The audit process

www.pwc.com

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Audit basics

Risk assessment

Substantive testing

Planning and understanding the

business

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Organizer

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Planning Activities view

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• Industry, regulatory and other external factors

• Nature of the entity

• Selection and application of accounting policies, including the reasons for changes thereto

• Objectives and strategies and related business risks

• Measurement and review of the entity’s financial performance

Understanding the entity and its environmentISA 315.11

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Risk assessment proceduresHow do I gain my understanding?

Inquiries of management

Analytical procedures

Observation and inspection

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Researching Your ClientIndividual Exercise

Tasks:

Research Liberate U Shoes by reading the

Learner Material - Understanding the

Entity - Liberate U Shoes.

Time: 15 minutes

T

We will then deliberate on the information

provided

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Per ISA 320.2...

Materiality

Misstatements, including omissions, are considered to be material if they, individually or in the aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements

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You are auditing a telecommunications client and noted that the an accountant wrongly added a 1% charge to all local phone calls on July 1 in the billing system.

Applying materiality on the job

Is this material?

QuestionQ

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Applying materiality on the job

What if this error occurred more frequently, for instance for every third phone call or on more days during the year?

What impact would this have on materiality?

The magnitude would be bigger and might become more material.

QuestionQ

AnswerA

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Applying materiality on the job

What if you discovered the error was a result of the CFO deliberately over charging the customer so the results for July would meet the budget?

Would this error then become material?

Yes. If the CFO is deliberately manipulating the financial results this is material because it indicates fraud which would dramatically change our perception of the integrity of management and our audit procedures.

QuestionQ

AnswerA

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Overall materiality

Materiality

Per ISA320.10, when establishing the overall audit strategy, the auditor shall determine materiality for the financial statements as a whole

Our assessment of materiality at the overall financial statement level is termed as overall materiality

It is the maximum amount of misstatement that could exist before information in financial statements is considered misleading

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Performance materiality

Materiality

Per ISA320.11, the auditor shall determine performance materiality for purposes of assessing the risks of material misstatement and determining the nature, timing and extent of further audit procedures

It takes into account the aggregation risk of individually immaterial misstatements that may cause the financial statements to be materially misstated

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Scoping view

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The three components of audit risk

Inherent risk

The susceptibility of an account balance or class of transactions or disclosure to misstatement, before consideration of any related controls.

Control risk

The risk that a material misstatement will not be prevented or detected and corrected by the client’s internal controls.

Detection risk

The risk that our audit procedures will not detect a material misstatement that exists in the financial statements.

Inherent risk

Control riskRisk of Material

Misstatement

+=

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Brick analogy

Any material misstatement

at all?Inherent Risk

Control Risk

Detection Risk

Audit Risk

Caught by controls?

Caught by our audit?

Wrong opinion

Yes

No

No

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Nature of the risk

Likelihood of the risk occurring

Likely Magnitude of the potential misstatements

Risk of material misstatement (RoMM)

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Inherent risk continuum

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Internal control frameworkRelationship with audit approach

DesiredEvidence

Filling the Evidence Bucket

Evaluate whether further evidence is necessary from tests of details

and/or substantive analytics

Tests of Details* or Substantive Analytics

Controls testing

* Generally, perform tests of details for significant risk

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Knowledge check #1

Risk of material misstatement is comprised of what two types of risks? Be prepared to explain each type of risk

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Knowledge check #2

What are the three criteria for assessing the level of inherent risk?

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Knowledge check #3

A financial statement level risk will not typically be categorised as a “normal” risk. Why?

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Knowledge check #4

The audit team determined that an assertion level risk has a high likelihood of occurring and the likely magnitude exceeds overall materiality. However, the client has adequate controls around this assertion, so they decide to assess the risk as normal. What has the audit team done incorrectly?

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Group Exercise

For each of the five scenarios determine:

1. What additional questions you will have for your client

2. Does the information represent a potential risk of material misstatement to the financial statements?

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Obtaining Audit Evidence

Filling the Evidence Bucket

Evaluate whether further evidence is necessary from tests of details

and/or substantive analytics

Tests of Details orSubstantive Analytics

Controls testing

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Obtaining Audit Evidence

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Substantive Testing Overview

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Key characteristics:

Targeted testing

• Preferred method

• Aims at establishing if there is materialmonetary misstatement

• Items to be tested are selected based onmonetary value of higher risk

• Applied to either a specific part or the whole of the account

• Results should not be projected to the untested items in a population

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Key characteristics:

Targeted testing

• Application to a representative group < 100% items

• Homogeneous populations

• Can be combined with targeted testing

Auditsampling

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Key characteristics:

• Particular attribute or characteristic

• NOT testing monetary values

• NO project misstatements Accept-rejecttesting

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Substantive Testing Overview

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The 4-step Process

Step 1

Determine suitability, assess reliability of underlying data and develop an independent expectation

Step 2

Define a

significant

difference or

threshold

Step 3

Compute

differences

Step 4

Investigate

significant differences and corroborate with evidence

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Tests of DetailsDefinition

One type of substantive test

Involves the examination of support for individual items that make up balance sheet and profit and loss accounts

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Tests of DetailsExamples of Procedures

Inspection

Inquiry

Recalculation

External Confirmation

Reperformance

Observation

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Reliability of Audit Evidence

More Reliable

• Original documents • Auditor obtained

evidence • Written evidence • External generated

evidence

Less Reliable

• Photocopies or facsimiles• Audit evidence obtained

indirectly• Oral evidence• Client generated evidence

Audit evidence is most reliable when the client’s internal controls are effective.

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Identified misstatements

Identified misstatements can arise from fraud or error Identified

misstatements should be posted to the summary of uncorrected misstatements (SUM)

The de minimis SUM posting level is used to determine which identified misstatements will be posted to the SUM We should also

include misstatements identified by us, which were corrected by the client, on the SUM.

Questions