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Kim Smith.
Kim Smith.-
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dennis98
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Hi
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?
Kim Smith
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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).
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