ZICA AUDITING PAPER

advertisement
ZAMBIA INSTITUTE OF CHARTERED ACCOUNTANTS
CHARTERED ACCOUNTANTS EXAMINATIONS
_______________
LICENTIATE LEVEL
_______________
L4: AUDITING
_________________
SERIES: DECEMBER 2012
___________________
TOTAL MARKS – 100 TIME ALLOWED: THREE (3) HOURS
_____________________
INSTRUCTIONS TO CANDIDATES
1.
You have fifteen (15) minutes reading time. Use it to study the examination paper
carefully so that you understand what to do in each question. You will be told when
to start writing.
2.
This paper is divided into TWO sections:
Section A:
Two (2) Compulsory Questions.
Section B:
Three (3) Optional Questions. Attempt any Two (2).
3.
Enter your student number and your National Registration Card number on the front
of the answer booklet. Your name must NOT appear anywhere on your answer
booklet.
4.
Do NOT write in pencil (except for graphs and diagrams).
5.
The marks shown against the requirement(s) for each question should be taken as
an indication of the expected length and depth of the answer.
6.
All workings must be done in the answer booklet.
7.
Present legible and tidy work.
8.
Graph paper (if required) is provided at the end of the answer booklet.
SECTION A
Attempt BOTH questions in this section.
QUESTION ONE
(a)
At a planning meeting held for the audit of one of your major clients whose year end
is 31 March 2012, the audit manager stated that the team should gather sufficient
appropriate audit evidence to enable the firm issue an appropriate audit report. He
informed the audit team members that even if the financial statements being audited
are for the year ended 31 March 2012 there is need to do some audit work covering
the period after 31 March.
Ben, one of the audit assistants in the audit team wants an explanation on the forms
of reports that can be issued by the auditor. He has stated that he is aware of the
provisions of ISA 700 Forming an opinion and reporting on financial statements and
ISA 705 Modifications to the opinion in the independent auditor’s report but is
unclear on the difference between an unmodified report and the modified report.
Required:
(b)
(i)
ISA 560 Subsequent events provides guidance on the auditor’s duties
regarding events after the period end. Discuss the reasons why it is
necessary for your audit firm to carry out audit procedures on events after
the client’s year end.
(4 marks)
(ii)
Describe the difference between unmodified and modified audit opinions.
Your answer should explain the forms of modifications that are available to
the auditor.
(6 marks)
Your firm Mulenga & Co Chartered Accountants has been appointed auditor of
Zambezi Ltd and this will be the first year that you will undertake the audit of the
financial statements of Zambezi Ltd.
The previous auditors Kabwe & Associates were dismissed by Zambezi Ltd because
of serious misunderstandings between management and the auditors.
You are the engagement partner of this audit and in familiarising yourself with the
new client you establish the following:
1. The company is in the agricultural industry and has coffee plantations in Northern
Province. The value of the coffee not yet harvested is treated as work in progress
and also any coffee not fully processed at the period end is included in work in
progress.
Zambezi Ltd contracts AgriProducts Ltd an independent company to value its
closing inventory at the year end. You have been informed that the experienced
engineer who carried out all the valuation work has just left the company. The
company now relies on the former engineer’s assistant who has little experience
in valuation of work in progress. AgriProducts Ltd’s fee for work done is at an
agreed rate of 1% of profit before tax.
2. 30% of the sales of Zambezi Ltd’s products are to the Far East. In order to keep
this market, the company agreed with its major customers that they deposit an
amount equivalent to their purchases for two months with Zambezi Ltd to enable
2
Zambezi Ltd give them three months credit. Experience over the last three years
has shown that a number of these customers have been given credit for values
far in excess of the deposit resulting in the write off of K235m in 2010.
The company has previously provided 3% of the total export debts as an
allowance for receivables but since last year the Managing Director has instructed
that the provision be discontinued as it reduces profit.
The foreign customers are invoiced in US$ and the foreign debts are recorded in
local currency using the exchange rate at the date of the sale.
3. The Managing Director’s pay is based on performance and the key indicator on
which his performance is based in the profit before tax that is made during the
year.
4. Bank reconciliations have not been prepared for the last six months. The balance
as per bank statement will be taken as the bank balance in the financial
statements.
5. The Finance Manager of Zambezi Ltd is a ZICA licentiate graduate with three
years experience most of which is in the internal audit department of companies
he has previously worked for.
Your assessment of the audit risk of Zambezi Ltd is that it is higher than the
acceptable level of risk that your firm is willing to accept.
Required:
(i)
Explain what is meant by audit risk clearly stating the action your company
will take in view of your assessment of audit risk of Zambezi Ltd as
unacceptably high.
(7 marks)
(ii)
Identify and explain the risks that your firm will have to deal with based on
the information that you have established in Zambezi Ltd.
(8 marks)
(iii)
State two (2) benefits to your firm of audit planning and give three(3)
matters that you will include in the audit plan of the audit of Zambezi Ltd’s
financial statements.
(5 marks)
(Total: 30 marks)
3
QUESTION TWO
(a)
(b)
The objective of an assurance engagement is for the auditor to give a reasonable
assurance that the financial statements give a true and fair view.
(i)
Explain the elements of an assurance engagement.
(5 marks)
(ii)
Explain what is meant by true and fair and give four (4) reasons why the
auditor does not give an absolute assurance.
(6 marks)
Chi Hu Ltd is a limited company that has been operating in Zambia for the last four
years. It is a company in the opaque beer industry and wishes to expand its activities
to the north western province of Zambia where the directors feel there are high
business prospects.
The company has had no statutory auditors auditing its financial statements during
the period that it has been operating. Because of its intended expansion program,
the company is in need of additional capital. It has approached its bankers for a long
term loan of $1 million repayable over a period of ten years. One of the conditions
for the bank to provide the required funds is that the applicant company must submit
a copy of its latest audited financial statements.
Ching Li, the Finance Director, has informed the rest of the board that the company
had no audited financial statements at the moment. The board has recommended
that a reputable firm of auditors be engaged to carry out the audit for the current
financial year. The board of directors of Chi Hu is largely comprised of executive
directors with only two non-executive directors.
The board has authorised Ching Li to advertise for audit services in the press.
The following advertisement has been put in the media by Chi Hu Ltd.
Expression of interest for audit services:
‘A reputable company in the opaque beer industry is seeking the services of a
reputable firm of auditors to carry out a statutory audit of the financial statements
for the year ended 31 March 2012.
Interested firms of auditors are requested to submit written bids detailing their offer.
Additional information that may be required can be obtained from the Finance
Director at the Head Office.
Sealed bids should be submitted and dropped in the tender box not later than 12
April 2012.’
You are the audit manager of your firm Best Service Chartered Accountants and your
partner has seen the above advertisement in the local press. He has asked you to
4
prepare tender documents for submission before the closing date and he wants to
review the tender documents before submission.
Your firm currently does not have any experience in the audit of companies in this
industry and the firm has only one office in Lusaka with a work force of 10
employees. Your partner has indicated to you that among other matters you should
include in the bid documents is that your firm has an office in Kitwe although this is
in the process of being established. He has also said that you should indicate that
the firm has qualified and experienced partners in this industry. His thinking is that if
your firm wins the tender it will recruit suitably qualified staff who can undertake the
audit.
Required:
(i)
Explain the rules regarding advertising of services that audit firms offer and list
the matters that audit firms such as yours would generally include in response
to the advertisement for audit services by a prospective client such as Chi Hu
Ltd.
(8 marks)
(ii)
Discuss the suggestions by your partner that you should include in the tender
documents the fact that your firm has a presence in Kitwe and has qualified
and experienced partners to undertake the assignment.
(4 marks)
(iii)
Discuss the composition of the board of directors of Chi Hu Ltd stating clearly
in your answer the role that non executive board members would play in Chi
Hu Ltd
(7 marks)
(Total: 30 marks)
5
SECTION B
Attempt any TWO questions in this section.
QUESTION THREE
Akoka, Ben and Chewe are small scale farmers who have been involved in various farming
activities in Lusaka west for a number of years. The three are neighbours who share
boundaries and the total acreage of their land is 200 hectares.
Each of the three has employed a number of workers. The challenge that they are facing is
that of raising finance to enable them expand their farming activities. Akoka has suggested
to the other two that they should consider teaming up and form one entity with a view of
listing on the stock exchange so that they can raise additional funds more easily. The three
agree that they engage a business consultant who would look at the feasibility of listing on
the Lusaka Stock Exchange.
The consultant has advised them that they should initially register a private limited company
and operate as such. The consultant has further advised that once the company has been in
operation successfully for a number of years then it can apply for listing on the Lusaka stock
exchange. Once they meet the listing requirements the stock exchange will approve the
listing of the company so that it becomes a public listed company whose shares will be
traded on the stock exchange.
Chewe is uncomfortable with the suggestion of listing the company on the Lusaka stock
exchange as he fears that the three will ultimately lose control of the company and all the
investment that they have made over many years. Chewe says the alternative to
incorporation is forming a partnership and this way they will raise the capital they want and
they will also save in terms of audit fees as there is no requirement for partnerships to have
their financial statements audited by external auditors.
One of the listing requirements of the Lusaka Stock Exchange is that all listed companies
must appoint independent auditors to audit the financial statements annually as required by
the company’s act 1994. Ben thinks that they would save substantial amounts of money in
having internal auditors audit the financial statements rather than engaging independent
auditors who are more expensive.
Required:
(a)
Discuss the reasons why a stock exchange such as the Lusaka stock exchange
requires that companies must meet the listing requirements before being listed.
(5 marks)
(b)
Explain why the Company’s Act 1994 requires that financial statements of listed
companies should be audited by independent auditors annually.
(4 marks)
6
(c)
Explain what is meant by a non statutory audit and state three (3) benefits of a
partnership having its financial statements audited by external auditors despite there
being no legal requirements to do so.
(5 marks)
(d)
Explain the differences between internal auditors and external auditors.
(6 marks)
(Total: 20 marks)
QUESTION FOUR
You are the audit manager of a medium size audit firm with offices in Lusaka, Ndola and
Kitwe.
Your firm has just introduced a training program for newly qualified ZICA graduates. This
program is part of the training that graduates are required to take before they can be
admitted as members of ZICA.
A group of ten trainees is about to complete its three year program and you have just
completed the recruitment of new trainees who will be posted to any of the three offices of
your firm. You have been asked to arrange a three day induction seminar for the new
trainees at which the new trainees are expected to be inducted on the operations of your
firm and other matters considered important in the performance of their work.
Your partner has asked you to discuss with him the content of the training materials that
you have prepared. In addition to other matters the partner has requested you to state the
position of the auditor when he relies on the work of a management expert and he gives an
inappropriate audit opinion based on misstatements arising because of the expert’s
negligence.
Required:
(a)
Describe the fundamental principle of objectivity of the statutory auditors clearly
explaining how this can be achieved by an audit firm.
(5 marks)
(b)
Discuss the reasons why auditors have rights to enable them carry out their work
efficiently clearly stating the rights that a firm such as yours have.
(6 marks)
(c)
Describe the composition of an audit team for a firm such as your firm clearly stating
who has overall responsibility for the audit opinion.
(4 marks)
(d)
Explain who a management expert is and in the context of the partner’s request
state the position of the partner giving an inappropriate opinion based on work
negligently performed by the management expert.
(5 marks)
(Total: 20 marks)
7
QUESTION FIVE
(a)
Statutory auditors carry out audit procedures with a view to collect sufficient
appropriate audit evidence on the financial statements being audited. The gathering
of audit evidence is done in various ways including through third party confirmations,
tests of control and substantive tests.
Required:
(b)
(i)
Distinguish between tests of control and substantive tests.
(3 marks)
(ii)
State and explain the financial statement assertions that are tested through
the circularisation of accounts receivables of a company at the year end.
(4 marks)
(iii)
Other than the circularisation of receivables state four (4) other situations the
statutory auditor may obtain third party confirmations.
(2 marks)
(iv)
Explain what is meant by analytical procedures clearly stating the situations in
an audit that analytical procedures may be used.
(5 marks)
(i)
Describe the substantive procedures that your firm will perform in verifying
the bank balance in the statement of financial position.
(4 marks)
(ii)
Describe the procedure your firm will follow in obtaining the bank
confirmations from your client’s bankers.
(2 marks)
(Total: 20 marks)
END OF PAPER
8
L4 AUDITING
SUGGESTED SOLUTIONS
9
SOLUTION ONE:
Zambezi Limited:
(a)
(i)
Why carry out work on events after period end.
The objective of conducting an audit is to form an opinion on the financial
statements being audited. ISA 560 Subsequent events provides guidance as
regards the auditors’ responsibilities for events that occur after the period
end.
IAS 10 Events after the reporting period deals with the accounting treatment
of events, favourable and unfavourable, occurring after the period end. These
events are classified into two namely adjusting and non adjusting events.
Management is responsible for correct accounting for such events requiring
that adjusting events are adjusted in the financial statements and non
adjusting events are appropriately disclosed in the financial statements.
The auditor’s concern is that he wishes to identify any events that occur after
the period end which will give him evidence of conditions that existed at the
period end. Some events will help the auditor confirm year end figures
especially those that are accounting estimates.
The ISA 560 Subsequent events gives the following as the objective of the
auditor as regards such events:
o
To confirm whether management has correctly accounted for events
after the period end in accordance with IAS 10 Events after the
reporting period. Where the accounting treatment by management is
incorrect, the auditor will require that management makes the
necessary amendments.
o
To respond appropriately to facts that become known to the auditor
after the auditor’s report which would have caused him to amend the
report had he known these facts before issuing the report.
Note: Marks should be awarded for any relevant points such as stating that
the auditor’s responsibility classified into active and passive responsibilities.
(ii)
The report of auditors:
Based on the audit evidence gathered during the audit, the auditor will issue
an appropriate audit report. This could either be an unmodified audit opinion
or it could be a modified audit opinion.
Unmodified audit opinion:
Is issued by the auditor when he concludes that the financial statements are
prepared, in all material respects, in accordance with the applicable financial
reporting framework.
10
In other words, the financial statements show a true and fair view and the
auditor does not have any matters that would cause him to modify his
opinion. The financial statements are free from material misstatements.
Modified audit opinion:
ISA 705 Modifications to the opinion in the independent auditor’s report gives
guidance as regards modified audit opinions.
A modified audit opinion is issued by the auditor when based on the evidence
gathered the auditor concludes that the financial statements as a whole are
not free from material misstatements. In this case the auditor has a matter of
concern that stops him from issuing an unmodified audit opinion.
Forms of modifications:
ISA 705 Modifications to the opinion in the independent auditor’s report gives
three forms of modifications as follows:
Qualified audit opinion:
This is where the auditor concludes that misstatements to the financial
statements are material but are not pervasive to the financial statements. In
other words the users of the financial statements will not be misled as a
result of the misstatement.
The form of modification will be ‘except for’ the matter at hand the financial
statements show a true and fair view.
Adverse audit opinion:
This is the worst form of opinion that the auditor will give. This is issued
where the auditor concludes that based on the audit evidence obtained he
concludes that misstatements are both material and pervasive to the financial
statements. The auditor will state that the financial statements do not show a
true and fair view.
Disclaimer of opinion:
In this situation the auditor states that he is unable to form an opinion. This
is done when the auditor cannot obtain sufficient appropriate audit evidence
on which to base the opinion and concludes that the possible effects on the
financial statements of undetected misstatements if any could be both
material and pervasive.
(b)
(i)
Audit risk:
This is the risk that the auditor will give an inappropriate audit opinion after
gathering audit evidence. For example where the auditor is supposed to give
an unmodified audit opinion but he gives a modified audit opinion. Among
other reasons, this arises from the fact that the auditor does not test all the
items in the financial statements of the client.
11
Audit risk can be denoted as follows:
Audit risk = Inherent Risk (IR) x Control Risk (CR) x Detection Risk (DR)
Inherent risk:
This is the risk that items will be misstated due to the characteristics of the
items concerned, for example the fact that they are estimates or that they
are important items in the financial statements.
12
Control risk:
This is the risk that a material misstatement, that could occur in an assertion
and that could be material will not be prevented or detected and corrected on
a timely basis by the internal controls established by the entity.
Detection risk:
This is the risk that the audit procedures performed by the auditor may not
detect a misstatement that exists and that could be material to the financial
statements.
Action when audit risk assessed as higher than acceptable risk:
In the event that audit risk is higher than acceptable the auditor’s action will
depend on whether this is a new appointment or it is an on-going audit.
The action that the auditor can take is to reduce detection risk. If this is done
then overall audit risk will also reduce. The auditor can do this by performing
more audit procedures and increasing the sample size. In other words the
more work the auditor carries out the lower the detection risk becomes.
If despite performing more work, the audit risk is still unacceptably high, the
auditor should decline any new appointments and should consider resigning
from existing audit engagement.
(ii)
Audit risks of Zambezi Ltd
Risk that the value of inventory may be misstated:
Due to the nature of the products of Zambezi Ltd, there is a risk that
inventory and particularly work in progress figures may be misstated. The
nature of inventory is that the management does not have experience to
determine the valuation.
The use an inexperienced valuer:
The risk of misstatement of inventory is compounded by the resignation of
the engineer who was experienced in valuing the inventory. The use on an
inexperienced assistant may result in the wrong valuation of inventory of
Zambezi Ltd.
Fee for services conducted by AgriProducts Ltd:
The fact that the expert company is paid for services rendered on the basis of
a percentage reduces their objectivity. AgriProduct Ltd will be more inclined
to give a valuation that is favourable to it in terms of the amount that will be
paid to it. In this case the higher the inventory figure the higher will the profit
of Zambezi Ltd and ultimately the higher the amount payable for valuation
services carried out.
Allowances for accounts receivable:
13
There is a risk that the allowance for receivables arising from export sales
may be misstated. This follows a directive by the managing director that the
provisions against these receivables be stopped despite evidence that
substantial amounts have been written off in the past.
14
Exchange losses:
There is a risk of suffering substantial exchange losses due to the fact that
foreign debts are invoiced in US dollars and the final receipt when the debts
are settled will be in local currency. The amount to be received will depend
on exchange rate movements between the date of the sale and the date
funds are received.
Managing director paid bonus based on profit:
There is a risk that the financial statements may be materially misstated
through fraudulent financial accounting with the aim of showing a better
performance than the actual performance. This will be to the advantage of
the managing director who gets a bonus based on profit made by the
company.
Bank reconciliations in arrears:
The fact that bank reconciliations have not been prepared for the last six
months means that there is a risk that the bank balance at the period end
may be misstated.
Qualification and experience of the finance manager:
The fact that the finance manager is only a licentiate holder of the ZICA
qualification and that he does not appear to have experience in the
preparation of financial statements means that there is a risk that material
errors and omissions may go undetected. There is a risk therefore that the
financial statements may be misstated due to errors and omissions arising
from lack of knowledge on the part of the finance manager.
(iii)
Benefits of the audit plan to Zambezi Ltd:
o
Helps the auditor to devote appropriate attention to important areas of
the audit.
o
Helps the auditor identify and resolve potential problems on a timely
basis.
o
Helps the auditor to properly organise and manage the audit
engagement so that it is performed in an effective and efficient manner.
o
Helps in the appointment of engagement team members with
appropriate levels of capabilities and competences in order to respond
to the risks anticipated and the proper assignment of work to audit
team members.
o
Facilitates the direction and supervision of engagement team members
and the review of their work.
o
Assists where relevant in assessing the need for an auditor expert and
coordinating the work done by experts.
Matters to include in the audit plan of Zambezi Ltd:
15
o
A description of the nature, timing and extent of planned risk
assessment procedures sufficient to assess the risks of material
misstatements.
o
An understanding and assessment of the control environment of the
organisation.
o
A description of the nature, timing and extent of planned further
procedures at the assertion level for each material class of transactions,
account balances and disclosure.
o
An explanation of the decision :
-
Whether to test the effectiveness of controls (where auditor may
want to place reliance on the effectiveness of relevant controls)
On the nature, timing and extent of planned substantive
procedures which will depend on the decision as the level of
control risk.
o
Audit procedures required to be carried out for the engagement in order
to comply with ISAs, for example, the use of external confirmations to
obtain sufficient appropriate evidence at the assertion level.
o
Materiality and the calculation of the materiality level.
o
The timetable of detailed audit work
o
The allocation of work to audit team members.
SOLUTION TWO:
Chi Hu Ltd
(a)
(i)
Elements of an assurance engagement:
An assurance engagement has five elements as follows:
Three party relationship namely:
o
The intended user who is the person who requires the assurance
report. In a listed company these are the shareholders.
o
The responsible party, which is the entity or organisation that is
responsible for preparing the subject matter which are the financial
statements.
o
The practitioner i.e. the auditor or professional who is the one who
reviews the subject matter and provides the assurance.
Suitable subject matter:
This is the data that the responsible party the company has prepared and
which requires verification i.e. the financial statements.
Suitable criteria:
16
This is the criteria against which the subject matter is compared against in
order for the subject matter to be assessed and an opinion provided.
Appropriate evidence:
Has to be obtained by the practitioner in order to give the required level of
assurance.
Assurance report:
Is the opinion that is given by the practitioner to the intended user and the
responsible party.
(ii)
True and fair:
Financial statements are produced by management which give a true and fair
view of the results of the entity. The auditor in reviewing these financial
statements gives an opinion on the truth and fairness of the financial
statements.
True – This means information is factual and conforms with reality in that
there are no factual errors. In addition it is assumed that to be true it must
comply with accounting standards and any relevant legislation. Lastly, true
includes data being correctly transferred from accounting records to the
financial statements.
Fair – Information is clear, impartial and unbiased, and also reflects plainly
the commercial substance of the transactions of the entity.
Why the auditor does not give absolute assurance:
The auditor does not give an absolute assurance largely because of the
inherent limitations of audits and the financial statements.
o
To a large extent audits are not objective and there is a lot of
subjectivity in arriving at conclusions. Subjectivity can be seen in the
following:
-
The audit opinion arrived at
Risk assessment conducted by the auditor.
How many items to test
Whether observed errors are representative
o
Not all items are tested. Conclusions on the whole population are
based on the results of sample tests.
o
Audit evidence at times indicates what is probable rather than what is
certain.
o
The financial statements have limitations in that they contain
estimates.
o
Limitations of control systems of the entity including:
17
(b)
(i)
Possibility of overriding the controls
Possibility of collusion and fraud
There could also be human error.
Rules for advertising by audit firms:
Audit firms are allowed to advertise their services and the following rules
apply:
o
Adverts should not bring the Zambia Institute of Chartered
Accountants in disrepute or discredit another member or firm.
o
The advertisement should not discredit the services of others.
o
The advertisement should not be misleading
o
The advertisement should not fall short of any regulatory or legal
requirements that may be there to regulate advertising.
Matters that should be included in a bid for professional services:
(ii)
o
The names of senior staff such as partners and their qualifications.
o
The experience of the partners in auditing companies similar to the
one the firm is bidding for.
o
Any reference for work that has been carried out by the firm.
o
The basis of the fees that will be charged by the firm.
o
The size of the firm and whether it has a national presence.
Partners’ information to be included in the bid documents:
Accountants are subject to the fundamental principles of professional ethics.
As auditors our firm and all those that work for it being accountants are
subject to these ethics. Breach of any of the fundamental principles could
result in disciplinary action being taken by the professional body against the
erring member.
One of the fundamental principles that should be observed is that of integrity.
This means that the accountant should be honest and straight forward in his
professional and business relationships. The suggestion by the partner that
we give false information in the tender document is clearly in breach of this
principle.
In this case I would remind the partner of the need for our firm to remain
truthful and not give misleading information. If the partner insists that I
include this information I would decline and inform him that this is against my
ethics. If necessary I would seek the guidance of my professional body in this
case ZICA on how this matter should be handled.
(iii)
The board of directors of Chi Hu Ltd:
The board of directors of a company such as Chi Hu Ltd is the supreme body
which directs the company to ensure that it achieves its objectives. Good
18
corporate governance guidance provides that the board should comprise a
mixture of both executive and non-executive directors.
In this case the question clearly states that the board comprises largely of
executive directors and only two non-executive directors. This is clearly
contrary to guidance and therefore the effectiveness of the board is put into
question.
Non-executive directors:
These are board members who have no role in the day to day running of the
company. Their only connection with the company is through their being
board members. Guidance states that the board should comprise a balance
between executive and independent non-executive board members. The
independent board members bring with them the independence that they
have which they are expected to apply in managing the company.
Role played by independent non-executive board members:
o
Will bring to bear objectivity to the board and will take executive
management to task on matters of concern.
o
Will help in reviewing the performance of the board and in particular
the performance of the board chairman. They will be in a position to
assess the performance of the board chairman.
o
The independent non-executive directors will sit on the board
committees which will enhance the performance of the said
committees and the board as a whole and these committees include:
-
The
The
The
The
audit committee
remuneration committee
risk committee and
nomination committee.
SOLUTION THREE:
(a)
Why companies need to adhere to listing rules:
The stock exchange is a market where shares can be bought and sold. The primary
market is where companies are able to raise capital by issuing shares to the public.
The secondary market is where shares can change hands through buying and selling
the shares through brokers.
The stock exchange requires that before a company can list on the stock exchange it
should meet the listing rules. The rules are set by the stock exchange in order to
protect the interests of the investing public so that they are not swindled by
unscrupulous promoters of companies.
If there were no rules established by the stock exchange then promoters could set
up a company with the sole purpose of raising funds on the stock exchange and
after misapplying the funds liquidate the company and get away with it because of
the limited liability that exists for listed companies. It is therefore important that
19
listing rules are followed so that confidence in the stock market is maintained by the
public.
The stock exchange is a major source of capital and if confidence in its operations
falls then fewer people will be willing to invest in companies through buying shares.
(b)
Need for the audit of financial statements of listed companies:
Listed companies are companies that are listed on a stock exchange such as the
Lusaka Stock Exchange and are able to raise capital through the issuing of shares to
the public.
Companies that are listed on a stock exchange are managed by executive
management headed by a chief executive or managing director and his team. These
are usually employees of the company who are employed on contract and can decide
to move on and leave the company.
The company is owned by the shareholders who do not take part in the day to day
running of the company. The shareholders therefore stand to lose all they have
invested in the event that the company fails. Management are therefore running the
company on behalf of the shareholders as agents for the shareholders who are the
principles. The problem that arises is that of the agent not acting in the best
interests of the principals.
Clearly it can be seen that there is a separation between management of the
company and ownership. The management has more information that the owners of
the company. The only link between the management and the shareholders is
through the financial statements prepared by the management and presented to the
members at the annual general meeting.
It is therefore a requirement that financial statements of listed companies be
subjected to annual independent audits conducted by external auditors. Audited
financial statements give confidence to the shareholders that management are
running the company in the best interests of the shareholders.
It is important to state that there are other stakeholders who have an interest in the
company who also benefit from audited financial statements of listed companies. For
example suppliers, customers and lenders rely on audited financial statements when
deciding to deal with a listed company.
(c)
The meaning of a non-statutory audit:
This is an audit conducted by external auditors on financial statements that is not
required by legislation. This is where the owners, proprietors, members, trustees,
professional and governing bodies or other interested parties want them rather than
that it is a legal requirement to have the financial statements audited by external
auditors.
This means that auditing may extend to other types of undertakings such as sole
traders, partnerships and other non-profit making organisations.
Benefits of partnership accounts being audited by external auditors:
20
(d)
o
Audited financial statements for partnerships can be a basis of settling
accounts between the partners.
o
Audited financial statements may be more acceptable by taxation authorities
than un audited financial statements.
o
Audited financial statements are beneficial to sleeping partners who may not
be actively involved in the running of the business. The sleeping partner will
also gain confidence that in the share of profits due to him.
o
In the event of the partnership business trying to obtain additional funds in
form of loans the lenders will place more reliance on audited financial
statements.
o
In the event of trying to sell the business audited financial statements will
form a good basis for price negotiations.
The differences between external and internal auditors:
Objectives:
The main objective of internal auditors is to improve the company’s operations
mainly in terms of validating the efficiency and effectiveness of the internal control
system of the company.
The main objective of the external auditor is to express an opinion on the truth and
fairness of the financial statements and other requirements as required by other
regulations and laws.
Reporting:
Internal audit reports are normally addressed to the board of directors or
management. The internal audit reports are not publicly available, being confidential
between the internal auditor and the recipient.
External audit reports are provided to the shareholders of the company. The report
forms part of the annual published financial statements and is therefore publicly
available to the shareholders and any other user of the financial statements.
Scope of work:
The work of the internal auditor normally relates to the operations of the
organisation, including the transaction processing systems and the systems to
produce the annual financial statements. The internal auditor may also provide other
reports to management, such as value for money audits which external auditors do
not become involved with.
The work of the external auditor relates only to the financial statements of the
organisation. However, the internal control systems of the organisation will be tested
as these provide evidence on the completeness and accuracy of the financial
statements.
21
Relationship with the company:
In most organisations, the internal auditor is an employee of the organisation, which
may have an impact on the auditor’s independence. However, in some organisations
the internal audit function is outsourced.
The external auditor is appointed by the shareholders of an organisation, providing
some degree of independence from the company and management.
Appointment process:
Internal auditors are appointed by management. The qualification requirements are
determined by management.
External auditors are appointed by members and formal auditing qualifications are
required.
SOLUTION FOUR:
(a)
Objectivity of the auditor:
Objectivity is one of the fundamental principles of professional ethics. In the context
of statutory auditors it is important that the audit team members observe this
principle. The principle simply means that the auditors or accountant must not allow
bias, conflict of interest or undue influence of other people to override professional
or business judgements.
How objectivity can be achieved:
Objectivity by members of the audit team can only be achieved when the audit team
members are independent of the audit client. It should be observed that where any
of the audit team members lacks this independence it is unlikely that such members
will be objective in the performance of the audit.
There are a number of situations which threaten the independence of the auditor
and ultimately the objectivity of the auditor. If any member of the audit team is no
longer independent of the client then the firm must apply relevant safeguards so as
to remove the threat to the independence of the auditor. This may mean removing
the particular audit team member from the audit team.
(b)
Auditor rights:
Rights of the auditor:
In order for the auditor to effectively carry out his duties he has certain rights. This
means that the client must oblige with any of the demands of the auditor and not
limit the rights of the auditor.
The following are some of the rights of the auditor:
o
Right of access to the company’s books and records at any reasonable time
to collect the evidence necessary to support the audit opinion.
22
(c)
o
Right to require from the officers of the company the information and
explanations the auditor considers necessary to perform their duty as
auditors.
o
Right to receive notice of and attend meetings of the company in the same
way as any member of the company.
o
Right to speak at general meetings on any matter affecting the auditor or
previous auditor.
o
When the company uses written resolutions the right to receive a copy of
these resolutions.
Composition of a typical audit team:
An audit team is chosen from among staff in the audit firm to carry out audit
assignments. Staff can belong to more than one audit team and these teams are not
permanent and staff may be moved from one team to another.
The typical composition of an audit team includes:
o
o
o
o
The engagement partner who is responsible for the audit.
An Audit Manager who is more involved in the conduct of the audit than the
partner.
An audit senior
Audit assistants.
It is necessary that the firm and the audit team members are independent of the
client that they are going to audit. It is important that the partner ensures that each
of the team members is independent of the client if they are going to be objective.
In the event that there is a lack of independence by one or more audit team
members then necessary safeguards must be put in place.
Responsibility for the overall opinion:
After the gathering of sufficient and appropriate audit evidence, the partner will form
the judgement on whether the financial statements show a true and fair view. It is
the partner who forms and signs the audit opinion after all matters arising have been
resolved.
(d)
The auditor opinion and expert advice:
There are situations when the statutory auditor may use the services of an expert.
An expert in this context is someone who is an expert in a field other than auditing
and accounting.
It is important to note that notwithstanding that the auditor will rely on the services
of the expert, he is responsible for his opinion.
In the case at hand management used the services of a management expert in the
valuation of buildings. It is the duty of the auditor to perform audit procedures which
will help him assess the reliability of the figures prepared by the management expert.
In the event such as this one where the management expert negligently performed
23
his dues resulting in the misstatements of the financial statements, the auditor
cannot pass the back and he may be sued for professional negligence.
It is therefore up to the auditor to ensure that he assesses the capabilities of the
expert engaged by management before he can place reliance on the work done by
him. The auditor should further carry out audit procedures to confirm the reliability
of the information given by the management expert.
24
SOLUTION FIVE:
(a)
(i)
Tests of control:
Tests of controls are tests carried out by the auditor with a view to test the
effectiveness of the controls established by the client. Carrying out tests of
control aims at confirming that the controls are operating as recorded during
the period under review.
Substantive tests
Substantive tests are conducted by the auditor on the transactions, balances
and disclosures made in the financial statements with an objective of
ensuring that there are no material misstatements at the assertion level in
the client’s financial statements.
Substantive tests include tests of detail of transactions, balances, disclosures
and substantive analytical reviews. In most cases the auditor must carry out
substantive tests in order to gather sufficient appropriate audit evidence upon
which basis he will arrive at an appropriate audit opinion.
(ii)
Financial statement assertions:
Financial statement assertions are the representations that are made by
management through the figures in the financial statements. The objective of
the auditor is to confirm whether or not the assertions made by management
are correct.
Assertions tested by circularisation of accounts receivables:
The following assertions are tested through the circularisation of accounts
receivables:
Valuation:
o
That the receivables balance is valued correctly. Confirmation by the
receivables confirms this assertion and any need for impairment that
may be there.
Existence:
The confirmation by the receivables confirms that the receivables existed at
the period end.
Rights and obligations:
Confirmation by the receivables confirms that the receivables included in the
total receivables figure in the statement of financial position belongs to the
client.
25
Cut off:
Confirmation of receivables tests the assertion of cut off meaning that sales
around the period end to receivables have been correctly recorded in the
correct accounting period.
Accuracy:
Confirmation of receivables confirms that the receivables figure in the
statement of financial position has been recorded accurately.
(iii)
Third party confirmations:
o Bank confirmations
o Accounts payables confirmations
o Inventory held by third parties
o Confirmations of loans to the client
o Confirmation of title to property held by third parties such as lawyers.
(iv)
Analytical procedures:
Analytical procedures are used in obtaining an understanding of an entity and
its environment and in the overall review at the end of the audit.
Analytical procedures actually mean the evaluation of financial and other
information or the review of plausible relationships in the information. The
review also includes identifying fluctuations and relationships that do not
appear consistent with other relevant information or results.
Uses of analytical procedures:
Analytical procedures are used at all the three levels of an audit as follows:
At the planning and risk assessment level:
Analytical procedures are used at the beginning of the audit to help the
auditor to obtain an understanding of the entity and assess the risk of
material misstatement. Audit procedures can then be directed to these
identified risky areas.
Analytical procedures as substantive procedures:
Analytical procedures can be used as substantive procedures in detecting the
risk of material misstatements at the assertion level doing work on the
income statement and the statement of financial position.
Analytical procedure in the overall review at the end of the audit:
Analytical procedures help the auditor at the end of the audit in forming an
overall conclusion as to whether the financial statements as a whole are
consistent with the auditor’s understating of the entity.
26
(b)
(i)
(ii)
Substantive audit procedures to audit bank balance:
o
Obtain bank confirmation from each bank for the client.
o
Reperform the arithmetic of the bank reconciliation.
o
Trace cheques shown as outstanding at the period end to the cash book
for the subsequent period. This is so as to identify and items not
cleared by the time of the audit and question management.
o
Obtain explanations for items in the cash book for which there are no
corresponding figures in the bank statement and vice versa and obtain
explanations for these.
o
Verify contra items appearing in the cash books or bank statements
with original entry.
o
Confirm balances per cash book according to the bank reconciliation by
inspecting the cash book and the general ledger.
o
Verify the bank balances with the reply to standard bank letter and with
the bank statement.
o
Consider whether there is a right of set off of overdrafts against positive
bank balances.
o
Review draft accounts to ensure that disclosure for the bank are
complete and accurate and in accordance with accounting standards.
Procedure for obtaining bank confirmation:
Obtaining bank confirmations is one usual audit procedures conducted by
external auditors. The purpose of obtaining bank confirmations is to confirm a
number of financial statement assertions in the figure of the bank balance.
The procedure for obtaining bank confirmations is as follows:
o
The client will write to the bank informing the bank that the client’s
auditors will be writing to the bank to confirm certain information with
the bank. The letter from the client should be signed by bank
signatories who have authority and in the event of joint accounts the
letter must be signed by all signatories.
o
The letter should reach the bank well before the period end.
o
The auditors will write to the bank on the auditor’s letter head
referring to the letter that was written by the client and requiring the
bank to provide the required information.
o
The reply will be sent directly to the auditor.
END OF SOLUTIONS
27
Download
Related flashcards
Create Flashcards