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Audit Risks
Audit responses
1
ESK co is a new client for Bannock and Co.
As the team is not so familiar with the
accounting policies, transactions, and
balances of ESK Co, there will be an
increased detection risk on the audit.
Bannock and Co. should ensure that it has a
suitably experienced team and sufficient time
should be set aside to be familiar with the
ESK Co transactions, documents, controls,
and the risk of material misstatement.
There is also less assurance over opening
balances as ESK CO did not perform the
audit last year
A new accounting system was introduced
in March 20X5 and a post-implementation
test has not been conducted.
Increased audit procedures should be
performed on the opening balances to
confirm their reasonableness
The audit team should undertake detailed
testing to confirm that all balances have been
completely and accurately transferred to the
new accounting system.
2
3
There is the risk of opening balances on
the new system being misstated and loss
of ongoing data if they are not transferred
from the old system correctly.
Peach co obtained an interest-bearing loan
repayable over three years in installments.
There is the risk that if the loan is not
correctly split up between the current and
non-current liability then it would give rise
to the classification errors and the liability
being misstated.
4
5
6
They should go through the documents of the
new system and test control in place.
Discuss with the management and review the
loan agreement to confirm the loan was
received and the interest rates charged and
installment periods.
Recalculate the loan and suggest the
management split up correctly between the
current and non-current liability.
Peach co has strict covenants in place
regarding the loans.
Increased the level of professional skepticism
and alertness to the manipulations.
There is an increased risk that the
existence of covenants gives an incentive
to manipulate the key balances by
overstating revenue and profit.
The external audit may place reliance on
the controls testing work undertaken by IA
departments.
If the internal audit has not performed
control testing effectively and reliance is
placed on such ineffective testing then
detection risk will be increased
Wiliam Knight wishes to complete the
audit just one month after the year's end.
The audit team should review the loan
covenants in detail to understand what Peach
co is required to comply with.
The audit team may rush to complete it
earlier leading to not having sufficient
appropriate evidence and additional
Reperform some of the control testing
performed by the internal department to
assess the effectiveness.
Discuss with the internal auditor about the
nature of work performed and review their
reports to determine effectiveness.
The audit team may consider increasing their
team size to obtain sufficient appropriate
evidence to lower the detection risk.
pressure on the team will also increase the
risk of detection.
7
8
9
10
The company is considering a stock
exchange listing next year.
Also, the auditor may consider the interim
audit. Use automated tools and technologies
to best utilize the time allocated.
Increased the level of professional skepticism
and alertness to the manipulations.
The director has the greater incentives to
window-dress the financial statement to
show a favorable position to attract
potential investors. Hence, assets and
income may be overstated and liabilities
and expenses may be understated.
Knight Electronics Co offers a three-year
servicing agreement which is paid for at
the start of the agreement.
A review of judgmental decisions and
significant one-off journal entries should be
performed.
As per the IFRS 15, the revenue should be
recognized over the period, and the
performance obligation satisfied. If the
annual service payment for three years is
recognized at the start of the agreement,
then the revenue will be overstated and
the deferred revenue will be understated.
The director of Peach co has extended the
useful life of the PPE by an average of 5
years despite the old machinery being sold
at a significant loss
Increased the testing over the cut-off revenue
and the completeness of the deferred
income(contract liability).
As per the IAS 16, the useful life of an
asset should be reviewed annually and the
useful life should be based on the
expected inflow of economic benefit to be
received over the period. There is the risk
that the depreciation expenses may have
been understated and the cost of PPE may
have been overstated.
Property has been revalued from $3·8m to
$8·4m based on a management
revaluation.
Also, the eight-year useful life should be
compared to how often these assets are
replaced, as this provides evidence of the
useful life of assets
The audit team should obtain a copy of the
contract with the customer and review it to
understand the performance obligations.
The auditor should discuss with the
management the rationale for the extension
of the useful life of the PPE and test its
reasonableness.
Discuss with the management the process
adopted for the revaluation, including the
whole class of assets revalued and carried by
an expert.
As per IAS 16, an independent valuator
should do the revaluation and adequate
Review the disclosure made and suggest the
disclosure should be made. The PPE will be management comply with IAS 16.
overstated if the valuation is not carried
out under the IAS 16.
11
12
13
Knight Electronics Co has recognized a
receivable in respect of damages it has
claimed against a supplier as its lawyer has
advised that the action is likely to be
successful.
IAS 37 Provisions, Contingent Liabilities,
and Contingent Assets state that
contingent assets should only be
recognized where it is virtually certain that
they will be received. If the receipt of
damages by Knight Electronics Co is not
virtually certain by the year's end, then
receivables and profits will be overstated.
During the year, a payroll clerk carried out
fraudulent transactions at the company
and there is a concern that additional
frauds may have occurred.
There is the risk that, if the actual amount
of loss is not a financial statement, then
the profit will overstate and the expenses
related to the fraud will be understated
During the year, the company’s credit
controller was absent for four months, and
they were not replaced. In addition, the
receivables collection period has increased
from 45 to 75 days
There is an increased risk concerning the
recoverability of receivables balances and
an allowance may be required. If this is the
case, receivables may be overvalued and
the allowance understated.
14
15
Warranty provision for the year-end 30
September remains the same as the prior
year while the warranty claim is
increased for television speaker deficiency
due to cheaper alternative
There is a risk that warranty provision
could be understated which could lead to
an understatement of expenses and
liability
During the year Akhil Co has raised new
finance by issuing $1m of shares at a
premium.
Discuss with the management the basis for
recognizing the receivables and test its
reasonableness.
Also, review the supporting document
provided by the legal experts to determine
the probability of inflow.
If the probability is not virtually certain, then
suggest the management disclose as a
contingent asset rather than that of a
receivable.
Increased the level of professional skepticism
and alert to the possibility of fraud or errors.
Additional substantive testing should be
conducted over the affected areas of the
accounting records, particularly payroll.
Discuss with the management the rationale
for not increasing the allowances for
receivables and test its reasonableness.
Discuss with the management the reason for
the increase in receivables and the
management process for identifying potential
irrecoverable debts.
Test the post-year-end cash receipts and
review the aged receivables and the long
outstanding debts to determine the adequacy
of the allowance for receivables.
Discuss with the finance director the
rationale for not increasing warranty
provision despite the increasing level of
warranty claims and assess its
reasonableness.
Review the level of warranty claims during
the current year and post year-end to verify
the adequacy of warranty provisions
Discuss with the management and review the
supporting document to confirm proceeds of
$1m were received.
16
17
18
There is the risk that if the new finance is
not correctly split up between the share
capital and the share premium, then the
share capital and share premium accounts
may be misstated.
In addition, legal may arise if the share
issue has not been issued by the
company's statutory constitutions.
Recalculate the split up between the share
capital and share premium and suggest the
management correctly account for it if the
split up is misstated.
Akhil CO has recognized $0.6m of research
expenditure in profit or loss with the
remaining $1.2 m having been capitalized
as development expenditure.
Obtain the breakdown of the cost and review
that only that cost is capitalized which meets
the capitalization criteria as per the IAS 38.
As per IAS 38, only those costs should be
capitalized that meet the PIRATE criteria
otherwise should be treated as research
expenditures. If The research cost has
been incorrectly classified as a
development expenditure, then the
intangible asset could be overstated and
the research expenses could be
understated.
Directors' remuneration disclosures have
been made in line with IFRS standards but
not local legislation.
When the local legislation is more
comprehensive than the IFRS standard,
then the company must comply with the
local legislation. There is the risk that
adequate disclosure could not be made if
the company complies with the IFRS rather
than the local legislation.
Review the supporting documents such as
receipts, and invoices to determine the
nature of expenditures.
Lapis Co purchases most of its raw
materials from overseas suppliers and
bears responsibility for goods in transit (up
to six weeks) from the point of dispatch by
the supplier.
Review the purchase contract with the
supplier of Lapis Co. to ascertain whether
risks are transferred from the supplier at the
point of dispatch.
The purchase should be recorded when
risk and obligations are transferred to
Lapis Co. If the purchase is not recorded at
the point of dispatch, purchase, payables,
and inventory could be understated.
Review the statutory constitution document
to confirm the legality of the claim.
Discuss with the management the rationale
to disclose only the remuneration payable
and review its reasonableness.
Review disclosure made by management in
line with local legislation requirements
regarding disclosure of remuneration payable
to each director along with names.
If disclosure is not adequate, suggest the
management include the names and
individual remuneration payable to each
director to ensure compliance with Local
legislation
Extend cut-off testing by reviewing pre and
post-year GRNs and supplier dispatch notes
to verify that inventory is recorded at the
correct point.
Review the controls the company has in place
to ensure that inventory is recorded from the
point of dispatch.
19
20
21
Work in progress
The company financial accountant was
taken ill and a temporary accountant has
been drafted to prepare the financial
statement.
There is an increased risk of errors in the
financial statement as the temporary
financial accountant may not be familiar
with the company's activities and so
errors/omissions may go unnoticed.
Akhil co payroll function is outsourced to
an external service organization.
A detection risk arises as to whether
sufficient and appropriate evidence is
available at Akhil co to confirm the
accuracy and completeness of control over
the payroll cycle and liabilities at the yearend.
Appropriate time should be allocated to
attending the inventory count and
understanding the inventory valuation
process for WIP.
Discuss with the management the basis for
assessing the percentage of completion of
WIP and test its reasonableness.
Discuss with the management about the
technical competency and experience of the
temporary accountant.
Increase substantive testing of the material
areas of the financial statement to reduce
audit risks, particularly those requiring
judgments.
Discuss with the management the extent of
records maintained at Akhil co for the periods
and any monitoring control that has been
taken by the management over payroll.
Consideration should be given to contacting
the service organization auditor to confirm
the level of control in place.