AA – HANDOUT
BOOKLET
To be used WITH the AA Notes
www.skans.edu.pk
0
Table of Contents
Sr#
Topics
Page#
1
Audit and Assurance
02
2
Assurance Engagements
04
3
Regulation of Auditors
07
4
Client acceptance/Client continuation
08
5
Planning
10
6
Systems of Internal Controls
18
7
Assertions, Procedures & Evidence
21
8
Receivable Substantive Procedures
23
9
Substantive Procedures Tangible NCA
25
10
Substantive Procedures - Inventory
27
11
Bank and Cash Substantive
29
12
Intangible Non-Current Assets Substantive
30
13
Long-term Loans Substantive
31
14
Trade Payables Substantive
31
15
Payroll Substantive
32
16
Directors’ Emoluments Substantive
33
17
Accounting Estimates Substantives
34
18
Relying on work of an expert
35
19
Review
36
20
Opinion
40
21
Audit Report
45
22
Corporate Governance
48
1
Audit and Assurance
Material
SKANS Notes
Past Exam Pack
Rules
•
•
•
Tests every week-on Saturdays.
Students will not be allowed to sit in classes if tests are missed. At least reschedule tests
with the TA before coming to class after missing test.
Assignments will ONLY be marked if submitted within the deadline.
Assumed Knowledge
2
Syllabus Contents
The AA Exam
Section A – 30 marks
Split into three 10-mark questions.
All OT Case Questions-each question carries 2 marks (MCQs, Multiple Response Questions, Drag
and Drop, Pull Down Menu etc.)
Section B - 70 marks
Split into 3 Constructed Response Questions
1 CR-30 marks
2 CRs-20 marks each (ALL CRs BASED ON CASE SCENARIOS)
3
Assurance Engagements
Who Needs Assurance and Why?
Shareholders
Public Co.
Also known as Quoted,
Floated, Listed Co.
Directors
Elements of Assurance Engagement
1. Three Party Relationship
2. Subject Matter
3. Suitable Criteria
4. Evidence
5. Report
4
Example
ABC Co. has applied for a loan from Big Bank. The Big Bank is considering the application and have
asked the Directors of ABC Co. to submit the external auditors’ report verifying the valuation of
tangible noncurrent assets in accordance with the applicable standards as these assets will be
held as security for loan.
Identify the elements of assurance engagement from the example above.
Types of Assurance
Reasonable Assurance Limited Assurance
Example
ABC Co has applied for a loan from BG Bank. The bank has asked the directors to provide verified
profit and cash flow forecasts along with the loan application. ABC’s directors have hired their
audit firm to provide an assurance on the forecasts.
What kind of assurance will be provided by the auditors on the profit and cash flow forecasts?
5
No assurance Assignments
1. Agreed Upon Procedures
2. Compilation Engagements
General Principles of External Audit
General
Principles
Compliance
with Ethics
Compliance
with ISA
Professional
Judgment
Professional
Skepticism
SAE
Inherent Limitations of External Audit
1. Sampling
2. Materiality
3. Subjectivity
4. Evidence-persuasive not conclusive
5. Limitations of Internal Controls
6
Regulation of Auditors
Note: ENSURE that you READ the ENTIRE chapter 2 from SKANS Notes.
Eligibility
- Exams of an RQB
- Membership of an RSB
Appointment and Removal of Auditors
1. Appointment of Auditors
2.
Forced
Removal
Removal of
Auditors
Resignation
Do not seek Reappointment
International Standards on Auditing
Who makes them?
IFAC
IAASB
Task Force
How are ISAs made?
Research
Debate
Public Feedback
Incorporate
Feedback
Approval
7
Client Acceptance/Client Continuation
How do Clients Approach Audit Firms?
Approach an
Audit Firm
Advertisement
Tender
Referral
Before Accepting an Audit Client
1. Resources
2. Independence
3. Clearance from the outgoing auditor
4. Client Screening
5. Preconditions of Audit
1. Resources
2. Independence
3. Clearance from the Outgoing Auditor
4. Client Screening
8
5. Pre-Conditions of Audit
Agreeing Terms of Engagement
Contents of Engagements Letter
Changes to the Engagement Letter
Changes to
Engagement Letter
Misunderstanding
Changes in Senior
Management
Changes in FRF
Changes in nature
and size
Changes in terms
9
Planning
Audit Strategy
Understanding the
Business
Risk Assessment
Materiality
Scope, Timing &
Direction
1. Understanding the Business
What Auditors Should Know
Understanding the Business
The entity and its
environment
The applicable reporting
framework
The components of systems
of internal controls
Sources of Information Auditors Use
10
2. Risk Assessment
Audit Risk
Inherent Risk
Control Risk
Detection
Risk
How is Risk Assessed?
Ways to Assess Risk
Making enquires
of mgt and others
Analytical
procedures
Observation and
Inspection
11
3. Materiality
Types Of
Materiality
Material By
Nature
Material By
Amount
Levels of Materiality
Planning Materiality
Performance Materiality
4. Scope, Timing & Direction
Scope
Timing
Direction
12
Interactive activity- examples for AA past exams
Risk of material misstatement in the F/S
The company’s financial accountant was
taken ill suddenly during the year and a
temporary accountant has been drafted in
to help prepare the financial statements.
Total assets linked bonuses are given to
directors
The client intends to undertake listing in
the next 12 months.
The client is holding a number of items in
inventory and the inventory holding period
has increased from 45 days to 54 days.
There is a significant amount of Work in
progress in inventory at the year end.
Inventory purchased from an overseas
supplier. The goods are in transit for weeks.
Client has responsibility of goods once
despatched by the supplier.
Client values its inventory at the lower of
cost NRV. Cost includes both production
and general overheads.
Year end: 31 December 2022
The client is planning to undertake the full
year-end inventory counts after the year
end (on 4 Jan 2023) and then adjust for
movements from the year end.
13
Company was sued by customer during the
year, decision pending at yearend.
Client is a retailer offering customers a
three months product warranty which
covers any defects. It is anticipated that the
warranty provision will decrease as
products are built to a high quality
Client sells TVs. It has a returns policy which
allows a customer to return goods within
28 days of purchase if they are not satisfied
with the product.
New accounting system during the
year/changes in accounting system
New accounting standard implemented
Client purchased and installed a new
manufacturing line. The costs include
purchase price ($2·2m), installation costs
($0·4m) and a five-year servicing and
maintenance plan ($0·5m). All costs,
incurred in the purchase and installation of
that asset, have been included within
property, plant and equipment.
Significant staff costs incurred in preparing
site for machine installation, all costs
included in wages and salaries.
Company spent $0.75m on refurbishing
stores. All of this expenditure has been
recognised in the statement of financial
position as property, plant and equipment
The client is a gym. Members pay
membership fee for 3 years in advance.
Client records all fee as revenue in the year
the fee is paid.
Internally developed software shown in the
SOFP at $5 million.
14
Company spent $1.8m on research and
development. $0.6m was expensed out in
research while $1.2m was capitalized as
development expense.
Company obtained an interest-bearing
bank loan during the year. The bank loan is
payable in five equal annual instalments.
PPE revalued during the year
Loss of key customer
Directors have left the company
No cash at bank, instead have an overdraft.
Current and quick rations are worsening.
Payables payment period has increased
from 32 days to 79 days
Terms of existing loan being re-negotiated
as client was unable to pay according to the
original terms
Applied for a new loan without which they
cannot make investments which are
essential for the client’s survival
Client outsourced its sales ledger
processing to an external service
organisation.
An expert has been used for valuation.
External Auditors wants to use the work of
Internal Auditors for testing internal control
systems.
Useful life of PPE has been extended
Receivable collection days have increased
from 35 days to 65 days. FD does not want
to increase the allowance this year.
15
An amount of $2 million paid to an athlete
for collaboration regarding advertising for a
period of 2 years. The entire amount has
been recognized as a marketing expense in
the current year.
Reconciliations not performed for e.g the
year end BRS was not done.
Unreconciled differences on some of the
reconciliations
Year end: 31 December 2022
Early close down of purchase ledgers
(purchase ledger closed down on 27 Dec
2022)
Late close down of sales ledger (sales
ledger closed down on 05 January 2023)
Client raised new finance through issuing
$1·1m of shares at a premium.
When letter sent to outgoing auditor, they
replied to say lots of problems in the
purchase system (i.e., weak internal control
over purchases)
A patent has been purchased for $1·1m and
this grants client the exclusive right for
three years to customize their portable
music players. Management has expensed
the full amount paid to the current year
statement of profit or loss.
Year end: 31 Aug 2015
The company breached the terms of its
overdraft facility in June 2015 and the bank
will only confirm the decision whether, or
16
not, to continue to support the business in
November 2015, which is after the
auditor’s report will be signed. The
company is dependent on the overdraft
facility.
Year end: 30 Sept 2015
Client placed an order for $2.4m of
machinery, paying $1m in advance. The
machinery was due to be received in July
2015 but will now be delivered post year
end.
Year end: 30 June 2015
On 29 May 2015, the directors announced
that a product was being discontinued
resulting in four members of staff being
made redundant. The costs of redundancy
are being included in the July 20X5 payroll
run.
A customer has returned $120,000 of faulty
goods to the company prior to the year-end
but a credit note is yet to be issued.
Detection risks (examples from AA Past exams)
- New audit client
-
Pressure to reduce time taken for conducting audit
-
Pressure to reduce testing
-
Inappropriate composition of audit team (unskilled team, junior members)
-
Auditor is unable to attend inventory counts at all locations
-
Client has outsourced a part of their accounting to a service organization
17
Systems of Internal Controls
What are Controls?
Responsibilities Regarding Controls
Responsibilities
Management
Auditors
Responsibilities of Auditors
Components of ICS
1. Understanding Components of Internal Controls
Control Environment
Risk Assement
Indirect Controls
Monitoring Controls
Control Activities
Direct Controls
Information and
Communication systems
18
2. Document
Documentation of
Controls
Narratives
Flowcharts
Questionnaires
3. Test
4. Report
5. Decide Extent of Substantive Procedures
Exam Focus
19
20
Assertions, Procedures & Evidence
Accepting Audit
Engagements
Planning
Substantive
Tests
TOCs
Review
Opinion and
Reporting
Substantive Procedures – What they are.
Procedures applied by auditors to test management assertions and gather sufficient
appropriate audit evidence to form a conclusion.
Management Assertions
Statement of Financial Position
1. Existence
Statement of Profit or Loss
1. Occurrence
2. Completeness
2. Completeness
3. Accuracy, Valuation and Allocation
4. Accuracy
4. Rights and Obligations
5. Cut-Off
5. Classification
5. Classification
6. Presentation and Disclosure
6. Presentation and Disclosure
21
Sufficient Appropriate Audit Evidence
Factors Affecting Sufficiency
1. Risk
Factors Affecting Appropriateness
1. Independent source
2. Materiality
2. Generated by the auditors
3. Controls
3. Collected from management
4. Auditors’ knowledge and experience
4. Written/Documented evidence
5. Reliability of Evidence
5. Original documents
Substantive Procedures
1. Substantive Analytical Procedures
2. Inspection
3. Inquiry
4. Observation
5. External Confirmation
6. Recalculation
7. Reperformance
22
Receivable Substantive Procedures
Balance as at 31 December 2023 - $750,000
Step 1:
Balances as per Ledgers
A
$ 200,000
B
$ 50,000
C
$ 250,000
D
$ 150,000
E
$ 100,000
Balance as per Receivable
Letter
Replies
Non Replies
Replies with
Differences
Dispute
Cash in
transit
Goods in
transit
Step 2: Verify assertions
Existence:
23
Completeness:
Rights & Obligation:
Accuracy, valuation, allocation
Year End Balances
Recoverability
Allowance for doubtful debts
24
Substantive Procedures Tangible NCA
Yearend balance as at 31 December 2023-$7,800,000
Step 1:
Land and Building
Plant and Machinery
Computer Equipment
Motor Vehicles
Fixtures and Fittings
$
1,800,000
3,500,000
2,000,000
300,000
200,000
Step 2:
Step 3:
Step 4: Test Assertions
Existence:
Completeness:
Rights & Obligation:
25
Accuracy, valuation, allocation
New Additions
Disposals
Revaluation
Depreciation
26
Substantive Procedures- Inventory
Inventory Balance as at 31 December 2022 - $560,000
Inventory
Raw Material
$250,000
Work in Process
$160,000
Finished Goods
$150,000
Inventory Count
Before
During
After
1. Existence
2. Completeness
3. Rights and Obligations
27
4. Cut Off
5. Accuracy, Valuation and Allocation
a) Cost of Raw Material
b) Work in Process
c) NRV
1. Aged/Obsolete Inventory
2. Damaged inventory
3. Estimated Costs to Sell
4. Estimated Selling Price
5. NRV Calculation
IMPORTANT: LEARN inventory related procedures from the BOOK! (inventory at third party and
perpetual inventory)
28
Bank and Cash Substantive
Balance as at 31 December 2023 - $700,000
Cash in Hand
$
50,000
Cash at Bank
ABL
UBL
SCB
250,000
180,000
220,000
Bank Confirmation Letter – Contents
1. No. of bank accounts
2. Title of accounts
7. no of loans outstanding
8. outstanding balance of loan
3. Balance at year end
9. Nature of loans
4. No. of accounts opened and closed
10. Assets held as security
during the year
5. Accounts with nil balances
6. Nature of accounts
Bank Reconciliation Statement
Balance as per the bank statement as at 31 Dec 2023
$39,000
Add cheques deposited by client but not credited by bank
$5,000
Add bank charges not recorded in the cash book
$70
Less cheques issued by client but not presented to the bank
($9,500)
Balance as per the cash book as at 31 Dec 2023
$34,570
29
Intangible Non-Current Assets Substantive
Research and Development as at 31 December 2023 $670,000
1. Break up Schedule
2. Classification
3. Probable economic benefits
4. Intention
5. Resources
6. Ability
7. Technical feasibility
8 Expense measured reliably
9. Amortization
10. useful life
11. Disclosures
Acquired Patents as at 31 December 2023 $1.1m
1. Cost:
2. Approval:
3. Right:
4. Amortization:
30
Long-term Loans Substantive
Loan balance:
Completeness of new loans during the year:
The rate of interest chargeable; repayment terms; any security provided; any covenants:
Finance cost
Verify split
Disclosures
Trade Payables Substantive
Completeness
• Compare to last year ( total payables as well as individual supplier balances)
• Trade payable days with last year
• Supplier list to last year list
• Audit trail: ________________ to ____________
• Reconciliation of PL to PLCA ( review reconciliation done by client)
• Reconciliation of PL to PLCA ( Re-perform! If differences, why? Invoice in transit? Cash in transit? Any
other adjusting tem?
• Review post year end payments- GRN date?
• Review invoices received post year end- GRN date?
Existence:
Accuracy, valuation, allocation:
31
Payroll Substantive
Substantive Analytical Procedures
1. Total expense to last year and budget
2. Monthly expense to corresponding periods last year and budget
3. Proof in total: take last year’s expense, incorporate changes due to 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. Obtain break up schedule
2. For a sample of employees:
a) Gross Pay/Net Pay
b) Statutory deductions
3. Evidence of Leavers/Joiners
4. First/Last pay of Leavers and Joiners
4. Match total NET PAY to Bank transfer list and cashbook.
5. Confirm Bona fide employees
6. Overtime
32
Directors’ Emoluments Substantive
1. Break up schedule
2. Basic Salary
•
Accuracy
•
Payment
3. Bonus
•
Approval
•
Accuracy
•
Eligibility
•
Payment
4. Benefits in Kind
•
Approval
•
Nature
•
Accuracy
5. Completeness of Remuneration
6. Disclosure
33
Accounting Estimates / Substantives
Law suits Provision/Contingency
1. Completeness of law suits
2. Nature of law suit
3. Likelihood of outcome
4. Amount involved
5. Assumptions underlying treatment
6. Disclosures
Redundancy Provision
1. Break up schedule
2. Approval and Announcement of redundancy
3. Accuracy of provision
4. Payment
5. Completeness of provision
6. Disclosure
Reorganization Provision
1. Break up schedule
2. Approval
3. Training/Retraining costs
4. Amount/Costs
34
5. Completeness
6. Disclosure
Relying on Work of an Expert
Expert should be:
Qualified (member of a professional body or industry association)
Experience
Independent
Expert’s Report should have:
Evaluating the Adequacy of the Auditor’s Expert’s Work (the audit procedures carried out to
evaluate the work done by the expert!)
Source Data
Assumptions
Conclusions
Service Organizations and Audit
EY (auditors)
Accounting Dept
In-house
Tetra Pak
Payroll Processing
Outsourced
Factors to Consider
1. understand outsourced areas-material?
2. control design and operation need to be checked
3. Who should check controls?
4. May need to use the work of service organization’s auditors
35
Review
Review of Financial
Statements
Subsequent Events
Going Concern
Written
Representation
Overall Review of
Financial Statements
Subsequent Events Review
Types of
Events
Adjusting
Events
Non-Adjusting
Events
Affect Going
Concern
Material but
do not affect
Going Concern
36
Auditors’ Responsibilities Regarding Subsequent Events
Year End
F/S
Approved
Audit
Report
Signed
AGM
Procedures to Identify
1. Enquire:
2. Minutes of Board meetings
3. Written Representation
4. Inspection of post year end F/S
5. Normal post year end work
Facts discovered after the financial statements have been issued.
(a) Discuss the matter with management and, where appropriate, those charged with governance;
(b) Amendment needed; and, if so,
(c) Inquire how management intends to address the matter in the financial statements.
If management amends the financial statements, the auditor shall:
(a) Carry out the audit procedures necessary in the circumstances on the amendment.
(b) Consider if audit report needs to be revised and issued.
37
Going Concern
Impact of
GC on F/S
Uncertainty
re GC
Company is
NOT a GC
Responsibilities Regarding GC
Responsibilities
Management
Auditor
Assesses if
Management
Assumption is correct
Checks adequacy of
disclosure
38
Written Representations/Management Representation Letter
Purpose of Written Representation
Refusal to Sign Written Representation
Overall Review of Financial Statements
1. Checklists
2. Accounting policies and disclosures
3. Final analytical review
4. Consider sufficiency of audit evidence
5. Consider adequacy of audit procedures
6. Discuss uncorrected misstatements
39
Opinion
40
Examples
Example 1: It is 1 July 20X5. Pacific Co operates a chain of 14 retail stores across the country, selling its
own range of cosmetic products. You are the audit supervisor of Caribbean & Co and the final audit is due
to commence shortly for the year ended 31 May 20X5. Draft financial statements show revenue of $45.2m
and profit before tax of $4.1m.
In March 20X5, a number of claims were received by the company from customers who suffered severe
allergic reactions after using one of Pacific Co's products. They allege that the product ingredients listed
on the label were incorrect. An internal investigation has suggested that one batch of the product had
been incorrectly labelled. The finance director has recognised a provision in the draft financial statements
of $0.5m.
During the audit of Pacific Co's provision for the legal claims, the audit team gathered audit evidence
showing that the provision should amount to $0.8m. The finance director has suggested that no
adjustment is made in the 20X5 financial statements as he believes $0.5m is a reasonable estimate and
that the difference of $0.3m is not material.
Example 2: Canopus Co manufactures paint products in seven factories across the country and the draft
financial statements show total equity and liabilities of $11.6m.
Canopus Co recently announced plans to fundamentally restructure its production processes due to a
change in the focus of the company’s operations. It has included a $2.1m restructuring provision in the
draft financial statements. The restructure involves a refurbishment of the factories, the purchase of new
plant and equipment and retraining of existing staff. These plans were finally agreed at a board meeting in
March 20X5 and announced to shareholders and employees just before the year end.
During the audit of Canopus Co's restructuring provision, the audit team discovered that $270,000 of costs
included did not meet the criteria for inclusion as per IAS 37 Provisions, Contingent Liabilities and
Contingent Assets. The finance director has suggested that no adjustment is made in the 20X5 financial
statements as the provision is a matter of judgement and the provision has been deemed reasonable by
the board.
Example 3: It is 1 July 20X5. You are an audit supervisor with Velo & Co and you are working on the final
audit of Encore Co for the year ended 30 April 20X5. Encore Co is a waste management company,
supplying its services to a variety of governmental and business organisations. Encore Co's draft profit
before tax is $5.3m (20X4: $4.6m) and total assets are $40.1m (20X4: $33.9m). You have been provided
with the following information regarding the draft financial statements.
41
Potential breach of transport regulations
In March 20X5. a former employee of Encore Co made a complaint to the transport authority, alleging
that Encore Co has breached the regulations concerning maximum driving hours and compulsory rest
breaks for drivers on a number of occasions. The transport authority has launched an investigation but
the directors of Encore Co are not intending to disclose this issue or make any provision as they do not
believe that the potential fine, which is $50,000 per breach, is material.
It is now 26 August 20X5 and the auditor's report for Encore Co is being finalised. On 12 August 20X5. the
transport authority announced that it was taking legal action against Encore Co in respect of 17 breaches
of the regulations. Encore Co's lawyers have advised that it is probable Encore Co will be found guilty of
all of the breaches. Encore Co s directors have informed you that no provision will be made in respect of
this matter, as the decision by the authority to take legal action was made after the year end, but they
have agreed to disclose the issue in the notes to the financial statements.
Example 4: You are an audit manager of Cranberry & Co and you are currently responsible for the audit of
Gooseberry Co, a company which develops and manufactures health and beauty products and distributes
these to wholesale customers. Its draft profit before tax is $6·4m and total assets are $37·2m for the
financial year ended 31 January 20X8. The final audit is due to commence shortly and the following matters
have been brought to your attention:
Gooseberry Co spent $1·9m in the current year developing nine new health and beauty products, all of
which are at different stages of development. Once they meet the recognition criteria under IAS® 38
Intangible Assets for development expenditure, Gooseberry Co includes the costs incurred within
intangible assets. Once production commences, the intangible assets are amortised on a straight-line basis
over three years. Management believes that this amortisation policy is a reasonable approximation of the
assets’ useful lives, as in this industry there is constant demand for innovative new products.
During the audit, the team discovers that the intangible assets balance includes $440,000 related to one
of the nine new health and beauty products development projects, which does not meet the criteria for
capitalisation. As this project is ongoing, the finance director has suggested that no adjustment is made in
the 20X8 financial statements. She is confident that the project will meet the criteria for capitalisation in
20X9.
Example 5: Dashing Co manufactures women’s clothing and its year end was 31 July 20X7. You are an
audit supervisor of Jaunty & Co and the year-end audit for Dashing Co is due to commence shortly.
The draft financial statements recognise profit before tax of $2·6m and total assets of $18m.
42
A few months have now passed and the audit team is performing the audit fieldwork including the audit
procedures which you recommended over the redundancy provision. The team has calculated that the
necessary provision should amount to $305,000. The finance director is not willing to adjust the draft
financial statements.
Example 6
Company yearend: 30/06/23
PBT: $5.75million
Lawsuit pending at yearend. Confirmation letter has been sent to the lawyer and they have confirmed that
it is highly likely client would have to pay $7m in damages. The client has included a disclosure in financial
statements regarding this and have refused to make any other adjustments.
Example 7
Company yearend: 31/12/23
PBT: $10million
Lawsuit pending at yearend and a disclosure regarding the lawsuit given for an amount of $0.8m. The
lawyer has confirmed that it may be possible that the company will have to pay this amount but is hopeful
that the outcome will favor the client. The auditor has sufficient audit evidence to suggest that the
disclosure is adequate.
Example 8
Weapons manufacturer
Yearend: 30/06/21
Revenue: $8.5million
Client has said that the government is the biggest customer. They have signed a confidentiality agreement
with the government that confidential information will not be disclosed as the matter is sensitive.
Management has refused to give the auditors access to documents related to revenue.
Example 9:
Yearend: 31/12/2023
PBT: $10m
Inventory: $2.1m
$0.5m of inventory was held in an off-site rented warehouse where the auditors could not attend
inventory count due to travel restrictions. A confirmation letter was sent to the third party but no reply
was received.
43
Example 10:
Yearend: 31/12/2020
Client has a significant loan that is being negotiated with the bank at yearend and no decision was made
at yearend on whether the loan will be given or not. The loan is essential for operations and expansion as
the company is looking to maintain its position in the market where competition has recently become
tough. The directors have refused to disclose the uncertainty.
44
Audit Report
Audit Report
Unmodified
Modified
Changes in
Opinion
Material
Uncertainty re
Going Concern
Additional
Paragraphs
Other Matter
Paragraph
Emphasis of
Matter
Paragraph
45
Unmodified Audit Report Contents
1. Title
2. Addressee
3. Opinion Para
4. Basis for Opinion para
5. Key Audit Matters
6. Other Information in Document Containing F/S
7. Responsibilities of Management
8. Responsibilities of Auditors
9. Report on Other Legal and Regulatory Matters
10. Engagement Partners Name and Signature
11. Address and Date
46
Examples
Example 1: Humphries Ltd operates a chain of food wholesalers across the country and its year end was
30 September 2011. The final audit is nearly complete and it is proposed that the financial statements and
audit report will be signed on 13 December. Revenue for the year is £78 million and profit before taxation
is £7·5 million. The following events have occurred subsequent to the year end.
A customer of Humphries Ltd has been experiencing cash flow problems and its year-end balance is £0·3
million. The company has just become aware that its customer is experiencing significant going concern
difficulties. Humphries believe that as the company has been trading for many years, they will receive
some, if not full, payment from the customer; hence they have not adjusted the receivable balance.
Example 2
Yearend: 31/12/23
Profit: $5.75m
The client had a law suit worth $1.22m pending at yearend. The lawyer confirmed that while there was a
possibility that the lawsuit may result in an outflow, there was good chance that the outcome will be
favorable for the client. The management has given a disclosure for the law suit in notes to the financial
statements.
Example 3
Yearend: 31/12/2020
Client has a significant loan that is being negotiated with the bank at yearend and no decision was made
at yearend on whether the loan will be given or not. The loan is essential for operations and expansion as
the company is looking to maintain its position in the market where competition has recently become
tough. The directors have given a disclosure for the uncertainty regarding going concern.
Example 4
You are the audit manager of Violet & Co and you are currently reviewing the audit files for several of your
clients for which the audit fieldwork is complete. The audit seniors have raised the following issues:
Daisy Designs Co (Daisy)
Daisy’s year end is 30 September, however, subsequent to the year end the company’s sales ledger has
been corrupted by a computer virus. Daisy’s finance director was able to produce the financial statements
prior to this occurring; however, the audit team has been unable to access the sales ledger to undertake
detailed testing of revenue or year-end receivables. All other accounting records are unaffected and there
are no backups available for the sales ledger. Daisy’s revenue is $15·6m, its receivables are $3·4m and
profit before tax is $2m.
Fuchsia Enterprises Co (Fuchsia)
Fuchsia has experienced difficult trading conditions and as a result it has lost significant market share. The
cash flow forecast has been reviewed during the audit fieldwork and it shows a significant net cash outflow.
Management are confident that further funding can be obtained and so have prepared the financial
statements on a going concern basis with no additional disclosures; the audit senior is highly sceptical
about this. The prior year financial statements showed a profit before tax of $1·2m; however, the current
year loss before tax is $4·4m and the forecast net cash outflow for the next 12 months is $3·2m.
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Corporate Governance
How is it adopted worldwide?
Basic Guidelines of Corporate Governance
Board
Structure
Sub
Committees
of the Board
Internal
Audit
Corporate
Governance
Guidelines Regarding Board Structure
1.
2 types of directors- EDs and NEDs
2.
Segregation in CEO and Chairman roles
3.
Balance in the board-Numbers and skills
4.
Diversity
5.
Sub committees of the board
6.
Induction
7.
CPD
8.
Annual performance appraisal
9.
Re-election ever 3 years
10. Regular board meetings (with agenda and minutes).
11. The company should have a sound system of internal control.
12. There should be adequate risk management.
13. There should be an internal function
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14.
Transparency in the annual report is important.
15.
Institutional shareholders should intervene in the company when needed.
Guidelines Regarding Sub-Committees
Sub Committees
Nomination
Committee
Remuneration
Committee
Risk
Management
Committee
Audit Committee
Guidelines Regarding 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.
Internal audit’s role in preventing and detecting fraud and error
- Assess main areas of fraud risk
- Assess adequacy and effectiveness of control systems.
- Regular reviews of compliance of controls.
- Detailed fraud investigation
- The presence of an internal audit department can itself act as a fraud deterrent
Independence of Internal Auditors
- monitor and review controls
- report to the audit committee
- be free to decide on the nature and scope of their work;
- be free to communicate fully with the external auditors
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Factors determining need of internal audit
1. Cost-beneficial?
2. Size and complexity of operations, number of employees
3. Changes in key risks and processes
4. Problems with existing controls
5. Need of special assignments that normally internal audit carries out.
The Difference Between Internal and External Audit
Internal Audit
External Audit
Appointment Process
Management
Shareholders
Objective
Effectiveness of ICS
Report to
Addressed to the Board
(not publicly available)
Related to operations of
the company
Employee or Outsourced
Express an opinion on truth
and fairness of F/S
Shareholders
Scope
Relationship with the
Organization
Planning and Evidence
Collection
Related to F/S
Independent
No materiality and
Materiality, Risk based
primarily internal evidence approach
Internal and external
evidence both
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