Page 90 - DCOM204_AUDITING_THEORY

Auditing Theory

Notes working papers; inspect legal documents (such as share options and pension plans), minutes of
meetings and significant contracts. The auditor needs also to consider to clients performance
measurement system. Inherent risk may be increased if the client has set unreasonable objectives
or if the performance measurement systems encourage manipulation of amounts in the financial
statements. The auditor should read financial statements, perform ratio analysis, and inquire of
management about key performance indicators that management uses to measure progress
toward its objectives.

Notes The auditor should understand the clients objectives related to reliability of financial
reporting; effectiveness and efficiency of operations; and compliance with laws and
regulations.

5.11 Assess Client Business Risk

The auditor uses knowledge gained from the strategic understanding of the client business and
industry to assess client business risk, the risk that client will fail to achieve its objectives. It is
managements responsibility to identify the business risks facing the company and respond
accordingly to those risks. The auditor’s main concern is the risk of material misstatement in the
financial statements due to client business risk. It is important to note that not all business risks
will turn into risks leading to material misstatement in the financial statements. ISA 315 stresses
the importance of all members of the audit team understanding the potential risk of
misstatements in each client’s financial statements. In particular, the standard introduces the
concept that the auditor is required to obtain an understanding of business risks and significant
risks to the extent that they are relevant to the financial statements. ISA 315 requires the audit
team to discuss risk factors as part of the audit planning process.

5.12 Perform Preliminary Analytical Procedures

Analytical procedures applied at the planning stage can assist the auditor in gaining an
understanding of the clients business and in assessing client business risk. ISA 520 states, “the
auditor should apply analytical procedures at the planning and overall review stages of the audit.” ISA 520
Analytical Procedures states that analytical procedures include the consideration of comparisons
of the entity’s financial information with, for example:

1. Comparable information for prior periods,
2. Anticipated results of the entity, such as budgets or forecasts, or expectations of the auditor,
such as an estimate for depreciation, and

3. Similar industry information, such as comparison of the entity’s ratio of sales to receivables
with industry averages or with other entities of comparable size in the same industry.

Application of analytical procedures may indicate aspects of the business of which the auditor
was unaware. In order to gain a better understanding of the client’s business and industry,
the auditor will calculate typical ratios and compare the company ratios to those of the
industry. Analytical procedures identify significant deviation from predicted amounts, which
show the auditor where to increase procedures to obtain corroborative evidence. ISA 315
paragraph 10 contains additional guidance on applying analytical procedures as risk
assessment procedures.

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