AAA(P7) – Identifying the audit risks vs Evaluating the audit risks!

Good question! Identifying a risk means spotting that it’s relevant to the financial statements. Assessing it has two aspects – how significant (potentially material) is it? And what is the likelihood of its occurrence?
So let’s consider any business that sells goods/services on credit. There is always some risk that some customers may not pay, which, if material, would overstate receivables and profit. This is an identified risk. To assess it, we would need to consider the specifics of the business – what proportion of sales are on credit terms? what type of customers does the business have? (small unincorporated businesses/large reputable companies/overseas customers in countries with a devaluing currency) what might the business be doing that increases the risk? Perhaps there are revenue targets and sales managers, aiming to achieve those targets, are less bothered about the creditworthiness of new customers – this would increase the assessed risk (of misstatement). But if there appear to be good relevant controls over the approval of new customers and setting credit limits, the assessed risk will be lower. Of course the auditor will have to carry out tests of controls to confirm that they are operating effectively and justify a reduction in substantive procedures – this is just one example of how the auditor responds to assessed risks.
So, in summary, identifying the risk is to specify what over/understatement could arise. And assessing/evaluating it is what directs the nature, timing and extent of audit procedures.

1. Not really – look at D18 answers, for example. The identification of the area of risk is summarised in the sub-headings.
2. Not always – it depends. Again see D18 answers. Where you are evaluating RoMM through a change in a ratio/trend (e.g. relating to revenue) – the materiality of revenue clearly doesn’t have to be assessed – it just “is”. But if you have something which might have been accounted for incorrectly as expense rather than capital (or vice versa), assessing its materiality is obviously relevant to its evaluation. (If immaterial – who cares?)
3. Again, where relevant.
4. This is an auditing exam, so rarely in detail – that’s not to say that you don’t need to know the detail. So for example, if development costs have been recognised as an asset, but you can see that the company is in financial difficulties, you might reference the most relevant criterion (in this case, availability of adequate financial resources) – rather than regurgitate them all.
1-4: This is why you have to plan an answer before you write it out – there’s a lot to think about – it can’t be made up as you write.
5. Not really – this is just my explanation to you. If you were asked to suggest, justify or critique an audit strategy (e.g. see S18 Q1(c)) a fundamental aspect of that is the extent to which you can rely on controls (if at all).

1. I don’t think there’s much call for using “I” and answers to Q1 refer to “our firm” rather than “we”. Personally I think it’s best avoided as the Q doesn’t ask what you, personally, would think or do.
2. Yes
3. Yes, but I would use SoPL for the statement.

Kim is away for a few days, but I’m sure she will see your kind comments. Thank you on her behalf.

Dear Abir – congratulations! I am always so pleased to here about students’ success!

Perhaps you could do me a favour? As the June exam is fast approaching, what ONE piece of advice would you offer to AAA students?

Kim