Q,Q 4

[Hamdy Hafez]

Ok, our new Q,Q regarding a very important area (audit risk), so as introduction we need to Explain what do we mean by the term ‘audit risk

According to ISA200. Objective and general principles governing an audit of financial statements:

Audit risk
Audit risk is the risk of giving an inappropriate opinion on the financial statements; for example failing to qualify when the financial statements contain a material error. Audit risk has three individual components in the formula:

Audit Risk = Inherent Risk x Control Risk x Detection Risk

Inherent risk
This is the risk of an assertion to a misstatement that could be material, either individually or when aggregated with other misstatements, assuming there are no related controls.

Control risk
This is the risk that the internal control system will fail to prevent or detect a material error. The auditor’s preliminary assessment of controls will help determine control risk.

Detection risk
This is the risk that the auditor will fail to detect a misstatement that exists in an assertion that could be material. For a given level of audit risk, the acceptable level of detection risk bears an inverse relationship to the assessment of the risk of material misstatement at the assertion level.

[Hamdy Hafez]

Quick quiz 4

You are the audit manager for Patricia, a limited company, which is a new audit client & you have descover the following information;
1) the company sells books , CDs & similar items
2) the company's turnover is in excess ($90m) & net profits of $5m , net profit has remained almost the same for the last five years
3) The company's sales through mail order & on-line ordering on the internet.
4) The directors plan to expand the range of goods sold through internet by sell a new fashion clothes, the directors believe that when one product has been sold on the Internet, then any other product can be as well.
5) The accounting system to record sales by the mail order division is relatively old. It relies on extensive manual input to transfer orders received in the post onto Patricia computer systems
6) Recently errors have been known to occur, in the input of orders, and in the invoicing of goods following dispatch. The directors maintain that the accounting system produces materially correct figures and they cannot waste time in identifying relatively minor errors. The company accountant, who is not qualified and was appointed because he is a personal friend of the directors, agrees with this view,
7) The directors estimate that their expansion plans will require a bank loan of approximately $30 million, partly to finance the enhanced web site but also to provide working capital to increase inventory levels. A meeting with the bank has been scheduled for three months after the year end. The directors expect an unmodified auditor’s report to be signed prior to this time.

Required:

(i) Identify and describe THE MATTERS that give rise to audit risks associated with Patricia.

(ii) Explain the enquiries you will make, and the audit procedures you will perform to assist you in making a decision regarding the going concern status of Patricia co. in reaching your audit opinion on the financial statements.

[dragoon_alex]

(i) Audit risk:

Patricia is a new client
Because it’s a new client, therefore audit firm don’t know the information about it, and it’s inherent risk

Turnover excess, but net profit remain same for last five years
It’s a big risk. Because the company’s net profit should also increase when turnover growth up. It’s mean that company may have error for cost of sale, which is made by control system; furthermore, director may just want to increase the sale revenue, and achieve the target, ignore the bad debt.

Director plan to sell new product
It’s may be a risk, and it may bring loss to the company.

Mail order division
This is very old accounting system, therefore it may not able to find error, it will increase the control risk.

Accountant is unqualified
It’s very big risk, because the unqualified account may not able to find error from account, and also increase the control risk

Accountant is a friend of director
Breach of independ. Accountant may just do what dirctor ask, and not give right information.

Loan
It’s also a risk, because company may not able pay the loan

Time limited
Director hope an unqualified auditor’s report done in 3 month, it may also become a inherent, because auditor firm may not have resource.



Question (ii) is talk about going concern, I haven't learnt yet, I will give answer later time.

[vervicy]

Patricia is new client and as a result audit risk will be high.

In planning the audit a risk based approach is required and as such with Patrica audit will have a high inherent and control risk and as such detection risk will have to be low as possible. as the auditor will have to carry out more audit work.

inherent and control risk are;

Turnover is in excess of $90m where as net profit is a constant 5m which is 6% of sales a test of control will have to conducted to determine the if the net profit and turnover are being accessed .

The company's sales through mail order & on-line ordering on the internet.
amount received for sale may not be recored on a timely basis, sale received through the post may be acounted for before mail is opent his could be the result of the excessive turnover.

Planning to sell clothes along with books and asumming that for each sale the other will sell may result in high risk and the two product does not necessary inter related and this could lost of customer.


When entering information the level of misstatememnt could be material enough and not be detected, assumming the age of the accounting system and the inputting of data the level of control is high resulting in errors not be detected quickly.

Directors knowing of error failing to correct them and the fact that the accountant is not qualified and also a friend does not give a objective view as to the preapartion of the accounts. Independence is treaten and self interest comes in to play. as the accounts may not be giving a true fair view resulting in information being bias.

11.

A copy of thr prior years file are draft budget will be required to help with the deteriming the figures. Areas that shold be focus on are;
- talking to the client to get past knowledge
-Test of control
-Substantive procedures where internal control cannot be relied upon.
-Detail anayalsis of the turnover will be required also a bank reconcilation will be rquired to deterime if the taking are being recorded properly.
This will help to determine the going concern of the copany also writtten statment from the directors to confirm this.





.

[Pixiefeet]

Audit Risk

An inherent risk exist because Patricia is a new Audit Client, therefore the Risk are very high.

Because of the system being relatively old it is also not reliable, sales figures may probably be calculated from online sales before actual monies are recieved hence the reason for the excessive turnover, staff can also manipulate the system because there is an apparent control risk.

What the company intends to sell is not a direct concern of the auditor but heed should be taken with regards to them being able to make a profit with the introduction of new products as this would also question whether they are able to pay the audit fee.

The unqualified accountant being a friend of the Directors, therefore this threatens the objectivity and independence of the accounts.

A number of tests should be conducted:
Test of controls (computers, who has access to them and the reliability),
Re-calculations and re-performances of the financial statements should be carried out to access the source of the excessive turnover figure as the present accountants figures are not raliable. If the directors continue to give objections then an qualified opinion should be given.

[Dazy]

Hello all,

The topic covered is C1 and this is very important topic from exam point of view. This is frequently examined. I must appreciate that the question is very well formed and the answers are also satisfactory.

With regard to answer to part (i), Dragoon and Vervicy have answered well covering all the required points. Pixiefeet has also covered all the points but the presentation of the answer can be improved. The answer should be written with proper headings to make it easy for the examiner to evaluate your answer.

Regarding part (ii), many of you have left the answer. The question is not that much difficult. I want you all to study the respective ISAs 200 and 570. The topic of going concern is covered in section F.2 in the GTG study text.

I hope you all will study the topic and will try to answer it.I will post my feedback after that..