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Q2 CG Notes

The document outlines the planning process for risk assessment in auditing, highlighting the distinction between business risk and audit risk, as well as the concept of 'RoMM' (Risk of Material Misstatement). It discusses the importance of materiality in determining audit procedures and the calculation of planning materiality based on various financial indicators. Additionally, it details the audit strategy, plan, approach, and procedures necessary to effectively respond to identified risks.

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Luphumlo Xhala
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7 views

Q2 CG Notes

The document outlines the planning process for risk assessment in auditing, highlighting the distinction between business risk and audit risk, as well as the concept of 'RoMM' (Risk of Material Misstatement). It discusses the importance of materiality in determining audit procedures and the calculation of planning materiality based on various financial indicators. Additionally, it details the audit strategy, plan, approach, and procedures necessary to effectively respond to identified risks.

Uploaded by

Luphumlo Xhala
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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QUARTER 2

PLANNING

Risk Assessment
- Business risk (risk that something can go wrong in terms of the
objectives of a business) vs Audit risk. Need to understand a business
first before we can properly identify any RoMM’s in client’s business.
- “Misstatement”: difference between what management has presented
and what it would have been had they followed IFRS/ applicable
legislation.
-“Material” will effect the judgement of users of the FS’s.

Audit Risk Equation:


AR= IR x CR x DR ……. Where IR x CR = RoMM

- “RoMM”: The risk that the FS’s are materially misstated prior to the
audit. Consists of two components: Inherent risk (assertion susceptible)
and Control Risk (risk that misstatement wont be prevented, detected
and corrected in a timely manner).
- The auditor can perform only DR. Inverse rel between DR and RoMM.
- Can never reduce control risk to 0 because of limitations to internal
control: cost/benefit, routine transactions, changing conditions,
management override, collusion and human error.

- RoMM can occur on two levels:


Financial Statement (effect multiple balances)
Inherent Risks: risk of fraud, error, going concern assumption, non-
compliance, tight audit deadlines, engagement with new client.
Control Risks: risk that controls aren’t effective due to management
override, lack of integrity or multiple locations/ complex business etc.
Detection Risks: risk auditor won’t detect MM due to tight audit
deadlines, a new client etc.
Assertion (effects a few specific balances)
These are further split into: account balances, class of transactions and
presentation and disclosure. NB: rebuttable presumed risk of fraud in
revenue.

- After the above, can detect “significant risks” which require special
audit consideration. E.g. fraud/complexity/related parties/non-routine
Materiality
- This deals with setting planning materiality. Materiality is used to:
- Determine the nature (what type), timing (when) and extent
(how much) of risk assessment procedures.
- Identify and assess RoMM
- Determine the nature, timing and extent of further audit
procedures.
- Planning: based on RoMM and the need to be conservative. Has an
inverse relationship with RoMM. Why set it at a conservative level? It is
by nature more conservative, materiality figure is likely to be large
enough to effect user’s judgement, likely to have specific users e.g.
banks who require the audited FS’s for specific uses, and it reduces rhe
risk of undiscovered MM’s.
- Performance: this is calculated at an amount less than planning
materiality to avoid aggregation risk. This is the one auditors use.
- Final: this is based on the actual results identified during audit.

Calculating Planning Materiality:


1) Stability of Indicators: looking for indicators that seem to be
relatively stable over time and in line with business expectations.
Disregard any that have large increase/decrease/erratic.
2) Use of Indicators from? SOFP/ SOCI(don’t gross up) / Both
We look at nature of the business, the users of FS’s and financial
results i.e. what looks significant.
3) Use of Figures from?
Actual to date: may contain MM’s but more reflective of current
conditions experienced by the business.
Prior year audited: free from MM’s but based on the prior year.
Budgeted: can we rely on this information? Compare to actual ytd
4) Computation: % range min max
Turnover 0.5% 1%
Total Assets 1% 2%
Gross Profit 1% 2%
Equity 2% 5%
Net Profit before tax 5% 10%
5) Conclusion: state the range in which planning materiality will be
set and in relation to RoMM where in the range it will be.
Risk Response
- Audit Strategy: broad overview of how the audit will be performed at
the overall financial statement level. Nature/timing/direction of audit
and determines what resources are needed.
- Audit Plan: nature/timing/extent if audit procedures carried out per
balance or transaction.
- Audit Approach: sets out the nature of the procedures to be carried out
(how they will obtain evidence to reduce audit risk).
- Audit Programme: detailed summary of the procedures necessary to
implement the audit approach.
- Nature of Audit Procedures (NPD)
Necessary?
How reliant are we on controls? Is there a complex or integrated
system where subst. only will be hard? High volumes? Audit
evidence available to test? Areas of significant risk?
Possible?
Can the control environment be relied upon? Are their controls in
place to ensure VAC? Are their sufficient staff or expertise?
Possible to use system CAAT’s? Can we place reliance on
automated/manual IT dependent controls (to do test of controls)
Desirable?
Cost beneficial/ client has requested you to perform the tests/
testing is an opportunity to train your staff/ value add/ client had
previous weaknesses in General IT controls with previous auditor
and thus needs to amend that.

Test of Controls
- Inspect – strong e.g. look for a signature
- Recalculate - strong e.g. redo a debtors age analysis for accuracy
- Observe – weak e.g. watch whether a control is being performed
- Enquire – weak e.g. whether something was done

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