ACCA AAA Audit Planning Notes by Sir Owais Mirchawala

PLANNING
AUDIT
Advanced Audit E
Assurance
Tutor :
Owais Mirchawala
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Exam technique 1 – Planning

questions and risk (part 1)
Home / Students / Study resources / Advanced Audit and Assurance (AAA) / Technical articles / Exam technique 1 – Planning questions and risk (part 1)
Business risk
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Candidates will be tasked with a question set at the planning stage of an engagement in section A. This will require
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candidates to evaluate risks relevant to an audit or assurance engagement. This article is intended to help
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(part 2): RoMM and audit risk in the AAA exam
candidates to achieve both the technical and professional marks usually associated with these types of
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requirements.
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ISA315 (Revised), Identifying and Assessing the Risks of Material Misstatement gives extensive guidance on the
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need to understand the client’s business, controls and operating environment in order to assess the risks on the
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engagement. Audit risk arises through these risks of material misstatement but also assess the risk that these may
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not be detected during the audit process. Candidates are tested on their skills in identifying and evaluating these
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risks
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Business risk in audit planning questions
ISA315 (Revised) explains that understanding the entity’s objectives, strategy and business model helps the auditor
to understand the entity at a strategic level, and to understand the business risks the entity takes and faces. An
understanding of the business risks that have an effect on the financial statements assists the auditor in identifying
risks of material misstatement, since most business risks will eventually have financial consequences and,
therefore, an effect on the financial statements.
ISA315 (Revised) defines business risk as a risk resulting from significant conditions, events, circumstances,
actions or inactions that could adversely affect an entity’s ability to achieve its objectives and execute its strategies,
or from the setting of inappropriate objectives and strategies.
A typical requirement in section A with a focus on business risk would be 'Using the exhibits provided, evaluate
the significant business risks facing the company/group'. The key elements to consider for this requirement to
note are as follows:
• Using the exhibits

Candidates are not required to have any industry specific knowledge. There will be sufficient detail in the scenario
to allow candidates to identify the key risks which should be evaluated. Candidates should focus on the risks arising
from the information provided and not speculate on additional risks which might arise.
• Evaluate
In order to evaluate effectively, Candidates will initially need to identify the risk arising from the information
provided and illustrate the impacts of the risk on the client. Candidates should make use of specific points that are
relevant to the client in the question rather than be discussed in a generic context.
Candidates should then expand on this issue in order to fully evaluate a point. There needs to be an assessment of
the scale of the risk in the context of the scenario. For example, an illustration of why this risk is particularly
significant for this client or discussing how the impact may be increased in the light of other risks and information
relevant to the scenario.
• Significant
In the context of the AAA exam, it is essential that candidates assess the significant business risks within the
scenario. These should be assessed as those issues which are a medium to high likelihood of occurrence and
impact, after consideration of any mitigation which is described in the scenario.
• Risk
Business risks, in the context of the AAA exam, are areas of uncertain occurrence and outcome, not factual
statements of something which has already happened and, therefore, is already fully quantified in the scenario.
Consider the example below from the September 2022 published question Winberry Co, a listed food delivery
company whose sales are made entirely online.
In this question, there are several different related risks which a candidate might identify. This topic will only be
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treated as one risk regardless of which of those are developed and marks will be available for many alternative
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development points.
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Examples of risks and evaluation are provided below.
Identification of the risk Initial development Further evaluation
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Impact
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Data breach may become

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The company will suffer
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The fact that the company
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public knowledge reputational damage and did not report the breach
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lose customers themselves may increase the

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reputational damage which

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Or would have occurred had this
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been disclosed immediately

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Customers will no longer (considering severity in the

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trust Winberry Co to protect

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context of the delay to
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their online data. reporting described in the

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scenario)
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The lack of trust in the

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website if customers do not

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trust Winberry to protect their

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data is a significant problem

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as Winberry Co only
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operates online and has no

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physical stores or outlets

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(considering severity in the

context of the specific
business model)
Identify Impact Scale

The company might be fined
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This will put pressures on These may be higher as a
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for data breaches

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cash flow and reduce profits result of Winberry Co not
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reporting the breach

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themselves (considering
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severity in the context of the

delay to reporting described
in the scenario)
The fall in profit may result in

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the breach of banking

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covenants (Linking to impact

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on other specific risks in the

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scenario)
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Further data weaknesses

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These may be more serious
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These will lead to more
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breaches where customer severe fines and bad
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been identified credit card or identity details publicity if this is the case.
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are lost (considering severity)
These examples are indicative not exhaustive, and candidates will be awarded credit for valid evaluation points
which relate to the scenario.
Professional marks associated with business risk
In most cases, the professional marks available for the evaluation of business risk will be commercial acumen.
These will be awarded in addition to the technical marks. Candidates will be awarded credit for professional skills
when answers demonstrate an awareness of potential commercial.
Examples where commercial acumen could be demonstrated in response to the above scenario
• Management’s failure to report the breach may lead to more serious consequences
• There is the additional risk of specific reputational damage which could impact share price as well as profits
• Linking the impact of any fine to the debt covenants on interest cover
• Linking the severity of the risk to the company being online only and, therefore, more exposed to the
consequences of data risk than a traditional retail outlet for groceries
It is possible to evaluate a risk severity in relation to the scenario without demonstrating commercial acumen and it
is also possible to demonstrate acumen in a risk not considered fully evaluated. Where a single response does
provide evaluation and demonstrate commercial acumen, credit will be awarded for both. The professional marks
are additional to, rather than, in place of technical marks.
Candidates should also note the following will not obtain marks for the identification and development of a risk.
Facts given in the question – there has been a data breach/credit card details may be lost – these are known and
therefore, not a risk. The risk is something uncertain as a result of the event or an uncertain event.
Risks which are flagged as mitigated in the scenario In the case of Winberry Co, the scenario was clear that
specialised staff were employed to ensure food safety legislation was complied with as part of the company risk
management strategy. These are likely to be easily replaceable given the ubiquitous nature of food. This might be
different in a particularly niche industry where experts are less readily available.
Extreme outcomes which are not likely – for example, 'the data breach will mean fines the company cannot
afford to pay and it will be bankrupt'. Whilst worst case scenarios exist, if this is not likely in the context of the
specific scenario, then it’s not necessarily a significant risk or an appropriate evaluation in this case. This outcome
might be valid in a different scenario, perhaps where the company has a history of severe data protection breaches,
with total disregard for data protection, and the company was already loss making, and experiencing cash flow
issues. Candidates are expected to tailor their answers to the specific scenario in the question. This is a
demonstration of professional judgement which is an important skill for auditors.
Summary
Candidates preparing for the AAA exam should be mindful that they will be required to evaluate risks in the context
of specific information provided in a scenario in the exam. The examining team are looking for depth of evaluation
of significant risks, rather than brief and untailored answers covering large numbers of risks. Candidates are
recommended to use past published questions to practice evaluation skills. Exam question practice is essential, but
candidates should remain mindful that they should not try and apply rote learnt or generic responses in the real
exam. They should ensure that their answer in the actual exam is tailored to the specific information provided in the
question, otherwise little credit will be awarded. Well prepared candidates using good technique often achieve full
marks in risk questions and this is often indicative of those candidates demonstrating the requisite professional
skills of an auditor.
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7/1/23, 12:41 PM =>
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Pale Company
Briefing Notes
To: Harvey Rebus, Audit engagement partner
From: Audit manager
Subject: Re: Audit planning for Pale Co
Date: 1 July 20X5
Introduction
These briefing notes include detail in relation to audit planning for Pale Company for the year ended 30
September 20X5. These briefing notes include detail relating to significant business risks to be considered in
planning of Audit for Pale Company. Further significant audit risks are also included in these briefing notes.
Audit procedures to be performed in relation to the change in fair value of the timber plantation asset caused
by the recent storms, are also included in these briefing notes. Lastly, ethical issues and other audit planning
implications which arise in relation to the phone call from the company’s chief finance officer, Mark York,
are also included in these briefing notes.
(a) Business Risk
International Expansion
Planned international expansion faces a risk of weak management control and supervision as it is an
expansion in remote developing country. As expansion is in a remote area, therefore management may not be
able to excercise suffecient control there, as a result investment in Farland may not be able to achieve its
profit targets. Further if management will spend too much time in control and supervision of this remote area
investment, then they may lose focus of their existing home country operations. Concern for control and
supervision of Farland investment is greater as Pale company will deal in processing of new type of timber in
Farland. They may lack expertise in relation to it and as a result it will require greater management time for
control and management.
Cancellation of grant
Considering news reports regarding Pale Company that they have made a payment of $15,000 to a
government official in Farland, Grant from international agency may get cancelled as Pale company action
may be regarded as an unethical business practice. Grant from international agency had a condition that Pale
company should be doing business in Ethical manner. Incentive payment made of $15,000 to a government
official may be regarded as unethical business practice, despite that it is normal in Farland. If the grant gets
cancelled that Pale company may not be able to complete its planned expansion of Farland considering that it
is already at limit of its bank borrowing agreement. Concern of ethical business practice is greater for Pale
company considering that it is also facing a legal claim from its employees over bad health and safety
environment at work place. If it also gets in knowledge of International agency then it may contribute
towards cancellation of grant based on unethical business practices done by Pale company.
Gold Standard accrediation
Pale Company may lose its Gold Standard accrediation if percentage of trees harvested according to gold
standard continue to decline and fall below 80% limit. During the year trees harvested according to gold
standard accrediation have already declined from 85% to 82%. If this decline will continue further than Pale
company may not be able to satisfy condition of 80% trees sold as per Gold standard. If Gold standard
accrediation is lost then Pale company may lose customer contracts which were gained on the basis of Gold
Standard status of Pale Company. This will include loss of Royal company contract which has contributed to
increase in revenue in current year. Gold standard accrediation may also get affected due to unethical
business practice concerns of Pale company, which include incentive payment made to government official
in Farland and claim made by employees over health and safety issues.
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7/1/23, 12:41 PM about:blank
Legal case
If Pale company is unsucessful in legal claim filed by its employees then it may have to pay compensation of
$19 million. Outflow of $19 million will create cash flow problems for Pale company considering that its
cash balances have already declined during the year by 33.8% and stand at $4.5 million. Further Pale
Company is at limit of its bank borrowing agreement, therefore it may not be able to arrange immediate
finance through bank loan. Claim filed of $19 million exceed, Pale company's entire year profit of $16.5
million, this indicates that this claim will be a significant concern if Pale company is unsucessful in it.
Further this claim filed by employees will also affect Reputation of Pale company and customers may not be
willing to do business with Pale company considering its unethical business practice of reducing staff
numbers and increasing pressure on its existing employees, which is also resulting in accidents.
Damage caused by Storm
Pale comapny has suffered a loss of $7.5 million due to recent storms in which many standing trees have
been completely destroyed and badly damaged. This will result in decline in Pale company profits when it is
recorded in current year financial statements. Due to this loss profit before tax of Pale comapny will decline
by 45.5% and will fall to $9 million. Loss of standing trees due to Storm will create problems in operations
of Pale company in some time, as due to loss of standing trees Pale company will have lesser timber to
harvest and process in future. This will affects its ability to fulfill customer orders and as a result customers
may switch to competitors. Pale company may not be able to overcome this problem in short term as it will
take time in growing new trees which are ready for harvest.
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Winberry Company
Briefing Notes
To: Olivia Fig, Audit engagement partner
From: Audit manager
Subject: Re: Winberry Co audit planning
Date: 1 July 20X5
Introduction
These briefing notes are in relation to audit planning for Winberry company for the year ended 30 September
20X5. Evaluation of significant Business risk in relation to Winberry company is part of these briefing notes.
Further Evaluation of significant risks of material misstatement in relation to Winberry company, are also
included in these briefing notes. These briefing notes also include principal audit procedures to be performed
in respect of the classification of the investment in Luxury Pet Supplies (LPS) Co.. Lastly these briefing
notes include Quince & Co’s responsibilities in relation to Winberry Co’s compliance with laws and
regulations regarding data protection issue.
(a) Business Risks
Perishable products
Winberry company deals in perishable grocerry items, which face a risk of inventory losses due to short shelf
life. If Winberry company is not able to sell these perishable grocerry items within their expiry date, then it
will suffer inventory losses, as a result of which its profits will decline. Further if any expired item is
delievered to customers then it may affect reputation of Winberry company, as it may affect health of
customer. During the year, one of the Winberry company's warehouse has been destroyed which has affected
northern region delieveries, this may result in delays in delieveries and as a result perishable inventory items
may get expired due to delays. Another concern is introduction of electric delievery vehicles which are also
causing delays uptill 4 hours, as a result of which perishable inventory items may get expired during
delievery process.
International expansion
Planned international expansion of Farland may not be successful if Winberry company fails to develop a
good warehousing and distribution network in Farland. As this expansion will be financed through bank loan,
therefore directors will have a pressure to achieve good performance early. If they fail to achieve good results
earlier then fixed interest cost of loan will affect results of other operations also. Loan will be on the basis of
covenant to maintan interest cover at 3 times. As new international operations may not be able to give good
results in starting years, interest cover of Winberry company may decline below 3 times, as fixed interest
cost due to loan for international expansion will deteriorate interest cover. Breach of loan covenant may
result in recall of existing bank loans also.
Data protection issue
If incident of cyber security attack comes in public knowledge then it will affect reputation of Winberry
company. Customers will lose trust on Winberry company website and they will be reluctant to do online
purchasing from there considering risk to their personal information including credit card details. This will
lead to loss of customers and decline in sales. This risk is a major concern for Winberry company's business
as their sales are entirely online through their website and online application. Loss to reputation will be
greater as Winberry company is hiding this incidend and this will create concern on their integrity also, if it
gets in to public knowledge from other sources.
Investment in Luxury Pet Supplies Company
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Investment in Luxury Pet Supplies Company is exposed to a risk of conflicts between Winberry company
and Dorian company, as it is a Joint venture investment. If management style of Winberry company and
Dorian comapny, will be different then it will result in delayed decision making in Luxury Pet Supplies
company. This will result in investment not being able to achieve its desired profit targets. Risk in this
investment is greater considering that Winberry company lacks expertise of Pet supplies market. If due to
conflicts it is decided that both of the venturers will do their businesses seperately then Winberry company
may not be able to operate in this segment considering their lack of expertise in relation to Pet supplies
market.
Destruction of Warehouse
Winberry company may face a loss of $67 million due to fire at warehouse, if insurance company do not
approve its claim for warehouse building and machinery. Due to this loss, profits of Winberry company will
decline and may convert in to a loss for the year, as existing profits before accounting for this loss are just
$53 million and destroyed warehouse represents $67 million in property, plant and equipment. Further a cash
flow burden will also be created due to construction of new warehouse and purchasing of machines. As this
warehouses was providing service to northern region customers of Winberry company, therefore due to its
destruction norther region customers may get delays in delievery. Further rest of the four warehouses which
are covering this loss of storage may also be facing extra operational burden. This may result in Winberry
company losing some of the customer orders due to lack of capacity.
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7/8/23, 9:42 AM about:blank
Mercurio Company
Briefing Notes
To: Ted Hastings, audit engagement partner
From: Audit manager
Subject: Re: Audit planning – Mercurio Co
Date: 1 July 20X5
Introduction
These briefing notes are in relation to audit planning for Mercurio Company for the year ended 30 September
20X5. It includes evaluation of significant business risks faced by Mercurio Company. Further evaluation of
significant risks of material misstatement in relation to Mercurio company audit planning, are also included
in these briefing notes. Impact of outsourcing the credit control function on our audit planning, is also
included in these briefing notes. Lastly principal audit procedures to be performed in respect of the holiday
pay obligation, are also included in these briefing notes.
(a) Business Risks
Animal Welfare
Mercurio company stores also sell animals along with pet related products. This creates a risk of breach of
animal welfare standards in relation to animals kept in stores of Mercurio company. Animals have to be kept
in clean and safe environment. If there is any breach of animal welfare standards then it can result in
regualtory breach of animal welfare regulations. This may lead to penalties and suspension of license.
Further if ill treatment of animals is done in stores of Mercurio company and this comes in public knowledge
then it can also affect reputation of Mercurio company. This risk is greater as Mercurio company has 264
stores and it has to make sure that animal welfare regulations are followed in them. Further Merucrio
company also has to make sure that animals are imported in proper clean and safe environment as it is also
importing some of its animals. Improt related restrictions also need to be complied by Mercurio compay.
Staff training
Mercurio company also faces a risk of inadequate staff training which may result in wrong advises given by
staff to customers in relation to nutrition and general animal health. If staff at Merucrio company stores have
inadequate training and they give wrong advise to customers in relation to animal nutrition and general
animal health, then it will affect repuation of Merucrio company as it will result in adverse impact on animal
health of animals held by customers. Further inadequate staff training may also result in accidents in relation
to animal handling. Staff at Mercurio company stores also have to handle animals kept in stores, and if they
are inadequately trained then they may injured animals OR may be themself. This risk is greater in relation to
abnormal animals kept in some stores, like spiders, snakes and other reptiles. This may require specific
training in relation to handling them.
Veterinary services
Veterinary services offered by Mercurio company faces a risk of negligence done by any vet employed by
Mercurio company. If any Vet makes negligence whille vaccinating animals of Customers OR while
performing health check ups, then it can results in legal issues for Mercurio company. Further it can also
result in loss of repuation as in case of negligence done by Vet of Merucrio company, customers may get
reluctant to bring their animals to Mercurio comapny stores. Veterinary services offered by Merucrio
company is not a very profitable segment as cost relation to veterinary services have increased in recent
years and Mercurio company is not able to shift this burden to customers considering their price sensitivity.
This may lead to decline in overall profits of Meruciro company. Further cost burdens may force Mercurio
company to reduce its quality control measures which increase risk of accidents and negligence.
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Stores purchased from Lakewall company
Mercurio company has spent $171 million for purchase of 20 stores from Lakewall company, this will lead to
liquiditiy issues for Mercurio company as its cash balances have already declined by 55% during the year.
Liquidity issues may affect operations of Mercurio company in adverse manner, as it may not be able to pay
its suppliers on time. Further Mercurio company may not be able to complete its planned refitting by January
20X6 due to liquidity issues. Company required cash reserves of $180 million to refit its 20 stores purchased
from Lakewall comapny, whereas current cash balance is just $36 million. Even if all cash reserves are spent
then also only 4 stores can be refitted. This will result in planned expansion strategy not getting successful.
Further stores purchased from Lakewall company may include some stores which are not at good locations,
and Mercurio company may have to sell them at a lesser value as compared to their purchase price.
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7/8/23, 1:54 PM Exam | GoCBE Global Pvt Ltd
The Sunshine Hotel Group
Briefing Notes
To: John Starling, audit engagement partner
From: Audit manager
Subject: Re: Audit planning, the Sunshine Hotel Group
Date: 1 September 2017
Introduction
These briefing notes are in relation to audit planning for The Sunshine
Hotel Group for the year ended 31 December 2017. Evaluation of
business risks in relation to The Sunshine Hotel group are included in
these briefing notes. Further evaluation of significant risks of material
misstatement, are also included in these briefing notes. In relation to
email received from the Finance director additional implications for
planning the Group audit and any relevant actions to be taken by the
firm, are also included in these briefing notes. Lastly briefing notes
include planned audit procedures to be performed on the claim of $10
million, assuming that the audit team is given access to all relevant
sources of audit evidence.
(a) Business risks
Luxury hotels
The Sunshine Hotel group only deals in luxury hotels, which exposes it to
a risk of falling sales in times of economic recession. Luxury products
suffer the most in times of economic recession as customers cut their
spending on luxury products first. Sunshine hotel group will face decline
in customers and sales if economic recession is faced in countries in which
it operates. Sunshine hotel group has high fixed cost due to its all
inclusive policy under which it has to provide all facilities to customers
irrespective of number of customers present in hotel. Further signigicant
spending on marketing cost and cost to maintan high standards of hotels,
also increase fixed cost of The Sunshine hotel group. High fixed cost will
become a concern when sales will decline due to economic recession.
Bad Investments
The Sunshine Hotel group has made bad investments of $98 million
during the year which donot generate any returns for the Group. Land
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purchased in Farland for $75 million is a bad investment as Farland is

suffering from political instability. The Sunshine Hotel group may not be
able to recover its investment from Farland, even by selling these lands,
considering political instability. Further another investment made of $23
million for purchase of hotel complex from competitor is also a bad
investment considering that due to local regulations, The Group cannot
develop its hotels there due to restriction on its key selling point of
private beaches. These bad investments will result in liqauidity issues for
The Group and will also result in fall in return in capital employed,
because these investments are not generating any positive returns for the
group.
Liquidity issues
The Sunshine Hotel group has already spent $103 million during the year
in investments of Farland, Hotel complex from competitor and License
agreement of Moulin Blanche. Further plan of investment of $45 million
through bank loan will result in liquidity issues for The Group. Planned
investment on the basis of bank loan will create fixed interest cost of $1.5
million which is 15% of group's existing Profit before tax. This fixed
interest cost will create further burden on cash flows of The Group.
Liquidity concerns are greater considering damage caused to two hotels
due to hurricanes. Group will have to invest $12.5 million till the repair
work is completed, as after that this amount will be reimbursed by
insurance company. Further claim of Ocean protection of $10 million will
also create burden on cash flows, considering cash balances left of $20
million only.
Damage to group hotels
Two of the group hotels have been damaged due to hurricanes, this will
result in ceasation of operations in those hotels. During the repair period,
The Group will not be able to generate revenue from these hotels.
Additional cost will be created in form of shifting customers to other group
hotels. Further refunds offered to customers will create burden on cash
flows of the Group. Operations of other hotels where customers are being
shifted will face extra burden, and may suffer decline in quality in those
hotels. Insurance policy is covering damage to the hotels caused,
however it may not cover damage caused to furniture and equipment
placed in hotel rooms. This will create further loss to the group.
Claim of Ocean Protection
Claim of Ocean protection indicates a regulatory breach done by The

Sunshine Hotel group. If the claim filed by Ocean protection is correct and
regulators get to know about this, then it will lead to penalties being
imposed on The Group. It may also lead to suspension of license in some

of the countries. Another risk which exist is reputational loss, which may
arise if public gets to know about environmental damage being done by
The Group. Customers will be reluctant to vist The Sunshine Hotel group,
hotels considering their damage to environment. Group has low cash
balances and it may not be able to negotiate with Ocean protection in a
better manner.
Connolly Company
Briefing Notes
To: Ali Stone, Audit partner
From: Audit manager
Subject: Re: Audit planning – Connolly Co
Introduction
These briefing notes are in relation to audit planning for Connolly

Company for the year ended 31 December 2014. These briefing notes
include evaluation of Business risks faced by Connolly company. Further
Risks of material misstatement to be considered in planning of audit for
Connolly company, are also included in these briefing notes. These
briefing notes also include principal audit procedures to be performed in
respect of the acquired ‘Cold Comforts’ brand name. Lastly ethical issues
relevant to the audit firm, and appropriate actions to be taken, are also
included in these briefing notes.
(a) Business Risks
Licensing of Drugs
Connolly company faces a risk that it may not be able to obtain license for
its four new drugs which are in development phase. If license for these
four new drugs will get rejected, then Connolly company will face a loss of
amount invested in development of these four new drugs. During current
year Connolly company has invested $3 million on development of these
four new drugs. Further this will also affect Connolly company's ability to
compete in innovative market in which it operates. Risk of license
rejection is high, considering a legal claim being faced by Connolly
comapny in relation to injury caused by a person who participated in
clinical trails of Connolly company drugs.
Advertisement
Connolly company faces a risk of regulatory breach if it runs television

advertisement in countries where it is prohibited. If Connolly company will
run television advertisement in countries where it is prohibited then it
may result in penalties being imposed on Connolly company. Further if
this breach is done multiple times then it may result in suspension of
license also in those countries. As Connolly company relies on heavy
advertisement to support its brand name, therefore risk of negligence by
marketing department in relation to running television advertisement in

prohibited countries is very high.
Patent rights
Connolly company may get itself involved in patent rights disputes, if

Connolly company copies patent of any other pharmaceticual company. It
may result in legal claim being filed against Connolly company and this
may lead to significant legal cost being incurred. If any patent breach will
be done by Connolly comapny then it may lead to compensations being
payable also. Further another risk in this situation is, that some other
company may copy Connolly company's patent, and as a result Connolly
company will have to incurre heavy legal cost in order to defend its patent
right. This risk is high considering that market is competitive and
company's may be aggressive in their innovation strategies which may
result in patents getting copied of each other.
Liquidity issues
Approach by Connolly company to its bank for extension in borrowing

facility indicates that Connolly company is suffering liquidity crisis. Further
Connolly company has also requested its bank for a loan to pay
compensation in relation to legal case filed against it. This also indicates
company's weak liquidity position. Connolly comapny has suffered a
negative cash flow during the year of $1.2 million. Further gearing of
Connolly company is also very high at a ratio of 0.8. Further loans will
increase this gearing to a higher level. This liquidity crisis will affect
Connolly company's ability to operate its operations in a smooth manner.
Considering a legal case being filed against the company and ongoing
development of four new drugs, liquidity issues may create significant
problems for Connolly company.
Legal case
Legal case filed against the company in relation to side affects in clinical
trails create a reputational risk for Connolly company. If matter of this
legal case comes in public knowledge then it will make consumers
reluctant to use Connolly company drugs, considering health risks of side
affects in it. This will result in decline in sales of Connolly comapny.
Further another risk due to this legal claim is regultory penalties being
imposed on Connolly company. If side affects suffered in clinical trails
were not reported to regulator while obtaining license then it may lead to
heavy penalties being imposed on Connolly company.
Exam technique 2 – Planning

questions and risk (part 2)
Home / Students / Study resources / Advanced Audit and Assurance (AAA) / Technical articles / Exam technique 2 – Planning questions and risk (part 2)
RoMM and audit risk in the AAA exam

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Risks of material misstatement (RoMM)

• Examinable documents
Risk of material misstatement (‘RoMM’) may exist at the financial statement or at the level of individual financial • Answering Section A questions in the AAA exam
statement assertions.
To understand where risks arise at the financial statement level, the auditor must identify significant classes of
transactions and balances in which material misstatements may arise.
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Where RoMM exist at the assertion level, this will arise through a combination of inherent risk and control risks.
Both must be assessed if controls are expected to be relied on as part of the overall assessment of the RoMM.
Inherent risks
ISA 315 (Revised 2019), Identifying and Assessing the Risks of Material Misstatement identifies five types of
inherent risk factors:
• complexity
• subjectivity
• change
• uncertainty
• susceptibility to management bias or other fraud risk factors
Candidates should consider whether these factors are present in the scenario provided to assist in identifying
RoMM.
Spectrum of risk
The auditor will then assess where on the spectrum of inherent risk these risks sit. This requires an assessment
of likelihood and magnitude of the potential misstatement. Significant audit risks are those at the upper end of the
spectrum of inherent risk. This will determine what is a significant RoMM.
Assessing the significance
Risks which could not create a material impact, or which are not significant will not be capable of obtaining credit
where candidates have been asked to evaluate ‘significant risks of material misstatement’.
Judging what is, or is not, a significant risk is a crucial skill for auditors and in the exam, the ability to make this
judgement relevant to a specific scenario is critical to obtaining the credit required to pass.
Worked example
Example
A company has a newly purchased and highly material intangible asset, such as a brand name.
The scenario the issue is compounded by management who are under pressure to achieve a
certain interest cover ratio or earnings per share. The company has also purchased a plot of
land for $3million.
Management will use their judgement to decide the useful life of the intangible asset.
The purchase of land is factual, and unless there is evidence to the contrary, this will be stated
at cost in the financial statements.
However, we have both judgement and management bias as inherent risk indicators in respect
of the brand name. This is more likely to be a significant risk than the land purchase.
The assessment of inherent risk is the first stage of identifying and evaluating a significant
RoMM.
Control risk
An assessment of control risk is also required in assessing whether this RoMM is likely to occur in the financial
statements. If there is information provided about controls in the scenario, this should form part of candidates’
judgement in determining whether a risk is significant or not.
Sometimes this will be at the assertion level, for example, in the example of Winberry (September 2022),
information was given in the scenario regarding the valuation of inventory:
Although these perishable items were ‘a significant proportion’, the scenario stated that the items are monitored by
‘experienced food and product technology professionals. Many candidates discussed that this would be a valuation
risk as inventory may be obsolete however, the scenario provides mitigation against these risks of valuation.
The statement that ‘the company complies with all food safety legislation’ also mitigated the risk that the groceries
may breach health and safety legislation.
Note: Candidates should note that this definition of ‘significant’ is a specific audit concept and
should not be switched for other words with a similar meaning. Similarly, the word ‘material’ has
a specific definition in audit and should not be replaced by similar words, such as ‘significant’.
Significant risk – an identified and assessed risk of material misstatement that, in the auditor’s judgement,
requires special audit consideration.
Candidates will be required to identify and assess those significant RoMMs in the context of the specific scenario.
Candidates may be asked to evaluate and prioritise significant RoMM arising in a scenario, or to explain why a
significant RoMM has been identified (see the separate article on ‘Answering Section A questions in the AAA
exam’ – access via the 'Related links' box).
Candidates can use the potential materiality of a misstatement alongside the inherent risk factors to help them
assess which issues give rise to significant RoMM.
Materiality
For guidance on how materiality is examined, see the specimen exam and the associated Read
the Mind of the Marker (Q1) material on the ACCA website. The Examiners Report for the
September 2022 examination will also provide additional guidance.
Evaluation of the risk
Significant risk, once identified, must be explained and evaluated in the context of the scenario. This often involves
applying financial reporting knowledge to evaluate where and how the risk arises in the scenario. This may be
supported by movements in ratios and trends, as well as any incidences of possible management bias.
In Winberry (Sept 2022), the scenario stated that the data breaches might give rises to fines from regulators.
Management had not self-reported the breach in an attempt to avoid a fine. Although, most candidates identified
there was a RoMM associated with the recording and disclosure of the potential fine, few evaluated how significant
an issue this may be.
One way to evaluate this would be to use the recognition criteria for a provision.
Examples of evaluated responses
These are examples of good analysis which well-prepared candidates have provided in the
exam and illustrates the depth of evaluation possible using the scenario specific information.
Application of judgement:
These are demonstrations of a candidate's judgement as they are assessing the information in
the scenario to draw conclusions and to evaluate the extent of the risk.
‘Given that the company do not wish to disclose the breach to the regulator, it is likely that a fine
would be probable should the regulator be made aware of the breach’
‘If the breach is not reported to the regulator and is not disclosed by any other party, then the
fine is not probable’
‘However, if it is possible the regulator would be made aware then there would be a contingent
liability which would require disclosure in the financial statements’
Demonstration of the wider commercial aspects of the lack of disclosure (credit for
commercial acumen):
‘The disclosure of the contingent liability would effectively notify the regulator of the breach,
making the likelihood of a fine more probable ‘
Further actions relevant to the assertion and scenario:

‘A reliable estimate can be made by reference to historical fines issued to other organisations
for similar breaches, hence a provision should be made’
Demonstration of recognition of potential management bias (scepticism by the

auditor): ‘Management may be reluctant to provide for the fine as the reduction in profit as a
result might mean interest cover covenants are breached’
Assessment of the scale and impact of the risk:

These are assessments of the impact and scale of the risk on the financial statements.
‘As a result, a provision might be omitted from the company liabilities and profits may be
overstated’
‘The amounts payable might be higher as a result of failure to self-report which increases the
impact of the misstatement’
‘The potential impact of the understated expenses on the interest cover covenant may make
this material by nature if it would result in a breach of covenants’
This demonstrates that the candidate has assessed the materiality of the breach, and even
without a specific figure being stated, management’s attitude and the risk of breaching the bank
covenants, are likely to make this risk material to the audit.
Linking the risk to wider issues:

‘Management’s failure to self-report may give rise to concerns regarding management’s
integrity. Which then gives rise to risks of material misstatement at the financial statements
level, thereby reducing the reliability of management’s assertion as a form of audit evidence’
Where more complex financial reporting is examined, such as those topics examined only at Strategic Business
Reporting (SBR) level, additional credit will be available for the relevant underlying financial reporting knowledge,
or where the candidate provides additional guidance on the relevant area of financial reporting raised in the
scenario.
Audit risk
Audit risk is the combination of RoMM and detection risk. Detection risks arise where there is a risk that a
material misstatement may not be detected. Where a question requires audit risks, both detection risks and RoMM
should be considered.
Some of these detection risks arise in special circumstances:
• Group audits where the group auditor is reliant on component auditors
• New clients where there is no past experience of the client and their business.
• Audits where quality management or ethical threats may prevent the auditor from obtaining sufficient
appropriate evidence. For example, in specialised industries where the audit team do not have appropriate,
specialised competencies or where intimidation or self-interest threats prevent appropriate challenge of
management.
A lack of professional scepticism increases detection risk.
Professional marks
Professional marks awarded in audit risk and RoMM questions typically fall into the following broad categories.
Analysis and evaluation

Candidates will be awarded a mark for prioritising their most significant risks. This must be clearly stated. Simply
saying ‘significant risks include...’ will not be awarded the professional skill mark. All the identified risks should
be significant, so this is not specific enough. Stating ‘the most significant risk is ….’ or ‘the two most significant
risks are…’ should be enough to obtain the credit provided that the identified risk is a significant risk.
A second professional skill mark is available for saying why that risk was selected. This may be justified based on
the likelihood or potential magnitude of the material misstatement. The mark here is for the demonstration of that
evaluation to determine why something is important. There is no specific correct answer that the examining team
are looking for, but rather a demonstration of the thought process behind the judgement.
This can be demonstrated in a conclusion at the end of the relevant requirement or through specific numbering and
ordering of paragraphs. The former approach is likely to be easier for candidates in exam conditions.
Professional scepticism and judgement
These skills will test the ability of the candidate to challenge management’s accounting decisions and treatments, or
to draw conclusions on why risks are significant in the specific scenario as well as the identification of areas of risk
and bias. Often the examining team will allow credit for identifying a specific risk of bias from the scenario and
additional marks for drawing conclusions on the accounting treatments used by management. Scepticism is
required to link risks and issues to management motives and consider the wider implications of the issue.
Commercial acumen
This skill can also be demonstrated through the evaluation of risks. Commercial acumen can sometimes be thought
of as ‘how the world works as opposed to how the auditor thinks. For example, in a scenario assessing the risks
arising in a group where a subsidiary has a year-end date a month earlier than the parent company, there are
several risks arising from the group accounting implications of this situation. There are, however, further risks
arising because the additional month of management accounts will make up the difference. Knowing that this extra
month will not have been subject to audit, as well as that the company month end procedures are often less
comprehensive than their year-end procedures, demonstrates a knowledge of commercial reality and this would
form part of the assessment of commercial acumen.
Summary
Candidates will be required to evaluate risks in the context of specific information provided in a scenario in the
exam. The examining team are looking for depth of evaluation of significant risks, rather than brief and untailored
answers covering large numbers of risks. Candidates are recommended to use past published questions to practice
evaluating risks in scenarios and remember to tailor their answer to the specific information in their current exam
scenario, little credit will be awarded.
Candidates who follow the rules of WHAT/WHY/IMPLICATION are likely to maximise their technical marks as well
as demonstrating good professional skills (and therefore professional skill marks).
Written by a member of the AAA examining team

Mercurio Company
Briefing Notes
To: Ted Hastings, audit engagement partner
From: Audit manager
Subject: Re: Audit planning – Mercurio Co
Date: 1 July 20X5
Introduction
These briefing notes are in relation to audit planning for Mercurio Company for the year ended 30 September
20X5. It includes evaluation of significant business risks faced by Mercurio Company. Further evaluation of
significant risks of material misstatement in relation to Mercurio company audit planning, are also included
in these briefing notes. Impact of outsourcing the credit control function on our audit planning, is also
included in these briefing notes. Lastly principal audit procedures to be performed in respect of the holiday
pay obligation, are also included in these briefing notes.
(a) Business Risks
Animal Welfare
Mercurio company stores also sell animals along with pet related products. This creates a risk of breach of
animal welfare standards in relation to animals kept in stores of Mercurio company. Animals have to be kept
in clean and safe environment. If there is any breach of animal welfare standards then it can result in
regualtory breach of animal welfare regulations. This may lead to penalties and suspension of license.
Further if ill treatment of animals is done in stores of Mercurio company and this comes in public knowledge
then it can also affect reputation of Mercurio company. This risk is greater as Mercurio company has 264
stores and it has to make sure that animal welfare regulations are followed in them. Further Merucrio
company also has to make sure that animals are imported in proper clean and safe environment as it is also
importing some of its animals. Improt related restrictions also need to be complied by Mercurio compay.
Staff training
Mercurio company also faces a risk of inadequate staff training which may result in wrong advises given by
staff to customers in relation to nutrition and general animal health. If staff at Merucrio company stores have
inadequate training and they give wrong advise to customers in relation to animal nutrition and general
animal health, then it will affect repuation of Merucrio company as it will result in adverse impact on animal
health of animals held by customers. Further inadequate staff training may also result in accidents in relation
to animal handling. Staff at Mercurio company stores also have to handle animals kept in stores, and if they
are inadequately trained then they may injured animals OR may be themself. This risk is greater in relation to
abnormal animals kept in some stores, like spiders, snakes and other reptiles. This may require specific
training in relation to handling them.
Veterinary services
Veterinary services offered by Mercurio company faces a risk of negligence done by any vet employed by
Mercurio company. If any Vet makes negligence whille vaccinating animals of Customers OR while
performing health check ups, then it can results in legal issues for Mercurio company. Further it can also
result in loss of repuation as in case of negligence done by Vet of Merucrio company, customers may get
reluctant to bring their animals to Mercurio comapny stores. Veterinary services offered by Merucrio
company is not a very profitable segment as cost relation to veterinary services have increased in recent
years and Mercurio company is not able to shift this burden to customers considering their price sensitivity.
This may lead to decline in overall profits of Meruciro company. Further cost burdens may force Mercurio
company to reduce its quality control measures which increase risk of accidents and negligence.
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Stores purchased from Lakewall company
Mercurio company has spent $171 million for purchase of 20 stores from Lakewall company, this will lead to
liquiditiy issues for Mercurio company as its cash balances have already declined by 55% during the year.
Liquidity issues may affect operations of Mercurio company in adverse manner, as it may not be able to pay
its suppliers on time. Further Mercurio company may not be able to complete its planned refitting by January
20X6 due to liquidity issues. Company required cash reserves of $180 million to refit its 20 stores purchased
from Lakewall comapny, whereas current cash balance is just $36 million. Even if all cash reserves are spent
then also only 4 stores can be refitted. This will result in planned expansion strategy not getting successful.
Further stores purchased from Lakewall company may include some stores which are not at good locations,
and Mercurio company may have to sell them at a lesser value as compared to their purchase price.
(b) Risks of Material misstatement
Materiality Level
Materiality level of Mercurio company will be based on its profit before tax. As per auditing standards this
materiality level will be between range of 5% to 10% of PBT. In case of Mercurio company it will be
between $3 million to $6 million. Our firm will have to use professional judgement in order to determine
actual materiality level from this range. This judgement will be based on risk assesment of Mercurio
company. As Mercurio company is an existing audit client of our firm, therefore from this perspective audit
risk of Mercurio company is low. However Merucrio company is a listed entity therefore it will have to face
greater regulatory requirements. From this perspective audit risk of Mercurio comapny audit will be
considered as higher. During the year Mercurio comapny purchased 20 new stores worth $171 million.
Considering this significant transaction during the year, audit risk of Mercurio company audit can be
considered as high. It can be concluded that overall risk of Merucrio comapny audit is high considering its
listed company status and major transaction in relation to purchase of 20 stores. Due to high audit risk,
auditor will opt lower level of materiality which is $3 million.
Stores purchased from Lakewall comapny
Mercurio company should classify those stores under property, plant and equipment head, on which its
assumption is to use in its business. Those stores on which management intention is to sell them OR the
intention is not yet decided, should be recognized as Investment property. Further those stores which are
planned to be sold in next 12 months should be classified as Held for sale. Mercurio company management
has not yet decided about the intention in relation to these 20 stores purchased, and they have shown all 20
stores together as an asset worth $171 million under assets head. A risk exist that management has done
wrong classification for some of its stores if they have clear intention for them, like those on which intention
is to use should be shown seperately under property, plant and equipment head. Due to wrong classification
of these 20 stores, valuation at year end may get affected as under each of the head there are different
valuation models. This will affect valuation of these 20 stores recorded in assets. Stores purchased from
Lakewall company worth $171 million exceed materiality level determined for Mercurio comapny audit of
$3 million, therefore these transactions are material to financial statement.
Revenue recognition
Mercurio company should recognize revenue from annual health care plans over the year in which it is
providing service. Revenue should be recognized as Mercurio company provides services in form of
essential vaccinations and quarterly health checkups of animals. Revenue should spread over the year as
company provides relevant service to customers. Management of Mercurio comapny wrongly recognizes
entire revenue of annual health care plan when the plan commences. This treatment is wrong, as when
company is recognizing revenue at start of plan, when service is not yet provided to customers. Due to early
recognition of revenue, Mercurio comapny has overstated its revenue and understated its deferred income
liability. Revenue from annual health care plans represents 10% of total revenue, which worth $80.3 million.
It exceeds materiality level determined for Mercurio comapny audit of $3 million, therefore it is material to
financial statements.
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Holiday pay obligation
Mercurio company should recognize liability of unused holiday pay obligation in relation to those unused
holidays which can get carry forward to next year. Company should record unused holiday pay obligation for
3 days only per employee as Mercurio company policy only allows carry forward of 3 days of unused
holidays. In case of Mercurio company unused holiday pay obligation has increased from $1,871 per
employee to $3,014 per employee in current year. This significant rise indicates a risk that management may
have wrongly estimated the holiday pay obligation in current year. Risk of misstatement is also high because
as per internal audit findings, mannual records are maintained in relation to holidays of staff, despite the
system has capability to record it. Due to wrong estimation of holiday pay obligation, liabilities and expense
recorded in relation to it will be overstated. Holiday pay obligation recorded at current year end worth $21.1
million exceed materiality level of $3 million determined for Mercurio company audit, therefore it is
material to financial statements.
Goods in transit
Mercurio comapny should write off the goods in transit which have been completely destroyed due to an
accident during transit. As per the purchase contract the risk and rewards were transferred to Mercurio
company when goods were shipped. Therefore Mercurio company should write off this inventory as it has
been destroyed. In relation to insurance claim, a disclosure note should be given as claim is submitted and is
due to be processed. It is currently in probable phase. Management of Mercurio company has not written off
the inventory, which has been destroyed. This is a wrong treatment and it will overstate inventory and profits
of Mercurio company. Goods in transit worth $12 million exceed materiality level of Mercurio company of
$3 million, therefore it is material to financial statements.
Financial analysis
Growth in revenue 7.7%

Growth in operating profit 56.3%
Growth in profit before tax 7.1%
Operating profit margin in
14.7%
20X4
Operating profit margin in
21.4%
20X5
Increase in trade receivable 90.9%
Revenue has shown an increase of 7.7%, which is a reasonable growth considering a steady growth achieved
by Mercurio company business every year and due to introduction of Mercurio range products. However
operating profit has shown an abnormal increase of 56.3% which indicates a risk of misstatement. In recent
years cost of vaccinantion and annual health plans have increased but selling prices were not increase due to
customer price sensitivity. This should have resulted in falling operating profit margins rather showing an
increase of more than revenue. Operating profit margins also showed an abnormal increase from 14.7% to
21.4%. Profit before tax has shown increase of 7.1% which is reasonable considering increase in revenue by
7.7%. Further trade receivables have shown an increase of 90.9% which is an abnormal increase. Merucrio
company management has not provided any valid reasoning for it and have only stated that it is due to
increase in credit sales. Total sales have only increased by 7.7%, therefore increase of 90.9% in trade
receivables due to higher credit sales is not justified. It indicates risk of bad debts being included in trade
receivables.
Conclusion
Stores purchased from Lakewall comapny are considered as most significant risk considering their value of
$171 million. It was a significant transaction as it represented 15.8% of total assets. Then risk relating to
revenue recognition policy for annual health care plans was second most significant risk as it affected
revenue of $80.3 million. Lastly unused holiday pay obligation was third highest risk as it represented head
of $21.1 million.
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Winberry Company
Briefing Notes
To: Olivia Fig, Audit engagement partner
From: Audit manager
Subject: Re: Winberry Co audit planning
Date: 1 July 20X5
Introduction
These briefing notes are in relation to audit planning for Winberry company for the year ended 30 September
20X5. Evaluation of significant Business risk in relation to Winberry company is part of these briefing notes.
Further Evaluation of significant risks of material misstatement in relation to Winberry company, are also
included in these briefing notes. These briefing notes also include principal audit procedures to be performed
in respect of the classification of the investment in Luxury Pet Supplies (LPS) Co.. Lastly these briefing
notes include Quince & Co’s responsibilities in relation to Winberry Co’s compliance with laws and
regulations regarding data protection issue.
(a) Business Risks
Perishable products
Winberry company deals in perishable grocerry items, which face a risk of inventory losses due to short shelf
life. If Winberry company is not able to sell these perishable grocerry items within their expiry date, then it
will suffer inventory losses, as a result of which its profits will decline. Further if any expired item is
delievered to customers then it may affect reputation of Winberry company, as it may affect health of
customer. During the year, one of the Winberry company's warehouse has been destroyed which has affected
northern region delieveries, this may result in delays in delieveries and as a result perishable inventory items
may get expired due to delays. Another concern is introduction of electric delievery vehicles which are also
causing delays uptill 4 hours, as a result of which perishable inventory items may get expired during
delievery process.
International expansion
Planned international expansion of Farland may not be successful if Winberry company fails to develop a
good warehousing and distribution network in Farland. As this expansion will be financed through bank loan,
therefore directors will have a pressure to achieve good performance early. If they fail to achieve good results
earlier then fixed interest cost of loan will affect results of other operations also. Loan will be on the basis of
covenant to maintan interest cover at 3 times. As new international operations may not be able to give good
results in starting years, interest cover of Winberry company may decline below 3 times, as fixed interest
cost due to loan for international expansion will deteriorate interest cover. Breach of loan covenant may
result in recall of existing bank loans also.
Data protection issue
If incident of cyber security attack comes in public knowledge then it will affect reputation of Winberry
company. Customers will lose trust on Winberry company website and they will be reluctant to do online
purchasing from there considering risk to their personal information including credit card details. This will
lead to loss of customers and decline in sales. This risk is a major concern for Winberry company's business
as their sales are entirely online through their website and online application. Loss to reputation will be
greater as Winberry company is hiding this incidend and this will create concern on their integrity also, if it
gets in to public knowledge from other sources.
Investment in Luxury Pet Supplies Company
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Investment in Luxury Pet Supplies Company is exposed to a risk of conflicts between Winberry company
and Dorian company, as it is a Joint venture investment. If management style of Winberry company and
Dorian comapny, will be different then it will result in delayed decision making in Luxury Pet Supplies
company. This will result in investment not being able to achieve its desired profit targets. Risk in this
investment is greater considering that Winberry company lacks expertise of Pet supplies market. If due to
conflicts it is decided that both of the venturers will do their businesses seperately then Winberry company
may not be able to operate in this segment considering their lack of expertise in relation to Pet supplies
market.
Destruction of Warehouse
Winberry company may face a loss of $67 million due to fire at warehouse, if insurance company do not
approve its claim for warehouse building and machinery. Due to this loss, profits of Winberry company will
decline and may convert in to a loss for the year, as existing profits before accounting for this loss are just
$53 million and destroyed warehouse represents $67 million in property, plant and equipment. Further a cash
flow burden will also be created due to construction of new warehouse and purchasing of machines. As this
warehouses was providing service to northern region customers of Winberry company, therefore due to its
destruction norther region customers may get delays in delievery. Further rest of the four warehouses which
are covering this loss of storage may also be facing extra operational burden. This may result in Winberry
company losing some of the customer orders due to lack of capacity.
(b) Risks of Material Misstatement
Materiality
Materiality level for Winberry company audit will be based on its profit before tax. It will be between range
of 5% to 10% of its PBT. In case of Winberry company audit its amount will be between $2.65 million to
$5.3 million. Our firm will have to use professional judgement in order to select materiality level from this
range, and it will be based on risk assesment of Winberry company audit. Winberry company is an existing
audit client of our firm, therefore audit risk will be low from this perspective. However as it a listed entity
therefore it will face higher regulatory requirements. Further there were few major transactions done during
the year, which include investment in LPS company of $30 million, purchase of electric vehicles worth $4
million and launch of new premium deleivery passes. Considering major transactions during the year and
listed company status, risk of Winberry company audit can be judged at medium level, and therefore auditor
will select middle range from materiality levels. It will be 7.5% of PBT which will be $3.975.
Destruction of warehouse
Winberry company should record impairment loss on warehouse which has been destroyed due to fire
incident. Recoverable amount of warehouse must have fallen below its carrying value as entire premises
have been destroyed. Impairment loss should be booked of entire carrying value as warehouse is destroyed.
Management of Winberry company has not recorded impairment loss on the basis that insurance company
will cover the loss amount. This is wrong accounting treatment as insurance claim should be treated
seperately and impairment loss should be booked seperately. Failure to record impairment has overstated
warehouse asset recorded in property, plant and equipment and it has also overstated profit. Carrying value of
destroyed warehouse recorded in financial statements is $67 million, which exceed materiality level of
$3.975 million, therefore material to financial statements.
Treatment of Joint venture
Winberry company should apply associate accounting on its joint venture investment in LPS company.
Investment in LPS company is a joint venture transaction as Winberry company and Dorian company have
equal voting rights and equal representation in board of LPS company. Further as per associate accounting, in
consolidated books Winberry company should show a share of profit in its profit and loss and carrying value
of investment in statement of financial position. Complete consolidation of LPS company will not be done
because associate accounting is applied on Joint venture investments. Management of Winberry company
has treated investment in LPS company as a subsidary on the basis that Winberry company is contributing
greater knowledge to this joint venture. This treatment is wrong as subsidary treatment is not determined on
the basis of knowledge contribution. It is based on ability to control, which donot exist with Winberry
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company as it has equal voting rights as Dorian company has. Due to wrong treatment on LPS company
invesment by treating it as a susidary rather than as a joint venture, all heads of consolidated financial
statement will be affected because Winberry company has done 100% consolidation of LPS company
accounts with itself. Amount invested in LPS company worth $30 million exceed materiality level of $3.975
million determined for Winberry company audit, therfore material to financial statements.
Revenue recognition
Revenue from annual delievery pass should be recognized by Winberry company over 12 months period as
service in relation to annual devievery pass will be provided over entire year. When annual delievery pass is
sold, Winberry company should recognize it as a deferred income liability. Then revenue should be booked
over 12 months period as the service is provided. Management of Winberry company records entire amount
as revenue when annual delievery pass is sold. This is wrong accouting treatment as at time of sale, service is
not provided of whole year. Due to early recognition of revenue, revenue of Winberry company will be
overstated and deferred income liability will be understated. Amount recognized in relation to annual
delievery pass worth $8.77 million, exceed materiality level of Winberry company audit of $3.975 million,
therefore material to financial statement.
Weak controls
Winberry company's internal audit department failed to assesed risk relating to data protection legislation,
which ultimately resulted in a cyber attack and data breach. Audit committee of Winberry company also
failed to highlight this issue on time. This indicates weak control environment at Winberry company. It
creates a control risk to financial statements of Winberry company. A risk exist that Winberry company may
not have identified its risks in other areas also and it may lead to misstatements in financial statement. Audit
committee is also responsible to review financial statements before they are sent to approval to board of
directors. Weakness at audit committee level also signifies risk of material misstatement at Winberry
company.
Financial analysis

Operating profit margin of
28.8%
20X5
Operating profit margin of
30.7%
20X4
Increase in long term
560%
borrowing
Revenue has shown an abnormal growth of 66.7% which is $239 million in amount terms. It includes wrong
revenue recognition in relation to LPS company worth $10 million and early revenue recognition of annual
delievery passes of $8.7 million. Even if these two values are adjusted then also revenue is showing growth
of $220 million. It is an abnormal growth and therefore carries a risk of material misstatement. Management
of Winberry company has ambitious growth plans, and they may have done manipulation to show better
results. Operating profit is showing growth of 56.3%. This can be justified considering growth in revenue
reported of 66.7%. Operating profit margin has declined from 30.7% in 20X4 to 28.8% in 20X5. This has
declined because operating profit has shown lesser growth as compared to revenue growth. Further profit
before tax has increase by 70.9%, which is an abnormal growth as it is even greater than revenue growth of
66.7%. It contains a risk of misstatement. Lastly long term borrowings have increased by 560% during the
year, from $5 million to $33 million. However it is explained by management that it is due to new loans in
relation to LPS company expansion and Eco friendly vans. Considering assets of Winberry company of $957
million, loans are at low level.
Conclusion
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Most significant risk of material misstatment in Winberry company audit is in relation to impairment not
recorded of Destroyed warehouse. It worth $67 million which is a highest value issue in Winberry company
financial statements. Second most significant risk is investment in LPS company which worth $30 million. It
is wrongly treated as a subsidary. Lastly third most significant risk is in relation to early revenue recognition
of premium delievery passes which worth $8.7 million.
about:blank 4/4
Encore company
Briefing Notes
To: Isabella Phoenix, Audit engagement partner
From: Audit manager
Subject: Re: Audit planning for Encore Co
Date: 1 July 20X5
Introduction
These briefing notes are in relation to audit planning for Encore company for the year ended 30 September
20X5. Evaluation of significant risks of material misstatement is included in these briefing notes. Further
justifications to include inventory in significant risks of material misstatement is also included in these
briefing notes. Audit procedures to be considered in relation to risks of material misstatement of inventory
are also part of these briefing notes. Lastly ethical and profesional issues to be considered by Garrick
company along with actions to be taken, are also included in these briefing notes.
(a) Risks of Material misstatement
Materiality level
Materiality level for Encore company audit will be based on its revenue. Range of materiality level for
revenue is 0.5% to 1% of revenue. In case of Encore company audit it will be between range of $24,500 to
$49,000. Our firm will have to use professional judgement in order to determine materiality level from this
range. This judgement will be based on risk assesemnt of Encore company audit. As Encore comapny is a
new audit client of our firm therefore audit risk will be higher. Further Encore company has weak controls in
its finance department, as finance department has only two staff members. Finance director is also new
therefore control risk is also higher. Considering higher risk in Encore company audit, lower level of
materiality will be used for Encore company audit, which will be $24,500.
Weak controls in payroll
Payroll head of Encore company may contain misstatements as Finance director has identifed that overtime
payments were not always authorized and several times sheets were also missing. A risk exist that payroll
cost may be overstated as staff may manipulate payroll head to get extra claims in payroll. Payroll head is a
significant head for Encore company as it is a manefacturing entity which makes boats on customer order.
Manefacturing businesses usually have high payroll cost. Payroll cost represents 40% of Encore company's
revenue. In order to deal with this issue, Encore company has outsourced its payroll function in last 4 months
of the year ended 30 September 20X5. However this issue existed in major part of the year.
Impairment of Dockyard
Encore company should record impairment charge in relation to damage caused to Dockyard by Storm. Due
to damage caused, recoverable amount of dockyard must have fallen below its carrying value. Impairment
expense should be recorded of amount of reduction in recoverable amount below its carrying value. Finance
director of Encore company has not recorded impairment charge on the basis that Dockyard was insured and
damage will be compensated by insurance company. It is a wrong accounting treatment as insurance
receivable cannot be netted off against the impairment loss created on Dockyard due to damage caused.
Insurance receivable should be assesed seperately according to chances of recovery, whereas impairment
charge should be booked seperately. Failure to record impairment on Dockyard has overstated profits and
Dockayard asset included in property, plant and equipment by $108,000. Value of Dokyard included in PPE
worth $108,000 exceed materiality level of $24,500 determined for Encore company audit, therefore material
to financial statemetns.
Capitalization of intangible asset

about:blank 1/3
Encore comapny should record expense of $75,000 in relation to its contribution in joint arrangement. In
case of Joint arrangement each party has to record their share of expense, revenue, assets and liabilities in
their own books. Encore company has contributed two staff members in this joint arrangement. Their payroll
cost of $75,000 is share of Encore company's contribution to joint arrangement. Encore company should
record it as an expense. Finance director of Encore company has recorded this $75,000 as an intangible asset
in Encore company books. It is a wrong accounting treatment as joint arrangement has just started, and from
very start capitalization criteria of development asset cannot be satisfied. In start research outflows are done
which should be expensed out. Due to wrong capitalization fo $75,000 Encore company has overstated its
intangible asset and profits. Amount capitalized worth $75,000 exceed materiality level of $24,500
determined for Encore company audit, therefore it is material to financial statements.
Historic Boat
Historic boat should be shown in financial statement as an equity contibution by shareholder, as it gifted by
one of the shareholder. Finance director of Encore company has shown it as an income in financial
statements. It is a wrong treatment as contribution by shareholder cannot be classified as an income. It should
be shown in equity head. Due to wrong recording as an income, Encore company has overstated its profit.
Further Encore company should show this boat as a non current asset as a seperate line item, because it is
just used as a show piece outside company's head office. Finance director has included it in property, plant
and equipment, which is a wrong treatment as this historic boat is not used in any sale, production OR
administrative process. Due to this wrong treatment proeprty, plant and equipment head is overstated in
financial statement. Historic Boat valued at $50,000 exceeds materiality level of $24,500 therefore material
to financial statements.
New Finance director and small finance function
Encore comapny has employed new finance director during the year ended 30 September 20X5. New
Finance director may lack understanding about Encore company's business and its controls. As a result
judgements taken by new finance director may be wrong. Further he may also lack suffecient knowledge to
supervise the finance function in starting few months as a result errors and omissions may go uncorrected.
Encore company has a small finance function with only two staff members in it. This indicates that they may
lack proper systems and controls in relation to finance function. Due to weak controls and systems, errors
may exist in Financial statement.
Financial analysis

Growth in operating
22.5%
profit
Revenue has increased by 5.3% which is a reasonable level of growth. However operating profit is showing
an abnormal growth of 22.5%. It indicates a risk of material misstatement as no reason of this abnormal
growth is provided by management. Income wrongly included in relation to historic boat may also have
contributed towards increase in operating profit. However other than that also operating profit contains a
high level growth which indicates that other errors may also exist due to weak controls in finance function.
Conclusion
Most significant risk to be considered in Encore comapny audit was in relation to weak controls in payroll
head, as payroll head worth $2 million which was 40% of company's total revenue. Unauthorized overtime
payment and missing time sheets in payroll head was the mose significant risk. Failure to record impairment
in relation to damaged dockyard was second most significant risk as its value of $108,000 exceeds other risk
in Encore company financial statement. Lastly risk in relation to intangible asset capitalized on joint
arrangement was third most significant risk in Encore company audit, as its value exceeded other risks
included.
(b) i) Justifications for considering inventory as a significant risk of material misstatement in Encore
company Financial statements
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Inventory head worth $637,000 on financial year end 30 September 20X5, exceed materiality level of
$24,500 determined for Encore company audit. Therefore this head will be considered as material to
financial statement. Further inventory head is showing an increase of 17%, which is an abnormal increase
therefore it should be considered as a risk to financial statement.
Raw material head included in inventory has shown an increase of 50% in year ended 30 September 20X5.
Management is giving its justification that extra purchases were done to gain benefit of bulk purchase
discount. However a risk exist that management may be giving a wrong reason and some obselete stock is
included in raw material head.
Labour cost recorded in job costing system is done mannually by staff involved in production process.
Mannual recording contains a risk of misstatement. Further already Finance director has highlighted that
payroll head was facing weak controls during the year in form of missing time sheets and unauthorized
overtime payments.
Production overheads are recorded as 10% of direct cost. This also contains a risk of misstatement as there is
no mandatory relationship between direct cost and production overheads. Company should monitor its
prodution overheads seperately and allocate them to product cost according to relevant activity level.
Finance director estimates percentage completion of work in progress. This also creates a risk of
misstatement as finance director is new and estimates made by him may not be correct. Further risk of
management biasness also exist as finance director may estimate higher stage of completion to overstate
inventory.
First boat included in Finished goods contains a risk of material misstaement that it should be derecognized
from inventory and revenue should be booked in relation to is as it has obtained license to sail and Encore
comapny has fulfilled its obligation under contract. Customer's inability to take deleivery is not a
determining factor to record revenue.
Lastly second boat included in finished goods has failed its inspection for license to sail. A risk exist that this
boat is defected and may not obtain license to sail and as a result, Encore company should value it at lower
of its cost and Net realizable value.
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The Sunshine Hotel Group
Briefing Notes
To: John Starling, audit engagement partner
From: Audit manager
Subject: Re: Audit planning, the Sunshine Hotel Group
Date: 1 September 2017
Introduction
These briefing notes are in relation to audit planning for The Sunshine
Hotel Group for the year ended 31 December 2017. Evaluation of
business risks in relation to The Sunshine Hotel group are included in
these briefing notes. Further evaluation of significant risks of material
misstatement, are also included in these briefing notes. In relation to
email received from the Finance director additional implications for
planning the Group audit and any relevant actions to be taken by the
firm, are also included in these briefing notes. Lastly briefing notes
include planned audit procedures to be performed on the claim of $10
million, assuming that the audit team is given access to all relevant
sources of audit evidence.
(a) Business risks
Luxury hotels
The Sunshine Hotel group only deals in luxury hotels, which exposes it to
a risk of falling sales in times of economic recession. Luxury products
suffer the most in times of economic recession as customers cut their
spending on luxury products first. Sunshine hotel group will face decline
in customers and sales if economic recession is faced in countries in which
it operates. Sunshine hotel group has high fixed cost due to its all
inclusive policy under which it has to provide all facilities to customers
irrespective of number of customers present in hotel. Further signigicant
spending on marketing cost and cost to maintan high standards of hotels,
also increase fixed cost of The Sunshine hotel group. High fixed cost will
become a concern when sales will decline due to economic recession.
Bad Investments
The Sunshine Hotel group has made bad investments of $98 million
during the year which donot generate any returns for the Group.
Land purchased in Farland for $75 million is a bad investment as Farland

is suffering from political instability. The Sunshine Hotel group may not be
able to recover its investment from Farland, even by selling these lands,
considering political instability. Further another investment made of $23
million for purchase of hotel complex from competitor is also a bad
investment considering that due to local regulations, The Group cannot
develop its hotels there due to restriction on its key selling point of
private beaches. These bad investments will result in liqauidity issues for
The Group and will also result in fall in return in capital employed,
because these investments are not generating any positive returns for the
group.
Liquidity issues
The Sunshine Hotel group has already spent $103 million during the year
in investments of Farland, Hotel complex from competitor and License
agreement of Moulin Blanche. Further plan of investment of $45 million
through bank loan will result in liquidity issues for The Group. Planned
investment on the basis of bank loan will create fixed interest cost of $1.5
million which is 15% of group's existing Profit before tax. This fixed
interest cost will create further burden on cash flows of The Group.
Liquidity concerns are greater considering damage caused to two hotels
due to hurricanes. Group will have to invest $12.5 million till the repair
work is completed, as after that this amount will be reimbursed by
insurance company. Further claim of Ocean protection of $10 million will
also create burden on cash flows, considering cash balances left of $20
million only.
Damage to group hotels
Two of the group hotels have been damaged due to hurricanes, this will
result in ceasation of operations in those hotels. During the repair period,
The Group will not be able to generate revenue from these hotels.
Additional cost will be created in form of shifting customers to other group
hotels. Further refunds offered to customers will create burden on cash
flows of the Group. Operations of other hotels where customers are being
shifted will face extra burden, and may suffer decline in quality in those
hotels. Insurance policy is covering damage to the hotels caused,
however it may not cover damage caused to furniture and equipment
placed in hotel rooms. This will create further loss to the group.
Claim of Ocean Protection
Claim of Ocean protection indicates a regulatory breach done by The

Sunshine Hotel group. If the claim filed by Ocean protection is correct and
regulators get to know about this, then it will lead to penalties being
imposed on The Group. It may also lead to suspension of license in some

of the countries. Another risk which exist is reputational loss, which may
arise if public gets to know about environmental damage being done by
The Group. Customers will be reluctant to vist The Sunshine Hotel group,
hotels considering their damage to environment. Group has low cash
balances and it may not be able to negotiate with Ocean protection in a
better manner.
(b) Risks of Material Misstatement
Materiality level
Materiality level for Sunshine Hotel group audit will be based on its profit
before tax. It will be selected from range of 5% to 10% of its PBT. In case
of Sunshine Hotel group audit it will be between range of $0.5 million to
$1 million. Our firm will have to use professional judgement based on risk
assesment of Sunshine Hotel Group, in order to select materiality level
from this range. As during this year audit, audit manager is changed, and
this will be first time new audit manager will be managing The Sunshine
hotel group, therefore risk of audit will be higher. Further during the year
major transactions were done in form of investments in Farland and a
hotel complex purchased from competitor. This also increases risk of
audit. Considering high risk of audit, our firm will select lower level of
materiality for Sunshine Hotel group audit. It will be $0.5 million.
Investment in Farland and Hotel complex
Impairment should be considered in relation to investment done in

Farland and investment done in Hotel complex purchased from
competitor. Both of these investment cannot be developed due to
problems in these investments. Investment done in Farland is facing
difficulty due to political instability, whereas investment done in Hotel
complex cannot be used by Sunshine Hotel group in its business due to
local regulatory restriction. Failure to develop these hotels for business of
Sunshine Hotel group, must have affected recoverable amount of these
investments. If the recoverable amount has fallen below carrying value
then impairment expense should be recorded. Mangement is still
recording these investments at their cost. It is a wrong accounting
treatment as due to restrictions on these investments, recoverable
amount must have fallen below carrying value of these investments.
Failure to record impairment will overstate assets and profits. Amount
invested in Farland worth $75 million and amount invested in Hotel
complex worth $23 million. Both of these amounts exceed materialiy level
of $0.5 million, therefore they are material to financial statements.
Impairment of damaged hotels

Sunshine Hotel group should record impairment loss in relation to hotels

which have been damaged by hurricanes. Due to damage caused,
recoverable amount of hotels must have fallen below as they are now
closed. Impairment loss should be recorded of amount of reduction in
recoverable amount below its carrying value. Management has not
recorded impairment loss as no accounting entries have been in relation
to this incident. It is a wrong accounting treatment as damaged hotels
should be impaired. Failure to record impairment will overstate assets and
profits of Sunshine Hotel Group. Damage caused worth $25 million
exceed materiality level of $0.5 million therefore material to financial
statements.
Revenue recognition
Sunshine hotel group should record deferred income liability in relation to

advance it receives on booking done by customer and amount paid eight
weeks before arrival date. Revenue should be recognized during actual
stay days of customer when Sunshine Hotel group provides service to
customer. A risk exist that management may be recording advance
amounts receieved as their revenue. This will be a wrong accounting
treatment as on the date when advance is received no service is provided
to customer. Early recognition of revenue will overstate revenue of
Sunshine Hotel group and understate deferred income liability. Revenue is
a significant head to financial statements and issue of advance relates to
40% of the amount received from customer, therefore this issue will be
Agreement with Moulin Blanche
Sunshine Hotel group should record agreement of Mouline Blanche as

intangible asset in its financial statements as it gives rights for 10 years
period. It should then be amortized over 10 years agreement period. In
the year ended 31 December 2017, amortization expense of $0.5 million
should be recorded. Management has recorded amount paid for
agreement of $5 million as a marketing expense during current year. This
is a wrong accounting treatment as amount paid of $5 million was not for
only one year. It was for a 10 years agreement. Due to wrong recording
as a marketing expense, management has understated its profits by $4.5
million and understated intanglible assets also by $4.5 million.
Misstatement of $4.5 million exceeds materiality level of $0.5 million
determined for Sunshine Hotel group audit. Therefore it is material to
Financial analysis
Growth in
13.6%
revenue
Growth in profit
11.11%
before tax
Revenue has shown growth of 13.6% which is a reasonable level of

growth considering management's claim that company is having
continued growth. However in revenue head a risk of misstatement exist
in relation to wrong revenue recognition policy being following were
advances received for customer. Profit before tax has shown growth of
11.11%, which is a reasonable growth considering growth in revenue by
13.6%. Profit before tax would have shown greater growth if Moulin
Blanche agreement would not have been expense out wrongly.
Conclusion
Most significant risk of material misstatement in relation to Sunshine

Hotel group is impairment of investments done in Farland and Hotel
complex purchased from competitor. Cumulative value of these
investments is $98 million and it faces a risk of impairment due to
company's inability to develop them. Second most significant risk is in
relation to hotels damaged due to hurricane. That loss amounts to $25
million which is also a significant value issue. Lastly risk in relation to
revenue recognition policy is also a significant risk as it affects 40% of the
amount received from customers.
8/28/23, 9:29 AM Exam | GoCBE Global Pvt Ltd
Margot Company
Briefing Notes
To: Ben Duval, Audit engagement partner for Margot Co
From: Audit manager
Subject: Re: Audit planning for Margot Co
Introduction
These briefing notes are in relation to Audit planning for Margot Company
for the year ended 30 June 20X9. These briefing notes include evaluation
of significant risks of material misstatment to be considered in audit
planning of Margot company. Further these briefing notes include audit
procedures to be performed in relation to impairment of the factory
and The development cost capitalised in respect of the new
packaging. The matters to be considered in planning to use an auditor’s
expert in the audit of the fruit, which are recognised as biological assets
of the company, are also included in these briefing notes. Lastly these
briefing notes include the audit implications of the email from Len
Larch, along with any further action to be taken by our firm.
(a) Risks of Material misstatement
Materiality level
Materiality level for Margot company audit will be based on its profit
before tax. Range of materiality level on profit before tax is 5% to 10% of
PBT. In case of Margot company audit it will be between range of
$105,000 to $210,000. Our firm will have to use professional judgement
in order to determine actual materiality level from this range for Margot
Company audit, based on risk assesment of audit. Margot Company is
new audit client of our firm, therefore risk will be considered as high.
Considering high audit risk, our firm will select lower materiality level. It
will be $105,000.
Impairment of factory
Impairment of damaged factory should be measured on the situation that

factory is currently damaged. Fair value less cost to sell and value in use
both should be based on current damaged situation of factory.
Management of Margot company has calculated value in use on the
assumption that factory has been repaired and new machines have been
installed. This is a wrong accounting treatment and it will give overstated
value in use, as it is not on the current damaged situation of factory.

Overstated value in use have increased the recoverable amount as it was
more than fair value less cost to sell. Greater recoverable amount has
resulted in lesser impairment being charged. This has resulted in
overstatement of profits and factory asset reported in financial statement.
Storm damaged factory worth $880,250, exceeds materiality level of
$105,000 determined for Margot company audit, therefore it is material
to financial statements.
Advertising cost capitalized
Margot company should expense out the advertising outflows it has done
during the year. Advertisement outflows are expensed out, and are not
capitalized because their benefit cannot be identified seperately. Finance
director of Margot company has capitalized advertising outflows on the
basis that it has directly resulted in increased sales. This is a wrong
accounting treatment as advertisement outflows can never be capitalized.
Further sale cannot be directly related to advertising only as in sales,
other factors also contribute. Due to wrong capitalization of adveritising
outflows profits and intangible assets are overstated by $225,000. It
exceeds materiality level determined for Margot company audit of
$105,000, therefore material to financial statements.
Research and development outflows
Margot company should divide its research and development outflows

between research phase spendings and development phase spendings.
Amount spent during research phase should be expensed out. Whereas
amount spent during development phase can be capitalized if
capitalization criteria is met, otherwise it will also be expensed out.
Mangement of Margot company has capitalized entire spending amount of
$220,000. It is a wrong accounting treatment as from the start of
spending development criteria cannot be satisfied. Further currently
development criteria is not met because Pro Pack, is currently testing
prototypes, which is a pre capitalization phase. Due to wrong
capitalization of Research and development outflows, profits and
intangible assets are overstated by $220,000. It exceeds materiality level
of $105,000 therefore material to financial statements.
Financial Analysis

Growth in online sales 90.4%
Growth in operating profit
7.6%
margin
Growth in current assets 52.9%
Decrease in gearing 12.5%
Revenue has increased by 8.7%, which is majorly due to growth in online

sales, which have increased by 90.4%. As per finance director growth in
online sales is due to new online sales portal and successful advertising
campaign. Despite of this reasoning given by Finance director a risk of
misstatement exist in growth in online sales as it is a very abnormal
growth. A risk exist that new online sales portal may contain some bugs
and erros as a result sales may be overstated. Growth in profit before tax
also indicates risk of misstatement as it is greater than overall revenue
growth of 8.7%. Increae in operating profit margin by 7.6% is also a
concern considering that company is giving offers of 'Buy One Get One
Free' to customers, this should have reduced the operating profit margin.
Current assets have increased by 52.9% which reprsents increase of $1.1
million. In this increase cash has only increased by $10,000. This means
that rest of the increase is due to debtors and inventory, which contains
risk of bad debt and obsolence, respectively. Lastly decline in gearing by
12.5% is also abnormal considering that company has taken a new loan
of $375,000 during the year.
Conclusion
Impairment of factory is considered as most significant risk as factory

worth $880,250, and mangement has charged impairmen wrongly in
relation to it. Greater impairment may be required in relation to this
factory. Further risk in relation to advertisement is also a significant risk
as its amount of $225,000 exceed other risk faced by Margot company.
Lastly risk relating to capitalization of research and development is
prioritized as it is also material but its amount is less than value of
impaired factory and advertisement amount.
Audit risk
Home / Students / Study resources / Advanced Audit and Assurance (AAA) / Technical articles and tricky topics / Audit risk
Relevant to FAU, AA and AAA

 Related Links
• The IAASB Clarity Project

This article outlines and explains the concept of audit risk, making reference to the key auditing standards
• Student Accountant hub
which give guidance to auditors about risk assessment
Identifying and assessing audit risk is a key part of the audit process, and ISA 315, Identifying and Assessing the
Risks of Material Misstatement Through Understanding the Entity and Its Environment, gives extensive guidance to
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auditors about audit risk assessment. The purpose of this article is to give summary guidance to FAU, AA and AAA
students about the concept of audit risk. All subsequent references in this article to the standard will be stated
simply as ISA 315, although ISA 315 is a ‘redrafted’ standard, in accordance with the International Auditing and
Assurance Standards Board (IAASB) Clarity Project. For further details on the IAASB Clarity Project, read the
article 'The IAASB Clarity Project' (see 'Related links').
What is audit risk?
According to the IAASB Glossary of Terms (1), audit risk is defined as follows:
‘The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially
misstated. Audit risk is a function of material misstatement and detection risk.’
Why is audit risk so important to auditors?

Audit risk is fundamental to the audit process because auditors cannot and do not attempt to check all transactions.
Students should refer to any published accounts of large companies and think about the vast number of
transactions in a statement of comprehensive income and a statement of financial position. It would be impossible
to check all of these transactions, and no one would be prepared to pay for the auditors to do so, hence the
importance of the risk‑based approach toward auditing. Traditionally, auditors have used a risk-based approach in
order to minimise the chance of giving an inappropriate audit opinion, and audits conducted in accordance with
ISAs must follow the risk‑based approach, which should also help to ensure that audit work is carried out efficiently,
using the most effective tests based on the audit risk assessment. Auditors should direct audit work to the key risks
(sometimes also described as significant risks), where it is more likely that errors in transactions and balances will
lead to a material misstatement in the financial statements. It would be inefficient to address insignificant risks in a
high level of detail, and whether a risk is classified as a key risk or not is a matter of judgment for the auditor.
Relevant ISAs
There are many references throughout the ISAs to audit risk, but perhaps the two most important audit risk-related
ISAs are as follows:
ISA 200, Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with
ISAs
ISA 200 sets out the overall objectives of the auditor, and the standard explains the nature and scope of an audit
designed to enable an auditor to meet those objectives. References to audit risk are frequently made by ISA 200,
and the standard also requires that the auditor shall plan and perform an audit with professional scepticism,
recognising that circumstances might exist that may cause the financial statements to be materially misstated.
Professional scepticism is defined as an attitude that includes a questioning mind and a critical assessment of
evidence.
ISA 315, Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity
and Its Environment
ISA 315 deals with the auditor’s responsibility to identify and assess the risks of material misstatement in the
financial statements through an understanding of the entity and its environment, including the entity’s internal
controls and risk assessment process. The first version of ISA 315 was originally published in 2003 after a joint
audit risk project had been carried out between the IAASB, and the United States Auditing Standards Board.
Changes in the audit risk standards have arguably been the single biggest change in auditing standards in recent
years, so the significance of ISA 315, and the topic of audit risk, should not be underestimated by auditing students.
The requirements of ISA 315 are summarised in the following table.
(1). The auditor shall perform risk assessment procedures in order to provide a basis for the
identification and assessment of the risks of material misstatement.
(2). The auditor is required to obtain an understanding of the entity and its environment,
including the entity’s internal control systems.
(3). The auditor shall identify and assess the risks of material misstatement, and determine
whether any of the risks identified are, in the auditor’s judgement, significant risks. This is in
order to provide a basis for designing and performing further audit procedures.
(4). ISA 330 then deals with the required responses to assessed risks.
Let us consider each of these four stages in more detail.
1. Risk assessment procedures

ISA 315 gives an overview of the procedures that the auditor should follow in order to obtain an understanding
sufficient to assess audit risks, and these risks must then be considered when designing the audit plan. ISA 315
goes on to require that the auditor shall perform risk assessment procedures to provide a basis for the identification
and assessment of risks of material misstatement at the financial statement and assertion levels. ISA 315 goes on
to identify the following three risk assessment procedures:
Making inquiries of management and others within the entity

Auditors must have discussions with the client’s management about its objectives and expectations, and its plans
for achieving those goals.
Analytical procedures
Analytical procedures performed as risk assessment procedures should help the auditor in identifying unusual
transactions or positions. They may identify aspects of the entity of which the auditor was unaware, and may assist
in assessing the risks of material misstatement in order to provide a basis for designing and implementing
responses to the assessed risks.
Observation and inspection

Observation and inspection may also provide information about the entity and its environment. Examples of such
audit procedures can potentially cover a very broad area, including observation or inspection of the entity’s
operations, documents, and reports prepared by management, and also of the entity’s premises and plant facilities.
ISA 315 requires that risk assessment procedures should, at a minimum, comprise a combination of the above
three procedures, and the standard also requires that the engagement partner and other key engagement team
members should discuss the susceptibility of the entity’s financial statements to material misstatement. Key risks
can be identified at any stage of the audit process, and ISA 315 requires that the engagement partner should also
determine which matters are to be communicated to those engagement team members not involved in the
discussion.
2. Understanding an entity
ISA 315 gives detailed guidance about the understanding required of the entity and its environment by auditors,
including the entity’s internal control systems. Understanding of the entity and its environment is important for the
auditor in order to help identify the risks of material misstatement, to provide a basis for designing and implementing
responses to assessed risk (see reference below to ISA 330, The Auditor’s Responses to Assessed Risks), and to
ensure that sufficient appropriate audit evidence is collected. Given that the focus of this article is audit risk,
however, students should ensure that they also make themselves familiar with the concept of internal control, and
the components of internal control systems.
3. Identification and assessment of significant risks and the risks of material misstatement
In exercising judgement as to which risks are significant risks, the auditor is required to consider the following:
• Whether the risk is a risk of fraud.
• Whether the risk is related to recent significant economic, accounting or other developments, and therefore
requires specific attention.
• The complexity of transactions.
• Whether the risk involves significant transactions with related parties.
• The degree of subjectivity in the measurement of financial information related to the risk, especially those
measurements involving a wide range of measurement uncertainty.
• Whether the risk involves significant transactions that are outside the normal course of business for the entity,
or that otherwise appear to be unusual.
4. ISA 330 and responses to assessed risks
The requirements of ISA 330, The Auditor’s Responses to Assessed Risks, will be covered in a future article, but
essentially ISA 330 gives guidance about the nature and extent of the testing required, based on the risk
assessment findings.
Audit risk and business risk

For the purposes of the F8 exam, it is important to make a distinction between audit risk and business risk (which is
not examinable in F8), even though ISA 315 itself does not make such a distinction clear. ISA 315(2) defines
business risk as follows:
‘A risk resulting from significant conditions, events, circumstances, actions or inactions that could adversely affect
an entity’s ability to achieve its objectives and execute its strategies, or from the setting of inappropriate objectives
and strategies.’
Hence, business risk is a much broader concept than audit risk. Students are reminded that business risk is
excluded from the FAU and F8 syllabus, although it is examinable in P7.
The audit risk model

Finally, it is important to make reference to the so called traditional audit risk model, which pre-dates ISA 315, but
continues to remain important to the audit process. The audit risk model breaks audit risk down into the following
three components:
Inherent risk
This is the susceptibility of an assertion about a class of transaction, account balance, or disclosure to a
misstatement that could be material, either individually or when aggregated with other misstatements, before
consideration of any related controls.
Control risk
This is the risk that a misstatement could occur in an assertion about a class of transaction, account balance or
disclosure, and that the misstatement could be material, either individually or when aggregated with other
misstatements, and will not be prevented or detected and corrected, on a timely basis, by the entity’s internal
control.
Detection risk
This is the risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will not
detect a misstatement that exists and that could be material, either individually or when aggregated with other
misstatements.
The interrelationship of the three components of audit risk is outside the scope of this current article. F8 students,
however, will typically be expected to have a good understanding of the concept of audit risk, and to be able to
apply this understanding to questions in order to identify and describe appropriate risk assessment procedures.
The UK and Ireland perspective

The UK Auditing Practices Board announced in March 2009 that it would update its auditing standards according to
the clarified ISAs, and that these standards would apply for audits of accounting periods ending on or after 15
December 2010. UK and Irish students should note that there are no significant differences on audit risk between
ISA 315 and the UK and Ireland version of the standard.
Conclusions
The concept of audit risk is of key importance to the audit process and F8 students are required to have a good
understanding of what audit risk is, and why it is so important. For the purposes of the F8 exam, it is important to
understand that audit risk is a very practical topic and is therefore examined in a very practical context. Any
definition or explanation of the audit risk model itself will usually only be allocated a small number of marks, but
many students still include such definitions in answers to case study and scenario questions which require a
practical application of audit risk assessment procedures. Students must also be prepared to apply their
understanding of audit risk to questions and come up with appropriate risk assessment procedures.
Written by a member of the F8 examining team
References
1. IAASB Handbook 2009, Glossary of Terms.
2. ISA 315, Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its
Environment, paragraph 4 (b).
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Rick Group
Briefing Notes
To: Carol Morgan, Audit engagement partner
From: Audit manager
Subject: Re: Audit planning for the Rick Group
Date: 1 July 20X5
Introduction
These briefing notes are in relation to Audit planning for Rick group for the year ended 30 September 20X5.
These briefing notes include evaluation of significant Audit risks to be considered in planning of Rick Group
Audit. Further evaluation of component auditor strategy along with ethical issues and responses to be taken,
are also included in these briefing notes. Principal audit procedures to be instructed to component auditor in
relation to sale of property to group's chief executive officer, are also included in these briefing notes. Lastly
advantages and disadvantages of performing joint audit on Michonne company audit along with
recommendation is also included in these briefing notes.
(a) Audit Risks
Materiality Level
Materiality level for The Rick group audit will be based on its profit before tax. Range of Materiality level
based on profit before tax is 5% to 10% of PBT. In case of Rick group audit it will be between range of $3
million to $6 million. Our firm will use professional judgement in order to determine materiality level from
this range based on risk assesment of Rick Group audit. Rick group is an existing audit client of our firm,
therefore from this perspective audit risk will be considered as low. However Rick Group is a listed group
therefore it will face greater regulatory requirements. Audit risk will be considered high because one of the
group's larger subsidaries, Daryl Company is audited by a different component auditor Neegan Associates.
This increases risk of our firm being a group auditor as we will have to rely on someone else work.
Considering high risk of audit, lower level of materiality will be used which is $3 million.
Different component auditor
One of the Group's subsidary, Daryl comapny is audited by a different audit firm, Neegan associates. It
creates audit risk for our firm, as being a group auditor our firm will have to rely on work of Neegan
associates while auditing consolidated financial statements. If Neegan associates will not audit Daryl
company accounts with quality, then misstatements may go un detected in Daryl company accounts. These
misstatements will also affect consolidated financial statements as they will also include Daryl company
accounts. Being a group auditor it will increase risk of our firm while giving opinion on consolidated
financial statements. This risk is further increased due to a fact that Neegan associates independence is also
in concern considering that they also provide non audit services to Daryl company along with audit activity.
Daryl company assets of $140 million represents 17.9% of the total group assets, therefore it is a significant
component of the group.
Revenue recognition policy
Rick group should record amount received from customers in advance, as a deferred income liability as
amount is recieved in advance when service is not provided to customer. This deferred income liability
should be recognized as revenue when benefit is provided to customer over the monthly subscription period.
Management of Rick group recognizes revenue when amount is billed and received from customer in
advance. This is a wrong accounting treatment as when customer is billed in advance, no service is provided
to customer at that time. Due to early recognition of revenue, revenue recognized is overstated and deferred
income liability is understated. Wrong revenue recognition policy will affect entire group revenue of $980
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million, which is a material head to financial statements as materiality level determined for Rick group audit
is $3 million.
Amortization of intangible asset
Rick group should charge amortization on content licenses according to their respective license periods
which are either three year OR five years. Licenses of three years should be amortized over three years and
ones with period of five years should be amortized over five years period. Management of Rick group is
amortizing all licenses over five years period, which is a wrong accounting treatment as it will understate the
amortization charge of licenses with three years period. If three year license is wrongly amortized over five
years period then per year amortization charge will be understated which will overstate profits and intangible
assets recorded in financial statemetns. Licenses recognized in intangibles assets worth $580 million exceed
materiality level of Rick group audit of $3 million, therefore this head is material to financial statements.
Local accouting standards followed by Daryl company
Daryl company accounts need to be translated to IFRS accounting standards while preparing consolidated
financial statements as group accounts of entire Rick group will be as per IFRS, whereas Daryl comapny
follows local accounting standards. A risk exist that while translating Daryl company accounts from local
reporting framework to IFRS some issues may be missed by the management. This issue was also indicated
in related party transaction done with group's CEO, where local accounting standards do not required
disclosure, whreas as per IAS 24 its disclosure is required. Inappropriate translation of accounts to IFRS may
affect multiple heads in consolidated financial statements. Daryl company's total assets of $140 million
exceed materiality level determined for Rick group audit of $3 million therefore material to financial
statements.
Impairment review of Daryl Company goodwill
Goodwill recognized in relation to Daryl company needs to be reviewed for impairment as in current year
Daryl comapny will suffer loss due to decline in significant number of customers. Due to loss during the year
recoverable amount of Daryl company invesment may have fallen, and as a result goodwill will suffer
impairment first. Management of Daryl company has not done impiarment on the basis that overall group
performance good. This is a wrong treatment as each investment should be reviewed for impairment
seperately. Failure to record impairment will overstate goodwill asset and profits in Rick group accounts.
Goodwill recognized in relation to Daryl company worth $38 million exceeds materialiy level of $3 million
determined for Rick group audit, therefore it is material to financial statement.
Movement in average selling price per customer
Average selling price per customer per month has declined from $8.125 in 20X4 to $7.7 in 20X5. This
decline is abnormal as management has claimed that selling price per customer per month has remained
constant at $8.20 in both 20X4 and 20X5. Further another concern in this decline is, that management has
claimed that during 20X5 premium subscriptions were offered to customers in which they pay extra for
family members. Due to premium subscriptions average selling price should have increased in 20X5 rather
than decline.
Financial analysis

Growth in assets 30%
Growth in subscription
31.25%
customers
Growth in revenue by 25.6% is an abnormal increase and it is primiraly due to an abnormal rise in number of
subscribed customers by 31.25%. Management has not provided any specific reason for this abnormal
increase. It indicates a risk of misstatement. Operating profit has increased by 11.6% whcih can be justified
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considering increase in revenue by 25.6%, as when revenue increases it also increases operating profit.
Further increase in profit before tax bt 2.3% is a reasonable increase considering increase in revenue and
increase in operating profit by greater extent. Total assets have increased by 30% during 20X5, which is an
abnormal increase as management of Rick group has not provided any specific reason for such an abnormal
rise.
Conclusion
Different component auditor of Daryl company is the most significant risk in Rick group audit as our firm
will have to rely on work of different audit firm, Neegan associates in relation to significant component of
group. This risk is also significant because Neegan associates was facing independence issues in Daryl
company audit. Second most significant risk in Rick group audit was its wrong revenue recognition policy of
early recognition of revenue in relation to subscriptions of customers. Lastly risk in relation to amortization
of intangible assets being done wrongly is also significant risk as it relates to a significant head of financial
statement worth $580 million.
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Pale Company
Briefing Notes
To: Harvey Rebus, Audit engagement partner
From: Audit manager
Subject: Re: Audit planning for Pale Co
Date: 1 July 20X5
Introduction
These briefing notes include detail in relation to audit planning for Pale Company for the year ended 30
September 20X5. These briefing notes include detail relating to significant business risks to be considered in
planning of Audit for Pale Company. Further significant audit risks are also included in these briefing notes.
Audit procedures to be performed in relation to the change in fair value of the timber plantation asset caused
by the recent storms, are also included in these briefing notes. Lastly, ethical issues and other audit planning
implications which arise in relation to the phone call from the company’s chief finance officer, Mark York,
are also included in these briefing notes.
(a) Business Risk
International Expansion
Planned international expansion faces a risk of weak management control and supervision as it is an
expansion in remote developing country. As expansion is in a remote area, therefore management may not be
able to excercise suffecient control there, as a result investment in Farland may not be able to achieve its
profit targets. Further if management will spend too much time in control and supervision of this remote area
investment, then they may lose focus of their existing home country operations. Concern for control and
supervision of Farland investment is greater as Pale company will deal in processing of new type of timber in
Farland. They may lack expertise in relation to it and as a result it will require greater management time for
control and management.
Cancellation of grant
Considering news reports regarding Pale Company that they have made a payment of $15,000 to a
government official in Farland, Grant from international agency may get cancelled as Pale company action
may be regarded as an unethical business practice. Grant from international agency had a condition that Pale
company should be doing business in Ethical manner. Incentive payment made of $15,000 to a government
official may be regarded as unethical business practice, despite that it is normal in Farland. If the grant gets
cancelled that Pale company may not be able to complete its planned expansion of Farland considering that it
is already at limit of its bank borrowing agreement. Concern of ethical business practice is greater for Pale
company considering that it is also facing a legal claim from its employees over bad health and safety
environment at work place. If it also gets in knowledge of International agency then it may contribute
towards cancellation of grant based on unethical business practices done by Pale company.
Gold Standard accrediation
Pale Company may lose its Gold Standard accrediation if percentage of trees harvested according to gold
standard continue to decline and fall below 80% limit. During the year trees harvested according to gold
standard accrediation have already declined from 85% to 82%. If this decline will continue further than Pale
company may not be able to satisfy condition of 80% trees sold as per Gold standard. If Gold standard
accrediation is lost then Pale company may lose customer contracts which were gained on the basis of Gold
Standard status of Pale Company. This will include loss of Royal company contract which has contributed to
increase in revenue in current year. Gold standard accrediation may also get affected due to unethical
business practice concerns of Pale company, which include incentive payment made to government official
in Farland and claim made by employees over health and safety issues.
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Legal case
If Pale company is unsucessful in legal claim filed by its employees then it may have to pay compensation of
$19 million. Outflow of $19 million will create cash flow problems for Pale company considering that its
cash balances have already declined during the year by 33.8% and stand at $4.5 million. Further Pale
Company is at limit of its bank borrowing agreement, therefore it may not be able to arrange immediate
finance through bank loan. Claim filed of $19 million exceed, Pale company's entire year profit of $16.5
million, this indicates that this claim will be a significant concern if Pale company is unsucessful in it.
Further this claim filed by employees will also affect Reputation of Pale company and customers may not be
willing to do business with Pale company considering its unethical business practice of reducing staff
numbers and increasing pressure on its existing employees, which is also resulting in accidents.
Damage caused by Storm
Pale comapny has suffered a loss of $7.5 million due to recent storms in which many standing trees have
been completely destroyed and badly damaged. This will result in decline in Pale company profits when it is
recorded in current year financial statements. Due to this loss profit before tax of Pale comapny will decline
by 45.5% and will fall to $9 million. Loss of standing trees due to Storm will create problems in operations
of Pale company in some time, as due to loss of standing trees Pale company will have lesser timber to
harvest and process in future. This will affects its ability to fulfill customer orders and as a result customers
may switch to competitors. Pale company may not be able to overcome this problem in short term as it will
take time in growing new trees which are ready for harvest.
(b) Audit Risks
Materiality Level
Materiality level for Pale Company audit will be based on its profit before tax. Range of materiality level for
profit before tax is 5% to 10% of PBT. In case of Pale company audit it will be between range of $0.825
million to $1.65 million. Our firm will use professional judgement in order to determine materiality level
from this range, based on risk assesment of Pale Company audit. As Pale company is a new audit client of
our firm, therefore risk of audit will be considered as high. Further it is first timber business client of our
firm. This also increase risk of audit. Audit risk is also high because Pale company has weak governance due
to lack of audit committee. Considering high risk of audit lower level of materiality will be used for Pale
company audit. It will be $0.825 million.
First year of Audit
Our firm will be auditing Pale company for the first time in year ended 30 September 20X5. It will increase
detection risk as in first year of audit our firm will lack suffecient knowledge about Pale Company's business
and its environment. Due to lack of suffecient knowledge, our firm will be unable to detect all issues in Pale
company's financial statements. This risk is higher because Pale company is our first client of Timber
industry, which means that our firms lack knowledge about Timber industry. Another issue in first year audit
is in relation to opening balances as they were not audited by our firm. Last year audit was done by Hare
associates, and therefore our firm will have to rely on their work in relation to opening balances which are
carried forward form previous year.
Provision for Legal case
Pale company should recognize provision for legal claim filed by employees if chances of outflow are
probable. Legal proceedings have started therefore present obligation is created in relation to it. Claim of
employees can be supported from management information that number of employees have also reduced
during the year and number of accidents have also increased. Considering this, chances of outflow are either
probable or atleast at possible stage. If chances of outflow are probable then provision will be given
otherwise a disclosure will be required if chances of outflow are possible. Mark York, comapny's CFO is not
willing to record a provision OR give a disclosure in relation to this claim, which is wrong as chances of
outflow are more than remote, and in that case atleast a disclosure will be required. Failure to record
provision will overstate profits and understate liabilities. Claim amount of $19 million exceeds materiality
level of $0.825 million, therefore material to financial statements.
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Recognition of Government grant
Pale company should treat grant received as a deffered income in its financial statement of year ended 30
September 20X5, as relevant expenditure in relation to grant will commence from November 20X5. Income
in relation to grant can only be recognized when Pale company starts to fulfill grant condition of training
local workforce and building accomodation. Mark York, Company's CFO plan to recognize half of the grant
as an income in current year of 20X5. It is a wrong accounting treatment as at current year end relevant
expenditure in relation to grant has not yet started. Justification provided by Mark York that income can be
recognized as it will cover management expenses done in relation to foriegn expansion, is wrong as grant
condition was in relation to training local workforce and building accomodations. Wrong recognition as an
income for half amount of grant of $10 million will overstate profits and understate deferred income liability.
Wrong recognition amount of $10 million exceed materiality level of $0.825 million determined for Pale
company audit, therefore material to financial statement.
Provision for return of grant
One of the conditin of government recieved is that Pale company should maintan ethical business practices.
Pale comapny is facing claim in news reports that it has paid $15,000 in Farland while doing international
expansion. It will be regarded as a bribe and is therefore an unethical business practice. Further claim of
employees of making them work extra by reducing staff numbers also indicate unethical business practice.
Considering possibility of failure of grant conditions, Pale company will be required to record a provision for
return of grant. If Pale company managment fails to consider this provision then it will misstate financial
statements. In contrast to this, Mark York plans to recognize grant amount as an income. This shows his
intention to ignore this possibiliy of returning grant. Failure to record provision in relation to will it
understate provision liabilities. Grant amount of $20 million exceed materiality level of $0.825 million
determined for Pale comapny audit, therefore material to financial statements.
Changes in fair value of timber plantation asset
Pale company should record an expense along with reduction in fair value of timber plantation asset by $7.5
million, casued due to damage by storm. Timber plantation asset are measured at fair value less cost to sell,
with fair value changes being recorded in P&L. Mangement has not yet recorded this loss of $7.5 million in
its financial statement. Management may be relucatant to record this loss as it will lead to reduction in profits
and in current year company is going for share issue. Failure to record this reduction in fair value will
overstate profits and timber plantation asset in financial statement. Loss amount is of $7.5 million which
exceeds materiality level of $0.825 million determined for Pale company audit, therefore materila to
Weak governance
Pale company has a small internal audit function with two staff members in it only. This means that Pale
company will have weak controls as independent appraisal of controls will not be done effectively due to
small internal audit function. Further small internal audit function is also reporting to company's CFO, which
is also a problem as internal auditor will be reluctant to identify issues in finance department as they are
supervised by CFO who is head of finance. Another issue in governance of Pale company is lack of audit
committee. One of the role of audit committee is to assist external auditor during audit activity if
management is not cooperating with external auditor. Lack of audit committee may affect auditor's ability to
deal with issues effectively. However it is to note that as Pale company is currently an unlisted entity
therefore having weak governance is not a legal issue, but still it increases risk for auditor as it may lead to
issues in financial statements.
Conclusion
Most significant risk in case of Pale comapny audit is that it is first year of audit for our firm. This risk is also
significant because Pale company is our first timber industry client. Second most significant risk is legal
claim filed of $19 million, for which finance director is doing wrong treatment by not giving disclosure and
by not making any provision. Lastly third most significant risk is in relation to govenrment grant. For which
Finance director is wrongly recognizing half amount as an income, and is ignoring a possibility of returning
grant due to unethical business practices.
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Crux Group
Briefing Notes
To: Norma Star, Audit engagement partner
From: Audit manager
Subject: Re: Audit planning for the Crux Group
Date: 1 July 20X5
Introduction
These briefing notes are in relation to Audit planning for The Crux Group for the year ended 30 September
20X5. These briefing notes include evaluation of significant Audit risks to be considered in planning the
audit of The Crux Group. Further it also includes principal audit procedures to be performed on the
segmental information relating to the Group’s revenue. Lastly these briefing notes include matters to be
considered in deciding whether Pegasus & Co should accept the engagement to provide advice on the
Group’s social and environmental information.
(a) Audit Risks
Materiality Level
Materiality level for The Crux Group Audit will be based on its profit before tax. It will be between range of
5% to 10% of its PBT. In case of The Crux Group audit materiality level will be between range of $4.05
million to $8.1 million.Our firm will use professional judgement in order to determine materiality level from
this range, based on risk assesment of Crux Group. In case of Crux Group audit risk is high as it is first year
of audit for our firm. During first year our firms lacks suffecient knowledge and expertise which increases
audit risk. Further Crux Group is a listed entity and as a result it may face greater regulatory requirements.
Considering high risk of audit, lower level of materiality level will be used for Crux Group Audit. It will be
$4.05 million.
First year of audit
Our firm will audit The Crux group for the first time in year ended 30 September 20X5. This will increase
detection risk of our firm as in first year of audit knowledge about client's business and its environment may
be insuffecient. This will affect out firm's ability to detect issues effectively from The Crux Group Financial
statements. Further in first year of audit, risk is also considered as high because our firm will have to rely on
previous auditor's in relation to opening balances. Last year financial statements were audited by a different
auditor, and opening balances are carried forwards from previous year. Any issues in previous yead audit will
affect opening balances of current year and it will increase risk of wrong opinion on overall financial
statements of current year.
Revenure recognition
The Crux Group should recognize revenue of cruise trips over the cruise trip period, that is the period over
which service is provided to customer. Revenue recongition should be spreaded over the cruise trip period
which can last up till six weeks. Management of The Crux group recognizes entire revenue when the trip
commences. This is a wrong accounting treatment as at start of cruise trip service to customer is still
outstanding. Early recognition of revenue will overstate revenue and understate deferred income liability.
Revenue from sale of cruise trip tickets represent 85% of revenue which worth $649 million, which exceeds
materiality level of The Crux group of $4.05 million, therefore material to financial statements.
Segmental reporting of Onboard Sales
Onboard sales done by The Crux group is a seperate segment of business as management maintans its
seperate records for performance measurement and it must have a seperate chief operating officer also.
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Further this segment is reporable segment as its revenue exceeds the 10% reporting threshold of IFRS 8.
Data of Onbaords sales should be reported seperately in fiancial statements of The Crux Group as a seperate
operating segment. Management of The Crux Group is not reporting onboards sales as a seperate segment
currently. Failure to report segmental data of onboards sales will misstate notes to the financial statements of
The Crux group financial statements. Onboard sales segment represent 15% of the revenue which worth
$114.6 million which exceeds materiality level of $4.05 million therefore material to financial statements.
Split of outflows between capital expenditure and revenue expenditure
The Crux group should split its outflow of $75 million between upgradation outflows and maintanence
outflows. Amount spent on upgradation of ships such as installation of cinemas and gyms, should be
capitalized as property, plant and equipment. Whereas amount spent on maintanence of ships should be
expensed out. A risk exist that management may not have seperated maintanence outflows from upgradtion
outflows, and has capitalized entire $75 million amount as a capital expenditure. If maintanence outflwos are
wrongly capitalized then it will overstate profits and assets of The Crux Group. Amount spent during the year
of $75 million exceed materiality level determined for The Crux group audit of $4.05 million, therefore
Disclosure of Related Party transaction
Ships purchased from Vella Shipbuilder company is a related party transaction as Key Management
Personnel of The Crux Group is also the Key Management personnel of Vella Shipbuilder comapny. Max
Draco is the Chairman of The group and also The Chairman of Vella Shipbuilder comapny. Position of
Chairman is regarded as Key Management Personnel as per Accounting standards. Further Vella Shipbuilder
company is also a related party of the group because close family member of Max Draco is Chief executive
officer at Vella Shipbuilder comapny. Son of Max Draco will be regarded as close family member of Max
Draco and his position as CEO will be regarded as Key Management personnel. As per accounting standard a
disclosure will be required in relation to this transaction that whether it was arms length transaction OR not.
Further amount of transaction and amount outstanding at year end will also be disclosed. A risk exist that
disclosure in relation to this related party transaction is not given in fianancial statements of The Crux Group.
Failure to give disclosure note will misstate notes to the financial statement. This issue is material to
financial statement due to its nature being related to Key Management personnel. Further it is also material
by amount as transaction with Vella Shipbuidler company is of $110 million which exceeds materiality level
of $4.05 million.
Capitalization of borrowing cost
Borrowing cost in relation to loan taken for costruction of ships should be capitalized as property, plant and
equipment as construction period of ships is of more than 12 months and loan is specific to construction of
ships. Normally ships of The Crux Group take three years in construction therefore it is a qualifying period
for capitalization of borrowing cost. Interest cost per year which needs to be capitalized is $11.7 million. A
risk exist that management may have expensed out this interest cost and have not capitalzied the borrowing
cost relating to loan taken for construction of ships. Failure to capitalze interest cost will understate profits
and understate property, plant and equipments. Borrowing cost amount per year of $11.7 million, exceeds
materiality level of $4.05 million, therefore material to financial statements.
Impairment of operating license
Impairment review should be done in relation to operating licenses recognized for Pioneer cruise segment in
The Crux group financial statement. Due to withdrawl of operating licences by various governments,
recoverable amount of these licenses must have fallen below their carrying value. Further assets of Pioneer
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cruise segment may also suffer imapirment as withdrawl of license is for unknown period and it will affect
recoverable amount of assets. If recoverable amount falls below carrying value then impairment expense will
be required. Management has not done impairment review as reduction in operating licenses of $1 million
represent routine amortization. Failure to record impairment will overstate profits and intangible assets in
financial statements. Licenses recognized worth $56 million exceeds materiality level of $4.05 million,
therefore material to financial statements.
Financial analysis
Growth in revenue 14%

Growth in revenue of Sunseeker
11.11%
cruises segment
Decline in revenue of Explorer
5.2%
cruises segment
Growth in Pioneer cruises segment 37.5%
Revenue has shown an increase of 14% which is an abnormal increase and management has not provided
any reason for it. Segmental revenue information is showing uneven movements between the segments, with
some showing high growth and other showing a decline. Sunseeker cruise segment has shown growth of
11.1%, whereas Explorer cruise segment has shown decline of 5.2%. No reasons are provided by
management for this movement. Growth in Pioneer cruise segment is abnormally high, and is 37.5%. It
indicates risk of misstatement as revenue is increasing despite of withdrawl of licenses. Operating profit has
increased by 43.5% which is abnormal growth considering revenue growth of 14%. Lastly profit before tax
has also shown abnormal growth of 24.6% which exceeds revenue growth of 14%.
Conclusion
Most signifiant risk in The Crux group financial statement is issue of First year of Audit. Our firm will audit
Crux group for the first time therefore risk of inability to detect issues due to lack of knowledge about client's
business and environment is most significant risk. Second most significant risk is in relation to wrong
revenue recognition policy being followed by The Crux group. Wrong revenue recognition policy in relation
to ticket sales affects 85% of the revenue. Lastly failure to show onboard sales as a seperate operating
segment is third most significant risk as this segment represents $114 million.
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Eagle Group
Briefing Notes
To, Maya Crag, Audit engagement partner,
From, Audit Manager
Subject: Re: Audit planning for the Eagle group
Introduction
These briefing notes are in relation to Audit planning for the Eagle group
for the year ended 31 December 20X8. It includes evaluation of
significant Audit risks to be considered in planning the Eagle group audit.
Further principal audit procedures to be used in audit of the goodwill
arising on acquisition of Lynx Company is also included in these briefing
notes. Evaluation of the audit strategy prepared by Vulture associates in
relation to audit of Lynx company and its implication for group audit, is
also included in these briefing notes. Lastly ethical and professional issues
to be considered in relation to request of Group finance director to
provide advise on integrated report of the group, and actions to be taken
by our firm in relation to it, are also included in these briefing notes.
(a) Audit Risks
Materiality level
Materiality level for The Eagle group audit will be based on its profit
before tax. Range of materiality level based on profit before tax is 5% to
10% of PBT. In case of Eagle group audit it will be between range of
$16.1 million to $32.2 million. Our firm will use professional judgement in
order to determine materiality level from this range, based on risk
assesment of Eagle group audit. Our firm will audit Eagle group for the
first time in current year, therefore audit risk will be considered high from
this perspective. Further one of the group subsidary, Lynx Company is
audited by a different audit firm, Vulture associates, this also increases
audit risk. Considering high audit risk lower level of materiality will be
selected which will be $16.1 million for Eagle Group audit.
First year of audit
Our firm was appointed as an auditor for Eagle group for the year ended
31 December 20X8. In first year of audit our firm will lack suffecient
knowledge about Eagle group's business and its environment. It will affect
our firms ability to detect issues effectively in financial statements of
Eagle group. Further in first year of audit another issue is in relation to

opening balances as last year financial statements were not audited by
our firm. If previous auditor of Eagle group have not done their work with
care, then misstatements will exist in opening balances, which will then
affect current year financial statements also. Reliance to be placed on
previous year auditors will increase risk for our firm.
Different component auditor
One of the group's component, Lynx company is audited by a different

audit firm, Vulture associates. This increases risk of our firm being a
group auditor, as accounts of Lynx company which are audited by a
different audit firm will become part of consolidated financial statements,
which is responsibility of our firm. If Vulture associates will not perform
audit of Lynx company with care, then misstatements in Lynx company
accounts will also affect consolidated financial statements. Further this
risk is higher as audit strategy prepared by Vulture associates in relation
to Lynx company audit had multiple defeciences which included reliance
on previous year auditor's test of controls and reliance on internal auditor
work. Reliance to be placed on Vulture associates work in relation to Lynx
company accounts increases audit risk of our firm.
Valuation of contingent consideration
Contingent consideration should be valued at present value of future cash

flow adjusted with probability percentage of condition of contingent
consideration being satisfied. In case of Lynx company acquisition, Eagle
group management has valued contingent consideration at present value
only. They have ignored impact of porbability percentage while calculating
value of contingent consideration. Issue of probability percentage is
important in case of Lynx company acquisition as condition of contingent
consideration depends on profit target, whereas in current year Lynx
company has suffered a loss. Valuation of contingent consideration done
by management is wrong. It will misstate goodwill balance and non
current liability to be recorded in relation to contingent consideration.
Amount of contingent consideration recorded of $271 million exceeds
materiality level of $16.1 million determined for Eagle group audit,
therefore material to financial statements.
Abnormal movement in goodwill head
Goodwill balance in Eagle group financial statements have increased by

$130 million. However management has only explained increase of $100
million which is due to acquisition of goodwill of Lynx company. No other
acquisition is explained by management in group financial statements.
Goodwill balance can only increase due to acquired goodwill, as internally
generated goodwill cannot be recognized in financial statement. A risk

exist that some misclassification is done of $30 million and it is included
in goodwill head.
Fair value adjustment
Fair value adjusment done in relation to acquisition of Lynx company

assets will require adjustment of excess depreciation every year to be
recorded on amount of fair value uplift recorded of $12 million. A risk
exist that management may not have recorded adjustment of excess
depreciation in consolidated financial statements. Further another risk is
that fair value adjustment estimated by Sidewinder comapny may be
wrong as fair value is subjective head. If excess depreciation is not
recorded then it will misstate profits and property, plant and equipment
head. Fair value adjustment of $12 million is below materiality level of
$16.1 million, therefore immaterial to financial statements indivdiually.
However overall head of Lynx company net assets is of $300 million and if
fair value adjustment in relation to it is of insuffecient value then it may
exceed materiality level.
Capitalization of intangible assets
Amount spent by Eagle group in relation to development of software and

on research and development activity can only be capitalized if
capitalization criteria is satisfied. Otherwise all cash flows done before
satisfiaction of capitalization criteria should be expensed out.
Management of Eagle group has capitalized total spending amount of $60
million which is spent on development of software and research and
development activity. It is a wrong accounting treatment as capitalization
criteria cannot be satisfied from start of spending. Some of the spending
may have been done before satisfiaction of capitalziation criteria and
therefore should be expensed out. Wrong capitalization outflows will
overstate profits and intangible assets. Amount capitalized during the
year worth $60 million exceed materiality level of $16.1 million, therefore
Amortization of intangible assets
Eagle group should amortize software of dealing with customer enquiries,

research and development asset in relation to robots and software in
relation to accounts, according to their respective useful lives.
Management has charged amortization on all three intangible assets at
single life of 15 years. It is a wrong accounting treatment as software for
dealing with customer enquiries, development asset in relation to robots
and accounting software, all may have different useful lives. Wrong useful
lives used will result in wrong amortization charge, which will misstate
profits and intangible assets. Value of intangible assets in concern worth

$60 million, exceed materiality level of $16.1 million determined for Eagle
group audit, therefore material to financial statements.
Abnormal movement head in NCI head
Non controlling interest head in Eagle group financial statements is

showing an abnormal movement as it has only increased by $2 million,
whereas increase of $49 million should have happened due to acquisition
during the year of Lynx company. This lesser rise may either be due to
wrong classification of new NCI created due to acquisition of Lynx
company OR due to substantial losses suffered by any subsidary of Eagle
group which has reduced NCI by greater extent and it is only showing rise
of $2 million instead of $49 million rise.
Abnormal movement in Non current liabilities
Non current liabilities of Eagle group only include loans of $550 million
and provisions of $100 million, which were $500 million and $120 million
in previous year. A risk exist that non current liabilities of Eagle group are
incomplete as contingent consideration created during the year of $271
million should also be included in non current liabilities. No new head is
created in non current liabilities nor the movement in existing heads is
showing inclusion of $271 million contingent consideration. A risk exist
that contingent consideration is recorded in any wrong head in financial
statement. Contingent consideration is a non current liabiltiy as it is
payable after four years.
Reversal of provision and reversal of impairment losses
Management of Eagle group has recorded reversal of provisions of $60

million and reversal of impairment losses of $30 million in current year.
These reversals are based on management estimates as provisions and
impairment values are subjective. Managment of Eagle group may have
manipulated these estimates in order to get additional income in current
year, as in current year revenue has declined by 3.7%. Decline in revenue
may have created pressure on management to manipulate estimates of
provisions and impairment losses.
Abnormal movemement in Finance charges
Finance charge in financial statements of Eagle group have reduced by $2

million. This is abnormal as additional finance charge created during the
year due to unwinding of discount of contingent consideration should be
of $40.65 million ($271 million X 18% X 10/12 months). Present value of
contingent consideration will be unwinded every year to arive at future
value at actual payment date. In current year of 31 December 20X8

unwinding of discount of 10 months has to be recorded as acquistion was
done on 1 March 20X8. Unwinding of discount is recorded as an interest
expense along with increase in liability value of contingent consideration.
Financial analysis
Decline in revenue 3.7%

Increase in operating profit 29.6%
Increase in staff cost 1.1%
Decline in other operating
92.5%
expenses
Increase in profit before tax 34.1%
Increase in current liabilities 9.1%
Increase in current assets 2.1%
Revenue has declined by 3.7%. It is explained by management that is

due to new competitor of Eagle group. Operating profit has increased by
29.6% and profit before tax has increased by 34.1%. This is abnormal as
revenue is declining but profits are increasing. This is due to non cash
incomes recognized in relation to reversal of provision and reversal of
impairment losses. Staff cost has increased by 1.1% which is abnormal as
company has reduced number of staff by 5,000 at start of year. Other
operating expenses have reduced by 92.5% which is an abnormal decline,
and management has not given any reason of it. Lastly current liabilities
have shown increase of 9.1% whereas current assets have only increased
by 2.1%. It is abnormal as current assets and current liabilities usually
move in line.
Conclusion
Most significant audit risk in relation to Eagle group audit is a fact that it
is first year of audit. Our firm will lack knowledge about Eagle group's
business and its environment. Second most significant risk is reliance on
work of Vulture associates in relation to component audit of Lynx
Company. Lastly third most significant risk is valuation of contingent
consideration which is done wrongly by management of Eagle Group. Its
amount exceeds all other risks identified in Eagle group audit.
Ryder Group
Briefing Notes
To, Mo Iqbal, group audit engagement partner
From, Audit Manager
Subject: Re: Ryder group audit planning
Date: 1 July 20X5
Introduction
These briefing notes are in relation to Audit planning for Ryder group for
the year ended 30 September 20X5. It includes evaluation of significant
Audit risks to be considered in audit planning of Ryder group. Further
additional information which need to be requested from management in
relation to disposal of Primal Burger company, is also included in these
briefing notes. These briefing notes also include principal audit procedures
to be performed in relation to investment in Peppers company and in
relation to government grant received. Lastly these briefing notes include
ethical issues to be considered and relevant actions to be taken by our
firm, in relation to phone call received from audit committee.
(a) Audit Risks
Materiality level
Materiality level for Ryder group audit will be based on its profit before
tax. Range of materiality level based on profit before tax is 5% to 10% of
PBT. In case of Ryder group audit it will be between range of $1 million to
$2 million. Our firm will use professional judgement in order to determine
materiality level from this range, based on risk assesment of Ryder group
audit. Ryder group is an existing audit client of our firm, therefore from
this perspective audit risk will be considered as low. However Ryder group
is a listed group therefore it will face greater regulatory requirements.
Further during the year major investments and disposals are being
planned and done as in current year Ryder group is doing group
restructuring, this increases overall audit risk. Considering high risk of
audit, lower level of materiality will be used of $1 million for Ryder group
audit.
Held for sale and discontinued operation in relation to Primal

Burger comapny
Ryder group should classify Primal Burger company as an investment held

at held for sale and discontinued operation as it meets the relevant
criteria of IFRS 5. Board approval was obtained during the year and active
location of buyer is also being done. Further sale is expected to happen in
next 12 months as managements expects that sale will be executed soon
after the year end. As per IFRS 5, investment in Primal burger company
will be shown as Held for sale and its assets will be valued at lower of
carrying value and fair value less cost to sell. Further as it was a complete
revenue stream therefore it will be shown as a discontinued operation in
consolidated Profit and loss. A risk exist that managment may not have
shown Primal burger company as held for sale and discontinued
operation. It will misstate presentation of Profit and loss and valuation of
investment in Primal burger comapny. Primal Burger comapny represents
assets of $110 million and revenue of $99 million, which both exceed
materiality level of $1 million, therefore a material head to financial
statement.
Investment in Valentine company
Investment in Valentine company is expected to happen in first quarter of

next year. It will be considered as subsequent period to current year as
next quarter means three months of next year, and subsequent period
normally continues till three months, as financial statements are normally
audited and approved by board after three months of year end.
Investment done in subsequent period will be considered as a non
adjusting event and disclosure note will be required in relation to it. A risk
exist that managmenet may not apply subsequent period treatment on
investment of Valentine company and fail to give disclosure note. It will
misstate notes to the financial statement. Investment in Valentine
company worth $100 million exceeds materiality level of $1 million
determined for Ryder group audit, therefore it is material to financial
statements.
Classification of investment in Peppers company
Investment in Peppers company should be classified as joint venture

investment as Ryder group and Smiths company both own 50% shares
each. It is a situation of joint control, unless any clause exist in contrary
to it in agreement between shareholders or in articles of association.
Equity accounting should be applied on this joint venture investment. A
risk exist that management of Ryder group may not have classified this
investment as a joint venture and may not have applied equity accounting
on it. If investment is wrongly classified then it will misstate share of
profit shown in consolidated profit and loss and carrying value of
investment shown in Statement of financial position. Investment in
Peppers company of $48 million exceeds materiality level determined for
Ryder group audit of $1 million, therefore material to financial

statements.
License included in property, plant and equipment
License acquired in relation to Monday coffee brand name should be

classified as an intangible asset, as license is an intangible. Management
has wrongly included it in property, plant and equipment. It is a wrong
accounting treatment as property, plant and equipment only includes
tangible assets. Wrong classification of license has understated intangible
assets and overstated property, plant and equipment head. License worth
$15 million exceed materiality level of $1 million determined for Ryder
group audit, therefore material to financial statement.
Wrong amortization on license
License to operate business for 24 hours should be amortized over three

years period as license provided was for three years. Yearly amortization
should be $15 million / 3 years = $5 million. Management of Ryder group
has wrongly depreciated license over 20 years period by including it with
property, plant and equipment and applying their policy on license.
Management has charged depreciation of only $15 million / 20 years =
$0.75 million. Amortization is charged lesser by $4.25 million. This will
overstate profits and intangible assets. Error done of $4.25 million exceed
materiality level of $1 million therefore material to financial statements.
Financial analysis
Groth in revenue 16.3%

Growth in revenue of Monday Coffee
40.9%
company
Decline in revenue of Primal Burger 3.8%
Growth in Inspiral Hotel 6.4%
Overall revenue has increased by 16.3% which is majorly due to growth

in Monday coffee business segment which has shown growth of 40.9%.
Growth in revenue in Monday coffee business is abnormal and reason
provided by group finance director is also unreasonable. As per finance
director increase in revenue in Monday coffee business segment of $45
million is due to new coffee shops opened during the year with an
investment of $43 million. Such a high return on investment in first year
seems unreasonable. Primal Burger company has shown a slight decline
of 3.8% and Inspiral hotel segment has shown growth of 6.4%. These
movements are within reasonable range. Further operating profit has
increased by 5.5% which is also reasonable considering revenue growth
of 16.3%. However increase in profit before tax by 11.11% is

unreasonable considering operating profit growth of 5.5%.
Conclusion
Most significant risk to be considered in Ryder group audit is classification

of Primal Burger segment as Held for sale and discontinued operation.
This segment represents significant portion of Ryder group financial
statements. Second most significant risk is disclosure requirement in
relation to investment in Valentine company which represents investment
of $100 million. Lastly third most significant risk is classification of
investment in Peppers company worth $48 million.
I
E Materiality E5m -> Income Statement
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ACCA AAA Audit Planning Notes by Sir Owais Mirchawala

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PLANNING

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Exam technique 1 – Planning

therefore, an effect on the financial statements.

• Using the exhibits

Examples of risks and evaluation are provided below.

Identification of the risk Initial development Further evaluation

Data breach may become

lose customers themselves may increase the

reputational damage which

been disclosed immediately

Customers will no longer (considering severity in the

trust Winberry Co to protect

their online data. reporting described in the

The lack of trust in the

website if customers do not

trust Winberry to protect their

data is a significant problem

operates online and has no

physical stores or outlets

(considering severity in the

Identify Impact Scale

for data breaches

reporting the breach

severity in the context of the

The fall in profit may result in

the breach of banking

covenants (Linking to impact

on other specific risks in the

Further data weaknesses

may exist and have not yet -

Professional marks associated with business risk

Our sites Useful links Most popular

myACCA Make a payment Professional insights

ACCA mail ACCA-X online courses ACCA Qualification

ACCA Careers Find an accountant Member events and CPD

ACCA Career Navigator ACCA Rulebook Supporting Ukraine

ACCA Learning Community News Past exam papers

Your Future Work for us

Contact us Planned system updates

To: Harvey Rebus, Audit engagement partner

From: Audit manager

Subject: Re: Audit planning for Pale Co

Date: 1 July 20X5

(a) Business Risk

Gold Standard accrediation

Damage caused by Storm

To: Olivia Fig, Audit engagement partner

From: Audit manager

Subject: Re: Winberry Co audit planning

Date: 1 July 20X5

(a) Business Risks

Data protection issue

Investment in Luxury Pet Supplies Company

To: Ted Hastings, audit engagement partner

From: Audit manager

Subject: Re: Audit planning – Mercurio Co

Date: 1 July 20X5

(a) Business Risks