AUDIT RISK

Si Audit Risk Explanation Auditor’s Response (Audit Procedure)

No.
1 Company has purchased non- There is a possibility this may be Review a breakdown of these costs to
current assets or has incurred wrongly classified as revenue ascertain the split of capital and revenue
refurbishment costs. expenditure and not as capital expenditure.
(December 2013) expenditure resulting in
understatement of non-current assets Review financial statements to confirm it is
and understatement of profits. classified as non-current asset.
2 Company has taken a long term This loan needs to be Inspect loan agreement to confirm it's a
loan. (June 2015, June 2016, correctly split between long-term loan.
March/June 2019) current and non-current
liabilities in order to ensure correct Review bank a/c to confirm the loan has
disclosure. been received.

Also as the level of debt has Review financial statements to confirm the
increased, there should be additional split between current and non-current
finance costs. liabilities.

There is a risk that this has been Review the disclosures for this loan note to
omitted from the statement of profit ensure compliance with relevant accounting
or loss, leading to understated standards.
finance overstated profit.
3 Bank has stated certain If entity is not able to maintain the Maintain professional skepticism by being
minimum balances of assets to minimum balance, there is a possibility alert.
be maintained it manipulated resulting in
overvaluation of assets. Use more experienced audit staff
Take more samples related to assets
4 The bank has attached loan If the loan covenants are Read notes to financial statements to
covenants to non-current breached, the loan become payable confirm going concern disclosures are
liability that if these covenants immediately and this may give rise to relevant, understandable and adequate.
are breached, the loan will be material uncertainties relating to going
repayable immediately. concern. There is a possibility that this
material uncertainty may not be
adequately disclosed in the notes to
financial statements.
4 Entity has incurred research and There is a possibility that the research Obtain a breakdown of research and
development cost and all the expenses may be wrongly classified as development cost.
development costs have been intangible assets resulting in over
capitalized valuation of intangible assets and Inspect documents relating to this cost and
understatement of expenses and ascertain its nature-revenue or capital to
(September 2016, December overstatement of profits. ensure that only projects which meet the
2013) capitalization criteria are included as an
Some of development expenditure intangible asset, with the balance being
may not have met the IAS 36 criteria expensed.
for capitalization resulting in over
valuation of intangible assets, Obtain a breakdown of research and
development costs.

AUDIT RISK AND AUDITOR’S RESPONSE 1

 understatement of expenses and Inspect documents relating to these costs
overstatement of profits. and ascertain its nature-revenue or capital.

Inquire technical management to confirm

technical and commercial feasibility of the
project.
5 Land and buildings will be There is a possibility that the Review if the entire class of assets has been
revalued at the year end. treatment of revaluation surplus or revalued.
(June 2016, June 2014) deficit may be wrong.
Review if the valuation is done by an expert.
The revaluation needs to be carried If so whether the expert's work can be relied
out and recorded in accordance with up on.
IAS 16 PPE, otherwise non-current
assets may be incorrectly valued. Review whether depreciation is charged on
the revalued figures by recalculating
depreciation to confirm accuracy.

Review allocation of revaluation surplus or

deficit in the financial statements.

6 Ordered Plant and Machinery, Only assets which physically exist at Inspect the asset to confirm its existence and
but Half of the order have not the year-end should be included in PPE ensure only appropriate assets are recorded
yet been delivered. "If items not yet delivered have been in the non-current asset register at the year
capitalized, PPE will be overvalued. end.

If depreciation is not appropriately Recalculate depreciation to confirm

charged when the asset is available for accuracy.
use, this may result in assets and
profit being over or understated.
7 During the year an asset has Profit on disposal may be Recalculate profit on disposal to confirm
been disposed of at a profit. wrongly calculated resulting in accuracy.
(June 2015) understatement or overstatement of
profits. Inspect non-current asset register to confirm
it has been removed from the non-current
If the asset is not removed from non- asset register.
current assets, it may result in over
valuation of non-current assets; it may
also result in wrong treatment of
depreciation.
8 During year-end inventory count There is a possibility that the goods Review goods received notes and goods
there were movements of goods could have been omitted or counted dispatched notes received during the
in and out. twice. This would result in inventory inventory count and review if it is included in
being under or over stated. the inventory count records as correctly.
9 Inventory held at different Auditor will not be able to Attend and observe inventory count.
warehouses. attend at all inventory
(September/December 2017) counts, increasing detection risk and Re-perform inventory count.
therefore they need to ensure that

AUDIT RISK AND AUDITOR’S RESPONSE 2

 they obtain sufficient evidence over Obtain external confirmation from third
the inventory counting controls, party warehouses to confirm existence and
and completeness and existence of rights and obligations.
inventory for any warehouses not
visited. Inspect ownership documents to confirm
which warehouses are owned by the entity
Some of warehouse may be owned by to confirm rights and obligations.
company and some rented from third
parties.

Only warehouses owned by company

should be included within PPE.

Otherwise, it will result in

overvaluation of PPE and
understatement of rental expenses if
company has capitalized all
warehouses.
10 The company values inventory Inventory should be valued at the Inspect purchase invoice to confirm the
as selling price less average lower of cost and NRV. inventory.
profit margin.
(March/June 2019) IAS 2 Inventories allows inventory as Testing should be undertaken to confirm cost
selling price less average profit and NRV of inventory and that on a line-by-
margin as long as it is a close line basis the goods are valued correctly.
approximation to cost.
In addition, valuation testing should focus on
If this is not the case, then inventory comparing the cost of inventory to the
could be under or overvalued. selling price less margin for a sample of
items to confirm whether this method is
actually a close approximation to cost.
11 Standard cost are not update If standards costs are not update Inspect purchase invoice of raw materials to
regularly regularly, it may result in under or over confirm cost.
valuation of inventory.
12 The company undertakes All inventories must be counted at Attend & Observe inventory count.
continuous (perpetual) least once a year. Otherwise, there is
inventory counts. possibility that inventory could be Re-perform inventory count.
(June 2014, March/June 2019) under or overvalued.
13 Goods in transit. At the year end, there is a risk that the The audit team should undertake detailed
(September 2016, June 2014) cut-off of inventory, purchases and cut-off testing of purchases of goods at the
payables may not be accurate and year end.
may be under/overstated. Review last GRN of the current year and the
first GRN of the next financial year ensure
that cut-off is complete and accurate.
14 The company undertakes As production will not cease, Inspect production records to confirm the
continuous production in its the exact cut-off of the work in percentage of completion of WIP.
factory. progress will need to be assessed.
(June 2016)

AUDIT RISK AND AUDITOR’S RESPONSE 3

 If the cut-off is not correctly
calculated, the inventory valuation
may be under or overstated.
15 The company outsources the A detection risk arises as to whether Inquire management to the extent of payroll
payroll work (June 2016, sufficient and appropriate evidence is work done by service organization.
March/June 2019) available at Company to confirm the
completeness and accuracy of controls Contact the service auditor to confirm the
over payroll. level of controls in place.

The payroll processing had Discuss with management the transfer

transferred to service entity. process undertaken and any controls put in
place to ensure the completeness and
If any errors occurred during the accuracy of the data.
transfer process, these could result in
the payroll charge and related Where possible, undertake tests of controls
employment tax liabilities being to confirm the effectiveness of the transfer
under/overstated. controls.

In addition, perform substantive testing on

the transfer of information from the old to
the new system.
16 The company outsourced its A detection risk arises as to whether Inquire management to the extent of payroll
sales ledger processing to an sufficient and appropriate evidence is work done by service organization.
external service organization available at Blackberry Co to confirm
the completeness and accuracy of Contact the service auditor to confirm the
controls over the sales and level of controls in place.
receivables cycle and balances at the
year end. Discuss with management the transfer
process undertaken and any controls put in
The sales ledger processing had place to ensure the completeness and
transferred to service entity. accuracy of the data.

If any errors occurred during the Where possible, undertake tests of controls
transfer process, these could result in to confirm the effectiveness of the transfer
sales and receivables being controls.
under/overstated.
In addition, perform substantive testing on
the transfer of information from the old to
the new system.
17 There have been a significant As these relate to pre year- Review a sample of the post year-end sales
number of sales returns made end sales, they should be returns and confirm if they relate to pre
subsequent to the year removed from revenue in year-end sales, that the revenue has been
end. the draft financial statements and the reversed and the inventory included in the
(June 2015) inventory reinstated. year-end ledgers.

If the sales returns have not been

correctly recorded, then revenue will

AUDIT RISK AND AUDITOR’S RESPONSE 4

 be overstated and inventory
understated.
18 A sales-related bonus scheme Sales staff seeking to maximize their Increased sales cut-off testing will be
has been introduced in the year. current year bonus may result in new performed along with a subsequent event
(March/June 2017, June 2014) accounts being opened from poor review of any post year-end cancellations of
credit risks leading to irrecoverable contracts as they may indicate cut-off errors.
receivables resulting in overvaluation
of receivables. Perform subsequent event review by
This may lead to sales cut- off errors verifying post year end cash receipt to
with employees aiming to maximize confirm the recoverability of receivables.
their current year bonus resulting
in overstatement of sales.
19 Receivables are considerably There are concerns about the Perform subsequent events review by
higher than the prior year creditworthiness some customers. verifying post yearend cash receipts from
(June 2016, June 2014) There is a risk that some receivables accounts receivables to confirm
may be overvalued as they are not recoverability.
recoverable.
Review whether allowances for irrecoverable
debts are reasonable.
20 The finance director of the There is a risk that receivables will be Discuss with the director the rationale for
company has decided to release overvalued, as some balances will be reducing the allowance for receivables.
the opening provision of irrecoverable and so will be overstated
allowance for receivables as he if not provided for. Perform subsequent events review by
feels it is unnecessary. verifying post yearend cash receipts to
(September 2016, September confirm recoverability.
/December 2017, December
2013) Review aged receivables ledger to asses the
need for an allowance on receivables.
21 Company's previous finance There is a risk that he may have Inquire those charged with governance what
director left after it was undertaken other fraudulent procedures they have adopted to identify
discovered that he had been transactions leading to an increased any further frauds by the previous finance
committing fraud with regards control risk which has not yet been director.
to expenses claimed. identified.
These would need to be written off in Maintain professional skepticism by being
the statement of profit or loss. alert throughout the audit for further
possible misstatements due to fraud.
If these have not been uncovered, the Additional substantive testing should be
financial statements could be conducted over the affected areas of the
materially misstated due to fraud. accounting records.
22 Senior management (e.g. There is no one in that department to Maintain professional skepticism by being
finance director) has left and his oversee the functions which may alert to possible misstatements due to fraud
or her replacement will-take result in material misstatement or error.
place after three months. due to fraud or error.
Perform more substantive procedures for
these three months.

AUDIT RISK AND AUDITOR’S RESPONSE 5

23 The bonus scheme for senior There is a risk that management Maintain Professional skepticism by being
management and directors of might be motivated to overstate the alert throughout the audit for possible
the Company has been changed; value of assets. misstatement due to fraud.
it is now based on the value of
year-end total assets. Perform more substantive procedures with
(September 2016) respect to asset.
24 Company is planning to make Redundancy provision will Review board minutes and correspondence
some employees redundant be required at the year end. to employees relating to redundancy.
after the year end.
Failure to provide will result Recalculate redundancy provision to confirm
in an understatement of accuracy.
provisions and expenses
25 New accounting software was There is a risk of the opening balances Review and reconcile opening balance.
introduced and the old and new may be not being accurately
systems were not run transferred to the new system The auditor should document and test the
in parallel. (September 2016, resulting in material misstatement due new system.
December 2013) to fraud or error.

If this is not done, this could result in

the auditor not identifying a
significant control risk.
26 Branches maintained their own There is a risk of the opening Review and reconcile opening balance.
financial records and now it is balances may be not be accurately
centralized at head office. transferred to the head office accounts
resulting in material misstatement due
to fraud or error.
27 The company is a new client for As the team is not so familiar Maintain professional skepticism (being
the audit firm. with the accounting policies, alert to possible misstatement due to fraud
(September/December 2017, transactions and balances, or error).
June 2014) there will be an increased detection
risk. Audit firm should ensure they have a
suitably experienced team.

Also, adequate time must be allocated for

the team members to obtain an
understanding of the company and the risks
of material misstatements.
28 A number of reconciliations, At the year end, it is important to Discuss this issue with the finance director
including the bank confirm that balances including bank and request that the December
reconciliation, were not balances are not under or overstated. reconciliation is fully reconciled.
performed at the year end.
(September 2016) It may affect valuation of bank The reconciling items should be tested in
balance. detail and agreed to supporting
documentation.

Re-perform bank reconciliations.

AUDIT RISK AND AUDITOR’S RESPONSE 6

29 No supplier statement or This a key control which is being Request management prepare a year-end
purchase ledger control account overridden and as such there is an purchase ledger control account
reconciliations have been increased risk of errors within trade reconciliation.
performed. payables and the year-end payables
(March/June 2018) balance may be under or overstated. The audit team should undertake a detailed
review of this reconciliation with a focus on
any unusual reconciling items.
30 Company has issued further This needs to be accounted for The audit team should confirm that
shares at a premium correctly, with adequate disclosure proceeds were received and that the split of
(March/June 2018) made & the equity finance needs to be share capital and share premium is correct
allocated correctly between share and appropriately recorded.
capital and share premium.
In addition, the disclosures for this finance
If this is not done, then the accounts should be reviewed in detail to ensure
may be misstated due to a lack of compliance with relevant accounting
disclosure or share capital and share standards and local legislation.
premium may be misstated.
31 Significant finance has been As the preference shares are Review share issue documentation to
obtained in the year, as the irredeemable, they should be confirm that the preference shares are
company has issued classified as equity rather than non- irredeemable.
irredeemable preference shares. current liabilities.
Confirm that they have been correctly
Failing to correctly classify the shares classified as equity within the accounting
could result in understated equity and records.
overstated non-current liabilities.
Review bank a/c to confirm total financing
proceeds of were received.
32 Audit reporting time is quite Auditor will not be able to obtain Perform interim audit
short. Sufficient and appropriate audit
evidence resulting in detection risk. Maintain professional skepticism by being
alert to increased risk of errors.
In addition, the finance team of
Hurling Co will have less time to
prepare the financial information
leading to an increased risk of errors
arising in the financial statements.
33 Current ratio of the company is There is a possibility for a Maintain professional skepticism by being
higher material misstatement due alert.
compared to previous year to fraud or error since
current assets may be Use more experienced audit staff
overstated or current Take more samples related to current asset
liabilities understated and
current liabilities.
34 Increase in gross profit margin, There is a possibility of wrong Review the classification of costs between
but operating margin has not Classification between direct expenses cost of sales and operating expenses.
increased proportionately (cost of sales) and indirect Expense
(March/June 2019) (operating expenses) leading to

AUDIT RISK AND AUDITOR’S RESPONSE 7

 understatement of cost of sales and Compare current year cost of sales and
overstatement of operating expenses. operating expenses with prior year and any
inconsistencies investigated.
35 Receivable days have increased This leads to an increased Perform subsequent events review by
from 49 to 91 days and risk of recoverability of verifying post year end cash receipts to
management has significantly receivables as they may be confirm the recoverability.
extended the credit terms given overvalued.
to customers. Review aged analysis to assess the need for
(June 2013) an allowance on receivables.
36 Inventory days have increased There is a risk that inventory Detailed cost and NRV testing to be
and inventory turnover has is overvalued. performed and the aged inventory report to
fallen. be reviewed to assess whether inventory
(June 2013) requires writing down.
37 Inventory includes overhead Only production overhead should be Review breakdown of production and
cost. included in inventory. nonproduction overheads and confirm only
(March/June 2018) production overheads are included in the
If nonproduction overheads are inventory.
included, it will result in overvaluation
of inventory. If general overheads (non-production) are
included, request management remove
them from the valuation to be included in
the draft financial statements.
38 Preliminary analytical review of Administration expenses tend to be Update the analytical review with the full
the draft statement of profit or fixed costs and hence would be year results and if significant fluctuations on
loss has identified a significant unlikely to fluctuate significantly with prior year remain, discuss these with
fall in administration expenses. changes in sales volumes. Hence there management.
is a risk that Administration expenses
are understated. Inspect invoices related to administrative
expense and obtain supporting evidence to
verify management explanations.
39 The company has decreased the "It is possible that the selling price The auditor should undertake detailed cost
selling price of products may have fallen so that the net and NRV testing to assess whether inventory
significantly and there are realizable value (NRV) of inventory is is overvalued and requires write down.
increased levels of inventory below cost.
expected at the year end.
(December 2014) IAS 2 Inventory requires inventory to
be stated at the lower of cost and NRV.

Hence it is possible that inventory is

overvalued.
40 Due to the fall in demand for IAS 2 Inventories requires that Detailed cost and NRV testing to be
goods, there are some goods inventory should be stated at the performed and the aged inventory
where the selling price may lower of cost and NRV. report to be reviewed to assess whether
be below cost. inventory requires writing down.
(June 2013) If the company fails to value inventory
at NRV, there is a risk that inventory
may be overvalued.

AUDIT RISK AND AUDITOR’S RESPONSE 8

41 The financial controller of the If it is probable that Eagle will make The audit team should write to the
company was payment to the financial controller, a company's lawyers to enquire of the
dismissed and is threatening to provision for unfair dismissal is existence and likelihood of success of any
sue the required. claim from the former financial controller.
company for unfair dismissal.
(December 2014, March/June If the payment is possible rather than
2018) probable, a contingent liability
disclosure would be necessary.

If Eagle has not done this, there is a

risk over the completeness of any
provisions or contingent liabilities.

42 The financial controller has been This increases the inherent and Auditor should maintain professional
dismissed and his tasks have control risk within Eagle as errors may skepticism by being alert throughout the
been allocated between have been made within the accounting audit for additional errors within the finance
the finance department team, records by the overworked finance department.
this has increased their team members and there is no one
workload. working in a supervisory capacity. In addition, discuss with the finance director
(December 2014) whether he will be able to provide the team
with assistance for any audit issues as there
is no financial controller available.
43 The purchase ledger supervisor There is an increased risk of The audit team should increase their testing
has left and no reconciliations of errors within trade payables on trade payables at the year end, with a
supplier statements and and the year-end payable may particular focus on completeness of
purchase ledger control account be under or overstated. payables.
have been performed.
(December 2014) A detailed review of the year-end purchase
ledger control account reconciliation should
be performed with a focus on any unusual
reconciling items.
44 The finance director has Under IAS 16 PPE , useful lives are to Discuss with the directors the rationale for
extended the useful lives of be reviewed annually, and if asset lives any extensions of asset lives and reduction
fixtures and fittings from three have genuinely increased, then this of depreciation rates.
to four years, resulting in the change is reasonable.
depreciation charge reducing. Also, the four-year life should be comp how
(March/June 2017, June 2013) often these assets are replaced, to
the useful life of assets.
45 A customer has been If experiencing there is an increased Perform subsequent events review by
encountering difficulties paying risk that the receivable is not verifying post year end cash receipts to
their outstanding balance. recoverable and hence is overvalued. confirm the recoverability.

(March/June 2017) Discuss with the finance director whether

he intends to make an allowance for this
receivable.

AUDIT RISK AND AUDITOR’S RESPONSE 9

 If not, review whether any existing
allowance for uncollectable accounts is
sufficient to cover the amount of this
receivable.
46 The company is intending to This amount should not be provided Discuss the issue with management and
propose a final dividend once for in the current year financial confirm that the dividend will not be
the financial statements are statements, as the obligation only included within liabilities in the current year
finalized arises once the dividend is announced, financial statements.
(March/June 2017) which is post year end.
In line with IAS 10 Events after the Review the financial statements to ensure
Reporting Date the dividend should that adequate disclosure of the proposed
only be disclosed. dividend is included.

If the dividend is included, this will

result in an overstatement of
liabilities and understatement of
equity.
47 The company is planning to If the adjustments are not The auditor should attend the inventory
undertake the full year-end completed accurately, then count held after the year end and note
inventory counts after the year the year-end inventory details of goods received and dispatched
end and then adjust for could be under or post year end, in order to agree to the
movements from the year end. overstated. reconciliation.
(March/June 2018)
During the final audit, the year-end
inventory adjustments schedule should be
reviewed in detail and agreed to supporting
documentation obtained during the
inventory count for all adjusting items.

The audit team should increase the extent of

inventory cut-off testing at the year-end and
at the date of count.
48 A large batch product has been The valuation of inventory as per IAS 2 Detailed cost and NRV testing to be
damaged in the production Inventories should be at the lower of performed to assess how much the
process and will be in inventory cost and NRV. inventory requires writing down by.
at the year end. No adjustment
has been made by management. Hence it is likely that this
(December 2013) inventory is overvalued.
49 Due to the damaged products, a It is likely that for any of the damaged Review the breakdown of sales of damaged
number of customers have goods sold, Minty will need to refund goods and ensure that they have been
complained. these customers. accurately removed from revenue.
(December 2013)
Revenue is possibly overstated if the
sales returns are not completely
and accurately recorded.

AUDIT RISK AND AUDITOR’S RESPONSE 10

50 The directors have each been The directors’ remuneration will not Discuss this matter with management and
paid a significant bonus and be complete and accurate if the bonus review the disclosure in the financial
separate disclosure of this in the paid is not disclosed in accordance statements to ensure compliance with local
financial statements is required with the relevant local legislation. legislation.
by local legislation. (June 2014)
51 A number of assets which had This is an indication that the Discuss the depreciation policy for non-
not been fully depreciated were company's depreciation policy of non- current assets with the finance director and
identified as being obsolete. current assets may not be appropriate, assess its reasonableness.
(March/June 2019) as depreciation in the past appears to Enquire of the finance director if the
have been understated. obsolete assets have been written off.

If an asset is obsolete, it should be If so, review the adjustment for

written off to the statement of profit completeness.
or loss.

Therefore, depreciation may be

understated and profits and
overstated.
52 The company is planning to The costs were incurred and adverts Discuss with management the rationale for
include a current asset, which shown in the year and there is no basis including the advertising as a current asset.
relates to advertising costs for including them as a current
incurred and adverts shown on asset at the year end. Review supporting documentation for the
TV before the year end. advertisements to confirm that all were
The costs should be recognized in shown before the year end.
operating expenses in the current year
financial statements. Request that management remove the
current asset and record the amount as an
If these costs are not expensed, expense in the statement of profit or loss.
current assets and profits will be
overstated and operating expenses
understated.

AUDIT RISK AND AUDITOR’S RESPONSE 11