Week 4 Lecture 1Before accepting a new client or continuing with an existing client:Obtain and review financial informationMake inquiries of third parties such as bankers.Communicate with previous auditor.Evaluate your ability to audit the clientoTechnical skillsoKnowledge of industryoPersonnelEvaluate your independence.Continuation (issues, fees, and client integrity)Understanding the entity and its environmentIndustry (market, competition, seasonality) and regulated regulations (e.g. SkyCity – gambling licence)Nature of the entityoOperations (suppliers and customers)oOwnership and governance structure (sources of funding)oHow entity is structured (related parties)Entity’s accounting policies.Objectives and strategies and related business risks.An auditor should assessInternal environment (employees)Local environment (competition)Global environment (regulatory/cultural)Business Risk - The risk that an entity’s business objectiveswill notbe attainedas a result of the external and internal factors, pressures and forces brought to bear on an entity and, ultimately, the risk associated with the entity’s survival and profitability.Not all business risks result in risks of material misstatement. Therefore, business risk is broader than the risk of material misstatement but includes it.The auditor is required to determine whether any identified risk is a ‘significant risk’, a risk of material misstatement that requires audit consideration.
Major audit implications of business riskExpectations (sales growth?)Viability (going concern)Risk of material misstatement (assertion)Control environment (top management structure and incentives)Recommendations (suggestions?)Response to assessed risksMore experienced staff assigned.Using experts.More supervision.Incorporating unpredictability into selection of further audit precedures.We are concerned about business risk because it may affect inherent risk.Identify risk of material misstatement The financial report level management (integrity, experience, pressure)The assertion level (problem accounts? judgement? unusual transactions? assets susceptible to loss?)Inherent risk“Susceptibility of account balance or class of transactions to material misstatement given inherent and environmental characteristics, but without regard to internal control”An assessment of IR and control risk (CR) can be combined or separate.Auditor is required to oAssess IR at financial report level from audit plan.oAssessment must then be related to assertions at account balance or class of transactions level when developing audit program.Inherent risk examples:Financial report leveloDisputes with auditor in the past – management integrityoManagement dominated by one person – management knowledgeoBusiness declining – pressure on management oHedging, obsolescence – nature of the businessoNew competitors – industry factorsAssertion leveloErrors in inventory valuations last yearoLease accounting is complexoJudgement needed for doubtful debtsoCash, alcohol, jewellery - assets susceptible to losso