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Article Presentation Sainsbury’s changes auditor of 20 years •Kadhim Shubber •January 16, 2015
Article Presentation
Sainsbury’s changes auditor of 20 years•Kadhim Shubber•January 16, 2015
Article Presentation• Summary
• http://www.ft.com/cms/s/0/08e1924c-9d81-11e4-9b22-00144feabdc0.html#axzz3PlEmGvuH
• Sainsbury’s is the third largest grocer, in terms or market share, in the UK. (Largest is Tesco)
• Last year Tesco admitted overstating profits. PwC gave them an unqualified opinion prior to this announcement.
• Sainsbury changing auditors to E&Y• How it relates to auditing
• How long should an auditor stay?
Article Presentation• Background research
• Price fixing (2007 fixing the price of milk)• New rotation rules
• EU. Mandatory rotation. 10 years or tender. 20 years manatory
• Why I chose this.• New rotation rules in the EU• Why did they change?
• PwC claims it is due to the new rules• Sainsbury’s said its intention to change its auditor followed a
recommendation by the audit committee to the board following a formal tender process.
• Sainsbury’s announced the tender process in June 2014, before it had emerged Tesco overstated its profits by £263m.
• PwC is currently being investigated by the Financial Reporting Council (FRC) for its role in the overstating of Tesco profits.
• Are these good rules?
Homework #1• Look through comments• 2--25. Client acceptance. Most did not mention the failure of
due diligence before even accepting the client• 3--30. Look at the assertions on page 12.
• 3--31. the net income was too low of a balance to start with.• Present finding of researching the audit report
Homework #1• Look through comments• 2--25. Client acceptance. Most did not mention the failure of
due diligence before even accepting the client• 3--30. Look at the assertions on page 12.
• 3--31. the net income was too low of a balance to start with.• Present finding of researching the audit report
Practice problem1. With respect to the concept of materiality,
which one of the following statements is correct?a) Materiality depends only on the dollar amount of an
item relative to other items in the financial statements.
b) Materiality depends on the nature of a transaction rather than the dollar amount of the transaction
c) Materiality is determined by reference to AICPA guidelines
d) Materiality is a matter of professional judgment
Chapter 4
Risk AssessmentRisk Assessment
Chapter 4
Risk AssessmentRisk Assessment
Risks
Client
Auditor
Financial Statements
Business Risk
Risk of Material Misstatement
Engagement Risk
Business Risk• Threats to management’s ability to achieve its objectives
4-10
Engagement Risk
An auditor’s exposureto financial loss and
damage toprofessional reputation.
Litigation
Adversepublicity
4-11
Audit Risk
The risk that an auditor expresses an inappropriate audit opinion when
the financial statements are materially misstated.
The risk that an auditor expresses an inappropriate audit opinion when
the financial statements are materially misstated.
4-12
• Applied at the assertion level because this directly assists the auditor in planning the appropriate audit procedures for the accounts, transactions, or disclosures
• Applied at the assertion level because this directly assists the auditor in planning the appropriate audit procedures for the accounts, transactions, or disclosures
Audit Risk Model (AU-C 200.A36-.48)
• Goal: Audit standards require auditors to design audits to reduce audit risk to an “acceptably low level”• http://pcaobus.org/Pages/default.aspx• AS 8
AUDIT RISKThe likelihood that a
material error or fraud will occur,
and not get caught by either the
internal controls orauditor’s procedures.
DETECTIONRISK
The likelihood that a material error
or fraud will not be caught by the
auditor’s procedures.
CONTROL RISKThe likelihood that a
material error or fraud will not be caught
by the client’s internalcontrols.
INHERENT RISKThe likelihood that,in the absence of internal controls, material error or fraud will enter the accounting
information system
=× ×
Audit Risk Model• Goal: Audit standards require auditors to design audits to
reduce audit risk to an “acceptably low level”
AUDIT RISKThe likelihood that a
material error or fraud will occur, and not get
caught by either theinternal controls or
auditor’s procedures.
DETECTIONRISK
The likelihood that a material error or fraud will not
be caught by the auditor’s procedures.
CONTROL RISKThe likelihood that a
material error or fraud will not be caught by the client’s internal
controls.
INHERENT RISKThe likelihood that,in the absence of internal controls, a material error or
fraud willenter the accountinginformation system
FinancialStatements
Accounting Information
System
Events,
Transactions SubstantiveProcedures
Internal Controls
=× ×
FinancialStatements
Accounting Information
System
Events,
Transactions SubstantiveProcedures
Internal Controls
Overall likelihoodmisstatement
doesn’tget caught
Likelihoodmisstatement
occurs
Likelihoodclient’scontrolsmiss it
Likelihoodauditor
misses it
AUDIT RISKThe likelihood that a
material error or fraud will occur, and not get
caught by either theinternal controls or
auditor’s procedures.
DETECTIONRISK
The likelihood that a material error or fraud will not
be caught by the auditor’s procedures.
CONTROL RISKThe likelihood that a
material error or fraud will not be caught by the client’s internal
controls.
INHERENT RISKThe likelihood that,in the absence of internal controls, a material error or
fraud willenter the accountinginformation system
=× ×
FinancialStatements
Accounting Information
System
Events,
Transactions SubstantiveProcedures
Internal Controls
=
The onlyway the
auditor canaffect audit
risk
The auditorcan only
assess this
The auditorcan only
assess this
Needs to beacceptably
low
AUDIT RISKThe likelihood that a
material error or fraud will occur, and not get
caught by either theinternal controls or
auditor’s procedures.
DETECTIONRISK
The likelihood that a material error or fraud will not
be caught by the auditor’s procedures.
CONTROL RISKThe likelihood that a
material error or fraud will not be caught by the client’s internal
controls.
INHERENT RISKThe likelihood that,in the absence of internal controls, a material error or
fraud willenter the accountinginformation system
=× ×
Risk of Material Misstatement
• Inherent Risk * Control Risk
• RMM is the risk that a material misstatement exists in the financial statements before auditors apply their substantive procedures
Assessing IR
INHERENT RISKThe likelihood that,in the absence of internal controls, a material error or
fraud will enter the accounting
information system
Events,
Transactions
• Factors affecting overall inherent risk:• Prior problems
• Overall business risk
• Factors affecting account inherent risk include:• Dollar size of the account
• Liquidity • Volume of transactions
• Complexity of the transactions • New accounting pronouncements
• Subjective estimates
Assessing CR
• Test internal controls– Design– Operating effectiveness
• Factors affecting CR– The environment in which the company
operates (its “control environment”).– The existence (or lack thereof) and
effectiveness of control activities.– Monitoring activities (audit committee, internal
audit function, etc.).• More on this in later chapters
Accounting Information
System
Internal Controls
CONTROL RISKThe likelihood that a
material error or fraud will not be caught by the client’s internal
controls.
Factors Affecting DR
• Nature, timing, and extent of audit procedures
• Sampling risk– Risk of choosing an unrepresentative sample.
• Nonsampling risk– Risk that the auditor may reach inappropriate
conclusions based upon available evidence
SubstantiveProcedures
DETECTIONRISK
The likelihood that a material error or fraud will not
be caught by the auditor’s procedures.
Detection Risk and the Nature, Timing, and Extent of Audit Procedures
Lower Detection Risk
Higher Detection Risk
Nature More effective tests.
Less effective tests.
Timing Testing performed at
year-end.
Testing can be performed at
Interim.
Extent More tests. Fewer tests.
FinancialStatements
Accounting Information
System
Events,
Transactions SubstantiveProcedures
Internal Controls
Assess Assess Determine / Solve for
Result
AUDIT RISKThe likelihood that a
material error or fraud will occur, and not get
caught by either theinternal controls or
auditor’s procedures.
DETECTIONRISK
The likelihood that a material error or fraud will not
be caught by the auditor’s procedures.
CONTROL RISKThe likelihood that a
material error or fraud will not be caught by the client’s internal
controls.
INHERENT RISKThe likelihood that,in the absence of internal controls, a material error or
fraud willenter the accountinginformation system
=× ×
Do you do more or less work in this situation?
FinancialStatements
Accounting Information
System
Events,
Transactions SubstantiveProcedures
Internal Controls
Assess Assess Determine / Solve for
Result
AUDIT RISKThe likelihood that a
material error or fraud will occur, and not get
caught by either theinternal controls or
auditor’s procedures.
DETECTIONRISK
The likelihood that a material error or fraud will not
be caught by the auditor’s procedures.
CONTROL RISKThe likelihood that a
material error or fraud will not be caught by the client’s internal
controls.
INHERENT RISKThe likelihood that,in the absence of internal controls, a material error or
fraud willenter the accountinginformation system
=× ×
Do you do more or less work in this situation?
Pop Quiz: All else held equal, would the following imply more work for the auditor or less work for the auditor?
1. Higher control risk
2. Higher inherent risk
3. Higher detection risk
4. Higher audit risk
AUDIT RISKThe likelihood that a
material error or fraud will occur, and not get
caught by either theinternal controls or
auditor’s procedures.
DETECTIONRISK
The likelihood that a material error or fraud will not
be caught by the auditor’s procedures.
CONTROL RISKThe likelihood that a
material error or fraud will not be caught by the client’s internal
controls.
INHERENT RISKThe likelihood that,in the absence of internal controls, a material error or
fraud willenter the accountinginformation system
=× ×
Using the Audit Risk Model Set a planned level of audit risk such that an opinion can be issued on the financial statements.
Assess the risk of material misstatement (IR x CR).
Use the audit risk equation to solve for the appropriate level of detection risk:
Set a planned level of audit risk such that an opinion can be issued on the financial statements.
Assess the risk of material misstatement (IR x CR).
Use the audit risk equation to solve for the appropriate level of detection risk:
AR = IR × CR × DR
DR = AR
IR × CR
Auditors use this level of detection risk to design audit procedures that will reduce audit risk to an acceptable level.
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Relationship of Misstatement and Risk
D = Direct relationship; I = Inverse relationship
Acceptableaudit risk
Inherentrisk
Controlrisk
Planneddetection risk
II
D
DR = AAR IR x CR
Relationship of Misstatement and Risk
D = Direct relationship; I = Inverse relationship
Acceptableaudit risk
Inherentrisk
Controlrisk
Planneddetection risk
Plannedaudit evidence
I
DI
I
I
D
D
Using the Audit Risk ModelLO# 3
Qualitative terms may also be used in the audit risk model.Qualitative terms may also be used in the audit risk model.
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