F8: Audit and Assurance

2 Designed to give you knowledge and application of: Section A: Audit Framework and Regulation Section B: Internal audit Section C: Planning and risk assessment Section D: Internal control Section E: Audit evidence Section F: Review Section G: Reporting

3 Designed to give you the knowledge & application of: Section C: Planning & Risk Assessment C1. Objective & general principles C2. Assessing the risks of material misstament C3. Understanding the entity & its environment C4. Materiality, fraud, laws & regulations C5. Analytical procedures C6. Planning an audit C7. Audit documentation

4 Learning Outcome C4: Assessing the risks of material misstatement & fraud  Define and explain the concepts of materiality and performance materiality. [2]  Explain and calculate materiality levels from financial information. [2]  Discuss the effect of fraud and misstatements on the audit strategy and extent of audit work. [2]  Discuss the responsibilities of internal and external auditors for the prevention and detection of fraud and error. [2]  Explain auditor’s responsibility to consider laws and regulations. [2]

5 Define & explain the concepts of materiality & performance materiality While establishing the audit strategy materiality levels are set for: i. the FS as a whole and; ii. some particular classes of transactions, account balances or disclosures, if misstatements of lesser amounts than materiality for the FS as a whole could reasonably be expected to influence the economic decisions of users taken on the basis of the FS. Performance materiality: the amount or amounts set by the auditor at less than materiality for the FS as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and undetected misstatements exceeds materiality for the FS as a whole. Materiality Misstatements, including omissions, which (either individually or in the aggregate) could reasonably be expected to influence the economic decisions of users of the FS Depends upon size or nature of misstatement Based on a consideration of the common financial information needs of the users as a group. Continued…

6 Tolerable misstatement The maximum error in a population that the auditor is willing to accept Materiality level Tolerable error Errors & fraud $ Subjective term : decided by auditor Material error Auditor need to concentrate Example Rohan Plc 0.2% of sales turnover Decides materiality level Therefore: Materiality level $2,000 Sales turnover $ 1,000,000 Continued…

7 ‘There is an inverse relationship between materiality & the level of audit risk’ Audit Risk Materiality Continued…

8 Calculation of materiality level Compute indicative materiality levels from financial information Refer to Example on page 162 Appropriate Benchmark Revenue ½ to 1% Profit before taxation 5 to 10% Total assets 1 to 2% The elements of the financial statements Items on which users of the entity’s financial statements tend to focus The entity’s ownership structure & the way it is financed Factors affecting identification of benchmark The nature of the entity, the industry & economic environment in which the entity operates The relative volatility of the benchmark

9 Qualitative Factors Relative significance Example Total income from investment $2,000 & amount of $500 received as dividend would be material. Compare with previous year Example Insurance premium paid by White co. is much lower as compared to last year. Transactions of non-recurring abnormal & nature Example Disposal of scrap materials. Statutory requirement Example Share capital recorded as $899,000 instead of $900,000.

10 Example Anna’s Boutique Materiality level Prepare Audit Plan  Decide the nature, timing and extent of the audit procedure  Determine the items which require extensive testing Designing audit plan While planning an audit, the auditor should consider the maximum tolerable misstatement.

11 Fraud  an intentional act  by management, those charged with governance, employees / third parties  involving the use of deception to obtain an unjust / illegal advantage According to applicable financial reporting framework - = Misstatement As shown in financial statement Amounts, classification, presentation, or disclosure of a reported financial statement item The effect of fraud and misstatements on the audit strategy & extent of audit work Continued…

12 Involves intentional misstatement, including omissions of amounts or disclosures in the financial statements, to deceive financial statement used Fraudulent financial reporting involves the theft of an entity’s assets & is often perpetrated by employees in relatively small & immaterial amounts. However, it can also involve the management who are usually more capable of disguising / concealing misappropriations in ways that are difficult to detect. Misappropriation of assets Continued…

13 Risk assessment process Inquire from management & others within entity Evaluate fraud/risk factors Enquire internal audit department Enquire those charged with governance Evaluate unusual relationships identified while performing analytical procedures Obtain information about entity and its environment Risk assessment process Refer to example on page 167

14 Refer to Test Yourself 3 on page 171 Effect of fraud & misstatements on audit strategy & extent of audit work Auditor should consider whether overall audit strategy and audit plan need to be revised He should not assume that instance of fraud or error is isolated occurrence He should communicate misstatements / fraud and their impact on audit strategy to audit committee He should perform further audit procedures to re-evaluate amount of misstatement If he perceives risk, he should perform extensive procedures Effect of fraud & misstatements on audit strategy & extent of audit work

15 Recap  Define and explain the concepts of materiality and performance materiality. [2]  Explain and calculate materiality levels from financial information. [2]  Discuss the effect of fraud and misstatements on the audit strategy and extent of audit work. [2]  Discuss the responsibilities of internal and external auditors for the prevention and detection of fraud and error. [2]  Explain auditor’s responsibility to consider laws and regulations. [2]