Understanding the audit client

In accordance with ISA 315, auditors must ensure that they understand the
business that they are auditing, otherwise it would be difficult to understand
whether the company’s control systems are appropriate or its FS is accurate.
1. What to understand?
 Nature of business
 Nature of competition
 Applicable accounting standards
 Internal control system
 Regulatory requirements
 Organizational structure
2. Why to understand?
 To assess the risk of material misstatement
 To assess the level of materiality
 To design the procedures and sample size
 To decide the team members.
3. How to understand?
 Previous year financial statement
 Analytical procedures.
 Any published article/magazine regarding company
 Discussion and inquiry with the management
 Independent external inquiry.
Note: While understanding the audit client, the auditors are required to assess
the risk of material misstatement of company’s FS.
 ISA 240 (Fraud)
Intentional act to gain unjust advantages
There are two types of frauds:
Misappropriation of Assets Fraudulent Financial statement
Small day to day frauds, carried out by Fraud in financial statement by
staff with organization directors with the users of FS:
 Theft of petty cash/inventory  Creative accounting to get
 False time sheet of payroll personal advantages.
 Collusion with
supplier/customer
 Ghost/fake employee
 Bogus supply of goods

Fraud Risk Indicators (For auditors): There are some factors which indicate
employee may be involve in fraud, such as;
 Late sitting in office
 Attending office on holidays
 Not reporting work
 Poor motivation (not satisfied with job)
 Expensive lifestyle
 Secretive behavior
Responsibilities to deal with fraud:
 It is ultimate duty of client’s management to prevent, detect and correct
the fraud and apply good control system and create environment of
honesty.
 It is the not the responsibility of the auditor to prevent, detect or correct
the fraud, he’s is only responsible to check the application of accounting
and should ensure that FS is free from any misstatement due to any error
or fraud.
If auditor spot/detect/suspect any fraud in FS, then some procedures should be
carried out in accordance with ISA 240, such as:
 Discuss with the management regarding any fraud.
 Ask management whether they have any doubt of fraud.
 Inquiry of past fraud.
 Evaluate the step taken by internal control regarding fraud
 Ask management about responding fraud
 Ensure there’s no misstatement in FS due to fraud.
Note: Auditors are required to obtain written representation (signed by
management) regarding fraud and responsibilities. Audit team should ensure that
management has disclosed everything regarding fraud in notes to account.
 ISA 250 (Laws and Regulation)
It is the responsibility of the management to comply with laws and regulations
such as;
 Company law
 Employment law
 Criminal law
 Tax law, health and safety etc.
Auditor is not responsible to detect non-compliance; he should only ensure that
there’s no misstatement in FS due to non-compliance.
There are two types of law and regulations:
Category Auditor’s responsibility
Laws that effect FS directly e.g. tax law Auditor is responsible to collect
sufficient and appropriate evidence to
ensure company is complying with
laws and regulations
Laws that effect FS indirectly e.g. Auditor is required to assess the
quality standards, health and safety materiality and also identify the non-
standards. compliance.

Non-compliance indicators: There are factors which cast doubt that company is
not complying with laws and regulations, such as;
 Increased penalty expenses
 Adverse media/public comments and opinions.
 Investigation by law or court.
 ISA 300 (Audit Planning)
The objective to plan an audit is to carry out it in effective manner
Benefits/Reason of audit planning:
 It is mandatory requirement to plan an audit for auditor.
 It helps the auditor in determining the risky areas of FS.
 It facilitates the auditor in determining sample size and procedures etc.
 It assists the auditor in building team along with the need of any expert.
 It creates sense of direction and responsibilities for each of audit team
member.
Planning activities:
Audit Strategy Audit plan
It is the overall strategy of entire audit It converts the audit strategy in to
which determine the scope, time and detailed plan. Following things need to
strategy will be used for detailed audit consider in planning;
plan;  Who should do (teams)
 Risk assessment  When to do (interim or final)
 Deciding materiality level  What to do (subject)
 Deciding audit team member  Why to do (objective)
 Preparing the audit firm budget  How to do (plan)
 Test of controls, substantive
procedures etc.
 ISA 320 (Materiality)
Every information is material if its omission or manipulation can affect the
decision making of the users, taken on the basis of financial statement.
Points to consider:
 Auditors deicide materiality level on the behalf of the shareholders.
 Deciding materiality level is the matter of the auditor’s judgement.
 Materiality is decided on the basis of the risk of misstatement.
 Materiality helps the auditor to decide the sample size, procedures, time
required etc.
Auditor decide materiality from two perspectives:
1. Amount (Quantity): This is the material misstatement which is further
determined into two perspectives:
(i) Overall materiality (Aggregated): It is the materiality of entire
financial statement. And is determined using benchmarking
percentages: E.g. 5% of PBT, 0.5% to 1% of Revenue or 1% to 2% of
Total assets.
(ii) Performance materiality (Individual): This is the materiality of
individual transaction or account which is lower than the overall
materiality.
2. Nature (Quality): The auditor decides the materiality based on the nature of
matter, not considering any amount. The amount may be higher or lower
than the quantitative threshold.
Revision of Materiality: Materiality is decided during the planning stage and its
actual circumstances are different, then it should be revised based on the actual
scenario.
Note: auditor is required to document each and everything related to materiality.
ISA 520 (Analytical procedures)
It means comparison of financial and non-financial information and ensuring
whether information is plausible or not and investigate any unusual thing.
It means comparison:
 With historic data
 With competitor
 With whole industry
 With budget
 With auditor’s own expectation
Analytical procedures are fundamental to audit process.
Analytical procedures are being performed to understand nature of activity and
its environment, risk assessment, identifying any unusual difference or fraud.
ISA 325 require the auditors to perform analytical procedures to assess the risk of
material misstatement and, assessment of risk, identifying unusual difference or
fraud.
Analytical procedures can be performed during substantive testing to gain reliable
and relevant audit evidence.
The audit team should perform analytical procedure during final audit review, to
ensure conclusion of FS is consistent with auditor’s understating of entity.