ACCA Paper F8 Notes June 2012 OpenTuition Slides

AUDIT AND ASSURANCE(INTERNATIONAL)

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F8

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P7 Advanced Audit & Assurance

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Click to edit Master title style

1

ACCA Paper F8 – Audit and assurance

June 2012 Exams

To fully benefit from these slides, watch free lectures http://opentuition.com/acca/f8/


2

Syllabus

A Audit framework and regulation

B Internal audit

C Planning and risk assessment

D Internal control

E Audit evidence

F Review

G Reporting


3

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



4

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

Click to edit Master title style Elements of an assurance engagement

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


6

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.



7

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


8

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.


9

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



10

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.


11

Evidence

•  Professional scepticism •  Sufficient, appropriate evidence

Sufficiency = quantity of evidence. Appropriateness = quality of evidence (relevance and its reliability)


12

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.”



13

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.


14

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



15

Recent Corporate Failures



16

OECD Principles of Corporate Governance

•  Fairness, including foreign and minority shareholders

•  Disclosure and transparency

•  Independence

•  Probity, honesty

•  Responsibility and accountability

•  Reputation

•  Judgement

•  Integrity


17

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.


18


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.



19


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


20


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].


21


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]



22


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.


23

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


24

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.



25

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


26

Definition of an audit

An audit is the independent examination of, and expression of opinion on, the financial

statements of an entity.


27

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.



28

Corporate governance – the purpose of an external audit


Shareholders Directors

Company Own

Appoint

Manage

Financial Statements

Prepare FS

Measure performance

Auditor Appoint independent

Adds credibility


29

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


30

Interim and final audit

1January 31December

Interim audit. Document system,

procedural tests

Final audit More direct checking

of balances

Planning visit



31

… 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


32

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


33

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



34

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.


35

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


36


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.



37


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.


38

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.


39

Regulation of auditors

International level

National level

The profession



40

Regulation of auditors

Education and work experience

Eligibility, such as

membership of a supervisory

body

Supervision and monitoring


41

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)


42

Professional ethics and ACCA’s Code

Fundamental principles

Threats Safeguards



43

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


44

Threats to objectivity, integrity and independence

Threats arise from:

•  Self-interest

•  Self-review

•  Familiarity

•  Advocacy

•  Intimidation

•  Management


45


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



46


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


47


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.


48


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.



49


Advocacy threats •  Where the assurance firm promotes a point of view or

opinion to the extent that subsequent objectivity is compromised


50


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.


51


Management threats •  Where the auditor begins to make management decisions

for the client.



52

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.


53

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


54

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



55

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.


56

Stages of an audit


Plan the audit

Auditor’s report

Understand entity

Satisfactory



Respond to risk







Unsatisfactory


57

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



58

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..


59

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


60

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.



61

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


62

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?


63

Analytical procedures

Ratio analysis: comparison with previous years, industry standards, budgets.

•  Reason

•  Artefact

•  Test

•  Implications

•  Other effects



64

Analytical procedures - RATIO

Gross profit %

2009 21% 2008 30%

•  Reason

•  Artefact

•  Test

•  Implications



65

Analytical procedures - RATIO

Receivables collection period

2009 54 days 2008 40 days

•  Reason

•  Artefact

•  Test

•  Implications



66

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



67

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


68

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:


69

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.



70

Stages of an audit


Plan the audit

Auditor’s report

Understand entity

Satisfactory



Respond to risk







Unsatisfactory


71

The use of assertions (ISA 315)

Accuracy

Completeness

Cut off

Allocation

Classification and understandability

Occurrence Valuation

Existence

Rights & obligations (ownership) (ACCA COVER)


72

The use of assertions

ISA 315, Audit evidence divides assertions into

•  Transactions and events

•  Account balances

•  Presentation and disclosure



73


If it relates to a transaction, then verify (controls and substantive evidence) the assertions of:

•  Occurrence

•  Completeness

•  Accuracy

•  Cutoff

•  Classification


74


If it relates to a year end balance then verify (controls and substantive tests) the assertions of:

•  Existence

•  Rights and obligations

•  Completeness

•  Valuation

•  Allocation


75


If it relates to the presentation and disclosure in the FS:

•  Occurrence

•  Rights and obligations

•  Completeness

•  Classification and understandability

•  Accuracy

•  Valuation



76

Sources of evidence

Procedures for obtaining audit evidence

Analytical Procedures

Enquiry and confirmation

Inspection

Observation

recalcUlation and reperformance


77

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


78

Relying on 3rd parties

•  Experts (eg estate agents, actuaries, lawyers)

•  Internal auditors

•  External auditors

Should be: •  Qualified

•  Experienced

•  Independent

•  Professional



79

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.


80

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.


81

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



82

Types of sampling

•  Random selection

•  Systematic selection

•  Haphazard selection

•  Sequence/block selection

•  Monetary unit sampling

•  Stratification


83

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


84

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



85

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.


86

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.


87

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.



88

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?


89

Control activities

•  Segregation of duties •  Comparison •  Authorisation •  Accounting reconciliations •  Computer controls •  Arithmetic controls •  Physical •  Maintaining a trial balance and control accounts


90

Inherent limitations of internal control

•  Human error

•  Collusion

•  Bypass of controls

•  Costs > benefits

•  Non-routine transactions



91

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


92

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


93

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



94

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.


95

Tests of control - methods

•  Enquiries, including management views

•  Inspection

•  Observation

•  Re-calculation and re-performance


96

Sales system

Ordering/granting - Despatch/invoicing - Recording/credit credit control



97

Purchases system

Ordering/granting – Receipt/invoicing - Recording/payment


98

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


99

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



100

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.


101

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


102

Fraud

•  Fraudulent financial reporting

•  Misappropriation of assets

•  Managers responsible for prevention or detection

•  Auditors should be aware of material misstatement due to fraud.



103

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


104

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


105

Cut-off - purchases

Included in? • Purchases • Payables •  Inventories

Included in? • Purchases • Payables •  Inventories

GRN GRN

! ! !

X X X

Year end

Before After



106

Cut-off - sales

GDN GDN

Included in? • Sales • Receivables •  Inventories

! ! X

Included in? • Sales • Receivables •  Inventories

X X !

Year end

Before After


107

•  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.


108

Receivables

•  Reconcile ledger to control account

•  Aged listings

•  Correspondence

•  Board minutes

•  Collection period

•  Receipts after year end



109

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


111

Cash

•  Bank certificate

•  Bank reconciliation

•  Cash count if material



112

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?


116

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.


117

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.


120

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.



121

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


123

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.



124

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.”


126

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


128

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


129

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



130

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…


131

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…


134

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



136

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


137

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


138

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



139

You have a VeSTeD interest in good answers

• Verbs

• Scenario

• Time

• Detail

Documents

ACCA Paper F8 Notes June 2012 OpenTuition Slides