KnS School of Business Studies

ACCA F8 & CA CAF 9 Audit & Assurance

AUDIT RISK – For Scenario based questions

Audit Risks kay cheetay Points

(Practical Points that affect Audit Risks)
1. Incurred revenue & capital expenditure during the year OR increase in capital expenditure
during the year. OR
2. Increase in subsequent expenditure during the year.

RISKS: There is a risk of incorrect classification between revenue and capital expenditure
as per IAS 16, resulting in both P.P.E and profit being overstated OR understated.

As per IAS 16 ….only purchase price plus directly attributable costs are part of the cost of
the asset. (Other future costs e.g. servicing and maintenance costs are amortized over the
period accordingly)

3. Increase in research & development cost (IAS 38)/Expenditure on Brands incurred during
the year e.g. Costs capitalized as development costs.

RISKS: There is a risk of incorrect classification between research and development

expenditure as per IAS 38, resulting in both I.A and profit being over stated and understated.

In case, question only mentions that cost has been capitalized as development costs than in
that case …….There is a risk of overstatement of Intangible asset and overstatement of
profit.

4. Various provisions made during the year e.g. Provision for lawsuit / warranty or
restructuring
RISK: There is a risk that because of wrong estimates and judgement (both Intentional and
unintentional), provision could be both undervalued or overvalued in the F/S.

5. There are pending cases against the company OR new cases imposed during the year
RISK: There is a risk of completeness of provisions or inadequate or no disclosure in the
F/S as per IAS 37.

(If it is probable that company will make a payment, a provision is required. If the payment
is possible rather than probable, a contingent liability disclosure would be necessary.

Prepared by: M.Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
ACCA F8 & CA CAF 9 Audit & Assurance
AUDIT RISK – For Scenario based questions

Both drafting’s are correct:

a)There is a risk over the completeness of any provisions or contingent liabilities.) or

b)There is a risk of provision being over / under valued and risk of inadequate or no
disclosure in the F/S as per IAS 37.

6. Imposition of new laws & regulations on the company

RISK: There is a risk of penalty not being recorded in the F/S resulting in profit being
overstated or risk of incorrect disclosure in the F/S.

7. Inadequate Internal controls/SOP’s / or lack of controls in Sales or Purchase department

RISK: There is a risk of controls not being operating effectively leading to overall ROMM
in the F/S or sales and debtors & purchases and payables being overstated or understated

8. During the year employees were made redundant e.g. Branch office was closed (Part of
restructuring)
RISK: There is a risk that because of wrong estimates the provision could be both
overvalued or undervalued. (OR SAY …There is a risk of completeness of Provision in the
F/S.)

9. Bank Loan obtained for 5 / 10 years

RISK: There is a risk of incorrect classification between current and long-term portion of
long-term loan & risk of incorrect disclosure of security provided against bank loan in the
F/S.
10. Bank Loan increased as compared to last year.

RISK: There should be additional interest costs therefore there is a risk that this has been
omitted from profit and loss a/c leading to understated finance costs and overstated profit.

11. Bank loan has loan covenants attached, plus the company is facing cash flow problems or
faces liquidity issues.

Prepared by: M.Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
ACCA F8 & CA CAF 9 Audit & Assurance
AUDIT RISK – For Scenario based questions
RISK: There is a risk that if these loan covenants (profit or assets targets) are breached and
the loan becomes repayable immediately than the company will face going concern risk.
(ISA 570)
In addition, there is a risk of manipulation of profits and net assets to ensure that bank
covenants are met.

12. Interest / Finance cost increased during the year because of increase in bank loan.

RISK: There is a risk that interest costs will be understated to manipulate profits especially
if there are profit based bonuses for senior management.

13. Introduction of new accounting software during the period and run in parallel during the
year
RISK: There is risk of data being lost & balances being misstated if they have not been
transferred completely and accurately, therefore there is a risk of overall R.O.M.M in the
F/S.

14. Senior management joins the organization with different prior experience (CFO has joined
a BANK who was previously CFO in a pharmaceutical company)
RISK: There is a risk that there will be overall errors in making judgements and estimates
leading to overall R.O.M.M in the F/S

15. Hiring of unqualified /incompetent / inexperienced staff in the finance department

RISK: There is an inherent as well as control risk that there will be overall R.O.M.M in the
F/S.

16. Revaluation of assets during the year (treatment of IAS 16)

RISK: There is a risk that if the treatment of revaluation is not done as per IAS 16 than both
PPE and profits will be over or under-stated.

17. New product has been manufactured by the company but it won’t be allowed to be sold by
the company or its expected that a new law will be imposed which will stop the sales of the
product.

RISK: There is risk of going concern for the company plus if stock is not written down than
profit and inventory will be overstated.

Prepared by: M.Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
ACCA F8 & CA CAF 9 Audit & Assurance
AUDIT RISK – For Scenario based questions
18. Top Management/Senior Management from the finance dept. has left the Company very
close to the balance sheet date.
RISK: There is an inherent risk of increased work load for the finance team resulting in
control risks (C.R) for the auditor leading to misstatements in the F/S.

Alternative Drafting
There is an inherent risk of increased work load for the finance team resulting in control
risks (C.R) as there will be errors within the accounting records by the over -worked finance
team and there is no supervision from senior mgmt.

19. Default of major customer/receivable during the year OR

20. Receivables balance is increasing over the years as compared to last year or collection in
days has increased as compared to last year.

RISK: There is a risk that if receivables are not recoverable and adequate provisioning is
not done than debtors will be overvalued.
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21. Out of court settlement with the customers / suppliers (before or after the B/S date)
RISK: There is a risk that resulting provision or liability will be over or under valued. (also
termed as completeness of provisions and disclosures)

22. Excess inventory & fixed assets in the warehouse.

RISK: There is a risk of Increased theft & misappropriation of assets resulting in loss of
sundry income leading to profit being understated.

23. First year of audit or it’s a new audit client

RISK: There is a risk of not detecting the errors in the F/S being the first year resulting in
detection risk (D.R) for the external auditor.
(As the team is not familiar with transactions and balances, there will be an increased
detection risk on the audit.)

24. Proper disclosures as per I.F.R.S or local laws are required in the F/S
RISK: There is a risk of incorrect or inadequate disclosures in the F/S.

Prepared by: M.Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
ACCA F8 & CA CAF 9 Audit & Assurance
AUDIT RISK – For Scenario based questions
25. Sales related bonus / incentive being offered to employees.
RISK: There is a risk of sales and debtors being overstated in the F/S by inaccurate sales
cutoff.

26. Subsequent fraud discovered by senior management after leaving the organization.
RISK: There is a risk that if previous fraud is not adjusted, than F/S will be materially
misstated. (or say overall R.O.M.M in the F/S will increase)

Alternative: There is a risk that if the impact of the fraud has not been quantified and
corrected in the statement of profit or loss or any other frauds have not been uncovered, the
financial statements could be misstated.

27. Risk of improper/ incorrect classification between current and non-current assets, current
and non-current liabilities.

28. Disposal of fixed assets during the year

RISK: There is a risk of wrong calculation of profit on disposal leading to profit being over
and understated.

29. Abnormal gain / loss on disposal of fixed assets during the year.
RISK: There is a risk of unreasonable depreciation policy (accounting estimate) leading to
both P.P.E and profit being under or overstated.

30. The company has both owned & rented assets.

RISK: There is risk that if rented assets are classified as owned assets than assets will be
overvalued and profit will be overstated.

31. Sudden conversion of accumulated losses into profits in the current year.
RISK: There is a risk of admin expenses being understated and profits being overstated.

32. Management bonus is linked on the total assets of the company.

RISK: There is a risk that management will manipulate assets of the company via
estimates and provisions and this will lead to assets being overvalued in order to increase
their personnel bonus.

Prepared by: M.Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
ACCA F8 & CA CAF 9 Audit & Assurance
AUDIT RISK – For Scenario based questions

33. Management bonus is linked on the profits of the company

RISK: There is a risk that management will manipulate profits of the company via
estimates and provisions and this will lead to profits being overstated in order to increase
their personnel bonus.

34. Sudden decrease in Admin expenses without any change in company’s operations.
RISK: There is a risk of profit being overstated.

35. Company has Intangible assets under IAS 38 (Patent, license, Franchise etc.)

RISK: There is a risk that if treatment is not done as per IAS 38 than both Intangible
assets and profits could be over/under stated.

INVENTORY

36. Assets/Inventory ordered/procured with no certainty that they will be received at the
yearend or not.
RISK: There is a risk of inaccurate cutoff leading to stock/purchases and payables both
being overstated at the B/S date.

OR there is a risk that if inventory / fixed assets are recorded before they physically exist
than both inventory / fixed assets and payables will be over-stated in the F/S.

IMP
37. There are various locations / stores for inventory counting at the B/S date and company /
client management is willing to get 100 per % stock counted at the B/S date.

Please note :100% verification of inventory at all locations is not always practically possible
for the external auditor.

RISK: There is a risk that auditor will not be able to obtain S.A.A.E over the existence and
completeness of inventory locations not visited by the auditor at the B/S date.

Prepared by: M.Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
ACCA F8 & CA CAF 9 Audit & Assurance
AUDIT RISK – For Scenario based questions

38. Company values its inventory at the lower of cost and net realizable value. Cost includes
both production and general overheads.
RISK: If general overheads are included in inventory cost, then this will result in
inventory being over-valued.

39. Inventory is destroyed by fire / flood BEFORE the B/S Date

RISK: There is a risk that inventory is damaged and not valued as per IAS 2 resulting in
closing stock being overvalued.

40. The company is planning to undertake the full year-end inventory count after the B/S date
and then adjust for inventory movements from the year end.

RISK: If the adjustments are not completed accurately, then the year-end inventory could
be under or over-valued.

41. Stock returned after / or before the B/S date being damaged or expired or product recalled
by the company. (inventory was at the B/S date)

RISK: There is a risk that if inventory is not valued as per IAS 2 then closing stock would
be overvalued plus refunds will need to be made to the customers and sales will have to be
reversed, which if not done, then revenue will be overstated and liabilities will be
understated.

42. Closing stock balance has increased as compared to last year. (or turnover in days have
increased)
RISK: There is a risk that stock is old fashioned / or out of demand and not being sold
resulting in its NRV being lower than cost and if not adjusted as per IAS 2, will result in
closing stock being overvalued.

43. In the case of W.I.P, expert service must be obtained

RISK: There is a risk of W.I.P being under or overvalued.

(The level of work in progress needs to be assessed at the year end. Assessing the percentage
of completion for partially constructed inventory can be very subjective, and an expert
should undertake this. If the percentage of completion is not calculated correctly, the
inventory valuation may be under or over-valued.

Prepared by: M.Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
ACCA F8 & CA CAF 9 Audit & Assurance
AUDIT RISK – For Scenario based questions
44. Useful life of assets or depreciation rates have been reassessed or reviewed by the
management during the year.
RISK: There is a risk that this has been done to manipulate the profits or to achieve some
kind of profit targets resulting in profit and PPE being overstated.

45. Contingent assets as per IAS 37 should only be recorded when virtually certain.
RISK: There is a risk that assets are not virtually certain and are recorded as assets
resulting in assets being overvalued in the F/S.

To comply with IAS 37 contingent assets should not be recognized until the receipt is
virtually certain. If recorded there is a risk of assets and profits being over-stated.

46. The client is requesting to complete the audit early quickly than last year.
RISK: This will result in detection risk for the external auditor plus there will be less time
for the finance team to prepare the financial statements leading to an inherent risk that
F/S will me be materially misstated.

47. Bank reconciliations are not made on timely basis.

RISK: There is a risk that differences will not be reconciled resulting in the risk of bank
balances being over /under valued.

48. Physical stock is not reconciled with General ledger or book records.
RISK: There is a risk that closing stock could be over/under valued.

49. If physical cash is not reconciled with General ledger (Cash Book cash column)
RISK: There is a risk that cash balance would be over / under valued.

50. New technology has been introduced by the company because of which old & existing
P & M have been impaired.
RISK: There is a risk that if impairment treatment is not done as per IAS 36 than both
P & M and profits will be overstated.

51. Sales ledger and creditors ledger were closed 10 days after the B/S date
RISK: There is a risk of incorrect cutoff in both sales and purchases leading to over /
under sales and debtors as well as purchases and payables.

52. No supplier statement or purchase ledger control account reconciliations have been
performed during the period.

RISK: There is an increased risk of errors within trade payables and the year-end payables
balance may be under or over-valued.

Prepared by: M.Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
ACCA F8 & CA CAF 9 Audit & Assurance
AUDIT RISK – For Scenario based questions
53. A patent / franchise has been purchased by the company for X no of years and if the
management has expensed the full amount in the current year P&L than…..

RISK: There is a risk that as the sum has been fully expensed and not treated in accordance
with IAS 38 than both intangible assets and profits are understated.

(In accordance with IAS 38 Intangible Assets, this should have been included as an
intangible asset and amortized over its useful life accordingly )

54. The company has raised new finance / equity through issuing of shares at a premium. This
needs to be treated correctly, with adequate disclosures made and proper allocation between
share capital and share premium in the B/S.

RISK: If this is not done, then there is a risk that accounts may be misstated due to a lack
of disclosure as well as share capital and share premium will be misstated.

55. During the year, company outsourced its ABC department / function to an external service
organization / service provider.

RISK: A detection risk arises as to whether sufficient and appropriate evidence is available
at the audit client to verify the completeness and accuracy of controls over that ABC
function / transactions and balances at the year end.

Few Accounting standards to be covered for Audit Risk Topic….

IAS 2,16,10,36,37,38 and IFRS 15

*Accounting Ratios and Audit Risks to be covered separately

Prepared by: M.Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
ACCA F8 & CA CAF 9 Audit & Assurance
AUDIT RISK – For Scenario based questions
Indicators for Risk of Going Concern

Other Risks

Prepared by: M.Sajid Kapadia (ACA, FCCA, APFA)