Chapter 3

Question 1

What is the audit strategy?

Answer 1

determines scope, timing and direction of audit and determines the development of the audit plan

Question 2

What is the audit plan?

Answer 2

• more detailed than audit strategy
• shows how the overall strategy will be implemented

Question 3

what are the key components of the audit strategy?

Answer 3

• understanding entity and its environment
• materiality
• risk assessment
• nature, extent and time of audit procedures
• direction, supervision and review of work

Question 4

what is the common content between the audit strategy and the audit plan?

Answer 4

• results of risk assessment
• determination of materiality
• special audit considerations
• deadlines

Question 5

what does the audit plan ensure?

Answer 5

• attention paid to important areas
• problems identified
• audit is properly organised and managed
• work assigned to appropriate members of the team
• reviews by senior auditors are faciliatated

Question 6

Why does the ISA (UK) 315 require the auditor to understand the entity?

Answer 6

• to assess risk
• help design and perform audit
• help develop audit plan and strategy

Question 7

What does the ISA (UK) 315 require the auditor to understand about the entity?

Answer 7

• industry, regulatory and external factors, including the applicable financial reporting framwork
• nature of the entity, including entity selection and applicable financial reporting framework
• entity objectives and strategies and related business risks
• entity financial performance
• internal controls

Question 8

What things would the audit firm need to understand with regards to financial reporting frameworks?

Answer 8

• accounting principles and industry specific practices
• revenue recognition
• accounting for financial instruments
  -foreign currency assets, liabilities and transactions

Question 9

What things would the audit firm need to understand with regards to accounting policies?

Answer 9

• methods used to measure, present and disclose significant and unusual transactions
• accounting policies in controversial or emerging areas
• changes in the environment e.g. tax changes that necessitate a change in accounting policies
• law and reporting standards that are new to the entity

Question 10

How does the ISA (UK) 315 expect the auditor to gain all the infomation?

Answer 10

• enquiries of management
• analytical procedures
• observation of processes
• inspection of documents
• prior knowledge of client
• discussion among audit team

Question 11

what is materiality?

Answer 11

an expression of the relative significance of a particular matter in the context of the financial statements as a whole

• An item is material if its omission or misstatement could reasonably be expected to affect the economic decision of users

Question 12

what does materiality influence?

Answer 12

drives the level of work to be carried out

Question 13

what makes something material or not?

Answer 13

• size
• nature i.e. transactions between company and director are material in nature no matter the size

Question 14

what are the thresholds of size for materiality?

Answer 14

If an error is greater than the upper then it would be material:
0.5%- 1% of revenue
1-2% total assets
5-10% profit before tax

Question 15

what is performance materiality?

Answer 15

If auditing a large number the materiality make come out as a large number so in these situations a smaller number is given called performance materiality:

an amount, less than materiality, to reduce the probability that aggregate of uncorrected misstatements exceed materiality as a whole

Question 16

When is risk assessed?

Answer 16

in the planning stage but re-assessed continually throughout the audit

Question 17

An effective risk assessment should:

Answer 17

• make audit more efficient with work directed to problem areas
• lead to fewer inappropriate opinions
• few negligence claims against auditor

Question 18

what is audit risk?

Answer 18

the risk that the auditor gives an inappropriate opinion on the financial statements

Question 19

what is the audit risk calculation?

Answer 19

inherent risk X control risk X detection risk

Question 20

what is inherent risk?

Answer 20

the susceptibility of an assertion about a class of transaction, account balance or disclosure to a misstatement that could be a material

Question 21

what is control risk?

Answer 21

the risk that a material misstatement would not be prevented, detected or corrected by the accounting and internal control systems

Question 22

what is detection risk?

Answer 22

risk that auditors procedures will not detected a misstatement

Question 23

what are the 3 levels inherent risk can be considered at?

Answer 23

• industry level
• entity level
• balance level- isolated to a particular account

Question 24

what does the ISA (UK) 315 require auditors to determine with inherit risk?

Answer 24

determine where on the spectrum an item lies. upper end may be significant risks

Question 25

How can the detection risk figure be kept low?

Answer 25

- more audit work - increased sample size - more reviews

Question 26

What does the ISA 315 define significant risk as?

Answer 26

an identified and assessed risk of material misstatement which, in the auditor’s judgement, requires special audit consideration.

Question 27

What are the inherent risk factors that should be used to determine the significance of risk according to the ISA 315?

Answer 27

- complexity - subjectivity - change - uncertainty - susceptibility to misstatement

Question 28

Auditor's must consider whether climate related risks have any influence on:

Answer 28

- the entities business model (supply chain) - industry factors (competitor environment, supplier and customer relationships) - regulatory factors (climate related laws and regulations) - external factors (economic conditions, interest rates etc)

Question 29

what are the 2 types of risk in relation to climate change to businesses?

Answer 29

- physical risks- flooding, wildfires - transactional risks- social and economic shifts to low carbon economy i.e. policy changes

Question 30

what are examples of some of the climate change risks to businesses?

Answer 30

- not complying with climate change regulations - sectorial risk i.e. crop failure - loses major investors if not climate change friendly business - business unable to adapt i.e. car manufacturing business

Question 31

What are examples of climate related MATERIAL misstatements that an auditor could assess?

Answer 31

- adverse weather- manipulate of financial statements to avoid reporting losses - greenhouse gas emissions from livestock- uncertainty over asset values for agricultural producers -consumer demand for more renewable forms of energy- existing inventory and manufacturing equipment may not be viable leading to possible overstatement if not reviewed.

Question 32

what is meant by error?

Answer 32

an unintentional misstatement in financial statements, including the omission of amounts or disclosures

Question 33

what is meant by fraud?

Answer 33

an intentional act involving the use of deception to obtain an unjust or illegal advantage

Question 34

What are the 2 fraud characteristics the ISA 315 identify?

Answer 34

1. misappropriation of assets: theft, i.e. ghost employees 2. fraudulent financial reporting

Question 35

what is the auditors responsibility in relation to fraud and error?

Answer 35

provide reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error

Question 36

what is the auditors first line of defense against fraud?

Answer 36

professional scepticism - auditor can accept documents as genuine but remain alter for conditions that indicate the report may not be authentic (ISA 240)

Question 37

What is meant by a related party?

Answer 37

an individual or organisation who is influenced by, or has influence over the entity - they can be difficult to identify in practice

Question 38

What is the risk with related parties?

Answer 38

- increased change of financial results to be manipulated as transactions may be carried out on a basis other than 'arms length'

Question 39

what is meant by analytical procedures?

Answer 39

involve the evaluation of financial information through analysis of plausible relationships among both financial and non-financial data

Question 40

What is stated in the ISA about analytical procedures?

Answer 40

- must be used at planning to identity risks (ISA 315) - used as a form of substantive procedure to gather audit evidence (ISA 520) - Used to assist in overall conclusion (ISA 520)

Question 41

What are the limitations to analytics procedures at the planning stage?

Answer 41

- require knowledge and experience of entity which is limited first year of audit - experienced staff may have to carry them out - quality depends on reliability of data

Question 42

What are possible sources of information to perform analytical procedures?

Answer 42

- interim accounts - budgets - management accounts - VAT returns - board minutes - non-financial information - discussion or correspondence with client - industry knowledge

Question 43

Which THREE of the following statements, relating to fraudulent financial reporting, are true? a)Fraudulent financial reporting is the intentional misrepresentation of a business’s financial statements with the aim to give a mistaken impression about the operating performance and profitability. b)Companies that commit financial statement fraud are often experiencing net losses or have profits less than expectations. c)Fraudulent reporting can be controlled with external auditing, regulations and an independent board of directors. d)Unlike other types of fraud, financial statement fraud is usually not concealed and is therefore relatively easy to spot.

Answer 43

a, b, c

Question 44

Which of the following transactions requires separate disclosure in the financial statements? a) Sale of a company car to the finance director’s son at its market value of $15,000. b) An agreement to purchase all stationery from a company owned by the commercial director. c) Allowing the marketing director’s husband to use office space free of charge to run his business. d) Sale of an item of inventory to the CEO’s wife for $200, where company revenue is $8bn.

Answer 44

all of them