identify and assess the risks of material misstatement of the financial statements whether due to
fraud or error, and sufficient to design and perform further audit procedures.

The appropriate procedures to obtain an understanding of the entity and its involvement include:
Why
1. To identify and assess the risks of material misstatement in the financial statements;
2. To enable the auditor to design and perform further audit procedures;
3. To provide a frame of reference for exercising audit judgment, for example, when setting
audit materiality.

What
1. Industry, regulatory and other external factors, including the reporting framework.
2. Nature of the entity, including selection and application of accounting policies, internal
control.
3. Measurement and review of the entity’s financial Performance.

How
1. Inquiries of management others within the entity.
2. Analytical procedures, observation and inspection.
3. Prior period knowledge.
4. Discussion of the susceptibility of the financial statement to material misstatement among
the engagement team.

5. Describe an attitude of professional skepticism.

An attitude of professional skepticism means, the auditor makes a critical assessment, with a
questioning mind neither assuming that the management is dishonest nor assuming
unquestioned honesty.

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6. Identify the sources of information for analytical procedures applied through the
course of the audit.

Analytical procedures should be used at the risk assessment stage.

Possible sources of information about the client:

 Interim financial information;

 Budgets;
 Management accounts;
 Non financial information;
 Bank and cash records;
 VAT returns;
 Board minutes; and
 Discussions or correspondence with the client at the year end.

7. Define materiality. When should it be considered?

Materiality
BSA framework for the preparation and presentation of financial statements states that a matter
is material if its omission or misstatement would reasonably influence the economic discussion
of users taken on the basis of financial statements.

BSA 320 Audit materiality states that materiality should be considered by the auditor when:
 Determining the nature, timing and extent of audit procedures; and
 Evaluating the effect of misstatements.

Materiality assessment will help the auditors to decide:

 How many and what extent items to examine;
 Whether to use sampling techniques; and
 What level of error is likely to permit an auditor to conclude the financial statements don’t
give a true and fair view.

Materiality must be reviewed constantly as the audit progresses and changes may be required
because:
 Draft accounts are altered due to material error, and
 External factors may cause changes in risk estimates.

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8. How is materiality used in the cause of an assurance engagement?

Planning materiality based

on draft financial statements
and other available
information
Compare and consider need
for additional testing

Apply planning materiality

to individual audit
objectives or balances

Test all items Actual errors detected

Sample from remaining Actual errors detected

items

Actual errors projected to

population
Final materiality based on
results obtained final
financial statements

Figure: Audit Materiality

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8. How do you define tolerable error? What is the available approach of the percentage
of materiality?

Tolerable error
Tolerable error is the maximum error that an auditor is prepared to accept in a class of
transactions or balances in the financial statements.

Different firm has different methods to calculate materiality level and this is one of the available
approaches as thus rule:

Items %
Profit before tax 5
Gross profit 0.50 – 1.00
Revenue 0.50 – 1.00
Total assets 1-2
Net Assets 2–5
Profit after tax 5 – 10

It is also important to bear up in mind that, materiality has qualitative as well as quantitative
aspects. For example, transactions relating to directors are considered material by nature
regardless of their value.

9. Define analytical procedures.

Analytical procedures means evaluation of financial information made by a study of plausible

relationships among both financial and non financial data. Analytical procedures also
encompass the investigation of identified fluctuations and relationships that are inconsistent
with other relevant information or significantly divided from predicted amounts.

10. What is audit risk? Draw a diagram containing contents ad sub contents of audit risk.

Audit risk
Audit risk is the risk that the auditors give an impropriate opinion on the financial statements.

Audit Risk

Risk that the financial Risk that the auditors will

statements contain a fail to detect any material
material misstatement misstatement

Detection risk
Inherent Risk Control Risk
Figure: Audit risk including contents and sub-contents

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 Define inherent risk, control risk and detection risk.

Inherent risk
The susceptibility of an account balance or class of transactions to misstatement that could be
material individually or when aggregated with misstatements in other balances or classes,
assuming there were no related internal controls.

Control risk
Control risk is the risk that the material misstatement would not be prevented, detected or
corrected by the accounting and internal control system.

Detection risk
Detection risk is the risk that the auditor’s procedures will not detect a material misstatement
that exists in an account balance or class of transactions that could be material either
individually or when aggregated with other misstatements.

11. Give few examples that might increase inherent risk.

Inherent risk is the risk that items will be misstated due to characteristics of those items.
Example of issues that might increase inherent risk are:

1) Balance is or includes an estimates;

2) Balance is improper in the accounts;
3) Financial statements are liable to misstatements because
 company is in trouble;
 company is seeking to raise fund; and
 other motivation for directors to misstate the figures. and
4) Financial statements contain balances with complex financial accounting requirements or a
choice of treatments.

The auditor must use their professional judgment and all available knowledge to assess inherent
risk and if no such information and knowledge is available then the inherent risk is high.

12. Which factors indicate the significant risk?

Some risks may be significant risks, which require special auditor concentration. BSA 315 sets
out the following factors which indicate that a risk might be a significant risk.

1) Risk of fraud;
2) Related to recent significant economic, accounting or other development;
3) The complexity of the transaction; and
4) Unusual transaction.

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15.What are the risk assessment procedures performed by an auditor to obtain an
understanding about an entity and its internal control?

The auditor should perform the following risk assessment procedures to obtain an understanding
of an entity and its internal control:

1) Inquiries of management and others within with-in the entity;

2) Analytical procedures;
3) Observation and inspection.

16. Identifying and assessing the risk (BSA 315.100).s

The auditor should indentify and assess the risks of material misstatements at the financial
statements level and at the assertion level for classes of transactions, account balances, and
disclosures.

The End

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