BBFD 3023 / 3024 Auditing 1 Lecture Week 1 2 INTRODUCING THE LECTURER • Associate Professor Puan Sri Dato’ Dr Mary Lee • Diploma in Commerce ( FA) from TARC • FCCA (UK) • ACMA & CGMA (UK) • CA (M) from MIA • MBA (Australia) • DBA (Australia) • FIIA – Fellow of The Institute of Internal Auditors (Malaysia) • CIPFA – Chartered Institute of Public Finance & Accountancy (UK) • CPA (Australia) • CPA (MICPA) • FCTIM (Chartered Tax Institute of Malaysia) RESOURCES REQUIRED • 1) ACCA Approved Workbook AA (BPP latest edition till June 2023) • 2) ACCA Practice & Revision Kit AA ( BPP latest edition till June 2023) • 3) Selected ACCA Technical Articles V 5 COURSEWORK TEST : 50% of overall assessment N Coursework Reference Assessment Type o Coursework Test 1 - AXP Certification (Topics/ Chapters/ Subjects covered or other Relevant Information) Issue to Feedback Marks to Students Students (100%) (Week) (Week) JULY/ 10 20% 30% AUG CWT 2 8 11 MGT 12 13 50% Final Exam 6 • • Chapter 1 : Concept of Audit & Other Assurance Engagement (BPP WB Chapter 1) 7 Objective of external audit • To obtain REASONABLE ASSURANCE about whether the FS AS A WHOLE ARE FREE FROM MATERIAL MISTATEMENT, whether due to FRAUD AND ERROR, thereby enabling the AUDITOR TO EXPRESS AN OPINION on whether the financial statements are prepared, in all material respects, in accordance with an APPLICABLE FINANCIAL REPORTING FRAMEWORK. • To report on the F/S , and communicate as required by the ISAs, in accordance with the auditor’s findings. (Auditor’s Report) 8 INTRODUCTION TO AUDIT –Why need to audit • Requirement under the Malaysia Companies Act 2016 –mandatory for company’s accounts to be audited by an independent party (EA) to protect the shareholders & stakeholders • Refer to Diagram on Page 3 • Shareholders own the company (Agency Theory) • Shareholders (Principals) appoint the Directors & Management to manage the Co as agents for them (running the company on the behalf of the shareholders) 9 and be accountable for their stewardship of the entity’s assets which are placed under their control. Management achieve this by preparing FS which are presented to the shareholders. • Shareholders will appoint an independent Auditor to provide an opinion and to provide assurance as to whether the FS are “presented fairly” or “ give a true & fair view” . • Audit opinion IS NOT an opinion of ABSOLUTE CORRECTNESS . Auditors act as agents for the shareholders, by giving them assurance over the F/S. • 10 • Other users of financial statements : • - internal stakeholders – management & employees who wants to know the performance of the company (Job security). Financial stability of the company - External stakeholders – eg shareholders ; suppliers ; customers ; bankers 11 TRUTH & FAIRNESS / fair presentation • True & Fair view in auditing means the F/S are free from MATERIAL misstatements and faithfully represent the financial performance and positions of the company • True – info is factual and conforms with reality • - it complies with the accounting standards & relevant legislation • - data is correctly transferred from the accounting records to the FS • Fair – info is clear, impartial & biased • - info reflects the commercial substance of the transactions of the entity (honest & clear representation, with no bias) . • Present Fairly - the F/S shows a true & fair view. They are factual and free from bias. • 12 ACCOUNTABILITY, STEWARDSHIP & AGENCY Pg3 * SHAREHOLDERS -Provides capital & invest (shares) in an entity -expects capital growth and dividends -manages the entity (stewards) -provides financial statement to users DIRECTORS -accountable to shareholders -acts as stewards of sh/h’s investment -shareholder’s agent 13 • Audit is the process and Assurance is the product. • Auditors go through the process of testing the client’s financial reports ( audit) • in order to give our client the confidence that their report is what it seems to be (assurance) • Auditor’s opinion - enhances credibility of the F/S by providing reasonable assurance that the F/S s are free from material misstatement 14 REASONABLE ASSURANCE (HIGH BUT NOT ABSOLUTE LEVEL OF ASSURANCE) Auditor designs & performs audit procedures sufficient & appropriate audit evidence (AE) Auditor cannot give 100% guarantee that the FS are free from material misstatements due to LIMITATIONS OF AN AUDIT eg not all items are tested 15 ASSURANCE • Assurance is a concept that is widely used in the business environment ( to seek expert advice on whether things are OK ) • Eg : shareholders need assurance that the published F/S of a company are accurate; so need the EA to check on the F/S • Directors need assurance that the systems inside the company are working and so need the internal auditors to check on these systems. 16 • Definition of an “ assurance engagement “ . (BPP Page 7) • - a practitioner (assurance provider) aims to obtain sufficient appropriate evidence in order to express a conclusion designed to enhance the degree of confidence of the intended users other than the responsible party about the outcome of the evaluation or measurement of a subject matter against suitable criteria. 17 Elements of an assurance engagement (Page 8 BPP ) • An assurance engagement performed by a practitioner will consist of the following elements: • (a) A three party relationship. The three parties are the intended user (the party who relies on the assurance report) , the responsible party (the person who prepares the subject matter being examined) and the practitioner (party who forms the opinion on the subject matter and gives the assurance) • (b) A subject matter. – what is it we are examining? • eg financial performance (eg historical financial information), ❖nonfinancial performance (eg key performance indicators), Assurance engagement • (c) Suitable criteria. The subject matter is evaluated or measured against criteria in order to reach an opinion. Eg IFRS • (d) Evidence. Sufficient appropriate evidence needs to be gathered to support the required level of assurance. • (e) An assurance report. A written report containing the practitioner's opinion is issued to the intended user, in the form appropriate to a reasonable assurance engagement or a limited assurance engagement. C riteria R eport E vidence S ubject matter T hreeparty relationship LEVELS OF ASSURANCE • An assurance engagement will provide the user with either : • Type of engagement Evidence- gathering procedures The assurance report 1) Reasonable assurance eg statutory audit /financial statement audit SAAE obtained by – understanding the entity; assessing risk; responding to risk; further procedures to draw a conclusion Positive form of expression “ in our opinion internal control is effective , in all material respects, based on XYZ criteria. The FS shows a true & fair view”. - High but not absolute assurance . Not 100% guarantee 20 2) Limited assurance eg review of cash flow forecasts or a review of financial statement - Auditor giving a moderate (low) level of assurance The evidence gathered is limited , involving techniques such as enquiry and analytical procedures . Enquiry means seeking information from client staff or external sources Analytical procedures – evaluate & compare financial and/or nonfinancial data for plausible relationships. Also include the investigation of identified fluctuations and relationships that are inconsistent with other relevant information or deviate significantly from predicted amounts (BPP Page 168) Negative form of expression – “ Based on our work described in this report, nothing has come to our attention that causes us to believe that internal control is not effective, in all material respects , based on XYZ criteria . “ 21 Limitations of an audit (auditor can only express an opinion and NOT to certify that the a/c are correct (refer to Diagram on Page 7) ● 1) Inherent limitations of internal control systems – an internal control system is operated by people and hence is liable to human error. In addition, there is the possibility of controls override by management and of collusion and fraud. It is impossible to remove all of these inherent limitations and as the auditor relies on the internal control systems, this can reduce the usefulness of the audit. 22 • • 2)Subjectivity – financial statements include judgemental and subjective areas and therefore the auditor is required to use their judgement in assessing whether the financial statements are true and fair. EG Judgements on what to test ; how much to test and the Audit Opinion to express 3)Sampling – it is not practical for an auditor to test 100% of transactions and so they have to apply sampling methodologies in selecting balances/transactions to test. Therefore, there could be an error in an item not selected for testing by the auditor. 23 ● . ● 4)Historic information – the audit report is often issued some time after the year end, and so the financial information can be quite different to the current position. In the current marketplace where companies’ financial positions can change quite quickly, the audit opinion may no longer be relevant as it is out of date. 24 ● 5)Evidence is persuasive not conclusive – the opinion is based on audit evidence gathered; however, while this evidence can indicate possible issues affecting the audit opinion, evidence involves estimates and judgements and hence does not give a definite conclusion. ● 6) Audit report format – the format of the opinion is determined by International Standards on Auditing. However, the terminology used is not usually understood by non-accountants. This means that users may not actually understand the audit opinion given. 25 Statutory audit & regulation (WB Chap 2) 26 Auditor duties – Section 266 of the Co Act 2016 Compliance with legislation • Whether the financial statements have been prepared in accordance with the applicable approved accounting standards (IFRS) • Truth and fairness of accounts • Whether the statement of financial position shows a true and fair view of the company's affairs at the end of the period and the statement of profit or loss and other comprehensive income (and statement of cash flows) show a true and fair view of the results for that period Adequate accounting records and returns • Whether adequate accounting records have been kept and returns adequate for the audit received from branches not visited by the auditor Agreement of accounts to records • Whether the accounts are in agreement with the accounting records and returns Consistency of other information • Whether the information in the directors' report is consistent with the financial statements Directors' benefits • Whether disclosure of directors' benefits has been made in accordance with the Companies Act 2016 Auditor rights Access to records • A right of access at all times to the books, accounts and vouchers of the company (in whatever form they are held) Information and explanations • A right to require from the company's officers such information and explanations as they think necessary for the performance of their duties as auditors Attendance at / notices of general meetings • A right to attend any general meetings of the company and to receive all notices of and other communications relating to such meetings which any member of the company is entitled to receive Right to be heard at general meetings • A right to be heard at general meetings which they attend on any part of the business that concerns them as auditors Rights in relation to written resolutions • A right to receive a copy of any written resolution proposed APPOINTMENT , REMOVAL & RESIGNATION OF AUDITORS • Appointed by and answerable to the shareholders . S 248 (2) of the Co Act 2016 requires every registered public company to appoint a company auditor at every AGM and the auditor will hold office until the conclusion of the next AGM. • Appointment : • - normally appointed annually • - by shareholders • - in particular circumstance eg the first auditors, casual vacancy , Di can appoint the auditors • Removal : • - resolution by shareholders • - Auditors entitled to : • - notice of resolution • - make written representation that they ought to stay in office • - speak at shareholder’s meetings • - must deposit a Statement of Circumstances at the Co. registered office within 14 days of ceasing office and send a statement to the regulatory authority • Statement of Circumstances • - is a document prepared by the auditor explaining REASONS for his removal, resignation , non-reappointment • The Law requires that auditor prepare this document : • - to ensure that auditors do not seek to avoid their responsibilities by “going quietly” where problems arise • - to enable investors to understand the reasons for the resignation or removal of the auditor & will result in greater undertstanding & transparency & reduce speculations against the company or the auditor 32 • Resignation : • - auditors may resign at any time • - give written notice with a statement of circumstances to members/ creditors • - notice of resignation is sent by the company to the regulatory authority • - auditors can call the Di to call a general meeting within 21 days to discuss the circumstances of the resignation • - right to speak at the general meeting on matters which concern them as auditors. International Standards on Auditing (ISA) – • ISAs are set by the International Auditing and Assurance Standards Board • The process in the development of the IAASB Standard: • 1) Research & consultation – a project task force is established to develop a draft standard or practice statement . • 2) Transparent debate – a proposed standard is discussed at a meeting open to the public • 3) Exposure for public comment – exposure drafts are put on the IAASB’s website and widely distributed for comment for a min of 120 days • 4) Consideration of comments – any comments as a result of the exposure draft are considered at an open meeting of the IAASB and it is revised as necessary • 5) Affirmative approval – approval is made by the affirmative vote of at least 2/3 of IAASB members Status of ISAs • As the statutory audit is governed by the local legislation, the status of ISAs will vary between countries. • - national standards may continue to exist , but aligned with the principles of ISAs. • - The ISAs could be adopted without or with any additional guidance relating to the national circumstances •- Audit Oversight Board (AOB) AOB is established under the Securities Commission Act Malaysia 1993 (SCMA). Came into force on 1 April 2010 to promote and develop an effective audit oversight framework and to promote confidence in the quality and reliability of audited financial statements in Malaysia. AOB is responsible for the registration of auditors of PLCs or schedule funds under Part 111A of the SCMA. Registration would ensure that only fit and proper auditors are involved in auditing. 38 Practice Review Committee (PRC) PRC is established to oversee the conduct of practice review. PRC applies to all member firms which are engaged in audit, irrespective of whether the audit firms are auditors of PLCs or otherwise. Audit firms are to be reviewed in cycles of five years each. Reviewers evaluate the work of the auditors . Review the audit working papers whether audit is conducted following the ISA and whether the work has been properly documented to provide SAAEs to support the audit opinion. 39 FINANCIAL STATEMENT ASSERTIONS (Pg 154 &155) • 1) Statement of Profit or Loss assertions ( assertions in relation to classes of transactions and events and related disclosures for the period under audit ) C O C A P C 2) Statement of the Financial Position assertions ( assertions in relation to account balance and related disclosure at the period end ) • C R A V E • • • P C 40 Evidence Gathering Techniques (Audit Procedures ) (Page 156) • • • • • • • A – Analytical Procedures E - Enquiry I - Inspection of documents ; Inspection of assets O - Observation U - Recalculation C - confirmation R – reperformance CAAT – computer assisted audit techniques (KIV) 41 Use of Analytical Procedures (ISA 520) • • • • Page 157 & Page 112 What is Analytical Procedures? - the evaluation of financial information by a comparison to financial and non-financial data and the investigation of significant differences and relationships which are inconsistent with other information. • 42 • • • • 3 main Types of AP : 1) Variance analysis – review of current year financial info in comparison with prior period or budgeted information 2) Ratio analysis – calculation of ratios and analysis and investigation of significant differences 3) Proof in total – use of interrelationships between data (financial and non-financial) to estimate an expected value in the F/s , compare with the client’s recorded values and then investigate on the differences, which should not be material. 43 • • • • Use of AP : 1) During the audit planning process , as a risk assessment procedures to obtain an understanding of the entity and its environment . Its use is compulsory to help identify areas of mm through looking at comparisons or trend analysis . Also to identify GC problems through ratios. 44 • • • 2) During the actual auditing as a substantive procedure . (Optional) . Through use of trend analysis ; Proof in total and Ratios 3) During the final review stage at the end of the audit - to review the overall F/S to see whether the F/S looks sensible and credible. Through ratios (Compulsory) 45 RATIOS ( BPP Workbook Page 113) • • • • • 1) Profitability Ratios (a) Returns on capital employed (ROCE) = PBIT/Debt (NCL) + Equity + reserves The returns ie the profit on every $ invested in the company’s resources ie its debt and its equity. (b) Gross Profit Margin = Gross Profit/Revenue x 100 = % This is a fundamental measure of a company’s performance and tells how profitable a company is after taking into account its direct production costs. • 46 • • • • • Unusual increase in the GP ratio could be due to : - overstatement of sales - understatement of purchases - understatement of other direct expenses - improper valuation of inventory 47 • • • • © Net Profit Margin = PBIT / Revenue 2) Liquidity Ratios (a) Current ratios = CA /CL ; ratio helps decide whether the CA will be able to generate sufficient cash to pay off the CL as and when they fall due. Increase in current ratio may indicate increased inventory, cash or receivables levels. Co maybe expanding or experiencing trading difficulties and is unable to sell its inventory. An increase may be due to decrease in trade payables or other current liabilities . 48 • • • • (b) Quick Ratio/acid test ratio = CA less inventories / CL Inventory can be hard to sell in a hurry. Therefore to exclude inventory as Quick assets of a company will be able to generate sufficient cash to pay off its CL as and when they fall due. © Inventory holding period = inventories /COS x 365 days = Number of days If the number of days is high, it can indicate overstocking of goods which will then be difficult to sell. Inventory valuation would have to be investigated. 49 • • • • • • (d) Receivables collection period = trade receivables/ Credit sales x 365 days It reflects the number of days it takes for the company’s trade debtors to pay . (e) Payables payment period = Trade payables / Credit Purchases x 365 days Number of days it takes for the company to pay its trade payables. 50 • • • • 3) Gearing ratio (a) Total long term debt /Share capital + Reserves x 100 Measures the company’s risk and stability . It expresses the relationship between the company’s borrowings (external debt financing) and its own funds (equity financing). High level gearing means the company must service on the high interest borrowings. 51 • • • • (b) Interest Cover ratio = PBIT/ Interest expenses Shows the capability of the entity to pay the interest. How many times a company could pay the interest. The higher the ratio, the better is the position of the entity to pay the interest expenses. SELF PRACTICE Q : Page 114 – Activity 2 : Ratios and Risk DRESS YOU LIKE CO 52