p7 advanced audit and assurance (int) · advanced audit and assurance (int)...

ACCA APPROVED CONTENT PROVIDER

ACCA PasscardsPaper P7Advanced Audit and Assurance (International)

Passcards for exams up to June 2015

ACP7(INT)PC14.indd 1 29/05/2014 17:30

File Attachment9781472711915.jpg

Professional Paper P7Advanced Audit and Assurance (INT)

(000)ACP7(INT)PC14_FP_Ricoh.qxp 5/13/2014 10:03 PM Page i

First edition 2007, Eighth Edition July 2014

ISBN 9781 4727 1135 9

e ISBN 9781 4727 1191 5

British Library Cataloguing-in-Publication DataA catalogue record for this book is available from the

British Library

Your learning materials, published by BPP LearningMedia Ltd, are printed on paper obtained from traceablesustainable sources.

Published by

BPP Learning Media Ltd,BPP House, Aldine Place,142-144 Uxbridge Road,London W12 8AA

www.bpp.com/learningmedia

Printed in the UK by RICOHUK Limited

Unit 2 Wells PlaceMersthamRH1 3LG

All rights reserved. No part of this publication may bereproduced, stored in a retrieval system or transmitted, inany form or by any means, electronic, mechanical,photocopying, recording or otherwise, without the priorwritten permission of BPP Learning Media.

©BPP Learning Media Ltd

2014

(000)ACP7(INT)PC14_FP_Ricoh.qxp 5/13/2014 10:03 PM Page ii

www.bpp.com/learningmedia

Page iii

ContentsPreface

Welcome to BPP Learning Media’s ACCA Passcards for Paper P7 Advanced Audit and Assurance (INT).

� They focus on your exam and save you time.

� They incorporate diagrams to kick start your memory.

� They follow the overall structure of BPP Learning Media’s Study Texts, but BPP Learning Media’s ACCAPasscards are not just a condensed book. Each card has been separately designed for clear presentation.Topics are self contained and can be grasped visually.

� ACCA Passcards are still just the right size for pockets, briefcases and bags.

Run through the Passcards as often as you can during your final revision period. The day before the exam, tryto go through the Passcards again! You will then be well on your way to passing your exams.

Good luck!

(000)ACP7(INT)PC14_FP_Page Bros.qxp 5/15/2014 5:20 PM Page iii

ContentsPreface

Page

1 International regulatory environments for audit and assurance services 1

2 Code of ethics and conduct 9

3 Professional liability 19

4 Quality control 27

5 Obtaining and accepting professionalappointments 33

6 Planning and risk assessment 39

7 Evidence 51

8 Evaluation and review (i) 59

9 Evaluation and review (ii): matters relating to specific accounting issues 69

Page

10 Evaluation and review (iii): matters relating to specific accounting issues 77

11 Group audits and transnational audits 85

12 Audit-related services and other assurance services 93

13 Prospective financial information 101

14 Forensic audits 107

15 Social, environmental and public sectorauditing 113

16 Internal audit and outsourcing 121

17 Reporting 133

18 Current issues 145

(000)ACP7(INT)PC14_FP_Ricoh.qxp 5/13/2014 10:03 PM Page iv

1: International regulatory environments for audit and assurance services

Topic List

International regulatory frameworks foraudit and assurance

Audit committees

Internal control effectiveness

Money laundering

Law and regulations

This chapter looks at the regulatory environment in whichauditing takes place. Directors of companies areencouraged to follow what has been set down as goodpractice by various government committees.

Those charged with governance need to ensure thatinternal controls perform effectively, as part of theirstatutory duties. Recent moves have sought transparencyby asking directors to report to shareholders on theseissues.

(001)ACP7(INT)PC14_CH01.qxp 5/13/2014 10:03 PM Page 1

Moneylaundering

Internal controleffectiveness

International regulatoryframeworks for audit and assurance

Law andregulations

Auditcommittees

International Regulatory FrameworkIFAC

IAASB IESBA

InternationalStandards on

Auditing (ISAs)

IESBACode ofEthics

Example: UK Regulatory FrameworkAuditors

EU requires member states to approve auditors.

In UK RSBs, eg ACCA

Audit framework

The FRC regulates corporate reporting in the UK, andissued the UK Corporate Governance Code.

The FRC issues auditing standards, practice notes andbulletins.


Moneylaundering



Law andregulations

Auditcommittees

1: International regulatory environments for audit and assurance servicesPage 3

Duties

Review of internal audit

Review of internal controls

Special investigations

Liaison with external auditors� Determine scope of external

audit� Forum to link directors/auditors� Deal with auditors’ reservations� Obtain information for auditors

Audit committees

AdvantagesIncreased confidence in financial statementsFrees executive directors to manageClear reporting lines for internal audit/impartiallink for external auditCreates culture opposed to fraud

DisadvantagesSelecting suitable independent non-executivedirectors can be difficultFormality may dissuade reporting onjudgmental issuesCost of audit committee

��

�

�

�

�


Moneylaundering



Law andregulations

Auditcommittees

Codes of Best Practice for corporate governance are increasingly common worldwide. We focus on some UKguidance, the UK Corporate Governance Code.

UK Corporate Governance CodeCompliance with the UK Corporate GovernanceCode is voluntary, but all UK listed entities mustreport on how they have applied it (in the annualreport).

This is known as the ‘comply or explain’ basis.Listed entities must either comply with the Code, orexplain why they have not done so.

Key effects on auditors� Auditors must review compliance

with code and statement ofcompliance/non-compliance.

� The Code requires companies toestablish an audit committee.

� Listed (UK FTSE 350)companies applying the Codemust put the external audit outto tender at least every tenyears.


Moneylaundering



Law andregulations

Auditcommittees


DirectorsInternal controls and risk management are very importantin fulfiling directors’ duties to the shareholders, which are:

Therefore directors:

� Set up a system of internal control� Review its effectiveness� Consider the need for internal audit

� To safeguard assets� To prevent and detect fraud

Protect the investment ofthe shareholder

As part of their audit:

� Ascertain what the controls are

� Review controls

� Evaluate controls

� Determine audit approach based on controls

Can also offer services:

� To review controls

� Report to shareholders

as a function separate from audit

Auditors


Moneylaundering



Law andregulations

Auditcommittees

Money laundering is the process by which criminals attempt to conceal the true origin and ownership ofthe proceeds of their criminal activity, allowing them to maintain control over the proceeds and, ultimately,providing a legitimate cover for their sources of income.

Money laundering is the attempt to conceal the origin of 'dirty' money by making it look legitimate or 'clean'.There are 3 stages:

Placement. This is the introduction or placement of the illegal funds into the financial system.

Layering. This is passing the money through a large number of transactions or 'layers', so that it becomesvery difficult to trace it to its original source.

Integration. This is the final integration of funds back into the legitimate economy.

1

2

3

Exam questions in this area may require you to identify that money laundering is taking place. This means usingprofessional skepticism.



� Appoint a ML Reporting officer (MLRO)� Undertake Customer Due Diligence� Report suspicion of money laundering� Maintain specific records� Put internal procedures in place to ensure

continued compliance with regulations� Train staff in all these issues

UK Money Laundering Regulations2007

� Possessing, dealing with or concealing theproceeds of any crime

� Attempting, assisting or incitement to commitmoney laundering

� Failure of an individual in the regulated sectorto report a suspicion money laundering

� Tipping-off

Criminal offences in the UK


Moneylaundering



Law andregulations

Auditcommittees

The auditor’s responsibilities for considering law andregulations as part of their audit is discussed in ISA 250Consideration of laws and regulations in an audit of financialstatements:� Procedures

Should plan so as to identify any examples of non-compliance

� EvidenceShould obtain sufficient appropriate audit evidence ofcompliance with laws and regulations with a direct effecton material amounts and disclosures in the FS.

� Document findingsDocument non-compliance and the results of discussionwith management, those charged with governance andthird parties.

Reporting non-complianceManagement

� Non-compliance should be discussed withthose charged with governance

Shareholders

� Consider the impact on audit report –modified opinion

Third parties

� Is there a statutory duty?� Is it in the public interest?� Obtain legal advice

Management are responsible for ensuring that laws and regulations are kept.


2: Code of ethics and conduct

Topic List

Fundamental principles andconceptual approach

Independence

Threats

Safeguards

Confidentiality

Conflicts of interest

Conflicts in application of principles

Much of this chapter is revision from your earlier auditingstudies.You must understand the principles-basedapproach and be familiar with the guidance issued byACCA and the IESBA.

In the exam you are likely to be faced with scenarioswhere you have to apply your knowledge, identify ethicalthreats and recommend appropriate safeguards.


ConfidentialityFundamental principlesand conceptual approach

Conflictsof interest


SafeguardsThreatsIndependence

ACCA Code of Ethics and ConductThe Code contains a conceptual framework, setting out five fundamental principles. This recognises that it isimpossible to define every single situation that may give rise to a threat, and to prescribe specific safeguards foreach. The ACCA Code has been based on the IESBA Code of Ethics for Professional Accountants.

ObjectivityTo not allow bias, conflicts ofinterest or undue influenceof others to overrideprofessional or businessjudgements.

Professional competence and due careTo maintain professional knowledge and skill at alevel required to ensure that a client or employer receivescompetent professional services based on currentdevelopments in practice, legislation, techniques andact diligently and in accordance with applicable technical and professional standards when providingprofessional services.

IntegrityTo be straightforwardand honest in all professional andbusiness relationships.


2: Code of ethics and conductPage 11

ConfidentialityTo respect the confidentiality of information acquired as aresult of professional and business relationships and,therefore, not disclose any such information to third parties without proper and specific authority, unlessthere is a legal or professional right or duty to disclose,nor use the information for the personal advantage of theprofessional accountant or third parties.

Professional behaviourTo comply with relevant laws and regulations and toavoid any action that discredits the profession.

Although not a fundamental principle, auditors must plan and perform the audit with professional skepticism. ISA 200defines this as follows.

Professional skepticism is an attitude that includes a questioning mind, being alert to conditions which mayindicate possible misstatement due to error or fraud, and a critical assessment of audit evidence.






Financialinterests

Loans andguarantees

Close businessrelationships

Family andpersonal

relationships

Employmentconnections withassurance client

Longassociation

Provision ofmultiple services

Gifts/hospitality

Fees

Litigation

Independence of mind is the state of mind thatpermits the provision of an opinion without beingaffected by influences that compromise professionaljudgement, allowing an individual to act with integrity,and exercise objectivity and professional scepticism.

Independence in appearance is the avoidance of facts andcircumstances that are so significant that a reasonable andinformed third party, having knowledge of all relevantinformation, including safeguards applied, would reasonablyconclude a firm's, or a member’s, integrity, objectivity orprofessional scepticism had been compromised.

Threats to independence

Objectives of this section of the ACCA code are to helpfirms and members to...

Identify threats to independence

Evaluate the significance of the threats indentifical

Apply safeguards, when necessary, to eliminatethe threats or reduce then to an acceptable level

1

2

3

Independence


SafeguardsThreats ConfidentialityFundamental principlesand conceptual approach



Independence


Compliance with the fundamental principles may potentially be threatened by a broad range of circumstances:

Threats

� Self-interest threat

� Self-review threat

� Advocacy threat

� Familiarity threat� Intimidation threat

eg financial interests, incentive compensation arrangements, undue dependence onfees

eg data being reviewed by the same person responsible for preparing it

eg acting as an advocate on behalf of an assurance client in litigation or disputes withthird parties

eg former partner of the firm being a director or officer of the client

eg threat of dismissal or replacement, being pressured to reduce inappropriately theextent of work performed in order to reduce fees






Work environmentRegulations

Individual

� Recruitment procedures� Appropriate disciplinary processes� Leadership that stresses the importance of ethical

behaviour� Policies and procedures to implement and monitor the

– quality of employee performance– quality control of engagements

� Using different partners and teams for the provision ofnon-audit services to assurance clients

� Discussing ethical issues with those charged withgovernance

� Consultation with another professional accountant

� ACCA code/IESBA code� ISAs

� Complying with continuing professionaldevelopment requirements

� Keeping records of contentious issues anddecisions

� Using an independent mentor

� Maintaining contact with legal advisers andprofessional bodies

Three categories of safeguards exist: those created by regulations, those created by the individual and those created in thework environment.





Independence


Accountants owe their clients a professional duty of confidence, except in the following situations:

Obligatory disclosureIf a member knows or suspects his client to have committed aterrorist offence, an offence of treason or a money launderingoffence he is obliged to disclose all the information at hisdisposal to a competent authority. In the UK, he is required toreport a suspicion of money laundering. Local legislation mayalso require auditors to disclose other infringements.

Voluntary disclosureIn certain cases voluntary disclosure may be made by themember where:� Disclosure is reasonably required to protect the member’s

interests� Disclosure is required by process of law� There is a public duty to disclose

� Conflicts of interest� Insider dealing

Areas of controversy

� Practice management issues, suchas staff disclosure procedures

� ‘Chinese Walls’, but how successfulare they?

� Engagement letters

Safeguards to consider






Auditors should identify potential conflicts of interest as they could result in the ethical codes being breached.

Conflicts between members’ and clients’ interests

Conflicts between the interests of different clients

Example: member competes directly with client.

Do not accept engagement

Example: clients in competition with each other.

Accept only if safeguards are sufficient

Safeguards include:

� Disclosure of the conflict to both clients� Separate engagement teams.





Independence


Auditor encounters a fraud

Conflict: duty to report vs.confidentiality

Take legal advice on whetherthere is duty to report

The general principles of the Code may conflict in some circumstances. This is because the Code is principles-based (not rules-based). Rather than simply following a rule, auditors must ensure they are independent byjudging how best to apply the fundamental principles. This sometimes involves balancing the principlesagainst each other. For example:

� Relevant facts� Ethical issues involved� Fundamental principles related to

the matter in question� Established internal procedures� Alternative courses of action

Matters to consider where there is aconflict:


Notes


3: Professional liability

Topic List

Legal liability and negligence

Restricting liability

Fraud and error

The expectations gap

The responsibility of the auditor is simple: to report to theshareholders on the truth and fairness of the financialstatements.

However, the auditor has subsidiary responsibilities andliabilities: to the company (in contract) and potentially tothird party users of the financial statements (in tort).

There are some methods by which auditors may restricttheir potential liability.

The auditor’s responsibilities for fraud and error are acommon area of public misunderstanding, and anexample of the expectations gap.



Fraud and error The expectationsgap


AUDITOR LIABILITY Negligence A common law concept whereby aperson who has suffered loss due to anotherperson’s wrongful neglect is compensated

In contractand tort

In criminal law:

� Various insolvency issues

� Insider dealing

� Money laundering issues

A successful claim for negligence requires:

1 An enforceable duty of care to have existed

2 The duty to have been breached

3 Loss to have resulted

In English (and many other) law(s) a contract forservice implies a duty of care. (In practice, thismeans to adhere to ISAs.)

Therefore, the auditor always owes thecompany (the client) a duty of reasonable care.


3: Professional liabilityPage 21

However, such a duty of care is only implied to the company.

Various other users of financial statements (individual shareholders, employees, prospective shareholders, taxauthorities, lenders, others) must seek to prove that is true in their case.

It is in the interest of auditors to avoid liabilityclaims from a wide range of parties.

� They can try to disclaim liability

� They can make good use of quality controlprocedures to avoid problems

If auditors are sued, they may choose to settleout of court.

� Cheaper

� Less adverse publicity

� Quicker

The Caparo caseCaparo Industries purchased Fidelity shares in the openmarket. After the audited accounts were published theybought more and in the end, bought enough to take overFidelity. Caparo later alleged that the audited accountswere misleading - a profit should really have been a loss.They argued the auditors owed a duty of care to investorsand potential investors. The House of Lords held thatauditors did not owe a duty of care to the public atlarge deciding whether to buy shares.

The key case that provides insight on judicialthinking on this issue is Caparo Industries plc vDickman and Others 1990.





Professional indemnity insuranceACCA requirement – insurance against civil claims.

If >6 employees → must have fidelity guarantee insurance too (covers fraud by firm)

IncorporationAuditors can incorporate in UK, and can obtained stock exchange listings.

Limited Liability Partnerships (LLPs)Many audit firms in the UK are LLPs. This provides limited liability but with the flexibility and tax structure of apartnership.

Liability limitation agreementsAuditors have wanted limited liability agreements/liability caps for some time. This is part of the ongoing debateover the future of audit.






Fraud is an intentional act by one or moreindividuals among management, thosecharged with governance, employees or thirdparties, involving the use of deception toobtain an unjust or illegal advantage.

The directors are responsible forpreventing and detecting fraud.

ISA 240 states that by conducting an audit inaccordance with ISAs the auditor obtainsreasonable assurance that FS are free frommaterial misstatement whether caused byfraud or error.

An error is an unintentional misstatement.

Exam focusLook for factors in questions which might indicate arisk of fraud. These could include:

� Management with poor integrity� Deficient internal control components� Unusual transactions� Financial reporting pressures� Problems in gaining sufficient appropriate evidence� Unique issues arising from systems





Reporting tothose chargedwith governance

Reporting tomembers

Reporting tothird parties

If the auditors suspect or detect any fraud (even if immaterial), as soon as they can theyshould tell:

� The appropriate level of management (employee fraud), or� Those charged with governance (management fraud)

In terms of the audit opinion given on the financial statements, if the auditor feels thatthe financial statements are materially misstated as a result of fraud, he should modifyhis report accordingly.If the auditor feels he has to withdraw from the engagement as a result of his discovery,he should consider whether there is a professional or legal requirement to report to theperson who appointed him.

When the auditors discover or suspect a fraud they should consider whether there is aduty to disclose.

The auditors would in practice seek legal advice to ensure that they were not breachingtheir ethical duties regarding confidentiality.

REPORTING FRAUD






Any gap between the expectations of users of audited financial statements, and those auditors.

Fraud is a common area where expectations diverge: it is sometimes incorrectly thought that the purpose of theaudit is to detect fraud.

Logically, there are 2 ways of narrowing the gap:

Educating users

Eg improve audit report’sexplanation of auditprocess

Extending auditors’responsibilities

Eg Requiring auditors to reporton the adequacy on fraudprevention controls

Expectations gap


Notes


4: Quality control

Topic List

Quality control: firm level

Quality control: individual audit

Probably the most important consideration in practicemanagement is quality control. This chapter covers thespecific guidance in relation to quality practice andprocedures: ISA 220 Quality Control for an Audit ofFinancial Statements and ISQC 1 Quality control forfirms that perform audits and reviews of financialstatements, and other assurance and related servicesengagements.


Quality control:individual audit

Quality control:firm level

� Observingacceptanceprocedures and not accepting‘difficult’ clients

� Instituting clientcare procedures

� Key maninsurance

� Setting up asystem of qualitycontrol

SafeguardsLitigation against the firm

Disciplinaryaction by

ACCABad publicity

Loss of the litigious client

Loss of other clients

Loss of keyClient loss other than personnel

through litigation

…to competitors

RISK OF BUSINESSFAILURE FORAUDIT FIRM


4: Quality controlPage 29

ISQC 1.11Quality control systems, policies and procedures are the responsibility of the audit firm. Under ISQC 1, the firm hasan obligation to establish and maintain a system of quality control to provide it with reasonable assurance that:

(a) The firm and its personnel comply with professional standards and applicable legal and regulatory requirements;and

(b) The reports issued by the firm or engagements partners are appropriate in the circumstances

� Sufficient and appropriate experience� Ability to carry out the job� Authority to carry out the job

Leadership responsibilities

� Recruitment� Capabilities� Career development� Compensation� Performance evaluation� Competence� Promotion� Estimation of personnel needs

Human resourcesThe entire business strategy of the firm should bedriven by the need for quality.




QC procedures must be:

� Relevant� Adequate� Operating effectively� Complied with

Corrective action includes:

� Remedial action with individual� Communication with training dept.� Changes in QC policies and procedures� Disciplinary action (if necessary)

Monitoring

This involves:

� Direction� Supervision� Review� Consultation� Resolution of disputes

Engagement performance

Assignment of engagement teams

The firm must also have standards as to whatconstitutes a suitable quality control review.

This is the responsibilty of the engagement partner.




4: Quality controlPage 31

� Leadership – engagement partnerresponsible

� Adhering to professionalrequirements (independence andobjectivity)

� Acceptance/continuance of audit� Appropriately

qualified/experienced staff� Engagement performance� Monitoring QC procedures

Individual audits

� Direction. Informing staff about:– The work to do – Potential problems– Nature of client – Responsibilities

� Supervision. Overall by engagement partner butmore practical supervision given within the auditteam

� Review. Includes consideration of whether:– Work complies with required standards– Significant matters/conclusions documented– Evidence is sufficient and appropriate

� Consultation. Contentious matters must bediscussed and properly reviewed

� Quality Control review. Evaluation of:– Significant judgements– Conclusions

Engagement performanceISA 220 Quality control for an audit offinancial statements applies the generalprinciples of ISQC 1 to individual audits.


Notes


5: Obtaining and accepting professional appointments

Topic List

Change in auditor

Advertising, fees and tendering

Acceptance

Agreeing terms

Exam questions could be set in the context of a changeof auditor. This could involve:

� Ethical issues� Practice management issues

Be prepared to link issues in the syllabus when you areworking through these passcards. Generally questions inthe exam are scenario-based and bring in lots of differentissues. Bear in mind that the professional appointmentmay be for a service other than audit.


Agreeingterms

AcceptanceAdvertising, feesand tendering

Change inauditor

Percieved not tobe value for money

Perceived to betoo high Interested in whether

price is negotiable

Audit fee

Not competetive

Disagreement withthe client

Auditor does notseek re-election

Another client isin competition Auditor has other ethical

CHANGE IN AUDITOR

Size

Client falls belowexemption limit

Client’s businessexpands beyondauditor’s capacity

Personality: client fallsout with the auditor

Auditor rotation: relationshipended for independenceresonsreasons


Agreeingterms


Change inauditor

5: Obtaining and accepting professional appointmentsPage 35

The medium used should not reflect adversely on the member, ACCA or the

accountancy profession.

Advertising

Estimate work involved/fees

Obtain further details from client

Work required

Consider practical issues

– Fees– Staff– Location

Background information

Prepare proposal

TenderingApproach by prospective client

Firm considers if it wants the work

Fees

� No prescribed basis� %/contingency only if unrelated to audit� Quoting too low a fee may introduce threat to

competence and due care� Fair and reasonable re:

– Seniority of staff– Time– Risk/responsibility


Agreeingterms


Change inauditor

ISQC 1 requires that a firm carry out the following steps when deciding whether to accept an audit:

Step 1 Obtain relevant information (eg from previous auditors, from other firm personnel)

Step 2 Identify relevant issues (eg client’s integrity, firm’s competence to carry out engagement)

Step 3 If resolvable issues exist, resolve them and document that resolution

Money laundering

Politically exposed persons (PEPs)

Firms must carry out ‘Know Your Client’ (KYC) procedures in order to comply with Anti-Money Launderingregulations. Examples include obtaining information such as the source of the client's funds, its business model,and expected patterns of business.

Being involved with PEPs may be risky for the firm – the firm must have risk management procedures to identifypotential PEPs.


Agreeingterms


Change inauditor

5: Obtaining and accepting professional appointmentsPage 37

It is vital to agree terms with a client so that there is no misunderstanding as to what the service will be, to prevent problems later on.This is usually achieved through the engagement letter.

Books/documentsWorking papers are owned by theauditor. The client has no right of accessto them.

In a new audit situation, the old auditorsmay grant the new auditors access totheir papers, however they are not yetrequired to do so by law or professionalregulations. However, UK law ischanging to give new auditors access byright.

� The objective/scope of the audit (law/standards)� Confirmation that preconditions for an audit exist� Confirmation of understanding of respective responsibilities� The form of any reports/communications� Inherent limitations (risk of undiscovered misstatements)� Arrangements regarding planning of the audit� Expectations in relation to representations� Basis on which the fees are computed/billing arrangements� Arrangements re. involvements of IA/3P in audit� Any restriction of the auditors’ liability where possible� Reference to further agreements between client/auditor

Items included in engagement letter

ISA 210 requires that auditors do not accept the engagement where written representations are not provided by managementon their responsibilities.


Notes


6: Planning and risk assessment

Topic List

Methodologies

Materiality

Risk

Analytical procedures

Planning is a key skill for an auditor. Auditors must plantheir audit so as to perform it in an effective manner. Twokey areas in planning are:

� Materiality� Risk

Exams regularly include scenarios where you need toidentify either business or audit risks, so you need tohave a thorough understanding of this area.


Methodologies Analyticalprocedures

RiskMateriality

ISA 315.15The auditor shall obtain an understanding ofwhether the entity has a process for identi-fying business risks relevant to financialreporting objectives and deciding aboutactions to address those risks.

� Recognises that most business risks will eventually havean effect on the financial statements

� Allows the auditor to gain a greater understanding of thebusiness and therefore increases the chance ofidentifying risks of material misstatement

� Enables auditor to give constructive business advice

Business risk approach

� Economic pressures causing reduced unit sales and eroding margins

� Economic pressures resulting in demands for extended credit

Inventory values (IAS 2)Going concern

Going concern

Receivables’ recoverability

� Customer dissatisfaction related to inability to meet order requirements

Examples ofbusiness risks

Risks of materialmisstatement


6: Planning and risk assessmentPage 41

‘Top down’ approach

Business

Financial statements

The approach starts with the business and itsobjectives and works back down to the financialstatements.

Impact of approach on proceduresControls testing: Auditor concentrates on morehigh level controls used by directors to managerisks.

Analytical procedures: Higher use than intraditional audit (consistent with desire tounderstand the entity).

Detailed testing: Reduced due to the two factorsabove but not eliminated.

Advantages� Added value to client as business focused� Audit efficiency/cost is reduced� Focuses on corporate governance� Lower engagement risk as the auditor

understands the client’s business

Top down approach



RiskMateriality

Systems auditAuditors always ascertain and evaluate the systems ofan audit entity. If auditors conclude systems are:

� Effective, they will undertake tests of controls andaim to reduce substantive testing

� Ineffective, they will not test controls and willundertake detailed substantive testing instead

REMEMBER

Substantive testing cannever be eliminated entirely

from an audit.

Exam focusIf auditors have judged that systems at a client areineffective, they may choose the transactions approachto the audit so that the transactions which have gonethrough the poor systems can be substantiated.

Transaction cycles approach:When auditors take a cycles approach theytest the transactions which result in theincome statement. They will trace transactionsthrough the system from order to payment.



SummaryThe auditor will choose the audit approach which best fits the situation at the client, but may use a combinationof the approaches discussed here. Therefore, directional testing can be used in a cycles or balance sheetapproach, an analytical approach can be used with a business risk approach, etc.

Primary test also gives comfort on

Type of account Purpose of primary test Assets Liabilities Income Expenses

Assets Overstatement (O) U O O ULiabilities Understatement (U) U O O UIncome Understatement (U) U O O UExpenses Overstatement (O) U O O U

Directional testing is an approach to testing used within a substantive approach. It is a methodology whichgives assurance using the double entry accounting system.



RiskMateriality

For you to considerYou have been asked to plan the audit of Hugues Co, a listed construction company. It has been an auditclient of your firm for a number of years. You have learnt the following:

The company issued a profits warning for the year three months prior to the year-end. Shareholders areaccustomed to receiving two dividends annually, after interim and final results are published. The company hasbeen badly affected by the general, poor economic condition in the country. Revenue on houses already builtis significantly down and advance orders on proposed new builds are also down. However, despite slowmovement in house sales nationally, the company recently purchased rights to buy land in the capital citywhere prices for land continues to rise.

Identify audit risks arising from the information you have been given.

(Some factors are given overleaf. You should note it is not intended to be a comprehensive answer to thequestion, however.)



Relevant factorsGeneral matters: The construction industry is subject to volatility and is therefore likely to be particularly hardhit if economic conditions are poor. Given shareholders expectations re. dividends, this could lead to profitmanipulation by creative accounting to give the ‘best-case’ picture in the accounts. The auditors may want torender materiality with regard to profit/loss quite low, particularly if the result is marginal. The issue of goingconcern should also be considered if revenue is low, profits have been affected and if this has affected or willadversely affect the share price.

Inventory: The fact that revenue on already built homes is low may mean that the company has high levels ofinventory, which should be investigated for obsolescence. The general increase due to poor economicconditions might hide specific and different selling problems with individual sites. Inventory affects profit.

Land: How should the transaction be accounted for? Timing of purchase: commitment or asset? Do the rightsthemselves have value? How have these transactions been accounted for before? Has the company enteredinto such transactions before or is it designed to affect the accounts?



RiskMateriality

Criteria of MaterialityAn item might be material due to its:(a) Nature eg transactions related to directors, such as remuneration or contracts with the company.(b) Value eg land with a value which comprised three-quarters of the asset value of the company.(c) Impact eg a proposed journal which is not material in itself could convert a profit into a loss.

Materiality is an expression of the relative significance or importance of a particular matter in the context ofthe financial statements as a whole.

Performance materiality is the amount or amounts set by the auditor at less than the materiality for thefinancial statements as a whole to reduce to an appropriately low level the probability that the aggregate ofuncorrected and undetected misstatements exceeds materiality for the financial statements as a whole or in a

particular class of transaction, account balance or disclosure.

Exam focusIn P7, calculating materiality will never get many marks by itself – it is likely to be starting–point for discussingother issues from the question scenario.



In order to calculate a level ofplanning materiality, theauditors will often take arange of values and use anaverage or weighted average.

Profit before tax5%

Gross profit1/2 – 1%Revenue1/2 – 1%

Total assets1 – 2%

Net assets2 – 5%

Profit after tax5 – 10%

Rules on materialityMateriality is judgemental, but a number of generally accepted rules exist.An example is the range of percentage values commonly applied. Whenassessing materiality in exam questions calculate the relevant matter as apercentage of the relevant indicator (profit, revenue, total assets) andassess whether it falls within these ranges.

Problems with materialityPrescriptive rules will not always be helpful when assessing materiality.There is a risk that a significant matter falls outside the boundaries of therules and there is a material misstatement in the financial statements.



RiskMateriality

Audit risk is the risk that the auditors give aninappropriate opinion on the financial statements. It is madeup of inherent risk, control risk and detection risk.

Overview of revised approachPerform risk assessment procedures (ISA 315)

Assess the risk of material misstatement (ISA 315)

Respond to assessed risk (ISA 330)

Perform further audit procedures (ISA 330)

Evaluate audit evidence obtained (ISA 330)

� Nature of controls� Attitude to controls

Control

� Chance of discovering misstatements

Detection

� Affecting client as a whole (managementintegrity, nature, IT, industry factors, pressures)

� Affecting individual balances (complexaccounts, assets at risk, staff)

Inherent



Business risk is the risk arising to abusiness from being in operation.

� Cash flow issues� Overtrading� Capital issues� Going concern� Breakdown of accounting systems� Credit risk� Loss of key supplier/customer� Loss of key employees� Physical disasters� Poor brand management� Breach of law/regulation: fines� Tax problems: fines� Environmental law: fines/compensation

Examples of risks

Financial risk Compliance riskRisk arising from thefinancial activities orfinancial consequencesof an operation.

Risk arising withregard to operations.

Risk that arises fromnon-compliance withlaws and regulations.

Operational risk

It is vital that you do not confuse audit risk with business risk



RiskMateriality

Analytical proceduresAnalytical procedures consist of comparing itemsexpected to have a relationship. Analyticalprocedures can be used in three ways during anaudit:� Risk assessment procedures� Substantive procedures� Overall review

In an analytical approach, this area is concentratedon more highly.

Analytical approaches are commonly taken on:

� Business risk approach assignments� Reviews� Assurance engagements� Prospective financial information

Techniques include:

Reasonableness Comparison Trendchecks analysis

Is taken in situations where:

� Auditor expects little change in figures� Auditor has high degree of knowledge of

expected changes

Analytical approach


7: Evidence

Topic List

Revision: audit evidence

Related parties

Written representations

Using the work of others

Auditors need to obtain evidence in order to reach theiraudit opinion. This evidence should be:� Sufficient (a measure of quantity)� Appropriate (a measure of quality)

Some issues in the financial statements can be difficultto obtain evidence about eg, related party transactions.Transactions may not be recorded, and onlymanagement have details of who the related parties are,therefore auditors will use written representations asevidence. Sometimes the auditors will use evidencecreated by third parties (internal audit or experts).


Related partiesRevision: auditevidence

Using the workof others

Writtenrepresentations

Auditors seek audit evidence aboutthe assertions (the representationsmade by the directors in the financialstatements). These are:

� Accuracy� Completeness� Cut-off� Allocation� Classification (understandability)� Occurrence� Valuation� Existence� Rights and obligations

Audit procedures� Inspection of assets/documentation� Observation� Enquiry� Confirmation� Recalculation� Reperformance� Analytical procedures� Audit automation tools

Auditors must gain sufficient, appropriate audit evidence.

� Sampling (statistical or not)� Materiality� Risk

Sufficient

� Source?� Oral?� Written?

Appropriate





7: EvidencePage 53

Related partyA related party is either:

(a) A related party as defined in the applicable financial reporting framework; or

(b) Where the applicable financial reporting framework establishes minimal or no related party requirements:

(i) A person or other entity that has control or signiicant influence, directly or indirectly through one or more intermediaries, over the reporting entity;

(ii) Another entity over which the reporting entity has control or significant influence, directly or indirectlythrough one or more internediaries; or

(iii) Another entity that is under common control with the reporting entity through having:

� Common controlling ownership

� Owners who are close family members; or

� Common key management





Auditors shall inquire of management regarding:

(a) The identity of the entity’s related parties.

(b) The nature of the related party relationships.

(c) Any transactions with the related parties during the period, and if so,their type and purpose.

(d) Controls to identify, account for and disclose related party relationshipsand transactions.

(e) Controls over authorisation and approval of significant related partytransactions and transactions outside the normal course of business.


7: EvidencePage 55

Issues� Inherent difficulties of (self) detection

– Not even necessarily evident to management– Transactions not necessarily charged for (not

processed)– Chance of concealment by management– Complex corporate structures

� Responsibility of management to identify relatedparties

� Materiality – judged in relation to related partiesnot entity

EvidenceThere are two key problems with regard to evidence:

� May be limited� May be created by the related party

Sources of evidence� Minutes of meetings of those charged with

governance� Analytical review of transactions� Confirmation of loans (eg who is guarantor)� Written representations� Correspondence with solicitors





ISA 580.9The auditor shall request written representations from management with appropriate responsibilities for thefinancial statements and knowledge of the matters concerned.

� Management fulfilled responsibility for preparationand presentation of FS

� FS prepared and presented in accordance withapplicable FR framework

� All relevant information provided� All transactions recorded and reflected� Description of management’s responsibilities

General representations

� Due to provisions of other ISAs

� To support audit evidence

� Where sufficient appropriate audit evidencecannot be obtained independently

Specific representations


7: EvidencePage 57

ISA 610 Using the work of internal auditors highlightsthree important things for external auditors toconsider when making use of the work of internalaudit in the audit.

Understanding/assessing the role and scope ofinternal audit in the organisationTiming of liaison and co-ordination

Evaluating specific audit work

Steps one and two will be carried out as part of theprocess of identifying and assessing the risks ofmaterial misstatement.

If the auditors decide to make use of the work ofinternal audit, they must evaluate that work toensure that it is sufficient and appropriate for themto base their opinion on. This is step three. The tableadjacent gives examples of questions which theymight ask.

1

2

3

Have the internal auditors sufficient and adequatetraining to carry out the work?

Are the internal auditors competent?

Does internal audit adopt a systematic anddisciplined approach?

Is the work of assistants properly supervised,reviewed and documented?

Are the conclusions reached appropriate given theevidence obtained?

Are reports produced consistent with the workundertaken?

Have any unusual matters discovered by theinternal audit department been resolved?

Using work of internal audit





ISA 620 identifies four issuesfor an auditor to assess.

Whether it isnecessary to use anauditor’s expertCompetence andobjectivity of theauditor’s expertThe auditor’sexpert’s scope ofworkThe actual work ofthe auditor’s expert

The following might require evidence from an expert:Asset valuation, determination of quantity/ completion of assets or of specialistamounts (eg pensions accounting)

The auditor must consider the professional certification of the expert, his reputation,his capacity in relation to the entity (ie employee or contracted third party)

Evaluate the expert’s written instructions to assess: objectives/ scope of work,general outline of matters covered, intended use of information, extent of theexpert’s access to information and files. Determine whether to include expert inrisk discussion.

Consider: the source data used, assumptions and methods used, the timing of thework, the results in the light of the auditor’s overall knowledge of the business.

1

2

3

4

ISA 620 Using the work of an auditor’s expert, distinguishes between two types of expert that may be used by the auditor:

Auditor’s expert – An individual or organisation with expertise is an area outside auditing or accounting. An auditor’sexpert may be an internal expert (ie belong to the auditor’s firm or network firm) or an external expert.Management’s expert – An individual or organisation with expertise in an area outside auditing or accounting whowill assist the entity in the preparation of the financial statements.-


8: Evaluation and review (i)

Topic List

Revision: Review procedures

Revision: Opening balances and comparatives

Revision: Other information

Revision: Subsequent events

Revision: Going concern

Most of this chapter is revision from your previousauditing studies. Any of the topics included here could bepart of a scenario question. Alternatively, these areascould form relatively easy marks in the exam.


Revision:Review procedures

Revision:Going concern

Revision:Subsequent events

Revision:Other information


Overall review Analytical procedures� Should be performed at end of audit

Accumulating and evaluating misstatementsAuditors must consider:

� Aggregate of known misstatements� Whether circumstances indicate that there may

be other misstatements (which are not knownabout)

Auditors then consider if these uncorrectedmisstatements are material.

All uncorrected misstatements are communicated toTCWG.

� Compliance with accounting regulations/examineaccounting policies

� Review for consistency and reasonableness– Presentation– Disclosure– New factors included

Exam focusAuditors should carry out a review of the financialstatements to, in conjunction with evidence alreadyobtained, draw an audit conclusion.


8: Evaluation and review (i)Page 61






Opening balances are those account balances that exist at the beginning of the period, reflecting the effectof transactions of the preceding period and its accounting policies.

Testing opening balances can be difficult for newauditors because they did not audit the prior yearfigures. They should:

� Ascertain whether prior report was unqualified

� Undertake discussions with management aboutopening figures

� Undertake substantive procedures on openingfigures if concerns arise

Incoming auditorsAuditors shall obtain sufficient appropriate auditevidence that:

� Opening balances correctly b/f

� They do not contain misstatements material tocurrent year figures

� Accounting policies are consistently applied orchanges adequately disclosed







� Check balances b/f correctly

� If unresolved prior year problem is material toCY, qualify report due to opening balances andcomparatives

� If material to CY but opening balances are notaffected, report should refer to comparatives

– Modification– Emphasis of matter paragraph

Continuing auditors

� Responsible for corresponding figures as part ofCY accounts

� Procedures as for continuing auditors

Incoming auditors: audited correspondingfigures

� Ensure there is clear disclosure that thecorresponding figures are unaudited

� Should carry out procedures as for continuingauditors, as far as possible

Incoming auditors: unaudited correspondingfigures

Corresponding figures are the corresponding amounts and other disclosures from the preceding periodwhich are part of the current year’s financial statements. They are distinguished from comparativefinancial statements which the auditor’s report should refer to separately if they exist.








Auditors should always ensure that the other informationdoes not contain:

� A misstatement of fact� An inconsistency with the audited financial statements

On discovering a material inconsistency, the auditor shoulddetermine whether the audited financial statements or otherinformation needs to be revised:

� If financial statements need revising, then modifyauditor’s report (ISA 705)

� If other information needs revising, include other matterparagraph in the auditor’s report.

If a material misstatement of fact is discovered in the otherinformation (but does not conflict with information in thefinancial statements), the auditor shall discuss this withmanagement.

� Financial summaries/highlights� Employment data� Report by management/directors on operations� Planned capital expenditures� Financial ratios� Names of officers/directors� Selected quarterly data

Example

Other informationFinancial and non-financial information other thanthe financial statements and the auditor’s report,which is included, either by law, regulation orcustom, in a document containing auditedfinancial statements and the auditor’s reportthereon.







� Enquiries of management

(Status of judgemental issues, new commitments, unusual accounting adjustments etc)

� Reading minutes of meetings

� Reviewing most recent financial information

Audit procedures

Prior to auditor’s report being signedAuditors shall perform procedures designed to obtainsufficient appropriate audit evidence that subsequentevents requiring adjustment or disclosure in the financialstatements have been identified. These are likely toinclude:

are events which occur between the date of theFS and the date of the auditors’ report, and factsthat beome known to the auditor after the date ofthe report.

There are two types of event (IAS 37):

� Provide further evidence of conditions thatexisted at the period-end (adjusting events).

� Indicative of conditions which arosesubsequent to the period-end (non-adjustingevents).

Subsequent events



Before FS issuedAuditors do not have any obligation to performprocedures or make enquiries regarding thefinancial statements after the date of their report.

If material subsequent events become known, theauditor shall:

(a) Discuss the matter with management andwhere appropriate, those charged withgovernance

(b) Determine whether the financial statementsneed amendment and, if so,

(c) Inquire how management intends to addressthe matter in the financial statements

If appropriate, the auditors should extend theirprocedures and issue a new audit report.

After FS issuedAuditors have no obligation to perform procedures ormake enquiries regarding the financial statementsafter they have been issued.

When management revise the financial statements theauditor shall:

(a) Carry out necessary audit procedures

(b) Review steps taken by management to ensureanyone in receipt of the previously issued financialstatements is informed

(c) Extend the audit procedures to the date of thenew auditor’s report

(d) Issue a new report on the revised financialstatements

The amended auditor’s report should contain anemphasis of matter or other matters paragraph.

After the auditor’s report has been signed







Going concern assumptionUnder the going concern assumption, an entity is viewed as continuing in business for the foreseeable future.General purpose financial statements are prepared on a going concern basis, unless management eitherintends to liquidate the entity or to cease operations, or has no realistic alternative but to do so.

Auditor responsibilities Risk assessmentThe auditor’s responsibility is to obtain sufficientappropriate audit evidence about theappropriateness of management’s use of the goingconcern assumption in the preparation andpresentation of the financial statements and toconclude whether there is a material uncertaintyabout the entity’s ability to continue as a goingconcern.

When performing risk assessment procedures, theauditor shall consider whether there are events orconditions that may cast significant doubt on the entity’sability to continue as a going concern (examples givenbelow). If management has performed a preliminaryassessment of the entity’s ability to continue as a goingconcern, the auditor shall discuss it with management.The auditor shall remain alert throughout the audit for anyfactors which would indicate problems.



EvaluationThe auditor shall evaluate management’s assessment of theentity’s ability to continue as a going concern.

Additional audit proceduresWhen events or conditions have been identified that maycast significant doubt on the entity’s ability to continue as agoing concern, the auditor shall obtain sufficient appropriateaudit evidence to determine whether or not a materialuncertainty exists through performing additional auditprocedures. Examples include:� Analysis and discussion of cashflow/profit/other

forecasts/interim FS with management� Read minutes of shareholder meetings� Make enquiries of lawyers regarding legal claims� Reading terms of debentures/loan agreements

Financial� Net liabilities� Fixed term borrowing approaching maturity

without realistic prospect of renewal/repayment� Negative operating cash flows� Adverse financial ratios� Substantial operating losses� Inability to finance new productsOperating� Loss of key management/markets/franchise� Labour difficulties/supply shortage� Emergence of highly successful competitorOther� Major legal proceedings/non-compliance

Examples







Emphasis of matter paragraphWithout qualifying our opinion we draw attention toNote X in the financial statements which indicatesthat the company incurred a net loss of ZZZ duringthe year ended December 31, 20X1 and, as of thatdate, the company’s current liabilities exceeded itstotal assets by YYY. These conclusions, along withother matters as set forth in Note X, indicate theexistence of a material uncertainty that may castsignificant doubt about the company’s ability tocontinue as a going concern.

Reporting

Qualified/adverse opinion:

If there are multiple material uncertainties that aresignificant to the financial statements as a whole, theauditor may consider it appropriate to express adisclaimer of opinion.

Adequate disclosure Adequate disclosure

� Going concern appropriate, but material uncertaintiesnot adequately disclosed Qualified/adverseopinion

� Going concern not appropriate Adverse opinion


In the exam you will be expected to evaluate the issuessurrounding items in FS from an audit perspective. Thekey matters you should consider are:

� Materiality � Relevant accounting standards� Risk � Audit evidence to be sought

Much of this will depend on the particular issues raised ina question. This chapter gives some pointers in terms ofaccounting standards/audit procedures. Remember any ofthe financial reporting areas you have previously studiedcould come up in this exam.

9: Evaluation and review (ii): matters relating to specific accounting issues

Topic List

Fair value

Inventory and construction contracts

Tangible and intangible non-currentassets

Financial instruments

Foreign exchange rates


Fair value Financialinstruments


Inventory andconstruction contracts

Tangible and intangible non-current assets

Accounting estimateAn approximation of a monetary amount in theabsence of a precise means of measurement. Theterm is used for an amount measured at fair valuewhere there is estimation uncertainty as well as forother amounts that require estimation.

� Refer to the market where FV=market value� Use the work of an expert� Consider management’s past history of

carrying out its stated intentions with respectto assets or liabilities

� Review written plans and otherdocumentation

� Consider management’s stated reasons forchoosing a particular course of action

� Consider management’s ability to carry out aparticular course of action

Audit procedures

The auditor is required to assess the entity’s process fordetermining accounting estimates including fair valuemeasurements and disclosures and the related controlactivities and to assess the arising risks of materialmisstatement.

Once the auditors have assessed the risks associatedwith determining fair value, they should design furtherprocedures to address those risks.

IFRS 13 Fair value measurement was recently issuedand contains extensive guidance on measuring FVs.There is a risk that this has not been followed.






9: Evaluation and review (ii): matters relating to specific accounting issuesPage 71

Is valuation basis reasonable?

� Purchase invoices� Price index� Enquire

Is calculation correct?

� Check maths� Consider if reasonable� Verify to invoices, personnel records, nominal

expense accounts� Use analytical procedures?

Standard costs

� Check maths of calculation� Is basis of calculation comparable?� Verify figures:

– Revenue to certificate– Contract price to contract– Work completed to invoices– Payments to remittances

� Discuss losses arising with management

Procedures

Revenue and profit recognised must reflect theproportion of work carried out at the accounting date(on a sales or cost basis). Profit should not be takenup if uncertain, and if losses are certain they should berecognised immediately.






� Depreciation

� Disposals

� Revaluations

� Impairments

Key issues

� Identify any indicators of impairment

� Review calculation of recoverable amount

� Assess reasonableness of cash flows used invalue in use calculation

� Consider the use of an expert to corroborate thenet realisable value

� Check that any impairment losses recognised arecorrectly written-off

Audit procedures

IAS 36 Impairment of assets is relevant to the valuationassertion

Main accounting aspects of IAS 16 Property, plantand equipment are assumed knowledge from earlierstudies



� Prepare analysis of movements� Obtain any third party

confirmations� Review specialist valuations� Inspect purchase documentation� Confirm authorisation� Review sales returns for income� Identify any indicators of

impairment� Review calculation of recoverable

amount

Audit tests

In other words, ensure that the criteria are met and disclosure isadequate.

Goodwill (IFRS 3)Positively purchased goodwill should becapitalised as an asset. Internallygenerated goodwill (including brands)

should not be capitalised.

Development costs (IAS 38)The criteria for allowing development costs to be capitalised are:� Technically feasible� Intention to complete or sell� Ability to use or sell� Existence of a market� Availability of resources� Expenditure can be measured reliably

Audit tests reflect these criteria:� Check accounting records� Review market research� Review budgets/forecast cash� Check amortisation






Valuation

� Utilise information from 3rd party, eg a broker� Gather data and develop own estimation model� Engage an expert� Check basis is appropriate per IAS 32/

IFRS 7/IFRS 9

Investment income

� Ensure only recognised when appropriate

Completeness/occurrence/measurement

� Check all income received� Review for unusual entries

Financial instruments

Classification

� Amortised cost � Fair value

Existence

� Examine certificates of title� Third party confirmations� Transfer documents� Purchase invoices/contracts� Sales invoicesOther aspects

� Consider business risk (management may notfully understand it)

� The more complex the financial instruments, thegreater the need for professional skepticism







The presence of foreign exchange is likely to increase audit risk.

Risk is that IAS 21 The effects of changes in foreign exchange rates is not complied with.

Audit procedures:

� Check monetary items in SOFP are translated at Closing Rate� Check non-monetary items translated at Historical Rate� Check SoPLOCI items translation at Historical Rate

If a parent has a different functional currency from its subsidiaries, then:

� Check that assets & liabilities translated at Closing Rate� Check that income statement items translated at Historical Rate (or average rate)� Check that exchange differences are reported in equity.

Individual company

Groups


Notes


In the exam you will be expected to evaluate the issuessurrounding items in FS from an audit perspective. Thekey matters you should consider are:

� Materiality � Relevant accounting standards� Risk � Audit evidence to be sought

Much of this will depend on the particular issues raised ina question. This chapter gives some pointers in terms ofaccounting standards/audit procedures. Remember any ofthe financial reporting areas you have previously studiedcould come up in this exam.

10: Evaluation and review (iii): matters relating to specific accounting issues

Topic List

Income

Liabilities

Expenses

Disclosure and other issues


Income Disclosure and other issues

ExpensesLiabilities

Revenue� Check classification� Agree to documentation (eg letter/application)� Agree receipt to bank statements

Capital� Accounting basis comparable to PY?� Discuss with directors� Agree any transfers between SoFP and

SoPLOCI (This should be like testingdepreciation.)

Government grants and assistance

Revenue recognitionAccounting treatment found in IAS 18 Revenue. Revenue is often audited by analytical procedures as it haspredictable relationships and there is generally lots of available information about it.

ISA 240 states that auditors must presume there is a risk of fraud in revenue recognition.



ExpensesLiabilitiesIncome

Deferred tax is the tax attributable to temporary differences, which are differences between the carrying amount ofan asset or liability in the statement of financial position and its tax base.

Page 79 10: Evaluation and review (iii): matters relating to specific accounting issues

� Obtain a copy of the deferred tax workings and the tax computation� Check the arithmetical accuracy of the deferred tax working� Agree the figures used to calculate timing differences to those on the tax computation and the financial

statements� Consider the assumptions made in the light of your knowledge of the business and any other evidence

gathered during the course of the audit to ensure reasonableness� Agree the opening position on the deferred tax account to the prior year financial statements� Review the basis of the provision to ensure:

– It is in line with accounting practice under IAS 12 Income taxes– It is suitably comparable to practice in previous years– Any changes in accounting policy have been disclosed

Deferred tax




Audit proceduresThe auditors have to assess thetreatment of provisions against theadjacent criteria. This will involveconsidering such evidence as:

� Reviewing correspondence

� Discussion with the directors

� Referring to comparable pastevents

� Seeking verification fromsolicitors

� Recalculating provisions foraccuracy

� Considering the nature of thebusiness

A provision is a liability of uncertain timing or amount, to be settled bythe transfer of economic benefits. A contingent liability is a possibleobligation that arises from past events and whose existence will beconfirmed only by the occurrence/non-occurrence of one or more eventsnot within the entity’s control, or a present obligation arising from pastevents that is not recognised because it is not probable that an outflowof resources will be required or the amount cannot be measured reliably.A contingent asset is a possible asset that arises from past events tobe confirmed by future events not wholly within the entity’s control.

A provision should be recognised as a liability when:

� An entity has a present obligation (legal or constructive) from apast event

� It is probable that an outflow of resources embodying economicbenefits will be required to settle it

� A reliable estimate can be made of the obligation





IFRS 2 Share-based payment

Equity-settledChoice of

Cash-settled equity-settledorcash-settled

Dr asset/expenseCr equity

Dr asset/expenseCr liability

� Transactions recognised when goods/services obtained/received� Transactions measured at fair value


Expenses Disclosure and other issues

LiabilitiesIncome

Audit procedures

� Review actuary’s report

� Assess reasonableness ofassumptions

� Review board minutes post year-end

IAS 19 Employee benefits

Types of plans

Defined contribution– accruals basis– no actuarial assumptions

Defined benefit– more complex– actuarial assumptions to

estimate future liabilities

Statement of financial positionLiability =

PV of defined obligation at SoFP date+ Actuarial gains/- actuarial losses– Past service cost not yet recognised– Fair value of assets at SoFP date

Statement of profit or lossExpense = total of:Current service costInterestExpected return on any planassetsActuarial gains/lossesPast service costEffect of anycurtailments/settlements




Accounting treatment found in IFRS 8 Operatingsegments.� Obtain schedule of workings� Discuss method with directors� Verify a sample of items to sales invoices

Segmental information

Accounting treatment found in IAS 33 Earnings pershare.

Likely to be material because of the nature of theratio: investor interest.� Recalculate to check accuracy� Ensure consistent with other years

Earnings per share

Accounting treatment found in IFRS 5 Non-currentassets held for sale and discontinued operations.May be material through size/nature.� Discuss with management� Review minutes/correspondence� Agree workings to FS� Trace sample to invoices

Discontinued operations

� Accounting treatment found in IAS 7 Statement ofcash flows.

� Statement of cash flows is often audited by theauditor reproducing it from the other auditedinformation (SoFP and SoCI). However, may bechecked line by line.

Statement of cash flows





Accounting treatment found in IAS 23 Borrowingcosts.

� Obtain client workings� Review for correctness� Agree relevant figures to FS� Agree figures to lender statement

Borrowing costs


11: Group audits and transnational audits

Topic List

Group auditors and componentauditors

Consolidation process

Auditing foreign subsidiaries

Transnational audit

When faced with a question about auditing in a groupcontext remember that there are two aspects:

� Single company audit issues (for the parent orsubsidiaries individually)

� Group audit issues (discussed in this chapter).


Group auditors and component auditors

Transnationalaudit

Auditing foreignsubsidiaries

Consolidationprocess

Financial statements that includethe financial information of morethan one component.

Group financial statements Group engagement teamGroup engagement partner

� Direction, supervision andperformance of group audit

� Opinion on group financialstatements

Responsibilities

The partner who is responsible forthe group audit engagement andthe auditor’s report on the groupfinancial statements.

Partners and staff who establishthe overall group audit strategy,communicate with componentauditors, perform work on theconsolidation process andevaluate the conclusions drawnfrom the audit evidence as thebasis for forming an opinion onthe group financial statements.

An entity whose financialinformation is included in the groupfinancial statements.

Component

NO reference to componentauditors in the report.

An auditor who, at the request ofthe group engagement team,performs work on financialinformation of a component for thegroup audit

Component auditorsAcceptance and continuanceMUST determine whether sufficientappropriate audit evidence can beobtained in the consolidationprocess and the financialinformation of components.


11: Group audits and transnational auditsPage 87

Group engagement team must obtain anunderstanding of:

� Whether the component auditorunderstands the relevant ethicalrequirements and is independent

� The component auditor’s professionalcompetence

� Whether the group engagement teamwill have sufficient involvement in thework of the component auditor

� Whether the component auditoroperates in a regulatory environmentthat actively oversees auditors

Understanding the componentauditors

Engagement team will communicate:

� Work to be performed and the use to be made of it

� A request to confirm that component auditor will co-operate with the groupengagement team

� Relevant ethical requirements

� Component materiality

� Identified significant risks

� Related parties

Component auditor will communicate:

� Identification of information reported on

� Risks of material misstatements in group financial statements

� Lists of uncorrected misstatements

� Indicators of management bias

� Material deficiencies in internal control over financial reporting

� Other significant matters including fraud/suspected fraud

Communication with the component auditors



Transnationalaudit



� Evaluate communications from component auditor� Discuss matters arising with component auditor or

component management� Decide whether it is necessary to review parts of

component auditor’s audit documentation� If conclusion is that component auditor’s work is

insufficient, determine additional proceduresrequired

Evaluation of component auditors work

The group engagement team shall determine the type of work to be performed on the financial information of components inresponse to assessed risks

Work to be done by group engagement team or componentauditor on their behalf

Group engagement team shall perform analytical procedures at group level.

Significant componentsGroup engagement team must be involved in risk assessment

Components that are not significant

Individualfinancial

significance

(Full) Audit offinancial

information

Significant due to risks of materialmisstatements due to specific circumstances

One of:– (full) audit of financial information using

component materiality– audit of one or more account balances

or classes of transaction relating to thelikely risks

– specified audit procedures relating tothe likely risks



Transnationalaudit



11: Group audits and transnational auditsPage 89

Check the transposition from the audited accounts of each subsidiary/associate to the consolidation schedules.

Check that adjustments made on consolidation are appropriate and comparable wi

p7 advanced audit and assurance (int) · advanced audit and assurance (int)...

Documents