Audit risk Auditor’s response

New client Ensure that experienced team is assigned to the

audit and audit team is given adequate time to
As the client is new the auditor will not have understand he business nature of client
complete knowledge of client’s business. As a Sample testing should be done on opening
result the detection risk increases. balances to ensure they are complete and
There is also risk on opening balances of Hart as accurate
previous audit was not performed by Morph & co
Directors bonus based on percentage of profit The audit team should remain alert to the risk
throughout the audit and should maintain their
There is risk that in order to increase profits the professional skepticism during the audit
directors may manipulate the profit as a result the More experienced team member should be
chances of material misstatement in financial assigned towards the estimation and judgmental
statement increases areas
25% deposit on signing the contract Discuss with management about how performance
obligation is satisfied and how revenue is
As per IFRS 15 the revenue can only be recognized recognized in correspondence with that and check
when performance obligation is satisfied. reasonableness of it
There is a risk that Hart co may recognize revenue Review contract to understand performance
on date of signing the contract instead of booking obligations
it as a deferred income. As a result both the
liabilities and profit will be misstated
Auditor will only attend wip count at 5 warehouses The audit should access which inventory counts
the audit team will attend, they should be
As wip is material balance and its valuation is a assigned to the warehouse where there is more
judgmental area. As auditor will only attend wip risk of material misstatement or have history of
valuation at 5 out of 17 the detection risk fraud & error
increases as auditor will not be able to gather For the warehouses audit team is not attending
sufficient evidence over valuation wip count they should review documentation and
should discuss with management what controls
were in place to ensure count is accurate and
complete
Warranty provision has been decreased Discuss with management the rational for
decreasing the provision liability and check its
There is a risk that in order to increase profits and reasonableness. Check post year end warranty
show company profitable the management is claims and compare it with the figure present in
decreasing the provision level as a result liabilities financial statements
and expenses both will be understated and profit Ensure adequate disclosures have been made for
will be overstated provision as per IAS 37
There is also a risk that inadequate disclosure have
been made for provision
Expenditure incurred for research and Review breakdown of invoices to check the nature
development of expenses. Development expenditure meeting
relevant criteria as per ias 38 should be capitalized
There is a risk that the capital and revenue while expenditure not meeting capitalization
expenditure may be incorrectly treated. There is criteria should be expensed out
chance expenditure not meet capitalization criteria
are capitalized. As a result the profit and assets
both will overstated
Machine delivery is delayed Compare the assets present in non current asset
register with physically present assets to ensure
As only assets physically present at reporting date only assets existed at year end are capitalized
can be capitalized , there is a risk that machine
which is in transit have capitalized as a result of For 1m paid recalculate the prepayment to ensure
which the non current assets will be overstated. it have been treated as prepayment in financial
statement
As 1m is paid for machine there is also a risk that
instead of treating it as prepayment it may have
been capitalized.

Company made right issue Review the cash book to ensure cash has been
received. Recalculate the share capital and share
There is a risk that company has did incorrectly premium to ensure correct split is done between
split between share capital and share premium as them.
a result of which both will be misstated
Check the policies of issuing shares in constitution
There is also a risk that company had not did issue and compare it with right issue to ensure issue
of shares as per company constitution have done correctly as per company constitution
Company payroll department is outsourced Discuss with management what controls were
taken place to ensure payroll records are complete
As payroll function is outsourced the detection risk and accurate and check its reasonableness.
increases. There is risk that may be sufficient and
appropriate evidence will not be available for Consideration should be given on contacting the
auditor to check whether payroll records are auditor of service organization to confirm what
accurate and complete controls were in place during performance of
payroll function.
Director remuneration is not disclosed as per local Check local legislation to understand the
legislation requirement of local legislation and camper it with
disclosure to ensure adequate disclosure have
Where there is local legislation is more done
comprehensive than ifrs the company must
comply with local legislation

There is a risk that disclosure will be disclosed

completed if additional information is not
provided
Relying on the work of internal audit department Before placing reliance on the work of internal
audit the auditor should perform audit procedures
If external auditor place reliance on poorly on the work to ensure its adequacy for the
performed or irrelevant testing , the auditor as a purposes of audit.
result may form incorrect conclusion on strength
of internal controls
This could result in auditor performing less level of
substantive testing as a result detection risk
increases
Gross margin is increasing while operation margin The classification of costs between cost of sale and
is decreasing operating expenses must be reviewed and should
be compared with last year, inconsistencies should
There is a risk that in order to increase gross profit
be investigated
margin company may have mistreated the
expenses and instead of including them in cost of
sale they have added them in operating expenses.
As a result the cost of sale will be understated and
operating expenses will be overstated
Inventory is not counted at year end instead The timetable of perpetual inventory should be
counted every month (perpetual inventory system) reviewed and ensure that all changes are made on
timely basis. Controls over inventory should be
Under perpetual inventory system each item of tested
inventory must be counted once a year and all
adjustments should be made on timely basis.
Inventory can be misstated if the perpetual
inventory is not complete.
Inventory is more in records than physically Discuss with management about this issue as soon
present as possible because at year end if issue is not
solved the reliance cannot be placed on figures
As at the year end the figure for inventory included in recorded which could result in demand
included in financial statement is based on for full inventory count
records, so in this way the inventory will be
overstated
Assets not fully depreciated but found obsolete Discuss the rational of depreciation policy with
finance director and check its reasonableness.
As being not fully depreciates but the assets are Ensure the asset which is obsolete is completely
obsolete this shows that company depreciation written off
policy is not reasonable. So there is a risk that
assets and profit both will be overstated
Current asset is recognized for advertisement Discuss with management about the rational for
expenses booking the current asset
Ask them to derecognize the current asset and
As per ias 37 contingent asset should be charge the 0.7m to operating expenses.
recognized if the economic inflow is virtual certain Check post year end journal to ensure correcting
As in above case the probability of future sales are entry have taken place
not virtual certain the by booking the current asset
, the assets are overstated
As by not booking expense at operating expense
the profit is also overstated
Company obtain bank loan Ensure that the cash was received. Recalculate the
split of loan to ensure correct amount is written
There is a risk that company has not correctly split under the current and non current liability
the loan between current and non current liability. Ensure adequate disclosure have been made
As a result of which both the current and non regarding the bank loan
current liability will be misstated
Indirect cost is capitalized with asset Discuss with management about the rational of
capitalization of service agreement. Ask them to
As per IAS 16 only expenditure occurred in correctly treat it by treating it as an expense
bringing the asset to running condition can be Check post year end journal to ensure correcting
capitalized entry has taken place
As service agreement is revenue expenditure does
not meet IAS 16 capitalization criteria so by
making it as part of asset it is incorrectly treated.
As a result both the profit and asset are overstated
Bank loan has 5% interest rate Recalculate the finance charge to ensure correct
amount is charged . Ensure than finance charge is
As the debt increase the finance cost also paid by year end and therefore in not payable at
increases as the interest rate is 5%. There is a risk year end
that company has not finance charge correctly as a
result of which the profit will be overstated.
Company has to undertake a stock exchange listing The audit team should remain alert to this fraud
within 12 months throughout the audit and more experienced team
members should be assign towards the estimates
In order to show company profitable so that they and judgmental areas
can easily list on stock exchange there is a risk that They should also maintain their professional
management may do manipulation in expenses to scepticism during the audit and must detect and
show more profit. As a result chances of material access the risks of material misstatements
misstatements in financial statements increases
Price promise for returning money Discuss with management the rational of refund
liability and check its reasonableness. Review post
This should be treated as per IFRS 15. The revenue year end refunds and compare it with the figure
should only recognized up to the extent that the included in financial statements
refund liability will be made
As the company made this liability for the first
time there is high risk of material misstatements as
the directors may have included wrong figure for
refund liability.
Faulty products sold to customer and recall has Review list of sales made between June and date
initated of recall and ensure they are correctly removed
from revenue.
As recall is initiated the company has to refund to Also check the reasonableness of refund liability
customers as well as they have to remove sales made by management.
from revenue figures. There is a risk that company Compare the figure with refunds made after recall
has not completely removed sales from revenue as
well have not recorded refund liability correctly as
result of which profit will be overstated while
liabilities will understated
Receivable collection days are increasing Review the aged receivables analysis to
understand the customer paying behavior.
There is a risk that figure of receivables figure Compare post year end payments from customers
included in financial statement includes the bad with the figure included in financial statement
and doubtful debts as a result of which the
receivables as well profit will be overstated
Payables period days are increasing Discuss with management why the payments to
customers are getting delayed. Review cash flow
There is a risk company may be unable to pay to statement of the company to check whether
their suppliers on time as a result of which the there’s any cash flow problem facing by the
creditworthiness of the company will be decreased company
which will cause the bad impact on goodwill of
company
Quick ratio and current ratio both are decreasing Detailed going concern testing should be done and
discuss with management to ensure going concern
As both are decreased from prior year there is a basis is reasonableness
risk of liquidity crisis which may lead to going
concern concerns
The inventory days have been increased Detailed NRV and cost testing should be done to
ensure inventory is valued accurately
As the inventory days have been increased by 9 Ager inventory report should also be review to
days compared to prior year there is a risk that access the inventory
may be inventory is overvalued
Inventory cost includes production and general Discuss with management the basis for including
overheads general overhead in the cost of inventory.
Request management to perform correcting entry
As per IAS 2 only costs bringing the inventory to and expense out the general overheads
warehouse only needs to be added in cost
But the general overheads are not directly linked
to inventory so by including this is incorrectly
treated. As a result the inventory will be
overvalued
Inventory count will take place after year end The auditor should attend the inventory count at
the year end and must record the goods received
As inventory count is taking place after the year and goods sold for reconciliation purposes. During
end and adjustments will be made. But there is a the final audit the auditor should compare the
risk that may be adjustment made is not complete changes made to inventory with the supportive
as a result inventory will be misstated documents to ensure changes made are complete
Purchase patent for 3 years but expensed out Discuss with management why they have
expensed out the purchase of patent. Request
As per IAS 38 the intangible asset should be them to perform correcting entry and also charge
included under the non current asset and must be amortization on patent.
amortized each year Review post year end journal to ensure correcting
As company instead of capitalizing they have entry have been performed
expensed out, it is incorrectly treated. As a result
of which no amortization will be charged causing
the profits to be overstated because of no
amortization and understated due to including
patent as an expense.
Fraud was done Discuss with management what controls are taken
after the fraud is being caught to detect similar
There is a risk that may be whole fraud is not frauds in future.
detected. As a result of which the risk of material The audit team should remain alert to this risk
misstatements increases. throughout the audit
Data transfer from company to service Discuss with management what controls were
organization taken during the data transfer to ensure it is
complete and accurate.
There is a risk that data transfer is not complete Where possible testing should be done on opening
and accurate as a result of which the risk of balances
material misstatements increases
There is also a risk that opening balances are
misstated
Employee has sued company The audit team should ask confirmation about the
probability of losing the case from company’s
There is a risk that provision made by company is lawyer
wrong. As a result of which the liability will be Review post year end cashbook to see whether
understated and profit will be overstated any payment have been done to financial
accountant.
No supplier reconciliation Request management to prepare reconciliation
statements on regular basis so that the frauds and
As the reconciliation statement is not made, the errors will be detected on time
frauds and error will not be detected and solved To ensure the figure of payable is corrected the
on time. As a result of which the risk of material auditor should do more audit testing to confirm
misstatement increases completeness of payable figure
As reconciliation statements are not prepared
there is a risk that payables may be understated as
a result late payments will be given causing the
decrease in goodwill of company
Receivable from customer is 40% confirmed and Discuss with management why they have included
written as contingent asset the receivable in financial statement. As inflow of
As per ias 37 contingent asset can only be cash is only 0% which means it is possible. So as
recognized once the economic inflow is virtual per certain criteria, when the probability is just
certain possible we have to do nothing. Request
As the inflow of payment from customer is only management to remove the receivable from the
40% confirm and it is included as receivable it is financial statement. Check post year end journal to
incorrectly treated as a result of which receivables ensure correcting entry have been performed
are overstated
Wip at year end Consideration should be given in hiring an
independent expert for valuation of inventory. The
As wip is the area of high risk the audit team may audit must access the completeness of work done
not be that expert as a result of which the risk of by independent expert and they should also access
material misstatement in wip increases as a result the capabilities of independent expert
the profit and inventory can be misstated in
financial statement
Inventory has been increased in comparison of last Detailed cost and nrv testing should be done to
year ensure the valuation of inventory is correct. Aged
inventory report should be reviewed to access the
As per IAS 2 inventory should be stated at lower of the inventory value
cost or nrv
There is a risk that may be the nrv of inventory has
fallen below the cost as a result inventory will be
over valued
Audit team will not attend all inventory counts The audit team should attend the inventory count
at the warehouse where there is more risk of
As auditor is not attending all the inventory counts misstatement or where there is history of fraud
the detection risk increases. There is a risk that and error
inventory count may not be complete and
accurate as a result of which the closing inventory
will be misstated
There is a non refundable deposit Discuss with management that how performance
As per IFRS 15 this deposit should not be obligations are satisfied and hoe revenue is
recognized as revenue until performance recognized in correspondence with it.
obligation is satisfied. The auditor should recalculate the liability portion
There is a risk that company may have included to ensure all the non refundable deposits are
this deposit in revenue instead of booking it as a accurately booked as liability
liability. As a result of which the profit and revenue
will be overstated and liabilities will be
understated
Allowance of receivables have been decreased Discuss with management the rational for
decreasing the allowance and check the
There is a risk that in order to increase profit the reasonableness of it
management is decided to decrease allowance. As Review post year end payment from customers
a result the receivable will include bad and and compare it with the figure included in financial
doubtful debt as a result of which both receivable statement and by this check the reasonableness of
and profit will be overstated management
For overdraft there is covenant of minimum profit The audit team should remain alert to this risk
throughout the audit. More experienced members
There is risk that in order to comply with should be assign towards the audit of estimates
requirement of loan the management may and judgmental areas
manipulate the profit as a result of which risk of
material misstatement increases
Purchased warehouse but legal documentation Discuss with management whether purchase was
not completed till year end completed by year end or not. Do check legal
document to verify ownership and ensure it was
As only those assets existed at year must only be issued before year end
included in non current assets.
If the transaction do not complete till year end
there is a risk that assets will be overstated if the
company incorrectly includes warehouse in assets
Issue of irredeemable preference shares Review issue documentation to insure issue was of
irredeemable shares. Confirm that they correctly
As irredeemable share are non redeemable than classified as equity and total cash of 5m was
this should be classified as equity rather than as recived
liability
There is a risk than these are classified as liability
as a result of which liabilities will be overstated
and equity will understated
Useful lives have been increased Discuss with management the rational for
increasing useful lives and checks its
As per IAS 16 the reasonableness of useful lives reasonableness.
should be tested annually and if the increase is Also the increased useful life should be compared
reasonable it should be increased. how often assets are replaces to access the useful
There is risk that in order to increase profits of the life of assets
company management may have increased the
useful lives as result both the profit and assets will
be overstated
Decrease in time of audit The timetable should be discussed with finance
director. If it is confirm that time will be reduced
As company requested auditor to complete audit interim audit should be performed to reduce time
one week earlier, as a result the detection risk pressure at final audit
increases, as a result of which auditor will be
unable to obtain sufficient evidence as a result
wrong opinion may be formed on financial
statements
Dividend announced after year end Discuss with management and ensure that
dividend is not included in financial statements.
As per IAS 10 if dividend is proposed after the year Ensure adequate disclosures have been made for
end it can only be disclosed dividend
There is a risk the company may include dividend
in financial statement as a result the Retained
earning will be understated and liability of
dividend will be overstated
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