In lectures and tutorials you were introduced to inherent risks and how they impact on the planning of an audit. You were told that there are difference “levels” of inherent risk analysis starting with a general inherent risk analysis which identifies a series of general inherent risks which may exist in an entity which could cause material misstatement. These general risks can be found on page 239 of the textbook.
The next “level” of inherent risk assessment is to identify whether there are specific examples of these risk factors that are applicable to an entity that is being audited. It is this level of assessment that I want you to focus on. I want you to look for specific examples of inherent risks that illustrate the general inherent risks listed on page 239 of the textbook. These examples are, what you believe can create the possibility of material misstatement. Note I have underlined the word material. This is because you need to find specific examples of inherent risks that, might result in material misstatement. As the auditor you would be focusing on things that could be wrong which are considered material – this can mean material by amount or material by nature and you would be looking for the possibility that the numbers are wrong, or the disclosure is wrong. For the assignment, I am going to get you to look at disclosure only.
One of the inherent risks you have to examine is examples specific to Virgin Australia that represent complex or non-routine transactions. How do you find example(s) of this? You can use one of two ways to identify appropriate inherent risks. I am happy with either. Firstly, you can look for an event which occurred during the reporting period which is an example of a non-routine transaction. Or you can look at the annual reports and, using your assumed accounting knowledge, look for accounts in the financial statements (or notes) that represent examples of complex or non-routine transactions. Remember the inherent risks you identify must be material either by nature or amount.
If you are not sure, non-routine transactions are events that do not occur on a day to day basis and hence stand out as having a potential to be misstated in the reports because the accountants for an entity are not normally exposed to these transactions on a daily basis to gain experience in how to record them. Once you have found a specific example of a complex or non-routine transaction, you then have to identify what the potential incorrect disclosure could be. In the next section I will tell you how I want you to present your answer.
The audit partner is very pedantic about how the answer should be set out – this will make it easier for the audit partner when using your report to begin the planning of the audit. The audit partner would like you to set out your answer as follows for question 2:
1. Use a heading to show which of the three factors you are discussing. E.g. If you were looking at the first risk factor your heading will be “Complex or non-routine transactions”.
2. Identify a specific example which illustrates the general inherent risk. You can use the annual report and look for examples of complex transactions in the financial reports. Alternatively, you can identify an event during the period involving Virgin (Part A of the assignment can guide you on finding relevant events) that represents in this case, a complex or non-routine transaction. You can focus on events or finding examples from the annual reports. It is up to you – just make sure you reference your work. In your answer provide a brief explanation of the event you have chosen or the account you have chosen from the financial reports.
3. Identify a specific potential disclosure that could be misstated as a result of the specific inherent risk you have identified. In other words, once you identify the inherent risk you must identify the appropriate Accounting Standard that would be used to disclose this event. For example, if you had identified an event associated with inventory you would identify AASB 102. You must then identify an example of a disclosure from that Accounting Standard that would be relevant in disclosing the inherent risk you have identified.