Question

Apple, Inc. has had a large turnover on their audit committee in the current year. Management would like us to make a presentation to the new members of the committee. Prepare a memo to the audit partner (your online facilitator) that explains the following:

1. The different roles and responsibilities of the preparer (management) of the financial statements, the auditor and the audit committee.

2. The audit expectation gap.

3. The auditor’s relationship with shareholders, board of directors, audit committee and internal auditors.

4. The audit risk model and its components.

5. The types of audit evidence.

Answer 1

ROLES AND RESPONSIBILITY OF PREPARER OF FINANCIAL STATEMENT

a)Management is responsible for preparing the financial statements in accordance with applicable law and regulations.

b)Managent is also required to:

• properly select and apply accounting policies;
• present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information;
• provide additional disclosures, when compliance with the specific requirements in IFRSs is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity’s financial position and financial performance; and
• make an assessment of the Company’s ability to continue as a going concern

2)Audit Expectation gap

According to the the American Institute of Certified Public Accountants (AICPA) in 1992, the expectation gap could be defined as "the difference between what the public and financial statement users believe auditors are responsible for and what auditors themselves believe their responsibilities are.

3)Auditor relation with shareholder

The auditors are supposed to monitor the performance of the management on behalf of the shareholders. They act as watchdogs to ensure that the financial statements prepared by the management reflect the true and fair view of the financial performance and position of the firm.

Auditor relation with board of directors

The auditor participates in Board meetings dealing with the financial statements. At the same meetings, the auditor explains his/her view on the company's accounting policies, risk areas, internal control routines and accounting processes.

Auditor relation with audit committee

The audit committee usually helps the board of directors to ensure that the organization complies with relevant regulations and ethical standards, to ensure that the internal auditors are independent and competent, to make sure that the financial statements have been prepared correctly and accurately, and that the compensations paid to the organization’s executives were according to fairness and professionalism.

4)Audit risk and its model

Audit Risk = Inherent Risk x Control Risk x Detection Risk

Audit risk may be considered as the product of the various risks which may be encountered in the performance of the audit. In order to keep the overall audit risk of engagements below acceptable limit, the auditor must assess the level of risk pertaining to each component of audit risk.

Components

Explanation of the 3 elements of audit risk is as follows:

Inherent Risk

Inherent Risk is the risk of a material misstatement in the financial statements arising due to error or omission as a result of factors other than the failure of controls (factors that may cause a misstatement due to absence or lapse of controls are considered separately in the assessment of control risk).

Inherent risk is generally considered to be higher where a high degree of judgment and estimation is involved or where transactions of the entity are highly complex.

For example, the inherent risk in the audit of a newly formed financial institution which has a significant trade and exposure in complex derivative instruments may be considered to be significantly higher as compared to the audit of a well established manufacturing concern operating in a relatively stable competitive environment.

Control Risk

Control Risk is the risk of a material misstatement in the financial statements arising due to absence or failure in the operation of relevant controls of the entity.

Organizations must have adequate internal controls in place to prevent and detect instances of fraud and error. Control risk is considered to be high where the audit entity does not have adequate internal controls to prevent and detect instances of fraud and error in the financial statements.

Assessment of control risk may be higher for example in case of a small sized entity in which segregation of duties is not well defined and the financial statements are prepared by individuals who do not have the necessary technical knowledge of accounting and finance.

Detection Risk

Detection Risk is the risk that the auditors fail to detect a material misstatement in the financial statements.

An auditor must apply audit procedures to detect material misstatements in the financial statements whether due to fraud or error. Misapplication or omission of critical audit procedures may result in a material misstatement remaining undetected by the auditor. Some detection risk is always present due to the inherent limitations of the audit such as the use of sampling for the selection of transactions.

Detection risk can be reduced by auditors by increasing the number of sampled transactions for detailed testing.

5)Types of Audit Evidence

types of audit evidence:1)Physical examination2)Confirmation3)Documentation4)Analytical procedures5)Inquiries of the client6)Recalculation7)Reperformance8)Observation

Physical Examination- Inspection or count of a tangible asset

Confirmation- Receipt of a direct written response from independent third party, verifyingthe accuracy of information specifically requested by the auditor.

Documentation- Examination of “client’s” documents and records to substantiate F/Sinformation (“vouching”)

Analytical Procedures– comparisons and studies of relationships between client industry and business.

Recalculation– rechecking a sample of calculations made by the client.

Re-performance– auditor’s independent tests of client accounting procedures or controls

Observation– Use of senses to asses client activities .