The audit process

Question 1

What is an external audit?

Answer 1

An independent examination and expression of opinion on the financial statements of a company.

Question 2

Who is an audit supposed to benefit/

Answer 2

The shareholders - it is a means of ensuring the people who manage the company do so in the best interests of the people who own it.

Question 3

Who appoints the auditors and what must they be for the audit to be credible?

Answer 3

The shareholders appoint auditors + they must be independent of the company if the audit opinion is to have credibility.

Question 4

Image of the key members of an audit on page 79

Answer 4

Shows how shareholders, company, auditors and directors all interact.

Question 5

What criteria must a small company meet to be exempt from an audit?

Answer 5

Turnover (revenue) no more than £10.2m
Total assets no more than £5.1m
No more than 50 employees

Important notes - they must meet at least two of these criteria, for both the current and previous financial year, to obtain this exemption. Some companies may still choose to have one, even if not legally required.

Question 6

What type of view might an external auditor say statements give of a company’s position and performance?

Answer 6

True and fair view

Question 7

Is there a strict definition of “true and fair” in the Companies Act 2006?

Answer 7

NO
but essentially it means that the financial statements contain no significant/material errors

Question 8

What does “true” mean?

Answer 8

Information is factual and complies with accounting standards.

Question 9

What does “fair” mean?

Answer 9

Information is clear, impartial and unbiased, reflecting the substance of transactions, rather than the legal form.

Question 10

Why is the audit process not a guarantee that the financial statements are correct?

Answer 10

. The nature of financial reporting is such that it involves management judgement and subjective decisions.
. Auditors only spend a limited amount of time at the client’s premises, testing only a sample of items due to the fact there is a cost/benefit element to auditing.

Question 11

Why do auditors develop an audit plan?

Answer 11

To ensure work is performed in an effective and efficient way, by reducing audit risk to an acceptably low risk.

Question 12

What is audit risk?

Answer 12

The risk of an auditor giving an incorrect opinion on the financial statements being audited; for example saying statements are true and fair when they contain a material misstatement.

Question 13

What are the main benefits of a risk-based approach?

Answer 13

. The main risk areas are identified early in the planning stage.
. The audit can be based around those risks.
. An efficient audit can be carried out - minimising audit risk.
. Reduces the chance of a negligence claim against the auditor.

Question 14

What are some important activities at the planning stage of an audit?

Answer 14

Understanding the entity
Assessing the risk of material misstatement
Establishing preliminary materiality.

Question 15

What is the benefit of understanding the client’s business, and the industry it operates within, when assessing the risk of misstatement?

Answer 15

This enables auditors to design audit procedures (tests) to address the assessed risks of material misstatement.

Question 16

What are some examples of higher risk transactions and balances from an audit standpoint?

Answer 16

. Complex transactions with a higher risk of error
. Transactions involving subjectivity and judgement - increased
risk of bias
. Those with a history of fraud or error.

Question 17

Define materiality

Answer 17

An item is considered material if “its omission or misstatement could influence the economic decision of users”.

Question 18

What must be considered when assessing materiality?

Answer 18

The amount (quantity) and the nature (quality) of any misstatements, or a combination of both.
(Quantity relates to its relative size whilst quality relates more to its relative prominence/influence).

Question 19

What are the industry guidelines used to measure materiality?

Answer 19

Above 1% of revenue
Above 1% of total assets
Above 5% of profit before tax

Question 20

What are the two types of test on an audit?

Answer 20

Test of controls
Substantive procedures

Question 21

When are the different audit tests typically performed?

Answer 21

Test of controls - before the year end
Substantive procedures - after the year end

Question 22

What are test of controls?

Answer 22

These test the operating effectiveness of a clients’ own controls in preventing, detecting and correcting material misstatements in the financial statements. They basically test the process which generates the financial statements.
E.g., if all supplier invoices are authorised for payment by a responsible official, an auditor would collect a sample and inspect for evidence of appropriate authorisation.

Question 23

What are substantive procedures?

Answer 23

Procedures to detect material misstatements in account balances and disclosures in the financial statements.
E.g., an auditor may obtain the breakdown of an expense account and cross-reference with a sample of items + supplier invoices to verify the correct amount has been recorded as an expense with the appropriate account code.

Question 24

What is fraud?

Answer 24

The intentional misstatement or misappropriation of assets by an individual or group of individuals.
E.g., theft of cash or inventory, payroll fraud, fictitious sales, understating expenses.

Question 25

Who is responsible for the detection and prevention of fraud in an organisation?

Answer 25

The board of directors

Question 26

How is a company supposed to detect and prevent fraud?

Answer 26

. Instil a good culture/expectations/reduce motivation to commit fraud
. Establish and monitor a system of internal controls to prevent and detect fraud e.g., authorisation of supplier invoices.

Question 27

What attitude should an external auditor maintain?

Answer 27

One of professional scepticism
(A questioning mind, alertness to conditions which might indicate possible misstatement, and a critical assessment of audit evidence).

Question 28

What is money laundering?

Answer 28

The process of making the proceeds of crime appear legitimate.

(also includes any gain from non-compliance with laws and regulations)

Question 29

Key examples of money laundering are

Answer 29

. Tax evasion
. Not returning payments from customers
. Offences involving saved costs, such as failure to comply with
health and safety legislation
. Benefits obtained through bribery and corruption.

Question 30

What are the three crimes under the Proceeds of Crime Act 2002?

Answer 30

Laundering
Failure to report
Tipping off

Question 31

What is laundering?

Answer 31

Acquisition, possession or use of the proceeds of crime, tax evasion, or fraud, or assisting another to retain proceeds.
Penalty up to 14 years in prison and/or a fine.

Question 32

What is failure to report?

Answer 32

Failure to make a “Suspicious Activity Report” (SAR) - disclosing knowledge or suspicion of money laundering - made to the National Crime Agency.
Penalty up to 5 years in prison and/or fine.

Question 33

What is tipping off?

Answer 33

Telling the subject of a report that a SAR has been submitted / warning them that suspicions have been aroused.
Penalty up to 5 years in prison and/or fine.