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AAA SMART COURSE 2021-22
KASHIF KAMRAN –FCCA
Lecture 9
(BLOCK 3 LECTURE 3)
Objective: Practice of audit risk/ RoMM
Types of questions:
1. Evaluate the audit risk OR risk of material misstatement? _______ marks
2. Evaluate the audit risk OR risk of material misstatement. You should utilize analytical procedure as
part of the risk assessment? ______ marks
Good answer- audit risk /RoMM
Source: Exam technique article part 2 risk

When describing RoMMs, an effective approach is to use the following steps to construct your answer

1. Calculate and conclude on the materiality of the issue where sufficient information is available –
a mark will be given for a correct and relevant calculation of materiality with an appropriate
conclusion – this will only be awarded once per issue and materiality marks may be capped in
an exam question.
2. Briefly describe the relevant financial reporting requirement – note that no credit is awarded
for the accounting standard names or numbers, only the accounting treatment.
3. Relate the risk in the scenario to the accounting treatment.
4. Illustrate the impact of the risk on the financial statements

Summary

1. Calculate/ comment on the materiality – 1 mark per comment (max of 3 marks)

2. Briefly describe- accounting treatment (1 mark per accounting treatment)- 2 to 4 sentences
max and keeping the accounting treatment close to case study.
3. Risk – in the accounting treatment ( e.g. disclosure, presentation, classification, recognition,
valuation)
4. Impact of risk on FS-
a. Under or overstatement
b. Thus the FS could be materially misstatement

For e.g.

 No disclosure is made/given- what is the impact on the FS? ( fs are MM)

 Share based payment expense is not recorded – what is the impact on FS? (expense is
understated and profit is overstated)

Marking scheme (latest_ March/Jun 21)

 Up to 3 marks for each audit risk evaluated unless otherwise indicated. Marks may be
awarded for other, relevant risks not included in the marking guide.
 Materiality calculations should be awarded 1 mark each (max 3 marks).
 In addition, ½ mark for each relevant trend or calculation which form part of a relevant
explanation of the risk (max 2 marks).
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Summary of marking scheme – when the question ask for evaluate the audit risk / RoMM?

Suppose- you read a case and you found the following issues from the case.
1. There was no disclosure of a related party transaction
2. Management has recognized the cash settled shared based payment plan inappropriately, that
is has credited the equity not liability. The expense recognized in $195000.
3. Long the term taken during the year was classified as a non-current liability. The loan is for 5
years and the amount of loan is $30 million
4. Provision was not recognized on a legal case on going. The claim filed by the customer is $0.5
million.
5. New audit client
6. There is no internal audit function in the company
The profit of the company is $ 1 million. The total assets of the company is $ 300 million.

Answer:
Related party
Related party transaction are material by nature(1) and requires a complete disclosure in the notes to
the financial statements(1). No disclosure (0.5) has been made by the management for the related
parties identified during audit, thus the FS are materially misstated. (0.5)= 3 marks

Cash settled share based payment

The expense recognized for cash settled share based payment is $195,000, which is 19.5% of the profit
before tax, thus material to the financial statement (1). For a cash settled share based payment plan
the right accounting treatment is to debit the expenses and credit the liability (1) . However
management has wrongly recognized equity instead of liability(0.5). Thus at present equity is
overstated and liability is understated. (0.5) = 3 marks

Long term loan

The long term loan of $30 million is 10% of the total assets, thus material to the financial statements.(1).
The long term loan should be classified as current liability (the loan to be paid within 1 year time) and
non- current liability (1). Thus the present classification of long term loan is wrong (0.5). Thus the
non-current liabilities are overstated and current liabilities are understated. (0.5)= 3 marks

Provision
The claim filed by the customer of $0.5 million is 50% of the profit before tax, thus material to
the financial statement. The provision should be recognized when there is a present obligation as a
result of a past event and a reliable estimate can be made. (1). Thus at present no provision is
recognized. (0.5). Thus the liability/ expenses is understated and profit is overstated. (0.5)= 2 marks

Evaluate the audit risk- 20 marks

 3 risk of 3 marks each (max) = 9 marks
 20-9 =11 marks / 2 mark risk= 6 risk worth 2 marks each.
 Total = 3 risk+ 6 risk = 9 risk for a 20 marks answer

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Statement by default- worth 2 marks( when there is no accounting treatment / nor materiality)
New audit client
The audit firm will have less knowledge of business being a new audit client which will increase the detection
risk in the first year audit. (2 marks) – only write detection risk if the question is on audit risk
Further, being a new audit client there is a potential risk in opening balances and the opening balances could be
materially misstatement if wrongly brought forward because we were not the auditor last year. (2 marks)
No internal audit function
This is a control risk. Because there is no internal audit function this means that the monitoring of internal
controls will be weak, which increases the risk of weaknesses in the internal control system going un-detected.
Weak internal controls will increases the overall risk of material misstatement in the financial statements. 2
marks

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Type 2 question: Evaluate the audit risk/ RoMM. You should utilize the analytical procedure as part of assessing
the audit risk/ RoMM?

You should utilize the analytical procedures? – 5 marks

Suppose – Sept 18 Q1 (example)

 Part (a) 24 marks

 5 marks for analytical procedures
 24-5 = 19 marks
 3 marks * 3 risk= 9 marks
 19-9= 10 marks/ 2 mark risk = 5 risk for 2 marks

AA paper – Calculate the FIVE ratio? – 5 marks

AAA paper – Utilize the analytical procedures? – 5 marks

 1 mark per ratio with comparative + comment on the associated risk identified from the ratio

Sept 18 – Q1 part (a) Answer:

Results of analytical procedures

Year to 31 December Year to 31 December

20X8 20X7

Current ratio 2.4 2.6

Debt/equity ratio 24.5% 23.9%

Operating profit margin 6.1% 4.5%

Interest cover 12.5t 9t

Effective tax rates 19.9% 25%

Current ratio has decreased over the last year from 2.6 to 2.4. There is a possibility that current assets could be overstated
as it has increased by 2.1% over the last year.

The debt to equity ratio has marginally increased from 23.9% to 24.5% during the year. The company took new borrowing
during the year of $50 million which increased the debt to equity ratio. Thus at present the result fail to identify any risk.

Operating profit margin has increased from 4.5% to 6.1%. The other income has increased by 50% over the last year
indicates a possibility that other income could be overstated due to management bias connected with reversal of
provision impairment losses.

Interest cover has increased from 9t to 12.5t because operating profit has increased over the last year and there is a
reduction in finance charge. This seems strange as finance cost may had increased considering a new loan of $50 million.
This finance charge may be understated.

Effective tax rate has fallen from 25% to 19.9%. This indicates a possibility that tax expense could be understated.

Summary

 If a question ask for utilize the AP, then there are 5 marks allocated to it
 To gain the 5 marks, calculate 5 ratio with comparative, no need to show formula or calculation just write the
answer.
 Once 5 ratios results are calculated, under the results, comment on the associated risk identified from these results
by carefully looking at the numerator and denominator and the info provided in the case.
 Not necessarily each results indicates a risk, if that is so, tell examiner that the results fails to indicate a risk.
 Common ratio to be calculated (if you carefully evaluate the past answers of examiner) – includes current ratio, debt
to equity ratio, interest cover, operating profit margin and effective tax rate. However if the data is provided you
can also find, inventory holding period, debtor collection period etc.
 Keep the length of comment to just a sentence or max 2 sentences no more than that

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If a question – does not ask for AP (MARCH 2020-Q1)

 3 mark risk
 2 mark risk
 In addition ½ a mark for any relevant trend/ calculation up to max of 2 marks

If a question ask for AP- Sept 18 Q1

 5 marks specifically for AP

 Remaining marks in question will be split into:
o 3 marks
o 2 marks

4 step model to write a RoMM/ audit risk= MTRI

Q1- How to answer (March 2020-Q1)

Briefing note

To: Carol Morgan, Audit engagement partner

From: Audit manager

Subject/Re: Audit planning for the Rick Group

Introduction:

The purpose of writing this briefing note is to evaluate the audit risk, comment on the audit strategy of the component, audit
procedures on sale of property to group CEO and the advantages and dis-advantages of joint audit.

(a) Audit risk

(b)(i) Audit strategy

(b)(ii) Audit procedures

(c) Joint audit

Conclusion (2 sentences long- sum up of the main findings from a / b and c)

How to get 4 marks?

 Presentation- yellow – 1 mark

 Logical flow- the order of the question a / b / c – 1 mark
 Clarity – how sound your explanation is in the full answer (subjective)

Examiner mention students mostly score 3 out of 4 professional marks

Assignment- lecture 10

 Read the March 2020 Q1 case study – to solve Q1 part a for 24 marks in live class tomorrow

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