MEMORANDUM

To: Technical representatives From: Roger Morris Date: 24 November 2010 Ref: TM 10/10

HAT AUDIT AND ACCOUNTANCY MANUAL – DECEMBER 2010 A new HAT Audit and Accountancy Manual has been issued and it is dated 12/10. This Manual reflects the requirements of the “Clarity” International Standards on Auditing (UK and Ireland). Note that in addition to all of the ISAs being ‘Clarified’, a number of them have also been ‘Revised’, so there are a number of fundamental new requirements. As the Manual reflects Clarified ISAs, it is therefore applicable for accounting periods ending

on or after 15 December 2010. For ease, the Manual has been dated 12/10, as the first accounting period to which it applies will be December 2010 year ends.

Whilst it is possible to ‘early adopt’ these requirements (as they are more onerous than the existing requirements), firms have a choice as to whether or not to do so. If firms do not wish to ‘early adopt’, the 04/09 Audit and Accountancy Manual should continue to be used for accounting periods which end before 15 December 2010. Therefore until late 2011, the 04/09 and 12/10 Audit and Accountancy Manuals will operate in parallel. In view of the level of changes, HAT’s Q3 / 2010 update (lasting for 90 minutes) has covered these changes for the majority of the users of the Manual. This update is running for one final time on Thursday 2 December 2010 ~ bookings can still be made by e-mailing sam@hatgroup.co.uk. As an overview, an ‘Executive Summary’ of the main changes which have been required as a result of the clarification and revision ISA (UK and Ireland) are set out on the next four pages. Note that a new letter of engagement should be issued to all clients as a result of the changes both to the “Technical” and “Terms of Business” paragraphs. The new Manual is being sent on CD to all users of the HAT Audit and Accountancy Manual. Any firm which wishes to receive a zipped version, but has not yet received one should contact Samantha Kennedy at sam@hatgroup.co.uk to request one to be e-mailed. If you have any questions on the new manual, please e-mail roger@hatgroup.co.uk.

HAT’S APPROACH TO ISA CLARITY ~

HOW THE STANDARDS ARE COMPLIED WITH ~ A SUMMARY

This is a summary of the main changes which ISA Clarity has required to the HAT Audit and Accountancy Manual Unless otherwise stated, the relevant ISA (UK and Ireland) has only been Clarified, and not Revised Where a standard has been excluded from this summary, there are no substantial changes required

ISQC 1 – Quality control for firms that perform audits and reviews of financial statements, and other assurance and related services engagements: The “competence” of the R.I. should be viewed more closely, including (for

example, EQCR’s on the initial engagements of a newly appointed R.I., and an extension of file reviews where substantial problems are identified on a cold file review for an R.I.)

ISA 210 (Revised) – Agreeing the terms of audit engagements: Reference to an appropriate financial reporting framework needs to be included

(note ~ a new engagement letter is required on the first “ISA Clarity” assignment) ISA 220 – Quality control for an audit of financial statements: The scope of an EQCR (including the scope for listed entities) has been amended;

Include criteria for an EQCR to be performed in Regulation of Auditor’s

checklist;

Extent and conduct of consultation is enhanced so it is clearer ISA 240 – The auditor’s responsibilities relating to fraud in an audit of financial statements: ISA 315 – Identifying and assessing the risks of material misstatement through understanding the entity and its environment: ISA 330 – The auditor’s responses to assessed risks: The concept and treatment of “significant risks” is included on the risk assessment

summary which will include a “cradle to grave” commentary from the team (split between planning ~ issues identified, and finalisation ~ results / conclusions) of how issues have been dealt with (note that risk assessment will now be narrative only);

A retrospective review of accounting estimates at the end of the prior period

should be performed;

The review of journals needs to specifically cover year end entries as well as those during the year;

The client’s business risk assessment process (whether formal or ad-hoc) needs to

be specifically discussed with them ISA 260 (Revised) – Communication with those charged with governance: ISA 265 (New) – Communicating deficiencies in internal control to those charged with governance and management: A differential between those charged with governance, and management is

introduced; Significant difficulties arising during the audit and matters which have been

communicated to management need to be communicated to those charged with governance;

Deficiencies in internal control need to be specifically communicated to

management (where they differ from those charged with governance) ISA 320 (Revised) – Materiality in planning and performing an audit: ISA 450 (New) – Evaluation of misstatements identified during the audit: The concept of “performance materiality” (which is set at a lower level than

materiality for the financial statements as a whole) is introduced to provide a “margin” to protect against unidentified misstatements ~ to be set by HAT at 75% of materiality (items between performance materiality and materiality shall be considered to be large items for the purpose of audit sampling);

“Lower” materiality levels (for example for matters such as directors

remuneration) to be explicitly documented ~ to be set by HAT at 5% of materiality;

The audit approach and plan should be revisited if aggregate misstatements

approach or exceed performance materiality during the assignment; The effect of prior period misstatements (where still relevant) need to be included

as part of the consideration ISA 402 (Revised) – Audit considerations relating to an entity using a service organisation: Use of a service organisation (including any knowledge of fraud, non-compliance

with laws or regulations, or uncorrected misstatements arising from the entity’s use of a service organisation) should be specifically covered when documenting knowledge about the entity;

When an AAF 01/06 is obtained, it shall be specifically reviewed insofar as the

controls tested by the service organisation’s auditor are relevant to the client

ISA 501 – Specific considerations for selected items: Regarding litigation, there are specific requirements to review correspondence

with external legal advisers and to review legal expense accounts. Details of these, along with minutes of management meetings are to be requested for the pre-planning meeting, since, discovery of issues towards the end of the audit assignment, may delay the finalisation of the audit, and the dating of the audit report;

Any request for confirmation to be obtained from the client’s solicitor should

include management’s assessment of the outcome of the litigation, which will then be commented upon by the solicitor

ISA 520 – Analytical procedures: When there is a difference between the auditor’s expectation and the results of

analytical procedures there should be an amount set below which no further investigation is required

ISA 540 (Revised) – Auditing accounting estimates, including fair value accounting estimates, and related disclosures: At the planning stage, the auditor shall understand (documented on the permanent

file along with consideration of accounting policies) how accounting estimates are used in the client’s financial reporting framework, and shall also discuss with the client how they make their accounting estimates, including dealing with new or amended requirements;

Any judgmental accounting estimate prepared either internally, or by an external

expert, which is greater than fifteen times materiality shall be deemed to be a significant risk (for example, property valuations, actuarial valuations and provisions, but not valuations of share portfolios where value is based on market value, as this is not judgmental). Accounting estimates which are significant risks should be specifically reviewed in detail

ISA 550 (Revised) – Related parties: There should be specific discussions with the client at the planning stage relating

to related party relationships and transactions, which should then be followed up and covered in the team discussion at the planning stage of the assignment;

Risk attaching to the potential material misstatement of related party disclosures

should be assessed; Any significant related party transactions (based on prior criteria, would be

deemed to be transactions in aggregate of greater than fifteen times materiality) outside the entity’s normal course of business automatically give rise to significant risks;

Certain new audit procedures will become required, therefore the K section audit

programme has been amended

ISA 580 (Revised) – Written representations: The mandatory requirements to obtain written representations have been

substantially extended. HAT’s pro-forma letter of representation previously included many of those representations on a non-mandatory basis. New “mandatory” paragraphs include (for example) acknowledgements that all transactions have been recorded and reflected in the financial statements, and that all relevant information has been provided. It should be noted that which the substance of the representations will remain largely the same, the wording of some will change to reflect current regulatory requirements

ISA 600 (Revised) – Special considerations – Audits of group financial statements (including the work of component auditors) There are a number of matters relevant to the audit of groups which are dealt with

in the HAT Groups Manual ISA 620 (Revised) – Using the Work of an Auditor’s Expert: There needs to be more detailed consideration of the use of the expert as part of

the audit assignment. An expert is generally defined as somebody whose expertise is not within the field of accounting and auditing, so the use of taxation personnel for audit reasons (as opposed to when providing a non-audit service) would be an auditor’s expert;

There are more detailed documentation requirements between the auditor and the

auditor’s expert ISA 706 (Revised) – Emphasis of matter paragraphs and other matter paragraphs in the independent auditor’s report: A new concept of an “Other Matter” paragraph is introduced for the audit report

to cover scenarios such as the comparatives being unaudited, or there being material inconsistencies between the financial statements and other information presented with the financial statements