Risk of Materal Mistatemnt is a Client spesific risk, and Auditor is not responsible for this Risk of Material Misstatement.

Kap Ch 5
of Material Misstatement.
As mentionaed above, External Auditor is not responisble for the Risk of matereal misstatement (inherent&contr
misstatement (inherent&control risk), External audit only ecalute these risks, this is a client spesific risk.
Kap Ch 6
Q51
B

Q52
B&E

Q53 Mater Min level Mater Max level

PBIT 9.5 mln 0.475 mln 0.950 mln
Revenue 124 mln 0.620 mln 1.2 mln

A is $1,5 mln is LEAST appropriate

Q54 easy
1C
2 NC
3C

Q55 easy
1E
2G
3F
Q56
4 easy

Q57
B

Q58 20x5 20x4

Rec Col period 35 30
Invent hold period 58 47

Q59
1

Q60
3&4
Q61 20x5 20x4
Gross margin 44.0% 46.7%
Current ratio 2.2 4.4 times

Q62 20x5 20x4

Pay period (days) 83 55
3

Q63
1
2
 6

Q64
2&3

Q65
3
Q66
3 opt

Q67
2 opt
3 opt easy
5 opt

Q68
4 opt easy
Q69
D opt

Q70
2 opt
easy
Q71
1 opt
easy

Q72
1C
2C
3D
4A

Q73
4 opt
Q74
3 opt

Q75
1 opt
4 opt
5 opt
 Darjeelin Sycamore Kangaro Aquamarin
g sd18 j15 o j13 e mj16
AUDID Risk&Responce for
5 New audit client
5 IAS 38 Research & Development 1 1
10 IAS 16 (new) PPE /reve&cap expe 1 1
5 Appropeitnes of depreciations 1 1 1
1 Revaluation of Land & Buliding 1
3 Profit/Loss on disposal of PPE 1
4 Intangible asset(Patent) (rev&cap exp) 1
1 Branch records

5 Supplier statement recon (PAYABLES)

6 Bank loan 1 1 1 1
3 Finance Cost 1 1 1
3 Loan covenants(overdraft/,,,) 1
1 Planned stock exchange listing 1
9 IAS 37 Provision on Claim(Conting Liab/Warrant) 1
3 Redundancy provision 1
4 Share/Bonus issue
1 Restructuring finance
2 Cut off Payables(purchases)
2 Reconciliation
1 New Suplier

2 Conting Asset
11 Receivable valuation 1 1 1
3 Perpetual inventory system
2 Inventory record exceptions
13 (Full year end) Inventory valuation (includin 1 1
3 Invent count movement 1
3 WIP 1
3 Cut off Inventory(Goods in transit)

4 Refunds for product recall/Sales Returns 1 1

4 Movement in revenue and margin 1
1 Risk of Profit Manipulation 1
5 IFRS 15 (Price prom/Rev Rec/Depos) 1 1
1 securty given for loan 1
2 Risk of Result Manipulation
2 Sales Cut-off
1 Return of Goods

1 Temporary cases
3 New System
 5 Fraud (Director bonus)
3 Finance director/Supervisor/Staff fraud 1
1 Competence of finance director 1

4 Outsourced payroll function/Receivables 1

3 Data transfer 1
5 Going concern uncertinities 1 1
4 Directors remunaration
3 Reporting timetable-/Detection Risk
1 Dividends

KNOWLADGE
1 Analytical procedures (3steps) 1
4 Ratio 1 1
3 Fraud Responsibilty 1
1 Quality Control 1
ch1 K 1 Review engagement 1
2 Materiality and performance materiality 1
2 Audit Risk and its companents 1
ch10 K 3 Preconditions for an audit
Risk ch5 K 2 Understanding of the entity
Plan ch6 K 2 Supervision and Review of assitant`s work
Ethics ch4 2 Accepting the audit engagement
Ethics ch4 1 Conflict of interest
Plan ch6 K 3 Planning Audit
ch13 K-479 1 Engagement letter (matters)
2 Engagement letter for recuring
1 inventory count
Plan ch6 K 1 Audit startegy
1 Professional scepticism

AUDID PROCEDURES for

Inventory valuation 1
Revenue 1
Receivables valuations
Disposal of Plant
director`s bonus & remuneration
Redundancy cost
Development expenditure

Audit Report 1
Payroll service organization 1

Ethical threats and safeguards***

Safeguards***
Redsmith Blackberry Harlem Centipade Sitia Venus Hurling Hart Recorder
d10 mj18 sd19 d16 Sparkle s16 sd15 mj17 sd20 Com j14

1 1 1
1 1
1 1 2 1
1

1 1
1 1 1
1

1 1 1

1 1 1 2 1

1 1 1 1
1
1 1
1 1

1 1
1 1 1 1 1
1 1
1
1 2 1 1 1 1 1
1
1
1

1
2 2

1 1

1
1 1

1 1
 1 1 1 1 1

1 1
1
1 1
1 1 1
1 1
1

1 1
1

1
1
1 1
1 1
1
1
1 1 1
1
1
1

1
1
1

1
1
Prancer
Constr Peony Scarlet Corley Peach
sd17 mj19 m20 mj 21 sd 21

1 1 Hart sd20
1 Scarlet m20
1 1 1 1 Harlem sd19
1 Peony mj19
Darjeeling sd18
Blackberry mj18
Prancer Constr sd17
Hurling mj17
Centipade d16
1 1 Aquamarine mj16
1 1 Venus sd15
Sycomer j15
1 1 Recorder Com j14
Redsmith d10
1 1 1 Kangaroo j13
1 1 Sitia Sparkle s16

Corley mj 21
Peach sd 21

1 1 1
1
1
1 1 1 1
1
1
1 1

1
1

1
1
 1 1

1
1
1
1
1

1 1

1
1

1
1

1
a) Analytical procedures
Analytical procedures can be used at all stages of an audit, hovewer, ISA 315 Identifying and Assessing the Risk of Materia
Misstatement through Understanding the Entity and Its Environment and ISA 520 Analytical Procedures identifies three
particular stages.

During the planning stage, analytical procedures must be used as risk assessment procedures in order to help the auditor
to obtain an understanding of enitity and assess the risk of materila misstatement. (ISA 315 Kaplan)

During the final audit, analytical procedures can be used to obtain ssufficient appropriate evidence. Substantive procedure
can either be tests of details or substantive analytical procedures.

At the final stage, the auditor must design and perform analytical procedures which assist them when forming overall
conclusion as to whether the financial statements are consistentwith the auditor`s understanding of the entity.
(b) Ratios to assist in planning the audit
20x8 20x7
Gross margin 37.3% 36.4%
Inventory holding period 54 45 days
OR
Inventory turnover 6.7 8.1
Receivable collection period 51 38 days
Payables collection period 58 40 days
Current ratio 1.65 3.08 times
Quick ratio 0.99 1.97 times

(c) Audit risks and auditor`s response

AUDIT RISK AUDIT RESPONSE

Research & Development
During the year, Darjeeling Co has spent $0,9m on developing
new product lines, some of which are in the early stages of
development.
This exependiture is classed as research and development
under IAS 38 Intangible Assets. The standard requries reserch
costs to be expensed to profit or loss and only development
costs to be capitalised as intangible asset. The company has
included all of this expenditure as an intangible asset.
Obtain a breakdown of the expenditure and veify that it
relates to the development of the new products. Review
expenditure documentation to determine whether the co
relate to the research or development stage. Discuss
the accounting treatments with the finance direcor and
ensure it is in accordance with IAS 38.

If research costs have been incorrectly classified as develop-

ment expenditure, there is a risk that intangible assets could
be overstated and expenses understated.

PPE Review the purchase documentation for the new

Darjeeling purchased and installed a new manufacturing line.
The costs include purchase price($2,2m), installation costs
($0,4m) and five-year servicing and maintenance plan($0,5m).
As per IAS 16 Property, Plant and Equipment, the cost of an
includes its purchase price and directly attributable costs
only.
manufacturing line to confirm the exact cost of the servic
and that it does relate to a five-year period.
Discuss the accounting treatment with the finance directo
and the the level of any necessary adjustment to ensure
treatment is in accordance with IAS 16.

IAS 16 does not allow servicing and maintanance costs to be

capitalised as part of the cost of a non-current asset, as they
are not directly related to the cost of bringing the asset to its
working condition.

The servicing costs relate to a five-year period and so should

be charged to profit or loss over this time. The upfront
payment represents a prepayment for five years; as the
services are received, the relevant proportion of the cost
should be charged to profit or loss. If service for 20x5 has
been carried out, then $0,1m($0,5m/5) should be charged to
profit or loss. There PPP and profits are overstated and
prepayments are understated.
Bank loan
The company has borrowed $4m from the bank via an eight-
year loan. This loan to be correctly split between current and
non-currect liabilties in order to ensure correct disclosure.
Current and non-current liabilities will be misstated if the
split is incorrect.
Finance cost
As the level of debt has incresed, there should be additional
finance costs as the loan has an interest rate of 5%.
There is a risk that this has been omitted from the statement
of profit and loss leading to understated finance cost and
overstated profit.
Planned estock exchange listing
Darjeeling Co intends to undertake a stock exchange listing in
the next 12 month. In order to maximise the success of the
potential listing, Darjeeling Co will need to present financial
statements which show the best possible position and
performance.
The directors therefore have an incentive to manipulate
the financial statements, by overstating revenue, profits and
assets.
Receivable valuation
The receivables collection period has increased from 38 to 51
days and management has extended the credit terms given
to customers on condition that sales order quantities were
increased. The increase in the receivables collection period
could be solely due to these incresed credit terms. However,
it could also be due to an increased risk over the recoverabilty
of receivables.
Receivables may be overvalued and expenses understated.
During the audit, the team would need to confirm that th
$4m loan finance was received. In addition, the split betw
current and non-currecnt liabilties and disclosures for this
loan should be reviewed in detail to ensure complience w
relevant acounting standards and local legislation.
Details of security should be agreed to the bank confirma
letter.
The finance costs should be recalculated and any increase
agreed to the loan documentation for confirmation of the
5% interest rate. Interest payments should be agreed to t
cash book and bank statements to confirm the amount w
paid and is not therefore a year-end payable.
Earl & Co should ensure that there is a suitable experienc
audit team. Also, adequate time should be allocated for te
members to obtain an understanding of the company and
the significant risks of overstatement of revenue, profits a
assets, including attendance at an audit team briefing.
The team needs to maintain professional scepticism and b
alert to the increased risk of manipulation.
Significant estimates and judgments should be carefully
reviewed in light of the misstatement risk.
Review and test the controls surrounding how Darjeeling
identifies receivables balance which may not be recovera
and procedures around credit control to ensure that they
operating effectively.
Extended post year-end cash receipts testing and a review
the aged receivables ledger to be performed to assess
valuation. Also consider the adequacy of any allowance fo
receivables.
Price Prmomise
This year the company made a "price promise" to match the
price of its competitors for similar products. Customers are
able to claim the difference from the company for one month
after the date of purchase of goods.
Discuss with management the basis of the refund liablity
$0,25m and obtain supporting documentation to confim t
reasonableness of the assumptions and calculations.

The company should account for the price promise in

accordance with IFRS 15 Revenue from Contracts with
Customers. As the company may be required a refund,
the anticipated refund amount should not be initially
recognised as revuenue but instead as a refund liabilty until
the one-month price promise period has ended.

This is a highly subjective area, with many judgments

requiered with regards to the level of likely refund due. As
this is a new liabilty, the directors may not have correctly
accounted for this sum resulting in overstated revenue,
under/overstated profits and liabilties.

Refund for product recall
Darjeeling Co has stopped further sales of one of its paint
products and a product recall has been initiated for any goods
sold since June.
This product recall wll result in Darjeeling Co paying refunds
to customers. The sales will need to be removed from 20x8
financial statements and a refund liabilty recognised. Also
inventory will need to be reinstated, albeit at a possibly
written down value.
Review the list of sales of the paint product made betwee
June and the date of recall, agree that the sales have been
removed from revenue and the inventory included.
If the refunds have not been paid before the year end,
review the draft financial statements to confirm that it is
included within current liabilties.
Failing to account for this correctly could result in overstated
reveune, understated liablities and misstated inventory.

Inventory valuation - damaged paint.
The company is holding a number of damaged paint products
in inventory and overall the inventory holding period has
increased from 45 days to 54 days.
Due to the issue with the paint consistency, the quality of
these products is questionable and management is
investigating whether these products can be rectified.
Discuss with the finance director whether any write down
will be made to this product, and what, if any, modificatio
will be required to rectify the quality of the product.
Testing should be undertaken to confirm cost and NRV of
affected paint products held in inventory and that on line
line basis the goods are valued correctly.

There is a risk that this inventory may be overvalued as its net

realisable value may be below cost.

Movement in revenue and margins
Revenue has increased by 16,8% in the year: and the gross
margin has increased slightly from 36,4% to 37,3%. This is a
significant increase in revenue.
Along with the increase in gross margin, may be related to
the incresed credit period and price promise promotion or
could be due to an overstatement of revenue.
During the audit a detailed breakdown of sales will be
obtained, discussed with management and tested in orde
understand the sales increase.
Also increased cut-off testing should be undertaken to ve
that revenue is recorded in the right period and is not
overstated.

Going concern uncertainties Detailed going concern testing to be performed during th

The payables payment period has increased from 40 to 58 audit, including the review of cash flow forecasts and
days. The current ratio has decreased from 3.08 to to 1.65. underlying assumptions. These should be discussed with
The quick ratio has also decreased from 1.97 to 0.99. management to ensure that the going concern basis is
reasonable.
In addition, the bank balance has moved from $0,56m to an
overdraft of $0,81m. These are all indicators that the company
could be experiencing a reduction in its cash flow which could
result in going concern difficulties or uncertainties.

These uncertainties may not be adequetely disclosed in the

financial statements.
SECTION C and D are related to Substantive procedure(ch7 I think)
(a) Fraud responsibility
Maple & Co must contuct an audit in acordance with ISA 240 The Auditor`s Responsibilties Relating to Fraud in an Audit of
Financial Statements and are responsible for obtaining reasonable assurance that the financial statements taken as a who
are free from materal misstatement, whether caused by fraud or error.

In order to fill this responisbilty, Maple & Co is required to identify and assess the risks of material misstatement of the
financial statements due to fraud.

They need to obtain sufficient appropriate audit evidence regarding the assessed risks of material misstatement due to
fraud, through designing and implementing appropriate responses. In addition, Maple & Co must respond appropriately to
fraud or suspected fraud identified during the audit.

When obtaining reasonable assurance, Maple & Co is responsible for maintaining professional scepticism throghout
the audit, considering the potential for management override of controls and recognising the fact that audit procedures
which are effective in detecting error may not be effective in detecting fraud.

To ensure that the whole engagement team is aware of the risks and responsibilities for fraud and error, ISAs require that
a discussion is held within the team. For members not present at the meeting, Sycamore`s audit engagement partner
should determine which matters are to be communicated to them.
If fraud is detected, the auditor must report this to management and those charged with governance.

(b) Audit risks and auditors' responses

AUDIT RISK
Finance director fraud
Sycamore Co's previous finance direcor left in December after
it was discovered that he had been committing fraud with
regards to expenses claimed. There is a risk that he may have
undertaken other fraudulent transactions; these would need
to be written off in the statement of profit or loss.
AUDIT RESPONSE
Discuss with the new finance director what procedures ha
been adopted to identify any further frauds by the previo
finance director.
In addition, the team should maintain their professional
scepticism and be alert ti the risk of further fraud and erro

If these have not been uncovered, the financial statements

could include errors.

Competence of finance director During the audit, careful attention should be applied to an
The new finance director was appointed in January 20x5 and changes in accounting policies and in particular any key
was previously a financoal controller of a bank. Sycamore Co judgmental decisions made by the finance director.
is a pharmaceutical company which is very different to a bank.

Ther is a risk that the new finance director is not sufficiently

to prepare the financial statements.

The financial statements could contain errors.

Development costs A breakdown of the development expendture should be

During the year, Sycamore Co has spent $1.8m on developing reviewed and tested in detail to ensure that only projects
new products; these are at different stages and the total which meet the capitalisation criteria are included as an
amount has been capitalised as an intangible asset. intangible asset, whith the balance being expensed.

In order to be capitalised it must meet all of the criteria under

IAS 38 Intangible Assets. There is a risk that some projects
may not reach fianl development stage and hence should be
expensed rather than capitalised.

Intangible assets and profit could be overstated.

Bank loan - allocation During the audit, the team would need to confirm that
Sycamore Co has borrowed $2.0m from the bank via a ten-
year loan
There is a risk that the loan is not split between current and
non-current liablities correctly resulting incorrect disclosure.
Bank loan - finance costs
Sycamore Co has borrowed $2.0m which should result in
additional finance costs.
There is a risk that this has been omitted from the statement
of profit or loss, leading to understated finance costs and
overstated profit.
Loan covenants - classification
The loan has a minimum profit target convenant. If this is
breached. The loan would be instantly repayable.
There is a risk the liabilty in incorrectly allocated as
non-curent liabilty rather than current liability if the
convenant is breached
Loan convenants - going concern impact if breached
The loan has a minimum profit target convenant. If this is
breached. The loan would be instantly repayable.
If the company does not have sufficient cash flow to meet
this loan repayment, then there could be going concern
implication.
There is a risk of inaduquate disclosure of going concern
issues.
Loan covenants - manipulation
The loan has a minimum profit target covenant.
There is a risk of manipulation of profit to ensure that
civenant are met.
Sales returns
the $2.0m loan finance was received. In addition, the split
between current and non-current liabilities and the
disclosures for this loan should be reviewed in detail to
ensure complience with relevant accounting standards.
The finance cost should be recalculated and any increase
agreed to the loan documentation for confirmation of int
rates and cashbook and bank statement to confirm the
amount was paid and is not therefore a year-end payable
Review the covenant calculations prepared by Sycamore a
identify whether any defaults have occurred; if so, review
the disclosure of the loan as a current liablity.
Review the covenant calculations prepared by Sycamore a
identify whether any defaults have occurred; if so, determ
the effect on the company.
Review cash flow forecasts and enquire of management h
they will deal with any need to make the loan repayment
The team should maintain their professional scepticism an
be alert to the risk that profit has been overstated to ensu
complience with the covenant.
Review a sample of the post year-end sales returns and
There have been a significant number of sales returns made
subsequent to the year-end. As these relate to pre year-end
sales, they should be removed from revenue in the draft
financial statements and the inventory reinstated.
If the sales returns have not been correctly recorded, then
revenue will be overstated and inventory understated.
confirm if they relate to pre year-end sales, that the reven
has been reversed and the inventory included in the year
ledgers.
In addition, the reason for the increased level of returns
should be discussed with management. This will help to
assess if there are underlying issues with the net realisabl
value of inventory.

Inventory count movement
During Sycamore Co's year-end inventory count there were
movements of goods in and out. If these goods in transit
were not carefully controlled, then goods could have been
omitted or counted twice.
During the final audit, the goods received notes and good
despatch notes received during the inventory count shou
be reviewed and followed through into the inventory cou
records as correctly included or not.

This would result in inventory being under or overstated.

Profit on disposal of PPE Recalculate the profit and loss on disposal calculaton and
Surplus plant and equipment was sold during the year, agree akk items to supporting documentation.
resulting in a profit on disposal of $210,000.

As there is a minimum profit loan covenant, there is a risk

that this profit on disposal may not have been correctly
calculated, resulting in overstated profits.

Appropriateness of depreciaton Discuss the depreciaton for plant and equipment with the
Significant profits or losses on dispossal are an indication that fianance director to assess its reasonabless.
the depreciation policy of plant and equpmnet may not be
appropriate.

Depreciation may be overstated as a result.

( c ) Quality control
Briefing/direction of the team
essing the Risk of Material
cedures identifies three

order to help the auditor

nce. Substantive procedures

when forming overall

ng of the entity.
 enditure and veify that it
he new products. Review
determine whether the costs
opment stage. Discuss
h the finance direcor and

tation for the new

he exact cost of the servicing
year period.

nt with the finance director

ary adjustment to ensure
 ld need to confirm that the
In addition, the split between
ties and disclosures for this
ail to ensure complience with
nd local legislation.

reed to the bank confirmation

alculated and any increase

tion for confirmation of the
ents should be agreed to the
s to confirm the amount was
-end payable.

ere is a suitable experienced

e should be allocated for team
anding of the company and
ement of revenue, profits and
an audit team briefing.

ofessional scepticism and be

anipulation.

ments should be carefully

rrounding how Darjeeling Co

which may not be recoverable
ontrol to ensure that they are

ceipts testing and a review of

be performed to assess
equacy of any allowance for
 basis of the refund liablity of
documentation to confim the
tions and calculations.

aint product made between

ee that the sales have been
inventory included.
id before the year end,
ments to confirm that it is
or whether any write downs
nd what, if any, modifications
uality of the product.

o confirm cost and NRV of the

inventory and that on line by

akdown of sales will be

gement and tested in order to

hould be undertaken to verify

right period and is not

to be performed during the

ash flow forecasts and
should be discussed with
e going concern basis is
ting to Fraud in an Audit of
tatements taken as a whole

al misstatement of the

al misstatement due to
t respond appropriately to

cepticism throghout
ct that audit procedures

nd error, ISAs require that

engagement partner
 rector what procedures have
urther frauds by the previous

aintain their professional

sk of further fraud and errors.

on should be applied to any

and in particular any key
the finance director.

ent expendture should be

o ensure that only projects
riteria are included as an
nce being expensed.

ld need to confirm that

 eived. In addition, the split
ent liabilities and the
be reviewed in detail to
nt accounting standards.

lculated and any increase

tion for confirmation of interest
atement to confirm the
refore a year-end payable.

ns prepared by Sycamore and

ave occurred; if so, review
urrent liablity.

ns prepared by Sycamore and

ave occurred; if so, determine

enquire of management how

make the loan repayment.

professional scepticism and

as been overstated to ensure

ar-end sales returns and

ar-end sales, that the revenue
ntory included in the year-end

ncreased level of returns

gement. This will help to
sues with the net realisable

s received notes and goods

the inventory count should
ugh into the inventory count

on disposal calculaton and

documentation.

nt and equipment with the

easonabless.