Risk based Audit techniques

Topics to be discussed
Segment 1 Segment 2
 Risk based Audit  Internal controls and its components
 What is an Audit  Audit risk and Assertion

 Objectives and Types of Audit Audit procedures with Interactive discussion

 Frameworks of auditing and accounting
 Code of ethics and Independence  Materiality and Performance materiality

 Overall Audit process flow  Audit Evidence and documentation

 Case Study on Independence  Audit Sampling and Sampling methods

 Audit report
 Emerging trends in audit
 Case study on Audit opinions
Segment 1
 What is Risk based Audit ?
• Risk-based auditing is an approach to auditing that focuses on identifying and prioritizing areas of risk within
an organization
• It is a method of auditing that is driven by the level of risk associated with a particular area or process within the
organization.

Benefits of Risk based audit :

 the risk-based approach to audit will minimize the chances of the risks that are present in the
financial statements
 Increases efficiency since the focus is primarily towards high risk or fraud risk areas
What is an Audit ?
a) an audit is an independent examination of an organization's financial report information and
internal controls
b) with a view to express an opinion

Overall Objectives of an Audit :

 Provide opinion on the financial statements

 Ensure compliance with the financial reporting frameworks
 Offer reasonable assurance that financial statements are free from material misstatement, whether
due to fraud or error, enhancing stakeholder confidence.
Objectives of an Audit
Types of Audits
What frameworks regulate the Audit and Accounting?
A framework is a structured set of rules and guidelines that governs how an organization prepares and presents its financial statements, ensuring consistency, transparency, and
comparability in reporting financial information

Accounting frameworks : Auditing frameworks :

 AICPA Audit and Accounting Guides (AAGs): Provide • International Framework for Assurance Engagements
industry-specific guidance for applying accounting (IFAE) – overall principles of an assurance engagement
principles and performing audits.
• COSO Framework (Committee of Sponsoring
 IFRS (International Financial Reporting Standards) Organizations of the Treadway Commission) – guidance
and Indian GAAP (Ind AS): Define the preparation and on ICOFR
presentation of financial statements. Understanding Ind
AS is crucial for conducting audits or assurance • International SAs, Indian SAs, GAAS, PCAOB standards
engagements in India. etc
Code of ethics for an auditor
 Why does an auditor required to be Independent ?

It is fundamental for an auditor to be Independent which ensures that his/her judgements are not influenced
by any relationship or interest with the auditee that could compromise the professional integrity.
Importance of being Independent
• Credibility of Financial statements
• Public trust
• Prevention of fraud and misconduct
• Regulatory compliance
 What are the threats to auditor’s independence ?
Auditor independence is essential for ensuring unbiased financial audits, but several threats can compromise this
objectivity and affect the reliability of audit results
• Self review threat – preparing accounting records and financial statements , valuation services, tax
services etc
• Self interest threat – close business relationships, financial interest, family or personal relationships,
gifts and hospitality etc
• Familiarity threat - long association with client
• Advocacy threat - commenting publicly on future events relating to the client, promotion of shares of a
listed audit client etc
• Intimidation threat – undue influence , cohesion etc

An auditor has to ensure Open communication with TCWG relating to any independence threats, ensure independent
evaluation of the work done and periodic rotation of team members as safeguard mechanisms to ensure that his/her
independence is not compromised
 Overall Audit Process Flow
The audit engagement letter is a formal document signed by both the auditor and client that outlines
the scope of the audit, auditor and management’s responsibilities, expected form and content of the
report , fees and billing arrangements etc
Case study - Independence of an auditor
XYZ Audit Firm is a well-established audit firm with a reputation for providing high-quality audits to a wide range of
clients. They have been auditing Sunshine Motors Pvt. Ltd., a car manufacturing company, for the past 8 years. Recently,
XYZ has been experiencing some challenges related to auditor independence due to certain actions and circumstances
involving the client. The firm’s management is concerned about the potential threats to auditor independence that may arise
from their continued relationship with Sunshine Motors.

Situation 1 : The senior audit partner at XYZ, Mr. Rajesh Kumar, owns a significant number of shares in Sunshine
Motors, a company he has been auditing for several years. Over the past year, the company has seen significant growth, and
the value of Rajesh’s shares has increased considerably. This has made Rajesh personally invested in the success of the
company. There is a possibility that this interest could influence his judgment during the audit, especially when reviewing
financial areas related to the valuation of Sunshine Motors’ assets.

Situation 2 : In addition to providing audit services, XYZ Audit Firm has been offering consultancy services to Sunshine
Motors. They helped the company redesign its internal financial reporting system. Now, during the audit, Mr. Rajesh Kumar
finds himself in the position of reviewing the new system and financial statements that his firm previously helped design.
The team is unsure whether it is appropriate to be auditing a system that their firm played a role in creating, raising
concerns about objectivity. (contd)
Case study - Independence of an auditor (contd)

Situation 3 : Mr. Rajesh Kumar has been the lead audit partner for Sunshine Motors for all 8 years. During this time, he
developed a personal relationship with several key executives, including the CFO, Mr. Arvind Sharma, who has become a
close friend of his. This long-standing relationship has led to Mr. Rajesh being very familiar with the management and
operations of Sunshine Motors. As a result, some audit staff members have expressed concerns that Mr. Rajesh might be
overly lenient in reviewing the company's financial statements due to his close ties with the client.

Situation 4 : In the past few weeks, Ms. Kapoor, the CEO, has been increasingly dissatisfied with the audit findings.
Sunshine Motors has been facing some financial difficulties, and there have been a few issues identified in the audit related
to revenue recognition and inventory valuation. Ms. Kapoor has expressed frustration with the audit team and made it clear
that if the findings are too negative, she may reconsider XYZ Audit Firm as the company’s auditor. This has led to some
tension in the office, and junior audit staff feel pressured to “tone down” certain audit findings in the final report.

Identify the type of Independence threats faced by the audit firm in each situation and explain the nature of such threat
Solutions to Case study - Independence of an auditor
Situation 1:
Self-interest Threat
Explanation: The senior audit partner, Mr. Rajesh Kumar, owns a significant number of shares in Sunshine Motors. His personal financial
interest in the success of the company creates a conflict that may compromise his ability to remain objective during the audit

Situation 2:
Self-review Threat
Explanation: XYZ Audit Firm is auditing the financial reporting system they helped design. This creates a risk of the team reviewing
their own work, which may compromise their ability to be impartial and critical.

Situation 3: Familiarity Threat

•Explanation: Mr. Rajesh Kumar has been auditing the client for 8 years and has developed a personal relationship with the CFO and
other executives. This close familiarity may lead to leniency or biased judgment during the audit process.

Situation 4:
Intimidation Threat
Explanation: The CEO, Ms. Kapoor, has expressed dissatisfaction with the audit findings and has implied that XYZ Audit Firm’s
services may be discontinued if the findings are too negative.
Segment 2
 Internal control and its types
What is Internal Control ? Types of Internal Controls
A set of measures, policies and procedures
Why Internal control ?
• Reliability of financial information
• Asset safeguarding
• Fraud prevention
• Operational efficiency
• Regulatory compliance
Components of Internal control
 Audit Risk

Audit Risk is the risk that auditors may issue an inappropriate opinion on an organization's financial
statements.
Types of Audit risk
 What are Assertions?
Types of Assertions :
What “Assertions” mean ?
• Account balance assertions are Existence,
• Assertions refer to the explicit or implicit Rights & Obligations, Completeness ,
representations made by management in the Valuation, allocation & accuracy, classification
financial statements. & presentation
• Auditors use these assertions to evaluate the • Class of transaction assertions are
completeness, accuracy, and validity of Occurrence, Completeness, Accuracy, Cut off,
financial information. Classification and Presentation
 Types of Audit procedures
 Test of Controls - Tests of controls are procedures performed to evaluate the effectiveness of an entity's
internal controls. These controls are designed to prevent or detect material misstatements in financial
reporting eg testing of authorization policy of the entity
 Substantive procedures - Substantive procedures are designed to detect material misstatements in
financial statements. These procedures address assertions made by management regarding financial
statements . Substantive procedures includes Inspection, Inquiry, Observation, Reperformance,
External confirmation and recalculation . Substantive Procedures are further classified into
a) Test of details -Tests of details involve examining the individual components of financial
statements to ensure that they are appropriately recorded and supported –eg verification of
confirmation from external parties, examination of supporting documents etc
b) Analytical procedures - Analytical procedures involve evaluating financial information by
studying plausible relationships among both financial and non-financial data eg Ratio analysis,
Trend analysis etc
Interactive discussion-1 Audit procedures for Trade receivables

Discuss among yourselves and bring out the various audit procedures to audit Trade receivables mapping them to the
appropriate assertions

Interactive discussion-2 Audit procedures for Employee additions during the year

Discuss among yourselves and bring out the various audit procedures to audit Employee additions and map them to the
appropriate assertions . Also bring out the audit evidence that can be obtained to verify the correctness of the employee
additions
 Materiality and Performance Materiality

• Materiality in an audit pertains to misstatements that, individually or collectively, could reasonably

impact the economic decisions of financial statement users.
• Materiality is computed as a percentage of Assets/Revenue/PBT/Gross margin based on the size, risk
profile and interest of the management of the entity
• Performance materiality is an amount set by the auditor, lower than the overall materiality, for either
the entire financial statement or specific assertions at the transaction class or account balance levels.
Its purpose is to mitigate the risk of cumulative errors exceeding the designated overall materiality in
balances, transactions, and disclosures.
 What is an Audit evidence ?
 Audit evidence – Information used by the auditors to arrive at a conclusion to form an opinion
What is Sufficient and Appropriate Audit evidence (SAAE) ?

a) Sufficiency – quantity of evidence obtained should be adequate – higher the risk or high significant
items – more extensive the audit evidence required
b) Appropriateness – quality – relevance – reliability of the audit evidence
Sources and Reliability of Audit evidence
i) Internal vs External
ii) Original vs Photocopies
iii) Written vs Oral
How an auditor gathers Audit evidence ?
 Audit Documentation
What is Audit documentation ?
Audit Documentation is the compilation of audit procedures, audit evidence obtained, and audit
conclusions reached by an auditor. These are also called Working papers. In recurring audits, the working
papers are usually split between two main files:
 Permanent Audit File (PAF) – documents of permanent nature eg ; long term agreements, MOA, AOA
 Current Audit File (CAF). - evidence directly pertaining to current period audit

Importance of Audit documentation

• Evidence that audit was done as per applicable regulations ; maintains records of significant matters
• It supports auditors conclusion, ensures accountability and enables conduct of quality control reviews
 Audit Sampling
What is Sampling?

• Audit technique provides assurance to auditors without verifying every single transaction

• Selecting and Examining a representative portion of a larger group to draw conclusion about that
group

Why is Sampling necessary?

 Cost – benefit considerations
 Reasonable assurance clarification
 Materiality perspective
 Stages and Methods of Sampling
Stages of Sampling Sampling Methods

Statistical Method – Random, Systematic and

Monetary units
Non - statistical method – Haphazard and
Block sampling
 Sampling Risks and software used for Sampling
Sampling vs Non-Sampling risk Software used for Sampling
Sampling Risk i. Audit Command Language (ACL)
Risk that the auditor’s conclusion based on ii. Interactive Data Extraction and Analysis
samples can differ if the entire population is (IDEA)
verified
iii. Arbutus Analyzer
Non- Sampling risk
iv. Team mater analytics
Any risk other than sampling risk . For eg –
Risk of judgement, lack of professional v. CaseWare IDEA
skepticism or ineffective audit procedures
 Audit report
• Audit report summarizes findings, conclusions and opinions on the financial statements of the entity
• It is issued by the auditor to the members of the organization
Opinions in an Audit report
Considerations while issuing an Audit opinion
 Emerging trends in Auditing
Technology in audit refers to the application of advanced tools, software, and methodologies to enhance the
efficiency, effectiveness, and accuracy of the audit process
Some of the emerging technologies and trends in auditing includes ;
Tools for Data Analytics eg journal entry testing and pattern analysis
Robotic Process automation eg sending multiple balance confirmations
Predictive analytics
Cyber security audit
Audit data standards
Continuous auditing
Computer Assisted Audit techniques
Case study– Types of Audit opinion

ABC Ltd. is a medium-sized manufacturing company based in India. It has been in operation for 10 years, producing
industrial machinery. The company has recently completed its financial year, and its financial statements are being audited
by Auditor & Co., a leading audit firm. The audit team has reviewed the financial records, including the balance sheet,
profit and loss statement, and cash flow statement. The audit team needs to form an opinion on the financial statements in
the following scenarios :

Scenario 1 - The audit team found that ABC Ltd. had not properly accounted for depreciation on some of its fixed assets.
The company had used an incorrect depreciation method that does not align with accounting standards. However, the
misstatement was not material enough to affect the overall financial health of the company. The rest of the financial
statements were found to be in compliance with accounting standards.

Scenario 2 - During the audit, the team also discovered that ABC Ltd. had not accounted for a significant liability related to
a lawsuit. The company had a pending legal case that could result in a major payout, but it had failed to disclose this in its
financial statements. The lawsuit, if successful, could have a substantial impact on the company's financial position.
Because the company ignored this liability, the audit team believes that the financial statements do not provide a true and
fair view of the company’s financial health. (contd)
Case study - Types of Audit opinion (contd)

Scenario 3 - Further investigation revealed that ABC Ltd. had not provided access to certain key documents related to its
revenue from a major contract. The company’s management could not provide sufficient evidence about the contract’s
terms, revenue recognition, or the financial impact of the contract. Without this information, the audit team could not obtain
enough evidence to form an opinion on the company's revenue or its overall financial position.

Scenario 4 - Finally, after reviewing all the other aspects of the financial statements, the audit team found that ABC Ltd.’s
financial records were accurate in all other areas. The company had a good system of internal controls, and the management
provided all the required documents and explanations. There were no significant errors or misstatements in the overall
presentation of the financial statements.
 Solution to Case study on Audit opinion
Scenario 1: Scenario 2:
Opinion Type Opinion Type
Unqualified Opinion with Emphasis of Adverse Opinion
Matter
Explanation
Explanation:
The failure to disclose a significant liability related to
The incorrect depreciation method is a misstatement, the lawsuit results in the financial statements not
but it is not material enough to affect the overall providing a true and fair view. The impact is material
fairness of the financial statements. The auditor can and pervasive, leading to an adverse opinion.
issue an unqualified opinion but highlight the issue in
an emphasis of matter paragraph.
Solution to Case study on Audit opinion (contd)
Scenario 3: Scenario 4
Opinion Type Opinion Type
Disclaimer of Opinion Unqualified Opinion
Explanation Explanation
The lack of access to key documents related to The financial records are accurate, and the
revenue prevents the audit team from obtaining management provided sufficient evidence. There are
sufficient audit evidence. This scope limitation is no material misstatements, so the auditors can issue a
material and pervasive, so the auditors cannot form clean, unqualified opinion.
an opinion and must issue a disclaimer.
 Time for self-assessment !

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