|] Lecture. 15 - Audit { Understand. client?s burinera and_indwotry When do you need 4o understand the client ? i} @ Whenever you are going fo engege ith Someone. youneed to hone i a basic idea that.we call Screening, We need O pretrminary idea how to interact, how to | Thatwin help te shape your objechve , proceed wrth your work [> What will be planned ? || As an auditor we need bo Check Client’s financial statements, verify their informaken , gather evidence | + As an auditor, time is also limited for aut there procedurer | To carry out there tasks io Q@ Short span.oF time, we need | to set priority ; which thing we have bo check Arséy | ehich information €o gather Arse, Lia need to first Understand what is the requirement - So it is essentiat to undestand the Client and *ndusty i | Auditor also engage in analyticat Procedure thaé help unde cstan the Company's future, ig Chapter I- Materiatity and Risk >> Whot is metteriality 2 4 Can be subjective or Objective 4 Tr we identity there isan ill motve behind the reported MAniplaton or Misrepresention of the mgt-tt is highly maker Scanned with CamScannerby JF it is anormat human error, ‘it is immaseiioks <2) 1173 Materiatity always helps us to determine whak ype of repork a» AN auditor will you issue. 3 | TF you did net find any materiality, whokever evidence you _ || have: gathered if itis immatedal: according to judgment (| auckitor, then issue standard ‘unqualified repork | TF another auditor finds the evidence te be material, he may issue (| quouihed report and iF it is highly matencu, he may issus Ar adverse opinion Tt depends op auditor's peccephon, thinking and how is Ene, | relation between mgt and Quclitur All the makeriatiey issue have to be reportedl 19 Scope powag! by Materiolity help uw Fo dekermint the Guditers responsibility || Auditor responsibility is Phat they have bo identify whakare. || the material anpect in the statement company May have 5 | Auditor's responsibility 15 NOE to disclose those Gnings but rather First “bring thre before. the mgt by giving thema notice, ask for ——— |) Clarificuhon and if mgt clarifes i a2 oO Fact, then Quoli for can | accephit.or aolvise to make necesscuy ackiwatments a > Steps in applying Materiatity ss Qa Stage = ® Planning phose @ After gethng Oly the information or evidence, evaluates that re Scanned with CamScannerPlanning Phane - Step4: Set preliminary, Juclg ment QbOuk. MALELIOLM by. 22 We need to set the threshold Ex: Threshold that we are not ready to accept Any formot miscalculatien in cash account» Zero tolerance. for cash acount | Threshold that there may have a 5% deviation from reports oF mgt! | with quditer's Observation 'n accounts receivables account This threshold is not Axed. Tris band on Judgment and company Pectures so we need to understand client, business Volume - | Se cuditor will set the threshold and work accorelingly - TE is the level of things they will accepE and will nok accept segments Ex: If we Set threshold level for cashaccount to zev, after verifying Ehe cash account and bank Statement account, iF we, And any type ef Mmanipulaben or miscalculation , it will be considered Material For the auditor based on threshold = 2+ Allocate preliminary judgment about materiality | | Evalucihon Phase - Step 2: Eshmate total misstatement’ in seqmen& | Material Current Assets Threshold ENidence Makenatity \| Cash ° ° NO AIR S000 10% 3000 No Taventory 50000 5% 4 0000 9. | ( Total c/a 30000 43000 Yes Auditor must recheck and gather evidence because it is justo level oF threshold Qbout the decision whether to engage more of lees Scanned with CamScannerMUSE Check all accounts @ad,eg: check 20% of botat inventor because it is nok feasible for auditor to check every account OF the inventory because i 1s more than the theshold level | AS an c.ucktor we should Concentrate on A/R accounts: We \ There is a different way to judge the issues, absolutely depenck I They decide. meteriality and uyshat to do further | | Current Asse& Material threshold _ Evidence. materi | Cash oO ° N AIR 5000, 6000 y | Inve nhory Boooo 10000 N | Tefal c/A 30000 16 000 N | Should check each aspect of me clients receivable accounts ._ Quditors facts, judgements Here, they decided about thew engagement by + — 1 initial level they have set the threshold = According fo threshold they voul Jet the information - Based on the info Chey ill idenhfy Lohethe those info are Factutl Evidence ~ They compare the evidence iy.th meatesiat threshold Material threshold are Cpplied basecl on the Preliminary jualynen that is whak you have From clients unde standyoxnd their busine cand Undlushy An amount may be materiat for one busines b material for another form oF business. wet 1k may not be. Scanned with CamScanner| | @ €g Taventory furnovel 4 % | | To end up all inventory ond replace wi cays for A Ceach 36 days A has a fre: 180 days for 8 ny depends.on the type sf || for the judgment, the better compa Company , business cund engagement & company eg Ais indushy belore pi threshold Based on Sizecf Company, We at factor a mateicd theeshold fr the Company. JF 5000 as mateial threshold for receivable [an importa 00 Is Nothing [Company size = 50,000, | is big issue BUE iF Company size iS 5,000,600 then 5 So there is relative. judgment other than the absoluke Ague. | aventory turnoved io mes 36 Boo _ bo = 36 doys = \80 da th new Ide, it taker 36 sh inv.) and it takes Bata (shoes) B is Boeing (planed than | This not Feasible for Seeing to have 1ov. turnover more is not Qn issue for them: times & year $O inv: turnover That is why Cuuclifor must understand the Client's business and reliminary juicigment and Sethng materak eG) Size oF company C Bolance Sheet Size— Total assets) can decide whether receivable Is | > Factors. affecting judgment © materauity isa relabve rather than An absolute concept: a Bases cre needled for evaluating materiality ) oF materiality by You need ro clearly menboo how you will sek leve factors and criteria wed te dleciqre whethe material eY 0 Scanned with CamScanner »© Quaitative factors affect makeiality 13 Tudgment, Knowledge, experience For quatitahve factor, whak are factors than rofFlusnce. judlgrend) 1 © Loan covenant 4 Loan covenant can be an issue of mareriatity When clients ask for loan from the bank, they need td submit an Quditecl Statement with their loan application. The basic a is fo by to present company od most prohtable and has a good future. TF there is a loss, possibilty tw get loan reduces So Com can bry fe manipulcite info. As ancuctitor, have to look fora ~ things in case oF Joan covenants # ] © What are the condihons of fund provider to ge t the loan? Check | those criteria fom client perspechve and how they meek those criteria? __#@ Especiouty in SPI CSmait Positive income) and SNI CGmau egies, income), Whenever there is SPE Or SNT, Quditor must be very | Carel to judge those Agure. cand inveshgate uvhether it is real — | €9° Company has net operating prokt dF ISoG. TE there is a debt | [covenant that Comp need fp have. pre, company con tum negadive | lacome in pesihve one so they can say they have co profit: | Another example : | In debt covencnt, after having loan, you cannot authorise to iss [dividend for next five years Asan audieor, Ensure that this info: || is disclosed properly in the fin: statement becane it will hampe the. || interest oF other stakeholders , especially Shateholders« Anotiner example : To gee benefit oF tax, youmay turn posihve income inte negative one: $0 that you get subsidy From govt oy othe Sechsy. Scanned with CamScanner+ Changing treods. SS 28 i Losing concern may turn. to preatable one.and Vice verse Ceperd on motve. woe 1 & Management Compensahen | ASK pokey About mgt reward System, payment System nipulcded there prohe figure by Consequently EPS or incre cusect in mkt thus most Shares YF mgt &9- In enon conapse, they mo Showing loan amt ad income | aNd Share value wor increakel way Sold out | |» Financ Statement User - Need to undestand who will wre this info: | if Conceal an illegcd cick > Known and likely misstatements a Whenever cuidkter is engaging io evaluation process, he munt be careh About choosing of his “orc © Audlitercan determine the misstated amount in account that is ‘known to them, that they have. absolutely idenbhecl- @ The auditor may not have igenhGed and have some indicaben in this case use the word ‘likely? due to their peicephon by make pryechon uring Kroon factor or considesing sampling boing linear equetion Scanned with CamScanner, TES not feasible to eliminate cul those crsis, Auditors have tp ace Lecture 16 Cauclit) 1S. Risic in Auaiting - 1) Risk is Uncertain fiture. There are two types of risk in generat ®_ Unavoidable - Tahereak ‘ he 4. ® Avoidable or manageable .- Apply some technique to ming risk Auditors Engage in assessment procedure and th the fin: Statements of the client and then cert from misrepresenta.ten and itis @ reliable one. It is not feasible for them to check each and Nery COmponent oF thai Fin. stotemnl become of time limitation, resource [imitabon, So they Opply sampting technique and fetious Gene Curation, So there js alusays a Pesci bility And accounts Not chevishenciy This uncecteunty is the risk. = ey have to. assey HAY that there cue fee of Mmussing Something, the documents have some emer, ™miSppropriatien: thak there is no way to eliminate the risk but there Is Away tp - manage it- To what extent they ave. ready to accept the risk? Three forms of risk Inherent Fiske Not possible. to eliminate - : ~ Conhl Cisk > Associated with Ics F-company — Detrection_risk. > | te — Acceptable Auctit. Rist... Conhol cisk ic high = FCs is weak = Not feasible ty measure in oun How will gou get the info thet CR is weak? L Based on perception Or Understan diag Scanned with CamScannerLe Ihenever you .aue engoged...9 the audit proceduss.and. then... : test basis when you ave guing to checle transactons of the Company, prachce $F Company And when you discuss with employees then geen better understanding to make juclg ment bohether CRis good | or rot + 5 Another way to ger understanding about RIB is sophisticated software to check reports, whebner the Software is | Capable to produce i€- To track transachon, whether SoFhwoue is capoivle fo track from date e& incephon fo last dete CF reporting whether softwore has Flowchart oF that transaction . Check Whether | software 18 realhme one and also Security measure, seancry phen through @ LIF CRAs high, what are the measwe and consequences? | — Collect more ¢uidence Why “ore evidence ? Since CR Is high, 1b means System has weakness, may not be | | capatie to idenhly the frowul, may not be Capable to prevent the | manipulation of misrepiercntahon. As an auditor need to be ass wed | by gother'ng more evidence by increamag Scumple. to cieeck.accounr and get assurance &» Audit Risk Model for Planning - PDR = AAR +/¢ IRx CA) POR = Plannecl derechon risk AAR = Acceptable Auolit cisk TR = Inherent Rise i | AAR = IRxX CRx POR CR = Convo! nsk Scanned with CamScanner| | PDR is most likely to make mistecke | | POR = Auditor failsto detect mistatement i Tt is quoditers duty te idenhry misstatement, frord, manipulaben~ i But due to Sampling technique, there is possibility oF missing || Something even after Complenng auclit procechure. I| TPF PDR Is high ; Collect More evidence > Fotlte detec is | EcR is high > Possibility te detec-low | | Lacceptable Auctit Risk 1s lou eee eee 4 L Asan qudiler,ready 10 14ke high risk CAPR high) 1 cole less eviclence and try te draw Conclusion as early a» possible. Crisk taicer ) 4 | L When AAR low, not ready to take risk, bo expose yourselts i Collect. More evidence 3 VIR = By defauit in the system i : » Audit Risk model Assess client business risk | Understand client's busines Gnd industry | - ASsess_ risk of material misstatement Taherent risic Control rise ris Scanned with CamScanner|. a. Ttustration.of cliffering. vid ee 2M00G LYN nn conr mn —_—— A) rent sri hawk drewhonk yee Mediuter 1. Sates and Conechon cycle A) Inherent risk~ Medium Ly sales and A/R are Sensifwe 1ofoi is a good possibildy that you have manipwatien 19 tne. | receivables, undue Credit sales, manipulation insGles |B) Conte! riSk~ Medium | 1 About comp. contol System. Check Gund verify | Toherent risk 1s low for poyrell and. personnel. cycle. becaux. employee (are third party ' whom info is disclosed. But IR 1s high for acquisine ancl payment cycle because If 15 much risky due to fin-scondans in (Depends on typescf cic, info, Osseb, document risk Should nvt belous. Thee cxcquisibon ov procurement procera Conhel risk depends en obsesvedion QS an Cuudlitor in the. company: Whak you have seen in the Company. Lou) CR Means comp: has mainteuned cu documents Which axe. transkerable., hows they transact With Suppliev, how they tase decision about procurement hous they disbuse the funds ong. FAR tewie low because Cudktor isnot willing fe take cist. Chased on perception) | POR is influenced by interochonof TR]cR| AAR» PDR is high for payroll because due to jow Ir/ca' the auditor is corleching less evidence CR is low, So Auditor percephon is that ICS is $ trong. SO Possibility adel detect is high: Scanned with CamScanner© Due tr higher POR, auditor not ready bo take risk CAPR=1ouw) Hy HESS Engagement risk || Wha is engagement ? & Decision the auditor.whenever they have offer lette From th lent, they will judge the client's mohve and reanon to be aud When they thik they can accept the offer and engape they issue a fetter cattecl engayement letter. Tr will be associcues| with some risk catleel engagement Fisk As Factors Affeching AAR. 1) Degree tv which externar users rely on the statements. 2) Likelihood that a client wit have Aoancie difhculhes ofter t | Qudit fepork is issuect 3) The auclétor's Cvalucnonc® mgt!s integrity > Factors aheching TR [1 Nature oF client's business L What type ct business reg) pital business is risky venhure- IMherent cist is high | 2) Rude Experience L TE auditor is newcomer 3) Culture. L Prachce in Company. and.counhy 7 Mo Experience, TR is high Scanned with CamScanner