REVISION NOTES-F8
Assurance
The practitioner examines the subject matter made available by the responsible party, matches it to the
suitable criteria using evidence and reports to the intended users.
Elements of an assurance engagement
1. An assurance engagement will require a three-party relationship comprising of:
a) The intended user who is the person who requires the assurance report.
b) The responsible party, which is the organisation responsible for preparing the subject
matter to be reviewed.
c) The practitioner (i.e. an accountant) who is the professional who will review the subject
matter and provide the assurance.
2. A second element which is required for an assurance engagement is suitable subject matter. The
subject matter is the data which the responsible party has prepared and which requires verification.
3. Thirdly this subject matter is then evaluated or assessed against suitable criteria in order for it to be
assessed and an opinion provided.
4. Fourth, the practitioner must ensure that they have gathered sufficient appropriate evidence in order to
give the required level of assurance.
5. Last, an assurance report provides the opinion which is given by the practitioner to the intended user
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Types of assurance assignments
Reasonable assurance
Limited assurance
Example: External Audit
Example: Review of financial statements
High level of assurance but NOT absolute or 100%
Moderate level of assurance
A high but not absolute level of assurance is The practitioner gathers sufficient evidence to be
provided, this is known as reasonable assurance.
satisfied that the subject matter is plausible; in this case
negative assurance is given whereby the practitioner
confirms that nothing has come to their attention which
indicates that the subject matter contains material
misstatements.
More testing (Analytical tests, test of controls and
substantive testing)
Lesser testing-focus on obvious errors only
(Analytical testing and Enquiry)
Going concern review carried out
No going concern review
Positive conclusion- Wording:
‘in our opinion the financial statements give (or do
not give) a true and fair view of the state of the
company’s affairs’.
The procedures undertaken are not nearly as
comprehensive as those in an audit, with procedures
such as analytical review and enquiry used extensively. In
addition, the practitioner does not need to comply with
ISAs as these only relate to external audits.
Negative conclusion-Wording:
“nothing has come to light to suggest errors or problems
exist’'
The assurance is therefore given on the absence of any
indication to the contrary.
Review engagements are often undertaken as an
alternative to an audit, and involve a practitioner
reviewing financial data, such as six-monthly figures. This
would involve the practitioner undertaking procedures to
state whether anything has come to their attention
which causes the practitioner to believe that the financial
data is not in accordance with the financial reporting
framework.
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Assignments were no assurance is given
1. Agreed-upon procedures : A report on factual findings is given but no assurance expressed. Users must
judge for themselves and drawn their own conclusions
2. Compilation engagement: Users of the compiled information gain benefit from the accountant’s
involvement but no assurance is expressed. It is used to collect, classify and summarise financial
information. It means to present data in a manageable and understandable form.
External audit
It is a review and assessment of the financial records to form an overall conclusion as to whether:
- The financial statements have been prepared using acceptable accounting policies, which have been
consistently applied.
- The financial statements comply with all the relevant regulations and statutory requirements.
- Adequate disclosure of all material matters relevant to the proper presentation of financial information
has been made.
Objective of external audit engagements: “Opinion”: The auditor’s report contains a clear written expression
of opinion on the financial statements.
General principles of external audit engagements
According to the International Standards on Auditing, the general principles of an audit are:
1. Compliance with Code of Ethics (IFAC’s)
2. Performance of an audit in accordance with ISAs
3. Audit with professional skepticism
4. Professional judgment
5. Sufficient appropriate audit evidence
True and Fair presentation
Financial statements are produced by management which give a true and fair view of the entity’s results. The
auditor in reviewing these financial statements gives an opinion on the truth and fairness of them. Although
there is no definition in the International Standards on Auditing of true and fair it is generally considered to have
the following meaning:
True – 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.
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Inherent Limitations of audit/ Reasons why absolute assurance cannot be given
1. 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.
2. Subjectivity – financial statements include judgmental and subjective areas and therefore the auditor is
required to use their judgment in assessing whether the financial statements are true and fair.
3. 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.
4. 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
judgments and hence does not give a definite conclusion.
5. Even if everything reported on was examined and found to be satisfactory, there may be other items
which should have been included– the completeness problem.
6. Auditors plan their work to detect material errors and frauds only – so small frauds (or large frauds split
into many small amounts) may go unnoticed.
An external audit has a number of other issues which reduce its usefulness
1. 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.
2. 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.
3. Auditors need to understand their clients in great depth if they are to understand how fraud could be
carried out and hidden. However, auditors cannot become too close to their clients or their
independence will be called into question.
4. Where auditors spot errors or fraud, their primary legal responsibility is to report this to management.
Any external reporting is hampered by rules on confidentiality.
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The auditor’s duties
Fundamental duties are to:
form an opinion on whether the financial statements give a true and fair view and are prepared in
accordance with applicable reporting framework
issue an audit report.
Duty to check and ensure: Adequate accounting records, Compliance with legislation, Truth and fairness,
Adequacy of financial statements disclosures
The auditor’s rights
1.
2.
3.
4.
5.
6.
Right of access at all times to the company’s books, accounts and vouchers.
Right to require from an officer of the company such information or explanations as they think
necessary for the performance of their duties as auditors.
Right to receive all communications relating to written resolutions.
Right to receive all notices of, and other communications relating to, any general meeting which a
member of the company is entitled to receive.
Right to attend any general meeting of the company.
Right to be heard at any general meeting which an auditor attends on any part of the business of the
meeting which concerns them as auditor.
Appointment of auditors
Only a member of a recognised supervisory body is eligible to be appointed as an auditor. The person to be
appointed as the auditor is required to hold a professional accountancy qualification.
1. Appointed by shareholders
2. Appointment runs from the end of the Annual General Meeting (AGM) until the end of the next AGM.
3. On appointment , need to get ‘clearance’ from outgoing auditor
For entities in which a share is owned by the state, the auditor is appointed by the Secretary of State or
Ministry of Finance (or a person authorised by the Ministry of Finance)
Removal of auditors
1. RESIGNATION: Sometimes it is necessary for the auditors to resign. If an auditor resigns, they should do so
in writing and they may wish to speak to the shareholders to explain their reasons
2. FORCED REMOVAL: Sometimes, the Board of Directors or some shareholders may wish to remove the
auditors. A General Meeting must be called so that the shareholders can vote on the proposal (via an
ordinary resolution).
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3. AUDITORS DO NOT WISHTO SEEK REAPPOINTMENT: Sometimes the auditors finish the annual audit and
decide they do not wish to audit the company in future years. As such,when the board asks them to accept
nomination for the following year, the auditors should politely decline and issue a Statement of
Circumstances.
Key points
 Directors cannot remove the auditors themselves.
 Auditors Can be removed by a simple majority at a general meeting.
 The auditors should be given notice of such a meeting
 They are allowed to speak at the general meeting

Deposit at the company’s registered office a statement of the circumstances connected with the
removal/resignation or a statement that there are no such circumstances. They can request an
Extraordinary General Meeting (EGM) of the company to explain the circumstances of the resignation.
Audit exemption for small companies
The main reasons for exempting small companies are:
- for owner-managed companies, those receiving the audit report are those running the company
(and hence preparing the accounts!)
- the advice/value which accountants can add to a small company is more likely to concern other
services, such as accounting and tax, rather than audit and which may also give rise to a conflict of
interest under the ethics rules
- the impact of misstatements in the accounts of small companies is unlikely to be material to the
wider economy
- it may also not be cost beneficial for the small entities.
Attempt questions to check your understanding:
June 2015-Q5c
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Client acceptance/continuance
Steps before accepting an audit client
Outgoing auditor- Professional
etiquette letter
The auditor should communicate
with the outgoing auditor the
client to assess if there are any
ethical or professional reasons
why they should not accept
appointment.
They should obtain permission
from the client’s management to
contact the outgoing auditor; if
this is not given, then the
engagement should be refused.
The previous auditor must obtain
permission from the client’s
management to respond; if not
given, then the auditor should
refuse the engagement.
Client- related issues
1.Formalities(of removal of outgoing
auditor fulfilled)
2.Reputation and integrity of the client’s
management assessed- If necessary, the
firm may want to obtain references if they
do not formally know the directors
3. Consider the level of risk attached to the
audit whether this is acceptable to the
firm. As part of this, they should consider
whether the expected audit fee is adequate
in relation to the risk auditing the client
Client screening
The purpose of client screening procedures
is to determine whether the prospective
client is suitable for the firm.
Practitioner-related issues (
Audit firm)
1.Any issues which might
arise which could threaten
compliance with ACCA’s Code
of Ethics and Conduct or any
local legislation, including
independence and conflict of
interest with existing clients.
If issues arise, then their
significance must be
considered.
2.Whether they are
competent to perform the
work and whether they
would have appropriate
resources( especially human
resource and time!) available,
as well as any specialist skills
or knowledge required for
the audit
The firm should evaluate the potential risk
to the firm of acceptance.
When a client is deemed to represent a
high audit risk to the firm, the firm should
carefully consider the implications arising
should it fail in meeting its objective of
giving an accurate audit opinion. If the firm
is not confident that the benefit to be
derived from accepting the appointment
outweighs the potential risks (including
financial and reputational risk of being
sued), then the firm should decline the
appointment.
Factors to consider:
- The state of the economic
sector in which the client
operates (a depressed sector
may indicate risk).
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-
-
-
The client’s previous audit
history (frequent changes of
auditors, and/or qualified
reports, are obviously bad
news).
The
experience
and
qualifications of the company’s
management and their attitude
towards controls.
The current operating and
financial position of the
company.
Directors’ understanding of
External Auditor’s role and
their own responsibilities
The accounting policies used
Evidence of client involvement
in
fraudulent
or
illegal
activities.
Management permission or
refusal to allow auditors to
examine significant documents,
such as the minutes of
directors’ meetings.
Preconditions for an audit
ISA 210 Agreeing the Terms of Audit Engagements provides guidance to auditors on the steps they should take
in accepting a new audit or continuing on an existing audit engagement. It sets out a number of processes that
the auditor should perform including agreeing whether the preconditions are present, agreement of audit terms
in an engagement letter, recurring audits and changes in engagement terms.
To assess whether the preconditions for an audit are present the auditor must
1. determine whether the financial reporting framework to be applied in the preparation of the
financial statements is acceptable.
2. assess the nature of the entity, the nature and purpose of the financial statements and whether
law or regulations prescribes the applicable reporting framework.
3. obtain the agreement of management that it acknowledges and understands its responsibility
for the following:
 Preparation of the financial statements in accordance with the applicable
financial reporting framework
 For internal controls
 To provide the auditor with access to all relevant information for the
preparation of the financial statements
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Agreeing the terms of engagement
Engagement letter ( compulsory for every new engagement ; sent before the audit starts)
Purpose of an engagement letter
An engagement letter provides a written agreement of the terms of the audit engagement between the auditor
and management or those charged with governance.
It confirms that there is a common understanding between the auditor and management, or those charged with
governance, of the terms of the audit engagement helps to avoid misunderstandings with respect to the audit.
Contents of an engagement letter
Matters to be included in an audit engagement letter:
– The objective and scope of the audit;
– The responsibilities of the auditor;
– The responsibilities of management;
– Identification of the financial reporting framework for the preparation of the financial statements;
– Expected form and content of any reports to be issued;
– Elaboration of the scope of the audit with reference to legislation;
– The form of any other communication of results of the audit engagement;
– The fact that some material misstatements may not be detected;
– Arrangements regarding the planning and performance of the audit, including the composition of the audit
team;
– The expectation that management will provide written representations;
– The basis on which fees are computed and any billing arrangements;
– A request for management to acknowledge receipt of the audit engagement letter and to agree to the terms
of the engagement;
– Arrangements concerning the involvement of internal auditors and other staff of the entity;
– Any obligations to provide audit working papers to other parties;
– Any restriction on the auditor’s liability;
– Arrangements to make available draft financial statements and any other information;
– Arrangements to inform the auditor of facts which might affect the financial statements, of which
management may become aware during the period from the date of the auditor’s report to the date the
financial statements are issued.
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Changes to engagement letters
Engagement letters for recurring/existing clients should be revised if any of the following factors are present:
-
-
Any indication that the entity misunderstands the objective and scope of the audit, as this
misunderstanding would need to be clarified.
Any revised or special terms of the audit engagement, as these would require inclusion in the
engagement letter.
A recent change of senior management or significant change in ownership. The letter is signed by a
director on behalf of those charged with governance; if there have been significant changes in
management they need to be made aware of what the audit engagement letter includes.
A significant change in nature or size of the entity’s business. The approach taken by the auditor
may need to change to reflect the change in the entity and this should be clarified in the
engagement letter.
A change in legal or regulatory requirements. The engagement letter is a contract; hence if legal or
regulatory changes occur, then the contract could be out of date.
A change in the financial reporting framework adopted in the preparation of the financial
statements. The engagement letter clarifies the role of auditors and those charged with governance,
it identifies the reporting framework of the financial statements and if this changes, then the letter
requires updating.
A change in other reporting requirements. Other reporting requirements may be stipulated in the
engagement letter; hence if these change, the letter should be updated.
What if management refuses to sign the engagement letter?
1. Identify the reason. Discuss the matter with the directors in an attempt to reach a suitable compromise.
2. Try to reach a suitable compromise keeping in mind your duties and responsibilities
3. Refuse the engagement if matter still not resolved
Attempt questions to check your understanding:
Sept/Dec Hybrid 2015-Q2 a,b
Dec 2013-Q4a,b
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Audit planning ( Audit Strategy and Audit Plan)
Importance of audit planning
1. It helps the auditor to devote appropriate attention to important areas of the audit.
2. It helps the auditor to identify and resolve potential problems on a timely basis.
3. It helps the auditor to properly organise and manage the audit engagement so that it is performed in an
effective and efficient manner.
4. It assists in the selection of engagement team members with appropriate levels of capabilities and
competence to respond to anticipated risks and the proper assignment of work to them.
5. It facilitates the direction and supervision of engagement team members and the review of their work.
6. It assists, where applicable, in the coordination of work done by experts
Audit Strategy: An audit strategy sets the scope, timing and direction of the audit and guides the development
of the more detailed audit plan.
Audit plan: Once the overall strategy has been planned, detailed consideration can be given to each individual
audit objective and how it can be best met.
A.UNDERSTANDING THE CLIENT/ KNOWLEDGE OF THE BUSINESS
The auditor obtains an understanding of the entity, its control environment and its detailed internal controls:
 to identify and assess the risks of material misstatements in the financial statements
and to provide a basis for designing and implementing responses to these risks
 to determine the extent to which the auditor would rely on the internal control system.
 to assess whether the team is competent to perform the audit
 To understand relevant law and regulations impacting the entity
 To consider the reliability of various evidence sources.
Understanding to be gained about
Understanding can be gained from
-
Industry, regulatory and other external factors(
for example financial reporting framework, laws
and regulations, stakeholders, economic
conditions like volatility of exchange rates,
competition, level of technology
Prior year financial statements: Provides
information in relation to the size of the client
as well as the key accounting policies,
disclosure notes and whether the audit
opinion was modified or not.
-
Nature of entity and accounting policies ( legal
structure, ownership and governance, main
sources of finance)
Discussions with the previous auditors/access
to their files: Provides information on key
issues identified during the prior year audit as
well as the audit approach adopted.
-
Objectives…strategies…related business risks!
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-
Measurement and review of Financial
performance ( measures important to the client,
KPIs, budgets, targets)
-
Internal control (gain an understanding about the
design and implementation of internal controls)
Prior year report to management: If this can
be obtained from the previous auditors or
from management, it can provide information
on the internal control deficiencies noted last
year. If these have not been rectified by
management, then they could arise in the
current year audit as well and may impact the
audit approach.
The client ‘s accounting systems
notes/procedural manuals: Provides
Identification of issues that arose in the prior year audit and information on how each of the key
how these were resolved. Also whether any points brought accounting systems operates and this will be
used to identify areas of potential control risk
forward was noted for consideration for this year’s audit.
and help determine the audit approach.
Miscellaneous
Internal control deficiencies noted in the prior year; if these
have not been rectified by management then they could arise
in the current year audit as well
Significant changes in the entity as compared to prior years.
Is the company using e-commerce?
Discussions with management: Provides
information in relation to the business, any
important issues which have arisen or changes
to accounting policies from the prior year.
Review of board minutes: Provides an
overview of key issues which have arisen
during the year and how those charged with
governance have addressed them.
Current year budgets and management
accounts: Provides relevant financial
information for the year to date. It will help
the auditor during the planning stage for
preliminary analytical review and risk
identification.
The client’s website: Recent press releases
from the company may provide background on
the business during the year as this will help in
identifying the key audit risks.
Financial statements of competitors: This will
provide information about the client ‘s
competitors, in relation to their financial
results and their accounting policies. This will
be important in assessing the client’s
performance in the year and also when
undertaking the going concern review.
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Important: Risks in companies using e-commerce
-loss of transaction integrity
-security risk e.g. virus attacks
-adoption of improper accounting policies e.g.improper revenue recognition
-non- compliance with tax and legal requirements
-failure to ensure that e-commerce contracts are binding in a court of law
-over reliance on e-commerce
-systems and infrastructure crashes
B. AUDIT RISK and Risk Response
Importance of risk assessment
1. Assessing engagement risks at the planning stage, this will ensure that attention is focused early on the
areas most likely to cause material misstatements.
2. It will help the auditor to fully understand the entity, which is vital for an effective audit.
3. Any unusual transactions or balances would also be identified early, so that these could be addressed in
a timely manner.
4. Assessing risks early should also result in an efficient audit. The team will only focus their time and effort
on key areas as opposed to balances or transactions that might be immaterial or unlikely to contain
errors.
5. In addition assessing risk early should ensure that the most appropriate team is selected with more
experienced staff allocated to higher risk audits and high risk balances.
6. A thorough risk analysis should ultimately reduce the risk of an inappropriate audit opinion being given.
7. It should enable the auditor to have a good understanding of the risks of fraud, money laundering, etc.
8. Assessing risk should enable the auditor to assess whether the client is a going concern.
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Audit Risk
Auditors use the audit risk model to direct audit resources to the performance of additional substantive
procedures in areas of the financial statement where audit risk is deemed to be high.
The formula for the audit risk model is:
Audit Risk = Risk of material misstatement in the financial statements x Detection Risk
Audit Risk Explained
Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are
materially misstated.
Audit risk is a function of two main components being the risks of material misstatement and detection risk. Risk
of material misstatement is made up of two components, inherent risk and control risk.
Risk of material misstatement in the financial statements explained
Risk of material misstatement is made up of a further two components, inherent risk and control risk.
Inherent risk
Inherent risk:
Definition: The susceptibility of an assertion about a class of transaction, account balance or disclosure to a
misstatement that could be material, either individually or when aggregated with other misstatements, before
consideration of any related controls.
Inherent risk describes something about the nature of a business or its transactions that make it particularly
susceptible to material misstatements.
Inherent risk is affected by the nature of an entity and factors which can result in an increase include:
– Changes in the industry it operates in.
– Operations that are subject to a high degree of regulation.
– Going concern and liquidity issues including loss of significant customers.
– Developing or offering new products or services, or moving into new lines of
business.
– Expanding into new locations.
– Application of new accounting standards.
– Accounting measurements that involve complex processes.
– Events or transactions that involve significant accounting estimates
– Pending litigation and contingent liabilities.
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Control risk
Definition: The risk that a misstatement that could occur in an assertion about a class of transaction, account
balance or disclosure and that could be material, either individually or when aggregated with other
misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal
control.
It is the risk that an organisation’s internal control systems do not adequately protect the organization either
because they have not been adequately designed and / or implemented.
The following factors can result in an increase in control risk:
– Lack of personnel with appropriate accounting and financial reporting skills.
– Changes in key personnel including departure of key management.
– Deficiencies in internal control, especially those not addressed by management.
– Changes in the information technology (IT) environment.
– Installation of significant new IT systems related to financial reporting.
It is important to appreciate that the auditor has no control over the extent of either inherent or control risk;
these are risks borne by the entity subject to audit. However, the auditor has to assess them in the process of
determining the extent of the detailed substantive procedures to be carried out.
Detection risk Explained
Definition: The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level
will not detect a misstatement that exists and that could be material, either individually or when aggregated
with other misstatements.
Detection risk is all down to the auditors and is the risk that the auditor’s procedures fail to detect a material
misstatement.
Detection risk is affected by sampling and non-sampling risk and factors which can result in an increase include:
– Inadequate planning.
– Inappropriate assignment of personnel to the engagement team.
– Failing to apply professional scepticism.
– Inadequate supervision and review of the audit work performed.
– Incorrect sampling techniques performed.
– Incorrect sample sizes
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Detection risk include sampling risk and non-sampling risk ( these are explained in detail with the topic of
sampling- below is an overview).
Sampling risk= sample is not representative of the population
Non-sampling risk = auditor’s procedures or the conclusion reached are incorrect.
Audit Risk
=
Needs to be at
an acceptably
low level
Inherent Risk
High
x
Control Risk
x
Detection risk
High
Must be low!
The audit risk model used by auditors, dictates that for a given level of audit risk, the acceptable level of
detection risk bears an inverse relationship to the assessment of the risk of material misstatement.
For example, on an audit assignment where the risk of material misstatement has been assessed as high, in
order to achieve a low level of audit risk, detection risk must be set as low.
In such circumstances the auditor would need to direct an appropriate level of resources to the testing of the
assertion in question. This will comprise adequate planning, proper assignment of personnel, the application of
professional scepticism and supervision and review of the audit work performed.
Analytical procedures
Analytical procedure is an audit procedure which seeks to provide evidence as to the completeness, accuracy
and validity of the information contained in the accounting records or in the financial statements.
The procedure consists of the systematic study and comparison of relationships among elements of financial
information and the investigation of significant fluctuations and variances from the expected relationship
Steps involved in analytical procedures
1. Expectation:This step involves developing an expectation of what the financial information figures should be.
This can be agreed through comparisons of financial information or considerations of relationships (ratio
analysis).
2. Identification:This step involves identification of significant variations between the actual data with the
expected data.
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3. Investigation of unusual variances: Once the variation has been computed, and if significant variations are
found, the auditor would consult the management in order to establish explanations for the variations revealed.
4. Performance of alternate procedures: If the auditor or the management does not find the variation
reasonable, then they investigate further and perform analytical procedures to satisfy themselves.
When performing an analytical procedure, the auditor compares numbers, ratios or even non-financial
information in order to identify unexpected trends or unexpected relationships,which may indicate the
existence of errors.
There are many different analytical procedures including the comparisons listed below
 year on year (e.g. revenue this year compared to revenue last year);
 to budget or forecast (e.g. actual purchases compared to budgeted purchases);
 to predictions made by the auditors-proof in total (e.g. auditors calculation of depreciation compared to
client’s calculation);
 to industry information (e.g. client’s revenue compared to competitor’s revenue).
 Comparison/analysis of relationships between different elements of the financial statements ( for
example gross profit compared to sales)
 Comparison of financial info with non-financial info ( for e.g. payroll expense matched to number of
employees)
 Nonfinancial information. For example, sales revenue for a client from the hotel industry might be based
on available data as to room occupancy rates.
Analytical Procedures at
the Planning stage
Analytical Procedures at
substantive testing stage
Analytical Procedures at
the Review stage
to assist the auditor in planning the nature, timing and extent of other audit
procedures. Use at this stage should add to the firm’s understanding of the
business and identify risk areas to which audit resources should
be targeted.
at the detailed testing stage – in most instances analytical procedures should be
used in conjunction with tests of detail
to achieve a particular audit objective in relation to specific financial statement
assertions..
At the final review stage the auditor must design and perform analytical
procedures that assist him when forming an overall conclusion as to whether the
financial statements are consistent with the auditor’s understanding of the entity
and that all of the audit
objectives with regard to the financial statements have been met.
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Using Ratios
In the Paper F8 exam you may be asked to compute and interpret the key ratios used in analytical procedures
at both the audit planning stage and when collecting audit evidence. Ratios and comparisons can be used to
identify where the accounts might be wrong, and where additional auditing effort should be spent.
Calculating a ratio is easy, and usually is little more than dividing one number by another. Indeed, the
calculations are so basic that they can be programmed into a spreadsheet. The real skill comes in interpreting
the results and using that information to carry out a better audit. Saying that a ratio has increased because the
top line in the calculation has increased (or the bottom line decreased) is rather pointless: this is simply
translating the calculation into words.
Gross Profit Margin = Gross profit/Sales Revenue x 100
Operating profit margin =Operating profit/Sales Revenue x 100
Return on capital employed = Operating profit/ Capital employed x 100
Current Ratio= Current Assets/Current Liabilities
Quick ( or asset test) ratios =Current assets minus inventory/ current liabilities
Inventory days =Inventory/Cost of sales x 365
Receivable days/ Receivables collection period =Trade receivables/Sales x 365
Trade payable Days/Payables payment period =Trade payables/Cost of sales x 365
Gearing =Long-term loan finance/ equity finance x 100
The gearing ratio can also be defined in other ways, particularly by comparing long-term loan finance to total
finance. As gearing increases so does the risk that the interest can’t be paid. But it is difficult to define a ‘safe’
level of gearing. For example, a property company with properties leased to tenants will have fairly predictable
rental income. Such a company can probably safely sustain substantial borrowings (though it could be in trouble
if interest rates increased significantly). A company with volatile streams of income would have to keep its
gearing lower as it must ensure that interest can be paid during the lean times.
Interest cover = profit before interest/ interest
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Responses to Risk
Having identified the audit risk candidates are often required to identify the relevant response to these risks. A
common mistake made by candidates is to provide a response that management would adopt rather than the
auditor.
In the past exams, in relation to the risk of valuation of receivables if a company has a number of receivables
who were struggling to pay, many candidates suggested that management needed to chase these outstanding
customers. This is not a response that the auditor would adopt, as they would be focused on testing valuation
through after date cash receipts or reviewing the aged receivables ledger.
Auditor’s responses should focus on how the team will obtain evidence to reduce the risks identified to an
acceptable level. Their objective is confirming whether the financial statement assertions have been adhered to,
and whether the financial statements are true and fair. Responses are not as detailed as audit procedures;
instead they relate to the approach the auditor will adopt to confirm whether the transactions or balances are
materially misstated.
ISA 330 lists the following overall responses that may be used by auditors in order to address the assessed
risks of material misstatement at the financial statement level:
 Emphasizing to the audit team the need to maintain professional scepticism.
 Assigning more experienced staff, those with special skills, or using experts.
 Providing more supervision.
 Incorporating additional elements of unpredictability in the selection of further audit procedures to be
performed.
 Making general changes to the nature, timing or extent of audit procedures
Examples from past exams
Audit Risk
Audit Response
The finance director Abrahams is planning to capitalize the full
$2.2 million of development expenditure incurred. However in
order to be capitalized it must meet all of the criteria under
IAS 38 intangible Assets
A breakdown of the development expenditure
should be reviewed and tested in detail to
ensure that only projects which meet the
capitalization criteria are included as an
intangible asset, with the balance being
expensed.
In September Abrahams Co introduced a new accounting
system. This is a critical system for the accounts preparation
and if there were any errors that occurred during the
changeover process, these could impact on the final amounts
in the trial balance.
The new system will need to be documented in
full and testing should be performed over the
transfer of data from the old to the new
system.
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C.MATERIALITY
Definition: ‘Misstatements, including omissions, are considered to be material if they, individually or in the
aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the
financial statements.’
In assessing the level of materiality there are a number of areas that should be considered.
Firstly the auditor must consider both the amount (quantity) and the nature (quality) of any misstatements, or a
combination of both.
The quantity of the misstatement refers to the relative size of it and the quality refers to an amount that might
be low in value but due to its prominence could influence the user’s decision, for example, directors’
transactions.
In assessing materiality the auditor must consider that a number of errors each with a low value may when
aggregated amount to a material misstatement.
The assessment of what is material is ultimately a matter of the auditor’s professional judgement, and it is
affected by the auditor’s perception of the financial information needs of users of the financial statements and
the perceived level of risk; the higher the risk, the lower the level of overall materiality.
Materiality is often calculated using benchmarks such as 5% of profit before tax or 2% of total assets. These
values are useful as a starting point for assessing materiality.
Auditors need to establish the materiality level for the financial statements as a whole, as well as assess
performance materiality levels, which are lower than the overall materiality.
Performance materiality is normally set at a level lower than overall materiality. It is used for testing individual
transactions, account balances and disclosures. The aim of performance materiality is to reduce the risk that the
total of errors in balances, transactions and disclosures does not in total exceed overall materiality.
Definition of performance materiality below:
‘Performance materiality means the amount or amounts set by the auditor at less than materiality for the
financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of
uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole. If
applicable, performance materiality also refers to the amount or amounts set by the auditor at less than the
materiality level or levels for particular classes of transactions, account balances or disclosures.’
Material by size (importance depends on value)-Quantitative factors
 1% of revenue;
 2% of total assets;
 10% of PBT.
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Material by nature
Examples
 Bank balances
 Related party transactions ( including remuneration and personal expenses of directors)
 Fraud/ Unlawful transactions (e.g. illegal payments)
 -Violation of regulatory requirements
 Incorrect selection or application of an accounting policy that has an immaterial effect on the current period
but is likely to have a material effect on future periods
 Failure to meet requirements of debt-covenants
 Key Performance Indicators of the company (e.g. converting loss into profit)
D.SCOPE.TIMING AND DIRECTION
Scope
1. Financial reporting framework for the financial
statements.
2. Are there industry specific or other special
reporting requirements?
3. Are there other factors which influence the overall
approach to the audit?
 Multiple locations
 Need of expert
 Whether the entity has an internal audit
function, and if so, in which areas and to what
extent work of the function can be used.
 Nature of business (considering need of
specialized knowledge).
 Effect of information technology on the audit
procedures
Timing
Deadlines for:
 Final reporting
 Any interim report
 Meeting with Those charged with governance and
Management to discuss important matters of audit
 Reports to management
 Reports to those charged with governance.
The normal timetable for an audit includes:
- An interim visit, usually at least threequarters of the way through the
accounting year
- Attendance at inventory count
- Year end confirmation letters
- The final audit shortly after the accounting
year-end
This pattern will often be modified to suit the needs of
the particular business.
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Direction
The ‘direction’ of the audit covers the overall approach and concerns such issues as:
1.
Reliance on controls or a fully substantive approach.
2.
Significant developments and changes in
 Industry (e.g. regulations and reporting requirements)
 Business (impact of IT, changes in processes, mergers, acquisitions)
 Financial Reporting Framework
 Others (e.g. legal environment)
3.
With respect to risk
 Identification of areas of financial statements where there is higher risk.
 Impact of risk at financial statements level on direction, supervision and review.
4.
With respect to materiality:; Setting materiality for planning purposes
5.
With respect to Internal Controls
 Internal control deficiencies identified in previous audits and actions to address them.
 Appropriateness of design, implementation and operating effectiveness of internal control.
 Whether it is more efficient to rely on internal control.
Audit plan
An audit plan converts the audit strategy into a more detailed plan and includes the nature, timing and extent
of audit procedures to be performed by engagement team members in order to obtain sufficient appropriate
audit evidence to reduce audit risk to a low level.
Audit planning is a detailed recording of each procedure and process required to perform an audit.
Once the overall strategy has been determined, the auditor should prepare a detailed plan of the areas
determined in the audit strategy. Once the audit strategy has been decided, the next stage is to decide how it is
going to be carried out; an audit plan is necessary. The audit plan contains the nature, timing and extent of the
procedures to be performed.
The audit plan covers:
 Allocation of work and duties to the assistants
 Allocation of time and cost
 Formation of various teams
 Audit tests/procedures
 Data gathering techniques
 Types of audit evidence desired
The audit plan is developed in order to reduce audit risk to an acceptably low level.
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Interim vs Final Audit
Interim Audit
An interim audit refers to audit work that is conducted during the accounting year, at intervals, fixed or not. The
audit of the remaining part of the year will be done at the end of the accounting year.
The auditor uses the interim audit to carry out procedures which would be difficult to perform at the year end
because of time pressure. There is no requirement to undertake an interim audit; factors to consider when
deciding upon whether to have one include the size and complexity of the company along with the effectiveness
of internal controls.
Typical work carried out at the interim audit includes:
- consideration of inherent risks facing the company. ( Risk would be initially considered at the
planning stage, but is, in fact, reassessed at all audit stages.)
- documenting and testing of internal controls
- testing of profit and loss transactions for the year to date
- identification of potential problems that may affect the final audit work.
Final audit
The final audit will take place after the year end and concludes with the auditor forming and expressing an
opinion on the financial statements for the whole year subject to audit. It is important to note that the final
opinion takes account of conclusions formed at both the interim and final audit.
Typical work carried out at the final examination includes:
Follow up of items noted at the inventory count
- Obtaining confirmations from third parties, such as bankers and lawyers
- Analytical reviews of figures in the financial statements.
- substantive procedures of account balances and transactions
- Reviews of events after the reporting period
- Consideration of the going concern status of the organisation.
Advantages of interim audit
a) The errors are discovered at early stage
b) As the auditor visits the entity frequently, the chances of fraud being committed reduce.
c) Fraud, if committed, will be discovered at an early stage, which results in minimising the loss due to the
fraud.
d) Most of the time, the audit staff is present at the client’s premises, which acts as a moral check and
result in minimising the chances of errors or fraud.
e) All the books and records of the client are always up-to-date.
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f)
As the audit is started earlier, more time is available for a detailed checking of accounts and hence this
allows for a comprehensive audit.
g) An interim audit minimises the work and time involved in conducting the audit at the end of the year
and therefore assures early completion of the audit reports.
h) If the auditor plans to rely on the internal controls, some extensive testing may be done at the interim
period only so that the workload at the end of the year will be reduced.
Disadvantages of interim audit
a) There is always a danger that the audited figures may be altered either innocently or
fraudulently. That is why ISA 330 states that when audit evidence (relating to the operating
effectiveness of internal controls or the financial statement assertions), is obtained during the
interim period, additional audit evidence (relating to the effectiveness of internal controls or the
financial statement assertions) must also be obtained for the remaining period.
b) It is just a waste of time in small entities.
c) The cost would be high.
Attempt questions to check your understanding:
Audit Risk
March/June Hybrid 2016-Q6a,b
Sept/Dec Hybrid 2015-Q4
June 2015-Q5b
Dec 2014-Q2
June 2014-Q3a
Dec 2013-Q1a,b,c
June 2013-Q3 ( Ratios)
Dec 2012-Q3a,b
Dec 2010-Q3 ( Ratios)
Planning-general
Sept/Dec Hybrid 2015-Q2c
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Internal control Systems
Internal controls: Internal control represents the system or policies and procedures implemented by an
organization.
Why does an auditor need to understand internal controls?
Internal controls assure management of the accuracy of the financial statements, that the operations of the
entity are conducted efficiently and that the entity has complied with all the laws and regulations which are
applicable to the entity.
The objectives of internal controls relevant to audit include:
1. Avoidance of fraud, errors, wastes and inefficiency
2. Maximum accuracy of all records, data and statements
3. Enables auditors to determine the degree of reliance they can place on the various systems. This will
enable the auditors to assess the correctness, truth and fairness of the financial statements.
4. Informing management about weaknesses detected in internal controls so that corrective action can be
taken.
5. Enabling planning of the audit
6. Understanding the components of internal control: While planning the audit, the auditor understands
the various components of the internal control so as to:
o identify the types of potential misstatements.
o consider the factors that affect the risk of misstatement.
o design effective substantive tests.
Components of internal control systems (5 in total)
Internal control components
ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its
Environment considers the components of an entity’s internal control. It identifies the following components:
1. Control environment
2. Entity’s risk assessment process
3. Information system and communication
4. Control activities
5. Monitoring of controls
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1
Control environment
2
Entity’s risk assessment
process
3
Information system,
(including the related
business processes,
relevant to financial
reporting), and
communication
Control activities relevant
to the audit
4
The control environment sets the tone of an organisation, influencing the
control consciousness of its people. It includes the attitudes, awareness, and
actions of TCWG concerning the entity’s internal control and its importance in
the entity.
The control environment has many elements such as:
a) Communication and enforcement of integrity and ethical
values – essential elements which influence the effectiveness
of the design, administration and monitoring of controls.
b) Commitment to competence – management’s consideration
of the competence levels for particular jobs and how those
levels translate into requisite skills and knowledge.
c) Management’s philosophy and operating style –
management’s approach to taking and managing business
risks, and management’s attitudes and actions towards
financial reporting, information processing and accounting
functions and personnel.
d) Organisational structure – the framework within which an
entity’s activities for achieving its objectives are planned,
executed, controlled and reviewed.
e) Assignment of authority and responsibility – how authority
and responsibility for operating activities are assigned and
how reporting relationships and authorisation hierarchies are
established.
f) Human resources policies and practices – recruitment,
orientation, training, evaluating, counselling, promoting,
compensating and remedial actions.
For financial reporting purposes, the entity’s risk assessment process includes:
- how management identifies business risks relevant to the
preparation of financial statements
- how it estimates their significance
- how it assesses the likelihood of their occurrence, and decides
upon actions to respond to and manage them and the results
thereof.
The information system relevant to financial reporting, which includes the
accounting system, consists of the procedures and records designed and
established to initiate, record, process, and report entity transactions (as well
as events and conditions) and to maintain accountability for the related
assets, liabilities, and equity.
Control activities are the policies and procedures which help ensure that
management directives are carried out. Control activities, whether within
information technology or manual systems, have various objectives and are
applied at various organisational and functional levels.
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Examples of controls are:
Segregation of duties :assignment of roles/responsibilities to different
people, thereby reducing the risk of fraud and error occurring. The concept is
that no individual person should be responsible for more than one of the
following duties:
(i) the authoristion of a transaction;
(ii) the recording of the transaction in the accounting records; and
(iii) the custody of the asset relating to the transaction.
Information processing: computer controls including general IT controls,
which cover a range of applications and support the overall IT environment
and application controls which operate on a cycle/business process level (
details given separately)
Authorisation: approval of transactions by a suitably responsible official to
ensure transactions are genuine.
Physical controls : restricting access to physical assets such as cash, inventory
and plant and equipment, thereby reducing the risk of theft.
Performance reviews : comparison or review of the performance of the
business by looking at areas such as budget v actual results.
Arithmetical controls: controls which check the arithmetical accuracy of
accounting records.
Account reconciliations : comparison of an account balance with another
source; often this source is from a third party, such as the bank, with
differences being investigated.
5
Monitoring of controls
It is the process to assess the effectiveness of internal control performance
over time. It involves assessing the effectiveness of controls on a timely basis
and taking necessary remedial actions. Management accomplishes the
monitoring of controls through ongoing activities, separate evaluations, or a
combination of the two..
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Computer Controls
GENERAL CONTROLS(Apply to the whole system)
Controls on the information system environment which ensure proper development of applications.
Examples include
 making regular back-ups of data and storing them off-site;
 having an IT help-desk and IT training for staff;
 keeping computers in locked rooms;
 having a disaster recovery plan;
 all computers have log in codes;
 anti-virus software and firewalls;
 segregation of duties between programmers and users.
 review of the data center or information processing facility should cover the adequacy of air
conditioning (temperature, humidity), power supply (uninterruptible power supplies, generators) and
smoke detectors
APPLICATION CONTROLS
Application controls are those controls that relate to the transaction and standing data relating to a computerbased accounting system.
They are specific to a given application and their objectives are to ensure the completeness and accuracy of the
accounting records and the validity of entries made in those records.
An effective computer-based system will ensure that there are adequate controls existing at the point of input,
processing and output stages of the computer processing cycle and over standing data contained in master files.
Application controls need to be ascertained, recorded and evaluated by the auditor as part of the process of
determining the risk of material misstatement in the audit client’s financial statements.
Input controls
Data input controls ensure the accuracy, completeness, and timeliness of data during its conversion from its
original source into computer data, or entry into a computer application. Examples are given below:
-
Format checks: These ensure that information is input in the correct form. For example, the
requirement that the date of a sales invoice be input in numeric format only – not numeric and
alphanumeric.
-
Range /Reasonableness checks: These ensure that input data is rejected or highlighted if it is
outside pre-set parameters.For example, where an entity rarely, if ever, makes bulk-buy purchases
with a value in excess of $50,000, a purchase invoice with an input value in excess of $50,000 is
rejected for review and follow-up.
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-
Compatibility/dependence checks: These ensure that data input from two or more fields is
compatible. For example, a sales invoice value should be compatible with the amount of sales tax
charged on the invoice.
-
Exception checks: These ensure that an exception report is produced highlighting unusual situations
that have arisen following the input of a specific item. For example, the carry forward of a negative
value for inventory held.
-
Sequence checks: ensure that sequential input of documentation/data is maintained. These
facilitate completeness of processing by ensuring that documents processed out of sequence are
rejected. For example, where pre-numbered goods received notes are issued to acknowledge the
receipt of goods into physical inventory, any input of notes out of sequence should be rejected.
Control totals: These also facilitate completeness of processing by ensure that pre-input, manually
prepared control totals are compared to control totals input. For example, the total of all the
invoices, such as the gross value, is manually calculated. The invoices are input, the system
aggregates the total of the input invoices’ gross value and this is compared to the control total. This
helps to ensure completeness and accuracy of input.
-
-
Existence checks : the system is set up so that certain key data must be entered, such as supplier
name, otherwise the invoice is rejected. This helps to ensure accuracy of input.
-
Check digit verification: Check digits are used to protect against the transposition of data i.e. errors
arising due to accidental reversal of digits. This process uses algorithms to ensure that data input is
accurate.
-
Document counts :the number of invoices to be input are counted, the invoices are then entered
one by one, at the end the number of invoices input is checked against the document count. This
helps to ensure completeness of input.
-
One for one checking: the invoices entered into the system are manually agreed back one by one to
the original purchase invoices. This helps to ensure completeness and accuracy of input.
Processing controls
Processing controls exist to ensure that all data input is processed correctly and that data files are appropriately
updated accurately in a timely manner.
For example, the balance carried forward on the bank account in a company’s general (nominal) ledger.
Other processing controls should include the subsequent processing of data rejected at the point of input, for
example:
- A computer produced print-out of rejected items.
- Formal written instructions notifying data processing personnel of the procedures to follow with regard
to rejected items.
- Appropriate investigation/follow up with regard to rejected items.
- Evidence that rejected errors have been corrected and re-input.
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Output controls
Output controls exist to ensure that all data is processed and that output is distributed only to prescribed
authorised users. While the degree of output controls will vary from one organisation to another (dependent on
the confidentiality of the information and size of the organisation), common controls comprise:
- Appropriate review and follow up of exception report information to ensure that there are no
permanently outstanding exception items.
- Careful scheduling of the processing of data to help facilitate the distribution of information to end users
on a timely basis.
- Ongoing monitoring by a responsible official, of the distribution of output, to ensure it is distributed in
accordance with authorised policy.
Term to remember: Standing Data
Standing data is the information that is held on computer files for long-term use. It is called standing data as it
tends to change less frequently than other data. Examples of standing data would be:
• the rate of sales tax to be applied to sales invoices;
• the hourly pay rate for a factory worker to be used when calculating payroll;
• employee bank account details.
Master file controls
The purpose of master file controls is to ensure the ongoing integrity of the standing data contained in the
master files. It is vitally important that stringent ‘security’ controls should be exercised over all master files.
These include:
-appropriate use of passwords, to restrict access to master file data
-the establishment of adequate procedures over the amendment of data, comprising appropriate segregation of
duties, and authority to amend being restricted to appropriate responsible individuals
-regular checking of master file data to authorised data, by an independent responsible official
Limitations of internal control components
The internal control system, even if well-designed and well-implemented, does not completely eliminate the
possibility of fraud or error. No internal control system can be perfect due to its inherent limitations.
-
Controls are far more expensive compared to the benefits from the system.
Overriding of controls by the management.
Control systems are not geared up to cater to non-routine transactions.
Possibility of human error.
Possibility of fraud on account of collusion between employees.
Possibility that, with a change in conditions, a control may not be modified and therefore may become
inadequate.
Obsolescence of controls.
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Responsibilities of various parties regarding ICS
Management: design and implement and effective ICS. Check and ensure it is working effectively on a
continuous basis
BOD: ensure that an effective ICS is designed, implemented and monitored by the management. Ensure ICS are
reviewed by internal and external auditors and their recommendations are implemented
Auditors: review and report on ICS and recommend changes
External auditor’s work regarding controls
Document/Evaluate
Narratives
Narrative notes consist of a written description of the system; they would detail what
occurs in the system at each stage and would include any controls which operate at
each stage.
Advantages of this method include:
– They are simple to record; after discussion with staff members of Oregano, these
discussions are easily written up as notes.
– They can facilitate understanding by all members of the internal audit team, especially
more junior members who might find alternative methods too complex.
Disadvantages of this method include:
– Narrative notes may prove to be too cumbersome, especially if the sales and
distribution system is complex.
– This method can make it more difficult to identify missing internal controls as the
notes record the detail but do not identify control exceptions clearly.
Flowcharts
Flowcharts are a graphic illustration of the internal control system for the sales and
despatch system. Lines usually demonstrate the sequence of events and standard
symbols are used to signify controls or documents.
Advantages of this method include:
– It is easy to view the sales system in its entirety as it is all presented together in one
diagram.
– Due to the use of standard symbols for controls, they are easy to spot as are any
missing controls.
Information is presented in a logical sequence.
– They ensure that a system is recorded in its entirety as all documents have to be
traced from beginning to end.
– Facilitates easy understanding of a system.
– Facilitates the highlights of strengths and weaknesses of a system.
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– Serves as a permanent record of a system that can be subject to a minor amendment
on a year-to-year basis.
– They can be prepared quickly by staff with little experience.
Disadvantages of this method include:
– They can sometimes be difficult to amend, as any amendments may require the whole
flowchart to be redrawn.
– There is still the need for narrative notes to accompany the flowchart and hence it can
be a time consuming method.
– Not generally suitable for recording systems with numerous unusual transactions.
– Only suitable for describing standard systems.
– Major amendment is not normally possible without redrawing.
– Time can be wasted by recording and checking areas that are of no audit significance.
– They are not normally appropriate for recording systems where there are subsystems
or subroutines.
Questionnaires
Internal control questionnaires are used to assess whether controls exist which meet
specific objectives or prevent or detect errors and omissions.
-
ICQ( designed to ask if certain controls are present)
ICEQ (designed to ask if certain errors can be prevented-i.e. test the
effectiveness of controls)
An Internal Control Questionnaire (ICQ) normally comprises a checklist of standard
controls that should exist in a specified functional area (for example sales and trade
receivables or purchases and trade payables). Questions about the existence of
specified controls are usually phrased to generate a ‘Yes’ or a ‘No’ answer, with an
affirmative answer confirming the existence of the control and a negative answer
indicating the absence of the control and a weakness in the system.
A problem associated with ICQs is that whilst they do identify areas where controls
appear to be weak, they do not provide evaluation of those weaknesses. For example,
whilst a ‘No’ answer may indicate weakness in controls, it is possible that other controls
in the system, of which the auditor is unaware, may compensate for the weakness.
Internal Evaluation Questionnaires (ICEQs) provide an alternative and improved means
of evaluating control systems, by asking key questions about those systems. Key
questions are phrased such that answers in the positive should alert the auditor to the
fact that there are deficiencies in the systems because systems objectives are not being
met. ICEQs are usually designed to include a list of points that the auditor should
consider before answering each key question.
The auditor issues the questionnaires to the client, who in turn gets it filled by the
appropriate employees. The feedback on the questionnaire enables the auditor to
assess the inherent limitations in the design of the internal controls.
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The ICEQs contain detailed questions relating to the functioning of internal controls.
They are to be answered by the clients. The answers to the questions are generally in a
narrative form.
Information relating to the following matters is included the ICQs and ICEQs:
_ segregation and rotation of duties
_ maintenance of records and documents
_ accountability for, and safeguarding of assets
_ procedure for authorisations
The feedback received on the questionnaires will then be tested by the auditors and the
weaknesses, if any, will be communicated in the form of a letter of weakness to the
client.
Advantages
Questionnaires are quick to prepare, which means they are a cost effective method for
recording the system.
They ensure that all controls present within the system are considered and recorded;
hence missing controls or deficiencies are clearly highlighted.
Questionnaires are simple to complete and therefore any members of the team can
complete them and they are easy to use and understand.
Disadvantages
It can be easy for the company to overstate the level of the controls present as they are
asked a series of questions relating to potential controls.
Without careful tailoring of the questionnaire to make it company specific, there is a
risk that controls may be misunderstood and unusual controls missed.
Test!
Test of controls are performed to obtain audit evidence about 2 things:
1. Whether the ICS is designed suitably (to prevent, detect or correct material
misstatements)
2. Whether the ICS are operating properly ( test of controls)
Test of controls- examples
 inspection of documents (e.g. authorizations)
 enquiries about internal controls which leave no audit trail ( e.g. is the person who
is SUPPOSED to perform the function actually performing it or is someone else is
doing so)
 Re-performance of control procedures ( e.g. reconciliations)
 examination of evidence of management views(e.g. minutes of meetings)
 Observation of controls
 Using TEST DATA(CAATs)
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If controls appear strong, they are tested to ensure they operated as described
throughout the year. If the results show they operated effectively, substantive testing
may be reduced.
Report control
weaknesses to
management
A letter on internal control (also referred to as a management letter or letter of
weakness) is a letter usually forwarded by an auditor to the senior management of a
company.
The letter should normally be forwarded immediately following the completion of the
tests of control and before the commencement of substantive procedures.
The letter contains weaknesses identified in the entity’s system of internal control as
identified by the auditor when performing tests of control and the purpose of the letter
is to bring these weaknesses to the attention of management.
The weaknesses identified in the main body of the letter should be those which could
lead to fraud or material error in or omission from the company’s financial statements,
and will be classified as those relating to:
(i) the design of the systems of accounting and internal control.
(ii) the operation of the systems of accounting and internal control.
For both categories the implication(s) of the weakness(es) should be identified,
however minor control issues which the auditor would wish to bring to the attention of
the company’s senior management should be included in an appendix to the letter of
weakness or in a supplementary report.
Examples of matters the external auditor should consider in determining whether a
deficiency in internal controls is significant include:
– The likelihood of the deficiencies leading to material misstatements in the financial
statements in the future.
– The susceptibility to loss or fraud of the related asset or liability, the subjectivity and
complexity of determining estimated amounts.
– The financial statement amounts exposed to the deficiencies.
– The volume of activity that has occurred or could occur in the account balance or
class of transactions exposed to the deficiency or deficiencies.
– The cause and frequency of the exceptions detected as a result of the deficiencies in
the controls.
Decide extent of
substantive testing
Internal control over financial reporting strong- decrease substantive testing
Internal control over financial reporting weak- inccrease substantive testing
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The Sales System
Control objectives for sales and despatch system
-
To ensure that orders are only accepted if goods are available to be processed for customers.
To ensure that all orders are recorded completely and accurately.
To ensure that goods are not supplied to poor credit risks.
To ensure that goods are despatched for all orders on a timely basis.
To ensure that goods are despatched correctly to customers and that they are of an adequate quality.
To ensure that all goods despatched are correctly invoiced.
To ensure completeness of income for goods despatched.
To ensure that sales discounts are only provided to valid customers.
Sales order
placed
-
Goods
dispatched
to the
customer
-
-
All sales orders documented on a sequentially numbered multi-part SALES ORDER
FORM.
Confirm from the customer ( preferably in writing except on telephonic sales, a verbal
reconfirmation/ call recording should be acceptable)
Inventory check
One copy of the GDN is sent with the goods, one copy stays in the warehouse, stapled
to the relevant sales order, and one copy is sent to the invoicing department.
New customer: credit checks, the obtaining of trade/bank references and the setting of
appropriate credit limits for customers
Existing customer: credit limit check, Customer credit limits should be regularly
reviewed and updated based on the level of sales transactions and credit risk
Any discounts committed to be authorized
Follow up on unfulfilled orders- On a regular basis, a sequence check of orders should
be undertaken to identify any missing orders.
Automated environment: access to master file limited to authorized individuals only
Sequentially pre-numbered Goods Dispatched Note
Matched to the sales order- Upon despatch, the GDN should be matched to the order; a
regular review of unmatched orders should be undertaken to identify any unfulfilled
orders.
Signed by the warehouse manager after quantity and quality checks
3 copies( warehouse, customer, accounts/invoicing)
Customer should sign the copies to acknowledge receipt of goods
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Sales invoice
raised and
entered in
the
accounting
system
-
Sequentially pre-numbered invoices
Matched to GDN
3 copies ( accounts/invoicing, customer, sales day book clerk if applicable)
Ensure the authorized price list is used to prepare the invoice
Any discounts authorized
Arithmetic checks on invoices
Sequence check on GDNs to ensure all GDNs have been invoiced
Sequence check on Invoices to ensure all invoices have been entered in the accounting
system
Customer statements should be sent monthly to ensure any errors and disputed
invoices are quickly identified and resolved
The sales ledger control account should be reconciled on a monthly basis to the
individual ledger to identify any errors. The reconciliations should be reviewed by a
responsible official and they should evidence their review.
Payment received from the customer
-
Match payment to invoice
Check validity of any settlement
discounts availed by the customer
Segregation of duties: receiving
payment and recording
Encourage bank transfers
A Bank Reconciliation Statement
should be prepared on a monthly basis
Other
controls
Goods returned by the customer
-
Sequentially pre-numbered credit note
Signed by the manager
Matched to invoice
Prepare a report for reasons for returns and actions
taken by the management.
Aged receivables report: prepare monthly and reviewed by a senior official
Exceptions reports created and reviewed ( old receivables, credit limit exceeded etc.)
Amendments to master file data should be restricted so that only senior officials can make
changes.
Attempt questions to check your understanding:
Dec 2014-Q5a
Dec 2013-Q3
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The Purchase System
The main objectives in purchase transactions are:
– Procurement is made only when the requirements are genuine.
– Purchases are made at the most optimum prices and terms.
– Purchases meet the required quality standards and if substandard quality is accepted, must be at negotiated
terms.
– Payments are made according to agreed terms.
– They are procured on time and the payments are made according to agreed terms.
Purchase
requisition
-
Sequentially pre-numbered
Authorized to ensure only those goods are ordered which are required
Monitor inventory level or Re-order level set
Inventory/ re-order level checked before raising the requisition to ensure only order
when required.
Purchase
order
-
Sequentially pre-numbered and matched to requisition
Authorized supplier list used and updated annually (this should take into account the
price of goods, their quality and the speed of delivery.)
Authorized
3 copies ( supplier, order department, warehouse)
Follow up on order placed but not yet received ( exception reports can be created in a
computerized environment) and sequence check can be performed for any unfulfilled
orders
-
Goods
received
-
Sequentially pre-numbered GRN
Matched to purchase order
Signed by the warehouse manager after quantity and quality checks
3 copies ( ordering department, warehouse for their records, account)
Invoice
received
from supplier
-
Match to GRN
File in an order ( CANNOT be Sequentially pre-numbered) but should be numbered
manually. This way, a sequence check can then be carried out to ensure all invoices
have been entered in the day book/ledger.
Arithmetic checks
Entered in the ledger /day book on a daily basis-application controls( such as control
total) should be applied to ensure completeness and accuracy over the input of
purchase invoices.
Stamp ‘entered’ when recorded
Segregation of duties ( order placement, goods received and recording)
Monthly reconciliation: PL to PLCA
-
-
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Payment made
-
Goods returned to the supplier
Segregation of duties ( Purchase order, goods received,
payment )
Before approving invoices for payment, a senior official
should match them to the audit trail ( esp. the GRN)
Bank transfer preferred
If payment by cheque: senior individuals only plus two
signatories for high amounts
Stamp invoice ‘paid’
Try and avail settlement discounts and pay according to
supplier’s terms to maintain supplier goodwill
Payment against specific invoices only ( avoid ‘on account
payment’)
Supplier statement reconciliation with PL
PL reconciliation with PLCA
Monthly BRS
Examples of application
controls to ensure the
Completeness and
accuracy of the input of
purchase invoices.
-
. Sequentially pre-numbered debit
notes
Authorized
Vendor-wise analysis to identify
consistent quality problems
Document counts – the number of invoices to be input are counted, the invoices are
then entered one by one, at the end the number of invoices input is checked against
the document count. This helps to ensure completeness of input.
Control totals – here the total of all the invoices, such as the gross value, is manually
calculated. The invoices are input, the system aggregates the total of the input
invoices’ gross value and this is compared to the control total. This helps to ensure
completeness and accuracy of input.
One for one checking – the invoices entered into the system are manually agreed
back one by one to the original purchase invoices. This helps to ensure completeness
and accuracy of input.
Check digits – this control helps to reduce the risk of transposition errors.
Mathematical calculations are performed by the system on a particular data field,
such as supplier number, a mathematical formula is run by the system, this checks
that the data entered into the system is accurate. This helps to ensure accuracy of
input.
Range checks – a pre-determined maximum is input into the system for gross invoice
value, for example, $10,000; when invoices are input if the amount keyed in is
incorrectly entered as being above $10,000, the system will reject the invoice. This
helps to ensure accuracy of input.
Existence checks – the system is set up so that certain key data must be entered,
such as supplier name, otherwise the invoice is rejected. This helps to ensure
accuracy of input.
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Attempt questions to check your understanding:
June 2015-Q4
June 2013-Q1b,c
The Payroll System
The main objective of a payroll is to ensure that:
– Wages and salaries are paid at the correct rates.
– Wages and salaries are paid to the right people.
– Wages and salaries are paid on time.
Key terms: 1. Clock cards/ timesheets 2.Payroll sheet 3.Pay slips 4.Bank Transfer List/payment list (instructions
to the bank)
Appointment/ leavers
-
Appointments: All appointment of staff, whether temporary or permanent, should only be made by the
human resources department, separate from the payroll department
-
There should be formal procedures requiring the interviews manager to provide detailed written
notification to a responsible official (for example the wages supervisor) of starters and leavers.
-
Update ‘starters and leavers’ details on a timely basis. Procedures should ensure that ‘starters’ and
‘leavers’ details are added to or deleted from the master file immediately after starting or leaving the
company’s employment.
-
All increases of pay should be proposed by the HR department and then formally agreed by the board of
directors.
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-
Standing data in the master file:
 ‘Read’ and ‘amend’ access to the master file should be available from specified
terminals to responsible officials who have a need and authorised cause to access the
information.
 Maintain a log of access attempts (Controls should include a computer log which
registers date and time access to the master file by the various users. This should
regularly be reviewed by a senior responsible official of the company)
 Match standing data to the personnel filed periodically
At random intervals a more senior responsible official of the company (for example the company accountant),
should access the wages master file and check its contents to the manual records maintained, input
documentation and notifications from the interviews manager as appropriate.
Calculations
-
Clock cards sequentially pre-numbered (which details the employee number and name)
-
Clock card machine supervised or in open view (Staff attendance machine kept near the security gate (to
ensure that there are no dummy attendances recorded).
-
Head count by area supervisor ( attendance matched to actual employees present)
-
Any overtime worked reviewed and then authorized. This should be evidenced by signature on the
employees’ overtime sheets.
-
Periodic verification of staff cards with personal files of employees (to ensure that there are no ghost
employees).
-
Data input: Use application and general IT controls ( for example range checks, passwords)
-
Gross pay, deductions, net pay:
 Preferably automatically calculated by the payroll system.
 Calculations re checked on a sample basis- A senior member of the payroll team should
recalculate the gross to net pay workings for a sample of employees and compare their results
to the output from the payroll system.
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Payments
-
Pay slips to be sequentially pre-numbered
-
Segregation of duties ( payroll sheet, recording, payment)
-
Salaries:
 Preferably through bank transfer
 Bank transfer list/payment list matched to payroll sheet prior to authorising the bank payment.
 When authorising the payments, the responsible official should on a sample basis perform
checks from payroll records to payment list and vice versa to confirm that payments are
complete and only made to bona fide employees.
 Bank transfer list/payment list preferably authorized by someone other than the person who
authorized payroll ( for example the Finance Director)
-
Wages (cash)/Pay packets
 All cash wages should only be paid upon sight of the employee’s clock card and
photographic identification as this confirms proof of identity.
 Uncollected wage packets should be kept in a safe place/ deposited in the bank
Attempt questions to check your understanding:
Sept/Dec Hybrid 2015-Q5 a,b
June 2014-Q1a,b
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Revenue and Capital Expenditure
Capital expenditure is incurred when a business spends money either to buy fixed assets or to add to the value
of an existing fixed asset.
Revenue expenditure is that expenditure which is incurred to maintain the existing capacity of an asset so that it
can do its daily work. Examples of revenue expenditure are cost of raw material and other stores, salaries and
wages, repairs and maintenance, stationery and printing, advertisements, postage, telephone, travel expenses
etc.
The main control objectives over revenue and capital expenditure are to ensure that:
 All expenditure is authorised.
 Proper segregation of capital and revenue expenses is made.
 Expenses are properly accounted for.
The transaction cycle for capital and revenue expenditure is quite similar for purchases. However, certain
additional control points, which are to be ensured, are mentioned below:
 Am authorized budget is prepared for all expenditure.
 Preparation of a report of capital budget versus actual expenditure.
 Preparation of a periodic variance report of those expenses that do not match the budget.
 Orders for capital items should be authorised by appropriate levels of management.
 A document may be prepared for showing the distinction between capital and revenue expenditure and for
providing guidance on which expenses to be capitalised.
 All vouchers of revenue expenditure need to have approval of maintenance manager.
 A senior person should check the accounting treatment for the expenses (especially repairs and
maintenance).
Non-Current Asset register
The purpose of a tangible non-current assets register is to list details of all the non-current assets owned by an
entity, in order to facilitate control over those assets. Typically, the register should record cost, depreciation and
net book value information of each asset along with identifying details. For example in the case of plant and
machinery – gross cost, annual depreciation rate, depreciation provision, net book value, date of acquisition,
serial number and description and location of asset.
 The register should be updated by individuals who are separated from the acquisition, custody and
disposal of assets.
 Periodical reconciliation of non-current register with the general ledger to be done and any differences
to be investigated.
 Preparation of an exception report if the non-current register does not match the non-current assets
account maintained in accounts.
 Invoices should bear appropriate ledger code (distinguishing revenue items from capital expenditure) in
order to facilitate correct recording.
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



Depreciation rates should be reasonable and authorised.
Depreciation calculations should be checked
NCA register should be used to confirm physical existence on a periodic basis
To ensure completeness of recording, periodic checks should be made to ensure that assets in existence
are completely recorded in the register.
Bank and Cash
The main objectives of cash and bank transactions are to ensure that:
 All money received is recorded.
 All money received is banked.
 Money is properly safeguarded.
 Payments are made to correct persons and properly recorded.
Main controls on bank and cash
 Segregation of duties between the person receiving the money, the person depositing it in the bank and the
one making the payments.
 Match bank deposit slips with the cash and cheque receipt register.
 Daily cash receipts immediately recorded in the customers’ accounts.
 Cash receipt register reconciled daily with the customer accounts.
 Periodical management review of the register is to be conducted to ensure that cheques are promptly
deposited into the bank.
 Bank reconciliation to be prepared periodically and differences to be investigated.
 Receivables’ ledger reconciled with control account.
 Cash kept under the custody of the cashier. And there should be restricted access to cashier’s room
 Security personnel to accompany the cashier while depositing or withdrawing cash from the bank
 Minimum cash balance to be maintained needs to be decided.
 Whenever cash balance exceeds minimum balance, excess balance deposited to be in the bank.
 Surprise cash counts by personnel other that the accounts department.
 Cash to be suitably insured for cash in hand, and cash in transit.
 Unused cheques to be kept under lock and key.
 Cheques books to be in the custody of a responsible person
Attempt questions to check your understanding:
June 2015-Q2
June 2012-Q1a
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Test of controls
In the F8 exam, you might be asked to:
-
Identify and explain deficiencies in the system
Recommend a control to address each of these deficiencies
Describe a TEST OF CONTROL the external auditors would perform to assess if each of these controls, if
implemented, is operating effectively.
What is a Test of Control? An audit procedure designed to evaluate the operating effectiveness of controls in
preventing, or detecting and correcting, material misstatements at the assertion level.
Examples of test of controls( also mentioned earlier):
 inspection of documents (e.g. authorizations)
 enquiries about internal controls which leave no audit trail ( e.g. is the person who is SUPPOSED to perform
the function actually performing it or is someone else is doing so)
 Reperformance of control procedures ( e.g. reconciliations)
 examination of evidence of management views(e.g. minutes of meetings)
 Observation of controls
 Using TEST DATA(CAATs)
If you are confused about how to word a TOC, start with “The auditor should….”
Example from a past exam
Deficiency
Customer credit limits are set by
sales ledger clerks.
Sales ledger clerks are not
sufficiently senior and so may set
limits too high, leading to
irrecoverable debts, or too low,
leading to a loss of sales.
Control
Credit limits should be set by a
senior member of the sales ledger
department and not by sales ledger
clerks. These limits should be
regularly reviewed by a responsible
official.
Test of Control
The auditor should take a sample
of new customers accepted in the
year and review the authorisation
of the credit limit, and ensure that
this was performed by a
responsible official.
And/or
The auditor should enquire of
sales ledger clerks as to who can
set credit limits.
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Another example from a past exam
Deficiency
Supplier statement reconciliations
are no longer performed.
This may result in errors in the
recording of purchases and
payables not being identified in a
timely manner.
Control
Test of Control
Supplier statement reconciliations
should be performed on a monthly
basis for all suppliers and these
should be reviewed by a
responsible official.
The auditor should review the file
of reconciliations to ensure that
they are being performed on a
regular basis and that they have
been reviewed by a responsible
official.
Management assertions, Audit procedures and Audit evidence
Management is responsible for the preparation of financial statements that give a true and fair view, but what
does this really mean?
For each item in the financial statements, management is making assertions.
The auditors need evidence that these financial statements are valid!
‘In representing that the financial statements are in accordance with the applicable financial reporting
framework, management implicitly or explicitly makes assertions regarding the recognition, measurement and
presentation of classes of transactions and events, account balances and disclosures’.
Consequently auditors use these assertions when considering the potential types of misstatements that may
occur and when designing and performing appropriate audit procedures.
Transactions include sales, purchases, and wages paid during the accounting period.
Account balances include all the asset, liabilities and equity interests included in the statement of financial
position at the period end.
ISA 315, Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its
Environment identifies the following assertions:
1.
2.
Assertions about classes of transactions and events and related disclosures for the period under audit
Assertions about account balances and related disclosures at the period end
A note of caution: ISA 315 has been recently revised. The solutions of the past exams may not reflect these
revisions at the moment. Students are requested to be careful when practicing past exams. The revised
summary is given below.
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Assertions about classes of transactions and events and related disclosures for the period under audit
-
This means that the transactions recorded or disclosed
actually happened and relate to the entity. For example
that a recorded sale represents goods which were ordered
by valid customers and were despatched and invoiced in
the period. An alternative way of putting this is that sales
are genuine and are not overstated.
-
Relevant test – select a sample of entries from the sales
account in the nominal ledger and trace to the appropriate
sales invoice and supporting goods despatched notes and
customer orders.
-
No omission
-
Relevant test – select a sample of customer orders and
check to despatch notes and sales invoices and the posting
to the sales account in the nominal ledger.
1. Occurrence – the transactions
and events that have been
recorded or disclosed, have
occurred, and such transactions
and events pertain to the entity.
2. Completeness – all transactions
and events that should have been
recorded have been recorded and
all related disclosures that should
have been included in the
financial statements have been
included.
Note the difference in the direction of the above test. In order to
test completeness the procedure should start from the underlying
documents and check to the entries in the relevant ledger to ensure
none have been missed. To test for occurrence the procedures will
go the other way and start with the entry in the ledger and check
back to the supporting documentation to ensure the transaction
actually happened.
3. Accuracy – amounts and other
data relating to recorded
transactions and events have
been recorded appropriately, and
related disclosures have been
appropriately measured and
described.
-
This means that there have been no errors while preparing
documents or in posting transactions to ledgers. The new
reference to disclosures being appropriately measured and
described means that the figures and explanations are not
misstated.
-
Relevant test – calculation checks on invoices, payroll, etc,
and the review of control account reconciliations are
designed to provide assurance about accuracy.
4. Cut–off – transactions and events
have been recorded in the
correct accounting period.
-
That transactions are recorded in the correct accounting
period.
-
Relevant test – recording last goods received notes and
despatch notes at the inventory count and tracing to
purchase and sales invoices to ensure that goods received
before the year–end are recorded in purchases at the year
end and that goods despatched are recorded in sales.
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5. Classification – transactions and
events have been recorded in the
proper accounts.
6. Presentation – transactions and
events are appropriately
aggregated or disaggregated and
clearly described, and related
disclosures are relevant and
understandable in the context of
the requirements of the
applicable financial reporting
framework.
-
Transactions recorded in the appropriate accounts – for
example,the purchase of raw materials has not been posted
to repairs and maintenance.
-
Relevant test – check purchase invoices postings to nominal
ledger accounts.
-
This means that the descriptions and disclosures of
transactions are relevant and easy to understand. There is a
new reference to transactions being appropriately
aggregated or disaggregated. Aggregation is the adding
together of individual items. Disaggregation is the
separation of an item, or an aggregated group of items, into
component parts. The notes to the accounts are often used
to disaggregate totals shown in the profit or loss account.
Materiality needs to be considered when judgements are
made about the level of aggregation and disaggregation
.
-
Relevant test – check the total employee benefits expense
is analysed in the notes to the financial statements under
separate headings– ie wages and salaries, pension costs,
social security contributions and taxes, etc.
Assertions about account balances and related disclosures at the period end
1. Existence – assets, liabilities and
equity interests exist.
2. Rights and obligations – the
entity holds or controls the rights
to assets, and liabilities are the
obligations of the entity
-
Means that assets and liabilities really do exist and there
has been no overstatement – for example,by the inclusion
of fictitious receivables or inventory. This assertion is very
closely related to the occurrence assertion for transactions.
-
Relevant tests – physical verification of non–current assets,
circularisation of receivables, payables and the bank letter.
-
Means that the entity has a legal title or controls the rights
to an asset or has an obligation to repay a liability.
-
Relevant tests – in the case of property, deeds of title can
be checked. Current assets are often checked to purchase
invoices although these are primarily used to confirm cost.
Long term liabilities such as loans can be checked to the
relevant loan agreement.
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3. Completeness – all assets,
liabilities and equity interests
that should have been recorded
have been recorded and all
related disclosures that should
have been included in the
financial statements have been
included.
-
That there are no omissions and assets and liabilities that
should be recorded and disclosed have been. In other
words there has been no understatement of assets or
liabilities.
-
Relevant tests – A review of the repairs and expenditure
account can sometimes identify items that should have
been capitalised and have been omitted from non–current
assets. Reconciliation of payables ledger balances to
suppliers’ statements is primarily designed to confirm
completeness although it also gives assurance about
existence.
4. Accuracy, valuation and
allocation – assets, liabilities and
equity interests have been
included in the financial
statements at appropriate
amounts and any resulting
valuation or allocation
adjustments have been
appropriately recorded and
related disclosures have been
appropriately measured and
described.
-
Means that amounts at which assets, liabilities and equity
interests are valued, recorded and disclosed are all
appropriate. The reference to allocation refers to matters
such as the inclusion of appropriate overhead amounts into
inventory valuation.
-
Relevant tests – Vouching the cost of assets to purchase
invoices and checking depreciation rates and calculations.
-
Means that assets, liabilities and equity interests are
recorded in the proper accounts.
-
Relevant tests – the test for transactions of checking
purchase invoice postings to the appropriate accounts in
the nominal ledger will be relevant again. Also that research
expenditure is only classified as development expenditure if
it meets the criteria specified in IAS 38.
-
This means that the descriptions and disclosures of assets
and liabilities are relevant and easy to understand. The
points made above aggregation and disaggregation of
transactions also apply to assets, liabilities and equity
interests.
-
Relevant tests – auditors often use disclosure checklists to
ensure that financial statement presentation complies with
accounting standards and relevant legislation. These cover
all items (transactions, assets, liabilities and equity
interests) and would include for example checking that
disclosures relating to non–current assets include cost,
additions, disposals, depreciation, etc.
5. Classification – assets, liabilities
and equity interests have been
recorded in the proper accounts.
6. Presentation – assets, liabilities
and equity interests re
appropriately aggregated or
disaggregated and clearly
described, and related disclosures
are relevant and understandable
in the context of the
requirements of the applicable
financial reporting framework.
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Methods for testing these assertions/Procedures to obtain evidence/sources of evidence
Audit evidence verifies the correctness of the assertions contained in the financial statements. Audit evidence
can be obtained from different sources.
Inspection
Observation
Analytical
procedures
Inspection involves examining
records or documents, whether
internal or external, in paper form,
electronic form, or other media, or a
physical examination of an asset.
Observation consists of looking at a
process or procedure being
performed by others
Analytical procedures consist of
evaluations of financial information
through analysis of plausible
relationships among both financial
and non-financial data. Analytical
procedures also encompass such
investigation as is necessary of
identified fluctuations or
relationships that are inconsistent
with other relevant information or
that differ from expected values by a
significant amount.
Example – the physical inspection of a freehold office
building to verify existence of the building.
Example – the examination of a purchase invoice to
vouch the validity of an entry in the trade creditors
ledger.
Example – the observation of the counting of
inventory by an entity’s personnel to ensure that they
are counted in accordance with procedures authorised
by the management of the entity.
Example – the observation of the opening of the mail
of an entity to ensure that at least two employees are
present to receive and witness the receipt of monies
received by the entity.
Example – the calculation of the average remuneration
(total wages and salaries divided by total employees)
paid to the employees of an entity, to assess the
reasonableness of the reported wages and salaries
costs as compared to a previous equivalent period.
Example – the calculation of an entity’s trade creditors
ratio to help assess the reasonableness of bad debt
provisions, the effectiveness of credit control and the
possibility of under/over statement of reported sales.
Assertions normally tested by the
analytical procedures are
Completeness, Accuracy, Valuation
and Classification
Inquiry
Inquiry consists of seeking
information of knowledgeable
persons, both financial and nonfinancial, within the entity or outside
the entity.
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External
confirmation
An external confirmation represents
audit evidence obtained by the
auditor as a direct written response
to the auditor from a third party, in
paper form, electronic form or by
other medium.
Example – direct confirmation of a trade receivables
balance – to verify the existence of a trade receivables
balance.
Example – letter from a loan company, confirming the
balance outstanding on a loan – to verify the loan
liability of the company.
Example – a certificate from a specialist, confirming
the value of specific inventories held – to verify the
valuation of inventories.
Recalculation
Recalculation consists of checking the Example – checking the accuracy of inventory
mathematical accuracy of documents calculations to verify the accuracy of the valuation of
or records. Recalculation may be
reported inventory.
performed manually or electronically.
Reperformance
Re-performance involves the
auditor’s independent execution of
procedures or controls that were
originally performed as part of the
entity’s internal control.
Example – Using computer assisted audit techniques
to re-perform the ageing of accounts receivable
balances.
Example – Reperforming the extraction of a trial
balance from the company’s general ledger.
Sufficient Appropriate evidence
The term ‘audit evidence’ describes the information obtained by the auditors in arriving at the conclusions on
which the audit opinion is based.
Audit evidence comprises source documents and accounting records underlying the financial statements
(subject to audit) and corroborating information from other sources.
The auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on
which to base the audit opinion.
Sufficient
(quantity of evidence)
Factors affecting sufficiency
1. Assessment of risk at the financial statement level and/or the individual
transaction level. As risk increases then more evidence is required.
2. The materiality of the item. More evidence will normally be collected on
material items whereas immaterial items may simply be reviewed to
ensure they appear correct.
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3. The nature of the accounting and internal control systems. The auditor
will place more reliance on good accounting and internal control systems
limiting the amount of audit evidence required.
4. The auditor’s knowledge and experience of the business. Where the
auditor has good past knowledge of the business and trusts the integrity
of staff then less evidence will be required.
5. The findings of audit procedures. Where findings from related audit
procedures are satisfactory (e.g. tests of controls over receivables) then
substantive evidence will be collected.
6. The source and reliability of the information. Where evidence is obtained
from reliable sources (e.g. written evidence) then less evidence is
required than if the source was unreliable (e.g. verbal evidence).
Appropriate
(quality of evidence)
Reliability of evidence
Following are the factors that influence the reliability of audit evidence:
1.
2.
3.
4.
5.
6.
7.
8.
Audit evidence is more reliable when it is obtained from independent
sources outside the entity.
Audit evidence that is generated internally is more reliable when the
related controls imposed by the entity are effective.
Audit evidence obtained directly by the auditor (for example, observation
of the application of a control) is more reliable than audit evidence
obtained indirectly or by inference (for example, inquiry about the
application of a control).
Audit evidence is more reliable when it exists in documentary form,
whether paper, electronic, or other medium.
Audit evidence provided by original documents is more reliable than audit
evidence provided by photocopies or facsimiles.
Evidence created in the normal course of business is better than evidence
specially created to satisfy the auditor.
The best-informed source of audit evidence will normally be
management of the company (although management’s lack of
independence may reduce its value as a source of such evidence).
Evidence about the future is particularly diffi cult to obtain and is less
reliable than evidence about past events.
Relevance of evidence: Audit evidence should be relevant to the area/ assertions
being tested.
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Substantive procedure
Substantive procedure is an audit procedure which is designed to detect material misstatements at the assertion
level.
Substantive procedures (or substantive tests) are those activities performed by the auditor that gather evidence
as to the completeness, validity and / or accuracy of account balances and underlying classes of transactions and
related disclosures.
Substantive procedures comprise the following
a) Analytical procedures
b) Tests of details (of classes of transactions, account balances, and related disclosures)
a) Analytical procedures
Analytical procedures mean the analysis of significant ratios and trends. It also involves the investigation of
resulting fluctuations and inconsistent relationships.
b) Test of detail
Test of detail is carried out for transactions and balances.
Details of transaction
These are tests to obtain evidence of individual debits and credits that make up an account to reach a conclusion
about the account.
The tests can be made through tracing and vouching of transactions.
Tracing: Supporting documents traced to records/account books
Vouching: Records/account books vouched/verified by matching to relevant supporting documents
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PROCEDURES on specific areas
Substantive on Receivables Key risk: overstatement
Receivables circularization (3rd party confirmation of receivables)
Types of receivable confirmation letters
1. Positive confirmation: Receivable asked to agree or disagree with the stated balance or write the
balance owing.
2. Negative confirmation: Receivable asked to reply only if he disagrees with the balance. This type of
confirmation should only be used when:
 The audit client has a strong internal control system over sales and trade
receivables.
 Other good corroborative evidence with regard to the existence of trade
receivables has already been obtained from other tests carried out.
 There are a large number of small balances.
 A substantial number of errors is not expected.
Method of sending confirmation letter
1. Obtain the receivables ledger and reconcile it to the control account
2. Select a sample of debtors to be circularized
3. Inform the client of the intended list.
4. Get the details of the debtors and prepare letters on client’s letterhead.
5. Get the letter signed by a senior person at the client.
6. Record names and amount circularized
7. Post/fax letters ensuring the replies are sent directly to the auditor.
8. Record replies received and test the ones not agreed.
9. For non-replies:
- with the client’s permission, the team should arrange to send a follow up
circularisation.
If the receivable does not respond to the follow up, then with the client’s
permission, the senior should telephone the customer and ask whether they are
able to respond in writing to the circularisation request.
- – If there are still non-responses, then the auditor should undertake alternative
procedures to confirm receivables. These procedures include verifying post year end
receipts from that customer, verifying order placement and dispatch documentation
and carrying out bad debt procedures
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10. – For responses with differences:
i. the auditor should identify any disputed amounts, and identify whether these relate to
timing differences or whether there are possible errors in the records of the client.
ii. Any differences due to timing, such as cash in transit, should be matched with cash
received after the year end
iii. The receivables ledger should be reviewed to identify any possible mispostings as this
could be a reason for a response with a difference.
iv. If any balances have been flagged as disputed by the receivable, then these should be
discussed with management to identify whether a write down is necessary
Substantive testing
Existence
1. Circularization of a sample of period end receivables (discussed above)
The receivable actually
exists
2. Verify audit trail from records to source document: Select a sample of yearend receivable balances and agree back to valid supporting documentation
of GDN and sales order to ensure existence
Accuracy, valuation,
allocation
1. Circularization of a sample of period end receivables (discussed above)
2. Invoice: inspect and recalculate
Receivables are included
in the financial
statements at the
correct amount
3. Recoverability procedures ( bad debts):
Select a significant sample of receivables and review whether there
are any after date cash receipts(ensure that a sample of slow
moving/old receivable balances is also selected)
Review the aged receivable ledger to identify any slow moving or old
receivable balances, discuss the status of these balances with the
credit controller to assess whether they are likely to pay
Calculate average receivable days and compare this to prior year,
investigate any significant differences
Review customer correspondence to identify any balances which are
in dispute or unlikely to be paid.
 Review board minutes to identify whether there are any significant
concerns in relation to payments by customers.
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4. Allowance for doubtful debts:
recalculate to ensure it is accurate
ensure rationale/basis reasonable and in line with your
understanding of the client’s business
written representation from management that the
basis/assumptions are reasonable and that the allowance is
adequate.
-Inspect post year-end sales returns/credit notes and consider
whether an additional allowance against receivables is required.
Rights & obligation
1. Circularization of a sample of period end receivables (discussed above)
The receivable belongs
to the client
Completeness
2. Invoice: inspect to confirm right over the receivable
There has been no
omission in recording of
receivables
1. Verify audit trail from source document to record:
 Select a sample of GDNs and agree to valid supporting
documentation of invoice.
 Ensure these invoices have been entered in the day books and
individual ledgers.
 Ensure the individual ledger is reconciled with the control
account)
2. Compare ratios/balances of this period to prior periods and budgets,
investigate any significant differences.
3. Ensure all disclosures relevant to receivables have been made.
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Substantive testing- Sales Revenue
1. Arithmetical accuracy of invoices checked
2. Recalculate discounts to ensure accuracy
3. Compare the overall level of revenue against prior years and budget and investigate any significant
fluctuations.
4.
For a sample of invoices match rates to standard price list to confirm accuracy
5. Select a sample of credit notes raised, trace through to the original invoice and ensure invoice correctly
removed from sales.
6. Completeness as above: Select a sample of trade customer orders placed and agree these to the
despatch notes and sales invoices through to inclusion in the sales ledger to ensure completeness of
revenue.
7. Cut-off: Note down the last GDN for the year. Take a sample of GDNs immediately before AND after the
year end and ensure they are recorded in the correct accounting period
Attempt questions to check your understanding:
June 2015-Q6a and Q6biii
Dec 2014-Q5b
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Substantive testing: Inventory- Key risk: overstatement
Inventory count
Before Inventory Count
1. Review the prior year audit files to identify whether there were any particular warehouses/areas where
significant inventory issues arose last year
2. Discuss with management whether any of the warehouses this year are new, or have experienced
significant control issues.
3. Consider locations. Ensure all locations are covered OR decide locations the audit team members will
attend, basing this on materiality and risk of each site.
4. Obtain a copy of the proposed inventory count instructions, review them to identify any control
deficiencies and if any are noted, discuss them with management prior to the counts.
5. Arrange to verify any inventory held by 3rd party
6. Establish whether expert help is needed
7. If an internal audit department exists, discuss the procedures that they carried out and review their
working papers.
The following matters should be covered in the instructions for the physical inventory count:
1. There should be adequate supervisory controls, with one individual assuming overall responsibility for
the inventory count.
2. Employees involved in the inventory count should be independent of those working in the stores and
production areas
3. Counters should work in pairs with one counting inventory and the other recording and checking
quantities counted.
4. Procedures should ensure that items are marked or tagged as ‘counted’ to avoid the possibility of
double counting or omission.
5. There should be adequate control over the issue and returning of inventory control sheets, possibly
involving the use of pre-numbered sheets with returned sheets being agreed to issued sequences for
completeness.
6. Inventory sheets should be completed in ink and signed by the relevant individuals involved in the
counting and recording process.
7. Movement of inventory during the count should be prohibited where possible and a special quarantine
area should be created in which to store any goods received.
8. In order to minimise disruption to the production process, raw materials together with parts and
finished goods inventories should be counted first with work-in-progress inventory being counted at the
end of the working day.
9. There should be stringent controls over cut-off issues with careful note being made of the number of the
last goods received, goods returned and goods despatched and raw materials/parts issued notes prior to
the inventory count.
10. There should be adequate procedures to identify, count and record inventory that is slow moving or
obsolete.
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During Inventory Count
The purpose of an auditor’s attendance at a client’s year-end inventory count is to assess the effectiveness of the
client’s inventory counting procedures in order to determine whether reliance can be placed upon them to
provide assurance about the existence and condition of inventory.
Auditor’s procedures during the count
1. Observe the counting teams to confirm whether the inventory count instructions mentioned above are
being followed correctly.
2. Perform a test of controls (i.e. test the system used for recording, issuing inventory etc.)
3. Confirm the procedures for identifying and segregating damaged goods are operating correctly, and
assess inventory for evidence of any damaged or slow moving items.
4. Test the counts that are being done by the client’s representative- Perform two-way testing: Match
physical stock with stock records(completeness) and records with physical stock(existence
5. Check cut-off arrangements- Identify and make a note of the last goods received notes and goods
despatched notes for the year end in order to perform cut-off procedures.
6. Note any inventory that is set aside or specially marked, providing possible indicators that inventory is
not owned by the company
7. Enquire as to the possibility of consignment or third party inventories being held by the company and
record appropriate notes for subsequent follow up
8. Obtain a photocopy of the completed sequentially numbered inventory sheets for follow up testing on
the final audit.
After Inventory Count
1. Discuss any weaknesses discovered during count with the management
2. Match final inventory sheets with the photocopies that you did at the time of inventory count- Check to
ensure that all sheets and records used at the inventory count are included in the final inventory count
sheets and records.
3. Ensure that slow-moving and obsolete inventory lines recorded at the inventory count are properly
highlighted in the sheets and records to be used in the valuation process.
4. Follow-up on any other matters recorded in working papers at time of count
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Substantive procedures
Completeness
Existence
Rights and obligation
During the inventory count, take a sample of physical inventory and ensure it is
completed recorded in the records/inventory ledger
During the inventory count, select a sample of inventory from the ledger and verify its
physical existence.
1. Inspect invoices/supporting documents to confirm right
2. IF there is any inventory at the 3rd party, confirmed it is owned by the client
by circularizing the 3rd party.
3. IF there is consignment stock, the agreement will need to be inspected to
confirm when risks and rewards(control) are transferred.
Accuracy, Valuation.
Allocation
1. Select a representative sample of goods in inventory at the year end, agree
the cost per the records to a recent purchase invoice and ensure that the cost
is correctly stated.
2. For a sample of manufactured items obtain cost sheets and confirm:



raw material costs to recent purchase invoices
labour costs to time sheets or wage records
overheads allocated are of a production nature.
3. Net Realisable Value:
a) For a sample of inventory, review post year end sales to see if
adjustments are required
b) For unsold items, discuss with mngt to determine whether they are
slow moving and provision has been created
c) Review aged inventory reports and identify any slow moving goods,
discuss with management why these items have not been written
down
d)
Perform a review of the average inventory days for the current year
and compare to prior year inventory days .Discuss any significant
variations with management.
e)
Compare the gross margin for current year with prior year.
Fluctuations in gross margin could be due to inventory valuation
issues. Discuss significant variations in the margin with management.
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f)
Follow up any damaged/obsolete items noted by the auditor at the
inventory counts attended, to ensure that the inventory records have
been updated correctly
g)
Determine estimated costs to completion. These costs represent
another important element of net realisable value. Determine costs to
be incurred in marketing, selling and distributing directly related to
the items in question.
h) Get a written representation from the management that inventory
has been correctly valued.
4. WIP
a) Cast the schedule of total WIP and agree to the trial balance and financial
statements.
b) Obtain the costing records for a sample of WIP and:



Agree labour costs to payroll;
Agree labour hours to time sheets;
Recalculate the overhead absorption rate
5. Procedures to confirm use of standard costs for inventory valuation
a) Discuss with management the basis of the standard costs applied to the
inventory valuation, and how often these are reviewed and updated.
b) Review the level of variances between standard and actual costs and discuss
with management how these are treated.
c) Obtain a breakdown of the standard costs and agree a sample of these costs
to actual invoices or wage records to assess their reasonableness.
Cut-off
Note down the last GDN and GRN for the year. Take a sample of GDNs and GRNs
immediately before AND after the year end and ensure they are recorded in the
correct accounting period
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Inventory Held by Third Parties
Where the entity has inventory that is held by third parties and which is material to the financial statements, the
auditor shall obtain sufficient appropriate audit evidence by performing one or both of the following:

Direct confirmation from the third party regarding quantities and condition (in accordance with ISA 505
External confirmations)

Inspection or other appropriate audit procedures (if third party's integrity and objectivity are doubtful, for
example)
The other appropriate audit procedures referred to above could include the following:
Procedures to confirm inventory held at third party locations
1. Send a letter requesting direct confirmation of inventory balances held at year end from the third party
regarding quantities and condition.
2. Attend the inventory count (if one is to be performed) at the third party warehouses to review the
controls in operation to ensure the completeness and existence of inventory.
3. Inspecting documentation in respect of third party inventory (eg warehouse receipts)
4. Requesting confirmation from other parties when inventory has been pledged as collateral
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Audit procedures for continuous (perpetual) inventory counts
In order that the company’s auditors may rely on the company’s revised continuous inventory checking system,
the auditor should ensure that:
I.
II.
III.
IV.
V.
VI.
Inventory records are kept up to date.
All inventory lines are counted at least once a year with higher value and desirable lines being counted
more frequently.
The counting of inventory is carried out by suitably experienced independent individuals in a systematic
and orderly manner.
All corrections to inventory records are authorised by a responsible official of the company.
Any material discrepancies noted between inventory records and physical quantities are investigated
immediately and reported to management for immediate further follow up as appropriate.
There are satisfactory procedures with regard to cut-off and receipt/issue documentation at the time of
inventory counts.
Procedures
1. The audit team should attend at least one of the continuous (perpetual) inventory counts to review
whether the controls over the inventory count are adequate.
2. The audit team should confirm that all of the inventory lines have been counted or are due to be
3. counted at least once a year by reviewing the schedules of counts undertaken/due to be undertaken.
4. Review the adjustments made to the inventory records on a monthly basis to gain an understanding of
the level of differences arising on a month by month basis.
5. If significant differences consistently arise, this could indicate that the inventory records are not
adequately maintained. Discuss with management how they will ensure that year-end inventory will not
be under or overstated.
6. Consider attending the inventory count at the year end to undertake test counts of inventory from
records to floor and from floor to records in order to confirm the existence and completeness of
inventory.
Attempt questions to check your understanding:
March/June Hybrid 2016-Q5
Sept/Dec Hybrid 2015-Q6a, bi
Dec 2014-Q6bii
June 2014-Q3b
Dec 2012-Q1a,b
June 2012-Q4a
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Substantive testing: Property, Plant & Equipment Key risk: overstatement
Completeness
1. Take a sample of physical assets and ensure they are completely recorded in the
NCA Register
2. Re-perform the NCA Register reconciliation to the General Ledger
3. Obtain a breakdown of additions, cast the list and agree included in the noncurrent assets register to confirm completeness of PPE.
4. Review the repairs and maintenance ledger to ensure capital expenditure has
not been accidently expensed off
Existence
1. Select a sample of assets from the NCA Register and inspect them to verify their
physical existence
2. Ensure disposed-off assets have been removed from the NCA Register as they
no longer exist.
Rights & Obligation
1. Inspect the ownership documents (title deeds, registration documents etc) to
ensure they are in client’s names.
2. Review insurance policies to confirm the asset is in client’s name.
Accuracy, valuation,
allocation
Additions during the year
1. Select a sample of additions and agree cost to supplier invoice to confirm
valuation.
2. Ensure all additions were authorized by inspecting the minutes of the board
meetings
3. Review the list of additions and confirm that they relate to capital expenditure
items rather than repairs and maintenance.
Disposals during the year
1. Disposal proceeds matched to supporting documents such as invoices and to
cash book and bank statement
2. Verify that the correct cost and depreciation has been removed from the
records
3. Recalculate profit/loss on disposal agree to the statement of profit or loss
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4. Check authorising documentation to ensure that the disposal was appropriately
authorised
5. Examine the sales documentation relating to the disposal and ensure that the
sale details match those in the authorising documentation.
Revaluation
1. Obtain a schedule of assets revalued this year and cast to confirm completeness
and accuracy of the revaluation adjustment.
2. Ensure all similar assets have been revalued
3. Verify depreciation has been calculated on the revalued amount
4. Agree the valuation to the expert’s report
5. Inspect the valuer’s report to ensure the valuer was skilled and independent
6. Agree the revalued amounts for these assets are included correctly in the noncurrent assets register.
7. Review the financial statements disclosures of the revaluation to ensure they
comply with IAS 16
Depreciation
1. Review the depreciation policy of the company to ensure that it is consistent
and appropriate(this can be done by comparison with last year and with
industry practice)
2. recalculate and re-perform depreciation charge to ensure its accuracy.
3. assess depreciation method is reasonable:
 compare with last year
 compare with industry practice
 review NCA Register with Net Book Value of zero which are
still in use
 review NCA Register for excessive profit/loss on disposal.
Enquire from the management the reason for this.
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4. enquire from the management whether they consider the depreciation method
to be reasonable- obtain a ‘written representation’
5. Review the disclosure of the depreciation charges and policies in the draft
financial statements.
General
Review the disclosure of the additions and disposals in the draft financial statements
and ensure it is in line with IAS 16 Property, Plant and Equipment.
Repairs and Maintenance
1. Obtain a schedule of the expenditure and cast to ensure accuracy.
2. For those items treated as capital and included with property, plant and equipment, agree to purchase
invoices and ascertain whether they are in fact of a capital nature.
3. For capital items, agree to the non-current assets register to ensure that they are correctly included.
4. For capital items, recalculate the depreciation charged to ensure it has been appropriately time
apportioned.
5. For items treated as repairs, agree to invoices to ensure they are not of a capital nature and that they
have been correctly expensed to the statement of profit or loss (income statement).
Attempt questions to check your understanding:
Dec 2014-Q6bi
June 2013-Q4a
June 2012-Q1b,c
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Research and development
1. Obtain and cast a schedule of intangible assets, detailing opening balances, amount capitalised in the
current year, amortisation and closing balances.
2. Agree the opening balances to the prior year financial statements.
3. Agree the closing balances to the general ledger, trial balance and draft financial statements.
4. Recalculate the amortisation charge for a sample of intangible assets and confirm it is line with the
amortisation policy.
5. For those expensed as research, agree the costs incurred to invoices and supporting documentation and
to inclusion in profit or loss.
6. For those capitalised as development, agree costs incurred to invoices and confirm technically feasible
by discussion with development managers or review of feasibility reports.
7. Review market research reports to confirm client has the ability to sell the product once complete and
probable future economic benefits will arise.
8. Review the disclosures for intangible assets in the draft financial statements are in accordance with IAS
38 Intangible Assets.
An acquired brand
1. Review board minutes for evidence of discussion of the purchase of the acquired brand, and for its
approval.
2. Agree the cost to the company’s cash book and bank statement.
3. Obtain the purchase agreement and confirm the rights of client in respect of the brand.
4. Discuss with management the estimated useful life of the brand and obtain an understanding of how
the useful life has been determined.
5. Recalculate the amortisation expense for the year and agree the charge to the financial statements
6. Confirm adequacy of disclosure in the notes to the financial statements.
Attempt questions to check your understanding:
Sept/Dec Hybrid 2015-Q6bii
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Bank and cash
General
procedures
1. Agree the bank balance on the trial balance to
the year end bank balance on the computer system, and
the balance on the financial statements.
2. Review the cash book and bank statements for any unusual items or large transfers
around the year end, as this could be evidence of window dressing.
3. Review the financial statements to ensure that the disclosure of cash and bank
balances are complete and accurate.
Bank confirmation Procedure for obtaining a bank letter
letter
1. The auditor will produce a confirmation letter in accordance with local audit
regulations and practices.
2. The letter will be sent to the client to sign and authorise disclosure and then it will
be forwarded on to the client’s bank. (Alternatively, the client may already have
provided a standard authority for the bank to respond to a bank letter each year.
In this case separate authority would not be required.)
Ideally the letter should be sent before the end of the accounting period to enable the bank
to complete it on a timely basis e.g. at the year-end.
3. The bank will complete the letter and send it back directly to the auditor.
Contents of a bank letter
The following matters should be confirmed in the confirmation from the company’s bank:
1. Titles and account numbers of all bank accounts held in the name, joint name or trade
name of client at the year end
2. Confirmation of balances held in those accounts at the year end
3. Full details of interest charged or received on accounts held during the year if not
specified on bank statements.
4. Details of overdrafts and loans repayable on demand together with details of other
loans and facilities.
5. Details of any assets of client which are held as security by the bank.
6. Details of any other assets held by the bank, for example share certificates, documents
of title or deed boxes.
7. Accounts with nil balance
8. Details of accounts closed in the last 12 months
9. A list of branches of the bank, or other banks, or associated companies where it is
known that a relationship has been established with the client.
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Audit procedures on the bank letter include:
1. Agree the balances for each bank account to the relevant bank reconciliation and
the yearend balance in the financial statements.
2. Agree total interest charges on the letter to the interest expense account in the
general ledger.
3. For any details of loans, ensure repayment terms are correctly disclosed in the
financial statements between current and non-current liabilities.
Period-end Bank
Reconciliation
Statement (BRS)
Obtain a copy of client’s bank reconciliation and perform the procedures below:
1.
2.
3.
4.
Cast the reconciliation to check arithmetical accuracy
Agree the bank balance to the trial balance.
Agree the reconciliation’s balance per the cash book to the year-end cash book.
Agree the balance per the bank statement to an original year-end bank statement
and also to the bank confirmation letter.
5. Trace all of the outstanding lodgments to the pre year-end cash book, post yearend bank statement and also to paying-in-book per year end.
6. Trace all un-presented cheques through to a pre year-end cash book and post yearend statement. For any unusual amounts or significant delays obtain explanations
from management.
7. Examine any old un-presented cheques to assess if they need to be written back
into the purchase ledger as they are no longer valid to be presented.
10. Agree all balances listed on the bank confirmation letter to client’s bank
reconciliations or the trial balance to ensure completeness of bank balances.
11. Examine the bank confirmation letter for details of any security provided by client
as this may require disclosure.
Completeness
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Cash
Generally cash balance is immaterial to the financial statements. However, cash is an area which is prone to
fraud, especially if the internal controls are not efficient. That is why cash verification is an important audit
procedure for internal auditors.
Physical verification of cash
Cash balances include the hard cash, unbanked cheques, credit card slips and IOUs. That is why all cash balances
need to be counted at the same time.
The audit working papers relating to the cash count will include the date of the count, time of the count, name
and signature of staff conducting the count and the name of the client’s staff available at the count.
Audit procedures for cash
The main audit work involved in verifying cash balances is a physical count.
Audit procedures include the following:
 The auditor should count cash at all locations simultaneously and in the presence of a company official.
(Simultaneous counting is necessary, to prevent the client from moving cash that has been counted at one
location to another location ready for the next count.)
 After the count the auditor should obtain a signed receipt for the amount of cash returned to the official,
 The auditor should check the cash balance obtained from the count against the client's cash records and
cash balance in the draft financial statements.
 Where appropriate, the auditor should also investigate the treatment of any money advances to employees
(for example, against wages or salary).
Attempt questions to check your understanding:
March/June Hybrid 2016-Q2
June 2015-Q6bii
June 2013-Q1d
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Substantive testing: Trade Payables- Key risk: understatement
1. Reconcile payables ledger to the general ledger.
Completeness
2. Check reconciliation of supplier account statements to trade payable ledger
balances, prepared by client. Enquire into any abnormalities and carry out further
reconciliations as required.
3. Obtain year-end supplier statements:
 Agree the balance on the statement to the individual account in client’s
payables ledger.
 Where necessary, reconcile the balances taking into account cash and
invoices in transit.
4. Compare trade payables individually and in total to prior, investigate any significant
difference, in particular any decrease for this year.
5. Calculate the trade payable days and compare to prior years, investigate any
significant difference.
6. Current supplier list matched to last year’s supplier list and explanations sought for
suppliers missing this year
7. Select population from purchase invoices received after the year-end. Trace to
evidence of goods receipt and where goods received prior year-end, ensure invoice
amount included in purchase accrual
8. Post year end payments reviewed. If they relate to purchases made before the year
end, ensure they were recorded as a liability at the year end!
9. Verify the Audit trail from source document to records (Take a sample of GRNs prior
to the end of the year and trace to purchase invoice. Ensure a liability has been
recorded)
Accuracy,
Valuation,
Allocation
1. Supplier circularization(rare in practice)
2. Verify supporting documentation ( Purchase order Goods Received Note, Invoice)
3. Supplier statements reconciled to individual supplier accounts ( as above)
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Cut-off
(purchases)
1. Select a sample of GRNs before the year end and after the year end and follow
through to inclusion in the correct period’s payables balance, to ensure correct cutoff.
2. Review after date payments; if they relate to the year under audit, then follow
through to the purchase ledger listing to ensure they are recorded in the correct
period
Existence
1. Supplier circularization(rare in practice)
2. Verify the Audit trail from records to source documents ( individual ledger to
purchase invoice and Goods Received Note)
Substantive procedures for supplier statement reconciliations
1.
Select a representative sample of year-end supplier statements and agree the balance to the purchase
ledger. If the balance agrees, then no further work is required.
2. Where differences occur due to invoices in transit, confirm from goods received notes (GRN) whether
the receipt of goods was pre year end, if so confirm that this receipt is included in year-end accruals.
3. Where differences occur due to cash in transit from client to the supplier, confirm from the cashbook
and bank statements that the cash was sent pre year end.
4. Discuss any further adjusting items with the purchase ledger supervisor to understand the nature of the
reconciling item, and whether it has been correctly accounted for.
Why supplier circularization is rare in practice
Third party evidence is a good source of audit evidence and a large proportion of the documentation available
when auditing trade payables is produced by third parties, for example, suppliers’ invoices, statements and
correspondence.
A trade payables circularisation may however be deemed appropriate where:
 supplier statements are, for whatever reason, unavailable.
 only faxed or photocopied supplier statements are available and there is some doubt as to their
authenticity.
 the auditor or the company, suspect that fraudulent manipulation with regard to supplier payments is
taking place within the company.
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Substantive testing: Accruals
1. Obtain or prepare a listing of accruals as at the end of the reporting period.
2. If the list is prepared by the client company, check the calculations and additions far arithmetical
accuracy. Check the amounts in the listing against the balances in the relevant main ledger expense
accounts and ensure that the amounts are the same.
3. Sample check computations of accruals by comparing to earlier relevant invoices and payment
records.
4. Review the bank statement for post year end payments that may relate to services used before the
year end. Trace these items to the accruals listing.
5. Compare the list of accruals to those for the previous period to obtain assurance as to the
completeness of the accruals.
6. Review the list of accruals for completeness, based on the auditor's knowledge of the business. The
auditor will review expense categories included in the income statement to identify areas of
possible accruals and check to list of accruals for inclusion.
7. Relate items on the list of accruals to other audit areas, such as the bank confirmation letter (which
might provide details of unpaid/accrued bank charges).
8. Test transactions around the accounting period end to determine whether amounts have been
recognised in the correct period.
Attempt questions to check your understanding:
June 2015-Q6bi
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Substantive testing: Payroll
Substantive Analytical procedures
1. Compare the total payroll expense to the prior year and investigate any significant differences.
2.
Review monthly payroll charges, compare this to the prior year and budgets and discuss with
management for any significant variances.
3.
Perform a proof in total of total wages and salaries, incorporating joiners and leavers and the annual
pay increase. Compare this to the actual wages and salaries in the financial statements and investigate
any significant differences.
Other procedures
1. Cast a sample of payroll records to confirm completeness and accuracy of the payroll expense.
2.
For a sample of employees, recalculate the gross and net pay and agree to the payroll records to
confirm accuracy.
3. Re-perform the calculation of statutory deductions to confirm whether correct deductions for this year
have been made in the payroll.
4. Select a sample of joiners and leavers, agree their start/leaving date to supporting documentation,
recalculate that their first/last pay packet was accurately calculated and recorded.
5. Agree the total net pay per the payroll records to the bank transfer listing of payments and to the
cashbook.
6. Agree the individual wages and salaries per the payroll to the personnel records for a sample to confirm
bona fide employees.
7.
Select a sample of weekly overtime sheets and trace to overtime payment in payroll records to confirm
completeness of overtime paid.
Substantive testing: Accrual for income tax payable on employment income
1. Agree the year-end income tax payable accrual to the payroll records to confirm accuracy.
2. Re-perform the calculation of the accrual to confirm accuracy.
3. Agree the subsequent payment to the post year-end cash book and bank statements to confirm
completeness.
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Substantive testing: Corporation tax
1. Agree the year end tax liability back to the year end tax computation.
2. Agree the year end tax liability to the post year end payment to the tax authorities.
3. Agree the corporation tax liability to the amount owed as per correspondence from the tax authorities.
Attempt questions to check your understanding:
Sept/Dec Hybrid 2015-Q5c
Dec 2014-Q1
June 2014-Q1c,d
Substantive testing: Long term loans
1. Agree loan balances back to the loan statement from the bank.
2. Inspect the bank confirmation letter for details of loans and overdrafts and trace these amounts to the
balance sheet to ensure they have been recorded.
3. Review Board minutes for evidence of new loans being taken out in the year and ensure they have been
recorded.
4. Inspect the bank statements for the year for evidence of a significant deposit, which may be proceeds of
a loan.
5. Recalculate expected interest charges during the year and compare to the client’s figure.
6. Verify the amount of the loan outstanding at the balance sheet date and ensure that this is accurately
stated and fully disclosed in the company’s balance sheet. The amount of the loan outstanding should
be disclosed as repayable within 12 months and repayable after 12 months from the balance sheet date.
7. Examine the loan agreement to verify the amount of the loan, the rate of interest chargeable, the
security provided and the repayment terms.
8.
Check the note to the company’s financial statements to ensure that full disclosure is made with regard
to any security for the loan.
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Substantive testing: Accounting estimates
Accounting estimates are approximations. Approximations are often made in conditions of uncertainty
regarding the outcome of events.
When transactions involve precise amounts and are supported by specific documents, verification is relatively
easier. However, this comfort is not available in the case of accounting estimates. There is greater risk of
material misstatement. Therefore greater care is needed when auditing them.
The auditor should adopt one or a combination of the following approaches in the audit of an estimate:
– review and test the process used by management to develop the estimate
– use an independent estimate for comparison with that prepared by management
– review subsequent events which confirm the estimate made.
F8 focus: Provision for fines/penalties, provision for legal claims, provision for restructuring(detailed formal plan,
valid expectation raised in those affected, implementation of plan started/public announcement, DO NOT
include retraining/relocation,marketing expenses etc), provision for warranties, provision for redundancies, Fair
Value
General procedures
1. Recalculate to ensure accuracy
2. Review process used by the management and controls over how the estimate was made.
3. Enquire of management how the accounting estimate is made and the data on which it is based-the
data used should be accurate, complete and assumptions reasonable.
4. Review the method of measurement used and assess the reasonableness of assumptions made. Review
the judgments and decisions made by management in the making of accounting estimates to identify
whether there are indicators of possible management bias.
5. Test the operating effectiveness of the controls over how management made the accounting estimate.
6. Develop an expectation of the possible estimate or a range of amounts to evaluate management’s
estimate.
7. – Obtain written representations from management and, where appropriate, those charged with
governance whether they believe significant assumptions used in making accounting estimates are
reasonable.
8. Review expert’s report if applicable
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9. Determine whether events occurring up to the date of the auditor’s report (after the reporting period)
provide audit evidence regarding the accounting estimate.
10. To confirm the probability and amount of a provision(or the need of a contingent liability disclosure):
- Inspect pinutes of board meetings
- Inspect client’s Correspondence with any 3rd party
- Inspect Other documents (copy of claims, copy of laws etc)
- Enquire from a relevant 3rd party
11. Ensure disclosures relating to accounting estimates are adequate and complete
12. If applicable, compare with last year to evaluate reasonableness of the estimate.
13. If applicable, compare last year’s provision with actual result to evaluate reasonableness of the
estimate.
14. Fair Value: Expert’s report
Examples extracted from past exams- read through them rather than rote learning them!
Scenario: Law suit filed by a former (ex) employee for unfair dismissal- decision pending
Substantive procedures to confirm completeness of provisions or contingent liability:
o
o
o
o
o
Discuss with management the nature of the dispute between the client and the former
employee to ensure that a full understanding of the issue is obtained and to assess
whether an obligation exists.
Review any correspondence with the former employee to assess if a reliable estimate of
any potential payments can be made.
Write to the company’s lawyers to obtain their views as to the probability of the exemployeer’s claim being successful.
Review board minutes and any company correspondence to assess whether there is any
evidence to support the former employee’s claims of unfair dismissal.
Obtain a written representation from the directors of client confirming their view of
chances of a successful claim.
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Scenario: sales ledger department is being made redundant and a redundancy provision has been
included in the financial statements.
Substantive procedures to verify redundancy provision
o
Discuss with the directors as to whether they have formally announced their intention to
make the sales ledger department redundant, to confirm that a present obligation exists
at the year end.
If announced before the year end, review supporting documentation to verify that the
decision has been formally announced.
Review the board minutes to ascertain whether it is probable that the redundancy
payments will be paid.
Obtain a breakdown of the redundancy calculations by employee and cast it to ensure
completeness.
Recalculate the redundancy provision to confirm completeness and agree components of
the calculation to supporting documentation.
Review the post year-end period to identify whether any redundancy payments have
been made, compare actual payments to the amounts provided to assess whether the
provision is reasonable.
Obtain a written representation from management to confirm the completeness of the
provision.
Review the disclosure of the redundancy provision to ensure compliance with IAS 37
Provisions, Contingent Liabilities and Contingent Assets.
o
o
o
o
o
o
o
Scenario: Customers of a hotel have filed a law suit claiming they got food poisoning- directors do not
feel a provision is needed
1. Review the correspondence from the customers claiming food poisoning to assess whether
client has a present obligation as a result of a past event.
2. Send an enquiry letter to the lawyers of client to obtain their view as to the probability of the
claim being successful.
3. Review board minutes to understand whether the directors believe that the claim will be
successful or not.
4. Review the post year-end period to assess whether any payments have been made to any of
the claimants.
5. Discuss with management as to whether they propose to include a contingent liability
disclosure or not, consider the reasonableness of this.
6. Obtain a written management representation confirming management’s view that the lawsuit is
unlikely to be successful and hence no provision is required.
7. Review the adequacy of any disclosures made in the financial statements.
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Scenario: Reorganisation provision has been made
1. Review the board minutes where the decision to reorganise the business was taken, ascertain if
this decision was made pre year end.
2. Review the announcement to shareholders to confirm that this was announced before the year
end.
3. Obtain a breakdown of the reorganisation provision and confirm that only direct expenditure
from restructuring is included.
4. Review the expenditure to confirm that there are no retraining costs included.
5. Cast the breakdown of the reorganisation provision to ensure correctly calculated.
6. For the costs included within the provision, agree to supporting documentation to confirm
validity of items included.
7. Obtain a written representation confirming management discussions in relation to the
announcement of the reorganisation.
8. Review the adequacy of the disclosures of the reorganisation in the financial statements to
ensure they are in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent
Assets.
Substantive testing: Capital and Other Issues
Substantive procedures: share capital issued
1. Review board minutes to confirm the issue of additional share capital during the year.
2.
Agree the issue of shares is permitted from a review of any statutory constitution agreements in place
(Where local law requires that companies should have an authorised share capital, the auditor should
check that the total authorised capital in the draft financial statements is consistent with the company's
constitution)
3.
Inspect the cash book and bank statements for evidence of cash receipts from the share issue.
4. Recalculate the split of proceeds between the nominal value of shares and premium on issue and agree
correctly recorded within share capital and share premium account.
5. Review the disclosure of the share issue in the draft financial statements and ensure it is in line with
relevant accounting standards and local legislation.
6. Check that the amount reported as issued share capital agrees with the amount recorded in the register
of members/shareholders, if the company has such a register. (In some countries there is a legal
requirement to maintain a register of members.)
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Substantive procedures: reserves
The auditor-will usually carry out tire following substantive procedures on reserves:
 Obtain an analysis of movements on all reserves during the period.
 Check the accuracy of these movements by checking supporting documentation.
 Ensure that any specific legal requirements relating to reserves have been complied with. (For example,
check that the entity has not breached legal restrictions on use of the share premium account.)
 Confirm that dividends have been deducted only from those reserves that are legally distributable (usually
the accumulated profits reserve/retained earnings).
 Check the authorisation for the amount of dividends paid by reviewing board minutes.
 Check the dividend calculations and check that the total dividends paid are consistent with the amount of
issued share capital at the relevant date.
Directors’ Emoluments
Emoluments include compensation paid for the services provided by the directors to the company and reward
for entrepreneurial contribution.
The various components of emoluments include:
 Basic salary
 Bonuses
 Share options
 Pension contributions
 Other benefits (e.g. provision of a company car, rented accommodation, health insurance etc.)
Main procedures for directors’ bonus and remuneration
1. Obtain a schedule of the directors’ remuneration including any bonus paid and cast the addition of the
schedule.
2. Agree the individual bonus payments to the payroll records.
3. Confirm the amount of each bonus paid by agreeing to the cash book and bank statements.
4.
Review the board minutes to confirm whether any additional bonus payments relating to this year have
been agreed.
5. Obtain a written representation from management confirming the completeness of directors’
remuneration including the bonus.
6.
Review any disclosures made of the bonus and assess whether these are in compliance with local
legislation
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Other procedures:
 Verify the accuracy of the emoluments recorded by recalculating the amount of emoluments applicable to
the directors with the recommendations of the remuneration committee.
 For all performance related bonus, verify the correctness of the bonus by comparing the bonus with the
achievement of the performance related targets i.e. ensure that performance related bonus is supported
with appropriate achievement of targets.
 Loyalty bonuses are given when a person completes a certain number of years in a company. Verify the
accuracy of the payments made along with adherence to the conditions of the loyalty bonus.
 Verify the directors’ rent accounts for the directors’ accommodation and trace entries therein with the
approvals of the remuneration committee and also confirm the correctness of the values with the rent
agreement.
 Verify the directors’ health insurance accounts paid for the directors and trace entries therein with the
approvals of the remuneration committee and also confirm the correctness of the values with the insurance
policies.
Attempt questions to check your understanding:
March/June Hybrid 2016-Q4
June 2014-Q3c
Dec 2013-Q1d
Dec 2012-Q4b
June 2012-Q4b
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Relying on work of others
In certain cases, auditors may rely on the work of third parties when gathering their audit evidence.
• Experts such as: lawyers; valuation experts;
• The client’s internal auditors (who have reviewed the internal controls).
• Service organization ( who work has been outsourced to by client)
• Another firm of external auditors (who may for example be auditing an overseas subsidiary of our client).
Why?
-
Avoid duplication of work
Improve efficiency and effectiveness
Improve trust of shareholders
Reduce cost
Reliance on the work of a management expert
ISA 500 Audit Evidence requires auditors to evaluate the competence, capabilities including expertise and
objectivity of a management expert.
1. Are they suitably qualified? (member of a professional body or industry association)
2. Do they have the experience?
3. Are they independent of the client?
4. The auditor should meet with the expert and discuss with them their relevant expertise in order to
understand their field of expertise.
5.
Evaluating the Adequacy of the Auditor’s Expert’s Work(the audit procedures carried out to evaluate
the work done by the expert!)
a) the relevance and reasonableness of that expert’s findings or conclusions, and their consistency
with other audit evidence
b) If that expert’s work involves use of significant assumptions and methods, the relevance and
reasonableness of those assumptions and methods in the circumstances
c) Adequacy and appropriateness of source data
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Audit considerations relating to entities using service organisations
When any work is outsourced to the service organisation, the auditor should consider its impact on the internal
control of the entity.
If the auditor concludes that outsourcing to service organisation significantly affects the accounting and / or
internal control system of the entity, they should obtain sufficient understanding of the entity and its
environment, including the internal control.
This will help him in assessing the risk of material misstatement and designing and performing further audit
procedures
Factors auditors should consider in relation to client’s use of the service organisation include:
1. The audit team should gain an understanding of the services being provided by the service organisation ,
including the materiality of that area and the basis of the outsourcing contract.
2. They will need to assess the design and implementation of internal controls at the service organisation
3. The team may wish to visit the service organisation and undertake tests of controls to confirm the
operating effectiveness of the controls.
4. If this is not possible, auditors should contact the service organisation’s auditors to request either a type
1 (report on description and design of controls) or type 2 report (on description, design and operating
effectiveness of controls).
5. The auditor is responsible for obtaining sufficient and appropriate evidence, therefore no reference may
be made in the audit report regarding the use of information from the service organisation’s auditors
Attempt questions to check your understanding:
March/June Hybrid 2016-Q6c
Dec 2014-Q6a
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Review
Subsequent events
Adjusting event: An event after the reporting period that provides further evidence of conditions that existed at
the end of the reporting period, including an event that indicates that the going concern assumption in relation
to the whole or part of the enterprise is not appropriate.
Non-adjusting event: An event after the reporting period that is indicative of a condition that arose after the end
of the reporting period.
Events after the balance sheet date
ADJUSTING
NON-ADJUSTING
Provide additional evidence
of conditions existing at the
balance sheet date
Concern conditions which did not
exist at the balance sheet date
Adjust the financial
statements to reflect the
event
Impacts going concern
Does not impact going
concern
Adjust the financial
statements to present
on an alternative basis(
break-up basis)
Do not adjust the
financial statements
If important to users
understanding disclose
in a note:
nature of event
estimate of financial
effect
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Auditor’s responsibilities-ISA 560
For the purposes of ISA 560, subsequent events are those events that occur between the reporting date and the
date of approval of the financial statements and the signing of the auditor’s report.
Period between the year-end date and the date the auditor’s report is signed
The auditor shall perform audit procedures designed to obtain sufficient appropriate audit evidence that all
events occurring between the date of the financial statements and the date of the auditor’s report that require
adjustment of, or disclosure in, the financial statements have been identified.
A. Review procedures management has established to ensure that subsequent events are identified.
B. Inspect: Read minutes of board meetings, shareholder meetings and audit committees that have
taken place since the year-end.
C. Obtain and review the latest available interim financial statements and/or management accounts,
budgets and other related management reports.
D. Perform normal post balance sheet work( e.g. checking receipts from trade receivables after the
yearend)
E. Enquire of the entity’s legal counsel concerning litigation and claims.
F. Enquire of management as to whether any subsequent events have occurred which might affect the
financial statements
G. Checking whether any events have occurred that could call into question the validity of the going
concern assumption
The auditor is not, however, expected to perform additional audit procedures on matters to which previously
applied audit procedures have provided satisfactory conclusions.
Period between the date the auditor’s report is signed and the date the financial statements are issued
The auditor has no obligation to perform any audit procedures regarding the financial statements after the date
of the auditor’s report.
However, if a fact becomes known to the auditor that, had it been known to the auditor at the date of the
auditor’s report, may have caused him to amend the auditor’s report, the auditor shall: discuss the matter with
management, determine whether the financial statements need amendment and, if so, inquire how
management intends to address the matter in the financial statements.
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If management amends the financial statements, the auditor shall carry out the necessary audit procedures,
extend the subsequent events testing to the date of the new auditor’s report, and provide a new auditor’s
report on the amended financial statements.
In situations where management refuses to make amendments to the financial statements, the auditor must
take all steps required to avoid reliance by third parties on the auditor’s report. The auditor should also consider
the need to resign from the audit.
Event specific procedures

Confirm event( maybe through enquiry, inspection or
observation) and calculate impact on financial statements(if
any or the need for a disclosure

Discussion with the management ( any adjustments to be
made, disclosure to be given, impact on going concern etc.)

Enquire: from any relevant 3 party to get further evidence
about the event( insurance company,lawyers, customer etc )

Review: minutes of the board meetings in which the event
and its impact was discussed

Review: accounting records and any correspondence with
rd
3 parties involved
rd
Attempt questions to check your understanding:
March/June Hybrid 2016-Q3
Dec 2011-Q5a, bi and bii
Dec 2008-Q5
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Going concern review
Under the ‘going concern assumption’, an entity is ordinarily viewed as continuing in business for the
foreseeable future (being to a date of at least, but not limited to, 12 months from the end of the reporting
period); with neither the intention nor the necessity of liquidation, cessation of trading or the seeking of
protection from creditors pursuant to laws or regulations.
Accordingly assets and liabilities are recorded on the basis that the entity will be able to realise its assets and
discharge its liabilities in the normal course of business.
Management’s responsibility
-
assess ability of the company to continue in the foreseeable future
disclose uncertainties that might affect the going concern status
adjust F/s and disclose if financial statement not prepared on a going concern basis
It is the responsibility of management to make an assessment of whether the going concern presumption is
appropriate, or not, when they are preparing the financial statements.
Auditor’s responsibilities
They carry out appropriate audit procedures to determine whether the management’s assumption of
going concern is appropriate and ensure that the organisation’s management have been realistic in
their use of the going concern assumption
2. Report if not appropriate. In forming the audit opinion, the auditor should consider two issues: have the
financial statements been prepared using the appropriate going concern assumption, and is there
adequate disclosure of any material uncertainty regarding the going concern status.
1.
Indicators of going concern problems
Financial Indicators
– Net liability or net current liability position.
– Fixed term borrowings approaching maturity without realistic prospects of renewal or repayment, or excessive
reliance on short-term borrowings to finance long-term assets.
– Adverse key financial ratios.
– Substantial operating losses.
– Arrears or discontinuance of dividends.
– Inability to pay payables on due dates.
– Difficulty in complying with the terms of loan agreements.
– Change from credit to cash-on-delivery transactions with suppliers.
– Inability to obtain financing for essential new product development or other essential investments.
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Operating Indicators
– Loss of key management without replacement.
– Loss of major market, franchise, licence, or principal supplier.
– Labour difficulties or shortages of important supplies.
Other Indicators
– Non-compliance with capital or other statutory requirements.
– Pending legal proceedings against the entity that may, if successful result in judgements that could not be met.
– Changes in legislation or government policy.
Audit Procedures
DONOT produce a list of generic audit procedures, but instead identify and highlight the factors from the
scenario that may call into question the entity’s ability to continue as a going concern.
1. Evaluate the management’s assessment
o
the process followed by management to make its assessment
o
the assumptions on which the assessment is based
o
management’s plans for future action
o
whether management has taken into consideration all the facts that the
auditor is aware of due to their audit procedures
2. Reading minutes of shareholders’ meetings to identify any current, or potential, cash flow
difficulties
3. Review post year end management accounts
4. Review cash flow forecast (sufficient cash to continue operations for next year?) In this
evaluation the auditor should pay particular attention to the\ reliability of the company’s
systems for generating the cash flow information, and whether the assumptions underlying the
cash flow appear reasonable.
5. Confirming the existence, terms and adequacy of borrowing facilities
6. Review events after the period end to identify those that affect the entity’s ability to continue as
a going concern
7. Review the terms of loan agreements and determining whether they have been breached
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8. Requesting written representations from management and, where appropriate, those charged
with governance, regarding their plans for future action and the feasibility of these plans.
9. View correspondence with major customers, suppliers and banks for evidence of dispute
10. Legal/solicitor letter- inspect correspondence to understand possible consequences of legal
action being brought against the company.
11. Obtaining and reviewing reports of regulatory action
12. Other procedures relevant to question given should also be considered!
Prepare this section AFTER revising Audit Opinion
REPORTING IN LINE WITH ISA 570, GOING CONCERN
Exam questions might ask the candidate to recognise indicators that an entity may not be a going concern, or
require candidates to arrive at an appropriate audit opinion depending on the circumstances presented in the
scenario. It may be the case that candidates are presented with a situation where the auditor has concluded
that there are material uncertainties relating to going concern and the directors have made appropriate
disclosures in relation to going concern and candidates must understand the new auditor reporting
requirements in this respect.
Under ISA 570 (Revised), if the use of the going concern basis of accounting is appropriate but a material
uncertainty exists and management have included adequate disclosures relating to the material uncertainties
the auditor will continue to express an unmodified opinion, but the auditor must include a separate section
under the heading ‘Material Uncertainty Related to Going Concern’ and:


draw attention to the note in the financial statements that discloses the matters giving rise to the
material uncertainty, and
state that these events or conditions indicate that a material uncertainty exists which may cast
significant doubt on the entity’s ability to continue as a going concern and that the auditor’s opinion is not
modified in respect of the matter.
The section headed ‘Material Uncertainty Related to Going Concern’ is included immediately after the Basis for
Opinion paragraph but before the KAM section.
Over and above the new reporting requirements under ISA 570, candidates need to understand how issues
identified regarding going concern interact with the requirements of ISA 701. By their very nature, issues
identified relating to going concern are likely to be considered a key audit matter and hence need to be
communicated in the auditor’s report. Where the auditor has identified conditions which cast doubt over going
concern, but audit evidence confirms that no material uncertainty exists, this ‘close call’ can be disclosed in line
with ISA 701. This is because while the auditor may conclude that no material uncertainty exists, they may
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determine that one, or more, matters relating to this conclusion are key audit matters. Examples include
substantial operating losses, available borrowing facilities and possible debt refinancing, or non-compliance with
loan agreements and related mitigating factors.
In summary if a confirmed material uncertainty exists it must be disclosed in accordance with ISA 570 and where
there is a ‘close call’ over going concern which has been determined by the auditor to be a KAM it will be
disclosed in line with ISA 701. This is illustrated in the following example:
Example – unmodified audit opinion but material uncertainty exists in relation to going concern and the
disclosures are adequate
Report on the Audit of the Financial Statements (extract)
Opinion
In our opinion, the accompanying financial statements present fairly, in all material respects, the financial
position of the Company as at 31 December 2015, and its financial performance and its cash flows for the year
then ended in accordance with International Financial Reporting Standards (IFRSs).
Basis for opinion
We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities
under those standards are further described in theAuditor’s Responsibilities for the Audit of the Financial
Statements section of our report. We are independent of the Company in accordance with the ethical
requirements that are relevant to our audit of the financial statements in Farland, and we have fulfilled our
other ethical responsibilities in accordance with these requirements. We believe that the audit evidence we
have obtained is sufficient and appropriate to provide a basis for our opinion.
Material uncertainty related to going concern
We draw attention to Note 6 in the financial statements, which indicates that the Company incurred a net loss
of $125,000 during the year ended 31 December 2015 and, as of that date, the Company’s current liabilities
exceeded its total assets by $106,000. As stated in Note 6, these events or conditions, along with other matters
as set forth in Note 6, indicate that a material uncertainty exists that may cast significant doubt on the
Company’s ability to continue as a going concern. Our opinion is not modified in respect of this matter.
Key audit matters
Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of
the financial statements of the current period. These matters were addressed in the context of our audit of the
financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion
on these matters. In addition to the matter described in the Material Uncertainty Related to Going
Concern section, we have determined the matters described below to be the key audit matters to be
communicated in our report.
[Include a description of each key audit matter]
Attempt questions to check your understanding:
Sept/Dec Hybrid 2015-Q3
June 2014-Q5a,b,c
June 2012-Q5a,b,c
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Written representations/Management representation letter
Written representations are necessary information that the auditor requires in connection with the audit of the
entity’s financial statements. Accordingly, similar to responses to inquiries, written representations are audit
evidence.
The auditor needs to obtain written representations from management and, where appropriate, those charged
with governance that they believe they have fulfilled their responsibility for the preparation of the financial
statements and for the completeness of the information provided to the auditor.
Written representations are needed to support other audit evidence relevant to the financial statements or
specific assertions in the financial statements, if determined necessary by the auditor or required by other
International Standards on Auditing.
This may be necessary for judgemental areas where the auditor has to rely on management explanations.
Written representations can be used to confirm that management have communicated to the auditor all
deficiencies in internal controls of which management are aware.
Written representations are normally in the form of a letter, written by the company’s management and
addressed to the auditor. The letter is usually requested from management but can also be requested from the
chief operating officer or chief financial officer.
Throughout the fieldwork, the audit team will note any areas where representations may be required
During the final review stage, the auditors will produce a draft representation letter. The directors will review
this and then produce it on their letterhead.
It will be signed by the directors and dated as at the date the audit report is signed, but not after.
The ISAs require auditors to obtain written representations from management on matters material to the
Financial Statements where other sufficient, appropriate, audit evidence cannot reasonably be expected to
exist.
Purpose of written representation
1. Acknowledging responsibility for the financial statements by management(ISA 580 requires that
“the auditor should obtain audit evidence that management acknowledges its responsibility for
fair presentation of the financial statements and for the completeness of the information
provided to the auditor)
2. Acknowledging responsibility for other matters (ICS, related party transactions etc)
3. Used as audit evidence there is no sufficient appropriate evidence in existence on a matter
which is material to the financial statements.
4. Acknowledges representations previously made verbally by management
5. Minimises misunderstandings between management and auditor
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Reliability of written representations
– Representations from management are a source of assurance evidence.
– They cannot be used instead of other (better) evidence which the assurance providers expect to exist.
– HOWEVER, they may be the only available form of evidence in certain circumstances.
– They are relatively unreliable as evidence.
– Corroborative evidence will always be sought, but may not always be available.
– If a representation appears to be contradicted by other evidence:the circumstances should be investigated,
andthe reliability of other representations made by managementshould be reconsidered.
Written representation letter contents
 No irregularities involving management or employees that could have a material effect on the financial
statements
 All books of account and supporting documentation have been made available to the auditors
 Information and disclosures with reference to related parties is complete
 Financial statements are free from material misstatements including omissions
 No non-compliance with any statute or regulatory authority
 No plans that will materially alter the carrying value or classification of assets or liabilities in the financial
statements
 No plans to abandon any product lines that will result in any excess or obsolete inventory
 No events, unless already disclosed, after the end of the reporting period that need disclosure in the
financial statements.
SPECIFIC MATTERS
Included here is anything else that the auditor would like a representation on for example:
 that a certain debt is recoverable;
 all bank accounts have been disclosed;
 any plans to reorganise the business or discontinue product lines have already been disclosed.
Refusal to Provide Requested Written Representations
If management refuses to provide a written representation, then the auditor should again review the possibility
of obtaining sufficient audit evidence from alternative sources in connection with the matter or issue under
review.
If the directors refuse to sign the representation letter, then the auditor has a number of options available to
him:
(i)
The auditor could discuss the matter with the directors and try to resolve their problems with the letter.
(ii)
The auditor could write a representation letter for the directors, then send this to the directors and ask
them to sign it.
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(iii)
If the auditor considers that he has not received all the information and explanations required for his
audit, then the auditor’s report should be qualified.
Before taking these actions, the auditor should explain to the directors the consequences of not signing
the representation letter, to try to avoid a confrontation.
(iv)
An auditor should reconsider the reliability of other representations.
If the representation is not consistent with other audit evidence, the auditor should perform audit procedures
to attempt to resolve the matter. For this, the auditor should reassess the appropriateness of the risk of material
misstatement on account of this inconsistency. If required, the auditor should revise the nature, timing and
extent of further audit procedures.
Overall review of financial statements
Procedures an auditor should perform include:
1.
Reviewing the financial statements to ensure compliance with accounting standards and local
legislation disclosure. This is sometimes done via the use of a disclosure checklist.
2. Reviewing the disclosure of the accounting policies to ensure that they are in accordance with the
accounting treatment adopted in the financial statements, and that they are sufficiently disclosed.
3. Reviewing the financial statements to ensure they are consistent with the auditor’s knowledge of the
business and the results of their audit work.
4. Reviewing the financial statements to assess whether they adequately reflect the information and
explanations previously obtained and conclusions reached during the course of the audit.
5.
Performing analytical procedures of the financial statements, under ISA 520 Analytical Procedures; this
helps the auditor to form an overall conclusion on the financial statements ( explained separately below)
6. Reviewing the aggregate of uncorrected misstatements to assess whether in aggregate a material
misstatement arises; if so discuss with management with regards to a potential adjustment.
7. As part of the overall review, the auditor should assess whether the audit evidence gathered by the
team is sufficient and appropriate to support the audit opinion.
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Final analytical procedures
Before the audit report is signed, it is sensible to do some final analysis of the Financial Statements (e.g. ratio
analysis) – just to make sure that the auditor is confident in the audit opinion.
There are 2 main reasons for this final analysis:
The Financial Statements may have been adjusted during the audit as mistakes were found, so the final figures
may never have been analysed or been subject to ratio analysis.
The auditor will have learned more about the company during the audit, so is in a better position at the end of
the audit to analyse the figures and understand trends in ratios.
The analytical procedures performed at this stage of the audit are not different to those performed at the
planning stage – the auditor will perform ratio analysis, comparisons with prior period financial statements and
other techniques to confirm that trends are as expected, and to highlight unusual transactions and balances that
may indicate a risk of misstatement.
The key issue is that, near the end of the audit, the auditor should have sufficient audit evidence to explain the
issues highlighted by analytical procedures, and should therefore be able to conclude as to the overall
reasonableness of the financial statements.
When the analytical procedures performed near the end of the audit reveal further previously unrecognised risk
of material misstatement, the auditor is required to revise the previously assessed risk of material misstatement
and modify the planned audit procedures accordingly. This means potentially performing further audit
procedures in relation to matters that are identified as high risk.
Attempt questions to check your understanding:
June 2013-Q1a
Dec 2010-Q5a,b
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Misstatements
Misstatements: A difference between the amount, classification, presentation, or disclosure of a reported
financial statement item and the amount, classification, presentation, or disclosure that is required for the item
to be in accordance with the applicable financial reporting framework.
Misstatements can arise from error or fraud.
Uncorrected misstatements: Misstatements that the auditor has accumulated during the audit and that have
not been corrected.
There are three categories of misstatements:
i. Factual misstatements are misstatements about which there is no doubt.
ii.
Judgemental misstatements are differences arising from the judgements of management concerning
accounting estimates that the auditor considers unreasonable, or the selection or application of
accounting policies that the auditor considers inappropriate.
iii. Projected misstatements are the auditor’s best estimate of misstatements in populations, involving the
projection of misstatements identified in audit samples to the entire populations from which the
samples were drawn.
The auditor has a responsibility to accumulate misstatements which arise over the course of the audit.
Identified misstatements should be considered during the course of the audit to assess whether the audit
strategy and plan should be revised.
The auditor will communicate the uncorrected misstatements and their implication on the auditor’s report to
those charged with governance.
The auditor will also request a written representation (including a summary of uncorrected misstatements) from
management and – where appropriate – those charged with governance as to whether they believe the effects
of uncorrected misstatements are immaterial, individually and in aggregate to the financial statements as a
whole.
The auditor may find:
1. Individual material misstatements
2. Individual immaterial misstatements
3. Immaterial misstatements which become material when aggregated
In all 3 cases, they have to be reported to the management.
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Examples of circumstances when misstatement is considered material when it lower than quantitative
(material by nature)
-
Affects compliance with regulatory requirements;
Affects compliance with debt covenants or other contractual requirements;
Affects ratios used to evaluate the entity’s financial position, results of operations or cash flows;
Has the effect of increasing management compensation, for example, by ensuring that the requirements
for the award of bonuses or other incentives are satisfied;
Audit Opinion
To understand different types of opinions, the following terms need to be understood.
Misstatement: Discussed above
Inability to obtain appropriate and sufficient evidence: The auditor was not able to get sufficient
appropriate audit evidence on which to base the opinion. The auditor’s inability to obtain sufficient
appropriate audit evidence is also referred to as a limitation on the scope of the audit and could arise from:
o
o
o
Circumstances beyond the entity’s control (e.g. accounting records destroyed)
Circumstances relating to the nature or timing of the auditor’s work (e.g. the timing of the
auditor’s appointment prevents the observation of the physical inventory count).
Limitations imposed by management (e.g. management prevents the auditor from
requesting external confirmation of specific account balances).
Pervasive: This is a term used to describe the effects or possible effects on the financial statements of
misstatements or undetected misstatements (i.e. due to an inability to obtain sufficient appropriate audit
evidence). There are three types of pervasive effect:
o
o
o
Those that are not confined to specific elements, accounts or items in the financial
statements.
Those that are confined to specific elements, accounts or items in the financial statements
and represent or could represent a substantial portion of the financial statements.
Those that relate to disclosures which are fundamental to users understanding of the
financial statements.
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Unmodified Opinion
Auditor concludes that the financial statements are prepared, in all material
respects, in accordance with the applicable financial reporting framework.
Wording
In our opinion, the financial statements present fairly, in all material respects,
(or give a true and fair view of) the financial position of ABC Company as of
December 31, 20X1, and (of) its financial performance and its cash flows for
the year then ended in accordance with International Financial Reporting
Standards.
Modified Opinion
a)Qualified
a) Qualified
b) Adverse
c) Disclaimer
Nature of matter: Material
Reason: material misstatement or inability to obtain appropriate and
sufficient evidence (regarding an accounting policy, transaction, balance or
disclosure etc)
Opinion: Qualified ‘Except for’
Wording:
QUALIFIED OPINION
In our opinion, except for the effects of the matter described in the Basis of
Qualified Opinion paragraph the financial statements present fairly, In all
material respects, (or give a true and fair view of) the financial position of ABC
Company as at December 31, 20X1 and (of) its financial performance and its
cash flows for the year then ended in accordance with International Financial
Reporting Standards.
BASIS FOR QUALIFIED OPINION
(Nature, amount , impact to be explained)
The company’s inventories are carried in the balance sheet at XXX.
Management has not stated inventories at the lower of cost and net realizable
value but has stated them solely at cost, which constitutes a departure from
International Financial Reporting Standards. The company’s records indicate
that had management stated the inventories at the lower of cost and net
realizable value, an amount of XXX would have been required to write the
inventories down to their net realizable value. Accordingly, cost of sales would
have been increased by XXX, and income tax, net income and shareholders’
equity would have been reduced by XXX, XXX and XXX, respectively.
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b) Adverse
Nature of matter: Material and pervasive
Reason: Misstatement in the F/S
Opinion: Adverse
Wording:
ADVERSE OPINION
In our opinion, because of the significance of the matter discussed in the Basis
of Adverse Opinion paragraph, the consolidated financial statements do not
present fairly (or do not give a nature and fair view of) the financial position of
ABC Company and its subsidiaries as at December 31, 20X1 and (of) their
financial performance and their cash flows for the year then ended in
accordance with International Financial Reporting Standards.
BASIS FOR ADVERSE OPINION
(Nature, amount , impact to be explained)
c)Disclaimer
Nature of matter: Material and pervasive
Reason: Inability to obtain appropriate and sufficient evidence
Opinion: Disclaimer
Wording:
DISCLAIMER OF OPINION
Because of the significance, of the matters described in the Basis for
Disclaimer of Opinion paragraph, we have not been able to obtain sufficient
appropriate audit evidence to provide a basis for an audit opinion.
Accordingly, we do not express an opinion on the financial statements
BASIS FOR DISCLAIMER OF OPINION
(Nature, amount , impact to be explained)
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Emphasis of Matter paragraph
A paragraph included in the auditor’s report that refers to a matter appropriately presented or disclosed in the
financial statements that, in the auditor’s judgment, is of such importance that it is fundamental to users’
understanding of the financial statements.
Circumstances in Which an Emphasis of Matter Paragraph May Be Necessary
 When a financial reporting framework prescribed by law or regulation would be unacceptable but for
the fact that it is prescribed by law or regulation.
 When facts become known to the auditor after the date of the auditor’s report and the auditor provides
a new or amended auditor’s report (i.e., subsequent events)
 An uncertainty relating to the future outcome of exceptional litigation or regulatory action.
 Early application (where permitted) of a new accounting standard that has a material effect on the
financial statements.
It cannot be given for a matter determined to be a key audit matter to be communicated in the auditor’s report
(the use of Emphasis of Matter paragraphs is not a substitute for a description of individual key audit matters.)
When the auditor includes an Emphasis of Matter paragraph in the auditor’s report, the auditor shall:
(a) Include the paragraph within a separate section of the auditor’s report with an appropriate heading that
includes the term “Emphasis of Matter”;
(b) Include in the paragraph a clear reference to the matter being emphasized and to where relevant disclosures
that fully describe the matter can be found in the financial statements. The paragraph shall refer only to
information presented or disclosed in the financial statements; and
(c) Indicate that the auditor’s opinion is not modified in respect of the matter emphasized.
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Other Matter paragraph
A paragraph included in the auditor’s report that refers to a matter other than those presented or disclosed in
the financial statements that, in the auditor’s judgment, is relevant to users’ understanding of the audit, the
auditor’s responsibilities or the auditor’s report
Examples of circumstances in which an Other Matter Paragraph may be necessary
 Prior Period Financial Statements Audited by a Predecessor Auditor
 Prior Period Financial Statements Not Audited
 Restriction on distribution or use of the auditor’s report
 Modification in auditor report for comparative financial statement.This is when reporting on prior
period financial statements in connection with the current period’s audit, if the auditor’s opinion on
such prior period financial statements differs from the opinion the auditor previously expressed (ISA
710).
It cannot be given for a matter determined to be a key audit matter to be communicated in the auditor’s report
When the auditor includes an Other Matter paragraph in the auditor’s report, the auditor shall include the
paragraph within a separate section with the heading “Other Matter,” or other appropriate heading.
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Matters to be communicated to TCWG
1. The auditor’s responsibilities
in relation to the financial
statements
– A statement that the auditor is responsible for forming and
expressing an opinion on the financial statements.
– That the auditor’s work is carried out in accordance with ISAs and in
accordance with local laws and regulations.
2. Planned scope and timing of
audit
This would include
– The audit approach to assessing the risk of serious misstatement,
whether arising from fraud or error.
– The audit approach to the internal control system and whether
reliance will be placed on it.
– The timing of interim and final audits, including reporting deadlines.
3. Significant findings from the
audit
This heading could include:
– Significant difficulties encountered during the audit, including delays
in obtaining information from management.
– Material weaknesses in internal control and recommendations for
improvement.
– Audit adjustments, whether or not recorded by the entity, that have,
or could have, a material effect on the entity’s financial statements.
For example, the bankruptcy of a material receivable shortly after the
year-end that should result in an adjusting entry.
4. A statement on independence
issues affecting the audit ( for
listed entities only)
This would include:
– That the audit firm has ensured that all members of the audit team
have complied with the ethical standards of ACCA.
– That appropriate safeguards are in place where a potential threat to
independence has been identified.
The lists of examples listed under the above headings are not exhaustive and in practice many more specific
matters would be communicated to those charged with governance such as:
– Modifications to the audit report.
– Any management representation points requested.
– Cases of suspected/actual fraud.)
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Audit report Contents
Column A and B will be in all reports. Column C explains the impact of various issues on the report-this will be in
addition to Column B and C.
Column A
Column B
Column C
Content
Explanation
Impact of various issues
1
Title & Addressee
2
Opinion
“we have audited..”
In modified opinion:
-
Name the client
Year end
Components of F/s +
accounting policies
“in our opinion”…..
3
Basis of Opinion
-
-
-
Conducted audit
according to ISAs
Our responsibilities
described in a separate
paragraph
We are independent in
accordance with IESBA
code of ethics/local codes
SAE gathered to provide a
basis for the opinion
-
Heading changes to the name of the
modified opinion
-
Wording of the opinion changes
Heading changes: Basis for
Qualified/Adverse/Disclaimer Opinion
Nature, amount, impact and reference to
accounting standard given
Material uncertainty relating to going concern”
paragraph (if needed)

draw attention to the note in the
financial statements that discloses the
matters giving rise to the material
uncertainty, and

state that these events or conditions
indicate that a material uncertainty exists
which may cast significant doubt on the
entity’s ability to continue as a going
concern and that the auditor’s opinion is
not modified in respect of the matter.
Disclosure correctly given- ‘we draw your
attention to notes to the account number 6
which relate to….”
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4
-
Key Audit Matters
For example:
-Highest risk areas
-
-Areas with greater
complexity, more
subjectivity
-areas where more
audit effort was
needed for example
consultations taken
-significant
events/transactions
-separate issues
interacted ( a long
term contract which
has an effect on
revenue recognition
as well as litigation
aspects)
-
Provide further
information about the
process that led to the
opinion so related to
matters included in the
F/S
Selected from matters
communicated to TCWG
According to auditor’s
judgment, the MOST
significant matters
relating to the audit
If modified opinion, the reason for the
modification is NOT a Key audit matter.
However, can give reference to the basis of
opinion paragraph.
When the auditor expresses a disclaimer of
opinion then the auditor’s report should
not include a KAM section.
‘Those matters that, in the
auditor’s professional judgment,
were of most significance in the
audit of the financial statements
of the current period. Key audit
matters are selected from matters
communicated with those charged
with governance.’ (1)
KAM are selected from matters
which are communicated with
those charged with governance.
Matters which are discussed with
those charged with governance
are then evaluated by the auditor
who then determines those
matters which required significant
auditor attention during the
course of the audit. There are
three matters which the ISA
requires the auditor to take into
account when making this
determination:
1.
Areas which were
considered to be susceptible
to higher risks of material
misstatement or which were
deemed to be ‘significant
risks’ in accordance with ISA
315 (Revised), Identifying and
Assessing the Risks of
Material Misstatement
through Understanding the
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Entity and Its Environment.
2.
Significant auditor
judgments in relation to
areas of the financial
statements that involved
significant management
judgment. This might include
accounting estimates which
have been identified by the
auditor as having a high
degree of estimation
uncertainty.
3.
The effect on the audit of
significant events or
transactions that have taken
place during the period.
COMMUNICATING KAM
Once the auditor has determined
which matters will be included as
KAM, the auditor must ensure
that each matter is appropriately
described in the auditor’s report
including a description of:
1.
Why the matter was
determined to be one of
most significance and
therefore a key audit matter,
and
2.
How the matter was
addressed in the audit (which
may include a description of
the auditor’s approach, a
brief overview of procedures
performed with an indication
of their outcome and any
other key observations in
respect of the matter).
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EOMP ( can be placed here or before Key Audit
Matters- auditor has to use his judgment)
-
-
Cannot be used for drawing attention to
a going concern uncertainty disclosure
as a separate paragraph is now required
for this
Should be headed as EOMP
Reference of the disclosure needs to be
given ( Note # 7…)
OMP
- placed here ( always AFTER Key audit matters)
- cannot be used for other information issues as
there is now a separate paragraph for this.
-none of the Key Audit Matters can be
mentioned here.
5
Other information
-
-
-
6
Responsibilities of
management and
TCWG
-
-
Management responsible
for other information in
the document containing
financial statements
Our opinion does not
cover OI, no assurance
give on it
Our responsibility to read
OI and find inconsistencies
with F/sIf OI changes not made,
they will be reported here.
Preparation of F/S
Internal control over
financial reporting
Assess ability of the
company to continue as a
going concern
TCWG’s responsibility to
oversee the financial
reporting process
Any uncorrected inconsistencies in Other
Information will be explained here.
-
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7
Auditor’s
responsibility for
audit of F/S
-
-
-
-
-
-
-
Reasonable assurance that
F/S free from material
misstatements- not a
guarantee that all
misstatements will be
detected
Issue audit report
Define material
misstatement in this para
Mention use of
professional judgment and
professional skepticism
Identify and assess risk of
material misstatement
due to fraud and error (
fraud could include
collusion, forgery,
intentional omissions,
misrepresentation,
override of internal
control)
Obtain understanding of
internal control over
financial reporting to
design audit proceduresno opinion given
Evaluate appropriateness
of accounting policies
Evaluate reasonableness
of accounting estimated
Conclude on
appropriateness of
management’s use of
going concern basis-also
mention that future
events/conditions may
still cause the company to
cease as going concern
Evaluate overall
presentation, structure,
content of F/S including
disclosures
Communicate with TCWG
‘ from matters
communicated with
TCWG, we determine the
-
most significant ones (KAM)
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8
Report on other
legal and regulatory
requirements
9
Engagement
partner’s name
10
Signatures
11
Auditor’s address
12
Date
APPLICATION OF ISA 701 WHEN A QUALIFIED OR ADVERSE OPINION IS ISSUED
ISA 705 (Revised), Modifications to the Opinion in the Independent Auditor’s Report outlines the requirements
when the auditor concludes that the audit opinion should be modified. ISA 705 (Revised) requires that the
auditor includes a Basis for Qualified/Adverse Opinion section in the auditor’s report. When the auditor
expresses a qualified or adverse opinion, the requirement to communicate other KAM is still relevant and hence
will still apply.
When the auditor issues an adverse opinion it means that the financial statements do not give a true and fair
view (or present fairly) because the auditor has concluded that misstatements, individually and in aggregate, are
both material and pervasive to the financial statements.
Depending on the significance of the matter(s) which has resulted in the auditor expressing an adverse audit
opinion, the auditor might determine that no other matters are KAM. In this situation, the auditor will deal with
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the matter(s) in accordance with applicable ISAs and include a reference to the Basis for Qualified/Adverse
Opinion or the Material Uncertainty Related to Going Concern section(s) in the KAM section of the report as
illustrated below.
Example – Qualified ‘except for’ opinion issued but no key audit matters
The audit of Turquoise Industries Co has been completed and the auditor discovered a material amount of
research expenditure which had been capitalised as an intangible asset in contravention of IAS 38 Intangible
Assets. The finance director refused to derecognise the research expenditure as an intangible asset and include
it in profit or loss and the auditor therefore issued a qualified ‘except for’ opinion on the basis of disagreement
with the entity’s accounting treatment for research expenditure.
The auditor has concluded that there are no KAM which require to be communicated in the audit report. The
KAM section of the report will therefore be as follows:
Key audit matters
Except for the matter described in the Basis for Qualified Opinion section, we have determined that there are no
key audit matters to communicate in our report.
When the auditor has expressed an adverse opinion on the financial statements and communicates KAM, it is
important that the descriptions of such KAM do not imply that the financial statements as a whole are more
credible in light of the adverse opinion.
DISCLAIMER OF OPINION ISSUED
A disclaimer of opinion is issued when the auditor is unable to form an opinion on the financial statements. ISA
705 states that when the auditor expresses a disclaimer of opinion then the auditor’s report should not include
a KAM section.
A note of caution: Forming an opinion and Reporting and communicating Key Audit Matters have been recently
revised. The solutions of the past exams may not reflect these revisions at the moment. Students are
requested to be careful when practicing past exams. The notes above used should be used when practicing.
Attempt questions to check your understanding:
Sept/Dec Hybrid 2015-Q6c
June 2015-Q3
Dec 2014-Q4
Dec 2014-Q6c
June 2014-Q5d
June 2013-Q5c
Dec 2012-Q5
June 2012-Q5d
Dec 2011-Q5biii
June 2011-Q5c
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Audit sampling
Audit sampling is the application of audit procedures to less than 100% of items within a population of audit
relevance, such that all sampling units have a chance of selection in order to provide the auditor with a
reasonable basis on which to draw conclusions about the entire population.
Audit sampling can be applied using either a statistical or a non-statistical approach. It involves testing a smaller
number of items and using the results to draw a conclusion about the whole balance or class of transactions.
It is necessary for auditors to sample as it is impossible to select all items for testing as this would take the audit
team too long and it would cost too much.
In addition, auditors do not provide 100% assurance in their audit report about the financial statements, they
only provide reasonable assurance and hence it is not necessary to test every item within a population.
Audit sampling is also widely known to reduce the risk of ‘over-auditing’ in certain areas, and enables a much
more efficient review of the working papers at the review stage of the audit.
In devising their samples, auditors must ensure that the sample selected is representative of the population. If
the sample is not representative of the population, the auditor will be unable to form a conclusion on the entire
population.
SAMPLING RISK
Sampling risk is the risk that the auditor’s conclusions based on a sample may be different from the conclusion if
the entire population were the subject of the same audit procedure.
ISA 530 recognises that sampling risk can lead to two types of erroneous conclusions:
1. The auditor concludes that controls are operating effectively, when in fact they are not. In substantive testing,
the auditor may conclude that a material misstatement does not exist, when in fact it does. These erroneous
conclusions will more than likely lead to an incorrect opinion being formed by the auditor.
2. The auditor concludes that controls are not operating effectively, when in fact they are. In terms of
substantive testing, the auditor may conclude that a material misstatement exists when, in fact, it does not.
NON SAMPLING RISK
Non-sampling risk is the risk that the auditor forms the wrong conclusion, which is unrelated to sampling risk. An
example of such a situation would be where the auditor adopts inappropriate audit procedures, or does not
recognise a control deviation.
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METHODS OF SAMPLING
Random selection: This method of sampling ensures that all items within a population stand an equal chance of
selection by the use of random number tables or random number generators. The sampling units could be
physical items, such as sales invoices or monetary units.
Systematic selection: This is a method of selection in which the auditor selects items using a constant interval
between selections. The first item may be selected on a random or haphazard basis, and thereafter the sampling
interval is derived by the auditor, for example, by dividing the population by the sample size.
Haphazard selection: The auditor selects the sample without following a structured technique – the auditor
would avoid any conscious bias or predictability.
Block selection: This involves selection of a block(s) of contiguous items from within the population. Block
selection cannot ordinarily be used in audit sampling because most populations are structured such that items in
a sequence can be expected to have similar characteristics to each other, but different characteristics from
items elsewhere in the population.
Monetary Unit Sampling: This is a type of value-weighted selection in which sample size, selection and
evaluation results in a conclusion in monetary amounts. This selection method ensures that each individual $1 in
the population has an equal chance of being selected.
STATISTICAL VERSUS NON-STATISTICAL SAMPLING
‘Statistical’ sampling: ‘An approach to sampling that has the following characteristics:
i. Random selection of the sample items, and
ii. The use of probability theory to evaluate sample results, including measurement of sampling risk.’
The ISA goes on to specify that a sampling approach that does not possess the characteristics in (i) and (ii) above
is considered non-statistical sampling.
The advantages of using statistical sampling rather than judgemental sampling (non-statistical sampling) include:
(1) The size of the sample is determined objectively having regard to the degree of risk associated with the area
being tested.
(2) Bias is eliminated.
(3) Results of statistical sampling can be more easily justified as being representative of the population as a
whole, thus increasing the level of confidence in the results of testing the sample. As a consequence of this,
the conclusion drawn from the results of sample testing are more easily justified where an audit client
disputes the audit conclusions.
(4) In instances when there is a large population, the use of statistical sampling techniques may reduce the
sample size, and therefore the amount of audit work required, as compared to the sample size that would
be selected using judgement sampling methodology.
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When might sampling not be appropriate
A sampling approach to testing would not be appropriate in the following circumstances:
(i) Where there is a statutory requirement to disclose specific items in the financial statements, for example
directors’ remuneration.
(ii) Where the population is very small and the results from sampling could not be relied on, for example when
conducting certain compliance tests.
(iii) Where the population is small in number but comprises material individual balances or transactions, for
example property additions.
(iv) Where the population is not homogenous and requires subdivision before sampling can be attempted, for
example purchase invoices and credit notes.
(v) When the auditor is put ‘on enquiry’ for example when testing for fraud.
(vi) Where the costs of sampling outweigh the benefits as compared to 100% testing.
EXTRAPOLATION: Extrapolation takes the result of a sample and projects that result over the whole population.
Imagine total sales are $10m. You select a sample of $1m (10% of the population) to test. If errors of $37k are
found in the sample, it could be inferred by extrapolation that there are errors of $370k in the total population.
Extrapolation can only be applied to statistical sampling.
COMPUTER ASSISTED AUDIT TECHNIQUES (CAATs)
Computer-assisted audit techniques (CAATs) are those featuring the ‘application of auditing procedures using
the computer as an audit tool’
The extent to which an auditor may choose between using CAATs and manual techniques on a specific audit
engagement depends on the following factors:
--the cost effectiveness of using CAATs
--the availability of audit time
--the availability of the audit client’s computer facility
--the level of audit experience and expertise in using a specified CAAT
--the level of CAATs carried out by the audit client’s internal audit function and the extent to which the external
auditor can rely on this work
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Audit test data is used to test the existence and effectiveness of controls built
into an application program used by an audit client.
Test data
As such, dummy transactions are processed through the client’s computerised system.
The results of processing are then compared to the auditor’s expected results to
determine whether controls are operating efficiently and systems’ objectiveness are being
achieved.
For example, two dummy bank payment transactions (one inside and one outside
authorised parameters) may be processed with the expectation that only the transaction
processed within the parameters is ‘accepted’ by the system. Clearly, if dummy
transactions processed do not produce the expected results in output, the auditor will
need to consider the need for increased substantive procedures in the area being
reviewed.
Test data should contain valid data ( to ensure the system processes it correctly) and
invalid data (to ensure system rejects it).
Live test data: data processed on the client’s system during a normal production run
Dead test data: data processed at a time when the normal production run is not taking
place
Integrated test facility: the auditor may seek permission from the client to establish an
integrated test facility within the accounting system. This entails the establishment of a
dummy unit, for example, a dummy supplier account against which the auditor’s test data
is processed during normal processing runs.
The term ‘audit software’ describes the computer software used by auditors to assist
them in their work, when examining the operations of, and testing the output of a
computer-based accounting system.
Audit Software
Computer programs designed to carry out tests of control and/or substantive procedures
This performs checks that auditors would otherwise need to do by hand.
Such programs may be classified as:
Packaged programs (off the shelf)
These consist of pre-prepared generalised programs used by auditors and are not ‘client
specific’. They may be used to carry out numerous audit tasks, for example, to select a
sample, either statistically or judgementally, during arithmetic calculations and checking
for gaps in the processing of sequences.
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Purpose written programs (bespoke)
These programs are usually ‘client specific’ and may be used to carry out tests of control
or substantive procedures. Audit software may be bought or developed, but in any event
the audit firm’s audit plan should ensure that provision is made to ensure that specified
programs are appropriate for a client’s system and the needs of the audit. Typically, they
may be used to re-perform computerised control procedures (for example, cost of sales
calculations) or perhaps to carry out an aged analysis of trade receivable (debtor)
balances.
Enquiry programs
These programs are integral to the client’s accounting system; however they may be
adapted for audit purposes. For example, where a system provides for
the routine reporting on a ‘monthly’ basis of employee starters and leavers,
this facility may be utilised by the auditor when auditing salaries and wages in
the client’s financial statements. Similarly, a facility to report trade payable
(creditor) long outstanding balances could be used by an auditor when
verifying the reported value of creditors
Uses of audit software
Highlighting of exceptions- For example, to identify exceptional wages payments outside
of stated parameters
Highlighting of trends- To highlight reported inventory movement both immediately
before and after reporting dates to identify possible manipulation of inventory figures
Performance of sequence checks- To verify completeness of sales reporting by ensuring
that all invoices have been recorded.
Calculation checks- To ensure that overhead costs are totalled correctly in the general
ledger.
Stratification of data – To subdivide the population of inventory lines with a view to
examining only material balances.
Selection of items for testing – To select trade receivables accounts for circularisation, to
verify the existence of trade receivables.
Detecting violation of system rules – For example, where other people besides the
accountant have been overriding overtime payments or employees amending their own
gross wages.
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The advantages of Computer-Assisted Audit Techniques (CAATs) are that they:
1. Enable the auditor to test program controls – if CAATs were not used then those controls would not be
testable.
2. Enable the auditor to test a greater number of items quickly and accurately. This will also increase the
overall confidence for the audit opinion.
3.
Allow the auditor to test the actual accounting system and records rather than printouts which are only
a copy of those records and could be incorrect.
4. Are cost effective after they have been setup as long as the company does not change its systems.
5. Allow the results from using CAATs to be compared with ‘traditional’ testing – if the two sources of
evidence agree then this will increase overall audit confidence.
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Responsibilities regarding fraud
External auditor-responsibilities regarding fraud
The main focus of audit work is to ensure that the financial statements show a true and fair view. The detection
of fraud is therefore not the main focus of the external auditor’s work.
Learn!
1. In accordance with ISA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements,
external auditors are responsible for obtaining reasonable assurance that the financial statements taken as a
whole are free from material misstatement, whether caused by fraud or error.
2.In order to fulfil this responsibility, they are required to identify and assess the risks of material misstatement
of the financial statements due to fraud.
3.They need to obtain sufficient appropriate audit evidence regarding the assessed risks of material
misstatement due to fraud, through designing and implementing appropriate responses. In addition, auditors
must respond appropriately to fraud or suspected fraud identified during the audit.
4.When obtaining reasonable assurance, auditors are responsible for maintaining professional scepticism
throughout the audit, considering the potential for management override of controls and recognising the fact
that audit procedures which are effective in detecting error may not be effective in detecting fraud.
5.To ensure that the whole engagement team is aware of the risks and responsibilities for fraud and error, ISAs
require that a discussion is held within the team, placing particular emphasis on how and where the entity’s
financial statements may be susceptible to material misstatement due to faud, including how fraud might occur
6.In situations where the external auditor does detect fraud, then the auditor will need to consider the
implications for the entire audit. In other words, the external auditor has a responsibility to extend testing into
other areas because the risk of providing an incorrect audit opinion will have increased.
Groups to report fraud to
1. Report to audit committee: Disclose the situation to the audit committee as they are charged with
maintaining a high standard of governance in the company. The committee should be able to discuss the
situation with the directors and recommend that they take appropriate action
2. Report to members: If the financial statements do not show a true and fair view then the auditor needs
to report this fact to the members through their audit report.
3. Report to professional body: If the auditor is uncertain as to the correct course of action, advice may be
obtained from the auditor’s professional body.
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Internal auditor’s responsibilities regarding fraud




Commenting on the process used by management to identify and classify the specific fraud and error
risks to which the entity is subject (and in some cases helping management develop and implement that
process)
commenting on the appropriateness and effectiveness of actions taken by management to manage the
risks identified (and in some cases helping management develop appropriate actions by making
recommendations)
periodically auditing or reviewing systems or operations to determine whether the risks of fraud and
error are being effectively managed
monitoring the incidence of fraud and error, investigating serious cases and making recommendations
for appropriate management responses.
In practice, the work of internal audit often focuses on the adequacy and effectiveness of internal control
procedures for the prevention, detection and reporting of fraud and error. It should be recognised, however,
that many significant frauds bypass normal internal control systems and that, in the case of management fraud
in particular, much higher level controls (those relating to the high level governance of the entity) need to be
reviewed by internal audit in order to establish the nature of the risks and to manage them effectively.
Laws and Regulations
An important part of an external audit is the consideration by the auditor as to whether the client has complied
with laws and regulations.
Key points
Management’s responsibility: Management have a responsibility to ensure that the operations of The client are
conducted in accordance with the provisions of laws and regulations. This includes compliance with laws and
regulations that determine amounts and disclosures in financial statements, including tax liabilities and charges.
Auditor’s responsibility: Auditors are not responsible for preventing non-compliance with laws and regulations,
and cannot be expected to detect non-compliance with all laws and regulations.
They have a responsibility to obtain reasonable assurance that the financial
statements are free from material misstatement, whether caused by fraud or error.
Auditor’s responsibility differs in relation to the two different categories of laws and regulations identified
below:
1. Laws and regulations which have a DIRECT effect on the determination of material amounts and
disclosures in financial statements. Here the auditor is responsible for obtaining sufficient appropriate
audit evidence regarding compliance.
2.
Laws and regulations which DO NOT HAVE A DIRECT EFFECT on the determination of material amounts
and disclosures in financial statements, but may impact the entity’s ability to continue to trade. Here the
auditor’s responsibility is limited to specified audit procedures to help identify non-compliance with
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those laws and regulations that may have a material effect on the financial statements. This includes
inquiring with management whether the entity is in compliance with such laws and regulations, and
inspecting correspondence with relevant licensing or regulatory authorities.
The auditor also has a responsibility to remain alert, by maintaining professional scepticism, to the possibility
that other audit procedures may bring instances of identified or suspected non-compliance with laws and
regulations.
DIRECT AND INDIRECT LAWS AND REGULATIONS- IMPORTANT EXAPLANATION TO GO THROUGH
There are many laws and regulations that a reporting entity may have to comply with in order to continue in
business. For example, many entities (particularly in the UK) will have to comply with strict health and safety
legislation; a food manufacturer may have strict food hygiene legislation to comply with, and an accountancy
firm will have a code of ethics to follow from its professional body.
Such laws and regulations will have both a direct effect on the financial statements and an indirect effect.
laws and regulations that have a direct
effect on the financial statements
laws and regulations that have an indirect effect on the
financial statements
Gather sufficient and appropriate audit
evidence that the entity has complied with
such laws and regulations. For example,
when auditing the payroll the auditor will be
concerned with gathering sufficient and
appropriate audit evidence to ensure that tax
legislation has been correctly applied by the
entity because if it has not (there is risk that
the entity could be fined for non-compliance
and the fines could be material, either in
isolation or when aggregated with other
misstatements. In addition, amounts within
the financial statements may also be
misstated as a result of the non-compliance
with laws and regulations.
The auditor will undertake procedures with the objective of
identifying non-compliance with such laws and regulations. ISA
250 gives examples of:

compliance with the terms of an operating license

compliance with regulatory solvency requirements, or

compliance with environmental regulations.
When designing procedures to help to identify non-compliance
with laws and regulations, the auditor should obtain a general
understanding of:

the applicable legal and regulatory framework, and

how the entity complies with that framework.
the auditor must maintain a degree of professional scepticism
and remain alert to the possibility that other audit procedures
applied may bring instances of non-compliance or suspected
non-compliance with laws and regulations to the auditor’s
attention, and such procedures could include:



reading minutes of board meetings
enquiring of management and/or legal advisers
concerning litigation or claims brought against the entity,
and
undertaking substantive tests on classes of transactions,
account balances or disclosures.
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REPORTING IDENTIFIED OR SUSPECTED NON-COMPLIANCE WITH LAWS AND REGULATIONS
Where the auditor discovers non-compliance with laws and regulations, the auditor must notify those charged
with governance.
However, care must be taken by the auditor because if the auditor suspects that those charged with governance
are involved, the auditor must then communicate with the next highest level of authority, which may include the
audit committee.
If a higher level of authority does not exist, the auditor will then consider the need to obtain legal advice.
The auditor must also consider whether the non-compliance has a material effect on the financial statements
and, in turn, the impact the non-compliance will have on their report.
There may be occasions when the auditor’s duty of confidentiality may be overridden by law or statute. This can
be the case when the auditor discovers non-compliance with legislation such as drug trafficking or money
laundering.
Attempt questions to check your understanding:
June 2015-Q5a
Dec 2012-Q1c
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Audit Documentation
Audit documentation’ means the record of audit procedures performed, relevant audit evidence obtained and
the conclusions the auditor reached.
Professional judgment is subjective. It needs to be supported by the facts and circumstances of the engagement
or by sufficient appropriate audit evidence.
Therefore, these matters need to be appropriately documented.
Need/ importance of documentation
1. Provides evidence of the auditor’s basis for a conclusion about the achievement of the overall objective
of the audit.
2. Provides evidence that the audit was planned and performed in accordance with ISAs and applicable
legal and regulatory requirements.
3. Assists the engagement team to plan and perform the audit.
4. Assists members of the engagement team responsible for supervision to direct, supervise and review
the audit work.
5. Enables the engagement team to be accountable for its work.
6. Retains a record of matters of continuing significance to future audits.
Contents of a working paper
1. Name of client – identifies the client being audited.
2. Year-end date – identifies the year end to which the audit working papers relate.
3. Subject – identifies the area of the financial statements that is being audited, the topic area of the
working paper, such as receivables circularisation.
4. Working paper reference – provides a clear reference to identify the number of the working paper, for
example, R12 being the 12th working paper in the audit of receivables.
5. Preparer – identifies the name of the audit team member who prepared the working paper, so any
queries can be directed to the relevant person.
6. Date prepared – the date that the audit work was performed by the team member; this helps to identify
what was known at the time and what issues may have occurred subsequently.
7. Reviewer – the name of the audit team member who reviewed the working paper; this provides
evidence that the audit work was reviewed by an appropriate member of the team.
8. Date of review – the date the audit work was reviewed by the senior member of the team; this should
be prior to the date that the audit report was signed.
9. Objective of work/test – the aim of the work being performed, could be the related financial statement
assertion; this provides the context for why the audit procedure is being performed.
10. Details of work performed – the audit tests performed along with sufficient detail of items selected for
testing.
11. Results of work performed – whether any exceptions arose in the audit work and if any further work is
required.
12. Conclusion – the overall conclusion on the audit work performed, whether the area is true and fair.
Audit documentation may be recorded on paper or on electronic or other media.
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The working papers should be so prepared so as to enable an experienced auditor, with no previous
connection to the audit, to understand:
-The nature, timing and extent of the audit procedures performed to comply with the International Standard on
Auditing (ISA).
-The results of the audit procedures and audit evidence obtained.
-Significant matters resulting during the audit and the conclusions expressed thereon.
Types of audit files
The files in which all the working papers are put are termed audit files.
Permanent file papers
The permanent file contains matters of continuing importance affecting the company or the audit. This generally
has future or long term use.










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Information concerning legal structure of entity (e.g., Memorandum and Articles of Association).
Other documents of continuing importance:
o terms of engagement;
o minutes of important meetings;
o debenture deeds;
o title deeds and lease agreements;
o royalty agreements.
Descriptions of nature and history of client's business, locations and products.
A list of client's investments (if any).
Organisation charts, with extra details for finance department.
Main accounting records, showing where kept and of what type (e.g., handwritten, computerised).
Copies of previous financial statements and auditor's reports thereon.
Previous reports to management (detailing weaknesses found in the accounting system.
Client's other professional advisers.
Client's insurance cover details.
Significant ratios and trends.
Accounting systems descriptions in flow chart and narrative form (see later).
Internal controls evaluation data: questionnaires and checklists (see later).
Principal accounting policies
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2. Current audit file papers
The current file which is broadly concerned with the accounts being audited. This generally serves an immediate
purpose. It generally contains the following papers:
Examples of the working papers ordinarily contained in a typical current audit file include:
-
-
Evidence of the planning process including audit programmes and any changes thereto.
Evidence of the auditor’s consideration of the work of internal auditing and conclusions reached.
Analyses of transactions and balances.
Analyses of significant ratios and trends.
The identified and assessed risks of material misstatements at the financial statement and assertion
level.
A record of the nature, timing and extent of audit procedures performed in response to risks at the
assertion level and the results of such procedures.
Evidence that the work performed by assistants was supervised and reviewed
An indication as to who performed the audit procedures and when they were performed.
Details of audit procedures applied regarding components whose financial statements are audited by
another auditor.
Copies of communications with other auditors, experts and other third parties.
Copies of letters or notes concerning audit matters communicated to or discussed with management or
those charged with governance, including the terms of the engagement and material weaknesses in
internal control.
Letters of representation received from the entity.
Conclusions reached by the auditor concerning significant aspects of the audit, including how exceptions
and unusual matters, if any, disclosed by the auditor’s procedures were resolved or treated.
Copies of the financial statements and auditor’s report.
Controls required to ensure the safe custody of audit documentation
1.
2.
3.
4.
Maintain a log
Prevent unauthorised changes to the documentation
Protection from theft: passwords, access restrictions
Retention of working papers: minimum 5 years
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Quality control for an audit of financial statements
1
Leadership responsibility
for quality
Engagement Partner
2
Ethical requirements
Engagement Partner to ensure independence not compromised throughout
the audit
3
Acceptance/ continuance
of client
Matters to consider before accepting new clients/continuing with previous
clients
4
HR policies
Engagement Partner should have skills, authority, time required for audit.
He should also ensure the team has relevant skills
5
Engagement performance
a) Direction
- Set by Engagement Partner
- Set in the planning meeting
- Responsibilities assigned to team
- Objective of work to be done communicated
- Risks
- Team told how to deal with problems as they arise
b) Supervision
- Mainly by Engagement Partner
- Should be continuous
- Ensure work according to planned approach
- Ensure important matters told to seniors
- Ensure audit approach modified if needed
- See if consultation is needed
c) Consultation (use of experts) where needed
- From outside the team or outside the firm
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d) Review
- By a senior team member
- Ensure work according to all relevant standards ( including
quality standards)
- Check if objective of work has been achieved
- Ensure conclusions are supported by sufficient appropriate
evidence
e) Engagement Quality Control Review (if needed)
- Reviewer will review significant judgments
- Reviewer will evaluate conclusions reached in making the audit
report
- Reviewer will ensure consultations have been taken where
needed
f)
6
Documentation
- Maintain and retain all documentation ( working papers)
- Ensure confidentiality
-The firm should ensure quality control procedures are adequate and
complied with.
Monitoring
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Corporate governance
Corporate governance is the system by which companies are directed and controlled. According to the UK
Corporate Governance Code the ‘purpose of corporate governance is to facilitate effective, entrepreneurial and
prudent management that can deliver the long-term success of the company’.
Corporate governance considers the responsibilities of directors, how the board of directors should be run and
structured, the need for good internal controls and the relationship with external auditors.
It is important for companies to consider good corporate governance principles as often it is management or
those charged with governance who run the company, but the owners are the shareholders and they are not
involved in the running of the business.
For these shareholders their only opportunity to raise concerns is at the annual general meeting, which only
occurs once a year and often attendance is low.
Shareholders need to ensure that their needs are taken into account by management, and that there is a
process in place for them to be informed as to how the business is operating.
Corporate governance represents the set of policies and procedures that determine how an organisation is
directed, administered and controlled.
Although the contents of corporate governance will vary from organisation to organisation, almost all will have
the following components: Accountability, compliance, transparency and integrity
TCWG: Those “charged with governance” are defined as the persons who are “accountable for ensuring that
the entity achieves its objectives, with regard to reliability of financial reporting, effectiveness and efficiency of
operations, compliance with applicable laws, and reporting to interested parties.”
Although there is no universal rule, in most instances these persons will either be the board of directors and/or
the audit committee
Provisions of international codes of corporate governance (such as OECD) that are most relevant to auditors.
The Principles cover six key areas of corporate governance:
1. Ensuring the basis for an effective corporate governance framework(should promote transparent and
efficient markets, be consistent with the rule of law and have a clear division of responsibilities among
different supervisory, regulatory and enforcement authorities)
2. The rights of shareholders and key ownership functions
3. The equitable treatment of shareholders
4. The role of stakeholders in corporate governance
5. Disclosure and transparency
6. The responsibilities of the board
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Important terms in corporate governance
An executive director: an executive director is a director responsible for the administration of a company.
They are primarily responsible for carrying out the strategic plans and policies as established by the board of
directors.
A non-executive director (NED): a non-executive director is a director without day-to-day operational
responsibilities of the company.
Responsibilities of the board of directors in corporate governance
- establish a code of corporate ethics
- ensure that that the organisation establishes policies, procedures and controls to manage the potential
risks it will face
- ensure compliance with laws and regulations
- ensuring that an effective system of internal controls is in place and functioning
- ensuring that a high quality and timely independent audit is conducted
- establish and oversee the work of audit and remuneration committee
The board of directors
-
-
-
The board should meet regularly.
The roles of chairman and CEO should not be performed by the same
individual. The roles of chairman (NED) and chief executive(ED) are both very
important and carry significant responsibilities; hence this prevents too much
power residing in the hands of one individual.
At least half of the board should be comprised of NEDs :There should be an
appropriate balance of executives and non-executives (excluding the
chairman), to ensure that the board makes the correct objective decisions,
which are in the best interest of the stakeholders of the company, and no
individual or group of individuals dominates the board’s decision-making
Non-executives need to be independent of the executive management so
that they can exercise judgment without bias or self interest
All directors should receive induction training when they first join the board
so that they are fully aware of their responsibilities.
The shareholders should review on a regular basis that the composition of the
board of directors is appropriate, and they do this by re-electing directors.
The directors need to consider, on an annual basis, whether the company
requires an internal audit department. Internal audit helps the director in
monitoring the company.
The performance of each board member should be appraised on an annual
basis.
There should be an on-going process of board development through
continuous professional development (CPD) of all board members.
Board sub-committees with appropriate composition should be made ( Audit
and Remuneration committee should only have NEDs whereas Risk and
Nomination should have a majority of NEDs)
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Director’s
remuneration
No director should be involved in setting their own remuneration as this may result in
excessive levels of pay being set.
Levels of remuneration should be sufficient to attract and retain the directors needed
to run the company successfully, but companies should avoid paying more than is
necessary for this purpose. A proportion of executive directors’ remuneration should
be structured so as to link rewards to corporate and individual performance.
Non-executive directors’ pay should not be based on meeting company targets as
their pay should be independent of how the company performs.
Accountability and
audit
The board should present a balanced and understandable assessment of the
company’s position and prospects.
Internal control
The board should maintain a safe and registered system of internal control to
safeguard the shareholders’ investment and the company’s assets.
Audit committee and
auditors
i. The board should establish an audit committee of at least three directors, all nonexecutive, with written terms of reference which deal clearly with its authority and
duties.
ii. The audit committee should monitor and review the internal audit and the reports
prepared by the internal audit team.
iii. With regard to the external auditors, the audit committee should
-Recommend their appointment.
-Approve their remuneration and terms of engagement.
-Monitor and review their independence, objectivity and effectiveness.
Relations with
shareholders
Dialogue with institutional shareholders: Companies should be ready, where
practicable, to enter into a dialogue with institutional shareholders based on mutual
understanding of objectives.
Constructive use of the AGM: Boards should use the AGM to communicate with
private investors and encourage their participation.
Institutional investors
Shareholder voting: Institutional shareholders have a responsibility to make careful
use of their votes.
Code provisions
i. Institutional shareholders should, on request, make available to their clients the
information on the proportion of resolutions on which votes were cast and nondiscretionary proxies lodged.
ii. Institutional shareholders should take steps to ensure that their voting intentions
are being translated into practice.
Dialogue with companies: Institutional shareholders should be ready, where
practicable, to enter into a dialogue with companies based on the mutual
understanding of objectives.
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Evaluation of governance disclosures:When evaluating companies’ governance
arrangements, particularly those relating to board structure and composition,
institutional investors should give due weight to all relevant factors drawn to their
attention.
Roles of the Audit Committee
Composition: entirely NEDs-at least one of them should have recent and relevant financial experience.
1. With regards to Financial statements, the Audit committee:
o reviews integrity of financial statements (including reviewing significant judgments)
o checks the clarity and completeness of the disclosures in the financial statements.
o monitors formal announcement regarding financial performance
2. With regards to Internal audit, it
o monitors effectiveness of IA, review their plan and ensure their recommendations
are actioned
o ensures IA is accountable to AC and preserve their independence + Chief Internal
auditor has access to Chairman
o approves appointment/termination of Chief Internal Auditor
3. With regards to External auditors, it
o Is responsible for oversight of the company’s relations with its external auditors.
o Recommends appointment, re-appointment and removal of external auditor
o Recommends remuneration and terms of engagement of EA
o Reviews and monitors independence of EA
o Develops and implements policy on EA providing non-audit services
o Reviews qualification and expertise of the EA
4. It reviews control systems (internal controls, internal financial controls, risk management)
5. It monitors compliance with laws and regulations
6. The audit committee should also review the procedures in place for whistle-blowing within the
company.
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Advantages of audit committee
1. Improves Public confidence in the credibility and objectivity of the financial statements. (They can create
a climate of discipline and control and reduce the opportunity for fraud)
2. It will help to improve the quality of the financial reportingguidance to BOD
3. An audit committee can help to improve the internal control environment of the company. The audit
committee is able to devote more time and attention to areas such as internal controls.
4. Helps in risk management: The audit committee can also provide advice on risk management to the
executive directors.
5. The audit committee will be responsible for appointing the external auditors and this will strengthen the
auditors’ independence and contribute to a channel of communication and forum of issues.
6. The NEDs bring considerable external experience to the board as well as challenging the decisions of
executive directors and contributing to independent judgements.
7. Senior management in the accounting and finance function can raise concerns and discuss accounting
issues with the audit committee.
8. The independence of the internal audit department is improved The audit committee will assume
responsibility for appointing and liaising with the external audit firm, thus ensuring the independence of
the external auditor especially in cases of dispute with management.
Limitations of audit committee
1. Although audit committees do oversee the work of auditors (both internal and external) they do not
have the authority to appoint or dismiss them. This limits the amount of power the committee has over
the organisation’s auditors.
2. Audit committees generally do not have as much technical expertise and knowledge as the auditors
they are overseeing.
3. Independent directors often do not have as thorough a knowledge of the organisation’s operations and
functioning as executive directors.
4. Most of the members of the audit committee are non-executive directors. The board may feel that the
audit committee has been formed to limit its powers and allow outsiders to run the company.
5. The non-executive directors have to be paid more for carrying out the responsibilities associated with
the audit committee. Hence, it increases the cost of the organisation.
Attempt questions to check your understanding:
March/June Hybrid 2016-Q1
Dec 2014-Q3
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Internal audit
An independent appraisal activity established within an organization as a service to it. A control in itself which
functions by examining and evaluating the adequacy and effectiveness of other controls
Steps to conduct internal audit
1.
2.
3.
4.
5.
Identify the risks which may occur if there are no controls in place
Identify controls in place
Evaluate whether the controls in place reduce the risk to an acceptable level, i.e. they are adequate.
Evaluate whether the controls are working effectively.
Report
Functions
1.
2.
3.
4.
5.
Reviewing accounting and internal control systems
Helping with risk assessment
Reviewing 3Es (economy, efficiency & effectiveness) of operations
Examining operating and financial information
Review of compliance with laws, regulations and other external requirements and with management
policies and directives and other internal requirements.
6. Carrying out special investigations (e.g. into suspected fraud)
Factors determining need of internal audit






Cost benefit analysis
Complexity of operations
Scale of operations
Changes in key risks and processes
Problems with existing controls
Ability of current management to carry out assignments which would normally be carried out by
internal auditors
 Need of special assignments that normally internal audit carries out (IT audits for example)
What does corporate governance say about Internal Audit?

IA should report to the Audit Committee. The AC will monitor if internal audit is effective. If there is no
IA department, the AC should determine whether there is need for one. In case they believe the internal
audit department is not required, it needs to explain the reason for this in the annual report.

Assistance to the board of directors:
The IA department checks reports that are not audited by the external auditors.
It can help the board with regards to accounting and auditing standards when required.
IA can liaison with external auditors which can reduce the time and cost of external audit.
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Differences between external and internal audit
Internal Audit
External Audit
Appointment process
Determined by management; appointed by
management.
Determined by statute; appointed
by members. Formal auditing
qualifications are required.
Objective
The main objective of internal audit is to improve
a company’s operations, primarily in terms of
validating the efficiency and effectiveness of the
internal control systems of a company.
Report to
Internal audit reports are normally addressed to
the board of directors, or other people charged
with governance such as the
audit committee. Those reports are not publicly
available, being confidential between the
internal auditor and the recipient.
Scope
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 rarely become involved
with.
The main objective of the external
auditor is to express an opinion on
the truth and fairness of the
financial statements, and
other jurisdiction specific
requirements.
External audit reports are provided
to the shareholders of a company.
The report is attached to the annual
financial statements of the
company and is therefore publicly
available to the shareholders and
any reader of the financial
statements.
The work of the external auditor
relates only to the financial
statements of the organisation.
Relationship with the
organization
Planning and evidence
collection
However, the internal control
systems of the organisation will be
tested as these provide evidence on
the completeness and accuracy of
the financial
statements.
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.
No materiality
The external auditor is appointed
by the shareholders of an
organisation, providing some
degree of independence from the
company and management
Materiality
Procedural or risk based
Risk based
Primarily internal sources of evidence
Internal and external sources of
evidence
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IA and risk management
IA ensures risk management systems are operating effectively and that the strategies implemented for business
risks are operating effectively.
Business risk (risk that the company’s objectives are not met or strategy not executed properly or inappropriate
objectives and strategies were set).
IA and fraud
-
Assess the adequacy and effectiveness of controls.
Be alert to suspicious activities
Report suspicious activities
Carry out special investigations if asked
Limitations of IA
-
independence issues as employees so may be concerned about job security
if it is not reporting to the AC, management can influence them (they will be checking the work of
the people they are reporting to).
Outsourcing Internal Audit
Advantages
-
Greater expertise, specialist skills and access to better audit technology without extra cost available
The risk of staff turnover is passed on to the firm
Lesser cost of training staff and retaining permanent staff
May be more independent
Lesser management time consumed in administering the department
IA will be immediately available (also good for short term)
The contract can be set for an appropriate time scale
Flexibility in terms of that the staff can be called in according to workload
Disadvantages
-
May not be independent if the same firm is offering external audit and internal audit
May be more expensive
The firm will not have in-depth knowledge of the company
Lesser control by the management over the standard of service
May have confidentiality issues
If the company has an existing IA department which is to be made redundant, they may face
opposition from the other staff
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Internal Audit assignments- examples to read through
1. VFM audit : A value for money audit focuses on whether the best combination of services has been
obtained for the lowest level of resources.
In performing a value for money audit there are three areas which an auditor will commonly focus on being
economy, efficiency and effectiveness, and these are known as the three Es.
Economy – Keeping the cost of resources used to a minimum.
Efficiency – The relationship between the output from goods and services and the resources used to produce
them.
Effectiveness – How well the organisation’s objectives have been achieved.
Deficiencies of value for money audit
There is no universal measure for outputs. For example, the output of a customer care executive in a call centre
can be measured by the number of calls attended by him. However, the output of a machine will be in terms of
the units manufactured.
Objectives of audit and measure of efficiency vary with the type of work being audited. For example, the
objective of a customer care executive is to satisfy the queries of a customer in the minimum time.
Hence, their efficiency would be determined on that basis. However, the objective of a machine is to produce
the maximum output with minimum resources.
Quality might be sacrificed to achieve economy and efficiency.For example, the customer care executive may
end the call without giving adequate answers to the queries posed by the customer. The servicing of the
machine may be delayed to avoid the machine’s downtime.
It is not easy to measure effectiveness. For example, the effectiveness of a customer care executive will
improve if they give detailed replies to the queries of the customers. However, it would result in low call
turnover and other customers would have to wait for a long time before their phone call is attended.
Therefore the measurement of effectiveness of this function is subjective, and not easy.
2. IT audit
An information technology audit is an examination of the controls within an information technology
infrastructure. This determines if the information systems are:
--safeguarding assets,
--maintaining data integrity and
--operating effectively and efficiently to achieve the organisation’s goals or objectives.
3. Best value audit
A best value review involves the following:
--Reviewing whether the products / services meet the requirements of the customers
--Determining whether there is balance between the cost and quality of the service or not
--Comparing product / service with competitors to find out the best and the worst features in the products of
the entity so as to make improvements.
4. Financial audit
The scope of internal audit for financial functions may involve internal control topics such as the efficiency of
operations, the reliability of financial reporting, deterring and investigating fraud, identifying errors,
safeguarding assets and compliance with laws and regulations.
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5. Operational audit (procurement, marketing, HR)
6. Mystery shopper reviews
7. Regulatory compliance review
INDEPENDENCE
Internal auditors should:
• monitor and review controls, not design and implement them;
• report to the audit committee if possible, not the finance director;
• be free to decide on the nature and scope of their work;
• be free to communicate fully with the external auditors.
EXTERNAL AUDIT RELIANCE ON INTERNAL AUDITWORK
Reliance on internal audit
ISA 610 Using the Work of Internal Auditors details the factors the external auditors should consider in order to
place reliance on the work of the internal audit (IA) department as follows:
1. Objectivity: They should consider the status of IA within the company and if they are independent of
other departments, in particular the finance department. In addition, consideration should be given as
to who IA reports to, whether this is directly to those charged with governance or to a finance director.
2. Technical competence: The technical competence of IA staff should be considered. Consideration
should be given to whether they are members of a professional body and have relevant qualifications
and experience.
3. Due professional care: The external auditors should consider if the IA department have exercised due
professional care, the work would need to have been properly planned including detailed work
programmes, supervised, documented and reviewed.
4. Communication: In order to place reliance there needs to be effective communication between the
internal auditors and the external auditor. This is most likely to occur when the IA department is free to
communicate openly and regular meetings are held throughout the year.
Attempt questions to check your understanding:
June 2014-Q4
June 2013-Q4b,c,d
June 2013-Q5a,b
Dec 2012-Q3c
June 2012-Q1d,e
June 2012-Q3d
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Fundamental principles of ethics
1. Integrity: Members should be straightforward and honest in all professional and business relationships.
2. Objectivity: Members should not allow bias, conflicts of interest or undue influence of others to
override professional or business judgements.
3. Professional competence and due care: to maintain professional knowledge and skill at the level
required to ensure that a client receives competent professional services, and to act diligently and in
accordance with applicable technical and professional standards.
4. Confidentiality : Members should respect the confidentiality of information acquired as a result of
professional and business relationships and should not disclose any such information to third parties
without proper and specific authority
There are, however, circumstances where auditors may disclose information to third parties without
first obtaining permission.
These can be categorised as obligatory and voluntary disclosures.
Obligatory: Auditors are obliged to make disclosure where, for example, there is a statutory right or
duty to disclose, such as if the auditor suspects the client is involved in money laundering, terrorism or
drug trafficking in which case they must immediately notify the relevant authorities.
In addition, auditors must make disclosure if compelled by the process of law, for example under a court
order or summons, under which they are obliged to disclose information.
Voluntary
In certain circumstances auditors are free, as opposed to obliged, to disclose information without
obtaining the client’s permission first. These circumstances can be categorised into the four areas
below:
Public interest – An auditor may disclose information which would otherwise be confidential if
disclosure can be justified in the ‘public interest’. This would be perhaps if those charged with
governance are involved in fraudulent activities;
Protect a member’s interest – Members/auditors may disclose information to defend themselves
against a negligence action, disciplinary proceedings or if suing for unpaid fees;
Authorised by statute/laws – There are cases of express statutory provision where disclosure of
information to a proper authority overrides the duty of confidentiality;
Non-governmental bodies – Auditors may be approached by non-governmental bodies seeking
information concerning suspected acts of misconduct not amounting to a crime or civil wrong.
Disclosure should only be made to those bodies with statutory powers to compel disclosure.
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5.
Professional behaviour: Members should comply with relevant laws and regulations and should avoid
any action that discredits the profession.
Threats
Once you have identified a threat from the scenario, you will need to name the threat, explain WHY it is a threat
and tell the safeguard.
QCR: Quality Control Review ( independent partner review)- Having a professional accountant who was not
involved with the non-assurance service review the non-assurance work performed
Chinese walls: The use of separate engagement teams, with different engagement partners and team members
This is a snapshot for basic revision- the assumption is that you have already
read through them in detail.
Self-interest : the threat that a financial or other interest will inappropriately influence the professional
accountant’s judgment or behaviour
Example
Safeguard
A member of the assurance team or the firm having a
direct financial interest in the assurance client.
Remove the individual from the audit team-the
self-interest threat created would be so significant
that no safeguards could reduce the threat to an
acceptable level.
- Nature, value and intent of offer to be
considered
- Not allowed unless insignificant ( politely
decline)
Gifts and hospitality
A firm having undue dependence on total fees from
a client.
Public interest(listed) clients:
If gross recurring fee from one client greater than
15% of the firm’s revenue for two consecutive
years,
-
Tell client’s TCWG
Independent QCR or external QCR before
OR after issuing 2nd year’s opinion
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Recent Service with an Audit Client
(if a member of the audit team has recently served
an employee of the audit client)
A member of the assurance team(or the firm) having
a significant close business relationship
Commercial relationship
- Common financial interest
Examples: joint venture with the client or a
controlling owner/ director, formal marketing of
each other’s product, combine the services of the
firm with those being offered by client and market
the package
A firm entering into a contingent fee arrangement
relating to an assurance engagement. (relating to the
outcome of a transaction or the result of the services
performed by the firm)
Overdue fee-might be regarded as being equivalent
to a loan to the client
Remove from team if worked at the client in the
year being audited at a position to exert significant
influence over the subject matter
-
If material, not allowed (The threat
created would be so significant that no
safeguards could reduce the threat to an
acceptable level.)
Politely decline the proposed contingent fee
arrangement
Inform the client that the fees will be based on the
level of work required to obtain sufficient and
appropriate audit evidence.
Discuss with those charged with governance the
reasons why the payments have not been made.
(if fees due from an audit client remain unpaid for a
long time, especially if a significant part is not paid
before the issue of the audit report for the following
year.)
Should agree a revised payment schedule which
will result in the fees being settled before much
more work is performed for the current year audit.
Loans and guarantee
Okay if in normal course of business under normal
lending conditions- otherwise not allowed.
Serving as a Director or Officer of an Audit Client
- No allowed.
(Particular reference made by the code to the role
of the Company Secretary. If allowed under local
laws or professional rules, the duties and activities
shall be limited to those of a routine and
administrative nature, such as preparing minutes
and maintaining statutory returns)
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Recruitment services ( especially hiring of senior
management)
Listed client: not allowed for directors or senior
positions related to f/s preparation
Firm can undertake roles such as reviewing a
shortlist of other candidates. However, they
must ensure that they are not seen to undertake
management decisions and so must not make the
final decision on who is
appointed
A member of the audit team entering into
employment negotiations with the audit client.
-
Compensation and Evaluation Policies (when a
member of the audit team is evaluated on or
compensated for selling non-assurance services to
that audit client.)
-
Remove the individual from the audit team
A review of any significant judgments
made by that individual while on the team.
Not allowed
Self-Review-the threat that the auditor will not appropriately evaluate the results of a previous judgment
made/or service performed by him
Example
Safeguard
Provision of other services to an audit client
Listed Clients: Most non-assurance services related
to financial reporting are not allowed.
(Note: other threats due to this are self-interest
because of the fee element and advocacy-see below)
Other clients: Segregation of duties, Chinese walls,
QCR
Temporary staff assignments-The lending of staff by
a firm to an audit client
Should ideally not be made a part of the audit
team
Generally acceptable if no management
responsibility taken up and the audit client shall be
responsible for directing and supervising the
activities of the loaned staff
Recent Service with an Audit Client- a member of
the audit team has recently served as a employee of
the audit client- The threat is that the member of the
audit team has to evaluate elements of the financial
statements for which he had prepared the
accounting records while with the client.
Remove from team if worked at the client in the
year being audited at a position to exert significant
influence over the subject matter
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Familiarity: the threat that due to a long or close relationship with a client , the auditor will be too
sympathetic to their interests or too accepting of their work
Long Association of Senior Personnel with an Audit
Client
Listed clients:
-
7 years plus 1 year of flexibility then a gap
of two years for audit partner
In the 2 years gap period, not participate in
the audit or, provide quality control for the
engagement, or consult with the
engagement team or the client regarding
technical or industry-specific issues
Other clients:
rotate members, QCR
Family and Personal Relationships
Remove from team if the relationship is with a
senior person at the client with influence over the
f/s.
Employment with an Audit Client
Listed client: for partners, ok if twelve months
have passed since the individual was Partner.
(the director or a senior member of the audit client
has been a member of the audit team or partner of
the firm in the past)
Other safeguards
-Modifying the audit plan;
-any work already undertaken by that individual
should be independently reviewed.
-Assigning individuals to the audit team who have
sufficient experience in relation to the individual
who has joined the client.
Advocacy: threat that the auditor will promote a client’s position to the point that the his objectivity is
compromised
Legal services to audit client ( for example contract
support, litigation, mergers and acquisition legal
advice and support to clients’ internal legal
departments)
If they relate to resolving a dispute or litigation
when the amounts involved are material to the
financial Statements: not allowed
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Auditor asked to promote client/shares in a client or
asked to accompany the client to a meeting with the
bank
Not allowed ( politely decline)
Intimidation: the threat that the auditor will be deterred from acting objectively because of actual or
perceived pressures, including attempts to exercise undue influence over the auditor
Threat of dismissal or replacement of auditor/or his
close family member over a disagreement about the
application of an accounting principle.
A dominant personality at the client attempting to
influence the decision making process, for example
the application of an accounting principle.
-
Tell client’s TCWG
-
ensure that all audit engagements are
conducted in accordance with
International Standards on Auditing
Ensure you gather sufficient appropriate
evidence
A firm being pressured to reduce inappropriately the
extent of work performed in order to reduce fees.
An auditor feeling pressured to agree with the
judgment of a client employee because the
employee has more expertise on the matter in
question.
Actual or Threatened Litigation(for example
regarding a previous audit report)- When the firm
and the client’s management are placed in
adversarial positions by actual or threatened
litigation, affecting management’s willingness to
make complete disclosures
Fee dependence, close personal relationships,
business relationships also cause intimidation
threats.
-
QCR
If a team member involved, remove from
team
Withdraw from engagement if very
significant
The safeguards for each will be the same as
discussed earlier.
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Conflict of Interest
Members should place their clients’ interests before their own and should not accept or continue engagements
which threaten to give rise to conflicts of interest between the firm and the client. Any advice given should be in
the best interests of the client.
A conflict of interest arises where an auditor acts for both a client company and for a competitor company of the
client. Where the acceptance/continuance of an engagement would, despite safeguards, materially prejudice
the interests of any clients, the appointment should not be accepted/continued, or one of the appointments
should be discontinued.
Managing conflicts of interest
1. Full disclosure is important – both companies should be fully aware that the firm is acting for the
other party.
2. Regular review of situation by an independent senior partner
3. Use of different partners and teams of staff for different engagements
4. Internal procedures within the firm :
o Procedures to prevent access to information, for example, strict physical
separation of both teams, confidential and secure data filing.
o Clear guidelines for members of each engagement team on issues of security and
confidentiality. These guidelines could be included within the audit engagement
letters.
o Potentially the use of confidentiality agreements signed by employees and
partners of the firm
5. Advising at least one or all clients to seek additional advice
Attempt questions to check your understanding:
Sept/Dec Hybrid 2015-Q1
June 2015-Q1
June 2014-Q3d
Dec 2013-Q4c
June 2012-Q3b,c
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Not for profit organizations
Important features to remember:
 There are no external shareholders therefore no dividends
 Income likely to be from donations/grants.
 Likely additional reporting/accounting rules.
 Their activities may be restricted by regulators
 They are Not forbidden from engaging in commercial activities
 3Es very important for them.
 Normally managed by a council made up entirely of volunteers ( like NEDs)

-
Examples: charities , housing associations, clubs. local authorities/councils, government bodies.
Charities
Risks
Higher level of cash transactions.
Income – completeness problem.
Lack of predictability regarding future income/expenditure. (analytical procedures aren’t very useful
here!)
Complexity of external regulations.
Complexity of taxation regulations.
Potential restrictions re: activities/use of income.
Control risks
-
Restricted number of employees so segregation of duties difficult
Volunteer staff-competence, training, lack of trust
Informal environment
Trustees (the time they give to the org, skills, qualifications, frequency of meetings, independence from
each other)
Obtain understanding of an entity and its
environment
By obtaining and examining constitution, by-laws,
rules and regulations.
Risk assessment
Generally control risk is high
Planning
Generally need to perform extensive substantive
procedures
Determine adequacy and effectiveness of controls
Generally less effective ( run by non-professionals
plus controls might not be cost beneficial)
Audit evidence gathering procedures
Extensive substantive testing.
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Wrapping up!
External Audit Process-summary
Engagement letter
Planning
1.Audit Strategy
.
a) Understanding the client (the environment, the accounting
system, internal control systems, accounting policies etc.)
b)Risk: The assessment of risk for the client and risk of fraud and
error and the identification of significant audit areas. Analytical
procedures are also performed.
c)Materiality: Financial statements will normally be useful
provided they do not contain ‘material’ errors or misstatements.
The auditor therefore determines preliminary materiality at this
stage
d) Scope, timing, direction
Scope: characteristics of the audit client, such as its
locations,whether the financial information to be audited has
been prepared in accordance with IFRS– the extent to which
audit evidence obtained in previous audits will be utilised,
whether computer-assisted audit techniques will be used and
the effect of IT on audit procedures etc , as these factors will
help to establish the scale of the
Timing: Establishing deadlines for completion of work and key
dates for expected communications
Direction: The ‘direction’ of the audit covers the overall
approach and concerns such issues as reliance on
systems(controls) or a fully substantive approach.
2. Audit Plan
(detailed implementation of audit strategy)
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Internal control system over
financial reporting
Deficiencies identified
and reported
a)Document the ICS
b)Test for deficiencies (in the design of the system
and carry out test of controls to tests if the system is
being implemented properly). CAATs (test data) can
be used to test automated controls.
-
c)Report deficiencies to the management
d)Decide extent of substantive testing
Substantive testingincludes: test of details and
substantive analytical
procedures.
(testing assertions made by
the management)
Verifying the amounts and disclosures in the financial statements primarily
through:
Analytical procedures
Enquire: Management/TCWG, 3rd parties, Internal Auditor
Inspection: documents, records, tangible assets
Observation
Recalculation/Reperformance
-Going Concern
-Subsequent events
-Overall review
Review
-
Opinion
Modified opinion
Unmodified opinion
Additional paragraphs: EOPM and OMP
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Essential reading before sitting for the F8 exam
Attempting questions on audit evidence or audit procedure- Mini-case studies might be given in the exam
Audit procedures are actions that auditors carry out during the audit. They are also known as ‘audit tests’ or
‘audit work’.
Audit evidence is obtained by the auditor as a result of the audit procedure.
For example, ‘performing a circularisation of receivables/debtors’ is an audit procedure, whereas ‘replies from
customers’ is audit evidence.
Deciding on audit procedure
For each scenario:
1. Think about how the accountant would have:
 calculated the numbers in the financial statements,
 the source documents used and
 the systems followed, and
then write about the documents etc, that one would expect to see.
2. Think about how to verify the other relevant facts in each case.
3. Consider the accounting/disclosure requirements of each scenario, and say how one can check if they
are being met.
WHY CANDIDATES DO NOT PASS PAPER F8
Very bad scripts
1. Very brief answers to most, if not all questions. In other words, some of the basic knowledge is known,
but there is little or no application of that knowledge to the scenario
2. Significant lack of understanding of audit procedures and the audit process. For example, where a
question asks for audit procedures to be listed and explained, a typical answer is ‘check the ledger’
providing no indication of which ledger will be ‘checked’ or what the ledger is being checked for
3. Lack of exam practice. In a significant minority of scripts, it appears that candidates have not attempted
any mock exams prior to the ‘real’ exam. Poor exam technique is identified as:
 answering questions in a random sequence (for example, Question 1 Part (a),
followed by Question 3 Part (b), followed by Question 2 Part (c), and so on)
 spending far too much time on one question, leaving little or no time for the
other questions
 not writing in the required style (eg providing the answer in one long paragraph
rather than splitting the answer up into individual points)
 focusing on theory only with no attempt to use the scenario.
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Marginal scripts
1. Answering questions correctly, but not including a sufficient number of relevant points to obtain a pass
standard
2. Having a good knowledge of auditing, but being unable to apply that knowledge to the scenarios
provided in the question
3. Not answering all the questions.
Pass standard scripts
1. are usually well presented, and make appropriate use of paragraphs, sentences and table formats where
appropriate
2. demonstrate that students are able to apply that knowledge to the question, clearly and succinctly.
Audit procedures are listed as well as explained
3. all questions are attempted, even though some sections may not be answered that well. A few marks
could normally be obtained from a valid attempt; obviously, no marks are awarded if the question is not
attempted at all.
Ready to sit paper f8?
This document identifies and explains some of the more common errors found in Paper F8, Audit and Assurance
exam scripts. Attempt the 10 questions in this article – they vary from easy to relatively hard – and list your
answers on a separate sheet of paper and then compare and contrast your answers with the suggested solutions
provided.
As you work through the 10 questions, you will note that some questions, for example Question 1, provide two
options. You must identify the correct option.
Other questions require a more detailed response, as explained in the question itself.
There are 14 marks available in total, and the pass standard is seven marks (50%). By the end of this exercise,
you should have learnt why many relatively easy marks are not always obtained by candidates sitting the Paper
F8 exam.
1
QUESTION 1
Option A
Which option is the correct
response to the following
statement? ‘Explain the purpose
of a written representation
letter.’
A management/written representation letter is addressed to the
auditors of a company, and is written by the directors of that
company at a time towards the end of an audit. The letter contains
information from management concerning matters that the
auditor may not have been able to obtain sufficient evidence on
from other sources, such as estimates for provisions, as well as
confirming management’s responsibilities for the financial
statements.
Option B
A management/written representation letter is addressed to the
directors of a company, and is written by the auditors of that
company at a time towards the end of the audit. The letter
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contains information on weaknesses in the company’s control
systems, identified by the auditor, examples of errors that could
occur because of each weakness, and recommendations on how to
mitigate those weaknesses.
2
QUESTION 2
Option A
Which of the following audit
procedures will help to confirm
the going concern status of an
entity?
Obtain, cast, and review cash flow forecasts prepared by
management to ensure that the company has sufficient cash to
continue trading.
Option B
Perform cut-off testing on sales and purchases to ensure sales and
purchases have been correctly recorded in the correct accounting
period.
3
QUESTION 3
State whether the following are tests of control or substantive procedures in a wages system:
-
4
Obtain a sample of clock cards and ensure they are signed by the shift foreman.
Obtain sample of clock cards and agree hours worked to hours shown on the wages
calculation sheets in the accounts office. (2 marks)
QUESTION 4
Option A
Which of the following audit
procedures can be performed
using test data on a wages
system?
For a fictitious employee, enter details of hours worked and rate of
pay to confirm that gross wages are correctly calculated.
Option B
Extract the data on gross wages from the client computer; perform
a month-by-month analysis on the auditor’s computer to identify
any unusual trends.
5
QUESTION 5
Option A
Audit work on inventory has
been completed. The directors
refuse to make an adequate
provision for obsolete stock.
Which of the following is a
suitable action for the auditor to
take?
Obtain additional audit evidence from purchase invoices on the
net realisable value of the disputed inventory
Option B
Obtain a management/written representation point confirming
management’s decision on the provision.
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6
QUESTION 6
State which of the following assertions is not relevant to account balances at the period end:
7
- Accuracy, valuation and allocation
- Measurement
- Completeness.
QUESTION 7
A scenario states that an engagement partner holds some shares in an audit client, with the question
requirement asking you to identify and explain the ethical issues and provide a resolution to each
issue. Identify the weaknesses in the following answer extract: ‘The audit partner must transfer the
shares to his son (who is 15‑years‑old).’
8
State the weaknesses in the following audit procedure in a sales system: ‘Check the invoice agrees to
the ledger.’ There are two marks available
9
‘Independence’ is a fundamental ethical principle of ACCA. True or false?
10
QUESTION 10
Option A
Which option provides a
suitable response to the
requirement: ‘List the contents
of an engagement letter’?
An explanation of how the audit fee is determined.
Option B
The letter explains how the fee for the audit is calculated. This is
included to show the client that fees reflect the experience of the
audit staff assigned to the audit, as well as the time taken on the
audit by each grade of staff.
Answers
QUESTION 1: OPTION A
Common error: Confusion between letters of weakness and management representation letters.
Option B is actually a letter of weakness, which the auditor would use to explain weaknesses in a control system.
A related error is defining the contents of a management letter as a letter of weakness (as in Question 2 Part (a)
of the June 2008 Paper F8 exam).
Avoiding this error is relatively easy. Just look for the term ‘representation’ in the name of the letter as this
identifies the fact that it is a letter from management to the auditors.
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QUESTION 2: OPTION A
Common error: Lack of understanding of the going concern concept.
A going concern review relates to the future of the company – ensuring it will remain in existence for the
foreseeable future. Option A is therefore correct, as these audit procedures relate to the future.
Option B’s procedures relate to the past or to standard audit work on the financial statements. The error is
avoided by remembering that the term ‘going concern’ relates to the future, even if it appears to refer to the
past.
QUESTION 3
Common error: Confusion between tests of control and substantive procedures.
The first statement is a test of control, because the auditor is checking that the foreman has signed the clock
card, presumably to confirm that the hours worked are correctly recorded on the card.
The second statement is a substantive procedure, because the auditor is comparing details between two
separate documents – effectively reperforming the actions of client staff.
Avoid this error by checking the wording of the question requirement carefully. If the examiner asks for a ‘test of
control’ then a test of control is required – a substantive procedure will not obtain any marks.
QUESTION 4: OPTION A
Common error: Confusion between test data and audit software.
Option A shows the use of test data – in this case, dummy data is entered into the computer system to check the
accuracy of the programmes being used to calculate gross wages.
Option B is an example of the use of audit software – obtaining data from the client’s computer systems for
further analysis on the auditor’s own computer systems. This error is best avoided by remembering that audit
software is used to analyse client data, and that test data is used on a client’s computer system
QUESTION 5: OPTION B
Common error: Repeating audit procedures when a clear decision at the end of the audit is required.
One problem in many auditing answers is that candidates are unwilling to make a final decision on an audit
issue. Option A is incorrect because it involves carrying out further audit work when the question clearly stated
audit work was complete.
Option B is therefore the correct answer as it provides the auditor with appropriate evidence on the decision
made by management.
This error is avoided by checking the context of the scenario or question. Where the examiner places the
question context at ‘the end of the audit’, or states that audit work is complete, then obtaining management
representations or proceeding to issue a modified audit report are likely to be the most appropriate ways
forward.
QUESTION 6: OPTION B
Common error: Use of old auditing terminology
Selecting the correct answer here is relatively simple as the assertion ‘measurement’ was made redundant in
the last revision of ISA 500. While detailed knowledge of ISAs is not a pre-condition for passing the Paper F8
exam, answers are expected to be technically correct. There is a need to ensure comments made do reflect
current audit terminology, especially on key issues such as assertions.
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QUESTION 7
Common error: Not explaining comments made in answers in sufficient detail.
:
The answer extract does not actually state the ethical issue – that is, that the shares are owned by the
engagement partner.
There is no explanation of why this is an ethical issue. Comment should be made that the engagement partner’s
independence is impaired; any action by the partner to decrease the share price (eg qualification of the financial
statements) may not be taken because the partner would lose money.
The resolution to the conflict is inappropriate – any shareholdings by minors are still deemed to be connected to
the parent (the partner). Candidates must read the question requirement carefully and ensure that answers
provide the necessary (and accurate) detail. To avoid an unclear answer, think: ‘what is the issue?’, ‘why is this
an issue?’, and ‘how can this issue be overcome?’.
QUESTION 8
Common error: Not stating audit procedures clearly.
First, it is unclear which ‘invoice’ or ‘ledger’ the answer refers to. Stating sales invoice and debtors ledger would
at least show which transaction cycle was being tested regarding what is being ‘checked’. Stating that the
invoice number and sales amount have been recorded in the correct customer’s account in the sales ledger
provides the necessary detail. Lack of necessary explanation is a very common error in auditing answers. To
overcome this weakness, practise answering questions to ensure answers do contain the necessary detail.
QUESTION 9
Common error: Confusion regarding fundamental ethical principles.
This statement is false. An auditor’s independence can be affected by many things, but it is not a fundamental
principle of ACCA. A significant minority of answers still refer to this ‘principle’.
QUESTION 10: OPTION A
Common error: Lack of understanding of the requirement verb ‘list’.
When the requirement verb ‘list’ is used in an exam question (as is often the case in Paper F8 Question 2, for
example), it simply means provide a list of points, each worth half a mark. Option B shows an answer to the
requirement ‘list and explain’, where some justification for each point is expected. Many candidates appear to
feel ‘safer’ providing an explanation, even when the requirement verb does not ask for it.
The result is some wasted time in the exam because only half a mark is available for the answer to a ‘list’
requirement verb, even for the ‘list and explain’ style answer given as Option B
How many marks did you get?
12 and over
Very well done – perhaps you should consider auditing as a career?
8 to 11
Good work – you are starting to think like an auditing exam candidate.
7 or less
Beware, you may want to increase your knowledge and question answering skills before you attempt the Paper
F8 exam. Hopefully, you have now identified some of the common errors in Paper F8 exam scripts and can avoid
these in the exam itself.
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