Requirement (b) for 17 marks asked candidates to evaluate the audit risks to be considered in planning the audit. There were some excellent answers to this requirement, with many responses covering a range of audit risks, all well explained, and all relevant to the scenario.
The best answers demonstrated that a methodical approach had been applied to the information in the scenario, and the better candidates had clearly worked through the information logically, identifying the risk factors, then going on to explain them fully and specifically.
The audit risks that were generally dealt with well included those relating to the foreign currency transactions and to the portfolio of short term investments.
The risk relating to whether research and development costs could be capitalised was also identified by the majority of candidates, but the issue of amortisation was not often discussed.
To achieve a good mark for this type of requirement, candidates should look for a range of audit risks, some of which are risks of material misstatement and some are detection risks.
Candidates however do not need to categorise the risks they are discussing or to spend time explaining the components of the audit risk model.
When discussing audit risks relating to a specific accounting treatment, well explained answers will include an evaluation of the potential impact of the risk factor on the financial statements, for example, in this scenario there was a risk that the short term investments were overstated in value and that profit also was overstated.
Materiality should be calculated when possible, as this allows prioritisation of the risks identified. Strong candidates, as well as providing detailed analysis and explanation of the risks, also attempted to prioritise the various risks identified thus demonstrating appropriate judgment and an understanding that the audit partner would want to know about the most significant risks first.
Candidates are reminded that it is those risks that could result in a material misstatement in the financial statements, which need to be identified and addressed.
Weak answers included answer points that were too vague to be awarded credit. Comments such as “there is a risk this has not been accounted for properly”, “there is risk that this is not properly disclosed” and “there is a risk that the accounting standard has not been followed” are unfortunately too common and will not earn marks due to the lack of specificity.
It would be beneficial for candidates to review their answers and to consider whether what they have written would provide the audit engagement partner with the necessary knowledge to understand the risk profile of the client in question.
Other common weaknesses in answers include the following points:
* Discussing business risks instead of audit risks – in particular business risks relating to theft of inventory, security issues in relation to e-commerce and exposure to foreign currency fluctuations were often discussed, sometimes in a lot of detail, but usually the related audit risk was not developed.
* Incorrect comments on accounting treatments – for example discussing that the licenses granted by Ted Co should be treated as intangible assets.
* Lack of knowledge on some accounting issues – in particular many candidates clearly did not know how EPS should be calculated and therefore did not realise that the finance director’s calculation was incorrect or how short term investments should be measured.
* Evaluation of the company’s corporate governance structure, but not linking this to audit risk.
* Incorrect materiality calculations.