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Essential Issues in Audit Workshop: A PracticalApproach
February 2016
Essential Issues in Audit Workshop: A PracticalApproach
February 2016
12/02/2016Uphold Public Interest
AUDITING ACCOUNTING ESTIMATES,INCLUDING FAIR VALUE ACCOUNTINGESTIMATES, AND RELATED DISCLOSURES –ISA 540
USING THE WORK OF INTERNAL AUDITORS– ISA 610
USING THE WORK OF AN AUDITOR'SEXPERT – ISA 620
AUDITING ACCOUNTING ESTIMATES,INCLUDING FAIR VALUE ACCOUNTINGESTIMATES, AND RELATED DISCLOSURES –ISA 540
USING THE WORK OF INTERNAL AUDITORS– ISA 610
USING THE WORK OF AN AUDITOR'SEXPERT – ISA 620
12/02/2016 Uphold Public Interest 2
Auditing Accounting Estimates, Including FairValue Accounting Estimates, and Related
Disclosures
Auditing Accounting Estimates, Including FairValue Accounting Estimates, and Related
Disclosures
12/02/2016 Uphold Public Interest 3
To obtain sufficient appropriate audit evidenceabout whether accounting estimates, including fair value
accounting estimates, in the financial statements,whether recognized or disclosed, are reasonable;and related disclosures are adequate,
in the context of the applicable financialreporting framework
To obtain sufficient appropriate audit evidenceabout whether accounting estimates, including fair value
accounting estimates, in the financial statements,whether recognized or disclosed, are reasonable;and related disclosures are adequate,
in the context of the applicable financialreporting framework
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Some financial statement itemscannot be measured precisely, butcan only be estimated. Theseitems are accounting estimates.
An accounting estimate is anapproximation of a monetaryamount in the absence of aprecise means of measurement.This term is used for an amountmeasured at fair value where thereis estimation uncertainty, as wellas for other amounts that requireestimation.
Some financial statement itemscannot be measured precisely, butcan only be estimated. Theseitems are accounting estimates.
An accounting estimate is anapproximation of a monetaryamount in the absence of aprecise means of measurement.This term is used for an amountmeasured at fair value where thereis estimation uncertainty, as wellas for other amounts that requireestimation.
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Examples of judgmental estimates included infinancial statement items?
Examples of judgmental estimates included infinancial statement items?
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Receivables — Uncollectible receivables — Allowance for loan losses — Valuation of long-term
unconditional promises to give
Inventories — Obsolete inventory — Net realizable value of inventories
when future selling prices and futurecosts are involved
— Losses on purchase commitments
Revenues — Airline passenger revenue — Subscription income — Freight and cargo revenue
Contracts — Revenue to be earned — Costs to be incurred — Percent of completion
Leases — Initial direct costs — Executory costs
Financial instruments — Valuation of securities — Probability of high correlation of a
hedge — Sales of securities with puts and calls
Receivables — Uncollectible receivables — Allowance for loan losses — Valuation of long-term
unconditional promises to give
Inventories — Obsolete inventory — Net realizable value of inventories
when future selling prices and futurecosts are involved
— Losses on purchase commitments
Revenues — Airline passenger revenue — Subscription income — Freight and cargo revenue
Contracts — Revenue to be earned — Costs to be incurred — Percent of completion
Leases — Initial direct costs — Executory costs
Financial instruments — Valuation of securities — Probability of high correlation of a
hedge — Sales of securities with puts and calls
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Productive facilities, natural resources,and intangibles
— Useful lives and residual values — Depreciation and amortization
methods — Impairment analysis — Recoverability of costs
Accruals — Property and casualty insurance
company loss reserves — Compensation in stock option plans
and deferred plans — Warranty claims — Actuarial assumptions in benefit
costs
Litigation — Probability of loss — Amount of loss
Other — Fair values in nonmonetary
exchanges
Productive facilities, natural resources,and intangibles
— Useful lives and residual values — Depreciation and amortization
methods — Impairment analysis — Recoverability of costs
Accruals — Property and casualty insurance
company loss reserves — Compensation in stock option plans
and deferred plans — Warranty claims — Actuarial assumptions in benefit
costs
Litigation — Probability of loss — Amount of loss
Other — Fair values in nonmonetary
exchanges
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Gain an understanding of the data on which they arebased including:- the method and model used in making the accounting
estimate; relevant controls; whether management has used an expert; the assumptions underlying the accounting estimates; whether there has been, or ought to have been, a
change from the prior period in the methods for makingthe accounting estimates, and if so, why; and
whether and, if so, how management has assessed theeffect of estimation uncertainty (the susceptibility of anaccounting estimate and related disclosures to an inherent lack ofprecision in its measurement).
Gain an understanding of the data on which they arebased including:- the method and model used in making the accounting
estimate; relevant controls; whether management has used an expert; the assumptions underlying the accounting estimates; whether there has been, or ought to have been, a
change from the prior period in the methods for makingthe accounting estimates, and if so, why; and
whether and, if so, how management has assessed theeffect of estimation uncertainty (the susceptibility of anaccounting estimate and related disclosures to an inherent lack ofprecision in its measurement).
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Evaluating the degree of estimationuncertainty associated with an accountingestimate includes consideration of:- Level of judgment involved Sensitivity to changes in assumptions Extent to which the estimate is based on
observable or unobservable inputs
Evaluating the degree of estimationuncertainty associated with an accountingestimate includes consideration of:- Level of judgment involved Sensitivity to changes in assumptions Extent to which the estimate is based on
observable or unobservable inputs
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The auditor should review the judgments anddecisions made by management in makingaccounting estimates to identify whether thereare indicators of possible management bias:- Susceptibility of an estimate to management bias
increases with subjectivity involved Indicators may affect auditor’s conclusion of
whether risk assessment or responses remainappropriate, but do not themselves constitutemisstatements for purposes of concluding onreasonableness of individual estimates
The auditor should review the judgments anddecisions made by management in makingaccounting estimates to identify whether thereare indicators of possible management bias:- Susceptibility of an estimate to management bias
increases with subjectivity involved Indicators may affect auditor’s conclusion of
whether risk assessment or responses remainappropriate, but do not themselves constitutemisstatements for purposes of concluding onreasonableness of individual estimates
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Changes in an accounting estimate or method wheremanagement has made a subjective assessment thatthere has been a change in circumstances
Use of an entity’s own assumptions for fair value whenthey are inconsistent with observable marketplaceassumptions
Selection or construction of significant assumptionsthat yield a point estimate favorable to management’sobjectives
Selection of a point estimate that may indicate apattern of optimism or pessimism
Changes in an accounting estimate or method wheremanagement has made a subjective assessment thatthere has been a change in circumstances
Use of an entity’s own assumptions for fair value whenthey are inconsistent with observable marketplaceassumptions
Selection or construction of significant assumptionsthat yield a point estimate favorable to management’sobjectives
Selection of a point estimate that may indicate apattern of optimism or pessimism
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In response to assessed risks, considerwhether specialized skills or knowledge inrelation to aspects of the accountingestimate are needed to obtain sufficientappropriate audit evidence Individuals become part of the engagement
team if the matters are accounting- andauditing-related Those with experience in a field other than
accounting or auditing are consideredauditor’s experts (ISA 620)
In response to assessed risks, considerwhether specialized skills or knowledge inrelation to aspects of the accountingestimate are needed to obtain sufficientappropriate audit evidence Individuals become part of the engagement
team if the matters are accounting- andauditing-related Those with experience in a field other than
accounting or auditing are consideredauditor’s experts (ISA 620)
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Obtain sufficient appropriate auditevidence about whether disclosuresrelated to accounting estimates are inaccordance with the applicablefinancial reporting framework
For estimates giving rise to significant risks,also evaluate the adequacy of thedisclosure of estimation uncertainty in thecontext of the applicable financialreporting framework
Obtain sufficient appropriate auditevidence about whether disclosuresrelated to accounting estimates are inaccordance with the applicablefinancial reporting framework
For estimates giving rise to significant risks,also evaluate the adequacy of thedisclosure of estimation uncertainty in thecontext of the applicable financialreporting framework
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The auditor must obtain written representationsfrom management and those charged withgovernance, saying that they believe significantassumptions used in making their accountingestimates are reasonable.Representations alone do not constitute sufficient
appropriate audit evidence
The auditor must include in the auditdocumentation the basis for the conclusions aboutthe reasonableness of accounting estimates andtheir disclosure that give rise to significant risks; andindicators of possible management bias, if any.
The auditor must obtain written representationsfrom management and those charged withgovernance, saying that they believe significantassumptions used in making their accountingestimates are reasonable.Representations alone do not constitute sufficient
appropriate audit evidence
The auditor must include in the auditdocumentation the basis for the conclusions aboutthe reasonableness of accounting estimates andtheir disclosure that give rise to significant risks; andindicators of possible management bias, if any.
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Obtaining an understanding of howmanagement (or owner-manager) identifiesthe need for accounting estimates is oftenrelatively straightforward
The ISA allows for different approaches forresponding to assessed risks depending on thenature of the accounting estimate
In many cases (other than for fair valueestimates), review of events occurring up to thedate of the auditor’s report may be aneffective and efficient approach
Obtaining an understanding of howmanagement (or owner-manager) identifiesthe need for accounting estimates is oftenrelatively straightforward
The ISA allows for different approaches forresponding to assessed risks depending on thenature of the accounting estimate
In many cases (other than for fair valueestimates), review of events occurring up to thedate of the auditor’s report may be aneffective and efficient approach
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USING THE WORK OF ANAUDITOR’S EXPERT
USING THE WORK OF ANAUDITOR’S EXPERT
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An individual ororganization
Expertise other thanaccounting or auditing
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Auditor’sExpert
Internal or external to thefirm
Assists the auditor inobtaining sufficient
appropriate auditevidence
Standard requires overriding question tobe asked: Is an auditor’s expert neededfor the engagement? Risk may increase when other expertise is
needed to prepare the financial statements Engagement partner should be satisfied that
engagement team collectively has appropriatecompetence and capabilities
Keep the situation under review as the auditprogresses − circumstances may change
Standard requires overriding question tobe asked: Is an auditor’s expert neededfor the engagement? Risk may increase when other expertise is
needed to prepare the financial statements Engagement partner should be satisfied that
engagement team collectively has appropriatecompetence and capabilities
Keep the situation under review as the auditprogresses − circumstances may change
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Relevant considerations Nature, significance and complexity of the matter Has management used an expert? What are the related risks of material misstatement? What sort of procedures are likely to be necessary?
An auditor’s expert not always needed in everycase In some cases, the auditor, although not an expert,
may have enough understanding of a field to performthe audit without an auditor’s expert
Relevant considerations Nature, significance and complexity of the matter Has management used an expert? What are the related risks of material misstatement? What sort of procedures are likely to be necessary?
An auditor’s expert not always needed in everycase In some cases, the auditor, although not an expert,
may have enough understanding of a field to performthe audit without an auditor’s expert
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Relevant considerations include Is the auditor’s expert’s work subject to professional or
industry requirements? Is the expert’s competence relevant to the matter at
hand? Is any accounting or auditing competence expected
in addition to competence in the expert’s particularfield and, if so, does the expert possess thatcompetence?
Do changing circumstances indicate a need toreconsider initial evaluation as the audit progresses?
Various sources of information may be used
Relevant considerations include Is the auditor’s expert’s work subject to professional or
industry requirements? Is the expert’s competence relevant to the matter at
hand? Is any accounting or auditing competence expected
in addition to competence in the expert’s particularfield and, if so, does the expert possess thatcompetence?
Do changing circumstances indicate a need toreconsider initial evaluation as the audit progresses?
Various sources of information may be used12/02/2016 Uphold Public Interest 21
Independence Objectivity required for all auditor’s
experts Use “threats and safeguards” approach
to evaluate objectivity Are threats to objectivity, e.g., familiarity and
self-review, eliminated or reduced to anacceptable level by safeguards?
A number of procedures may beperformed to evaluate objectivity
Independence Objectivity required for all auditor’s
experts Use “threats and safeguards” approach
to evaluate objectivity Are threats to objectivity, e.g., familiarity and
self-review, eliminated or reduced to anacceptable level by safeguards?
A number of procedures may beperformed to evaluate objectivity
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Understanding needs to be sufficient todetermine nature, scope and objectives ofthe expert’s work and to evaluate theadequacy of that work for the auditor’spurposes Understand relevant aspects of the expert’s field The auditor does not need to become expert in
the field himself or herself
Sources of information similar to those whenevaluating the expert’s competence,capabilities and objectivity
Understanding needs to be sufficient todetermine nature, scope and objectives ofthe expert’s work and to evaluate theadequacy of that work for the auditor’spurposes Understand relevant aspects of the expert’s field The auditor does not need to become expert in
the field himself or herself
Sources of information similar to those whenevaluating the expert’s competence,capabilities and objectivity
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Agreement is always needed Nature, scope and objectives of the expert’s work Respective roles and responsibilities of the auditor and
the expert Communication between the auditor and the expert Need for the expert to observe confidentiality
requirements Level of detail and formality of the agreement Use a “sliding scale” approach
Agreement need not always be formally in writing
Agreement is always needed Nature, scope and objectives of the expert’s work Respective roles and responsibilities of the auditor and
the expert Communication between the auditor and the expert Need for the expert to observe confidentiality
requirements Level of detail and formality of the agreement Use a “sliding scale” approach
Agreement need not always be formally in writing
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Evaluate for the auditor’s purposes The expert’s findings or conclusions The expert’s assumptions and methods
(when significant to the expert’s work) The source data used by the expert (when
significant to the expert’s work)
Evaluate for the auditor’s purposes The expert’s findings or conclusions The expert’s assumptions and methods
(when significant to the expert’s work) The source data used by the expert (when
significant to the expert’s work)
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No reference to the auditor’s expert inunmodified auditor’s report Unless required by law or regulation (Not in Kenya) If required, indicate that the reference does not
reduce the auditor’s responsibility
If reference is needed in relation to amodification Indicate that the reference does not reduce the
auditor’s responsibility
May need expert’s permission to makereference
No reference to the auditor’s expert inunmodified auditor’s report Unless required by law or regulation (Not in Kenya) If required, indicate that the reference does not
reduce the auditor’s responsibility
If reference is needed in relation to amodification Indicate that the reference does not reduce the
auditor’s responsibility
May need expert’s permission to makereference
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ISA 610 (REVISED 2013)USING THE WORK OF INTERNAL AUDITORS
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An effective internal audit function cansignificantly strengthen the monitoring ofcontrol.
ISA 610(R) recognises that an external auditoris able to use the work of an internal auditorto assist in an audit engagement and incertain instances, be part of the engagementteam.
Extent of reliance is dependent on evaluationof internal audit function by external auditor.
An effective internal audit function cansignificantly strengthen the monitoring ofcontrol.
ISA 610(R) recognises that an external auditoris able to use the work of an internal auditorto assist in an audit engagement and incertain instances, be part of the engagementteam.
Extent of reliance is dependent on evaluationof internal audit function by external auditor.
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Differences are: Objectives Independence
For an external audit, elements areregulated by legislation. For an internal audit, elements are
determined by management.
Differences are: Objectives Independence
For an external audit, elements areregulated by legislation. For an internal audit, elements are
determined by management.
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In evaluating internal audit, externalauditors should consider: Organisational status; Scope of internal auditing; Technical competence; and Due professional care.
In evaluating internal audit, externalauditors should consider: Organisational status; Scope of internal auditing; Technical competence; and Due professional care.
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The overall responsibility for audit engagementremains with an external auditor.
The external auditor is required to undertakegeneral evaluation as part of review of internalcontrols.
If the external auditor plans to rely on internalaudit, they should carefully review internalauditor’s working papers and procedures toensure testing is sufficient to meet theirrequirements, and that conclusions outlined inworking papers are appropriate.
The overall responsibility for audit engagementremains with an external auditor.
The external auditor is required to undertakegeneral evaluation as part of review of internalcontrols.
If the external auditor plans to rely on internalaudit, they should carefully review internalauditor’s working papers and procedures toensure testing is sufficient to meet theirrequirements, and that conclusions outlined inworking papers are appropriate.
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Amendments introduced in 2013 - ISA 610 (Revised2013) with an effective date for audits of financialstatements for periods ending on or after December15, 2014 for the section on - the use of internal auditorsto provide direct assistance.
Review Objectivity and Competence of the internalauditor
Internal Audit Direct Assistancei. may be prohibited by law or regulation from obtaining
direct assistance;ii. evaluate the existence and significance of threats to
objectivity and the level of competence of the internalauditors who will be providing such assistance.
Amendments introduced in 2013 - ISA 610 (Revised2013) with an effective date for audits of financialstatements for periods ending on or after December15, 2014 for the section on - the use of internal auditorsto provide direct assistance.
Review Objectivity and Competence of the internalauditor
Internal Audit Direct Assistancei. may be prohibited by law or regulation from obtaining
direct assistance;ii. evaluate the existence and significance of threats to
objectivity and the level of competence of the internalauditors who will be providing such assistance.
12/02/2016 Uphold Public Interest 32
Performance of procedures that:a. involve making significant judgments in the audit
b. relate to higher assessed risks of material misstatementwhere the judgment required in performing therelevant audit procedures or evaluating the auditevidence gathered is more than limited
c. relate to work with which the internal auditor havebeen involved and which has already been, or will be,reported to management or those charged withgovernance by the internal audit function
d. Relate to decisions the external auditor makes inaccordance with this ISA regarding the internal auditfunction and the use of its work or direct assistance
Performance of procedures that:a. involve making significant judgments in the audit
b. relate to higher assessed risks of material misstatementwhere the judgment required in performing therelevant audit procedures or evaluating the auditevidence gathered is more than limited
c. relate to work with which the internal auditor havebeen involved and which has already been, or will be,reported to management or those charged withgovernance by the internal audit function
d. Relate to decisions the external auditor makes inaccordance with this ISA regarding the internal auditfunction and the use of its work or direct assistance
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When using the internal auditor to provide directassistance, the external auditor shall:-
a. obtain written agreement from an authorized representative of theentity that the internal auditors will be allowed to follow theexternal auditor’s instructions, and that the entity will not intervenein the work the internal auditor performs for the external auditor
b. obtain written agreement from the IAs that they will keepconfidential specific matters as instructed by the external auditorand inform the external auditor of any threat to their objectivity.
c. direct, supervise and review the work performed by internalauditors {nature, timing and extent of direction, supervision, andreview - checking back to the underlying audit evidence }
When using the internal auditor to provide directassistance, the external auditor shall:-
a. obtain written agreement from an authorized representative of theentity that the internal auditors will be allowed to follow theexternal auditor’s instructions, and that the entity will not intervenein the work the internal auditor performs for the external auditor
b. obtain written agreement from the IAs that they will keepconfidential specific matters as instructed by the external auditorand inform the external auditor of any threat to their objectivity.
c. direct, supervise and review the work performed by internalauditors {nature, timing and extent of direction, supervision, andreview - checking back to the underlying audit evidence }
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