Significant and non-significant audit areas and audit decision tree

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Significant and non-significant audit areas and
audit decision tree
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Session Objectives

• To define and explain the process of
  identification of significant and non-significant
  audit areas
• To explain the significance of the Audit Decision
  Tree

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What is an Audit Area

• An audit area is just another name for an account
  area
• An Account Area is a set of transactions or a
  part of the accounts that are processed in a
  similar way and have a similar inherent risk
  profile
• There can also be non-financial areas important
  to audit

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Significant and Non Significant Audit Areas -I

• Significant audit areas are those account areas
  that impact significantly upon an entitys
  financial statements.
• For these audit areas we must obtain sufficient,
  relevant and reliable audit evidence to certify
  that the financial statements are true and fair.
• There is a risk of material misstatement of these
  audit areas
• Due to their value, context or nature
• Due to inherent risks of misstatement
• Due to the control risk in the entity

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Significant and Non Significant Audit Areas-II

• All other audit areas are non-significant wherein
  even if there are errors they will not have an
  impact on the audit opinion.
• To ensure optimum utilisation of audit resources
  the focus of audit needs to be on significant
  audit areas.
• Thus identification of non significant audit
  areas is a vital part of the audit planning to
  ensure that audit is both effective and
  efficient. It also saves on resources.

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Significant and Non Significant Audit Areas -III

• All audit areas should be assessed for
  significance and non significance to the
  financial statements
• The analysis should be based upon
• materiality by value and
• materiality by nature and context
• The results of auditors Understanding of the
  business operations of the entity should also
  help in this assessment.
• Analytical procedures may also be applied for
  such identification.

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Significant and Non Significant Audit Areas -IV

• Identification of non significant audit areas is
  usually dependent upon analysing audit areas into
  their smaller constituent parts.
• The auditors should be careful to consider the
  aggregate value of all non-significant audit
  areas in relation to materiality.

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Audit Decision Tree
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Decision regarding the Audit Approach to be
adopted

• to determine the most appropriate audit approach,
  the auditors should consider
• If a risk exists
• If controls can be relied upon in relation to
  that risk
• If an analytical procedure can be used
• If other substantive procedures need to be used

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Approach of Audit

• The audit approach chosen will
• reflect understanding of the auditee entity and
  its business
• take account of audit judgement on Planning
  materiality
• respond to the specific risk factors identified
  in the course of risk assessment

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Cost-effective audit approach

• Optimum mix of the following objectives
• minimising sampling risk
• minimising audit cost
• maximising assurance on the audit objectives

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The Audit Decision Tree

• A tool to help us decide how much audit work we
  need to do
• It is a diagrammatic representation of the
  results of the audit planning process
• It is designed to give us sufficient (e.g 95)
  assurance that the accounts are free from
  material misstatement
• We need to apply the decision tree to each audit
  assertion for each significant audit area.

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Identifying account areas

• Account areas are identified based on whether
• Transactions are subject to similar controls or
  risks or
• How items are disclosed in the accounts
• Number of account areas
• Too few ? differences in controls not
  considered
• Too many ? inefficient audit
• Auditors must use their professional judgement in
  defining areas

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Audit Decision Tree
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Results of decision tree

• Three levels of substantive testing
• Focussed
• Standard
• Minimum
• Determines type of work done and sample sizes

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Assurance Factors
Assurance factor Substantive Control Confidence
Focussed 3 95 0 95
Standard 2 86 9 95
Minimum 0.7 50 45 95
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Case study