Audit scoping refers to the process of setting extent, nature, and timing of audit procedures to be performed. The scope of auditing is dependent on the risk assessment. If the risk of assessed material misstatement is higher, an auditor needs to plan extensive audit procedures.
On the contrary, if the assessed risk of material misstatement is low, the performance of limited audit procedures can be sufficient.
Explanation for audit scoping
An assurance audit is conducted in the following sequence.
- Understanding audit client business. (scoping)
- Assessment for risk of material misstatement. (scoping)
- Designing audit procedures. (scoping)
- Obtaining sufficient and appropriate audit evidence. (execution)
- Forming an opinion on the set of financial statement. (execution)
- Reporting audit findings. (reporting)
First and second stages (scoping)
Audit scoping is about the first three stages in the given list. These stages include business understanding and risk assessment.
Business understanding can be obtained in different ways. These ways include understanding business operations, products, policies, internal controls, monitoring aspects, management policies etc.
During business understanding, an auditor might discover different risks. For instance, if an audit client has raised a loan in foreign currency, currency fluctuation is risk. Similarly, if the loan comes with a variable interest rate, there is a risk of interest rate fluctuation.
It’s important to note that risk assessment is dependent on the business understating. If your business understanding is strong, you’ll be able to identify risks and vice versa.
Here are some common risks of material misstatement in the external audit.
- Risk of assets overstatement.
- Risk of liability understatement.
- Risk of incorrect calculations like depreciation, amortization, impairment, value in use, deferred tax, provisions, and figures.
- Risk of incorrect notes to the financial statement.
Given risks are mentioned to clear your understanding. There can be different risks depending on the business’s internal business policies and external environment.
Third stage (scoping)
An auditor needs to design audit procedures based on the assessed risk of material misstatement. The audit procedures aim to collect sufficient and appropriate audit evidence. It’s important to note that all the identified risks must be covered with sufficient and appropriate audit procedures. Otherwise, it might lead to impairment of audit quality.
Example for audit scoping
Your firm is appointed as auditor of XYZ Plc. It’s a new audit client and you need to assess the risk of material misstatement. First of all, you need to perform KYC – Know Your Client procedures. These procedures help in understanding business/products.
You approach management and ask for revenue streams as a job in charge. In the list of revenue, it’s discovered that there are local and international revenue from product sale. So, you start assessing risk in terms of local sales, exports, and foreign currency. Based on the identified risks, you design audit procedures and allocate a task to the audit team member. So, you’ve completed the planning aspect/scoping on the head of revenue/sales.
Further read on, tothefinance.
Audit scoping refers to the setting extent, timing, and nature of audit procedures. The scoping is dependent on the risk assessment, which can be done via business and external environment understanding.
So, extensive audit procedures need to be planned if the assessed risk of material misstatement is higher. On the other hand, if the risk of material misstatement is lower, assurance can be obtained with limited audit procedures.