Aue3761 2023 TL 102 0 B PDF

AUE3761/102/0/2023
Tutorial Letter 102/0/2023
The audit process

AUE3761
Year module
Department of Auditing
This tutorial letter contains important information

about your module.
BARCODE
CONTENTS
Page
1 INTRODUCTION .......................................................................................................................... 3
2 IMPORTANT INFORMATION REGARDING THIS TUTORIAL LETTER .................................... 3
2.1 DUE DATE ...................................................................................................................................... 3
2.2 LECTURERS AND CONTACT DETAILS ....................................................................................... 3
2.3 METHOD OF STUDY FOR THIS TUTORIAL LETTER .................................................................. 4
2.4 STUDY PROGRAMME ................................................................................................................... 4
3 ACADEMIC CONTENT TO STUDY FOR THIS MODULE .......................................................... 4
LESSON 1: INTRODUCTION TO THE AUDIT PROCESS ....................................................................... 5
LESSON 1.1: Auditing concepts (an introduction to auditing) .................................................................... 7
LESSON 1.2: Regulation of the auditor .................................................................................................... 10
LESSON 1.3: King IV Report on Corporate Governance in South Africa ................................................. 19
LESSON 2: THE PRELIMINARY AUDIT ENGAGEMENT ...................................................................... 24
LESSON 2.1: The preliminary audit engagement stage ........................................................................... 25
LESSON 3: PLANNING AN AUDIT ......................................................................................................... 36
LESSON 3.1: Planning an audit of financial statements .......................................................................... 38
LESSON 3.2: Understanding the entity and its environment .................................................................... 41
LESSON 3.3: Identifying and assessing risk ............................................................................................ 47
LESSON 3.4: The auditor’s responsibilities relating to fraud .................................................................... 75
LESSON 3.5: Consideration of laws and regulations in an audit of financial statements ......................... 81
LESSON 3.6: Materiality ........................................................................................................................... 87
LESSON 3.7: The auditor’s responses to risk .......................................................................................... 98
LESSON 3.8: The overall audit strategy ................................................................................................. 105
LESSON 3.9: The audit plan .................................................................................................................. 110
LESSON 3.10: Audit documentation ...................................................................................................... 115
4 SELF-ASSESSMENT QUESTIONS ........................................................................................ 120
5 SELF-ASSESSMENT SOLUTIONS......................................................................................... 140
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1 INTRODUCTION
It is with great pleasure that I present to you in this tutorial letter the first lessons that you need to
study for Module AUE3761: The audit process. We already provided you with Tutorial Letter 101,
which contains important information regarding administrative arrangements, support services,
contact details, your prescribed textbooks, and so forth. Make sure that you carefully read through
Tutorial Letter 101 and that you keep it at hand throughout your studies. Also note that the tutorial
letters for this module are not printed. If you would like to print it, you should do so at your own
cost. Alternatively, you may refer to myUnisa and study your lessons online.
2 IMPORTANT INFORMATION REGARDING THIS TUTORIAL LETTER

2.1 DUE DATE
The due date of this tutorial letter is on/before the date when test 1 is written (dates to
be communicated via myUnisa).
This implies that you need to study the content of all the lessons provided to you in this tutorial
letter (section 3); answer the questions (section 4); compare your answers to the questions
(section 5) and write the test on the due date. Note that the test will be written online. More
information on this will be communicated on myUnisa.
2.2 LECTURERS AND CONTACT DETAILS
The lecturers responsible for this module and to whom you should direct your enquiries, are:
Lecturer Telephone number
Mrs S Abed 012 429 4544

Mrs A Botha 012 429 6147
Mr T Diale (co-ordinator) 012 429 8497
Mr K Joubert 012 429 4068
If you would like to send an e-mail with your query about the content of this tutorial letter you
may send an e-mail to: AUE3761@unisa.ac.za.
All the lecturers on this module have access to this mailbox and will gladly assist you with
your query. However, please note that if your query is of an administrative nature, lecturers
would not be able to assist you. Direct your e-mail to the relevant e-mail address provided to
you in Tutorial Letter 101 and the Study @ Unisa guide. When sending an e-mail, make sure
that you do so by using your Unisa mylife e-mail address.
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2.3 METHOD OF STUDY FOR THIS TUTORIAL LETTER
You should start off your studies by referring to the lessons in section 3 of this tutorial letter. Read
through the lessons; make sure that you understand the learning outcomes; study the relevant
sources provided and do the activities. You should also refer to myUnisa for additional
activities, videos or important announcements. After studying a lesson consider whether you
can achieve the learning outcomes before continuing to the next lesson.
After completion of the lessons, you should attempt the self-assessment questions provided in
section 4 of this tutorial letter. You should then mark your answers by referring to the self-
assessment solutions in section 5 of this tutorial letter to make sure that you have mastered the
concepts studied in this tutorial letter.
After you have studied the academic content in this tutorial letter, you will write the test on all the
topics in this tutorial letter. All arrangements for this test, will be made available to you on
myUnisa.
If you require any assistance with your studies; do not understand the concepts; or struggle when
applying these concepts to a practical scenario, you are welcome to contact your lecturers. An e-
tutor might also be allocated to you to whom you may address any questions that you may have
regarding the academic content of this module.
2.4 STUDY PROGRAMME
You are responsible for pacing yourself when studying this tutorial letter according to your own
personal circumstances. The following study programme is an example of how you could plan
your studies:
Lesson to study Time frame
Lessons 1.1, 1.2, and 1.3 (important revision) Week 1
Lessons 2.1, 3.1 and 3.2 Week 2
Lesson 3.3 Week 3
Lessons 3.4 and 3.5 Week 4
Lessons 3.6 and 3.7 Week 5
Lessons 3.8, 3.9 and 3.10 Week 6
Write the test On the due date communicated on myUnisa
3 ACADEMIC CONTENT TO STUDY FOR THIS MODULE

The content that you need to study for this tutorial letter is set out in lessons 1 to 3.
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LESSON 1: INTRODUCTION TO THE AUDIT PROCESS
INTRODUCTION
In your second year of auditing studies (AUE2601), you were made aware of the different stages
of the audit process. If you can recall from prior auditing knowledge, you will know by now that
there are four stages in the audit process. This module will deal with each stage in detail and is
arranged to follow the logical flow of the audit process.
The following is a schematic representation of the stages of the audit process.
FIGURE 1:1 The stages of the audit process
Each of the stages in the audit process will be covered in Module AUE3761. The lessons start
with the auditor’s first encounter with an audit client. The decision to accept or reject the
engagement with the audit client follows. When the decision has been taken to accept the
engagement, the audit is planned on a date that will allow sufficient time to finalise the audit. After
the planning has been finalised, the auditor should obtain audit evidence by performing tests of
controls and substantive procedures to form a conclusion and report on the audit findings in the
audit report.
Remember that the auditor continuously reassesses the audit risk throughout the audit to
determine whether he or she is achieving the objective of reducing the audit risk to an acceptable
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level. If this desired result is not achieved, the auditor should revisit the drawing board to
determine whether
• the risks have been correctly identified initially; and/or
• the audit procedures have been correctly designed to resolve the identified risks.
The result of the above revisit should lead to corrective action. This will ensure that an audit is
performed in the most efficient and effective manner.
The first lesson in this module mainly consists of revision from your second year auditing studies.
As these principles do not necessarily form part of a specific stage of the audit process and can
be considered throughout the audit process, it is important that you revise the concepts set out in
lesson 1 before delving deeper into each stage of the audit process.
This lesson is presented in the following units:
Lesson Title
1.1 Auditing concepts (an introduction to auditing)

1.2 Regulation of the auditor
1.3 King IV Report on Corporate Governance in South Africa
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LESSON 1.1: Auditing concepts (an introduction to auditing)
LEARNING OUTCOME
At the end of the lesson, you should be able to do the following:

• Explain various auditing concepts you will apply later in your auditing studies.
INTRODUCTION
Does the following look familiar: “wud pcm b4 I cul”? Some text “language” is hard to understand
if you have not been introduced to it. (wud pcm b4 l cul = What are you doing? Please call me
before lunch. See you later.)
The same applies to auditing, where you need to learn the meaning that auditors assign to certain
words or concepts. An example is the term “material”. Seamstresses can make clothes from
material, but an auditor uses the term “material” to indicate the significance of amounts or events.
In your AUE2601 studies, you already learnt about various auditing concepts, and it is important
for you to revise them from the references below.
When revising these auditing concepts, don’t learn them by heart as we will not require
you to answer theory questions in your third year of auditing studies. However, it is
important for you to understand them and identify issues relating to these concepts in a
practical scenario.
The concepts that you should revise are set out in figure 1.1.1.
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FIGURE 1.1.1 Summary of concepts to revise from previous auditing studies
Concept Checklist of concepts that you need to revise and be

familiar with
The auditor • The overall objective of an audit and an auditor.

(Study sources: International • The types, characteristics and classification of auditors.
Standard on Auditing (ISA) 200 • The need for auditors.
para 11, and Auditing notes • Specific theories as they relate to businesses, auditing
Chapter 1) and the profession.
• Difference between assurance and non-assurance

engagements.
• The meaning of the auditing expectation gap.
Assurance and non- • Types of assurance engagements.
assurance engagements • Elements of assurance engagements.
(Study sources: International • Public interest score in terms of the Companies Act 71 of
Standard on Assurance 2008 and an audit of financial statements.
Engagements (ISAE) 3000, ISA • Differentiate between statutory or non-statutory
200 paragraps A47 to A54 and engagements.
Auditing Notes Chapter 1) • Inherent limitations of an audit.
• Roles of various parties in an audit of financial
statements.
Auditing postulates
• Awareness of the meaning and the eight suggested
(Study sources: Auditing Notes auditing postulates.
Chapter 1 Appendix)
The accounting • Identify the domineering accounting bodies in South

profession Africa.
(Study sources: Auditing Notes • Identify the relevant pronouncements that regulate the
Chapter 1) auditing profession.
• Purpose of performing an audit (ISA 200 paragraphs 3 and

A1)
Objectives of the • The auditor's responsibility (ISA 200 paragraph 7)
independent auditor for • The overall objective of the auditor (ISA 200 paragraph 11)
assurance engagements • What is reasonable assurance? (ISA 200 paragraphs 5; 17
and A30-A54)
(Study sources: ISA 200 • What is materiality? (ISA 200 paragraph 6)
(respective paras as indicated) • What is professional judgment, professional scepticism and
and Auditing Notes Chapter 1) risks of material misstatement? (ISA 200 paragraph 7)
• What is a form of opinion? (ISA 200 paragraph 8; A12-A13)
• Other important definitions (ISA 200 para 13)
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Activity 1.1.1
Some concepts that you revised in this lesson will form part of a quiz that will be made available
on myUnisa after completing lessons 1 to 3.
Summary
In this lesson, we discussed and explained various auditing concepts that will help you understand
the learning material containing these concepts.
Self-assessment
Having worked through the lesson and the references to the prescribed study material, determine
if you are able to do the following:
1. Explain various auditing concepts that you will apply later in your auditing studies.
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LESSON 1.2: Regulation of the auditor
LEARNING OUTCOMES

• Identify, discuss and apply the requirements related to the duties, rights,
responsibilities and liability of auditors in terms of the Auditing Profession Act 26 of
2005 and the Auditing Profession Amendment Act 5 of 2021 (APA).
• Identify, discuss and apply the requirements related to the duties, rights and
responsibilities of auditors and audit committees in terms of the Companies Act 71
of 2008.
• Identify, discuss and apply the ethical principles regulating the auditing and
accountancy profession by referring to the IFAC Code of Ethics for Professional
Accountants, the SAICA Code of Professional Conduct (CPC) for Chartered
Accountants, the IRBA CPC for Registered Auditors and the IRBA Rules for Improper
Conduct.
• Explain the auditing firm’s responsibilities for its system of quality control and quality
control for audits and review of financial statements.
INTRODUCTION
In the previous lesson we highlighted a few auditing concepts that you should revise to help you
with a basic understanding of the Accounting and Auditing Profession. Now that you refreshed
your memory on those concepts, you should also revise the concepts that play a role in the
Regulation of the Auditor. These concepts were explained to you in detail in your second year
auditing studies and will remain relevant and very important throughout your auditing
studies which include your third year and postgraduate studies. It is therefore of utmost
importance that you are familiar with the concepts that should be revised in this lesson as
questions relating to the regulation of the auditor will be integrated with other topics in tests or
examinations throughout your studies.
REGULATION OF THE AUDITOR
The Auditor is regulated by the following Acts and Codes:

• The Auditing Profession Act 26 of 2005 and the Auditing Profession Amendment Act 5 of
2021 (APA) (Refer to section 1.2.1).
• The Companies Act 71 of 2008 (Companies Act) For the purpose of this lesson, only the
sections related to the auditors and audit committees (Refer to section 1.2.2).
• Ethical principles for accountants and auditors as stipulated in the IFAC Code of Ethics for
Professional Accountants, the SAICA Code of Professional Conduct (CPC) for Chartered
Accountants, the IRBA CPC for Registered Auditors and the IRBA Rules regarding
Improper Conduct (Refer to section 1.2.3).
• Quality control guidelines as set out by the International Standard on Quality Management
1 (ISQM 1) and the International Standard on Auditing (ISA) 220, Quality control for an
audit of financial statements (Refer to section 1.2.4).
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1.2.1 APA
Revise and study
Note the duties, rights, responsibilities and liability of auditors in terms of the Auditing Profession
Act 26 of 2005 and the Auditing Profession Amendment Act 5 of 2021 (APA).
Study sources:
• Both Acts should be studied and are included in the SAICA Student Handbook, Volume
2B; or can be downloaded from the internet. You are only expected to know certain
sections of the APA; therefore, only need to familiarise yourself with Chapter I (Sections 1
and 2), Chapter III Part 2 (Sections 37 and 38), Chapter IV (Sections 41, 44 – 46) and
Chapter VI (Section 52).
• Relevant sections in Auditing Notes for South African Students, chapter 3.
Specifically note the sections of the APA below which is often assessed in tests or examinations:
Sections 37 and 38 dealing with registration procedures for individuals and firms as registered
auditors.
Section 41 dealing with conduct and liability of registered auditors relating to public practice.
Section 44 dealing with duties in relation to an audit.
Section 45 dealing with the duty to report on irregularities.
Section 46 dealing with the limitation of the auditor’s liability.
Section 52 dealing with reportable irregularities and false statements in connection with audits.
How will you be assessed on this information?
We will provide you with a scenario in which certain information is provided and from the
scenario you should be able to identify, discuss and apply the requirements set out in the APA.
For example, if we describe in the scenario that one of the partners of the audit firm is not
registered with IRBA, you should be able to identify that all partners of an audit firm should be
registered with IRBA (We will not tell you this explicitly but you should know and be able to
identify this) and that the audit firm then do not comply with the APA section 38 (you do not
have to mention the section, only that it is in non-compliance with the APA).
We can also provide you with some information which might point to a Reportable Irregularity
(RI), and you should then be able to identify whether or not it is a RI by comparing the given
information to the definition and requirements of an RI.
For some assistance when determining whether an event can be identified as a RI, you can
also refer to Auditing Notes page 3/79 setting out questions that you can ask yourself to
determine whether or not an act can be identified as a RI. Additionally, you can also refer to the
IRBA guide on Reportable Irregularities (IRREG) for guidance on what constitutes a RI.
Appendix 7 of this guide includes examples illustrating the application of the guide when
determining whether or not a RI exists. (This guide can be downloaded from the IRBA website
or is included in the SAICA Student Handbook volume 2B.)
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Self-assessment questions
Refer to section 4 of this tutorial letter and attempt questions 1 and 2.
1.2.2 COMPANIES ACT
Revise and study
Note the duties, rights and responsibilities of auditors and audit committees in terms of the
Companies Act 71 of 2008 (Companies Act).
Study sources:
• The Companies Act is included in the SAICA Student Handbook, Volume 2B or can be
downloaded from the internet. As part of this lesson, you are only expected to know certain
sections and only need to familiarise yourself with Chapter 3 Part C (Sections 90 – 93) and
Part D (Section 94).
• Relevant sections in Auditing Notes for South African Students, chapter 3.
The sections noted above in the Companies Act:
Section 90 dealing with the appointment of auditors.

Section 91 dealing with the resignation of auditors and vacancies.
Section 92 dealing with the rotation of auditors.
Section 93 dealing with the rights and restricted functions of auditors.
Section 94 dealing with audit committees.
Once again, we will provide you with a scenario in which certain information is provided; and
from the scenario you should be able to identify, discuss and apply the requirements set out in
the Companies Act. As previously indicated, the information will not be explicitly mentioned, but
you should be able to identify if something is not in accordance with the requirements of the
sections in the Companies Act mentioned above (you do not have to mention the section,
only that it is in non-compliance with the Companies Act).
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Activity 1.2.2.1
Some concepts that you revised in this lesson will form part of a Quiz that will be made available
on myUnisa after completing lessons 1 to 3.
1.2.3 ETHICAL PRINCIPLES FOR ACCOUNTANTS AND AUDITORS
Before delving more into the theory of ethical principles for accountants and auditors, it is
important to understand the definition of ethics. Ethics can be defined by looking at the three
core concepts namely good, self and other and is reflected in the golden rule which states do to
others whatever you would like them to do to you. In short, it can be referred to as the concept of
good for self, good for others which means that one should not only do what is good for oneself,
but always consider what is good for others. The three core concepts in the definition of ethics
can be presented as a triangle as depicted in figure 1.2.1.
Figure 1.2.1: Core concepts in the definition of ethics
Good
Self Other
(Source: Rossouw & Van Vuuren, 2017:5. Business ethics 6th Edition.)
The triangle represents a balance between one’s own interest (“self-interest) or needs and those
of others. In different environments the “self” can include individuals, an organisation or a
professional, such as a CA(SA). The “good” refers to a behaviour that is good, fair and not just
for the self but also for others; hence, the principle good for self, good for others. Everyone has
a different view of what is good, fair and just but it is important that there is a common
understanding in terms of what it entails. The “other” refers to the different stakeholders which
includes shareholders, investors, employees, suppliers and consumers, the local community,
government and so forth.
Ethical values and attitudes can be divided into three spheres (see figure 1.2.2). In many
instances they are aligned and not distinct from one another. For example, a dishonest individual
in his or her personal capacity (personal ethics) might often also be dishonest at work (business
ethics) or in a professional capacity (professional ethics).
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Figure 1.2.2: The different spheres of ethics
Personal Business
ethics ethics
Professional
ethics
Personal ethics refers to a personal value system applied by an individual to decision-making,

conduct and interaction between the self and others1. In other words, it refers to an individual’s
values and beliefs of what is right and wrong and how they interact with others.
Business ethics refers to the ethical principles and values applied by the organisation to
decision-making, conduct and relationship between the organisation, its stakeholders and
society (King IV)1. If business ethics is applied correctly, an organisation should be able to meet
its operational goals without discarding the reputation of the organisation. The organisation is
therefore the moral agent which needs to act with integrity and fairness towards others and
stakeholders. The organisation’s ethical or unethical behaviour is usually measurable during
economic activity which is guided by principles, norms and standards the organisation should
adhere to in order operate in a good and just manner. In terms of an ethical business culture,
reference to “The apples and the barrels” is often made where the barrel refers to organisational
factors and the apples to the individuals in the organisation and whether they are good or bad.
To learn more about unethical behaviour at an organisation, click on the link and watch the
following video: https://youtu.be/F124NIzh3Yg.
Professional ethics refers to the fundamental ethical principles and values applied by a
professional to decision-making conduct and the relationship between the professional, its
stakeholders and society1. It refers to the moral behaviour to the benefit of society. The
principles for professional ethics are generally set out in the various professional codes of conduct
and can be seen as an agreement between the professionals and their clients and provides
credibility to the services that professionals render. To encourage ethical behaviour, it is important
that there is consequence management for unethical behaviour. In the next section you will learn
more about the ethical principles for accountants and auditors as set out in various codes of
conduct.
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Definitions as set out in the SAICA Competency Framework 2021.
Something to think about:
We are all confronted by ethical dilemmas on a daily basis. Sometimes we are made aware of
unethical behaviour in the news, social media; or sometimes we have a choice between ethical
or unethical behaviour in our own personal or work circumstances. The ethical choices we make
today may reflect heavily in our future professional career and it is therefore important that we
build an ethical mindset from the start.
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To assist us to make ethical decisions, we may refer to different ethical philosophies. There
are many and you can read more about them Examples of ethical philosophies include virtue
ethics, utilitarian ethics, deontological ethics, egalitarianism ethics, common approach
to ethics, fairness or justice approach to ethics and stakeholder theory and so forth. To
assist you, we have sourced some videos for you, but you should also do some research on
your own to learn more about ethics. Although we will not require you to list the theory related
to these theories, we may require you to apply the principles to a real-life scenario. You may
access some of the videos by clicking on the following links:
Virtue ethics: https://ethics.org.au/ethics-explainer-virtue-ethics/

Consequentialism: https://ethics.org.au/ethics-explainer-consequentialism/
Consider the following dilemmas you might be confronted with and consider whether it is ethical
or unethical:
1. Do you think it is ethical to google answers and concepts during your online examination
and use it as part of your answer sheet, while you need to declare that the formulated
answers are your own work and that you did not receive assistance from anyone?
2. Do you think it is ethical to use answers for your online examination that you received from
an external party for which you paid for?
3. Is it ethical to accept a huge bank deposit from the National Student Financial Aid Scheme
(NSFAS), much bigger than what you are entitled to in terms of the funding stipulations and
not report the incorrect bank deposit to the Scheme since they have made the mistake and
not you?
4. Owing to the tough economic outlook and increase in prices of food, electricity and fuel, do
you think it is ethical to declare a lower household income on the NSFAS application to
ensure that you receive funding as your family will not be able to pay for your studies with
the household income that is left after all the household expenses have been deducted?
5. Do you think that someone who has cheated on his wife will conduct himself ethically in the
workplace if confronted with opportunities to gain from unethical behaviour?
6. Is it unethical to join an online class for which you obtain Continuing Professional
Development (CPD) points as a trainee accountant, but instead of participating in the class,
do other chores as you do not have enough available time in your busy schedule?
Revise and study
For the ethical principles regulating the auditing and accountancy profession, you should consult
the following study sources:
• The IFAC Code of Ethics for Professional Accountants
• The SAICA CPC for Chartered Accountants
• The IRBA CPC for Registered Auditors
• The IRBA Rules regarding Improper Conduct
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Specifically note the following:
• The SAICA CPC conforms in all material respects with the IFAC Code of Ethics for
Professional Accountants for Parts 1, 2 and 3. You should therefore study from the SAICA
CPC.
• From the SAICA CPC you should study the definitions and Part 1 (Sections 100 – 120);
Part 2 (Sections 200 – 270); Part 3 (Sections 300 – 360); Part 4A (Sections 400 – 800).
• IRBA adopted Parts 1 and Part 3 of the SAICA CPC in the IRBA CPC; and it is therefore
not necessary to refer to it again if you referred to the SAICA CPC.
• The IRBA Rules regarding improper conduct provide the auditor with a list of acts or
omissions which constitute improper conduct. Also refer to the definitions and Sections
2.1 – 2.17.
The Codes and Rules mentioned above are included in the SAICA Student Handbook, Volume
2B or can be downloaded from the internet. You may also refer to Auditing Notes, Chapter
2 for a detailed discussion of the ethical principles included in the different sources.
PLEASE NOTE: We are not referring to the sections of these codes in detail in this lesson, since
these concepts were also dealt with in detail in your second year auditing studies as the sources
mentioned above. You are thus required to have an in-depth knowledge of the ethical
principles set out in the codes mentioned above when starting with your AUE3761 studies; and if
not keep abreast of and update your knowledge so that you can apply all the knowledge you
already obtained to a practical scenario.
As you may be aware, ethics is a hot topic for discussion at this stage. This means that the
ethical principles that should be studied in the above sources become even more important and
you can expect that ethics can be tested in most of your assessments throughout your auditing
studies.
Similarly, as mentioned before, we will provide you with a scenario in which certain information
is provided and from the scenario you should be able to identify, discuss and apply the ethical
principles regulating the auditing and accounting profession, as set out in the different codes
and rules. Once again note that you do not have to mention the section but just mention
that it is in non-compliance with the CPC.
Make sure that you know the fundamental principles setting out the standard behaviour
expected of CA(SA)s and auditors. These fundamental principles include integrity,
objectivity, professional competence and due care, confidentiality and professional
behaviour.
You should also know the different categories of threats to these fundamental principles. The
different kinds of threats include self-interest, self-review, advocacy, familiarity and
intimidation threats.
Whenever you are expected to deal with ethical conduct of a CA(SA), or an auditor make sure
that you are able to do the following:
1. Identify threats related to compliance with the fundamental principles that are present
and threatened in a scenario (in some cases there might be more than one threat
applicable),
2. Evaluate how significant the threat is and if it is not at an acceptable level,
3. Deal with the threat by eliminating or reducing the threat to an acceptable level by
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• eliminating the circumstances, including interests or relationships that are creating the
threats
• applying safeguards, if available and appropriate, to eliminate or reduce threats
• declining or ending the specific professional activity.
1.2.4 QUALITY CONTROL GUIDELINES FOR AUDIT FIRMS AND AUDITS
Revise and study
There are two auditing standards of importance when it comes to the quality control of audits,
namely the International Standard on Quality Management 1 (ISQM 1) (previously known as
International Standard on Quality Control 1 (ISQC 1)) and ISA 220, Quality control for an audit of
financial statements. ISQM 1 gives guidance to audit firms, while ISA 220 gives guidance to the
engagement team.
 Quality management for audit firms
According to ISQM 1 paragraph 5, the requirement of quality control applies to all firms in respect
of audits and reviews of financial statements and assurance or related service engagements other
than audits or reviews.
Study ISQM 1 paragraphs 1-19, 23, 28-35, 53 and 57 and note the following:
• The auditing firm’s objective in establishing and maintaining a system of quality
management (ISQM 1 paragraphs 14-15).
• The definitions (ISQM 1 paragraph 16).
• The components of a system of quality management (ISQM 1 paragraph 6; 23, 28-35).
• The responsibility of evaluating the system of quality management (ISQM 1 paragraph 53).
• Documenting the system of quality management (ISQM 1 paragraph 57).
 Quality management for an audit of financial statements
According to ISA 220 paragraph 9, the engagement partner is ultimately responsible for the
overall quality of each audit engagement the partner is assigned to.
Study ISA 220 paragraphs 1-21; A38-A42 and note the following:
• The auditor’s objective in implementing quality management procedures for engagements
(ISA 220 paragraph 11).
• The definitions (ISA 220 paragraph 12).
• Responsibilities of leadership for quality audits (ISA 220 paragraphs 13-15).
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• The ethical requirements that the engagement partner shall comply with throughout the
audit engagement (ISA 220 paragraphs 16-21).
• Requirements in terms of independence relating to the engagement partner (ISA 220
paragraph 16, A38-A42).
You are required to have a foundational level of competence for the topic, which means that
you should be able to identify and describe the fundamental concepts studied. You are not
required to have technical expertise or detailed knowledge of the topic.
We can therefore provide you with a scenario and you should be able to identify whether or not
an audit firm or an engagement partner adhere to certain quality control guidelines stipulated
in ISQM 1 and ISA 220.
Summary
In this lesson, we referred you to different Acts, Codes and Rules that play a role in the Regulation
of the Auditor. This includes knowledge of the requirements stipulated in the APA, Companies
Act; ethical principles required of accountants and auditors, as included in the different CPCs and
Rules; as well as knowledge of the quality control guidelines that should be adhered to by audit
firms and for audits. It is very important that you understand and can apply your knowledge of this
lesson content to a practical scenario as you may expect this knowledge to be tested and
integrated with other topics throughout your third year and postgraduate auditing studies.
Self-assessment
if you can do the following:
1. Identify, discuss and apply the requirements related to the duties, rights,
responsibilities and liabilities of auditors in terms of the APA.
2. Identify, discuss and apply the requirements related to the duties, rights and
responsibilities of auditors and audit committees in terms of the Companies Act.
3. Identify, discuss and apply the ethical principles regulating the auditing and
accountancy profession by referring to the IFAC Code of Ethics for Professional
Accountants, the SAICA CPC for Chartered Accountants, the IRBA CPC for
Registered Auditors and the IRBA Rules regarding Improper Conduct.
4. Explain the auditing firm’s responsibilities for its system of quality control and
quality control for audits and review of financial statements.
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LESSON 1.3: King IV Report on Corporate Governance in South Africa
LEARNING OUTCOMES
At the end of the lesson, you should be able to the following:

• In terms of the King IV Report on Corporate Governance in South Africa, demonstrate an
understanding of the principles and recommendations of King IV by
- making appropriate recommendations on practical aspects of corporate governance with
specific reference to King IV evaluating the compliance and/or non-compliance with King
IV.
INTRODUCTION
In your second year auditing studies, concepts related to corporate governance, specifically those
related to the King IV Report (hereafter referred to as “King IV” or “The Report”), were explained
to you in detail. The knowledge that you already obtained remains relevant and very important
throughout the rest of your auditing studies. Therefore, make sure that you are up to date
with these concepts and that your memory is refreshed. Don’t worry if you cannot remember all
the detail, we will refer you to the appropriate study resources you should consult to refresh your
memory.
You may refer to King IV, which is included in the SAICA Handbook Volume 2B, or you may
download it from the internet. For additional explanatory information, you may also refer to
Auditing Notes Chapter 4.
KING IV consists of a foreword and seven parts. As part of your studies, you should consult
Part 1 (Glossary of terms) and study Part 2 (Fundamental concepts), Part 3 (King IV application
and disclosure), Part 4 (King IV on a page – will not be examined but provides a summary of all
the principles in King IV), Part 5 (King IV Code on Corporate Governance) and Part 6 (Sector
supplements - only part 6.5). Part 7 (Content Development process and King Committee) will not
be examined, and you do not have to study this.
The following sections provide a high-level guideline of all the concepts you should be familiar
with and study in terms of King IV.
PART 1: GLOSSARY OF TERMS
The glossary of terms can be consulted whenever you need clarification of the terms used in King
IV.
PART 2: FUNDAMENTAL CONCEPTS
Revise and study
For the underpinning philosophies of King IV, refer to Part 2 of the Report. The philosophies are
set out in figure 1.3.1 below, and you should have a thorough understanding of these concepts.
19
Figure 1.3.1: The underpinning philosophies of King IV
The organisation as
Corporate
Integrated thinking an integral part of
citizenship
society
Stakeholder Sustainable
Integrated reporting
inclusivity developement
PART 3: KING IV APPLICATION AND DISCLOSURE
Revise and study
Refer to Part 3 of King IV and note the following:

 The legal status of King IV.
 The meaning of the application regime of King IV, called the “apply or explain” regime.
 Note the governance outcomes of King IV which include ethical culture, good performance,
effective control and legitimacy.
 The meaning of proportionality in terms of King IV.
 The disclosure requirements in terms of King IV.
PART 5: KING IV CODE ON CORPORATE GOVERNANCE
Revise and study
Refer to Part 5 of King IV and note the five parts and the principles contained therein. The
highlights of the five parts are set out in figure 1.3.2, and you should make sure that you have a
thorough understanding of these parts and their principles so that you can apply your knowledge
to a practical scenario.
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Figure 1.3.2: The five Parts of King IV and highlights of their principles
Part 5.1: • Principle 1: The governing body should lead ethically and effectively.
• Principle 2: Govern the ethics of the organisation in a way that
Leadership, ethics and supports the establishemnet of an ethical culture.
• Principle 3: Ensure that the organisation is and is seen to be a
corporate citizenship responsible corporate citizen.
Part 5.2: • Principle 4: Focuses on elements of the value creation process.

• Principle 5: Deals with reporting and disclosure to enable
Strategy, performance and stakeholders to make informed assessments relating to performance
reporting and future prospects.
• Principle 6: The board should serve as the custodian of good

governance.
• Principle 7: Provides guidance on the board composition.
Part 5.3: • Principle 8: Deals with effective board structures and delegation of
authority.
Governing structures and • Principle 9: Focuses on the importance of board performance
delegation evaluation.
• Principle 10: Sets out the appointment, role, delegation and acess to
professional services of the board.
• Principle 11: Recommends the governing of risk to achieve the

company's strategic objectives.
• Principle 12: Focuses on governing of information technology to
Part 5.4: achieve the company's strategic objectives.
• Principles 13: Deals with practices related to compliance to ensure
Governance functional that the company is ethical and a good corporate citizen.
areas • Principle 14: Recommends practices to ensure fair, responsible and
transparent remuneration policies.
• Principle 15: Focuses on practices that the board should follow to
ensure an effective control environment for the integrity of information.
• Principle 16: Deals with practices related to adopting a stakeholder

Part 5.5: inclusive approach.
• Principle 17: Suggests practices related to promoting good
Stakeholder relationships governance to ensure responsible investments.
Recommended practices for each of the principles provided in figure 1.3.2 can be studied directly
from King IV. As a guideline you may also refer to the summary of the principles and
recommended practices in Appendix 1 in Chapter 4 of Auditing Notes (Refer to pages 4/54 to
4/56).
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PART 6: SECTOR SUPPLEMENTS
King IV contains five sector supplements which provide guidance on how King IV should be
interpreted an applied in different sectors and organisational types. For the purposes of your
studies, you should only have a basic level of knowledge and understanding of Part 6.5 which
deals with small and medium enterprises.
PART 7: CONTENT DEVELOPMENT AND KING COMMITTEE
This part is not examinable.
How can King IV be assessed in a test or examination?
Take note that King IV is often integrated with other topics related to statutory, regulatory and
ethical matters and most of the time there might be a direct link between them. Note that you
do not have to mention the principle number but just mention that it is in non-compliance
with King IV.
When approaching a question, you firstly need to make sure whether or not King IV is
applicable. Let the scenario guide you; and if it is a listed company, you should know that King
IV applies since, according to the JSE’s listing requirements, all listed companies adhere to
King IV. All other types of companies are not required by law to comply with King IV, but it is
often seen as good practice for a company to comply. Therefore, if a scenario indicates that
the company adheres to “good corporate governance” you may assume that the company
complies with King IV.
Note that King IV is often integrated with other topics You should also consider compliance
with other Acts or Codes such as the Companies Act, the APA or the SAICA CPC and so
forth. Therefore, make sure that you read the required section very carefully so that you are
sure what requirements you should provide in your answer. Often, you need to make sure that
you also meet the requirements in other Acts and Codes.
When answering a question related to King IV, make sure if you should limit your answer
to only include issues of non-compliance with King IV and then only mention the areas the
company did not comply with.
If you have determined that the company in the scenario should comply with King IV, be on the
lookout for information, such as the composition of the governing body, (which is your board of
directors) and its sub-committees. The information will be given for a reason, and you should
then evaluate the composition based on recommended practices in terms of King IV.
We can also ask you to evaluate whether there is a lack of good corporate governance
against the philosophies of good corporate governance, and you should then be able to
identify if the governing body is not leading in an ethical and effective manner. For example,
consider independence, knowledge, skills, experience, diversity and so forth when considering
the governing structures and delegation.
As with other topics, the technique of answering questions where you need to apply your
knowledge to a specific scenario comes with practise and you therefore need to work through
all the activities and questions available to you. Very importantly, do not make assumptions,
only focus on the information provided in a question.
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Summary
In this lesson, we referred you to knowledge already obtained in your second year auditing studies
related to The King IV Report on Corporate Governance in South Africa which you had to revise
in this lesson. It is very important that you understand and that you can apply your knowledge of
this lesson content to a practical scenario, as you may expect this knowledge to be tested and
integrated with other topics throughout your third year and postgraduate auditing studies.
Self-assessment
if you can do the following:
1. In terms of the King IV Report on Corporate Governance in South Africa, demonstrate an

understanding of the principles and recommendations of King IV by
- making appropriate recommendations on practical aspects of corporate governance
with specific reference to King IV
- evaluating the compliance and/or non-compliance with King IV.
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LESSON 2: THE PRELIMINARY AUDIT ENGAGEMENT
In this lesson, the first stage of the audit process is explained, namely the preliminary audit
engagement stage, as illustrated in figure 2.1.
FIGURE 2.1: The first stage of the audit process
This lesson is presented in the following unit:
Lesson Title
2.1 The preliminary audit engagement stage
In lesson 2.1, we explain the aspects that the auditor should consider before deciding whether to
accept a new client, or whether or not a relationship with an existing client should be continued.
Several legal and ethical considerations related to this decision are also explained.
Learning outcomes
The learning outcomes for this lesson are set out in the separate lesson.
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LESSON 2.1: The preliminary audit engagement stage
LEARNING OUTCOMES

• Evaluate whether or not a prospective audit client should be accepted.
• Evaluate whether or not a long-term relationship with an existing audit client should
be continued.
• Evaluate whether or not the audit firm can perform an audit in terms of the
International Standards on Auditing.
• Evaluate whether or not the audit engagement agreement is properly drafted in an
audit engagement letter.
Introduction
Imagine for a moment that you owned a spaza shop. To make sure your business survives in the
long term, you would have to plan for a variety of factors. Firstly, you would plan the layout of your
shop to prevent customers from stealing cash and/or stock. Secondly, you would make sure that
your affairs, such as business registration or taxation registration with the South African Revenue
Service, are in order with the authorities, to prevent them from closing your business down.
Thirdly, you would plan to have the correct stock to offer to your customers to convince them to
support you in the long term.
Similarly, an audit firm should ensure that it safeguards its own business to stay sustainable in
the long term. Therefore, audit firms perform procedures to ensure that they only accept clients
that will not cause harm to the firm, and that the firm performs quality work.
The preliminary audit engagement stage is a very important stage of an audit. During this stage,
an audit firm should consider and perform the activities depicted in figure 2.1.
Figure 2.1: The activities to consider in the preliminary audit engagement stage
1. Establish whether 2. Investigate 3. Determine skills,

the pre-conditions for prospective or competence and
an audit are present existing clients (see resources (see section
(see section 2.1.1) section 2.1.2) 2.1.3)
4. Consider statutory
5.Establish the terms
and ethical
of engagement (see
requirements (see
section 2.1.5)
section 2.1.4)
25
The activities set out in figure 2.1 can briefly be described as follows:
1. Establish whether the pre-conditions for an audit are present to determine whether a
new client should be accepted or whether the firm should continue its relationship with an
existing client.
2. Investigate prospective or existing clients to determine whether the client should be

accepted, or whether the firm should continue its relationship with an existing client.
3. Determine skills, competence and resources to establish whether the audit firm can
perform the audit in compliance with standards.
4. Consider ethical and statutory requirements to establish if there are any reasons not to
perform the audit.
5. Establish the terms of the engagement and formalise the agreement in an audit
engagement letter.
These activities will be dealt with in more detail later in this lesson. Keep in mind that these
activities are not performed as separate steps but are usually considered altogether. Before
dealing with each of them separately, study the references below.
Study
• The relevant section dealing with “Preliminary engagement activities” in chapter 6 of Auditing
Notes
• International Standard on Quality Control (ISQM 1) paragraphs 20–22, 29–30, 32; A67–A71
• ISA 210, Agreeing the terms of engagements, all paragraphs and Appendix 1
• ISA 220, Quality control for an audit of financial statements, paragraphs 16–25; A38–A47;
A49–A57; A59–A72
• ISA 300, Planning an audit of financial statements, paragraphs 6; A5–A7
• SAICA handbook: International Framework for Assurance Engagements (Frame)
paragraphs 17–19
Let us discuss what you studied in the study sources above so that you have a better
understanding of the activities that may take place during the preliminary audit engagement stage.
2.1 ACTIVITIES IN THE PRELIMINARY AUDIT ENGAGEMENT STAGE
It is of utmost importance that the auditor obtains adequate knowledge and information of the
client’s business before accepting the engagement by performing preliminary audit engagement
activities. Some events or circumstances identified when obtaining the necessary knowledge and
information might affect the auditor’s ability to plan and perform the audit. To obtain this
knowledge and information when deciding whether or not to accept or continue with an audit client
relationship, the auditor may turn to the following sources (Refer to ISQM 1 paragraph A69.):
• Discussions with those charged with governance and review of available internal
documentation, such as management reports.
• Communication with existing or previous providers of professional accountancy services
or auditors.
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• Communication with third parties such as bankers, legal counsel or industry peers.
• Inquiry from the auditor’s firm personnel, for example to establish independence threats
etc.
• Background searches for example on the internet or searches in financial magazines.
The knowledge and information obtained when consulting the sources above should be used
when certain aspects are considered when dealing with each of the activities in the preliminary
audit engagement stage, as set out in figure 2.1. Each of the activities are discussed under the
following headings.
2.1.1 ESTABLISHING THE PRE-CONDITIONS OF AN AUDIT
Before accepting or continuing a relationship with an audit client it is important to consider the
preconditions for an audit, as stated in ISA 210 paragraphs 6–8; A2–A21. A summary of these
considerations includes the following:
• The client’s use of an acceptable financial reporting framework when preparing the
financial statements.
• That management understands their responsibility which includes
o preparing financial statements according to the applicable financial reporting
framework (this includes International Financial Reporting Standards (IFRS) or
IFRS for SMEs in the private sector and Generally Recognised Accounting Practice
(GRAP) in the public sector)
o implementing and monitoring internal controls to enable the preparation of financial
statements that are free from material misstatement due to fraud or error,
o providing the auditor with access to all information and persons within the entity to
enable the auditor to obtain the necessary audit evidence.
• Management may not impose a limitation on the scope on the auditor, which will influence
the auditor’s opinion on the financial statements.
If any of the preconditions of the audit are not present, the auditor should discuss the matter with
management and should not accept the audit engagement, unless required by law or regulation
to do so.
2.1.2 INVESTIGATE PROSPECTIVE OR EXISTING CLIENTS
During this activity in the preliminary audit engagement stage, the auditor should also decide
whether or not he or she wants to perform the audit. For example, consider the industry to be
associated with the owners of the entity to be associated with or whether there was any indication
when obtaining knowledge or information of the entity that taking on the audit would not be a good
business decision. When making this decision the auditor should specifically consider the
integrity of the client in terms of ISQM 1, which includes (refer to ISQM 1 paragraph A68):
• The identity and business reputation of the client’s principal owners, key management and
those charged with governance.
• The nature of the client’s operations including the complexity of its ownership and
management structure.
• Management of the client’s attitude towards aggressive interpretation of accounting
policies and the internal control environment.
• The client’s aggressive concerns to maintain low audit fees.
• Inappropriate limitation on the scope of work.
• The client’s involvement in money laundering or criminal activities.
• Reasons for proposed appointment of the firm and not renewing the engagement with the
previous firm.
27
• The identity and business reputation of related parties.
If the auditor, feels comfortable to accept the engagement when taking all the considerations
during this activity into account, the auditor should consider if the firm will be able to perform the
audit by determining whether the firm has the skills, competence and resources to complete the
audit.
2.1.3 DETERMINE SKILLS, COMPETENCE AND RESOURCES
When accepting a new audit client or when deciding to continue the relationship with an existing
audit client, the audit firm should consider whether or not they have the necessary competence,
capabilities and resources to conduct the audit. Resources may include human, technological and
intellectual resources (refer to ISQM 1 and ISA 220, as indicated under the study section of this
lesson). Among the aspects that should be considered is the following:
• Do the audit firm’s personnel have knowledge of the relevant industry or subject matters;
and if not, will it be possible to obtain resources externally from a firm’s network for
example?
• Do the audit firm’s personnel have experience, skills and knowledge of the relevant
regulatory or reporting requirements?
• Does the audit firm have sufficient personnel with the necessary competence and
capabilities?
• Does the audit firm have access to experts, if needed?
• Does the audit firm have individuals available to perform the engagement’s quality control
review, if applicable?
• Does the audit firm have sufficient time to complete the engagement in the given
timeframe?
• Does the audit firm have appropriate IT systems in place which is compatible with the
clients’ systems?
• Does the audit firm have the necessary intellectual resources in place to be able to conduct
the audit, for example industry specific guides, subscription to websites etc.
If the auditor established that the firm has the necessary skills, competence and resources to
perform the audit by considering the questions above, the auditor should consider whether or not
all statutory and ethical requirements are adhered to in the next activity of the preliminary audit
engagement stage.
2.1.4 CONSIDER STATUTORY AND ETHICAL REQUIREMENTS
The auditor should consider the statutory and ethical requirements and make sure that all the
requirements have been complied with before accepting the audit client.
Statutory requirements
In terms of statutory requirements, the auditor should make sure that he or she complies with the
Companies Act and the Auditing Profession Act (Refer to lesson 1.2.). Examples of requirements
in these Acts include registration requirements for individual auditors and auditing firms, whether
or not the previous auditor has been removed and a new auditor has been appointed, rotation of
auditors and so forth.
Ethical requirements
As per the SAICA CPC AND IRBA CPC, it is important that the auditor for new audit engagements,
communicate and establish with the previous auditor whether or not there were any ethical
reasons why the new auditor should not accept the engagement.
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In terms of ethical requirements, the auditor should also consider if there are any threats to the
five fundamental principles, which include integrity, objectivity, professional competence and due
care, confidentiality and professional behaviour, and if so, can the threats be safeguarded. If the
threats cannot be safeguarded and reduced to an acceptable level, the auditor should not accept
the audit engagement (Refer to lesson 1.2.).
ISA 300 also requires the auditor to evaluate independence as part of ethical requirements as
required by ISA 220. If any threat to independence is identified, the auditor should take action to
eliminate the threat or reduce it to an acceptable level by instituting safeguards. If this is not
possible, the auditor should consider withdrawing from the audit client or declining the
engagement.
If the auditor is satisfied that all statutory and ethical requirements are met, the auditor should
formalise the engagement by establishing the terms of the engagement and drafting the
engagement letter in the next step of the preliminary audit engagement stage.
2.1.4 ESTABLISH THE TERMS OF THE ENGAGEMENT
Once the auditor has decided to accept the audit engagement of a new audit client, the terms
should be recorded in the audit engagement letter (also referred to as the contract between the
auditor and audit client) which refers to the following aspects (Refer to ISA 210 paragraphs 9–12;
A13; A22–A28.):
• The objective and scope of the audit of the financial statements.
• The responsibilities of the auditor.
• The responsibilities of management.
• The financial reporting framework used when preparing the financial statements.
• Reference to the expected form and content of reports that the auditor will issue, and a
statement indicating that this might deviate from the expectation in certain cases.
• Reference to specific laws, regulations, ISAs and ethical or other pronouncements of
professional bodies that apply to the audit or auditor.
• Reference to the fact the audit has inherent limitations and therefore some material
misstatements may not be detected, even though the audit is planned properly and
performed in accordance with ISAs. The audit therefore does not provide absolute
assurance but reasonable assurance that the financial statements are free from material
misstatements.
• That the auditor from time to time may require management to provide them with written
representations.
• The expectation that management should provide the auditor with access to all information
and persons.
• The agreement that management should provide the auditor with information of any
subsequent events that took place from the date of the auditor’s report to the date the
financial statements are issued.
• The basis on which the audit fees are computed and the billing arrangements.
• A request that management acknowledge the receipt of the audit engagement letter and
agree to the terms thereto by signing it.
• Any arrangements concerning the involvement of third-party auditors, experts, internal
auditors, the previous auditors and so forth.
• Reference to the auditor’s responsibilities when identifying or suspecting non-compliance
with laws and regulations to appropriate authorities outside the entity.
• Reference to the restriction of the auditor’s liability if such a possibility exists.
• Any reference to further agreements or obligations between the auditor and the client.
29
(Please refer to ISA 210 Appendix 1 for an example of an audit engagement letter.)
If the auditor decides to continue its relationship with an existing client, the auditor should assess
whether the audit engagement letter should be revised, or whether the client should be reminded
of the terms. Examples where this might be necessary include where there was a change in senior
management or ownership of the audit client or a change in legal or regulatory requirements.
Refer to ISA 210 paragraph A30 for more examples.
Activity 2.1.1
Ms Sparkle has approached you to accept Atomic Limited, a company manufacturing radioactive
products, as a client. She informs you that the company has not been registered in terms of the
stipulations of the law regulating dangerous and environmentally threatening substances.
REQUIRED
1.1 Based on the scenario, describe one aspect according to ISQM 1 that you will consider
determining whether you should accept Atomic Limited as a client.
1.2 Now, based on the scenario, describe one aspect according to ISA 220 that you will
consider determining whether you should accept Atomic Limited as a client.
Feedback on activity 2.1.1
ISQM 1 deals with quality control for audit firms, whereas ISA 220 deals with quality control
at engagement level. Although these standards deal with different levels of quality control, some
requirements are applicable to both levels and appear in both standards.
1.1 Because Ms Sparkle did not register Atomic Limited, as required by legislation, the
integrity of the client is questionable (ISQM 1 paragraph A68).
1.2 The same answer as in 1.1 is found in paragraph A39 of ISA 220.
NOTE: To pass this module, it is important to study all the references to become familiar with the
Auditing Standards, the Standards on Quality Control and the Framework. Do not wait until next
year, because you will not have the time to go back to all this work in your postgraduate studies.
When studying the references in the Standards and the Framework, do not attempt to learn all
the theory but rather make summaries to ensure that you understand the most important
concepts. Remember that we will not request you to answer any theory questions, but that you
should be able to apply your theoretical knowledge to different practical scenarios.
Also note that when studying and making summaries, use the opportunity to take note of the
same content that is repeated in the various study references. This will prevent you from studying
similar content repeatedly when you revise the lesson later.
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Activity 2.1.2
Your audit firm has performed the audit of Jingle Limited for the past eight years. During a meeting
with the chief executive officer (CEO), he told you that Jingle Limited has appointed a new chief
financial officer (CFO), Ms Mamabolo.
You learn later that Ms Mamabolo’s sister is married to the only senior audit manager in your audit
firm who is qualified to perform the audit.
REQUIRED
Explain, according to ISA 220, whether your firm should continue with the audit of this existing
client. You may assume that the audit firm will not be able to acquire the services of another
suitably qualified audit manager.
According to ISA 220 paragraphs 16–21, your firm should not continue with the audit of this
existing client, because the relationship between the CEO and the audit manager poses a threat
to the audit firm’s independence.
Activity 2.1.3
At this stage, you should have a basic idea of the concepts that should be considered in the
preliminary audit engagement stage. To refresh your memory, log onto myUnisa to watch an
exciting video that we have prepared for you.
You can also assess yourself on the basic concepts of the preliminary audit engagement stage
by answering a few multiple-choice questions. These questions will form part of a quiz which is
available on myUnisa after you completed your studies for lessons 1 to 3 of this module.
Activity 2.1.4
BACKGROUND
Una Auditors Inc decided to accept Petersons (Pty) Ltd as a new audit client. During their audit
they will have to use experts to assist them in determining the appropriateness of certain
accounting estimates. The following audit engagement letter has been drafted:
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Letterhead (Una Auditors Inc)
Mr Zippo Lighter
Financial Director of Petersons (Pty) Ltd
Petersons (Pty) Ltd
PO Box 4477
MODIMOLLE
0510
Dear Sir
We are pleased to announce our acceptance of Petersons (Pty) Ltd as a client and we hope to
add value to your business. This letter, once signed by you and returned to us, serves as a formal
letter of appointment.
Our appointment is based on the following terms and conditions:
1. According to Petersons (Pty) Ltd’s memorandum of incorporation (MOI), an audit must be

performed.
2. We will conduct the audit for the year ended 31 August.
3. On 15 October, we will sign off the financial statements, comprising the statement of
financial position, statement of comprehensive income, statement of changes in equity,
statement of cash flows, and a summary of significant accounting policies and explanatory
notes.
4. Our role is to certify the fair presentation of the financial statements presented to us by your
chief financial officer.
5. We will perform the audit in accordance with the International Standards on Auditing (ISA)
and we will comply with all the relevant ethical requirements. We will plan and perform the
audit to obtain reasonable assurance that the financial statements are free from material
misstatements. The audit procedures that we will select will depend on our judgement and
include the assessment of the risks of material misstatements.
6. You should provide us with the draft financial statements prepared in accordance with the
International Financial Reporting Standards by 15 September and allow us to access all
financial information and persons within the entity, which we deem necessary to perform our
duties.
7. You are also responsible for the internal controls necessary to enable the preparation of
financial statements that are free from material misstatements.
8. Our fees will be based on the previous year’s invoice for a similar audit, adjusted for inflation.
9. The form and content of our report will depend on our audit findings.
Kindly sign the letter and return it to us.
Kind regards
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Mike Blimey
Senior Audit Manager
Signed ........................
Zippo Lighter
Financial Director of Petersons (Pty) Ltd
REQUIRED
List the weaknesses of the audit engagement letter according to ISA 210.
Weaknesses in the proposed audit engagement letter
Reference: ISA 210
1. The letter is not dated. (1)
2. The letter is not addressed to the appropriate representative of management, that is,
the board of directors or the audit committee. (1)
3. It does not indicate the year to be audited. (1)
4. This is the first audit and imposing a deadline by promising sign-off of the annual financial
statements on 15 October is inappropriate. (1)
5. Auditors do not “certify”; they give an opinion on fair presentation. (1)
6. It is not mentioned that an audit includes evaluating the appropriateness of accounting

policies, the reasonableness of accounting estimates and overall presentation of the
financial statements. (3)
7. The letter does not alert the client that the unavoidable risk still exists that some material
misstatements might not be detected, even though the audit is properly planned and
performed, because of the inherent limitations of an audit coupled with the inherent
limitations of internal control. (3)
8. There is no indication that written representations of management will be requested. (1)
9. No reference is made to using an expert should this be appropriate. (1)
10. There is no indication that management should inform the auditor of any subsequent
events.
(1)
11. There is no indication that management should provide the auditors with access to all
information and persons necessary to perform the audit. (1)
33
12. Basing the fees on a similar audit of a previous year, specifically in the instance of a first
audit, is not an appropriate method of fee charging. Fees should be negotiated with the audit
committee based on time, skill and experience. (2)
13. The explanation of why the letter must be signed and returned does not refer to the
acknowledgement of the terms of the engagement. (1)
14. The letter should be signed by the designated auditor and not the senior audit manager.
(1)
15. The designated auditor is not identified. (1)
Additional comments on the activity
In the activity we presented you with a letter.
Do you know the difference between a business letter, memorandum and a business
report?
In an assessment, we can ask you to prepare your answer in any of the formats mentioned
above where you can earn marks for your communication skills.
You can learn more about these documentation styles by referring to the short videos at the
following links:
Business letter:
https://www.youtube.com/watch?v=7xUTguLaaXI
Memorandum:
https://www.youtube.com/watch?v=eHZdnldGuls
Writing a powerful business report:

https://www.youtube.com/watch?v=Sq2SDdz1i8U
Refer to section 4 of this tutorial letter and attempt question 7.
Summary
In this lesson, we discussed and explained considerations and procedures pertaining to the
preliminary audit engagement stage.
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Self-assessment
Having worked through the lesson and the references to the prescribed study material,
determine if you are able to do the following:
1. Evaluate whether or not a prospective audit client should be accepted.

2. Evaluate whether or not a long-term relationship with an existing audit client should
be continued.
3. Evaluate whether or not the audit firm can perform an audit according to the
International Standards on Auditing.
4. Evaluate whether or not the audit engagement agreement is properly drafted in an
audit engagement letter.
35
LESSON 3: PLANNING AN AUDIT
Lesson 1 identified that the audit process consists of four stages. In this lesson, the second stage
of the audit process is discussed.
FIGURE 3.1: The second stage of the audit process
In the previous lesson, the first stage of the audit process, the preliminary audit engagement
stage, was explained. The aim of this lesson is to explain the second stage of the audit process
- planning an audit.
This lesson is divided into the following units:
Lesson Title
3.1 Planning an audit of financial statements
3.2 Understanding the entity and its environment
3.3 Identifying an assessment risk
3.4 The auditor’s responsibility relating to fraud
3.5 Consideration of laws and regulations in a financial statements audit
3.6 Materiality
3.7 The auditor’s response to risk
3.8 The overall audit strategy
3.9 The audit plan
3.10 Audit documentation
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Planning an audit of financial statements can be divided into different phases. In this lesson, the
first unit provides a general overview of the phases of planning an audit (lesson 3.1). The different
aspects of the planning stage of an audit are then discussed (lessons 3.2 to 3.9) followed by an
explanation of the general requirements of audit documentation that should be borne in mind
throughout all the stages of the audit process (lesson 3.10).
Learning outcomes
The learning outcomes for each of the lessons are set out in the separate lessons.
37
LESSON 3.1: Planning an audit of financial statements
LEARNING OUTCOMES
• Describe the role and timing of audit planning.

• Explain the auditor’s objective in planning an audit.
• Discuss who is involved in the planning of an audit.
• Identify the phases in the planning stage of an audit.
Introduction
In this lesson, we give a general overview of planning an audit of financial statements.
How important is planning in your everyday life? Think about a few examples and maybe discuss
some of your plans for your studies and the progress you have made thus far with your fellow
students. Also, discuss why you think it is important to plan an audit of financial statements. You
may refer to the various Forum discussions in the lessons to interact with your fellow students on
matters such as these.
In the same way that important events in your life must be planned, an audit must be planned.
You cannot just walk into an audit client’s offices and demand all their information. As the auditor,
you need to plan the audit to ensure that you request the correct and relevant information and
perform the applicable audit procedures that will support your audit opinion.
ISA 300, Planning an audit of financial statements, requires the auditor to plan an audit of financial
statements (ISA 300 paragraph 1).
Study
ISA 300, Planning an audit of financial statements, paragraphs 2, 4, 5, 11, A1-A4, A14 and the
relevant section dealing with planning in chapter 6 of Auditing Notes.
Note the following in the above study sources:
• The role and timing of planning (ISA 300 paragraphs 2 and A1-A3)
• The auditor’s objective in planning an audit (ISA 300 paragraph 4)
• Members involved in planning an audit (ISA 300 paragraphs 5 and A4)
• The nature, timing and extent of the direction and supervision of the audit team and the
review of their work should also be planned (ISA 300 paragraphs 11 and A16). (Note that
ISA 220 contains further guidance on the direction, supervision and review of audit work.)
Planning should be seen as a continuous process that starts at the beginning of an audit
engagement and ends on the completion of the current audit engagement. It is continuous in the
sense that it might sometimes be necessary to modify the planned audit due to unforeseen
circumstances.
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The planning stage of an audit has different phases (figure 3.1.1) which do not necessary flow
from one to another as the auditor should sometimes refer back to an earlier planning phase. This
should be considered by the auditor throughout the planning of an audit.
FIGURE 3.1.1: The phases of the planning stage of an audit
Understanding the entity and its

environment
(lesson 3.2)
Identification and assessment of

risk
(lesson 3.3)
Considering the auditor's

responsibilities to fraud
(lesson 3.4)
Planning an audit
Consideration of laws and

regulations in an audit
(lesson 3.5) Audit documentation
(lesson 3.10)
Determine materiality
(lesson 3.6)
The auditor's responses to risk

(lesson 3.7)
Developing the overall audit

strategy
(lesson 3.8)
Developing the audit plan

(lesson 3.9)
Note: Figure 3.1.1 shows the phases of the planning stage of an audit. The different phases
should not be seen as “stand-alone” units, as they are all interrelated. For example, when
referring to materiality, it is important that the auditor considers it when he or she performs his
or her risk assessment procedures and formulates responses in the audit plan. It is also
important that the auditor considers materiality throughout the audit and make changes, if
necessary.
39
Activity 3.1.1
Answer the following questions:
a) Describe the role and timing of the planning stage of an audit.

b) Describe the auditor’s objective in planning an audit.
c) Who is involved in the planning of an audit?
a) Refer to ISA 300 paragraphs 2 and A1-A3.

b) Refer to ISA 300 paragraphs 4.
c) Refer to ISA 300 paragraphs 5 and A4.
Summary
This lesson provided a general overview of the planning of an audit of financial statements.
Planning an audit is essential for the auditor to conduct the audit effectively.
In this lesson, we established that the planning stage of the audit process consists of different
phases. These phases will be explained in the lessons that follow.
Self-assessment
After working through the lesson and the references to the prescribed study material, determine
if you can answer the following questions:
1. Describe the role and timing of audit planning.

2. Explain the auditor’s objective in planning an audit.
3. Discuss who is involved in planning an audit.
4. Identify the phases in the planning stage of an audit.
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LESSON 3.2: Understanding the entity and its environment
LEARNING OUTCOME
• Describe, in relation to an entity, the principles that an auditor should come to

understand during the planning stage of the audit.
Introduction
We have already established that ISA 300, Planning an audit of financial statements, requires the
auditor to plan an audit of financial statements (Refer to lesson 3.1.). We also identified that the
planning stage consists of different phases.
The aim of this lesson is to explain the auditing principles related to the first phase of the planning
stage of an audit, namely understanding the entity and its environment during the planning
stage of an audit.
Reflect
Think about reasons why it is important for an auditor to obtain an understanding of the accounting
and internal control systems as part of the audit process.
Feedback on reflection
You will remember that the ultimate objective of an audit of financial statements is to enable the
auditor to express an opinion on whether the financial statements fairly present, in all material
respects, the financial position of the entity at a specific date, as well as the results of its
operations and cash flow information for the period ended on a specific date, in accordance with
an identified financial reporting framework and/or statutory requirements. This opinion is
expressed on concluding the audit.
To express this opinion, the auditor performs certain procedures and activities aimed at obtaining
evidence relating to the financial statement assertions on which the financial information is based.
(In your second-year auditing studies you were introduced to financial statement assertions; and
we will often refer to them in the upcoming lessons.)
When auditing the financial statements, the auditor’s sole concern is with the accounting and
internal control systems relevant to the financial statement assertions.
When studying the accounting systems and the internal control systems, an auditor gains
knowledge of the design and operations of the systems.
41
Knowledge and understanding of the accounting and internal control systems applicable to all the
classes of transactions and account balances of an undertaking will assist the auditor to:
• Evaluate the adequacy and suitability of the systems as a basis for compiling reliable
financial information, in other words, assess the systems as a basis for confidence in
controls.
• Understand the risk of material misstatement (a term that is explained in lesson 3.3) and
design audit procedures accordingly.
• Formulate the most suitable audit approach, based on the suitability of the accounting and
internal control systems, in other words, decide on the nature, timing and extent of the tests
of internal controls and substantive procedures.
• Plan the audit efficiently
• Ultimately express an opinion on the fair presentation of the financial statements.
During the planning stage of the audit, the auditor often turns to different sources such as -the
four Ps: People ( management, internal auditors, lawyers, etc); Papers (for example previous
financial statements, minutes of meetings, press releases by the entity, etc); Premises (
warehouses or offices from where business operations are conducted, etc) and Analytical
Procedures ( year-to-year or month-to-month key ratio comparisons, etc) to -obtain an
understanding of the entity and its environment, the applicable financial reporting framework and
the entity’s system of internal control. Without this understanding, the auditor may find it difficult
to identify and assess risks of material misstatement (dealt with in detail in lesson 3.3) and will
therefore not be able to formulate the appropriate responses to deal with these risks. The auditor
will also not be able to set the appropriate levels of materiality (dealt with in detail in lesson 3.6)
and assign the necessary resources to perform the audit.
In the first part of this lesson, we will take a closer look at understanding the entity and its
environment and the applicable financial reporting framework (section 3.2.1) before looking at
understanding the components of an entity’s system of internal control (section 3.2.2).
3.2.1 UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT AND THE APPLICABLE
FINANCIAL REPORTING FRAMEWORK
Study
1. ISA 315 (Revised 2019), Identifying and assessing risks of material misstatement,
paragraphs 19–20 and A48–A89.
2. Relevant section dealing with “Understanding the entity and its environment”, in chapter 7
of Auditing Notes.
• The specific aspects the auditor should obtain an understanding of, as set out in paragraph
19. For a detailed discussion and some examples of what each of the aspects include or
entails, refer to the examples in the application and other explanatory material set out in
paragraphs A56-A89.
• The process of understanding an entity and its environment and its financial reporting
framework is dynamic and iterative (an ongoing process); therefore, the auditor’s
expectation may change as new information is obtained throughout the audit (paragraph
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A48). If the auditor’s initial expectation changed, he or she might also find it necessary to
change his or her planning and the audit responses. The process of understanding will also
assist the auditor in identifying which classes of transactions, account balances and
disclosures are expected to be significant and should be a focus point throughout the
audit (paragraph A49).
• The reasons why it is important to understand the entity, its environment and applicable
financial reporting framework (paragraphs A50-A51).
• The nature and extent of the required understanding is a matter of the auditor’s professional
judgment and depends on the scalability of an entity (size and complexity) which differs
from each other (paragraphs A52-A55).
• The auditor also has to identify and consider the laws and regulations that apply to the
audit client and how it may affect their financial statements.
Activity 3.2.1
Give examples of the aspects that should be considered when obtaining an understanding of an
entity’s organisational structure and ownership.
Refer to ISA 315 (Revised 2019) paragraph A56. Examples of aspects to consider include:
• Does the entity’s structure include subsidiaries, divisions, joint ventures or components in
multiple locations?
• Who are the owners of the entity, and do related party relationships exist between them
and other people or entities?
• Are the owners also the managers of the entity?
• What does the entity’s IT environment look like? Is it complex? Is it outsourced to an
external service provider and so forth?
Expand on Activity 3.2.1 - With reference to the other aspects, the auditor should obtain an
understanding of in ISA 315 (Revised 2019) paragraph 19, see if you can also list examples of
what the auditor should consider for each of the other aspects.
3.2.2 UNDERSTANDING THE COMPONENTS OF THE ENTITY’S SYSTEM OF INTERNAL

CONTROL
Study
1. ISA 315 (Revised 2019), Identifying and assessing risks of material misstatement,
paragraphs 21–27; A48–A89 and Appendix 3.
2. Relevant section dealing with “Internal control”, in chapter 5 of Auditing Notes.
43
• An entity’s system of internal control consists of five components, as set out in figure
3.1.
FIGURE 3.1: The five components of internal control
The entity's process to

The control The entity's risk
monitor the system of
environment assessment process
internal control
(para 21) (paras 22 and 23)
(para 24)
The information system

Control activities
and communication
(para 26)
(para 25)
ISA 315 (Revised 2019) provides guidance to the auditor to gain an understanding of each of the
components of internal control. Refer to the referenced paragraphs in figure 3.1 for those
considerations and summarise the most important aspects for each of them. For a detailed
discussion and some examples of what each of the control components include or entails, refer
to the examples in the application and other explanatory material of ISA 315 (Revised 2019).
•
• The limitations of internal controls.
• The auditor should determine whether control deficiencies have been identified for each
of the components of the entity’s system of internal control, and if any of them are significant
as per ISA 265 paragraphs A6-A7 (this is dealt with in more detail in lesson 4.2).
Activity 3.2.2
Identify the elements of a good control environment.
Refer to ISA 315 (Revised 2019) paragraphs 21; A102-A103 and Appendix 3 for the elements of
a good control environment which include:
• Management performs their responsibilities with integrity and adhere to ethical values.
• Independence is maintained if those charged with governance are separate from
management regarding the oversight of the entity’s system of internal control.
• The entity’s assignment of authority and responsibility to achieve its objectives.
• The entity’s commitment to competence.
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• The entity’s policies on accountability of responsibilities in terms of the objectives of the

system of internal control.
Expand on activity 3.2.2 -See if you can also identify the elements for each of the other
components of internal control.
Note: We do not require you to memorise these theoretical concepts and will never require you
to write it down. in an assessment. It is, however, important for you to understand these
elements and apply your knowledge to a practical example to identify weaknesses and suggest
improvements. Refer to activity 3.2.3 for a practical example.
Activity 3.2.3
You have obtained an understanding of an entity’s internal control and have made the following
observation:
A creditor’s clerk, who has no formal training and who was previously employed as a sales
representative, does not sign off the creditor’s reconciliation before submitting it for review to the
financial manager. Payment is then authorised by the financial manager prior to it being reviewed
by him. The organisation has no formal procedures in place for the creditor’s function. As a trainee
auditor, you know that management is responsible for running all aspects of the business, and to
this end, they must put policies and procedures in place to achieve the orderly and efficient
operation of the business. It thus follows that if the client has an effective accounting system and
internal controls then the information produced by the system will be valid, accurate, complete
and timeously produced.
REQUIRED
Describe four control weaknesses in the above scenario and indicate what control could be put
in place to overcome each of these weaknesses.
(Source: AUE2601)
Weaknesses in internal control Suggested control

1. The creditor’s clerk has no formal training
1. Management must ensure that the staff
and was previously employed as a sales member is adequately trained for the position
representative. and should only employ people who have the
necessary experience (Refer to the control
environment component of internal control.).
2. There is no proof that the creditor’s 2. The creditor’s clerk needs to be made aware
reconciliation has been performed and of the interrelation between his or her work and
completed correctly. that of others; and should realise how
important it is to reconcile properly before
handing over to the financial manager for
45
Weaknesses in internal control Suggested control
payment (Refer to the control activity
component of internal control.).
3. The financial manager authorises payment 3. Management must have a proper
without first inspecting that the creditor’s organisational structure in place to ensure that
reconciliation has been completed properly a proper review is always done (Refer to the
and signed it off. control activity component of internal control).
4. There are no formal procedures in place for 4. There should be standard policies and
the creditor’s function. procedures in place to ensure that the
creditor’s clerk and the financial manager are
aware of the control consciousness of the
entity (Refer to the control environment
component of internal control.).
Important to note
As part of understanding an entity and its environment, it is important for an auditor to obtain more
information of the entity’s system of internal control. In your second-year auditing studies, you
already spent a lot of time on gaining an understanding of the concepts of general and application
internal controls as well as the internal controls that should be in place in the five business cycles
of an entity. Therefore, we will not go into the detail of these concepts again and assume that you
have a good knowledge and understanding of the internal control concepts. If not, you should
revise them from your previous auditing studies. Your knowledge and understanding of general
and application internal controls as well as the detail of internal controls present in the five
business cycles are not tested in this tutorial letter (it will be tested and revised as part of Tutorial
Letter 103). As part of the revision in Tutorial Letter 103, we will also refer you to ISA 265, which
deals with communicating deficiencies in internal control to those charged with governance and
management. For now, as part of this tutorial letter, in a practical scenario, you only need to
identify and describe the aspects the auditor should consider when obtaining an understanding
of the entity’s environment; the applicable financial reporting framework and the system of internal
control. Later in this module you will also learn how the effectiveness of an entity’s internal controls
affects control risk. This will be elaborated on in lesson 3.7 as part of the auditor’s response to
his or her assessment of risk.
Summary
In this lesson, we described, in relation to an entity, the things that the auditor should come to
understand during the planning stage of the audit.
Self-assessment
Having worked through the lesson and the references to the prescribed study material, see if you
can answer the following question:
1. Describe, in relation to an entity, all the principles that an auditor should come
to understand during the planning stage of the audit.
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LESSON 3.3: Identifying and assessing risk
LEARNING OUTCOMES

• Identify events or conditions (risk indicators) and inherent risk factors from a
scenario.
• Identify, describe and assess the audit risks and risks of material misstatement for
each identified event or condition (risk indicator) and inherent risk factor at
o financial statement level
o assertion level.
• Identify, describe and assess significant risks.
Introduction
In lesson 3.1, we identified that the planning stage consists of different phases.
The first phase in the planning stage of an audit, namely understanding the entity and its
environment, was explained in lesson 3.2. The aim of this lesson is to explain the auditing
principles related to the second phase of the planning stage of an audit, namely identifying and
assessing risk. This will enable you to identify inherent risk factors, events or conditions (risk
indicators) from a scenario and describe the risks of material misstatement at financial statement
and assertion level.
Risks are all around us and form part of our daily live. Think about it for a moment and discuss
the risks that affect your life with your fellow students in your chat groups or in the Forum
discussion.
Feedback: Risks affect individuals differently. Some risks that affect most of our daily lives include
health risks, safety and security risks and financial risks. To deal with these risks we attempt to
minimise the effect that they will have on our lives. For example, if you feel sick, you will identify
that a disease is threatening your health and you will see a doctor to have it treated. Just like
individuals, entities and their business operations are also affected by risks. Management is
responsible for identifying, assessing and responding to risks that affect their entity’s business;
and auditors are responsible for identifying and assessing risks and formulating audit responses
to deal with risks that affect the entity’s financial statements.
Risk identification and assessment are performed during the planning stage of an audit. Once the
engagement letter has been issued and signed, the auditor can start identifying and assessing
risks by gaining an understanding of the entity and its environment, including the entity’s
internal control and the financial reporting framework used by the entity.
The identification and assessment of risk should be performed at financial statement level and
at assertion level, from where risks of material misstatement are placed on the spectrum of
inherent risk. This helps the auditor to identify significant risks, which require the auditor to
formulate specific responses to deal with these risks. Once the risk assessment is completed, the
auditor is required to stand back and evaluate the completeness of the risk assessment,
whereafter audit procedures should be formulated to respond to the identified and assessed risks
in the obtaining audit evidence stage of the process. All of this and more are dealt with in detail
47
in this lesson, except for responses to risks, which are dealt with later in this module (lesson 3.7
and Tutorial Letters 103 and 104). A summary of the risk assessment process is depicted in figure
3.3.1.
Figure 3.3.1: Summary of the risk assessment process
The risk assessment process is dynamic and iterative (ongoing process)

Identification and
Understand an entity and Understand the applicable assessment of risk of
its environment including financial reporting material misstatement at
internal controls framework of the entity the financial statement
and assertion levels
Identify significant classes

Place risks of material of transactions, account
Identify significant risks misstatement on the balances and disclosures
spectrum of inherent risk as well as relevant
assertions
Stand back and revise the

risk assessment
Based on the risk assessment, formulate audit procedures to respond

to the risks
This lesson is structured under the following headings:
3.3.1 Definitions and important terms or concepts

3.3.2 Introducing ISA 315 (Revised 2019), Identifying and assessing the risks of material
misstatement
3.3.3 Identifying and assessing the risks of material misstatement
3.3.4 Risks of material misstatement at financial statement level
3.3.5 Risks of material misstatement at assertion level
3.3.6 Assessment of risk
3.3.7 What happens after risk assessment procedures have been performed?
3.3.8 Documentation
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3.3.1 Definitions and important terms or concepts
Before looking at the content of this lesson, which describes the what and the how of identifying
and assessing risks of material misstatement, it is important to first gain an understanding of a
few definitions, terms or concepts.
 Risk of material misstatement (ISA 200 and ISA 315 (Revised 2019) paragraph 04)
This is the risk that the financial statements are materially misstated prior to the audit and
consists of two components at assertion level, namely inherent and control risk.
 Inherent risk (IR) (ISA 315 (Revised 2019) paragraph 04)

This is the susceptibility of an assertion about a class of transaction, account balance or
disclosure to a misstatement that could be material, either individually or when aggregated
with other misstatements before any related controls are considered.
In other words, inherent risk involves the risks related to the entity and excludes the
risks related to weaknesses in the entity’s controls. Examples of inherent risks include
transactions that require complex calculations, the use of estimates, going concern
issues, external circumstances and so forth.
Inherent risk can be identified by referring to inherent risk factors, which are defined
according to ISA 315 (Revised 2019) paragraph 12(f)) as characteristics of events or
conditions that affect susceptibility to misstatement, whether due to fraud or error, of
an assertion about a class of transactions, account balance or disclosure, before
consideration of controls. Such factors may be qualitative or quantitative.
Qualitative inherent risk factors relating to the preparation of information required by

the applicable financial reporting framework include complexity, subjectivity,
change, uncertainty or susceptibility to misstatement due to management bias
or other fraud risk factors insofar as they affect inherent risk.
Other inherent risk factors include the quantitative or qualitative significance or the
volume or lack of uniformity in composition of items of the class of transactions,
account balance or disclosure.
Refer to ISA 315 (Revised 2019) Appendix 2 for a better understanding of these
inherent risk factors and examples thereof. We will look at practical examples later in
this lesson.
 Control risk (CR) (ISA 315 (Revised 2019) paragraph 04)

This involves the risk that a misstatement that could occur in an assertion about a class of
transaction, account balance or disclosure that could be material, either individually or when
aggregated with other misstatements, will not be prevented or detected and corrected on a
timely basis by the entity’s controls.
In other words, control risk involves the risks related to weaknesses in an entity’s
controls.
49
 Detection risk (DR) (ISA 200 paragraph 13(e))
This involves the risk that the procedures that the auditor performs to reduce audit risk to an
acceptably low level will not detect a misstatement that could be material, either individually
or when aggregated with other misstatements.
In other words, a detection risk involves the risks related to the detection of risks
by the auditor.
 Audit risk (ISA 200 paragraph 13(c))

Audit risk is the risk that the auditor can express an inappropriate audit opinion when the
financial statements are materially misstated. Audit risk can be expressed as a function of
the risk of material misstatement (RMM), which consists of inherent risk (IR) and control risk
(CR) and detection risk (DR). As explained below, the equation should be balanced
throughout the audit process.
Audit risk = RMM* x DR

(*RMM = IR x CR)
As stated in ISA 200: paragraph A42, there is an inverse relationship between detection
risk and the combined level of inherent and control risk (RMM). For example, when
inherent risk and control risk are high, the acceptable level of detection risk must be low
to reduce the audit risk to an acceptably low level. This low level can be achieved
through performing audit procedures.
However, if the inherent and control risks are low, the auditor could accept a higher
detection risk, thereby, reducing the audit risk to an acceptably low level. (Because the
client’s internal controls, accounting and internal control systems are so efficient that
they should prevent/identify and timeously correct any material errors/omissions, the
auditor can accept a higher detection risk.)
 Spectrum of inherent risk (ISA 315 (Revised 2019) paragraph A209)

The spectrum of inherent risk refers to a range. Whenever the auditor assesses a risk of
material misstatement, the spectrum of inherent risk assists the auditor when using his or
her professional judgment to place the risk within a range from higher to lower on the
spectrum of inherent risk. (ISA 315 (Revised 2019) paragraph A209). This is done by
referring to the likelihood and magnitude of a misstatement, which you will learn more
about later in this lesson.
 Significant risk (ISA 315 (Revised 2019) paragraph 12(l))

An identified risk of material misstatement:
(i) for which the assessment of inherent risk is close to the upper end of the spectrum
of inherent risk due to the degree to which inherent risk factors affect the combination
of the likelihood of a misstatement occurring and the magnitude of the potential
misstatement should that misstatement occur
(ii) is to be treated as a significant risk in accordance with the requirements of other ISAs.
(For example, ISA 240 paragraph 27 (risks related to fraud) and ISA 550 paragraph
18 (risks involving related party relationships and transactions).
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 Business risk (ISA 315 (Revised 2019) paragraph 12(b))

A risk resulting from significant conditions, events, circumstances, actions or inactions that
could adversely affect an entity’s ability to achieve its objectives and execute its strategies,
or from setting inappropriate objectives and strategies.
Students have often asked me to explain the difference between business risk
and audit risk. Business risk is broader and mainly relates to management and
an entity’s goals and objectives, including the risks that may affect the entity’s
business operations. In short, business risks include anything that potentially
influence net profit. Audit risk relates to the auditor and the entity’s financial
statements and whether a specific condition, event, circumstance, action or
inaction might cause the financial statements of an entity to be materially
misstated (for example an overstatement or understatement or incorrect financial
reporting framework being used). It is, however, possible that a business risk
sometimes results in an audit risk. For example, if there is a new entrant in the
market, there is a business risk that the company might lose customers and
ultimately close their business (it affects the net profit negatively). This will also
result in an audit risk, namely that the financial statements might not be
presented, using the correct financial reporting framework and still disclose the
business as a going concern (misstatement of the financial reporting framework).
Are you able to identify the difference between these two risks? Make sure you
do, as this is extremely important and can often lead to you missing out on
receiving marks for some of your answers.
 Risk assessment procedures (ISA 315 (Revised 2019) paragraph 12 (j))

The audit procedures designed and performed to identify and assess the risks of material
misstatement, whether due to fraud or error, at financial statement and assertion level.
 Relevant assertions (ISA 315 (Revised 2019) paragraph 12 (h))

A relevant assertion is an assertion that has an identified risk of material misstatement
connected to it for a specific class of transactions, account balance or disclosure (a line item,
such as inventory, in the financial statements).
 Significant class of transactions, account balance or disclosure (ISA 315 (Revised

2019) paragraph 12 (k))
This is a class of transactions, account balance or disclosure (a line item, such as inventory,
in the financial statements) with one or more relevant assertions.
 Professional scepticism (ISA 200 paragraphs 15; A18-A19; ISA 315 (Revised) paragraphs
A12-A13)
Professional scepticism is a concept that acknowledges that there might be circumstances
that will cause misstatement in the financial statements. It includes, for example, being alert
to contradictory audit evidence and being unbiased towards it; or being alert to the fact that
misstatements could occur due to fraud or error. It basically comes down to always being
sceptical and not just accepting whatever management says is the truth.
The definitions, concepts and terms described in the section above are only a few and as you
study ISA 315 (Revised 2019), more of them will be introduced and explained.
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3.3.2 Introducing ISA 315 (Revised 2019), Identifying and assessing the risks of material
misstatement
Study
As an introduction to ISA 315 (Revised 2019), Identifying and assessing the risks of material
misstatement, study paragraphs 01–09; and note the following: Do not try to memorise any of the
concepts that should be studied, as we will never require you to write down any theory. Rather
make sure that you understand the concepts.
• The auditor’s objective in conducting an audit of financial statements (ISA 315 (Revised
2019) paragraph 02).
• The auditor is required to exercise professional judgement and professional scepticism
when planning and conducting an audit (ISA 315 (Revised 2019) paragraph 03).
• Risks of material misstatement may be identified at financial statement level and assertion
level (ISA 315 (Revised 2019) paragraph 02).
• Risks of material misstatement at financial statement level consist of two components,
namely inherent and control risk, and should be assessed separately. Inherent risk may
vary for different classes of transactions, account balances or disclosures on the spectrum
of inherent risk (ISA 315 (Revised 2019) paragraphs 04 and 05). (Refer to the previous
section for the definition of spectrum of inherent risk.)
• Risks of material misstatement at assertion level are assessed to determine the nature,
timing and extent of further audit procedures to be designed and performed to obtain
sufficient appropriate audit evidence (ISA 315 (Revised 2019) paragraph 05).
• Identified and assessed risks of material misstatement may include risks due to error and
risks due to fraud (ISA 315 (Revised 2019) paragraph 06).
• The process of identifying and assessing risk is iterative and dynamic, which essentially
means that it is not a stand-alone or one-off process. Sometimes initial expectations of risks
are developed during the early stages of the audit process and may be further refined as the
audit progresses (ISA 315 (Revised 2019) paragraphs 07).
• To deal with assessed risks of material misstatement, the auditor should design and
implement (to be explained in detail in other lessons) (ISA 315 (Revised 2019) para 08):
o overall responses for risks identified at financial statement level
o further audit procedures for risks identified at assertion level
• ISA 315 (Revised 2019) considers scalability when identifying and assessing risks of
material misstatement based on the complexity of an entity. This essentially means that while
the standard applies to all entities, which includes complex or less complex entities, specific
considerations can be taken into account for either. It should be noted that the size of an
entity is not necessarily an indication of an entity’s complexity, as smaller entities might
sometimes be complex and large entities might be less complex. Throughout ISA 315
(Revised 2019) reference is made to scalability and examples should be considered when
identifying and assessing risks of material misstatement (ISA 315 (Revised 2019) paragraph
09).
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3.3.3 Identifying and assessing the risks of material misstatement
Study reference: ISA 315 (Revised 2019) paragraphs 13 –18; 28, A11–A23; A25; A27–A35; A37–
A46
Before continuing with this section, refresh your memory by referring to the following concepts,
which you studied earlier in this lesson:
Risks of material misstatement, inherent risk, control risk, detection risk, audit risk,
business risk and risk assessment procedures
Risks of material misstatement are identified and assessed by the auditor to gain an idea of the
nature, timing and extent of audit procedures to be performed during the audit. It is necessary for
the auditor to obtain sufficient appropriate audit evidence through these audit procedures to
substantiate the audit opinion expressed in the financial statements. Remember that ISA 200
stipulates that when conducting an audit, the auditor’s overall objective is to obtain sufficient
appropriate audit evidence to reduce audit risk to an acceptably low level.
Risks of material misstatement may exist at two levels in the financial statements, namely at the
financial statement level and at the assertion level. When identifying risks at these levels, the
auditor is required to identify relevant assertions and related significant classes of transactions,
account balances or disclosures. Once identified, the auditor should assess inherent risk and then
control risk, separately. Identified and assessed risks of material misstatement at these two levels
can be due to fraud or error.
To identify and assess risks of material misstatement, auditors can obtain evidence through
inquiries, analytical procedures, observation and inspection. Sources of these types of audit
evidence can include management; those charged with governance; key parties, such as internal
auditors; external parties, such as regulators; or consultation of publicly available information such
as press releases issued by the entity and reports issued by investors or analysts. When gathering
audit evidence from the sources mentioned above, the auditor should always consider relevance
and reliability of the information in accordance with ISA 500. The auditor may also consider
procedures performed when deciding to accept or continue with client relationships; information
gathered as part of another engagement; or the use information from previous experience with
the client, as long as the information is reliable and remains relevant.
The audit engagement team, which typically includes the engagement partner and engagement
team members, should discuss all the information gathered from parties indicated in the previous
paragraph; and should consider the application of the financial reporting framework of the audit
client.
It is important to note that throughout the identification and assessment of risks of material
misstatement process, the auditor should exercise professional scepticism. This means that an
auditor should always have a mindset that there is a possibility that management may cheat;
therefore, the auditor should not trust anybody, or the evidence given. It is therefore important to
always verify the evidence and document how professional scepticism was exercised.
Last but not least, when auditing different clients, the auditor should always use his or her
professional judgment when considering the scalability of an entity. For example, for more
complex entities the auditor should consider performing more risk assessment procedures and
vice versa. A first-time audit engagement might also seem complex at first, as the auditor is not
familiar with the client and the risk assessment process should be more extensive than for
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recurring audits. The risk assessment process might also be more formalised for more complex
entities.
In order to summarise what you studied in the section above, let’s look at a practical example
of Zozzo (Pty) Ltd (the discussion of this example is also published on myUnisa).
Practical example of obtaining audit evidence when identifying and assessing

risks of material misstatement
You are part of an audit team of a client, Zozzo (Pty) Ltd (Zozzo) which has been audited by
your audit firm for the past three financial years. Zozzo operates in the retail industry, from one
location and does not have complex business operations. All pre-engagement audit activities
have been performed and the necessary audit engagement letter has been signed. The next
phase of the audit entails planning the audit and at this stage your audit team is identifying and
assessing risks of material misstatement.
Prior to the meeting, the audit team, through analytical procedures, determined that Zozzo’s
turnover declined by more than 30% and that they have a current ratio of less than 1. The lower
turnover might indicate that the audit client suffered from a loss of sales and customers and the
poor current ratio indicates that their liabilities exceed their assets. From inspection of previous
minutes of board meetings, you identified that the Board approved that Zozzo should apply
for additional funding to stay operational and pay all their employees. In a press release of
Zozzo it was noted that the audit client suffered from bad publicity during the financial year, as
they apologised for a controversial advertisement, which was the main cause of the decline in
turnover. According to investor reports, many investors withdrew their capital from Zozzo
based on this controversy.
For the moment, imagine yourself in a boardroom where the management of Zozzo, the audit
engagement partner, the audit manager and you are sitting around the table. The main purpose
of the meeting is to have a discussion (inquiries) where more clarity is provided on some
information that your team already obtained in understanding an entity and its environment as
well as the financial reporting framework used by Zozzo.
In the meeting, the engagement partner starts discussions by asking the chief executive officer
(CEO) and chief financial officer (CFO) to explain whether there were any significant changes
to the entity’s system of internal control in the current financial year. They both indicated that no
changes took place.
In relation to the decline in turnover and current ratio of less than 1, the engagement partner
requested the CEO and CFO to provide more information on the issues and specifically refers
to the financial reporting framework as the entity still presents its financial statements on a
going concern basis. The CEO and CFO explained that the company has seen an increase in
turnover in the last month prior to the year-end; and that there is an indication that the sales will
increase in the coming financial year. Zozzo obtained the required funding based on the financial
figures for the last month prior to the year-end. This makes the CEO and CFO hopeful that the
company will be able to continue with their operations in the near future.
After discussing the issues at hand, the engagement team had a separate discussion with the
key audit team members. The engagement partner noted from experience with the previous
audits of Zozzo that there was a good system of internal control in place and that management
was always eager to correct misstatements. After a system walk-through in the current financial
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year, this still seemed to be the case. In prior years, the audit client had no going concern issues
and the correct financial reporting framework was applied. However, the engagement partner is
a little concerned that there might be misstatements in the financial statements, as he is not
convinced that sales increased; therefore, also questions the basis on which the funding was
obtained. These concerns therefore raise the question as to whether the correct financial
reporting framework was applied, as he has his doubts that Zozzo will be able to continue as a
going concern. It also raises a red flag in terms of the funding obtained and the audit team
should therefore be alert to the fact that management might have manipulated the financial
figures to obtain the required funding.
Reflect on how risk assessment procedures were performed by taking the information,
discussions and the sections you had to study from ISA 315 (Revised 2019) in this section into
account..
Feedback on the practical example of Zozzo
With the information and discussions presented in the scenario of Zozzo, taken into account, your
reflection may include the following:
Based on the theory according to How the theory was applied during
ISA 315 (Revised 2019) the risk assessment process at
Zozzo
Risk assessment procedures can be The sources from where information
performed through inquiries, was gathered for Zozzo, namely
analytical procedures, observation inquiries from management (the
and inspection. The sources should, meeting held with management),
however, be reliable and relevant. inspection of previous minutes of board
Refer to ISA 315 (Revised 2019) meetings, investor reports and internal
paragraphs 14; A19-A35 to obtain a press releases all seem to be reliable
better understanding of these and relevant. In some cases, an
procedures. external press release such as a
newspaper article might be
questionable but in this case a press
release issued by Zozzo was
considered, which might be more
reliable.
Previous experience from prior According to ISA 315, it is acceptable to
audits can be considered in the current use previous experience as long as the
audit. The auditor may also consider information remains relevant and
procedures performed when deciding reliable. In this case there were no
to accept or continue with client internal control system changes, and a
relationships, information gathered as walk-through of the system took place
part of another engagement; or use to confirm its relevance and reliability.
information from previous experience
with the client as long as it is reliable
and remains relevant. Refer to ISA 315
(Revised 2019) paragraphs 15-16; A37-
A41.
55
Zozzo
Discussions of certain aspects should In the scenario, the engagement
be held with role players of an entity, partner brought certain issues to the
but it is also important to discuss or attention of the audit team members so
bring certain matters to the attention of that they are aware of what is
key audit team members so that they happening at Zozzo. In terms of
are aware of the issues. Refer to ISA scalability, it will not always be effective
315 (Revised 2019) paragraphs 17-18; to involve all the audit team members in
A42-46. discussions but, most certainly, all key
members should be involved.
ISA 315 (Revised 2019) requires that By discussing the issues in the
the engagement audit team should scenario, it is evident that the exchange
consider whether the correct financial of information might assist the audit
reporting framework is used. Refer to team in considering whether or not the
ISA 315 (Revised 2019) paragraphs 17; correct financial reporting framework
A42-46. was used. In this case whether or not
the correct financial framework was
used is questionable, as the
engagement partner questions whether
Zozzo would be able to continue as a
going concern. This will definitely be
identified as a risk of material
misstatement and audit procedures
should be performed to gather sufficient
appropriate audit evidence to
substantiate whether or not the financial
statements are presented correctly.
Risks of material misstatement might be From the scenario, two main risks of
due to error or fraud. Refer to ISA 315 material misstatement can be identified:
(Revised 2019) paragraphs 13(a); A11. 1. Whether the financial statements are
The auditor should always be alert to presented according to the correct
whether risks of material misstatement financial reporting framework. This
are due to error and fraud; and most risk might be due to error.
importantly, always exercise 2. A concern was raised by the
professional scepticism when audit engagement partner that he doubts
evidence is contradictory. Refer to ISA that sales increased in the month
315 (Revised 2019) paragraphs A12- prior to year-end. The fact that Zozzo
A14. obtained funding based on figures
for the month before year-end might
also add to this concern. There is
therefore a possibility of a risk of
material misstatement due to fraud,
as management might have
manipulated some figures and this
issue should be further investigated
In this case, even though
management was not involved in
fraudulent activities in the past and
even though they always corrected
previous misstatements, the auditor
should exercise professional
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Zozzo
scepticism in an unbiased manner
and look at contradictory audit
evidence.
Later in this lesson, you will learn
that a risk of material misstatement
due to fraud is classified as a
significant risk to which special
attention should be paid.
The auditor needs to exercise Zozzo operates in the retail industry
professional judgement in terms of and does not seem to be a complex
scalability of an entity. Refer to ISA entity. The reasoning behind classifying
315 (Revised 2019) paragraphs A44- Zozzo as a less complex entity is that,
A46. from the scenario, it does not appear
that Zozzo have complex business
operations and therefore transactions,
and only operates their business from
one location. The auditor will therefore
take this into account when conducting
the audit.
Hopefully, you have a better understanding of the identification and assessment of risks of
material misstatement by considering the aspects mentioned in this section. As mentioned, risks
of material misstatement can be identified and assessed at two levels: financial statement level
and assertion level. In the following sections we will take a closer look at what each of these
entails.
3.3.4 Risks of material misstatement at financial statement level
Study reference: ISA 315 (Revised 2019) paragraphs 28(a), 30, A193-A198, Appendix 2
Before continuing with this section, refresh your memory by referring to the following concepts,
Inherent risk factors, spectrum of inherent risk
When auditors identify and assess risks of material misstatement at financial statement level, they
specifically determine which risks will affect the financial statements as a whole. These risks
typically affect many assertions, not only one or two. An example of this will be if there is a risk
of material misstatement, that management will override controls: it will affect the financial
statements as a whole and thus many assertions. Risks of material misstatement at financial
statement level generally require an overall response, according to ISA 330. You will learn more
about this later in this module (lesson 3.7 and Tutorial Letters 103 and 104).
Risks of material misstatement are usually identified by looking at the inherent risk factors present
at the entity. This means that certain events or conditions at an entity relate to one or more of the
inherent risk factors that might point to a possibility of misstatement due to fraud or error. These
inherent risk factors include complexity, subjectivity, change, uncertainty or susceptibility to
misstatement due to management bias or other fraud risk factors. For a better understanding
57
of what these inherent risk factors include and mean, refer to ISA 315 (Revised 2019) appendix
2 and figure 3.3.2.
Figure 3.3.2: Explanation of the meaning of inherent risk factors
Complexity • Refers to difficult or complicated issues.
• Can be influenced by different ideas or opinions

Subjectivity (something which is not a fact and not clear cut).
• Refers to something that is different or modified from

Change before.
Uncertainty • Refers to something that creates doubt.
Susceptibility to
• Relates to something that is likely to take place as it is
misstatement due to difficult to resist it.
management bias* or fraud
*Bias is best described as something that is favoured against or for something. So, if it is in favour of
management, they might be biased towards a certain outcome such as higher profits that will benefit them.
It is important that the auditor consider all five inherent risk factors in the risk assessment process
and indicate how they are affected. As part of this assessment, risks are considered in terms of
the likelihood that they will occur and their magnitude to determine where the risks should be
placed on the spectrum of inherent risk (the range). We will look at practical examples later in
this lesson.
Risks of material misstatement at financial statement level can arise from risks arising from
external events, such as a decline in turnover; and risks due to fraud (as explained in the example
of Zozzo). Additionally, risks of material misstatement at financial statement level may also arise
due to deficiencies in the control environment. An auditor therefore needs to obtain an
understanding of the entity’s system of internal control, specifically the control environment, to
assess risks of material misstatement at financial statement level. When an auditor obtains an
understanding of an entity’s control environment and components of the system of internal
controls, the auditor might realise that it will be difficult to obtain sufficient appropriate audit
evidence to base an audit opinion on; and might therefore even decide to withdraw from the audit
engagement, if possible, according to applicable laws and regulations (examples of such
instances are provided in ISA 315 (Revised 2019) paragraph A198).
Some risks of material misstatement at financial statement level may also affect individual
assertions and not only the financial statements as a whole. When a risk of material
misstatement at financial statement level affects individual assertion(s), those risks should be
borne in mind when identifying and assessing risks of material misstatement at the assertion level
so that further audit procedures can be designed and performed. If we refer to the scenario of
Zozzo, we can identify such an example.
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Practical examples of risks of material misstatement at financial statement

level that may also have an effect at assertion level
Zozzo suffered from a decline in turnover and had to apply for funding to stay operational.
• Firstly, the going concern issue can be identified from this scenario (inherent risk factor
related to change according to ISA 315 (Revised 2019) Appendix 2)) and relates to a
risk of material misstatement at financial statement level, as the financial statements
might be prepared based on an incorrect accounting basis. It affects the financial
statements as a whole, as well as many assertions.
• Secondly, the issue of obtaining funding and susceptibility to misstatement of figures to
secure the funding can be identified (inherent risk factor related to susceptibility to
misstatement due to management bias or fraud, according to ISA 315 (Revised 2019)
Appendix 2)). In this case it can be identified as a risk of material misstatement at
financial statement level due to fraud, as it will affect many assertions (overstatement of
assets and revenue and understatement of liabilities and expenses). However, it can
also be identified as a risk of material misstatement due to fraud at assertion level, as it
might, for example, affect the existence (one relevant assertion) of inventory (an example
of a related significant account balance).
Now that you have a better understanding of risks of material misstatement at financial statement
level; and that some of them may also apply to individual assertions and transactions or account
balances that can be referred to as relevant assertions and related significant classes of
transactions, account balances or disclosures, let’s take a closer look at the risks of material
misstatement at assertion level.
3.3.5 Risks of material misstatement at the assertion level
Study reference: ISA 315 (Revised 2019) paragraphs 28(b); 29; 31; A186–A191; A201-A203;
A205-A214
Before you continue with this section, refresh your memory by referring to the following concepts
you studied earlier in this lesson:
Inherent risk factors, spectrum of inherent risk, relevant assertions, significant class of
transactions, account balance or disclosures
Risks of material misstatement at assertion level are risks that do not only relate to the financial
statements as a whole, but also to individual assertions and classes of transactions, account
balances or disclosures. To determine whether this is the case, the auditor needs to use and refer
to assertions listed in ISA 315 (Revised 2019) paragraph A190 and consider if any potential
misstatements may occur for any of them. To refresh your memory of the assertions, make sure
you log into myUnisa and watch the exiting video that we prepared for you, which summarises all
the assertions. If risks of material misstatements are identified for any of the assertions, it is
referred to as relevant assertions and the class of transactions, account balance or disclosure
identified for those relevant assertions are referred to as a significant class of transactions,
account balance or disclosure (the line item in the financial statements). To be able to identify
these significant classes of transactions, account balances or disclosures, the auditor might find
it necessary to use automated tools and techniques.
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The practical example below illustrates what a risk of material misstatement at assertion level
looks like and what we mean when referring to a significant class of transactions, account balance
or disclosure and its relevant assertions.
Practical example of risks of material misstatement at assertion level,

significant class of transactions, account balance and relevant assertions
In the example of Zozzo, we identified that the issue of obtaining funding and the susceptibility
to misstatement due to management bias or fraud of figures to secure the funding can be
identified as a risk of material misstatement due to fraud at financial statement level. We
identified this as a risk of material misstatement, as Zozzo’s management would want the
financial statements to reflect a positive picture so that the banks would feel comfortable to give
them funding and be assured that they would be able to repay the loan. So, how do you make
your financial statements look better? Well, by showing a healthy statement of financial position
where it seems as if you have many assets and income and not as many liabilities and expenses.
Management may therefore want to increase (overstate) Zozzo’s assets and revenue and
decrease (understate) their liabilities and expenses for all account balances and classes of
transactions. As the risk may affect more than one class of transaction or account balance, the
risk is identified at financial statement level. However, if you “drill” down into the different
accounts that make up the financial statements, you will see that it ultimately affects individual
classes of transactions (for example sales or cost of sales) and account balances (for example
inventory or trade payables) and therefore risks of material misstatement at the financial
statements due to fraud can also be identified at assertion level.
Seeing that the risk of material misstatement relates to overstatement of assets or revenue and
understatement of liabilities and expenses, the relevant assertions for these examples can be
identified as follows:
Classes of Example of a Relevant assertions Note

transactions, significant class
account balances of transaction,
and disclosures account balance
identified or disclosure
Assets and Inventory (assets) Existence (assets) 1
revenue Sales (revenue) Occurrence
(overstatement) (revenue)
Liabilities and Trade payables Completeness 2
expenses (liabilities) (liabilities)
(understatement) Cost of sales Completeness
(expenses) (expenses)
Note 1: As the risk for assets and revenue is overstatement, there might be a risk that the
transactions and events recorded in the financial statements do not relate to the entity
(occurrence) (false transactions) and that account balances, such as assets in the financial
statements, do not exist for Zozzo. Completeness, for example, is not a relevant assertion for
assets and revenue in this case, as the risk is not that some transactions might not have been
recorded. Sales (revenue) and inventory (asset) can therefore be identified as examples of a
significant class of transactions and an account balance.
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Note 2: As the risk for liabilities and expenses is understatement, there might be a risk that
some transactions and events might not have been recorded in the financial statements relating
to the completeness assertion. Occurrence or existence is not a relevant assertion for liabilities
and expenses in this case, as there is a low risk that transactions and events that do not relate
or exist for Zozzo will be recorded as expenses or liabilities. Cost of sales (expense) and trade
payables (liability) can therefore be identified as examples of a significant class of transactions
and an account balance.
3.3.6 Assessment of risk
Remember that we previously discussed that risks of material misstatement consist of two audit
risk components, namely inherent risk and control risk. Inherent risk should be considered
before control risk based on the possibility of occurring and being material. These risks may
sometimes arise externally, for example from events or conditions beyond the entity’s control,
such as declining economic conditions or internally, for example from deficiencies in the entity’s
control environment (refer to more examples of inherent risk factors in ISA 315 (Revised 2019)
Appendix 2).
Assessing Inherent risk
Study reference: ISA 315 (Revised 2019) paragraphs 31-33; A205-A217; A218–A225; Appendix
2
Before continuing with this section, refresh your memory by referring to the following concepts
you studied earlier in this lesson:
inherent risk, inherent risk factors, spectrum of inherent risk, significant risk
When assessing inherent risk, the likelihood and magnitude of the misstatement should be
determined by taking the inherent risk factors into account. This is necessary to determine where
on the spectrum of inherent risk (the range) the identified risk is assessed so that the auditor
will know how to deal with the risk through further audit procedures.
Explanation:
Likelihood of a misstatement is the possibility that the misstatement may occur.
To determine the magnitude of a misstatement, qualitative and quantitative aspects should be

considered; for example, determine if the misstatement is material based on the entity’s size,
nature or circumstances.
When assessing inherent risk, the likelihood and magnitude of the misstatement based on each
of the inherent risk factors should be determined to establish if it should be placed on the lower
or higher spectrum of inherent risk. This is where the auditor should use professional judgment,
which may vary based on the nature, size and complexity of the entity.
The higher the combination of likelihood and magnitude, the higher the assessment of inherent
risk and vice versa. It should be noted that it is not necessary for both to be high for inherent
risk to be assessed as high. Sometimes there may be a low likelihood but a very high
magnitude; therefore, inherent risk should still be assessed as high. Refer to examples in ISA
315 (Revised 2019) paragraph A220.
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The auditor may also allocate risks of material misstatement within categories along the
spectrum of inherent risk. Therefore, it is not necessary to have one spectrum of inherent risk
for every risk of material misstatement.
Remember that the goal of placing risks of material misstatement on the spectrum of inherent
risk is to determine whether the inherent risk should be assessed as high or low. The higher
the inherent risk, the better the internal controls should be to mitigate the risk; or the auditor
should be required to perform many substantive procedures. If the inherent risk is lower, the
auditor should perform fewer substantive procedures.
Auditors should exercise professional judgement when placing risks of material misstatement on
the spectrum of inherent risk. Determining where on the spectrum of inherent risk (the range) a
risk of material misstatement lies will also help the auditor to identify which of those risks are
significant (in layman terms, the “scary risks”), as specific responses may be required in terms
of ISA 330 and the other relevant ISAs.
To identify significant risks, the auditor will firstly focus on those risks of material misstatement
that have been placed on the upper spectrum of inherent risk. Risks that are assessed towards
the upper end of the spectrum of inherent risk should be classified as significant risks so that
auditors will focus more attention on them and design a more precise response when conducting
audit procedures. As the assessment of significant risks is a matter of professional judgement, it
will differ from one entity to another and from one financial year to another. There are, however,
exceptions that include risks of material misstatement that have been identified and assessed
due to fraud and where related-party transactions and relationships exist. These two types of risks
are always regarded as significant risks. This means that the likelihood and magnitude will always
be considered as high; and they will therefore be placed on the upper end on the spectrum of
inherent risk. When dealing with these types of risks, ISA 240 and ISA 550 provide further
requirements and guidance.
As previously mentioned, each of the inherent risk factors need to be considered when assessing
inherent risk. The lower the effect of inherent risk factors on the likelihood and magnitude of a
risk, the lower the assessed risk is likely to be placed on the spectrum of inherent risk. However,
the higher the effect of inherent risks on the likelihood and magnitude of a risk, the higher the
assessed risk is likely to be placed on the higher or upper end of the spectrum of inherent risk
and thereby the chances of classifying it as a significant risk also increases.
Examples of matters that might determine that the inherent risk might be high and
therefore be classified as a significant risk:
• Transactions with multiple acceptable accounting treatments where subjectivity is involved
• Accounting estimates with high uncertainty and complexity (for which ISA 540 (Revised)
provides additional guidance)
• Complex calculation for account balances and quantitative disclosures
• Accounting principles subject to a different interpretation
• Changes in the business environment that involve changes in accounting, for example
mergers and acquisitions (for which ISA 600 provides additional guidance)
Apart from determining significant risks when assessing inherent risk, the auditor should also
establish whether there are any risks of material misstatement for which substantive procedures
alone will not provide sufficient appropriate audit evidence. The only way to gather enough audit
evidence in this case will be to test the operating effectiveness of controls. An example of this is
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where a business operates in a highly automated environment with little or no manual intervention.
In such instances, audit evidence may only be available in electronic form, and it might be more
difficult to detect errors if appropriate controls are not operating effectively. In this instance, audit
evidence should not be obtained through substantive procedures alone and there should be a
greater focus on control testing. Another example relates to accounting estimates (ISA 540
(Revised)), where it may be applicable to refer to complex models, as audit evidence will not be
obtained through substantive procedures alone.
By taking all the information in this section into account, let’s see if we can assess inherent risk
for Zozzo, based on one of the previous examples used.
Practical example of assessment of inherent risk
We already identified the following as a risk of material misstatement at financial statement and
assertion level.
The annual financial statements may be materially misstated due to fraud, as management
might manipulate figures (overstatement of assets/revenue and/or understatement of
liabilities/expenses) to obtain funding.
This risk of material misstatement was identified based on the inherent risk factor of
susceptibility to misstatement due to management bias or other fraud risk factors as far as they
affect inherent risk.
In terms of the likelihood of the inherent risk factor, we may use professional judgement and
determine that it is high. This is based on the discussions during which the engagement partner
raised some concerns about possible misstatement and its nature, which is fraud. The
magnitude can also be assessed as high due to its qualitative nature, which is fraud.
Based on the findings above, inherent risk can therefore be assessed as high for this risk of
material misstatement and should be placed on the upper end of the spectrum of inherent
risk.
All risks placed on the upper end of the spectrum of inherent risk – in fact, all risks of
material misstatement due to fraud – should be classified as significant risks and be dealt
with according to ISA 240.
After considering inherent risk, the auditor should assess control risk.
Assessing control risk
Study reference: ISA 315 (Revised 2019) paragraphs 34, A226–A229.
Before continuing with this section, refresh your memory by referring to the following concept,
Control risk
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The auditor may assess control risk in different ways, depending on preferred audit techniques or
methodologies. To determine how control risk should be assessed, the auditor should decide
whether or not he or she is going to test the operating effectiveness of controls. Depending
on the answer to the question, control risk should be assessed as follows:
• If the answer is YES: If the auditor decides to test the operating effectiveness of controls,
control risk should be assessed. Remember that the auditor only tests the operating
effectiveness of controls if he or she expects the controls to operate effectively. An auditor
will only expect controls to be operating effectively if he or she evaluates the design and
implementation of identified controls. If the auditor tests the operating effectiveness of the
controls during the execution phase of the audit, he or she will be able to confirm his or her
initial expectation. If not, he or she should revise the assessment of control risk.
• If the answer is NO: If the auditor does not plan to test the operating effectiveness of
controls, and thereby do not plan to assess control risk, control risk should be assessed
as being the same as the assessment of inherent risk.
Practical example of assessment of control risk
Based on the initial discussions between the engagement partner and key audit team members
in the example of Zozzo, the engagement partner noted from experience during the previous
audits that there is a good system of internal control in place. Remember that this is a recurring
audit. Therefore, the design and implementation of internal controls have been tested in a
previous audit and it is not necessary to do it again. However, by exercising professional
scepticism, the auditor cannot just take management’s word that there were no changes to the
system of internal control, and therefore performed a walk-through in the current financial year
to confirm that there indeed were no changes. Based on this, the auditor expects the controls to
be working effectively and will therefore test the controls. Control risk can be assessed as low,
as there were no changes in the controls of Zozzo during the year under review.
3.3.7 What happens after risk assessment procedures have been performed?
Study reference: ISA 315 (Revised 2019) paragraphs 35-37; A230-A236
Once the auditor has completed the risk assessment procedures, he or she should stand back
and evaluate by double-checking that the risk assessment is complete and whether the audit
evidence provides a sufficient and appropriate basis for the identification and assessment of risks
of material misstatement. The auditor should for example reconsider the assessment of risk of
material misstatement of classes of transactions, account balances or disclosures that are
material but were not identified as significant. All this should be properly documented.
If the audit evidence is sufficient and appropriate, the auditor should be able to design the nature,
timing and extent of audit procedures to be performed during the audit. If not, the auditor should
perform additional risk assessment procedures until sufficient appropriate audit evidence has
been obtained.
As the audit progresses, it may happen that the auditor comes across new information that differs
from the information on which the risk assessment was based. The risk assessment may then not
be a true reflection of the applicable circumstances; therefore, the planned audit procedures may
not be effective to detect material misstatements. In these cases, the auditor is required to stand
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back and revise the risk assessment so that audit procedures can be planned and performed
accordingly.
3.3.8 Documentation
Study reference: ISA 315 (Revised 2019) paragraphs 38; A237–A241
The auditor should document the results of the identified and assessed risks of material
misstatement at financial statement level and assertion level, significant risks and risks for which
substantive procedure alone cannot provide sufficient appropriate audit evidence. Discussions of
these risks and the rationale if significant judgments were made or how professional scepticism
was exercised should also be documented. For example, include the rationale in documentation
of why certain risks were identified as significant risks or why and how certain judgements were
made. Depending on the scalability of an entity, audit documentation is sometimes very detailed
but for less complex entities it can be simple and relatively brief. It is up to the auditor to decide.
For less complex entities, audit documentation can be prepared separately or form part of the
documentation of the overall audit strategy and audit plan, or form part of audit documentation of
further audit procedures.
You should make sure that you are able to apply your theoretical knowledge of everything you
studied in this lesson to a practical scenario. Let’s look at the following activity.
Activity 3.3.1
Your firm was appointed as the auditor of Connect (Pty) Ltd (Connect), a company established
by two business partners. Connect’s main business involves the import, marketing and selling a
range of cellphones to the public.
You obtained the following knowledge during the planning stage of the audit after several
meetings were held with management:
• All cellphones are imported. During the year, Connect entered into a forward exchange
contract (FEC) for cellphones purchased from one of its one-off foreign suppliers to hedge
itself against foreign currency fluctuations.
• The CFO of Connect indicated that the company would present the audited financial
statements to the bank. Owing to a global recession, the company is currently experiencing
liquidity problems and the bank will only authorise a long-term loan based on the audited
financial statements for the year ended 31 December 20xx.
• Connect’s accounting department consists of a number of competent staff members, most
of which have been with the company for several years.
• During the financial year Connect installed a new well-known, well-developed, off-the-shelf
IT system to deal with financial reporting. Management was adamant that the newly installed
system should be well-designed, monitored and tested after installation.
REQUIRED
a) Identify, describe and assess the risks of material misstatement at financial statement
level with respect to the financial statements of Connect.
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b) Identify, describe and assess the risks of material misstatement at assertion level with
respect to inventory in the financial statements of Connect. Identify the relevant audit
assertion(s) for each identified risk. Present your answer as follows:
Description of risks of material misstatement at Relevant audit

assertion level for inventory assertion(s)
1. ……………………………………………………….. 1. ………………….

SOLUTION TO PART A
Notes on answering part A of this question
This question requires you to identify, describe and assess the risks of material
misstatement at financial statement level. What does this imply?
• To refresh your memory, refer to the explanation of the term “risk of material
misstatement”.
• Remember that risk of material misstatement refers only to the two components of
inherent risk and control risk. Therefore, only describe inherent risks and control risks
and exclude risks dealing with detection risk from your answer. Detection risk only affects
the auditor. Remember that inherent risk should be assessed before control risk.
 Financial statement level implies that you should describe the risks and the effect they
have on the financial statements as a whole. Therefore, do not describe risks that involve
specific line items and assertions in the financial statements, as this will be describing
risks of material misstatement at assertion level.
 Risks of material misstatement can be indicated by inherent risk factors which include
complexity, subjectivity, change, uncertainty or susceptibility to misstatement due to
management bias or other fraud risk factors. Examples of each of these inherent risk
factors are included in ISA 315 (Revised 2019) Appendix 2. When reading through the
scenario, see which ones you can identify.
 You should identify, describe and assess risks of material misstatement at financial
statement level, which means that you need to
- identify inherent risk factors, events or conditions (risk indicators) that may indicate
the existence of risks of material misstatement from the scenario and describe them
as risks of material misstatement at financial statement level and
- assess them.
How should you approach a question on risks of material misstatement at financial statement
level? During your thought process, you should apply the following steps:
Step 1: Identify the inherent risk factors, events or conditions (risk indicators) that may
influence your risks of material misstatement that are present while reading
through the given scenario.
Step 2: Consider what effect the inherent risk factors, events or conditions (risk
indicators) will have on risk.
Step 3: Describe the risk of material misstatement at financial statement level.
Step 4: Assess the risks of material misstatement at financial statement level based on
the effect that magnitude and likelihood will have on the spectrum of inherent
risk.
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Remember that if you described the inherent risk factor, event or condition (risk indicator), you
did not necessarily describe the risk. No marks will be awarded for not describing the risk and
the effect it has on the financial statements. You need to link the inherent risk factor, event
or condition (risk indicator) to the risk of material misstatement in the financial
statements and the effect it has in the scenario. Therefore, explain how the risk of material
misstatement will affect the financial statements. Remember that risks of material
misstatement may be due to error or fraud. Therefore, start describing the risks of material
misstatement as follows:
“The AFS may be materially misstated due to error because …”

“The AFS may be materially misstated due to fraud because …”
Then follow this up by explaining why the financial statements will contain material
misstatements.
Examination technique: Before formulating your answer and while reading the information
line by line, highlight or jot down the inherent risk factors, events or conditions (risk indicators)
in the margin next to the applicable sentence to make sure that you do not leave anything out.
Suggested solution to part A
Before evaluating your solution, quickly write down the following:
 Identified, inherent risk factors, events or conditions (risk indicators).

 Effect of the inherent risk factors you identified as at risk.
STEP 1: Inherent risk factors STEP 2: Effect of

Relevant inherent Identified events or conditions (risk the inherent risk
risk factors indicators) from the scenario of factors on risk
according to ISA 315 Connect based on the
(Revised 2019) scenario*
Complexity Complex transactions in terms of the
import of goods and the FEC
Subjectivity/uncertainty Spot rates/conversion rates are based

on management’s choice of the This will increase
source (for example, which date etc) inherent risk and it
and they might be uncertain in some should therefore be
instances. assessed in terms of
Susceptibility to Use financial statements to obtain likelihood, magnitude
misstatement due to financing and the spectrum of
management bias or inherent risk.
fraud
Change There is an indication of possible

liquidity problems
Change Change in the IT system This will decrease

inherent and control
risk and it should
therefore be assessed
it in terms of likelihood,
magnitude and the
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STEP 1: Inherent risk factors STEP 2: Effect of
Relevant inherent Identified events or conditions (risk the inherent risk
risk factors indicators) from the scenario of factors on risk
according to ISA 315 Connect based on the
(Revised 2019) scenario*
spectrum of inherent
risk.
The decrease in
inherent risk is
attributable to the fact
that a misstatement
might not occur, as
management is
adamant about
implementation of
controls.
The decrease in control

risk is attributable to
the fact that a
misstatement might not
occur, as the system is
a well-developed off-
the shelf system.
*Note that in a test or exam, you should not write step 2 down as you should be able to assess risk
in terms of likelihood and magnitude and then conclude on the spectrum of inherent risk. Therefore,
please refer to the solution below and some of the self-assessment questions and make sure that
you are able to include the aforementioned detail as well.
STEP 3
This step entails “expanding” the inherent risk factor, event or condition (risk indicator) and
describing it as a risk. Begin your sentence as follows:
“The AFS may be materially misstated due to error or fraud (choose one) because …”
Describe the effect on the AFS (why) because the question requires you to identify the risks of
material misstatement at financial statement level. (Make sure that you do not describe business
risks and that your risk is related to the impact it has on the financial statements.)
Identification and assessment of risks of material misstatement at financial statement level

for Connect
Inherent risks include:
1. Identification:
• There is complexity and the AFS may therefore be materially misstated due to error,
as Connect imports cellphones and the accounting treatment of importing and hedging
is complex and certain costs may or may not be included according to the accounting
standards, for example VAT, transport costs, import duties and so forth.
Assessment:
• The likelihood is low as staff seems to be competent and experienced.
• The magnitude is medium/high as all Connect’s products are imported and therefore
may have a huge impact on the AFS.
• Conclusion on the spectrum of inherent risk is set as medium.
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(Note that this risk also relates to assertion level and that it is then described differently.)
2. Identification:
• There is subjectivity/uncertainty and the AFS may therefore be materially misstated
due to error, as Connect imports cellphones and the accounting treatment is subjective
as staff may be uncertain and has a choice of what spot/conversion rates and which
dates to use.
Assessment:
• The likelihood is low as staff seems to be competent and experienced.
• The magnitude is medium/high as all Connect’s products are imported and therefore
may have a huge impact on the AFS and therefore is material.
3. Identification:
• There is a possibility of change as the AFS may be materially misstated due to error as
the entity needs to adhere to international laws and regulations which might result in
penalties or closure of the business. The incorrect financial reporting framework may
therefore be used as the going concern assumption might not be properly accounted for
and/or disclosed.
Assessment:
• The likelihood is low/medium as there is no other evidence pointing to this.
• The magnitude is high as the AFS as a whole is affected and therefore is material.
4. Identification:
• There is susceptibility to misstatement due to management bias or fraud as the AFS
may be materially misstated due to fraud, as the management might engage in
fraudulent financial reporting by overstating assets and revenue and understating
liabilities and expenses to ensure that financing will be obtained from the bank.
Assessment:
• The likelihood is high as management is motivated to reflect a healthy financial position
(likelihood is always high where fraud is a possibility).
• The magnitude is high as all classes of transactions and account balances may be
affected in the AFS and therefore is material (magnitude is always high where fraud is
a possibility).
• The inherent risk should be placed on the upper end of the spectrum of inherent risk,
which will result in it being classified as a significant risk (all risks related to fraud
should be placed on the upper end).
5. Identification:
• There is change as the AFS may be materially misstated due to error as the incorrect
financial reporting framework may be used; therefore, the going concern assumption
might not be properly accounted for and/or disclosed, as indicated by the liquidity
problems that Connect currently experiences.
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Assessment:
• The likelihood is medium as there is not overwhelming evidence of going concern
issues.
• The magnitude is high as the AFS as a whole is affected and therefore is material.
• Conclusion on the spectrum of inherent risk is medium/high.
Control risks include:
6. Identification:
• The AFS is not likely to be misstated due to error, as the off-the-shelf system seems to
be well-developed and tried and tested.
Assessment:
• This will decrease control risk as the likelihood and magnitude can be assessed as
low as they are using a well-developed off-the-shelf system. The risk can therefore be
placed as low on the spectrum of inherent risk.
SOLUTION TO PART B
Notes on answering part B of this question
Part B of the question requires you to identify, describe and assess the risk of material
misstatement at assertion level. What does this imply?
 At assertion level, it implies that you should identify relevant assertions and describe
the risks that affect significant classes of transactions, account balances and disclosures,
in this case, inventory in the financial statements.
 You should identify, describe and assess risks of material misstatement at assertion
level, which means that you need to:
- identify inherent risk factors, events or conditions (risk indicators) from the
scenario and describe them as risks of material misstatement at assertion level
- identify the relevant assertions; and
- assess them in terms of the relevant assertion(s).
How should you approach a question on risk of material misstatement at t assertion level?
You should apply the following steps:
Step 1: From the inherent risk factors, events or conditions (risk indicators) that you
identified, consider whether any individual assertions are affected.
Step 2: Identify the significant classes of transactions, account balances or
disclosures that are affected (think about all the line items in the AFS that
might be affected)
Step 3: For each identified classes of transactions, account balances or disclosures,
identify the relevant audit assertions.
Step 4: Identify, describe and assess the risk of material misstatement at assertion
level.
Remember that if you described the inherent risk factor, event or condition (risk indicator),
you did not necessarily describe the risk. No marks will be awarded for describing the inherent
risk factor. You need to link the inherent risk factor, event or condition (risk indicator)
to the risk of material misstatement at assertion level for the significant classes of
transactions, account balances and disclosures. Therefore, always try to describe the
risk by starting with:
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“There is a risk that revenue (for example) might be …”
Then follow this up by explaining what the risk might be. The solution to this question clearly
illustrates it. In this question you are required to indicate the relevant audit assertion(s) for
each risk.
Examination technique: Before formulating your answer and while reading the information
line by line, highlight or jot down the inherent risk factors, events or conditions (risk indicators)
in the margin next to the applicable sentence to make sure that you do not leave anything
out.
Solution to part B
In the solution to part A, we already identified the inherent risk factors, events or conditions (risk
indicators). Now we need to identify whether there are any significant classes of transactions,
account balances or disclosures for those identified risks of material misstatement and their
relevant assertion(s).
STEP 1: Inherent risk factors STEP 2: Significant STEP 3: Relevant

Relevant inherent Identified events or classes of audit assertion(s)
risk factors conditions (risk transactions,
according to ISA indicators) from the account balances,
315 (Revised scenario of Connect disclosures
2019)
Complexity Complex transactions in 1. purchases and 1. accuracy/cut-off
terms of the import of FEC gains and 2. accuracy,
goods and the FEC losses valuation and
2. trade payables allocation/
3. inventory completeness/
existence
3. accuracy,
valuation and
allocation/
completeness/
existence/rights
Susceptibility to Use financial statements 1. liabilities 1. completeness/
misstatement to obtain financing 2. assets accuracy, valuation
3.eExpenses and allocation
4. revenue 2. existence/
accuracy, valuation
and allocation
3. completeness
4. occurrence
Change Liquidity problems Relate to risk of material misstatement at
financial statement level, as it affects many
classes of transactions, account balances and
disclosures.
Change Change in the IT system Relate to risk of material misstatement at
financial statement level, as it affects many
classes of transactions, account balances and
disclosures. If only one class of transactions
were affected by this change, for example
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sales, relevant assertions should be identified.
However, this is not stipulated as such in the
scenario.
Identification and assessment of risks of material misstatement at assertion level for

inventory for Connect
Identification:
Description of risks of material misstatement at Relevant audit assertion(s)

the assertion level for inventory
1. There is a risk that inventory might not be translated at accuracy, valuation and
the correct exchange rates on the transaction date or allocation
at the year-end.
2. There is a risk that by determining the cost of inventory, accuracy, valuation and
the incorrect omission or inclusion of import duties or allocation
insurance are taken into account.
3. There is a risk that inventory in transit at the year-end completeness
may be incorrectly excluded when the right of
ownership has transferred to Connect
(understatement).
4. There is a risk that inventory in transit at the year-end, existence and rights and
for which the right of ownership has not been obligations
transferred to Connect, may be included.
5. There is a risk that cellphones can become obsolete accuracy, valuation and
due to short life expectancy in this fast-growing allocation
technological environment; therefore, inventory might
be incorrectly recorded in the AFS.
6. There is a risk that cellphones might be susceptible to existence, accuracy, valuation
theft, which increases the risk of misstatement of the and allocation
inventory value if such items do not exist and are not
identified and written off in the AFS.
7. There is a risk that imported inventory may be damaged existence, accuracy, valuation
and therefore overstated, as it might not be identified and allocation
and written off correctly.
8. There is a risk that inventory may be overstated existence, accuracy, valuation
because Connect wants to obtain finance from the and allocation
bank.
Assessment:
As we identified more than one relevant assertion for inventory, inventory would be classified as
a significant account balance. The risk of material misstatement at assertion level related to
inventory can be assessed as follows:
Existence: high risk

Accuracy, valuation and allocation: high risk
Completeness: medium risk
Rights and obligations: medium risk
Classification: low risk
Presentation: low risk
The high assessment of risk for existence, accuracy, valuation and allocation is based on
the fact that there is a higher risk that inventory might be overstated and incorrectly measured.
The likelihood can therefore be assessed as high as inventory is an asset account balance
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which in many cases have a higher risk for being overstated and incorrectly measured due to its
complexity. In most cases the magnitude for inventory for a retail company can also be assessed
as high as inventory is likely to be a material. These risks may also be classified as a significant
risk as they are placed on the higher spectrum of inherent risk. Specific responses should
therefore be formulated to deal with these risks.
A medium risk is assessed for completeness on the spectrum of inherent risk, which mostly
relate to understatement. Seeing that understatement for inventory is not likely, likelihood can
be assessed as low/medium. Magnitude can be assessed as high as inventory is likely to be
a material account balance.
The low risk assessment for classification and presentation on the spectrum of inherent risk
is based on the fact that it is not affected in terms of the scenario. The likelihood and magnitude
can therefore be assessed as low.
Activity 3.3.2
Refer to the scenario provided in activity 3.3.1.
Identify, describe and assess the significant risks related to inventory of Connect.
Remember that significant risks include the following:

• risks of material misstatement, which can be placed on the upper end of the spectrum of
inherent risk which include all risks of material misstatement due to fraud
• those to be treated as a significant risk in accordance with the requirements of other ISAs
(ISA 240 paragraph 27 and ISA 550 paragraph 18)
Based on our identification and assessment or risk for activity 3.3.1 we identified the following:
The AFS may be materially misstated due to fraud, as the management might engage in
fraudulent financial reporting by overstating assets and revenue and understating liabilities and
expenses to ensure that financing will be obtained from the bank.
This risk of material misstatement at financial statement level due to fraud also affects risks of
material misstatements at assertion level. In terms of the question asked, this risk is specifically
related to inventory. The following significant risk for inventory is therefore identified and
assessed:
There is a risk that inventory may be overstated because Connect wants to obtain finance from
the bank and management may want to manipulate the figures.
For inventory, existence and accuracy, valuation and allocation were identified as relevant
assertions. The risk for these assertions is assessed as high (both in terms of likelihood and
magnitude) and should be placed on the upper spectrum of inherent risk. This and the fact that
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the risk might be due to fraud, classify the risk of material misstatement as a significant risk. The
auditor will therefore have to formulate specific responses to deal with this risk to reduce audit
risk to an acceptable low level.
Additional comments: According to ISA 240, the auditor has additional responsibilities in
respect of the fraud that is identified above. These responsibilities are discussed in lesson 3.4.
Activity 3.3.3
Log onto myUnisa and watch the video on identification and assessment of risk. I hope that you
enjoy it and learn from it!
Refer to section 4 of this tutorial letter and do questions 8 to 13. Additional questions dealing with
identification and assessment of risk may also be placed on myUnisa from time to time, as this
topic is regarded as VERY IMPORTANT, and you may expect a question on this in most of your
assessments. Therefore, make sure that you frequently monitor the site for this module.
Summary
As part of planning an audit of financial statements, the auditor must identify and assess audit
risks and risks of material misstatement at financial statement and assertion level. This lesson
explained the auditing principles related to identifying and assessing risk.
Self-assessment
whether you can do the following:
1. Identify events or conditions (risk indicators) and inherent risk factors, from a
scenario.
2. Identify, describe and assess the audit risks and risks of material misstatement for
each identified event or condition (risk indicator) and inherent risk factor at
• financial statement level
• assertion level
3. Identify, describe and assess significant risks.
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LESSON 3.4: The auditor’s responsibilities relating to fraud
LEARNING OUTCOMES

• identify, describe and assess (evaluate) the risk of material misstatement of the
financial statements due to fraud (significant risks)
• Respond appropriately to fraud or suspected fraud identified during the audit
• Formulate audit procedures to obtain appropriate evidence in response to the
assessed fraud risk.
Introduction
The aim of this lesson is to explain the auditing principles related to
• the identification and assessment of fraud risk factors
• the formulation of audit procedures to gather evidence in response to the risk of material
misstatement due to fraud
• the appropriate response by the auditor when fraud is identified.
In the previous lesson, you learnt about identification and assessment of risk. In some instances,
the inherent risk factors that the auditor has identified point to the possibility of fraud. In such
instances, the risks of material misstatement are referred to as significant risks and are classified
at the upper end of the spectrum of inherent risk, which indicates the importance for the auditor
to respond accordingly to these risks. In order to deal with significant risks, the auditor must design
and perform appropriate audit responses to determine whether or not the financial statements are
materially misstated due to fraud.
Study
1. ISA 240, The auditor’s responsibilities relating to fraud in an audit of financial statements.
Also take note of the appendices to this standard as they contain examples of fraud risk
factors (Appendix 1), examples of possible audit procedures to deal with the assessed risks
of material misstatement due to fraud (Appendix 2) and examples of circumstances that
indicate the possibility of fraud (Appendix 3).
2. Relevant section dealing with “The auditor’s responsibilities relating to fraud in an audit of
financial statements”, in chapter 5 of Auditing notes.
Log onto myUnisa and open lesson 3.4. We have selected a few videos on some
well-known or recent fraudulent schemes that occurred internationally and nationally
and made the links available to you in the lesson.
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FRAUD AND ERROR
The main difference between fraud and error is that fraud is intentional, whereas error is
unintentional.
Now think about the examples below that may affect a company’s financial statements materially,
and point out the differences in intention that you can see:
1. A journal entry is processed to record the impairment of a major asset, but the debits and
credits are accidentally switched around.
2. The executive directors of a company decide to overstate profits to secure higher

performance bonuses by increasing the useful life of a major assets class to an unrealistic
level for depreciation purposes.
Feedback
1. The first example is an unintentional error. When the auditor discovers the error,
management will be willing to correct the error to ensure that the financial statements are
accurate.
2. The second example is intentional. When the auditor discovers this error, management
may conceal their intent.
Reflect
Read ISA 240 paragraph 4 again and consider the responsibilities of those charged with the
governance of the entity and management. You may also refer to the relevant section in
Auditing Notes. Make sure that you make notes of what you read as you work through this lesson
so that you can easily refer to your notes when doing your revision.
Reflect
Read paragraphs 10 and 11 of ISA 240 again and reflect on the points below:
• The auditor’s objective in identifying and assessing the risks of material misstatement due
to fraud (ISA 240 paragraph 10).
• The definitions of “fraud” and “fraud risk factors” (ISA 240 paragraph 11). For examples of
fraud risk factors, refer to ISA 240 Appendix 1.
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Reflect
The auditor should be aware of the ways in which fraud can be committed and concealed. Read
the sections on “fraudulent financial reporting” and “misappropriation of assets” in chapter
7 of Auditing Notes. For examples of risk factors which relate to each of type of fraud, refer to ISA
240 Appendix 1.
Study
At this point in the lesson, after you have encountered the objectives of the auditor and the
definitions of fraud and fraud risk factors, you can proceed to the responsibilities of the auditor in
respect of fraud.
Note the following in relation to the responsibilities of the auditor (you may refer to the
relevant sections in chapter 7 of Auditing Notes and/or ISA 240):
• maintain professional scepticism
• discussions among the audit team
• conduct risk assessment procedures and related activities
• identify and assess risks of material misstatement due to fraud at the financial statement and
assertion levels
• determine responses to the assessed risks of material misstatement due to fraud
• evaluation of audit evidence
• consider continuance of the engagement
• request written representations from management
• communications to management and those charged with governance and external authorities
if applicable
• documentation of the above
Activity 3.4.1
Your firm has recently been appointed as the auditor of Pebbles Ltd, a large company that
markets sophisticated electronic equipment. The previous auditor lost the audit as a direct result
of conflict with Ms Merry, the CEO of Pebbles Ltd, over the company’s adoption of various
questionable accounting policies. The conflict became very heated, mainly due to Ms Merry’s
aggressive nature, and led to a qualified audit report.
While familiarising yourself with the company and its environment, you discover that Ms Merry
has surrounded herself with an aggressive team of loyal managers. You consider that their loyalty
is partially due to management not being paid a salary, but being given a monthly retainer,
superior fringe benefits and a percentage of the reported profits.
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REQUIRED
Describe the risks of material misstatement in the annual financial statements of Pebbles Ltd
because of fraudulent financial reporting.
The management of Pebbles Ltd are remunerated based on reported profits; therefore, they have
an incentive to misstate/manipulate reported information to ensure that they maximise their
personal earnings.
TAKE NOTE: All the information necessary to answer such questions is found in the
question itself, even if you must think “out of the box”.
Activity 3.4.2
Refer to lesson 3.3, activity 3.3.1 where you were required to identify, describe and assess the
risks of material misstatement of Connect.
REQUIRED
a) Identify the risk of material misstatement at financial statement level which might be due to
fraud.
b) For the risk of material misstatement due to fraud that you identified in a), give a brief overview
of the overall audit responses that you include to deal with the risks of material misstatement
due to fraud.
Solution to part a:
There is susceptibility to misstatement due to management bias or fraud; therefore, the AFS may
be materially misstated due to fraud, as the management might engage in fraudulent financial
reporting by overstating assets and revenue and understating liabilities and expenses to ensure
that financing will be obtained from the bank.
Solution to part b:
Overall audit responses to deal with the identified risk of material misstatement due to fraud at
financial statement level include:
• Increase sensitivity to the selection of the nature and extent of documentation to be examined
for material transactions (ISA 240 paragraph A33), for example perform substantive analytical
procedures, in addition to the normal inspection of invoices and supporting documentation for
selected items. This may include comparison of sales month by month, per product line or
business segment to comparable months in prior periods. With the use of computer assisted
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audit techniques (CAATs), these comparisons can be made in great detail and can be used
to identify unusual circumstances for further investigation (ISA 240 Appendix 2).
• Assign staff with much experience; and, if necessary, staff who have proven success in using
CAATs. Also consider using IT specialists or forensic experts.
• In terms of supervision, allocate audit managers with several years of experience in the
client’s type of business to supervise the audit (ISA 240 paragraphs A34–A35).
• Include unpredictability when formulating audit responses. This may include performing
substantive procedures on unexpected classes of transactions or account balances to adjust
the timing of audit procedures, using different sampling methods or conducting surprise audits
(ISA 240 paragraph A36).
For more examples of possible audit procedures to deal with the assessed risks of material
misstatement due to fraud, refer to ISA 240 Appendix 2. Keep this in mind when you learn more
about formulating substantive procedures in Tutorial Letter 104 which you will study later in this
module.
Activity 3.4.3
Refer to activity 3.4.2. After identifying and assessing risks of material misstatement at financial
statement level, you identified and assessed the risk of material misstatement at assertion level
relating to revenue as high and significant and therefore formulated specific audit responses to
deal with the risk. After performing the substantive analytical procedures to compare sales month
on month, per product line or business segment and to comparable months in prior periods, you
have found that revenue is materially overstated on a product line that was discontinued years
ago. The sales were recorded by means of a journal, debiting the debtors account of a close
corporation (CC) and crediting sales. The journal was initiated by the store manager and approved
by the sales manager. The approval procedures for journals are that the initiator signs and the
CFO approves any adjustments to sales. After further investigation, you could not find a deposit
on the bank statement, which allegedly cleared the debtors account of the CC raised in the
journal.
You contacted the CC and enquired about the payment. The accountant of the CC provided you
with a bank account number at CNA Bank, into which they deposited the funds owed. After
handing this information to the forensic specialist, she obtained a subpoena to request the
information from CNA Bank and established that all the executive directors were receiving pay-
outs from the said account.
REQUIRED
a) Does the approval of the journal confirm that fraud has been committed?
b) If you combine the facts in a above with the finding that the sales were raised on a
discontinued product, what is your view on fraud then?
c) When considering all the facts represented in the scenario, what is the road forward for the
auditor?
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a) No. However, it may compel the auditor to increase his or her professional scepticism that
management has overridden controls (ISA 240 paragraphs A7–A9).
b) The incorrect approval procedures (management override), combined with the raising of sales
for a fictitious product (misstatement of financial statements due to fraud), definitely raise
professional scepticism to the maximum. The auditor must gather additional evidence, and
any invoices or delivery notes accompanying the journal will have to be confirmed with third
parties or handed to an expert (ISA 240 paragraph A9). This matter also becomes a
significant risk (see learning unit 3.3).
c) After the forensic specialist has gathered the information to prove that fraud has been
committed by those charged with governance, the auditor must
i. obtain legal advice about communicating the fraud to those charged with governance,
because they are involved (ISA 240 paragraph A63)
ii. be cautious when relying on any representations made by management or those charged
with governance (ISA 240 paragraph A64)
iii. treat the matter as a reportable irregularity and report it to the Independent Regulatory
Board for Auditors (ISA 240 paragraph A65)
iv. include all evidence and documentation of decisions in the audit documentation (ISA 240
paragraphs 44–47)
v. decide if he or she can continue with the engagement (ISA 240 paragraph 38).
Summary
As part of planning an audit of financial statements, the auditor must identify and assess risks at
financial statement level as well as at assertion level. Should this assessment reveal possible
fraud risks, those fraud risks need additional treatment. This lesson explained the auditor’s
responsibilities with respect to fraud.
Self-assessment
1. Identify, describe and assess (evaluate) the risk of material misstatement of the
financial statements due to fraud (significant risks).
2. Respond appropriately to fraud or suspected fraud identified during the audit.
3. Formulate audit procedures to obtain appropriate evidence in response to the
assessed fraud risk.
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LESSON 3.5: Consideration of laws and regulations in an audit of financial

statements
LEARNING OUTCOME

• Describe the responsibility of the auditor for an entity’s compliance with laws and
regulations in an audit of financial statements.
Introduction
The aim of this lesson is to explain the auditor’s responsibility to consider laws and regulations in
an audit of financial statements. The auditor considers the entity’s non-compliance with laws and
regulations during the risk assessment of the entity, as discussed in lesson 3.3. The auditor is not
responsible for the entity’s compliance, but the possibility that non-compliance with laws and
regulations can lead directly to material misstatement of financial statements necessitates the
auditor’s consideration of such compliance. Secondly, such non-compliance may be fundamental
to the operating aspects of the business and, therefore, indirectly cause the material
misstatement of financial statements.
Have you ever heard about NOCLAR? Although you will not be assessed on the
content of NOCLAR, it is important for you, as an accounting and auditing student, to understand
what it is about, and we therefore selected a video for you and made the link available on myUnisa
to update your knowledge on this topic.
Study
ISA 250, The consideration of laws and regulations in an audit of financial statements paragraph
2, and the relevant section dealing with important considerations of laws and regulations in
chapter 7 of Auditing Notes.
Note the effect of laws and regulations on financial statements that is explained in this paragraph.
Study
ISA 250 paragraph 12, for a definition of non-compliance.
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Activity 3.5.1
Explain what is meant by non-compliance for the purposes of ISA 250.
Non-compliance is an act of omission or commission by an entity, either intentional or

unintentional, which is contrary to the prevailing laws or regulations. Such acts may include
transactions entered into by, or in the name of, the entity, or by management on its behalf, those
charged with governance or employees. Non-compliance does not include personal misconduct
by management, those charged with governance, or employees of the entity. For example, if the
CEO has been charged for not paying fines imposed on him/her personally, it does not mean that
an entity is not compliant with laws and regulations.
Study
ISA 250 paragraph 6, which describes the effect of non-compliance on financial statements and
on the operations of the business.
Activity 3.5.2
Describe three possible consequences of non-compliance with laws and regulations that could
be fundamental to the operational aspects of the business; and, as a result, may have a material
effect on the financial statements.
1. An entity may not be able to continue its business, for example, a regulating authority may
force the entity to discontinue its operations (see the comment below).
2. An entity may incur material penalties (for non-compliance with the terms of an operating
licence, non-compliance with regulatory solvency requirements or non-compliance with
environmental regulations, etc.).
3. An entity might suffer reputational damage and lose customers which leads to a decline in
turnover due to non-compliance with laws and regulations.
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Comment: These three instances threaten the going concern assumption; and if the
financial statements are not prepared on an appropriate basis, they may be materially
misstated.
Study
ISA 250 paragraphs 4–9, and the relevant section dealing with the auditor’s duties and
responsibilities regarding laws and regulations, in chapter 7 of Auditing Notes.
In these paragraphs, the responsibility of the auditor regarding non-compliance with laws and
regulations is explained.
You should have noted from the paragraphs mentioned above that the auditor’s responsibility
remains unchanged, and he or she is still required to obtain reasonable assurance that the
financial statements, taken as a whole, are free from material misstatement. If you did not note
this, study the relevant paragraph in ISA 250 until you find it.
Study
ISA 250 paragraph 11 and note the objectives of the auditor.
The first requirement that the auditor must satisfy to achieve the objectives in paragraph 11 is to
consider compliance with laws and regulations. This is further detailed in paragraphs 13 to 18.
Study these paragraphs before attempting to answer activity 3.5.3.
Activity 3.5.3
Certain laws and regulations are well-established, known to the entity and within the entity’s
industry or sector, and relevant to the entity’s financial statements. Examples of such laws and
regulations are the Income Tax Act 58 of 1962 (applicable to all entities) and laws pertaining to
pension funds (for all companies operating a pension fund on behalf of their employees).
REQUIRED
List four examples of the direct effects that non-compliance with laws and regulations, such as
the two pieces of legislation mentioned in the examples above can have on an entity’s financial
statements.
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1. The form and content of financial statements do not comply with an acceptable reporting
framework.
2. Industry-specific financial reporting issues are not correctly disclosed in the financial
statements.
3. Accounting for transactions under government contracts are not correctly disclosed in the
4. The accrual or recognition of expenses for income tax or pension costs are not correctly
calculated and not properly disclosed in the financial statements.
These are just a few and there are many more.
Study
ISA 250 paragraphs 19–22, and the relevant section dealing with the audit procedures on the
non-compliance with laws and regulations, in chapter 7 of Auditing Notes.
The second requirement that the auditor must satisfy to achieve the objectives in paragraph 11 is
to perform audit procedures when non-compliance is identified or suspected. This is further
detailed in paragraphs 19 to 22. Study these paragraphs before attempting to answer activity
3.5.4.
Activity 3.5.4
Assume that management or those charged with governance did not take the remedial action that
the auditor considered appropriate in the circumstances, despite the non-compliance not being
material to the financial statements.
REQUIRED
Describe the applicable considerations and the possible actions that an auditor can take in such
circumstances.
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In exceptional cases, the auditor may consider whether withdrawal from the engagement is
necessary. This applies to those cases where withdrawal is possible under applicable laws or
regulations.
When deciding whether withdrawal from the engagement is necessary, the auditor may consider
seeking legal advice. If withdrawal from the engagement is not possible, the auditor may consider
alternative actions, including describing the non-compliance under “Other matters” in the auditor’s
report. This will be dealt with in Tutorial Letter 105 of this module when the audit report is
explained.
Study
ISA 250 paragraphs 23–29, and the relevant section dealing with the reporting of non-compliance
of the client with laws and regulations, in chapter 7 of Auditing Notes.
The third requirement that the auditor must satisfy to achieve the objectives in paragraph 11 is
the reporting of identified or suspected non-compliance. This is further detailed in paragraphs 23
to 29. The documentation that must be kept by an auditor under these circumstances is explained
in paragraph 30. Study these paragraphs before attempting to do activity 3.5.5. Remember these
documentation requirements when studying the Standard on Audit Documentation in lesson 3.9
of this module.
Activity 3.5.5
Assume the auditor suspected that management or those charged with governance were involved
in non-compliance.
REQUIRED
Describe the reporting requirements of the auditor.
The auditor must communicate the matter to the next higher level of authority at the entity, such
as an audit committee or supervisory board, if it exists. If no higher authority exists, or if the auditor
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believes that the communication may not be acted on; or he or she is unsure about the person to
report to, the need to obtain legal advice must be considered.
Further to the reporting requirements, you should note that the auditor’s report can be affected in
various ways. This will only be explained after you have learnt about the various forms of audit
opinion in Tutorial Letter 105 of this module.
Summary
It should be evident to you that an auditor must consider a wide variety of factors that can affect
the financial statements, even factors you will not encounter during your auditing studies. This is
a good reason why you should study intensely and read widely. When doing your articles as a
trainee accountant, question the way in which audits are performed to learn what factors to
consider when audit plans are compiled.
Self-assessment
After working through the lesson and the references to the prescribed study material, see if you
1. Describe the responsibility of the auditor for an entity’s compliance with laws and
regulations in an audit of financial statements.
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LESSON 3.6: Materiality
LEARNING OUTCOMES
• Calculate planning and performance materiality levels.

• Describe how materiality levels and risk of material misstatement are related and apply
this knowledge to a given scenario.
Introduction
We have already established that ISA 300, Planning an audit of financial statements, requires
that the auditor should plan an audit of financial statements (refer to lesson 3.1). We have further
identified that the planning stage consists of different phases of which materiality is an important
component.
The aim of this lesson is to explain the auditing principles related to determining materiality
during the planning phase of an audit.
“Materiality” is an auditing concept that is used to help the auditor decide whether or not to accept
the figures and disclosures in the financial statements. Remember, the audit report is the final
product. To decide whether or not to accept the reasonableness of the financial statements, the
auditor must determine materiality figures during the planning stage of an audit (planning
materiality during the performance of an audit (performance materiality) and at the final stage of
the audit process (final materiality).
Besides the quantitative aspect of materiality (dealing with figures), materiality also relates to
matters that are material by nature, which is qualitative. In summary, two features should be
considered when dealing with materiality, namely the quantitative and the qualitative aspects.
Take note that ISA 320 deals with planning materiality and performance materiality, while ISA 450
deals with final materiality. ISA 320 will be discussed in this lesson, while ISA 450 will be dealt
with in Tutorial Letter 104 of this module.
Study
ISA 320, Materiality in planning and performing an audit, and the relevant sections dealing with
the concepts of materiality, planning materiality and performance materiality, in chapter 7 of
Auditing Notes.
• Consider the definition of materiality in the context of an audit (ISA 320 paragraph 2).
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• The calculation of planning materiality and performance materiality, which is subjective by
nature. Consequently, this calculation is based on professional judgement where different
auditors will possibly come up with different materiality figures, using different benchmarks
(ISA 320 paragraphs 4, A4 and A5). Also take note that ISA 320 recognises the use of
benchmarks, but it does not prescribe any percentages to be used when setting materiality
figures (ISA 320 paragraphs A8–A10). For this module you will be given benchmarks and
percentages in a scenario of a question. When calculating materiality figures, it is important
to consider the nature of the business. For an entity that is capital-intensive, you are likely to
use total assets in your materiality calculation. The materiality calculation bases will differ
from one audit firm to another.
• The auditor will calculate the following three categories of materiality figures: planning
materiality, performance materiality and final materiality (ISA 320 paragraph 5).
• Materiality does not only relate to figures in which an error is detected above the set materiality
figure ( quantitative). It also relates to matters that are material by nature (qualitative). For
example, a fraudulent activity that is quantitatively less than the materiality figure will most
definitely be material by nature (ISA 320 paragraph 6).
• Materiality and audit risk should be considered throughout the audit but specifically when
performing the risk assessment; determining the nature; timing and extent of further audit
procedures and evaluating and forming an audit opinion (ISA 320 paragraph A1). This
essentially means that you will always keep materiality in mind as the audit progresses and
that you sometimes have to revise your planning and performance materiality levels (ISA 320
paragraphs 12–13 and A14). However, it is only at the end of the audit that final materiality
will be determined.
• Planning materiality is also referred to as “materiality for the financial statements as a whole”
and the auditor may establish materiality levels to be applied to classes of transactions,
account balances or disclosures. This means that, in principle (and in practice), a planning
materiality level will be set for the financial statements as a whole, and planning materiality
levels (of a lesser amount) will be applied to classes of transactions, account balances and
disclosures (performance materiality).
• Consider the definition of performance materiality (ISA 320 paragraph 9). Take note that
performance materiality levels are always lower than planning materiality levels.
• Look at the documentation of materiality levels (ISA 320 paragraph 14).
Calculation of planning materiality
Take note that the calculation of materiality when planning an audit is subjective by nature and it
will differ from one audit firm to another. The following is an example of a framework that an audit
firm uses to calculate materiality levels for the financial statements as a whole when planning an
audit:
STEP 1
Determine which figures to use
• Use the unaudited figures of the current year if they are available.
• If the unaudited figures of the current year cannot be used because they are not available,
consider using the budgeted figures if they are available.
o Use the budgeted figures if there were not material deviations from them.
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• If both the unaudited and budgeted figures are not available, use the figures of the previous
year.
o If the figures of the previous year were audited, it must be determined whether any major
changes have taken place in the company in the current year.
o If major changes have taken place since these figures were audited, you should adjust
these figures to reflect the changes.
STEP 2
Consider the indicators

(Note that each audit firm has its own policy on the indicators and intervals that will be
used for the calculation of materiality when planning an audit.)
• The following indicators and intervals are often used:
Indicator Interval
Turnover 0.5%–1%
Gross profit 1%–2%
Net profit before tax 5%–10%
Total assets 1%–2%
Equity 2%–5%
Note: If you are not provided with percentages to apply in a question scenario, you should use
these percentages to calculate materiality.
STEP 3
Determine which of the indicators is appropriate for the calculation of materiality when
planning an audit
The following factors should be considered:

• Profit before tax is usually used for entities that are profit-oriented. However, if the profit before
tax from continuing operations seem to be volatile (meaning changing rapidly or being
unpredictable), indicators from gross profit or turnover should be considered.
• If a company made a loss, the indicator of net profit before tax cannot be used.
• Expected issues with an indicator can be determined by performing analytical procedures.
• The inherent characteristics of the company should be considered for an entity that is capital-
intensive, for example, as a manufacturer you are likely to use total assets for your materiality
calculation; or in the instance of an entity that renders services, it is likely that this entity is not
capital-intensive and therefore total assets will not be an appropriate indicator to use.
• The stability of the figures is important, for example consider the following:
o If the turnover figure for the year under review fluctuates dramatically from the previous
year to the next, the turnover indicator cannot be used.
o If the turnover figure for the year under review increases dramatically, but the accounts
receivable figure reflects a dramatic decrease, it could be an indication of fraud or an error
in either one of these balances. Consequently, the turnover indicator cannot be used.
STEP 4
Calculate the materiality interval for each of the suitable indicators
• Calculate both the lowest and the highest limits of the intervals for each suitable indicator.
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STEP 5
Decide on a materiality figure to use when planning an audit
• Exclude any indicator when the range of figures is an outlier with respect to other indicators.
• The auditor should be conservative in his or her decision on the materiality figure to use when
planning an audit.
• If the inherent risk is assessed as low, a figure in the upper range of the amounts calculated
will be selected; and if the inherent risk is assessed as high, a figure in the lower range of
amounts calculated will be selected. Remember, there is an inverse relationship between
materiality and risk of material misstatement, that is if the
• risk of material misstatement is high, materiality is set low to compensate for the risk
• risk of material misstatement is low, materiality is set high because a smaller chance exists
that a material misstatement will occur.
Example
• Gross profit = R5 000 000
The audit firm applies the following percentages to gross profit in its materiality calculations:
• high risk of material misstatement: 0,5% (lower-end percentage used)
• medium risk of material misstatement: 1% (average percentage used)
• low risk of material misstatement: 2% (upper-end percentage used)
Risk of material
Set materiality Result
misstatement
High (0,5%) R25 000 (low) • Increased sample sizes
• Can tolerate fewer errors in sample tested
• Most conservative
Medium (1%) R50 000 (medium) • Sample sizes smaller than above
• Can tolerate a few more errors in samples tested
• More conservative
Low (2%) R100 000 (high) • Smallest sample sizes
• Can tolerate more errors (we do not expect many
errors)
• Less conservative
• A conclusion must be drawn on a specific figure for materiality. Materiality, within a range of
figures will not be acceptable.
Calculation of performance materiality
Once the auditor determined planning materiality, the auditor should be able to set performance
materiality. Performance materiality can be set for each account balance, class of transactions
and disclosures. This means that a different materiality figure can be determined for revenue in
comparison with other account balances or classes of transactions, for example liabilities. In the
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end, this also influences the extent of substantive procedures performed for different account
balances and/or classes of transactions. Let’s look at an example:
Account balance/classes of Level of performance Effect on substantive

transactions materiality procedures performed
Revenue Low Increase
Liabilities High Decrease
When calculating performance materiality for specific account balances or classes of

transactions, the auditor will always use planning materiality as a basis. Performance materiality
is determined by using a fixed percentage based on the auditor’s professional scepticism (once
again this may differ across audit firms) and the entity’s assessed level of risk of material
misstatement. Let’s look at an example:
• If an entity’s risk of material misstatement is assessed as high, the auditor would opt for a
lower-performance materiality to reduce detection risk. The auditor may then choose to
determine performance materiality as 70% of planning materiality.
• If an entity’s risk of material misstatement is assessed as normal or medium, the auditor
does not need to adjust detection risk; and may then choose to determine performance
materiality as 80% of planning materiality.
• If an entity’s risk of material misstatement is assessed as low, the auditor would opt for a
higher-performance materiality to increase detection risk. The auditor may then choose to
determine performance materiality as 90% of planning materiality.
By looking at the examples above, it is evident that the performance materiality value will
always be lower than the planning materiality.
As a last note on materiality, some misstatements might sometimes be regarded as insignificant

as they will not affect decisions made by the users of financial statements (say for example, it
may be determined that misstatements of less than 2% of materiality may be insignificant). These
misstatements can then be ignored when considering misstatements as part of the schedule of
audit differences. These insignificant misstatements are sometimes referred to as “clearly trivial”
(unimportant). But remember, a clearly trivial misstatement based on value can sometimes still
be regarded as material due to its nature, especially where fraud was involved. The auditor’s
professional scepticism is therefore once again important.
(Source: Penning, G., Butler, R., Nathan, D., O’Reilly, G., Kunz, R., Motholo, V., Rudman, R.,
Scholtz. 2018. Auditing fundamentals in a South African context. Second edition. Oxford
University press)
Activity 3.6.1
You are a member of the team that is auditing Consumex Ltd, a listed company that sells a wide
range of consumer goods. You and other members of the team are discussing the materiality
figure for planning and performing the current audit. As a starting point, you use the planning
materiality figures of the prior year, set for the various account balances and classes of
transactions, with a clear understanding that these figures would probably be adjusted as risk of
material misstatement is identified and assessed and further audit procedures get underway.
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Before the discussion among the team members starts, Beckie Zulu, a junior trainee, asks, “When
deciding on our planning materiality, is there a ‘cost/benefit’ issue that we should be considering?”
During the identification and assessment of the risk of material misstatement, the following
information was obtained.
1. The company negotiated two major long-term loans during the year. Both loans included
loan covenants which require strict adherence to specified liquidity ratios. The company has
not had to contend with this in prior years. (3)
2. The number of major transactions with related parties increased considerably during the
year. (4)
3. A charge of price fixing of certain consumables has been brought against Consumex Ltd
and three other companies in the same sector. Although the company’s legal counsel was
not confident that the charge could be successfully defended, they stated that the penalty
could not be estimated yet. (3)
4. Halfway through the year, the company relaxed its credit terms to boost sales. The amount
of credit made available to customers was increased dramatically and repayment terms
were extended. (4)
5. The company started trading in derivatives for the first time in its history. (4)
6. The automated (computerised) inventory control system, which had proved somewhat
unreliable, was substantially upgraded just before the end of the prior financial year. Interim
tests of controls conducted on the system by your computer audit division found the
upgraded system to be “very reliable, well-designed and capable of producing a great deal
of information about the company’s inventory”. (3)
REQUIRED
a) Respond to the question that Beckie Zulu posed. (4)
b) Indicate whether the information in each of points 1 to 6 above would increase or decrease
(or have no effect on) the planning (and performance) materiality figures from the prior year.
Justify your answer. (21)
a) Cost/benefit considerations
1. Indirectly, the existing cost/benefit considerations should not influence the auditor’s
decisions or performance negatively.
2. The stricter (lower) the materiality figure, the greater the quantity of audit work that must be
performed and vice versa. For example, if we decide on a materiality figure of R100
(hypothetically, of course) we would get a great deal of assurance, but we would have to do
much audit work. If we decided on a figure of R10 000, we would have to do a lot less audit
work but would get less assurance.
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3. Our objective is to perform sufficient audit work to reduce audit risk to an acceptable level
so it is a question of balancing the audit work to be done with the level of assurance we
want.
4. We do not want to perform unnecessary audit work, but at the same time we must gather
sufficient, appropriate evidence to meet our audit objective and reduce the audit risk to an
acceptable level.
5. What we cannot do is change our materiality figure to justify doing less work to reduce cost.
We must aim to carry out a cost-efficient but effective audit.
b)
1. 1.1 It will likely result in a lower (stricter) materiality figure for those account headings
that affect the liquidity ratios specified in the loan covenant.
1.2 As the auditors, we would want to be satisfied that these account headings are as
fairly stated as possible. We are aware that there will be specific reliance on liquidity
ratios and that important contractual obligations, which the company did not face in
the prior year, must be met.
2. 2.1 It is debatable whether this will affect the materiality figure directly. The key aspects
of related-party transactions are the identification of related parties and related-party
transactions and the disclosure thereof.
2.2 Our likely response will be to intensify our search for the above and to ensure that
disclosure is done according to the IASs.
2.3 It could also be argued that as this is potentially a significant risk, a stricter materiality
figure for the size (magnitude) of related-party transactions we want to identify will
be set. For example, we want to identify all transactions with related parties over
R10 000 instead of, say, R50 000, which may have been the prior year’s figure.
2.4 However, generally speaking, it is qualitative materiality about which we are more
concerned with related parties.
3. 3.1 This is probably a significant risk. In a general sense, it may cause the auditor some
concern about the overall integrity of management and may cause us to be more
alert to the possibility of other illegal activities/fraud in identifying and assessing risk.
This, in turn, may translate into stricter figures for certain classes of
transaction/account headings.
3.2 However, at this stage, it is only a charge. Disclosure is the most likely treatment in
the AFS, as it appears to be a contingent liability; hence, it is material due to
qualitative factors.
4. 4.1 There is an increased risk here that accounts receivable will be overstated.
4.2 As credit limits have increased dramatically and credit terms were extended, a
strong possibility exists that the allowance for bad debts will be understated,
particularly if Consumex Ltd applies the same criteria for setting the allowance as it
did in the prior year.
4.3 In addition, when considering that accounts receivable will be one of the accounts
used in determining adherence to the loan covenants, a stricter materiality figure
should be set for the performance of the accounts receivable audit.
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5. 5.1 As the company has not traded in derivatives before, we would not have had to
consider any risk associated with it in prior years.
5.2 Trading in derivatives can be very dangerous, as poor trades can inflict significant
damage to a company. In addition, from a financial reporting perspective, valuations
and disclosure of derivatives and derivative dealings can be very complex.
5.3 Depending on the extent of the trading that has occurred, we may even consider it
to be a significant risk, requiring special audit attention.
5.4 It is very likely that the necessary experience and expertise will have to be added to
the audit team and that strict materiality figures will be set for affected account
headings and appropriate attention will be applied to the qualitative aspects.
6. 6.1 As the internal control system for a very important cycle (inventory) in a consumer
product company has improved and our computer audit team regards it as “reliable
and well-designed”, we could probably increase (make less strict) our materiality
figure for performing the inventory audit. The system is more likely to detect errors
and it can produce information we need to help with matters, such as
“obsolescence” and so forth.
6.2 We should be mindful of the fact that inventory may be one of the account headings
affecting the loan covenants.
(Source: Graded questions on Auditing 2022 by Richard, Roets & Adams)
Comments on activity 3.6.1
In part (b) of the question, the relationship between materiality and audit risk is evident. Take note
of the importance of the reasoning provided for the increase or decrease in the materiality levels.
Marks will be awarded for the reasoning given.
Activity 3.6.2
Your firm has been appointed as the external auditor of a manufacturing company, XYZ (Pty) Ltd
to perform an audit for the eight months ending 31 January 20xx. The company has only existed
for eight months.
The following extracts from the statement of comprehensive income and the statement of financial
position refer:
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8 months ending 31 8 months ending 31 January 20xx

January 20xx – actual – budgeted figures
figures
R’000 R’000
Turnover 6 167 5 117
Profit before tax 2 027 1 789
Total assets 814 713
The external auditor used the following indicators and intervals for the calculation of materiality:
Turnover 0.5%–1%
Profit before tax 5%–10%
The external auditor estimated the risk of material misstatement for the financial statements, as
a whole, as low.
REQUIRED
Compute, providing reasons, the planning materiality figure for the financial statements, as a
whole, to be used for planning the 31 January 20xx audit of XYZ (Pty) Ltd.
STEP 1
Determine which figures to use
• The calculation will be based on the draft financial statement figures for the eight months
ending 31 January 20xx, as these are available. There is no indication that these figures will
change substantially, and they are most likely to approximate the figures in the financial
statements on which an audit opinion must be expressed.
• The external auditor was appointed to issue an opinion on the financial statements for the
eight months ending 31 January 20xx; therefore, the actual figures for the eight months will
be used.
STEP 2
Consider the indicators
The following indicators and intervals are used by the external auditor and were provided in the
question:
Turnover 0.5%–1%
Profit before tax 5%–10%
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STEP 3
Determine which of the indicators is appropriate for the calculation of materiality in

planning an audit
XYZ (Pty) Ltd made a profit for the eight months ending 31 January 20xx; therefore, profit before
tax is a suitable indicator. Furthermore, the turnover also appears to be appropriate as the
company manufactures goods that are sold to customers. Similarly, total assets are also an
appropriate indicator as the company is capital-intensive as the company is in the business of
manufacturing and therefore will have manufacturing equipment as part of the assets line item in
the statement of financial position.
(Note that it is important to motivate why an indicator is suitable or not, to earn full marks.
If the use or exemption of an indicator is not explained, marks cannot be awarded.)
STEP 4
Calculate the materiality interval for each of the suitable indicators
Indicator Calculation
Turnover 0.5%–1% of R6 167 000 =
R30 835–R61 670

Profit before tax 5%–10% of R2 027 000 =
R101 350–R202 700

Total assets 1%–2% of R814 000 =
R8 140–R16 280
STEP 5
Decide on a materiality figure to use when planning the audit
The total assets indicator should be excluded, as the range of figures is an outlier with respect to
the other indicators.
In view of the risk of material misstatement being assessed as low, the materiality figure to be
used for the planning of the audit should be set at the higher end of the two suitable indicator
ranges, thus R202 700.
Comments on activity 3.6.2
This question required you to determine the planning materiality for the financial statements
as a whole.
In specific circumstances, the auditor may determine performance materiality levels for
specific classes of transactions, account balances or disclosures. For example, if you are
required to calculate the performance materiality for; say, accounts receivable for the entity in this
example, you should take the following into account:
• risk of material misstatement was assessed as low, therefore your performance materiality
should be set at a higher level, for example 90% of planning materiality.
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• planning materiality was calculated as R202 700; thus, performance materiality for
accounts receivable may be calculated as R202 700 x 90% = R182 430.
Also consider that you might be required to determine whether or not a misstatement is clearly
trivial.
Activity 3.6.3
In order for you to revise what you have just learnt in terms of materiality, log onto myUnisa and
watch the exciting video that we have prepared for you.
Refer to section 4 of this tutorial letter and do questions 11 and 13.
Summary
In this lesson, we dealt with the practical application and calculation of audit materiality, and the
interaction between audit risk and audit materiality.
Self-assessment
1. Calculate the planning and performance materiality levels.
2. Describe how materiality levels and risk of material misstatement are related and
apply this knowledge to a scenario.
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LESSON 3.7: The auditor’s responses to risk
LEARNING OUTCOMES
• Explain and apply the audit risk model.

• Explain how the auditor should respond to risks of material misstatement at financial
statement level.
• Explain how the auditor should respond to risks of material misstatement at
assertion level.
• Determine which audit approach the auditor should follow.
Introduction
In lesson 3.3, you studied concepts to help you identify and assess an entity’s risk at financial
statement and assertion level as part of the planning stage of an audit. In order to mitigate the
identified risks, the auditor has to develop responses to deal with them.
Study
By now, you should understand that risks can be classified as inherent, control and detection
risks. The levels of an entity’s inherent risk and control risk (over which the auditor does not have
control ) are necessary to establish a level of detection risk (the risk controlled by the auditor) so
that the auditor can develop an overall audit strategy and audit plan to keep the audit risk at a
required level. The importance of determining the different levels of inherent, control and detection
risk (the risk components) and the relationship between the components are explained by
referring to the audit risk model as follows:
Audit risk (AR) = Inherent risk (IR) x Control risk (CR) x Detection risk (DR)
As mentioned before, even though AR comprises three components (IR, CR and DR), the auditor
only has full control over the level of DR. The auditor has no control over IR; and, as the client
has designed and implemented the system of internal controls, the auditor also does not have
control over CR. Once the levels of IR and CR are determined, it is necessary to establish DR. It
is important for the auditor to establish DR correctly so that the audit risk can be maintained at an
acceptable low level. (Remember audit risk is defined as the risk that the auditor expresses an
inappropriate audit opinion when the financial statements contain material misstatements. As an
auditor, you therefore want to keep the audit risk LOW as you do not want to formulate your
opinion incorrectly.)
Let us look at an example:
The auditor needs to maintain the AR at an acceptable level for each engagement. To do this,
the auditor assesses the IR and CR to determine the level of DR. For example:
• For a set level of AR, if the CR and IR together are high, the DR must be reduced and
set at a low level to balance the audit risk equation. A low level of DR means that there is
an increased risk that the auditor might not detect material misstatements in the financial
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statements. The auditor therefore has to respond to reducing the level of DR by increasing
the extent of his or her audit procedures.
• For a set level of AR, if the CR and IR together are low, a higher level of DR will be
acceptable to balance the audit risk equation. A high level of DR means that the auditor
might detect material misstatements in the financial statements more easily and will
therefore respond to the levels of risk by reducing the extent of his or her audit
procedures.
Once the auditor determined the extent of audit procedures to be performed to deal with the
assessed levels of risk, he or she starts to develop the overall audit strategy and audit plan setting
out the nature, timing and extent of audit procedures that will be carried out.
Note: The examples above generally only refer to IR or CR but you should remember that your
assessment of risk is conducted at two levels: financial statement level and assertion level. It is
therefore possible to have a low IR at financial statement level, but a high IR for a certain account
balance (assertion level). This means that your responses to risk might in some cases only be
directed at a specific account balance.
Responses to risks at financial statement level
After completion of your risk assessment and after determining the levels of IR, CR and DR at
financial statement level, the auditor develops responses to deal with the DR levels.
Study
• ISA 330, The auditor’s responses to assessed risks, paragraphs 5 and A1–A3
• ISA 240, The auditor’s responsibilities relating to fraud in an audit of financial statements,
paragraphs 29-30 and A34–A37
Note that at financial statement level, the responses listed in the studied ISA paragraphs relate
to overall responses and not to specific account balances, classes of transactions and related
disclosures.
Note the following from the study sources above:
1. The auditor’s responses to risk at financial statement level may include, for example:
• emphasising the need to maintain professional scepticism
• making sure the audit team comprises more experienced staff
• including more supervision
• incorporating additional elements of unpredictability into the audit procedures
• making general changes to the nature, timing or extent of audit procedures
2. When the auditor obtains an understanding of an entity’s system of internal control and
performs his or her risk assessment with the conclusion that the internal controls are not
working effectively, the auditor may decide to follow a substantive audit approach (approaches
are dealt with later in this lesson) and
• may conduct more audit procedures at the year-end rather than on an interim date
• perform more substantive procedures
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• increase the number of locations to be audited
3. When suspecting that fraudulent activities took place during the period under review, the
auditor should make sure that the overall responses include audit procedures to deal with risks
due to fraud. These responses can include increased sensitivity when selecting the nature
and extent of documentation to be audited; relying more on management representations;
assigning team members with specialised skills and knowledge and more experience and
incorporating unpredictability in the selection of audit procedures (you may also refer to lesson
3.4 which dealt with the auditor’s responsibilities relating to fraud).
Responses to risks at assertion level
We already established that different levels of required DR can be set for different account
balances, classes of transactions and related disclosures for different assertions based on your
risk assessment at assertion level.
In order to respond to these different levels of DR, the auditor has to decide what audit procedures
should be performed to obtain sufficient acceptable audit evidence to deal with the DR. To do
this, the auditor will establish an audit plan setting out the nature, timing and extent of the planned
audit procedures.
Read
• ISA 330, The auditor’s responses to assessed risks, paragraphs 6 - 23 and A4 – A58
• ISA 240, The auditor’s responsibilities relating to fraud in an audit of financial statements,
paragraphs 31-34 and A38 – A49
Note: For this tutorial letter it is not necessary to provide a list with detailed audit procedures that
you will perform to deal with the identified risks at assertion level. This will only be required of you
once you studied the contents of Tutorial Letters 103 and 104. At this stage of your studies, you
should only be able to provide a response by indicating, for example (this will be explained in
more detail in the lesson 3.9 where you learn more about the audit plan):
• whether or not you will perform tests of controls or substantive audit procedures for a
specific account balance, classes of transactions and related disclosures
• whether you will increase or decrease your audit procedures for a specific account
balance, classes of transactions and related disclosures
• whether or not you will use an expert
• whether or not it will be necessary to obtain a written confirmation letter from
management
• whether or not you might rely more on external audit evidence rather than on internal
evidence
In terms of the auditor’s response to risks due to fraud, the auditor should ensure that he or she
• considers the appropriateness of journal entries and/or other adjustments to the financial
statements
• reviews accounting estimates for bias
• considers the business rationale behind significant transactions
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After studying the concepts of and references to your prescribed study material, you should have
a better understanding of the auditor’s responses to identified risks. However, it is also important
for the auditor to respond appropriately to decide on which audit approach to follow, as discussed
in the next section.
Audit approaches
The auditor should decide between two audit approaches to follow, namely the combined audit
approach, which includes both tests of controls and substantive testing; or the substantive audit
approach, which only consists of substantive testing.
In order for the auditor to decide between the two audit approaches, the auditor first needs to
decide whether he or she can place reliance on the client’s internal controls; thus, whether or not
the client’s control risk is assessed as low. This is important because if the client has a high control
risk, it will not make sense to follow a combined audit approach. The relationship between the
internal control environment and control risk is therefore of utmost importance when deciding
which audit approach to follow.
Revision of 2nd year Auditing
The relationship between internal control and control risk
Control risk is defined as follows:
The risk that a misstatement, which may occur in a financial statement assertion that may be
material, either individually or in combination with other misstatements, will not be prevented or
detected and timeously corrected by the accounting and internal control systems.
Once an understanding of the accounting and internal control systems has been obtained, the
auditor should decide to what extent he or she can expect to trust the systems and should form a
preliminary evaluation of control risk. Control risk is first determined at financial statement level
and then at assertion level and only after inherent risk has been assessed.
Because of the inherent limitations of internal control, a risk always exists that material
misstatements in an account balance or class of transactions will not be prevented or detected
and corrected by the accounting and internal control systems.
This is important to an auditor, because he or she decides on an acceptable level of audit risk;
and if the control risk is increased, he or she should manage it by decreasing the detection risk.
It is important that an auditor understands the accounting and internal control systems of the
auditee and decide whether the client audit system is reliable.
If the accounting and internal control systems are believed not to be functioning effectively, the
auditor would assess the control risk as high. The opposite is also true: If the accounting and
internal control systems are expected to be functioning effectively to prevent, detect and correct
material misstatements, the auditor would assess the control risk as low. The control risk
therefore directly depends on the design and functioning of the accounting and internal control
systems.
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In table 3.7.1, the way in which auditors evaluate control risk is summarised.
TABLE 3.7.1: Evaluating control risk
Control risk Reason

Internal controls related to the assertion are present, which should prevent
Low (note 1)
a material misstatement, or should detect and correct it.
High (note 2) Accounting system and internal controls are ineffective.
The auditor has decided not to rely on the internal controls because it would
High (note 2) serve no purpose, but rather to carry out extensive substantive procedures
to reduce the audit risk to an acceptable level.
Notes
(1) If the auditor has assessed the control risk as low, he or she should perform the tests of
controls required to obtain sufficient, appropriate audit evidence to prove that the internal
controls were operating effectively during the audit period.
(2) If the auditor has assessed the control risk as high, he or she should determine which
errors and irregularities are likely to occur because of the weaknesses in the accounting
system and internal controls and should determine appropriate substantive procedures that
could detect such errors and irregularities. Take note that the auditor will only perform
substantive procedures in areas of weak internal controls for which he or she considers
the risk of material misstatement as high.
In your second year auditing studies (AUE2602), the following internal control aspects relevant to
an auditor when deciding to place reliance on internal controls were also discussed:
• The controls in a manual and an automated (computerised) environment within the

various business cycles:
o If an entity’s accounting system is partly or entirely computerised (automated), an

auditor must obtain an understanding of the computer environment and the
computerised (automated) applications that take place in that environment. This
understanding is part of an auditor’s assessment of the capacity of the accounting
system to generate reliable financial information. A preliminary understanding of the
computer environment and computerised (automated) applications is required to help
the auditor to design audit procedures. Remember, that we discussed that the auditor
obtains this understanding during the planning phase as part of understanding an entity
and its environment (lesson 3.2).
o If an auditor intends to rely on the entity’s internal control systems as a result of the
preliminary gaining of an understanding thereof, whether computerised (automated) or
influenced by computer processing, he or she should study those controls in the same
way as the internal controls in a manual system would be studied.
o The auditor cannot simply accept that all transactions included in computerised
(automated) reports are authorised, have occurred, and are complete and accurate. He
or she must first test the application controls.
Remember that, as the auditor, you should be able to formulate tests of controls to evaluate
( test) the manual controls, general controls and application controls. You need to identify
the manual, general and application controls a client has in place from a given scenario to
formulate these tests of controls. This is dealt with in more detail in Tutorial Letter 103 of
this module.
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• General and application controls
A prerequisite for confidence in the automated (computerised) application controls is

confidence in the general controls. This requires that the general controls should first be
assessed by the auditor before any application controls can be tested and a decision taken
to rely on them.
In summary: If the general controls cannot be relied on, there is no need to test the
application controls and substantive testing must be performed. If the general controls can
be relied on but not the application controls, once again substantive testing must be applied.
Audit approaches that the auditor must follow can be graphically illustrated as in figure 3.2.2:
FIGURE 3.7.1: Audit approaches to be followed
Scenario 1
Cannot Cannot rely Audit approach:
rely on on substantive
general AND application testing
controls controls
Scenario 2
Cannot Can rely on

rely on application Audit approach:
general AND controls substantive
controls testing
Scenario 3
Can rely Cannot rely Audit approach:

on general on substantive
AND
controls application testing
controls
Scenario 4
Can rely Can rely on
on general application Audit approach:
AND combined audit
controls controls
approach
The audit approaches to be followed form part of the auditor’s audit plan (lesson 3.9).
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Study
The relationship between control risk and tests of controls
If an auditor decides to rely on an auditee’s internal control system and has assessed the control
risk as low (which means that the system of internal control seems to be effective), he or she must
test the system to establish whether or not it is effective. We refer to tests of controls that are
procedures the auditor follows to gather audit evidence on the effectiveness of the internal control
system and the operation of the systems during the reporting period. The tests of controls are
discussed in Tutorial Letter 103. You should also remember that the auditor can never perform
tests of controls only and that his or her audit procedures should always include some substantive
procedures.
Based on the results of the tests of controls, the auditor should decide whether his or her initial
assessment of the control risk justifies his or her reliance on the internal control system. If the
auditor’s reliance on the internal control system is not justified, the auditor must raise the control
risk.
Activity 3.7.1
We have prepared a few multiple-choice questions for you on myUnisa to refresh your memory
of some basic concepts that you have studied thus far in lessons 3.1 to 3.7.
Summary
In this lesson, we discussed how the auditor will respond to risks identified in his or her
assessment of risk, and the audit approach that should be followed. In the next two lessons you
will learn more about the auditor’s responses to the overall audit strategy (lesson 3.8) and audit
plan (lesson 3.9).
Self-assessment
if you are able to do the following:
1. Explain and apply the audit risk model.

2. Explain how the auditor should respond to risks of material
misstatement at financial statement level.
3. Explain how the auditor should respond to risks of material
4. Determine which audit approach the auditor should follow.
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LESSON 3.8: The overall audit strategy
LEARNING OUTCOME
• Identify and describe the aspects that will influence the scope, timing and direction
of the audit when establishing the overall audit strategy.
Introduction
We have already established that ISA 300, Planning an audit of financial statements, requires
that the auditor should plan an audit of financial statements (Refer to lesson 3.1.). We also
established that the planning stage consists of different phases.
Some phases in the planning stage of an audit were already discussed in the previous lessons.
The aim of this lesson is to explain the audit principles related to developing the overall audit
strategy during the planning phase of an audit.
When planning an audit, the auditor is required to establish the overall audit strategy (ISA 300:
paragraph 02). The overall audit strategy gives a preliminary idea of the scope, timing and
direction of the audit and the resources that will be needed for the audit.
At the beginning of each year, we often hear people discuss their New Year’s resolutions. What
were your resolutions for the year, and did you fulfil them?
Feedback: Individuals make different New Year’s resolutions. Maybe one of your resolutions is
to pass this module, to take a vacation or a trip to visit your family or to lose extra weight by going
to the gym more often. However, many of these resolutions are not carried out because we do
not do the necessary planning to make our resolutions become reality.
Look at the following example: If your resolutions include taking a vacation or a trip to visit your
family during the year, you need to have a preliminary idea of what activities you would like to do
on your vacation or during your visit and when and where you would like to go. For example, do
you want to do deep-sea diving in March at the coast, or do you want to go to the bushveld to see
the Big Five in July or visit your family who lives in another province than you? This preliminary
idea can be called your strategy. Once you have drafted your strategy of when and where you
want to go, you can start focusing on the details of planning your trip, for example specific dates,
searching for accommodation, and so forth.
Just like a trip, an audit must be planned. If you do not plan for the audit, you will possibly not
succeed in gathering sufficient audit evidence to form an audit opinion. Therefore, as an auditor,
you must first establish an overall strategy of the range of activities you should perform, the dates
on which the audit activities should take place, and whether you need to focus on specific areas
during the audit. This can be called your overall audit strategy. Once your overall audit strategy
is in place, you can start working on the details of planning the audit. This is your audit plan, which
is explained in the next lesson.
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Study
ISA 300, Planning an audit of financial statements paragraphs 7, 8, 12, A8 to A11, A18, A20 and
the Appendix.
ISA 240, The auditor’s responsibilities relating to fraud in an audit of financial statements,
paragraphs 29–30; A34–37.
ISA 250, Consideration of laws and regulations in an audit of financial statements, paragraphs 14
and A12.
The section dealing with the overall audit strategy as part of planning, in chapter 6 of Auditing
Notes.
• The audit strategy sets the scope, timing and direction of the audit (ISA 300 paragraph 7).
Scope Refers to the range of activities the auditor must perform
For example, if the company is governed by industry-specific regulations, the

auditors should familiarise themselves with such requirements and make sure
that the reporting complies with these requirements.
Note that this is only one example and that there are many more. Please refer
to the Appendix to ISA 300.
Timing Refers to the timing, that is, when audit procedures should be performed
The auditors can perform audit procedures at one of the following times:
• before year-end (interim)
• at the year-end or after the year-end
• early verification, just prior to year-end, and rolling forward at year-end
• both at the interim stage and after the year-end
Direction Refers to the areas of focus
The auditors should consider significant factors and should direct their
attention to the areas of focus.
For example, if the risk assessment procedures determined that the company
experienced going concern issues, the auditor should direct his or her efforts
to this specific area.
• The considerations in establishing the overall audit strategy (ISA 300 paragraphs 8, A8-
A11 and the Appendix) should be noted. The appendix has a detailed list of considerations in
establishing the overall audit strategy.
• The overall audit strategy should be updated and changed throughout the audit (ISA 300
paragraphs 10 and A15).
• The auditor should include the overall audit strategy in the audit documentation (ISA 300
paragraphs 12, A18-A21).
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Activity 3.8.1
Your audit firm has recently been appointed as the auditor of AUE (Pty) Ltd (AUE). AUE is a
subsidiary of CTA Ltd (CTA). The holding company is listed, and it has numerous subsidiaries.
Subsidiaries are required to comply with and report on group corporate governance policies. The
audit of AUE has a tight deadline. All systems of the company are automated (computerised).
CTA has a large internal audit department that it uses to conduct evaluations and reviews at its
subsidiaries. Profit margins at AUE are low and overall revenue has declined over the past year.
Two months before year-end, you begin planning for the audit of AUE.
REQUIRED
Identify and describe the aspects that will have an influence on the scope, timing and direction of
the overall audit strategy of AUE’s audit. (Note that you are not required to focus on CTA, the
holding company, as this may also include other answers related to the consolidation.
Examination technique: When working through the scenario, approach it line by line to identify
the aspects that will influence your audit strategy.

The overall audit strategy sets the scope, timing and direction of audit procedures.
To assist you in identifying the issues in the scenario that will affect the scope, timing and
direction of the audit strategy, we have included the scenario again and references to the
suggested solution.
subsidiary (affects scope and direction – refer to points 1 and 6) of CTA Ltd (CTA). The holding
company is listed (affects scope – refer to point 1) and it has numerous subsidiaries (affects
direction – refer to point 6). Subsidiaries are required to comply with and report on group
corporate governance policies (affect scope – refer to point 1). The audit of AUE has a tight
audit deadline (affects timing – refer to point 4). All systems of the company are automated
(computerised) (affects scope – refer to point 2).
CTA has a large internal audit department that it uses to conduct evaluations and reviews
at its subsidiaries (affects scope and timing – refer to points 3 and 5). Profit margins at AUE
are low and overall revenue has declined over the past year (affect direction – refer to point
7).
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Two months before the year-end, you begin planning for the audit of AUE (affects timing –
refer to point 4).
The solution to activity 3.8.1 is as follows:
AUDIT STRATEGY
Scope 1. The fact that AUE is a subsidiary of CTA will affect the scope of the engagement
because
• the holding company is a public company; thus, the audit is a statutory
audit that must comply with the Companies Act 71 of 2008, and the
Auditing Profession Act 26 of 2005 (AUE’s audit must therefore also
comply with the Companies Act and the Auditing Profession Act.)
• the holding company is listed; thus, it is likely that AUE will have
additional reporting obligations
• AUE must comply with and report on group corporate governance
policies, in which the auditors might be required to be involved
• it is likely that AUE will have to adopt the group accounting policies or
disclosures with which the auditors must familiarise themselves.
2. The fact that AUE uses automated (computerised) systems will affect the scope
because computer-assisted audit techniques will be used whenever possible.
3. The fact that the CTA has an internal audit function that conducts evaluations
and reviews at its subsidiaries will affect the scope of the audit because the
internal audit department may be able to assist with information relating to AUE’s
internal control system.
Timing 4. Owing to tight audit deadlines, early verification audit procedures could be
performed in the two months before year-end and rolled forward at year-end.
5. As the holding company is listed; reporting timelines to the holding company
must be taken into consideration.
6. The involvement of the internal auditors, the holding company’s auditors and
other senior personnel in the audit, must be considered to schedule timeous
meetings.
Direction 7. The fact that AUE is one of numerous subsidiaries will affect the direction of
the audit because attention should be given to the identification of related parties
and disclosure of related-party relationships and transactions.
8. The low-profit margins and the decline in revenue will affect the direction of
the audit because
• they raise a risk relating to the going concern of AUE, for which a careful going
concern evaluation should be conducted
• AUE’s financial position might be manipulated (decline in revenue); therefore,
attention should be paid to the completeness of sales (understatement).
Note: When answering this type of question, it is important to explain your answer. Do not, for example,
just write down that the holding company is listed, remember to explain why or how the listing of the
holding company will affect your scope.
Activity 3.8.2
We have prepared a short video for you on audit strategy. Log onto myUnisa to view it as part of
lesson 3.8.
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Refer to section 4 of this tutorial letter and do questions 12 and 13.
Summary
This lesson explained auditing principles related to establishing the overall audit strategy during
the planning stage of an audit. The overall audit strategy sets out the scope, timing and direction
of the audit. Now that you have gained a better idea of the overall audit strategy, we can explain
the development of the audit plan, which is discussed in the next lesson.
Self-assessment
if you can answer the following question:
1. Identify and describe the aspects that will influence the scope, timing and direction
of the audit when establishing the overall audit strategy.
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LESSON 3.9: The audit plan
LEARNING OUTCOME
• Identify and describe the aspects that will influence the nature, timing and extent of
the audit when developing the audit plan.
Introduction
In lesson 3.1, you learnt that the planning stage of an audit consists of different phases. For a
reminder of the different phases of the planning stage of an audit, you may refer back to figure
3.1.1.
In this lesson, we will explain the last phase of the planning stage of an audit, namely developing
an audit plan. However, even though this is seen as one of the last phases of the planning stage,
you should remember that the audit plan must be updated throughout the audit process.
Do you remember our discussion of planning a trip in the previous lesson? We said that once you
have a preliminary idea (strategy) for your trip, you can start planning the details of your trip (plan).
As with planning a trip, the audit plan is guided by the completion of the overall audit strategy,
and it is more detailed than the audit strategy.
Remember how we explained that the overall audit strategy sets out the scope, timing and
direction of the audit (refer to lesson 3.7)? In this lesson, we will explain that the audit plan
includes the nature, timing and extent of audit procedures to be performed during the audit.
Study
1. ISA 300, Planning an audit of financial statements paragraphs 9, 10, 12, A12-A15; A18-A21.
2. The section dealing with the audit plan as part of planning, in chapter 6 of Auditing Notes.
3. The section dealing with general observations relating to the nature, timing and extent of
further audit procedures in chapter 6 of Auditing Notes.
• The audit plan sets out the nature, timing and extent of audit procedures (ISA 300
paragraphs 9 and A12-A14). More details of the nature, timing and extent of audit procedures
are discussed later in this module (refer to Tutorial Letter 104). In brief, it may be summarised
as follows:
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Nature Refers to the type of audit approach and the purpose and type of audit
procedures to be performed (ISA 330 paragraphs A4 and A5)
The auditor can decide to follow one of the following approaches:
1. He or she can follow a combined audit approach, according to which both

tests of controls and substantive procedures should be performed. This
approach is followed when the auditor intends to rely on the operating
effectiveness of internal controls or when substantive procedures alone
cannot provide sufficient appropriate audit evidence.
2. He or she can follow a substantive procedure approach, according to

which both tests of detail and analytical procedures should be
performed. This approach is followed when the risk assessment
procedures have not identified appropriate and sufficient controls relevant
to the assertion or because testing controls would be inefficient.
Timing Refers to the timing when audit procedures should be performed (ISA 330
paragraph A6)
The auditor can perform audit procedures at one of the following times:
• before the year-end (interim)
• at and after the year-end
• early verification, just prior to the year-end and rolling forwards to the
year-end
• both at the interim stage and after the year-end.
Extent Refers to how many tests or audit procedures you will perform and in how
much detail (ISA 330: paragraph A7)
This refers to the number of tests of detail and/or analytical procedures you will
perform. For example, if the audit client has a strong control environment, you
will perform tests of controls with fewer tests of detail and more analytical
procedures.
Note: Later in your studies, you will learn about audit sampling to determine
the sample sizes used to collect audit evidence.
• The audit plan should be updated and changed throughout the audit (ISA 300
paragraphs 10 and A15).
• The auditor should include the audit plan in the audit documentation (ISA 300
paragraphs 12, A18-A20).
Note: In order to identify and describe aspects that will have an influence on the nature, timing
and extent of the audit plan, you may also refer to the lesson dealing with the auditor’s responses
to risks (ISA 330 and Tutorial Letter 103 which you will study later on in this module) where the
nature, timing and extent of audit procedures are described in more detail.
Activity 3.9.1
Note: This activity is the same activity as the one in lesson 3.8 that deals with the overall audit
strategy, but now you are required to formulate the audit plan.
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subsidiary of CTA Ltd (CTA). The holding company is listed, and it has numerous subsidiaries.
Subsidiaries are required to comply with and report on group corporate governance policies. The
audit of AUE has a tight deadline. All systems of the company are automated (computerised).
CTA has a large internal audit department that it uses to conduct evaluations and reviews at its
subsidiaries. Profit margins at AUE are low and overall revenue has declined over the past year.
Two months before the year-end, you begin planning for the audit of AUE.
REQUIRED
Identify and describe the aspects that will influence the nature, timing and extent of the audit when
developing the audit plan for AUE.
Examination technique: Work through the scenario line by line to identify the aspects that will
influence your audit plan.
The audit plan sets the nature, timing and extent of audit procedures.
To assist you in identifying the issues in the scenario that will affect the nature, timing and extent
of the audit plan, we have included the scenario again and provided references to the suggested
solution.
subsidiary (affects nature) of CTA Ltd (CTA). The holding company is listed, and it has numerous
subsidiaries. Subsidiaries are required to comply with and report on group corporate governance
policies. The audit of AUE also has a tight audit deadline (affects timing). All systems of the
company are automated computerised (affects nature).
CTA has a large internal audit department (affects nature and extent) that it uses to conduct
evaluations and reviews at its subsidiaries. Profit margins at AUE are low and overall revenue
has declined over the past year (affects nature, timing and extent).
Two months before the year-end, you begin planning for the audit of AUE (affects timing).
The solution to activity 3.9.1 is as follows:
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AUDIT PLAN
Nature • Follow a combined audit approach with both tests of controls and substantive
procedures. This approach is chosen because
• you intend to rely on the operating effectiveness of internal controls (owing to
the existence of an internal audit department); and
• substantive procedures alone will not provide sufficient appropriate audit
evidence.
• Computer-assisted audit techniques should be used to test the automated
(computerised) applications or controls.
• Specific risks can be dealt with as follows:
• Perform substantive procedures to deal with the going concern risk.
• Perform substantive procedures on related-parties and inter-group transactions
and balances.
• Perform substantive procedures on internal audit reports.
• Perform tests of controls and substantive procedures to test for completeness
of sales.
Note that you don’t have to describe detailed audit procedures as part of this section
of the audit plan for this tutorial letter. You only have to mention the type of audit
procedures (substantive procedures or tests of controls) you will perform and the
classes of transactions, account balances and related transactions on which the
procedures have to be performed. Later in your studies (Tutorial Letters 103 and 104),
you will learn more about detailed audit procedures after which you should be able to
formulate and describe detailed audit procedures.)
Timing Because of tight audit deadlines, early verification audit procedures could be performed
just before the year-end and rolled forward at the year-end.
For example, important balance sheet work such as debtors’ circularisation, creditors’
reconciliations or fixed asset verification could be done before the year-end and “rolled
forward”. Fixed asset schedules should also be prepared and changed before the year-
end could be audited after the year-end.
Initial substantive procedures, for example scrutiny of books and discussions, could
take place before the year-end, but the final going concern evaluation should be
conducted after the year-end.
Tests of controls and substantive audit procedures on sales can also be performed
before the year-end and rolled forward at the year-end.
Meetings with internal auditors, the holding company’s auditors and other senior
personnel, who should be involved in the audit, must be scheduled before and after the
year-end so that important matters, such as expectations and reporting timelines, can
be communicated.
Extent The number of tests or audit procedures could be reduced if you can rely on the internal
audit department.
However, comprehensive tests should be conducted on risk areas such as going

concern, related parties and completeness of sales.
Note: When answering this type of question, it is important to explain your answer. Do not, for example,
just write down that you will follow a combined audit approach; motivate what is meant by it and why
you are following the applicable approach.
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Additional comments on activity 3.9.1
While doing the activity, did you notice the difference between the overall audit strategy and
the audit plan? Remember, the overall audit strategy is a preliminary plan that sets out the
scope, timing and direction of the audit, whereas the audit plan sets out the nature, timing
and extent of the audit procedures. Another difference is that the overall audit strategy
provides an overview of audit procedures to be performed, whereas the audit plan is more
detailed in the sense that it provides more information on the audit procedures (nature,
timing and extent of tests of controls or substantive procedures) that should be performed
during the audit.
Activity 3.9.2
We have prepared a short video for you dealing with the audit plan. Log onto myUnisa to view it
as part of lesson 3.9.
Refer to section 4 of this tutorial letter and do question 11.
Summary
In this lesson, we explained concepts related to developing the audit plan. The audit plan sets out
the nature, timing and extent of the audit procedures.
You should now have a good understanding of each of the different phases when planning an
audit (stage 2 of the audit process). Before moving on to the next stage of the audit process, you
should also familiarise yourself with the general requirements for preparing the audit
documentation that should be kept throughout the audit process (Refer to lesson 3.10.).
Self-assessment
1. Identify and describe the aspects that will influence the nature, timing and extent of
the audit when developing the audit plan.
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LESSON 3.10: Audit documentation
LEARNING OUTCOMES
• Explain the purpose of audit documentation.

• Explain the auditor’s objective in preparing audit documentation.
• Evaluate audit documentation based on the requirements of ISA 230.
• Explain the requirements for assembling the final audit file.
Introduction
The publication of ISA 320, Audit documentation, requires the auditor to prepare audit
documentation for an audit of the financial statements. Audit documentation prepared by the
auditor should provide evidence that supports the basis for the auditor’s report and evidence that
the audit was planned and performed according to the ISAs and applicable legal and regulatory
requirements.
Study
ISA 230 and the relevant sections dealing with audit documentation in chapter 17 of Auditing
Notes.
• the purpose of audit documentation (ISA 230 paragraphs 2 and 3)

• the auditor’s objective in preparing audit documentation (ISA 230 paragraph 5)
• the definitions of “audit documentation”, “audit file” and “experienced auditor” (ISA 230
paragraph 6)
• The audit documentation that should be prepared on a timely basis (ISA 230 paragraphs 7
and A1)
• the ISA requirements of audit documentation for the audit procedures performed and the
audit evidence obtained (ISA 230 paragraphs 8–13, A2–A20)
• the requirements for assembling the final audit file (ISA 230 paragraphs 14–16, A21–A24)
The auditor should prepare and update audit documentation throughout the different stages of
the audit process. In addition to the requirements of ISA 230, a list of other ISAs with specific
audit documentation requirements can be found in the Appendix to ISA 230. Figure 3.10.1
represents the list in the appendix to ISA 230, indicating the different stages of the audit process.
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FIGURE 3.10.1: Specific audit documentation requirements in other ISAs for each stage of
the audit process:
•ISA 210 "Agreeing the terms of audit engagements" - paragraphs

The preliminary 10-12
engagement activities •ISA 220 "Quality contrl for an audit of financial statements" -
paragraphs 24-25
•ISA 300 "Planning an audit of financial statements" - paragraph 12

•ISA 315 (Revised 2019) "Identifying and assessing the risks of
material misstatement" - paragraph 38
•ISA 240 "The auditor's responsibilities relating to fraud in an audit
of financial statements" - paragraphs 45-48
Planning an audit •ISA 250 "Consideration of laws and regulations in an audit of
financial statements" - paragraph 30
•ISA 260 "Communication with those charged with governance" -
paragraph 23
•ISA 320 "Materiality in planning and performing an audit" -
paragraph 14
•ISA 330 "The auditor's responses to assessed risks" - paragraphs

28-30
•ISA 450 "Evaluation of misstatements identified during the audit" -
paragraph 15
•ISA 540 "Auditing accounting estimates, including fair value
Obtaining audit accounting estimates, and related disclosures" - paragraph 39
•ISA 550 "Related parties" - paragraph 28
evidence •ISA 600 "Special considerations - audits of group financial
statements (including the work of component auditors" -
paragraph 50
•ISA 610 "Using the work of internal auditors" - paragraphs 36-37
•ISA 720 "The auditor's responsibilites relating to other
information" - paragraph 25
•ISA 700 “Forming an opinion and reporting on financial

statements” does not require specific audit documentation to be
Evaluating, concluding prepared by the auditor. However, the auditor will use the audit
documentation and evidence obtained during the first three stages
and reporting of the audit process to form an opinion and to provide the auditor's
report.
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Activity 3.10.1
The following working paper for bank and cash was prepared by a first year trainee accountant
on the audit of Jewels (Pty) Ltd:
Client name Jewels (Pty) Ltd Year 30 June 20xx
A1
end
Prepared by TR Ainee
Audit section Bank and cash
BOTSWANA BNB BANK – ACCOUNT NUMBER 690191000
Description of the account

Jewels (Pty) Ltd has several bank accounts with various local and foreign banks. The foreign bank
accounts, such as the account with Botswana BNB Bank (690191000), are mainly used to facilitate trade
with foreign suppliers. Mr A Ruby, the accountant, prepares bank reconciliations monthly, which are
reviewed by Ms A Diamond, the financial manager.
This is a material account balance and the risk of misstatement relating to this account is assessed as
higher. The only relevant assertion relating to this account is accuracy, valuation and allocation.
Work performed
The bank reconciliation was inspected.
REQUIRED
Evaluate working paper A1 of Jewels (Pty) Ltd by identifying and describing the shortcomings
in terms of the requirements of audit documentation. Base your answer on ISA 230.
Shortcomings of working paper A1, based on ISA 230:
• The working paper indicates the name of the preparer but does not indicate the date on
which it was prepared.
• The working paper does not indicate by whom it was reviewed.
• The working paper does not indicate the date on which it was reviewed.
• The working paper does not contain a detailed explanation of the audit procedures
performed.
• The working paper does not contain the results of the audit procedures performed.
The following is an example of how the working paper given in activity 3.10.1, should have looked
to comply with the requirements of ISA 230:
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Client name Jewels Year 30 June 20xx Comments An indication of who
Prepared by
(Pty) Ltd
TR Ainee
end
Date 10 July 20xx
A1 performed the work and the date
[ISA 230 para 9(b)]
Reviewed YOU Date 13 July 20xx Comments This indicates who

by reviewed the work and the date
[ISA 230 para 9(c)]
Audit Bank and cash
section
BOTSWANA BNB BANK – ACCOUNT NUMBER

690191000
Description of the account

Comments Recording of the
Jewels (Pty) Ltd has several bank accounts with various local identification of the specific items
and foreign banks. The foreign bank accounts, such as the is tested. This documentation
account with Botswana BNB Bank (690191000), are mainly should have sufficient detail for
used to facilitate trade with foreign suppliers. Mr A Ruby, the the reviewer to understand what
work has been performed. (Most
Accountant, prepares bank reconciliations monthly which are of the time, the reviewer will not be
then reviewed by Ms A Diamond, the Financial Manager. present during the audit.) [ISA 230
paragraphs 8 & 9(a)]
This is a material account balance and the risk of
misstatement relating to this account is assessed as high.
The only relevant assertion relating to this account is Comments Since the risk is
higher, the audit work performed
accuracy, valuation and allocation. (described below) is inadequate.
Additional work should be
Work performed performed. Refer to bullet three
• Obtained bank reconciliations of one month and under “Additional comments”.
inspected that the financial manager had signed as proof
of review.
Comments A detailed
• Followed reconciling items through from the bank explanation of the audit
reconciliation of the previous month. procedures performed is given
• Discussed bank and cash with the financial manager. (ISA 230 paragraph 9)
Conclusion
Comments Results of audit
The bank and cash do not appear to be materially misstated. procedures performed (ISA 230
paragraph 8).
Although ISA 230 does not

specifically require work papers to
include an objective, it is useful to
have an objective for the
procedures. The conclusion could
then be tied to the objective to
establish whether or not the
objective had been achieved.
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Additional comments on the example

• Audit documentation is commonly referred to as “working papers” or “work papers”.
• In practice, the form and content of audit documentation may vary considerably, since such
work papers are drawn up in accordance with the auditor’s professional judgement. Audit
documentation can be recorded on paper or on electronic or other media. Examples of audit
documentation include audit programmes, analyses, memorandums, summaries of
significant matters, letters of confirmation and representations, checklists, correspondence
(including e-mails) concerning significant matters, and so forth. Irrespective of the format in
which work papers are kept, all the requirements of ISA 230 regarding content should be
complied with.
• The reviewer should evaluate if sufficient and appropriate evidence was obtained of the
item audited. For example, the reviewer might consider that the audit procedures were not
sufficient and might also request the audit team to perform other audit procedures. In activity
3.9.1; the risk was assessed as high, which might necessitate performing other audit
procedures in addition to those described in working paper A1. For example, the reviewer
may request the audit team to re-perform the bank reconciliations, trace the bank reconciling
items to supporting documentation, re-perform the calculations on the bank reconciliation,
agree amounts from the general ledger to the financial statements and so forth.
• Audit documentation is the property of the audit firm, and the firm is in no way obliged to
make it available to the audit client or any third party, unless required to do so by law.
• The final audit file should be assembled timeously, which is usually not more than 60 days
after the date of the auditor’s report. The final audit file should be kept until the end of its
retention period. If documents need to be modified or added after the final audit file has been
completed, the auditor should comply with additional audit documentation requirements.
Summary
Audit documentation includes all the working papers drawn up on the conduct of the audit. These
working papers should be sufficiently completed and detailed to provide an overall picture of the
audit, which will ultimately enable the auditor to express an audit opinion in the auditor’s report.
Self-assessment
can answer the following questions:
1. Explain the purpose of audit documentation.

2. Explain the auditor’s objective in preparing audit documentation.
3. Evaluate audit documentation based on the requirements of ISA 230.
4. Explain the requirements for assembling the final audit file.
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4 SELF-ASSESSMENT QUESTIONS
4.1 Introduction
This section contains questions on the lessons included in this tutorial letter. The suggested
solutions to these questions are available in the next section of this tutorial letter. We strongly
suggest that you first attempt to answer these questions on your own without looking at the
solution. If you struggle, you can always request assistance from your e-tutor or lecturer. After
writing down your answers, you can perhaps ask someone in your study group to critically review
your answer by comparing it to the solution and provide you with feedback. We believe that you
will benefit hugely from this method of doing self-assessment questions.
The self-assessment questions in this section only cover certain aspects of the study
material. Make sure that you attempted to answer all the questions in the activities of each
lesson. This does not mean that the areas that are not covered are less important. All the
study material in the various topics is of equal importance. Note that from time to time we
might make more questions available to you on myUnisa.
4.2 Important principles to remember when answering a question
Principles of importance when

Detail guidelines
answering a question
Question • Read the “required” section thoroughly.
• Make sure that you understand what is required of you.
• Read the text section (case study/scenario) of the question
carefully.
• Make notes, write down thoughts and underline important
words, keeping the theory in mind.
• Understand the given situation in the question.
• Search for relevant information/answers in the question, in
other words, do not do a “memory dump”. Apply your
knowledge and theoretical principles to the information
provided in the question.
• Use the mark allocation as a guideline to determine how
many points should be written down.
• If asked to “describe”, 1½ marks will be allocated for each
valid answer; list or a short answer may be worth less and
will earn you 1 mark per valid answer.
Layout • Make sure that you answer a question in the requested
format, for example a letter, memorandum, table, and so
forth. Marks will be allocated for using the required format.
• If no specific layout of the question is prescribed, your answer
should be presented as follows: use
- bullets
- numbers
- appropriate headings/sections.
• If possible, leave lines open between the various headings
and sentences.
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Principles of importance when

Detail guidelines
answering a question
Language • A high standard of language usage should be maintained, for
example, instead of “look” use “inspect” or instead of “hear”,
ABCD •
use “enquire”.
Do not use “SMS” language.
• Do not use abbreviations that are not generally accepted.
Handwriting • Take note that if you choose to write out your answer that
your handwriting should be neat and legible.
Time • Answer all the questions.

• In order to apply time management, you should keep in mind
that the available time in the examination is limited to three
hours for 100 marks. Therefore, 1.8 minutes are available to
earn 1 mark; for example, a question of 20 marks should be
answered in a maximum of 36 minutes. Thus, it is easy to
calculate how much time you should spend on each question.
• With reference to the question section above and the answer
section below, it means that you will have to write down 10
valid points in 27 minutes to earn 15 marks (this time
allocation only applies to “describe” questions).
• Keep to the time calculated for each question.
Answer • Answer only what is required.
• Use and make the information provided in the question
applicable to the answer.
• Provide clear and specific answers based on the facts and
requirements of the question.
• Remember that marks will be allocated for logical arguments,
proper presentation of the facts, good auditing language and
clear facts.
• The number of points required per answer is indicated by the
marks allocated to the question. You will earn 1½ mark for
each valid point which is properly described. For each valid
point listed or for a short answer, 1 mark will be allocated,
unless otherwise indicated in the question.
4.3 Self-assessment questions to be attempted
Question Reference Topic

number
1 Lesson 1.2 Regulation of the auditor (APA)
2 Lesson 1.2 Regulation of the auditor (APA – RI)
3 Lesson 1.2 Regulation of the auditor (ethical concerns)
4 Lesson 1.2 Regulation of the auditor (ethical concerns)
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Question Reference Topic
number
5 Lesson 1.3 Corporate Governance (King IV)
6 Lesson 1.3 Corporate Governance (King IV)
7 Lesson 2.1 Preliminary audit engagement activities
8 Lesson 3.3 Risks of material misstatement at financial statement and
assertion levels
9 Lesson 3.3 Significant risks of material misstatement at financial
statement level and risks of material misstatement at
assertion level
10 Lesson 3.3 Risks of material misstatement at financial statement and
assertion level
11 Lessons 2.1, 3.3, • Risks of material misstatement at financial statement and
3.6, 3.9 assertion levels
• Planning materiality
• Preliminary audit engagement activities
• The audit plan
12 Lessons 3.3 and • Risks of material misstatement at financial statement and
3.8 assertion levels
• The overall audit strategy
13 Lessons 1.2, 2.1, • Fundamental principles of ethics
3.3, 3.6 and 3.7 • Preliminary audit engagement activities
• Risks of material misstatement at financial statement and
assertion levels
• Materiality
• The overall audit strategy
QUESTION 1
A question dealing with the Regulation of the auditor will be uploaded on myUnisa.
QUESTION 2
A question dealing with the Regulation of the auditor will be uploaded on myUnisa.
QUESTION 3 20 marks
You have been appointed as a first-year trainee accountant at TJM Incorporated (TJM).
TJM is a medium-sized audit firm. All TJM’s audit partners are chartered accountants and
registered auditors. TJM was appointed as the new auditors for PerfectViews (Pty) Ltd
(PerfectViews), with a financial year end of 30 September. PerfectViews manufactures and
installs aluminium windows and doors and has operations in South Africa and Namibia.
The correct process was followed in appointing TJM as the new external auditor for the 20x1
financial year in terms of the Companies Act. The audit will be led by Mrs Prang, one of TJM’s
audit partners who predominantly has audit clients in the insurance and mining industries. She
will be assisted by one audit manager, one third year trainee, yourself and two postgraduate
accounting students. In comparison with the previous auditors, the audit team appears to be
smaller and less experienced.
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To assist PerfectViews with their cash flow constraints, as part of audit fee negotiations with Mrs
Prang, PerfectViews offered to renovate TJM’s offices by replacing their wooden window frames
with aluminium frames and the clear glass of the windows with tinted glass. The cost of the
renovations will amount to 80% of the audit fee, which means that PerfectViews only has to pay
20% of the audit fee in cash to TJM. The audit fee is based on the audit fee charged by the
preceding auditors plus 5% inflation.
REQUIRED
Discuss any ethical considerations that TJM auditors should consider regarding the audit fee
arrangement. (20)
QUESTION 4 30 marks
You have been appointed as a first-year trainee accountant at Tlhahlobo Incorporated, a medium-
sized audit firm. You will be part of the audit team auditing Frosties (Pty) Ltd (Frosties) for the 28
February 20x1 year-end for the first time. Most of Tlhahlobo’s audit clients have December or
September year ends. The audit partner in charge of the audit is Mrs A Zwane (recently married
to Mr T Zwane, the Chairperson of the Board at Frosties).
,
Tlhahlobo Incorporated has four audit partners, all of which registered with IRBA and 25 audit
staff members. Frosties will be the firm’s largest and most computerised client. Except for you,
none of the other audit team members, including the audit partner, are familiar with complex
computerised environments.
Frosties is a South African company specialising in the manufacturing and supply of frozen
confectionaries and desserts to some of South Africa’s finest restaurants, hotels, coffee shops,
wholesalers and retailers. Products are also available directly to the public from the factory shop
based in Cape Town. The product range include a variety of full cream ice cream, sorbet ice
cream and frozen yogurt which are packaged in cartons, tubs, lollies or dipped sugar cones. All
the products are distributed to most major cities in South Africa directly from the factory shop.
The following people are on Frosties’ Board of the Directors:
Mr T Zwane Board chairperson, Master’s in Business Science (MBA)

Mr J Royle Chief executive officer, Master’s in Business Leadership (MBL)
Ms Z Zidane Chief financial officer, CA(SA)
Ms C Naidi Chief operations officer, CA(SA)
The company was established six years ago and financed by five private investors who provided
long-term loans. The loans are not secured but, in terms of the loan agreements, investors may
call up their loans immediately if the company does not achieve a pre-determined net profit before
tax.
As part of your risk assessment procedures, you identified numerous journal entries that were
captured prior to the year-end. All these journal entries have supporting documentation and were
authorised by Ms Zidane. A month after the year-end, it came to light that the authorised journal
entries passed just prior to the year-end had not complied with internal controls requirements as
it had only been authorised by one person and not two, as required.
In one of the meetings between the board of directors of Frosties and the audit team, Mr Royle
asked Mrs Zwane to lend them two trainee accountants to assist them at the accounting
department during July and August 20x1.
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After the meeting concluded, Ms Naidi invited Mrs Zwane for coffee to find out if she would be
interested in joining her on an all-inclusive trip to Qatar to watch the 20x1 FIFA World Cup that
was to take place at the end of the year. The trip was scheduled as a team building exercise and
to thank the auditors for their hard work.
REQUIRED
Discuss the ethical concerns that arise based on the SAICA Code of Professional Conduct
(CPC). Your answer should deal with the threats to the fundamental principles and suggest
the appropriate safeguards that should be put in place to reduce the threat to an acceptable level
if possible. (30)
QUESTION 5
A question dealing with Corporate Governance will be uploaded on myUnisa.
QUESTION 6
A question dealing with Corporate Governance will be uploaded on myUnisa.
QUESTION 7 12 marks
You have been appointed as a third-year trainee accountant at Audit Incorporated. Zo-Jo Limited
(Zo-Jo) have been one of the audit firm’s audit clients for the past three financial years and the
following information is available to you:
PRELIMINARY AUDIT ENGAGEMENT ACTIVITIES
In the first meeting with Zo-Jo’s management, before the commencement of the audit of the 20x1
financial year-end, the audit partner in charge of the audit became aware of certain information
which might determine whether or not Audit Incorporated should accept
Zo-Jo as an audit client for the fourth consecutive year. The matters of concern are as follows:
1. The wife of the chief executive officer (CEO) of Zo-Jo is the sister of the audit partner in
charge of the audit.
2. The number of Zo-Jo’s supermarket stores increased from 20 to 40 in the financial year,
while the number of audit team members scheduled to perform the audit remains the same.
3. For the first two months of Zo-Jo’s financial year, Audit Incorporated outsourced three
trainee accountants to Zo-Jo to assist them in their accounting department. These trainee
accountants are included in the audit team performing the audit.
4. The chief financial officer (CFO) requested Audit Incorporated to consult them on
preparation of their tax returns. The audit partner in charge of the audit agreed on one
condition that the CFO of Zo-Jo take full responsibility for the returns.
REQUIRED Marks
Identify and describe the threats for each of the concerns listed and make
suggestions of safeguards that should be implemented to eliminate or reduce the
threats.
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Present your answer as follows:
Threats Safeguards
(1½ mark each) (1½ mark each)

1. …………………………………….. 1. ……………………………………..
2. …………………………………….. 2. ……………………………………..
3. …………………………………….. 3. ……………………………………..
4. …………………………………….. 4. …………………………………….. (12)
QUESTION 8 28 marks
You are one of the trainee accountants on the audit of Goldrush (Pty) Ltd (Goldrush). Your audit
senior has presented you with the following information on Goldrush:
BUSINESS BACKGROUND OF GOLDRUSH
Goldrush was established by Chereé Naidoo in 1981 in South Africa. Goldrush started as a small
company managed from Chereé Naidoo’s residence and has since developed into one of the
largest jewellery manufacturers in South Africa. Its core business is the manufacturing and selling
of gold and silver jewellery to most leading jewellery retailers in the country. Goldrush’s
manufacturing operations are conducted on the Witwatersrand.
Chereé Naidoo is the owner and the CEO of Goldrush. She is assisted by Dan Brown as the Chief
Operations Officer (COO) and Thabo Mabula as the CFO.
Goldrush’s financial statements for the 28 February 20x1 year-end are presented and disclosed
as a going concern, even though the profit of Goldrush has decreased by more than 40%. Chereé
Naidoo has requested Dan Brown to provide her with information on what might have caused the
decrease in profit during the financial year.
Dan Brown responded to her request via e-mail as follows:
Chereé Naidoo
From: Dan Brown

Sent: 21 March 20x1 15:25
To: Chereé Naidoo
Subject: Contributors to the decrease in the profit for the year ended 28 February 20x1
Dear Chereé
I refer to your request regarding information on the reasons that might have contributed to the decrease
in Goldrush’s profit during the past financial year. I hereby include the following comments:
During the past three to four years, the rising gold price had a huge impact on the manufacturing of gold
jewellery. During the 20x1 financial year, the gold price increased by 25%. Owing to the increase in the
gold price, it became unaffordable for most consumers to purchase gold jewellery, which ultimately led
to a decrease in the number of manufacturers in the jewellery business sector.
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Goldrush’s most popular sales item used to be small, gold earrings and Goldrush used to produce a
large volume of these small, gold earrings in a year. As a result of the increase in the gold price over
the years, the manufacturing volumes of small, gold earrings dropped about 66%. The decision was
made to put the manufacturing of these small, gold earrings on hold from July 20x0 as it was not
profitable to continue with the manufacturing thereof.
Furthermore, because of the rising gold price, the fee charged to manufacture a piece of gold jewellery
could not be increased accordingly, as this would have made gold jewellery even more unaffordable.
This resulted in a decrease in profits during the past financial year.
Not only had Goldrush suffered from a decrease in profits during the past financial year, but because
jewellery retailers work on a percentage mark-up, many jewellery retailers had been resistant to
purchase gold jewellery from Goldrush because of the increase in its selling prices. Owing to the
increase in Goldrush’s selling prices and because of the recession, many of Goldrush’s clients had to
close their doors as it became difficult to trade in the jewellery industry. According to Thabo Mabula, the
increase in Goldrush’s outstanding debtors balance and allowance for credit losses (previously known
as allowance for bad debts) at year-end might also be an indication of retailers who are unable to pay
existing debt. Thabo provided me with the following information on debtors at year- end:
Description 28 February 20x1 29 February 20x0

Outstanding balance as at year-end R1 342 000 R 940 500
Allowance for credit losses R114 200 R70 538
Days outstanding 95 65
Another factor that had an impact on the business operations of Goldrush was the implementation of
the Consumer Protection Act 68 of 2008 (CPA). Goldrush did not adhere to the CPA during the financial
year and this resulted in a fine that had to be paid by Goldrush. The fine was calculated based on the
turnover of Goldrush for the year ended 28 February 20x1.
To enable Goldrush to increase its profit in the next financial year, Goldrush has to put a plan into action
to reinvent itself by focusing on fashion jewellery made of other metals. To be able to do so, 60% of the
shares of Butterfly Jewellers (Pty) Ltd were acquired in September 20x0. Butterfly Jewellers specialises
in the design and manufacturing of fashion jewellery and will hopefully assist Goldrush in expanding its
business.
Lastly, during the financial year, Goldrush had to pay a service bureau a material amount of money. The
reason for this was that Goldrush had lost all its accounting data on 1 January 20x1. As no backup was
made of the accounting data during the financial year, a service bureau was contracted to process all
the accounting records from the hard copies again. In order for Goldrush to prepare financial statements
at the year end. As this was an unforeseen circumstance, Goldrush had not budgeted for these
additional costs, and this therefore resulted in a decrease in the actual profit.
If you have any further queries, do not hesitate to contact me.
Regards
Dan Brown
Comment on the background:
Can you draw up an e-mail which complies with appropriate business writing skills?
In an assessment, we can ask you to prepare your answer in an e-mail format where you can
earn marks for your communication skills.
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You can learn more about writing an e-mail, including some business writing tips, by referring
to the short videos on the following links:
Writing an email:
https://www.youtube.com/watch?v=amJZXjxnhTI
Business writing tips:

https://www.youtube.com/watch?v=LrKesGslOYs
REQUIRED Marks
8.1 With reference to the business background of Goldrush.
At the financial statement level for the 28 February 20x1 year end:
(a) Identify the five inherent risk factors and
(b) for each inherent risk factor, describe the inherent risks of
material misstatement present in the financial statements of the
Goldrush group.
(a) Inherent risk factors (b) Description of the inherent

risks of material misstatement at
financial statement level
(½ mark each) (1½ marks each)
1.…………………………… 1.………………………………
(17)
(1)
Communication skills – layout, structure, logical argument.
8.2 With reference to the business background of Goldrush,
Describe and assess the risks of material misstatement at assertion

level for the accuracy of the allowance for credit losses in the financial
statements of Goldrush for the 28 February 20x1 year-end. (10)
QUESTION 9 27 marks
You are the audit senior on the audit of Farmville (Pty) Ltd (Farmville) for the year ended 31
December 20x0. The following information of the company is available to you:
Background information
Farmville is a dairy and free-range livestock farm. The farm is situated in the Free State. The
products that are produced on the farm are sold to local and international grocery retail outlets
and butcheries. This is the first time that your audit firm is providing audit services to Farmville.
The directors and founding owners of Farmville are as follows:
Mr Stew Chief Executive Officer

Mr Steak Chief Operations Officer (cousin of Mr Stew)
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Ms Hen Chief Financial Officer (cousin of Mr Stew)
Directors’ remuneration is determined according to each director’s service agreement on an

annual basis. Each director’s salary package consists of a fixed salary, a travel allowance and an
annual performance bonus based on Farmville’s profit for the financial year.
The South African government has put pressure on the directors of Farmville to be involved in the
country’s equity scheme. As a result, Farmville’s shareholders issued 50% of the shares in the
farm at no cost to 100 previously disadvantaged black employees during the financial year.
During the year under review, Farmville lost most of its livestock due to a drought that hit the Free
State. The farm has applied to the Land Bank to obtain financing. This will help them to obtain
infrastructure to have enough water on the farm, even in the event of a drought. The application
is pending approval on condition that the farm provides the bank with its audited financial
statements by no later than 15 January 20x1.
Not only has Farmville lost its livestock due to drought during the past financial year, but because
of a problem with electricity in the main storage facility where the dairy products are stored,
Farmville had to discontinue producing dairy products for a few months. This led to a significant
decrease in its turnover during the financial year.
The main assets of Farmville are property, plant and equipment which consist mainly of land and
tractors. The land will be provided as security to obtain financing from the Land Bank. Many of
the tractors on the farm are not in a working condition but have a significant carrying value in the
In the past, Farmville engaged Mr Value (a land surveyor) to value the land. To ensure that the
land surveyor remains independent from the client, your audit firm decided to use Mr Worth to
value the land for the year ended 31 December 20x0. Mr Worth has his own land surveyor
practice.
REQUIRED Marks
9.1 With reference to the background information of Farmville.
(a) Identify the events or conditions (risk indicators) at the financial

statement level; and
(b) for each identified event or condition (risk indicator), describe the
significant risks of material misstatement present in the financial
statements of Farmville.
Tip: To assist you in identifying significant risks, refer to ISA 315
(Revised 2019) paragraphs 12 (l), A204 and A221 to see if any of the
matters listed in these paragraphs might influence whether or not the
risk of material misstatement can be classified as significant.
(a) Events or conditions (risk (b) Description of the significant

indicators) risks of material
misstatement at financial
(1 mark each) statement level
(1½ marks each)
1.…………………………… 1.……………………………… (15)
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9.2 With reference to the background information of Farmville:
(a) Describe the risks of material misstatement at assertion level that

relate to the items of property, plant and equipment in the financial
statements of Farmville.
(b) For each risk described, indicate the relevant audit assertion(s).
(a) Description of the risks of (b) Relevant audit assertions

material misstatement at
assertion level for property,
plant and equipment
(1½ mark each) (1 mark each)
1.…………………………… 1.………………………………
(12)
QUESTION 10 30 marks
You are a first year trainee accountant forming part of the audit team on the audit of Travel with
Flair (Pty) Ltd (Travel with Flair) for the year ended 28 February 20x1. The following information
of the company is available to you:
BACKGROUND INFORMATION
Travel with Flair is South Africa’s first fully automated online travel agency. Stephan van Eck
launched Travel with Flair in 2009 after his first online travel agency in Switzerland, Mr Jet, had
proved to be very successful. Travel with Flair is a wholly owned subsidiary of Mr Jet and both
companies have the same financial year-end. The auditors of Mr Jet require the audited financial
statements of Travel with Flair within two weeks after the year-end to audit the consolidated
results in time. This is the first time that your audit firm is providing audit services to Travel with
Flair.
Travel with Flair operates its business from an office situated in Cape Town. Customers can make
bookings for flights, hotel accommodation and car rental with a variety of international and national
suppliers through Travel with Flair, using the internet. During the 20x1 financial year, Travel with
Flair experienced rapid growth in its business. The company’s number of bookings and revenue
figures increased by more than 55% from the prior financial year. Two senior executives are set
to receive share options in Travel with Flair based on the reported profits.
Owing to the rapid growth of the company, Stephan van Eck has a new vision for Travel with Flair
and plans to expand Travel with Flair’s business by opening ten new holiday resorts all over South
Africa. To finance this expansion, Travel with Flair must apply for a bank loan. The approval of
the loan is dependent on the audited 20x1 financial statements.
In May 20x0, two key staff members in the accounting department went on maternity leave and
the CFO was fired. During the financial year, the CFO has been in a major public labour dispute
with Travel with Flair. The dispute was settled in court during October 20x0. The posts of the two
key staff members from the accounting department and the CFO’s post were filled by temporary
staff members who were on training for the first two months. These temporary staff members
were not performing at optimal level after the training period.
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Travel with Flair’s revenue comprises:
• Commission received from a variety of international and national suppliers with whom the
bookings for flights, hotel accommodation and car rental are made. Revenue from
commission is recognised as soon as the booking has been finalised. A booking is finalised
as soon as the payment has been received from the customer. Suppliers should pay the
commission to Travel with Flair at the end of the month following the month in which a
booking has been finalised. Commission is calculated, using the percentage as agreed with
the supplier in the service level agreement.
• Service fees received are fees charged on every booking made for flights, hotel
accommodation and car rentals. Revenue from service fees is recognised as soon as a
booking has been finalised. A booking is finalised as soon as the payment has been
received.
REQUIRED Marks
10.1 With reference to the background information of Travel with Flair.
(a) Identify the events or conditions (risk indicators) at financial statement

level,
(b) identify the applicable inherent risk factor for each event or condition
and
(c) for each identified event or condition (risk indicator), describe the
inherent risks of material misstatement at financial statement level for
Travel with Flair.
(a) Events or (b) Inherent risk

(b) Description of the
conditions (risk factors inherent risks of
indicators) material
misstatement at
financial
statement level
(1 mark each) (½ mark each) (1½ marks each)
1. ………………………. 1. ……………………….. 1. ……………………….. (20)
10.2 With reference to the background information of Travel with Flair:
Identify and describe the control risks of material misstatement at financial

statement level for Travel with Flair. (3)
10.3 With reference to the background information of Travel with Flair:
(a) Describe the risks of material misstatement at assertion level that

relate to revenue.
(b) For each risk described, identify the relevant audit assertion(s).
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(a) (b)
Description of the risks of Relevant audit assertions
material misstatement at
assertion level relating to
revenue
(1½ marks each) (1 mark each)
1.………………..…………………… 1.…………………….………………. (10)
You are a senior audit manager at AccountAble Incorporated (AccountAble). You are a member
of the audit team performing the 31 March 20x1 year-end audit of AFRICHIC (Pty) Ltd
(AFRICHIC). The following information about the company is available to you.
AFRICHIC offers an extensive range of locally supplied and imported products via online retailing.
AFRICHIC owns a warehouse in Midrand where they store the products to ensure timeous
delivery. AFRICHIC outsources the delivery of goods to a company called OnTrac.
The online retailer industry is regulated by the Competition Commission of South Africa (CCSA).
AccountAble was appointed as the auditors of AFRICHIC in November 20x0 by means of a tender
process. Mr Pantsy Pants is the managing partner of AccountAble and the partner in charge of
the audit. Even though AccountAble was appointed as one of the best audit firms from all the
firms that tendered, Mr Pantsy Pants is the father of AFRICHIC’s CFO which raised the suspicion
of favouritism when awarding the audit. The fact that the audit firm renders audit services mainly
in the mining industry also raised some of these suspicions. The directors of AFRICHIC requested
that the audit should be completed within two weeks after the financial year-end, as they would
need to submit the auditor’s report to the CCSA for regulation purposes. The strict audit deadline
will place the auditors under extreme pressure.
Owing to the current economic climate, AFRICHIC has seen a decline in the demand for online
sales as a general trend in the past few months. This appears to be a big concern for management
of AFRICHIC as their bonuses are determined based on the profit that is made by the company.
Most of AFRICHIC’s systems are automated. During the financial year, measuring the inventory
balance has presented certain challenges, mainly due to the limitations of the accounting system
which affects all classes of transactions and account balances. Inventory is measured at the lower
of cost or net realisable value and the cost price is determined in terms of the first-in-first-out
(FIFO) cost formula.
COMPUTATION OF PLANNING MATERIALITY
Based on your risk assessment, inherent risk was assessed as high. Use the following information
to determine AFRICHIC’s planning materiality for the year ended 31 March 20x1:
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Unaudited financial Budgeted financial Interval used to
Item results results calculate
Rand Rand materiality
Turnover 60 000 000 70 000 000 0.5% - 1%
Gross profit 25 000 000 28 000 000 1% - 2%
Expenses 28 000 000 25 000 000 1% - 2%
Net profit/(loss) before tax (3 000 000) 3 000 000 5% - 10%
Total assets 19 000 000 25 000 000 1% - 2%
Total liabilities 15 000 000 15 000 000 0.5% - 1%
Equity 4 000 000 10 000 000 2% - 5%
PRELIMINARY AUDIT ENGAGEMENT LETTER
The audit partner reviewed the draft audit engagement letter and requested that you peruse the
following review notes before sending it to AFRICHIC:
1. Address the engagement letter to the correct party. In your letter, you addressed it to the
shareholders.
2. Replace the sentence that indicates that audit fees will be R200 000 for the audit of the 31
March 20x1 year end with an appropriate sentence.
3. In the engagement letter it is indicated that it is the responsibility of the auditors to prepare
the financial statements in accordance with the International Financial Reporting Standards.
4. As the auditors, we do not certify the fair presentation of the financial statements.
5. In the engagement letter it is indicated that the audit is performed according to generally
accepted accounting practices.
6. I am not comfortable with the following sentence, and it should therefore be replaced: “Our
audit will be designed to provide absolute assurance that all fraud and errors that are material
to the financial statements will be discovered.”
7. Is the following sentence correct: “Due to the relationship between Mr Pantsy Pants and the
CFO, we will not require any management representation letters”?
8. Insert a sentence regarding the restriction of access to persons and information.
9. The engagement letter indicates that once the audit client received the letter, the shareholders
do not need to acknowledge receipt thereof but should read through the terms and conditions
and keep a copy for future reference. Is this sentence correct?
10. Once you amended the engagement letter, sign the letter and send it to the audit client.
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REQUIRED Marks
11.1 With reference to the background information:
At financial statement level for the 20x1 financial year:

(a) Identify the events or conditions (risk indicators).
(b) For each identified event or condition (risk indicator) in (a) above,
describe the inherent risks of material misstatement.
(a) Events or conditions (risk (b) Description of inherent

indicators) risks of material misstatement
at the financial statement level
(1 mark each) (1½ marks each)
(17)
1.……………………………..…… 1.………………………….………
Communication skills – layout, structure and logical argument. (1)
(a) Describe the risks of material misstatement at assertion level

relating to the inventory balance in the statement of financial position
on 31 March 20x1.
(b) For each risk described, identify the relevant audit assertion(s).
(a) Description of the risks of material (b) Relevant audit

misstatement at assertion level relating assertion(s)
to the inventory balance

(17)
1.……………………………..…… 1.…………………….………
11.3 With reference to the computation of planning materiality:
(a) Describe the steps that should be followed by the auditor to calculate
the planning materiality.
(b) Substantiate your methodology giving reasons.
(15)
Note: You have to apply your answers to the information provided in the
scenario to earn marks.
11.4 With reference to the preliminary audit engagement letter:
Describe an improvement for each of the review notes listed according to the
International Standard on Auditing 210. (15)
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11.5 With reference to the background information as well as your risk
assessment:
Identify and describe the aspects that will have an influence on the nature and
timing of the audit plan for AFRICHIC. (15)
The following information relates to the audit of Happychef (Pty) Ltd (Happychef):
Happychef is a very popular South African company selling a premium quality of cookware
sourced from France, India and China. The inventory balance in Happychef’s annual financial
statements is material. Customers have the option of ordering cookware online or to visit one of
the nine outlets situated across South Africa. The warehouse where cookware is delivered to and
from is situated in Port Elizabeth.
You are a member of the audit team of ISA Incorporated performing the audit of Happychef.
Happychef’s year end is 31 December. As part of your audit procedures, you requested the
minutes of the board meetings held during the financial year. The following is an extract of the
minutes of the board meeting that took place on 11 December 20x0. You also received the
minutes of the board meetings that took place on 15 March 20x0 and 15 June 20x0. The board
meeting of 15 October 20x0 was cancelled.
Supporting
documents
(this column is
Minutes of the board meeting of 11 December 20x0
only provided for
illustrative
purposes)
1. Welcome
1.1 The chairperson welcomed the board members to the meeting.
1.2 An attendance register was signed by all board members
present.
1.3 Mr Pots (non-executive director) sent his apology as he could
not attend the meeting.
Attendance
register
2. Approval of the minutes of the previous meeting
The minutes of the meeting of 15 June 20x0 was approved by the
board members with no amendments.
Minutes
3. External auditors
3.1 The services of AU & DIT Incorporated were discontinued and
ISA Incorporated was appointed as the company’s new auditors,
effective from 15 December 20x0.
3.2 The engagement letter was discussed and signed.
Engagement
letter
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Supporting
documents
(this column is
Minutes of the board meeting of 11 December 20x0
only provided for
illustrative
purposes)
4. Specialised computer system auditors
4.1 During the financial year, accounting software changes and Not applicable
upgrades were made, and the automated online sales platform was
updated to ensure that the systems are protected against
unauthorised access. The board members agreed that the
transition from the old to the new accounting system took place
without any problems.
4.2 The board members agreed that the computer system,
including the online sales platform, should be audited by a
company specialising in computer audits. This will give the board
members the peace of mind that the systems are working
effectively. Comptech Incorporated was appointed to perform this
specialised audit.
5. Removal of executive director
Mr Wok, one of the executive directors, was removed by the
shareholders in November 20x0. The removal is based on a charge
of involvement with fraudulent transactions at the Finance
Department. To ensure that Happychef’s reputational risk is kept
Details of the
to a minimum, Mr Wok was removed with immediate effect. Mr
removal and
Wok’s legal team brought a litigation suit against Happychef,
litigation suit
claiming that Mr Wok was treated and removed unjustly. Owing to
numerous reports on this matter in the media, the directors agreed
that the litigation suit may result in negative publicity for the
company.
6. Marketing committee presentation
Happychef did not achieve its sales budget for the past nine
months. This is mainly attributed to the poor economic environment
in South Africa, leaving consumers with little money to spend on
luxury goods. In an effort to improve the turnover and to satisfy
Sales strategies
investors, the marketing committee presented a few new sales
strategies that will be implemented from 1 March 20x1.
7. Additional items
No additional items were added by the board members. Not applicable
8. Meetings for 20x1
The board meetings for the 20x1 financial year will take place on Not applicable
15 March 20x1, 15 June 20x1 and 15 October 20x1.
9. Closure
The meeting was adjourned at 13:00. Not applicable
PERSONNEL AND PAYROLL CYCLE
Employees working at Happychef are paid on the 25th of each month or on the last working day
before the 25th. At the year end, the workforce of Happychef consisted of 80 employees who
work in the warehouse, 60 employees who work at the head office in Port Elizabeth and another
40 employees who work at the different outlets situated across the country. All employees, except
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those at the warehouse, are paid by means of electronic funds transfer. Employees working at
the warehouse are paid in cash.
As part of the computer software changes and upgrades made during the financial year,
Happychef decided to upgrade to another payroll computer software programme, namely PayU.
PayU is also used to account for transactions directly in the general ledger. Since
1 October 20x0, all salaries and wages have been calculated, using PayU. At year end, the PayU
system indicated that there are a total of 200 employees employed by Happychef.
All employees, except those who work in the warehouse, are paid a fixed monthly salary.
Employees at the warehouse are paid according to the hours they have worked during the month,
and they clock in and out, using a biometric reader, which is linked to the PayU system. During
the financial year the biometric reader did not work for two months, and employees were required
to sign in and out using a register. The hours were then captured onto the PayU system by two
of the employees at the Human Resource Department, using a general username and password.
The human resource manager identified a few irregularities in the hours that were captured and
was concerned that warehouse employees were not completely honest when recording their
hours in the register.
During festive seasons, warehouse employees are usually required to work overtime. Overtime
is paid at 1.5 times the normal hourly rate and are limited to 25 hours for each employee.
REQUIRED Marks
Describe the risks of material misstatement at financial statement level for

Happychef for the year ended 31 December 20x0.
(14)
Communication skills – style
(1)
Identify and describe the aspects that the auditor should consider when
developing the audit strategy for Happychef. Your answer should focus on
the scope and timing of the audit strategy. (15)
12.3 With reference to the personnel and payroll cycle:
(a) Describe the risks of material misstatement at assertion level

relating to salaries and wages in the statement of comprehensive
income for the year ended 31 December 20x0 for Happychef.
(b) For each risk described in (a), identify the relevant audit assertion(s).
(a) (b)
Description of the risks of Relevant audit assertion(s)
material misstatement at the
assertion level relating to
salaries and wages
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1.……………………………..…… 1.………………………….……...… (14)
Communication skills – layout (1)
The following information relates to the audit of Living Well (Pty) Ltd (Living Well):
You are a third-year trainee accountant employed at a medium-size audit firm, namely ISA
Incorporated. Most clients of an audit firm operate in the retail sector, and none of them are listed
companies.
Living Well approached your audit firm to find out whether the firm will be interested in accepting
them as an audit client. The chief executive officer (CEO) of Living Well indicated that they want
to build a strong long-standing business relationship with the firm and, were therefore, looking for
a firm that will be willing to be perform the audit for the current and following financial years.
Living Well is in the business of selling natural and organic health products from a warehouse
situated in Pretoria. The company has been in business for the past decade and has been
consistently profitable over the previous financial years. Living Well’s turnover for the 20x1
financial year is reported as R5 million (budgeted for 20x1: R4.9 million; reported for 20x0: R4.5
million). The company is not capital-intensive and does not own the warehouse from where they
operate. The company sources its products from both local and international wholesalers; must
therefore also must comply with various local and international laws and regulations. To make
sure that all laws and regulations are adhered to, Living Well has an exceptional team of legal
advisors who advises them on all legal requirements and changes thereto on a regular basis.
To deliver products to some of Living Well’s major customers, the company owns a fleet of mini
trucks, most of which are between two and three years old. The account balance of mini trucks,
as part of the property, plant and equipment account balance is included as R3 million in the
statement of financial position for the 20x1 financial year (budgeted for 20x1: R3.1 million;
reported for 20x0: R3.8 million). The mini trucks are carried on the financial statements, at cost,
less accumulated depreciation and impairment losses. Depreciation on mini trucks is charged on
a straight-line basis over their estimated useful lives, which is indicated as five years, according
to Living Well’s accounting policy. During the 20x1 financial year, it became very popular for
customers to request that products be delivered to them; therefore, Living Well decided to include
delivery of products to the customer’s premises as part of their customer service. Owing to this
decision, the frequency of trips that the fleet of mini trucks made to deliver products to customers
increased substantially, which caused mini trucks to break down more often due to overuse. As
these trucks might have to be replaced or undergo major maintenance in the next financial year,
there is uncertainty whether the depreciation and impairment losses have been calculated
correctly.
As part of a broad-based black economic empowerment (BBBEE) deal, Living Well is planning to
expand considerably in the 20x2 financial year. The deal will involve a listed company, which
requires Living Well to be audited externally for the first time for the 28 February 20x1 year- end.
As Living Well had a public interest score of less than 100, the company was reviewed
independently in prior years by an accounting firm who is not registered to perform audits. As part
of the BBBEE deal, the listed company will buy 80% of the shares in Living Well. The transaction
137
will be finalised by the end of June 20x1, after the audit report for the 20x1 year has been obtained
and all the legal requirements have been met and registered.
The chief financial officer (CFO) of Living Well is a registered chartered accountant. During the
20x1 financial year, he had to appear in court regarding financial irregularities which were alleged
to have occurred under his direction. He denied his involvement but was subsequently proved to
have been lying in court. He then acknowledged that he had lied but said he had been instructed
to do so by one of the executive directors of the company. As a result, the CFO committed perjury
and the court found him guilty of a criminal offence. Owing to this outcome, Living Well dismissed
both the CFO and the executive director involved from their duties as from 30 April 20x0. The
litigation suit was finalised during the 20x1 financial year and luckily did not seem to have any
effect on Living Well’s profitability.
MATERIALITY
ISA Incorporated uses the following intervals to calculate materiality for all their audit clients:
Indicator Interval
Turnover 0.5%–1%
Gross profit 1%–2%
Net profit before tax 5%–10%
Equity 2%–5%
The audit firm calculates performance materiality as follows:
Level of assessment of risk of material Performance materiality percentage

misstatement
High 70%
Medium 80%
Low 90%
REQUIRED Marks
Refer to the background and materiality information of Living Well when answering the
following questions:
13.1 Discuss whether or not the CFO complied with the fundamental principles
of ethics, as stipulated in the SAICA Code of Professional Conduct. Note that
your answer does not have to include the threats.
(8)
13.2 Discuss the matters that ISA Incorporated should consider when deciding
whether or not to accept Living Well as a new audit client for the 28 February
20x1 year-end, and possibly any future audits. Focus only on the information
given in the scenario. (11)
13.3 (a) Identify the inherent risk factors at financial statement level for Living
Well for the 28 February 20x1 financial year, and for each identified
inherent risk factor,
(b) describe the risks of material misstatement; and
(c) assess each risk of material misstatement based on likelihood,
magnitude and the spectrum of inherent risk.
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(a) (b) (c)
Inherent Description of risks of Assessment of risks
risk factors material misstatement of material
misstatement based
on likelihood,
(½ mark each) (1½ marks each) magnitude and
spectrum of inherent
risk
(1 mark each)
1.……………… 1.………………………….… 1.…………………………..
(25)
Communication skills – layout and logical argument
(2)
13.4 Describe and assess the risks of material misstatement at assertion level
with respect to the mini trucks account balance in the statement of financial
position of Living Well for the 28 February 20x1 financial year. Limit your
answer to the accuracy, valuation and allocation audit assertion. (9)
13.5 (a) Calculate planning materiality. (6)

(b) Calculate performance materiality of the mini trucks account balance. (3)
Substantiate your calculations with reasons explaining why you used

certain figures. Focus only on the information available in the scenario.
13.6 Identify and describe the aspects that the auditor should consider when
developing the overall audit strategy for Living Well for the 20x1 year end.
Your answer should focus on the scope of the audit strategy only. (6)
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5 SELF-ASSESSMENT SOLUTIONS
5.1 Introduction
This section contains the solutions to the self-assessment questions that were provided in the
previous section of this tutorial letter.
5.2 Important principles to remember before you work through the solutions.
You must take note of the following important principles before working through the answers to
the various questions:
• You must write out the answer within the required time.
• Mark your answer against the suggested solution.
• Take note of the mistakes/omissions made and correct your answer.

• When working through the solutions, you must not study the
solutions by heart. Rather try to understand how we arrived at the
solution then you will be able to apply the principles to other
questions as well.
• Make notes of the mistakes made and aspects to concentrate on in

your lessons to obtain marks. This will make the revision process
easier.
5.3 Suggested solutions to the self-assessment questions
QUESTION 1
Solution to be uploaded on myUnisa.
QUESTION 2
QUESTION 3 20 marks
Ethical considerations regarding the audit fee arrangement
1. Mrs Prang is a CA(SA) and is therefore bound to comply with the SAICA Code of
Professional Conduct (CPC) (1½).
2. In terms of the SAICA CPC and ISAs, the auditor must negotiate and quote the appropriate
audit fee (1½). By not doing so, he creates a self-interest threat (½) to professional
behaviour as the audit firm will benefit from the audit fee arrangement by keeping the fee
as low as possible. (1½)
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3. The audit fee quote should indicate the basis on which the fees are charged, which
include resources allocated to the audit; the time spent on the audit and necessary skills
and experience required to conduct the audit. (1½)
4. It is inappropriate to charge the same audit fee than the preceding auditor and only
adjust it with inflation mainly due to the following reason (1½):
4.2.1 Seeing that staff assigned to the audit might be insufficient in comparison with the
preceding auditors, it might be difficult to perform the audit; therefore, the fee is not a
true reflection and may be deemed inappropriate (1½). This creates a threat to
professional competence and due care (½).
5. If TJM only recognises the 20% payment reflected in the bank (cash) as revenue and
not also the 80% that was exchanged for the renovation service, it might indicate that TJM
do not act with integrity and comply with IFRS and taxation laws (1½). This creates a
threat to integrity (½).
6. If Mrs Prang does not comply with IFRS and taxation laws (as per above), it will create a
threat to professional behaviour (½) as she will bring the profession into disrepute/
discredit the profession. (1½)
7. There is a familiarity threat (½) as PerfectViews and TJM might not appear independent
from each other due to the arrangement of PerfectViews doing renovations for TJM (1½).
8. The arrangement can also lead to an advocacy threat (½) as TJM might want to give
PerfectViews a favourable audit opinion to be sure not to influence the audit fee
arrangement and the services that go with it (1½).
9. In conclusion, there appear to be no safeguards for the above-mentioned threats and the
proposed audit fee arrangement should not be accepted by Mrs Prang. (1½)
((11 x 1½) + (6 x ½) = 22½, maximum 20)

QUESTION 4 30 marks
Ethical considerations based on the SAICA Code of Professional Conduct
1. Ms Zidane and Ms Naidi (board of directors) and Mrs Zwane (the auditor) are CA(SA)s
and are therefore bound to comply with the SAICA Code of Professional Conduct (CPC).
(1½)
2. The audit trainees, by virtue of their training contract, are also bound to comply with the
SAICA CPC. (1½)
3. There is a familiarity (½) and self-interest threat (½) to Mrs Zwane’s objectivity
(independence) as a family relationship exists between the audit firm and the audit client
(the partner and chairperson of the Board of Frosties are husband and wife) (1½).
The threat should be assessed by the audit firm, but the most appropriate safeguard is that
the partner should not be involved in the audit. (1½)
141
Alternatively, the audit partner should not form part of significant decision-making, or
all work should be reviewed by another partner, although this might influence the audit
fee; therefore, it is best that the partner is not involved in the audit. (1½)
Other safeguards include having an engagement quality control reviewer to review the
audit and any decisions made on the audit; however, this might also influence the audit
fee. (1½)
However, even if a safeguard is implemented, the audit firm might still not be seen as
independent from the public’s view which might influence the credibility of the audit; and
the firm’s reputation may be harmed when the threats to independence are made public.
(1½)
Frosties is also one of the largest clients of the audit firm; therefore, the firm’s
independence might be questioned if they are dependent on the audit client’s audit
fees. (1½)
4. There is a self-review threat (½) to Mrs Zwane and the audit trainees in terms of
professional competence and due care as well as a potential familiarity threat (½) to
objectivity to the audit trainees (some of the trainees might become friendly with the
client’s staff) if Mrs Zwane decides to lend the trainee accountants to assist Frosties in
the accounting department. (1½)
There is also a self-interest threat (½) to professional behaviour (½) as they will be in
contravention of laws and regulations, specifically Section 90 of the Companies Act,
by having the auditors maintain accounting records and information. (1½)
The appropriate safeguard is that Ms Zwane should not agree to the request to lend
Frosties the trainee accountants. (1½)
5. There is a self-interest (½)familiarity (½) and intimidation threat (½) to the audit team’s
integrity, objectivity/independence and professional behaviour if Mrs Zwane accepts
the all-inclusive trip to Qatar (1½).
The appropriate safeguard is that the offer should not be accepted. (1½)
6. There is a self-interest threat (½) to professional competence and due care as only
one member of the audit team is familiar with complex computerised environments (1½).
The appropriate safeguard is to appoint audit team members with the appropriate skills
and experience in the audit of complex computerised environments; or to involve an expert
in computer audits. (1½)
7. There is a self-interest threat (½) to professional behaviour and integrity as the CFO
overrides controls in terms of the journals that were passed which only had the approval
of one person (1½).
An appropriate safeguard is to request that when a significant change is made to the

accounting records (such as passing journals) by a member of management, it should also
be approved by someone else in management. (1½)
((19 x 1½ = 28½) + (11 x ½ = 5½), maximum 30))
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Comments
When answering a question related to the CPC, you should always start by referring to who the
CPC will apply based on the information given in the scenario. Refer to points 1 and 2 of the
solution to illustrate this.
To answer the rest of this question, you firstly had to name the threat (1) and explain the issue
relevant in the given scenario, giving rise to the threat (2). Lastly, you had to formulate and
describe a safeguard (3) to deal with the issue.
QUESTION 5
QUESTION 6
QUESTION 7 12 marks
Threats Safeguards
(1½ mark each) (1½ mark each)

1. There is a familiarity threat to 1. The audit partner should not be
objectivity as the wife of the CEO is the involved in the audit; and another audit
sister of the audit partner in charge of partner at the firm should be allocated
the audit. The audit partner is therefore to the audit, if possible. If this is not
not independent from the audit client. possible, the audit should not be
(1½) accepted. (1½)
2. There is a self-interest threat to 2. Audit Incorporated should increase the

professional competence and due care number of personnel on the audit team
as the audit firm might not have enough of Zo-Jo; or consider using other
personnel (resources) on the audit to auditors at some locations to assist
finalise the audit within the given with inventory counts for example.
timeframe especially as the audit client (1½)
expanded their business operations,
but the audit team remains the same.
(1½)
3. There is a self-review threat to 3. Audit Incorporated may not be
professional competence and due involved in accounting functions of Zo-
care as some audit team members ;and should therefore not accept Zo-Jo
assisted Zo-Jo in their accounting as an audit client. Audit incorporated
department. This is also a should consider obtaining legal advice.
contravention of section 90 of the (1½)
Companies Act. (1½)
143
4. There is no threat seeing that 4. Audit firms are allowed to assist audit
consulting with an audit client is clients in some cases. In this case the
allowed and the CFO takes full CFO will take responsibility for the tax
responsibility of the tax returns. (1½) returns. This should be clearly
communicated in the audit
engagement letter. (1½)
(8 x 1½) = 12 marks)
QUESTION 8 28 marks
8.1 Inherent risks of material misstatement at the financial statement level 18 marks
(a) Inherent risk factors (b) Description of the inherent risks of material
misstatement at financial statement level
1. Complexity (½) 1.1 The AFS might be materially misstated due to error
because Goldrush acquired 60% of the issued shares
of Butterfly (Pty) Ltd, which necessitates the
preparation of consolidated financial statements for
the first time, which might be complex. (1½)
1.2 The AFS might be materially misstated due to error

as intergroup balances might not be eliminated. (1½)

if the accounting policies were not applied consistently
by all the companies in the group. (1½)

because of the related-party relationship that exist
between Goldrush and its subsidiary, as the disclosure
of these relationships and transactions might be
incorrect in the financial statements; or might not be at
arm’s length. (Note that the inherent risk factor of
susceptibility to misstatement due to management
bias or fraud is also applicable to this risk as
management might try to hide related party
transactions/relationships). (1½)
2. Subjectivity (½) 2.1 There are no risks identified in the scenario in

relation to subjectivity. (1½)
3. Change (½) 3.1 The AFS might be materially misstated due to error
as the going concern assumption might not be
appropriate, as indicated by the going concern
inherent risk factors: the existence of a volatile market
in the jewellery business sector; the decrease in sales
volumes; discontinued business operations; decrease
in profits; loss of a large number of clients; increase in
the outstanding debtors balance and outstanding days
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(a) Inherent risk factors (b) Description of the inherent risks of material
misstatement at financial statement level
and the fines that have to be paid in terms of the CPA.
(1½)
3.2 The AFS might be materially misstated due to

error, as the service bureau (use of the work of a third
party) might not be competent and appropriately
qualified to process all the accounting data on behalf
of Goldrush. (1½)

error, as the internal controls at the service bureau
might not operate effectively which could lead to
incorrect accounting data. (1½)
4. Uncertainty (½) 4.1 There are no risks identified in the scenario in

relation to uncertainty. (1½)
5. Susceptibility to misstatement 5.1 Owing to the overwhelming evidence of identified

due to management bias or fraud going concern inherent risk factors, the AFS might be
(½) materially misstated due to fraud to disclose a better
financial position as Goldrush is currently experiencing
numerous going concern issues (overstatement of
assets and income and understatement of liabilities
and expenses. (1½)

fraud, since management are also the owners of the
entity and might engage in fraudulent financial
reporting by inflating the performance and position
(e.g. overstatement of revenue) of the entity or by
reflecting a poor performance and position (e.g.
overstatement of expenses). (There might be various
reasons for this, which include the entity to save on
taxation to be paid over to the South African Revenue
Service or to show a good performance to attract
investors. (1½)
((5 x ½ = 2½) + (11 x 1½ = 16½) plus 1 mark for communication skills = 20, maximum 18)
145
Comments
 This question requires you to describe the inherent risks of material misstatement at
financial statement level which implies that you should describe the risks and the effect they
have on the financial statements as a whole. Therefore, do not describe risks that involve
specific line items and assertions in the financial statements, because this will be describing
risks of material misstatement at assertion level.
 How should you approach a question when requested to describe risks of material misstatement
at financial statement level? You should apply the following steps:
Step 1: Identify the events or conditions (risk indicators) present at Goldrush while reading
through the scenario.
Step 2: Then identify to which inherent risk factor each of those events or conditions relate.
Step 2: Describe the inherent risks of material misstatement at financial statement level for
each of the inherent risk factors.
 Remember, by describing the event or condition (risk indicator), you did not necessarily describe
the risk. You have to link the event or condition (risk indicator) to the risk of material
misstatement in the financial statements in the given scenario. It is therefore important that
you explain what effect the risk will have on the financial statements. Remember that risks of
material misstatement may be due to error or fraud, and you must indicate it in your description.
 This question required you to consider each inherent risk factor. If the inherent risk factor is
not applicable, the auditor should document it to illustrate that it was considered (see points 2
and 4 of the answer).
 For this question you were not required to identify the control risks, but if you were, you should
have included the following in your answer and presented it separately from your inherent risks:
• The AFS may be materially misstated due to fraud as management are also the
owners of the entity and therefore may override internal controls to inflate the
performance and position of the entity or by reflecting a poor performance and position.
(Note that management being the owner of the entity is both an inherent and control
risk. The risks are, however, described differently.)
• The AFS may be materially misstated due to error in a poor control environment
because it seems that not all the general internal controls are in place, as indicated by
the fact that no backups were made of the accounting data.
8.2 Risks of material misstatement at assertion level 10 marks
The identified risks of material misstatement at assertion level related to accuracy for
allowing credit losses include the following (1½ marks each):
• There is a risk that management might use inappropriate estimates to calculate the
allowance for credit losses.
• There is a risk that the allowance for credit losses might be understated by not identifying
and including all the relevant debtors in the calculation of the allowance to increase
profits.
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• There is a risk that the allowance for credit losses might be understated to overstate
debtors in the attempt to improve the financial position of the entity at year end.
• There is a risk that the allowance for credit losses might be calculated incorrectly as the
incorrect ageing may be used.
• There is a risk that the allowance for credit losses might not be correctly transferred to
the debtors.
The assessment of risks of material misstatement at assertion level related to the

accuracy for the allowance of credit losses
The risk can be assessed as high (1½ marks) (in terms of likelihood and magnitude as
indicated below) and can even be classified as a significant risk as it may be assessed at
the upper end on the spectrum of inherent risk (1½ marks).
The likelihood is assessed as high due to (1½ marks each):

• the use of estimates, where subjectivity is involved might be inappropriate
• there is a high possibility that the allowance for credit losses might be measured
incorrectly.
The magnitude is also assessed as high as the allowance of credit losses forms part of
trade debtors which is an asset which can be classified as material. (1½ marks)
Due to the risk being classified as significant, specific responses must be formulated. (1½)
(11 x 1½ = 16½, maximum 10)
QUESTION 9 27 marks
9.1 Significant risks of material misstatement at financial statement level
(a) Events or conditions (b) Description of the significant risks of material

(risk indicators) misstatement at financial statement level

1. Managed by its 1. The AFS might be materially misstated due to fraud, as
shareholders. management might engage in fraudulent reporting to reflect a
better picture of the financial performance of the farm
(overstatement of assets and income and understatement of
liabilities and expenses). (Inherent risk)
The AFS might be materially misstated due to fraud as
management might override internal controls to report a good
performance and position of the entity. (Control risk)
(Explanation in terms of ISA 315 (Revised 2019) paragraph
12(l) - this can be classified as a significant risk as it is related
to fraud.)
2. Directors receive 2. The AFS might be materially misstated due to fraud, as
performance bonuses based directors might engage in fraudulent financial reporting, for
on profits. example, overstatement of revenue and understatement of
expenses to maximise performance bonuses.
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(a) Events or conditions (b) Description of the significant risks of material
(risk indicators) misstatement at financial statement level

12(l) - this can be classified as a significant risk, as it is related
to fraud.)
3. Related parties (owners 3. The AFS might be materially misstated due to error, because
who are close family of the related-party relationship that exists between Farmville
members). and the owners who are close family members, as the
disclosure of these relationships and transactions might be
incorrect in the financial statements.
12(l) - this can be classified as a significant risk, as it is related
to related parties.)
4. Financials to be used to 4. The AFS may be materially misstated due to fraud, as the
obtain funding from the Land directors might engage in fraudulent financial reporting to
Bank. ensure that funding will be obtained from the Land Bank
(especially due to the going concern problems); for example,
overstatement of assets and income and understatement of
liabilities and expenses.
12(l) – this can be classified as a significant risk as it is related
to fraud.)
5. Discontinue the production 5. The AFS might be materially misstated due to error
of dairy products due to an accounting on an inappropriate accounting basis as the going
electricity problem; loss of concern assumption might not be properly accounted for and/or
livestock due to drought; disclosed.
lack of funds to raise capital to (Explanation in terms of ISA 315 (Revised 2019) paragraph
build the water infrastructure. A204 – As there is several indicators that the entity might not
(maximum of 1 mark) be able to continue as a going concern, this risk may be placed
on the upper end of the spectrum of inherent risk and can
therefore be classified as a significant risk.)
6. Numerous going concern 6. Owing to evidence of numerous identified going concern
inherent risk indicators inherent risk factors, the AFS might be materially misstated
present. because of fraud to disclose a better financial position in an
attempt hide the going concern issues (overstatement of assets
and income and understatement of liabilities and expenses).
12(l) – this can be classified as a significant risk, as it is related
to fraud.)
((6 x 1) + (6 x 1½) = 15)
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9.2 Risks of material misstatement at assertion level
(a) Description of the risks of material misstatement at (b) Relevant audit

assertion level for property, plant and equipment assertion(s)

1. There is a risk that the items of property, plant and equipment Existence (quantity
might be overstated because the farm wants to obtain finance overstated) or
from the Land Bank; and/or management are the owners of the Accuracy, valuation and
entity, and they would like the financial position to look good. allocation (items values
inflated)
2. There is a risk that the tractors might not be valued at the Accuracy, valuation and
correct amount. Most tractors are not in working condition and allocation
should be written off.
3. There is a risk that the items of property, plant and equipment Accuracy, valuation and
might be valued incorrectly due to the use of the incorrect useful allocation
life and/or residual value (1½ mark), because tractors are no
longer in a working condition but are carried at significant
carrying amounts (1½ mark).
4. There is a risk that the land might not be accounted for at the Accuracy, valuation and
correct value owing to the drought suffered during the year. allocation
5. There is a risk that the expert (land surveyor) to be engaged Accuracy, valuation and
might not be competent, experienced and/or objective; allocation
therefore, the land could have an incorrect value in the AFS.
6. There is a risk that Farmville might not have the right to Rights and obligations
ownership of the items of property, plant and equipment,
because they will be offered as security to obtain financing.
4. There is a risk that the land offered as security to obtain a Presentation
loan was not disclosed in the AFS.
((8 x 1½ = 12) + (8 x 1 = 8), maximum 12))
10.1. Inherent risks of material misstatement at financial statement level 20 marks
(a) Events or (b) Inherent risk (c) Description of the inherent risks of
conditions (risk factors material misstatement at financial
indicators) statement level

1. Tight audit Complexity and/or The AFS might be materially misstated due to
deadline. subjectivity and/or error as the financial results prepared by the
uncertainty management of Travel with Flair might be
incomplete due to time pressure.
2. Conducting Complexity and/or The AFS might be materially misstated due to

business subjectivity and/or error as Travel with Flair conducts business
internationally. change internationally and the accounting treatment of
forex transactions is complex.
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(a) Events or (b) Inherent risk (c) Description of the inherent risks of
conditions (risk factors material misstatement at financial
indicators) statement level

The AFS might be materially misstated due to
error, as the going concern assumption might
not be properly accounted for and/or disclosed,
the company may not adhere to international
laws and regulations which in turn might lead
to penalties.
3. Travel with Flair Susceptibility to The AFS may be materially misstated due to
experienced rapid misstatement due to fraud to obtain the loan from the bank, for
growth in its management bias or example overstatement of revenue and
business. fraud understatement of expenses (refer to point 5
below).
4. Share options Susceptibility to The AFS may be materially misstated due to

based on reported misstatement due to fraud, as senior executives might engage in
profits. management bias or fraudulent financial reporting, for example
fraud overstatement of revenue and
understatement of expenses to receive share
options.
5. 20x1 AFS to be Susceptibility to The AFS may be materially misstated due to
used to obtain misstatement due to fraud, as the directors might engage in
financing from the management bias or fraudulent financial reporting, for example
bank. fraud overstatement of assets and revenue and
understatement of liabilities and expenses to
ensure that financing is obtained.
6. Travel with Flair is Change The AFS might be materially misstated due to
currently in a error accounting on an inappropriate
labour dispute accounting basis as the going concern
with one of its assumption might not be properly accounted
staff members. for and/or disclosed. This might be due to the
fact that the entity might be liable for legal
damages resulting in negative publicity for the
entity and a decline in sales and turnover.
(6 x 1 = 6) + (6 x ½ = 3) + (7 x 1½ = 10½), maximum 20)
10.2. Control risks of material misstatement at financial statement level 3 marks
The following control risks of material misstatement can be identified at financial statement
level:
• The AFS might be materially misstated due to error in a poor control environment, as there
might be errors in the financial records due to a lack of knowledge of temporary staff
members and poor training. (1½)
• The AFS might be materially misstated, as errors might be occurring in the preparation of
financial records due to a lack of experienced personnel with appropriate accounting and
financial reporting skills to record complex accounting transactions. (1½)
(2 x 1½ = 3)
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10.3. Risk of material misstatement at assertion level 10 marks

assertion level relating to revenue assertion(s)

1. There is a risk that revenue might be overstated because the Occurrence
number of bookings and revenue increased by more than 55%
from the prior financial year.
2. There is a risk that commission received might be calculated, Accuracy
using a percentage other than the percentage agreed on in the
service level agreements between Travel with Flair and its
suppliers.
3. There is a risk that commission received from international Accuracy
suppliers might not be properly converted into rands in the
4. At the year end, there is a risk that revenue from commission Completeness
received for the current financial year is recognised after year- Cut-off
end and not in the current financial year, as suppliers only pay
the commission at the end of the month following the month in
which a booking was finalised.
5. At the year end, there is a risk that revenue from services Occurrence
rendered might be incorrectly recognised in the current financial Cut-off
year if a booking has not been finalised (payment has not been
received).
6. There is a risk that revenue received from commission earned Classification
and service fees might not be recorded separately in the proper
accounts.
7. There is a risk that revenue received from commission earned Presentation
and service fees might not be disclosed separately in the AFS.
(7 x 1½ = 10½) + (9 x 1 = 9), maximum 10)
11.1 Inherent risks of material misstatement at financial statement level 18 marks
Events or conditions Description of the inherent risks of Comments

(risk indicators) material misstatement at financial
statement level

Operating The AFS might be materially misstated In this scenario we mentioned
internationally due to error, as AFRICHIC imports the importing of products, so
products and the accounting treatment we want students to identify
for importing and hedging is complex the risk relating to the
or might be incorrect. complexity of foreign
transactions.
Operates in a stringent The AFS might be materially misstated To award full marks, we
industry; or the industry due to error/fraud as AFRICHIC might specifically want students to
151
Events or conditions Description of the inherent risks of Comments
(risk indicators) material misstatement at financial
statement level

is regulated by the unintentionally/intentionally not comply identify that non-compliance
Competition with the laws and regulations, which with the CCSA regulations will
Commission of South could lead to penalties and/or closure of lead to penalties, or closure of
Africa (CCSA) and need this business venture. the business affecting the
to adhere to going concern basis in the AFS
international laws and
regulations
Management’s integrity The AFS might be materially misstated In the scenario we mentioned
is questionable due to due to fraud as management might the independence threat, and
the independence threat manipulate figures or override controls to obtain full marks, students
because they lack integrity due to the need to mention the
independence threat. independence threat and the
fact that management do not
have integrity
Tight audit deadline The AFS might be materially misstated No comment.
due to error, as the financial results
prepared by AFRICHIC (client) might
be incomplete due to time pressure.
Third party reliance: The AFS might be materially misstated Note there is a difference
Audit report should be due to fraud, as the directors might between third party reliance
submitted to the CCSA engage in fraudulent financial reporting and using the work of a third
for regulation purposes to ensure that it is acceptable to the party. The risk when using the
CCSA for regulation purposes. work of a third party relates to
the possibility that the third
party may not be objective,
competent and appropriately
qualified to perform the work
required to collect audit
evidence.
The entity has The AFS might be materially misstated No comment.
experienced a decline in due to error accounting on an
online activity (revenue) inappropriate accounting basis, as
the going concern assumption might
not be properly accounted for and/or
disclosed if the company is not profitable
in the current line of business.
Management members The AFS might be materially misstated No comment.
receive bonuses based due to fraud, as the directors might
on profits engage in fraudulent financial reporting,
for example overstatement of profits and
understatement of expenses, to
maximise bonuses.
((7 x 1 = 7) + (7 x 1½ = 10½) plus 1 mark for communication skills (layout), maximum of 18)
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(a) Description of the risks of material (b) Relevant

misstatement at assertion level relating to audit Remember we are
the inventory balance assertion(s) dealing with the
statement of
financial position in
(1½ marks each) (1 mark each) this example
1. There is a risk that inventory in transit Existence
(imported) might have been included in the and/or Assertions
inventory balance before the risks and rights and applicable:
rewards have passed to AFRICHIC. obligation Existence
2. There is a risk that imported inventory in Completeness Rights and
transit for which rights of ownership might Obligations
have transferred may be omitted. Completeness
3. With reference to imported inventory (1½ Accuracy, valuation
marks each): and allocation
- There is a risk that imported inventory Accuracy,
might not be correctly translated at the valuation and When identifying
correct exchange rates at the transaction allocation the relevant
date or at year-end OR there is a risk that assertion relating
imported inventory might not be correct to the risk of
due to the complexity of foreign material
exchanges and as a result, inventory assessment at
might contain errors. assertion level,
- There is a risk that when determining the Accuracy, please ensure
cost of inventory, the import duties or valuation and that you only list
insurance might not be taken into allocation applicable
account. assertions. If, for
4. There is a risk that inventory might not be Accuracy, example, you list
valued correctly due to the limitations of the valuation and existence and
accounting system. allocation completeness
5. There is a risk that inventory might be Accuracy, with regard to a
damaged when transported from overseas or valuation and specific risk, you
between local branches and might therefore allocation will be awarded
require a write-off. no marks, as they
(Note that you should not only indicate that contradict each
inventory is damaged but also the effect it other.
has on the AFS. The effect is that inventory (In respect of
is included in the inventory balance and not existence, items
written off.) are recorded that
6. There is a risk that inventory might be Existence should not have
overstated for management to receive their been and in
performance bonuses increase inventory, respect of
decrease cost of sales and increase profits). completeness,
7. There is a risk that the inventory cost of Accuracy, items have not
imported products might be determined valuation and been recorded but
incorrectly according to the first-in-first-out allocation should have been
cost formula as the date for which risks, and recorded).
rewards have passed to AFRICHIC might be
applied incorrectly.
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(a) Description of the risks of material (b) Relevant
misstatement at assertion level relating to audit
the inventory balance assertion(s)

8. There is a risk that inventory might not be Accuracy,
measured at the lower of cost and net valuation and
realisable value. allocation
9. There is a risk that products purchased by Existence
customers online might have been disclosed and/or
as inventory of AFRICHIC when such rights and
products do not belong to them. obligation
((10 x 1½ = 15) + (10 x 1 = 10), maximum 17)
11.3 Computation of planning materiality 15 marks
Column A: Column B:
This is what your answer should
This is what the theory says…. look like…
Step 1: Determine which figures to The unaudited figures of the current

use year are available and should be
• Use unaudited figures for current used in the computation (1½ mark).
year, if available.
• If the unaudited figures of the current The budgeted figures of the current
year are not available, the budget year are also available but will not be
and audited figures of the prior year used, as unaudited figures are
should be considered. available (1½ mark).
Step 2: Consider the indicators Marks are awarded when calculating
Use what is provided, if nothing is the intervals below.
provided use the norms.
• Turnover - 0.5% – 1%
• Gross profit - 1% – 2%
• Net profit before tax - 5% -10%
• Total assets – 1% – 2%
• Equity – 2% – 5%
Step 3: Determine which of the Turnover is a suitable indicator and
indicators is appropriate for the can be used, since the company is in
calculation of materiality in the the business of sales (1½ mark).
planning phase
• If a company made a loss, the net The company made a loss during the
profit before tax indicator cannot be financial year and therefore net profit
used. before tax is not a suitable indicator to
• Take the inherent characteristics of be used (1½ mark).
the company into account. For
example, you are likely to use total Total assets are not a suitable
assets for an entity that is capital- indicator and therefore not used as
intensive. the company is not capital-intensive
• Consider the stability of the figures. (1½ mark).
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Column A: Column B:
This is what your answer should
This is what the theory says…. look like…
Equity is not a suitable indicator and is,

therefore, not used (1½ mark).
Note that you have to explain why the

indicator is suitable to earn full marks.
Step 4: Calculate the materiality Turnover:
interval for each of the suitable 0,5% – 1%
indicators R60 000 000 (unaudited figure)
Both the lowest and highest limits of the = R300 000 – R600 000
intervals for each suitable indicator
should be calculated.
Step 5: Decide on a materiality figure In view of the inherent risk being
to use when planning an audit. assessed as high (1½ mark),
• Exclude indicators where the range the materiality figure to be used for
of figures is an outlier. the planning of the audit should be
• If the inherent risk is assessed as set at the lower end (1½ mark),
low, a figure in the upper range of the thus
amounts calculated will be selected. R300 000 (1½ mark).
• If the inherent risk is assessed as
high, a figure in the lower range of
amounts calculated will be
selected.
• Remember, there is an inverse
relationship between materiality
and inherent risk.
Note: It is not necessary for you to include the theory

(column A) in your answer. We only included the
information for illustration purposes. Make sure that you
apply the theory and that your answer looks like column B,
otherwise you will not earn any marks.
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11.4 Improvements to the audit engagement letter 15 marks
Review note as provided in the question Suggested improvement
1. Address the engagement letter to the The audit engagement letter should be
correct party. In your letter you addressed it addressed to an appropriate representative of
to the shareholders. management; that is, the board of directors or
the audit committee. (1½)
2. Replace the sentence that indicates that • Fees should be negotiated with the
audit fees will be R200 000 for the audit of the audit committee based on time, skill
31 March 2020 year-end with an appropriate and experience. (1½)
sentence. • Therefore, it should not refer to an exact
audit fee (1½) that will be charged and
• should be replaced by: “Our fees will be
based on the time, skill and experience
of the team conducting the audit”. (1½)
(maximum of 1½ marks)
3.The engagement letter, indicates that it is the Management is responsible for compiling the
responsibility of the auditors to prepare the financial statements and it should be
financial statements in accordance with the mentioned as such in the audit engagement
International Financial Reporting letter. (1½)
Standards.
4. As the auditors, we do not certify the fair Auditors do not “certify”; they provide an
presentation of the financial statements. opinion on the fair presentation of financial
statements. (1½)
5. It is indicated in the engagement letter that The letter should indicate that the audit will be
the audit is performed according to performed according to International
generally accepted accounting practices. Standards on Auditing and not in accordance
with generally accepted accounting practices.
(1½)
6. I am not comfortable with the following “Because of the inherent limitations of an audit
sentence “Our audit will be designed to together with the inherent limitations of internal
provide absolute assurance that all fraud and control, there is still the unavoidable risk that
errors that are material to the financial some material misstatements may not be
statements will be discovered.” Replace the detected, even though the audit is properly
sentence. planned and performed in accordance with the
ISAs.”
OR
“Our audit will be designed to provide
reasonable assurance that all fraud and errors
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Review note as provided in the question Suggested improvement
that are material to the financial statements will

be discovered.” (1½)
7. Is the following sentence correct: “Due to Despite healthy relationships between the
the relationship between Mr Pantsy Pants external auditor and management, there
and the CFO, we will not require any written should be an indication in the engagement
confirmations”? letter that written confirmation of
representations of management will be
requested. (1½)
8. Insert a sentence on the restriction of Access should not be restricted; and as
access to persons and information. auditors, we should have access to any
information or persons to perform the audit we
deem necessary. (1½)
9. The engagement letter indicates that once Management should be requested to
the audit client received the letter, the acknowledge receipt of the audit engagement
shareholders do not need to acknowledge letter and to agree to the terms of the
receipt thereof, but should read through the engagement outlined therein. (1½)
terms and conditions and keep a copy for
future reference. Is this sentence correct?
10. Once you amended the engagement The designated auditor should sign the letter,
letter, sign the letter and send it to the audit and not the senior audit manager (me). (1½)
client.
(10 x 1½ = 15)
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11.5 The audit plan 15 marks
AUDIT PLAN Always

Nature remember to
• Follow a combined audit approach, using both tests of controls include what
and substantive procedures. (1½ marks) type of approach
• This approach is followed because (1½ marks each) you will follow in
- we intend to rely on the operating effectiveness of internal your answer!
controls
- substantive procedures alone will not provide sufficient
appropriate audit evidence
• Computer-assisted audit techniques (CAATs) should be used to
test the automated (computerised) applications or controls. (1½ If there is mention
marks) of an automated
• Specific risks can be dealt with as follows: (1½ marks each) system in the
- Owing to the limitations of the accounting system when scenario,
measuring inventory, perform tests of controls and remember to
substantive procedures to test for the accuracy, valuation include the use of
and allocation of inventory. CAATs.
- Perform substantive procedures to deal with compliance
of laws and regulations in the online retailer industry, as
regulated by the CCSA.
- Perform substantive procedures to deal with the going
concern risk. Remember to refer
- Perform tests of controls and substantive procedures to to all the specific
test for the occurrence and accuracy of income and risks that have been
expenses to confirm the validity and accuracy of identified in your
management’s bonuses, which are based on profits. risk assessment;
- Perform substantive procedures on the recognition of DO NOT forget to
state what type of
imported inventory.
audit procedures
- Perform substantive procedures to test for the accuracy of you will perform on
opening balances, as this is a new audit client. each of the risks,
- Perform substantive procedures on i.e. tests of controls
estimates/assumptions/judgements used by or substantive
management on impairment of inventory, due to a decline procedures to
in the demand for online products. obtain marks.
- Perform more tests of controls and substantive
procedures to make sure that transactions are valid,
accurate and complete, due to the familiarity risk that
exists.
Timing
• Owing to the tight deadline to finish the audit, the auditors may Don’t just
choose to perform audit procedures as follows (1½ marks each): mention the
- Before year-end (interim) tight deadline,
- Early verification just prior to the year-end and rolled indicate the
forward at the year-end. impact on the
timing.
• The necessary planning should be done to make provision for
the attendance of the physical verification of inventory at the
warehouse in Midrand.
(15 x 1½ = 22½, maximum 15 marks)
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12.1 Risks of material misstatement at the financial statement level 15 marks
Identified inherent risks include the following:
1. The annual financial statements (AFS) might be materially misstated due to error, as
Happychef imports cookware and the accounting treatment for importing and hedging is
complex and/or might be incorrect. (1½)
2. The AFS might be materially misstated due to error, as the going concern assumption may
not be properly accounted for and/or disclosed; and the company might possibly not adhere
to international laws and regulations which could lead to penalties. (1½)
(Note: It is important to explain the effect non-adherence will have on international laws and
regulations; that is, penalties which might result in a decline of profits that might, in turn,
influence the going concern disclosure of the entity. If the answer is not explained in this way,
it is not clear what the effect on the AFS will be, and marks can, therefore, not be awarded)
3. The AFS might be materially misstated due to error, as the going concern assumption might
not be properly accounted for and/or disclosed; the entity might be liable for legal damages
in terms of the ongoing litigation, resulting in negative publicity and a decline in turnover for
the entity. (1½)
(Note: It is important to explain the impact that the ongoing litigation will have; that is, a decline
of profits that might influence the going concern disclosure of the entity. If the answer is not
explained in this way, it is not clear what the impact on the AFS will be, and marks can
therefore not be awarded)
4. The AFS might be materially misstated due to fraud, as the directors might engage in
fraudulent reporting to achieve budgets (1½) to satisfy investors, for example overstatement
of revenue/assets and understatement of expenses/liabilities.
5. The AFS might be materially misstated due to error accounting on an inappropriate
accounting basis, as the going concern assumption might not be properly accounted for;
and/or disclosed because the company did not achieve the budget due to a decrease in
sales. (1½)
6. The AFS might be materially misstated due to fraud, as management lacks integrity because
- one of the executive directors has been dismissed due to involvement in fraudulent
transactions in the finance department and there might be more instances of fraud (1½)
- There is a possibility that company might have contravened the Labour law if the executive
director was removed unjustly, which shows management’s disregard to laws and regulations
(1½),
7. There is a possibility that AFS might be materially misstated due to fraud, as management
know that the new auditors have limited knowledge of the entity. (1½)
Identified control risks include the following:
8. The AFS might be materially misstated due to error, as the internal controls at the various
locations might not be operating effectively due to decentralisation of the business. (1½)
9. There is a possibility that the AFS might be materially misstated due to error, as the financial
data might not be properly transferred and/or tested from the old accounting system to
the new accounting system. (1½)
10. The AFS might be materially misstated due to error since the personnel at Happychef are not
familiar with the new system. (1½)
159
((11 x 1½) plus 1 mark for communication skills, maximum 15 marks)
(Note: According to ISA 315 (Revised 2019), auditors need to do their identification and
assessment or risks separately for inherent and control risks. The communication mark will be
awarded if the answer was split between the two components)
Comments
 This question requires you to describe the risk of material misstatement at financial statement
level, which implies that you should describe the risks and the effect they have on the financial
statements as a whole. Therefore, do not describe risks that involve specific line items and
assertions in the financial statements, because this will be describing risks of material
 For this question we only required you to describe the risks of material misstatements. However,
sometimes we may ask you to include the inherent risk factors and the assessment of each risk.
Refer to question 7 for a good example.
 How should you approach a question when requested to describe risks of material misstatement
at financial statement level? You should apply the following steps:
Step 1: Identify the existing events or conditions (risk indicators) at the audit client while reading
through the scenario.
 Remember, by describing the events or conditions (risk indicators) you do not necessarily describe
the risk. If you do not link the events or conditions (risk indicators) to the risk of material
misstatement and the effect it has on the financial statements, you will not receive marks.
Remember that risks of material misstatement may be due to error, or fraud and you need to
indicate it in your description.
 Make sure that you do not describe a business risk instead of a risk of material misstatement at
financial statement level. To illustrate the difference between the two, refer to the following:
Business risk: There is a risk that the business is not profitable due to the decrease in sales.
(This risk will be dealt with by management by implementing strategies to improve sales.)
Risk of material misstatement at the financial statement level: Owing to the risk that the
business might not be profitable, the AFS may be materially misstated by accounting for the
business as a going concern in the financials, while it might not be viable in the foreseeable future.
Do you see the difference between the two risks? A business risk relates to the business as a
whole, whereas a risk of material misstatement at financial statement level refers to the risk that
the financials, as a whole, might be incorrect. Therefore, make sure that your answer describes
an audit risk correctly and the effect it has on the AFS.
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12.2 The overall audit strategy 15 marks
Scope
1. First time that ISA Incorporated is providing audit services to Happychef.

• The auditors of Happychef will have to conduct audit procedures on opening
balances. (1½)
2. Happychef’s systems are automated (computerised).

• Computer-assisted audit techniques will be used whenever possible; therefore, the
auditor must be familiar with the use of CAATs or should appoint an expert to assist
them. (1½)
3. Use of specialised computer system auditors (third party)

• The fact that the board members decided to appoint specialised computer system
auditors to audit the computer system should be taken into account when
determining whether reliance can be placed on the expert. (1½)
4. Compliance with laws and regulations.

• Seeing that Happychef allegedly contravened the Labour law, the auditors need to
confirm whether they have complied with all the other applicable acts, such as the
Companies Act. (1½)
5. Multiple locations (9 outlets)/decentralisation of the business

• May result in the use of other auditors in the major cities, for simultaneous inventory
counts. (1½)
Timing
1. Inventory counts
• As the company is spread across the country, the inventory counts that need to take
place at yearend have to be carefully planned. Resources (time and number of staff)
should, therefore, be considered to make sure that inventory counts are attended.
(1½)
2. Multiple locations/decentralisation of the business:

• As the company is spread across the country, audit procedures should be planned
by considering that the auditors might need to visit some of the offices. Therefore,
sufficient time for visits should be planned, or if the auditors decide to make use of
auditors at other locations, it will be necessary to schedule meetings with these
auditors. (1½)
3. Subsequent events in terms of litigation

• The auditors should plan sufficient time after the year-end to follow up on litigation
issues which should be updated in the financial statements. (1½)
4. Overall timing of audit procedures

• There is no imposed audit deadline; therefore, the audit procedures at and after year-
end can be considered. (1½)
161
5. Report of third party on the specialised computer systems
• The auditor should consider the timing of the availability of the report from the third
party to ensure that the impact will be considered in the audit approach, and to ensure
that the management expert’s work can be relied on. (1½)
6. Use of CAATS
• The auditors should make arrangements to ensure that the data and information are
available timeously, and that the results and the impact of the CAATS are properly
considered during the audit. (1½)
(11 x 1½ = 16½ marks, maximum 15 marks)
Comments
This question specifically required that your answer deal only with the scope and timing of the overall
audit strategy, and not the direction. Therefore, make sure that you understand what these terms
mean by referring to lesson 3.8.
To assist you in answering a question which deals with the overall audit strategy, it is always important
to keep the risks that you have identified during your risk identification in mind. This will guide you in
describing the range of activities you need to perform (scope)and when the auditor will perform the
audit procedures(timing).
Let’s look at an example:
During your risk identification, you might have identified that the audit client is new. (Even though this
does not relate to a risk of material misstatement at financial statement but rather to an audit risk,
specifically detection risk, you still had to identify it as a risk and should formulate a response in your
audit strategy to deal with it.) The risk involved with a new audit client is that the opening balances in
the AFS might be incorrect. To deal with this risk, you must explain what you, as the auditor, will do
(the activity) to mitigate this risk. This will affect your scope of the overall audit strategy.
As part of the scope of the overall audit strategy, you must describe the range of activities that the
auditor will perform during the audit to deal with the identified risks. Therefore, with reference to the
example above, for the auditor to feel confident that there are no mistakes in the opening balances
of the new audit client, he or she will have to conduct audit procedures on the opening balances (the
activity).
Please note that no marks were allocated if you only identified and wrote down the headings. You
had to explain your answer in the paragraphs under the headings.
If you did not do well in this question do the question again and see whether you can apply what we
have just explained to you by referring to your risk identification answers in question 5.1.
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12.3. Risks of material misstatement at assertion level 15 marks

assertion level for salaries and wages assertion(s)

1. There is a risk that cash wages might be stolen during the Completeness (1)
cash withdrawal, the making up of pay packets, at the pay-
out, or if unclaimed, and that they might therefore not be
accounted for correctly. (1½)
2. There is a risk that some salaries and wages were not Completeness (1)
completely or accurately transferred from the old computer Accuracy (1)
software programme to PayU. (1½)
3. There is a risk that the salaries and wages account might Accuracy (1)
contain errors, as personnel are unfamiliar with the new
system. (1½)
4. There is a risk that fictitious employees were included in the Occurrence (1)
cash wage system and in the AFS (1½) (especially seeing
that PayU shows that there are 200 employees employed
instead of 180 employees (80 + 60 + 40).
5. There is a risk that the employees logged incorrect hours in Accuracy (1)
the register when entering or exiting the warehouse. (1½)
6. There is a risk that fraudulent transactions were included in Occurrence (1)
the salaries and wages due to unauthorised access to the
PayU system, especially as access is not restricted (use of a
general username and password). (1½)
7. There is a risk that overtime was calculated incorrectly, Accuracy (1)
especially as overtime is limited to 25 hours at a rate above
the normal rate. (1½)
((7 x 1½ = 10½) + (8 x 1 = 8) plus 1 mark for communication skills, maximum 15)
Comments
This question dealt with the risk of material misstatement at assertion level. An important action to
remember when answering a question on the risk of material misstatement at assertion level is to
always list the relevant assertion(s) affected by your risk.
This question relates to classes of transactions (salaries and wages) and not account balances.
Therefore, the possible relevant assertions that might be applicable when answering this question
are occurrence, completeness, accuracy, cut-off, classification and presentation (Refer to ISA 315
(Revised 2019), paragraph A190.).
163
To identify the risks related to salaries and wages, you first need to look at the scenario to see what
risks might be applicable in this instance. This is the part with which most students struggle, but it
becomes easier when you practise how to answer these questions.
When looking at these assertions, you might ask yourself, “What is the difference between occurrence
and accuracy and when do I write which one?”
To answer this question, we should look at the definitions in ISA 315 (Revised 2019), paragraph
A190.
• In terms of occurrence, transactions should have occurred (taken place) and should
relate to the entity. Therefore, when looking at answer number four above, which states that
there might be a risk that fictitious employees are being paid, it relates to occurrence because
these transactions might not have taken place in the first place. Similarly, when looking at
answer number six, there is a risk that unauthorised transactions might be included in salaries
and wages. Unauthorised transactions mean that these transactions should not be taking
place; therefore, it also relates to occurrence.
• Accuracy, on the other hand, relates more to the measurement of transactions. Answers
four and six have nothing to do with the measurement of the transactions and relate to whether
or not a transaction actually took place; therefore, accuracy is not applicable to answers four
and six.
For this topic, it is thus of utmost importance that you practise by doing as many questions as possible.
You may refer to the self-assessment questions on this topic for more examples and if you struggle
with them, you are welcome to contact your e-tutor or lecturer for assistance.
13.1 Fundamental principles of ethics 8 marks
The CFO is a professional accountant (registered as a Chartered Accountant) in business and

should therefore comply with the SAICA Code of Professional Conduct (CPC). (1)
The CFO, therefore, has failed to comply with the following fundamental principles of ethics set
out in the SAICA CPC:
Integrity (1)
He has not been honest in his professional capacity in that he allowed financial irregularities to
occur under his direction and lied about it in court. (1½)
Objectivity (1)
He has allowed one executive director to influence his professional judgement while he should
have remained independent and impartial and should, therefore, have refused to comply with the
executive director’s instruction to lie in court, regardless of the consequences. (1½)
Professional behaviour (1)

He discredited the profession because he was involved in financial irregularities and lied about it
in court. This amounts to the failure to comply with laws and regulations. (1½)
From the scenario there was no clear indication that the CFO transgressed the other fundamental
principles, namely professional competence and due care and confidentiality. (1½)
(4 x 1 = 4) + (4 x 1½ = 6), maximum 8)
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13.2 Preliminary audit engagement activities 11 marks
ISA Incorporated should consider the following matters when deciding whether or not to accept
Living Well as a new audit client:
13.2.1 Seeing that Living Well operates in the retail industry in which most of their other audit
clients operate, they should have the necessary knowledge and expertise required to
perform the audit. (1½)
13.2.2 The audit firm needs to consider whether it will be a problem for them not to have any
reference to prior auditors, since this is the first time that Living Well will be audited. (1½)
The audit firm should have detailed discussions with those entrusted with governance to
ensure that they understand what responsibilities they and the auditors have so that they
know what is expected of them during the audit. (1½)
13.2.3 The audit firm should consider the integrity of the audit client seeing that financial
irregularities took place under the direction of the previous CFO and one executive director,
even though both of them have been dismissed during the financial year. (1½)
13.2.4 Seeing that Living Well will considerably expand their business, the audit firm needs to
consider whether the audit firm will have enough resources and the necessary expertise
to audit a large company and should take this into consideration for future audits. (1½)
13.2.5 The audit firm needs to consider whether there will be additional reporting requirements
and specific deadlines they need to adhere to as the holding company is a listed company.
For future audits, this should be carefully considered as ISA have no experience of listed
companies. (1½)
13.2.6 Depending on the outcome of the audit, the audit firm needs to carefully consider whether
or not they will be willing to perform the audit and be associated with the client in the future
(1½). If so, an audit engagement letter should be signed at the beginning of each audit
(1½).
(8 x 1½ = 12, maximum 11)
13.3. Risks of material misstatement at financial statement level 27 marks
(a) (b) (b)

Inherent risk Description of risks of Assessment of risks of
factors material misstatement material misstatement based
on likelihood, magnitude and
(½ mark each) (1½ marks each) spectrum of inherent risk
(1 marks each)
1. Complexity (½) 1. The AFS might be materially 1.
The likelihood is medium as
misstated due to error, as Living
Well imports products and the there are no reasons from the
accounting treatment of importing
scenario that increase the
and hedging is complex. (1½) likelihood. (1)
The magnitude is medium as only
some products are imported (the
ratio is unknown). (1)
Conclusion on the spectrum of
inherent risk is medium. (1)
2. Complexity 2. The AFS might be materially 2.
and/or change (½) misstated due to error, as the The likelihood is low that the
company may not adhere to local entity has competent legal
and international laws and
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(a) (b) (b)
(1 marks each)
regulations and changes thereto advisors advising them on a
which might lead to penalties or regular basis. (1)
closure of business operations The magnitude is low, as not all
(½). This might lead to the going transactions involve adherence to
concern assumption not being some laws and regulations. (1)
properly accounted for and/or Conclusion on the spectrum of
disclosed (1). inherent risk is low. (1)
Or
On the other hand, the AFS might
not be materially misstated as the
company has an exceptional team
of legal advisors who will guide
them in terms of legal
requirements (1½).
3. Susceptibility to 3. The AFS might be materially 3.

misstatement due misstated due to fraud, as one of The likelihood is high, as
to other fraud risk the executive directors and the management had previously been
factors (½) previous CFO were involved in involved in fraud and potential
financial irregularities. (1½) fraud is present. (1)
The magnitude is high, as
management had previously been
involved in fraud and there is a
potential for fraud (1)
inherent risk is high. (1)
(Note that this is also classified as
a significant risk.)
4. Uncertainty 4. The AFS might be materially 4.
and/or subjectivity misstated due to error, as there is The likelihood is high, there is
(½) uncertainty about some estimates uncertainty, and the use of mini
that should be used to write off trucks has increased. (1)
assets. (1½) The magnitude is high for the
applicable account balance but
not as the AFS as a whole. (1)
inherent risk is high, not for the
AFS, as a whole, but rather for the
related account balance. (1)
5. Susceptibility to 5. AFS may be materially 5.
misstatement due misstated due to fraud, as the The likelihood is high, as
to management directors might engage in management would benefit from a
bias (½) fraudulent financial reporting, for healthy financial position and
example, overstatement of potential fraud is present. (1)
revenue and understatement of
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(a) (b) (b)

(1 marks each)
expenses to ensure that the AFS The magnitude is high, as
is a healthy financial position for management would benefit from a
the BBEEE deal. (1½) healthy financial position and
potential fraud is present. (1)
6. Susceptibility to 6. The AFS might be materially 6.
misstatement due to misstated due to fraud, as The likelihood is high, as
management bias or management know that the new management would benefit from a
fraud and/or auditors have limited knowledge of healthy financial position and
Change (½) the entity. (1½) potential fraud is present. (1)
The magnitude is high, as
management would benefit from a
healthy financial position and
there is potential for fraud. (1)
((6 x ½ = 3) + (12 x 1½ = 18) + (16 x 1 = 16) plus 2 marks for communication skills,
maximum 27)
Comments
This question requires you to identify, describe and assess the risks of material
misstatement at financial statement level. What does this imply?
• To refresh your memory, refer to the explanation of the term “risk of material
misstatement.”
• Remember that risk of material misstatement refers only to the two components of
inherent risk and control risk. Therefore, only describe inherent risks and control risks,
and exclude risks dealing with detection risk from your answer. Detection risk only affects
the auditor. Remember that inherent risk should be assessed before control risk. In the
scenario there were no risks described which affect control risk, and the question
specifically required you to answer in terms of the inherent risk factors that were
identifiable from the scenario.
 The financial statement level implies that you should describe the risks and the effect
they have on the financial statements as a whole. Therefore, do not describe risks that
involve specific line items and assertions in the financial statements, as this will be
167
describing risks of material misstatement at assertion level.
 Risks of material misstatement can be indicated by inherent risk factors which include
complexity, subjectivity, change, uncertainty or susceptibility to misstatement due
to management bias or other fraud risk factors. Examples of each of these inherent
risk factors are included in ISA 315 (Revised 2019) Appendix 2. As you read through the
given scenario, see which ones you can identify.
 Note that the inherent risk factors indicated in ISA 315 (Revised 2019) were required and
you were not required to identify the risk indicators. Make sure you know the difference
between the two concepts.
 You should identify, describe and assess risks of material misstatement at financial
statement level, which means that you had to approach the question in the following
manner:
Step 1: Identify the inherent risk factors, events or conditions (risk indicators) that may
influence your risks of material misstatement that are present while reading
through the given scenario.
Step 3: Assess the risks of material misstatement at financial statement level.
Remember that if you described the inherent risk factor, event or condition (risk indicator), you
did not necessarily describe the risk. No marks will be awarded for not describing the risk and
the effect it has on the financial statements. You need to link the inherent risk factor, event
or condition (risk indicator) to the risk of material misstatement in the financial
statements and the effect it has in the given scenario. Therefore, explain how the risk of
material misstatement will affect the financial statements. Remember that risks of material
misstatement may be due to error or fraud. Therefore, start describing the risks of material
misstatement as follows:
“The AFS may be materially misstated due to error because …”

“The AFS may be materially misstated due to fraud because …”
Then follow this up by explaining why the financial statements will contain material
misstatements.
In terms of the assessment of risk, you need to consider three components namely likelihood,
magnitude and the spectrum of inherent risk. This means you should:
1. Indicate whether the risk is high, medium or low in terms of likelihood and explain why
you say so.
2. Indicate whether the risk is high, medium or low in terms of magnitude and explain
why you say so.
3. Based on the above, you should conclude on the spectrum of inherent risk and indicate
whether the risk is high, medium or low.
Very important: Make sure you look at the solution of this question thoroughly and
understand the different concepts, as this is almost always tested in every assessment.
Examination technique: Before formulating your answer and while you are reading the
information line by line, highlight or jot down the inherent risk factors, events or conditions
(risk indicators) in the margin next to the applicable sentence to make sure that you do not
leave anything out.
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Description of the risks of material misstatement at assertion level relating to the mini
trucks account balance for the accuracy, valuation and allocation audit assertion:
13.4.1 There is a risk that the mini trucks account balance might be overstated (therefore the
depreciation and impairment losses might be understated) because Living Well might want
to show a healthy financial position for the investor in the BBBEE deal. (1½)
13.4.2 Owing to the uncertainty regarding the calculation of depreciation, there is a risk that the
mini trucks account balance was not valued correctly due to the use of an incorrect useful
life for the calculation of depreciation. (1½)
13.4.3 Owing to the increased frequency of using mini trucks for delivery, there is a risk that the
impairment of mini trucks was not calculated correctly. (1½)
Assessment of the risks of material misstatement at assertion level relating to the mini
trucks account balance for the accuracy, valuation and allocation audit assertion:
13.4.4 The risk of material misstatement at assertion level for the mini trucks balance for the
accuracy, valuation and allocation audit assertion can be assessed as high. (1½)
13.4.5 The high assessment of risk is based on the likelihood that there is a higher risk that the
mini truck account balance might be overstated and incorrectly measured due to the high
level of uncertainty involved with accounting estimates (1½).
13.4.6 Some risks of material misstatement identified might be classified as significant risks due
to the susceptibility to misstatement because of management bias involved (fraud)
and can therefore be placed on the upper spectrum of inherent risk. (1½)
13.4.7 Specific responses should therefore be formulated to deal with the risks of material
misstatement identified for the mini trucks account balance for the accuracy, valuation and
allocation audit assertion. (1½)
((7 x 1½ = 10½, maximum of 9 marks)
Comments
This question dealt with the risk of material misstatement at t assertion level. An important action to
remember when answering a question on the risk of material misstatement at assertion level, is to
always list the assertion(s) affected by your risk. In this question you were required to describe risks
only in relation to one audit assertion, namely accuracy, valuation and allocation. However, if this was
not the case, make sure that you know the difference between the assertions in relation to classes of
transactions and account balances. (Refer to ISA 315 (Revised 2019) paragraph A190).
For this topic, it is of utmost importance that you practise by doing many questions. You may refer to
the self-assessment questions on this topic for more examples, and if you struggle with them, you are
welcome to contact your e-tutor or lecturer for assistance.
169
13.5 Materiality calculation 9 marks
(a) Planning materiality
• The company is in the business of retail and is not capital-intensive, therefore, turnover
will used to calculate materiality (1½).
• As the unaudited figures are available for the current financial year, budgeted figures
and reported figures of the prior year should not be used, and planning materiality should
be calculated, using the unaudited figures (1½).
• Planning materiality can be calculated as follows:
R5 000 000 x 0.5% = R25 000 (½)
R5 000 000 x 0.75% = R37 500 (½)
R5 000 000 x 1% = R50 000 (½)
• Based on the assessment of inherent risk, considering the presence of fraud and many
inherent risks being placed on the higher end of the spectrum of inherent risk, it can be
argued that materiality could be set as follows
- Inherent risk of material misstated is assessed as high, therefore planning materiality
should be set as low (1½), which is R25 000 (1½).
((4 x 1½ = 6) + (3 x ½ = 1½), maximum 6)
(b) Performance materiality of the mini trucks account balance
• Based on the assessment of inherent risk above, the following alternative applies:
- The inherent risk of material misstatement is assessed as high, the percentage used
to determine performance materiality is 70% (1½).
• Calculation of performance materiality:

- R25 000 (as calculated above) x 70% = R17 500 (1½).
(2 x 1½ = 3, maximum 3)
13.6 The overall audit strategy 6 marks
Aspects that should be included as part of the scope of the overall audit strategy:
1. First time that ISA Incorporated is providing audit services to Living Well.
• The auditors of Living Well will have to conduct audit procedures on opening
balances. (1½)
• No reliance can be placed on previous auditors as this is the first time that Living
Well is being audited. We therefore need to conduct the audit without reference to
prior year’s auditing working papers or discussions with previous auditors, but we
should be able to do a quality audit as there is no deadline to be met. (1½)
2. Compliance with laws and regulations.

• Seeing that Living Well need to comply with a few national and international laws
and regulations, the auditors need to consult legal advisors to determine whether
the company has complied with all the applicable acts. (1½)
3. Involvement of a fraud specialist.

 Owing to the CFO and one executive officer being involved in financial irregularities,
the auditors may consider involving a fraud specialist. (1½)
(4 x 1½ = 6 marks)
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Comments
This question specifically required that your answer deal only with the scope of the overall audit
strategy, and not the timing and direction. Therefore, make sure that you understand what these terms
mean by referring to lesson 3.8. You should also only focus on the information, specifically the
information given in the scenario. This means that some of your answers might be correct, but not
specifically in terms of the given scenario.
To assist you in answering a question dealing with the overall audit strategy, it is always important to
keep the risks that you have identified during your risk identification in mind. This will guide you in
describing the range of activities you need to perform (scope). Apart from the aspects identified during
your risk assessment, you should also make sure that there are no other aspects that should be
included in your audit strategy.
©
UNISA 2023
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AUE3761/102/0/2023

Tutorial Letter 102/0/2023

The audit process

This tutorial letter contains important information

2 IMPORTANT INFORMATION REGARDING THIS TUTORIAL LETTER

2.2 LECTURERS AND CONTACT DETAILS

Lecturer Telephone number

Mrs S Abed 012 429 4544

2.4 STUDY PROGRAMME

Lesson to study Time frame

Lessons 1.1, 1.2, and 1.3 (important revision) Week 1

Lessons 2.1, 3.1 and 3.2 Week 2

Lesson 3.3 Week 3

Lessons 3.4 and 3.5 Week 4

Lessons 3.6 and 3.7 Week 5

Lessons 3.8, 3.9 and 3.10 Week 6

Write the test On the due date communicated on myUnisa

3 ACADEMIC CONTENT TO STUDY FOR THIS MODULE

LESSON 1: INTRODUCTION TO THE AUDIT PROCESS

The following is a schematic representation of the stages of the audit process.

FIGURE 1:1 The stages of the audit process

This lesson is presented in the following units:

1.1 Auditing concepts (an introduction to auditing)

LESSON 1.1: Auditing concepts (an introduction to auditing)

At the end of the lesson, you should be able to do the following:

Concept Checklist of concepts that you need to revise and be

The auditor • The overall objective of an audit and an auditor.

• Difference between assurance and non-assurance

The accounting • Identify the domineering accounting bodies in South

• Purpose of performing an audit (ISA 200 paragraphs 3 and

At the end of the lesson, you should be able to do the following:

REGULATION OF THE AUDITOR

The Auditor is regulated by the following Acts and Codes:

Revise and study

How will you be assessed on this information?

Refer to section 4 of this tutorial letter and attempt questions 1 and 2.

1.2.2 COMPANIES ACT

Revise and study

The sections noted above in the Companies Act:

Section 90 dealing with the appointment of auditors.

How will you be assessed on this information?

1.2.3 ETHICAL PRINCIPLES FOR ACCOUNTANTS AND AUDITORS

Figure 1.2.1: Core concepts in the definition of ethics

Personal ethics refers to a personal value system applied by an individual to decision-making,

Something to think about:

Virtue ethics: https://ethics.org.au/ethics-explainer-virtue-ethics/

Revise and study

How will you be assessed on this information?

Refer to section 4 of this tutorial letter and attempt questions 3 and 4.

1.2.4 QUALITY CONTROL GUIDELINES FOR AUDIT FIRMS AND AUDITS

Revise and study

 Quality management for audit firms

 Quality management for an audit of financial statements

How will you be assessed on this information?

LESSON 1.3: King IV Report on Corporate Governance in South Africa

At the end of the lesson, you should be able to the following:

PART 1: GLOSSARY OF TERMS

PART 2: FUNDAMENTAL CONCEPTS

Revise and study

PART 3: KING IV APPLICATION AND DISCLOSURE

Revise and study

Refer to Part 3 of King IV and note the following:

PART 5: KING IV CODE ON CORPORATE GOVERNANCE