AUDIT RISK

NOVEMBER 2011

? valuation of inventory – when, for example, there are considerable levels

of aged inventory

? completeness of liabilities – this could arise if provisions have been

incorrectly treated as contingent liabilities

? completeness of revenue – this could be relevant where the entity being

audited has significant cash sales.

Responses to audit risks

Having identified the audit risk candidates are often required to identify the

relevant response to these risks. A common mistake made by candidates is to

provide a response that management would adopt rather than the auditor.

From Question 3b June 2011, in relation to the risk of valuation of receivables,

as Donald Co had a number of receivables who were struggling to pay, many

candidates suggested that management needed to chase these outstanding

customers. This is not a response that the auditor would adopt, as they would

be focused on testing valuation through after date cash receipts or reviewing

the aged receivables ledger.

Auditor’s responses should focus on how the team will obtain evidence to

reduce the risks identified to an acceptable level. Their objective is confirming

whether the financial statement assertions have been adhered to, and whether

the financial statements are true and fair.

Responses are not as detailed as audit procedures; instead they relate to the

approach the auditor will adopt to confirm whether the transactions or

balances are materially misstated. Therefore, in relation to the risk of going

concern, the response is to focus on performing additional going concern

procedures, such as reviews of cash flow forecasts.

Also, auditor responses should not be too vague such as ‘increase substantive

testing’ without making it clear how, or in what area, this would be addressed.

In addition, candidates’ must ensure that they do not provide impractical

responses. A common example of this is to request directly from the

company’s bank as to whether the bank will provide a loan or renew a bank

overdraft. The bank is not going to provide this type of information to the

auditor, especially if they have not yet informed the company, and therefore

this response will not generate any marks.

Limited range of risks identified

In order to score well in risk questions it is advisable to aim to identify a

breadth of points from the question scenario. If the question asks for a specific

number of audit risks, such as five, then it is not sufficient to identify just one

or two risks. In addition, a common mistake is to identify a risk such as going

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