L3 Overview and planning of the financial report audit

Question 1

What are the two differences between accounting and auditing?

Answer 1

Accounting:
- Measure and record accounting data in accordance with accounting standards.
- Prepare the financial report in accordance with the identified financial reporting framework.

Auditing:
- Obtain sufficient and appropriate audit evidence about the propriety and accuracy of the accounting data in accordance with auditing standards.
- Provide an auditor’s opinion on whether the financial report is presented fairly in accordance with the identified financial reporting framework.

Question 2

List the four assertions about classes of transactions and events

Answer 2

• Occurrence
• Completeness
• Accuracy
• Cut-off

Question 3

Define the assertion, ‘occurence’

Answer 3

Transactions and events that have been recorded have occurred and pertain to the entity.

Question 4

Define the assertion, ‘completeness’

Answer 4

All transactions and events that should have been recorded have been recorded.

Question 5

Define the assertion, ‘accuracy’

Answer 5

Amounts and other data related to recorded transactions and events are appropriately recorded.

Question 6

Define the assertion, ‘cut-off’

Answer 6

Transactions and events have been recorded in the correct accounting period.

Question 7

List the four assertions about account balances

Answer 7

• Existence
• Rights and obligations
• Completeness
• Accuracy, valuation and allocation

Question 8

Define the assertion, ‘existence’

Answer 8

Assets, liabilities and equity interest exist.

Question 9

Define the assertion, ‘rights and obligations’

Answer 9

The entity holds or controls the rights to assets, and liabilities are the obligation of the entity.

Question 10

Define the assertion, ‘completeness’

Answer 10

All assets, liabilities and equity interests that should have been recorded have been recorded.

Question 11

Define the assertion, ‘accuracy, valuation and allocation’

Answer 11

Assets, liabilities and equity interests are included in the financial report at appropriate amounts and any resulting valuation adjustments are appropriately recorded.

Question 12

What are audit procedures and audit evidence?

Answer 12

Audit procedures are the actions that an auditor takes in acquiring evidence. While the audit evidence is all the information used by the auditor in arriving at the conclusions on which the auditor’s opinion is based. This includes underlying accounting data and corroborating information.

Question 13

What is involved in an inspection (one of the common audit procedures)?

Answer 13

Involves the examination of documents, records or tangible assets,

Question 14

What is involved in an observation (one of the common audit procedures)?

Answer 14

Involves the auditor observing the behaviour of operating personnel and the functioning of the business.

Question 15

What is involved in an external confirmation (one of the common audit procedures)?

Answer 15

A type of enquiry by which an auditor normally obtains written statements from outside parties such as banks, solicitors or debtors on information that they are qualified to give.

Question 16

What is involved in a recalculation (one of the common audit procedures)?

Answer 16

Recalculating certain items and comparing it to the clients calculation.

Question 17

What is involved in a re-perfomance (one of the common audit procedures)?

Answer 17

Re-performing procedures or controls that were originally performed as part of the entity’s internal control.

Question 18

What is involved in an analytical procedure (one of the common audit procedures)?

Answer 18

Using ratio or horizontal analysis to detect any unusual relationship or fluctuations.

Question 19

What is involved in an enquriy (one of the common audit procedures)?

Answer 19

Where the auditor asks questions to management, clients, personnel for explanations.

Question 20

What is audit risk?

Answer 20

It is the function of the risk of material misstatement and of detection.

Question 21

What is inherent risk?

Answer 21

Susceptibility of an assertion to material misstatement given inherent and environmental characteristics, but without regard to prescribed control procedures.

Question 22

What is control risk?

Answer 22

Risk that material misstatement might not be prevented or detected by internal control procedures.

Question 23

What is detection risk?

Answer 23

Risk that auditors’ substantive procedures will lead auditor to conclude no material misstatement exists when, in fact, one does.

Question 24

What is business risk?

Answer 24

The risk that an entity’s business objectives will not be attained as a result of the external and internal factors, pressures and forces brought to bear on an entity and, ultimately, the risk associated with the entity’s survival and profitability.

Question 25

Why is professional scepticism critical to the audit process?

Answer 25

This is because they need to have a questioning mind, be alert to conditions that may indicate possible misstatement due to error or fraud, and critically assess audit evidence.

Question 26

Why is professional judgement critical to the audit process?

Answer 26

It is required for decisions such as: - determining materiality - assessing audit risk - evaluating audit evidence - assessing the reasonableness of accounting estimates - evaluating management judgements about applying the relevant financial reporting framework (including the appropriateness of accounting treatments and policies and the appropriateness of the going concern basis).

Question 27

True or False: The auditor obtains evidence to support these assertions for material components of the financial report.

Answer 27

True

Question 28

What is sufficient appropriate audit evidence and its relationship to auditing procedures?

Answer 28

Sufficiency relates to the quantity of audit evidence necessary to provide the auditor with a reasonable basis for an opinion on the financial report. The quantity of audit evidence required is affected by the risk of material misstatement and the quality of the audit evidence. Appropriateness relates to the quality of the audit evidence. Thus, it must be relevant and reliable. - Relevance is the connection between the audit procedure and the assertion being considered. - Reliability is influenced by its nature and source

Question 29

How may an auditor use the work of an expert or component auditor?

Answer 29

When using the work of an internal or external expert, an auditor must assess the capabilities, competence and objectivity of the expert and obtain sufficient appropriate evidence that the work is adequate for the purposes of the audit. When part of the entity or group is audited by a component auditor, the group auditor is responsible for the opinion on the primary financial report. - The group auditor must be satisfied that the component auditor is independent and competent and that their work provides satisfactory evidence to support the group auditor's opinion.

Question 30

Describe the general requirement to document audit work

Answer 30

Auditors need to document important evidence. Audit working papers are necessary for the planning, coordination and review of the audit work. These provide documentary evidence that the audit has been properly carried out.

Question 31

Describe the contents of audit working papers

Answer 31

There are two main categories of audit working papers: - Permanent file (stores documents, schedules and other info pertinent to the current audit and of continuing significance to the audit engagement in future years). - Current working paper file (contains all papers accumulated during the current year's examination)

Question 32

Explain the importance of planning to the audit process

Answer 32

Planning is required to conduct an efficient and effective audit.

Question 33

Explain how an auditor develops an overall audit strategy

Answer 33

Auditors will choose an audit strategy of either a lower assessed level of control risk or a predominantly substantive approach, depending on the interrelationship between materiality, audit risk and sufficient appropriate audit evidence. The choice will take into account the cost effectiveness of each approach.

Question 34

Describe the process of assigning and scheduling audit staff

Answer 34

The number and capabilities of audit staff required on an audit depend on the complexity and extent of audit work required.

Question 35

Outline the types and uses of analytical procedures and distinguish those that are useful in obtaining an understanding of an entity and assessing business risk

Answer 35

Analytical procedures involve the use of: - Ratios (used in the planning stage) - Trend analysis - Operating statistics The risk analysis approach requires analytical procedures to be used during the planning stage of the audit. This allows auditors to understand the business and identify areas of potential risk, thereby assisting in the determination of the nature, timing and extent of audit procedures.

Question 36

Identify the important aspects of the auditor’s understanding of an entity and its environment

Answer 36

Planning requires that auditors gain an understanding of the entity and its environment. This knowledge assists the auditor to identify the events, transactions, practices and risks that may have a significant effect on the financial report, particularly the appropriateness of the accounting policies adopted and the reasonableness of assumptions and estimates incorporated into the entity's financial report. The auditor is then able to assess the potential impact of these risks on the financial report and respond to those risks.

Question 37

Explain how auditors prepare a detailed audit plan or audit program

Answer 37

It will be prepared to reflect detailed procedures for the strategy chosen and will be approved by the audit partner.