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AUDIT AND ASSURANCE(INTERNATIONAL)
Paper
F8
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ACCA QUALIFICATIONCOURSE NOTES
JUNE 2012 EXAMINATIONS
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F1 Accountant in Business / FAB Foundations in Accountancy
F2 Management Accounting / FMA Foundations in Accountancy
F3 Financial Accounting / FFA Foundations in Accountancy
F4 Corporate & Business Law (English & Global)
F5 Performance Management
F6 Taxation (UK)
F7 Financial Reporting
F8 Audit and Assurance
F9 Financial Management
P1 Governance, Risk & Ethics
P2 Corporate Reporting
P3 Business Analysis
P4 Advanced Financial Management
P5 Advanced Performance Management
P6 Advanced Taxation (UK)
P7 Advanced Audit & Assurance
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1
ACCA Paper F8 – Audit and assurance
June 2012 Exams
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Syllabus
A Audit framework and regulation
B Internal audit
C Planning and risk assessment
D Internal control
E Audit evidence
F Review
G Reporting
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Examiner and Exam Format
Examiner December 2011: Pami Bahl
Format of the Exam
Question 1 Application of audit procedures to a scenario 30
Question 2 Short factual questions on ISAs and other knowledge-based areas 10
Question 3 Questions with short practical scenarios covering topics such as: internal audit, risk assessment, planning , controls, evidence, conclusions and reporting
20
Question 4 20
Question 5 20
Total 100
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Assurance
It is often not possible to check the situation yourself
Skill? Time? Location?
Therefore rely on someone else
Standards? How much checking?
Report
Audit is only one form of assurance
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There are the five elements in an assurance engagement:
• A three party relationship involving a practitioner, a responsible party, and intended users
• An appropriate subject matter
• Suitable criteria
• Sufficient appropriate evidence
• A written assurance report in the form appropriate
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Three party relationship
• Practitioner: for example an auditor. Responsible for determining the nature, timing and extent of procedures and must pursue doubts and queries
• A responsible party: the person responsible for the
information and assertions
• The intended users: the person(s) for whom the practitioner prepares the assurance report. The responsible party can be one of the intended users.
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Appropriate subject matter
Many types: • Financial performance • Non-financial performance eg the key indicators of efficiency
and effectiveness.
• Physical characteristics eg capacity of a facility. • Systems and processes eg an entity’s internal control or IT
system • Behaviour eg corporate governance, compliance with
regulation
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Appropriate subject matter
Must be: • Identifiable, and capable of consistent evaluation or
measurement against the identified criteria
• Such that the information about it can be subjected to procedures for gathering sufficient appropriate evidence.
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Criteria
Criteria are the benchmarks used to evaluate or measure the subject matter. Without the frame of reference provided by suitable criteria, any conclusion is open to individual interpretation and misunderstanding.
Examples:
• Financial Statements: IFRS • Internal Control: an internal control framework. • Compliance: the applicable law, regulation or contract.
They must be available to intended users
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Suitable criteria
Suitable criteria exhibit the following characteristics: • Relevance: contribute to conclusions that assist decision-making
by the intended users. • Completeness: include all relevant factors that could affect the
conclusions.
• Reliability: allow reasonably consistent evaluation of the subject matter.
• Neutrality: so that conclusions that are free from bias.
• Understandability: to allow conclusions that are clear, comprehensive, and not subject to significantly different interpretations.
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Evidence
• Professional scepticism • Sufficient, appropriate evidence
Sufficiency = quantity of evidence. Appropriateness = quality of evidence (relevance and its reliability)
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Assurance report
A written report containing a conclusion. Positive form (reasonable assurance engagement): “In our opinion internal control is effective, in all material respects, based on XYZ criteria.” Negative form (limited assurance engagement): “Based on our work described in this report, nothing has come to our attention that causes us to believe that internal control is not effective, in all material respects, based on XYZ criteria.”
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Assurance report
A practitioner does not express an unqualified conclusion for either type of assurance engagement when: • There is a limitation on the scope of the
practitioner’s work.
• The assertion is not fairly stated, and the subject matter information is materially misstated.
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Corporate governance
Corporate governance: the system by which companies are directed and controlled
Historically:
• Annual general meeting once a year
• Accounts once a year
• Audited once a year
• Directors’ board meetings - often (but not always) frequently
• Directors’ conversations and meetings - frequently
Corporate governance: the system by which companies are directed and controlled
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Recent Corporate Failures
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OECD Principles of Corporate Governance
• Fairness, including foreign and minority shareholders
• Disclosure and transparency
• Independence
• Probity, honesty
• Responsibility and accountability
• Reputation
• Judgement
• Integrity
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The UK Corporate Governance Code
The purpose of corporate governance is to facilitate effective entrepreneurial and prudent management that can deliver long-term success of the company
Main principles
• Leadership • Effectiveness • Accountability • Remuneration • Relations with shareholders
The ‘‘comply or explain’’ approach is the trademark of corporate governance in the UK.
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The UK Corporate Governance Code
Leadership
• Every company should be headed by an effective board which is collectively responsible for the long-term success of the company.
• There should be a clear division … between the running of the board and the executive responsibility for the running of the company’s business. No one individual should have unfettered powers of decision. [Split roles of CEO and Chairman]
• The chairman is responsible for leadership of the board
• Non-executive directors [NEDs] should constructively challenge and help develop proposals on strategy.
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The UK Corporate Governance Code
Effectiveness • Appropriate balance of skills, experience, independence and
knowledge. [NEDS ≥ 50% board; ≥ 2 in small companies ]
• A formal, rigorous and transparent procedure for the appointment of new directors to the board [Nomination committee]
• All directors should be able to allocate sufficient time
• Induction on joining the board and update and refresh their skills and knowledge.
• The board should be supplied in a timely manner with necessary information.
• The board should undertake a formal and rigorous annual evaluation of its own performance and that of its committees and individual directors.
• All directors should be submitted for re-election at regular intervals
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The UK Corporate Governance Code
Accountability • The board should present a balanced and understandable
assessment of the company’s position and prospects.
• The board is responsible for determining the … significant risks …should maintain sound risk management and internal control systems.
• The board should establish formal and transparent arrangements for applying the corporate reporting, risk management and internal control principles, and for maintaining an appropriate relationship with the company’s auditor. [Audit committee. Must examine internal control. Must consider need for internal audit].
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The UK Corporate Governance Code
Remuneration
• Levels of remuneration should be sufficient to attract, retain and
motivate directors of sufficient quality… but avoid paying more than is necessary.
• A significant proportion of executive directors’ remuneration should be structured so as to link rewards to corporate and individual performance.
• There should be a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors. No director should be involved in deciding his or her own remuneration. [Remuneration committee]
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The UK Corporate Governance Code
Relations with shareholders • There should be a dialogue with shareholders based on the mutual
understanding of objectives. The board as a whole has responsibility for ensuring that a satisfactory dialogue with shareholders takes place.
• The board should use the AGM to communicate with investors and to encourage their participation.
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Audit committee
Liaison with external auditors:
• Scope of external audit
• Forum to link directors/auditors
• Deal with auditors’ reservations
• Obtain information for auditors.
Review of internal audit
Special investigations
Review of internal control Financial Statements
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Internal audit
• It functions by examining, evaluating and reporting to management and the directors on the adequacy and effectiveness of internal control.
• It is a key part of effective corporate governance.
• Importance referred to in UK Combined Code of Corporate Governance – directors must review need for internal audit department
• Would normally report to the audit committee
Internal audit is an appraisal or monitoring activity established by management and directors for the review of
internal control as a service to the entity.
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Internal audit
• Helps achievement of corporate objectives
• Aids risk assessment and management
• Improves efficiency, effectiveness and economy
• Designs internal control system
• Checks operation of internal controls system
• Value for money audits
• Test IT controls
• Liaises with external auditors/shares work
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Definition of an audit
An audit is the independent examination of, and expression of opinion on, the financial
statements of an entity.
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Positive and negative assurance
Positive • The accounts show a true and fair view • The cash flow forecast is correct • The appointment of the employee was fair Negative • We have discovered nothing wrong with the accounts • The basis of the forecast is not unreasonable • There is no evidence of discrimination in the appointment.
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Corporate governance – the purpose of an external audit
Corporate governance: the system by which companies are directed and controlled
Shareholders Directors
Company Own
Appoint
Manage
Financial Statements
Prepare FS
Measure performance
Auditor Appoint independent
Adds credibility
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Stages of an audit
Assess risk of material misstatement
Plan the audit
Auditor’s report
Understand entity
Satisfactory
Tests of controls Report significant deficiencies to those charged with governance
to management and all weaknesses to management
Respond to risk
Expect effective controls
Restricted substantive tests
Expect ineffective controls
Full substantive tests
Overall review of F/S
Report to management
Unsatisfactory
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Interim and final audit
1January 31December
Interim audit. Document system,
procedural tests
Final audit More direct checking
of balances
Planning visit
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… planned and performed the audit to obtain reasonable assurance whether the financial statements are free from material misstatement…. ….in our opinion the financial statements show a true and fair view….
Auditors’ responsibility
• No guarantees • Not every error discovered • Not certifying accuracy
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Relevant to all companies?
Should it be a legal requirement that the financial statements of small entities be subjected to an audit?
Small entities: • Managers and owners the same • Simple trading • Simple records • Limited internal controls which management can override
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Auditors’ rights
• Access to records
• Information and explanations
• Attendance at and notice about general meetings
• Right to speak at general meetings on relevant matters
• Rights to receive proposed resolutions
• Right to resign before audit completion
• Right to have information circulated to the shareholders
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Auditors’ duties
Typical duties: • To issue an audit report, giving opinions on: >truth and fairness of the Financial Statements >whether the Financial Statements are properly prepared >any other opinions required. • When leaving a client, to issue a Statement of Circumstances • After resignation, to supply information to the new auditors.
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Appointment, resignation and removal
Appointment • Resolution at each general meeting (re-appointment not
automatic). • Directors pre first GM and to fill casual vacancy. • Secretary of State
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Appointment, resignation and removal
Resignation
• Auditors give written notice and statement of circumstances
• Written notice sent to regulatory authority by company
• Statement of circumstances sent to members by company; regulatory authority by auditors.
• Auditors can require directors to call an EGM.
• Auditors can receive all notices relating to general meetings relating to their resignation and can speak at those meetings.
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Appointment, resignation and removal
Removal
• Special notice (28 days) sent to auditor
• Auditors can make representations about why they should stay in office.
• If resolution passed, company must notify regulatory authority.
• Auditors must deposit statement of circumstance at company’s office + sent to regulatory authority.
• Auditors can receive notice and speak at GM where their term of office would have expired.
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Who can be an auditor?
• Must pass an approved set of professional examinations, set by a Recognised Qualifying Body (RQB) eg the ACCA
• Must become a member (and stay a member!) of a Recognised Supervisory Body (RSB) eg the ACCA
• The auditor must not be a director or employee of the company, or of any associated companies
• The auditor must not be an employee or business partner of a
director or employee of the company, or of any associated companies.
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Regulation of auditors
International level
National level
The profession
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Regulation of auditors
Education and work experience
Eligibility, such as
membership of a supervisory
body
Supervision and monitoring
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Auditing standards and Quality Control
Recognised Statutory Body For example ACCA National Standards In UK, set by Auditing Practices Board International Standards on Auditing Set by International Auditing and Assurance Standards Board (IAASB) – part of the International Federation od Accountants (IFAC)
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Professional ethics and ACCA’s Code
Fundamental principles
Threats Safeguards
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Fundamental Principles: ACCA’s Code
• Integrity - straightforward and honest
• Professional competence and due care – current developments, legislation and techniques
• Confidentiality – should not disclose information unless a legal or professional right or duty.
• Professional behaviour – comply with the law and avoid any action which discredits the profession
• Objectivity – avoid bias, conflict of interest, undue influence
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Threats to objectivity, integrity and independence
Threats arise from:
• Self-interest
• Self-review
• Familiarity
• Advocacy
• Intimidation
• Management
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Threats to objectivity, integrity and independence
Self-interest threats • Financial. For example, owning shares in the client, • Close business relationships. For example, • Employment (ex-partners >2 years) • Partner on client board • Family and personal relationships • Loans and guarantees • Overdue fees • Contingent fees • High percentage fees • Low-balling • Recruitment for the client
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Threats to objectivity, integrity and independence
Self-review threats
• Recent service with assurance client
• Other services
• Preparing accounting records and accounts
• Valuation services
• Taxation services
• Internal audit services
• Corporate finance
• Other service
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Threats to objectivity, integrity and independence
The problem of supplying multiple services
• For example: taxation, payroll, IT, management consultancy.
• A controversial issue: pros and cons.
• Large firms can use separate departments.
• In the US listed companies are not allowed to obtain other services from their auditor.
• In most jurisdictions, no hard and fast rules.
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Threats to objectivity, integrity and independence
Familiarity threats
• Because of a close relationship, members of the assurance firm become too sympathetic to members of the client firm, so that objectivity and scepticism are lost
• Care needed where senior audit staff have a long association with the client.
• ACCA suggest that the lead partner should be changed at least every 5 years.
• Other partners involved changed at least every 7 years.
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Threats to objectivity, integrity and independence
Advocacy threats • Where the assurance firm promotes a point of view or
opinion to the extent that subsequent objectivity is compromised
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Threats to objectivity, integrity and independence
Intimidation threats • Where the assurance team is deterred from acting properly
by actual or perceived threats. • Examples are actual/threatened litigation. In some cases
there might be physical intimidation.
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Threats to objectivity, integrity and independence
Management threats • Where the auditor begins to make management decisions
for the client.
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Acceptance procedures
• Ensure professionally qualified to act: legal/ethical
• Adequate resources: staff, time
• The fee
• Obtain references: investigate directors
• Audit risk
• Is the accounting reporting framework acceptable?
• Money laundering regulations
• Expertise and competence
• Credit rating of client
• Communicate with present auditors.
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Appointment flowchart Approach by new audit client
1st audit?
Permission to contact old auditor?
Write for information
Permission for old auditors to reply?
Relevant information provided?
Make own decision
Decline appointment
Give old auditor notice and use information
obtained in other ways
Accept/reject
No
No
No
No
Yes
Yes
Yes
Yes
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Engagement letters
• Define auditors’/management responsibilities
• Written evidence of auditors’ acceptance
• Send to board of directors/or audit committee prior to first audit
• Identify any reports to be produced in addition to audit report
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Engagement letters
• Objective of audit
• Management responsibilities
• Applicable reporting framework
• Test nature – inherent responsibilities
• Unrestricted access to records
• Confidentiality of reports
• Planning
• Fees
• Internal audit.
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Stages of an audit
Assess risk of material misstatement
Plan the audit
Auditor’s report
Understand entity
Satisfactory
Tests of controls Report significant deficiencies to those charged with governance
to management and all weaknesses to management
Respond to risk
Expect effective controls
Restricted substantive tests
Expect ineffective controls
Full substantive tests
Overall review of F/S
Report to management
Unsatisfactory
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ISA 300 Audit planning
• Plan audit work…..effective manner
• General strategy detailed approach
• Planning objectives are:
Appropriate attention to important areas
Identify potential problems
Work completed expeditiously
Proper staffing and work assignment
Coordination with other parties
Facilitate review
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Risk
Total risk
Business risk
• Financial risk
• Operational risk
• Compliance risk
Audit risk = risk of inappropriate opinion
ISA 315 – auditor should obtain an understanding of the entity and its environment…sufficient to identify and assess the risk of material misstatement in the financial statements..
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Risk assessment – audit risk model
AR = IR x CR x DR
Control risk
Risk of material misstatement
Audit Risk
Non-sampling Risk Sampling Risk
Detection Risk Inherent Risk
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Assessing risk ISA 330
• To reduce audit risk to an acceptable level determine responses at the financial statement level and the assertion level
• Financial statement level: more experienced staff, more supervision, professional scepticism
• Assertion level: design and perform audit procedures whose nature, timing and extent are responsive to the assessed risks of material misstatement.
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Risk assessment – audit risk model
Inherent risk – susceptibility to misstatement that could be material…assuming no related internal controls
Complex transactions, inexperienced staff, cash-based business, pressure to perform
Control risk – risk that a material misstatement will not be prevented, detected or corrected
Control environment Design of internal control
Operation of internal control
Detection risk – failure of the auditor to detect a material misstatement
Auditor’s experience, new client, time/fee pressure, poor planning, industry knowledge
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Analytical procedures
Ratio analysis: comparison with previous years, industry standards, budgets.
• Risk assessment eg risk of misstatement
• Are FS consistent with our understanding of entity?
• Source of substantive testing eg do figures look reasonable?
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Analytical procedures
Ratio analysis: comparison with previous years, industry standards, budgets.
• Reason
• Artefact
• Test
• Implications
• Other effects
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Analytical procedures - RATIO
Gross profit %
2009 21% 2008 30%
• Reason
• Artefact
• Test
• Implications
• Other effects
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Analytical procedures - RATIO
Receivables collection period
2009 54 days 2008 40 days
• Reason
• Artefact
• Test
• Implications
• Other effects
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Materiality
• A matter is material if it omission or misstatement would reasonably influence the economic decisions users.
• Affected by size and nature of misstatement
• Based on consideration of the common financial information needs of users as a group
• ½ - 1% of revenue • 1 – 2% of total assets • 5 – 10% of profit before tax
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Performance materiality
• Materiality for financial statements as a whole
• Additionally, a lesser amount when designing audit procedures to reduce the risk that misstatements in aggregate exceed FS materality (performance materiality)
• Allows percentages (benchmarking) but take into account:
• Items where users focus • Nature of entity/life cycle/environment • Ownership/structure/financing • Volatility of benchmark
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Evaluation of misstatements identifies
• All communicated to management
• Management asked to correct them or explain why not
• Assess materiality of uncorrected misstatements
• Obtain written representations from management that they believe uncorrected misstatements are not material:
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Gaining an understanding of the entity (ISA 315)
• Nature of the entity
• Industry, regulator
• Accounting policies
• Objectives and strategies
• Internal controls
• Control environment
• How entity identifies business risks
• Measurement of financial performance.
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Stages of an audit
Assess risk of material misstatement
Plan the audit
Auditor’s report
Understand entity
Satisfactory
Tests of controls Report significant deficiencies to those charged with governance
to management and all weaknesses to management
Respond to risk
Expect effective controls
Restricted substantive tests
Expect ineffective controls
Full substantive tests
Overall review of F/S
Report to management
Unsatisfactory
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The use of assertions (ISA 315)
Accuracy
Completeness
Cut off
Allocation
Classification and understandability
Occurrence Valuation
Existence
Rights & obligations (ownership) (ACCA COVER)
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The use of assertions
ISA 315, Audit evidence divides assertions into
• Transactions and events
• Account balances
• Presentation and disclosure
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The use of assertions
If it relates to a transaction, then verify (controls and substantive evidence) the assertions of:
• Occurrence
• Completeness
• Accuracy
• Cutoff
• Classification
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The use of assertions
If it relates to a year end balance then verify (controls and substantive tests) the assertions of:
• Existence
• Rights and obligations
• Completeness
• Valuation
• Allocation
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The use of assertions
If it relates to the presentation and disclosure in the FS:
• Occurrence
• Rights and obligations
• Completeness
• Classification and understandability
• Accuracy
• Valuation
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Sources of evidence
Procedures for obtaining audit evidence
Analytical Procedures
Enquiry and confirmation
Inspection
Observation
recalcUlation and reperformance
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How much audit evidence?
ISA500: Sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base an audit opinion.
Sufficient = quantity Appropriate = relevant and reliability
External better than entity’s records
• Auditor-direct obtained better than indirect evidence
• Entity – better if a good internal control system
• Written – better than oral
• Originals better than photocopies
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Relying on 3rd parties
• Experts (eg estate agents, actuaries, lawyers)
• Internal auditors
• External auditors
Should be: • Qualified
• Experienced
• Independent
• Professional
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Relying on 3rd parties
Should agree the following in writing: • Nature, scope and objectives of work • Respective responsibilities • Nature, scope and timing of communications • That the expert observes confidentiality Auditor must examine the expert’s work with respect to: • Consistency with other evidence • Assumptions made • Use and accuracy of source data.
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Audit documentation
It is essential that the entire audit process is documented to: • Document show that the audit work has been done properly • Enable senior staff to review the work of junior staff • Help the audit team in future years • Encourage a methodical, high-quality approach.
Working papers will be retained for some years (at least 7) for safety.
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Sampling
ISA 530…consider objectives of audit procedure and the attributes of the population…Consider nature and characteristics of audit evidence, possible error conditions and the rate of expected error.
Sampling risk
Audit risk
Non-sampling risk
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Types of sampling
• Random selection
• Systematic selection
• Haphazard selection
• Sequence/block selection
• Monetary unit sampling
• Stratification
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Monetary unit sampling – say 4 items wanted
80 80 70 150
400 550 90 640
1,600 2,240 20 2,260
700 2,960 50 3,100
1,010 4,020 80 4,100 30 4,130
600 4,730 380 5,110
5,000/4 = 1,250 Choose first at random – say, 605 Then: 1,855
3,105
4,455
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Size of sample
• Sampling risk: risk that conclusion based on sample is different to conclusion if all items examined. Reduced as sample size increased.
• Non-sampling risk: risk of wrong conclusion arising from reasons other than sampling. Reduced by proper planning supervision and review
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Sampling risk – tests of control
Risk of
Under-reliance: sample does not support auditor’s assessment of control risk, actual compliance rate would support that assessment.
Over-reliance: sample does support auditor’s assessment of control risk, but actual compliance rate would not support that assessment.
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Sampling risk – substantive procedures
Risk of
Risk of incorrect rejection: sample implies balance materially misstated, but actually not materially misstated.
Risk of incorrect acceptance: sample implies that balance is non materially misstated, but in fact it is materially misstated.
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Tests of control
• Evaluation of systems (enquiry, analytical procedures, observation, inspection)
• Tests of controls should be carried out if suitable controls exist.
• Controls must be operating effectively
Otherwise:
• Substantive procedures
• Substantive procedures might be more efficient if there are relatively few large transactions.
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Components of internal control
• Control environment • Control activities/procedures • Risk assessment process • Information system • Monitoring controls
What can go wrong? How can we stop it?
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Control activities
• Segregation of duties • Comparison • Authorisation • Accounting reconciliations • Computer controls • Arithmetic controls • Physical • Maintaining a trial balance and control accounts
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Inherent limitations of internal control
• Human error
• Collusion
• Bypass of controls
• Costs > benefits
• Non-routine transactions
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Recording and assessing the accounting system
• Narrative notes
• Flowcharts
• Questionnaires
Internal control questionnaires (ICQs)
“How good is the system?” “Yes” = good; “No” = bad
Internal control evaluation questionnaires (ICEQs).
“Can specific problems occur?” “Yes” = bad; “No” = good
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Assessing internal control
• Record the system
• Assess the system
• Test the system
• Consider changing to substantive testing
• Report weaknesses in a management letter (emphasise that other problems might also exist).
Weakness Consequences Recommendedaction to remove
weakness
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Communicating weaknesses in internal control
• Significant deficiencies should be communicated to those charged with governance. Defined as:
– When a control is designed, implemented, or operated …is unable to prevent or detect misstatements on a timely basis; or
– Such a control is missing
• Other weaknesses to management
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Control objectives, procedures, tests
• Control objective: unauthorised overtime cannot be paid
• Control procedure: all time sheets are authorised by a manager
• Control tests: auditor inspects time sheets, enquires of the wages department, traces large payments of wages back to authorised time sheets.
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Tests of control - methods
• Enquiries, including management views
• Inspection
• Observation
• Re-calculation and re-performance
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Sales system
Ordering/granting - Despatch/invoicing - Recording/credit credit control
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Purchases system
Ordering/granting – Receipt/invoicing - Recording/payment
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Wages system
• Hiring and rates authorised
• Correct employees paid
• Paid authorised amounts for work done
• Deductions properly made and recorded
• Deductions paid to authorities; net paid to employees
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Capital expenditure system
• Expenditure authorised
• Tenders received
• Goods received
• Invoices authorised
• Recorded as capital expenditure in main ledger and fixed asset (non-current asset) register
• Physical inspection
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Cash system
• All monies are received, banked, recorded and safeguarded against loss/ theft.
• All payments are authorised and made to correct payees.
• Payments are not made twice for same liability.
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Inventory system
• All inventory movements authorised
• Inventory properly recorded
• Cut-off correct
• Physical safeguards against loss, theft, damage
• Proper valuation procedures
• Reasonable levels of inventory
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Fraud
• Fraudulent financial reporting
• Misappropriation of assets
• Managers responsible for prevention or detection
• Auditors should be aware of material misstatement due to fraud.
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Non-current assets
• Physical inspection.
• Additions: check to invoices.
• Disposals: check to receipts.
• Check major additions/disposals to board minutes.
• Scrutinise repairs and maintenance account
• Re-perform depreciation calculations.
• Verify documents of title.
• Check that no assets need to be written down faster/valuation
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Inventory counts
• Plan in advance: instructions, briefing, tidy inventory.
• Identify damaged and third party inventories.
• Pre-number shelves, inventory locations.
• Issue sequentially pre-numbered inventory sheets.
• Sign off each location as counted.
• Check: inventory sheet.
• Account for all inventory sheets.
• Check prices. Re-perform calculations, check additions.
Inventory is difficult to audit: quantity, description, condition, value, ownership
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Cut-off - purchases
Included in? • Purchases • Payables • Inventories
Included in? • Purchases • Payables • Inventories
GRN GRN
! ! !
X X X
Year end
Before After
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Cut-off - sales
GDN GDN
Included in? • Sales • Receivables • Inventories
! ! X
Included in? • Sales • Receivables • Inventories
X X !
Year end
Before After
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• Two types: Positive: want a reply from everyone written to. Negative: want a reply only if balance out of agreement. (Not
recommended by ISA 505) • Replies should go directly to auditors’ offices so that auditor
retains control • Can stratify sample so that a large percentage covered. • Ask about old debts. • Ask about Cr balances
Receivables circularisations
Write to selected debtors and ask for confirmation of amounts owing.
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Receivables
• Reconcile ledger to control account
• Aged listings
• Correspondence
• Board minutes
• Collection period
• Receipts after year end
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Payables
• Reconcile ledger to control account
• Correspondence
• Board minutes
• Payables period
• Statement reconciliation
• Payments after year end
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Prepayments/accruals
• Compare to last year
• Payments after year end
• Invoices paid last few months
• Letter of representation
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Cash
• Bank certificate
• Bank reconciliation
• Cash count if material
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Computer systems
• General controls – development, prevention of unauthorised changes etc., backup. Can be classified as development and administrative controls.
• Application controls – initiation, recording, processing and recording transactions.
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Computer systems
• Input controls • Processing controls • Controls over standing data • Controls over output
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Real-time systems
• Access controls
• Controls over passwords
• Programming controls
• Firewalls
• Transaction logs
• File controls
• Balancing
• Pre-processing authorisation
• System development/maintenance controls
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Computer assisted audit techniques (CAAT)
• Audit programmes: interrogate accounting data. Select samples to investigate
Re-perform calculations
Look for unusual items
• Test data: operated on by client’s programs. Are programs operating correctly?
Are controls operating?
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Audit report
Definition • A clear expression of opinion on the financial
statements as a whole. • Based on review and assessment of conclusions drawn
from evidence obtained in the course of the audit. The financial statements should have been prepared in
accordance with the International Financial Reporting Standards (IFRSs) or International Accounting Standards (IASs) where there is not yet an IFRS.
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Financial statements
• Statement of financial position
• Income statement
• Statement of changes in equity
• Cash flow statement
• Notes
• Any other material identified as being part of the financial statements
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Basic Unqualified Report
INDEPENDENT AUDITOR'S REPORT
(To the members of ABC Company plc) Report on the Financial Statements We have audited the accompanying financial statements of ABC Company plc, which comprise the statement of financial position as at December 31, 20X8, and the income statement, statement of changes in equity and cash flow statement for the year then ended, and a summary of the significant accounting policies and other explanatory notes.
Title Addressee
Financial statements
audited Introductory paragraph
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Concepts in reporting
Auditor's Responsibility Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing. Those Standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement.
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Basic Unqualified Report (cont’d)
Opinion
In our opinion, the financial statements give a true and fair view of ("or present fairly, in all material respects,") the financial
position of ABC Company as of December 31, 20X8, and of its financial performance and cash flows for the year then ended in
accordance with International Financial Reporting Standards.
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Basic Unqualified Report (cont’d)
We believe the audit evidence we obtained is sufficient and appropriate to provide a basis for our audit opinion.
In our opinion, the financial statements give a true and fair view of ("or present fairly, in all material respects,") the
financial position of ABC Company as of December 31, 20X1, and of its financial performance and cash flows for the year
then ended in accordance with International Financial Reporting Standards.
Report on Other Legal and Regulatory Requirements [Form and content of this section will vary depending on the
nature of the auditor's other reporting responsibilities.]
AUDITOR Date: Address:
Opi
nion
pa
ragr
aph
Auditor’s signature
Equivalent terms
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True, fair and reasonable assurance
• True: the information is factual and conforms with reality.
• Fair: Information is free from discrimination and bias and is in compliance with expected standards and rules. Reflect the commercial substance of the transactions.
• An audit gives reasonable assurance that the accounts are free from material misstatement – auditors’ judgement is vital.
• A matter is material if it omission or misstatement would reasonably influence the decisions of an addressee of the audit report
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Implications of audit report
• Proper records kept • Proper returns from branches not visited • Accounts agree with the records and returns • All necessary explanations received • Details of director’s emoluments properly disclosed • Details of directors’ loans and other transactions correct • Information in directors’ report consistent with the
accounts.
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Auditors’ Reports
Emphasis of matter and other matters
Matters that do not affect the
auditor’s opinion
Matters that do affect the
auditor’s opinion
Qualified opinion: • Do contain a material misstatement; or
• Unable to obtain sufficient appropriate audit evidence to conclude FS free from material
misstatement
• Unmodified, or • Modified
Modified
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Emphasis of matter
• A paragraph in an auditor’s report used when the auditor specifically wishes to draw the readers’ attention to some matter already properly and clearly disclosed within the financial statements and which is fundamental ti user’s understanding of the FS
• Such a paragraph does not constitute a qualification of the auditor’s opinion.
“Without qualifying our opinion above, we draw attention to Note 10 to the financial statements. Five days before the directors formally approved the financial statements, the company received notification that they are to be named as defendants in a proposed legal action …. At this early stage it is not possible to estimate the ultimate outcome of this matter, and no provision has been included within the financial statements.”
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Other matters
• A paragraph in an auditor’s report used to refer to a matter not presented or disclosed in the FS that is relevant to users’ understanding of the audit, auditor’s responsibility or the audit report.
• Such a paragraph does not constitute a qualification of the auditor’s opinion.
“Without qualifying our opinion above, we draw attention to the fact that we were appointed as auditors 11 months into the financial year…
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Going concern
Should assess going concern over the 12 months from the balance sheet date
• Negative operating cash flows • Inability to pay suppliers when due • Operating losses • Borrowing facilities not agreed • Loss of key staff/key customers • Technology changes • Legislative changes • Non-compliance with regulations
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Going concern
Effect on audit report if going concern in doubt: • If disclosed – emphasis of matter • If not disclosed – disclaimer, adverse, limitation in scope if
directors do not adequately make an assessment of going concern
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Qualification matrix
Nature of circumstance
Material but not pervasive
Pervasive
FS contain a material misstatement
Except for…might
Adverse opinion
Unable to obtain sufficient, appropriate evidence
Except for… Disclaimer of opinion
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Insufficient evidence – qualified opinion
…Except as discussed in the following paragraph…
We did not observe the counting of inventories at 31/12/200X…unable to determine inventory quantities by other methods…
In our opinion, except for the effects of such adjustments to inventory, if any, had we been able to satisfy ourselves as to physical inventory…. The financial statements give a true and fair view…
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Insufficient evidence – disclaimer of opinion
…Except as discussed in the following paragraph…
We were not able to observe all physical inventories at 31/12/200X…unable to determine inventory quantities by other methods…
Because of the significance of of the matters discussed…we do not express an opinion on the financial statements.
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Material misstatement – qualified opinion
…As discussed in paragraph 13, no depreciation has been provided…not in accordance with International Accounting Standards…
The provision for the year should have been £X….profits would be decreased by £Y.
In our opinion, except for the matter referred to above the financial statements give a true and fair view…
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Material misstatement – adverse opinion
…As discussed in paragraph 14, no bad provision for irrecoverable debts has been established for a major customer owing £2M and who has gone into liquidation with little prospect of substantial recovery of amounts owed.
In our opinion, because of the effects of the matter referred to above the financial statements do not give a true and fair view…
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ISA 560 – Events after the reporting period
• Adjusting events: evidence of conditions that existed at the date of the statement of financial position.
• Non-adjusting events: conditions arose after the date of the statement of financial position.
If accounts already issued, may have to take steps to prevent users relying on the accounts
Events occurring between the period end and the date of the auditors’ report and also facts discovered after the
audit report has been issued
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IAS 37 – Contingent liabilities and assets
• Present obligation probably requiring outflow of resources: provision recognised and disclosures required
• Possible obligation, or present obligation that will probably not require outflow of resources: no provision, but disclosure
• Possible obligation, or present obligation where likelihood of an outflow is remote: no provision, no disclosure.
Contingent liability: possible liability arising from past events…. existence confirmed by future events
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IAS 37 – Contingent liabilities and assets
• Inflow of economic benefits virtually certain: asset is not contingent
• Inflow of economic benefits is probable but not virtually certain: no asset recognised but disclosures
• Inflow is not probably: no asset recognised and no disclosure
Contingent asset: possible asset arising from past events…. existence confirmed by future events
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Management representations
Should be obtained on specific matters and also on matters material to the FS when other appropriate audit evidence cannot be reasonably obtained.
Cannot substitute for other audit evidence except:
• Where knowledge is confined to management
• Reliance on judgement/opinion
Otherwise:
• Corroboration
• Consistent
• Reasonable
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Written representations
Examples of letter of representation paragraphs:
• No material irregularities
• Disclosed all liabilities
• No subsequent events
• No plan to shut down any part of operations
• No inventory is valued an more than its NRV
• All charges on assets have been disclosed
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You have a VeSTeD interest in good answers
• Verbs
• Scenario
• Time
• Detail
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