Auditing: Client Acceptance, Audit Planning, Preliminary Risk Assessment

This document provides an overview of client acceptance decision, audit planning, and preliminary risk assessment in the field of auditing.

Running head: AUDITING
Auditing
Name of the student
Name of the university
Student ID
Author note

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Table of Contents
Question 1..................................................................................................................................2
(a) Client acceptance decision..........................................................................................2
(b) Audit planning.............................................................................................................3
(c) Preliminary risk assessment........................................................................................4
(d) Preliminary materiality calculation.............................................................................4
Question 2..................................................................................................................................5
Question 3..................................................................................................................................7
Reference..................................................................................................................................10
Appendix..................................................................................................................................12

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Question 1
(a) Client acceptance decision
Accepting the client engagement involves following procedures regarding whether to accept
the engagement or not –
 Evaluating the management’s integrity – irregularities and material error as well as
fraud is more likely when the management is not honest. Hence, the auditor shall
analyse the previous year’s financial records, minutes of meeting and other documents
related to business operation to assess whether they indicate any misstatement or
fraud (Lai and Chen 2015)
 Recognising unusual risks and special circumstances – in this step the auditor shall
focus on identification of intended errors related to financial statements. Legal
liability of the auditor may differ based on the intended users of statements,
particularly under the negligence of common law
 Assessing the competence to perform audit – it is crucial that which personnel will be
assigned for the audit. Answer to this will help to determine type and amount of
supervision required. Nature of the client and its business will have large impact on
staffing decision (Hsieh and Lin 2015)
 Evaluation of independence – the auditor shall evaluate whether they will be able to
work in independent environment
 Determination of auditor’s ability to apply due care – earlier appointment provides
more time for planning and business risk may enhances if the engagement is made
after or near closure of fiscal year (Hsieh and Lin 2015)

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(b) Audit planning
Nature and extent of audit planning is direct function that is dependent upon the
complexity and size of the client’s business. Audit planning involves the following steps –
 Obtaining understanding of client’s business and the industry – key aspects to be
focussed under this are –
 Objectives and goals of management
 Regulatory forces
 Services, products, customers, competition and market
 Operating cycle and core processing
 Financing and operating cycle
 Reviewing the audit documentation from the previous audit performed by accounting
firm or the predecessor auditor that will assist in development of outline for audit
program (Coetzee and Lubbe 2014)
 Timing for various audits shall be considered. For instance, testing for internal
control shall be performed in early days of the engagement, controls regarding
inventory shall be performed near or at the data of balance sheet
 Interim financial statements shall be analysed for identify the transactions and
accounts that varies from the expectation. Performing such analytical process is
compulsory in audit planning for identifying accounts that is misleading and require
special attention
 Assistance from outside shall be determined that includes use of specialists as and
when required (Christensen et al. 2016).

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(c) Preliminary risk assessment
ASA 315 deals with identification and assessment of risks of the material
misstatement through understanding the organisation and its business environment.
Preliminary risk assessment procedure includes the following –
 Inquiries of the management and other staffs within the organisation who as per the
judgment of auditor may possess the information that will help in risk identification
for material misstatement owing to error or fraud (Knechel and Salterio 2016)
 If audit engagement partner has performed any other engagement for the company,
he/she shall determine whether the obtained information is relevant for identifying
risks for the material misstatement
 Where the auditor plans to use the information obtained by the previous auditor
through his experience and performance of audit procedure, the auditor shall
determine whether any changes have taken place since then that may have an impact
on the current audit (Contessotto and Moroney 2014)
 Engagement partner as well as other key engagement members of the audit team shall
discuss client’s financial statement’s susceptibility to the material misstatement and
application of required framework for financial reporting to the circumstances and
facts of the entity. Further, the engagement partner must determine the matters those
are to be communicated to the members of engagement team those are not involved in
discussion (Contessotto and Moroney 2014)
(d) Preliminary materiality calculation
Preliminary estimation of materiality at the level of financial statement is known as
planning materiality. For computing materiality following bases and threshold limits are
considered –

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 0.5% to 1% of total revenue
 5% to 10% of the net earnings
 1% to 2% of the gross profit
 1% to 2% of the total assets
 2% to 5% of the shareholder’s equity
Range of 50% to 75% of the planning materiality is generally used for computing the
tolerable misstatement at the level of financial statement (Choudhary, Merkley and Schipper
2017)
Question 2
Inherent risk description Inherent risk assessment Proposed substantive
procedure
1. Administrative expenses
It is identified from the
previous year’s financial
statement that the
administrative expenses have
significantly increased from
£ 451,271 to £ 793,558.
Audit assertions involved
with the accounts are – (i)
classification that is the
expenses included under
administration have not been
classified properly.
Likelihood is there that any
item for which proper head
was not available has been
included under
administrative expenses (ii)
cut-off that is the expenses
reported pertain to the
current period. in other
words, expenses from other
periods have not been
included under current
Risk assessment – high
Materiality for the risk
occurring will be high as
overstating the administrative
expenses will lead to
lowering of net profit. Net
profit is a major aspect that is
looked by the users for taking
decisions regarding
investment and other.
Further, lowering of profit
will leave lower amount with
the entity for making
payment to the shareholders
and other creditors
It is found from the notes that
major portion of increase in
administrative expenses is
due to payment to directors
remuneration amounting to £
250,000 that was nil in the
previous year. Hence, the
auditor shall review the
remuneration policy of the
company and the
appointment procedure of
auditor new appointed during
the period, if any. Other
major expenses included in
administrative expenses are
miscellaneous expenses and
accountancy fees. The
auditor shall check the
payment term of accountant
including salary, cash
benefits and other benefits.
These documents shall be
reconciled with the payment
related documents and pay

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period. slip of the accountant. In case
of miscellaneous expenses,
each of the expenses shall be
scrutinized with associated
documents. Further, it shall
be verified that whether the
expenses are properly
authorised by the signing
authority.
2. Cash
Cash is material item by its
nature. In case of Sheridan
AV it is identified from their
balance sheet that for
previous year they have nil
cash balance however for the
current they have reported
cash amounting to £ 426,359.
As cash is the most liquid
item, likelihood of error and
fraud is most common to
cash. Key assertion involved
with cash are – (i) existence
that is the cash amount
reported by the entity
actually exists on the date of
balance sheet (ii)
completeness that is all the
cash related transactions that
is payments and receipts
have been considered while
reporting the final amount
(iii) accuracy that the cash
amount reported under
current assets are exact and
accurate (iv) classification
that is the cash transactions
have been presented and
classified in fair manner. For
example credit sales have not
been recorded as cash sales.
Risk assessment – high
Materiality for the risk
occurring will be high as
overstating cash will have
big impact on the
performance of the company
that will misguide the users
who will analyse the
financial statement for
making decisions. For
instance, overstatement of
cash balance will enhance the
company’s liquidity position
that will misguide the
creditors who will look into
the company’s liquidity
position for lending.
It is found that the entity did
not provide any break-up
regarding the cash balance.
However, the auditor shall
carry out the following
procedures for cash –
 Confirming the cash
balance through sending
the confirmation directly
to the bank. Further the
cut-off statement on the
date of balance sheet
shall be asked from the
bank and reconciled the
same with the reported
cash balance.
 Cash related payments
shall be reconciled with
the vouchers and the
same shall be confirmed
with the bank account
 Authorisation of cash
payments shall be
verified and the auditor
shall assure that all the
payments are properly
verified.
3. Inventories
Inventory is material by its
nature as it is highly
Risk assessment – medium
Materiality for the risk
occurring will be medium as
It is found that the inventory
level increased due to
increase in level of raw

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susceptible to theft and fraud.
It is found from the balance
sheet of the company that the
amount of inventory
increased to £ 226,549 from
£ 164,302 in previous year.
Key assertions involved with
inventories are – (i) existence
that is inventory amount
reported by the entity
actually exists on the date of
balance sheet (ii)
completeness that is all the
inventory related transactions
that is purchase and issuance
have been considered while
reporting the final amount
(iii) accuracy that the
inventory amount reported
under current assets are exact
and accurate (iv) rights and
obligation that is the
inventory reported under
inventory are owned by the
entity that is the inventory
held on behalf of another
entity shall not be included as
part of inventory.
though overstating the
inventories will misstates the
financial position it not have
direct impact on the user’s
decision as the financial
statement users generally do
not look into the inventory
balance.
material as well as finished
goods. The auditor shall
carry out the following
substantive procedure for
audit of inventories –
 Unit costs of inventory
shall compared with the
previous year
 Inventory valuation
process of the entity shall
be verified and the value
of inventory shall be
reconciled with the
authorised valuation
procedure
 Reconciling inventory
count with the general
ledger though tracing
valuation that is compiled
from physical inventory
count with the general
ledger of the entity. This
will assist in verifying
that counted balance
carried forward to the
accounting records of the
entity.
Question 3
Control risk description Control risk assessment Proposed substantive
procedure

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It is identified from the sales
process of Sheridan AV that
the one staff is taking order
as well as reconciling sales.
Rob Cole the distribution and
warehousing assistant is
responsible for identifying
the stock items mentioned in
the order and reconciling the
need with the stock. If the
ordered items are not there in
the stock he notifies the sales
department. In case the goods
are in stock he creates the
dispatch note. Further, the
despatch noted signed by the
customer is received by Rob.
Risk assessment – high
Materiality for the risk
occurring will be high as one
staff is responsible for taking
order as well as reconciling
sales it will provide him the
opportunity of misstating the
inventories through fraud or
creation of error. For
instance, as he is responsible
for warehousing activities, it
is easy for him to notify the
sales department that the
goods is not in stock even if
the foods are there in the
stock. It will not be
recognised by other person as
he is only responsible for
stock maintenance.
To begin with the auditor
shall verify the company’s
internal control system and
procedures and reconcile the
same with the actual
procedure. In the given case
as only one staff is, that is the
distribution and warehousing
assistant is engaged for
taking order as well as
reconciling sales. Engaging
same staff for more than one
activity will leave the scope
for him to misstate the
accounts. Hence, the auditor
shall suggest the entity to
engage 2-3 more people who
will be responsible for
despatching the goods to the
customers and receiving
signed copy for assuring that
all the despatched goods
have been received by the
customer. Segregation of
duties will reduce the
chances of likely
misstatement and frauds.
It is identified from the
annual report that the liability
of the £ 64,000 has been
recorded as the loan taken
from the director. Loan from
the director for significant
amount will made him the
creditors of the company and
it will violate the
professional ethics. Further,
the company did not disclose
any details regarding the
loans like interest rate or
anything else like other
monetary benefits allowed to
him in exchange of loan,
repayment schedule, terms of
Risk assessment – medium
Materiality for the risk
occurring will be medium as
though loan taken from the
director will make him
interested party for the
business and hence, he will
be in a position to influence
his decision, other members
there in the board who can
take decisions if something
wrong is going on.
The auditor shall verify
whether the proper
disclosures have been made
by the entity regarding the
loan taken from the director.
Details of disclosures are
amount taken as loan,
indication of interest rate or
anything else like other
monetary benefits allowed to
him in exchange of loan,
repayment schedule, terms of
loan and purpose for which
loan has been taken.

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loan and purpose for which
loan has been taken.
It is found from the minutes
of recent meetings held on
15th January 2021 that it is
decided by MR David
Sheridan that for boosting
sales he is going to introduce
executive bonus scheme
based on sales target and it
will be effective
immediately. However,
target sales based bonus
scheme will influence the
executive to increase the
sales at any cost for their
personal benefit. Though it is
mentioned that the bonus
payment will be considered
only after considering the
sales along with profit before
tax and exceptional items,
misstating the sales items
only will enable them to earn
bonus as inflate sales will
inflate the overall profits.
Risk assessment – high
Materiality for the risk
occurring will be high as
inflating the sales will alter
the actual performances of
the company. Hence, in that
way it will misguide the
users who take various
decisions based on the annual
report. Further, the high
amount of bonus will reduce
the cash balance of the
company which in turn will
largely affect its liquidity
position. It will also provoke
the executives to sales more
quantity without giving
importance to quality which
may ruin the goodwill of the
company in the long run.
The auditor shall verify the
bonus plan minutely and
reconcile the same with the
bonus payment. Another
major account here required
to be checked is the sales
account. Sales recorded in
the income statement shall be
matched with the sales
register. For large amount of
sales 3rd party confirmation
shall be obtained. Further the
cash sales shall be reconciled
with cash balance and credit
sales shall be reconciled with
the accounts receivables.
Apart from that unit price of
sales shall be compared with
previous period sales price.
Moreover, the auditor shall
verify that the sales staff are
not engaged in taking orders
and despatching orders.
Segregation of duties for
different activities will
reduce the chances of frauds.

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Appendix
Financial statement

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