INDIVIDUAL REVIEW SOLUTION 2

1. Business risk is the risk that a business will fail financially and, as a result, will be
unable to pay its financial obligations. Audit risk is the risk that the auditor will
conclude that the financial statements are fairly stated and an unqualified
opinion can therefore be issued when, in fact, they are materially misstated.
Audit failure is a situation in which the auditor issues an incorrect audit opinion
as the result of an underlying failure to comply with the requirements of
auditing standards.
When there has been a business risk/failure, but not an audit failure, it is
common for statement users to claim there was an audit failure, even if the most
recently issued audited financial statements were fairly stated. Many auditors
evaluate the potential for business failure in an engagement in determining the
appropriate audit risk.

2. An error is an unintentional misstatement of the financial statements. Fraud

represents intentional misstatements. The auditor is responsible for obtaining
reasonable assurance that material misstatements in the financial statements are
detected, whether those misstatements are due to errors or fraud.
An audit must be designed to provide reasonable assurance of detecting material
misstatements in the financial statements. Further, the audit must be planned
and performed with an attitude of professional skepticism in all aspects of the
engagement. Because there is an attempt at concealment of fraud, material
misstatements due to fraud are usually more difficult to uncover than errors. The
auditor’s best defense when material misstatements (either errors or fraud) are
not uncovered in the audit is that the audit was conducted in accordance with
auditing standards

3. An auditor's best defense for failure to detect a fraud is an audit properly

conducted in accordance with auditing standards. ISA 315 states that the auditor
should assess the risk of material misstatements of the financial statements due
to fraud. Based on this assessment, the auditor should design the audit to
provide reasonable assurance of detecting material misstatements due to fraud.
ISA 315 also states that because of the nature of fraud (including defalcations), a
properly designed and executed audit may not detect a material misstatement
due to fraud.

4. An engagement letter from the auditor to the client specifies the responsibilities
of both parties and states such matters as fee arrangements and deadlines for
completion. The auditor may also use this as an opportunity to inform the client
that the responsibility for the prevention of fraud is that of the client. A well-
written engagement letter can be useful evidence in the case of a lawsuit, given
 that the letter spells out the terms of the engagement agreed to by both parties.
Without an engagement letter, the terms of the engagement are easily disputed.

5. Misappropriation of assets represents the theft of assets by employees.

Fraudulent financial reporting is the intentional misstatement of financial
information by management or a theft of assets by management, which is
covered up by misstating financial statements.
Misappropriation of assets ordinarily occurs either because of inadequate
internal controls or a violation of existing controls. The best way to prevent theft
of assets is through adequate internal controls that function effectively. Many
times theft of assets is relatively small in dollar amounts and will have no effect
on the fair presentation of financial statements. There are also the cases of large
theft of assets that result in bankruptcy to the company. Fraudulent financial
reporting is inherently difficult to uncover because it is possible for one or more
members of management to override internal controls. In many cases the
amounts are extremely large and may affect the fair presentation of financial
statements
There are also the cases of large theft of assets that result in bankruptcy to the
company. Fraudulent financial reporting is inherently difficult to uncover
because it is possible for one or more members of management to override
internal controls. In many cases the amounts are extremely large and may affect
the fair presentation of financial statements

6. Prior to accepting a client, the auditor should investigate the client. The auditor
should evaluate the client’s standing in the business community, financial
stability, and relations with its previous CPA firm. The primary purpose of new
client investigation is to ascertain the integrity of the client and the possibility of
fraud. The auditor should be especially concerned with the possibility of
fraudulent financial reporting since it is difficult to uncover. The auditor does not
want to needlessly expose himself or herself to the possibility of a lawsuit for
failure to detect such fraud.

7. The new auditor (successor) is required by the IESBA, Code of Ethics for
Professional Accountant, to communicate with the predecessor auditor. This
enables the successor to obtain information about the client so that he or she may
evaluate whether to accept the engagement. Permission must be obtained from
the client before communication can be made because of the confidentiality
requirement in the Code of Ethics for Professional Accountant. The predecessor is
required to respond to the successor’s request for information; however, the
response may be limited to stating that no information will be given. The
successor auditor should be wary if the predecessor is reluctant to provide
information about the client
8. Changes that affect the consistency of the financial statements may involve any
of the following:
a. Change in accounting principle
b. Change in reporting entity
c. Corrections of errors involving accounting principles.

An example of a change that affects consistency would be a change in the

method of computing depreciation from straight line to an accelerated method. A
separate explanatory paragraph is required if the amounts are material.
Comparability refers to items such as changes in estimates, presentation, and
events rather than changes in accounting principles. For example, a change in the
estimated life of a depreciable asset will affect the comparability of the
statements. In that case, no explanatory paragraph for lack of consistency is
needed, but the information may require disclosure in the statements.

9. A qualified opinion states that there has been either a limitation on the scope of the
audit or a departure from IFRS in the financial statements, but that the auditor
believes that the overall financial statements are fairly presented. This type of
opinion may not be used if the auditor believes the exceptions being reported
upon are extremely material, in which case a disclaimer or adverse opinion
would be used.
An adverse opinion states that the auditor believes the overall financial statements
are so materially misstated or misleading that they do not present fairly in
accordance with IFRS the financial position, results of operations, or cash flows.
A disclaimer of opinion states that the auditor has been unable to satisfy him or
herself as to whether or not the overall financial statements are fairly presented
because of a significant limitation of the scope of the audit, or a nonindependent
relationship under the Code of Professional Conduct between the auditor and the
client.
Examples of situations that are appropriate for each type of opinion are as
follows:

OPINION TYPE EXAMPLE SITUATION

Disclaimer Material physical inventories not
observed and the inventory cannot be
verified through other procedures.
Lack of independence by the auditor.

Adverse A highly material departure from IFRS.

Qualified Inability to confirm the existence of an

asset which is material but not extremely
material in value.