Audit Principles and Techniques: formula sheet

Key formulas

Objective of a financial statement audit

Opinion on whether statements are prepared, in all material respects, in accordance with the applicable financial reporting framework

Based on SA 200. It is an opinion, not a guarantee of viability or management efficiency.

Three core auditor actions (SA 200)

Assess risks of material misstatement → obtain sufficient appropriate evidence → form opinion

Done with professional judgment and professional skepticism throughout.

Fundamental ethical principles

Integrity, Objectivity, Professional competence and due care, Confidentiality, Professional behaviour

Five principles listed in SA 200. Learn them as a list of five.

Level of assurance

Audit gives reasonable assurance, not absolute assurance

Use this phrase when asked about limitations of an audit.

Overall objectives of the auditor (SA 200, para 11)

(a) Reasonable assurance that financial statements as a whole are free from material misstatement (fraud or error) → opinion; (b) Report and communicate as required by SAs

Reasonable assurance is a high level of assurance, not absolute assurance.

Fundamental ethical principles

Integrity + Objectivity + Professional competence and due care + Confidentiality + Professional behaviour

Five principles in the Code of Ethics. Independence is a separate requirement for audit engagements.

Independence

Independence = independence of mind + independence in appearance

Section 141(3) covers disqualifications; section 144 lists prohibited non-audit services.

Professional skepticism (para 15)

Plan and perform the audit recognising that financial statements may be materially misstated

Honest-management belief does not justify accepting less-than-persuasive evidence (A22).

Risks reduced by skepticism (A19)

Overlooking unusual circumstances; over-generalising; inappropriate assumptions on nature, timing, extent

Learn all three; examiners ask for them.

Purpose of planning (SA 200)

Plan effectively + focus effort on high-risk areas + test populations

These are the three things the auditor must do, as listed in SA 200 guidance on the nature of audit procedures.

Hierarchy of planning documents

Overall audit strategy → Audit plan → Audit programme

Strategy sets scope, timing and direction. Plan sets nature, timing, extent of procedures. Programme lists the actual steps.

Content of an audit plan

Plan = nature + timing + extent of procedures

Use this phrase whenever asked what an audit plan contains.

Risk assessment link

Assessed risks of material misstatement → nature, timing, extent of further audit procedures

Per SA 200, risks are assessed at assertion level to decide what further procedures give sufficient appropriate evidence.

Detection risk

Detection risk can be reduced, not eliminated

Because of inherent limitations of an audit, some detection risk always remains.

Working papers test

Documentation must let an experienced auditor with no prior connection understand significant judgments

This is the standard of sufficiency for documentation under SA 200 guidance.

Sufficient appropriate audit evidence

Sufficient appropriate = Sufficiency (quantity) + Appropriateness (relevance + reliability)

Required to reduce audit risk to an acceptably low level (SA 200, para 17).

Risk and quantity

Higher assessed risk → more evidence; higher quality → less evidence

More evidence may not compensate for poor quality (SA 500, A4).

Audit procedures to obtain evidence

Inspection, observation, confirmation, recalculation, reperformance, analytical procedures, inquiry

Often used in combination. Inquiry alone is ordinarily not enough (SA 500, A2).

If evidence is insufficient

Obtain further evidence via other SAs, or extend work, or perform other necessary procedures; else assess effect on report

Based on SA 200, A71.

Means of selecting items for testing

100% examination | specific items | audit sampling

SA 500, A52. Use any one or a combination, based on risk of material misstatement and on practicality and efficiency.

Audit procedures to obtain evidence

Inspection, observation, confirmation, recalculation, reperformance, analytical procedures + inquiry

SA 500, A2. Inquiry alone ordinarily is not sufficient evidence of no material misstatement or of control operation.

Purpose of sampling

Conclusion about the whole population from a tested sample

SA 500, A56. Sampling is dealt with in SA 530.

Direction of testing

Overstatement: test recorded items. Understatement: test subsequent disbursements, unpaid invoices, supplier statements, unmatched receiving reports

SA 500, A27 uses accounts payable as the example of how relevance depends on direction.

Focus of effort

More effort where risk of material misstatement is higher

SA 200, A49: direct effort to areas most expected to contain risks, less to other areas.

Audit risk model

Audit risk = Risk of material misstatement × Detection risk

The multiplication is a conceptual model. SA 200 says audit risk is a function of these two, and risk assessment need not be exact.

Risk of material misstatement

Risk of material misstatement = Inherent risk × Control risk

SA 200 says the SAs usually refer to a combined assessment. You may assess the two separately or together.

Full model

Audit risk = Inherent risk × Control risk × Detection risk

Inherent and control risk are the entity's risks. Only detection risk is under your control.

Planned detection risk

Detection risk = Audit risk ÷ Risk of material misstatement

Rearrangement used in numerical questions. Higher assessed risk means lower acceptable detection risk and more substantive work.

Sample size factors (tests of details)

Higher assessed risk, higher assurance needed, lower tolerable misstatement, higher expected misstatement → larger sample. More other substantive procedures on the same assertion, stratification → smaller sample.

From SA 530 Appendix 3. For large populations, population size has little effect on sample size.

Scope of the opinion

Opinion = whether statements are prepared, in all material respects, per the applicable framework

For a fair presentation framework, it reads as presented fairly or true and fair view.

Opinion types (modification logic)

Material but not pervasive → qualified | Material and pervasive misstatement → adverse | Material and pervasive inability to get evidence → disclaimer

Qualified applies to either a misstatement or a limitation of scope that is material but not pervasive. This is taught under SA 705.

Areas with significant inherent limitations

Fraud (SA 240); related parties (SA 550); laws and regulations (SA 250); going concern (SA 570 Revised)

Taken from SA 200 on inherent limitations.

Last resort

Reasonable assurance not obtainable and qualified opinion insufficient → disclaim opinion or withdraw (if legally permitted)

Stated in SA 200.

Extra statutory reporting

Section 143(3)(i): report on adequacy and operating effectiveness of internal financial controls

This is an additional duty under law, not part of the opinion on the statements.

Quick revision

• An audit opinion says whether the financial statements are prepared, in all material respects, in accordance with the applicable framework.
• The opinion does not assure the entity's future viability or management's efficiency or effectiveness.
• The auditor must exercise professional judgment and maintain professional skepticism throughout.
• The auditor identifies and assesses risks of material misstatement, whether due to fraud or error.
• Audit risk is a function of the risks of material misstatement and detection risk.
• Risk assessment is a matter of professional judgment, and it may be expressed in quantitative or non-quantitative terms.
• The auditor obtains sufficient appropriate audit evidence by responding to the assessed risks.
• Items can be selected for testing by examining all items, selecting specific items or using audit sampling.
• Audit sampling lets the auditor draw conclusions about a whole population from a tested sample.
• Under section 143(3)(i) of the Companies Act 2013, the auditor also reports on internal financial controls.
• Documentation of a failure to achieve an objective helps the auditor judge its effect on the overall objectives.
• In answers, always follow provision, analysis of facts, conclusion.

Common mistakes

• Saying an audit guarantees the accounts are correct or the company is sound. Fix: Write 'reasonable assurance' and note that the opinion does not assure future viability or management efficiency.
• Treating internal audit and statutory audit as the same. Fix: Contrast them: statutory is mandated by law and gives an opinion on financial statements; internal is for management and reviews controls, risk and operations.
• Listing independence as one of the five fundamental principles. Fix: SA 200 lists integrity, objectivity, competence and due care, confidentiality and professional behaviour. Treat independence as a separate requirement that supports them.
• Saying the auditor gives absolute assurance. Fix: The objective is reasonable assurance about the financial statements as a whole, not absolute assurance.
• Treating the audit strategy, audit plan and audit programme as the same thing. Fix: Give each a one-line distinction: strategy is broad direction, plan is nature, timing and extent, programme is detailed procedures.
• Saying the audit plan is fixed once approved. Fix: State that the strategy, plan and programme are updated when risks, client circumstances or evidence change.
• Treating sufficiency and appropriateness as the same thing. Fix: Sufficiency is quantity. Appropriateness is quality (relevance and reliability). Write both definitions.
• Saying more evidence cures weak evidence. Fix: State that obtaining more audit evidence may not compensate for its poor quality.
• Treating vouching and verification as the same thing. Fix: Vouching starts from recorded transactions and goes to documents. Verification deals with assets and liabilities: existence, rights, valuation, disclosure.
• Saying inspecting an asset proves ownership and valuation. Fix: State that inspection gives reliable evidence of existence, but not necessarily of rights and obligations or valuation (SA 500, A16). Add title deeds or invoices.

Exam tips

• Start every answer with a one-line definition, then the objective. Examiners reward structure.
• Use the phrase 'reasonable assurance' and state what the audit does not assure.
• For compare-and-contrast questions, use fixed heads such as objective, appointment, report user and scope.
• In case-based questions, name the audit type from the facts before explaining it.
• Quote section 143(3)(i) only for the auditor's reporting on internal financial controls; avoid citing other sections unless you are sure.
• Quote SA 200 para 11 objectives and para 15 skepticism almost word for word; examiners reward exact conditions.
• In case questions, name the principle first, then apply the facts. Do not just list all principles.
• Always mention both limbs of independence and, where relevant, sections 141(3) and 144.