PROFESSIONAL SKEPTICISM

Auditor’s questioning. Ask questions, get

answers, verify answers (corroborate).
Being alert for:
• Audit evidence that contradicts other audit
evidence obtained.
• Information that brings into question the
reliability of documents and responses to
inquiries to be used as audit evidence.
• Conditions that may indicate possible
fraud.
PROFESSIONAL JUDGMENT
• Materiality and audit risk.
• The nature, timing and extent of audit procedures used
to meet the requirements of the ISAs and gather audit
evidence.
• Evaluating whether sufficient appropriate audit
evidence has been obtained.
• The evaluation of management’s judgments in applying
the entity’s applicable financial reporting framework.
 OVERALL AUDIT RISK
Audit risk is the risk that the auditor expresses an
inappropriate audit opinion when the financial statements
are materially misstated.
Audit Risk = Inherent Risk x Control Risk x Detection Risk

Auditors will want their overall audit risk to be at an

acceptable level. Inappropriate opinion will result in
damages / costs
 INHERENT RISK
Inherent risk is the susceptibility of an assertion to a
misstatement that could be material individually or when
aggregated with other misstatements, assuming there
were no related internal controls.

Susceptibility = likelihood
Assertion = statement / claim by management.
 CONTROL / DETECTION
• Control risk is the risk that a material misstatement, that
could occur in an assertion and that could be material
will not be prevented or detected and corrected on a
timely basis by the entity's internal control.
• Detection risk is the risk that the procedures performed
by the auditor to reduce audit risk to an acceptably low
level will not detect a misstatement
 INITIAL AUDIT PLANNING
1. The auditor decides whether to accept a new client / continue
serving an existing one. (The auditor wants to make this
decision early, before incurring any significant costs that cannot
be recovered).
2. The auditor identifies why the client wants or needs an audit.
3. To avoid misunderstandings, the auditor obtains an
understanding with the client about the terms of the
engagement.
4. The auditor develops an overall strategy for the audit, including
engagement staffing and any required audit specialists.
 CLIENT ACCEPTANCE
Auditor will not accept the client if there is high risk
• Clients who lack integrity;
• High Risk Sectors – Nature & Size of Client
• Argue constantly about the proper conduct of the audit and fees
 AGREEING TERMS OF ENGAGEMENT
• Preconditions – An acceptable financial reporting framework
• Terms are recorded in an Engagement Letter
1. The objective and scope of the audit of the FS;
2. The responsibilities of the auditor;
3. The responsibilities of management;
4. Identification of Financial Reporting Framework
5. Expected form and contents of the report
6. Because of inherent limitations, the risk of misstatement is
unavoidable
7. Planning, performance of audit, engagement team
8. Expectation that Management will provide representation
9. Billing arrangements (10) Acknowledgement by Mgmt.
 UNDERSTANDING BUSINESS
• Industry, regulatory and other external factors, including the
applicable financial reporting framework
• Nature of the entity, including operations, ownership and
governance, investments, structure and financing
• Entity's selection and application of accounting policies
• Objectives and strategies and related business risks that might
cause material misstatement in the financial statements
• Measurement and review of the entity's financial performance
• Internal control
 HOW ?
1. The permanent audit file (where information of
continuing importance is kept)
2. Audit working papers of the previous year
3. Information from the clients website
4. Publications related to industry in which entity operates
5. Inquiries of management, appropriate individuals within
the internal audit function and others within the entity
6. Analytical procedures (current / prior / industry)
7. Observation and inspection of records, documents
8. Discussion by the audit team of the susceptibility of the
financial statements to material misstatement
9. Other engagements undertaken for the same entity
 ANALYTICAL PROCEDURES
2013 2014 Change
Revenue 4,205 3,764 12%
Cost of Sales (1,376) (1,555) (12%)
Gross Profit 2,829 2,209 28%
Admin Expenses (667) (798) (16%)
Selling Expenses (423) (460) (8%)
Interest Payable (50) (49) 2%
Net Profit 1,689 902 87%
• Mason Air Services provides helicopter support to
emergency services.
• Under a five year contract, they charge an annual fee to
cover the maintenance of equipment. The annual fee is
payable in advance with the first annual payment being paid
on the date the contract commences.
• Customers are also charged an additional fee per 'flying
hour'. This charge is also set out in the contract. However,
when preparing sales invoices, rather than going back to the
contract the FC use the last invoice to pick up the hourly
charge.
• Their customers comprise solely of the police, the
ambulance service, the fire service and the coastguard .
• MAS owns the helicopters and funded the purchase with a
secured loan carrying high interest. The anticipated draft
PBIT for 20X0 is modest at around $500,000 when
compared with the expected revenue of $45m.
• The contract with the police force expires in March 20X1. It
is thought that the contract will be put out to tender.
• A new contract for the provision of air ambulances was
signed during the year with increased flying hour charges.
• Although no new helicopters have been purchased during
the year to 31 December 20X0 there has been a lot of
refitting, replacement and adding of specialist equipment to
some of the aircraft.
• The company maintains around $2m of aircraft spares which
are included within inventory. Approximately a quarter of this
value is made up of specialist equipment taken out of aircraft
when it was replaced by newer or more advanced
equipment. The directors have estimated the value of this
equipment and have included it within inventory as they say
it still works as well as it did when it was installed.
• MaxSleep is owned by two sisters, who are joint
Managing Directors. MaxSleep manufactures and sell
expensive high quality beds, crafted by hand
• Both sisters have other business interests, and only spend a
few days working at the company. They rely on the small
accounts department to keep them informed. There is no
finance director but the financial controller is a qualified
accountant.
• MaxSleep requires customers who place an order to pay a
deposit of 40% at the time the order is placed. The beds will
take 4 to 8 weeks to build, and the remaining 60% of is due
within a week of the final delivery .
• Risks and rewards of ownership of the beds do not pass to
the customer until the beds are delivered and signed for.
Beds also come with a two year guarantee and the financial
controller has made a provision in respect of the expected
costs to be incurred in relation to beds still under guarantee.
• The company undertakes a full count of raw materials at the
year end. The quantities are recorded on inventory sheets
and the financial controller assigns the costs based on the
cost assigned in the previous year or, if there was no cost
last year, using the latest invoice. Most beds are made of
oak or other durable woods and the cost of these raw
materials is known to fluctuate considerably.
• It is expected that work in progress will be insignificant this
year, but there will be a material amount of finished goods
awaiting dispatch. One of the MDs will estimate the value of
these finished goods and has said she will take into account
the order value when doing so.
• Donald Co runs airline business. They have placed orders
for another six planes at an estimated total cost of $20m it is not
certain whether these planes will be received by the year end.
• In addition the company has spent an estimated $15m on
refurbishing their existing planes. In order to fund the expansion
Donald Co has applied for a loan of $25m. It has yet to hear from
the bank as to whether it will lend them the money.
• The company receives bookings from travel agents as well as
directly via their website. The travel agents are given a 90-day
credit period, however, due to difficult trading conditions a
number of the receivables are struggling to pay.
• The website was launched in 20X0 and has consistently
encountered difficulties with customer complaints that tickets
have been booked and paid for online but Donald Co has no
record of them and hence has sold the seat to another customer.
• Donald Co used to sell tickets via a large call center located near
to their head office. However, in May they closed it down and
made the large workforce redundant