ADVANCED AUDIT AND ASSURANCE

Auditor – External Auditor- Practitioner

Shareholders
Agency theory
AUDIT – Verification – Financial Statements – Applicable FR
Framework
ASSURANCE- Confidence – Enhance the credibility of the financial
statements
Cycle 1
Shareholders/Investors

Auditor – Independent Party- Assurance

Financial Statements
Anything that comes from the management = we never put a blind
trust – Everything provided by the management is subject to a
skeptical /negative/ Questioning mind of the auditor
Management – Document – Proofread
Calculation – Recalculate
Cycle 2
Shareholders

Directors – Prepare and present the financial

statements in accordance with the Applicable FR Framework ,
Verification

Middle Management
Client – Invitation – Audit Firm
1. Knowledge of the Client = Checkbox/Check list – 8 elements
2. Accept the engagement or should we reject
3. Proposal Document
4. Audit Engagement Letter/Terms of Agreement
5. Audit Planning – ISA 300/330- Strategy – Audit Plan
6. Evidence – ISA 500 series
7. Reporting – Output – Reasonable Assurance – Less than 100%-
Opinion
Engagements
1. Assurance Engagement
2. Other Assignments – Moderate level of
assurance/Limited/Negative - Statement/review statement –
ISRES standards
1. Forensic Audit
2. Due Diligence Review
3. Prospective Financial Information
4. Performance Information
5. Sustainability – ISSA 5000 ED
Quality Management in an audit of Financial Statements
1. ISQM 1 – Firm Level – SoQM
2. ISQM 2 – EQR and ISA 220 revised – Engagement Performance
and the engagement resources
Assignment 1 – Quality Management in an audit of Financial
Statements
Q2 of PreJune 2024 Exam – 25 marks – Due Date 18 June 2024

Time = 1800hrs

Submit PDF Documents of the response option via WhatsApp

Rules
1. All Assignments to be justified
2. All Assignments to include headings at all times before explanation
ISQM 1
Introduction

- Objectives of a SoQM
- Let it introduce us to 8n components of a SoQM

1. Governance and Leadership

2. Risk Assessment Process
3. Acceptance and Continuance of Client Relationship
4. Engagement Performance

- The audit firm should ensure that it develops systems for every
engagement it performs in line with quality management standards. In
addition, there should be sufficient and appropriate reviews and
supervision in every audit engagement offered by an audit firm.

5. Relevant Ethical Requirements

6. Information and Communication
7. Engagement Resources
8. Monitoring and Remediation
If a question says evaluate – it is a must to insert a conclusion except for
business risk questions which will be covered later
PLANNING AND RISK ASSESSMENT
Question 1 – 50 marks

Risk of Material Misstatement – RoMM – 12 marks to 18 marks

Audit Risk – RoMM + Detection Risk – 20 – 24 marks

Business Risk – Implications/Negative effects on the KPIs of a business- max

12 marks on average 10 marks

Audit Procedures – 10 Marks on average its 8 marks

Ethical and Professional Issues – 8-15 marks

40 Technical Marks and 10 Professional Skills Marks

THE WORK OF OTHERS
1. The Work of an Expert –ISA 620
Chemical Engineer, Agronomist – Review the work done by an expert –
Conclusion
The duty of an expert is not to form a conclusion but to help in gathering SAAE
The expert must produce a report –Working Papers
This expert must be mentioned in the audit planning documents.

2. The work of an Internal Auditor – ISA 610

Internal Auditor – to monitor the effectiveness of the ICS set by the
organization
They can help us in gathering evidence but not on risky areas.
The EA is then supposed to review the work done by the Internal Audit
Department
Normal

Internal Audit Team – Head of IA – Audit Committee

Internal Audit Team – Head of IAD – Finance Director

Finance Director – to prepare and present the financial statements

Prerequisites before they start the work

1. Independence
2. Competence
3. Experience

Technical Article – Audit in Specialized Industries

Technical Article – Risk and Understanding the entity
Planning an audit of Historical Financial Statements

-Planning is done after the acceptance of a client

- This is not a once off process but a recurring process.

- This is a regular activity which takes place each year irrespective of whether
the client is a new audit client or an existing audit client.

-Planning is a very important activity as the audit firm would want to meet the
deadlines as stated in the invitation from the client, audit engagement letter
and also the laws and regulations.
-Planning leads to perfection of the audit work, execution of the audit process
and the overall quality of the audit.
-Planning an audit result in an organized and disciplined audit.
Knowledge of the Business / Knowledge of the Client
-For an auditor to plan an audit of financial statements, they need sufficient
appropriate knowledge of the business.
-The more an auditor obtains knowledge of the business, the better the
quality of work to be performed.
-In other planning will never be done without acquiring knowledge of the
business.
- When the auditor is obtaining knowledge of the business, they are gathering
sufficient knowledge of its environment and its operations.
GP Margin

2021 =50% 2022 = 70% 2023 = 80% 2024 = 90%

Average GP Margin for the clothing sector = 30%

Implausible Relationship – There is a possibility that this gross profit margin is

window dressed.
-When the auditor is skeptical, this means that they develop a questioning
mindset.
Examples of Knowledge of Business

1. Ownership Structure
2. Financial Performance and Position
3. Internal Control Systems
• Order --------- Processing of order ---- Signature – Client Pays ---
Receipting Officer --- Issue a receipt --- Goods are dispatched to the
client alongside a good dispatch note ---Security Officer checks the
goods before leaving the premises- Client collects the goods.
• If the ICS are effective, then the risk of material misstatements in the
financial statements is low.
• If they are ineffective then the RoMM in the financial statements
becomes very high.
4. Governance System
5. Stakeholders
6. Laws and Regulations

Ways of the obtaining knowledge of business

1. Inquiries – Management, Audit Committee, Internal Auditor
2. Review the press
3. Correspond with the previous auditor
4. Review of the F/S of the client especially the prior year's figures –
Performing an analytical review – to find implausible relationships
5. Company Website
• Knowledge of the client increases as the auditor associates more with
the client which means in the first year audit the auditor will always
have less knowledge of the business but as they acquire experience in
auditing the client (recurring audit) then their knowledge of the business
will also be improving.
• In the first year audit the risk that the auditor will issue an inappropriate
audit opinion will be very high. This risk is known as the detection risk.

Audit Planning = Audit Strategy + Audit Plan- ISA 300/ISA 330

Audit Strategy
This document consists of 4 key items/headings
1. Scope
2. Timing
3. Direction
4. Resources
Scope

The auditor must set the scope for the upcoming audit
The Scope of the auditor is governed by the ISAs and the relevant laws and
regulations.
The scope of the audit helps the auditor to determine the amount of work
expected of them depending on the size and complexity of the client’s
business.
Knowledge of business comes first before the determination of the scope of
work.

Timing
The auditor has got a limited time to perform an audit of the financial hence in
order to meet the deadlines expected of them they must design a timetable.
-The auditor will need to set a proper timetable at the planning stage of audit
so as to ensure that the deadlines agreed with the management are achieved
successfully.
The auditor based on the Knowledge of Business acquired will need to
determine whether there is a need for an interim audit and final audit.

Interim Audit is a process of verifying the internal control systems before the
reporting date , normally in complex clients to reduce the time needed for an
audit of financial statements so as to meet the deadlines issued by the
management.
Interim Audit will only focus on the internal control systems, ie Test of
Controls to determine if the internal control systems are operating effectively
so as to determine the amount of Substantive Procedures to be carried in the
Financial Statements. To elaborate this, lets appreciate the relationship
below;
If the ICS are not operating effectively == The amount of substantive
procedures in the financial statements will be higher as the effectiveness of
the ICS will determine the misstatements that are likely to be found in the
financial statements. This means if they are ineffective, the level of RoMM in
the financial statements will be higher.
However interim audit is not mandated by the law, it is at the discretion of the
auditor whereas the final audit is mandatory.

Final Audit is the verification of the financial statements done immediately

after the year end; all listed companies are subject to the final audit.

If the auditor did not carry out the interim audit, then it means they have to
first perform the TOCs to verify the effectiveness of the ICS before they
perform their Substantive Procedures in the Financial Statements.
However, if the auditor has carried out the interim audit, then it is not
necessary for the auditor to perform TOCs, they will go straight to the financial
statements.
Disclaimer – Interim audits are done for clients which are extremely large and
complex to the extent that the auditor will feel like completing the work within
a stipulated deadline might be difficult.

If an auditor concludes that there is a need for interim audit, then a proper
timetable for that interim audit must also be designed separately from that of
the Final Audit.
Audit Methodology

Step 1 – Review the ICS of the client

Step 2 – Conclude whether the systems are effective or ineffective

Step 3 – Perform Substantive Procedures on the Financial Statements

Step 4- Conclude basing on the results of the Substantive Procedures carried
out

Disclaimer – An auditor does not express an opinion on the Internal

Control System, the job of the auditor is to express an opinion on the
Financial Statements.

Direction
Direction just means the focus of the auditor

The auditor should determine which areas to focus on during the fieldwork.
The focus of the auditor is on risky areas where greater professional
skepticism is required and those areas where there is a higher risk of window-
dressing/manipulation.
Audit is done on a sample and material basis, in other words immaterial
misstatements can be found by the auditor during the audit, but it is not their
area of focus.

Inherent Risk Factor

The inherent risk factor of the management is as follows

SOPL SOFP
Income – Overstated Assets are overstated
Expenses are understated Liabilities are understated

Estimates
These are areas that involve a higher level of management judgements.

An auditor does not put a blind on the management because if the F/S are to
be manipulated then the management is responsible for that manipulation.

Thus, all estimates are risky by their nature.

Examples of Estimates

1. Depreciation Expense
2. Provisions
3. Work In Progress
4. Going Concern
An auditor determines these risky areas during the Knowledge of Business.
After they determine the risky areas the auditor will need to set materiality in
the financial statements.

ISA 320 – Materiality

Materiality – An amount is material if its omission or disruption would
negatively impact the decision of the users of financial information.
The materiality of the auditor is set when the following conditions are
satisfied.
Condition 1
1. The risk of manipulation (RoMM) in the Financial Statements is High –
The auditor must set a low materiality threshold meaning they will be
performing more audit procedures in a bid to reduce the detection risk

Condition 2
2. The risk of manipulation (RoMM) in the Financial Statements is Low –
The auditor must set a higher materiality threshold meaning they will be
performing less audit procedures.

Example
$
1. 500-----------------------------Materiality Level ---- Risky Client
2. 1000------------ 1----------------1
3. 750------------------------------------2
4. 1100----------------2----------------------3
5. 2500--------------------3--------------------4
6. 450
7. 950-------------------- Materiality Level ---- Low risk client ----- 5
8. 790 ---------------------------------------------------------------------------6
9. 600--------------------------------------------------------------------------------7
Materiality at 950 – 4 transactions --- Low Risky Client ---- Higher

Materiality at 500 – 8 Transactions ---------------------------Lower

ISA 320 prescribes the following aggregate materiality thresholds

Revenue - SOPL = Cash Sales * Credit Sales

Profit Before Tax -------------- 5% --------10% --- Material ---- SOPL Items
Total Assets ------------------- 1% ----------2% ---- Material---- SOFP Items

Revenue-------------------------½ % ---------1% ---Material ---- SOPL Items

Depreciation Expense = 500

Profit Before Tax = 3000

Working = 500/3000 * 100 = 16.7%--- Material to the Financial Statements

Depreciation Expense = 500

Revenue = 200 000
Working= 500/200 000 * 100 = 0.25%----- Immaterial to the Financial
Statements

Loan = 5000

Total Assets = 30 000

Working = 5000/30 000 *100 = 16.7%------------- Material to the Financial
Statements

Any Misstatement that is 60% or above of the materiality thresholds it's not
material but material and pervasive which means it affects a substantial
proportion of the Financial Statements
AUDIT STRATEGY
1. Scope
2. Timing
3. Direction
4. Resources
Resources
-The amount of resources to be taken to the fieldwork should be planned for
before the fieldwork commences.
-These resources should be in line with the size and complexity of the client
business in relation to the scope, timing and risky areas involved.
Audit Plan
Comprises of two elements
1. Audit Procedures
2. Sample Size
Audit Procedures
- Audit Procedures during the planning phase can be described to be risk
mitigation strategies
- These procedures will be carried out during the fieldwork
- Determining Audit Procedures before the start of the assurance
engagement enhances the sceptical mindset of the auditor.
- Audit Procedures are made for every risky area in the financial
statements. Examples of these risky areas may be the receivables,
payables, revenue, purchases, operating expenses, etc

Entertainment Industry – DSTV

1. 20 % of the subscriptions is collected before the customers purchases a
piece of viewing equipment. This viewing equipment is then delivered a
month after the payment of the deposit. The final balance for the
subscriptions is then paid when the customers get viewing equipment.

The entity is not supposed to recognize revenue coming from subscriptions

until the performance obligations are met.

Revenue in Exhibit 3 coming from subscriptions is $200 000

20% of Subscriptions becomes the unearned Income/ Deferred Income

DI – Liability of an income nature

DR Bank a/c
Cr Deferred Income
IH = Income is overstated = Revenue
If the 20% has been recognized in the F/S then revenue is overstated by 40 000
and liabilities are understated by 40 000.

Materiality based on revenue = 40 000/200 000 = 20%

20% Deposit from Subscriptions

The 20% deposit coming from subscriptions in advance amounting to $40 000
is 20% of the revenue of the entity. This means it is material to the financial
statements based on the materiality threshold above. Revenue coming from
subscriptions should be recognized when the customers get the viewing
equipment which means on initial deposit the management should recognize
deferred income amounting to 40 000 in the financial statements as the
performance obligations for the recognition of revenue are not yet met. There
is a possibility that the 20% deposit is recognized before the delivery of the
viewing equipment. This means that the revenue may be overstated by 40 000
and differed income understated by 40 000.

MTRI Concept

M - Materiality

T – Accounting Treatment

R – Risk

I – Impact to the Financial Statements

Sample Size

The auditor at the planning stage of the audit should determine the sample
size for each risky area in the financial statements.

Sample Size means the percentage of transactions the auditor will verify from
each account balance.

The sample should be at least 50% of the transactions in an account balance

but less 100% of the account balance – The sample size should be
representative of the population.
Audit Risk – 24 marks

At the planning stage of the audit, the auditor will identify the risky areas in
the financial statements where attention needs to be given when the audit
commences.

The approach that the auditor uses to assess risky areas in the financial
statements is called the Audit Risk Approach/Audit Risk Model.

It is mandatory for the auditor to assess risks at the planning stage of the audit.

Audit Risk

Risk of Material Detection Risk

Misstatement
Auditor
F Statements

Audit Risk = RoMM * Detection Risk

Risk Material Misstatement = Inherent Risk * Control Risk
2 Questions
1 Question – Audit Risk ---------------- Detection Risk
2nd Question – RoMM -------------- NO Detection Risk Here
RISK ASSESSMENT
1.Business Risk ------ 8 -12 marks
Technical Article – Understanding Business Risks
Marking Scheme – Business Risk
8 Marks – 4 Business Risks
12 Marks – 6 Business Risks
10 Marks – 5 Business Risks
2 Marks for each Business Risk Identified and explained
2.Audit Risk and RoMM -- 18-24 marks
Standard RoMM – 3 marks +1 mark + 1 mark = 5 marks
18 Mark – 3 risks + 1
18 Marks – 6 RoMM
3 Marks
MTRI Concept
Materiality – 1 mark
Accounting Treatment – 1 mark
Risk Identified – ½ mark
Impact to the Financial Statements – ½ mark
Calculations – ½ mark for each calculation relevant to the scenario up to
a maximum of 2 marks
Analytical Procedure – 1 mark
Audit Risk Reponses
Maximum of 2 detection risks in the scenario
Detection Risk – 2 marks
Control Risk – 2 marks
Disclosures – IAS 24, IAS 38 , IFRS 8 …….
Identification and explanation of a RISK – 2 Marks
Technical Articles for the Audit Risk and RoMM.
-Risk and Understanding the Entity
- Exam Technique Article Part 1 of AAA Exam
- Exam Technique Article Part 2 of AAA Exam
- ISA Handbook – ISA 315 ISA 220 ISA 530

BUSINESS RISK
This is a risk resulting from significant conditions, events,
circumstances, actions, inactions that could adversely affect the
entity’s ability to achieve its objectives and execute its strategies or
from setting inappropriate objectives and strategies.
There is no materiality for business risk. There is no need to think like an
auditor but rather a finance director.
 Never write the response to Business Risk
 Never write the definition of Business Risk.
Critical Success Factors
1. Profitability
2. Market Capitalization
3. Liquidity
4. Market Share
5. Reputation
6. Stakeholder Relationship – Customer Loyalty, Supplier Loyalty,
Employees Loyalty, Government Loyalty
Other Assignments
1.Due Diligence Review – DDR
2.Assurance of Prospective Financial Information – PFI
3.Forensic Audit
4. Assurance on Performance Information
5.ISSA 5000 – Sustainability – Additional Engagement
6.ISSA 5000 ED – Sustainability – Standalone Engagement

Review Engagements
This is a moderate assurance engagement.
Instead of performing 8 Audit Procedures normally expected of an
audit service, for a review engagement the auditor will only perform
2 procedures which are Inquiry and Analytical Procedures.
These are also called “agreed upon procedures”.
In a review engagement the output is a review statement not an
opinion.
Hence reasonable assurance is never offered for review
engagements.
Due Diligence Review -
Strengths Weaknesses Opportunities Threats
Buyer ------------------------------------------------------------ Seller

Auditor
The purpose of DDR is to help the buyer in taking relevant merger or
acquisition decision by providing information about the seller.
This is a review engagement in which the buyer is being enlightened by the
auditor with relevant, adequate and reliable information about the seller on
whether to acquire the business or to merge with the entity.

When performing a DDR of a Seller the audit firm critically evaluates the
diversified aspects of the seller business in a bid to provide the most useful
information about the seller.

Diversified Aspects
1.Financial Aspect – Liquidity, Gearing Level, Profitability, Cash Flows

2.Commercial Aspect – Reputation, Stakeholder Relationship, Viability,

Market Share, Customer Retention.
3.Legal Aspects – Litigations, laws and regulations, tax evasion, money
laundering

4.Operational Aspect – Idle Times

5.Technical and IT Aspect -

6.Human Resources Aspect – Governance

7. Corporate Social Responsibility

8. Sustainability – Environmental, Social, Governance

The Auditor is kind of performing a SWOT Analysis of the Seller
FORENSIC AUDIT

- Investigation – Fraudulent Activity – Criminal activity – Asset

Misappropriation, Corruption, bribery, etc.
- Agreed Upon Procedure – No Reasonable Assurance but moderate
assurance
- Output – Statement – Forensic Audit Report
3 Questions
1. Who did it? - Perpetrator
2. How did it happen?
3. What was the total amount of loss incurred?

Forensic Audit is a Specialist Skill – Higher Level of Competence in Audit

and Law because the engagement itself is a fault- and fact-finding
exercise.
Preacceptance Procedures

1.Intended Users
2.Competence - Highly experienced personnel, senior members of the audit
firm
3. Fees – High level of Fees
4. Scope
5. Reporting

6. Court Proceedings ----

After the forensic audit exercise, the auditor is to produce a detailed report
known as the forensic audit report.

The auditor’s report can also contain recommendations to avoid the re

occurrence of fraudulent activity in the future.
Ethical Issues

1. Management Threat
2. Self-Review Threat
3. Advocacy Threat
4. Self Interest Threat – Dependent on the management
ASSURANCE ON PROSPECTIVE FINANCIAL INFORMATION
Prospective Financial Information is the financial information that is based
upon the assumptions about events that may occur in the future.
An entity will make PFI based on Assumptions.
Future means Assumptions
Future means Uncertainty
Future might not bring the same results as expected.
Assumptions in the F/S – They are risky by their nature – They are based
on the judgement of the management.
Since there are a lot of Assumptions in the future, the auditor must exercise
professional skepticism (Critical Thinking) and perform audit
procedures around assumptions provided by the management to verify
whether they are true and fair.
In other words, the auditor is verifying the validity of the assumptions
provided by the management.
PFI is a review engagement that is offered by the audit firm to evaluate the
appropriateness of Forecasted Financial Information.
The output of this engagement is always a moderate/negative/Limited
Assurance.
Assumptions can be risky meaning there is a greater possibility of
Management Bias.
The management will prepare PFI/FFI based upon the best estimate inorder
to secure a bank loan , Initial Public Offering and to assess their going
concern.
Two types of Assumptions used by the management
1. Best Estimate – Contains a basis of Assumption /FORECAST
2. Hypothetical Assumption – Wild Guesses about the future
/Projections
Projection
2019 -2024 – Profits has been increasing by 5 % so in 2025 it will also
increase by the same 5%.
Forecast- Not only looking at trends but also qualitative analysis.
2019 -2024 – Profits has been increasing by 5 %
What about 2025?
PESTEL Analysis – Well – 10^%
PEST Analysis – Well -5%
Climatic Analysis based on forecasted weather reports by the met dept
Demand and Supply of Inventory/Goods
Monetary Policy /Fiscal Policy
Market Analysis – Market Satisfaction/Market Share
Why Forecasts?
Forecasts are less risky than projections because they contain the best
estimate unlike Hypothetical Assumptions which are more risky.
The auditor needs to be skeptical in determining the type of Assumption
used by the management in preparing Forecasted Financial Information
Matters to consider when accepting a PFI
1.Subject Matter – Is it a sales forecast / cash flow forecast/Profit forecast.
The subject matter will tell auditor how much work they need to do. The
subject matter will also tell the auditor the nature of expertise that they will
need to have during the conduct of the engagement.
2.Time Period of Prospective Financial Information -The lower the time
period of FFI the less risky for the auditor. The higher the time period the
riskier it becomes.
3.Intended Users – Who wants to make use of the report? Is it the bank? If
it is the bank, is it the bank alone? This will determine the liability of the
auditor.
4.Nature of Estimate – Best Estimate / Hypothetical Assumption
5. Scope
6.Fees
7.Competence
8. Deadlines
9. Ethical Issues
Audit Procedures
A question will ask a student to prepare the examination procedures when
dealing with PFI – These are pure audit procedures asked in a different way.
Examples of Audit Procedures Performed by the Auditor when
gathering Sufficient Appropriate Audit Evidence
1. Inquiry/Discuss
2. Review – Document
3. Recalculate – Assumptions – Estimates – Complex Areas
4. Analyse- Analytical Procedures
2024 – Trade Receivables = 20 000
Inventory Holding Period was 20 days
2025 – Trade Receivables = 25 000
Inventory Holding Period is 40 days
Implausible Relationship – AP are performed to discover implausible
relationships
5. External Confirmations – Correspond / Circularize a confirmation-
Only works for 3rd Parties – Evidence gathered from third parties is
more reliable than evidence from management.
6. Reperformance – Only works for Test of Controls – Outside the scope
of AAA
7. Observe - Only works for Test of Controls – Outside the scope of AAA
8. Written Representations – Last resort evidence to be gathered by
the auditor from the management.
Auditor is not satisfied by the information given by the management
especially on risky and judgemental areas for example Management
Estimations/ Management Assumptions/ Management’s Views on a
Particular Event. The auditor will seek a representation letter
from the management as a way of certifying whether their views
are true and fair.

Audit Procedures/ Examination Procedures for PFI

-Priority procedures when dealing with PFI will be Analytical
Procedures and Inquiry
- In every answer of AAA, these procedures must be available.
How to write a normal audit procedure versus PFI

A subsidiary called Shumba Limited was purchased during the year.

The total purchase consideration consisted of contingent
consideration and cash consideration.

Audit Procedure 1– Review the board Minutes to confirm the

approval of acquiring Shumba Limited.

C- Case Specific
A-Action- 8 Actions of the Auditor – Blue Colour
S- Subject Matter- Black Colour
P-Purpose – Gather SAAE – Purple Colour

Audit Procedure 2 – Review the board minutes to confirm the

business rationale of acquiring Shumba Limited.

The value of the contingent consideration was 300 million whilst

the value of the cash consideration was 450 million.

Audit Procedure 3 – Review the bank statement as of 1 March 2024

to confirm the cash consideration of 450million paid to acquire
Shumba Limited.
Audit Procedure 4 – Recalculate the PV of the contingent
consideration using the discount rate of 10% to confirm the accuracy
of the PV

The fair value of the NCI was 50 m

Audit Procedure 5 – Review the stock market quotations as of 1

March 2024 to confirm that the right share price has been used to
determine the fair value of the Non-Controlling Interest.

Audit Procedure 6 – Recalculate the Fair Value of the NCI in Shumba

Limited to confirm its accuracy.
The fair value of the Net Assets in the subsidiary was 20m.

Audit Procedure – Review the report of the Edgars Limited

(Professional Valuer) to confirm the reasonableness of the basis in
determining the fair value of the net assets in Shumba Limited of 20m.

SBR – Calculate Goodwill

Purchase Consideration ( 300 + 450) 750m
Add Fair Value of NCI 50m
Less Fair Value of Net Assets -20m
Goodwill 780m

Contingent Consideration is based on the chances of getting the

consideration and the PV of that consideration.
200m ------- 2025 = profit must increase by 25%
The chances of meeting this target is 50%
Cost of Capital = 10%
Step 1 – Present Value = Discount Rate * 200M = 110m
Step 2 – Chances = 50% * 110m = 55m
Prospective Financial Information
2024
Bank Loan 300m
Will be used to purchase a subsidiary called Shumba Limited
It is likely that the loan will carry an interest of 5% and it is likely that the
loan will be receivable in August 2025.
1. Correspond with the bank manager to confirm that the loan will be
receivable in August 2025.
2. Correspond with the bank manager to confirm the conditions of
issuing the loan of 300m in August 2025.
3. Review the letters coming from CBZ Bank to confirm the terms and
conditions of the loan.
4. Recalculate the finance cost of 5% to confirm its accuracy
5. Review the minutes of previous discussions by the board confirming
that Shumba Limited will be purchased in 2025 to confirm the
reasonableness of the claims.
Normal AP – Review the loan agreement to confirm the Ts and Cs of the
Loan.
RISK ASSESSMENT
All your answers in Question 1 must indicate a possibility not a conclusion
because you have not yet verified information in the Financial Statements.
Future Tense – It is possible that the expenses may be understated and
profit overstated.
It is possible that liabilities may be understated and income overstated.
Audit Risk Approach
-This is a mandatory part of Audit .
Audit Risk comprises of two main components
1.Risk of Material Misstatement
2.Detection Risk
AR = RoMM * DR
RoMM = Inherent Risk * Control Risk
Audit Risk = IR + CR + DR
5% = 30% + 20% + x%
-45% = x

AR = 5%
IR=30%
CR =20%
DR = -45%------------ Detection risk has to go down
- Carry more substantive procedures
- Assigning more experienced staff on risky areas
- Reviewing the work of experts and internal auditors
- Not assigning juniors on risky areas
3 Questions
1.Evaluate Risk of Material Misstatements – No Detection Risk
2. Evaluate Audit Risks – Detection Risk
3. Explain why this is a Significant Risk in the audit of ???- June 2024 March
24

Inherent Risk – 75% of the risks in AAA Paper

The susceptibility that an account balance or transaction could be
materially misstated assuming there are no controls in the organization.
Inherent Risk Factor
1.Assets are Overstated
2.Liabilities are Understated
3.Income is Overstated
4.Expenses are Understated
Examples
1. Company operates in a Fashion Industry
Clothes are the inventories of this company
There might be particularly obsolete inventory- This obsolete inventory
could be inappropriately valued
IAS 2 – Lower of Cost and Net Realizable Value
NRV of Obsolete inventory could be lower than its cost, management could
have not written down this obsolete inventory to NRV
This means Inventory may be overstated , expenses are understated

2. Company has got Research and Development Costs of $10m

IAS 38 – Research Costs – Expensed in the SOPL
Development Costs – Capitalized in the SOFP
What if the research costs have been capitalized rather than expensed out?
This may lead to understatement of expenses and overstatement of
intangible assets as well as profit.
3. Company has capitalized Development Costs of $10m
1. What if the development costs did not meet the criteria for
Capitalization?
2. Understatement of Research Cost and overstatement of Intangible
Assets as well as profit.

4. The Company is Listed

-In order to deceive the Shareholders for directors to get good bonuses at
the end of the year, the directors can manipulate profit.
The directors can show better profitability in order to impress the S/H
Directors have got a self-interest to get this bonus – Their capability of
fabricating or manipulating the financial statements is high.
5. The Company is negotiating a loan.
- Loan Covenant between the company and the bank
- There are conditions that must be fulfilled in order for a company to get
a loan – Better Financial Performance, Better Financial Position
- Directors have a self-interest to show better performance and position
to the bank.
- Fabricate the cash flows of the company, massage the liquidity ratios of
the company, they might manipulate the current ratio of the company
- They might understate Liabilities and Overstate Assets
- They might understate expenses and overstate Profit
- They want to present a favourable picture to the bank in order to secure
a loan.
6.Receivable Collection Period Has Increased
- Despite the increase in Receivables Collection Period
- What if the allowance for bad debts has not been adjusted?
- What if irrecoverable debts have not been written off?
- The expenses may be understated and profit/debtors overstated!
7.Directors are paid bonus on performance
8. Inventory Holding Period Has Increased
-Maybe there is an economic downturn
-Inventory has been slow moving/Obsolete
-IAS 2 – Lower of Cost and NRV
-There is a possibility that inventory could be inappropriately valued
particularly the slow moving and obsolete inventory
-The slow moving/Obsolete inventory has not been written off to NRV
-Inventory could be overstated
-Expenses understated.
Conclusion
When an auditor is studying/analysing the financial statements, they will
find a lot of inherent risks on the basis that there are no internal control
systems in the organization.
Control Risk - 1 or 2 risks in the Scenario
The auditor is assuming that the internal control systems in the
organization may fail to prevent or detect material misstatements on a
timely basis.
Internal Control Systems cannot give a 100% assurance that everything is
fine, there can be a failure of ICS due to human error.
Audit Committee
1. There must be periodic inventory counts – Control Activity
2. Cash must be banked on a daily basis – Control Activity
3. There must be reconciliations at the end of each working day – Control
Activity
These control activities must be monitored for them to be effective.
Internal Audit Function Performs the monitoring.
Example
1. No Internal Audit Function – No monitoring – Increases the risk of
Fraud and error – Increases the manipulation of the financial statements
– Increases the RoMM in the Financial Statements.
- This may promote Management Override of Internal Control Systems
2.Internal Auditor Reports to the Finance Director
-The Internal Auditor is not independent
-The internal auditor might feel pressurized working under the Finance
Director – Intimidation Threat
-No proper monitoring
-Increases the risk of Fraud in the Financial Statements
-Increases the RoMM in the Financial Statements
3. The company is doing inventory counts in 25 locations. Last year
they only had 10 Locations
-Monitoring becomes loose /goes down – more locations
-It makes the ICS to become weaker increases the possibility of
Misstatements in the Financial Statements.
RoMM – Inherent Risk * Control Risk
RoMM – Entity Risk
Entity Risk = Inherent Risk * Control Risk
Detection Risk
- This is unusual
- This is the risk that the auditor fails to detect a material misstatement in
the Financial Statements.

What Causes the Failure of the Auditor

1.Sampling Risk
- This is the risk that the sample size was inappropriate
* Bigger Sample Size
*Smaller Sample Size
*Material Misstatements were not captured in a sample
*They chose a sample that was not representative of the population
2.Non-Sampling Risk
-There are situations in audit where the issue is not about the sample size
-Could be something else leading to the failure of the auditor
ISA 220 Revised
For example, a junior was engaged to perform a risky area in the Financial
Statements.
2.The Audit Manager was busy or was sick and they did not have the
chance to supervise or review the working papers of the audit.
Audit Engagement Partner
Audit Manager – Lack of Guidance/ Supervision
Job In Charge – Audit Supervisor
Audit Team
3.It is a First Year Audit – Less Knowledge of the Business – More
chances of the failure of the auditor – Increase the detection risk
-By Default, First Year Audits have got a higher Detection Risk
Response
In the first-year audit to avoid the risk of Failure, experienced audit
team members should be taken to the audit and more time should be
reserved on planning the audit engagement so as to accumulate as much
knowledge of business as possible.
Audit Report
There are two types of Audit Reports prepared by the auditor
after gathering Evidence;
1. Communication with those charged with Governance – ISA
260/265.
2. Audit Report to the Shareholders – ISA 700

ISA 260/265 -Communication with those charged with governance

1.Who are TCWG – Policy Makers, Strategists (Non-Executive Directors in
the Audit Committee, Executive Directors)
Structure of a Client
Upper Management - TCWG

Middle Management

Auditor
Matters to be communicated to TCWG
1. Tendering Process – PreAcceptance and Post Acceptance
Invitation --- Proposal Document --- Audit Engagement Letter

2. Overall Scope and Approach to the Audit – Refusal to provide

evidence is termed as Scope Limitation.
Scope Limitation will give rise to a Disclaimer of Opinion in the Audit
Report to the Shareholders
3. Disagreements with the management –
Is the issue material or not
If it is material --- It will give rise to a Qualified Opinion in the audit
report to the shareholders.
4.Changes in accounting policies or accounting policies that could
materially affect the financial statements.
5.Any adjustments arising as a result of the audit procedures which could
materially affect the financial statements.
Schedule of Unadjusted Misstatements – Management Integrity
Total Assets = 5000
Misstatement = 4500
Materiality = 4500/5000 * 100 = 90% - Is no longer material to the
financial statements, it’s now material and pervasive which means it affects
a substantial proportion of the Financial Statements.
Any Misstatement that is above 60% of any aggregate materiality threshold
will be regarded as material and pervasive and it will result in Adverse
Opinion.
6. Material Uncertainties Relating to Going Concern (MURGC)- IAS 1
7.Any Expected Modifications to the Audit Report to the Shareholders.
How is the Audit Report to the Shareholders modified?
1.Change of Opinion from unqualified to;
-Disclaimer of Opinion
-Qualified Opinion
-Adverse Opinion
2. Addition of a paragraph in the Audit Report to the Shareholders
Audit Report to the Shareholders is static ie it has a standard format – if the
auditor adds any paragraph on top of the specified paragraphs then the
report becomes modified.
Disclaimer – Addition of a paragraph in the audit report to the
Shareholders will never change the opinion, it remains unqualified but
the report will be modified.
Presentation
1. Describe and explain the motive of communicating with those
charged with governance?
AUDIT REPORT TO THE SHAREHOLDERS
- Output of the Audit Engagement
- Covered by 7 ISA Standards
1.ISA 570 – Going Concern
2.ISA 700 – Standard Audit Report
3.ISA 701 – Key Audit Matters
4.ISA 705 – Adverse Opinion and Qualified Opinion
5.ISA 706 – Emphasis of Matter Paragraph
6.ISA 720 – Other Information Paragraph
7--------------Other Matters Paragraph
1.The Format of the Standard/Unmodified Audit Report to the
Shareholders
2 types of Companies
1. Listed Company
2. Non-Listed Company
Disclaimer – Question Papers prior to 2016 are not relevant for this
topic because AAA is now using the new format of the Audit Report
Listed Company Non-Listed Company
1.Opinion – Unqualified 1.Opinion – Unqualified Opinion
2.Basis of Opinion 2.Basis of Opinion
3.Key Audit Matters 3.Other Information Paragraph
4.Other Information Paragraph 4.Responsibilities – Auditor
Management
5.Responsibilities – Auditor 5.Other Legal and Regulatory
Management Requirements
6.Other Legal and Regulatory
Requirements
2. The Format of the Modified Audit Report to the Shareholders
Listed Company Non-Listed Company
1. Opinion – No Longer 1.Opinion – No Longer unqualified
unqualified
2.Basis of Opinion 2.Basis of Opinion
3.MURGC Paragraph 3.MURGC Paragraph
4.Key Audit Matters 4.Emphasis of Matter Paragraph
5.Other Matters Paragraph 5.Other Matters Paragraph
6.Other Information Paragraph 6.Other Information Paragraph
7.Responsibilities – Auditor 7.Responsibilities – Auditor
Management Management

8-Other Legal and Regulatory 8-Other Legal and Regulatory

Requirements Requirements

An Audit Report to the Shareholders can be modified when;

1. There is a change of Opinion – The opinion is no longer
unqualified
2. When the Auditor inserts an additional paragraph that is
not in the Standard Audit Report
Listed Company Non-Listed Company
1.MURGC Paragraph 1.MURGC Paragraph
2.Emphasis of Matter Paragraph
2.Other Matters Paragraph 3.Other Matters Paragraph
Disclaimer –
1.When the auditor inserts an additional paragraph in the audit report
it means that there are in agreement with the management hence the
opinion will not change – ie – It remains unqualified but the report will
be modified.
2. It is discretional for an auditor to add a paragraph in the audit report
that is not on the Standard Audit Report – ie – It is not mandatory
3.All paragraphs that are going to be added by the auditor in the audit
report will reflect the correct disclosure of different transactions to the
notes of the Financial Statements in accordance with relevant IFRS
Standards hence the auditor by adding a paragraph that is not on the
Standard Audit Report they will be alerting the Shareholders and the
users of Financial Information of the note number pertaining to the
correct disclosure of a transaction in case they didn’t manage to read
that specific note number!
ISA 705 – Qualified Opinion, Adverse Opinion, Disclaimer of Opinion
ISA 320 – Materiality – Quantitative Misstatements
Materiality Total Assets Profit Before Revenue
Threshold Tax
Percentiles – 1-2% 5-10% ½-1%
Material
i. Opinion if the Qualified Qualified Qualified
misstatement Opinion Opinion Opinion
is material
Material Material Material
Misstatement Misstatement Misstatement
ii. Material and Adverse Adverse Adverse
Pervasive Opinion Opinion Opinion
This means the The The The
Misstatement affects Misstatement is Misstatement is Misstatement is
a substantial over 60% of the over 60% of the over 60% of
Proportion of the Total Assets Profit Before Revenue
Financial Tax
Statements.
iii. Percentiles – Less than 1% Less than 5% Less than 1/2
Immaterial %
Unqualified Unqualified Unqualified
Opinion Opinion Opinion
iv. Scope Disclaimer of Disclaimer of Disclaimer of
Limitation Opinion Opinion Opinion
The Auditor The Auditor The Auditor
was not able to was not able to was not able to
gather Evidence gather Evidence gather Evidence

If Fraud is immaterial to the Financial Statements, it must be

communicated to TCWG in accordance with ISA 260/265 so that
appropriate actions can be taken.
Qualitative Misstatements
Disclosure Going Concern Disclosure Other Disclosures
IAS 10, IAS 24, IFRS 8, ias
ISA 570 & IAS 1 37
1.Full Disclosure Add a paragraph in the Add a paragraph in the
Audit Report highlighting Audit Report highlighting
the disclosure – MURGC the disclosure:
Paragraph
1.Emphasis of Matter
Opinion – Unqualified Paragraph – NLC – Only
modified for EOMP
Modified Audit Report
2.Key Audit Matters
Paragraph – LC-
Unmodified Report
2.Brief Disclosure The Auditor will not ADD any The Auditor will not ADD
Paragraph any Paragraph

-This indicates a material -This indicates a material

misstatement misstatement

Opinion – Qualified Opinion – Qualified

Modified Audit Report Modified Audit Report

3.No Disclosure The Auditor will not ADD any The Auditor will not ADD
/Incorrect Paragraph any Paragraph
Disclosure
-This indicates a material and -This indicates a material
pervasive misstatement misstatement

Opinion – Adverse Opinion – Qualified

Modified Audit Report Modified Audit Report

ISA 570 – Going Concern
-IAS 1 stipulates that the financial statements should be prepared on a
going concern basis – i.e. – The entity will continue to operate for the
foreseeable future (At least for one reporting period.)
- If by any chance the going concern status of an organization is affected,
then events leading to the preparation of the Financial Statements on a
Break-Up Basis should be fully disclosed in the Financial Statements to
inform the shareholders and other users of Financial Information of an
unfortunate event.
Examples
- NAD – The warehouse has been destroyed by fire after the reporting
date
- The entity is highly geared i.e., its gearing ratio is higher than expected
- The entity has got an assumption that they will be able to meet their
obligations hence the company’s liquidity will be said to be
compromised.
Management’s Responsibilities for Going Concern
-To make a valid assumption about the future of the business.
-To assess the going concern status of the business.
-To provide the auditor access to all information and explanations.
Auditor’s Responsibilities for Going Concern
-To evaluate the assumption provided by the management by gathering
Sufficient Appropriate Audit Evidence (Performing Audit Procedures)
Audit Procedures
1. Review the board minutes to confirm the business rationale of future
plans and events.
2. Review the cash flow forecast to confirm the underlying assumption
taken by the management to predict their future cash flows and confirm
the reasonableness of the assumptions taken.
3. Review the correspondence from the government to identify any
significant issues affecting the going concern status.
4. Review the correspondence from the legal expert to identify any
significant issues which can impact the business’s foreseeable future.
5. Seek a Representation Letter from the management to confirm the
appropriateness of the information given.

MURGC Paragraph
The auditor will add a Material Uncertainties Relating to Going Concern
Paragraph only if the management provides a full disclosure of a material
uncertainty affecting their going concern status.
The purpose of this paragraph will be to highlight to the shareholders and
other users of Financial Information – The specific note number containing
a disclosure in case they didn’t manage to read it so that they would know
what’s happening in their entity.
For opinions and rules of opinions regarding going concern please see
the table above!
Non-Listed Entity
ISA 706 – Emphasis of Matter Paragraph
Emphasis means material/significant
This is an optional paragraph in the audit report and its discretional to the
auditor.
This paragraph will highlight correct disclosures including note numbers of
the events about the entity in the notes to the financial statements.
Emphasis of Matter Paragraph will only come in when the disclosure is
material and correctly disclosed
EOMP = Correct Disclosure + Material Event
The EOMP will not change the opinion of the auditor ie the opinion
remains unqualified.
Material Uncertainties Relating to Going Concern – (EOMP+ MURGC
Para + Unqualified Opinion)
ISA 701 – Key Audit Matters
Key Audit Matters means something material/significant
This is a mandatory paragraph in the audit report as it is in the Standard
Audit Report
This paragraph will highlight correct disclosures including note numbers of
the events about the entity in the notes to the financial statements.
One of the events in which KAM will appear in the Audit Report is when the
disclosure is material and correctly disclosed
KAM = Correct Disclosure + Material Event
The KAM will not change the opinion of the auditor ie the opinion remains
unqualified.
However Key Audit Matter may sometimes come as a result of
1.Areas with high risk of Management Bias – Estimates – Any area that
requires the judgement of the management (Subjective Areas).
2. Adoption of a new accounting standard – When company becomes
listed for the first time, they will adopt IAS 33 – Earnings Per Share , IFRS 8
– Operating Segments.
3.Adjusting and Non-Adjusting Events
4.Material Uncertainties Relating to Going Concern – (KAM + MURGC
Para + Unqualified Opinion)
5.Any other risky area faced during the conduct of the audit.

NB- KAM will never modify the audit report , it is in the Standard Audit
Report for Listed Companies.
ISA 706 – Other Matters Paragraph
Inserted only one condition – Change of an auditor – First Year Audit
Other Matters Paragraph will modify the audit report but never changes
the opinion of the auditor ie opinion remains unqualified.
Contents of the Other Matters Paragraph
1.Name of Previous Auditor
2.The date of the Previous Auditor’s Report
3.The type of Opinion issued by the previous auditor
ISA 720 – Other Information Paragraph
One of the favourite questions of the examiner
Mandatory paragraph in the audit report for both listed and Non-Listed
Companies.
Other Information Paragraph does not modify the audit report ie it is in the
Standard Audit Report
Other Information is found in the Annual Report of an entity
1.Director’s Report
2.Chairman’s Statement
3.CEO’s Report
4.Additional Performance Measures
-The auditor does not express an opinion on other information in the
annual report, they express an opinion on the Financial Statements.
-This means that other information paragraph will never change the
opinion of the auditor.

Responsibilities of the Auditor on Other Information

1- To read other information in the Annual Report.
2- Identify any material inconsistencies in the other information as
published by the management.
3- Highlight those material inconsistencies in the Other Information
Paragraph
4- If there are no material inconsistencies found by the auditor in other
information then the auditor should insert another information
paragraph that contains the following phrase “We have nothing to
report on other information!”

NB – It is mandatory to insert the other information paragraph

even if there are no material inconsistencies in the other
information as provided by the management.
Responsibilities of the Management and the auditor Paragraph
- This will highlight the auditor and the management responsibilities in
the course of the auditor.
- Management and Auditor will clearly state on whether there have
fulfilled their responsibilities during the conduct of the audit.