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CA Intermediate · Auditing and Ethics · Risk Assessment and Internal Control

In the audit of Rao Steels Ltd, the auditor identifies a significant risk that revenue is overstated through year-end cut-off manipulation. Management says its control environment is strong and that the audit team may rely on controls for this area. Under the Standards on Auditing, what is the correct audit response?

The auditor should evaluate the design and implementation of relevant controls and perform substantive tests specifically responsive to the significant risk, such as cut-off testing. Substantive analytical procedures alone are insufficient, and management's assurance about the control environment cannot replace audit evidence.

  1. AEvaluate the design and implementation of relevant controls and perform substantive procedures specifically responsive to the significant risk, which cannot be only substantive analytical proceduresCorrect
  2. BRely solely on management's representation about the control environment
  3. CPerform only substantive analytical procedures since they are cost effective for significant risks
  4. DIgnore the risk because revenue recognition risk is presumed only for listed companies

Explanation

For significant risks the auditor must understand and evaluate the relevant controls and perform substantive procedures that respond specifically to the risk. Substantive analytical procedures alone are not sufficient, and management representation is not a substitute for audit evidence. The presumption of fraud risk in revenue recognition applies to entities generally, not only listed ones.

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