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Was wondering if you could help with the following. In the Dali question from 2015 the co offers warranties so the answer says that the audit risk is that a provision is not recognised and so profits could be overstated. Obviously a co is more llikely to overstate profit than understate it. But is it also valid to say there is a risk of understatement if maybe a co wants to do profit smoothing – overstate a provision in a year that profits are large so it can then reduce the provision another year when profits are lower than normal?
You are welcome to ask any questions you like!
The risk you explain may be valid – depending on the scenario. Dali includes, for example, aspirations to float on a stock exchange, an equity-settled share-based payment plan and a recommendation to revalue assets – all of which point “in the same direction” to a risk of overstatement of profit. It would therefore be contrary to suggest a pressure “in the opposite direction”.
Generally, in exam questions, the “default” position is that the risk of omitting/understating a liability (typically a provision) is greater than the risk of overstating it. This is because omission can be an oversight or relatively easily suppressed – and also more difficult for the auditor to substantive (looking for evidence of something that hasn’t been recorded).