Audit of Financial Statements
What the domain tests
This domain tests audit planning, risk, materiality, assertions, audit procedures and documentation. Expect questions on the audit risk model and on choosing procedures for a given assertion.
Core rules
- Audit planning establishes scope, timing, direction and extent, considering materiality, risk and the entity's environment.
- Audit risk = inherent risk x control risk x detection risk. Detection risk is the auditor's risk; inherent and control risks belong to the entity.
- Assertions include occurrence, completeness, accuracy, cut-off, classification, existence, rights and obligations, and valuation and allocation.
- Procedures include risk assessment, tests of controls, substantive analytical procedures and tests of detail.
- Materiality is a matter of professional judgement and is revised as the audit progresses.
- Working papers document the audit and support the opinion.
Worked example
The auditor tests sales around year-end. Matching credit notes after the year-end to sales invoices tests cut-off: goods returned after year-end may show sales recorded in the wrong period. If invoices dated next year are included in this year's sales, sales and debtors are overstated. The auditor then considers whether the misstatement is material, whether controls failed, and whether the financial statements need adjustment. Analytical review of monthly sales may also reveal an unusual spike.
Traps
Do not treat sampling risk as non-sampling risk; do not set materiality once and never revise it; do not assume low inherent risk without evidence; and do not confuse tests of controls with substantive testing.