BS427-Assignment2

Total -40 marks.

Due date: 13 June 2020 2359hours.

1. What is the link between the assessment of audit risk and the concept of reasonable
assurance? (3 marks)

The auditor should have enough credible audit evidence to reduce the audit risk to an acceptable
low level to achieve fair assurance. This means that, in conducting an audit of the financial
statements, the auditors' goal is to ensure that financial statements are represented fairly in
accordance with the applicable financial reporting framework. This is to ensure that the financial
statements are free from audit risk such as material misstatements and therefore allowing the
auditor to give his reasonable assurance.

2. What is professional skepticism and how it is linked to audit risk? (3 marks)

Professional skepticism is a skeptical mindset that alerts people to circumstances that may signify
potential error or fraud mistakes and a vital audit evaluation. The professional skepticism of the
auditor is important in view of the characteristics of fraud. Professional skepticism includes an
interrogative attitude and a critical evaluation of audit evidence. The auditor should act in a way that
acknowledges the risk, that there will be material fraud errors, irrespective of past experience with
the company and irrespective of the auditor's convictions about the fairness and competence of
management.

3. What is the relationship between business risk and risk of material misstatement? (3 marks)

Business risk is a factor(s) that increases the liability of a business or organization, which contributes
to a loss. Anything which threatens the ability of an organization to accomplish or achieve its
objectives is called business risk, while material misstatements constitute a form of business risk. It
is a significant misstatement is incorrect information in the financial statements that influence
someone who is relying on these statements to make economic decisions which in turn may lead to
business failure if the information is incorrect.

4. Business risk is classified into the following categories; Explain in your own words the
following three types of business risk. Provide examples to support your answers. (4marks)
a. Financial

Financial risk is the risk of material incorrect financial statements, despite the audit opinion
saying that financial statements are free of material misconceptions. Example of financial
risk is the interest rate volatility.

b. Operational
 Operational risk arises from within the corporation—when the day-to-day operations of a
company fail to perform. Example a company faced operational risk when its internal anti-
money laundering operations team was unable to adequately stop money laundering in
Mexico.

c. Compliance

Compliance risk arises in industries and sectors which are highly regulated with laws. For
example, in order to sell the wine to a retailer who sells it to consumers, the wine industry
has to adhere to a three-tier system of distribution, where the wholesaler is required.
Cellars cannot directly sell to retail stores.

5. Threats to independence fall under the following categories. Describe in your own words the
different types of threats. Support your answers with examples (8 marks)
a. Self-review
There is a threat of self-review if the auditor audits his own work or work done in
another organization. Example the auditor shall prepare a company financial statements
while also acting as company's auditor. The auditor can't then claim to form an honest
or fare opinion on the audit of the company’s financial statements.

b. Self interest
There is a threat of self-interest if the auditor is directly or indirectly involved in the
company and depends on the company for a major outstanding fee. Example The audit
committee prepares for a report for a company. But the audit department has not yet
received the Company's audit fees. The audit team may then tempter with the report to
send a satisfactory report in order to make sure the company pay off the fee.

c. Advocacy
When the auditor supports the company, there is a possibility to promoting, which can
undermine it’s the auditor’s objective. Example The auditor supports the sale of a
company and even serves as the auditor. The auditor can then produce a positive report
to increase the sales price of the company

d. Familiarity
Members having a close or longstanding relationship with an attest client or knowing
individuals or entities who performed non-attest services for the client. Examples a
member of the firm having recently been a director or officer of the client.

e. Intimidation
When the auditor is too close to or acquainted with staff, officers or customers'
supervisors, to a point where their objectivity is compromised. Example A Company is
dissatisfied with the report concluded by an audit firm and threatens switch auditors.
The company is the auditor’s main customer and of course they do not want to lose its
customer and therefore, the integrity of an auditor could be undermined when the
auditor when trying to keep its customer sends a report appealing to company.
6. Explain the difference between the independence of the mind and independence in
appearance. Provide examples to support your answer. (3marks)
independence of the mind is when the auditor can effectively keep an unbiased approach
throughout the audit, while independence in appearance depends on the interpretation by
others of that independence and therefore their trust in the auditor.

7. Management assertions are classified as follows. Explain in your own words the three
management assertion category and the specific assertions under each category. (16 marks)
a. Assertions about the classes of transactions
i. Occurrence
The occurrence assertion concerns whether recorded transactions included in
the financial statements actually occurred during the accounting period.
ii. Completeness
This assertion addresses whether all the truncations that should be included in
the financial statements are in fact included.
iii. Classification.
The classification assertion addresses whether transactions are recorded in the
appropriate accounts.
iv. Cut off.
The cut-off assertion addresses whether the transaction are recorded in the
proper accounting period.

b. Assertions about account balances at period end.

In this section address existence, completeness, valuation and allocation, and rights and
obligation.
i. Existence
Assets, liabilities and equity interest accounts exist.
ii. Completeness
This assertion addresses whether all assets, lability and equity interest that
should have been recorded have been recorded
iii. valuation and allocation
the valuation and allocation assertion deals with whether assets, liabilities and
equity interests have been included in the financial statements at appropriate
amounts, including any valuations adjustments to reflect assets amounts at net
realizable value.
iv. rights and obligation.
This assertion addresses whether assets are the rights of the entity and whether
the liabilities are the obligation of the entity at a given date.

c. Assertions about presentation and disclosure.

With the increasing in the complexity of transaction and the need for expanded
disclosure about these transactions, assertion about presentation and disclosure have
increased.
i. Occurrence & rights and obligations
 This assertion addresses whether disclosed event have occurred and are the
rights and obligations are of the entity.
ii. Completeness
This assertion deals with whether all required disclosure have been included in
the financial statements.
iii. Accuracy & valuation
The accuracy and valuation assertions deal with whether financial information is
disclosed fairly and at appropriate amounts.
iv. Classification and understandability.
This assertion relates to whether amounts are appropriately classified in the
financial statements and notes, and whether the balance descriptions and
related disclosure are understandable.