Chapter 4 - Planning an audit (basics) Flashcards by aaa a

PERFORMANCE

Gross profit margin

Gross Profit/Revenue x 100%

Profitability BEFORE looking at overhead expenses

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PERFORMANCE

Operating margin

Operating Profit/ Revenue x 100%

Profitability AFTER looking at overhead expenses

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PERFORMANCE

Return on capital employed

Operating Profit/ Equity + Debt x 100%

How effectively resources are used to generate profit

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List some of the benefits of planning:

Attention to important areas
Problems identified timely
Organised effectively/efficiently
Staff with appropriate competence selected
Facilitates direction of work
Aids coordination of work

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Is Audit Strategy detailed or rough/general

Overall/Rough/General

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What are the general principles covered in Audit strategy?

Understanding the entity/environment
Materiality
Analytical Procedures
Risk Assessment
Audit Approach
Coordination of audit (timing, team, locations, deadlines, budget)

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What 4 sources can you use to obtain an understanding?

Firm
Client
Yourself
“Other”

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How can you use your FIRM to obtain an understanding?

Partner
Management briefing
Industry experts
Last year’s team

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How can you use the CLIENT to obtain an understanding?

Discussion
Observation
Analytical Procedures
Website

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You can use your past experiences to obtain an understanding of the client.

TRUE/FALSE

TRUE

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List some OTHER ways to obtain an understanding of a client.

Websites
Companies House
Industry Surveys
Credit reference agencies

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What should the auditor understand about the ENVIRONMENT?

Law and Regulations
Industry conditions (competition, tech, seasonality)
Data protection regulations

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What should the auditor understand about the ENTITY?

Operations
Internal Control Systems
Accounting Policies
Objectives/Strategies
Structure/Finance
Investments

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Define MATERIALITY

Omission or misstatement of that information could influence the user’s economic decisions taken on the basis of the F/S.

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What are the materiality ranges for:

Profit before Tax

Gross Profit

Revenue

Total Assets

Net Assets

Profit after Tax

Profit before Tax 5%

Gross Profit 0.5% - 1%

Revenue 0.5% - 1%

Total Assets 1% - 2%

Net Assets 2% - 5%

Profit after Tax 5% - 10%

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Matters can be MATERIAL by NATURE

Suggest how.

Related Party Transactions
Small amounts that impact critical points
turning profit into loss
net assets into net liabilities
affect Companies 2006 threshold to determines if a company is small or medium sized
Misleading descriptions (accounting policies)

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Define PERFORMANCE MATERIALITY

Below materiality threshold

Reduce the risk of small misstatements aggregating to exceed materiality for the whole F/S

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WHEN do we use ANALYTICAL PROCEDURES?

Planning stage (identify risk)
Evidence stage (substantive procedures)
Completion stage (forming conclusion on F/S)

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What are the LIMITATIONS of analytic procedures?

Need a sound knowledge of entity (difficult if first year audit)
Experienced staff required
Quality depends on source data

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SHORT - TERM LIQUIDITY

Current Ratio

Current Assets/Current Liability

Assess ability to pay current liabilities from current assets

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SHORT - TERM LIQUIDITY

Quick Ratio

Current Assets excluding inventory/Current liability

Assess ability to pay current liabilities from reasonably liquid assets

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Solvency

Gearing ratio

Net Debt/Equity

Assess reliance on external finance

Solvency

Interest Cover

Profit before Interest Payable/Interest payable

Assess ability to pay interest charges

Efficiency

Trade receivables collection period

Trade receivables/Revenue x 365

Assess average time taken to collect cash from credit customers

Efficiency Inventory Holding Period

Inventory/Cost of Sales x 365 Assess average time inventory is held

Efficiency Trade payables payment period

Trade payables/Purchase x 365 Assess average time taken to pay suppliers

Define business risk

Risk that could affect an entity's ability to achieve objectives/execute strategies.

Define audit risk

Risk that the auditor expresses an inappropriate opinion on the F/S

Audit risk is made up of what three risks: 1. 2. 3.

1. Inherent risk 2. Control risk 3. Detection risk

Explain inherent risk

A material misstatement in the balances, transactions, disclosures that are not related to internal controls

Explain control risk

A misstatement is not prevented/detected/corrected by internal control systems.

Explain detection risk

Procedures performed by the auditor won't detect a material misstatement

Detection risk is made up of: 1. 2.

1. Sampling risk | 2. Non Sampling risk

What is a sampling risk?

A conclusion drawn from the results of a sample test is different from the conclusions that would have been drawn from the whole population.

What are some RISK factors that are common to most audits?

1. Management override 2. Journals 3. Revenue Recognition 4. Cyber security

What is management override?

Management manipulate accounting records.

How can JOURNALS be a risk factors?

- Inappropriate/Fraudulent activities - Unusual items - Round number entries - Journals made by individuals who don't norm do so - made outside of office hours - posting to suspense account

The risk of misstatement is higher where management reward is linked to revenue/profit TRUE/FALSE

TRUE

LIST some audit approaches to reduce AUDIT RISK.

- Emphasise professional scepticism to staff - Assign extra/more experienced staff - Use experts/internal auditors - Provide more supervision - Incorporate more unpredictability

At the assertion level, the responses to assessed risk should be adjusted by: 1. 2. 3.

1. Nature - type of test 2. Extent - how much testing 3. Timing - during the year/at year end/after year end

If the auditor wants to rely on the work of others, internal audit/third party, it needs to be assessed on:

General assessment: competent and independent Specific assessment: is it suitable for the purpose

Why should you do limited substantive testing even if controls are expected to be effective and are actually effective?

Inherent limitation of controls (collusion, management override, human error, non routine transaction)

The audit procedure should include the nature/timing/extent of:

- Planned risk assessment procedures | - Further audit procedures

DATA ANALYTICS can be embedded into the AUDIT PLAN to:

- Transaction analysis (looks at 100% of transactions, controls might have failed) - Judgmental areas (sensitivity analysis to test assumptions on NRV of inventory) - Analytical Procedures (use external market/economic data to form expectations)

BENEFITS of using data analytics:

- Practical way to deal with Big data - Enables 100% checking (no sampling risk) - Enhances quality of info (visual representation of results) - Faster - Audit procedures carried out on a continuous basis rather than at year end only

The results of data analytics still need to be evaluated using professional skills and judgement of the auditor to analyse results and draw conclusions TRUE/FALSE

TRUE

PROBLEMS of using data analytics:

- Cost especially in small firms - Staff training - Data security must be ensured - Quality of analytics depend on underlying data used

What is cyber-security?

Protection of DATA, SYSTEMS, NETWORKS in cyberspace. No unauthorized modification/disclosure/destruction. Protect information systems from failure.

What are the KEY RISKS of an entity's IT systems:

Hacking Fraud theft of funds Deliberate sabotage Viruses Denial of service attacks

What are the BUSINESS risks of an entity's IT system?

- Reputational Damage - Breaches of Data Protection Legislation --> FINES - Misstatements in F/S

List the IT SECURITY CONTROLS.

Business Continuity Planning - business will continue even if disaster/system failure System Access Control - Protect systems/Detect unauthorized access Compliance - with legal requirements and organisational policies Personnel Security - trustworthy employees/training/reporting arrangements Security policy - written version available to all employees (look in workbook)

What is cloud computing?

Access data from any location

What are the benefits of cloud computing?

Saving costs compared to traditional IT storage at site

What are the problems of cloud computing?

Passes control to cloud-based service provider Data could be lost, stolen or corrupted Consider if they're reliable