MGAD10H3 Chapter Notes - Chapter 3: Capital Structure, Audit Risk, Audit Evidence

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Published on 4 Nov 2012
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Chapter 3 Audit Planning I
Learning objectives
1. Identify the different stages of an audit
2. Explain the process used in gaining an understanding of the client
3. Explain how related parties can impact risk
4. Define fraud risk and understand audit procedures to reduce the risk
5. Explain the going concern assumption
6. Describe corporate governance
7. Explain how a client’s information technology (IT) can affect risk
8. Explain how client closing procedures can affect reported results
CAS 240 the auditor’s responsibilities relating to fraud in an audit of financial statements
CAS 300 planning an audit of financial statements
CAS 315 identifying and assessing the risks of material misstatement through understanding
the entity and its environment
CAS 550 related parties
CAS 570 going concern
3.1 Stages of an audit
Planning stage gaining an understanding of the client, identifying risk factors,
developing an audit strategy, and assessing materiality
Materiality information that impacts the decision-making process of the users of the
financial statements
Audit strategy a strategy that sets the scope, timing, and direction of the audit and
provides the basis for developing a detailed audit plan
Execution (performing) stage detailed testing of controls and substantive testing of
transactions and accounts
Reporting stage evaluating the results of the detailed testing in light of the auditor’s
understanding of their client and forming an opinion on the fair presentation of the
client’s financial statements
3.1.1 Planning an audit
CAS 300 requires that an auditor plan their audit to reduce audit risk to an acceptably
low level
Audit risk is the risk that an auditor issues an unmodified or clean audit opinion when
the financial statements are in fact materially misstated
Efficiency refers to the amount of time spent gathering audit evidence. Effectiveness
refers to the minimization of audit risk
Preliminary risk identification understand the client, identify related parties, fraud
risk, going concern risk, corporate governance, understand internal controls, understand
IT environment, significant accounts, significant classes of transactions, closing
procedures, and materiality
3.2 Gaining an understanding of the client
Risk due to: nature of the client’s business, industry, level of competition, client’s
customers and suppliers, and regulatory environment
CAS 315 requires the following: make inquiries of management and others of entity to
identify risks, perform analytical procedures at the planning stage to identify unusual or
unexpected relationships, and perform observations to corroborate responses made by
management and others. These steps allow an auditor to understand potential issues at
the entity level, industry level, and the economy level
3.2.1 Entity level
The auditor will ask questions about what the client does, how it functions, how its
ownership is structured, and what its sources of financing are
Major customers consideration of payment, future sales, long-term contracts, number
of clients
Major suppliers quality of goods, contracts, payment to suppliers
Importer vs. exporter stability of international countries, currency, and risk
management (hedging)
Adapting to changes in technology going concern
Warranties contingent liabilities
Discounts profit margin risks
Operations - # of locations, location of operation
Employees complexity of payroll system, unionization
Capital structure going concern, liquidity
3.2.2 Industry level
Level of competition, reputation, government support/regulations positioning in the
industry
Level of demand seasonality
3.2.3 Economy level
Economic upturn risk of overstatement in revenue, understatement in expenses
Economic downturn reverse
3.3 Related parties
Included: parent companies, subsidiaries, joint ventures, associates, company
management, and close family members of key management
As per CAS 550: discuss with the team about susceptibility of misstatement due to
related parties, ask management to identify all related parties and provide explanations,
understand the processes related to related parties, remain attentive to documents
that have potential for related party transactions, and identify and assess the risk that
transactions may not be in the normal course of operation
3.4 Fraud risk
Indicators of fraud: turnover of key employees, key personnel avoiding to take leave,
overly dominant management, poor compensation practices, inadequate training
programs, complex business structure, poor internal auditing staff, high turnover of
auditors, unusual transactions, weak internal controls
Types of fraud: financial reporting intentionally misstating or omitting facts,
misappropriation of assets theft
3.4.1 Incentives and pressures to commit a fraud
Reasons: competitive industry, poor operations, threat of bankruptcy or takeover,
meeting expectations, stock performance, debt renegotiations
3.4.2 Opportunities to commit fraud
Examples: estimations and judgement required, transactions at year-end, adjusting and
reversal entries, related party transactions, poor internal controls, complex transactions,
poor corporate governance
3.4.3 Attitudes and rationalization to justify a fraud
Rationalizations: poor tone from top, effective internal controls not a priority,
maximization of profits, attitude to compliance
3.4.4 Audit procedures relating to fraud
CAS 240: ask management if they are aware of fraud, audit team to attend planning
meeting, perform preliminary analytics, management override
3.5.1 Going Concern indicators
As per CAS 570: debt-to-equity ratio, long-term loans, prolonged losses, inability to pay
debts, supplier reluctance to provide goods on credit, loss of customers, high staff
turnover, increase in competition
Conclusion of going concern: assessment of cash flows, revenue/expenses, interim
financial statements, debt contracts, meeting minutes, discussion with lawyers

Document Summary

Cas 240 the auditor"s responsibilities relating to fraud in an audit of financial statements. Cas 300 planning an audit of financial statements. Cas 315 identifying and assessing the risks of material misstatement through understanding the entity and its environment. Planning stage gaining an understanding of the client, identifying risk factors, developing an audit strategy, and assessing materiality. Materiality information that impacts the decision-making process of the users of the financial statements. Audit strategy a strategy that sets the scope, timing, and direction of the audit and provides the basis for developing a detailed audit plan. Execution (performing) stage detailed testing of controls and substantive testing of transactions and accounts. Reporting stage evaluating the results of the detailed testing in light of the auditor"s understanding of their client and forming an opinion on the fair presentation of the client"s financial statements. Cas 300 requires that an auditor plan their audit to reduce audit risk to an acceptably low level.