Question

A. A review engagement is carried out in accordance with the International Standard for Review Engagements (ISRE) 2400. During review engagement, the auditor should apply the same materiality considerations as would be applied if an audit opinion on the financial statements were being given. Although there is a greater risk that misstatements will not be detected in a review than in an audit, the judgment as to what is material is made by reference to the information on which the auditor is reporting and the needs of those relying on that information, not to the level of assurance provided.

Required:

i. Differentiate between ‘audit engagement’ and ‘review engagement’ in respect of their objective and comparative level of assurance.

ii. Justify the need for a review of financial statements.

iii. Explain the reason why ‘there is a greater risk that misstatements will not be detected in a review than in an audit’s.


B. Assume that maria, CPA is using 10% of the net income before taxes, current assets or current liabilities as her major guidelines for evaluating materiality. What qualitative factors should she also consider in deciding whether the misstatements may be material.       


C. Discuss the three categories of factors that affect acceptable risk and list the factors that the auditor can use to indicate the degree to which category exists.      

Answer 1

(i)

Audit Engagement	Review Engagament
It is meant to provide reasonable assurance that the financial statements are free from material misstatement	It is meant to ascertain that whether or not financial stataments are believable or not.
Here a variety of methods being used such as study and evaluation of internal controls, inspection of documents, physical counts of assets and making enquiries with all managements.	A review provides limited assurance that the financial statements are conforming to the generally accepted accounting principles

(ii)

-To ascertain liquidity position of the company by applying various liquidity ratios. This would help to ascertain to compute long term and short term sustainibility of the enterprise.

- To evaluate the solvency status of the entity.

- To assess the financial and non financial data which would be helpful in attaining the plauible relationships between them and understanding the business.

- To verify whether the financials are in conformity with the genarally accepted accounting principles.

- Comparing the Ratios of the company with the industry ratios to assess the strength of the company in the industry.

(iii)

There are 3 types of misstatements which leads to greater risk in misstateements would not being detected in audit review:

• Factual Misstatements: These are clear miststaments where there would be no doubt at all. Eg: A deviation from IFRS requirement such as a missing disclosure.
• Judgemental Misstatement: These are the differences arising from the judgements of management concerning accounting estimates or accounting policies applied, auditor considers unreasonable.
• Projected misstatements: These are the best estimates of miststaments in populations, involving the projection of miststatements identified in audit samples.

(B)

• Misstaments may be material if they affect trend in earnings.
• Contractual obligations may also lead a material misstatement in financial statements.
• Amounts relating to fraud are considered much important than unintentional errors of equal amounts.

(C) The three types of risks are :

• Inherent Risk: It refers to the risk that could not be protected or detected by the entity's internal control. It is generally considered to be higher where a high degree of judgement and estimation is involved or where the transactions are complex.
• Control Risk: This risk or internal control risk is the risk that current internal control could not detect or fail to protect significant error or misstatements in the financial statements. Organizations must have adequate internal controls in place to prevent and detect instances of fraud or error.
• Detection Risk: This risk is the risk that auditor fails to detect the material misstatement in the financial statement and then issued an incorrect opinion to the audited financial statements. Detection risks can be reduced by auditors by increasing the no. of sampled transactions for detailed testing.