Drafting pre requisites:

Briefing notes:

• To: sender (see who sent mail)

• From: Name of engagement partner or audit manager
• Subject: Client name and subject of scenario
• Date: same date when mail was sent

Introduction:

• Purpose of developing notes (the core topic under discussion in scenario)

• FY which is given in question.
• Content of all requirements of the question.

Pre-requisite paragraph of audit risk part:

• Overall materiality: Overall materiality used to assess significance of risk identified is based on --
------ (benchmark that is given in the scenario).
• Benchmark calculation: Compute the range subject to the benchmark. Mention reason for
selecting higher or lower side of risk: justify the reason based on any control deficiencies (CR),
inherit risk (IR) and detection risk (DR) if identified in the case scenario.
• Preliminary and final level of materiality: Preliminary materiality shall be determined based
upon the aforementioned benchmark, but “professional judgment is required to determine the
final level materiality during course of audit”

Benchmarks for taking higher side of the the materiality benchmark:

• New client
• Inherit risk of management bias
• Risk identified at planning stage or previous audit

For final level materiality:

Assess significant/potential issues that are indicated based on findings from:

• Additional information
• Test of controls
• Substantive procedures

Format for the audit risk part:

• Current scenario: management accounting treatment and trends from analytical procedure
pertinent to that particular transaction or balance.
 • Materiality: quantitative and qualitative both. Qualitative would mean say that the amount may
convert profit into loss, affect liquidity or gearing ratio such that the decision of investor would
change.
• IFRS: what should be the right treatment according to relevant IFRS and what should be the
disclosure requirements as per the standard.
• Audit risk: what risk of material misstatement may arise or is arising with respect to the current
management accounting treatment. Also mention the risk of over/under statement of account
head.
• Corroborative evidence: what evidences are given in the case study which enforces that the
management does not have motive to follow the right accounting treatment and disclosure
requirements.
• Significance of issue and likely response of the auditor: impact on audit planning relevant to
the particular head of accounts and application of professional judgement and skepticism. Also
mention what impact shall the management assertion cast on the audit report (modified or
unmodified).

Scenarios (risk description only, other components as mentioned above shall be according to the case)

1. Initial audit:

Risk:

• Increased detection risk due to no experience with the client

• Difficult to detect material misstatement

Response:

• Rigorous audit planning

• Thorough understanding of business
• Correspondence with the predecessor auditor
• Planning audit procedures as per ISA 510 : verification of opening balance/comparative
information and appropriateness of accounting policies in previous year.

2. Management bias:

Risk:

Aggressive management earning: attempt to reflect favourable financial position (overstatement of

assets and understatement of liabilities) and favourable financial performance (overstatement of
revenue and profit and understatement of expenses) by using creative accounting and biased
judgement.

3. Owner managed status (family controlled business):

Risk:
• Easy to override controls
 • Ability to pressurize CFO to manipulate the financial statements
• Incentive to overstate the profits in order to increase the dividend yield.

4. Analytical procedures:

• Make appendix of calculations of relevant ratios: GP margin, NP margin, ROCE, Operating

profit margin, liquidity ratio (current and quick acid test) and gearing ratio.

• Relate with the corroborative evidence from the scenario of any unusual trend.

• Conclude the trend with reasonable justification – say inappropriate accounting policy,
over/understatement risk, aggressive earning etc.

• Risk of material misstatement that may arise as a result of above findings.

5. IFRS 15 – response (other components shall be same as that discussed in the component of the
audit risk approach):

As a part of response of auditor he shall: Investigate similar contracts for same misstatement. Seek
any further misstatement in same regard.

6. Hiring of expert for purpose of valuation by management:

Risk of objectivity, qualification and competence of expert

7. Related party transaction (other than the component discussed in audit risk approach)

• Risk: related party transaction may have been initated in order to

• Window dress the financial statements (to increase asset valuation and share price)
• Fake transaction/economic substance does not represent underlying transaction: risk of
overstatement and need for professional skepticism.
• Above risk may be applicable on the opening balance as well.

8. No audit committee and limited resources of internal audit

• Having audit committee is requirement of code of corporate governance for listed

companies
• For unlisted companies it is a good practice – especially if it is going to be listed in future.
• This is because internal audit department is reportable to audit committee
• The scope of internal audit is set by the audit committee
 Having no audit committee and limited resources and staff of internal audit would mean:

• Internal audit dept directly reporting to CFO, who is likely to lack independence if the entity
has owner managed status or has self interest in the entity.
• Any recommendation made to CFO therefore may be ignored
• Lack of resources and insufficient staff would mean deficient controls of financial reporting
and higher chances of error and manipulation of transaction and balances

9. Fair valuation by management expert

• Audit risk of fair value not being accounted for properly

• Expert not being competent, objective and competent
Response: allocation of experienced audit team

10. IFRS requiring disclosures:

Risk of :
• Ommission of disclosure
• Inadequate disclosure
• Misleading disclosure

11. Loss making subsidiary:

Risk:
• The impairment of subsidiary (CGU) may not be recorded
• Lack of experience of management for dealing with loss making subsidiaries
• Hence goodwill might be over/understated

12. Average useful life for amortisation:

Risk:
• Instead of using useful life that is specific to the intangible asset, using average useful life
shall smooth out the profits.
• Hence risk that management may be using aggressive earning management technique
which arises inherit risk of management bias.

13. Management reluctant to discuss significant matter and obstructs access to information
Risk:
• Scope of limitation
• Obstructing auditor’s work
• Likely to hide something
• Hence the accounting treatment of relevant area may not be appropriate

Response: increase professional skepticism

14. Subsidiary following the local accounting regulations:
• Risk of not following the parent’s accounting policies as per IFRS-3.
• This point should be mentioned in every risk identified where management seems to be
not accounting for the relevant

15. Disposal and acquisition of subsidiary after reporting period

• Materiality of subsidiary based on: f.v of net assets and cost of investment as % of total
assets.
• IFRS 10: subsequent event disclosure
• IFRS 3: disclosure of acquisition of subisidiary within time period of reporting year end and
authorization of financial statements.

16. Government grant and IAS 37

Whenever discussing the reporting requirements of IAS 20, always discuss about application of IAS
37 in case if entity fails to fulfill the conditions attached with the government grant.

17. Discounts offered and yet profitability margin is high:

• In case if entity is offering the discounts to its customers, and still op margin is high, the risk
is that operating expenses are understated.

• Moreover, we shall also corrobate it with yoy pattern of revenue, if revenue is decreasing
or increasing with less ratio, whereas the op margin is increasing with high ratio, again the
risk arises that the operating expenses are understated.

• This shall apply other way round as well, if in case the revenue is increasing and op margin
is decreasing or increasing with less ratio, then the risk arises that the operating expenses
are overstated.

18. Control risks of online sales (to be mentioned along with risk of not following IFRS-15)
• Timing of revenue may not be accounted for appropriately (cut off may not be applied
appropriately)
• Discounts changing frequently – valuation risk
• Hence need for updated accounting system

19. Transfer of data into new data management system

Same points of business risk, just relate with any particular head that might have risk of
inappropriately being accounted for.
20. One time fees paid to celebrity as sponsorship against services
Risk of not recording prepayment and recording expense over the period of time.

21. Ratios:
OP margin: correlate with revenue trend (apply same logic of under over stated in case if the trend
of op profit and revenue are not same)
Then if operating expenses are component wise provided, relate those expenses with revenue
trend to identify any abnormal pattern
ROCE: same logic of revenue trend applies – over/under stated
Current ratio
D/E ratio
Interest Cover
Effective tax rate: Correlate the effective tax rate and nominal tax rate, and relate with any
information provided about temporary and permanent differences.

In case where no inconsistency is found, do mention about auditor conducting high level detailed
analysis that is required to identify trends that may be obscured by management.

22. Consolidation of foreign subsidiaries:

• Calculate materiality based on f.v na and coi as ratio of total assets.
• Risk of not following IAS 21 restranslation of reserves and accounting for monetary items.
• And risk of not following the consolidation procedures as per IFRS 3 and IFRS 10.

23. Component auditor:

Apply ISA 600 series.

24. Adopting accounting policy similar to that of competitor and industry

Risk:
Inappropriate accounting policy may be adopted, since the circumstances and estimates of
competitors may be different as compared to that of the entity.

25. Foreign operations (foreign subsidiary)

Risk of not adhering IAS 21 requirements.
Highly volatile currency, retranslation of income and expenses becomes problematic and prone
to error and complication.

26. Intra group transactions

Individual statements of parent entity, risk that the intra group transaction might not be recorded
appropriately, or simply omitted.
Consolidated statements, risk that intra group transactions and balances may not be eliminated,
and therefore consolidated financial statements may not be presented as that of a single
economic entity.
27. Restriction by CFO to access audit committee
Mention requirements of ISA 260, communication with TCWG.
And ISA 210, premise of management.
Risk:
• CFO has to hide something
• Control environment may not be strong
• No ethical culture may exist

Corporate governance requirement of having audit committee to assess effectiveness of

external audit process.