Case study on audit planning and testing
Auditing: Guide to the Case Study
- This guide provides some suggestions on how to do the case study. Many of the examples given in this guide are just examples and are NOT based on the actual case study.
- There are many possible factors affecting audit planning & testing but you should focus on the facts given in the case study when answering the questions. E.g., if the case study does not mention an audit committee, there is no need to discuss the lack of an audit committee.
- Get straight to the point - Answer the requirements directly. There is no need to write an introduction or a summary. You do not need to cover issues that are not directly relevant to the requirements, e.g., factors about accepting/continuing an engagement or auditor independence issues. You do not need to explain any general theory about the audit process (e.g., from audit planning to audit completion). If you find yourself copying definitions and theories from the textbook etc., then your answer is most likely too general to get marks. Your answer should focus on "application" - i.e., identify inherent and control risk factors based on the facts given in the case, and explain audit tests that are suitable for the two audit objectives of the two accounts specified in the requirements.
- Ensure your answers correctly address the specific audit objectives of the account/transaction class involved. Focus your analysis on the sales accuracy objective and provision for warranty's valuation objective, not any other audit objective or any other accounts/transaction classes.
- To ensure you answer the requirements correctly, you should first make sure you understand the basic accounting treatment of the account(s)/transactions involved. E.g., what is the correct journal entry for recording sales or making a provision for warranty? (Please note that you do not need to explain the accounting treatment or journal entries in the case study.) What kind of fraud/error is likely to affect the accuracy audit objective of sales in this particular case study, driven by what kind of incentives/pressures (according to the facts given)?
Assessing inherent/control risks:
- Identify the circumstances that affect the inherent/control risks of the audit objectives of the transaction class/account specified in the requirements.
Consider the following points when writing your answer:
> How does a particular risk factor affect the likelihood of misstatement for this audit objective of this particular transaction class/account balance? Does this factor result in an increase or decrease of the risk? What is the nature of the likely misstatement, i.e., error or fraud? Indicate the direction of the likely misstatement if a fact clearly suggests that an overstatement or an understatement is more likely. Briefly explain how exactly this risk factor can cause a misstatement, e.g., what kind of error or fraud is likely to occur due to this risk factor?
> These points can actually be covered in one or two brief sentences for each risk factor. An example is as follows: "The merger of the audit client and company B is a non-routine transaction, which is likely to cause accounting staff to make mistakes relating to the [---audit objective] of the [---] account because the accounting staff are less experienced in recording non-routine transactions. This increases the inherent risk of both overstatements and understatements due to errors."
> Note that in the example above, the reason for the misstatement is briefly but clearly explained. Do not simply do the following: "[fact given in the case, e.g., poor economic conditions] increases inherent risk of misstatements for the sales accuracy objective." This sentence shows no understanding of the reasons why poor economic conditions are likely to increase the risk of misstatements for sales revenue. Think about the basic links between the "fact given" and "misstatements of sales accuracy".
> If the risk of misstatement is due to the possibility of fraud, very briefly explain the motivation/incentives for the fraud and how these affect the specific audit objective of the account in the question, e.g., "The pressure for top management to meet shareholders' profit expectations create incentives for them to overstate profit by overstating sales, which increases the inherent risk of overstatement due to fraud for the sale occurrence objective."
> Many incentives are general risk factors (i.e., they affect many audit objectives and many accounts). You do not need to analyse any audit objective or account other than the two specified in the requirements. However, you should clearly explain the link between the fact/incentive and those specified accounts. E.g., if you just write "[fact] gives managers incentives to overstate profit because...", this is a good starting point but think about what's missing from this sentence - how do you link the incentive to overstate profit to misstatement of sales revenue or provision for warranty? This is actually very easy to do, and this link only needs to be explained once in your answer.
> In requirement (1) assessment of inherent risk, give an example of one type of fraud that can be committed to breach the audit objective specified (i.e., one type for sales accuracy and one type for the valuation objective of provision for warranty). The examples can be very simple types of fraud, e.g., "A type of fraud to overstate sales by breaching the sales classification objective is to classify other types of revenues or gains as sales revenue".
Appropriate audit procedures (tests of control and substantive tests)
- Again, ensure your audit procedure directly addresses the audit objective/transaction class/account in question.
- Briefly but clearly explain the audit procedure that needs to be performed. Give enough details to show the reader how this is actually a suitable procedure for the audit objective and account/transaction class in question, e.g., what kind of test (physical inspection of what? External confirmation with whom?), what kind of documents, and the direction of the test (e.g., tracing or vouching). It also helps to briefly explain how this audit procedure is suitable for the type of misstatement/risk you have identified, e.g., how can this procedure detect this kind of error or fraud?
General information
- Application of audit principles using the facts of the case is much more important than giving basic definitions and general theory without application. Given that there is a page limit, there is no need to define concepts like the purpose of an audit or provide definitions of the elements of the audit risk model. It is usually not necessary to state any general theory/definitions, but if you think it is necessary, then incorporate definitions, main audit concepts and audit standard requirements naturally into your arguments in the context of the case study. For example, you do not need to provide a general discussion of the quantitative/qualitative guidelines for materiality. Simply apply the concepts, e.g., "motor vehicles constitute 14% of total non-current assets and are therefore a material component of non-current assets based on the 10% materiality threshold suggested by AASB 1031."
- You do not have to specifically cite Auditing/Accounting standards unless they are directly relevant to the requirements. There is usually no need to cite any specific Auditing/Accounting Standards.
- Some of you may feel there is too much to say, given the page limit. Start with the most obvious key points first, and if there is still room, explain additional points that are directly relevant to the requirements. Do not waste time on issues that are not directly relevant to the requirements or tothe facts in the case study.
- It is important to cover as many risk factors as you can identify with brief, clear and accurate explanations, instead of explaining only one or two risk factors in a lot of detail without mentioning any of the other risk factors. However, if you just put in all kind of facts from the case without correct explanations or if you incorrectly classify inherent/control risks, you will not receive marks for these.