EXPLAIN THE PURPOSE OF AN ENGAGEMENT LETTER AND LIST FOUR ITEMS WHICH SHOULD BE INCLUDED IN AN AUDIT ENGAGEMENT LETTER.

[MAGPIE (203), SCARLET(208), VENUS (217)]

THE AUDIT ENGAGEMENT LETTER OUTLINES THE NATURE OF THE CONTRACT BETWEEN THE AUDIT FIRM AND AUDIT CLIENT.
ITS PURPOSE IS TO MINIMISE THE RISK OF ANY MISUNDERSTANDING OF THE TERMS OF THE ENGAGEMENT BETWEEN THE AUDITOR AND THE CLIENT AND CONFIRM ITS ACCEPTANCE OF THE ENGAGEMENT.
THE PURPOSE OF THE ENGAGEMENT LETTER IS ALSO TO SET OUT THE TERMS AND CONDITIONS OF THE ENGAGEMENT AND THE RESPONSIBILITIES OF THE AUDITOR AND MANAGEMENT.

MATTERS WHICH SHOULD BE INCLUDED IN THE ENGAGEMENT LETTER INCLUDE:

1. THE OBJECTIVE AND SCOPE OF THE AUDIT.

2. THE AUDITOR'S RESPONSIBILITY.
3. MANAGEMENT'S RESPONSIBILITY.
4. IDENTIFICATION OF THE APPLICABLE FINANCIAL REPORTING FRAMEWORK FOR THE PREPARATION OF THE FINANCIAL STATEMENT.
5. THE FORM OF ANY OTHER COMMUNICATION OF RESULTS OF THE AUDIT ENGAGEMENT.
6. THE FACT THAT SOME MATERIAL MISSTATEMENTS MAY NOT BE DETECTED.
7. THE EXPECTATION THAT MANAGEMENT WILL PROVIDE WRITTEN REPRESENTATION.

FORMULA:-

GROSS PROFIT MARGIN = GROSS PROFIT/REVENUE*100

INVENTORY HOLDING PERIOD = INVENTORIES/COST OF SALES*365
RECEIVABLES COLLECTION PERIOD = RECEIVABLES/REVENUE*365
OPERATING PROFIT MARGIN = OPERATING PROFIT/REVENUE*100
PAYABLES PAYMENT PERIOD = TRADE PAYABLE/COST OF SALE*365
GEARING = LONG AND SHORT TERM BORROWINGS/ TOTAL EQUITY (SHARE CAPITAL + RESERVES)*100
INTEREST COVER = PROFIT BEFORE TAX + FINANCE COSTS/ FINANCE COSTS
CURRENT RATIO = INVENTORY+CASH+TRADE RECEIVABLE (CURRENT ASSET)/TRADE PAYABLE+OVERDRAFT (CURRENT LIABILITIES)
QUICK RATIO = TRADE RECEIVABLE (CURRENT ASSET - INVENTORY)/TRADE PAYABLE+BANK (CURRENT LIABILITIES)
RETURN ON CAPITAL EMPLOYED (ROCE) = PROFIT BEFORE INTEREST AND TAX/ (SHARE CAPITAL+ RESERVES+ BORROWINGS)

DESCRIBE THE PRECONDITIONS OF AN AUDIT:- [ESK (204), CORLEY APPLIANCES (206), PRANCER CONSTRUCTION (213)]

AUDITORS SHOULD ONLY ACCEPT A NEW AUDIT ENGAGEMENT OR CONTINUE AN EXISTING AUDIT ENGAGEMENT IF THE PRECONDITIONS OF AN AUDIT ARE PRESENT.

ISA 210 AGREEING THE TERMS OF AUDIT ENGAGEMENT REQUIRES THE AUDITOR'S TO:-
1. DETERMINE WHETHER THE FINANCIAL REPORTING FRAMEWORK TO BE APPLIED IN THE PREPARATION OF THE FINANCIAL STATEMENTS IS ACCEPTABLE.

2. OBTAIN THE AGREEMENT OF MANAGEMENT THAT IT ACKNOWLEDGES AND UNDERSTANDS ITS REPONSIBILITIES FOR THE FOLLOWINGS:-

- PREPARING THE FINANCIAL STATEMENTS IN ACCORDANCE WITH THE APPLICABLE FINANCIAL REPORTING FRAMEWORK.
- INTERNAL CONTROL NECESSARY FOR THE PREPARATION OF THE FINANCIAL STATEMENTS TO BE FREE FROM MATERIAL MISSTATEMENT WHETHER DUE TO FRAUD OR ERROR; AND
- PROVIDING THE AUDITOR WITH ACCESS TO INFORMATION RELEVENT FOR THE AUDIT AND ACCESS TO STAFF WITHIN THE ENTITY TO OBTAIN AUDIT EVIDENCE.

EXPLAIN THE BENEFITS OF AUDIT PLANNING:- [HART (207), RECORDER COMMUNICATION (219)]

1. HELPING THE AUDITOR TO DEVOTE APPROPRIATE ATTENTION TO IMPORTANT AREAS OF THE AUDIT.
2. HELPING THE AUDITOR TO IDENTIFY AND RESOLVE POTENTIAL PROBLEMS ON TIMELY BASIS.
3. FACILITATING THE DIRECTION AND SUPERVISION OF ENGAGEMENT TEAM MEMBERS AND THE REVIEW OF THEIR WORK.
4. ASSISTING, WHERE APPLICABLE, IN COORDINATION OF WORK DONE BY THE EXPERTS.

DEFINE AUDIT RISK AND COMPONENT OF AUDIT RISK:- [HURLING(214), AQUAMARINE(216)]

AUDIT RISK IS THE RISK THAT THE AUDITOR EXPRESSES AN INAPPROPRIATE AUDIT OPINION WHEN FINANCIAL STATEMENT ARE MATERIALLY MISSTATED.
AUDIT RISK IS A FUNCTION OF TWO COMPONENTS, BEING THE MATERIAL MISSTATEMENT AND DETECTION RISK.
MATERIAL MISSTATEMENT IS MADE UP OF A FURTHER TWO COMPONENTS, INHERENT RISK AND CONTROL RISK.

INHERENT RISK:-
INHERENT RISK IS THE SUSCEPTIBILITY OF AN ASSERTION ABOUT THE CLASS OF TRANSACTION, ACCOUNT BALANCE OR DISCLOSURE TO A MISSTATEMENT WHICH COULD BE MATERIAL, EITHER INDIVIDUALLY OR AGGREGATED WITH OTHER
MISSTATEMENT, BEFORE CONSIDERATION OF ANY RELATED CONTROLS.

CONTROL RISK:-
CONTROL RISK IS THE RISK THAT THE MISSTATEMENT WHICH COULD OCCUR IN AN ASSERTION ABOUT THE CLASS OF TRANSACTION, ACCOUNT BALANCE OR DISCLOSURE AND WHICH COULD BE MATERIAL, EITHER INDIVIDUALLY OR AGGREGATED
WITH OTHER MISSTATEMENTS, WILL NOT BE PREVENTED, OR DETECTED AND CORRECTED, ON A TIMELY BASIS BY ENTITY'S CONTROL.

DETECTION RISK:-
DETECTION RISK IS THE RISK THAT THE PROCEDURE PERFORMED BY THE AUDITOR TO REDUCE AUDIT RISK TO AN ACCEPTABLY LOW LEVEL WILL NOT DETECT A MISSTATEMENT WHICH EXISTS AND WHICH COULD BE MATERIAL, EITHER INDIVIDUALLY
OR AGGREGATED WITH OTHER MISSTATEMENTS.
DETECTION RISK IS AFFECTED BY SAMPLING AND NON-SAMPLING RISK.

EXPLAIN WHY ANALYTICAL PROCEDURES ARE USED DURING THE THREE STAGES DURING THE AUDIT.

1. DURING THE PLANNING STAGE, ANALYTICAL PROCEDURES MUST BE USED AS RISK ASSESSMENT PROCEDURES IN ORDER TO OBTAIN AN UNDERSTANDING OF THE ENTITY AND ASSESS THE RISK OF MATERIAL MISSTATEMENT.
2. DURING THE FINAL AUDIT, ANALYTICAL PROCEDURES CAN BE USED TO OBTAIN SUFFICIENT APPROPRIATE EVIDENCE. SUBTANTIVE PROCUDURES CAN BE EITHER TEST OF DETAILS AND SUBSTANTIVE ANALYTICAL PROCEDURES.
3. AT THE FINAL REVIEW STAGE, THE AUDITOR MUST DESIGN AND PERFORM THE RISK OF ANALYTICAL PROCEDURES WHICH ASSIST THEM WHEN FORMING AN OVERALL CONCLUSION AS TO WHETHER THE FINANCIAL STATEMENT ARE CONSISTENT
WITH THE AUDITOR'S UNDERSTANDING OF THE ENTITY.

EXPLAIN THE PURPOSE OF CONTENTS REQUIRED FOR ALL AUDIT DOCUMENTATION:-

CONTENT EXPLANATION
TO IDENTIFY WHO PREPARED THE WORKING PAPERS IN CASE
NAME OF PREPARER
OF QUERIES.
WORKING PAPER SHOULD BE REFERENCED TO THE RELEVENT
REFERENCE
SECTION OF THE AUDIT PLAN.
TO IDENTIFY WHO REVIEWED THE WORKING PAPER AND
NAME OF REVIEWER
DEMONSTRATE THAT IT HAS BEEN REVIEWED.
EVERY WORKING PAPER SHOULD STATE THAT OBJECTIVE FOR
OBJECTIVE THE REVIEWER TO ASSESS WHETHER THE OBJECTIVE HAS
BEEN ACHIEVED.

CONCLUSION TO IDENTIFY ANY ISSUE IN THIS AREA WHICH WILL NEED TO

BE FOLLOWED UP BY THE AUDIT MANAGER.

RESULTS THE WORKING PAPER SHOULD DOCUMENT THE RESULTS

THAT SUPPORTS THE CONCLUSION DRAWN FROM THE TEST.
COMMON POINTS OF SUBSTANTIVE PROCEDURE :-

REVENUE:- [KNIGHTS ELECTRONICES CO(201) AND DARJEELING CO(211)]

1. COMPARE THE OVERALL LEVEL OF REVENUE AGAINST PRIOR YEARS AND BUDGET FOR THE YEAR AND INVESTIGATE ANY SIGNIFICANT FLUCTUATION.
2. CALCULATE THE FINAL GROSS PROFIT MARGIN FOR ABC COMPANY AND COMPARE THIS TO THE PRIOR YEAR AND INVESTIGATE ANY SIGNIFICANT FLUCTUATIONS.
3. FOR THE SAMPLE OF INVOICES, RECALCULATE INVOICE TOTALS INCLUDING DISCOUNTS AND SALES TAX.
4. SELECT A SAMPLE OF DISPATCHED NOTES BOTH PRE AND POST YEAR END AND FOLLOW THESE THROUGH TO SALES INVOICES IN THE CORRECT ACCOUNTING PERIOD TO ENSURE THAT CUT-OFF HAS BEEN CORRECTLY APPLIED.
5. SELECT A SAMPLE FROM THE CUSTOMER ORDERS AND AGREE THESE TO THE DISPATCHED NOTES AND SALES INVOICES THROUGH THE INCLUSION IN THE DETAILED SALES LISTING AND REVENUE GENERAL LEDGER ACCOUNT
TO ENSURE COMPLETENESS OF REVENUE.

TRADE RECEIVABLES:- [ESK CO(204)]

1. OBTAIN A BREAKDOWN OF THE LIST OF INDIVIDUAL CUSTOMER BALANCES, CAST AND AGREE THE TOTAL TO THE TRIAL BALANCE/TRADE RECEIVALBLE ACCOUNT.
2. REVIEW THE AFTER DATE CASH RECEIPT AND FOLLOW THROUGH TO PRE YEAR END RECEIVABLE BALANCES.
3. SELECT A SAMPLE OF TRADE RECEIVABLE FROM THE LISTING AND PREPARE A RECEIVABLE CIRCULATION.
4. DISCUSS THE BOARD MINUTES WITH MANAGEMENT TO ACCESS WHETHER THERE ARE ANY SIGNIFICANT CONCERNS FOR RECOVERABILITY OF RECEIVABLES.
5. REVIEW THE LIST OF THE INDIVIDUAL CUSTOMER BALANCES FOR ANY CREDIT BALANCES AND DISCUSS WITH THE MANAGEMENT WHETHER THESE SHOULD BE CLASSIFIED AS PAYABLES.

DIRECTOR'S BONUSES:- [HART CO(207), RECORDER COMMUNICATION(219)]

1. REVIEW THE SCHEDULE OF CURRENT LIABILITIES AND CONFIRM THE BONUS ACCRUAL IS INCLUDED AS A YEAR-END LIABILITY.
2. CONFIRM THE AMOUNT OF EACH BONUSES PAID BY THE AGREEING TO THE POST YEAR END BANK LEDGER ACCOUNT AND BANK STATEMENT.
3. AGREE THE AMOUNT PAID TO EACH DIRECTOR AND CONTRACTS TO ENSURE THE AMOUNT INCLUDED IN THE CURRENT YEAR FINANCIAL STATEMENT ARE FULLY ACCRUED AND DISCLOSED.
4. OBTAIN A WRITTEN REPRESENTATION FROM MANAGEMENT CONFIRMING THE COMPLETE OF DIRECTOR'S REMUNERATION INCLUDING THE BONUS.
5. REVIEW THE BOARD MINUTES TO IDENTIFY ANY ADDITIONAL PAYMENTS RELATING TO THIS YEAR HAVE BEEN AGREED FOR ANY DIRECTORS.

TRADE PAYABLES:- [BLACKBERRY(212)]

1. OBTAIN THE TRADE PAYABLE LEDGER, RECALCULATE TO CONFIRM ARITHMETICAL ACCURACY AND AGREE TO THE FINANCIAL STATEMENT.
2. AGREE THE SAMPLE OF PRE-YEAR-END GRN'S TO PURCHASE INVOICES AND INTO THE LIST OF INDIVIDUAL SUPPLIER BALANCES.
3. CALCULATE THE TRADE PAYABLES PAYMENT PERIOD, COMPARE WITH THE PRIOR YEAR AND DISCUSS SIGNIFICANT DIFFERENCES WITH MANAGEMENT.
4. PERFORMANCE THE SUPPLIER STATEMENT RECONCILIATIONS FOR SUPPLIERS WHERE STATEMENTS ARE AVAILABLE. DISCUSS ANY DISCREPANCIES WITH MANAGEMENT.
 COMMON POINTS FOR AUDIT RISK:-

AUDIT RISK AUDITOR'S RESPONSE

NEW AUDIT CLIENT:-
IDENTIFY

MORE TIME AND RESOURCES WILL NEED TO BE DEVOTED TO

THERE IS A LACK OF CUMULATIVE AUDIT OBTAINING AN UNDERSTANDING OF ABC CO AT THE START OF
KNOWLEDGE AND EXPERIENCE. THE AUDIT. MORE SUBTANTIVE PROCEDURE WILL NEED TO BE
DETECTION RISK IS HIGH. PLANNED AND PERFORMED AND LARGER SAMPLES TESTED IN
OPENING BALANCE MAY BE MISSTATED AS XYZ CO ORDER TO LOWER DETECTION RISK.
DID NOT PERFORM THE AUDIT LAST YEAR.

STOCK ENCHANGE LISTING:-

IDENTIFY
ABC CO SHOULD ENSURE THAT THERE IS A SUITABLE
THERE IS A POSSIBILITY THAT THE DIRECTORS MAY EXPERIENCED AUDIT TEAM.THE AUDIT TEAM SHOULD
TRY TO MANIPULATE THE FINANCIAL STATEMENT TO MAINTAIN THE PROFESSIONAL SCEPTICISM AND BE ALERT TO
ACHIEVE THE DESIRED RESULT, RESULTING IN ANY MANIPULATION THROUGHOUT THE AUDIT.
POSSIBLE PROFIT, REVENUE AND ASSET
OVERSTATEMENT.

FRAUD:-
IDENTIFY DISCUSS WITH THE FINANCE DIRECTOR THE DETAILS OF ANY
FRAUD PERPETRATED BY THE PAYROLL CLERK AND WHAT
THERE IS A RISK THAT THE CLERK MAY HAVE PROCEDURES HAVE BEEN ADOPTED TO IDENTIFY ANY SIMILAR
UNDERTAKEN A SIGNIFICANT NUMBER OF FRAUDS.
FRAUDULENT TRANSACTIONS WHICH HAVE NOT YET IN ADDITION, THE TEAM SHOULD MAINTAIN A PROFESSIONAL
IDENTIFIED. SCEPTICISM AND BE ALERT TO THE RISK OF FURTHER FRAUD
CONTROL RISK IS ALSO INCREASED. AND ERRORS.

DEVELOPMENT EXPENDITURE:-
IDENTIFY
OBTAIN A BREAKDOWN OF THE EXPENDITURE CAPITALISED
IF THE RESEARCH COST HAVE BEEN INCORRECTLY AND AGREE TO SUPPORTING DOCUMENTATION AS TO
CLASSIFIED AS DEVELOPMENT EXPENDITURE, THERE WHETHER THE COST RELATE TO THE RESEARCH OR
IS A RISK THAT INTANGIBLE ASSETS ARE DEVELOPMENT STAGE.
OVERSTATED AND EXPENSES UNDERSTATED.

NEW LOAN:-
IDENTIFY
REVIEW THE LOAN AGREEMENT TO CONFIRM THE DETAILS
IF THE LOAN IS NOT ALLOCATED CORRECTLY AND REPERFORM THE COMPANY'S CALCULATION TO CONFIRM
BETWEEN NON-CURRENT AND CURRENT LIABILITIES, THAT THE LOAN HAVE BEEN CORRECTLY SPLIT INTO NON-
THIS WOULD LEAD TO THE CLASSIFICATION ERROR CURRENT AND CURRENT LIABILITES.
WITH CURRENT AND NON-CURRENT LIABILITIES
BEING MISSTATED.

DIVIDEND:-
IDENTIFY
DISCUSS THIS ISSUE WITH THE MANAGEMENT AND CONFIRM
IF THE DIVIDEND IS RECOGNISED, IT WILL RESULT IN THAT THE DIVIDEND WILL NOT BE RECOGNISED WITHIN
AN OVERSTATEMENT OF LIABILITIES. FAILING TO LIABILITIES IN THE FINANCIAL STATEMENT.
DISCLOSE THE PROPOSED DIVIDEND WILL RESULT IN
A LACK OF COMPLETENESS OF DISCLOSURE.
PPE:-
IDENTIFY

THERE IS A RISK THAT SOME ITEMS OF REVENUE REVIEW SUPPORTING DOCUMENTATION SUCH AS INVOICES TO
EXPENDITURE MAY HAVE BEEN CAPITALISED IN ESTABLISHED THAT THEY ARE CAPITAL IN NATURE.
CONTRAVENTION OF IAS 16 PROPERTY, PLANT AND
EQUIPMENT WHICH WOULD MEAN THAT PPE IS
OVERSTATED AND EXPENSES ARE UNDERSTATED.

NEW SALES SYSTEM:-

IDENTIFY DISCUSS WITH THE FINANCE DIRECTOR WHETHER ANY ISSUE
HAS ARISEN SINCE THE NEW SALES SYSTEM HAS BEEN IN
OPENING BALANCE FROM THE OLD SYSTEM MAY OPERATION WHICH MAY GIVE RISE TO A MISSTATEMENT IN
NOT HAVE BEEN TRANSFERRED CORRECTLY. IN THE FINANCIAL STATEMENT.
ADDITION, FURTHER ERRORS COULD HAVE ARISEN IF THE TEAM SHOULD ALSO DISCUSS THE ACCOUNTING
THERE ARE ISSUES WITH OPERATION OF NEW TREATMENT WITH FINANCE DIRECTOR AND ENSURE IT IS IN
SYSTEM. AS A RESULT, SALES AND RECEIVABLES MAY ACCORDANCE WITH IAS 38.
BE MISSTATED.

PATENT COST:-
IDENTIFY

INVENTORY DAMAGED BY FIRE:-

IDENTIFY
THE AUDIT TEAM SHOULD DISCUSS WITH THE MANAGEMENT
THE PROCESS FOR IDENTIFYING DAMAGED INVENTORY ITEMS
THERE IS A RISK THAT THE DAMAGED INVENTORY FOLLOWING THE FIRE AND REVIEW THE OUTCOME OF THE
HAS NOT BEEN FULLY WRITTEN OFF AND REMAINS INVENTORY COUNT AND AGREE THAT THE ITEMS IDENTFIED
WITHIN THE CLOSING INVENTORY. INVENTORY MAY HAVE BEEN WRITTEN OFF CORRECTLY.
BE OVERSTATED AND COST OF SALES ARE
UNDERSTATED.
INSURANCE CLAIM:-
IDENTIFY DISCUSS WITH THE MANAGEMENT WHETHER ANY
AS THE INSURANCE COMPANY HAS NOT RESPONDED NOTIFICATION OF PAYMENT HAS BEEN RECEIVED FROM THE
TO THE CLAIM, RECOGNISING THE AMOUNT INSURANCE COMPANY AND REVIEW THE RELATED
CLAIMED OVERSTATES PROFIT AND OTHER CORRESPONDANCE.
RECEIVABLES.

INVENTORY VALUATION:-
IDENTIFY
THEY SHOULD ALSO OBTAIN SUPPORTING DOCUMENTATION
THERE IS A RISK THAT THE NRV OF THE INVENTORY IN RESPECT OF THE ADDITIONAL COSTS IN ORDER TO
IS LESS THAN THE COST AND THEREFORE THAT THE ESTABLISH NRV.
INVENTORY IS OVERSTATED AND COST OF SALES
UNDERSTATED.

PPE USEFUL LIVES:-

IDENTIFY THE AUDIT TEAM SHOULD DISCUSS WITH THE DIRECTOR THE
RATIONALE FOR ANY EXTENTIONS OF ASSET LIVES AND
IT APPEARS THAT PPE IS OVERSTATED AND REDUCTION OF DEPRECIATION RATES.
DEPRECIATION EXPENSES ARE UNDERSTATED.
DIRECTOR'S BONUS:-
IDENTIFY
THE AUDIT TEAM SHOULD BE AWARE OF THE INCREASED RISKS
THERE IS A RISK THAT THE DIRECTOR WILL TRY TO OF MANIPULATION AND SHOULD ASSIGN MORE EXPERIENCED
OVERSTATE THE PROFIT, AND THEREFORE THEIR AUDIT MEMBERS TO SIGNIFICANT ESTIMATES AND
BONUSES BY INCREASING THEIR REVENUE AND JUDGEMENTAL AREAS.
INCOME RECORDED AND DECREASING EXPENSE.

WARRANTY PROVISION:-
IDENTIFY THE AUDIT TEAM SHOULD ALSO COMPARE THE PRIOR YEAR
PROVISION WITH THE ACTUAL LEVEL OF CLAIMS IN THE YEAR,
THERE IS A RISK THAT THE WARRANTY PROVISION TO ACCESS THE REASONABLENESS OF THE JUDGEMENTS MADE
MAY BE UNDERSTATED, LEADING TO THE BY MANAGEMENT.
UNDERSTATED EXPENSE AND LIABILITY.

TEMPORARY ACCOUNTANT:-
IDENTIFY DISCUSS WITH THE MANAGEMENT TECHNICAL COMPETENCY
AND EXPERIENCE OF THE TEMPORARY FINANCIAL
ACCOUNTANT. IN ADDITION, THE AUDIT TEAM SHOULD
INCREASE SUBSTANTIVE PROCEDURES ARE UNDERTAKEN ON
THE MATERIAL AREAS OF THE FINANCIAL STATEMENT TO
REDUCE AUDIT RISK.
 DISCUSS WITH THE MANAGEMENT TECHNICAL COMPETENCY
AND EXPERIENCE OF THE TEMPORARY FINANCIAL
THERE IS AN INCREASED RISK OF ERRORS IN THE ACCOUNTANT. IN ADDITION, THE AUDIT TEAM SHOULD
FINANCIAL STATEMENT AS A TEMPORARY FINANCIAL INCREASE SUBSTANTIVE PROCEDURES ARE UNDERTAKEN ON
ACCOUNTANT MAY NOT BE FAMILIAR WITH THE THE MATERIAL AREAS OF THE FINANCIAL STATEMENT TO
COMPANY'S ACTIVITIES AND SO ERROR MAY BE REDUCE AUDIT RISK.
UNNOTICED.