Question

Define 'professional judgement' and describe TWO areas where professional judgement is applied when planning an audit of financial statements. 

Answer 1

Answer: following Two are area where professional judgement is applied when planning in audit of financial statements

1.MATERIALITY Determining materiality involves the exercise of professional judgment. A percentage is often applied to
a chosen benchmark as a starting point in determining materiality for the financial statements as a
whole. Factors that may affect the identification of an appropriate benchmark include the following:

• The elements of the financial statements (for example, assets, liabilities, equity, revenue, expenses);
• Whether there are items on which the attention of the users of the particular entity’s financial statements tends to be focused (for example, for the purpose of evaluating financial performance users may tend to focus on profit, revenue or net assets);
• The nature of the entity, where the entity is at in its life cycle, and the industry and economic environment in which the entity operates;
• The entity’s ownership structure and the way it is financed (for example, if an entity is financed solely by debt rather than equity, users may put more emphasis on assets, and claims on them, than on the entity’s earnings); and
• The relative volatility of the benchmark.

2.DRAWING CONCLUSION - The audit shall exercise professional judgment in drawing conclusion. drawing of conclusions based on the audit evidence obtained, for example, assessing the
reasonableness of the estimates made by management in preparing the financial statements.

Professional judgment needs to be exercised throughout the audit. It also needs to be appropriately
documented. In this regard, the auditor is required to prepare audit documentation sufficient to enable an
experienced auditor, having no previous connection with the audit, to understand the significant professional
judgments made in reaching conclusions on significant matters arising during the audit.