MASTER AUDIT RISK SHEET
Heading Audit Risk Full Sentence Auditor Response
The auditor should compare
Increased revenue or revenue with prior year figures and
pressure to improve results, expectations, perform cut-off
Revenue Overstatement there is a risk revenue may testing around the year end, and
Risk be overstated due to inspect sales invoices and goods
fictitious sales or cut-off despatch notes to confirm that sales
errors. have been recorded in the correct
accounting period.
The auditor should apply increased
Sales bonuses or professional scepticism, review
management bonuses linked manual journal entries posted near
Management Bias /
to profit/revenue, there is a the year end, and perform detailed
Fraud Risk
risk management may substantive testing on revenue
manipulate revenue. transactions to identify any unusual
or fictitious sales.
The auditor should inspect post
Goods returned after year year-end sales returns and agree
end relating to current year them to the original sales invoices
Revenue Cut-Off Risk
sales, there is a risk revenue to determine whether revenue
cut-off may be incorrect. recognised before the year end
should be reversed.
The auditor should review and test
Weak sales systems or controls within the sales system,
website booking problems, inspect system error reports, and
Sales System Control
there is a risk sales reconcile website booking records
Risk
transactions may not be to the accounting records to ensure
accurately recorded. transactions are complete and
accurate.
The auditor should review the aged
receivables analysis, inspect post
Extended credit terms given
year-end cash receipts from
Receivable to customers, there is a risk
customers, and assess whether an
Recoverability Risk receivables may not be
adequate allowance for
recoverable.
irrecoverable debts has been
recognised.
The auditor should inspect
correspondence with customers
Customers struggling to pay, regarding overdue balances, review
Receivable
there is a risk receivables post year-end receipts, and
Overstatement Risk
may be overstated. recalculate the expected credit loss
allowance to ensure receivables are
fairly valued.
The auditor should recalculate the
Release/removal of receivables allowance using
Allowance for receivable allowance, there historical recoverability data and
Receivables Risk is a risk receivables and review whether management’s
profit may be overstated. decision to reduce the allowance is
reasonable.
Inventory Valuation Risk Inventory not valued at The auditor should compare
lower of cost and NRV, inventory cost with selling price
MASTER AUDIT RISK SHEET
Heading Audit Risk Full Sentence Auditor Response
less costs to sell and ensure
there is a risk inventory and inventory has been valued at the
profit may be overstated. lower of cost and net realisable
value in accordance with IAS 2.
The auditor should inspect damaged
Damaged or faulty inventory inventory items, review customer
with no adjustment made, complaints and returns records, and
Damaged Inventory Risk
there is a risk inventory may confirm whether appropriate
be overstated. inventory write-downs have been
recognised.
The auditor should review selling
Decline in selling prices or
prices achieved after the year end
increased competition, there
NRV Risk and compare these with inventory
is a risk inventory NRV may
cost to assess whether any
be below cost.
inventory write-down is required.
The auditor should review the basis
Additional overheads
of overhead allocation and confirm
Inventory Overvaluation included in inventory
that only production-related
Risk valuation, there is a risk
overheads have been included in the
inventory may be overstated.
valuation of inventory.
The auditor should attend inventory
Various inventory storage
counts at material locations and
locations, there is a risk
Inventory Existence Risk review inventory count instructions
100% verification may not
to ensure inventory quantities are
be possible.
accurately recorded.
The auditor should obtain direct
Inventory held at third-party
written confirmation from third-
Third-Party Inventory warehouses, there is a risk
party warehouse providers and
Risk inventory existence may not
reconcile the confirmed balances to
be confirmed.
the inventory records.
The auditor should observe whether
Inventory movements during controls over goods received and
count, there is a risk despatched during the inventory
Inventory Count Risk
inventory quantities may be count are operating effectively and
misstated. perform cut-off testing around the
year end.
The auditor should discuss the stage
Continuous production
of completion of work in progress
environment, there is a risk
WIP Valuation Risk with production staff and review the
WIP valuation may be
costing calculations used to value
inaccurate.
WIP at the year end.
The auditor should review
Development costs development projects and inspect
IAS 38 Development Cost capitalised, there is a risk supporting documentation to
Risk IAS 38 recognition criteria confirm that the costs capitalised
may not be met. meet the recognition criteria of IAS
38.
Development Cost Development projects still in The auditor should inspect
Overstatement Risk early stages, there is a risk feasibility studies, budgets, and
MASTER AUDIT RISK SHEET
Heading Audit Risk Full Sentence Auditor Response
project plans to determine whether
development expenditure
the projects are technically and
should be expensed.
commercially viable.
The auditor should inspect purchase
Significant expenditure on
agreements for intangible assets and
patents/intangibles, there is a
Intangible Asset Risk recalculate amortisation charges to
risk intangible assets may be
ensure they have been correctly
overstated.
recognised.
Increased capital The auditor should inspect a sample
expenditure or repairs of expenditure invoices and verify
Capital vs Revenue
expenditure, there is a risk whether the costs have been
Expenditure Risk
incorrect classification correctly classified as capital or
between capital and revenue. revenue expenditure.
The auditor should inspect goods
Assets ordered near year end received notes and supplier
PPE Existence Risk but not received, there is a documentation after the year end to
risk PPE may be overstated. confirm whether the assets existed
at the reporting date.
The auditor should inspect disposal
Disposal of fixed assets not
documentation and agree disposed
removed from register, there
Asset Disposal Risk assets to the fixed asset register to
is a risk assets may be
ensure they have been removed
overstated.
correctly.
The auditor should review
Useful lives of assets
management’s assumptions
extended, there is a risk
Depreciation Risk regarding useful economic lives and
depreciation may be
compare them with industry
understated.
practice and prior years.
The auditor should obtain valuation
Revaluation of assets during
reports prepared by independent
the year, there is a risk
Revaluation Risk valuers and assess whether the
assets may be incorrectly
assumptions used are reasonable
valued.
and appropriate.
The auditor should review cash
flow forecasts, inspect loan
Decline in business or agreements, and assess
Going Concern Risk profits, there is a risk management’s going concern
regarding going concern. assessment to determine whether
the business can continue operating
for the foreseeable future.
Increased bank loans and The auditor should inspect loan
borrowings, there is a risk of agreements and confirm whether
High Gearing Risk
going concern issues due to loan repayments and covenants can
high gearing. be complied with by the company.
The auditor should recalculate the
Loan covenants attached to
covenant ratios and review whether
borrowings, there is a risk
Loan Covenant Risk the company has breached any
loans may become
conditions attached to the loan
immediately repayable.
agreements.
Liquidity Risk Cash flow difficulties or The auditor should review bank
MASTER AUDIT RISK SHEET
Heading Audit Risk Full Sentence Auditor Response
correspondence, inspect post year-
overdrafts, there is a risk the
end cash flows, and assess the
company may not meet
company’s ability to meet its short-
obligations.
term liabilities.
Increase in provisions and The auditor should inspect legal
contingent liabilities, there is correspondence, discuss the matters
Provision Risk a risk these may be with management, and review
understated or difficult to supporting calculations for
verify. provisions recognised.
Customer warranty claims, The auditor should review prior
there is a risk warranty year warranty claims data and
Warranty Provision Risk
provisions may be recalculate the warranty provision
understated. to assess whether it is reasonable.
Planned redundancies, there The auditor should inspect board
is a risk no provision has minutes and redundancy
Redundancy Provision
been made under IAS 37. announcements to determine
Risk
whether a constructive obligation
exists requiring a provision.
Introduction of new The auditor should review controls
New Accounting System accounting systems, there is over the system implementation and
Risk a risk data may not transfer reconcile balances transferred from
completely or accurately. the old system to the new system.
The auditor should increase
Old and new systems not
substantive testing and review
System Changeover Risk run in parallel, there is a risk
reconciliations between the old and
errors may not be detected.
new accounting systems.
The auditor should assess whether
Key IT personnel leaving
sufficient replacement staff and
IT Staff Risk during system changes, there
controls are in place to maintain the
is a risk errors may occur.
reliability of the accounting system.
Centralisation of accounting The auditor should reconcile
records, there is a risk balances transferred to head office
Balance Transfer Risk
balances may be transferred records with the original branch or
incorrectly. store accounting records.
The auditor should increase audit
Key personnel leaving close
testing and carefully review work
Staffing Risk to year end, there is a risk
performed by new or less
errors may increase.
experienced staff members.
The auditor should perform
Weak internal controls in
walkthrough tests and evaluate
sales or purchases systems,
Internal Control Risk whether the internal controls are
there is a risk transactions
operating effectively throughout the
may be misstated.
year.
The audit partner should ensure the
Tight audit deadlines, there
audit is properly planned and
is a risk audit procedures
Detection Risk adequately staffed so sufficient
may not detect all material
audit evidence can still be obtained
misstatements.
before completion.
First Year Audit Risk First year audit engagement, The auditor should review
there is a risk opening predecessor auditor working papers
MASTER AUDIT RISK SHEET
Heading Audit Risk Full Sentence Auditor Response
and perform audit procedures on
balances may contain errors. opening balances to confirm they
are free from material misstatement.
The auditor should apply increased
Previous fraud identified in
professional scepticism and perform
Fraud Risk the company, there is a risk
additional testing on journals,
further fraud may exist.
estimates, and unusual transactions.
Payroll outsourced to a third The auditor should obtain a type 1
party, there is a risk payroll or type 2 report on the service
Service Organisation
controls may be weak. organisation’s controls and test
Risk
reconciliations between payroll
reports and accounting records.
The auditor should review board
Related party transactions
minutes and inspect related party
carried out, there is a risk
Related Party Risk transactions to ensure they have
transactions may not be
been properly disclosed in the
disclosed correctly.
financial statements.
Excess inventory or fixed The auditor should inspect physical
assets held, there is a risk of security controls and review
Misappropriation/Theft
theft or misappropriation. inventory count discrepancies to
Risk
identify any evidence of theft or
missing assets.
Ratios Analysis
1. Used to compare business performance with prior year or competitors.
2. Used to display business performance in front of investors.
Profitability Ratios
1. Gross Profit Margin:
Gross Profit/Sales * 100
MASTER AUDIT RISK SHEET
Reason for change: Changes in selling price, Purchase cost, Production cost
etc.
2. Operating Profit Margin:
Profit before interest/Sales * 100
Performance: Higher is better.
Reason for change: Changes in gross profit ratio and changes in expenses to
sales ratio.
3. Return on Capital Employed:
Profit before interest and tax/Capital Employed * 100
How much return in % we can pay our investors annually on their investment.
Performance: Higher is better
Reason For change: Changes in profit or changes in capital employed (loan
paid or taken).
Capital Employed: Non current liabilities + equity(capital) or Total Assets –
Current Liabilities
4. Asset turnover(times)
Sales/Capital employed
It shows how well assets are utilized to generate sales.
Operating Profit margin * Asset turnover = R.O.C.E
Profit Before interest & tax/Sales * Sales/Capital employed
5. Non-Current Asset turnover (times)
Revenue/Net book Value of non-current assets
Liquidity Ratios
1. Current Ratio/Working Capital Ratio
Current Assets/Current Liabilities
Answer given in ratio 1.
Performance- 2:1
Current assets must be enough to pay its current liabilities in short run and
operate the business smoothly.
MASTER AUDIT RISK SHEET
Reasons for change: Money invested in non-current assets, increase in cash
expenses, Loan taken or paid back, Capital investment or drawings.
2. Quick Ratio/Acid Test Ratio:
(Current Assets – Closing inventory)/Current Liabilities
It shows company ability to pay its current liabilities on an immediate basis.
Performance: It should be above 1
Reasons for change: Changes in inventory levels with inventory sold too
quickly or too slowly.
General Point:
Quick ratio and Current Ratio can be improved if surplus non-current assets
can be sold, bank loan can be taken, inventory sold quickly on discount but
above cost price.
Efficiency Ratios:
1. Inventory Turnover(times)
Cost of Sales/ Inventory
It shows the speed at which inventory is being sold.
Performance: A greater inventory turnover means more sales will be earned
and holding cost will reduce also. Risk of obsolete inventory will reduce.
2. Inventory turnover(days)
Inventory/Cost of sales *365
It shows in how many days our inventory will be sold.
Performance: Lower the better
3. Trade Receivable days:
Trade Receivables/Credit Sales * 365
It shows in how many days our customer will pay us.
Performance: Lower Trade Receivable days are better for business as the risk
of doubtful debt will reduce and cash balance will improve in lesser time, but
cash discount may require to be offered and lesser credit days offered can
reduce sales as well.
4. Trade Payable days:
Trade Payables/Credit Purchases *365
It shows in how many days we need to pay our supplier.
Performance: Higher trade payables days means the company will have more
cash available for longer times with the company, but cash discount offer will
be missed and can cause bad reputation with the supplier.
MASTER AUDIT RISK SHEET
5. Working Capital cycle days:
Trade receivable days+ Inventory days – Trade Payable days
It shows the time in which the cashflow is tied up for the business. It should be
shorter to avoid liquidity problems.
6. Net Working Assets to revenue ratio:
Revenue/Net working capital *100
It shows how well working capital is utilized to generate sales.
Higher the better as it shows the efficiency of working capital used.
Risk Ratios:
1. Interest Cover:
Profit before interest and tax/Interest expense
It shows the proportion of interest that needs to be paid from operating profit.
The higher the better for the business since then the higher profit will be left
for ordinary shareholders.
2. Gearing ratio:
Non-Current Liabilities + Preference share capital/(NCL +PSC +OSC+
Reserves)*100
Or
Debt to Equity ratio:
Non-Current Liabilities + Preference share capital/(OSC+ Reserves)*100
It shows the outside investment in the total investment of the business.
Higher the gearing shows higher risk for the business.
Investor Ratios:
1. Earnings per share:
Profit after interest, tax, and preference dividend/ No. of ordinary shares
MASTER AUDIT RISK SHEET
It shows how much profit a business can pay on one share to an ordinary
share.
Higher EPS will boost confidence of shareholders in a company.
2. Dividend yield:
Dividend paid and proposed per share/Market price per share *100
It shows the % amount recovered by ordinary shareholders on their
investment in a year.
3. Dividend per share:
Total dividend paid/No. of ordinary shares
4. Dividend cover: (times)
Profit after interest, tax, and preference dividend/ Ordinary dividend paid
It shows how many times a business can pay its ordinary dividend.
Higher the better as it gives business an option to pay higher dividend if there
is a demand for it from shareholders.
5. Price Earnings ratio(times)
Market price per share/Earning per share
It shows how market price fluctuates to the change in earnings per share.
Higher price earnings ratio means that investor has more confidence in the
business.
6. Return on Equity:
Profit after interest, tax and preference dividend/Value of equity *100
It shows how much company generates profit for the ordinary shareholders
with the money they have invested in the company.
Limitation of Ratios:
1. Ratios have no value unless compared.
2. It shows historic business performance which is not an indicator of future busi-
ness performance.
3. It does not consider non-financial information.
MASTER AUDIT RISK SHEET
4. Comparable company may have used different accounting policies or have
different operations or focus on different market segments, hence compar-
ison may not be fair.
User of Ratios:
Owners, Manager, Banks, Employees, Shareholder, Government and Trade
Payables.