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Planning an audit involves establishing the overall audit strategy for the engagement
and developing an audit plan, in order to reduce audit risk to an acceptably low level
(ASA 300). Planning starts with an understanding of the entity and its environment.
Planning also involves (1) setting materiality levels, (2) assessing audit risk and its
components, (3) obtaining an understanding of the internal control structure and then
(4) developing a preliminary audit strategy for significant assertions. Auditors should
also perform analytical procedures as part of the planning process as well as
consider the risk of fraud.
8.18
The activities that the auditor will carry out include procedures to:
Identify and assess the risks of material misstatement due to fraud.
Ensure the audit team is aware of the risks of fraud and their responsibilities
in response to those risks.
Design and implement appropriate responses to the fraud risks identified.
Respond to any fraud or suspected fraud identified during the audit.
8.20
transactions.
7.
Management shows an excessive interest in increasing the entitys share
price.
8.
There is a high turnover of internal audit and information technology
staff.
9.
Employees ignore internal controls and do not focus on reducing risks of
misappropriations of assets.
10. The entitys industry is highly competitive.
11. Employees anticipate future redundancies.
12. Management attempts to justify marginal or inappropriate accounting on
the basis of materiality on a recurring basis.
Required
For each of the foregoing risk factors, use the following codes to identify the risk
component that is most directly related to (a) fraudulent financial reporting or
misappropriation of assets and (b) incentives/pressures, opportunity or
attitude/rationalisation.
FFR = fraudulent financial reporting
MA = misappropriation of assets
I/P = incentives/pressures
O = opportunity
A/R = attitude/rationalisation
Note: some of these may have more than 1 correct answer. Attempt has been made
to include the best answer in the table below.
Factor
(a) FFR or MA
FFR
I/P
FFR
I/P
MA
A/R
FFR
FFR
A/R
MA
FFR
A/R
FFR
MA
A/R
10
FFR
I/P
11
MA
I/P
12
FFR
A/R
8.23
Client evaluation
The client has gone through 2 auditors in <6 years; this does not reflect well
on managements integrity.
Permission should be sought to contact the previous auditors, the audit
should not be accepted if this is not received.
We should communicate with the previous auditor to establish if there are any
reasons why weshould not accept appointment.
We should also ensure that the previous auditor has properly resigned.
We should obtain further details of the issues with the previous auditors,
including the details of accounting policies being followed.
We should review prior year financial reports and obtain copies of the most
8.26
Tirthe Ltd sells a range of indoor and outdoor furniture by recycling and
reinterpreting old furniture and other wood, metal, glass and plastic products
obtained from a variety of sources such as derelict buildings, deceased estate
auctions and so on. Revenue comes from sales to the general public and
businesses such as hotels and restaurants. Some small items are collected by
customers but generally goods are delivered by Tirthe Ltd. The directors have
reported that it has been another good year for the organisation and that they
expect the coming year to be successful.
The draft income statement for 2015 together with audited figures for 2014
are given below:
30 June
30 June 2014
2015
(draft)
(actual)
Revenue
Cost of sales
Gross profit
536 994
(322 187)
214 807
617 140
(302788)
314 352
Other income
7 186
(95 438)
(50 575)
(7 434)
(92 064)
(79 933)
(7 623)
Operating expenses
Administration
Selling and distribution
Finance costs
61 360
141 918
Required
You are planning the audit of Tirthe Ltd for the year ended 30 June 2015, discuss the
issues to be considered in your audit planning from the information contained in the
income statements.
Note: There were many different ways to approach this question; below is an
example only. Analytical procedures were required in order to answer the question
well, but you do not need to have used the exact same ratios and analysis as below.
Many of your overall comments, however, should be similar to those given below.
Trend analysis
30 June
2014
(actual)
617 140
(302 788)
314 352
7 186
30 June
2015
(draft)
536 994
(322 187)
214 807
(92 064)
(79 933)
(7 623)
141 918
(95 438)
(50 575)
(7 434)
61 360
Formulae
Gross profit Net sales
Profit margin
Times interest
earned
Change
%
(13)
6
(32)
(100)
4
(37)
(2)
(57)
2014
51%
2015
40%
(314,352/617,140)
(214,807 / 536,994)
23%
11%
(141,918/617,140)
(61,360 / 536,994)
20%
((141,918 + 7,623) /
7,623)
9%
((61,360 + 7,434) /7,434)
understatement of sales) and cut-off for receivables to ensure sales have been
recorded in the correct period.
Cost of sales (increase of 6%)
Cost of sales have increased when sales revenue has fallen. This may indicate
occurrence problems for purchases (overstatement) or cut-off problems relating to
payables and inventory. It may also indicate completeness problems for inventory
quantities (understatement).
Gross profit (decrease of 32%)
Gross profit margin has fallen from 51% to 40% this may indicate difficult trading
conditions which contradict the directors assertion about it being a good year.
Investigations into the causes of the change are required, it maybe that there has
been an adjustment to pricing policy leading to reduced profit percentages.
Other income (none this year)
There is no other income this year, this may refer to interest income, or other
investment income. In which case this would indicate the downturn in trade has
reduced cash balances or other investment balances. A review should be conducted
to establish the ability of the company to meet liabilities as they fall due to assess the
possible going concern risk - it should be noted that it usually takes more than one
year of reduced performance to create going concern problems.
Administration (increase of 4%)
Admin costs are likely to be fairly fixed (or stepped) and therefore it might be
expected that admin costs do not change much unless there is a significant change
in volume of trade.
Selling and distribution (decrease of 37%)
There has been a decrease in sales which may suggests fewer deliveries, it may
also be the case that reducing spend on marketing may have led to the fall in sales.
There is a possibility that some costs have been incorrectly allocated to cost of sales
- given the increase in cost of sales referred to above.
Interest payable (decrease of 2%)
A small decrease in the amount paid would not indicate any significant risk. Levels of
cash balances, loans and overdraft levels would indicate the extent to which this
expense appears realistic.