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CHAPTER 1: Audit and assurance

To ic &ist The nature o# assurance services Revision: Audit o# ()* True and #air concept The regulator #ramework Audit stages Auditing *+Es

INTRODUCTION
The world over has seen a tremendous growth in information availability and peoples eagerness to knowing what is happening globall have also necessitated the change in the audit environment! "ecause o# this turbulent$ d namic and comple% environment$ the need #or assurance, quality and reliability o# that in#ormation becomes cardinal! Auditors are e%pected to give assurance on the financial statements assertions made b management in the #inancial statements the prepare! This assurance must be given to the shareholders o# a compan and other stakeholders globall who ma rel on such in#ormation provided b pro#essionals! &n other words$ pro#essionals should use their rofessional s!ills and acumen to provide a wider range o# assurance services to meet the demand #or such assurances! This chapter there#ore covers a number o# issues pertaining to the nature, im ortance and level o# assurances to be given! &t also covers benefits and limitations of audits, res onsibility #or preparation o# #inancial statements and other brie# re'uirements needed #or audit assurance services provision! A brie# e%planation o# audit conce ts and audit stages has been covered including audit in relation to small entities" A mention o# the a roved accounting and auditing standards under the I##$% has also been made!

'"( The nature of assurance services '"' #ssurance services


#ssurance engagement ) I$# '((
The ob,ective o# an assurance engagement is #or a pro#essional accountant to evaluate or measure a sub,ect matter that is the responsibilit o# another part against identi#ied suitable criteria$ and to e%press a conclusion that provides the intended user with a level o# assurance about the sub,ect matter! Assurance engagements per#ormed b pro#essional accountants are intended to enhance the credibility of information about a sub,ect matter b evaluating whether the sub,ect con#orms in all material respect with the criteria$ thereb improving the likelihood that the in#ormation will meet the needs o# an intended user! There are a number o# assurance services that could be provided b the practitioner! The general t pes o# assurance and engagement are considered here under! An assertion based engagement$ where the accountant declares that a given premise or assertion is either correct or not$ e!g! a statutor audit! (or the statutor audit$ the auditors opinion is given in relation to the assertions made b the directors in the #inancial statements! The level o# assurance is high on this t pe o# audit! A direct re orting engagement$ where the accountant reports on issues that have come to his attention during his evaluation!

The standard states that #or it to be an assurance engagement$ it would depend on whether it e%hibits all the #ollowing elements! -a. A three part relationship involving Practitioner Responsible part &ntended user A sub,ect matter *uitable criteria *u##icient appropriate evidence /hether the assurance report is in appropriate #orm!

-b. -c. -d. -e.

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+hy is it im ortant to have assurance,

&t should be appreciated that in this global world$ there is growth in the availability of information to various users! Ph sical in#ormation is more easil available due to the growth in international communication methods such as the use o# +orld +ide +eb and the increased reporting on &nternet! There is also an increasing public re'uirement #or corporate accountabilit and #or social and environmental awareness and a rapidl increased and reliance on in#ormation technolog s stems! "usinesses have gone global and in#ormation has to be communicated across the whole world! This ma lead to the need #or in#ormation to be interpreted or converted to a #amiliar #orm$ and in the long run leads to the growing desire #or international harmon in reporting particularl on #inancial matters!

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&evel of assurance

As alread indicated above$ various levels o# assurance ma be given in engagements and would var depending on the engagement itsel#$ the criteria and sub,ect matter! However$ it is important to be aware that a level of absolute assurance cannot be given in such engagements due to the limitations inherent in the process! However$ two levels o# assurance tend to be identi#ied: Reasonable level of assurance 1 where the practitioner would conclude that the sub,ect matter materiall con#orms with the criteria! &imited level of assurance 1 where the practitioner has no reason to believe that the sub,ect matter does not con#orm with the criteria!

(or e%ample$ a statutory audit gives a reasonable .high/ level of assurance! However$ there is no assurance given on Agreed 1 upon procedures and the report provided is ,ust #actual #indings o# procedures! This has been covered in Part C o# the stud manual!

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Ty es of assurance engagements

As mentioned in 1!1 above$ two general t pes o# assurance engagements were outlined -assertion based and direct reporting.! However$ assurance engagements ma var depending on the sub,ect matter$ which are likel to #all into one o# the three categories: Data -#or e%ample$ #inancial statements or pro,ections. $ystems and rocesses -#or e%ample$ intended control s stems or computer s stems. %ehaviour -#or e%ample$ social and environmental or corporate governance.

The assurance services to be provided on the sub,ect matter must have several characteristics:

&t must be identi#iable Capable o# consistent evaluation and measurement Capable o# being sub,ect to procedures and evidence gathering!

Throughout this te%t a number o# assurance services will be looked at and will be in the #orm o#$ among others: Audits and reviews Reports on s stems and control Reports on risk assessment Reports on management per#ormance Reports on per#ormance related data Reports relating to e3commerce Reports on lenders and other services Reports on prospective #inancial in#ormation Reports on social and environmental per#ormance Reports on corporate governance!

*tudents ma not be #amiliar with or #ind it di##icult to identi# the t pe o# assurance service to a situation given! All ou need to do is to appreciate the #ollowing #actors: /hat is the sub,ect matter4 E!g! #inancial statements The responsible part $ e!g! management The criteria to use$ e!g! accounting standards or law to be applied &ntended users$ e!g! shareholders

5our common sense ma also be re'uired and awareness o# the business!

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Im lications of assurance services for the accountancy rofession

I86&IC#TION O9 #$$UR#NC: 6RO;I$ION The increase in #ee income #rom assurance services ma replace #ee income On audit lost due to a dwindling audit re'uirement! &t ma also cause e%isting #ees to #all due to less audit work being re'uired in the light o# assurance work alread undertaken! The accountanc pro#essional will increasingl re'uire its members to have a On s!ills broad skills base and to be all round business pro#essionals$ e%pert in both #inance and other areas! On liability Assurance services other than audit are o#ten based on areas o# risk to the business -which is wh the re'uire assurance services in relation to them.! This will lead to an increase in the potential liabilit o# accountants! The accountant will also need to ensure the have limited their liabilit in respect o# users$ and that the have identi#ied ver clearl in contract to whom the e%tend liabilit !

I86&IC#TION O9 #$$UR#NC: 6RO;I$ION On ublic &n e%tending the range o# services that audit #irms provide$ there is potential #or erce tion increasing the e%pectations gap which e%ists between what the auditors are re'uired to do -in respect o# the statutor audit. and what the public thinks that the do! There is a danger that i# assurance services are misunderstood$ the public might see assurance services simpl as audit$ re ac!aged! This could lead to assurance services su##ering the same distrust in terms o# value #or mone and necessit $ as is sometimes the case with the statutor audit!

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Revision2 Ob3ectives and rinci les governing the audit of financial statements!

7The ob,ective o# an audit o# #inancial statements is to enable an auditor to e%press an opinion whether the #inancial statements are prepared$ in all material respects$ in accordance with an identi#ied #inancial reporting #ramework! The phrases used to e%press an auditors opinion are 4give a true and fair view5 or 4 resents fairly, in all material res ect5 which are e'uivalent terms! A similar ob,ective applies to the audit o# #inancial or other in#ormation prepared in accordance with appropriate criteria! $ource 3 .Old International #uditing 6ractices Committee5s 7lossary of terms/ However$ the &nternational (ederation o# Accountants -&(ACs. International Standards on Auditing (ISA) 200 Objective and general principles governing an audit of financial

statements summari9es what audits are all about! &t re'uires that auditors compl with the <Code of :thics for 6rofessional #ccountants=, >uality Control standards and International $tandards on #uditing" &t also re'uires that auditors approach their work with an attitude o# pro#essional skepticism!

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-a. -b. -c. -d. -e. -#. -g.

:thical rinci les governing the auditor5s rofessional res onsibilities are2
&ndependence &ntegrit :b,ectivit Pro#essional competence and due care Con#identialit Pro#essional behaviour and Technical standards!

These ethical principles were covered in our paper 1!6 Auditing and have also been revised in chapter two and three! The audit report reassures readers o# the accounts that a !nowledgeable$ im artial pro#essional accountant has e%amined the accounts! Definition2 An audit can thus be de#ined as an undertaking by an independent kno!ledgeable and impartial professional aimed at giving an opinion as to !"et"er t"e financial statements of an entity give a true and fair vie! or presents fairly in all material respect of its operations for a particular period#$ The auditor should conduct an audit in accordance with basic principles and essential procedures and an other guidance and material! The auditor should plan and per#orm an audit with an attitude o# pro#essional skepticism recogni9ing that circumstances ma e%ist$ which cause the #inancial statements to be materiall misstated! (or e%ample$ the auditor would ordinaril e%pect to #ind evidence to support management representations and not assume the are necessaril correct!

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Reasonable #ssurance2

Reasonable assurance is a concept relating to the accumulation o# the audit evidence necessar #or the auditor to conclude that there are no material misstatements in the #inancial statements taken as a whole! &t relates to the whole audit process! The assurance the auditors give is governed b the #act that auditors use ,udgement in deciding what audit procedures to use and what conclusions to draw! However$ the #ollowing limitations need to be taken into account! -a. Auditing is not a purel ob3ective e%ercise! Auditors have to make ,udgement in a number o# areas including ris! assessment$ what constitutes a significant error$ what tests to per#orm and ultimatel what o inion to give! ;

-b. -c.

<ot ever item in the accounting records is chec!ed b the auditors! Tests conducted are normall based on a sam le basis! &imitations of accounting and internal control s stems$ e!g! accounting and internal control s stems ma not be able to deal with unusual transactions and ma not be #le%ible enough to cope with changing circumstances! &nternal controls ma not operate as per design due to collusion! This ma necessitate fraudulent behaviour! Division o# res onsibilities ma assist to control this problem! +anagement and sta## ma not tell the truth during their representations to the auditors #or #ear o# being victimi9ed! This ma render the opinion o# the auditor incorrect! The audit evidence collected b the auditor is ersuasive and not conclusive due to the #act that accounts ma be based on estimates$ which ma also be a##ected b uncertaint ! This ma re'uire a signi#icant degree o# ,udgement! The report o# the auditors is produced months after the year?end! This means that events or the position o# the clients ma have changed! Reporting immediatel a#ter the ear3end ma also lead to insu##icient audit evidence collected! Not all as ects o# the audit are re#lected in the audit report given b the auditor! The auditors opinion is not a guarantee o# the #uture viabilit o# the entit = managements e##ectiveness and e##icienc and that no fraud was perpetuated in the compan ! Corru t practices b auditors ma render the auditors to give an opinion that lacks the salt it is worth!

-d.

-e.

-#.

-g. -h.

-i.

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Res onsibility for the financial statements"

&*A 0>> clearl indicates who is responsible #or #inancial statements though non3auditors and the members o# the public do not appreciate this! The standard sa s: <+hile the auditor is res onsible for e@ ressing an o inion on the financial statements, the res onsibility for re aring and resenting the financial statements in accordance with the a licable financial re orting framewor! is that of the management of the entity with oversight from those charged with governance" The audit of financial statements does not relieve management or those charged with governance of its res onsibility="

<on3auditors and members o# the public should also know or appreciate that the responsibilit to prevent and detect #raud is not that o# the auditor but that o# management!

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6ublic $ector 6ers ective2

&(AC has also clearl indicated the applicabilit o# auditing principles on audits conducted in the public sector or private sector! This relates to the audit ob,ective and scope$ mandate and legal re'uirements and it sa s: %Irrespective of !"et"er an audit is being conducted in t"e private or public sector t"e basic principles of auditing remain t"e same# &"at differs for audits carried out in t"e public sector is t"e audit objective and scope# '"ese factors are often attributed to differences in t"e audit mandate and legal re(uirements or t"e form of reporting (for e)ample public sector entities may be re(uired to prepare additional financial reports)*# It is furt"er said t"at+ %&"en carrying out audits of public sector entities t"e auditor !ill need to take into account t"e specific re(uirements of any ot"er relevant regulations ordinances or ministerial directives !"ic" affect t"e audit mandate and any special auditing re(uirements including t"e need to "ave regard to issues of national security# Audit mandate may be more specific t"an t"ose in t"e private sector and often encompasses a !ider range of objectives and a broader scope t"an in ordinarily applicable for t"e audit of private sector financial statements# '"e mandate and re(uirements may also affect for e)ample t"e e)tent of t"e auditor$s discretion in establis"ing materiality in reporting fraud and error and in t"e form of t"e audit report# ,ifference in audit approac" and style may also e)ist# -o!ever t"ese differences !ould not constitute a difference in t"e basic principles and essential procedures*#

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True and fair andAor resents fairly conce ts2

Arising #rom the purpose o# an audit$ e%ternal auditors give an opinion on the truth and #airness o# #inancial statements! This is not an opinion o# absolute correctness! <True and 9air= concept is not de#ined in law or audit guidance$ but the #ollowing can assist in stating what @true and #air viewA entails! An auditor obtains evidence 4on a test basis5! He does not check ever thing! The auditor gives <reasonable= and not <absolute= assurance! &n an opinion given b the auditor$ a true and #air view is used to describe the #inancial statements audited! The auditor ma also use < resents fairly in all material res ect= to mean one and the same thing!

<True= entails that the in#ormation is #actual and con#orms with realit $ not #alse! &n addition$ the in#ormation con#orms with re'uired standards and laws! The accounts have been correctl e%tracted #rom the books and records! <9air= entails that the in#ormation is #ree #rom discrimination and bias and in compliance with e%pected standards and rules! The accounts should re#lect the commercial substance o# the compan s underl ing transactions! True and #air view would there#ore be given i#: Applicable accounting standards have been #ollowed and applied correctl The Com any5s #ct has been complied with The stoc! e@change rules and regulations have been abided to!

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The regulatory framewor!


Definitions

Accounting *tandards are basic principles and essential procedures and other related guidance that must be #ollowed in the preparation o# #inancial statements and)or an other statement that #orms part o# the #inancial statement! These are principles$ regulations$ rules or guidelines that govern the preparation o# #inancial statements! The are authoritative statements o# how particular t pes o# transactions and other events should be re#lected in #inancial statements! Each countr or regulator bod ma have its own accounting standards! The regulator bodies and)or the pro#essional accountanc bodies in the countries concerned there#ore promulgate accounting standards! (or instance$ the International #ccounting $tandards are developed and issued b the International accounting $tandards5 %oard .I#$%/" These are the standards that have been adopted b Bambia Institute of Chartered #ccountants .BIC#/ an institution that regulates all accountants in Cambia! <ow the &A*" is producing the International 9inancial Re orting $tandards .I9R$s/ and so #ar si% -;. &(R*s have been issued! Auditing *tandards are basic principles and essential procedures and other related guidance that must be #ollowed in the audit o# #inancial statements and)or an other works done b the auditor! These principles and procedures are used at all levels o# the audit process in order to assist the auditor in arriving at a reasonable opinion on the work that the per#orm! Currentl $ the International $tandards on #uditing .I$#s/ are produced b the International #udit and #ssurance $tandards %oard .I##$%/, a technical standing committee o# &(AC! The &AA*" develop and issue$ on behal# o# the Council o# &(AC$

standards and statements on auditing and related services! *uch standards and statements improve the degree o# uni#ormit o# auditing practices and related services throughout the world! The &nternational Auditing Practice *tatements -&AP*s. are issued in order to provide practical assistance to auditors in implementing the &*As or to promote good practice and are not intended to have the authorit o# &*As! The approved &nternational *tandards on Auditing and &nternational Auditing Practice *tatements have been reproduced in cha ter 1 ) 6ractice 8anagement"

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Roles and functions of International #udit and #ssurance $tandards %oard .I##$%/

The &AA*" role is to enhance the 'ualit and uni#ormit o# practice throughout the world and strengthening public con#idence in the global auditing and assurance pro#ession! &n #ul#illing their role$ their main ob,ective is to serve the public interest b : *etting$ independentl and under its own authorit $ high 'ualit standards on auditing$ 'ualit control$ reviews$ other assurance$ and related services$ and (acilitating the convergence o# national and international standards thereb enhancing the 'ualit and uni#ormit o# practice throughout the world and strengthening public con#idence in the global auditing and assurance pro#essional!

The &AA*" operates as a technical standing committee o# &(AC whose main pre3 occupation is to support the Council o# Committee to develop and issue standards through the #ollowing rigorous process as detailed below: Research and Consultation 1 a task #orce is ordinaril established with the responsibilit to develop a dra#t standard or practice statement! The task #orce develops its position based on appropriate research and consultation! Trans arent debate 1 a proposed standard is presented as an agenda paper #or decision and debate at an &AA*" meeting$ which is open to the public! :@ osure for ublic comment 1 e%posure dra#ts are placed on the &AA*"s website and are widel distributed #or public comment! The e%posure period is ordinaril no shorter than 10> da s! Consideration of comments received on e@ osure 1 the comments and suggestions received on the dra#t as a result o# e%posure are considered at an &AA*" meeting$ which is open to the public and the e%posure dra#t is revised as appropriate! &# #urther comments are needed on the same dra#t either due to insu##icient comments or are lacking in some wa $ then the e%posure is re3issued #or #urther comments! #ffirmative a roval 1 the approval o# e%posure dra#ts$ re3e%posure dra#ts$ and international standards and practices statements is made b the a##irmative vote o# at least two3thirds o# members! 0"*

:nforcement and Com liance

1>

As alread mentioned$ the &*As are produced b the &AA*"$ a technical standing Committee o# &(AC! &(AC has an e%ecutive committee that carries out polic and decisions! &(AC other various standing committees are: (orum on Ethic Committee Education Committee (inancial and +anagement Accounting Committee Public *ector Committee &n#ormation Technolog Committee and +embership Committee

&(AC issued the statement o# polic o# Council Regulation o# Pro#essional Accountanc Euali#ication primaril to tackle the problem o# &ntra3Countr Recognition o# 'uali#ication! This set minimum standards #or accountanc 'uali#ications on the #ollowing areas! :ducation2 The theoretical knowledge to be contained in the bod o# knowledge o# accounting should include at least compulsor knowledge in anal sis and critical assessment o# #inancial statements! Audit Consolidated accounts Cost and management accounting Feneral accounting &nternal control s stems Gegal and pro#essional re'uirements relating to audit)accounting *tandards relating to #inancial statements

Others to includeC "asic principles o# #inancial management o# undertaking! "usiness$ general and #inancial economics Civil and commercial law &n#ormation technolog law Gaws o# insolvenc and similar procedures +athematics and statistics Provision o# #inancial services$ advises$ etc Pro#essional conduct and ethics *ocial securit and law o# emplo ment Ta% Accountants should have covered these sub,ects in a breadth and depth su##icient to enable them to per#orm their duties to the e%pected standards!

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:@amination2 Accountants should demonstrate that the have passed an e%amination o# pro#essional competence! This e%amination must assess not onl the necessar level o# theoretical knowledge but also the abilit to appl that knowledge competentl in a practical situation! :b,ective evaluation o# pro#essional e%amination is a ke re'uirement!

:@ erience
Apart #rom the sound theoretical knowledge that should be possessed$ accountants should be able to appl that knowledge competentl in the world o# work!

Compliance Committee
To keep under review the relevance and e##icac o# the membership obligations o# &(AC and the e%tent to which the member bodies compl therewith and to carr out such work as will enable them to e%ecute these duties and to make recommendations to the "oard and Council o# &(AC! The committee must compare and contrast the investigative and disciplinar processes o# members bodies and their ade'uac and e##icac $ to report on these and make recommendations to the "oard and Council o# &(AC! The standards b the &AA*" contain basic principles and essential procedures -identi#ied in bold lettering. together with related guidance in the #orm o# e%planator and other material$ including appendices! The basic principles and essential procedures are to be understood and applied in the conte%t o# the e%planator and other material that provides guidance #or their application! &t is there#ore necessar to consider the whole te%t o# a standard to understand and appl the basic principles and essential procedures! The nature o# the standards re'uires pro#essional accountants to e%ercise pro#essional ,udgment in appl ing them! &n e%ceptional circumstances$ a pro#essional accountant ma ,udge it necessar to depart #rom a basic principle or essential procedure o# a standard to achieve more e##ectivel the ob,ective o# the engagement! /hen such a situation arises$ the pro#essional accountant should be prepared to ,usti# the departure! Pro#essional accountants should be aware o# and consider practice statements applicable to the engagement! A pro#essional accountant who does not consider and appl the guidance included in a relevant practice statement should be prepared to e%plain how the basic principles and essential procedures in the standard-s. addressed b the practice statement have been complied with!

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#udit stages

Audits can be carried out #or enterprises both large and small and whether the are new or old! All audits will #ollow the same chronolog regardless o# the si9e o# the compan being audited! There are 11 stages that need to be #ollowed in order to accomplish the audit process!

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Determine audit approach


*tage 1: The auditor needs to carr out some research on the present conditions and #uture prospects o# the industr $ histor and present conditions and #uture prospects o# his client$ the management and ke personnel o# the client$ the products and the trading processes o# the client and the location o# the clients operations among others! Hetermine the scope o# the audit and the auditors approach! (or statutor audits the scope is laid down b legislation and e%panded b auditing standards! The auditor should carr out risk assessment procedures! The auditor should also prepare the audit strateg and plan$ which should be placed on the #ile!

*tage 0:

#scertain the system and control *tage 2: Hetermine the #low o# documents and e%tent o# controls in e%istence in the clients s stem! This is a #act3#inding e%ercise that re'uires that the accounting s stem is discussed and the #low documented #or all the necessar departments! "ased on stage three above$ prepare a comprehensive record o# the s stem to #acilitate evaluation o# the s stems! This could be in #orm o# charts$ internal control 'uestionnaire and #lowcharts and narrative notes! Con#irm the s stem recorded to ensure that it is the same as that in operations! A walk3through test here would be necessar ,ust to con#irm that what the sta## has said is in line with what the do!

*tage 6: *tage 8:

#ssess the system and internal controls

*tage ;:

The s stems are evaluated in order to gauge their reliabilit and #ormulate a basis #or testing their e##ectiveness in practice!
Test the system and internal controls

*tage ?:

This is onl done i# the controls are evaluated as e##ective in stage 8 above! &# controls are e##ective$ tests designed to establish compliance with the s stem should be selected and per#ormed! Tests o# control that cover a large number o# items than walk3through tests and covers a more representative sample o# transactions through the period should be carried out! &# the controls are strong$ the records should be reliable and the amount o# detail testing can be reduced! &# controls are ine##ective in practice$ more

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e%tensive procedures will be re'uired! At this stage$ the auditor can send an interim report to management identi# ing weaknesses and recommending improvements!
Test the financial statements

*tage B:

Hetailed substantive tests are carried out to substantiate the #igures given in the #inancial statements! *ubstantive tests also serve to assess the e##ect o# errors should errors e%ist! These are tests carried out in the event that errors produced could be material or else the could be no need to do so!
Review the financial statements

*tage D:

(inancial statements are reviewed in order to determine the overall reliabilit o# the account b making a critical anal sis o# the contents and presentation!

:@ ress an o inion

*tage 1>: *tage 11:

Ipon evaluating the evidence gathered$ the auditor e%presses an opinion to the members in #orm o# an audit report! A #inal report to management is issued that contains #urther suggestions #or improvements in the s stems and to place on record speci#ic points in connection with the audit and the accounts! This report is a non3statutor end product o# the audit!

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#uditing $mall and medium :nter rises and their e@em tions"

&nternational Auditing Practice *tatement -&AP*. 1>>8$ @The *pecial Considerations in the Audit o# *mall EntitiesA contain basic principles and essential procedures together with related guidance that appl to the audit o# the #inancial statements o# an entit $ irrespective o# its si9e$ its legal #orm$ ownership or management structure$ or the nature o# its activities! The &AA*" recogni9es that small entities give rise to a number o# special audit considerations! The &AP* does not establish an e%emptions #rom the re'uirements o# &*As! All audits o# small entities are to be conducted in accordance with &*As! NOTE. '"e /astern Sout"ern and 0entral African 1ederation of Accountants (/S0A1A) "as issued some guidelines on Small and 2edium Si3ed /nterprises to be follo!ed by regional members before t"e final standard is issued by t"e IAAS4# '"is

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guidance "as not yet been issued# At t"e time of !riting t"is manual /S0A1A !as still receiving comments from member countries and individuals# The ob,ective o# this &AP* is to describe the characteristics commonl #ound in small entities and indicates how the ma a##ect the application o# &*As! The practice statement includes: Hiscussion o# the characteristics o# small entities= and Fuidance on the application o# &*As issued on the audit o# small entities!

&t must be appreciated that in most countries$ the ma,orit o# the companies are small in nature meaning that the emplo ee #ew sta## and are owner3managed! This entails that the owners -shareholders. manage the companies themselves as opposed to directors in larger companies! The guidance there#ore provided b the board is to assist auditors in e%ercising pro#essional ,udgement with respect to the application o# &*As!

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Characteristics of small entities

The audit o# a small entit di##ers #rom the audit o# a large entit as documentation ma be unsophisticated$ and audits o# small entities are ordinaril less comple% and ma be per#ormed using #ewer assistants! Euantitative indicators o# the si9e o# an entit ma include balance sheet totals$ revenue and the number o# emplo ees$ but such indicators are not de#initive! There#ore it is not possible to give an ade'uate de#inition o# a small entit solel in 'uantitative terms! However the practice statement de#ines a small entit as an entit in which: -a. There is concentration o# ownership and management in a small number o# individuals -o#ten a single individual.! The owner ma emplo ee a manager to run the entit but is in most cases directl involved in running the entit on a da 3to3 da basis= and :ne or more o# the #ollowing are also #ound: (ew sources o# income due to a limited range o# products or services and operate #rom a single or limited number o# locations! Insophisticated record keeping in order to compl with an statutor or regulator re'uirements and to meet the needs o# the entit $ including the preparation o# the #inancial statements!

-b.

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-b.

Gimited internal controls together with the potential #or management override o# controls! The si9e and economic considerations in small entities mean that sophisticated internal controls are o#ten neither necessar nor desirable due to #ew emplo ees that do not support ade'uate segregation o# duties!

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#rguments for or against small com any audits

Ty e of User $hareholder (or Reason *hareholders are not involved in management thus the need the reassurance given b auditors through audited accounts! &t ma also deter the directors #rom treating the assets o# the compan as their own to the detriment o# the minorit shareholders! Audited #inancial statements are invaluable in arriving at a #air valuation o# the shares in an un'uoted compan either #or ta%ation or other purposes! /here all the shareholders are also e%ecutive directors or closel related to them$ the bene#it gained #rom an audit ma not be worth its cost!

Against %an!s and other institutional creditors (or

"anks rel on accounts #or the purpose o# making loans and reviewing the value o# securit !

1;

Against

There is doubt whether banks rel on audited accounts o# companies to a greater e%tent than those o# unincorporated associations o# a similar si9e$ which have not been audited! A review o# the wa in which the bank accounts o# the compan have been conducted and o# #orecasts and management accounts are at least as important to the banks as the appraisal o# the audited accounts! There is no reason wh a bank should not make an audit a precondition o# granting a loan!

Trade creditors (or Against

Creditors and potential creditors should have the opportunit to assess the strength o# their customers b e%amining audited #inancial statements either through themselves or through a credit compan ! &n practice$ onl limited reliance is placed on the accounts available #rom a compan registrar as the are usuall #iled so late as to be o# little signi#icance in granting short3term credit!

Ta@ authorities (or Against

The ta%ation authorities rel on accounts #or computing corporation ta% and checking other ta% returns! There is little evidence to suggest that the ta% authorities rel on audited accounts to a signi#icantl greater e%tent than those$ which$ whilst being unaudited have been prepared b an independent accountant!

:m loyees (or Against 8anagement (or Against

Emplo ees are entitled to be able to assess audited accounts when entering wages negotiations and considering the #uture viabilit o# their emplo er! There is little evidence to suggest that in the case o# small companies$ such assessments are made!

The audit provides management with a use#ul independent check on the accurac o# the accounting s stems and the auditor is #re'uentl able to recommend improvements in those s stems! &# the law were changed$ the management o# a compan could$ i# the so desire$ still elect to have an independent audit! &t is likel $ however$ that a s stems review accompanied b a management consultanc report would represent a greater bene#it #or a similar cost!

1?

D"-

6roblems of small com any audits

The problems pertaining to the audit o# small companies arises #rom the #act that the are owner managed! This in itsel# reduces the problem associated with cor orate governance though it ma mean that management lacks accounting skills! The are also likel to have unso histicated internal controls thus making audits to be signi#icantl risk ! &n this particular case$ the control risk is higher due to lack o# controls and or either internal controls have been overridden and insu##icient evidence as to the e##ectiveness o# their operations! :thers could be understatements o# income and the inclusion o# e%penses$ which are in #act personal e%penses o# the owner!

D"0

#udit considerations and rocedures"

The &AP* make commentar on the application o# international standards on auditing! The commentar provides guidance on the application o# &*As to the audit o# a small entit and also takes into account the special considerations relevant to the audit o# small entities! However$ the overall approach o# the auditor is the same #or an particular audit undertaken in terms o# lanning$ collection o# audit evidence$ analyEing o# the accounting s stems and internal controls! Audit considerations and procedures could mean e%tending substantive procedures to support un'uali#ied opinion! (or instance$ there ma be insu##icient evidence in some business due to most transactions being carried out in cash #orm$ thus necessitating ade'uate substantive test! The other important evidence that ma be use#ul is that #rom management in the #orm o# management representations! This ma reduce the problem o# the auditor not able to misunderstand their role and responsibilit in relation to the #inancial statements! The representation ma also remind management o# its responsibilit to ensure the completeness and accurac o# the accounting records and sa#eguarding o# the entit s assets! +ore so$ the auditor cannot solel rel on management representations to obtain assurance as to the completeness o# the accounting records! The auditor should also report an weaknesses in the accounting and internal control s stem to management as soon as possible and recommend an improvements!

D"1

The #uditor5s Re ort

/here the auditor is unable to design or carr out procedures to obtain su##icient appropriate audit evidence as to the completeness and accurac o# the accounting records$ this ma constitute a limitation on the scope o# the auditors work! (or e%ample$ the #ollowing paragraphs o# an auditors report ma be included:

1B

6aragra hs of an auditor5s re ort qualified when com leteness of accounting records is not substantiated ) sco e limitation which does not revent the auditor from e@ ressing an o inion" &<HEPE<HE<T AIH&T:R* REP:RT T:J The compan s recorded sales include KL in respect o# cash sales! There was no s stem o# control over such sales on which we could rel #or the purpose o# our audit and there were no satis#actor audit procedures that we could per#orm to obtain reasonable assurance that all cash were properl recorded! &n our opinion$ e%cept #or the e##ects o# such ad,ustments$ i# an $ as might have been determined to be necessar had we been able to satis# ourselves as to the completeness and accurac o# the accounting records in respect o# sales$ the #inancial statements give a true and #air view o# -presents #airl . the #inancial position o#J atJ and the results o# its operations and cash #lows #or the ear then ended in accordance with -&*As or relevant national standards. and compl with -relevant standards or laws.!

AIH&T:R

Hate M address

6aragra hs of an auditor5s re ort with disclaimer of o inion when com leteness of accounting records is not substantiated ) sco e limitation, which is so significant that the auditor is unable to e@ ress an o inion" &<HEPE<HE<T AIH&T:R* REP:RT T:J The compan s sales were made entirel on a cash basis! There was no s stem o# control over such sales on which we could rel #or the purpose o# our audit and there were no satis#actor audit procedures that we could per#orm to obtain reasonable assurance that all cash were properl recorded! "ecause o# the signi#icance o# the matter discussed in the preceding paragraph$ we do not e%press an opinion on the #inancial statements! AIH&T:R Hate and Address

>uestion2 #udit of small com anies


The international auditing practice statement -&AP*. on small and medium si9e enterprises gives guidance on the audit o# small companies! Fenerall $ the audit o# small

1D

companies creates special problems #or auditors due to some characteristics that *mall Entities posse! Required2 "rie#l discuss the reasons wh small companies create special problems #or auditors in line with characteristics o# small entities! Also consider the reasons wh auditors should direct their work more to veri#ication o# items b ph sical inspection and third part evidence than is the case when auditing larger companies!

#nswer2
Regardless o# the audit that is undertaken$ need be #or larger companies or smaller ones$ the auditing principles to be applied are essentiall the same! However$ due to the nature and characteristics o# small entities$ the audit o# small entities can raise some di##iculties in the application o# the principles! *mall business entities are normall owner managed and o#ten have #ew emplo ees! This entails that the owner ma dominate the accounting and #inancial management o# the compan and small number o# emplo ees ma render the s stems not to run smoothl thus making the internal controls weak or non3e%istence! &n bigger companies$ the directors are entrusted with the responsibilit to manage the compan b the shareholders as opposed to smaller companies! This in itsel# makes the internal controls to run more e##icientl due to the separation o# management and ownership! The large number o# emplo ees ma also provide a check whereb the work o# one person is proved independentl or is complementar to the work o# another! "ecause o# the limitations in the e##ectiveness o# internal controls$ the auditor will need to e%tend the audit procedures and)or carr out detailed substantive tests in order to increase the value o# the audit! The procedures ma include veri#ication o# assets and liabilities$ inventor counts and con#irming the trade receivables b direct communication! This ma assist to authenticate the integrit o# the #igures in the #inancial statements! (urther more$ due to the limitations in the e##ectiveness o# internal controls$ the auditor ma seek to obtain relevant and reliable audit evidence su##icient to enable him to draw reasonable conclusions! Reliabilit ma entail getting evidence #rom independent sources outside the in#luence o# the client! Third parties such as banks$ insurance companies etc can make the evidence more reliable and the auditor should ensure that ph sical inspections are carried out to prove be ond reasonable doubt that in the absence o# e##ective internal controls$ the #inancial statements are #airl presented!

Cha ter roundu


0>

#n assurance engagement is one where a ractitioner e@ resses a conclusion designed to enhance the degree of confidence of the intended user other than the res onsible arty about the outcome of the valuation or measurement of a sub3ect matter against criteria" Two assurance engagements have been identified being assertions based and direct re orting" Two levels of assurance have been identified as reasonable level and limited level of assurance" The ur ose of an audit is to give an inde endent o inion on the truth and fairness of the financial statements" The auditor gives the o inion whereas the res onsibility to re are the financial statements rests on management" The audit of small com anies may give s ecial roblems" Fowever, the audit should endeavour to gather relevant, reliable and sufficient evidence to add value to the audit" #udits will follow the same chronology regardless of the siEe of the com any being audited"

Now try >' from the :@am >uestion %an! at the bac! of the manual

CF#6T:R *2 Rules of 6rofessional Conduct


To ic list
1 Ethical considerations 0 &ndependence$ ob,ectivit and integrit 2 Competence and pro#icienc 6 Con#identialit

Introduction
5ou have learnt about rules o# pro#essional conduct #or auditors previousl in paper L.4 Auditing. &n paper P6 we will e%amine #urther the issues in more detail and consider some o# the comple% ethical issues that auditors ma #ace! Throughout this chapter we will re#er to the ethical guidance o# the &nternational (ederation o# Accountants -&(AC.! &(AC guidelines provide e%amples o# potential issues and sa#eguards to mitigate them! *ome parts o# this chapter constitute revision o# what ou did in paper G!6 but that does not mean ou should ignore them! Pro#essional issues are ke s llabus area! 5ou particularl need to work through the 'uestions given so that ou practice a lying ethical guidelines in given scenarios!

01

The same areas covered in the lower paper have been covered in slight more detail in order to allow #or more comple% reasoning on ethical issues! These includes fundamental rinci lesC integrity, ob3ectivity, inde endenceC confidentialityC changes in rofessional a ointmentsC feesC ownershi of boo!s and a ers and conflicts of interest"

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'"'

:thical considerations
Code of ethics

Nust like an pro#essionals such as Gaw ers$ Hoctors$ Engineers$ etc$ Accountants are re'uired to uphold codes o# ethics because o# their positions o# trust in societ $ and people rel on them! &nternational (ederation o# Accountants -&(ACs. Code o# Ethics gives the ke reason o# wh accountanc bodies produce ethical guidance as being o# ublic interest" The ublic interest is considered to be the collective well 1 being o# the communit o# people and institutions the pro#essional accountant serves$ including clients$ lenders$ governments$ emplo ers$ emplo ees$ investors$ the business communit and others who rel on the work o# pro#essional accountants! &(AC has laid down #undamental principles in its 0ode of /t"ics to be #ollowed b members and students o# pro#essional accountanc bodies! &t is also important to note that Cambia &nstitute o# Chartered Accountants -C&CA. is a member #irm o# &(AC! 5ou must be #amiliar with Code o# Ethics in our earlier paper G!6 Auditing! However$ the have been revised below and bee#ed up!

'"*

9undamental rinci les

The #undamental principles in the Code o# Ethics issued b &(AC covers the #ollowing areas: &ndependence$ ob,ectivit and integrit Competence and pro#icienc 00

Changes in pro#essional appointment Con#identialit

"elow we consider each o# the #undamental principles outlined above!

*"(

Inde endence, ob3ectivity and integrity

If the o inion that the auditor e@ resses on the financial statements is to be credible, then it is essential that the auditor is and is seen to be inde endent from the client" Pro#essional accountants must operate with a high degree o# integrit and ob,ectivit in all #orms o# business dealings including the audit! Integrity ? # rofessional accountant should be straightforward and honest in all rofessional and business relationshi s" +oral uprightness should be the hallmark o# a pro#essional accountant! Ob3ectivity ? # rofessional accountant should not allow re3udice or bias, conflict of interest or influence of others to override rofessional or business 3udgements" The rules governing the award o# 7registered auditor status are aimed at ensuring that auditors are independent and operate with high integrit and ob,ectivit !

*"' +hat is inde endence,


As stated earlier$ a provider o# audit and assurance services must 7be$ and be seen to be independent! (or this to be the case$ the Code o# Ethics issued b &(AC states that independence re'uires: Inde endence of mind2 The state o# mind that permits the provision o# an opinion without being a##ected b in#luences that compromise pro#essional ,udgment$ allowing an individual to act with integrit $ and e%ercise ob,ectivit and pro#essional skepticism! Inde endence in a earance2 The avoidance o# #acts and circumstances that are so signi#icant that a reasonable and in#ormed third part $ having knowledge o# all relevant in#ormation$ including sa#eguards applied$ would reasonabl conclude a #irms$ or member o# the audit or assurance teams$ integrit $ ob,ectivit or pro#essional skepticism had been compromised! The degree o# independence re'uired is stringent #or a low level assurance engagement to non 1 audit client than #or audit!

2#2

Threats to inde endence

02

&ndependence can be threatened in a number o# wa s! The #ollowing are some o# the e%amples provided b &(AC *"*"' 9inancial interests A #inancial interest in a client ma be sel# 1 interest threat! However$ the signi#icance o# the threat will depend on several #actors$ such as The nature o# the interest The degree o# control that the owner has over the interest The role o# the owner The materialit o# the interest A #inancial interest could include owning shares in a compan $ or being a trustee o# a trust that holds shares in a compan $ or having a retirement plan that owns shares in the compan ! A threat to independence could also be caused b such an interest in the client being held b a person who is connected to an assurance provider! 5ou should be prepared to identi# whether such a relationship e%ist$ and discuss whether it causes a threat to independence! *"*"* &oans and guarantees

*uch loans are speci#icall banned b the rules o# ethical conduct! :ne e%ception would be when a member o# the assurance team receives a loan #rom a client in the ordinar course o# business #or a personal transaction on terms which are available to an member o# the public$ e!g! such a loan is possible i# the client is a bank! *"*"Close business relationshi s

Assurance providers and their clients have a business relationship! However$ the business relationship ma become too close and sel# interest and ) or intimidation threats could arise! The #ollowing are some o# the e%amples provided in the code: Assurance provider and client or client sta## enters into a ,oint venture! Assurance provider and client combine services and market them ,ointl Assurance provider uses client to market its product! The assurance provider ma purchase goods or services #rom the client on an arms length basis! This ma not seem so unreasonable! *"*"0 9amily and ersonal relationshi s

As business relationships build overtime$ it is possible that the become personal! "usiness associates ma well become #riends! &t is also possible that #amil and #riends #ind it natural to seek pro#essional advice and services #rom #amil members!

06

*uch personal relationships between assurance providers and clients could cause sel# 1 interest$ #amiliarit ) or intimidation threats! This calls #or an evaluation o# a situation with regard to a number o# #actors$ such as the responsibilities o# the individual in relation to the assurance service$ the closeness o# the relationship and the role o# the individual in the assurance client! The 'uestion is$ when is close too close4 *"*"1 :m loyment connections with the assurance client

A #irms independence ma be threatened where there are close links between sta## and s stems o# the client and the #irm due to #low o# sta## between them! The code gives the #ollowing e%amples: A director or o##icer o# the client was recentl emplo ed b the #irm An emplo ee) partner o# the #irm knows that the are going to work #or the client An emplo ee) partner o# the #irm has recentl worked #or the client A partner) emplo ee o# the #irm serves on the clients board o# directors A partner) emplo ee o# the #irm serves as the clients compan secretar ! The above situations could all raise sel# 1 interest$ #amiliarit and)or intimidation threats! However$ the situation needs to be evaluated with regard to certain #actors: The position o# the relevant individual at either the client or the #irm! The #ormer position o# the relevant individual at either the client or the #irm The likel amount o# involvement with the assurance team)engagement The length o# time that has elapsed between roles! *"*"D &ong association of senior ersonnel with assurance clients

Gong association with an engagement team and a client could cause a #amiliarit threat! (actors to consider in relation to this are: The length o# time the individual has been on the assurance team The role o# the individual The structure o# the #irm The nature o# the assurance engagement! *"*"G 6rovision of non? assurance services to assurance clients

Assurance providers o#ten provide other services to their clients! The bene#it o# so doing revolve around the bene#it o# their accumulated knowledge and skill in relation to the client! However$ providing other services could create sel# interest or sel# review threats! E%amples o# other services provided include: Having custod o# clients assets *upervising clients emplo ees in their recurring duties Preparing source data #or e%ample$ pa roll time records

08

Preparing accounting records and #inancial statements Ta%ation &nternal audit &T s stems Temporar sta## Gegal services Recruitment services Corporate #inance services

(actors such as the siEe and nature of the firm will be ver signi#icant here! &t is important to consider the arties that undertake the work$ and the im lications of the wor! for assurance service" *"*"H 9ees

&t is natural that an assurance service will be provided #or a #ee$ but #ees themselves ma raise sel# 1 interest threat! This is particularl possible in the #ollowing situations: The #ee represents a significant ro ortion o# total income (ees are consistentl overdue and take on the #eatures o# a loan (ee is signi#icantl lower than market average (ee is contingent on outcome o# work per#ormed *"*"I 7ifts and hos itality

#cce ting gifts andA or hos itality from a client may create self ) interest and familiarity threats" Or it could 3ust be a courteous invitation to lunch" #t what oint do such matters become significant in relation to inde endence, *"*"'( #ctual or threatened litigation

&itigation, threatened litigation or even otential litigation between a client and assurance rovider may create a sel# 1 interest or intimidation threat!

2#5 $afeguards to audit inde endence


There are three general categories o# sa#eguard identi#ied b the &(AC code: *a#eguards created b the pro#ession$ legislation or regulation *a#eguards within the assurance client *a#eguards within the #irms own s stems and procedures E%amples o# sa#eguards created b the pro#ession$ legislation or regulation: Educational training and e%perience re'uirements #or entr into the pro#ession Continuing pro#essional development re'uirements Corporate governance regulations 0;

Pro#essional standards Pro#essional or regulator monitoring and disciplinar procedures E%ternal review b legall empowered third part o# reports$ returns$ communication or in#ormation produced b a pro#essional accountant!

E%amples o# sa#eguards in the work environment: &nvolving an additional pro#essional accountant to review the work done or otherwise advise as necessary Consulting an independent third part $ such as a committee o# independent directors$ a pro#essional regulator bod or another pro#essional accountant Rotating senior personnel Hiscussing ethical issues with those in charge o# client governance Hisclosing to those charged with governance the nature o# service provided and e%tent o# #ees charged &nvolving another #irm to per#orm or re3per#orm part o# the engagement!

*"-"'

$afeguards against s ecific threats

&(AC has given e%amples o# sa#eguards against speci#ic threats in their ethical guide These are discussed in the table below: #rea of threat Team member or connected person$ or network #irm has a direct )material indirect #inancial interest in assurance clients Team member has a direct)material indirect #inancial interest in the assurance client as a trustee! I9#C safeguards &ndividual or #irm should disclose o# interest be#ore the engagement$ or reduce interest to being material! Alternativel $ individuals should be removed #rom the assurance team! *uch an interest should not be held where the #irm or member o# the assurance team and) or their close relatives bene#it #rom the trust$ the interest is material to the trust$ the trust is able to hold signi#icant in#luence over the client$ and the relevant trustee has signi#icant in#luence over investment decisions! The #irm should consider restricting emplo ees #rom holding such interest Threat ma or ma not be signi#icant and should be evaluated! :nl i# the threat is signi#icant should the interest be diverted! The risk arising might be mitigated b the #irm obtaining a review b a pro#essional accountant #rom a di##erent network #irm!

Retirement bene#it plan o# #irm or network #irm has a #inancial interest in audit client! Assurance client which is a bank or similar institution provides a material loan to the #irm on

0?

normal commercial terms! A loan is made or accepted b the #irm #rom)to a client who is not a bank A #irm or team member purchases goods and services #rom the assurance client in the normal course o# business and on arms length basis! A #irm has a material ,oint #inancial interest in a business venture with an assurance client! An immediate #amil member o# a member o# the assurance team is director$ o##icer or emplo ee o# the assurance client in a position to e%ert direct and signi#icant in#luence over the sub,ect matter o# the assurance engagement! A member o# the assurance team$ partner or #ormer partner has ,oined the assurance team! *uch a loan made to an assurance team member on normal terms re'uires no sa#eguard! There is no applicable sa#eguard! *uch a transaction should not be entered into! &# the transactions are o# a nature or a magnitude so as to be signi#icant$ sa#eguards might be applicable! These could include eliminating or reducing the transaction$ removing the team member #rom the team$ discussing the matter with the audit committee! The business relationship should be reduced so that the #inancial interest is immaterial! Alternativel $ either the business relationship or the provision o# assurances must be terminated! The individual should be removed #rom the assurance team! Alternativel $ the #irm should withdraw #rom the engagement! Consider the appropriateness or necessit o# modi# ing the plan #or the engagement! Assign the assurance team to someone o# su##icient e%perience in relation to an individual who has le#t the #irm! &nvolve an additional accountant not previousl involved with the team to review! Conduct a 'ualit control review o# the engagement! &n addition$ the #ollowing sa#eguards are essential: The individual concerned must not be entitled to bene#its)pa ments #rom the #irm unless the are made in accordance with #i%ed$ pre3 determined rates! The individual concerned must not continue to participate in the #irms a##airs$ or appear to! *uch individuals should not be assigned to the assurance team!

A member o# the assurance team was a director$ o##icer or emplo ee o# the client during the period under review!

0B

A member o# the assurance team was a director$ o##icer or emplo ee o# the client prior to the period under review

&nvolve an additional pro#essional accountant to review the work done b the individual and advice as necessar ! Hiscuss the issue with those charged with governance! /ithdraw #rom the engagement or stand down #rom the position! /ithdraw #rom the engagement or stand down #rom the position! Rotate the senior personnel o# the assurance team! &nvolve another pro#essional accountant to review! Conduct independent internal 'ualit reviews!

A partner or emplo ee o# the #irm serves as an o##icer on the board o# the assurance client! A partner or emplo ee o# the network #irm serves on the board o# assurance client! A partner has served one assurance client #or an e%tended period A partner has served one listed assurance client #or an e%tended period!

Gead engagement partner should be rotated a#ter a prede#ined period o# less than seven ears! He should not participate in the assurance engagement until a #urther period o# time$ normall two ears$ has elapsed! (ees #rom assurance services to a Hiscuss the #ee levels with the audit committee$ take client constitute a signi#icant steps to reduce the #irms dependence on the client$ percentage o# the #irms income! undertake e%ternal 'ualit control reviews$ consult a third part $ such as a regulator bod ! (ees #rom an assurance client Hetermine policies and procedures to monitor and constitute a signi#icant percentage implement 'ualit control o# assurance o# one partners #ee income engagements$ and involve an additional pro#essional accountant to review the work! (ees in relation to assurance work Hiscuss the level o# outstanding #ees with the audit #rom the previous ear remain committee or others charged with governance! outstanding prior to issuing the &nvolve a pro#essional accountant who did not take current ear report! part in the engagement to review the work per#ormed! A #irm obtains an assurance The #irm must demonstrate that appropriate sta## and engagement at signi#icant low time are used on the engagement and that applicable #ees than were charged b a standards are being complied with! predecessor #irm! A #irm is asked to enter into a #ee A #irm should not enter into such a #ee arrangement arrangement #or an assurance service under which the amount o# the #ee is contingent on the result o# the assurance work or on items that are the sub,ect o# the assurance engagement! 0D

A #irm is asked to enter into a di##erent kind o# contingent #ee arrangement Gitigation between the #irm and client is taking place or appears likel !

Hisclose to the audit committee the e%tent and nature o# the #ees charged! :btain a review o# the #inal #ee b an independent third part ! &mplement 'ualit control policies and procedures! +ake disclosures to the audit committee$ remove an individual involved in the litigation #rom the assurance team$ and involve a previousl uninvolved pro#essional accountant to review the assurance work!

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Com etence and roficiency

The principle o# pro#essional competence imposes the #ollowing obligations on Pro#essional accountants: To maintain pro#essional knowledge and skill at the level re'uired to ensure that clients receive competent pro#essional service$ and To act diligentl in accordance with applicable technical and pro#essional standards when providing pro#essional services!

Competent pro#essional service re'uires the e%ercise o# sound ,udgement in appl ing pro#essional knowledge and skill in the per#ormance o# such service! Pro#essional competence ma be divided into two separate phrases: Attainment o# pro#essional competence$ and +aintenance o# pro#essional competence!

The maintenance o# rofessional com etence re'uires a continuing awareness and an understanding o# relevant technical pro#essional and business developments! Continuing pro#essional development develops and maintains the capabilities that enable a pro#essional accountant to per#orm competentl within the pro#essional environments! Diligence encompasses the responsibilit to act in accordance with the re'uirements o# the assignment$ care#ull $ thoroughl and on a timel basis! A pro#essional accountant should take steps to ensure that those working under the pro#essional accountants authorit in a pro#essional capacit have appropriate training and supervision! /here appropriate$ a pro#essional accountant should make clients or other users o# the pro#essional services aware o# limitations inherent in the services to avoid the misinterpretation o# an e%pression o# opinion as an assertion o# #act!

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Changes in rofessional a
2>

ointment

The rules o# pro#essional conduct also deals with behaviour e%pected when a change o# assurance provider occurs! The rules are #urther en#orced b the re'uirements o# the Companies Act and &nternational *tandard on Auditing 01>$ Terms :# engagement! These rules are known as the pro#essional clearance procedures! +ore on changes in pro#essional appointments will be discussed in chapter 2

1"( Confidentiality
The statutor right to receive in#ormation and e%planations #rom the client must not be abused b the assurance provider! Con#idential data regarding the clients business must not be divulged to third part without the consent o# the client unless there is a statutor dut to make the disclosure! There are also other matters relating to con#identialit issues that the assurance provider should be aware o#! These include the #ollowing: Hata obtained during the audit regarding the clients a##airs must not be used #or personal gain b the assurance provider! Con#idential in#ormation obtained regarding one client during the audit o# another client must not be disclosed or misused! *uch con#licts o# interest ma mean that the assurance provider would have to resign #rom one o# the clients or both! A con#lict o# interest could also arise where the assurance provider accepts commission pa ment #rom the third part perhaps as a result o# providing advice to a client! A #urther con#lict o# interest could also arise when a pro#essional acts #or two clients who are in competition!

1"'

#reas of controversy2 Confidentiality

Particularl controversial areas with regard to con#identialit are con#licts o# interest as introduced above and insider dealing! 1"'"' Conflict of interest

Con#licts o# interest can arise when a #irm has two or more audit clients$ both o# whom have reason to be unhapp that their auditors are also auditors o# the other client!

21

This situation can arise when the clients are in direct competition with each other$ particularl when the auditors have access to sensitive in#ormation$ which is o#ten the case! This situation is di##icult #or an audit #irm! Audit #irms tend to claim that problems do not arise #rom these situations$ as di##erent teams o# audit sta## and engagement partners are used on the two audits! This helps to maintain independence and con#identialit with regard to the two clients! However$ clients o#ten perceive these sa#eguards to be insu##icient$ and in such a situation$ the audit #irm might well #ace losing a substantial client! Auditors o#ten give their clients business advice unrelated to audit! &n such a position$ the ma well become involved when clients are involved in issues such as: *hare issues Takeovers <either situation is inherentl wrong #or an auditor to be in! The #ollowing things should be considered however: -a. &n respect o# share issue$ audit #irms should not underwrite an issue o# shares to the public o# the client the audit! -b. &n respect o# takeovers$ i# auditors are involved in the audit o# both the predator and target compan $ the should not: "e the principal advisors to either part &ssue reports assessing the accounts o# either part other than their audit report! &# the #ind the possess material con#idential in#ormation$ the should contact the appropriate bod or regulator! 1"'"* $afeguards relating to conflicts of interest

The Code o# ethics suggests the #ollowing sa#eguards: <oti# ing all relevant parties that the are acting #or two or more parties in respect o# a matter where their respective interests are in con#lict$ and obtaining their consent that the ma act! <oti# ing all relevant parties that the have relationships with clients or third parties that could give rise to con#licts o# interest! *uch sa#eguards ma $ however$ be precluded in some circumstances due to the constraints o# con#identialit ! The use o# separate engagement terms$ with separate internal reporting lines! Procedures to prevent access to in#ormation -e!g! strict ph sical separation o# such teams$ con#idential and secure data #illing.!

20

1"'"-

Clear guidelines #or engagement personnel on issues o# securit and con#identialit ! Regular review o# the application o# sa#eguards b a senior individual not involved with either client engagement! Policies and procedures #or dealing with con#licts o# interests! Insider dealing

&nsider dealing can be described as dealing in securities whilst in possession o# insider in#ormation as an insider$ the securities being price3 a##ected b the in#ormation! There are various anti 1 avoidance measures in legislation$ including those relating to the disclosure o# in#ormation to other parties! -Criminal Nustice Act 1DD2.! Auditors can be seen as insiders in the conte%t o# insider dealing as the are priv to sensitive in#ormation which might price 1 a##ect the securities! (or auditors$ the dut not to deal as an insider is an e%tension o# their pro#essional dut o# con#idence$ which the owe to clients! This dut o# con#idence does not ,ust cover in#ormation passed to third parties but in#ormation used #or personal gain! Audit #irms must take care that insider3dealing regulations are not breached #or two reasons: the law and their pro#essional duties! +an #irms insist that sta## sign #orms each ear$ which state that neither the nor an o# their 7connected persons have dealt in an client compan shares! 1"'"0 $afeguards relating to insider dealing

The notable sa#eguard relates to sta## disclosure procedures! &# such con#irmations reveal that relationships do e%ist$ the #irm should la down clear procedures #or ensuring that the members o# sta## concerned is not involved in undertaking work #or that client on behal# o# the #irm and that controls e%ist #rom preventing that member #rom having access to the #iles on the client i# considered prudent! *uch restrictions can easil be set up in computer s stems! Tutorial note2 >uestions on ethics at this level are unli!ely to require you to regurgitate all the rules" Rather, they will resent scenarios in which you, as an auditor, must ma!e ethical 3udgement" Therefore, you must be familiar enough with the guidelines to a ly them to a scenario, and to 3ustify your a lication" Try the ractice question below before loo!ing at our answer"

>uestion
22

5ou are an audit manager with Chali M Co! a #irm o# Certi#ied Accountants! The +anaging partner o# the #irm is concerned that certain issues$ which have arisen in relation to the clients #or whom ou are responsible$ ma mean that the #irm is in breach o# the &(ACs Code o# Ethics! *he has asked ou to consider each issue and to make recommendations #or corrective action as appropriate: a. :ne o# our clients -Chola Gtd. has been asked to tender #or the construction o# an e%tension to the local swimming pool! 5ou have been asked to advise Chola Gtd regarding the #inancial stabilit o# a number o# subcontractors who will be emplo ed b Chola Gtd to carr out some o# the construction work! :ne o# these -/ale Gtd. is also a client o# our #irm! b. The partner in charge o# the audit o# +ushibwe Plc$ a ma,or client o# the #irm -speciali9ing in home improvements.$ has recentl had a new kitchen installed b this compan ! c. The #irm has agreed to provide a training course in basic #inancial control techni'ues #or the senior management team o# Kapungwe Plc which is an audit client o# the #irm! d. The audit partner responsible #or the audit o# Chile Plc regularl pla s s'uash with the #inance director o# this compan at a local sports club! Required Considering each issue separatel make recommendations #or corrective action!

#nswer
a. The main issue is that the audits o# Chola and /ale are con#idential! Inder no circumstance ma in#ormation gained during one audit be disclosed to another client without e%press permission being granted! The re'uest #or in#ormation regarding the #inancial stabilit o# an audit client clearl raises a potential con#lict o# interest and i# the #irm wishes to retain both clients then this t pe o# work should perhaps be declined! Another issue raised b this case is that the in#ormation is re'uested #or a speci#ic purpose and$ there#ore$ in the event that /ale Gtd subse'uentl su##ered #inancial di##iculties$ Chola Gtd ma #ind it easier to succeed in an action #or damages i# the #inancial appraisal was negligentl per#ormed! A commercial ,udgement ma have to be made between the amount o# the consultanc #ee as a 7one o## item o# additional #ee income and the necessit to withdraw #rom the audit o# /ale Gtd -with the loss o# the audit #ee on a recurrent basis.$ i# it is decided to go ahead with the #inancial appraisal work!

26

b. The main issue here is whether the kitchen was supplied b +ushibwe Plc as a transaction in the ordinar course o# business in a personal capacit to the partner concerned! &# the transaction was genuinel at 7arms length and the partner could demonstrate that no bene#its accrued as a result o# the auditor)client relationship then there is no problem! &# -as is likel . the partner had negotiated an discounts or special terms$ as most customers will attempt to do in relation to purchase o# this nature$ then he should withdraw #rom this particular audit and another partner within the #irm should assume responsibilit #or this audit to avoid an suggestion o# compromising the independence o# the partner concerned and the #irm! c. Presumabl $ this work would be charged as a separate #ee outside the routine audit and sub,ect to a separate letter o# engagement! The problem is that the auditor must not be seen to be o##ering advice which con#licts with independence! The partner responsible #or the audit o# Kapungwe Plc certainl should not take part in the training courses$ nor should an member o# the audit team! The courses could be provided b emplo ees o# the audit #irm who have no contact with the audit o# Kapungwe Plc and the matters covered should not be discussed with sta## normall emplo ed on the audit! &t will be ver di##icult to make comments regarding internal control weaknesses$ subse'uentl $ i# these weaknesses relate in an wa to topics covered in the course! The ethical rules also e%clude the provision o# accountanc services to Plc audit clients! There is insu##icient in#ormation given to decide whether or not the training courses o##ered would constitute 7accounting services! :n balance$ there is a risk o# compromising independence with such assignments and the should be avoided$ even when no #ee is charged! d. The 'uestion o# when a personal #riendship becomes a possible area o# comprise to independence is alwa s di##icult! &# the s'uash games are simpl that$ then there is no probabl no need to worr ! However$ i# the game is #ollowed b a meal and a #ew drinks in the bar at which business matters are discussed then a potential con#lict o# interest arises$ especiall i# the auditor does not pa ! These sorts o# situations need to be handled with care! The 'uestion o# what is reasonable is down to the integrit and pro#essionalism o# the individuals concerned! &n case o# doubt$ these situations should not be allowed to continue or the individual concerned should cease to be involved with the audit!

Cha ter roundu


#ccountants require an ethical code because they hold ositions of trust, and eo le rely on them" I9#C has issued guidance in its Code of :thics" The I9#C code gives e@am les of a number of situations where inde endence might be threatened and suggests safeguards to inde endence" 28

There are various safeguards to audit inde endence" 6articularly controversial areas with regard to confidentiality are conflicts of interest and insider dealing" $afeguards relating to confidentiality include engagement letters, and staff disclosure olicies"

Now try > * from the e@am >uestion ban! at the bac! of the manual

CF#6T:R -2 Changes in rofessional a


To ic list 1 Change in auditors 0 Advertising and #ees 2 Tendering 6 Acceptance 8 Agreeing terms ; "ooks and documents

ointments

Introduction
&t is a commercial #act that companies change their auditors! The 'uestion that #irms o# auditors need to understand is= wh do companies change their auditors4 &n this chapter we shall e%amine some o# the common reasons!

2;

Changing o# auditors is related to the #act that man auditing #irms advertise their services! The Association o# Chartered &nstitute o# Certi#ied Accountants -ACCA. and other accountanc pro#essional bodies to which C&CA members also belong have set out rules #or members who advertise their services! /e shall e%amine these rules and the reasons behind them in section *" As ou ma discover in section 1$ the audit #ee can be a ver ke item #or an entit when it makes decisions about its auditors! Hetermining the price to o##er to potential clients can be a di##icult process$ but it is ,ust one part o# the whole process o# tendering! Audits are o#ten put out to tender b companies! /e shall e%amine all the matters #irms consider when tendering #or an audit in section -" Ginked to the tendering process is the process o# accepting the audit engagement i# it is o##ered! &*EC 1 sets out some basic re'uirements #or all audit #irms accepting engagements! This is discussed in section 0" The general issues surrounding trans#erring books and documents are discussed in section D"

'"(

Change in auditors

*ome common reasons behind companies changing the auditor include audit fees, auditor not see!ing re?election and the siEe of com any"

'"'

+hy do com anies change their auditors?

&t is a #act o# li#e that companies normall change their auditors! <ot all new clients o# an audit #irm are new businesses= some have decided to change #rom their previous auditors! :bviousl $ it is o#ten not in the interests o# audit #irms to lose clients! There#ore a ke issue in practice management is to understand wh companies change their auditors$ so that$ as #ar as the are able$ the can seek to prevent it!

'"*

#udit fee

The audit #ee can be a ver sensitive issue considering that an audit is required by statute and it must be done! +an people perceive audit #ees as having ver little intrinsic value in relation to an audit! *etting #ees will be discussed later in the chapter! Here$ we shall e%plore some o# the #ee related reasons that make companies to change their auditors! '"*"' 9ee erceived to be too high

2?

This is a common reason #or auditors being changed! &t is strongl linked to peoples perception that an audit has no intrinsic value! &# directors o# a compan believe that audit is a necessar evil$ the will seek to obtain it #or as little mone as the can! +uch o# the 7value in cost terms o# an audit is as a result o# carr ing out an audit awa #rom a clients premises! This is because the most e%pensive audit sta## -managers and partners. o#ten does not carr out their work on site! '"*"* 6erceived not to be value for money

This o#ten goes hand in hand with the audit #ee being seen to be too high! However$ it is possible that a compan could be pa ing their audit #ee that the consider reasonable #or an audit= the ,ust believe that another #irm could give them a better audit #or a smaller #ee! '"*"Not com etitive

Again this issue can be linked with the value #or mone perception! &t is true to sa that in some cases$ audit #irms will o##er audit services at low prices! However$ audit #irms are able to sell other services to the same clients at pro#itable prices! &t is through practices like this that the problem o# lowballing can arise! Gow balling issues were also discussed in paper G!6 Auditing! &n such conditions$ a well 1set audit #ee ma not be competitive even i# it is a reasonable #ee #or the service provided! '"*"0 Interest in whether rice is negotiable

This reason ma be linked to all o# the above related issues$ or it ma ,ust arise out o# interest on the clients part! &t costs the client ver little$ e%cept #or some time on his part to put the audit out to tender! He might even do this with ever intention o# keeping the present auditor! Putting the audit out to tender would give him more insight into how competitive his audit #ee is and keep his auditor 7honest$ in that the auditor will have to ,usti# his #ee and the risk o# it being higher than competitors in the tender! The b 3product might be that he receives a competitive tender which o##ers him #ar more than he receives #rom his current auditor and thus he decides to changes his auditor$ an wa ! &t could also mean that when the auditor is #orced to ,usti# his position$ the current auditor reassesses his service and comes up with a much better competitive deal!

'"-

The auditor does not see! re?election

Another ke reason that ma prompt the change o# the current auditor is when the current auditor chooses not to stand #or re3election #or another ear! The #ollowing are the possible reasons behind this:

2B

There could be ethical reasons behind the auditor choosing not to stand The auditor might have to resign #or reasons o# competition between client The auditor might disagree with the client over accounting policies The auditor might not want to reduce his audit #ee

'"0

$iEe of the com any

This can be a ma,or reason #or a change in auditors! There are two ke reasons: Client e%periences rapid growth to a point where the audit is no longer practicable #or the audit #irm! Client retrenches or restructures in such a wa that it no longer needs a statutor audit! &n either situation$ there is little that the auditor can do to prevent losing the work due to lack o# su##icient e%pertise or competence in the changed organi9ation!

&n the #irst instance$ the auditor ma no longer be able to provide the audit #or several reasons: &nsu##icient resources *ta## Time (ee level issue &n the second instance$ the client has chosen no longer to take advantage o# the audit!

'"1

Other reasons

These reasons ma have been touched on in relation to the other reasons given above! /e shall consider them brie#l here! '"1"' 6ersonality

(or man small owner3managed companies$ audit is a personal service! The relationship between such a client and the auditor ma be strongl based on personalit $ and i# the relationship breaks down$ it ma be necessar #or the audit relationship to discontinue! Personalit ma be such an issue #or bigger entities and audit #irms where the audit engagement partner could be trans#erred$ while the audit sta ed within the #irm! '"1"* #udit rotation

Audit rotation is one o# the sa#eguards to audit independence! " its nature$ audit rotation ma sometimes mean that the audit is moved #rom one #irm to another or partners have changed! 2D

*"(

#dvertising and fees

Pro#essional accountanc bodies issue guidance on the issue o# advertising and pro#essional #ees!

*"'

#CC# guidance

+ost C&CA members are also members o# the ACCA! /e shall there#ore use the ACCA guidance here! Auditors are in business$ and in business it is necessar to advertise! However$ accountants are pro#essional people and people rel on their work! &t is important there#ore that their advertisements do not pro,ect an image that is inconsistent with that #act! ACCA allows members to advertise their work in an wa the see #it! &n other words$ it is a matter o# ,udgement #or the member sub,ect to the #ollowing general rule:

ACCA STATEMENT
7The medium used to advertise should not re#lect adversel on the member$ ACCA or the accountanc pro#ession! Advertisements and promotional material should not: Hiscredit the services o##ered b others whether b claiming superiorit #or the members or #irms own services or otherwise "e misleading either directl or b implication (all short o# the re'uirements o# the "ritish Code o# Advertising Practice$ including: o Gegalit o Hecenc o Clarit o Honest o Truth#ulness

*"*

9ees

&t is generall inappropriate to advertise #ees! Three issues arise with regard to #ees: Re#erring to #ees in promotional material Commissions *etting and negotiating #ees

6>

The last two issues are inter3related and are also closel connected with tendering which is discussed in the ne%t section!

*"*"' #dvertising fees


The #act that it is di##icult to e%plain the services represented b a single #ee in the conte%t o# an advertisement$ and that con#usion might arise as to what a potential client might e%pect to receive in return #or that #ee$ means that it is seldom appropriate to include in#ormation about #ees in short advertisements! &n longer advertisements$ where re#erence is made to #ees in promotional material$ the basis on which those #ees are calculated$ hourl and other charging rates etc should be clearl stated! The ke issue to remember with regard to advertising #ees is that the greatest care should be taken so as not to mislead potential clients! &t is appropriate to advertise #ree consultations to discuss #ee issues! This #ree consultation will allow #ees to be e%plained$ thus avoiding the risk o# con#usion! &t is inappropriate to advertise discounts on e%isting #ees!

*"*"*

$etting and negotiating fees

As this is a ke part o# the tendering process$ this is discussed below in section 2!

*"*"- Commissions
ACCA has provided guidance on commission! ACCA members are allowed to o##er commission -and b implication receive commission. #or introducing clients #rom the #ollowing people: An emplo ee o# a member Another public accountant The reason given behind this is that it is onl appropriate to deal in commissions with people who are sub,ect to similar ethical re'uirements! This results in independence not being a##ected!

*"*"0 Use of the #CC#ABIC# logo


+embers o# ACCA)C&CA ma be either associates or #ellows! &n which case$ the are allowed to use the designator letters such as ACCA)AC&CA or (CCA)(C&CA behind their name! A #irm ma describe itsel# as a #irm o# 7Chartered Certi#ied Accountants where: At least hal# o# the partners are ACCA)C&CA members$ and 61

Those partners hold at least at least 81O o# voting rights under the partnership agreement

A #irm in which all the partners are Chartered Certi#ied Accountants ma use the description 7+embers o# the Association o# Chartered Certi#ied Accountants! A (irm which holds a #irms auditing certi#icate #rom ACCA ma describe itsel# as Registered Auditors!

3.0 Tendering
/hen considering a tender$ it is important to consider both #ees and practical issues!

-"'

roach

A #irm puts together a tender i# &t has been approached b a prospective client$ and The partners have decided that the are capable o# doing the work #or a reasonable #ee!

/hen approached to tender$ the auditor has to consider whether he wants to do the work! 5ou should be aware o# all the ethical considerations that would go into this decision! The auditor will also have to consider (ees Practical issues -"'"' 9ees

Hetermining whether the ,ob can be done #or a reasonable price will involve a substantial number o# estimates! The ke estimates will be how long the partner thinks it will take to do the work! This will involve meeting with the prospective client to discuss their business and s stems and making the estimate #rom there! The #irst stage o# setting the #ee is there#ore to ascertain what the ,ob will involve! The ,ob should be broken down into its respective parts$ #or e%ample$ audit and ta@, or i# it is a com le@ and Aor ure audit, what aspects o# the ,ob would be undertaken b what level o# sta##! The second stage is closel linked with the #irst$ there#ore! &t involves ascertaining which sta##$ or which level o# sta##$ will be involved and in what proportions the will be involved! :nce estimates have been made o# how long the work will take and what level o# e%pertise is needed in each area$ the #irms standard charge out rates can be applied to that in#ormation$ and a #ee estimated!

60

Clearl $ it is commerciall vital that the estimates o# time and costs are reasonable$ or the audit #irm will be seeking to undertake the work at a loss! However$ it is also ethicall important that the #ee estimate is reasonable$ or the result will be that the client is being misled about the sustainable #ee level! -"'"* &owballing

Problems can arise when auditing #irms appear to be charging less than this$ or at least less than 4mar!et rate5 #or the audit! The practice o# undercutting$ usuall at tender #or the audit o# large companies$ has been called lowballing" &n other cases$ the audit #ee has been reduced even though the auditors have remained the same" The problem here is that$ i# the audit is being per#ormed #or less than it is actuall worth$ then the auditors independence is called into 'uestion! This is alwa s going to be a topical debate$ but in terms o# negotiating the audit #ee the #ollowing #actors need to be taken into account! -a. The audit is perceived to have a #luctuating 7market price as an other commodit or service! &n a recession$ prices would be e%pected to #all as companies aim to cut costs ever where$ and as auditors chase less work -suppl #alls.! Audit #irms are also reducing sta##ing levels and their own overhead costs should be lower! -b. Companies can reduce e%ternal audit costs through various legitimate measures: E%tending the si9e and #unction o# internal audit Reducing the number o# di##erent audit #irms used word 1wide *elling o## subsidiar companies leaving a simpli#ied group structure to audit The tender process itsel# simpl makes auditors more competitive E%change rate #luctuations in audit #ees -b. Auditing #irms have increased productivit $ partl through the use o# more sophisticated in#ormation techni'ues in auditing! The ACCAs guidance on 'uotations states that it is not proper to secure work b 'uoting a lower #ee so long as the client has not been mislead about the level o# work that the #ee represents! &n the event o# investigations into allegations o# unsatis#actor work$ the level o# #ees would be considered with regard to members conduct with re#erence to the ethical guidelines! -"'"6ractical issues

The #irm will have to consider the practical points arising #rom the approach! Common considerations include: Hoes the proposed timetable #or the work #it with the current work plan? Hoes the #irm have suitable personnel available?

62

/here will the work be per#ormed and is it accessible and cost e##ective? Are -non3accounting. specialist skills necessar ? /ill sta## need #urther training to do the work? &# so$ what is the cost o# that #urther training?

Certain in#ormation will be re'uired to put together a proposal document! &t is likel that audit sta## would have to have a meeting with the prospective client to discuss the #ollowing issues: /hat the client wants #rom the audit #irm$ #or e%ample: o Audit o <umber o# visits -interim and #inal. o Ta% work /hat the #uture plans o# the entit are$ #or e%ample: o &s it planning to #loat its shares on an e%change in the near #uture? o &s growth or diversi#ication anticipated? /hether the entit is seeking its #irst auditors and needs an e%planation o# an audit /hether the entit is seeking to change its auditors &# the entit is changing the auditor$ the reason behind this

-"*

Contents of an audit ro osal

An audit proposal$ or tender$ does not have a set #ormat! The prospective client will indicate the #ormat that he wants the tender to take! This ma be merel in document #orm$ or could be a presentation b members o# the audit #irm! Although each tender will be tailored to the individual circumstances$ there are some matters which are likel to be covered in ever proposal! These are setout below 8atters to be included in audit ro osal The #ee and how it is has been calculated An assessment o# the needs o# the prospective client The assumptions made to support that proposal The proposed approach to the engagement A brie# outline o# the #irm An outline o# the ke sta## involved

&# the tender is being submitted to an e%isting client$ some o# those details will be unnecessar ! However$ i# it is a competitive tender$ the #irm should ensure the submit a comparable tender$ even i# some o# the details are alread known to the client! This is because the tender must be comparable to competitors and must appear pro#essional!

-"-

:valuation of a tender
66

Each compan will have its own criteria #or what it wants #rom a #irm o# auditors! This means that there are no hard and #ast rules about how a tender will be evaluated! However$ there are some general points to bear in mind when putting together a proposal! :valuation factors2 Fee The #ee as discussed earlier$ can be the most important #actor #or people assessing tender! &t is possible that a reader might look at the #ee and decide not to continue reading the tender$ despite the rest o# the content Auditors provide a pro#essional service and the #irst impressions prospective client ma have o# the #irm are the sta## involved with the proposal and the tender document itsel#! &t is there#ore vital that the pro#essionalism which should mark the audit relationship is clear! An audit can cause a disruption to the ordinar course o# a business$ particularl in the #inance department! The client might be seeking the least disruptive approach! This might mean the look #or an audit with the shortest number o# proposed da s on site! &t is important that the relationship between the auditors and management o# the entit is good and the client perceives that the are getting value #or mone ! &t is important to highlight ke sta## and to #oster relationships with management #rom the outset o# the relationship$ and this means during the tender process!

Profe

ionali m

6ro osed a

roach

6ersonal service

-"0

#cce tance

IS60 7 sets out !"at a firm must consider and document in relation to accepting or continuing engagement !"ic" t"e integrity of t"e client !"et"er t"e firm is competent to do t"e !ork !"et"er t"e firm meets t"e et"ical and legal re(uirements in relation to t"e !ork#

0"( :thical and legal requirements


0"' :thical requirements

There are a number o# ethical and legal procedures associated with accepting engagements which ou have studied previousl in paper G!6 Auditing! These are summari9ed below: .a/ 6rocedures before acce ting nomination

68

Ensure that there is no ethical issues which are a barrier to accepting nomination Ensure that the auditor is pro#essionall 'uali#ied to act and that there are no legal or technical barriers -see below.! Ensure that the e%isting resources are ade'uate in terms o# sta##$ e%pertise and time! :btain re#erence #or the directors i# the are not known personall to the audit #irm! Consult the previous auditors to ensure that there are not an reasons behind the vacanc which the new auditors ought to know! This is also a courtes to the previous auditors!

.b/

6rocedures after acce ting nomination Ensure that the outgoing auditors removal or resignation has been properl conducted in accordance with the law -see below.! The new auditors should see a valid notice o# the outgoing auditors resignation$ or con#irm that the outgoing auditors were properl removed -see below.!

0"'"'

Ensure that the new auditors appointment is valid! The new auditors should obtain a cop o# the resolution passed at the general meeting appointing them as the compan s auditors -see below.! *et up and submit a letter o# engagement to the directors o# the compan ! :ligibilityAineligibility to act as an auditor

Eligibilit to act as an auditor is likel to arise #rom membership o# some kind o# regulator bod ! "odies o# this t pe will o##er 'uali#ications and set up rules to ensure compliance with an statutor re'uirements related to auditors! &n this wa national governments will control who ma act as an auditor to limited liabilit companies$ or to an other bod re'uiring a statutor audit! &n some countries$ regulation is developed pro#essional accountanc like the ACCA b the statutor authorities$ e!g! in the IK! :n the other hand$ the regulator bod could be a direct e%tension o# national government! The national bod should have rules to ensure that those eligible #or appointment as a compan auditor are either: &ndividuals holding an appropriate 'uali#ication or (irms controlled b 'uali#ied persons Regulator bodies should also have procedures to maintain the competence o# members! The regulator bod s rules should: 6;

Ensure that onl #it and proper persons are appointed as compan auditors Ensure that compan audit work is conducted properl and with pro#essional integrit &nclude rules as to the technical standards o# compan audit work -e!g! #ollowing &nternational *tandards on Auditing. Ensure that eligible persons maintain an appropriate level o# competence Ensure that all #irms eligible under its rules have arrangements to prevent: o &ndividuals not holding an appropriate 'uali#ication o Persons who are not members o# the #irm #rom being able to e%ert in#luence over an audit which would be likel to a##ect the independence or integrit o# the audit

The regulator bod s rules should provide #or ade'uate monitoring and en#orcement o# compliance with its rules and should include provisions relating to: Admission and e%pulsion o# members &nvestigation o# complaints against members Compulsor pro#essional indemnit insurance Ip3 to date lists o# approved auditors and their names and addresses should be maintained b the regulator bod ! This register o# auditors should be made available to the public! +embership o# a regulator bod is the main prere'uisite #or eligibilit as an auditor! *ome countries allow a 7#irm to be appointed as a compan auditor! A #irm ma be either a bod corporate -such as a compan or a partnership.! A person should be ineligible #or appointment as a compan auditor i# he or she is: An o##icer or emplo ee o# the compan A partner or emplo ee o# such a person A partnership in which such a person is a partner There ma be #urther rules about connections between the compan or its o##icers and the auditor$ depending on local statutor rules! 0"'"* &egal requirement on a ointment to a com any audit

The auditors should be appointed and there#ore be answerable to the shareholders" The table below shows what the position should ideall be!

6?

8embers

R&FHT* :( APP:&<T+E<T Appoint auditors at each general meeting where accounts are laid b positive resolution -re3appointment o# e%isting auditor not automatic. Auditors hold o##ice until conclusion o# ne%t general meeting at which accounts are laid Can appoint auditor: -a. "e#ore compan s #irst annual general meeting at which accounts are laid$ auditors hold o##ice until conclusion o# that meeting -b. To #ill a casual vacanc Can appoint auditors i# no auditors are appointed or reappointed at general meeting at which accounts are laid!

Directors

$ecretary of state 0"'"-

&egal requirements at the end of an audit relationshi

&t is important #or auditors to know the legal procedures at the end o# an audit relationship because as part o# their client acceptance$ the have a dut to ensure that the old auditors were properl removed #rom o##ice! An audit relationship can come to an end either b resignation of auditors or removal o# auditors b the client! R:$I7N#TION O9 #UDITOR$ Auditors deposit written notice together with a statement o# circumstances relevant to members)creditors or statement that no circumstance e%ist *ent b compan to regulator authorit *ent b : -a. Auditors to regulator authorit -b. Compan to ever one entitled to receive a cop o# accounts Auditors can re'uire directors to call e%traordinar general meeting to discuss circumstances o# resignation Hirectors must send out notice #or meeting within 01 da s o# having received re'uisition b auditors Auditors ma re'uire compan to circulate statement o# circumstances to ever one entitled to notice o# meeting Can receive all notices that relate to: -a. A general meeting at which their term o# o##ice would have e%pired

1! Resignation rocedures 0! Notice of resignation 2! $tatement of circumstance 6! Convening of general meeting

8! $tatement rior to general meeting ;! Other rights of auditors

6B

-b. A general meeting where casual vacanc caused b their resignation to be #illed Can s ea! at these meetings on any matter which concern them as auditors! R:8O;#& O9 #UDITOR$ Either special notice -0Bda s. with cop sent to auditor :r i# elective resolution in place$ written resolution to terminate auditors appointment Hirectors must convene a meeting to take place within reasonable time! Auditors can make representations on wh the ought to sta in o##ice$ and ma re'uire compan to state in notice representations have been made and send copies to members -a. Compan must noti# regulator authorit -b. Auditors must deposit statement o# circumstance at compan s registered o##ice within 16 da s o# ceasing to hold o##ice! *tatement must be sent to regulator authorit Can receive notice o# and speak at: -a. Feneral meeting at which their term o# o##ice would have e%pired -b. Feneral meeting where casual vacanc caused b their removal to be #illed

1! Notice of removal

0!Re resentations 2! If resolution assed

6! #uditors rights

1"(

#uditor rights and duties

The law gives auditors both rights and duties! The audit is primaril a statutor concept$ and eligibilit to conduct an audit is o#ten set down in statute! *imilarl $ the rights and duties o# auditors can be set down in law$ to ensure that the auditors have su##icient power to carr out an e##ective audit!

1"' Duties
The auditors should be re'uired to report on ever balance sheet and income statement laid be#ore the compan in general meeting! The auditors ma also be re'uired to consider the #ollowing! Compliance with legislation Truth and #air #airness o# accounts /hether the accounts have been prepared in accordance with the relevant legislation /hether the balance sheet shows a true and #air view o# the compan s a##airs at the end o# the period and the income statement -and cash #low statement. show a true and #air view o#

6D

Proper records and returns Agreement o# accounts to records Consistent o# other in#ormation

the results #or the period /hether proper accounting records have been kept and proper returns ade'uate #or the audit received branches not visited b the auditor /hether accounts are in agreement with the accounting records /hether the other in#ormation within the accounts is consistent with the accounts

1"*

Rights

The auditors must have certain rights to enable them to carr out their duties e##ectivel ! The principal rights auditors have$ e%cept those dealing with resignation or removal$ are set out in the table below! Access to records &n#ormation and e%planation Attendance at)notices o# general meetings Right to speak at general meeting Rights in relation to written resolutions Rights to re'uire la ing o# accounts A right o# access at all times to the books$ accounts and vouchers o# the compan A right to re'uire #rom the compan s o##icers such in#ormation and e%planations as the think necessar #or the per#ormance o# their duties as auditors A right to attend an general meeting o# the compan and to receive all notices o# and communications relating to such meetings which an member o# the compan is entitled to receive A right to be heard at general meetings which the attend on an part o# the business that concerns them as auditors A right to receive a cop o# an written resolution proposed A right to give notice in writing re'uiring that a general meeting be held #or the purpose o# la ing the accounts and reports be#ore the compan -i# elective resolution dispensing with la ing o# accounts in #orce.

&# the auditors have not received all the in#ormation and e%planations the consider necessar $ the should sate this #act in their audit report! +ore on this has been captured in chapter 16$ Reporting! Gaws ma make it an o##ence #or a compan s o##icer knowingl or recklessl to make statement in an #orm to an auditor which: Purports to conve an in#ormation or e%planation re'uired b the auditor &s materiall misleading$ #alse or deceptive!

D"( Requirements of I$>C '


8>

This standard sets out standards and guidance in connection with the acceptance and continuance o# client relationships and speci#ic engagements! I$>C '"*H The firm should establish olicies and rocedures for the acce tance and continuance of client relationshi s and s ecific engagements designed to rovide it with reasonable assurance that it will only underta!e or continue relationshi s and engagements where it2 Fas considered the integrity of the client and does not have information that would lead to conclude that the client lac!s integrity Is com etent to erform the engagement and has the ca abilities, time and resources to do so, and Can com ly with ethical requirements The firm should obtain such information as it considers necessary in the circumstances before acce ting an engagement with a new client, when deciding whether to continue an e@isting engagement, and when considering acce tance of a new engagement with an e@isting client" +here issues have been identified, and the firm decides to acce t or continue the client relationshi or a s ecific engagement, it should document how the issues were resolved"

The #irm should carr out the #ollowing steps: 1! :btain relevant in#ormation 0! &denti# relevant issues 2! &# resolvable issues e%ist$ resolve them and document that resolution Obtain information The standard outlines three general sources o# in#ormation: The communications auditors must make with the previous auditors according to the &(AC code :ther relevant communications$ #or e%ample with other parties in the #irm$ bankers or legal counsel *earches on relevant databases &n deciding whether to continue an engagement with the e%isting client$ or to accept a new engagement with an e%isting client$ the #irm should also consider signi#icant matters that have arisen in the course o# the previous )e%isting relationship$ #or e%ample$ e%pansion into a business area in which the audit #irm has no e%perience! Identify issues

81

The standard gives a list o# matters that the auditors might consider in relation to the acceptance decision! 8atters to consider2 Integrity of a client The identit and business reputation o# the clients principal owners$ ke management$ related parties and those charged with governance <ature o# the clients operations$ including its business practices &n#ormation concerning the attitude o# the clients principal owners$ ke management$ those charged with governance towards matters such as aggressive interpretation o# accounting standards)internal control environment /hether the client is aggressivel concerned with maintaining the #irms #ees as low as possible &ndications o# an inappropriate limitation in the scope o# work &ndications that client ma be involved in mone laundering or other criminal activities The reasons #or the proposed appointment o# the #irm and non3 reappointment o# the previous #irm! Ho #irm personnel have knowledge o# relevant industries)sub,ect matters4 Ho #irm personnel have e%perience with the relevant regulator or reporting re'uirements$ or the abilit to gain the necessar skills and knowledge e##ectivel 4 Hoes the #irm have su##icient personnel with the necessar capabilities and competence4 Are e%perts available$ i# needed4 Are individuals meeting the criteria and eligibilit re'uirements to per#orm the engagement 'ualit control review available where applicable4 &s the #irm able to complete the engagement within the reporting deadline4

Com etence of the firm

&n addition$ the #irm needs to consider whether acceptance would create an con#lict o# interest! I$>C '"-0 +here the firm obtains information that would have caused it to decline an engagement if that information had been available earlier, olicies and rocedures on the continuance of the engagement and the client relationshi should include consideration of2

80

The rofessional and legal res onsibilities that a ly to the circumstances, including whether there is a requirement for the firm to re ort to the erson or ersons who made the a ointment or, in some cases, to regulatory authorities, and The ossibility of withdrawing from the engagement or from both the engagement and the client relationshi

*uch procedures might include discussion with client management and those charged with governance$ and$ i# re'uired discussions with the appropriate regulator authorit !

>uestion ) #cce ting nomination


5ou are a partner in Fina and Co$ a #irm o# Chartered Certi#ied Accountants! 5ou have ,ust success#ull tendered #or the audit o# Tulile Gimited$ a chain o# sandwich shops across Gusaka cit ! The tender opportunit was received cold$ that is$ the compan and its o##icers are not known to the #irm! The compan has ,ust been incorporated and has not previousl had an audit! 5ou are about read to accept nomination -a. /hat procedures should ou carr out prior to accepting nomination4 &n course o# our acceptance procedures ou received a re#erence #rom a business contact o# ours concerning one o# the #ive directors o# Tulile Gimited$ +r! +wewa! &t stated that our business contact had had done some ta% work #or +r! +wewa ten ears previousl $ when he had #ound +r! +wewa to be di##icult to keep in contact with$ slow to provide in#ormation and he had suspected +r! +wewa o# being economical with the truth when it came to his ta% a##airs! As a result o# this distrust$ he had ceased to carr out work #or him! -b. /hat e##ect will ou think this re#erence will have on our accepting nomination #or this audit4

#nswer
-a. The #ollowing procedures should be carried out: Ensure that & and m audit team are pro#essionall 'uali#ied to act and there are no ethical barriers to m accepting nomination! Ensure that there are su##icient resources to enable m #irm to carr out the audit! :btain re#erences about the directors as the are not known personall b me or an one else in m #irm The auditor must use his pro#essional ,udgement when considering the responses concerning new clients! The guidance cannot legislate #or all situations so it does not! &n the circumstance given above there is no correct answer there#ore$ in

-b.

82

practice an auditor would have to make a ,usti#ied decision which he then documents! +atters to be considered The re#erence raises three issues #or the auditor considering accepting nomination The issue that the director has been di##icult to maintain a relationship with in the past The issue that the director was slow to provide in#ormation in the past The suspicion o# a lack o# integrit in relation to his ta% a##airs! The auditor must consider these in the light o# several #actors: The length o# time that has passed since the events /hat re#erences which re#er to the interim time sa The di##erence between accepting a role o# auditing a compan and personal ta% work The directors role in the compan and there#ore the audit The amount o# control e%ercised b the director o Relationships with other directors o &n#luence At this stage he should not be considering how highl he values the opinion o# the re#eree! That should have been considered be#ore he sent the re#erence! At this stage he should onl be considering the implications o# the re#erence #or his current decision! Auditing a compan is di##erent #rom auditing personal a##airs in terms o# obtaining in#ormation and contacting personnel! &n this case$ the ke issue is the 'uestion over the integrit o# the director! As we do not have in#ormation about interim re#erences and details o# the business arrangements it is di##icult to give a de#inite answer to this issue! However$ +r! +wewa is likel to onl have limited control over decisions o# the entit being one o# the #ive directors$ which might lead to the auditor deciding that the re#erence was insu##icient to prevent him #rom accepting nomination! &# +r! +wewa were the #inance director$ the auditor would be more inclined not to take the nomination!

G"( Client screening


+an audit #irms use a client acceptance checklist to assist them in making the decision and ensuring that such re'uirements are met!

G"'

#greeing terms

Certain issues must be agreed in writing when an audit is accepted

86

G"*

Clarifying the agreement

&t is important when entering into a contract to provide services to ensure that both parties #ull understand what the agreed services are! +isunderstanding could lead to a break down in the relationship$ and eventuall result in legal action being undertaken!

G"-

:ngagement letter

An auditor will outline the basis #or the audit agreement in his tender to provide services! However$ once he has accepted nomination$ it is vital that the basis o# his relationship is discussed with the new client and laid out in contractual #orm! This is the role o# the engagement letter$ which ou should be #amiliar with! Matter !hich hould "e clarified in the audit agreement Responsibilities o# both parties o Auditor is responsible #or reporting on the #inancial statements to members o Hirectors have a statutor dut to maintain records and take responsibilit #or the #inancial statements o Hirectors are responsible #or the detection and prevention o# #raud (ees o Gevel o "illing and credit terms o Potential increases Timing o Audit timing

In practice, the auditor and the ne client ill meet to negotiate the terms o! the audit agreement, hich the auditor ill later clari!y in the engagement letter. The !irst audit should not ta"e place until the client has returned the engagement letter ith an indication that he agrees to its terms.

H"(

%oo!s and documents

Audit working papers belong to the auditor

H"'

Ownershi

As ou know$ audit working papers are owned b the auditor! &n the event o# auditors taking over an audit #rom another #irm$ the are not entitled to take over all the audit #iles that that #irm has put together on the client!

88

The ACCA rules state that in order to ensure continuit o# a clients a##airs$ the previous auditors must provide the new auditors with all the reasonable carr 3 over in#ormation the re'uest$ and the should do so promptl ! The previous auditor should ensure that he trans#ers all the books and documents belonging to the client to the new auditors without dela ! He is onl allowed to keep the books where he is entitled to e%ercise lien

H"*

The right of lien

A lien is a creditors right to retain possession o# a debtors propert until the debtor pa s what is owed to the creditor! &# the previous auditor is still owed #ees b the client$ he ma have a right to e%ercise a lien over some o# the clients books! Feneral liens over propert can rarel be established! However$ it ma be possible #or an auditor to have a particular lien when the debtor owes a debt speci#icall in respect o# that propert ! A right o# particular lien will onl e%ist where the #ollowing conditions are #ul#illed! The documents must be the propert o# the client itsel# -not a closel related third part . The documents must have come into the members possession b proper means The work must have been done and a #ee note rendered in respect o# it The #ee must relate to the retained documents

H"-

Third arty rights to information

As discussed in chapter 0$ the auditor owes a dut o# con#identialit to the client! This means that documents containing in#ormation about the client should not be given to third parties unless: The client agrees to the disclosure be#ore it is made Hisclosure is re'uired b statute or court order Hisclosure is otherwise in accordance with the rules o# pro#essional conduct

H"0

Client rights to information

Audit working papers are the propert o# the auditor and as such$ the client has no right o# access to them! The auditor ma allow the client access to the working papers i# he so chooses! However$ the position is more complicated when the work undertaken is something other than audit! (or e%ample$ i# the accountant puts together the #inancial statements on behal# o# the client$ those #inancial statements will belong to the client! /ith ta% work$ documents created in carr ing out ta% compliance work will belong to the client!

8;

Cha ter roundu


Common reasons behind companies changing the auditors include audit #ee$ auditor not seeking re3election and si9e o# compan ! ACCAs general rule is 7The medium used should not re#lect adversel on the member or the accountanc pro#ession! &t is generall inappropriate to advertise #ees! ACCA onl allows members to deal in commission #rom #ellow accountants Re'uirements #or the eligibilit $ registration and training o# auditors are e%tremel important as the are designed to maintain standards in the auditing pro#ession! The law gives auditors both rights and duties! /hen approaching a tender$ it is important to consider both #ees and practical issues! &*EC 1 sets out what a #irm must consider and document in relation to accepting or continuing engagement$ which is the integrit o# the client$ whether the #irm is competent to do the work$ whether the #irm meets ethical re'uirements in relation to the work! Certain issues must be agreed in writing when an audit is accepted! Audit working papers belong to the auditor!

Now try question -"' from the e@am >uestion ban! at the bac! of the manual

CF#6T:R 02 6rofessional res onsibility and liability

"

To ic list 1 (raud 0 Pro#essional liabilit under statute 2 Pro#essional liabilit in the tort o# negligence 6 Pro#essional indemnit insurance 8 Current issues

Introduction

8?

Auditors have responsibilities to several parties! This chapter e%plores the various res onsibilities and liability that can arise in respect o# them! &t also looks at sa#eguards against liabilities$ particularl the issue o# insurance covered in section 0" Criticall and centrall to widespread public belie#$ auditors do not have a res onsibility to detect and revent fraud" The responsibilities that auditors do have with regard to #raud and error are outlined in section '" Auditors are re'uired to #ollow the guidance o# ISA280 '"e auditor$s responsibility to consider fraud in an audit of financial statements in relation to this issue! The auditors responsibilit to members and other readers o# the accounts in tort and contract can give rise to liability, particularl in the event o# negligence" Case law on this matter is comple% and not wholl satis#actor ! &t results into auditors being liable to some readers and others! However$ auditors5 liability is a d namic issue in that it evolves as the cases are brought to court" There are some interesting current developments #or auditors with regard to liabilit $ #or e%ample limited liability artnershi " This and other issues pertaining to the topics covered in this chapter are outlined in section 1"

'"(

9raud

Auditors do not have a responsibilit to prevent and detect #raud$ but must consider whether there are caused misstatements in the #inancial statements

'"'

+hat is fraud,?

#raud is an intentional act by one or more individuals among management, those charged ith governance $management !raud%, employees $employee !raud% or third parties involving the use o! deception to obtain an unjust or illegal advantage. #raud may be perpetrated by an individual, or colluded in ith people internal or e&ternal to the business. (raud is a wide legal concept$ but the auditors main concern with #raud is that it causes a material misstatement in #inancial statements! &t is distinguished #rom error$ which is when a material misstatement is caused b mistake$ #or e%ample$ in the application o# an

8B

accounting polic ! *peci#icall $ there are two t pes o# #raud causing material misstatement in #inancial statements= fraudulent financial re orting and misa ro riation of assets" '"'"' 9raudulent financial re orting

This ma include: 8ani ulation$ falsification or alteration o# accounting records)supporting documents 8isre resentation -or omission. o# events or transactions in the #inancial statements &ntentional misa lication o# accounting principles *uch #raud ma be carried out b overriding controls that would otherwise appear to be operating e##ectivel $ #or e%ample b recording #ictitious ,ournal entries or improperl ad,usting assumptions or estimates used in #inancial reporting! #ggressive earnings management is a topical issue and at its most aggressive$ ma constitute #raudulent #inancial reporting! Auditors should consider issues such as unsuitable revenue recognition, accruals, liabilities, rovisions, reserves accounting and large numbers o# immaterial breaches o# #inancial reporting re'uirements to see whether together$ the constitute #raud! '"'"* 8isa ro riation of assets

This is the the#t o# the entit s assets -#or e%ample$ cash$ and inventor .! Emplo ees ma be involved in such #raud in small and immaterial amounts! However$ it can also be carried out b management #or larger items who ma then conceal the misappropriation! (or e%ample b : :mbeEEling recei ts 1 #or e%ample b diverting them to private bank accounts $tealing hysical assets or intellectual ro erty 1 #or e%ample inventor or selling data Causing the entity to ay for goods not received 1 #or e%ample pa ments to #ictitious vendors Ising assets #or personal use!

*"(

Res onsibilities with regard to fraud

+anagement and those charged with governance in an entit are primaril responsible #or prevention and detection o# #raud! &t is up to them to put a strong emphasis within the compan on #raud prevention!

8D

#uditors are res onsible for carrying out an audit in accordance with International $tandards on auditing, one of which is &*A 06> The auditors responsibilit to consider #raud in an audit o# #inancial statements! The details o# this standard are covered below!

*"'
*"'"'

The auditors5 a
7eneral

roach to the ossibility of fraud

This is a ke re'uirement #or an auditor as per &*A! I$# *0("In lanning and erforming the audit to reduce audit ris! to an acce table level, the auditor should consider the ris!s of material misstatements in the financial statements due to fraud" #n overriding requirement of the I$# is that auditors are aware of the ossibility of being misstatement due to fraud" The I$# goes on to require the following2 I$# *0("*0 The auditor should maintain an attitude of rofessional s!e ticism throughout the audit, recogniEing the ossibility that a material misstatement due to fraud could e@ist, notwithstanding the auditor5s ast e@ erience with the entity about the honesty and integrity of management and those charged with governance" I$# *0("*G 8embers of the engagement team should discuss the susce tibility of the entity5s financial statements to material misstatements due to fraud" The engagement artner must consider what matters discussed should be assed on to other members of the team not resent at the discussion" The discussion itself usually includes2 #n e@change of ideas between the engagement team about how fraud could be er etrated # consideration of circumstances that might be indicative of aggressive earnings management # consideration of !nown factors that might give incentive to management to commit fraud # consideration of management5s oversight of em loyees with access to cashAother assets # consideration of any unusualAune@ lained changes in lifestyle of management Aem loyees #n em hasis on maintaining rofessional s!e ticism throughout the audit

;>

# consideration of how un redictability will be incor orated into the audit # consideration of what audit rocedures might be carried out to answer any sus icions of fraud # consideration of any litigations of fraud that have come to the auditors5 attention # consideration of the ris! of management override of controls

-"(

Ris! assessment rocedures

The auditor would undertake risk assessment procedures as set out in &*A 218 -see chapter #ive. which would include assessing the risk o# #raud! These procedures would include: &n'uiries o# management and those charged with governance Consideration o# when #raud risk #actors are present Consideration o# results o# anal tical procedures Consideration o# an other relevant in#ormation

&n identi# ing the risk o# #raud$ the auditor is re'uired b the &*A to carr out some speci#ic procedures: I$# *0("-0 +hen obtaining an understanding of the entity and its environment, including its internal control, the auditor should ma!e enquiries of management regarding2 8anagement5s assessment of the ris! that the financial statements may be materially misstated due to fraud 8anagement5s rocess for identifying and res onding to the ris!s of fraud in the entity, including any s ecific ris!s of fraud that management has identified or account balances, classes of transactions or disclosures for which a ris! of fraud is li!ely to e@ist 8anagement communication, if any, to those charged with governance regarding its rocesses for identifying and res onding to the ris!s of fraud in the entity, and 8anagement5s communication, if any, to em loyees regarding its views on business ractices and ethical behaviour"

I$# *0("-H The auditor should ma!e enquiries of management, internal audit and others within the entity as a ro riate, to determine whether they have !nowledge of any actual, sus ected or illegal fraud affecting the entity"

;1

I$# *0("0The auditor should obtain an understanding of how those charged with governance e@ercise oversight of management5s rocesses for identifying and res onding to the ris!s of fraud affecting the entity and the internal control that management has established to mitigate these ris!s" I$# *0("0D The auditor should ma!e inquires of those charged with governance to determine whether they have !nowledge of any actual, sus ected or illegal fraud affecting the entity" I$# *0("0H +hen obtaining an understanding of the entity and its environment, including its internal control, the auditor should consider whether the information obtained indicates that one or more fraud ris!s factors are resent" $igns of high fraud ris!s include indication of2 &ac! of integrity :@cessive ressures 6oor control systems Unusual transactions &ac! of audit evidence

&ac! of integrity Here$ assess the previous e%perience or incidents which call into 'uestion the integrit or competence o# management (actors to consider include: i. +anagement dominated b one or small group and no e##ective oversight board or committee! ii. Com le@ cor orate structure where comple%it does not seem to be warranted! iii. Jey ersonnel not taking holida s iv. 6oor relations between e%ecutive management and internal auditors v. 9requent changes in legal advisors or auditors vi. Histor o# legal and regulation violations! :@cessive ressures This particularl relate to #inancial reporting pressures within an entit

;0

(actors to consider include: Industry volatility Inadequate wor!ing ca ital due to declining pro#its or too rapid e%pansion 6ressure on accounting personnel to complete #inancial statements in an unreasonabl short period o# time! Dominant owner 1 management 6erformance 1 based remuneration

6oor control systems This covers weaknesses in the design and operation o# the accounting and internal control s stem! (actors to consider include: A wea! control environment within the entit ! * stems that in their design$ are inadequate to give reasonable assurance o# preventing or detecting error or #raud! 6oor security o# assets &ac! of access controls over &T s stems Evidence that internal controls have been overridden b management

Unusual transactions (actors to consider include: Unusual transactions$ especiall near the ear end that has a signi#icant e##ect on earnings! Com le@ transaction or accounting treatment Inusual transactions with related arties 6ayments for services #or e%ample law ers$ consultants or agents that appear e%cessive in relation to the services provided! &arge cash transactions Transactions dealt with outside the normal s stems!

&ac! of audit evidence This relates to problems in obtaining su##icient appropriate audit evidence The #actors to consider include: i. Inadequate records$ #or e%ample incomplete #iles$ e%cessive ad,ustments to accounting records!

;2

ii. iii. iv. v.

Inadequate documentation of transaction$ #or e%ample lack o# proper authori9ation$ supporting documentations not available and alterations to documents! An e@cessive number of differences between accounting records and third part con#irmations$ con#licting audit evidence and une%plainable changes in operating ratios :vasive, delayed or unreasonable res onses b management to audit in'uiries Ina ro riate attitude of management to the conduct o# the audit!

-"' Res onding to assessed ris!s


The auditor must then come up with responses to the assessed risks I$# *0("D' The auditor should determine overall res onses to address the assessed ris!s of material misstatement due to fraud at the financial statement level and should design and erform further audit rocedures whose nature, timing and e@tent are res onsive to the assessed ris!s at the assertion level" I$# *0("DD In determining overall res onses to address the ris!s of material misstatement due to fraud at the financial statement level the auditor should2 i/ Consider the assignment and su ervision of ersonnel ii/ Consider the accounting olicies used by the entity, and iii/ Incor orate an element of un redictability in the selection of the nature, timing and e@tent of the audit rocedures" The auditor may have to amend the nature, timing or e@tent of lanned audit rocedures to address assessed ris!s" The auditor should also consider the following2 #udit rocedures res onsive to management override of controls Kournal entries and other ad3ustments #ccounting estimates %usiness rationale for significant transactions

I$# *0("GD To res ond to the ris! of management override of controls, the auditor should design and erform audit rocedures to2 Test the a ro riateness of 3ournal entries recorded in the general ledger and other ad3ustments made in the re aration of the financial statements ;6

Review accounting estimates for biases that could result in material misstatements due to fraud, and Obtain an understanding of the business rationale of significant transactions that the auditor becomes aware of that are outside of normal course business for the entity, or that otherwise a ear to be unusual given the auditor5s understanding of the entity and its environment"

-"*

:valuation of audit evidence

The auditor evaluates the audit evidence obtained to ensure that it is consistent and that it achieves its aim o# answering the risks o# #raud! This will include a consideration o# results o# anal tical procedures and other misstatements #ound! The auditor must also consider the reliabilit o# management representations! The auditor must obtain written representation that management accepts its responsibilit #or the prevention and detection o# #raud and has made all relevant disclosures to the auditors!

-"-

Documentation

The auditor must document: i. ii. iii. iv. v. The signi#icant decisions as a result o# the teams discussion o# #raud The identi#ied and assessed risks o# material misstatement due to #raud The overall responses to assessed risks Results o# speci#ic audit tests An communications with management

-"0

Re orting

There are various reporting re'uirements in &*A 06>

I$# *0("IIf the auditor has identified a fraud or has obtained information that indicates a fraud may e@ist, the auditor should communicate these matters as soon as racticable to the a ro riate level of management" I$# *0("I1 If the auditor has identified fraud involving2

;8

i/ ii/ iii/

8anagement :m loyees who have significant roles in internal control, or Others, where the fraud results in a material misstatement in the financial statements

The auditor should communicate these matters to those charged with governance as soon as racticable" The auditor should also ma!e relevant arties within the entity aware of material wea!nesses in the design or im lementation of controls to revent and detect fraud which has come to the auditor5s attention, and consider whether there are any other relevant matters to bring to the attention of those charged with governance with regard to fraud" The auditor may have statutory duty to re ort fraudulent behaviour to regulators outside the entity" If no such legal duty arises, the auditor must consider whether to do so would reach their rofessional duty of confidence" In either event, the auditor should ta!e legal advice"

-"1

+ithdrawal from engagement

The auditor should consider the need to withdraw #rom the engagement i# the auditor uncovers e%ceptional circumstances with regard to #raud!

>uestion
There is a distinction between #raud on behal# o# the compan -such as b management. and #raud against the compan -b the emplo ee.! Required: i. Hiscuss what responsibilit auditors have to detect #raud and comment on whether ou consider there is a greater e%pectation #or 7management #raud or 7emplo ee #raud! ii. :utline how the auditors might conduct their audit in the light o# this responsibilit !

#nswer
The primar responsibilit #or the prevention o# and detection o# #raud and irregularities rests with management! This responsibilit ma be partl discharged b institution o# an ade'uate s stem o# internal control including$ #or e%ample$ authori9ation controls covering segregation o# duties! The auditors duties do not re'uire them speci#icall to search #or #raud unless re'uired b statute or the speci#ic terms o# their engagement! However$ the auditors should recogni9e the possibilit o# material irregularities or frauds which could$ unless

;;

ade'uatel disclosed$ distort the results or state o# a##airs shown b the #inancial statements! &*A 06> states that in planning and per#orming the audit to reduce audit risk to an acceptable low level the auditor should consider the risks o# material misstatement in the #inancial statements due to #raud! Accordingl $ in obtaining su##icient appropriate audit evidence to a##ord a reasonable basis o# support #or their report$ the auditors seek reasonable assurance$ through the application o# procedures that compl with auditing standards$ that #rauds or irregularities which ma be material to the #inancial statements have not occurred or that$ i# the have occurred$ the are either corrected or properl accounted #or in the #inancial statements! :m loyee fraud involves the#t$ misappropriation or embe99lement o# the enterprises #unds$ usuall in the #orm o# cash or other readil reali9able assets such as inventor or non current assets! 8anagement fraud o#ten involves the manipulation o# records and the accounts -#or e%ample b 7window dressing.$ t picall b the enterprises senior o##icers with a view to bene#iting in some indirect wa ! :m loyee frauds Emplo ee #rauds are more likel to be encountered where internal controls are weak! /hen evaluating controls the auditors will need to place special emphasis on the #ollowing control aspects: *egregation o# duties Authori9ation -particularl o# e%pense items and new ledger accounts. Completeness and accurac o# accounting data *a#eguard procedures -#or e%ample signing che'ues. Comprehensiveness o# controls -#or e%ample$ portable non current assets. Custod arrangements -cash$ portable non current assets.

&n addition$ where accounting procedures are computeri9ed$ the auditors should be concerned to ensure that a lack o# computer controls cannot be e%ploited to suppress evidence that an irregularit ma e%ist or indeed to allow an irregularit to occur! /hen carr ing out their detailed audit testing the could discover circumstances that are indicative o# emplo ee #raud! E%amples o# such circumstances include: +issing vouchers or documents$ inade'uate accounting records Evidence o# #alsi#ied documents Insatis#actor e%planations (igures$ trends or results which do not accord to e%planations Ine%plained items on reconciliations or suspense accounts Evidence o# disputes ;?

Evidence o# undul lavish li#e st les b emplo ees Inusual investment o# #unds held in #iduciar capacit Evidence that the s stem o# internal control is not operating as intended

The auditors programme o# work needs to be su##icientl #le%ible to #ollow up an such points arising and an irregularities or #rauds detected +an substantive procedures normall per#ormed b the auditors ma assist in isolating emplo ee #rauds$ i# the are occurring! (or e%ample$ tests per#ormed on the debtors ledger ma be aimed at revealing overstatement or bad debts$ but the design o# such tests also assists with cash understatement ob,ectives and ma reveal irregularities such as 7teeming and lading! 8anagement frauds /hen seeking to evaluate the possibilit o# management #raud the auditors will consider the business environment b identi# ing: Circumstances which ma e%ert undue in#luence on management -#or e%ample the desire to retain the con#idence o# depositors or creditors ma encourage overstatement o# results. Compan per#ormance -#or e%ample the deliberate distortion o# the #inancial statements to meet a pro#it #orecast$ to increase pro#it related remuneration or to avoid the appearance o# insolvenc .

*ome o# the designs listed above$ such as lavish li#est le$ usual investment o# #unds and control problems -particularl management over3ride o# controls. ma indicate management #rauds! :ther signs include manipulation o# evidence$ or an undul comple% corporate structure! &# the auditors conclude that there is a high risk o# management #raud the will concentrate on techni'ues such as anal tical procedures$ scrutin o# unusual transactions$ review o# post balance sheet events -including going concern evaluation.$ and review o# the #inancial statements #or an material distortions!

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6rofessional liability under statute

Auditors ma have pro#essional liabilit under statutor law! Inder certain legislation$ notabl insolvenc legislation$ auditors ma be #ound to be o##icers o# the compan and could be charged with criminal o##ences or #ound liable #or civil o##ences in connection with the winding up o# the compan !

;B

Auditors ma also be #ound guilt o# the o##ence o# inside dealing$ which is a criminal o##ence$ as the are priv to inside in#ormation! Auditors could be #ound guilt o# a criminal o##ence i# the knew or suspected a person was laundering mone and the #ailed to report their suspicions to the proper authorit !

1"(

6rofessional liability in the tort of negligence

Auditors ma have pro#essional liabilit in the tort o# negligence! <egligence is a common law concept! &t seeks to provide compensation to a person who has su##ered loss due to another persons wrong#ul neglect! To succeed in an action #or negligence$ an in,ured part must prove three things: A dut o# care which is en#orceable at law! This dut o# care was breached! The breach caused the in,ured part loss! &n the case o# negligence in relation to #inancial advisors)auditors$ this loss must be pecuniar -i!e! #inancial. loss!

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+ho might bring an action for negligence,

The #ollowing parties are likel to bring action in negligence against the auditors$ i# #or e%ample$ the have given the wrong audit opinion through lack o# care! The compan *hareholders The bank :ther lenders :ther interested third parties

A ke di##erence between the various potential claimants is the nature of the duty of care owed to them!

1"'"'

The audit client

The auditor owes a duty of care to the audit client automaticall under law! The audit client is a compan ! &t is a basic ma%im o# compan law that the compan is all the shareholders acting as a bod ! &n other words$ the compan cannot be represented b a single shareholder!

;D

The compan has a contract with the audit #irm! &n the law o# man countries$ a contract #or the suppl o# a service such as an audit has a dut or reasonable care implied into it b statute! &n other words$ whatever the e%press terms o# an written contract between the compan and the audit #irm$ the law alwa s implies a dut o# care into it! There#ore$ i# the compan -i!e! all the shareholders acting as a bod . want to bring a case #or negligence$ the situation would be as #ollows: C&I:NT Hut o# care e%ists4 "reached4 Goss arising4 Automatic +ust be proved +ust be proved

&n order to prove whether a dut o# care had been breached$ the court has to give #urther consideration to what the dut o# 7reasonable care means in practice! 1"'"* The auditors5 duty of care

The standard o# work o# auditors is generall as de#ined b legislation! A number o# ,udgements made in law cases show how the auditors dut o# care has been gauged at various points in time because legislation o#ten does not state clearl the manner in which the auditors should discharge their dut o# care! &t is also not likel that this would be clearl spelt out in an contract setting out the terms o# an auditors appointment! %elow are some of the case laws on the auditors dut o# care:

Case study 1
9e :ingstone 0otton 2ill &"en ;opes ; < considered t"e degree of skill and care re(uired of an auditor "e declared. =it is t"e duty of an auditor to bring to bear on t"e !ork "e "as to perform t"at skill care and caution !"ic" a reasonably competent careful and cautious auditor !ould use# &"at is reasonable skill care and caution depend on t"e particular circumstances of t"e case#$ ;opes !as careful to point out !"at constitutes reasonable care depends very muc" upon t"e facts of a particular case# Anot"er criterion by !"ic" t"e courts !ill determine t"e ade(uacy of t"e auditors$ !ork is by assessing it in relation to t"e generally accepted auditing standards of t"e day#

Case study 2
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;ord ,enning in t"e case of 1omento (Sterling Area) ;td v Selsdon 1ountain pen co ;td 7>?@ soug"t to define t"e auditor$s proper approac" to !ork by saying. = t"ey must come to it !it" an in(uiring mind A not suspicious of dis"onesty=# but suspecting t"at someone may "ave made a mistake some!"ere and t"at a c"eck must be made to ensure t"at t"ere "as been none#$ '"e auditors "ave a responsibility to keep t"emselves abreast of developments# Auditing Standards are likely to be taken into account !"en t"e ade(uacy of t"e !ork of auditors is being considered in t"e courts of la! or in ot"er contested situations# &"en t"e auditors are e)ercising judgement t"ey must act "onestly and carefully# Obviously if auditors are to be careful$ in forming an opinion t"ey must give due consideration to all relevant matters# Brovided t"ey do t"is and can be seen to "ave done so t"en t"eir opinion s"ould be above criticism# -o!ever if t"e opinion reac"ed by t"e auditors is one t"at no reasonably competent auditor !ould "ave been likely to reac" t"en t"ey !ould still possibly be negligent# '"is is because "o!ever carefully t"e auditors appear to "ave approac"ed t"eir !ork it clearly could not be careful enoug" if it enabled t"em to reac" a conclusion !"ic" !ould be generally regarded as unacceptable# If t"e auditors$ suspicions are aroused t"ey must conduct furt"er investigations until suc" suspicions are eit"er confirmed or allayed# Over t"e years t"ere "ave been many occasions !"ere t"e courts "ave "ad to consider cases in !"ic" it "as been "eld on t"e facts of t"ose cases t"at t"e auditors oug"t to "ave been put upon en(uiry# 1"'"Third arties

The auditor onl owes a dut o# care to parties other than the client i# one has been established! 4The third arties5 in this conte%t means an one other than the compan -audit client. who wished to make a claim #or negligence! &t there#ore includes an individual shareholders in accompan and an potential investors! &t also includes$ importantl $ the bank$ who is ver o#ten a ke #inancier o# the compan ! The ke di##erence between third parties and the compan is that third parties have no contract with the audit #irm! There is there#ore no implied dut o# care! the situation is there#ore as #ollows: TFIRD 6#RTI:$ Hut o# care e%ists4 "reached4 Goss arising ?1 +ust be proved +ust be proved +ust be proved

Traditionall the courts have been averse to attributing a dut o# care to third parties to the auditor! /e can see this b looking at some past cases that have gone to court! A ver important case is Caparo industries plc v Hickman and others 1DD>$ which is described here!

Case study 3
'"e facts as pleaded !ere t"at in 7>@8 0aparo industries purc"ased 700 000 1idelity s"ares in t"e open market# On <une 72 7>@8 t"e date on !"ic" t"e accounts audited by 'ouc"e 9ose !ere publis"ed t"e purc"ased a furt"er ?0 000 s"ares# 9elying on information in t"e accounts furt"er s"ares !ere ac(uired# On September 8 0aparo made a bid for t"e remainder and by October "ad ac(uired control of 1idelity# 0aparo alleged t"at t"e accounts on !"ic" t"ey "ad relied !ere misleading in t"at an apparent pre A ta) profit of some C7#5million s"ould in fact "ave been s"o!n as a loss of over C800 000# '"e plaintiffs argued t"at 'ouc"e o!ed a duty of care to investors and potential investors# '"e conclusion of t"e -ouse of ;ords "earing of t"e case in 1ebruary 7>>0 !as t"at t"e auditors of a public company$s accounts o!ed no duty of care to members of t"e public at large !"o relied upon t"e accounts in deciding to buy s"ares in t"e company# And as a purc"aser of furt"er s"ares !"ile relying upon t"e auditors$ report a s"are"older stood in t"e same position as any ot"er investing member of t"e public !"om t"e auditor o!ed no duty of care# '"e purpose of t"e audit !as simply t"at of fulfilling t"e statutory re(uirement of 0A 7>@?# '"ere !as not"ing in t"e statutory duties of company auditors to suggest t"at t"ey !ere intended to protect t"e interest of investors in t"e market# And in particular t"ere !as no reason !"y any special relations"ip s"ould be "eld to arise simply from t"e fact t"at t"e affairs of t"e company rendered it susceptible to takeover bid# In its report '"e 1inancial Aspects of 0orporate Dovernance t"e 0adbury 0ommittee gave an opinion on t"e situation as reflected in t"e 0aparo ruling# It felt t"at caparo did not lessen auditors$ duty to use skill and care because auditors are still fully liable in negligence to t"e companies t"ey audit and t"eir s"are"olders collectively# Diven t"e number of different users of accounts it !as impossible for the House o# Gords to have broadened the boundaries o# the auditors legal dut o# care! '"e decision in 0aparo v ,ickman considerably narro!ed t"e auditors$ potential liability to t"ird parties# '"e judgement appears to imply t"at members of various suc" groups !"ic" could include creditors$ potential investors ot"ers !ill not be able to sue t"e auditor for negligence by virtue of t"eir placing reliance on t"e audited annual accounts#

?0

A more recent court case produced a development in t"e subject of auditor liability# In ,ecember 7>>? a -ig" court <udge a!arded electronic security group A,' CE?m plus interest and costs (C80m) in damages for negligence against t"e former 4,O 4inder -amlyn (44-) partners"ip#

Case study 4
'"e firm "ad jointly audited t"e 7>@@F@> accounts of 4ritannia Security Droup (4SD) !"ic" A,' ac(uired in 7>>0 for C70?m but later found to be !ort" only C80m# Alt"oug" under 0aparo auditors do not o!e a duty of care in general to t"ird parties t"e judge found t"at 44- audit partner 2artyn 4is"op !"o confirmed t"at t"e firm stood by 4SD$s accounts at a meeting !it" A,' in t"e run Aup to t"e ac(uisition "ad t"ereby taken on a contractual relations"ip !it" A,'# '"is development "as occurred apparently because (post 0aparo) solicitors and bankers are advising clients intent on ac(uisition to get direct assurances from t"e target$s auditors on t"e trut" and fairness of accounts# 44- appealed t"is decision t"e liable partners because of a s"ortfall in insurance cover !ere left facing t"e prospect of coming up !it" C58m# An out of court settlement !as reac"ed !it" A,'# &n spite o# the ,udgement in Caparo$ the commercial realit is that creditors and investors especiall institutional ones do use audited accounts! * 061 CA 1DB8 re'uires a compan to #ile accounts with the registrar! /h is this statutor re'uirement4 &t is surel because the public$ including creditors and potential investors$ have a need #or credible and independent view o# the compan s per#ormance and position! &t would be un,ust i# auditors$ who have secondar responsibilit #or the #inancial statements being prepared negligentl $ bore the #ull responsibilit #or losses arising #rom such negligence ,ust because the are insured! &t would also be un,ust i# the auditors could be sued b all and sundr ! /hile the pro#ession has generall welcomed Caparo$ two obvious problems are raised b the decision! &s a restricted view o# the use#ulness o# audited accounts in the pro#essions long3 term in interests (or private companies there will be an increase in the incidence o# personal guarantees and warranties given b the directors to banks and suppliers!

Recent developments in the I* appear to redress the balance o# liabilit b highlighting the responsibilities o# management with regard to published #inancial statements! The $arbane ) O@ley #ct *((* re'uires chie# e%ecutive o##icers and #inance o##icers to certi# that the accounts o# listed companies are not misleading and present the compan s #inancial position and results #airl ! &n addition$ the are re'uired to con#irm that the are responsible #or internal controls and have reported signi#icant control weaknesses to the auditors)audit committee!

?2

The IK companies Act re'uires directors not to make misleading statements to the auditors! However$ auditors retain liabilit to shareholders #or negligence and breach o# dut $ there#ore the need to corroborate statements made to them and ensure the are not rel ing on representations recklessl ! 1"'"0 %an!s and other ma3or lenders

"anks and ma,or lenders have generall been e%cluded #rom the e%tent o# negligent auditors liabilit b the decision in Caparo! "anks o#ten include clauses in loan agreements re#erring to audited accounts and re'uesting that the have access to audited accounts on a regular basis or when reviewing the loan #acilit ! &n other words$ banks ma document a 7relationship with the auditors to establish that a dut o# care e%ists! A recent *cottish case involved a situation similar to this and ma suggest that ,udicial thinking on the matter is developing!

Case study 5
In a 'oyal (an" o! )cotland v (ennerman *ohnstone +aclay and others ,--, t"e bank !"o provided an overdraft facility to t"e company being audited claimed t"e company "ad misstated its position due to a fraud and t"at t"e auditors !ere negligent in not discovering t"e fraud# '"e auditors claimed t"at t"ey "ad no duty of care to t"e bank# -o!ever t"e judge determined t"at t"e auditors !ould "ave kno!n t"at t"e bank re(uired audited accounts as part of t"e overdraft arrangement and could "ave issued a disclaimer to t"e bank# '"e fact t"at t"ey "ad not issued a disclaimer !as an important factor in deciding t"at t"e auditors did o!e a duty of care to t"e bank#

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$ettlements out of court

+an liabilit claims are settled out o# court! The advantages o# doing so are claimed to be saving in time and cost$ and also perhaps a lower settlement! An out o# court settlement also avoids a high pro#ile court case which potentiall damages #irms reputation! Arguments against an out o# court settlement include the allegations that the o#ten arise through the unwillingness o# an auditors insurance compan to risk a settlement in court! An out o# court settlement also leaves the 'uestion o# the #irms responsibilit unsettled$ but nevertheless the #irms insurance premium ma rise!

1"- Disclaimers
Auditors ma attempt to limit liabilit to clients! This ma not alwa s be e##ective in law!

?6

The cases above suggest that a dut o# care to third part ma arise when an accountant does not know that his work will be relied upon b a third part $ but onl knows that it is a kind o# which is liable in the ordinar course o# events to be relied upon b a third part ! Conversel $ an accountant ma sometimes be in#ormed or be aware$ be#ore he carries out certain work that a third part will rel upon the results! An e%ample is a report upon the business o# a client which the accountant has been instructed to prepare #or the purpose o# being shown to a potential purchaser or potential creditor o# the business! &n such a case an accountant should assume that he will be held to owe the same dut to the third part as to his client! The "annerman case suggests this will also be necessar #or audit work! However there are areas o# pro#essional work -#or e%ample when acting as an auditor under the Companies Act.$ where it is possible #or liabilit to be limited or e%cluded! There are other areas o# pro#essional work -#or e%ample when preparing reports on a business #or the purpose o# being submitted to a potential purchaser. where although such limitation or e%clusion ma be included$ its e##ectiveness will depend on the view which a court ma subse'uentl #orm o# its reasonableness!

8!6

&itigation avoidance

The other aspect o# how #irms are tr ing to deal with litigations is b putting in measures aimed at avoiding litigations! This strateg has various aspects! (ollowing criticall the client acceptance procedures! These procedures are ver important! Per#ormance o# work! (irms should make sure that all audits are carried out in accordance with pro#essional standards and best practice! Eualit control! This does not ,ust include controls over individual audits but also stricter 7whole 1 #irm procedures! &ssue o# appropriate disclaimers! /e discussed above the importance o# these!

>uestion
Although auditors can incur civil liabilit under various statutes it is #ar more likel that the will incur liabilit #or negligence under the common law$ as the ma,orit o# cases against auditors have been in this area! Auditors must be #ull aware o# the e%tent o# their responsibilities$ together with steps the must take to minimi9e the danger o# pro#essional negligence claims! Required: Hiscuss the e%tent o# an auditors responsibilities to shareholders and others during the course o# their normal pro#essional engagement! Gist si% steps which auditors should take to minimi9e the danger o# claims against them #or negligent work!

?8

#nswer
Res onsibility under statute

An auditor o# a limited liabilit compan has a responsibilit $ imposed upon him b statute$ to #orm and e%press a pro#essional opinion on the #inancial statements presented b the directors to the shareholders! He must report upon the truth and #airness o# such statements and the #act that the compl with the law! &n so doing$ the auditor owes a dut o# care to the compan imposed b statute! "ut that dut also arises under the common law -law o# tort.! Res onsibility under contract

The companies Act does not state e%pressl the manner in which the auditor should discharge his dut o# care$ neither is it likel that this will be clearl spelt out in an contract setting out the terms o# an auditors appointment -eg the engagement letter.! Although the articles o# a compan ma e%tent the auditors responsibilities be ond those envisaged b the companies Act$ the cannot be used so as to restrict the auditors statutor duties$ neither ma the place an restrictions upon the auditors statutor rights which are designed to assist him in the discharge o# those duties! '"e comments of ;opes ;< !"en considering t"e degree of skill and care re(uired of an auditor in 9e :ington 0otton 2ill are still relevant# = it is t"e duty of an auditor to bring to bear on t"e !ork "e "as to perform t"e skill care and caution !"ic" a reasonably competent careful and cautious auditor !ould use# &"at is reasonable skill care and caution must depend on t"e particular circumstances of eac" case$ Clearl $ with the advent o# auditing standards$ a measure o# good practice is now available #or the courts to take into account when considering the ade'uac o# the work o# the auditor! Res onsibility in tort

The law o# tort has established that a person owes a dut o# care and skill to 7our neighbours -common and well known e%amples o# this neighbour principle can be seen in the law o# trespass$ slander$ libel and so on.! &n the conte%t o# the pro#essional auditor the wider implications$ however$ concern the e%tent to which the auditor owes a dut o# care and skill to third parties who rel on #inancial statements upon which he has reported but whom he has no direct contractual or #iduciar relationship! &iability to third arties &n Caparo &ndustries plc v Hickman M others 1DD>$ it was held that the auditors o# a public compan s accounts owed no dut o# care to the members o# the general public ?;

who relied upon the accounts in deciding to bu shares in the compan ! And as a purchaser o# more shares$ a shareholder placing reliance on the auditors report stood in the same position as an other investing member o# the public to whom the auditor owed no dut ! The purpose o# the audit was simpl that o# meeting the statutor re'uirements o# the Companies Act! There was nothing in the statutor duties o# a compan auditor to suggest that the were intended to protect the interest o# investors in the market! &n particular$ there was no reason wh an special relationship should be held to arise simpl #rom the #act that a##airs o# the compan rendered it susceptible to take3over bid! A case between "H: "inder Haml n and AHT seems to have moved the argument on! &n this case it was argued that pro%imit between a prospective investor and the auditors o# a compan could be created i# the investor asked the auditors whether the stood b their last audit! An appeal is likel in this case as the auditors involved #ace a large short#all in insurance proceeds! The recent *cottish "annerman case suggests that ,udges ma be more likel to impute a dut o# care to the auditors i# the were aware that the bank made use o# audited accounts and did not disclaim liabilit to them! &n order to provide a means o# protection #or auditors arising #rom the comments in -a. above$ the #ollowing steps should be taken! i. Agreements concerning the duties o# the auditor should be: Clear and precise &n writing Con#irmed b a level o# engagement$ including matters speci#icall e%cluded ii. Audit work should be: Relevant to the s stem o# internal control$ which must be ascertained$ evaluated and tested! Controls cannot be entirel ignored:- #or the auditor to have an con#idence in an accounting s stem there must be present and evident the e%istence o# minimum controls to ensure completeness and accurac o# the records. Ade'uatel planned be#ore the audit commences Reviewed b a senior member o# the #irm to ensure 'ualit control o# the audit and to enable a decision to be made on the #orm o# the report iii. An 'ueries arising during the audit should be: Recorded on the current working papers Cleared and #iled iv. A management letter should be: *ubmitted to the client or the "oard o# Hirectors in writing immediatel #ollowing an audit *een to be acted upon b the client v. All members o# an auditing #irm should be #amiliar with: The standards e%pected throughout the #irm The standards o# the pro#ession as a whole b means o# ade'uate training$ which should cover the implementation o# the #irms audit

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vi.

manual and the recommendations o# the pro#essional accountanc bodies &nsurance should be taken out to cover the #irm against possible claims!

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6rofessional indemnity insurance

+ost pro#essional accountanc bodies re'uire that auditors take out pro#essional indemnit insurance!

D"'

+hat is rofessional indemnity insurance,

Pro#essional indemnit insurance is insurance against civil claims made by client and third arties" (idelit guarantee insurance is insurance against liability arising through an acts o# #raud or dishonest b an partner$ director or emplo ee in respect o# mone or goods held in trust b the #irm! &t is important that accountants have insurance so that i# negligence occurs$ the client can be compensated #or the error b the accountant! The appropriate compensation could be greater than the resources o# the accountanc #irm! Remember that accountants usually trade as artnershi s, so all the artners are 3ointly and severally liable to claims made against individual artners" D"'"' #dvantages and disadvantages

A ke advantage o# such insurance is that it rovides funds for an innocent arty to be compensated in the event o# a wrong having been done to them! An advantage to the auditor is that it rovides some rotection against ban!ru tcy in the event o# success#ul litigation against the #irm! This is particularl important #or a partnership$ as partners ma be sued ersonally #or the negligence o# their #ellow partners! # ke disadvantage is that the e@istence of insurance against the cost of negligence might encourage auditors to ta!e less care than" /ould otherwise be the case Their pro#essional dut re'uires!

Another problem associated with such insurance are that there are limits o# cover -linked with the cost o# bu ing the insurance. and an compensation arising #rom claim could be higher than those limits! This could lead to partners being bankrupted despite having insurance! A simple disadvantage associated with the above is the regular cost o# the insurance to the partnership! ?B

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Current issues

#s auditor liability is an im ortant ractical issue, there are regularly develo ments in this area"

G"' &iability
The ma,or accountanc #irms have been interested in methods o# reducing personal liabilit #or partners in the event o# negligence #or some time! (or e%ample$ some ears ago KP+F -one o# the big #our o# the accountanc #irms. incorporated its IK audit practice! This is allowed under Companies Act 1DBD! The new arrangement created 4a firm within a firm5! KP+F Audit plc is a limited compan wholl owned b the partnership$ KP+F! The reason behind this is to protect the partners #rom the crushing e##ects o# litigation! The other side o# incorporation means that KP+F Audit plc is sub,ect to the statutor disclosure re'uirements o# companies! An alternative to incorporation as a compan is incorporation as a limited liabilit partnership! Gimited liabilit partnership can be operated in some countries$ #or e%ample$ some o# the states in the I*A and the IK! G"'"' &imited liability artnershi s

The Gimited liabilit partnership Act 0>>> enables IK #irms to establish limited liabilit partnerships as se arate legal entities" These combine the #le%ibilit and ta% status o# a partnership with limited liabilit #or members! The e##ect o# this is that the partnership$ but not its members$ will be liable to third parties= however the personal assets o# negligent partners will still be at risk! *everal prominent pro#essional partnerships have incorporated as Gimited liabilit partnerships -GGPs.! Gimited liabilit partnerships are set up b similar procedures to those #or incorporating a compan ! An incorporation document is sent to the Registrar o# Companies! The Registrar will issue a certi#icate o# incorporation to con#irm that all statutor re'uirements have been #ul#illed! &n a similar wa to traditional partnerships$ relations between partners will be governed b internal partner arrangements! :r b #uture statutor regulations Each member o# the partnership will still be an agent o# the partnership unless he has no authorit to act and an outside part is aware o# this lack o# authorit !

?D

Cha ter roundu


Auditors do not have a responsibilit to prevent and detect #raud$ but must consider whether it has caused misstatements in the #inancial statements! Auditors ma have pro#essional liabilit under statutor law! Auditors ma have pro#essional liabilit in the tort o# negligence! The auditor owes a dut o# care to the audit client automaticall under law! The auditor onl owes a dut o# care to parties other than the audit client i# one has been established! Auditors ma attempt to limit liabilit to clients! This ma not alwa s be e##ective in law! Pro#essional accountanc bodies re'uire that auditors take pro#essional indemnit insurance! As auditor liabilit is an important issue$ there are regularl developments in this area!

Now try > 0 from the :@am >uestion %an! at the bac! of the manual

CF#6T:R 12 6ractice 8anagement


To ic list B>

Practice management Risk e%posure 1Audit #irms Regulator #ramework Eualit control in audit work Eualit control on an individual audit

Introduction
Practice management is an essential component o# audit #irms in practice! :ne wa o# managing the practice is b ensuring that audit engagements undertaken are in line with rofessional ethical requirements" (or instance$ how auditors should go about in obtaining pro#essional work! &n this case$ client screening ma be vital! 5our appreciation o# earlier chapters such as rules of rofessional conduct, changes in rofessional a ointments and rofessional res onsibility and liability" Audit #irms ,ust like an other business #aces ris!s such as losing clients, ris! of litigation or adverse ublicity! These ma cause the business to #ail and as such the audit #irm need to hedge against such risks! &n this chapter$ we look at a number o# safeguards that a #irm can put in place to hedge against these risks and ma include having a framewor! in place to mitigate the risks! Also to avoid such risks$ 'ualit control measures are ke and have been considered in this chapter!

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6ractice management

*ome audit #irms ma #ail due to #ailure to manage the business risk! This could be due to not abiding b the regulations and pro#essional re'uirements e%pected o# them! &n this comple%$ turbulent and d namic audit environment$ practice management should be taken as an important re'uirement #or audit #irms!

Im ortant2
5ou should be able to describe risks to which practices are e%posed and outline various steps$ which can be taken to manage them! Eualit control practices and procedures take a center stage in reducing #ailure o# a business thus cardinal in sustaining a practice! As a student$ ou should be able to do the #ollowing among others: :utline the regulator #rame work to ensure 'ualit services How 'ualit control policies and procedures a##ect the nature$ timing and e%tent o# an audit #irms at di##erent levels! *peci# ob,ectives o# 'ualit control policies! "e able to recommend policies and procedures$ which can be e%ercised internall at the level o# audit #irms and individual audits! B1

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Ris! e@ osure )#udit firms

Gike an other business$ audit #irms also #ace risks that ma render the business to #ail! However$ it is important that the audit #irm strive to reduce these risks to an acceptable level through the implementation o# 'ualit control procedures! "elow we consider a number o# risks that ma be speci#ic to audit #irms and enhance business #ailure!

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&itigation

/hen clients are not happ with the work o# the auditor$ the ma decide to take the issue at hand to court! The auditor has certain responsibilities under the laws o# tort and contracts that needs to be #ul#illed! &t is also the responsibilit o# the auditor to uphold pro#essional duties o# care to his clients! /here the auditor has #ailed to abide b the above re'uirements$ then the resultant could be litigation against him! The client can make a claim under civil law and the redress to the claimant would be compensation once the court upholds the claim! This ma result in business #ailure in that: /here the audit #irm relies to a greater e%tent on the lost client$ #or its source o# income$ the business ma not continue! The litigation itsel# ma also impact so heavil on the business due to adverse publicit arising #rom the litigation! o This ma lead to loss o# other e%isting clients o +a not bring in other clients thus impacting on income generation o +a also lose ke sta## wanting to uphold their pro#essional standing However$ clients ma also be lost due to some reasons alread discussed in chapter 2 1 changes in pro#essional appointments! *"*

Disci linary action from rofessional bodies"

A pro#essional bod to which an audit #irm belongs ma decide to discipline the audit #irm #or misconduct under certain b elaws thus could result in e%clusion #rom membership! The practice certi#icate ma be withdrawn! (or instance$ C&CA is a member o# &(AC and b virtue o# C&CA being a member o# this bod $ and then members o# C&CA are liable #or disciplinar action #rom &(AC! *"-

Com etition

All businesses in the same sector compete #or business! This is not an e%ception to audit #irms whose business is so competitive! The risk o# competition should be managed though this is restricted due to the re'uirements put in place on who should be an auditor #or practice purposes! (or instance$ C&CA regulates the issuance o# practice certi#icates in the #orm o# auditing and non3audit! The Practice Committee under C&CA takes a rigorous process that ensures that practice certi#icates are onl issued to deserving pro#essionals B0

and C&CA has the powers to withdraw these certi#icates when the possessing them have been #ound wanting! *"0

Ris! management

Risk management is an important undertaking in an business and auditors has to manage their business e##ectivel in order to avoid loss o# business! A risk management strateg and s stem must be developed and put in place! (or instance$ the auditor should avoid loosing clients! Auditors should also take out pro#essional indemnit insurance and)or take client care procedures! Risk management plans should be developed and availed to members o# the audit #irm so that ever one is aware o# the impeding risks and possible mitigation measures!

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Regulatory framewor!

&n this section$ the emphasis is that the regulator #ramework or pro#essional re'uirements pla a pivotal role in risk management thus avoiding business #ailure! &t has been mentioned in chapter 1 that the &nternational Auditing and Assurance *tandards "oard -&AA*".$ a standing committee o# &(AC$ issues international standards on auditing and other practice statements! Adhering to these standards and statements can assist in the reduction o# some o# the risks outlined above! "elow we reproduce the standards and other guidance!

International $tandards on #uditing .I$#/


NO 1>> 11> 10> 0>> 01> 00> 02> 06> 08> 2>> 218 20> 22> 6>1 Title Assurance engagements Flossar o# terms (ramework o# &*As :b,ective and general principles governing an audit o# #inancial statements Terms o# audit engagement Eualit control #or audit work Hocumentation (raud and error Consideration o# laws and regulations in an audit o# #inancial statements Planning Inderstanding the entit and its environment and assessing the risk o# material misstatement Audit materialit The auditors procedures in response to risks Auditing in a computer in#ormation s stem environment

B2

6>0 8>> 8>1 81> 80> 82> 86> 8;> 8B> ;1> ;0> ?>> ?>1 ?1> ?0> B>>

Audit considerations relating to entities using service organi9ations Audit evidence Audit evidence 1 additional considerations #or speci#ic items &nitial engagements 1 opening balances Anal tical procedures Audit sampling and other selective testing procedures Audit o# accounting estimates *ubse'uent events +anagement representation Considering the work o# internal auditing Ising the work o# e%perts The independent auditors report on a complete set o# #inancial statements +odi#ied audit reports Comparatives :ther in#ormation in documents containing audited #inancial statements The auditors report on special purpose audit engagement

International $tandards on Review :ngagements


06>> Engagement to review #inancial statements

International $tandards on #ssurance :ngagement


2>>>R 26>> Assurance engagements other than audits or reviews o# historical #inancial in#ormation The e%amination o# prospective #inancial in#ormation

International $tandards on Related $ervices


66>> 661> Engagements to per#orm agreed 1upon services regarding #inancial in#ormation Engagements to compile #inancial in#ormation

International #udit 6ractice $tatements


&AP* 1>>8 &AP* 1>1> &AP* 1>12 &AP* 1>16 The *pecial Considerations in the Audit o# *mall Entities The Consideration o# Environmental +atters in the Audit o# (inancial *tatements Electronic Commerce E##ect on the audit o# (inancial *tatements Reporting on compliance with &nternational (inancial reporting *tandards

Other guidance
ACCAs Rules o# pro#essional Conduct &(ACs Code o# Ethics #or Pro#essional Accountants The Combined Code -o# the Committee on Corporate Fovernance. B6

This provides a #ramework #or auditors to #ollow in order to ensure 'ualit o# work carried out and consistenc between audit #irms! :nce these standards and guidance have been #ollowed then the client can be assured o# a service! This also entail that i# the auditors do not #ollow the standards and guidance given$ then disciplinar action can be meted on them and also a recipe #or negligence litigation!

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>uality control in audit wor! .I$# **(/

The purpose o# &*A 00> is to establish standards and provide guidance on the 'ualit control policies and procedures o# an audit #irm regarding audit work generall and procedures regarding the work delegated to assistants on an individual audit! The standard sa : 3 <>uality control olicies and rocedures should be im lemented at both the level of the audit firm and on individual audits=" 0"'

>uality control of audit firms"

&t should be appreciated that the audit sector is 'uite wide and the 'ualit control re'uirements would depend on the t pe o# accounting sector in which the #irm #alls! The accounting sector #alls into three categories in terms o# si9e! (or instance$ larger firms which are recogni9ed according to the #ee incomes= medium siEed firms 1 recogni9ed either according to the number o# partners the have -sa $ more than 1;. and small firms, which constitutes the remainder! However$ it is important to note that #irms continue changing in si9e and the re'uirements ma continue changing in as #ar as 'ualit control re'uirements are concerned! Eualit control regulations are the same #or all audit #irms regardless o# si9e! However$ the impact on large and small #irms ma di##er! (or e%ample$ large #irms ma emplo international 'ualit control procedures or national and regional ones! (or small #irms with single partners ma need to make e%tensive use o# e%ternal e%perts! The ob,ectives o# the 'ualit control policies to be adopted b an audit #irm will ordinaril incorporate the #ollowing: 0"'"'" 6rofessional requirements2 Personnel in the #irm are to adhere to the principles o# independence$ integrit $ ob,ectivit $ con#identialit and pro#essional behaviour! The #ollowing procedures could be carried out: -a. Assign an individual or group to provide guidance and to resolve 'uestions on matters o# integrit $ ob,ectivit $ independence and con#identialit !

B8

-b.

Communicate policies and procedures regarding independence$ integrit $ ob,ectivit $ con#identialit and pro#essional behaviour to personnel at all levels within the #irm! +onitor compliance with policies and procedures relating to independence$ integrit $ ob,ectivit $ con#identialit and pro#essional behaviour! $!ills and com etence2

-c. 0"'"*

The #irm is to be sta##ed b personnel who have attained and maintained the technical standards and pro#essional competence re'uired to enable them to #ul#ill their responsibilities with due care! The #ollowing procedures pertaining to hiring$ pro#essional development and advancement could be carried out: Firing2 -a. +aintain a program designed to obtain 'uali#ied personnel b planning #or personnel needs$ establishing hiring ob,ectives$ and setting 'uali#ications #or those involved in the hiring #unction! Establish 'uali#ications and guidelines #or evaluating potential hires at each pro#essional level! &n#orm applicants and new personnel o# the #irms policies and procedures relevant to them!

-b. -c.

6rofessional develo ment2 -a. -b. Establish guidelines and re'uirements #or continuing pro#essional education and communicate them to personnel! +ake available to personnel in#ormation about current developments in pro#essional technical standards and materials containing the #irms technical policies and procedures and encourage personnel to engage in sel#3development activities! Provide to the e%tent necessar $ programs to #ill the #irms needs #or personnel with e%pertise in speciali9ed areas and industries!

-c.

#dvancement2 -a. Establish 'uali#ications deemed necessar #or the various levels o# responsibilit within the #irm!

B;

-b. -c. 0"'"-

Evaluate per#ormance o# personnel and advise personnel o# their progress! Assign responsibilities #or making advancement decisions #ssignment2

Audit work is to be assigned to personnel who have the degree o# technical training and pro#icienc re'uired in the circumstances! The #ollowing procedures could be carried out: -a. Helineate the #irms approach to assigning personnel$ including the planning o# overall #irm and o##ice needs and the measures emplo ed to achieve a balance o# audit manpower re'uirements$ personnel skills$ individual development and utili9ation! Assign an appropriate person or persons to be responsible #or assigning personnel to audits! Provide #or approval o# the scheduling and sta##ing o# the audit b the auditor! Delegation2

-b. -c. 0"'"0

The polic is that there is to be su##icient direction$ supervision and review o# work at all levels to provide reasonable assurance that the work per#ormed meets appropriate standards o# 'ualit ! The procedures are that= -a. -b. -c. Procedures #or planning audits should be in place! Procedures #or maintaining the #irms standards o# 'ualit #or the work per#ormed! Procedures aimed at providing on3the3,ob training during the per#ormance o# audits!

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>uality control on an individual audit

&*A 00> Eualit control #or audits o# historical #inancial in#ormation re'uires #irms to implement 'ualit control procedures over individual audit engagements! I$# **( The engagement team should im lement quality control rocedures that are a licable to the individual audit engagement"

B?

&n order #or this to be done properl $ the audit engagement partner should ensure that ade'uate control procedures are carried out being the person having the ultimate responsibilit #or the audit engagement! The #ollowing re'uirements ma enhance the 'ualit control procedures: 0"*"' &eadershi res onsibilities

I$# **("* The engagement team should im lement quality control rocedures that are a licable to the individual audit engagement" This entails that the ultimate responsibilit rests in the engagement partner and as such must set an e%ample with regards the importance o# 'ualit ! 0"*"* :thical requirements

I$# **("H The engagement artner should consider whether members of the engagement team have com lied with ethical requirements" Ethical re'uirements include Code o# Ethics such as integrit $ ob,ectivit $ and pro#essional competence and due care$ pro#essional conduct and con#identialit ! Also contained in the &*A is detailed guidance on independence as per &*A 00>!10 below:

I$# **("'* The engagement artner should form a conclusion on com liance with inde endence requirements that a ly to the audit engagement" In doing so, the engagement artner should2 .a/ Obtain relevant information from the firm and, where a licable networ! firms, to identify and evaluate circumstances and relationshi s that create threats to inde endence"

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.b/

:valuate information on identified breaches, if any, of the firm5s inde endence olicies and rocedures to determine whether they create a threat to inde endence for the audit engagement" Ta!e a ro riate actions to eliminate such threats or reduce them to an acce table level by a lying safeguards" The engagement artner should rom tly re ort to the firm any failure to resolve the matter for a ro riate action, and Document conclusions on inde endence and any relevant discussions with the firm that su orts these conclusions" #cce tance or continuance of client relationshi s and s ecific audit engagements

.c/

.d/ 0"*"-

&t is important that the re'uirements o# the standard on 'ualit control are adhered to be#ore accepting or continuing with the audit assignment! &n the event that the engagement partner come across or obtains in#ormation that would cause him not to accept the engagement$ the engagement partner should communicate this in#ormation to the #irm so that 'uick action can be taken! &n this wa $ then the #irm can onl accept those engagements that are #ree #rom problems that ma put the audit #irm into ridicule and at risk o# sa $ litigations! 0"*"0 #ssignment of engagement teams

The audit engagement partner should ensure that a #ormidable team$ 'uali#ied and e%perienced in the audit to be carried out is put in place! An thing short o# this ma put the audit #irm at risk! 0"*"1 :ngagement erformance

This ma include issues such as providing direction to the audit$ supervision$ review$ consultation and 'ualit control review! -a. Direction 1 this entails that the engagement partner should hold a meeting with the audit team in order to discuss the audit assignment especiall the risk associated to the audit! The &*A suggests that direction includes in#orming members o# the engagement team o#: Their responsibilities The nature o# the entities business Risk3related issues Problems that ma arise The detailed approach to the per#ormance o# the engagement -audit program.!

BD

-b. $u ervision 1 the overall supervision o# the audit should be done b the engagement partner! However$ more practical supervision is given within the audit team b senior sta## to more ,unior sta##! This should be done through the #ollowing activities: Tracking the progress o# the audit engagement Considering the capabilities and competence o# individual members o# the team$ and whether the have su##icient time and understanding to carr out their work! Addressing signi#icant issues arising during the audit engagement and modi# ing the planned approach appropriatel ! &denti# ing matters #or consultation or consideration b more e%perienced engagement team members during the audit engagement!

.c/ Review Review includes consideration o# whether: The work has been per#ormed in accordance with pro#essional standards and regulator and legal re'uirements! *igni#icant matters have been raised #or #urther consideration Appropriate consultations have taken place and the resulting conclusions have been documented and implemented! There is need to revise the nature$ timing and e%tent o# work per#ormed The work per#ormed supports the conclusions reached and is appropriatel documented! The evidence obtained is su##icient and appropriate to support the auditors report$ and The ob,ectives o# the engagement procedures have been achieved!

&t goes there#ore that be#ore the audit report is issued$ the engagement partner must be sure that su##icient and appropriate audit evidence has been obtained to support the audit opinion reached!

.d/ Consultation Consultations in an audit engagement must be done on di##icult and contentious matters that arise during the cause o# the audit and the team should ensure that such matters are concluded and properl recorded!

D>

&# di##erences in opinion on the matter arise between the partner and the team$ or between the engagement partner and the 'ualit control reviewer$ these di##erences should be resolved according to the #irms polic #or such di##erences o# opinion! .e/ >uality control review

The engagement partner is responsible #or appointing a reviewer$ i# one is re'uired! All signi#icant matters that arise #rom the review should be discussed with the reviewer and the audit report should onl be issued a#ter the 'ualit control review has been success#ull completed! A 'ualit control review should include the #ollowing: An evaluation o# the signi#icant ,udgements made b the engagement team An evaluation o# the conclusions reached in #ormulating the auditors report

A 'ualit control #or a listed entit will include a review o#: The engagement teams evaluation o# the #irms independence towards the audit! The signi#icant risks identi#ied during the engagement and the responses to those risks Nudgements made particularl with respect to materialit and signi#icant risks! /hether appropriate consultations has taken place on di##erences o# opinion)contentious matters and the conclusions drawn! *igni#icance and disposition o# corrected and uncorrected misstatements identi#ied during the audit! +atters to be communicated with management$ i!e! those charged with governance! /hether the audit documentation selected #or review re#lects the work per#ormed in relation to signi#icant ,udgement)supports the conclusions reached! The appropriateness o# the proposed audit report! 8onitoring the quality of audit wor!

0"*"D

+onitoring and control is essential in 'ualit control and acts as a tool that #acilitates the success o# the audits being undertaken! Results arising #rom the monitoring #acilitate decision making on issues that ma lender the audits not to achieve the set ob,ectives! The engagement partner should there#ore consider the results o# monitoring o# the #irms 'ualit control s stem and consider whether the have an impact on the speci#ic audit he is conducting!

>uestion2
P"L an audit #irm has been engaged to carr out an audit o# #inancial statements #or one o# its clients *tar Gtd! The audit partner in charge has deplo ed three assistant auditors to carr out the audit and report back to him! The audit has been #inali9ed but *tar Gtd has written to the partner in charge o# standards complaining about the non3involvement o# D1

the senior partner on site and e%cessive #ees charged #or the audit considering that onl three assistant auditors were deplo ed! The client contends that the are pa ing high #ees in order to <train staff on the 3ob=" However$ the partner has responded back indicating that the 'ualit o# work would not be a##ected and has sought #or an audience with the client so that he can present to them the standards that are #ollowed in the o##ice! (orthwith$ the partner has asked ou to prepare #or him some notes #or presentation to the client on how our #irm ensures that 'ualit work is achieved through out the #irm on all audits!

Required2
-a. -b. -c. "rie#l outlining the purpose o# &*A 00> Eualit Control #or Audit /ork *tating speci#ic procedures that should be #ollowed on individual audits *tating general procedures to be #ollowed b audit #irms!

#nswer2
-a. Eualit control is dealt with in the &nternational *tandards on Auditing -&*A. 00> Eualit Control #or Audit /ork! All #irms registered to undertake audit work are re'uired to compl with all &*As issued including &*A 00>! All audit #irms are sub,ect to man risks when the carr out an audit assignment and ma include the risk o# issuing a wrong report on a set o# accounts$ being negligent which results in loss to the client or a third part $ and putting #inancial success above audit 'ualit ! These risks ma render the audit #irms be e%posed to court action with damages being pa able$ loss o# clients$ loss o# their audit license and adverse publicit and loss o# reputation! /e have developed 'ualit control policies and processes within the #irm in order to preserve audit 'ualit ! +anagement structures within the #irm are designed to prevent commercial considerations taking precedence over the 'ualit o# audit work! P"L$ like an other audit #irms$ audit sta## and partners all #ollow this standard as a basis #or the success#ul deliver o# all audits! *ta## training there#ore does occur on audit assignments to develop the competencies o# the sta## #or #uture assignments but the 'ualit o# their work and all sta## through out the #irm will be care#ull monitored and reviewed to ensure that this complies with the o##ice standard laid down! -b. >uality control on individual audits D0

The 'ualit control on an individual audits can be considered in relation to direction$ supervision and review! The &*A 00> re'uires that the auditor implements those 'ualit control procedures$ which are in the conte%t o# the policies$ and procedures o# the #irm$ appropriate to the individual audit! &t means that the auditor and the assistants with supervisor responsibilities will consider the pro#essional competence o# assistants per#orming work delegated to them when deciding the e%tent o# direction$ supervision and review appropriate #or each assistant! An delegation o# work will be done with reasonable assurance that persons having the degree o# pro#essional competence re'uired in the circumstances will per#orm such work with the due care! Direction2 The partner or an other senior auditor should provide appropriate direction #or an works delegated in order #or the assistants to per#orm the work properl ! Hirection involves providing assistant with su##icient in#ormation #or the assignment through ade'uate communication! The must be in#ormed o# issues and problems that are cardinal #or the audit to be e%ecuted properl ! As part o# communication$ the audit plan and overall strateg are important tools o# providing direction including the provision o# time budgets! $u ervision2 *upervision entails supervisors carr ing out responsibilities aimed at enhancing the per#ormance o# the audit! &t ma involve the #ollowing #unctions: +onitoring the progress o# the audit to consider whether assistants have the necessar skills and competence to carr out their assigned work= assistants understand the audit direction and the work is being carried out in accordance with the overall audit strateg and audit plan! Addresses signi#icant accounting and auditing 'uestions arising #rom the audit being carried out$ assessing their signi#icance in relation to the overall audit strateg and audit plan! Resolve an di##erences o# pro#essional ,udgement between personnel and consider the level o# consultation that is appropriate!

Review2 The work per#ormed b assistants need to be reviewed b personnel with re'uisite competence and skills taking into account the #ollowing: /ork has been per#ormed in accordance with the audit plan /ork per#ormed and the results have been su##icientl documented All signi#icant matters arising #rom the audit have been resolved or are re#lected in the audit conclusions :b,ectives o# the audit procedures have been achieved

D2

.c/

The conclusions reached are consistent with the results o# the work per#ormed and support the audit opinion! >uality control in an audit firm

&t is a re'uirement that audit #irms implement 'ualit control policies and procedures designed to ensure that all audits are conducted in accordance with &*A 00> and other relevant national standards or practices! The nature$ timing and e%tent o# an audit #irms 'ualit control policies and procedures depend on a number o# #actors such as the si9e and nature o# its practice$ its geographic dispersion$ its organi9ation and other appropriate cost)bene#it considerations! Thus 'ualit control policies adopted b #irms in these categories ma var depending on their re'uirements such as documentation! The ob,ectives o# the 'ualit control policies adopted b an audit #irm will ordinaril incorporate the #ollowing: 6rofessional requirements2 personnel in the #irm should adhere to the principles o# independence$ integrit $ ob,ectivit $ con#identialit and pro#essional behaviour! $!ills and com etence2 the #irm should be sta##ed b personnel who have attained and maintained the technical standards and pro#essional competence re'uired to enable them to #ul#ill their responsibilities with due care! #ssignment2 audit work is to be assigned to personnel who have the degree o# technical training and pro#icienc re'uired in the circumstances! Delegation2 there must be su##icient direction$ supervision and review o# work at all levels to provide reasonable assurance that the work per#ormed meets appropriate standards o# 'ualit ! Consultation2 whenever necessar $ consultations within or outside the #irm is to occur with those who have appropriate e%pertise! #cce tance and retention of client2 prospective clients should be evaluated and reviews carried out on an ongoing basis o# the e%isting clients! &n making a decision as to whether a client should be retained or not$ the #irms independence and abilit to serve the client properl and the integrit o# the client management are to be considered! 8onitoring: the continued ade'uac and operational e##icienc o# 'ualit control policies and procedures is to be monitored! Fenerall $ the #irms 'ualit control procedures should be communicated to sta## in a manner that provides reasonable assurance that the policies and procedures are understood and implemented!

Chapter roundup
Audit #irms ,ust like an other #irm ma #ace a risk o# business #ailure! :bserving regulator and pro#essional re'uirements can mitigate the risk o# business #ailure! Eualit control can be either on audit #irms and)or individual audits! D6

The &*A 00> re'uires #irms to implement 'ualit control procedures over individual audit engagements!

No! tr# $% from the E&am $ue tion 'an( at the "ac( of the manual

CF#6T:R D2 Regulatory :nvironmental

D8

TO6IC &I$T 1 Corporate governance 0 &nternal Control and audit committee 2 Consideration o# laws and regulation

Introduction
&n chapter 8$ we looked at the #rameworks that audit #irms use to ensure that the services the o##er are 'ualit services! &n this chapter we will look at the #rameworks that have been developed to ensure that companies deal #airl with their members$ and the auditors role in respect o# that #ramework$ given members$ given their pivotal position between the compan and its members! &n this chapter we shall look at the ke areas o#: Corporate governance -section1.$ &nternal control and audit committee -section 0. and lastl consideration o# laws and regulations in the audit o# #inancial statements -section2.!

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Cor orate 7overnance


%ac!ground to cor orate 7overnance

Cor orate governance ? is the s stem b which organi9ations are directed and controlled -Cadbur Report.! The #ollowing are some o# the #eatures o# poor corporate governance Domination by a single individual &ac! of adequate control information &ac! of su ervision &ac! of inde endent scrutiny &ac! of contact with shareholders :m hasis on short ) term rofitability 8isleading accounts and information The risks o# poor corporate governance in an organi9ation include the #ollowing: Risk that organi9ation makes large looses$ hence bankruptc becomes inevitable! :rganisation ma be closed down as a result o# serious regulator breaches! These risks have given rise to a number o# reports to be produced in various countries aiming at addressing the problems posed b poor corporate governance! The notable reports on corporate governance include the #ollowing: D;

Re ort Cudbur Hampel Freenbur Combined code Turbull internal *mith Higgs *arbanes 1 :%le Act 0>>0 King

Lear 1DD>s 1DD>s 1DD>s 1DDB

Country IK IK IK IK post 1DDB

Issues covered

Feneral Corporate Fovernance issues Feneral Corporate Fovernance issues Remuneration o# directors *ummar o# reports one to three above IK (ocused on risk management and

Control post 1DDB post 1DDB 0>>0 1DD6 -Revised 0>>0. IK IK I*A (ocused on the role o# internal audit (ocused on the role o# the non 1 e%ecutive Hirectors! Changes to listing rules post Enron scandal Companies listed on /all *treet must #ul#ill these rules!

*outh A#rica Feneral Corporate Fovernance issues!

#ll re orts on cor orate governance as outlined above where loo!ed at in a er *"0 #uditing have not been re eated here" Cor orate governance re orts have also being re roduced in a Cor orate 7overnance manual at this same level" &ssues o# corporate governance have also been addressed in the :rgani9ation o# Economic Corporation and Hevelopment -:ECH. report! The :ECH principles are important in that the intend to assist members and non3member governments in their e##ort to evaluate and improve the legal$ institutional and regulator #ramework #or corporate governance in their countries as given below:

Countries should ensure that the have an e##ective corporate governance #ramework as a basic #or commitment to good corporate governance! The rights o# shareholders and ke ownership #unctions are clearl spelt out! *hareholders are e'uitabl treated to enable #ull participation in corporate governance issues! The role o# stakeholder in corporate governance is clearl spelt out! Hisclosure o# vital in#ormation and transparenc The responsibilities o# the "oard!

D?

These principles pla a pivotal role in enhancing corporate governance and the must be taken into account whenever audits are conducts! Auditors must ensure that b and large management abides to these principles that enhance corporate governance!

'"* 6rinci les of cor orate 7overnance


Hebates on corporate governance are based on three di##ering views associated with ownership and management o# organi9ations! These theories are as #ollows: *tewardship theor Agenc theor *takeholder theor '"*"' $tewardshi theory

Inder this approach$ power is seen to be vested in the stewards$ that is the e%ecutive managers! :ther interest groups take little or no part in the running o# the compan /here share holders do not take an active interest in the organi9ation$ particularl i# the do not e%ercise their right to vote as abrogated under stewardship approach$ it is not an acceptable approach! '"*"* #gency theory

This approach takes the stance that$ rather than acting as stewards$ management will act in an agency ca acity" &t is based on the assumption that management will be seeking to serve their own sel# 1 interests and looking a#ter the per#ormance o# the compan whose goals are co 1 indent with their own! This approach has a ver negative stance o# short 1 term or tactical stance! '"*"$ta!eholder theory

This view e%tends the stewardship approach in that it states that management has a duty of care, not onl to the owners o# the compan in terms o# ma%imi9ing shareholder value$ but also to the wider communit o# interest or stakeholders! The obvious drawback o# this approach is the problem o# producing either a de#initive list or a rank order o# importance o# stakeholders and their interests! Culture also presents a ma,or potential drawback regarding the applicabilit o# the theor in terms o# the best mechanism #or addressing their needs!

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6rinci les on which cor orate governance code are based


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+ost corporate governance codes are based on a set o# principles and the include the #ollowing: -a. To minimiEe ris! #or e%ample: (inancial risk Gegal risk Reputation risk -b. To ensure adherence to and satisfaction of the strategic ob3ectives o# the organi9ation -c. To fulfill res onsibilities to all stakeholders and to minimi9e potential conflict of interest between owners$ management and wider stakeholders! -d. To establish clear accountability at senior levels within an organi9ation! -e. To maintain the inde endence o# those who scrutini9e the behaviour o# the organi9ation and its senior e%ecutive managers$ #or e%ample: <on 1 e%ecutive directors &nternal and e%ternal auditors! -#. To rovide accurate and timely re orting o# trustworth independent #inancial and operational data to both the management and owners -members. o# the organi9ation to give them a true and balanced picture o# what is happening in the organi9ation! -g. To encourage more roactive involvement of ownersA members in the e##ective management o# the organi9ation through recogni9ing their responsibilities via voting or other mechanisms! -h. To romote integrity$ that is straight#orward dealings and completeness!

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The role of the %oard

The role o# the board is to de#ine the purpose o# the compan and the values b which the compan will per#orm its dail e%istence and to identi# the stakeholders relevant to the business o# the compan ! The board must then develop a strateg combining all three #actors to ensure that management implements that strateg ! :ther tasks the board should per#orm include: +onitoring the chie# e%ecutive o##icer :verseeing strateg +onitoring risks and control s stems +onitoring the human capital aspect o# the compan in regard to succession$ morale$ training$ remuneration etc Ensuring that there is e##ective communication o# its strategic plans both internall and e%ternall !

-"' %oard membershi


All reports on corporate governance re'uire the roles of chairman and chief e@ecutive to be held b two di##erent people!

DD

Inde endent non? e@ecutive directors have to be on the board! Their number and status should mean that their views carr signi#icant weight! Non ) e@ecutive directors rovide assurance to shareholders that management is acting in the interest o# the organi9ation! To ensure independence o# non3 e%ecutive directors$ the #ollowing sa#eguards suggested b corporate governance reports must be taken into account: The should not have business$ financial or other connection with the compan $ apart #rom #ees and share holdings! The should not take part in share o tion schemes and their service should not be ensionable! # ointment should be #or a speci#ied term and re? a ointment should not be automatic! The board as a whole should decide on their nomination and selection! 6rocedures should e%ist whereb non 1 e%ecutive directors ma take independent advice$ at the compan s e%pense i# necessar !

-"* Directors remuneration


The Freenbur committee in the IK set out principles which provide a good summar o# what remuneration polic should involve: Hirectors remuneration should be set3 up b independent members o# the board! This means that independent non3 e%ecutive directors should #orm part o# the remuneration committee! An #orm o# bonus should be related to measurable per#ormance or enhanced shareholder value! There should be transparenc o# directors remuneration including pension rights in the annual accounts!

&n order #or readers o# the accounts to achieve a #air picture o# remuneration arrangements$ the accounts need to disclose: -a. Remuneration polic -b. Hetails o# packages o# individual directors! The #ollowing are the necessar disclosures regarding remuneration polic : -a. -b. -c. -d. -e. Remuneration levels Comparator companies +ain components o# remuneration Per#ormance criteria measurement Pension provision

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-#. Contracts o# service -g. Compensation #or loss o# o##ice! Hetails o# individual directors package will have to be disclosed! The #ollowing details should be disclosed: -a. "asic salar -b. "ene#its 3 in kind -c. Gong 1 term incentives -d. &ndividuals entitlement to share options and pension entitlement earned during the ear!

2!2 Directors5 Relationshi s with shareholders and sta!eholders


-"-"' Relationshi with shareholders A ke aspect o# the relationship is the accountabilit o# directors to shareholders particularl institutional shareholders! This can be ensured b re'uiring all the directors to submit themselves #or regular re3election! Corporate governance reports suggest that this should be once ever three ears! The need #or regular communication with shareholders is emphasi9ed in most reports! Particularl important is communication with institutional shareholders such as pension #unds who ma hold a signi#icant proportion o# shares! The annual general meeting is the most signi#icant #orum #or the communication$ and governance guidance suggests that boards should activel encourage shareholders to attend annual general meeting! The Hampel report contained some use#ul recommendations on how the annual general meeting could be used to enhance communications with shareholders: <otice o# the AF+ and related papers should be sent to shareholders at least twent working da s be#ore the meeting Companies should consider providing a business presentation at the AF+$ with a 'uestion and answer session! *hareholders should be able to vote separatel on each substantiall separate issue$ the practice o# 7bundling unrelated proposals in a single resolution should cease! Companies should propose a resolution at the AF+ relating to the report and accounts!

The most important document #or communication with shareholders is the annual report and accounts covered in the ne%t section! -"-"* Relationshi with sta!eholders

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How much the board is responsible #or the interests o# stakeholders other than shareholders is a matter o# debate! The Hampel report claimed that although relationships with other stakeholders were important! +aking the directors responsible to other stakeholders would mean that there was no clear ardstick #or ,udging directors per#ormance! However$ the :rganisation #or Economic Corporation and Hevelopment -:ECH. guidelines see rather wider importance #or stakeholders in corporate governance$ concentrating on emplo ees$ creditors and government! Creditors suppl e%ternal capital to the #irm and emplo ees$ human capital! The guidelines comment that: 7The com etitiveness and ultimate success of a cor oration is the result of teamwor! that embodies contribution from a range of different resource roviders, including investors, em loyees, creditors and su liers"5 The :ECH guidelines stress that the corporate governance #ramework should there#ore ensure that respect is given to the rights of sta!eholders that are protected b the law! These rights include rights under labour laws, business law, and insolvency law The corporate governance #ramework should also permit 4 erformance ) enhancing mechanisms for sta!eholder artici ation"5 E%amples o# this are emplo ee representation on the board o# directors$ emplo ee share ownership$ pro#it3 sharing arrangements and the right o# creditors to be involved in an insolvenc proceedings!

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Re orting on cor orate governance

#nnual re orts must convey a #air and balance view of the organiEation" The corporate governance reports suggest that the directors should e%plain their res onsibility for re aring accounts! The should report that the business is a going concern, with supporting assumptions and 'uali#ications as necessar ! &n addition #urther statements ma be re'uired depending on the ,urisdiction such as2 &n#ormation about the board o# directors: Changes in the composition o# the board in the ear$ the identit o# the chairman$ chie# e%ecutive and senior non 1 e%ecutive director and in#ormation about the independence o# the non3 e%ecutives$ #re'uenc o# attendance at board meetings$ how the board per#ormance has been evaluated! "rie# report on the remuneration, audit and nomination committees covering the terms o# re#erence$ composition$ and #re'uenc o# meetings! &n#ormation about relation with auditors including reasons #or change and steps taken to ensure auditor ob,ectivit and independence when non3 audit services are provided A statement that the directors have reviewed the effectiveness o# internal controls, including risk management!

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A statement on relations and dialogue with shareholders A statement that the compan is a going concern" $ustainability re orting, de#ined b the king report as including the nature and e%tent o# social$ trans#ormation$ ethical$ sa#et $ health and environmental management policies and practices!

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Internal control and audit committees

1"' Internal control


"oards should regularl review ris! management and internal control and carr out a wider review annuall $ the result o# which should be disclosed in the accounts! &nternal controls are important to management$ as the contribute to: *a#eguarding the compan s assets Helping to prevent and detect #raud and There#ore sa#eguarding the shareholders investment! Food internal controls help the business to run efficiently! Control s stem reduces identi#ied risks to the business! &t also helps to ensure reliabilit o# reporting$ and compliance with laws! The ultimate res onsibility #or a compan s s stem o# internal controls lies with the board of directors" &t should set procedures o# internal control and regularl monitor that the s stem operates as it should! Part o# setting up an internal control s stem will involve assessing the risks #acing the compan $ so that the s stem can be designed to ensure those risks are avoided! :nce the directors have set up a s stem o# internal control$ the are responsible #or reviewing it regularl $ to ensure that it still meets its ob,ectives! The board ma decide that in order to carr out their review #unction properl the have to emplo an internal audit #unction to carr out this task! /hen deciding whether an internal audit #unctions is re'uired$ directors will consider the e@tent of systems and controls$ and the relative e@ ense o# obtaining checks #rom other parties$ such as e%ternal auditors! &# the board does not see the need #or an internal audit #unction$ in the IK$ the combined code re'uires companies to consider the need #or one annuall $ so that the need for internal audit is regularly reviewed" The combined code also recommends that the board o# directors report on their review o# internal controls as part o# their annual report!

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The statement should be based on an annual assessment o# internal control which should con#irm that the board has considered all signi#icant aspects o# internal control! &n particular the assessment should cover: The changes since the last assessment in risks #aced$ and the compan s abilit to respond to changes in its business environment! The scope and 'ualit o# management7s monitoring o# risk and internal control$ and o# the work o# internal audit$ or consideration o# the need #or an internal audit i# the compan does not have one! The e%tent and #re'uenc o# reports to the board! *igni#icant controls$ #ailings and weaknesses which have or might have material impacts upon the accounts The e##ectiveness o# the public reporting processes!

1"* #udit committee


The Cadbur Report into corporate governance issues recommended that all listed com anies should have an audit committee" An audit committee is comprised o# non 1 e%ecutive directors and e%its to provide a 7bridge between the e%ecutive directors o# the compan and the e%ternal auditors! Audit committees have been success#ul in strengthening the auditors role 1"*"' Com osition and a ointment

The committee is appointed b the "oard o# Hirectors and should pre#erabl comprise o# at least three directors that have diverse$ complementar backgrounds and are independent o# management and the compan ! &n addition the chairman o# the audit committee must have leadership e%perience and a strong #inance$ accounting and ) or business background and not be the chairman o# the "oard o# Hirectors! All committee members shall be #inanciall literate$ or become #inanciall literate within a reasonable period o# time a#ter appointment! (urthermore$ at least one member shall have accounting and) or related #inancial management e%pertise as determined b the "oard o# Hirectors +embers o# the committee shall be considered independent so long as the do not have an relationship with the compan that ma inter#ere with the e%ercise o# independent ,udgment! This means the shall not accept an consulting$ advisor $ or other compensator #ee #rom the compan and are not an a##iliated person o# the compan or its related entities! 1"*"* 8eetings

The Audit Committee should ideall meet at least four times each year! The purpose o# these meetings is to: Review and approve e%ternal audit plans!

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Review and approve the hal# 1 ear #inancial report! Ipdate the e%ternal audit plans! Review and approve the annual #inancial report!

(urthermore$ the committee can meet as and when appropriate to discuss an other matters that warrant committee attention! 1"*"6ur ose of the #udit Committee

The purpose o# the audit committee is to provide assistance to the "oard o# Hirectors in #ul#illing its corporate governance and oversight responsibilities in relation to the compan s #inancial reporting$ internal control structure and e%ternal audit #unctions! &n doing so$ it is the responsibilit o# the committee to maintain #ree and open communication between the committee$ e%ternal auditors$ and management o# the compan ! &n discharging its oversight role$ the committee is empowered to investigate an matter brought to its attention with #ull access to all books$ records$ #acilities$ and personnel o# the compan and authorit to engage independent counsel and other advisers as it determines necessar to carr out its duties!

1"- Duties and res onsibilities of #udit Committee


The #ollowing are the responsibilities o# audit committees: 1"-"' 9inancial re orting The primar responsibilit o# the Audit Committee is to oversee the compan s #inancial reporting processes on behal# o# the "oard and report the results o# its activities to the "oard! The "oard o# Hirectors is responsible #or the compan s #inancial reports including the appropriateness o# the accounting policies and principles that are used b the compan ! The e%ternal auditors are responsible #or auditing the compan s #inancial reports and #or reviewing the compan s interim #inancial reports! The committee$ in carr ing out its responsibilities believes its policies and procedures should remain #le%ible$ in order to best react to changing conditions and circumstances! The committee will take appropriate actions to set the overall corporate 7tone #or 'ualit #inancial reporting! The other principal duties and responsibilities o# the Audit Committee regard:

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1"-"*

#ssessment of accounting, financial and internal controls

The committee discusses with management and the e%ternal auditors$ the ade'uac and e##ectiveness o# the accounting and #inancial controls! An opinion obtained #rom e%ternal auditors on the compan s choice o# accounting policies or methods should include an opinion on the appropriateness and not ,ust the acceptabilit o# that choice or method! The committee will meet periodicall with management and e%ternal auditors to discuss issues and concerns warranting committee attention$ including but not limited to their assessments o# the e##ectiveness o# internal controls and the process #or improvement! The committee shall provide su##icient opportunit #or the e%ternal auditors to meet privatel with the members o# the committee! The committee shall review with the e%ternal auditor an audit problems or di##iculties and managements response! The auditor shall receive regular reports #rom the e%ternal auditor on the critical policies and practices o# the compan $ and all alternative treatments o# #inancial in#ormation within accepted accounting principles that have been discussed with management! 1"-"# ointment of e@ternal auditors

The committee shall be directl responsible #or making recommendations to the "oard o# Hirectors on the appointment$ reappointment or replacement -sub,ect$ i# applicable$ to shareholder rati#ication.$ remuneration$ monitoring o# the e##ectiveness$ independence o# the e%ternal auditors$ including resolution o# disagreements between management and the e%ternal auditor regarding #inancial reporting! The committee shall pre3 approve all audit and non audit services provided b the e%ternal auditors and shall not engage the e%ternal auditors to per#orm an non 1 audit ) assurance services that ma impair or appear to impair the e%ternal auditors ,udgment or independence in respect o# the compan ! 1"-"0 #ssessment of the e@ternal audit

The committee$ at least on an annual basis$ shall obtain and review a report b the e%ternal auditors describing -or meet and discuss with them.: The audit #irms internal 'ualit control procedures An material issues raised b the most recent internal 'ualit control review o# the audit #irm$ or b an in'uir or investigation b governmental or pro#essional authorities$ within the preceding #ive ears$ and an steps taken to deal with an such issues All relationships between the e%ternal auditor and the compan to assess the auditors independence!

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&n addition$ the committee shall set clear hiring policies #or emplo ees or #ormer emplo ees o# the e%ternal auditor in order to prevent the impairment or perceived impairment o# the e%ternal auditors ,udgment or independence in respect o# the compan ! 1"-"1 Inde endence of the e@ternal auditors

The committee shall review and assess the independence o# the e%ternal auditor$ including but not limited to an relationship with the compan or an other entit that ma impair or appear to impair the e%ternal auditors ,udgment or independence in respect o# the compan ! (urthermore$ the committee shall dra#t an annual statement #or inclusion in the compan s annual report o# whether the committee is satis#ied the provision o# non3audit services is compatible with e%ternal auditor independence! 1"-"D $co e of the e@ternal audit

The committee shall discuss with the e%ternal auditors the overall scope o# the e%ternal audit$ including identi#ied risk areas and an additional agreed 1 upon procedures! The committee shall also review the e%ternal auditors compensation -#ees. to ensure that an e##ective$ comprehensive and complete audit can be conducted #or the agreed compensation level! 1"-"G Communication with sta!e holders

The committee shall review the hal# 1 ear #inancial report or the annual #inancial report prior to the #illing o# these reports with the Registrar o# companies The committee shall review and discuss all representation letters signed b management to ensure that the in#ormation provided is com lete and a ro riate! The committee shall establish procedures #or the receipt$ retention$ and treatment o# complaints received b the compan regarding accounting$ internal accounting controls$ or auditing matters$ and the con#idential$ anon mous submissions b emplo ees o# the compan o# concerns regarding 'uestionable accounting or auditing matters! 1"-"H Committee erformance

The committee shall per#orm an evaluation o# its per#ormance at least annuall to determine whether it is #unctioning e##ectivel b re#erence to current best practice!

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D"(

%enefits and drawbac!s of the #udit Committee

D"' %enefits
The Cabur committee summed up the benefits that an audit committee can bring to an organi9ation! These include the #ollowing: &mprove the 'ualit o# #inancial reporting$ b reviewing the #inancial reports on behal# o# the "oard! Create a climate o# discipline and control which will reduce the opportunit #or #raud Enable the non 1 e%ecutive directors to contribute an independent ,udgment and pla a positive role Help the #inance director$ b providing a #orum in which he can raise issues o# concern$ and which he can use to get things done which might otherwise be di##icult *trengthen the position o# the e%ternal$ b providing a channel o# communication and a #orum #or issues o# concern Provide a #ramework within which the e%ternal auditor can assert his independence in the event o# a dispute with management *trengthen the position o# the internal audit #unction$ b providing a greater degree o# independence #rom management -internal auditors will report to the audit committee.! &ncrease public con#idence in the credibilit and ob,ectivit o# #inancial statements

D"* Drawbac!s
The Cudbur Committee$ however$ warned that the e##ectiveness o# the audit committee ma be compromised i#: &t acts as a barrier between the e%ternal auditors and the main -e%ecutive. board The audit committee #alls under the in#luence o# the dominant board member &t is not able to attract non 1 e%ecutive directors who have su##icient understanding o# the auditors role There are considerable costs associated with running o# the audit committee!

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International $tandards on #uditing .I$#/ *1( Consideration of laws and regulations in the audit of financial statements

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G"'

Introduction

The purpose o# this &nternational *tandard on Auditing -&*A. is to establish *tandards and provide guidance on the auditors responsibilit to consider laws and regulations in an audit o# #inancial statements! The auditors ke re'uirements are set out in the &*A! I$# *1("* +hen designing and erforming audit rocedures and in evaluating and re orting the results thereof, the auditor should recogniEe that noncom liance by the entity with laws and regulations may materially affect the financial statements" The term <noncom liance= as used in this I$# refers to acts of omission or commission by the entity being audited, either intentional or unintentional, which are contrary to the revailing laws or regulations" $uch acts include transactions entered into by, or in the name of, the entity or on its behalf by its management or em loyees" 9or the ur ose of this I$#, noncom liance does not include ersonal misconduct .unrelated to the business activities of the entity/ by the entity5s management or em loyees" &aws and regulations vary from country to country" National accounting and auditing standards are therefore li!ely to be more s ecific as to the relevance of laws and regulations to an audit" This &*A applies to audits o# #inancial statements and does not appl to other engagements in which the auditor is speci#icall engaged to test and report separatel on compliance with speci#ic laws or regulations!

G"*

Res onsibility of 8anagement for the Com liance with &aws and Regulations

I$# *0("I It is management5s res onsibility to ensure that the entity5s o erations are conducted in accordance with laws and regulations" The res onsibility for the revention and detection of noncom liance rests with management" The following olicies and rocedures, among others, may assist management in discharging its res onsibilities for the revention and detection of noncom liance2 8onitoring legal requirements and ensuring that o erating rocedures are designed to meet these requirements" Instituting and o erating a ro riate internal control" Develo ing, ubliciEing and following a code of conduct"

1>D

:nsuring em loyees are ro erly trained and understand the code of conduct" 8onitoring com liance with the code of conduct and acting a ro riately to disci line em loyees who fail to com ly with it" :ngaging legal advisors to assist in monitoring legal requirements" 8aintaining a register of significant laws with which the entity has to com ly within its articular industry and a record of com laints"

&n larger entities$ these policies and procedures ma be supplemented b assigning appropriate responsibilities to the #ollowing: G"An internal audit #unction! An audit committee!

The #uditor5s Consideration of Com liance with &aws and Regulations

The auditor is not$ and cannot be held responsible #or preventing noncompliance! The #act that an annual audit is carried out ma $ however$ act as a deterrent! &n accordance with speci#ic statutor re'uirements$ the auditor ma be speci#icall re'uired to report as part o# the audit o# the #inancial statements whether the entit complies with certain provisions o# laws or regulations! &n these circumstances$ the auditor would plan to test #or compliance with these provisions o# the laws and regulations! I$# *1("'1 In order to lan the audit, the auditor should obtain a general understanding of the legal and regulatory framewor! a licable to the entity and the industry and how the entity is com lying with that framewor!" To obtain the general understanding of laws and regulations, the auditor would ordinarily2 Use the e@isting understanding of the entity5s industry, regulatory and other e@ternal factorsC Inquire of management concerning the entity5s olicies and rocedures regarding com liance with laws and regulationsC Inquire of management as to the laws or regulations that may be e@ ected to have a fundamental effect on the o erations of the entityC Discuss with management the olicies or rocedures ado ted for identifying, evaluating and accounting for litigation claims and assessmentsC and

11>

Discuss the legal and regulatory framewor! with auditors of subsidiaries in other countries .for e@am le, if the subsidiary is required to adhere to the securities regulations of the arent com any/"

I$# *1("'H #fter obtaining the general understanding, the auditor should erform further audit rocedures to hel identify instances of noncom liance with those laws and regulations where noncom liance should be considered when re aring financial statements, s ecifically2 .a/ Inquiring of management as to whether the entity is in com liance with such laws and regulationsC and .b/ Ins ecting corres ondence with the relevant licensing or regulatory authorities" I$# *1("'I 9urther, the auditor should obtain sufficient a ro riate audit evidence about com liance with those laws and regulations generally recogniEed by the auditor to have an effect on the determination of material amounts and disclosures in financial statements" The auditor should have a sufficient understanding of these laws and regulations in order to consider them when auditing the assertions related to the determination of the amounts to be recorded and the disclosures to be made" The auditor should be alert to the fact that audit rocedures a lied for the ur ose of forming an o inion on the financial statements may bring instances of ossible noncom liance with laws and regulations to the auditor5s attention" 9or e@am le, such audit rocedures include reading minutesC inquiring of the entity5s management and legal counsel concerning litigation, claims and assessmentsC and erforming substantive tests of details of classes of transactions, account balances, or disclosures" The auditor should obtain written re resentations that management has disclosed to the auditor all !nown actual or ossible noncom liance with laws and regulations whose effects should be considered when re aring financial statements" In the absence of audit evidence to the contrary, the auditor is entitled to assume that the entity is in com liance with these laws and regulations" G"-"' #udit 6rocedures when Noncom liance is Discovered

The Appendi% to this &*A sets out e%amples o# the t pe o# in#ormation that might come to the auditors attention that ma indicate noncompliance! These are reproduced here as #ollows: &nvestigation b government departments or pa ment o# #ines or penalties!

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Pa ments #or unspeci#ied services or loans to consultants$ related parties$ emplo ees or government emplo ees! *ales commissions or agents #ees that appear e%cessive in relation to those ordinaril paid b the entit or in its industr or to the services actuall received! Purchasing at prices signi#icantl above or below market price! Inusual pa ments in cash$ purchases in the #orm o# cashiers che'ues pa able to bearer or trans#ers to numbered bank accounts! Inusual transactions with companies registered in ta% havens! Pa ments #or goods or services made other than to the countr #rom which the goods or services originated! Pa ments without proper e%change control documentation! E%istence o# an in#ormation s stem$ which #ails whether b design or b accident$ to provide an ade'uate audit trail or su##icient evidence! Inauthori9ed transactions or improperl recorded transactions!

I$# *1("*D
+hen the auditor becomes aware of information concerning a ossible instance of noncom liance, the auditor should obtain an understanding of the nature of the act and the circumstances in which it has occurred, and sufficient other information to evaluate the ossible effect on the financial statements" +hen evaluating the ossible effect on the financial statements, the auditor considers2 The otential financial consequences, such as fines, enalties, damages, threat of e@ ro riation of assets, enforced discontinuation of o erations and litigation" +hether the otential financial consequences require disclosure" +hether the otential financial consequences are so serious as to call into question the true and fair view .fair resentation/ given by the financial statements"

I$# *1("*H
+hen the auditor believes there may be noncom liance, the auditor should document the findings and discuss them with management" Documentation of findings would include co ies of records and documents and ma!ing minutes of conversations, if a ro riate" If management does not rovide satisfactory information that it is in fact in com liance, the auditor would consult with the entity5s lawyer about the a lication of the laws and regulations to the circumstances and the ossible effects on the financial statements" +hen it is not considered a ro riate to consult with the 110

entity5s lawyer or when the auditor is not satisfied with the o inion, the auditor would consider consulting the auditor5s own lawyer as to whether a violation of a law or regulation is involved, the ossible legal consequences and what further action, if any, the auditor would ta!e" I$#*1("-(A-' +hen adequate information about the sus ected noncom liance cannot be obtained, the auditor should consider the effect of the lac! of sufficient a ro riate audit evidence on the auditor5s re ort" The auditor should consider the im lications of noncom liance in relation to other as ects of the audit, articularly the reliability of management re resentations" In this regard, the auditor reconsiders the ris! assessment and the validity of management re resentations, in case of noncom liance not detected by the entity5s internal controls or not included in management re resentations" The im lications of articular instances of noncom liance discovered by the auditor will de end on the relationshi of the er etration and concealment, if any, of the act to s ecific control activities and the level of management or em loyees involved"

G"0 Re orting of Noncom liance


?!6!1 To 8anagement

The auditor should$ as soon as practicable$ either communicate with those charged with governance$ or obtain audit evidence that the are appropriatel in#ormed$ regarding noncompliance that comes to the auditors attention! However$ the auditor need not do so #or matters that are clearl inconse'uential or trivial and ma reach agreement in advance on the nature o# such matters to be communicated! &# in the auditors ,udgment the noncompliance is believed to be intentional and material$ the auditor should communicate the #inding without dela ! &# the auditor suspects that members o# senior management$ including members o# the board o# directors$ are involved in noncompliance$ the auditor should report the matter to the ne%t higher level o# authorit at the entit $ i# it e%ists$ such as an audit committee or a supervisor board! /here no higher authorit e%ists$ or i# the auditor believes that the report ma not be acted upon or is unsure as to the person to whom to report$ the auditor would consider seeking legal advice!

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G"0"* To the Users of the #uditor5s Re ort on the 9inancial $tatements &# the auditor concludes that the noncompliance has a material e##ect on the #inancial statements$ and has not been properl re#lected in the #inancial statements$ the auditor should e%press a 'uali#ied or an adverse opinion! &# the auditor is precluded b the entit #rom obtaining su##icient appropriate audit evidence to evaluate whether noncompliance that ma be material to the #inancial statements$ has$ or is likel to have$ occurred$ the auditor should e%press a 'uali#ied opinion or a disclaimer o# opinion on the #inancial statements on the basis o# a limitation on the scope o# the audit! &# the auditor is unable to determine whether noncompliance has occurred because o# limitations imposed b the circumstances rather than b the entit $ the auditor should consider the e##ect on the auditors report! G"0"To Regulatory and :nforcement #uthorities

The auditors dut o# con#identialit would ordinaril preclude reporting noncompliance to a third part ! However$ in certain circumstances$ that dut o# con#identialit is overridden b statute$ law or b courts o# law -#or e%ample$ in some countries the auditor is re'uired to report noncompliance b #inancial institutions to the supervisor authorities.! The auditor ma need to seek legal advice in such circumstances$ giving due consideration to the auditors responsibilit to the public interest!

G"1

+ithdrawal from the :ngagement

The auditor ma conclude that withdrawal #rom the engagement is necessar when the entit does not take the remedial action that the auditor considers necessar in the circumstances$ even when the noncompliance is not material to the #inancial statements! (actors that would a##ect the auditors conclusion include the implications o# the involvement o# the highest authorit within the entit $ which ma a##ect the reliabilit o# management representations$ and the e##ects on the auditor o# continuing association with the entit ! &n reaching such a conclusion$ the auditor would ordinaril seek legal advice! #s stated in the Code of :thics for 6rofessional #ccountants issued by the International 9ederation of #ccountants, on recei t of an inquiry from the ro osed auditor, the e@isting auditor should advise whether there are any rofessional reasons why the ro osed auditor should not acce t the a ointment" The e%tent to which an e%isting auditor can discuss the a##airs o# a client with a proposed auditor will depend on whether the clients permission to do so has been obtained and)or the legal or ethical re'uirements that appl in each countr relating to such disclosure! &# there are an such reasons or other matters which need to be disclosed$ the e%isting auditor would$ taking account o# the legal and ethical constraints$ including where appropriate permission o# the client$ give details o# the in#ormation and discuss #reel

116

with the proposed auditor all matters relevant to the appointment! If ermission from the client to discuss its affairs with the ro osed auditor is denied by the client, that fact should be disclosed to the ro osed auditor"

G"D 8oney laundering


+one laundering is law is an increasingl important issue #or auditors to be aware o#! 8oney laundering is the process b which criminals attempt to conceal the true origin and ownership o# the proceeds o# their criminal activit $ allowing them control over the proceeds and$ ultimatel $ providing a legitimate cover #or their sources o# income! &n other words$ dirt mone is #used into the mone market to have it cleared! +one laundering is a particularl hot topic internationall ! The 9inancial #ction Tas! 9orce on 8oney &aundering .9#T9/, which is an intergovernmental bod $ has issued #ort recommendations to world governments to help combat mone laundering! (or the purposes o# paper 2!2$ there are three recommendations: The criminalisation o# mone laundering +easures to be taken b businesses to prevent mone laundering +easures relating to international co3operation

+an countries have now taken measures to criminali9e mone laundering and related issues! &n the IK$ there are various statutes relating to this issue$ making it illegal to: Possess$ deal with or conceal the proceeds o# an crime Attempting$ assisting or incitement to commit mone laundering (ailure o# an individual in the regulated sector to in#orm relevant parties o# a knowledge or suspicion o# mone laundering 4Ti ing off5 - this is making a disclosure which is likel to pre,udice an investigation into mone laundering.

5ou can see that the last two o# these o##ences ma impact on accountants in their ever da work as these would both appl to them! There also a number o# regulations applicable to business people set out in the +one Gaundering Regulations 0>>2 with which accountants must also compl ! G"D"' Im act on accountants

/e have seen above that accountants are directl a##ected b two o# the ke o##ences o# mone laundering! The have no legal right to report a suspicion o# mone laundering b a client! &n respect o# this issue the are not constrained b their pro#essional dut o# con#idence$ although such reports must be made in good #aith!

118

&# an accountant has reasonable grounds to believe that an o##ence is being committed or is about to be committed and he makes a report to the relevant authorities in good #aith$ he is protected b the law #rom having a civil action against him b the client! However$ i# he did not have reasonable grounds to make the report$ he ma be sued b the client #or breach o# con#identialit ! &n addition$ the accountant is entitled to carr out normal$ pro#essional recommendations about s stems and practices in relation to mone laundering without committing the o##ence o# tipping o##! He#ences to mone laundering include: Having made a report to the <ational criminal intelligence *ervice or to the +one Gaundering Reporting o##icer Having a reasonable e%cuse #or not making such a report when nit had been the intention to do so Ac'uiring or using propert in good #aith!

As businesses$ audit #irms come within the re'uirements o# the regulations! The re'uire s stems to be set up to prevent mone laundering in businesses such as: Appointing a +one Gaundering Reporting :##icer Indertaking Customer Hue Hiligence -CHH. Reporting suspicions o# mone laundering +aintaining speci#ic records Putting in place internal controls to ensure continued compliance with the legislation Training sta## in all these issues

(ailing to do these things is a criminal o##ence! &t is also a criminal o##ence to proceed with a transaction a#ter reporting it to the relevant authorit without obtaining permission to proceed$ or to continue with a business relationship that has been prohibited! G"D"* 6roblems for accountants

Ke problems #or accountants are: The clash with the dut o# con#identialit Carr ing out audit reporting re'uirements without tipping o## Responding to audit clearance letters when mone laundering suspicions e%ist

&t is likel that #urther ethical guidance is needed to clari# the auditors position with regard to con#identialit ! At the present time$ the auditor should not risk committing a mone laundering o##ence b not making a relevant report!

11;

&n terms o# reporting re'uirements$ the auditor is entitled to make normal pro#essional reports to management$ shareholders and those charged with governance! However$ i# the auditor has made a report concerning mone laundering$ this could clearl have a large impact on the #inancial statements i# the directors are #ound guilt and et the is barred #rom disclosing that report to the shareholders in his report$ or even resigning i# this would constitute tipping o##$ bearing in mind that the auditor is re'uired b law to make a statement o# circumstances! &n terms o# pro#essional clearance letters$ an e%iting auditor with suspicions o# mone laundering is best advised not to respond to 'uestions in a pro#essional clearance letter re#erring to their satis#action as to the identit o# an entit or individual or whether an report o# suspicion has been made! G"D"Jey issues in anti ) money laundering rogramme

The #ollowing are ke issues: G"D"0 /ritten policies and procedures Comprehensive coverage o# mone laundering regulation re'uirements An emphasis on timel resolution o# problems and suspicions arising Clear management support #or anti 1 mone laundering policies and procedures Education and training o# all members Regular review o# policies and procedures to ensure the are e##ective International issues

This is an international issue! &ncreasingl countries are supporting each other in terms o# investigations and e%traditions! The proceeds o# Crime Act 0>>0 makes issues that would be an o##ence in the IK i# the are carried out elsewhere in the world!

Cha ter roundu


&t is important that compan management deals #airl with the investment o# shareholders Auditors report on the truth and #airness o# #inancial statements onl $ in their statutor role! Gisted companies are re'uired to con#irm to the re'uirements o# the Combined Code! Audit committees are made up o# non3 e%ecutive directors and are perceived to increase con#idence in the #inancial reports! &nternal control is a ke part o# good corporate governance! Hirectors are responsible #or maintaining a s stem o# control that sa#eguard the compan s assets!

11?

Auditors must be aware o# aware o# law and regulations as part o# their planning and must be aware o# an statutor dut to report non3compliance b the compan ! +one laundering law is an increasingl important issue #or auditors to be aware o#!

>uestion
5ou have recentl been appointed as head o# the internal audit #unction #or a large Cambian listed compan that trades internationall $ having worked within its #inance #unction #or two ears period to our new appointment! 5our compan has also appointed a new chie# e%ecutive$ headhunted #rom a large I* corporation where she had held the post o# vice president$ #inance! Required2 As part o# the new chie# e%ecutives orientation programme$ ou have been asked to prepare a detailed report which provides ke in#ormation on the principles o# good corporate governance #or Cambian listed companies! 5ou should address the #ollowing in our report$ remembering that her background is in I* governance and procedures! a. b. c. The role and responsibilities o# the board o# directors! The role and responsibilities o# the audit committee! Hisclosure o# corporate governance arrangements!

Tutorial notes" 5ou need to know about the IKs Combined Code since it represents best practice in one o# the ma,or stock markets in the world! This 'uestion re'uires listing o# the main corporate governance re'uirements! To2 Chie# E%ecutive 9rom2 &nternal Auditor Date2 12 Nanuar 0>L; $ub3ect: Corporate governance The Combined Code was originall published in the IK in 1DBB to bring together the recommendations o# the Cudbur $ Freenbur and Humpel reports! &t was updated in 0>>2! The IK guidance in some wa s is less prescriptive than guidance in America and elsewhere$ being based more on companies disclosing reasons #or non3 compliance with the guidelines in the Code!

11B

.a/ Role and res onsibilities of the board All listed companies should be an e##ective board! The board must meet regularl and have certain matters reserved #or its decision such as mergers and ma,or asset ac'uisitions and disposals! The should present a balanced and understandable assessment o# the compan s position and prospects in the annual accounts and other reports such as interim reports and reports to regulators! The board should review the e##ectiveness o# the internal control annuall and report to shareholders that the have done so! The review should cover all controls including #inancial$ operational and compliance controls and risk management! As part o# their responsibilit #or ensuring that internal controls are e##ective$ the board should appoint an audit committee" .b/ Role and res onsibilities of the audit committee The audit committee should consist o# at least three independent non3 e%ecutive directors$ at least one o# whom has relevant and recent accounting e%perience! i/ Review of financial statements and systems The committee should review both the interim -i# published. and annual accounts! This should involve assessment o# the ,udgements made about the overall appearance and presentation o# the accounts$ and also an changes in accounting policies and practices$ ma,or ,udgemental areas and compliance with standards and legal re'uirement! As well as reviewing the accounts$ the committees review should cover the #inancial reporting and budgetar s stems! This involves considering per#ormance indicators and in#ormation s stems that allow monitoring o# the most signi#icant business and #inancial risks$ and the progress towards #inancial ob,ectives! ii/ &iaison with e@ternal auditors The audit committee will be responsible #or the appointment or removal o# the e%ternal auditors as well as #i%ing their remuneration! The should consider whether there are threats to the independence o# the e%ternal audit$ in

11D

particular whether the provision o# non3 audit services ma lead to a con#lict o# interest! The audit committee should also be in contact with e%ternal auditors during their audit! The committee should discuss the scope o# the e%ternal audit prior to the start o# the audit! The committee should also act as a #orum #or liaison between e%ternal auditors$ the internal auditors and the #inance director and help the e%ternal auditors to obtain the in#ormation the re'uire! &# problems arise during the audit$ the audit committee should be available #or consultation$ and see that the concerns raised b the e%ternal auditors are resolved! iii/ Review of internal audit The audit committee should review on an annual basis the work o# internal audit! The review should cover the #ollowing aspects iv/ *tandards including ob,ectivit $ technical knowledge and pro#essional standards *cope including how much emphasis is given to di##erent t pes o# review Resources Reporting arrangements /ork plan$ especiall review o# controls and coverage o# high risk areas Giaison with e%ternal auditors Results

Review of internal control The audit committee should monitor continuall the ade'uac o# internal control s stems$ #ocusing particularl on the control environment$ managements attitude towards controls and overall management controls! Committee members should check that there are s stems in place to promote compliance with legislation! The should review reports on the operation o# codes o# conduct and review violations! Each ear the committee should be responsible #or reviewing the compan s statement on internal controls prior to its approval b the board! The committee should also address the risks o# #raud$ ensuring emplo ees are aware o# risks= there are mechanisms in place #or sta## to report #raud$ and #raud to be investigated!

v/

Review of management

10>

The audit committee can pla an important part in the review o# risk recommended b the Turnbull report! This includes con#irming that there is a #ormal polic in place #or risk management and that the Polic is backed and regularl monitored b the board! The should also review the arrangements #or ensuring that managers and sta## are aware o# their responsibilities! The should also ensure that there are channels #or sta## to report improprieties! vi/ Investigations The committee will also be involved in implementing and reviewing the results o# one3 o## investigations! Audit committees should be given speci#ic authorit to investigate matters o# concern$ and in doing so have access to su##icient resources$ appropriate in#ormation and outside pro#essional help! c. Disclosure requirements i. The combined code re'uires the #ollowing general disclosures: A narrative statement o# how the applied the principles set out in the Combined Code$ providing e%planations$ which enable their shareholders to assess how the principles have been applied! ii. A statement as to whether or not the complied throughout the accounting period with the provisions set out in the Combined Code! Gisted companies that did not compl throughout the accounting period with all the provisions must speci# the provisions with which the did not compl $ and give reasons #or non3 compliance! The directors should e%plain their responsibilit #or preparing accounts! The should report that the business is a going concern$ with supporting assumptions and 'uali#ications as necessar !

In addition the following further statements are required2 i/ &n#ormation about the board of directors2 changes in the composition o# he board in the ear$ the identit o# the chairman$ chie# e%ecutive director and in#ormation about the independence o# the non3 e%ecutives$ #re'uenc o# attendance at board meetings$ how the boards per#ormance has been evaluated! "rie# report on the remuneration, audit and nomination committees covering terms o# re#erence$ composition and #re'uenc o# meetings

ii/

iii/ &n#ormation about relations with auditors including reasons #or change and steps taken to ensure auditor ob,ectivit and independence when non3 audit services have been provided

101

iv/ A statement that the directors have reviewed the effectiveness of internal controls, including ris! management, within the #ramework o# Turnbull guidelines! v/ A statement on relations and dialogue with shareholders

vi/ A statement that the compan is a going concern vii/ An o erating and financial review"

Now try question D from the e@am question ban! at the bac! of the manual

100

6#RT % P)*CESS

102

CHAPTER ? :Audit planning


TO6IC
Planning an audit o# #inancial statements +aterialit Risk Ising the work o# another auditor Considering the work o# internal auditors Feneral planning issues

Introduction:
Audit planning was undertaken in paper 0!6 and it is assumed that ou know how to plan an audit and how to dra#t a lanning memorandum! &n this chapter there#ore$ audit planning has been revised including general issues! The use o# work o# another auditor and considering the work o# internal auditors has also been included$ as some o# the issues need to be taken into account when planning an audit! However$ a lot of em hasis has been laced on ris!s associated with the audit assignment" Risk #actors are important in an audit undertaking and thus needs to be incorporated in audits carried out! The risk3based approach is normall taken! The #all into two categories namel : $ ecific assignment ris! .!nown as audit ris!/" %usiness ris! associated with the client, which may form art of inherent ris! and therefore im acts on the audit"

As a student$ ou are e%pected to develop the skill o# identi# ing risks in a client environment generall and the actual audit to be undertaken!

106

'"(

6lanning an audit of financial statements

Im ortant: Audit planning was cover in paper 0!6! &n this chapter$ audit planning must be seen in the conte%t o# identi# ing risk areas and considering the audit strateg to appl to the audit! As a student taking this paper$ ou should concentrate on the general issues in planning an assignment such as logistics, use of IT, time budgets, assignment ob3ectives and re orts required, reliminary materiality, financial statements com onents of audit ris!, and audit strategy" :ther issues ma include materiality, ris! assessments and current issues and develo ments! Though anal tical procedures are important in planning and as part o# substantive procedures$ we #eel this was covered ade'uatel in paper 0!6 advanced auditing! However$ anal tical procedures have been emphasi9ed in chapter D 7audit evaluation and review

'"'

#n overview of audit lanning"

&*A 2>> Planning states that the auditor should plan the audit work so that the audit engagement will be per#ormed in an e##ective manner! Ade'uate planning o# the audit work helps to ensure that appropriate attention is devoted to important areas o# the audit$ the potential problems are identi#ied and that the work is completed e%peditiousl ! Planning also assists in the proper assignment o# work to assistants and in coordination o# work done b other auditors and e%perts! '"'"' The Overall #udit $trategy

I$# -(("H The auditor should establish the overall audit strategy for the audit The &*A also states that the auditor should develop and document the overall audit strategy, setting out in general terms how the audit is to be carried out$ and the audit lan which details speci#ic procedures to be carried out to implement the strateg and complete the audit! Note2 The old standard on planning used the terms audit lan and audit rogramme$ which are now called the overall audit strategy and audit lan respectivel ! The establishment o# the overall audit strateg involves: -a. Hetermining the characteristics o# the engagement that de#ines its scope$ such as the #inancial reporting #ramework used$ industr 1speci#ic reporting re'uirements and the locations o# the components o# the entit ! -b. Ascertaining the reporting ob,ectives o# the engagement to plain the timing o# the audit and the nature o# the communications re'uired$ such as deadlines #or interim and #inal reporting$ and ke dates #or e%pected communications with management and those charged with governance! 108

-c. Considering the important #actors that will determine the #ocus o# the engagement teams e##orts$ which ma include determination o# materialit levels$ areas o# high risk o# material misstatements etc! I$# -(("'' Once the overall audit strategy has been established, the auditor is able to start develo ing a more detailed audit lan in order to address the various matters identified in the overall audit strategy" This also takes into account the need to achieve the audit ob,ectives through the e##icient use o# the auditors resources! '"'"* The #udit 6lan

I$# -(( states that the auditor should develo the audit lan for the audit in order to reduce audit ris! to an acce tably low level" The audit plan replaces the audit rogramme, which was a re'uirement in the old standard! This is a more detailed plan than the overall audit strateg -termed as the audit plan be#ore. and includes the nature$ timing and e%tent o# audit procedures to be per#ormed b engagement team members in order to obtain su##icient appropriate audit evidence to reduce audit risk to an acceptabl low level! :nce the audit plan has been documented$ it would serve as a record o# the proper planning and per#ormance o# the audit procedures! The audit manager or audit senior prior to the per#ormance o# #urther audit procedures should approve the audit plan! The audit plan was looked at in an earlier paper 0!6 The audit plan should include issues such as: A description o# the nature$ timing and e%tent o# planned risk assessment procedures su##icient to assess the risks o# material misstatement! This is dealt with in I$# -'1, <understanding the entity and its environment and assessing the ris!s of material misstatement=" A description o# the nature$ timing and e%tent o# planned #urther audit procedures at the assertion level #or each material class o# transactions$ account balances and disclosure as determined b I$# --( <the #uditor5s rocedures in Res onse to #ssessed ris!=

These two standards have been looked at below!

10;

I$# -(("'D Requires that the overall audit strategy and audit lan should be u dated and changed as necessary during the course of the audit" I$# -(("'H Requires that the auditor should lan the nature, timing and e@tent of direction and su ervision of engagement team members and review of their wor!" '"*

Documentation

The auditor should document the overall audit strateg and the audit plan$ including an signi#icant changes made during the audit! &n doing so$ the auditor does the #ollowing: Records the ke decisions considered necessar to properl plan the audit and to communicate signi#icant matters to the engagement team$ e!g! a planning memorandum that contains ke decisions regarding the overall scope$ timing and conduct o# the audit could be done! The planning memorandum is used has a communication tool to the audit sta## to be emplo ed on the audit! A planning memorandum is a document in which the auditor describes the planned strateg or approach #or the audit$ based on their #indings regarding the knowledge o# the business and risk and materialit assessment! &t has not been reproduced here! &t is assumed that ou learnt how to develop a planning memorandum and its contents in our paper 0!6 Auditing! However$ it could include headings such as: 3 3 3 3 3 3 3 3 Nob Time Table Changes since previous audit Planning decisions &nternal Audit department "rie#ing instructions *upervision and review (inancial ratios$ and Time budget

The audit plan su##icientl demonstrates the planned nature$ timing and e%tent o# risk assessment procedures$ #urther audit procedures at the assertion level #or each material class o# transaction$ account balance and disclosure in response to the assessed risks$ e!g! standards audit programs or completion check lists ma be used! Hocument signi#icant changes to the plan$ gives reasons #or the signi#icant changes and the auditors response to the events$ conditions or results o# audit procedures that resulted in such changes!

10?

&t is also import that communication is done with those charged with governance and management!

'"-

:@am les of 8atters the #uditor may consider in establishing the Overall #udit $trategy"

The &*A 2>> gives as part o# the appendi% e%amples o# matters the auditor ma consider in establishing the overall audit strateg ! These ma be considered as part o# the scope o# the audit engagement! The auditor should consider the #ollowing matters when establishing the scope o# the audit engagement: The #inancial reporting #ramework on which the #inancial in#ormation to be audited has been prepared$ including an need #or reconciliation to another #inancial reporting #ramework! &ndustr 3speci#ic reporting re'uirements such as reports mandated b industr regulations! The e%pected audit coverage$ including the number and locations o# components to be included! The nature o# the control relationships between a parent and its components that determine how the group is to be consolidated! The e%tent to which other auditors audit other components! The nature o# the business segments to be audited$ including the need #or speciali9ed knowledge The reporting currenc to be used$ including an need #or currenc translation #or the #inancial in#ormation audited! The need #or a statutor audit #or standalone #inancial statements in addition to an audit #or consolidation purposes! The availabilit o# the work o# internal auditors and the e%tent o# the auditors potential reliance on such work! The entit s use o# service organi9ations and how the auditor ma obtain evidence concerning the design or operation o# controls per#ormed b them!

'"0

Re orting Ob3ectives, Timing of the #udit and Communications Required"

The auditor ma consider the #ollowing matters when ascertaining the reporting ob,ectives o# the engagement$ the timing o# the audit and the nature o# communications re'uired! The entit s timetable #or reporting$ such as at interim and #inal stage! The organi9ation o# meeting with management and those charged with governance to discuss the nature$ e%tent and timing o# the audit work!

10B

The discussion with management and those charged with governance regarding the e%pected t pe and timing o# reports to be issued and other communications$ both written and oral$ including the auditors report$ management letters and communications to those charged with governance! The discussion with management regarding the e%pected communications on the status o# audit work through out the engagement and the e%pected deliverables resulting #rom the audit procedures! Communication with auditors o# components regarding the e%pected t pe and timing o# reports to be issued and other communications in connection with the audit o# components! The e%pected communication with the engagement team members$ nature and timing o# meetings and timing o# the review o# work per#ormed! An other e%pected communication!

'"1

Understanding the entity and its environment and assessing the ris! of material misstatement"

I$# -'1 The auditor should obtain an understanding of the entity and its environment, including its internal control, sufficient to identify and assess the ris!s of material misstatement of the financial statements whether due to fraud or error, and sufficient to design and erform further audit rocedures" The standard set out various methods b which the auditors ma obtain this understanding: &n'uiries o# management and others within the entit Anal tical procedures :bservation and inspection Audit team discussion o# the susceptibilit o# the #inancial statement material misstatement Prior period knowledge

&t is important that the auditor uses the above techni'ues and conduct discussions with management #or ever audit to be undertaken! The auditor ma use his prior period knowledge$ but must carr out procedures to ensure that there have been changes in the ear meaning that it is no longer valid! The &*A outline a number o# areas o# the entit and its environment that the auditor should gain an understanding o#! These are summari9ed here$ but more detail is given in the standards! <ature o# the entit &ndustr $ regulator and other e%ternal #actors 10D

:b,ectives$ strategies and relating business risks +easure and review o# the compan s per#ormance! &nternal control

The purpose o# obtaining the understanding is to assess the risks o# material misstatement in the #inancial statements #or the current audit! The &*A sa s that the auditor should identi# and assess the risks o# material misstatement at the #inancial statement level$ and the assertion level #or classes o# transactions$ account balances and disclosures! &t re'uires the auditor to take the #ollowing steps: *tep 1 Identify ris!s through the process o# obtaining an understanding o# the entit ! *tep 0 Relate the ris!s to what can go wrong at the assertion level *tep 2 Consider whether the risks are o# a magnitude that could result in a material misstatement! *teps 6consider the li!elihood o# the risks causing a material misstatement! *ome risks identi#ied ma be signi#icant risks that ma be indicated b the #actors below! &n this particular case$ the ma present special audit considerations: Risk o# #raud &ts relationship with recent developments The degree o# sub,ectivit in the #inancial in#ormation The #act that it is an unusual transaction &t is a signi#icant transaction with a related part The comple%it o# the transaction

Routine$ non comple% transactions are less likel to give rise to signi#icant risk than unusual transactions or comple% matters o# directors ,udgement because the later are likel to have more management intervention$ comple% accounting principles or calculations$ greater manual intervention or there is a lower opportunit #or control procedures to be #ollowed! /hen the auditor identi#ies a signi#icant risk$ i# he hasnt done so alread $ he should evaluate the design and implementation o# the entit s controls in that area!

:@am le2

12>

The audit team at Cebra Gtd a manu#acturing compan has been carr ing out procedures to obtain an understanding o# the entit ! &n'uiries in the inventor s stem have revealed that Cebra Gtd designs and produces household goods on order #or a number o# Cairo Road stores in Gusaka! Cebra Gtd also makes a number o# standard so#as$ which it sells$ to a number o# wholesalers at Kamwala *hopping Comple%! According to the terms o# the contract with the Cairo road stores$ no uncalled inventories designed #or them should be sold to wholesalers! Cebra at times produces 1>O more than ordered b Cairo road stores as a precaution to meet the re'uirements when the compan does their 'ualit control checks! This is in anticipation that certain stores will re,ect some o# the items supplied!

Comments2
(rom the in#ormation given above$ two important risks can be identi#ied! The risk o# having obsolescent inventories and that o# losing customers due to reduced production 'ualit standards o# the items produced! Gooking at the two risks and relating them to the level o# assertion$ the #ollowing can be deduced!

#nswer2
Inventories2 The production o# e%cess items as opposed to those ordered ma entail that in the absence o# a read market #or their sale$ and the ma become obsolete! This risk o# obsolete ma mean that the inventor as a whole in the #inancial statements will not be carried at an appropriate value! &nventor normall ma account #or up to 1>O o# the total value o# the balance sheet thus #orm a material balance! &# obsolete inventor is included$ the likelihood that inventor ma be materiall misstatement could be high! There#ore$ the #ollowing #actors ma contribute to the likelihood o# these risks causing a misstatement! The e%tent to which management reviews inventor levels and scrap items that are obsolete! (or instance how regular are the inventories reviewed in order to identi# problems such as slow moving4 /hether such items are identi#ied and scrapped at the inventor count /hether such items can be used in production or converted into saleable products at a reasonable value!

&osing customers"

121

Here the problem is the going concern ris!" :nce most o# the customers are lost$ especiall the reliable ones$ then the #uture o# the business ma be brick! The compan ma start #acing o erational roblems such as lower levels o# sales and insu##icient li'uidit thus impacting on the #inancial statements! "ecause o# not taking into account inventor that is obsolete$ the resulting problems could be that sales and debtors ma be overstated thus not carried at a correct value! This ma also result into a drastic #all in pro#its when obsolete inventories are #inall written o##! /hat needs to be done is to review the compan s controls over the recording o# sales and debtors and what debt collection procedures are in place! This can assist in the identi#ication o# the likel risks that ma a##ect the #inancial statements that could be material!

'"D

I$# --( The auditor5s rocedures in res onse to assessed ris!s

&*A 22> outlines the auditors procedures in response to assessed risks that ma assist in the reduction o# audit risk to an acceptabl low level! The auditor should determine overall responses to assessed risks at the #inancial statement level$ and should design and per#orm #urther audit procedures to respond to assessed risks at the assertion level! Overall res onses could include emphasi9ing to the audit team the need #or pro#essional skepticism$ assigning additional)alternative sta## to the audit$ using e%perts$ providing more supervision on the audit and incorporating more unpredictabilit into the audit! The evaluation o# the control environment that will have taken place as part o# the assessment o# the clients internal control s stems will help the auditor determine whether the are going to take a substantive approach -#ocusing mainl on substantive procedures. or a combined approach -tests o# control and substantive procedures.! &n accordance with this approach$ the auditor should then determine #urther audit procedures designed to answer the assessed risks! The auditor must carr out substantive procedures on material items! &n addition$ the auditor must carr out the #ollowing substantive procedures! Agreeing the #inancial statements to the underl ing accounting records! E%amining material ,ournal entries E%amining other ad,ustments made in preparing the #inancial statements!

'"G

#nalytical review rocedures

Anal tical procedures are normall carried out at all stages o# the audit$ #rom planning to #inal review! 5ou should have ade'uate done anal tical procedures at paper 0!6 Auditing! (or the purpose o# this paper$ anal tical procedures have been dealt with in chapter B as one o# the means o# obtaining audit evidence -substantive procedures.! The have also been addressed to a larger e%tent in chapter D$ Audit Evaluation and Review! &n this 120

particular chapter$ anal tical procedures are more to do with business risk approach$ to allow the auditor to understand the entit s business rather than to improve the #igures in the #inancial statements! I$# 1*("* ) states that the auditor should a ly analytical rocedures as ris! assessment rocedures to obtain an understanding of the entity and its environment and in the overall review at the end of the audit"

'"H

Documentation requirements

&*As 218 and 22> contain a number o# documentation re'uirements! The #ollowing matters should be documented! The discussion among the audit team concerning the susceptibilit o# the #inancial statements to material misstatements$ including and signi#icant decisions reached! Ke elements o# the understanding gained o# the entit including the elements o# the entit and its control speci#ied in the &*A as mandator $ the sources o# the in#ormation gained and the risk assessment procedures carried out! The identi#ied and assessed risks o# material misstatement *igni#icant risks identi#ied and related controls evaluated! The overall response to address the risks o# material misstatement! <ature$ e%tent and timing o# #urther audit procedures linked to the assessed risks at the assertion level! &# the auditors have relied on evidence about the e##ectiveness o# controls #rom previous audits$ conclusions about how this is appropriate!

'"I

Terms of engagement

&n practice$ the auditor and the new client will meet to negotiate the terms o# the audit agreement$ which the auditor will later clari# in the engagement letter! The #irst audit should not take place until the client has returned the engagement letter with an indication that he agrees to its terms! &t is important that certain issues are agreed upon in writing when an audit is accepted! This entails that both parties involved in the contract o# providing services #ull understand what the agreed services are! An misunderstanding could lead to a break down in the relationship and eventuall result in legal action being taken! I$# *'( ) $tates that the auditor and the client should agree on the terms of the engagement" (or recurring audits the auditor should consider whether circumstances re'uire the terms o# the engagement to be revised and whether there is a need to remind the client o# the e%isting terms o# the engagement!

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(or acceptance o# a change in engagements$ an auditor who$ be#ore the completion o# the engagement is re'uested to change the engagement to one$ which provides a lower level o# assurance$ should consider the appropriateness o# doing so! /here the terms o# engagement are changed$ the auditor and the client should agree on the new terms and the auditor should not agree to a change o# engagement where there is no reasonable ,usti#ication #or doing so! &# the auditor is unable to agree to a change o# the engagement and is not permitted to continue the original engagement$ the auditor should withdraw and consider whether there is an obligation$ either contractual or otherwise$ to report to other parties$ such as board o# directors or shareholders the circumstances necessitating the withdraw! #udit engagement letter &t is in the interest o# both client and auditor that the auditor sends an engagement letter$ pre#erabl be#ore the commencement o# the engagement$ to help in avoiding misunderstandings with respect to the engagement! The engagement letter document con#irms the auditors acceptance o# the appointment$ the ob,ective and scope o# the audit$ the e%tent o# the auditors responsibilities to the client and the #orm o# an reports! The auditor will outline the basis #or the audit agreement in his tender to provide services! However$ once he has accepted nomination$ it is vital that the basis o# his relationships is discussed with the new client and laid down in contractual #orm! The #ollowing matters should be clari#ied in the audit engagement: Responsibilities o# both parties Auditor is responsible #or reporting on the #inancial statements to members Hirectors have a statutor dut to maintain records and take responsibilit #or the #inancial statements Hirectors are responsible #or the detection and prevention o# #raud (ees The level o# #ees "illing and credit terms Potential increases Timing o# the audit The #ollowing principle contents are included in &*A 01>! The ob,ective o# the audit o# #inancial statements +anagement responsibilit #or the #inancial statements The applicable reporting #ramework The scope o# the audit$ including re#erence to applicable legislation$ regulations or pronouncement o# pro#essional bodies to which the auditor adheres

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The #orm o# an reports or other communications result o# the engagement The #act that because o# the test nature and other inherent limitations o# an audit$ together with the inherent limitations o# an accounting and internal control s stem$ there is an unavoidable risk that even some material misstatement ma remain undiscovered! Inrestricted access to what records$ documentation and other in#ormation re'uested in connection with the audit!

>uestion
*tandalone *olutions an audit #irm is about to undertake an audit o# #inancial statements o# a new client Tropical3to s Gtd$ a compan that manu#acture Tropicals and To s in Cambia #or the ear ended 21 Hecember 0>>8! The audit partner o# *tandalone solutions has written to ou in#orming ou that ou will be in3charge o# the audit! Additional in#ormation is that Tropical3to s Gtd has a turnover K0>$ >>>$>>> and a work #orce o# about 18>! The compan has 8 shops at Kamwala +arket Comple% and the other 8 are at Town Center +arket Comple%$ which operate as retail shops! However$ the also sell to other retail traders on wholesale! The senior partner has asked ou to draw up an outline audit lan #or the assignment when the client will be visited and the kind o# work that will be done or carried out during each visit! The e%pected deadline #or our audit report is 21 Nanuar 0>>;! Re'uired: To draw up an outline audit plan o# Tropical3to s Gtd #or the ear ended 21 Hecember 0>>8 and that our plan should include the #ollowing: -a. -b. -c. The appro%imate timing in the compan s ear o# each stage o# the audit o# this new client stating wh ou have selected that particular timing! The ob,ective o# each stage The kind o# work that will be carried out at each stage o# the audit!

roaching the answer

5ou must acknowledge that Tropical3to s is a new client and as such a lot more in#ormation is needed #or lanning purposes and audit" A number o# visits can be carried out and can be termed as initial, interim and final or first and final visits or as man visits as it ma be possible depending on the need to do so! The planning ma involve looking at the systems available in the compan and determining as to whether the are running accordingl ! This will determine the direction o# the #inal audit! 5ou also need to look at how the final audit would be carried out and outline the work that should be done!

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&# it is decided that an initial$ interim and #inal visits be carried out$ and then the answer can be #ormulated in the #ollowing manner!

#nswer
Initial visit -a. Timing2 *ince this is a new client$ the visit must take place as soon as possible a#ter the terms o# engagement have been agreed and accepted b the directors o# Tropical3 to s Gtd! -b. Ob3ective2 To build up detailed background knowledge o# a compan needed #or planning o# audit work at a later stage! -c. #udit wor!2 The #ollowing details can be obtained: The histor and development o# the compan The nature o# the commercial environment within which the compan operates$ in this case Tropical3to s in the manu#acturing o# tropicals and to s and its products are not complicated! The nature o# the compan products and manu#acturing processes The plan o# organi9ation within the compan The accounting and internal control s stems operating within the compan The accounting and other records o# the compan and how the are maintained!

A number o# data gathering techni'ues will be used such as interviewing$ observation$ reviewing clients s stems documentation$ in'uiries$ etc! This is an in#ormation gathering stage and no detailed testing o# internal controls would be done to con#irm the operations o# the s stems! /alk3through tests will be used! Interim visit2 -a. Timing: At this point$ we need to decide how man interim visits we can conduct! *ince it is a new compan $ two interim visits would be appropriate$ one towards the middle o# the ear$ sa +a )Nune and the other towards the ear3end! -b. Ob3ective: To carr out detailed tests on a clients accounting and internal control s stems in order to determine the reliance that could be placed on them! -c. #udit wor!2 Huring the initial visit and #rom the in#ormation gathered$ we should have alread done the documentation o# the clients s stem using narrative notes and #lowcharts! /e could also have assessed the strengths and weaknesses o# the s stems and determine the e%tent to which we wish to rel on them! &# the internal controls were said to be e##ective then selective tests can be per#ormed designed to establish compliance with the s stem! (urther tests can be carried out in order to establish the e%tent to which both tests o# control and substantive test can be done! The #ollowing conclusions can be mage:

12;

&# the controls are e##ective then we can onl carr out restricted substantive tests! &# the controls are ine##ective then we shall need to carr out more e%tensive substantive procedures! :nce this is done$ it is normal practice$ as appropriate$ to send management a letter identi# ing the weaknesses and making recommendations #or improvements!

9inal visit2 -a. Timing: This is the time the #inal audit is carried out ,ust a#ter the ear3end or it could be done on a continuous basis! This should be in line with the clients activities such as inventor count$ circulari9ation o# accounts receivables$ and preparation o# client schedules and #inali9ation o# accounts! -b. Ob3ective: To carr out the necessar substantive procedures b substantiating the accounting records and eventuall in the #inancial statements! This should enable us to decide as to whether we have obtained su##icient appropriate audit evidence to be able to draw reasonable conclusions so that the are in a position to e%press an opinion on the compan s #inancial statements! -c. #udit wor!2 The audit work to be carried out at the #inal visit would include the #ollowing: *"( Consideration and discussion with management o# known problem areas! Attendance at inventor count! Peri#ication o# assets and liabilities$ income and e%penditure (ollowing up interim audit work Carr ing out review o# post balance sheet events Anal tical procedures :btaining management representations Reviewing #inancial statements Hra#ting the audit report!

8ateriality .I$# -*(/

Im ortant2 8ateriality considerations are im ortant at lanning stage" #n item might be material due to its nature, value or im act on readers of the financial statements" I$# -*( states that the auditor should consider materiality and its relationshi with audit ris! when conducting an audit" 12?

Definition2 &n#ormation is material i# its omission or misstatement could in#luence the economic decision o# users taken on the basis o# the #inancial statements! +aterialit depends on the si9e o# the item or error ,udged in the particular circumstances o# its omission or misstatement! Thus materialit provides a threshold or cut3o## point rather than being a primar 'ualitative characteristic which in#ormation must have i# it has to be use#ul! The ob,ective o# an audit o# #inancial statements is to enable the auditor to e%press an opinion whether the #inancial statements are prepared in all material respect in accordance with an applicable #inancial reporting #ramework! The assessment o# what is material is a matter o# pro#essional ,udgement! +aterialit considerations are important at the planning stage! Assessment should be based on most recent and reliable #inancial in#ormation and will hold to determine an e##ective and e##icient audit approach! The audit should be able to decide 1 how man and what items to be e%amined= whether to use sampling techni'ues and what level o# error is likel to lead to a 'uali#ied audit opinion4 An item might be material due to its nature$ value or impact on readers o# the #inancial statements! &t is there#ore an e%pression o# relative signi#icance o# a particular matter in the conte%t o# #inancial statements as a whole! +aterialit should be considered b the auditor when: -a. Hetermining the nature$ timing and e%tent o# audit procedures$ and -b. Evaluate the e##ect o# misstatement! 8ateriality criteria" Nature How a particular item might b their nature a##ect the leaders$ e!g! transactions relating to directors remuneration or contracts with the compan ! +aterialit ma be e%pressed in terms o# percentage! *ome items would be signi#icant in the #inancial statement b virtue o# their si9e$ e!g! i# a compan had bought a piece o# land with a value which comprises three3'uarters o# the asset value o# the compan $ that would be material! Pro#it variations or understatement or overstatement b 8O or more would be material! Also K1>>$ >>> to a small compan ma not be material to a bigger compan ! *ome items ma have a signi#icant impact on #inancial statement$ e!g! a small activit that is proposed b the compan that turns a pro#it into a loss! The di##erence between a small pro#it and a small loss could be material to some

;alue

Im act

12B

leaders!

*"'

Rules on materiality"

Though materialit is ,udgemental and need to be assessed properl during audit assignments$ there are some generall accepted rules about materialit ! (or instance$ items relating to directors are generall material and percentage guidelines are o#ten given #or materialit ! This gives the auditor some sort o# benchmark against which to assess 'ualit o# auditing and there#ore assist in situations o# litigations and issues o# discipline! &t also provides a #ramework within which the auditor can base his thoughts on materialit !

*"*

6roblems with materiality

&t has been stated above that auditors use ,udgement and some prescriptive rules in order to determine materialit during the audit assignments! The problem is so much on prescriptive rules which posses signi#icant risk when applied to determine the benchmarks! (or instance= A signi#icant matter that #alls outside the boundaries o# the rules could be overlooked$ leading to a material misstatement in the #inancial statements! Thus all percentage calculations on assets and pro#its must be handled with care taking into account various issues that impact on the compan being audited! Pro#its are sub,ect to ta% and dividends and thus become ke #actors in the #inancial statements being audited! /here the pro#it motive but rather assets do not drive a compan $ then the #ocus on materialit should be based or applied on the assets! *imilarl $ those companies that are driven b costs$ materialit should be applied on them! Alwa s remember that the nature$ value and impact o# an item as much to do with the determination o# materialit and as such should guide the process! This #ollows the t pe o# business and anticipated users o# the #inancial statements! Alwa s ask oursel# as to whether the matter would reasonabl in#luence a reader!

-"(

Ris!

As an auditor$ it is important to appreciate the two t pes o# risks$ namel audit risk -assignment or engagement risk. and business risk! The auditor must assess the risk o# material misstatements arising in #inancial statements and carr out procedures in response to assessed risks!

-"'

#udit ris!

&s the risk that auditor ma give an inappropriate opinion on the #inancial statements! Audit risk has two components: risk o# material misstatement in #inancial statements$ i!e!

12D

inherent and control ris! and the risk o# the auditor not detecting the material misstatements in #inancial statements$ i!e! detection ris!" -"'"' Inherent ris!2

&s the susceptibilit o# an account balance or class o# transactions to material misstatements either individuall or when aggregated with misstatements in other balances or classes$ irrespective o# related internal controls! The auditors should obtain su##icient data and in#ormation or knowledge that is available to assist them makes pro#essional ,udgement and understanding o# the entit in order to assess inherent risk properl ! &n the absence o# this$ then inherent ris! will remain relatively high! &n order to assess inherent risk properl $ the #ollowing #actors should be looked at!

9actors affecting the client as a whole The integrit and attitude to Hominance b a single individual can cause problems risk o# directors and management

16>

-"'"*

Control ris!

&s the risk that a misstatement could occur in an account balance or class o# transactions= could be material either individuall or when aggregated with misstatements in either balances or classes$ and would not be prevented$ or detected and collected on a timel +anagement e%perience and knowledge Inusual pressure on management <ature o# business &ndustr #actors &n#ormation technolog Changes in management and 'ualit o# #inancial management Tight reporting deadlines$ market or #inancial e%pectations Potential problems include technological$ obsolescence or over3dependence on single product Competitive conditions$ regulator re'uirements$ technolog developments$ changes in customer demand Problems include lack o# supporting documentation$ concentration o# e%pertise in a #ew people$ potential #or unauthori9ed access

(actors a##ecting individual account balances or transactions (inancial statements Accounts$ which re'uire ad,ustment in previous period or accounts prone to re'uire high degree o# estimation! misstatement Comple% accounts Accounts which re'uire e%pert valuation or are sub,ect to current pro#essional discussion Assets at risk or being Cash$ inventor $ portable non 1current assets stolen Eualit o# accounting *trength o# individual departments s stems High volume transactions Accounting s stems ma have problems coping Inusual transactions Transactions #or large amounts$ with unusual names$ not selected promptl ! Transactions that do not go through the s stem$ that relates to speci#ic clients or processed b certain individuals *ta## *ta## changes or areas o# low morale! basis$ b the accounting and internal control s stems! This means that the client accounting and internal controls s stem ma #ail to detect material misstatement! Thus a preliminar assessment o# control risk at the planning stage o# the audit is re'uired to determine the level o# controls and substantive testing to be carried out! -"'"Detection ris!

&s the risk that an auditors substantive procedures will not detect a misstatement that e%ists in an account balance or class o# transactions that could be material$ individuall or

161

when aggregated with misstatements in other balances or classes! This is as a result o# the auditors inabilit to e%amine all the evidence! The auditors inherent and control risk assessments in#luence the nature$ timing and e%tent o# substantive procedures re'uired to reduce detection risk and thereb audit risk! (or audit purposes$ the auditor should consider whether an opinion could be given on an entit whose inherent risk is 'uite high and i# not what would be the best wa o# dealing with the issues!

-"*

%usiness ris!

This is the risk arising to companies as a result o# being in o erational! &t is inherent to the compan in its operations! &t is risks at all levels o# the business and ma be split into three categories: -a. -b. -c. 9inancial ris! 1 which arises #rom the #inancial activities or #inancial conse'uences o# an operation$ #or e%ample$ cash #low issues or overtrading! O erational ris!s 1 which arise with regard to operational$ e!g! the risk that a ma,or supplier will be lost and the compan will be unable to operate! Com liance ris! ? which arises #rom non3compliance with laws or regulations that surround the business! The compliance risk is attached to environmental issues$ #or e%ample environmental risk! Relationshi between business ris! and audit ris!

-"*"'

:n one hand$ the two risks are completel unrelated in that: "usiness risk arises in the operations o# the business! Audit risk is #ocused on the #inancial statements o# the business! Audit risk e%ists onl in relation to an opinion given b auditors! :n the other hand$ the two are strongl connected in that inherent and control risks though limited to risks pertaining to the #inancial statements$ in audit risk$ inherent risk ma also include business risk since business risk includes all risks #acing the business! Although audit risk is ver #inancial statement #ocused$ business risk does #orm part o# the inherent risk associated with the #inancial statements$ because i# the risks materilise$ the going concern basis o# the #inancial statements could be a##ected!

.ase study on E/.ommence and ris"s


Issues pertaining eGcommence are still ne! to most of t"e people especially students# It is a topical area t"at needs to be appreciated and be familiar !it" t"e issues arising for audit and assurance services to be provided# In any case !"at is needed is t"at you must

160

appreciate t"e business environment in !"ic" t"e company is operating and similar businesses# '"is may give you a !ider scope of being in a position to identify a number of risks !eaknesses and strengt"s and ot"er scenarios a company may be e)posed to !"en operating in an eGcommence type of environment# '"e scenario belo! may assist you appreciate risk in an eGcommence environment in relation to a number of issues#

'is" in an e/commence0
Bost 1ast is a company operating in t"e telecommunication industry and operates in :ab!e ;usaka and ;ivingstone to!ns# ,ue to a number of transportation problems t"e company "as been facing problems in terms of mail delivery and no! t"ey "ave decided to diversify t"eir business and start operating as a message transmitter company kno!n as 2ess0o ;td# '"is is in line !it" an enabling environment t"at "as been provided by a leading telecommunication company Ham 'el 0om# ;td# &"o "ave invested "eavily in telecommunication e(uipment !it" lo!er c"arges available# It is e)pected t"at by operating in t"is market over"ead costs !ill be reduce drastically as no delivery Ian and drivers !ill be needed or involved in t"e ne! business# -o!ever t"e company !ill be e)posed to ot"er significant ne! business risks# Issues o! Technological0 It must be appreciated t"at t"e ne! business of 2ess0o ;td re(uires t"e used of tec"nology issues and t"erefore raises a number of business risks# 2ess0o ;td need to ensure t"at it is capable of sustaining itself in t"is turbulent and comple) environment# '"e follo!ing issues may affect t"e company.

Loss o! e&isting customers 2ess0om ;td could lose a number of customers !"o may be unable to used computers to access t"e services offered by t"e company and some may not "ave access to internet facilities in t"eir locations# 2ess0om ;td need to carry out a researc" to determine for instance "o! many customers could cope !it" t"e ne! c"anges# '"is researc" may be e)pensive to t"e company t"us increasing over"eads in t"e s"ort run# .ost o! system upgrading 'ec"nology "as been c"anging fre(uently due to latest developments in t"e I' environment and as suc" 2ess0om !ould be re(uired to keep its tec"nology up to date for continued (uality service provision# '"e cost of upgrading its tec"nology bot" in terms of money and business interruptions could be substantial to t"e company#

162

1iruses 2ess0om staff may not "ave ade(uate kno!ledge in computers and as suc" computers may be susceptible to a number of viruses t"at may eit"er be posted t"roug" eGmails and could disrupt business# '"e system invested in may also not be up to standard# '"ese may affect customers t"us interrupting sales and loss of good!ill t"ereby impacting on t"e going concern status of 2ess0om ;td# .ustomers 0ustomers may be lost due to t"e c"ange in t"e business from p"ysical delivery of mails to onGline message transmission# '"is entails t"at t"ere !ill be no p"ysical contact !it" t"e customers# '"is could be a significant factor t"at may contribute to loss of business# '"e fact t"at messages !ill no! be transmitted onGline in itself entails t"e reduction of personal touc" !it" customers# 2ersonnel &it" t"e tec"nology t"at may be needed 2ess0om may re(uire (ualified and e)perienced staff !it" t"e e)pertise to "andle tec"nical issues in t"e I' environment# '"is kind of e)pertise may not be available and recruitment !ould be t"e only solution# '"is is an added cost and t"e business may face a number of interruptions in t"e process due to nonGavailability of skilled personnel leading to customer dissatisfaction#

.ompetition
'"e market t"at 2ess0om "as entered is !ider and it "as t"erefore e)posed itself to substantial competition !it" ot"er telecommunication service providers !"o are already establis"ed# '"is may need substantial investment in advertising to try and "ave a competitive edge# 0osts may increase substantially and no meaningful reduction in over"eads !ould be seen# #raud e&posure 0omputer fraud can come in main !ays suc" as "acking !eb site not secured credit card fraud# Ot"er !ould include fraud perpetuated by staff due to over reliance on computer e)pert personnel# ,ue to t"e convention of t"e systems audit risk may also be en"anced and auditors !ill need to consider t"is during t"e audit assignment# Legislation It is a re(uirement t"at any information given via t"e computer must be in line !it" t"e data protection act# It !ill t"erefore be vital t"at !"atever data is given is protected and t"at t"e company "as complied !it" la! pertaining to personal data# '"e !eb site needs to be secured ade(uately#

166

;egislation pertaining to eGcommence type on trading need to be embraced so t"at 2ess0om ;td can keep up !it" t"e developments in t"is area# Impact on audit ris" Inherent ris" '"e risks identified above could "ave a significant impact on t"e going concern .ontrol ris" '"e ne! operations !ill re(uire ne! systems especially computeri3ed systems# 3etection ris" OnGline transactions may increase detection risk and may re(uire t"e use of 0AA's # '"e fact t"at 2ess0om is in eGcommence type of business re(uires t"at auditors possess t"e e)pertise to audit eGcommence transaction# Analytical revie! procures may need to e)tremely ade(uately due to t"e fact t"at information or transactions in t"e t!o business may not be comparable# Sufficient appropriate audit evidence may not be obtained#

0"(

I$# D(( )Using the wor! of another auditor

7rou #ccounting and the holding com any auditors


&n3group accounting the group auditor has a dut to report on the truth and #airness o# group accounts! This means that the work o# the other auditors must be looked at in order to incorporate their opinion o# the other auditors in the group accounts! The planning should there#ore include issues arising #rom the work o# another auditor and determine to what e%tent the principal auditor can rel on their work!

0"'

Res onsibility of the rinci al auditors

As indicated above$ the dut o# the principal auditor is to report on the group accounts$ which includes the balances and transactions o# all the components o# the group! This means that even i# the #inancial statements o# the group include some amounts derived #rom accounts$ which have not been audited b the principal auditor$ the still take responsibilit #or the opinion! The #ollowing ke terms would assist in understanding this area o# audit! 6rinci al auditor 1 those with the responsibilit to report on the #inancial statements o# an entit when those #inancial statements include in#ormation o# one or more components audited b other auditors!

168

Other auditors 1 are auditors other than the principal auditors with the responsibilit #or reporting on the #inancial in#ormation o# a component included in the #inancial statement audited b the principal auditors! :ther auditors include a##iliated #irms$ correspondent #irms$ as well as unrelated auditors! Com onent 1 is a division$ branch$ subsidiar $ ,oint venture$ associated undertaking or other entit whose #inancial in#ormation is included in #inancial statement audited b the principal auditors!

0"*

Rights of rinci al auditors

The principal auditors have rights to re'uire #rom auditors o# subsidiaries the in#ormation and e%planation the re'uire$ and to re'uire the principal compan to obtain the necessar in#ormation and e%planations #rom subsidiaries! The principal auditors ma also have the rights: The rights to re'uire #rom the other auditors such in#ormation and e%planations as the ma reasonabl re'uire! The right to re'uire that the parent compan to take all reasonable steps to obtain reasonable in#ormation and e%planations #rom the subsidiar and this will include #oreign subsidiaries!

&t is important there#ore that the other auditors cooperate with the principal auditors!

0"-

I$# D(("* Using the wor! of another auditor

*tates that when the principal auditor uses the work o# another auditor$ the principal auditor should determine how the work o# the auditor would a##ect the audit!

0"0

#cce tance as rinci al auditor

I$# D(("D
The auditor should consider whether the auditor5s own artici ation is sufficient to be able to act as the rinci al auditor" In this conte@t, the I$# indicates that the rinci al auditor should consider the following2 The materiality of the ortion of the financial statements which they do not audit The degree of his !nowledge regarding the business of the com onents" The ris! of material misstatements in the financial statements of the com onents audited by other auditors"

16;

The erformance of additional rocedures as set out in the standard regarding the com onents audited by the other auditor resulting in the rinci al auditor having significant artici ation in such an audit"

1"(

I$# D'( Considering the wor! of internal auditors

The purpose o# &*A is to establish standards and provide guidance to e%ternal auditors in considering the work o# internal auditing! I$# D'("* The e@ternal auditor should consider the activities of internal auditing and their effect, if any, on e@ternal audit rocedures"

1"'

Understanding and reliminary assessment of internal auditing

I$# D'("I *tates that the e%ternal auditor should obtain a su##icient understanding o# internal audit activities to identi# and assess the risks o# material misstatement o# the #inancial statements and to design and per#orm #urther audit procedures! I$# D'("'' *tates that the e%ternal auditor should per#orm an assessment o# the internal audit #unction when internal auditing is relevant to the e%ternal auditors risk assessment! /hen obtaining an understanding and per#orming an assessment o# the internal audit #unction$ the important criteria are the #ollowing: OrganiEational status 1 consider the speci#ic status o# the internal audit in the entit ! /here does the internal audit report in the organi9ation4 Higher level reporting status would be appropriate! An constraints or restrictions placed on internal auditing b management would need to be care#ull considered! &n particular$ the internal auditors will need to be #ree to communicate #ull with the e%ternal auditors! $co e of function 1 the nature and e%tent o# internal auditing assignments per#ormed! Hoes management act on internal audit reports4 This should be a concern b the e%ternal auditor! Technical competence 1 whether internal auditing is per#ormed b persons having ade'uate technical training and pro#icienc as internal auditors! &n this case$ the e%ternal auditors ma review the policies #or hiring and training the internal audit sta## and their e%perience and pro#essional 'uali#ications! Hue pro#essional care 1 whether internal auditing is properl planned$ supervised$ reviewed and documented! The e%istence o# ade'uate audit manuals$ work programs and working papers would be considered!

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1"*

Timing of liaison and coordination

/hen planning to use the work o# internal auditing$ the e%ternal auditor need to consider the internal auditing tentative plan #or the period and discussed it at an earl stage as possible! /here internal auditing would be a #actor in the e%ternal auditors work$ then it is desirable to agree in advance the timing o# such work$ the e%tent o# audit coverage$ materialit levels and proposed methods o# sample selection$ documentation o# the work per#ormed and review and reporting procedures! Giaison could be done through meetings to be held at appropriate intervals$ access to internal audit reports and the e%ternal auditor also to advice the internal auditors on an signi#icant matters that ma a##ect internal auditing! I$# D'("'D $tates that when the e@ternal auditor intends to use s ecific wor! of internal auditing, the e@ternal auditor should evaluate and erform audit rocedures on that wor! to confirm its adequacy for the e@ternal auditor5s ur oses" The re'uires that the #ollowing be done as part o# evaluation: Persons having the technical training per#orm the work and pro#icienc as internal auditors and the work o# assistants is properl supervised$ reviewed and documented! *u##icient appropriate audit evidence is obtained to be able to draw reasonable conclusions Conclusions reached are appropriate in the circumstances and an reports prepared consistent with the results o# the work per#ormed$ and An e%ceptions or unusual matters disclosed b internal auditing are properl resolved!

D"(

7eneral lanning matters

As part o# the audit strateg $ the auditor carries out a number o# administrative issues that should make the audit success#ul! These ma include the #ollowing among others: logistics, the use of IT$ time budgets and subsidiary ob3ectives of the assignment" "elow we consider each one o# them!

D"'

&ogistics"

Gogistics ma include things such as sta##$ client management$ locations o# the audit and deadlines! D"'"' $taff Ho sta## have the correct level o# education and 'uali#ication4

16B

/hether sta## have been provided with ade'uate travel logistics /hether sta## have special skills to carr out the audit in 'uestion such as &T and language barriers Are the going to be available #or the audit assignment and at the particular time4 Relationship with other audit sta## and client sta##

However$ it should be important to note that sta## re'uirement ma di##er #rom on assignment to another and not all the above issues ma be applicable at an point in time! (or e%ample$ special skills ma be re'uired in planning and carr ing out an audit in an e3 commerce environment! The #ollowing skills ma be considered when carr ing out an audit in an e commerce environment! Inherent ris! evaluation 1 a degree o# specialist understanding o# the inherent nature o# the &T environment will be re'uired to understand the inherent risk arising #rom the business being involved in e3commerce! Control environment assessment 1 considerable knowledge o# the control environment will be ver critical in this case! Hetermining procedures 1 in an &T environment$ it is important that specialist knowledge is available in order to ascertain the t pe o# procedures to carr out and their timing! :valuating going concern 1 an understanding o# the &T environment will be re'uired in order to properl assess the impact o# that environment on the going concern assumption! D"'"* Client management This relates to the re'uirement o# the client in terms o# sta## to be emplo ed on an audit! The client would pre#er that the same audit sta##s be deplo ed on recurring assignments! This ma not be possible all the times but the partner doing the planning will tr and bear in mind the needs o# the client on such matter! Consistenc o# audit sta## ma help audit e##icienc in terms o# knowledge o# the business! D"'"&ocations

The person planning the audit should take into account the location o# the audit in terms o# distance #or audit sta## to travel$ mobilit and location o# audit review b manager or engagement partner! /here there are multiple locations$ consider in addition to the above which location to visit$ allocation o# sta## and liaising with client sta## to ensure each site visit is convenient! D"'"0 Deadlines

The audit team should know the deadlines o# the audits being carried out in order to carr out audits e##ectivel ! The #ollowing issues ma be considered: 16D

Hate o# inventor count Hate the #inancial statements are due to have been dra#ted b Hates o# main audit visits Hates o# manager review Hate o# engagement partner review Hate o# engagement partners post audit meeting with client management Hate on which the audit report is due to be signed! Hate o# AF+

D"*

Use of IT

Consider whether the client is operating in an &T environment and that the s stem is computeri9ed! &# so then consider the use o# Computer Assisted Audit Techni'ues -CAATs.! /hether the auditors will use computers to complete the working papers! &# so the should be e'uipped with laptops! Consider also some o# the speci#ic issues that could be done on the computer such as anal tical reviews!

D"-

Time budgets

Audits must be done in a cost e##ective manner thus time budgets determination are important #or an audit undertaking! The engagement partner must there#ore determine the time to be taken to carr out an audit #or the purpose o# calculating audit #ees! &t is important that time is estimated accuratel $ the audit team is aware o# the time budget and that all variations in time budget are recorded! Time budget will be based on prior ear time record$ risk assessment and materialit considerations! &# #or instance ou spent much time on inventor count last time and the situation as not changed et more time ma be allocated! /here again it will take more time to obtain audit evidence due to di##iculties in contacting sa $ third parties$ more time ma be allocated and where audit evidence is easil available$ less time ma be allocated!

Cha ter roundu


#uditor must lan their wor! so that it is underta!en in an effective manner and this includes determining the audit strategy and audit lan" 8ateriality considerations are im ortant at the lanning stage" #n item might be material due to its nature, value and im act on readers of financial statements" #uditors must assess the ris! of materiality misstatements arising in financial statements and carry out rocedures in res onse to assessed ris! %usiness ris! is the ris! arising to com anies through being in o eration" In lanning, it is im ortant to ta!e into account the wor! of internal auditors and using the wor! of another auditor" There are various administrative matters, which auditors must also consider as art of their overall audit strategy" 18>

Now try >G from the :@am >uestion %an! at the bac! of the manual

CF#6T:R H2 #UDIT :;ID:NC:

To ic Audit evidence Related parties +anagement representations Reliance on work o# others Hocumentation and working papers INTRODUCTION" 181

:ne o# the ma,or parts o# an audit is gathering audit evidence! &t is important that sufficient and a ro riate audit evidence is obtained in order to support the #inancial statements assertions! Audit evidence must also be su##icientl documented! Audit evidence can be obtained through a number o# methods and include: ins ections, inquiries, confirmation, deduction, analytical rocedures, observation, com utations and com uter audit tools" :thers ma include: Related arties$ which is a di##icult method due to its nature! However$ the auditor can also rel on management re resentations on related parties though sub,ective in nature$ thus the auditor need to be care#ul when such t pe o# evidence is being obtained! An auditor is not a person who can be said to be a 4!now it all5 but can rel on the work o# others such as e@ erts in areas where the ma not have the e%pertise! The relevant procedures that the auditor would take in obtaining audit evidence as indicated above have been outlined in this chapter!

'"(

#udit evidence .revision/

Audit evidence is the in#ormation obtained b the auditor in arriving at the conclusions on which the audit opinion is based! Audit evidence will comprise source documents and accounting records underl ing the #inancial statements and corroborative in#ormation #rom other sources! The basic 'uestion that ou need to ask oursel# about audit evidence is that: what is it that ou should do to support our audit opinion ade'uatel and avoid litigations$ loss o# business$ loss o# clients and o## course uphold our standing as an auditor4 #uditors need to obtain sufficient, a ro riate audit evidence"

'"'

Obtaining evidence

Audit evidence is a vital part o# an audit! Auditors must there#ore obtain evidence to support #inancial statements assertions and the evidence must be su##icient and reliable! This could be done through carr ing out substantive procedures designed #or the purpose! 9inancial statements assertions are the representations o# the directors that are embodied in the #inancial statements! " approving the #inancial statements$ the directors are making representations or assertions about the in#ormation therein! The are asserting that the individual items in the #inancial statements are correctl described$ show #igures$ which are mathematicall correct or #airl estimated$ and that the accounts as a whole show a true and #air view! These representations or assertions ma be described in general terms in a number o# wa s$ e!g! :@istence 1 an asset or liabilit e%ists at a given date Rights and obligations 1 an asset or liabilit pertains to the entit ! 180

Occurrence 1 a transaction or event took place$ which pertains to the entit at a given date! Com leteness 1 there are no unrecorded assets$ liabilities$ transactions or events$ or undisclosed items! ;aluation 1 an asset or liabilit is recorded at an appropriate carr ing value 8easurement 1 a transaction or event is recorded in the proper amount and revenue or e%penses are allocated to the proper period! 6resentation and Disclosure 1 an item is disclosed$ classi#ied and described in accordance with the applicable reporting #ramework -e!g! relevant legislation and applicable accounting standards.

'"*

6rocedures of obtaining evidence

Auditors can obtain audit evidence using one or more o# the #ollowing procedures!

6ROC:DUR:$ Ins ection of assets

The auditor must inspect the assets recorded in the accounting records to con#irm their e%istence$ provide evidence o# valuation but not to con#irm rights and obligations! Con#irming that the assets are recorded in accounting records gives evidence o# com leteness" Hocuments #or items recorded in the accounting records must be inspected in order to determine as to whether those items e%ist or a transaction occurred! Con#irming that the have been recorded is a test #or com leteness! /hen documents are inspected$ a number o# things can be veri#ied such as evidence o# items received a#ter the balance sheet date$ their valuation$ measurement$ rights and obligations$ presentation and disclosure and also con#irm authori9ation! 5ou can observe how a particular task is being per#ormed$ such as pa ment o# wages to workers$ post3opening etc! this is limited in itsel# because it re'uires the auditor to be present! 5ou can seek in#ormation #rom client sta## or outside the organi9ation! However the source and integrit o# the in#ormation matters! The auditor can write to banks or other sources to con#irm the authenticit o# account balances or custod o# certain items! Checking the arithmetic calculations o# #igures in accounting records$ e!g! adding up ledger #igures! This involves the use computer audit tools to check the authenticit o# data and in#ormation through the computer such as CAATs 182

Ins ection of documents

Observation :nquires Confirmation Com utation


#udit automation tools

#nalytical rocedures

This involves the anal sis o# signi#icant ratios and trends including the resulting investigation o# #luctuations and relationships that are inconsistent with other relevant in#ormation or deviate #rom predictable amounts! Risk areas can be identi#ied in this wa !

'"-

Com uter #ssisted #udit Techniques

/here the use o# CAATs is the onl wa to secure su##icient appropriate audit evidence about a client$ especiall those operating in an e3commerce and)or operating a paper3less o##ice$ a number o# tests ma be conducted which ma #all into three categories as indicated below! '"-"' #udit software

This is so#tware that can be used to per#orm checks on data stored in the computer and which cannot be done ph sicall b the auditor! The so#tware can be used to do the #ollowing: &nterrogation so#tware$ which accesses the clients data #iles Comparison programs$ which compare versions o# the program &nteractive so#tware #or interrogation o# on3line s stems! Resident code so#tware to review transactions$ as the are processed!

Although audit interrogation so#tware ma be used during man tests o# control and substantive procedures$ its use is particularl appropriate during substantive testing o# transactions and especiall balances! " using the so#tware the auditor ma scruitinise large volumes o# data and concentrate skilled manual resources on the investigation o# results$ rather than on the e%traction o# in#ormation and selection o# samples! +a,or considerations when deciding whether to use #ile interrogation so#tware are as #ollows: As a minimum auditors will re'uire a basic understanding o# data processing and the enterprises computer application$ together with a detailed knowledge o# the audit so#tware and the computer #iles to be used! Hepending on the comple%it o# the application$ the auditors ma need to have a sound appreciation o# s stems anal sis$ operating s stems and$ where program code is used! E%perience o# the programming language to be utili9ed! Auditors need to consider how eas it is to trans#er the clients data onto the auditor PC! The client ma lack #ull knowledge o# the computer s stem$ and hence ma not be able to e%plain #ull all the in#ormation it produces! Test data

'"-"*

186

Ising this tool$ the auditor tests the s stem to see whether it can process data in the wa that it should! *ome valid data is input so that the results can be compared with the alread calculated results! The other wa test data can be used is to check the controls in the computer that prevent the processing o# invalid data! This ma be in #orm o# codes #or non3e%isting customers or customer credit limits above those alread set! The non3 processing o# this t pe o# transaction entails that the controls are working! However$ test data has some problems in terms o# corruption o# data #iles which as to be corrected! Test data tests the operating s stem at a single point in time and onl control being run and those known b auditors are tested! '"-":mbedded audit facilities

This t pe o# CAATs consists o# audit modules that are incorporated into the computer element o# the enterprises accounting s stem! The &ntegrated Test (acilit -&T(. and the * stems Control and Review (ile -*CAR(. are some o# the common ones used! This is important in order to avoid cheating b the &T department that ma change the program o# processing during the duration o# the test in order to #acilitate the audit and give the correct results! The program used #or testing ma be changed with another version that ma be used to siphon o## the compan s #unds into his)her own bank account!

'"0 $ufficient and a

ro riate audit evidence

<$ufficiency= and <# ro riateness= are interrelated and appl to both tests o# control and substantive procedures! *u##icienc is the measure o# the quantity o# audit evidence! Appropriateness is the measure o# the 'ualit and reliabilit o# the audit evidence! Auditors normall look #or enough reliable audit evidence! This is evidence that is probable rather than what is de#inite$ meaning that audit evidence is rather persuasive than conclusive! The audit can onl give reasonable assurance that the #inancial statements are #ree #rom misstatement$ so not all sources o# evidence is e%amined! &*A 82> Audit sampling is based on the premise that auditors do not normall e%amine all the in#ormation available to them! &t would be impractical to do so and using audit sampling will produce valid conclusions! #udit sam ling

188

&*A on audit sampling is to establish standards and provide guidance on the use o# audit sampling and other means o# selecting items #or testing when designing audit procedures to gather audit evidence! I$# 1-( states that when designing audit rocedures, the auditor should determine a ro riate means for selecting items for testing so as to gather sufficient a ro riate audit evidence to meet the ob3ectives of the audit rocedures" This means that audit sampling is based on the premise that auditors do not normall e%amine all the in#ormation available to them! &t would be impractical to do so and using audit sampling will produce valid conclusions! "elow we look at some de#initions o# ke terms used in audit sampling: #udit sam ling 1 involves the application o# audit procedures to less than 1>>O o# items within a class o# transactions or account balance such that all sampling units have a chance o# selection! This will enable the auditor to obtain and evaluate audit evidence about some characteristic o# the items selected in order to #orm or assist in #orming a conclusion concerning the population! $am ling ris! 1 arises #rom the possibilit that the auditors conclusion$ based on a sample ma be di##erent #rom the conclusion reached i# the entire population were sub,ected to the same audit procedure! 6o ulation 1 is the entire set o# data #rom which a sample is selected and about which an auditor wishes to draw conclusions! $am ling units 1 are the individual items constituting a population! $tatistical sam ling 1 is an approach to sampling that involves random selection o# a sample$ and the use o# probabilit theor to evaluate sample results$ including measurement o# sampling risk! Those without these two characteristics #all into non3 statistical sampling! $tratification 1 is the process o# dividing a population into subpopulations$ each o# which is a group o# sampling units$ which have similar characteristics -o#ten monetar values.! :rror 1 means either control deviations$ when per#orming tests o# control$ or misstatements$ when per#orming tests o# detail or substantive procedures! :@ ected error 1 is the error that the auditor e%pects to be present in the population! Tolerable error 1 is the ma%imum error in the population that the auditor would be willing to accept!

18;

#nomalous error 1 means an error that arises #rom an isolated event that has not recurred other than on speci#icall identi#iable occasions and is there#ore not representative o# errors in the population! Non?sam ling ris! 1 arises #rom #actors that cause the auditor to reach an erroneous conclusion #or an reason not related to the si9e o# the sample! (or e%ample$ ordinaril the auditor #inds it necessar to rel on audit evidence that is persuasive rather than conclusive$ the auditor might use inappropriate audit procedures$ or the auditor might misinterpret audit evidence and #ail to recogni9e an error! I$# 1-("'H states that in obtaining audit evidence, the auditor should use rofessional 3udgement to assess the ris! of material misstatement .which includes inherent ris! and control ris!/ and design further audit rocedures to ensure this ris! is reduced to an acce tably low level" I$# 1-("** states that when designing audit rocedures, the auditor should determine a ro riate means of selecting items for testing" The means available to the auditor are: *electing all items -1>>O e%amination. *electing speci#ic items$ and Audit sampling

The standards also points out that some testing procedures do not involve sampling$ such as: Testing 1>>O o# items in a population Testing all items with a certain characteristic -#or e%ample$ over a certain value. as selection is not representative!

However it is important to note that the auditors ,udgment as to what is su##icient appropriate audit evidence is in#luenced b a number o# #actors! Risk assessment The nature o# the accounting and internal control s stems The materialit o# the item being e%amined The e%perience gained during previous audits The auditors knowledge o# the business and industr The results o# the audit procedures The source and reliabilit o# in#ormation available!

&# the auditors are unable to obtained su##icient appropriate audit evidence$ the auditors should consider the implications #or their report!

18?

>uestion2 The &*A 8>>!0 states that the auditor should obtain su##icient and appropriate audit evidence to be able to draw reasonable conclusion on which to base the audit opinion! &n line with the above standard$ discuss the e%tent to which the #ollowing sources o# audit evidence could be said to be su##icient and appropriate4 -a. -b. -c. -d. :ral representation b management in respect o# the completeness o# sales conducted on a cash basis! (lowcharts o# the accounting and control s stem prepared b a compan s internal audit department! 5ear3end debtors statements Ph sical inspection o# a non current assets held b a third part !

4it0 5ou must appreciate the !act that su!!iciency entails the 6uantity o! evidence obtained and appropriateness entails relevance and reliable. The solution can there!ore be bro"en do n into three sections namely relevance, reliability and then su!!iciency.

#nswer2
$ufficiency: As per standard$ the auditor needs to obtain su##icient$ relevant and reliable audit evidence to enable him give an audit opinion on the #inancial statements! However$ his ,udgement ma be in#luenced b #actors such as !nowledge of the business and the environment within which the entit operates= the ris! of misstatement and the degree o# persuasiveness! -a. The auditor needs to decide as to whether the representations regarding the completeness o# sales is su##icient and should consider the #ollowing: The nature o# the business and the inherent risk o# unrecorded cash sales The materialit o# the item considering that cash sales are a material #igure in this case! How persuasive is the audit evidence in light o# other audit evidence! An possible management bias The auditors e%perience o# the liabilit o# the management and sta## and the records! The #inancial position o# the enterprise

An perceived risk o# material misstatement o# sales ma invite additional work to be carried out b the auditor b carr ing out procedures pertaining to s stems and controls testing$ substantive testing and anal tical review!

18B

-b.

The auditor needs to ensure that #low charts prepared b internal auditors are su##icient to meet their e%pectations! This is in line with what is reliable audit evidence! Audit evidence generated b the auditor himsel# is more reliable than that generated b the client! The client prepared #low charts are not there#ore su##icient as a basis #or the auditors evaluation o# the s stem! The auditor needs to per#orm walk through tests b tracing a small number o# transactions through the s stem to determine as to whether the are working or not! However$ i# the auditor is satis#ied that the #low charting is accurate and can be relied on$ then there would be no need to prepare #lesh #low charts! Hebtors statements can onl provide su##icient$ relevant and reliable audit evidence i# acknowledgement has been received #rom the various debtors through the debtors circulari9ation! However$ additional evidence needs to be corrected b substantiating the sales$ returns and cash pa ments as part o# persuasive evidence! All these would depend on the assessed materialit and the risk o# misstatement! Care need to be taken when rel ing on con#irmation received #rom debtors as the could be coming #rom #ictitious entities that do not e%ist! This is an issue o# #raud! A ph sical inspection needs to be carried out to at the third parties premises or wherever it is held in order to authenticate the e%istence o# the asset! This is su##icient evidence in as #ar as e%istence is concerned! However$ more evidence would be needed to prove the ownership and valuation o# the asset as part o# the evidence re'uired! Hocuments such as title deed$ mortgage deeds etc need to be checked!

-c.

-d.

ro riate ) relevance

The relevance o# audit evidence ma as well mean the 'ualit o# the audit evidence obtained and should be considered in relation to the overall audit ob,ective o# #orming an opinion and reporting on the #inancial statements! Evidence to be obtained #rom the audit o# the balance sheet and pro#it and loss account items must be o# 'ualit to support management assertions and would be gather in order to check their completeness$ e%istence$ ownership$ valuation and disclosure in case o# balance sheet items and pro#it and loss account respectivel e%cept #or ownership #or P M G! -a. The representation b management in respect o# the completeness o# sales is relevant in determining the completeness o# cash sales in the pro#it and loss account! The relevance o# this will also be supported b the e##ectiveness o# the s stems operated b the entit and the controls over cash sales!

18D

-b.

(low charting done b the internal audit department would be relevant to the e%ternal auditor in the determination o# the e##ectiveness and e##icienc o# the accounting and internal control s stems though much depends on the reliance that the auditor ma place on! The auditor needs to ascertain as to whether the entit s s stem o# recording and processing transactions is not de#ective! However$ the e##ectiveness and e##icienc o# the s stem would make the e%ternal auditor to have more reliance on the controls and as a determinant to the level o# tests o# the balance sheet items to be carried out! Thus the auditors opinion as to whether the #igures in the #inancial statements are not misstated is not directl relevant! The ear3end debtors statement provides evidence as to whether the sales and debtors #igures are properl stated! Thus the auditor could make the #ollowing conclusions: The completeness o# the debtors$ as omissions #rom the sales ledger listing would be identi#ied b con#irmations to that listed! The e%istence o# the debtors recorded in the sales ledger The con#irmations o# the debtors at the ear3end through debtors circulari9ation and other corroborative evidence!

-c.

However$ care need to be take during circulari9ation so that con#ormation do not come #rom #ictitious debtors! -d. The ph sical inspection o# a non3current asset held b a third part provides evidence as to the e%istence o# the asset and to some e%tent the completeness o# the recording o# asset! The auditor can check that the asset in#act is also recorded in the third part register o# assets kept #or sa#ekeeping!

ro riate ) reliable

The reliabilit o# audit evidence can be assessed to some e%tent on the #ollowing presumptions: Hocumentar evidence is more reliable than oral evidence Evidence #rom outside the enterprise or independent sources such as a bank letter$ is more reliable than that secured solel #rom within the enterprise! Evidence originated b the auditor b such means as anal sis and ph sical inspection is more reliable than evidence obtained #rom others or b others -auditors alwa s sa 7show me not 7tell me. :riginal documents are more reliable than photocopies or #acsimiles!

1;>

Evidence #or a #igure in the accounts is usuall obtained #rom several sources! However$ cumulative e##ect o# several evidence sources$ which give a constant view$ is greater than that #rom a single source! Foing b the above guidance$ the oral representation b management would be regarded as relativel unreliable as the are oral and internal! There#ore in order to ,usti# the completeness o# cash sales$ and in the absence o# e%ternal or auditor generated evidence$ then additional evidence need to be obtained in #orm o# representation letter #rom management as part o# the documentar evidence! As indicated under relevance$ the e%tent to$ which the e%ternal auditor would rel on the #low charts$ would depend on the auditors overall assessment o# the internal audit department! The #actors to consider would include the independence$ the scope o# its work$ due pro#essional care that has been e%ercised$ pro#essional competence and level o# resource available #or internal audit department! The e%ternal auditor should document this assessment i# he has to make use o# the #low charts in the planning o# the audit and design o# tests! The ph sical inspection o# the non current asset held b a third part #or its e%istence is evidence originated b the auditor and would be considered as more reliable than that generated b others!

-a.

-b.

-c.

*"(

Related arties

Related parties consist o# companies trading with organi9ations or individuals other than at arms length! &*A 88> covers issues pertaining to these! Parties are considered to be related i# one part has the abilit to control the other part or e%ercise significant influence over the part in making #inancial and operating decisions! /hereas related part transactions are a trans#er o# resources or obligations between related parties$ regardless o# whether a price is charged! The standard addresses a number o# issues and has been summari9ed below:

I$# 11("*

1;1

The auditor should erform audit rocedures designed to obtain sufficient a ro riate audit evidence regarding the identification and disclosure by management of related arties and the effect of related arty transactions that are material to the financial statements" The auditors knowledge o# the client must be su##icient to identi# related part transactions #or the #ollowing reasons: The #inancial reporting #ramework ma re'uire disclosure in the #inancial statements o# certain related part relationships and transactions$ such as those re'uired b &A* 0 The e%istence o# related parties or related part transactions ma a##ect the #inancial statements! (or e%ample ta% liabilit and the ta% laws in various ,urisdictions$ which re'uire special consideration when related parties e%ist$ ma a##ect e%penses! The source o# audit evidence a##ects the auditors assessment o# its reliabilit ! A greater degree o# reliance ma be placed on audit evidence that is obtained #rom or created b unrelated third parties! A related part transaction ma be motivated b considerations other than ordinar business considerations$ #or e%ample pro#it sharing or even #raud!

*"'

Inherent difficulties of detection

An audit cannot be e%pected to detect all material related part transactions! The risk that undisclosed related part transactions would not be detected b the auditors is especiall high when: Related part transactions have taken place without charge! Related part transactions are not sel#3evident to the auditor Transactions are with a part that the auditors could not reasonabl be e%pected to know is a related part ! Active steps have been taken b management to conceal either the #ull terms o# a transaction$ or that a transaction is$ in substance$ with related part The corporate structure is comple%

I$# 11("+here there is any indication that such circumstances e@ist, the auditor should erform modified, e@tended or additional rocedures as are a ro riate in the circumstances"

*"*

Res onsibilities of management

1;0

Nust like #raud$ management is responsible #or identi#ication o# related part transactions! *uch transactions should be properl approved$ as the are #re'uentl not at arms length! +anagement is also responsible #or the disclosure o# related part transactions! I$# 11("IA'( The auditor should review information rovided by directors and management identifying related arty transactions and should be alert for other material related arty transactions" +hen obtaining an understanding of the accounting and internal control systems and ma!ing a reliminary assessment of control ris!, the auditor should consider the adequacy of control rocedures over the authoriEation and recording of related arty transactions"

*"-

#udit rocedures

The #ollowing audit procedures are given in the standard! En'uire o# management and the directors as to whether transactions have taken place with related parties that are re'uired to be disclosed b the disclosure re'uirements$ such as &A* 06 that are applicable to the entit ! Review prior ear working papers #or names o# known related parties! Review minutes o# meetings o# shareholders and directors and other relevant statutor records such as the register o# directors interests! Review accounting records #or large and unusual transactions or balances$ in particular transactions recogni9ed at or near the end o# the #inancial period Review con#irmations o# loans receivable and pa able and con#irmations #rom banks! *uch a review ma indicate the relationship$ i# an $ o# guarantors to the entit ! Review investment transactions$ #or e%ample purchase or sale o# an interest in a ,oint venture or other entit ! En'uire as to the names o# all pensions and other trusts established #or the bene#it o# emplo ees and the names o# their management and trustees! En'uire as to the a##iliation o# directors and o##icers with other entities Review the register o# interest in shares to determine the names o# principal shareholders En'uire o# the auditors currentl involved in the audit$ or predecessor auditors$ as to their knowledge o# additional related parties! Review the entit s ta% returns made under statute and other in#ormation supplied to regulator agencies #or evidence o# the e%istence o# related parties! Review invoices and correspondences #rom law ers #or indications o# the e%istence o# related parties or related part transactions!

I$# 11("'' 1;2

During the course of the audit, the auditor needs to be alert for transactions, which a ear unusual in the circumstances and may indicate the e@istence of reviously unidentified related arties" The &*A gives the #ollowing e%amples o# transactions to be alert o#: Those with abnormal terms o# trade$ such as unusual prices$ interest rates$ guarantees and pa ment terms! Transactions that appear to have no logical business reason #or their occurrence! Transactions in which substance di##ers #rom #orm Transactions processed or approved in a non3routine manner or b personnel who do not ordinaril deal with such transactions! Inusual transactions$ which are entered into shortl be#ore or a#ter the end o# the #inancial period! High volume or signi#icant transactions with certain customers or suppliers as compared with others Inrecorded transactions such as the receipt or provision o# management services at no charge!

I$# 11("'* Huring the course o# the audit$ the auditor carries out audit procedures$ which ma identi# the e%istence o# transactions with related parties! The #ollowing audit procedures are given in the standard: 6rocedures2 *"-"' The auditor should erform detailed tests o# transactions and balances! Review minutes o# meetings o# shareholders and those charged with governance! Review accounting records #or large or unusual transactions or balances$ pa ing particular attention to transactions recogni9ed at or near the end o# the reporting period! Review con#irmations o# loans receivable and pa able and con#irmations #rom banks! *uch a review ma indicate guarantor relationship and other related part transactions! Review investment transactions$ #or e%ample$ purchase or sale o# an e'uit interest in ,oint venture or other entit ! :@amining Identified Related 6arty Transactions and disclosures

I$# 11("'-

1;6

In e@amining the identified related arty transactions, the auditor should obtain sufficient a ro riate audit evidence as to whether these transactions have been ro erly recorded and disclosed" The standard e%plains that given the nature o# related part relationships$ audit evidence o# a related part transaction ma be limited$ #or e%ample$ regarding the e@istence of inventory held b a related part on consignment or an instruction #rom a parent compan to a subsidiar to record a royalty e@ ense! "ecause o# the limited availabilit o# appropriate audit evidence about such transactions$ the auditor should consider per#orming the #ollowing audit procedures: Con#irm the terms and amount o# the transaction with the related part ! Ins ect information in possession o# the related part ! Confirm or discuss in#ormation with persons associated with the transaction$ such as banks$ law ers$ guarantors and agents! Hiscuss the purpose o# the transaction with management or the directors

*"0

8anagement .Directors/ Re resentations

I$# 11("'1 The auditor should obtain a written re resentation from management concerning the com leteness of information rovided regarding the identification of related artiesC and the adequacy of related arty disclosures in the financial statements"

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#udit Conclusions and Re orting

I$# 11("'D If the auditor is unable to obtain sufficient a ro riate audit evidence concerning related arties and transactions with such arties or concludes that their disclosure in the financial statements is not adequate, the auditor should modify the auditor5s re ort a ro riately" Audit evidence must be documented su##icientl ! /orking papers are the tangible evidence o# all work done in support o# the audit opinion!

-"( 8anagement re resentations


+anagement representation ma be the onl suitable evidence available when knowledge o# the #acts is con#ined to management and the matter is principall one o# ,udgement or opinion! &*A 8B> establishes the standard and provides guidance on the use o# management representations as audit evidence$ the procedures to be applied in evaluating and

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documenting management representation and the actions to be taken i# management re#uses to provide appropriate representations! Re resentations The auditors receive man representations during the audit$ both unsolicited and in response to speci#ic 'uestions! *ome o# these representations ma be critical to obtaining su##icient appropriate audit evidence! Representations ma also be re'uired #or general matters$ e!g! #ull availabilit o# accounting records! These are all covered in &*A 8B> 1 +anagement representations! I$# 1H("* ) The auditor should obtain a management" ro riate re resentations from

#c!nowledgement by management of its res onsibility for the financial statements" I$# 1H("- ) The auditor should obtain audit evidence that management ac!nowledges its res onsibility for the fair resentation of the financial statements in accordance with the a licable financial re orting framewor!, and has a rove the financial statements" The auditors should receive a signed cop o# the #inancial statements$ which incorporate a relevant statement o# management responsibilit as acknowledgement! Alternativel $ the auditors ma obtain such evidence #rom: Relevant minutes o# meetings o# the directors or those charged with governance or :btain a rewritten representation #rom management!

Re resentations by management as audit evidence" The standard sa s that management representations cannot be a substitute #or other audit evidence that the auditor could reasonabl e%pect to be available! :ral representations should be con#irmed in writing and auditors should seek other evidence to corroborate statements made b management!

I$# 1H("0 ) The auditor should obtain written re resentations from management that2 .a/ .b/ It ac!nowledges its res onsibility for the design and im lementation of the internal control to revent and detect errorC and It believes the effects of those uncorrected financial statement misstatements aggregated by the auditor during the audit are immaterial both individually and in aggregate to the financial statements ta!en as a whole" # summary of such items should be included in or attached to the written re resentations"

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Huring the course o# an audit$ management makes man representations to the auditor$ either unsolicited or in response to speci#ic in'uiries! /hen such representations relate to matters$ which are material to the #inancial statements$ the auditor will need to: -a. -b. -c. *eek corroborative audit evidence #rom the sources inside or outside the entit Evaluate whether the representations made b management appear reasonable and are consistent with other audit evidence obtained including other representations! Consider whether the individuals making the representations can be e%pected to be well in#ormed on the particular matters!

There are instances where management representation ma be the onl audit evidence available: Knowledge o# the #acts is con#ined to management= #or e%ample$ the #acts are a matter o# management intention! The matter is principall one o# ,udgement or opinion$ #or e%ample$ the trading position o# a particular customer!

I$# 1H("I ) If other audit evidence contracts a re resentation by management, the auditor should investigate the circumstances and when necessary, reconsider the reliability of other re resentations made by management" /here such situations arise$ the auditor should make #urther in'uiries #rom management in order to authenticate the representation in case it was misunderstood or ma be the evidence was misinterpreted! &# the e%planation #rom management is insu##icient$ then #urther audit procedures ma be re'uired! Documentation of re resentations by management The &*A indicates that the auditor should include in audit working papers evidence o# managements representations in the #orm o# a summar o# oral discussions with management or written representations #rom management! A written representation is more reliable audit evidence than an oral representation and can take the #orm o#: A representation letter #rom management A letter #orm the auditor outlining the auditors understanding o# managements representation$ dul acknowledged and con#irmed b management or Relevant minutes o# meetings o# the board o# directors or similar bod or a signed cop o# #inancial statements!

%asic elements of a management re resentation letter

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The &*A indicates that when re'uesting a management representation letter$ the auditor would re'uest that= &t be addressed to the auditor Contain speci#ic in#ormation$ and "e appropriatel dated and signed

The management representation letter will usuall be dated on the da the #inancial statements are approved$ but i# there is an signi#icant dela between the representation letter and the date o# the auditors report$ then the auditors should consider the need to obtain #urther representation! The members o# management who have the primar responsibilit #or the entit usuall sign a management letter and its #inancial aspects -that is the senior e%ecutive o##ice and the senior #inancial o##icer. based on their knowledge and belie#! :@am le of a management re resentation letter An e%ample o# a management representation letter is provided in an appendi% to the &*A! &t is not a standard letter$ and representations will var #rom one period to the ne%t! Im ortant2 The most important points to remember about a letter o# representation are: The circumstances in which it can be used The auditors response i# the client #ails to agree to it!

5ou should also be able to dra#t appropriate representations i# asked! E&ample0 -Entit letterhead. -To Auditors. -Hate.

This representation letter is provided in connection with our audit o# the #inancial statements o# A"C Compan #or the ear ended Hecember 21$ 0>L1 #or the purpose o# e%pressing an opinion as to whether the #inancial statement gives a true and #air view o# -or presents #airl $ in all material respects. the #inancial position o# A"C Compan as o# Hecember 21$ 0>L1 and o# the results o# its operations and its cash #lows #or the ear then ended in accordance with -indicate relevant #inancial reporting #ramework. Q-&# re'uired add 7on behal# o# the board o# directors -or similar bod .R! /e acknowledge our responsibilit #or the #airness o# the #inancial statements in accordance with -indicate relevant #inancial reporting #ramework.

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/e con#irm$ to the best o# our knowledge and belie#$ the #ollowing representations: S&nclude here representations relevant to the entit ! *uch representations ma include the #ollowingT There have been no irregularities involving management or emplo ees who have a signi#icant role in the accounting and internal control s stems or that could have a material e##ect on the #inancial statements! /e have made available to ou all books o# accounts and supporting documentation and all minutes o# meetings o# shareholders and the board o# directors -namel those held on +arch 18$ 0>L1 and *eptember 2> 0>L1$ respectivel .! /e con#irm the completeness o# the in#ormation provided regarding the identi#ications o# related parties! The #inancial statements are #ree #rom material misstatements$ including omissions! The compan has complied with all aspects o# contractual agreements that could have a material e##ect on the #inancial statements in the event o# non3compliance! There has been no compliance with re'uirements o# regulator authorities that could have a material e##ect on the #inancial statements in the event o# non3compliance! The #ollowing have been properl recorded and when appropriate$ ade'uatel disclosed in the #inancial statements! The identit o#$ and balances and transactions with related parties! Gosses arising #rom sale and purchase commitments Agreements or options to bu back assets previousl sold Assets pledged as collateral /e have no plan or intentions that will alter the carr ing value or classi#ication o# assets and liabilities re#lected in the #inancial statements! /e have no plans to abandon lines o# products or other plans or intentions that will result in an e%cess or obsolete inventor $ and no inventor is stated at an amount in e%cess o# net reali9able value! The compan has satis#actor title to all assets and there are no liens or encumbrances on the compan s assets$ e%cept #or those that are disclosed in <ote % to the #inancial statements! /e have recorded or disclosed$ as appropriate$ all liabilities$ both actual and contingent$ and have disclosed in <ote L on the #inancial statements all guarantees that we have given to third parties! :ther than J Hescribed in <ote % to the #inancial statements$ there have been no events subse'uent to period and which re'uire ad,ustment o# or disclose in the #inancial statement or notes thereto! The J claim b L 9 Compan has been settled #or the total sum o# %%%$ which has been properl accrued in the #inancial statements! <o other claims in connection with litigation have been or are e%pected to be received!

-a. -b. -c. -d.

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There are no #ormal or in#ormal compensating balance arrangements with an o# our cash and investment accounts e%cept as disclosed in <ote % to the #inancial statements$ we have no other line o# credit arrangements! /e have properl recorded or disclosed in the #inancial statements the capital stock repurchase options and arrangements$ and capital stock reserved #or options$ warrants$ conversions and other re'uirements!

JJJJJJJJJJJJJJJ! -*enior E%ecutive :##icer. JJJJJJJJJJJJJJJJ! -*enior (inancial :##icer.

#ction if management refuses to rovide re resentation I$# 1H("'1 ) states if management refuses to rovide a re resentation that the auditor consider necessary, this constitutes a sco e limitation and the auditor should e@ ress a qualified o inion or a disclaimer of o inion" &n such circumstances$ the auditor should consider whether it is appropriate to rel on other representations made b management during the audit!

>uestion
+anagement representations are an important source o# audit evidence! This in#ormation can be obtained either orall $ in writing$ #ormall or in#ormall ! The #orm part o# the audit evidence and as such should be part o# the documentation and working papers #or that particular audit and part o# the total audit evidence! -a. -b. E%plain what management representations to the auditor are4 The auditor needs to discuss the contents o# the letter o# representation at an earl stage o# the audit in order to ,usti# its acceptance as audit evidence! E%plain wh this is important! /hat action the auditor should take i# he is not satis#ied with the representations made b management4

-d.

Fits2 '"is (uestion is more to do !it" audit evidence# As a student you must appreciate t"e re(uirement of t"e standard on t"e type of evidence needed to support t"e opinion of 1?>

t"e auditor# 1ocus your reasoning on sufficient and appropriate audit evidence arising from a letter of representation# '"us (a) re(uires a brief e)planation of management representation+ (b) is about t"e need to discuss t"e letter of representation and (c) re(uires you to state t"e action you can take in t"e event t"at t"e auditor is not "appy !it" t"e representation given#

#nswer2
-a. +anagement representations are normall contained in a letter o# representation$ which is signed b the appropriate directors or managers! Representations relate to matters$ which are material to the #inancial statements whose knowledge o# the #acts is con#ined to management or where the directors have used ,udgement or opinion in the preparation o# #inancial statements! A letter o# representation ma include representations on issues such as: The directors have decided to settle an emplo ees legal claim outside court and thus indicate that no #urther similar claims are e%pected to be paid! The compan has satis#actor title to all assets and there are no liens or encumbrances on the compan s assets e%cept #or those that are disclosed! All liabilities have been recorded and disclosed as appropriate including actual and contingent in a not to the #inancial statements!

+anagement representations there#ore #orm part o# the total audit evidence and part o# the auditors working papers! -b. Hiscussing management representations at an earl stage is an important act b the auditor because it #acilitates the planning process! &t makes the auditor to be aware o# the areas in which representations ma be re'uired! &t also acts as prior warning to management o# errors! +anagement ma also be aware o# the areas where representation ma be needed and reminds them o# their responsibilities in relation to such written con#irmations! At the time when representations have been given and accepted b the auditor$ the will have alread been discussed and agreed on! &# the discussions are le#t until the last stage o# the audit$ management ma ,usti# their action b indicating that the auditor could have raised the issues much earlier! Hiscussion held at the last stage ma ,eopardi9e the relationship that subsists between management and the auditors! +anagement would alwa s claim that the do not have su##icient time or opportunit to assemble appropriate corroborative evidence and thus ma avoid the issue o# representations! *uch ob,ections ma be made especiall where there are tight reporting deadlines in the case o# entities that are part o# the group! *o management ma become reluctant to compl with the auditors re'uests i# done at a late hour!

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-c. According to &*A 8B>!18$ i# management re#uses to provide written representation that the auditor considers necessar $ it ma constitute a limitation o# scope #or their report and the auditor should e%press a 'uali#ied opinion or a disclaimer o# opinion! (urther$ the auditor should consider whether it is appropriate to rel on other representations made b management during the audit!

0"(

Documentation and wor!ing a ers"

Hocumentation is an important undertaking b the auditor in the conte%t o# the audit o# #inancial statements! &t #orms part o# the audit evidence re'uired in &*A ! Hocumentation supports the #acts presented in the audit report and thus acts as a hedge against litigations! &*A 02> states that the auditor should document matters$ which are important in providing audit evidence to support the auditors opinion$ and evidence that the audit was carried out in accordance with &*As! Hocumentation means that the material -in the working papers. prepared b and #or$ or obtained and retained b the auditor in connection with the per#ormance o# the audit! /orking papers ma be in the #orm o# data stored on paper$ #ilm$ electronic media or other media! /orking papers assist in the planning and per#ormance o# the audit:3 &n the supervision and review o# working papers Record the audit evidence resulting #rom the audit work per#ormed to support the auditors opinion!

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9orms and Content of +or!ing 6a ers

I$# *-( states that 4the auditor should re are wor!ing a ers which are sufficiently com lete and detailed to rovide an overall understanding of the audit" The auditor is re'uired to record in the working papers in#ormation on planning the audit$ the nature$ timing and e%tent o# the audit procedures per#ormed and the results thereo#$ and the conclusions drawn #rom the audit evidence! The #ollowing reasons ,usti# wh working papers are important: The include the auditors reasoning on all signi#icant matters$ which re'uire the e%ercise o# ,udgment! &ncludes auditors conclusions on various audit activities The record all relevant #acts known b the auditor!

However$ the e%tent o# working papers is a matter o# pro#essional ,udgement due to the #act that not all matters that the auditor comes across can be recorded! /hat is more

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important is that$ the wa the working papers have been documented should make the other auditor with no previous e%perience to make sense out o# them! At least the work per#ormed and the basis o# the principle decisions taken ma be understood but not the detailed aspects o# the audit! This ma need a thorough discussion with the auditors who per#ormed the audit! The #orm and content o# working papers are a##ected b matters such as the #ollowing: <ature o# the assignment (orm o# the auditors report <ature$ si9e and comple%it o# the business <ature and comple%it o# the entit s internal control <eeds in the particular circumstances #or direction$ supervision and review o# work per#ormed b assistants *peci#ic audit methodolog and technolog used in the course o# the audit! /orking papers should be designed and organi9ed in such a wa that the meet the circumstances and the auditors needs #or each individual audited! The use o# standardi9ed working papers such as checklists$ specimen letters$ standard organi9ation o# working papers ma improve the e##icienc with which such working papers are prepared and reserved! The #acilitate delegation o# work while providing a means to control its 'ualit ! The auditor also needs to be care#ul or satis# himsel# with the documentation prepared b the client! This ma improve audit e##icienc ! /orking papers ma be in two #orms: Current audit #ile to include all in#ormation currentl being generated and the Permanent audit #iles$ which ma have in#ormation permanent in nature especiall #or recurring audits!

0"* Confidentiality, $afe Custody, Retention and Ownershi of +or!ing 6a ers"


&*A 02> re'uires that the auditor should adopt appropriate procedures #or maintaining the con#identialit and sa#e custod o# the working papers and #or retaining them #or a period su##icient to meet the needs o# the practice and in accordance with legal and pro#essional re'uirements o# record retention! However$ the working papers are a propert o# the auditor! "elow is a list o# issues that ma be included in the working papers: &n#ormation obtained in understanding the entit and its environment$ including its internal control$ such as the #ollowing: 1?2

o &n#ormation concerning the legal and organi9ational structure o# the entit o E%tracts or copies o# important legal document$ agreements and minutes o &n#ormation concerning the industr $ economic environment and legislative environment within which the entit operates! o E%tracts #rom the entit s internal control manual! Evidence o# the planning process including audit programs and an changes thereto! Evidence o# the auditors consideration o# the work o# internal auditing and conclusions reached! Anal sis o# transactions and balances The identi#ied and assessed risks o# material misstatements at the #inancial statement and the assertion level! A record o# the nature$ timing and e%tent o# audit procedures per#ormed in response to risks at the assertion level and the results o# such procedures! Evidence that per#ormed b assistants was supervised and reviewed! An indication as to who per#ormed the audit procedures and when the were per#ormed! Hetails o# audit procedures applied regarding components whose #inancial statements are audited b another auditor! Copies o# communications with other auditors$ e%perts and other third parties Copies o# letters or notes concerning audit matters communicated to or discussed with management or those charged with governance$ including the terms o# the engagement and material weaknesses in internal control! Getters o# representation received #rom the entit ! Conclusion reached b the auditor concerning signi#icant aspects o# the audit$ including how e%ceptions and unusual matters$ i# an $ disclosed b the auditors procedures were resolved or treated! Copies o# the #inancial statements and auditors report!

>uestion2
The o##ice o# the Auditor Feneral is carr ing out an audit o# the Constitution Review Commission a#ter it concluded its work #or the ear ended 21 Hecember 0>>8! +ost o# its activities pertain to purchase o# goods and services$ mostl allowances given to the Commissioners! 5ou are the senior auditor responsible #or the audit o# the Commission #or the ear ended 21 Hecember 0>>8 together with an assistant auditor to assist ou carr an audit! E%plain wh it is necessar #or an auditor to prepare working papers4

#nswer2

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/orking papers are necessar #or the #ollowing reasons: (acilitates the review o# work b the audit manager or team leader and give assurance that the work that was delegated was properl per#ormed! The can be used #or #uture re#erence$ detailed problems encountered$ evidence o# work done and conclusions drawn there#rom in arriving at the audit opinion! That the audit was properl planned$ e%ecuted$ opinion reached in accordance with the work and documentation available! The are able to di##erentiate in#ormation that is current and permanent To provide evidence that auditing standards were #ollowed and other rules and regulations pertaining to that particular audit! The provide evidence about the accounting and internal control s stem o# the client!

>uestion
5ou are an audit senior responsible #or understanding the entit and its environment and assessing the risk o# material misstatements #or the audit o# +usonda #or the ear ending 21 Hecember 0>>;! +usonda is a compan listed on a stock e%change! +usonda is engaged in the wholesale import$ manu#acture and distribution o# basic cosmetics and toiletries #or sale to a wide range o# stores$ under a variet o# di##erent brand names! 5ou have worked on the audit o# this client #or several ears as an audit ,unior! 5ou are now nearing the completion o# the audit o# +usonda #or the ear ending 21 Hecember 0>>6! Hra#t #inancial statements have been produced! 5ou have been given the responsibilit o# per#orming a review o# the audit #iles be#ore the are passed to the audit manager and the audit partner #or their review! 5ou have been asked to concentrate on the proper completion o# the audit working papers! *ome o# the audit working papers have been produced electronicall but all o# them have been printed out #or ou! Required Hescribe the t pes o# audit working papers ou should e%pect to see in the audit #iles and the #eatures o# those working papers that show that the have been properl completed!

#nswer
T pes and #eatures o# audit working papers i/ Ty es of audit wor!ing a ers include2 1! * stems documentation -#lowcharts$ s stems manuals$ narrative notes$ checklists and 'uestionnaires$ etc!.= 0! Constitutional documents=

1?8

2! 6! 8! ;! ?! B! D!

Agreements with banks and other providers o# #inance= Hetails o# other advisors used b the entit such as law ers= Regulator documentation relating to the stock e%change listing= Audit planning documentation= Audit work programs= /orking papers showing the work per#ormed= Gead schedules showing summaries o# work per#ormed and conclusions on individual account areas and the amounts to be included in the #inancial statements= 1>! Trial balances$ management accounts and #inancial statements= 11! *tandard working papers relating to the calculation o# sample si9es$ #or e%ample= 10! *chedules o# unad,usted di##erences= 12! *chedules o# review points= 16! Getters o# weakness and management representation letters! ii/ 9eatures of audit wor!ing a ers2 1! All working papers -without e%ception. should show b whom the were prepared and when$ and when the were reviewed and)or updated$ and b whom$ b means o# signatures and dates 1 these ma be electronic in the case o# electronic working papers= 0! Audit planning documentation should include the risk assessment which should be cross re#erenced to the audit program$ and the audit program should be cross re#erenced to the audit working papers and vice versa= 2! /orking papers showing the work per#ormed should be cross re#erenced to the audit program and the lead schedule on that particular section o# the audit #ile$ and should describe the nature o# the work per#ormed$ the evidence obtained$ and the conclusions reached= 6! Each section o# the audit #ile should have a lead schedule which should be cross re#erenced back to the relevant working papers= 8! Trial balances should be cross re#erenced back to the relevant section o# the audit #ile$ and cross re#erenced #orward to the #inancial statements= ;! The #inancial statements should be cross re#erenced to the trial balance= ?! *chedules o# unad,usted di##erences should be cross re#erenced to the sections o# the #ile to which the relate= B! *chedules o# review points should all be 7cleared to show that all outstanding matters have been dealt with! Disadvantages There are costs in terms o# sta## time and$ again$ a certain level o# resentment among sta## who ma #eel that the are being 7spied on$ or that the are no longer trusted! Training would also be re'uired and additional administrative work would need to be undertaken b local managers!

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Reliance on wor! of others

&*A ;0> 1 Ising the work o# an e%pert provides guidance on using the work o# an e%pert as audit evidence!

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Determining the need to use the wor! of an e@ ert

The standard states, <+hen using the wor! erformed by an e@ ert, the auditor should obtain sufficient a ro riate audit evidence that such wor! is adequate for the ur ose of the audit=" Though the auditor ma have the general education and e%perience in business matters$ he ma lack certain knowledge such as an actuar or engineer! The &*A ;0> gives e%amples o# the audit evidence that should be obtained in #orm o# reports$ opinion$ valuations and statements o# an e%pert! ;aluation of certain ty es of assets$ e!g! land and buildings$ plant and machiner $ works o# art and precious stones! Heterminations o# quantities and hysical conditions o# assets$ e!g! minerals stored in stockpiles$ underground mineral and petroleum reserves$ the remaining use#ul li#e o# plant and machiner ! Hetermination o# amounts using s ecialiEed techniques or methods$ e!g! actuarial valuation or pension accounts! The measurement o# work completed and to be completed on contracts in progress! &egal o inions$ e!g! interpretations o# agreements$ statutes and regulations!

/hen determining the need to use the work o# an e%pert$ the auditor should consider the #ollowing: The knowledge and previous e%perience o# the e%pert on the matters being considered The risk o# material misstatements based on the nature$ comple%it o# the matter! The 'uantit and 'ualit o# other audit evidence e%pected to be obtained!

&ssues pertaining to the engagement o# an e%pert should be discussed with management! Inless management is not willing to do so$ then the auditors should consider engaging an e%pert themselves! This could also be avoided where there is alternative su##icient audit evidence could be obtained!

Com etence and ob3ectivity of the e@ ert

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I$# D*("HAI when lanning to use the wor! of an e@ ert, the auditor should evaluate the rofessional com etence of the e@ ert" This involves considering the e@ ert5s Pro#essional certi#ication$ or licensing b $ or membership in an appropriate pro#essional bod E%perience and reputation in the #ield in which the auditor is seeking audit evidence

However$ the impairment o# the e%perts ob,ectivit ma increase in the #ollowing manner! The e%pert is emplo ed b the entit The e%pert is related in a wa to the entit $ especiall where the e%pert is #inanciall depended upon or having an investment in the entit !

/here the auditors have some reservations about the e%pert$ the ma discuss with management and consider whether su##icient appropriate audit evidence can be obtained concerning the work o# an e%pert! Additional procedures ma also be undertaking to seek #urther evidence #rom another e%pert!

The e@ ert5s sco e of wor!


I$# D*("'' The auditor should obtain sufficient a ro riate audit evidence that the sco e of the e@ ert5s wor! is adequate for the ur oses of the audit" This evidence ma be obtained through a review o# the Terms o# Re#erence on which the e%pert was engaged and ma cover matter such as: The ob,ectives and scope o# the e%perts work A general outline as to the speci#ic matters the e%perts report is to cover The intended use o# the e%perts work The e%tent o# the e%perts access to appropriate records and #iles Clari#ication o# the e%perts relationship with the entit $ i# an ! Con#identialit o# the entit s in#ormation &n#ormation regarding the assumptions and methods intended to be used b the e%pert and their consistenc with those used in prior periods!

:valuating the wor! of the e@ ert


I$# D*("'* The auditor should evaluate the a ro riateness of the e@ ert5s wor! as audit evidence regarding the assertion being considered" $hould evaluate whether the substance of the e@ ert5s findings is ro erly reflected in the financial statements or su orts the financial statements assertions, and consideration of2 The source o# data used

1?B

The assumptions and methods used /hen the e%pert carried out the work The reasons #or an changes in assumptions and methods The results o# the e%perts work in the light o# the auditors knowledge o# the business and the results o# other audit procedures!

The auditors do not have the e%pertise to ,udge the assumptions and methods used! These are the responsibilities o# the e%pert! However$ the auditors should seek to obtain an understanding o# these assumptions to consider their reasonableness based on other audit procedures! I$# D*("'1 If the results of the e@ ert5s wor! do not rovide sufficient a ro riate audit evidence or if the results are not consistent with other audit evidence, the auditor should resolve the matter" &n this regard$ #urther discussions with the entit and e%pert ma be inevitable! Additional audit procedures$ including the possibilit o# engaging another e%pert or modi# ing the audit and report ma be necessar !

Reference to an e@ ert in an auditor5s re ort


I$# D*("'D +hen issuing an unmodified auditor5s re ort the auditor should not refer to the wor! of an e@ ert" The standards sa that such a re#erence ma be misunderstood to be a 'uali#ication o# the auditors opinion or a division o# responsibilit $ neither o# which is appropriate! &# the auditor issues a modi#ied audit report$ the ma re#er to the work o# the e%pert! &n such cases$ auditors should obtain permission in advance #rom the e%pert! &# such permission is not given$ then the auditors ma have to seek legal advice!

Internal audit
At times it ma not be possible to use the work o# the e%perts! &n this case$ the e%ternal auditors ma #ind it possible to use the work o# internal auditors in arriving at their audit opinion! This sub,ect matter is covered ade'uatel under internal audit and outsourcing"

Cha ter round u


#uditors need to obtain sufficient, a ro riate audit evidence"

1?D

:vidence should be obtained in order to rove the financial statements assertions" 6rocedures designed to obtained evidence include ins ection, observations, analytical rocedures, com utations, inquiries, deduction and confirmation" Other evidence could be obtained from related arties, e@ erts and reliance on other and through management letters" Fowever, related arty transactions can be a difficult area to gain audit evidence" 8anagement re resentations may be the only suitable evidence available when !nowledge of facts is confined to management and the matter is rinci ally one of 3udgement or o inion" 8anagement re resentations can never be a substitute for evidence the auditors e@ ect to be available" #ll evidence obtained should be documented # more senior audit staff member should review wor!ing a ers before an audit conclusion is drawn"

Now try >H from the :@am >uestion %an! at the bac! of the study manual"

CF#6T:R I2 #udit :valuation M Review

1B>

To ic &ist Review o# ()*s presentation and disclosure :pening balances Comparatives :ther in#ormation Foing concern *ubse'uent events Compliance with &(R*s INTRODUCTION Audit evaluation and review is normall carried out at the end o# the audit$ though it is important that the review is also done during the audit assignment as part o# control measures! Evaluation and review is important in the sense that it #acilitates the process o# giving an audit opinion on the #inancial statements without which a true and #air view opinion ma not be ,usti#ied! This chapter there#ore covers the #ollowing areas: Review o# #inancial statements procedures that includes anal tical procedures and checklists -Paragraph 1. :pening balances and comparatives in relation to corresponding #igures$ and comparing #inancial statements have been included in paragraph 0 and 2! Procedures to be carried out when dealing with initial engagements have also been addressed in the same paragraphs! The auditors responsibilit in relation to other in#ormation has been included in paragraph 6! &n paragraph 8 and ; we deal with the going concern and subse'uent events respectivel ! &n paragraph ?$ we conclude b looking at the critical role o# the auditor$ which is to ensure that #inancial statements give a true and #air view in line with the applicable reporting #ramework! This guidance is provided in &AP* 1>16 Reporting b auditors on compliance with international #inancial reporting standards!

'"( Review of financial statements resentation and disclosure


&t is important that the auditor per#orms and documents an overall review o# the #inancial statements be#ore the can reach an opinion! The review helps the auditor to authenticate the work that has been done in line with the overall audit plan and other audit procedures! The review will also assist in discovering as to whether ade'uate disclosure has been made in the #inancial statements! *ome procedures pertaining the audit o# #inancial statements have been looked at in Chapter 11 though much was also done in paper 0!6 Auditing!

1B1

A#ter the auditor has substantiall carried out substantive procedures$ the auditor dra#ts a set o# #inancial statements$ which must be supported b appropriate and su##icient audit evidence! The auditor should undertake an overall review o# the #inancial statement as a basis #or giving an audit opinion based on the results #rom the review! The review o# the #inancial statements in con,unction with the conclusions drawn #rom other audit evidence obtained$ gives the auditor a reasonable basis #or the opinion on the #inancial statements! A senior member o# the audit team with appropriate skills and e%perience should carr out the review! The review there#ore reduces the likelihood o# litigations that ma arise as a result o# the opinion given b the auditor$ which is not ade'uatel supported b #acts!

'"*

Com liance with accounting regulations

&n chapter 1$ we looked at the concept o# 4true and fair5 and or 4 resents fairly5 in all material respect$ and that compliance with accounting regulations among others$ assists in establishing what is true and #air! &n the overall review o# #inancial statements$ the auditor should consider whether: The in#ormation presented in the #inancial statements is in accordance with local and national statutor re'uirements$ e!g! the Companies Act! The accounting policies emplo ed are in accordance with accounting standards$ properl disclosed$ consistentl applied and appropriate to the entit ! &n this particular case$ the &A*s promulgated b the &nternational Auditing and Assurance *tandards "oard!

&n e%amining the accounting policies$ auditors should consider: Policies commonl adopted in particular industries Policies #or which there is substantial authority support /hether an de arture #rom applicable accounting standards is necessar #or the #inancial statements to give a true and #air view! /hether the #inancial statement re#lect the substance o# the underl ing transactions and not merel their form!

/hen compliance with local and national statutor re'uirements and accounting standards is considered$ the auditors ma #ind it used to use a checklist in order to ensure that all the re'uirements are met!

'"-

Review for consistency and reasonableness

The auditor should consider whether the #inancial statements are consistent with their knowledge o# the entit s business and with the results o# other audit procedures$ and the manner o# disclosure is #air! The principle considerations are as #ollows:

1B0

/hether the #inancial statements ade'uatel re#lect the in#ormation and e%planations previousl obtained and conclusions previousl reached during the course o# the audit! /hether it reveals an new #actors$ which ma a##ect the presentation o# or disclosure in$ the #inancial statements! /hether anal tical procedures applied when completing the audit$ such as comparing the in#ormation in the #inancial statements with other pertinent data$ produce results$ which assist in arriving at the overall conclusion as to whether the #inancial statements as a whole are consistent with their knowledge o# the entit s business! /hether the presentation adopted in the #inancial statements ma have been undul in#luenced b the directors desire to present matters in a #avourable or un#avourable light! The potential impact on the #inancial statements o# the aggregate o# uncorrected misstatements -including those arising #rom bias in making accounting estimates. identi#ied during the course o# the audit and the preceding periods audit$ i# an !

'"0

#nalytical rocedures

Anal tical procedures have also been mentioned in chapter B as one o# the means o# obtaining audit evidence! Here we look at analytical rocedures as art of the overall review rocedures at the end of an audit and as an audit strategy" Anal tical review can be and should be carried out at all stages o# the audit #rom planning to #inal review! The #ollowing areas are likel to be covered as part o# anal tical review procedures: &mportant accounting ratios Related items Changes in products and customers Price and mi% changes /ages changes Pariances Trends in production and sales Changes in material and labour content o# production :ther pro#it and loss account e%penditure Pariances caused b industr and econom #actors

An signi#icant #luctuations and une%pected relationships must be investigated and documented! '"0"' #nalytical 6rocedures a lication

Anal tical procedures are used more heavil in a business risk approach$ as the are consistent with the auditors desire to understand the entit s business rather than to improve the #igures in the #inancial statements!

1B2

The &*A is to establish standards and provide guidance on the application o# anal tical procedures during an audit! I$# 1*("* ) states that the auditor should a ly analytical rocedures as ris! assessment rocedures to obtain an understanding of the entity and its environment and in the overall review at the end of the audit" :ther than appl ing anal tical procedures on business risk assessment the can also be applied as substantive procedures on elements$ which remain on business approach! " de#inition$ anal tical procedures mean evaluation o# #inancial in#ormation made b a stud o# plausible relationships among both #inancial and non3#inancial data! Anal tical procedures also encompass the investigation o# identi#ied #luctuations and relationships that are inconsistent with other relevant in#ormation or deviate signi#icantl #rom predicted amounts! Anal tical procedures are important at all stages o# the audit$ namel : Planning *ubstantive procedures$ and :verall review!

#nalytical rocedures consists of com aring items, for e@am le, current year financial information with rior year financial information, and analyEing redictable relationshi s, for e@am le, the relationshi between receivables and credit sales" Use of analytical rocedures on an audit There are a number o# #actors$ which the auditor should consider when deciding whether to use anal tical procedures as substantive procedures! 9actors to consider The plausible and predictabilit o# the relationships identi#ied #or comparison and evaluation! The ob,ectives o# the anal tical procedures and the e%tent to which their results are reliable! The detail to which in#ormation can be anal 9ed :@am le The strong relationship between selling e%penses and turnover in businesses where the sales #orce is paid b commission

Anal tical procedures ma be more e##ective when applied to #inancial in#ormation or individual sections o# an operation such as individual #actories or shops 1B6

The availabilit o# in#ormation

(inancial: budgets or #orecasts

<on3#inancial: the number o# units produced or sold The relevance o# the in#ormation available /hether the budgets are established as results to be e%pected rather than as tough targets -which ma well not be achieved. The comparabilit o# the in#ormation Comparison with average per#ormance in available an industr ma be o# little value i# a large number o# companies di##er signi#icantl #rom the average! The knowledge gained during previous The e##ectiveness o# accounting and audits internal controls The t pes o# problems giving rise to accounting ad,ustments in prior periods! (actors$ which should also be considered when determining the reliance that the auditors should place on the results o# substantive anal tical procedures$ are:

Reliability factors :ther audit procedures directed towards the same #inancial statements assertions

:@am le :ther procedures auditors undertake in reviewing the collectabilit o# accounts receivable$ such as the review o# subse'uent cash receipts$ ma con#irm or dispel 'uestions arising #rom the application o# anal tical procedures to a pro#it o# customers accounts$ which lists #or how long monies have been owed! Auditors normall e%pect greater consistenc in comparing the relationship o# gross pro#it to sales #rom one period to another than in comparing e%penditure$ which mat or ma not be made within a period$ such as research or advertising! A pattern repeated monthl as opposed to annuall

The accurac with which the e%pected results o# anal tical procedures can be predicted

The #re'uenc with which a relationship is observed

1B8

Reliance on the results o# anal tical procedures depends on the auditors assessment o# the risk that the procedures ma identi# relationships -between data. do e%ist$ whereas a material misstatement e%ist -that is relationships in #act do not e%ist.! &t depends also on the results o# investigations that auditors have made i# substantive anal tical procedures have highlighted signi#icant #luctuations or une%pected relationships! 6ractical Techniques /hen carr ing out anal tical procedures$ auditors should remember that ever industr is di##erent and each compan within an industr di##ers in certain aspects! &mportant accounting ratios Fross pro#it margin$ in total and b product$ area and months)'uarter Receivable ratios -average collection period. &nventor turnover ratio -inventor divided into cost o# sales. Current ratios -current assets to current liabilities. Euick or acid test ratio -li'uid assets to current liabilities. Fearing ratio -debt capital to e'uit capital. Return on capital emplo ed -pro#it be#ore ta% to total assets les current liabilities. Pa ables and purchases &nventories and cost o# sales <on3current assets and depreciation$ repairs and maintenance e%penses &ntangible assets and amorti9ation Goans and interest e%penses &nvestments and investment income Receivables and bad debt e%penses Receivables and sales

Related items

&t should be appreciated that ratios mean nothing when used in isolation! The should be calculated #or previous periods and comparable companies! The auditor should also e%amine other ratios that ma be relevant to other business and #or particular clients such revenue per passenger mile #or an airline operator client$ or #ees per partner #or a pro#essional o##ice! Other analytical techniques included" 1! :@amine related accounts2 in con,unction with each other! :#ten revenue and e%penses accounts are related to balance sheet accounts and comparisons should be made to ensure relationships are reasonable!

1B;

0! 2!

Trend analysis2 sophisticated statistical techni'ues can be used to compare this period with previous periods! Reasonableness tests2 these involve calculating e%pected values o# an item and comparing it with its actual value! (or e%ample$ #or straight3line depreciation!

Trend analysis2 trend anal sis is likel to be ver important i# an anal tical procedure approach is taken! &n#ormation technolog can be used in trend anal sis$ to enable auditors to see trends graphicall with relative ease and speed! +ethods o# trend anal sis include: *catter graph "ar graphs Pie charts An other visual representations Time series anal sis$ and statistical regression

Time series analysis involves techniques such as eliminating seasonal fluctuations from sets of figures, so that underlying trends can be analyEed" &n time series: *ales ma be below the level o# the previous ear or *ales are below e%pectations!

'"1

$ummariEing errors

Huring the course o# the audit errors will be discovered$ which ma be material or immaterial to the #inancial statements! &t is ver likel that the client will ad,ust the #inancial statements to take account o# material and immaterial errors during the course o# the audit! At the end o# the audit$ however$ some errors ma still be outstanding and the auditors will summari9e the unad,usted errors! "oth current ear and previous ears errors will be summari9ed so that where reversals are to be carried out that a##ects$ #or instance$ opening and closing balances$ the are ad,usted properl ! Also cumulative errors ma be shown which have increased #orm ear to ear! The errors ma be shown in accordance with their e##ects on the income statements and balance sheets respectivel ! '"1"' :valuating the effect of misstatements

As part o# the completion procedures$ the auditors should consider whether the cumulative e##ect o# unad,usted errors is material!

1B?

I$# -*("'* states that2 In evaluating whether the financial statements are re ared in all material res ects, in accordance with an a licable financial re orting framewor!, the auditor should assess whether the aggregate of uncorrected misstatements that have been identified during the audit is material" The aggregate o# uncorrected misstatements comprises: -a. -b. $ ecific misstatements identi#ied b the auditors$ including the net e##ect o# uncorrected misstatements identi#ied during the audit o# the previous period i# the a##ect the current periods #inancial statements Their best estimate o# other misstatements which cannot be 'uanti#ied speci#icall -i!e! pro,ected errors.

&# the auditor concludes that the aggregate o# misstatements ma be material$ the must consider reducing audit risk b e%tending audit procedures or re'uesting management to ad,ust the #inancial statements #or the misstatements identi#ied! I$# -*("'1 If management refuses to ad3ust the financial statements and the results of e@tended audit rocedures do not enable the auditor to conclude that the aggregate of uncorrected misstatements is not material, the auditor should consider the a ro riate modification to the auditor5s re ort in accordance with I$# G((, <The #uditor5s Re ort on 9inancial $tatements"= &# the aggregate o# the uncorrected misstatements that the auditors have identi#ied approaches the materialit level$ the auditors should consider whether it is likel that undetected misstatements$ when taken with aggregated uncorrected misstatements$ could e%ceed the materialit level! Thus$ as aggregate uncorrected misstatements approach the materialit level the auditors should consider reducing the risk b : Per#orming additional audit procedures or " re'uesting management to ad,ust the #inancial statements #or identi#ied misstatements!

I$# -*("'G If the auditor has identified a material misstatement resulting from error, the auditor should communicate the misstatement to the a ro riate level of management on a timely basis, and consider the need to re ort it to those charged with governance in accordance with I$# *D( <Communication of #udit 8atters with Those Charged with 7overnance"=

1BB

'"D

Com letion chec!lists

Checklists are prepared and carried out in order to ensure that all the ma,or audit procedures have been carried out and that all material amounts are supported b appropriate audit evidence! &t #orms part o# the review procedures that makes the auditor to have more con#idence about the work per#ormed!

*"( O ening balances


*"' #udit rocedures

The auditor should carr out speci#ic procedures to opening balances at a new audit client! @:pening balancesA are those account balances$ which e%ist at the beginning o# the period! :pening balances are based upon the closing balances o# the prior period and re#lect the e##ects o#: Transactions o# prior periods Accounting policies applied to the prior period!

I$# 1'( Initial :ngagements 1 :pening balances provides guidance on opening balances$ when the #inancial statements o# an entit are audited #or the #irst time$ and when the #inancial statements #or the prior period were audited b another auditor! &n an initial audit engagement$ the auditor will not have previousl obtained audit evidence supporting such opening balances! I$# 1'("* 9or initial audit engagements, the auditor should obtain sufficient a evidence that2 ro riate audit

.a/ The o ening balances do not contain misstatements that materially affect the current eriod5s financial statements" .b/ The rior eriod5s closing balances have been correctly brought forward to the current eriod or when a ro riate, have been restated, and .c/ # ro riate accounting olicies are consistently a lied or change in accounting olicies have been ro erly accounted for and adequately disclosed" The su##icienc and appropriateness o# the audit evidence re'uired b the auditor and to be obtained as audit evidence regarding opening balances would depend on matters such: The accounting policies #ollowed b the entit

1BD

/hether the prior periods #inancial statements were audited and i# so$ whether the auditors report was modi#ied! The nature o# the accounts and the risk o# their misstatement in the current periods #inancial statements! The materialit o# the opening balances relative to the current periods #inancial statements!

The auditor should consider whether opening balances re#lect the application o# appropriate accounting policies and that those policies are consistentl applied in the current periods #inancial statements! /hen there are an changes in the accounting policies or application thereo#$ the auditor should consider whether the are appropriate and properl accounted #or and ade'uatel disclosed! *"'"' 6rior eriod balances audited

/hen the prior periods #inancial statements were audited b another auditor$ the current auditor ma be able to obtain su##icient appropriate audit evidence regarding opening balances b reviewing the predecessor auditors working papers! &n these circumstances$ the current auditor would also consider the pro#essional competence and independence o# the predecessor auditor! &# the prior periods audit report were modi#ied$ the auditor would pa particular attention in the current period to the matter$ which resulted in the modi#ication! "e#ore communicating with the predecessor auditor$ the current auditor must consider the relevant parts o# Code o# Ethics #or Pro#essional Accountants issued b &(AC! *"'"* 6rior eriod balances not audited"

/hen the prior periods #inancial statements were not audited or when the auditor is not satis#ied b using the audit procedures describes above$ the auditor must per#orm other procedures such as those discussed below! (or current assets and liabilities some audit evidence can usuall be obtained as part o# the current periods audit procedures! (or e%ample$ the collection -pa ment. o# opening accounts receivable -accounts pa able. during the current period will provide some audit evidence o# their e%istence$ rights and obligation$ completeness and valuation at the beginning o# the period! &n the case o# inventories$ however$ it is more di##icult #or the auditor to be satis#ied as to inventor on hand at the beginning o# the period! There#ore$ additional procedures will usuall be necessar such as: :bserving a current ph sical inventor count and reconciling it back to the opening inventor 'uantities! Testing the valuation o# the opening inventor items 1D>

Testing gross pro#it and cut3o## rocedures may rovide sufficient a ro riate audit

# combination of these evidence"

(or non3 current assets and liabilities$ the audit will ordinaril e%amine the records underl ing the opening balances! &n certain cases$ the auditor ma be able to obtain con#irmation o# opening balances with third parties$ #or e%ample$ #or long3term debt and investments! &n other cases$ the auditor ma need to carr out additional audit procedures!

*"* #udit conclusion and re orting


I$# 1'("''
If, after erforming rocedures including those set out above, the auditor is unable to obtain sufficient a ro riate evidence concerning o ening balances, the auditor5s re ort should include2 .a/ .b/ .c/ # qualified o inion # disclaimer of o inion In those 3urisdictions where it is ermitted, an o inion which is qualified or disclaimed regarding the results of o erations and unqualified regarding financial osition"

The details o# the above reports can be re#erred to in the actual standard! If the o ening balances contain misstatements, which could materially affect the current eriod5s financial statements, the auditor should inform management and, after having obtained management5s authoriEation, the redecessor auditor" I$# 1'("'* If the effect of the misstatement is not ro erly accounted for and adequately disclosed, the auditor should e@ ress a qualified o inion or an adverse o inion, as a ro riate" The report will also be modi#ied i# accounting policies are not consistentl applied! I$# 1'("'If the current eriod5s accounting olicies have not been consistently a lied in relation to the o ening balances and if the change has not been ro erly accounted for and adequately disclosed, the auditor should e@ ress a qualified o inion or an adverse o inion as a ro riate" 1D1

&# the prior period auditors report was modi#ied$ the auditor should consider the e##ect on the current periods #inancial statements! (or e%ample$ i# there was a scope limitation$ such as one due to the inabilit to determine opening inventor in the prior period$ the auditor ma not need to 'uali# or disclaim the current periods audit opinion! I$# 1'("'0 Fowever, if the modification regarding the rior eriod5s financial statements remains relevant and material to the current eriod5s financial statements, the auditor should modify the current auditor5s re ort accordingly"

-"(

Com aratives

The auditors responsibilities #or comparatives var depending on whether the are corresponding #igures or comparative #inancial statements! &*A ?1> Comparatives establishes standards and provides guidance on the auditors responsibilities regarding comparatives! I$# G'("* The auditor should determine whether the com aratives com ly in all material res ects with the financial re orting framewor! a licable to the financial statements being audited" The e%istence o# di##erences in #inancial reporting #rameworks between countries results in comparatives #inancial in#ormation being presented di##erentl in each #ramework! Fenerall comparatives can be de#ined as corresponding amounts and other disclosures #or the preceding #inancial reporting period-s.$ presented #or comparative purposes! "ecause o# these variations in countries approach to comparatives$ the &*A re#ers to the #ollowing #rameworks and methods o# presentation! Corres onding figures are amounts and other disclosures #or the preceding period included as part o# the current period #inancial statements$ which are intended to be read in relation to the amounts and other disclosures relating to the current period -re#erred to as 7current period #igures.! These corresponding #igures are not presented as complete #inancial statements capable o# standing alone$ but are an integral part o# the current period #inancial statements intended to be read onl in relation to the current period #igures!

1D0

Com arative financial statements are amounts and other disclosures o# the preceding period included #or comparison with the #inancial statements o# the current period$ but do not #orm part o# the current period #inancial statements! Comparatives are presented in compliance with the relevant #inancial reporting #ramework! The essential audit reporting di##erences are that: (or corresponding #igures$ the auditors report onl re#ers to the #inancial statements o# the current period! (or comparative #inancial statements$ the auditors report re#ers to each period that #inancial statements are presented!

I$# G'( rovides guidance on the auditor5s res onsibilities for com aratives and for re orting on them under the two framewor!s in se arate sections"

-"'

Corres onding figures

3.+.+ The auditor , re pon i"ilitie


I$# G'("D The auditor should obtain sufficient a ro riate audit evidence that the corres onding figures meet the requirements of the a licable financial re orting framewor!" Audit procedures per#ormed on the corresponding #igures are usuall limited to checking that the corresponding #igures have been correctl reported and are appropriatel classi#ied! Auditors must assess whether: Accounting policies used #or the corresponding #igures are consistent with those o# the current period or whether appropriate ad,ustments and)or disclosures have been made! Corresponding #igures agree with the amounts and other disclosures presented in the prior period or whether appropriate ad,ustments and)or disclosures have been made!

+hen the financial statements of the rior eriod have been audited by other auditors andAor were not audited" The incoming auditors assess whether the corres onding figures meet the conditions s ecified above and also follow the guidance in I$# 1'( initial engagements ) o ening balances" &# the auditors become aware o# a possible material misstatement in the corresponding #igures when per#orming the current period audit$ then the must per#orm an necessar additional procedures!

1D2

-"'"* Re orting I$# G'("'( +hen the com aratives are resented as corres onding figures, the auditor should issue an audit re ort in which the com aratives are not s ecifically identified because the auditor5s o inion is on the current eriod financial statements as a whole, including the corres onding figures" The auditors report will onl make an speci#ic re#erence to corresponding #igures in the circumstances described below! /e will look at speci#ic e%amples o# the wording o# auditors reports in such circumstances below! (irstl $ there is the problem o# what happens when the auditors report #or the previous period was modi#ied! I$# G'("'* +hen the auditor5s re ort on the rior eriod, as reviously issued, include a qualified o inion, disclaimer of o inion, or adverse o inion and the matter which gave rise to the modification is2 .a/ .b/ Unresolved, and results in a modification of the auditor5s re ort regarding the current eriod figures, the auditor5s re ort should also be modified regarding the corres onding figuresC or Unresolved, but does not result in a modification of the auditor5s re ort regarding the current eriod figures, the auditor5s re ort should be modified regarding the corres onding figures"

If a modified re ort was issued, but the matter, which gave rise to it, is resolved and ro erly dealt with in the financial statements, the current re ort will not usually refer to the revious modification" If the matter is material to the current eriod, however, the auditors may include am em hasis of matter aragra h to deal with it" &n per#orming the audit o# current period #inancial statements$ the auditors$ in certain unusual circumstances$ ma become aware o# a material misstatement that a##ect the prior period #inancial statements on which an unmodi#ied report has been previousl issued! I$# G'("'1 In such circumstances, the auditor should consider the guidance in I$# 1D( $ubsequent events and2

1D6

.a/ .b/

If the rior eriod financial statements have been revised and reissued with a new auditor5s re ort, the auditor should be satisfied that the corres onding figures agree with the revised financial statementsC or If the rior eriod financial statements have not been revised and reissued, and the corres onding figures have not been ro erly restated andAor a ro riate disclosures have not been made, the auditor should issue a modified re ort on the current eriod financial statements modified with res ect to the corres onding figures included therein"

In these circumstances described above, if the rior eriod financial statements have not been revised and an auditor5s re ort has not been reissued, but the corres onding figures have been ro erly restated andAor a ro riate disclosures have been made in the current eriod financial statements, the auditors may include an em hasis of matter aragra h describing the circumstances and referencing to the a ro riate disclosures" In this regard the auditors also consider the guidance in I$# 1D( $ubsequent events" -"'"0 Incoming auditors2 #dditional requirements

/hen the prior period #inancial statements were audited b other auditors$ in some countries the incoming auditors can re#er to the predecessor auditors report on the corresponding #igures in the incoming auditors report #or the current period! I$# G'("'G +hen the auditor decides to refer to another auditor, the incoming auditor5s re ort should include2 .a/ .b/ .c/ That the financial statements of the rior eriod were audited by another auditor The ty e of re ort issued by the redecessor auditor and, if the re ort was modified, the reasons therefore, and The date of that re ort" *uch a re#erence would be added to the #irst paragraph o# the audit report! The #inancial statements o# the compan as o# Hecember 21$ 0>L>$ were audited b another auditor whose report dated +arch 21$ 0>L1$ e%pressed an un'uali#ied opinion on those statements! The situation is slightl di##erent i# the prior #inancial statements were not audited I$# G'("'H +hen the rior eriod financial statements are not audited, the incoming auditor should state the auditor5s re ort that the corres onding figures are unaudited"

1D8

The inclusion o# such a statement does not$ however$ relieve the auditors o# the re'uirement to per#orm appropriate procedures regarding opening balances o# the current period! Clearl disclosure in the #inancial statements that the corresponding #igures are unaudited is encouraged! I$# G'("'I &n institutions where the incoming auditor identi#ies that the corresponding #igures are materiall misstated$ the auditor should re'uest management to revise the corresponding #igures or i# management re#uses to do so$ appropriatel modi# the report!

-"* Com arative financial statements


-"*"' The auditors5 res onsibilities

I$# G'("*( The auditor should obtain sufficient a ro riate audit evidence that the com arative financial statements meet the requirements of the a licable financial re orting framewor!" This involves the auditor evaluating whether: -a. Accounting policies o# the prior period are consistent with those o# the current period or whether appropriate ad,ustments and)or disclosures have been made= and -b. Prior period #igures presented agree with the amounts and other disclosures presented in the prior period whether appropriate ad,ustments and disclosures have been made! &n whatever case$ the above re'uirement should be adhered to and the guidance given in &*A 81>! (or an possible material misstatement in the prior ear #igure during the per#ormance o# the current period audit$ the auditor should per#orm additional procedures appropriate to the circumstance! -"*"* Re orting"

I$# G'("*0 +hen the com aratives are resented as com arative financial statements, the auditor should issue a re ort in which the com aratives are s ecifically identified because the auditor5s o inion is e@ ressed individually on the financial statements of each eriod resented"

1D;

The auditor ma there#ore e%press a modi#ied opinion or include an emphasis o# matter paragraph with respect to one or more #inancial statements #or one or more period$ whilst issuing a di##erent report on the other #inancial statements! The auditors ma become aware o# circumstances or events that materialit a##ect the #inancial statements o# a prior period during the course o# the audit #or the current period! I$# G'("*1 +hen re orting on the rior eriod financial statements in connection with the current year5s audit, if the o inion on such rior eriod financial statements is different from the o inion reviously e@ ressed, the auditor should disclose the substantive reasons for the different o inion in an em hasis of matter aragra h" -"*"Incoming auditor2 additional requirements

Again$ there are procedures where other auditors audit the prior period #inancial statements! I$# G'("*D +hen the financial statement of the rior eriod were audited by another auditor2 .a/ .b/ The redecessor auditor may reissue the audit re ort on the rior eriod with the incoming auditor only re orting on the current eriodC or The incoming auditor5s re ort should state that the rior eriod was audited by another auditor and the incoming auditor5s re ort should indicate2 I" That the financial statements of the rior eriod were audited by another auditorC II" The ty e of re ort issued by the redecessor auditor and if the re ort was modified, the reasons thereofC and III" The date of that re ort" &n per#orming the audit on the current period #inancial statements$ the incoming auditors ma become aware o# a material misstatement that a##ects the prior period #inancial statements on which the predecessor auditors had previousl reported without modi#ication I$# G'("*H In these circumstances, the incoming auditor should discuss the matter with management and, after having obtained management5s authoriEation, contact the redecessor auditor and ro ose that the rior eriod financial statements be restated" If the redecessor agrees to reissue the audit re ort on the restated

1D?

financial statements of the rior eriod, the auditor should follow the guidance in aragra h above" The predecessor auditor ma not agree with the proposed restatement or the ma re#use to reissue the audit report #or the primar period #inancial statements! &n such cases$ the introductor paragraph o# the auditors report ma indicate that the predecessor auditors reported on the #inancial statements o# the prior period be#ore restatement! &n addition$ i# the incoming auditors are engaged to audit and the per#orm su##icient procedures to be satis#ied as to the appropriateness o# the restatement ad,ustment$ the also include the #ollowing paragraph in the report

4/e also audited the ad,ustment description in <ote L that were applied to restate the
0>L1 #inancial statements! &n our opinion$ such ad,ustments are appropriate and have been properl applied! The other circumstance is that the prior period #inancial statement ma not have been audited! I$# G'("-( +hen the rior eriod financial statements are not audited, the incoming auditor should state in the auditor5s re ort that the com arative financial statements are unaudited" Again the inclusion o# such a statement does not relieve the auditors o# the re'uirement to carr out appropriate procedures regarding opening balances o# the current period! Clear disclosure in the #inancial statements that the comparative #inancial statements are unaudited is encouraged! I$# G'("-' In institutions where the incoming auditor identifies that the rior year unaudited figures are materially misstated, the auditor should request management to revise the rior year5s figures or if management refuses to do so, a ro riately modify the re ort" 78E)TION. -a. -b. E%plain the importance o# comparatives to the conduct o# an audit! Passion$ a #irm o# Chartered Certi#ied Accountants$ has recentl been appointed to provide audit services to Tele Gink! The compan is one o# Cambias leading providers o# communications solutions serving customers in <orthern$ eastern$ *outhern and /estern parts o# Cambia! &ts principal activities include networked &T services$ local and national telecommunications services$ and higher3value

1DB

broadband and &nternet products and services! &n Cambia$ Tele Gink serves over 8 million businesses and residential customers$ as well as providing network services to other operators! Gast ear$ Tele Ginks previous auditors issued a modi#ied audit report a#ter a dispute with its management! The e%pressed a 'uali#ied opinion due to their disagreement as to the ade'uac o# the provision #or doubt#ul receivables! This disagreement as to the accounting treatment was the reason wh Tele Ginks management had sought a change o# auditor$ and had appointed Passion as its new auditors! At the conclusion o# the #irst audit o# Tele Ginks #inancial statements #or the current ear$ the auditors have noted the receivable$ #or which no provision was made last ear$ has still not been settled and once again Tele Ginks management have made no provision #or the amount in the current ears #inancial statements! The matter is still material in the conte%t o# the current ears #inancial statements! Required2 *uggest in outline how the auditors should address the matter in their audit report #or the current ear! Note0 the #ull wording o# the report is not re'uired!

#nswer2
-a. Corres onding figures Amounts and disclosures derived #rom preceding #inancial statements are included with -and are intended to be read in relation to. the current period #igures! /hen comparatives are presented as corresponding #igures$ the are not speci#icall identi#ied in an auditors report because the auditors opinion is on the current periods #inancial statements as a whole$ including the corresponding #igures -&*A ?1>.! (or initial engagements -&*A 81>.$ the auditor seeks to obtain su##icient$ appropriate audit evidence to con#irm that: :pening balances do not contain misstatements that materiall a##ect the current periods #inancial statements Prior periods closing balances have been properl brought #orward as the current periods opening balances

1DD

Accounting policies have been consistentl applied -or changes properl accounted #or per &A* 1!

An auditor must be satis#ied with the opening position$ in particular$ to #orm an opinion on the current ears pro#it -or loss.! A new auditor$ however$ does not have previousl 3obtained audit evidence to support transactions and accounting policies o# the prior period! To obtain the necessary assurance on the o ening rocedures can be erformed, for e@am le2 osition, additional

# review of wor!ing a ers and accounting records for the revious year?end !e t by the client5s management Audit work on the current ears transactions and balances will also provide some evidence to support the completeness$ valuation$ e%istence and rights or obligations o# the opening balances!

Also$ a predecessor auditor ma make their audit working papers available to a new auditor! &n rare circumstances$ i# these procedures are unsatis#actor $ some o# the opening balances ma need to be substantivel tested in order to #orm an opinion on them! &# the scope o# a new auditors work -with respect to the opening position. is e##ectivel limited$ the lack o# audit evidence ma result in a 'uali#ication! -b. Im lications for audit re ort on current year5s financial statements &# the absence o# the provision is material to the current ears #inancial statements$ the auditor should give a modi#ied audit report to the current ears #inancial statements$ #or$ without doing so$ the balance sheet will not be re#lecting a true and #air view o# the #inancial position as at the balance sheet date! However$ the cause o# the 'uali#ication will have arisen simpl because the previous ears grounds #or 'uali#ication remains unresolved$ and not because o# an controversial actions taken b management during the current ear! Provision #or the doubt#ul debtors this ear should be increased b the same amount as it should have been #or the preceding ear$ and net pro#its decreased #or the preceding ear onl ! The retained earnings #or both ears should similarl be reduced b the same amount #or each ear! The current ears pro#its will not be a##ected b the absence o# the provision in the current ear$ as the charge should onl be re#lected against the pro#its o# the preceding period! The modi#ied audit report will$ there#ore$ in the introductor paragraph indicate that Passion have audited the current ears #inancial statements$ but that the #inancial statements o# the preceding ear were audited b a predecessor #irm who

0>>

had e%pressed a 'uali#ied opinion due to their disagreement as to the ade'uac o# the provision #or doubt#ul debtors! The second paragraph will con#irm that the audit was conducted in accordance with &nternational *tandards on Auditing$ and will summari9e what is entailed in the audit process! The third paragraph will e%plain the #inancial implications o# the matters re#erred to above$ and the #inal paragraph will give the 'uali#ied opinion on grounds o# material disagreement over the accounting treatment$ i!e! using the phrase 7J! e%cept #or the e##ect on the #inancial statements o# the matter re#erred to in the preceding paragraph J!

0"(

Other information

Auditors should seek to resolve inconsistencies or misstatements o# #act between #inancial statements and other published in#ormation! &*A ?0> :ther &n#ormation in Hocuments Containing Audited #inancial *tatements establishes standards and provides guidance on the auditors consideration o# other in#ormation$ on which the auditors have no obligation to report$ in documents containing audited #inancial statements! I$# G*("* The auditor should ready other information to identify material inconsistencies with the audited financial statements" 3e!initions0 Other information is #inancial and non3#inancial in#ormation other than the audited #inancial statements and the auditors report$ which an entit ma include in its annual report$ either b custom or statute! A material inconsistency e%ists when other in#ormation contradicts in#ormation contained in the audited #inancial statements! A material inconsistenc ma raise doubt about the audit conclusions drawn #rom audit evidence previousl obtained and$ possibl $ about the basis #or the auditors opinion on the #inancial statements! E%amples o# other in#ormation: A report b management or the board o# directors on operations (inancial summaries or highlights Emplo ment data Planned capital e%penditures 0>1

(inancial ratios <ame o# o##icers and directors *elected 'uarterl data!

#uditors have no res onsibility .statutory or contractual obligation/ to re ort that other information is ro erly stated because an audit is only an e@ ression of o inion on the truth and fairness of the financial statements" Fowever, they may be engaged se arately, or required by statute, to re ort on elements of other information" In any case, the auditors should give consideration to other information as inconsistencies with the audited financial statements may undermine their re ort" *ome countries re'uire the auditors to report speci#ic procedures to certain other in#ormation$ #or e%ample$ re'uired supplementar data and interim #inancial in#ormation! &# such other in#ormation is omitted or contains de#iciencies$ the auditors ma re'uire re#erring to the matter in their report! /hen there is an obligation to report speci#icall on other in#ormation$ the auditors responsibilit is determined b the nature o# the engagement and b local legislation and pro#essional standards! /hen such responsibilit involves the review o# other in#ormation$ the auditor will need to #ollow the guideline on review engagements in the appropriate &*As!

0"'

#ccess to other information"

&t is important to access other in#ormation timel ! The auditors there#ore must take arrangements with the client to obtain such in#ormation prior to the date o# their report! &n circumstances where all the other in#ormation ma not be available prior to that date$ the auditors should #ollow the guidance below: I$# G*("''A'*A'If, on reading the other information, the auditor identifies a material inconsistency, the auditor should determine whether the audited financial statements or the other information needs to be amended" If an amendment is necessary in the other information and the entity refuses to ma!e the amendment, the auditor should e@ ress a qualified or adverse o inion" If an amendment is necessary in the other information and the entity refuses to ma!e the amendments, the auditor should consider including in the auditor5s re ort an em hasis of matter aragra h describing the material inconsistencies or ta!ing other actions" The actions taken b the auditors will depend on the individual circumstances and the auditors ma consider taking legal advice! 0>0

0"* 8aterial misstatements of facts


A 7material misstatement o# #act in other in#ormation e%ists when such in#ormation$ not related to matters appearing in the #inancial statements$ is incorrectl stated and presented! I$# G**"'D If the auditor becomes aware that the other information a ears to include a material misstatement of fact, the auditor should discuss the matter with the entity5s management" /hen discussing the matter with the entit s management$ the auditors ma not be able to evaluate the validit o# the other in#ormation and managements responses to the auditors en'uires$ and would need to consider whether valid di##erences o# ,udgement or opinion e%ist! I$# G*("'GA'H +hen the auditor still considers that there is an a arent misstatement of fact, the auditor should request management to consult with a qualified third arty, such as the entity5s legal counsel and should need to consider the advice received" If the auditor concludes that there is a material misstatement of fact in the other information which management refuses to correct, the auditor should consider ta!ing further a ro riate action" *uch an action could include such steps as noti# ing those ultimatel responsible #or the overall direction o# the entit and obtaining legal advice!

0"-

#vailability of other information after the date of the auditors5 re ort"

All other in#ormation should be obtained as earl as possible! &#$ on reading the other in#ormation$ the auditors identi# a material inconsistenc or become aware o# an apparent material misstatement o# #act$ the should decide whether the audited #inancial statements or the other in#ormation need to be revised! -a. -b. /hen revision o# the audited #inancial statements is appropriate$ the guidance in &*A 8;> *ubse'uent Events would be #ollowed! /hen revision o# the other in#ormation is necessar and the entit agrees to make the revision$ the auditors should carr out an necessar procedures$ including a review o# the steps taken b management to ensure that individuals in receipt o# the previousl issued #inancial statements$ the auditors report thereon and the other in#ormation are in#ormed o# the revision! 0>2

The above procedures will appl i# management re#uses to revise other in#ormation$ as the auditors consider necessar !

1"( 7oing concern


&t is important #or the auditor to consider whether the going concern basis is appropriate and whether disclosure o# an going concern problems is su##icient! 1"' The going concern assum tion

The going concept states that the entit is viewed as continuing in business #or the #oreseeable #uture with neither the intention nor the necessit o# li'uidation$ ceasing trading or seeking protection #rom creditors pursuit to law and regulations! Accordingl $ assets and liabilities are recorded on the basis that the entit will be able to reali9e its assets and discharge its liabilities in the normal course o# the business! This is a management responsibilit and the should indicate so as part o# the #inancial statements issue to be disclosure! I$# 1G("* ) states, when lanning and erforming audit rocedures and in evaluating the results thereof, the auditor should consider the a ro riateness of management5s use of the going assum tion in the re aration of the financial statements" &*A also states that when preparing accounts$ management should make an e%plicit assessment o# the entit s abilit to continue as a going concern! +ost accounting #rameworks re'uire management to do so$ e!g! &A* 1:3 Presentation o# #inancial statements! However$ this is a #undamental principle that should not be ignored even i# #inancial reporting #ramework does not include an e%pert responsibilit ! +anagement should consider the #ollowing #actors when making the assessments The degree o# uncertaint associated with the outcome o# an event or conditions being assessed increases signi#icantl the #urther into the #uture the assessment are made! An ,udgement made about the #uture is based on in#ormation available at the time! The ,udgement is a##ected b the si9e and comple%it o# the entit $ the nature and conditions o# its business and the degree to which it is a##ected b the e%ternal #actors!

The following list gives e@am les of ossible indicators of going concern roblems" -a. (inancial indicators! <et liabilities or net current position

0>6

-b. -c.

(i%ed3term borrowings approaching maturit without realistic prospects o# renewal or repa ment$ or e%cessive reliance on short3term borrowings &ndications o# withdrawal o# #inancial support b creditors <egative operation cash #lows indicated b historical or prospective #inancial statements Adverse ke #inancial ratios *ubstantial operating losses or signi#icant deterioration in the value o# assets to generate cash #lows! Arrears or discontinuance o# dividends &nabilit to pa creditors on due dates &nabilit to compl with terms o# loan agreements Change #rom credit to cash3on3deliver transactions with suppliers &nabilit to obtain #inancing #or essential new product development or other essential investments! :perating indications Goss o# ke management without replacement Goss o# ma,or markets$ #ranchises$ license$ or principal supplier Gabour di##iculties or shortages o# important supplies! :ther indicators <on3compliance with capital or other statutor re'uirements Pending legal proceedings against the entit that ma $ i# success#ul$ result in ,udgment that could not be met! Changes in legislation or government polic

The signi#icance o# such indications can o#ten be mitigated b other #actors! -a. The e##ect o# an entit being unable to make its normal debt repa ment ma be counterbalanced b managements plans to maintain ade'uate cash #lows b alternative means$ such as b disposal o# assets$ rescheduling o# loan repa ment$ or obtaining additional capital! The loss o# a principal supplier ma be mitigated b the availabilit o# a suitable alternative source o# suppl !

-b.

1"*

#uditor5s res onsibilities

Auditors are responsible #or considering: The appropriateness o# the going concern assumption 0>8

The e%istence o# material uncertainties about the going concern assumption that need to be disclosed in the accounts!

I$# 1G("''A'* In obtaining an understanding of the entity, the auditor should consider whether there are events or conditions and related business ris!s, which may cast significant doubt on the entity5s ability to continue as a going concern" The auditor should remain alert for evidence of events or conditions and related business ris!s, which may cast doubt on the entity5s ability to continue as a going concern throughout the audit" If such events or conditions are identified, the auditor should, in addition to erforming the rocedures in aragra h *D, consider whether they affect the auditor5s assessments of the com onents of audit ris!" &n some cases$ management ma alread have made a preliminar assessment o# going concern! &# so the auditor should review potential problems management had identi#ied$ and management plans to resolve them! Alternativel auditors ma identi# problems as a result o# discussions with management! I$# 1G("'GA'H The auditor should evaluate management5s assessment of the entity5s ability to continue as a going concern" The auditor should consider the same eriod as that used by management in ma!ing its assessment under the a licable financial re orting framewor!" If management5s assessment of the entity5s ability to continue as a going concern covers less than twelve months from the balance sheet date, the auditor should as! management to e@tend its assessment eriod to twelve months from the balance sheet date" &n evaluating managements assessment$ the auditor should consider: The process management #ollowed to make its assessment The assumptions on which the assessment is based and +anagements plans #or #uture action! 8anagement should not need to ma!e a detailed assessment and auditors carry out detailed rocedures, if the entity has a history of rofitable o erations and ready access to financial resources" I$# 1G("** The auditor should inquire of management as to its !nowledge of events or conditions and related business ris!s beyond the eriod of assessment used by 0>;

management that may cast significant doubt on the entity5s ability to continue as a going concern" The degree o# uncertaint associated with the outcome o# an event or condition increases as the event or condition is #urther into the #uture$ the indications o# going concern issues will need to be signi#icant be#ore the auditor considers taking action! Auditors do not have to carr out speci#ic procedures to identi# potential problems$ which ma occur a#ter the period covered b managements assessment! However$ the should be alert during the course o# the audit #or an indications o# #uture problems! 1"*"' #dditional audit rocedures when events or conditions are identified"

I$# 1G("*D +hen events and conditions have been identified which may cast significant doubt on the entity5s ability to continue as a going concern, the auditor should2 .a/ .b/ Review management5s lans for future actions based on its going concern assessmentC 7ather sufficient a ro riate audit evidence to confirm or dis el whether or not a material uncertainty e@ists through carrying out audit rocedures considered necessary, including considering the effect of any lans of management and other mitigating factors, and $ee! written re resentations from management regarding its lans for future action"

.c/

+hen the auditor believes such events or conditions may cast significant doubt on the entity5s ability to continue as a going concern, certain audit rocedures may ta!e on additional significance" Thus additional rocedures may be carried out in order to ensure that sufficient audit evidence that management5s lans are feasible and that the outcome of these lans will im rove the situation" The &*A outlines a number o# audit procedures that are relevant in this regard and ma include the #ollowing: Anal 9ing and discussing cash #low$ pro#its and other relevant #orecasts with management! Anal 9ing and discussing the entit s latest available interim #inancial statements! Reviewing the terms o# debentures and loans agreements and determining whether an have been breached! Reading minutes o# the meetings o# shareholders$ those charged with governance and relevant committees #or re#erence to #inancing di##iculties! &n'uiring o# the entit s law ers regarding the e%istence o# litigation and claims and the reasonableness o# managements assessment o# their outcome and the estimate o# their #inancial implications!

0>?

Con#irming the e%istence$ legalit and en#orceabilit o# arrangements to provide or maintain #inancial support with related and third parties and assessing the #inancial abilit o# such parties to provide additional #unds! Considering the entit s plans to deal with un#illed customers orders! Reviewing events a#ter period end to identi# those that either mitigate or otherwise a##ect the entit s abilit to continue as a going concern!

The auditors should discuss with management its plans #or #uture action$ #or e%ample plans to li'uidate assets$ borrow mone or restructure debt$ reduce or dela e%penditure or increase capital$ and assess whether these are #easible and are likel to improve the situation! /hen anal sis o# cash #low is a signi#icant #actor in considering the #uture outcome o# events or conditions the auditor considers: The reliabilit o# the entit s in#ormation s stem #or generating such in#ormation$ and /hether there is ade'uate support #or the assumptions underl ing the #orecast! How recent #orecasts have di##ered #rom actual results!

I$# 1G("-( %ased on the audit evidence obtained, the auditor should determine if, in the auditor5s 3udgement, a material uncertainty e@ists related to events or conditions that alone or in aggregate, may cast significant doubt on the entity5s ability to continue as a going concern" &# the material uncertaint e%ists when the magnitude o# its potential impact is such that clear disclosure o# the nature and implications o# the uncertaint is necessar #or the presentation o# the #inancial statements$ then the accounts should: Ade'uatel describe the principal events or conditions that give rise to the signi#icant doubt on the going concern and management plans to deal with the situation! *tate clearl that there is a material uncertaint related to events or conditions that will make the entit not to reali9e its assets and discharge its liabilities in the normal course o# the business!

I$# 1G("-If adequate disclosure is made in the financial statements, the auditor should e@ ress an unqualified o inion but modify the auditor5s re ort by adding an em hasis of a matter aragra h that highlights the e@istence of material uncertainty relating to an event or condition that may cast significant doubt on the entity5s

0>B

ability to continue as a going concern and draws attention to the note in the financial statements that discloses the matters"

1"-

#uditor5s re ort

An e%ample o# an emphasis o# matter in such circumstances is given in the &*A! 9:ithout 6uali!ying our opinion, e dra attention to Note ; in the !inancial statements hich indicates that the company incurred a net loss o! <<< during the years ended 3ecember =>, ,-;> and, as o! that date, the company?s current liabilities e&ceeded its total assets by <<<. These conditions, along ith other matters as set !orth in Note ;, indicate the e&istence o! a material uncertainty hich may cast signi!icant doubt about the .ompany?s ability to continue as a going concern@. However$ the auditor ma come across a number o# multiple uncertainties! &n such cases a disclaimer o# opinion ma be issued instead o# adding an emphasis o# matter paragraph! I$# 1G("-0 If adequate disclosure is not made in the financial statements, the auditor should e@ ress a qualified or adverse o inion, as a ro riate" The re ort should include s ecific reference to the fact that there is a material uncertainty that may cast significant doubt about the entity5s ability to continue as a going concern" 1"-"' #dverse o inion"

I$# 1G("-1 If, in the auditor5s 3udgement, the entity will not be able to continue as a going concern, the auditor should e@ ress an adverse o inion if the financial statements have been re ared on a going concern basis" This applies whatever the level o# disclosure in the accounts! i# a basis other than the going concern basis is used$ and the auditors consider it appropriate$ the can issues an un'uali#ied opinion with an emphasis o# matter paragraph! 1"-"* &imitation in sco e I$# 1G("-G I! management is un illing to ma"e or e&tend its assessment hen re6uested to do so by the auditor, the auditor should consider the need to modi!y the auditor?s report as a result o! the limitation on the scope o! the auditor?s or". /here management assessment is inade'uate$ the auditor can still obtain su##icient alternative evidence! Alternativel since it is not the responsibilit o# the auditor to 0>D

recti# the lack o# anal sis b management$ a modi#ied report ma be appropriate because it ma not be possible #or the auditor to obtain su##icient appropriate evidence!

1"0

$ignificant delay in the signature or a statement

roval of financial

/henever there is a signi#icant dela in approving the accounts$ the auditor considers the reasons #or the dela that ma lead to doubts about the going concern status o# the business! The dela ma prompt the auditor to per#orm additional procedures on going concern!

>uestion2
5ou are planning to audit Trick *tars$ a renowned +otor vehicle transport compan whose services ranges #rom motor vehicle spares and repairs$ haulage and ware housing$ and similar activities! 5ou have been provided with the dra#t accounts #or the ear ended Hecember 0>>6! $ummary income accounts Turnover Cost o# sales Fross pro#it Administrative e%penses &nterest pa able and similar charges <et -loss. pro#it 0>>6 J5((( 01$D60 -0>$6>;. 1$82; -1$8;6. -6?>. .0IH/ 0>>2 J5((( 02$10> 0>$D6B 0$1?0 -1$88B. -2?>. *00

Summar# "alance heet


<on3current assets Current assets &nventor -parts M consumables. Receivables Current liabilities "ank loan :verdra#t Trade pa ables Gease obligation :ther pa ables Gong 1 Term liabilities "ank loan Gease obligations 01> 1>$28; 1D> 8$D8> ;$16> 8>> 0$6D> 2$>0; 616 6>; ;$D;0 18>> D6; D$26> 100 6$?2B 6$B;> 3 1$B0; 0$6D> 3 0DB 6$;16 0$>>> 3

0$66; G,(HH

0$>>> G,1HD

The Chie# E%ecutive :##icer has in#ormed ou that the #all in turnover is due to the #ollowing: The loss$ in Nul $ o# a long3standing customer to a competitor$ and A decline in trade in the repair o# motor vehicles!

"ecause o# the decline in the repairs business$ the compan has decided to close the workshop and sell the e'uipment and spares inventor ! <o entries have been made in the dra#t accounts to back this decision! Huring the ear$ the compan replaced its #leet o# haulage vehicles #unding them b a combination o# leasing and b increased overdra#t #acilit ! This #acilit will be reviewed in Nanuar 0>>8 a#ter the audited accounts are available! The dra#t accounts show a loss #or the ear ended 0>>6 but the #orecast indicates a return to pro#itabilit in 0>>8$ as the Chie# E%ecutive :##ice is optimistic about generating additional turnover #rom new contracts! Re'uired: -a. -b. *tate the circumstances particular to Trick *tar which ma indicate that the compan is not a going concern and e%plain wh these circumstances given cause #or concern! Hescribe the audit work ou would undertake in order to ascertain as to whether Trick *tar is a going concern!

#nswer2
-a. The gross pro#it percentage has #allen b 0!2?O! Though the turnover has not reduced drasticall $ the #all in gross pro#it margin is more serious! This is due to the #act that e%penses seems to remain constant and interest rates are growing meaning that e%penses are likel to increase!

The dra#t accounts show a loss o# K6DB$ >>>$ which is an indication that bigger problems are likel to come especiall that the compan has also lost some o# the ma,or customers! Receivables have increased b almost 08O in ear 6 and this translates into an increased debtors period or ageing "ad debts are likel to increase since ma,or customer have pulled out! The increase in bad debts ma also result in reduced pro#its thus worsening the situation!

011

The li'uidit level seems to be worsening as seen b the drop in the ratio #rom 1!>2 to >!B8 in 0>>6! The ratio ma worsen #urther due to the provision #or bad debts$ which is emmunent$ and as such the various obligations arising #rom loans and leases ma not be met! The compan seems to be rel ing on short3term #inance such as overdra#ts! This will crease a problem in #uture and the compan ma #ind di##iculties to borrow in #uture! Even i# the #urther credit is negotiated$ the gearing will increase #urther thereb making it di##icult to borrow or make other #inance arrangements! The loss o# ma,or customers ma impact on the pro#itabilit o# the compan due the risk o# unpaid debts! +a,or customers at least have more capacit to repa debts than the smaller ones! *ome ad,ustments have not et been made in the dra#t accounts pertain to assets! &# this is done$ the compan Us net asset position #or non current assets would be worsened when these assets are written down to recoverable amounts! &nventor ma also be written down to net reali9able value$ #urther bad debt provision will be re'uired= closure costs o# redundanc ma need to be provided! All these have an e##ect on the current loss! The compan ma be anticipating a renewal o# an overdra#t within three months! This is a shorter period within which ou can see tangible improvements in the compan Us activities! The auditors are likel to report on a #undamental uncertaint likel to occur within three months! -b. The #ollowing would assist to determination as to whether Trick *tar is a going concern or not: Check whether the non3current assets have been #airl stated including the repair inventor ! &t is most likel that the assets ma be overstated considering that the #inancial position is not all that good! Receivables should also be checked and reviewed #or ageing and determine the cash recover polic ! (or na amounts outstanding #rom customers$ the must be checked and investigated! Trick *tar is optimistic that new contracts will materiali9e! This must be discussed with the +anaging Hirector and possibl get a representation on the same! Hiscuss the issue pertaining to the loss o# ma,or customers in order to determine as to whether the business will manage to sustain itsel# with the remaining customers! Fet the management view on the same b discussing the impact o# the issues on the business generall ! Check as to whether the compan will be able to meet obligations arising #rom the lease and loan commitments in the post balance sheet period! Also review entries in the income statement #or understatement! (rom the cash #low statements and pro#it #orecast= o Hiscuss assumptions made with the directors

010

o Per#orm some sensitivit anal sis #le%ing the ke assumptions such as interest rates$ date o# pa ment o# creditors and receipts #rom customers! o Check that all commitments have been cleared in accordance with the agreements! o Rework some calculations o Check i# #uture pro#its are likel to meet #uture obligations (or the overdra#t #acilit $ check whether management abide b the terms given! Also check #or an correspondence #rom the bank on the same and discuss an issues or concerns raised b the bank! :btain a management representation to signi# that the compan will continue in operation #or the #oreseeable #uture$ sa ne%t 10 months!

D"( $ubsequent events


&t is important that auditors consider the e##ect o# subse'uent events on the accounts! These are events that occur a#ter the balance sheet date!

D"'

:vents after the balance sheet date

&*A 8;> subse'uent events 1 provides guidance on the auditors responsibilit regarding subse'uent events! *ubse'uent events include both: Events occurring between the period end and the date o# the auditors report$ and (acts discovered a#ter the date o# the auditors report!

I$# 1D("* $tates that the auditor should consider the effect of subsequent events on the financial statements and on the auditor5s re ort" The accounting treatment o# event a#ter the balance sheet date is considered in &A* 1> 1 events a#ter the balance sheet date! The treatment in the balance sheet is #or both #avourable and un#avourable events occurring a#ter period end and identi# two t pes o# events! That provide #urther evidence o# conditions that e%isted at period end$ and Those that is indicative o# conditions that arose subse'uent to period end!

012

-..

E/ent occurring up to the date of the auditor, report

I$# 1D("0 The auditor should erform audit rocedures designed to obtain sufficient a ro riate audit evidence that all events u to the date of the auditor5s re ort that may require ad3ustment of, or disclosure in the financial statements have been identified" These procedures are in addition to procedures$ which ma be applied to speci#ic transactions occurring a#ter period end to obtain audit evidence as to account balances as at period end$ #or e%ample the testing o# inventor cut3o## tests and pa ments to creditors! The standard also indicates that the audit procedures to be per#ormed b the auditor on events that ma re'uire ad,ustments should be done as near as possible to the date o# the auditors report and the include the #ollowing: 2rocedures0 Review procedure established b management in the identi#ication o# subse'uent events! Read minutes o# various shareholders and discuss matters brought up in the meetings #or which minutes are not et available! Read the entit s latest available interim statements and other related in#ormation! In6uiries. Carr out both oral and written in'uiries o# an litigations and claims #rom the legal counsel! Current status o# items accounted #or on the basis o# preliminar data or sub,ective ,udgment! An new commitments$ borrowings or guarantees entered into! *ales or destruction o# assets &ssues pertaining to shares$ debentures or an agreement to merge or li'uidate made Hevelopments involving risk areas$ provisions and contingencies Inusual accounting ad,ustments +a,or events such as going concern issues$ a##ecting appropriateness o# accounting policies #or estimates!

Review and updates o# these procedures ma be re'uired$ depending on the length o# the time between the procedures and the signing o# the auditors report and the susceptibilit o# the items to change over time! I$# 1D("G

016

+hen the auditor becomes aware of events, which materially affect the financial statements, the auditor should consider whether such events are ro erly accounted for and adequately disclosed in the financial statements" D"9acts discovered after the date of the auditor5s re ort but before the financial statements are issued"

A#ter the auditor has issued the report$ it is not the auditors responsibilit to per#orm audit procedures or make an in'uiries regarding the #inancial statements! The #inancial statements are a responsibilit o# management and it is managements responsibilit to in#orm the auditor o# #acts or events$ which ma a##ect the #inancial statements! This could be a material subse'uent event between the date o# the auditors report and the date the #inancial statements are issued! I$# 1D("I +hen, after the date of the auditor5s re ort but before the financial statements are issued, the auditor becomes aware of a fact which may materially affect the financial statements, the auditor should consider whether the financial statements need amendment, should the matter with the management and should ta!e action a ro riate in the circumstances" /hen the #inancial statements are amended$ the auditor should e%tend the procedures discussed above to the date o# their new report$ carr out an other appropriate procedures and issue a new audit report dated the da it is signed! I$# 1D("'' +hen management does not amend the financial statements in circumstances where the auditor believes they need to be amended and the auditor5s re ort has not been released to the entity, the auditor should e@ ress a qualified o inion or an adverse o inion" &# the auditors report has been released to the entit $ the auditor should noti# those responsible with governance not to issue the #inancial statements or the auditors report to third parties! However i# the #inancial statements have been release alread $ then the auditors must take action or steps to prevent reliance on the auditors report! The action taken will depend on the auditors legal rights and obligations and the recommendations o# the auditors law ers!

D"0

9acts discovered after the financial statements have been issued"

As alread indicated above$ the auditor has no obligation to make an in'uir regarding such #inancial statements a#ter the #inancial statements have been issued!

018

I$# 1D("'0 +hen, after the financial statements have been issued, the auditor becomes aware of a fact which e@isted at the date of the auditor5s re ort and which, if !nown at that date, may have caused the auditor to modify the auditor5s re ort, the auditor should consider whether the financial statements need revision, should discuss the matter with management, and should ta!e the action a ro riate in the circumstances" The #ollowing procedures are indicated in the standard to be undertaken when management revises the #inancial statements! To carr out the audit procedures necessar in the circumstance To review the steps taken b management to ensure that an one in receipt o# the previous issued #inancial statements together with the auditors report thereon is in#ormed o# the situation! &ssue a new report on the revised #inancial statements!

I$# 1D("'D The new auditor5s re ort should include an em hasis of a matter aragra h referring to a note to the financial statements that more e@tensively discusses the reasons for the revision of the reviously issued financial statements and to the earlier re ort issued by the auditor" #or e&ample0 &n our opinion$ the revised #inancial statements give a true and #air view -or presents #air in all material respect.$ as at the date the original #inancial statements were approved$ o# the #inancial position o# the compan as o# Hecember 21$ 0>%1$ and o# the results o# its operations and its cash #lows #or the ear then ended in accordance with -relevant national legislation.! &n our opinion$ the original #inancial statements #or the ear to Hecember 21$ 0>L1$ #ailed to compl with -relevant national legislation. Hate Address Auditor /here local regulations in the countr permits the auditor to restrict the audit procedures regarding the revised #inancial statements to the e##ect o# subse'uent events which caused the revision$ the new auditors report should contain a statement to that e##ect! &n the event that management does not take necessar steps to ensure that an one in receipt o# the previousl issued #inancial statements together with the auditors report thereon is in#ormed o# the situation and management does not revise the #inancial statements when the auditor believes the should$ the auditor should take steps to take on

01;

a timel basis to prevent reliance on their report! The actions taken will depend on the auditors legal rights and obligations and the recommendations o# the auditors law er! 78E)TION0 +r! Pot "err is a +anaging Hirector o# PC limited whose #inancial ear3end is Hecember! The compan has ,ust #inished preparing its ear3end #inancial statements #or the ear 0>>6 and now the have communicated to the auditors #or commencement o# the audit! 5our partner has tasked ou to carr out an audit o# PC! Ipon commencement o# the audit$ the managing director has noticed that the auditor has e%tended his e%amination to accounting in#ormation$ which relates to the ne%t accounting period! :ne o# the issues he is looking at is that o# the current managing director who was appointed in <ovember 0>>6 to replace +r! Nonnes whose contract was terminated and paid K8> million as compensation ,ust a#ter his termination! Huring our investigation$ ou have #ound out that$ the compan law ers are in the process o# taking +r! Nonnes to court so that the could recover the mone paid to him! This was a#ter the compan discovered that be#ore +r! Nonnes le#t$ he had alread gone into contractual agreement to ,oin the board o# directors o# a rival compan ! This constituted a breach o# contract and the reason wh a case has been brought against him in order to recover the mone back! 'e6uired0 -a. -b. -c. E%plain to +r! Pot "err the nature and purpose o# reviewing events that take place a#ter the balance sheet date! /hat audit procedures would ou carr out in order to identi# some material subse'uent events4 Hiscuss the audit implications o# the compan s decision to sue +r! Nonnes #or the recover o# the compensation paid to him!

#nswer2
-a. As part o# the responsibilities o# the auditor during the cause o# the audit assignment$ is that o# veri# ing events that occur a#ter the balance sheet date but be#ore the sign the audit report and be#ore the approval o# the #inancial statements! The auditors review o# the K8> million paid to +r! Nonnes is within the re'uirements o# &*A 8;> on post balance sheet events! The purpose o# reviewing post balance sheet events is basicall to allow the auditor ascertain that management has correctl dealt with these events$ both #avourable and un#avourable. in the #inancial statements! These events need to be

01?

re#lected in the #inancial statements i# the have to show a true and #air view o# both the income statements and the balance sheet! The preparation o# the #inancial statements does not take into account subse'uent events e%cept where the statute re'uires to do so or to take into account an event which provides in#ormation about a condition e%isting at the balance sheet date$ e!g! reali9able values o# inventor or indicate that the going concern concept is no longer applicable! *o where events have a material e##ect on the compan s #inancial statements$ disclosure is re'uired in order #or them to show a true and #air view! -b. The audit procedures ma include discussions with management on material subse'uent events! However$ it is important that subse'uent events review takes place closer to the date o# the audit report being issued! /here appropriate$ a management letter o# representation should be re'uested #rom management! :ther procedures would include the #ollowing: Review relevant accounting records to determine subse'uent cash in #lows #or receivables$ check items uncleared at the ear3end on the bank reconciliation$ check the <RP o# inventories and ensure that there is no window dressing o# an kind! Review various documents such as budgets$ pro#it #orecasts$ cash #low pro,ections and management accounts in order to determine the compan s position in as #ar as business engagements are concerned! (or an contingencies$ determine whether some will have no impact on the accounts or disclosure is re'uired! This is aimed at identi# or determining the likel risk that ma arise a#ter the #inancial statements have been approved! Procedures aimed at ensuring that all events a#ter the balance sheet date have been identi#ied and considered properl in the #inancial statements b management! Hetermine the e##ect o# these events on the ()*! Review board minutes in order to identi# certain correspondence that ma provide evidence as to the t pe o# transaction management has carried out! An other in#ormation that the auditor ma come across$ either #orm outside the compan $ competitors$ supplier and customers should be reviewed!

-c.

Here$ it is important to appreciate that the pa ment to +r! Nonnes ma have been included in the accounts as part o# directors remuneration #or the ear ended Hecember 0>>6! The issue at hand is that the compan has taken action to recover the said pa ment to +r! Nonnes and as to whether the accounts should be ad,usted or not! The auditor should carr out #urther investigations #rom management in order to determine the degree o# recover especiall getting in#ormation #rom the compan legal advisor! &# it is probable that the compensation will be recovered$ a 01B

contingent gain should be disclosed in the notes to the accounts as per &A* 1>! The summar o# the #acts should also be disclosed in the notes! However$ an estimated o# legal #ees or costs should be deducted #rom the amount e%pected

G"(

Com liance with International 9inancial Re orting $tandards

Regardless o# the reporting #ramework used$ the auditor must ensure that the #inancial statements audited give a true and #air view o# the operations o# the entit ! Countries globall adopt various reporting standards and compliance to these standards is ke in the preparation o# #inancial statements! Flobali9ation also entails that common standards must be used in order to sustain uni#ormit $ thus the compliance with &*As and &(R*s! However$ a problem ma arise in the use o# these standards due to the available national standards! Reconciliation ma be needed as a means o# harmoni9ing the reporting re'uirements! This means that even i# e reconciliation has been made$ the auditor cannot vividl state and give an un'uali#ied opinion that the #inancial statements audited complies with the &(R*s! &nternational Auditing Practice *tatements 1>16 Reporting on compliance with international #inancial reporting standards gives the auditors guidance! &t provides guidance #or reporting when the #inancial statements are prepared: G"' *olel in accordance with &nternational (inancial Reporting *tandards &n accordance with &(R*s and a national #inancial reporting #ramework= or &n accordance with a national #inancial reporting #ramework with disclosure o# the e%tent o# compliance with &(R*s 9inancial statements that do not com ly with I9R$s

&n this particular case$ when the #inancial statements indicate that the have been prepared in accordance with &(R*s$ the auditor should go a step #urther to speci# certain material departures$ e!g! a note describing the accounting policies used states that the #inancial statements are prepared in accordance with &(R*s e%cept #or the non3disclosure o# sales #or geographical segments! G"* 9inancial statements re ared in accordance with more than one re orting framewor!"

(or #inancial statements to have been prepared in accordance with more than one #inancial reporting #ramework$ the must compl with each o# the indicated #rameworks individuall ! An #inancial statements that have been prepared in accordance with one reporting #ramework but with some ad,ustments or a note on some supplementar statement reconciling the results to those that would be shown under another #inancial 01D

reporting #ramework has not been prepared in accordance with that other #ramework! This is because the #inancial statements do not include all the in#ormation in the manner re'uired b that other #ramework! The #inancial statements must compl with both #inancial reporting #rameworks simultaneousl and without an need #or reconciling statements i# the are to be regarded as having been prepared in accordance with both! &n practice$ simultaneous compliance with both &(R*s and a national #inancial reporting #ramework is unlikel $ unless the countr has adopted &(R*s as its national #inancial reporting #ramework or has eliminated all barriers #or compliance with &(R*s!

Cha ter roundu


It is im ortant that the auditor documents and carries out an overall review of the financial statements before they can reach an o inion" #nalytical rocedures form art of the review in order to determine com liance with accounting regulations, consistency and reasonableness" #s art of the review rocess, the auditor should consider the cumulative effect of errors on the financial statements being audited" 9or a new client, rocedures need to be a lied for o ening balances" Fowever, the auditor5s res onsibility may vary de ending on whether com aratives relate to corres onding figures or com arative financial statements" #ny inconsistencies or misstatements of fact between financial statements and other ublished information need to be resolved conclusively" The auditor should consider the a ro riateness of the going concern basis and as to whether the disclosure of the same is sufficient" The auditor should also consider the effect of subsequent events on the accounts" The auditor should ensure that the financial statements give a true and fair view under the relevant re orting framewor!"

Now try > I from the :@am >uestion ban! at the bac! of the manual

00>

CF#6T:R '(2 Internal Control and :valuation of Control ris!


To ic list 1 Components o# internal controls 0 Gimitation o# accounting and control s stem 2 Assessing the risks o# material misstatements 6 Acting on control risk assessment 8 &nternal controls in a C&* environment ; Hocumentation o# accounting and control s stem ? Hesign$ maintenance and monitoring internal controls B *mall entities

Introduction
The modern audit encompass reliance on internal controls in order to reduce the amount o# testing o# #inal balances The evaluation o# a clients s stem is essential as the auditor gains an understanding o# the entit ! &n this chapter we shall look at some o# the detailed re'uirements o# &*A 218 with regard to internal controls$ and shall also setout control issues the auditor ma come across! The auditors will assess risks o# material misstatement arising and ma respond to those risks b carr ing out tests o# controls! /e shall also e%amine the detailed controls that businesses operate in ke accounting areas: sales$ purchases and wages together with the tests o# controls that the auditors ma carr out!

'"(

Com onents of internal control system


001

&nternal control has been de#ined as the process designed and e##ected b those charged with governance$ management and other personnel to provide reasonable assurance about the achievement o# an entit s ob,ectives with regard to reliabilit o# #inancial reporting$ e##ectiveness and e##icienc o# operations and compliance with applicable laws and regulationsJdesigned and implemented to address identi#ied business risks that threaten achievement o# an o# these ob,ectives! I$# -'1 Understanding the entity and its environment and assessing the ris!s of material misstatements, deal with the whole area o# controls! &t re'uires that auditors 7obtain an understanding o# internal control relevant to the audit! The &*A states that internal control has #ive elements: The control environment The entit s risk assessment process The in#ormation s stem -including related business processes)communication. Control activities +onitoring o# controls

In obtaining an understanding of internal control, the auditor must gain an understanding of the design of the internal control .is it ca able of effectively reventing or detecting and correcting material misstatements,/ and the im lementation of that control .has it been o erated correctly in the year,/"

'"'

Control environment

Control environment is the #ramework within which controls operate! The control environment is ver much determined by the management o# a business! Control environment includes the governance and management #unctions and the attitudes$ awareness and actions o# those charged with governance and management concerning the entit s internal control and its importance in the entit ! A strong control environment does not$ b itsel#$ ensure the e##ectiveness o# the overall internal control s stem$ but can be a positive #actor when assessing the risks o# material misstatement! A weak control environment can undermine the e##ectiveness o# controls! Aspects o# the control environment -such as management attitudes towards control. will nevertheless be a signi#icant #actor in determining how controls operate! Controls are more likel to operate well in an environment where the are treated as being important! &n addition consideration o# the control environment will mean considering whether certain controls -internal auditors$ budgets. actuall e%ist!

000

The &*A re'uires auditors to 7obtain an understanding o# the control environment! &n evaluating the design o# the entit s control environment$ the auditor should consider the #ollowing element! CONTRO& :N;IRON8:NT Communication and en#orcement o# integrit and ethical values Commitment to competence Participation o# those charged with governance Essential elements which in#luence the e##ectiveness o# the design$ administration and monitoring o# controls +anagements consideration o# the competence levels #or particular ,obs and how those levels translate into re'uisite skills and knowledge &ndependence #rom management$ their e%perience and structure$ the e%tent o# their involvement and scrutin o# activities$ the in#ormation which the receive$ the degree to which di##icult 'uestions are raised and pursued with management and their interaction with internal and e%ternal auditors +anagements approach to taking and managing business risks$ and managements attitudes and actions towards #inancial reporting$ in#ormation processing and accounting #unctions and personnel The #ramework within which an entit s activities #or achieving its ob,ectives are planned$ e%ecuted$ controlled and reviewed How authorit and responsibilit #or operating activities are assigned and how reporting relationships and authori9ation hierarchies are established Recruitment$ orientation$ training$ evaluation$ counseling$ promoting$ compensating and remedial actions

+anagements philosoph and operating st le :rganisational structure Assignment o# authorit and responsibilit Human resource policies and practices

The auditor should see whether control environment elements have been implemented b a combination o# in'uiries and other risk assessment procedures: :bservation &nspection

'"*

:ntity5s ris! assessment rocess

The &*A sa s 7the auditor should obtain an understanding o# the entit s process #or identi# ing business risks relevant to #inancial reporting ob,ectives and deciding about actions to address those risks$ and the results thereo#! (actors to consider include how management: &denti#ies business risks relevant to #inancial reporting

002

Estimates the signi#icance o# the risks Assesses the likelihood o# their occurrence Hecides upon actions to manage business risks

&# the entit has a good risk management process$ this should assist the auditor in determining the risks o# material misstatement!

'"-

Information system

The auditor is re'uired to consider the in#ormation s stem relevant to #inancial reporting ob,ectives$ including the accounting s stem! The &*A sets out detailed re'uirements #or the auditor to obtain an understanding o# the in#ormation s stem$ including the related business processes$ relevant to #inancial reporting$ including the #ollowing areas: The classes o# transactions in the entit s operations that are signi#icant to the #inancial statements -(*. The procedures$ within both &T and manual s stems$ b which those transactions are initiated$ recorded$ processed and reported in the (* The related accounting records$ whether electronic or manual$ supporting in#ormation$ and speci#ic accounts in the (*$ in respect o# initiating$ recording$ processing and reporting transactions How the in#ormation s stem capture events and conditions$ other than classes o# transactions$ other than classes o# transactions$ that are signi#icant to the #inancial statements The #inancial reporting process used to prepare the entit s #inancial statements$ including signi#icant accounting estimates and disclosures *o the auditor needs to understand the whole #inancial reporting s stem$ including how items such as depreciation -not a transaction. are reported$ how the use o# ,ournals is controlled$ how incorrect processing o# transaction is controlled -#or e%ample b the use o# control accounts.! &n addition$ the &*A sa s that 7the auditor should understand how the entit communicates #inancial reporting roles and responsibilities and signi#icant matters relating to #inancial reporting!

'"0

Control activities

Control activities are the policies and procedures in addition to the control environment that help ensure that management directives are carried out in order to achieve the entit s speci#ic ob,ectives! Control activities include those designed to revent or to detect and correct errors" E%amples include those relating to authori9ation$ per#ormance reviews$ in#ormation processing$ ph sical controls$ and segregation o# duties!

006

'"0"'

6erformance reviews

These control activities include reviews and anal ses o# actual per#ormance versus budgets$ #orecasts$ and prior period per#ormance= relating di##erent sets o# data 1 operating or #inancial 1 to one another$ together with anal ses o# the relationships and investigative and corrective actions= comparing internal data with e%ternal sources o# in#ormation!

'"0"*

Information rocessing

A variet o# controls are per#ormed to check accurac $ completeness$ and authori9ation o# transactions! The two broad groupings o# in#ormation s stems control activities are application controls and general &T3controls! -+ore on this in section 8. '"0"6hysical controls

These activities encompass the ph sical securit o# assets$ including ade'uate sa#eguards such as secured #acilities over access to assets and records= authori9ation #or access to computer programs and data #iles= and periodic counting and comparison with amounts shown on control records -#or e%ample comparing the results o# cash$ securit and inventor counts with accounting records.! '"0"0 $egregation of duties

$egregation implies a number of eo le being involved in the accounting process! Assigning di##erent people the responsibilities o# authori9ing transactions$ recording transactions$ and maintaining custod o# assets is intended to reduce the opportunities to allow an person to be in a position to both perpetrate and conceal errors or #raud in the normal course o# the persons duties!

'"1

8onitoring of controls

The &*A sa s 4the auditor should obtain an understanding of the ma3or ty es of activities that the entity uses to monitor internal control over financial re orting, including those related to those control activities relevant to the audit, and how the entity initiates corrective actions to its controls5" &n man entities internal auditors or personnel per#orming similar #unctions contribute signi#icantl to the monitoring o# an entit s controls through separate evaluations! The 008

e%ternal auditors ma make use o# the work o# internal auditors in carr ing out their own work

'"D

Confirming understanding

&n order to con#irm their understanding o# the control s stems$ auditors will o#ten carr out 7walk 1 through tests! This is where the pick up a transaction and #ollow it through the s stem to see whether all the controls the anticipate should be in e%istence were in operation with regard to that transaction!

'"G

$mall com anies ) the roblem of control

+an controls$ which would be relevant to a large enterprise$ are neither practical nor appropriate #or the small enterprise! (or these the most important #orm o# internal control is generall the close involvement o# the directors or ro rietors" However$ that ver involvement will enable them to override controls and$ i# the wish$ to e@clude transactions #rom the records! Auditors can have di##iculties not because there is a general lack o# controls but because the evidence available as to their operation and the completeness o# the records is insu##icient! *egregation o# duties will o#ten appear inade'uate in enterprises having a small number o# sta##! *imilarl $ because o# the scale o# the operation$ organi9ation and management controls are likel to be rudimentar at best! The onus is on the proprietor$ b virtue o# his da 1 to da involvement$ to compensate #or this lack! This involvement should encompass ph sical$ authori9ation$ arithmetical and accounting checks as well as supervision! However it is important to stress that in a well run compan there will be a s stem o# internal control! &n an case$ all companies must compl with the provisions o# the Companies Act concerning the maintenance o# a proper accounting s stem! /here the manager o# a small business is not himsel# the owner$ he ma not possess the same degree o# commitment to the running o# it as an owner 1 managed would! &n such cases$ the auditor will have to consider the ade'uac o# controls e%ercised b shareholders over the manager in assessing internal control!

'"H

&imitation of accounting and control systems

There are alwa s inherent limitations to internal controls

00;

An internal control s stem can onl provide the directors with reasonable assurance that their ob,ectives are reached$ because o# inherent limitations" These include: The costs o# control not outweighing their bene#its Collusion between emplo ees The potential #or human error The possibilit o# controls being b 3 passed or overridden b management Controls being designed to cope with routine and not non 1 routine transactions These #actors show wh auditors cannot obtain all their evidence #rom tests o# the s stems o# internal control! The ke #actors in the limitations o# controls s stem are human error and potential #or #raud! The sa#eguard o# segregation o# duties can help deter #raud! However$ i# emplo ees decide to perpetrate #rauds in harness$ or management commit #raud b overriding s stems$ the accounting s stem will not be able to prevent such #rauds! This is one reason that auditors need to be alert to the possibilit o# #raud$ the sub,ect o# &*A 06> was discussed in chapter 0!

*"(

#ssessing the ris!s of material misstatement

The auditors must assess the ade'uac o# the s stems as a basis #or the #inancial statements and must identi# risks o# material misstatements! I$# -'1"'(( The auditor should identify and assess the ris!s of material misstatement at the financial statement level, and at the assertion level for classes of transactions, account balances, and disclosures" The #ollowing are e%amples o# conditions and events that ma indicate the e%istence o# risks o# material misstatement! High degree o# comple% regulation Foing concern and li'uidit issues including loss o# signi#icant customers! Changes in the industr in which the entit operates Changes in the suppl chain E%panding into new locations Entities or business segments likel to be sold Comple% alliances and ,oint ventures *igni#icant transactions with related parties Gack o# personnel with appropriate accounting and #inancial reporting skills! Changes in ke personnel including departure o# ke e%ecutives! /eaknesses in internal control$ especiall those not addressed b management! 00?

Changes in the &T environment! &n'uiries into the entit s operations or #inancial results b regulator or government bodies! *igni#icant amount o# non3routine or non3s stematic transactions Application o# new accounting pronouncements Accounting measurements that involve comple% processes Events or transactions that involve signi#icant measurement uncertaint $ including accounting estimates! Pending litigation and contingent liabilities$ #or e%ample$ sales warranties$ #inancial guarantees and environmental remediation!

*"'

#cting on control ris! assessment

&# the auditors believe the s stem o# controls is strong$ the ma choose to test controls to assess whether the can rel on the controls having operated e##ectivel ! *"'"' Test of control Tests of control are per#ormed to obtain audit evidence about the e##ectiveness o# the: Hesign o# the accounting and internal control s stems$ i!e! whether the are suitabl designed to prevent or detect and corre6ct material misstatement= and :peration o# the internal controls throughout the period Tests o# control ma include the #ollowing -a. -b. -c. -d. -e. -#. &nspection o# documents supporting controls or events to gain audit evidence that internal controls have operated properl $ e!g! veri# ing that a transaction has been authori9ed &n'uiries about internal controls which leave no audit trail$ e!g! determining who actuall per#orms each #unction not merel who is supposed to per#orm it Re 3 per#ormance o# control procedures$ e!g! reconciliation o# bank accounts$ to ensure the were correctl per#ormed b the entit E%amination o# evidence o# management views$ e!g! minutes o# management meetings Testing o# internal controls operating on computeri9ed s stems or over the overall in#ormation technolog #unction$ e!g! access controls :bservation o# controls! Auditors will consider the manner in which the control is being operated

Auditors should consider: How controls were applied The consistenc with which the were applied during the period

00B

" whom the were applied

Heviation in the operation o# controls -caused b change o# sta## etc. ma increase controls risk and tests o# control ma need to be modi#ied to con#irm e##ective operation during and a#ter an change! The use o# CAATs -Computer Assisted Audit Techni'ues. ma be appropriate! &n a continuing engagement$ the auditor will be aware o# the accounting and internal control s stems through work carried out previousl but will need to update the knowledge gained and consider the need to obtain #urther audit evidence o# an change in control!

*"'"*

Revision of ris! assessment

The auditors ma #ind that the evidence the obtain #rom controls testing indicates that controls did not operate as well as the e%pected! &# the evidence contradicts the original risk assessment$ the auditors will have to amend the #urther procedures the have planned to carr out! &n particular$ i# controls testing reveal that controls have not operated e##ectivel throughout the ear$ the auditor ma have to e%tend substantive testing! *"'"Communication of wea!nesses

*igni#icant weaknesses on internal controls should be communicated in writing with those charged with governance!

>uestion
Hescribe the in#ormation ou will seek$ and procedures ou will per#orm in order to understand the entit and its environment and assess risk #or the audit o# +usonda #or the ear ending 21 Hecember 0>>6!

#nswer:
.a/ &n#ormation and procedures: understanding the entit and its environment and risk assessment #or +usonda! i. Inderstanding the entit and risk assessment is likel to involve a review o# prior ear risk assessments as a starting point and the identi#ication o# changes during the ear #rom the in#ormation gathered that ma alter that assessment!

00D

ii.

Risk assessment procedures involve en'uiries o# management and others$ anal tical procedures and observation and inspection! +embers o# the engagements team should discuss the susceptibilit o# the #inancial statements to material misstatements! Risk assessment also involves obtaining an understanding o# the relevant industr $ regulator and other matters including the #inancial reporting #ramework$ the nature o# the entit $ the application o# accounting policies$ the entit s ob,ectives and related business risks$ and its #inancial per#ormance! This ma involve: 1! a review o# prior ear working papers noting an particular issues that arose warranting attention in the current ear= 0! Hiscussions with the audit senior or manager working on +usonda in prior ears to establish an particular problem areas= 2! Hiscussions with +usonda -and their other advisors such as banks and law ers. to establish an particular problem areas= 6! A review o# an third part in#ormation on the client such as press reports= 8! A review o# management accounts$ an #inancial in#ormation provided to the stock e%change or dra#t #inancial statements that ma be available to establish trends in the business= ;! A review o# an changes in stock e%change re'uirements= ?! A review o# s stems documentation -either generated b +usonda or held b the #irm. to see i# it needs updating! B! Auditors should obtain an understanding o# the control environment$ the entit s process #or identi# ing and dealing with business risk$ in#ormation s stems$ control activities and monitoring o# controls!

iii.

iv.

Risks should be assessed at the #inancial statements level$ and at the assertion level$ and identi# signi#icant risks that re'uire special audit consideration$ and risks #or which substantive procedures alone do not provide su##icient$ appropriate audit evidence! Anal tical procedures are o#ten used to highlight areas warranting particular audit attention! &n the case o# +usonda$ the are likel to #ocus on inventor $ which is likel to have a signi#icant e##ect on pro#it -there ma be slow moving or obsolete inventor that needs to be written down. and on propert $ plant and e'uipment which -as a manu#acturer and distributor. is likel to be a signi#icant item on the balance sheet! Risk assessment will #acilitate the determination o# materialit and tolerable error -calculations are normall based on sales$ pro#it and assets. that will be used in determining the sample si9es and in the evaluation o# errors!

v.

vi.

-"(

Internal controls in a CI$ environment

02>

There are s ecial considerations for the auditor when a system is com uteriEed" &nternal controls in a Computeri9ed &n#ormation * stem -C&*. environment includes both manual procedures and procedures designed into computer programs! *uch manual and computer control procedures comprise two t pes o# control! 7eneral CI$ controls aim to establish a #ramework o# overall control over the computer in#ormation s stems activities to provide a reasonable level o# assurance that the overall ob,ectives o# internal controls are achieved! CI$ a lication controls are the speci#ic controls over the relevant accounting applications maintained b the computer! The purpose o# application controls is to establish speci#ic control procedures over the accounting applications in order to provide reasonable assurance that all transactions are authori9ed and recorded$ and are processed completel $ accuratel and on a timel basis!

-"'

7eneral controls
*tandards over s stem design$ programming and documentation (ull testing procedures using test data Approval b computer users and management *egregation o# duties so that those responsible #or design are not responsible #or testing &nstallation procedures so that data is not corrupted in transition Training sta## in new procedures and availabilit o# ade'uate documentation *egregation o# duties (ull records o# program changes Password protection o# programs so that access is limited to computer operations sta##! Restricted access to central computer b locked doors$ ke pads +aintenance o# programs logs Pirus checks on so#tware: use o# anti3virus so#tware and polic prohibiting use o# non3 authorised programs or #iles "ack 1 up copies o# programs being taken and stored in other locations Control copies o# programs being preserved and regularl compared with actual programs *tricter controls over certain programs b use o# read onl memor

7:N:R#& CONTRO&$ Hevelopment o# computer applications

Prevention or detection o# unauthori9ed changes to programs

021

Testing and documentation o# program changes

Complete testing procedures Hocumentation standards Approval o# changes b computer users and management Training o# sta## using programs

Controls to prevent wrong programs or #iles being used Controls to prevent unauthori9ed amendments to data #iles Controls to ensure continuit o# operation

:peration controls over programs Gibraries o# programs Proper ,ob scheduling *ee section below on real 1 time s stems *toring e%tra copies o# programs and data #iles o## site Protection o# e'uipment against #ire and other ha9ards "ack3up power sources Emergenc procedures Hisaster recover procedures eg availabilit o# back3up computer #acilities! +aintenance agreements and insurance

The auditors will wish to test some or all o# the above general C&* controls$ having considered how the a##ect the C&* applications signi#icant to the audit! Feneral C&* controls that relate to some or all applications are usuall interdependent controls$ i!e! their operation is o#ten essential to the e##ectiveness o# C&* application controls! As application controls ma be useless when general controls are ine##ective$ it will be more e##icient to review the design o# general controls #irst$ be#ore reviewing the application controls! The purpose o# C&* application controls is to establish speci#ic control procedures over the accounting applications in order to provide reasonable assurance that all transactions are authori9ed and recorded$ and processed completel $ accuratel and on timel basis! C&* application controls include the #ollowing!

-"*

lication controls

#66&IC#TION CONTRO&$ Controls over completeness +anual programmed agreement o# control totals Hocument counts :ne #or one checking o# processed output to source documents

020

Programmed matching o# input to e%pected input control #ile Procedures over resubmission o# re,ected controls

Controls over input: accuracy

Controls over input: authori9ation Controls over processing

Programmes to check data #ields -#or e%ample value$ re#erence number$ date. on input transactions #or plausibilit Higit veri#ication -e!g! re#erence numbers are as e%pected. Reasonableness test -e!g! PAT to total value. E%istence checks -e!g! customer name.m Character checks -no une%pected characters used in re#erence. <ecessar in#ormation -no transaction passed with gaps. Permitted range -no transaction processed over a certain value. +anual scrutin o# output and reconciliation to source Agreement o# control totals -manual)programmed +anual checks to ensure in#ormation input was Authori9ed &nput b authori9ed personnel *imilar controls to input must be completed when input is completed$ #or e%ample$ batch reconciliations! *creen warnings can prevent people logging out be#ore processing is complete :ne to one checking C clical reviews o# all master #iles and standing data Records count -number o# documents processed. and hash totals -#or e%ample$ the total o# all the pa roll numbers. used when master #iles are used to ensure no deletions Controls

Controls over master #iles and standing data

Control over input$ processing$ data #iles and output ma be carried out b : C&* personnel Isers o# the s stem A separate control group +a be programmed into application so#tware! The auditors ma wish to test the #ollowing C&* application controls

022

T:$TIN7 O9 TF: #66&IC#TION CONTRO&$ +anual controls e%ercised b the user

&# manual controls e%ercised b the user o# the application s stem are capable o# providing reasonable assurance that the s stems output is complete$ accurate and authori9ed$ the auditors ma decide to limit tests o# control to these manual controls!

T:$TIN7 O9 TF: #66&IC#TION CONTRO&$ Control over s stem output

Programmed control procedures

&#$ in addition to manual controls e%ercised b the user$ the controls to be tested use in#ormation produced b the computer or are contained within computer programs$ such controls ma be tested b e%amining the s stems output using either manual procedures or CAATs! *uch output ma be in the #orm o# magnetic media$ micro#ilm or printouts! Alternativel $ the auditor ma test the control b per#orming it with the use o# CAATs! &n the case o# certain computer s stems$ the auditor ma #ind that it is not possible or$ in some cases$ not practical to test controls b e%amining the s stems output! The auditor ma consider per#orming tests o# control b using CAATs$ such as test data$ reprocessing transaction data or$ in unusual situations$ e%amining the coding o# the application program!

-"-

On ) line systems

:n3line computer s stems are computer s stems that enable users to access data and programs directl through terminal devices! The ma be based on main#rame computers$ minicomputers or microcomputers structured in a network environment! :n3 line s stem allows users to initiate various #unctions directl $ including the #ollowing! Enter transactions$ e!g! sales transactions in a retail store$ cash withdrawals in a bank +ake en'uiries$ e!g! current customer account or balance in#ormation Re'uest reports$ e!g! a list o# inventor items with negative 7on hand 'uantities Ipdate master #iles$ eg set up new customer accounts Electronic commerce activities -ordering and pa ing #or goods b internet.

026

Hata entered on 1line is usuall sub,ect to immediate validation! Hata$ which #ails validation$ is re,ected= o#ten users are o##ered on 1 screen #acilities #or altering the data and re3entering it! Inlimited access #or all #unctions -enter transactions$ read$ change$ delete program)data #iles etc. is undesirable$ because the user ma be able to make unauthori9ed changes! E%tent o# access depends on application and access control so#tware designs! * stems$ which do not provide supporting documents$ ma give details o# transactions on re'uest or through the use o# transaction logs! Again unrestricted access is not desirable because o# the potential #or unauthori9ed changes to programs! The e%tent o# access depends on the re'uirements o# the s stem$ in man s stems programmers would onl have access to programs maintained in a separate development and maintenance librar ! -"-"' Internal control in an on?line com uter system

Feneral C&* controls should include: -a. #ccess controls" These are procedures designed to restrict access to programs and data! These include the use o# passwords and speciali9ed access control so#tware -eg on3line monitors that maintain control over menus$ authori9ation tables$ passwords$ #iles and programs that users are permitted to access. -b. Controls over asswords" These are procedures #or the assignment and maintenance o# passwords! These should restrict access to authori9ed users! -c. * stem development and maintenance controls -d. 6rogramming controls" These procedures designed to prevent or detect improper changes to computer programs$ which are accessed through on3 line devices! Access ma be restricted b controls such as the use o# separate operational and program development libraries! &t is important #or on3line changes to be ade'uatel documented! -e. Transaction logs" These are reports$ which are designed to create an audit trail #or each on3line transaction! -#. (irewall! These are a combination o# hardware and so#tware that protects the server #rom unauthorised access through the &nternet! C&* application controls should include: -a. 6re? rocessing authoriEation" This is permission to initiate a transaction$ such as the use o# a bankcard together with a personal identi#ication number be#ore making cash withdrawal through an automated teller machine! -b. Terminal device edit reasonableness and other validation tests" These are programmed routines that check the input data and processing results #or completeness! -c. Cut 1o## procedures! These ensure that transactions are processed in the proper accounting period! These are particularl necessar in s stems$ which have a continuous #low o# transactions!

028

-d. -e. -#.

9ile controls" These are procedures$ which ensure that the correct data #ields are used #or on3line processing! 8aster file controls" *ince master #iles data ma have a pervasive e##ect on processing results$ more stringent en#orcement o# these controls procedures ma be necessar ! "alancing! This is the process o# establishing control totals over data being submitted #or processing through the on 1line terminal devices and comparing the control totals during and a#ter processing to ensure that complete and accurate data are trans#erred to each processing phase!

0"( :lectronic Data interchange systems


Electronic Hata &nterchange -EH&. s stems allow businesses to transmit standard business documents such as sales invoices or purchase orders electronicall EH& s stems pose a number o# problems #or auditors! -a. :riginating documents ma be eliminated$ and there ma be a lack o# evidence o# the operation o# controls! -b. The conse'uences o# problems ma be enhanced! Freater integration between the various aspects o# an entit s accounting s stem is likel $ and problems with one business ma have a serious impact upon its suppliers or competitors! Computer #ailure ma rapidl lead to material losses! -c. The risk o# unauthori9ed access to data ma be increased! <ot onl will a business have to have its own controls but it will have to rela s well on the controls operated b its business partners! Controls over transmission including acknowledgements$ agreements b both parties o# amounts transmitted$ authentication codes and encr ption are particularl important! Transactions should be monitored continuousl b checking the se'uence o# transaction numbers and integrated test #acilities within the computer! Gimitation controls$ such as onl allowing transactions with certain businesses could be built into the organisations computer s stem! There should also be virus protection and appropriate insurance$ and contingenc plans and back3up arrangements! Auditors are likel to place signi#icant reliance on controls and ma be able to test compliance with agreed best practice! Auditors ma also be able to obtain assurance on the working o# controls o# business partners b obtaining a certi#icate #rom their auditors!

1"(

Data base systems

Hata base s stems consist o# two components: The data base The data base management s stem -H"+*.

02;

There must be e##ective control over the database$ the H"+* and applications! The e##ectiveness o# the controls depends on the nature o# the database administration tasks and how the are per#ormed! The characteristics o# database s stems mean that general C&* controls have greater in#luence than C&* application controls! Feneral C&* controls have a pervasive e##ect on application processing in database s stems and the can be classi#ied into the #our groups discussed below -a. -b. *tandard approach #or development and maintenance o# application programs! Hata ownership! The database administrator must clearl assign responsibilit #or the accurac and integrit o# each item o# data! A single data owner should be responsible #or de#ined access rules -who can use the data. and securit rules -what #unctions the can per#orm.! Restriction o# access to the database through the use o# passwords etc! *egregation o# duties! Responsibilities #or per#orming the various activities re'uired to design$ implement and operate a database should be divided among technical$ design$ administrative and user personnel! Their duties include s stem design$ database design$ administration and operation!

-c. -d.

D"(

Documentation of accounting and control systems

The auditor must keep a record o# the clients s stems$ which must be updated each ear! There are several techni'ues #or recording the assessment o# control risk$ that is$ the s stem! :ne or more ma be used depending on the comple%it o# the s stem! <arrative notes (lowcharts Euestionnaires -#or e%ample &CE. /hatever method o# recording the s stem is used$ the record will usuall be retained on the permanent audit #ile and updated each ear! /e shall concentrate on the two t pes 'uestionnaires in this s llabus! Each o# these 'uestionnaires has a di##erent purpose! Internal Control >uestionnaires .IC>s/ are used to ask whether controls e%ist which meet speci#ic control ob,ectives! &nternal Control Evaluation Euestionnaires -&CEEs. are used to determine whether there are controls$ which prevent or detect speci#ied errors or omissions!

D"'

Internal Control >uestionnaires .IC>s/

The ma,or 'uestion which internal control 'uestionnaires are designed to answer is 7How good is the s stem o# controls4

02?

/here strengths are identi#ied$ the auditors will per#orm work in the relevant areas! &#$ however$ weaknesses are discovered the should then ask: /hat errors or irregularities could be made possibl b these weaknesses4 Could such errors or irregularities be material to the accounts4 /hat substantive procedures will enable such errors or irregularities to be discovered and 'uanti#ied4 An &CE is ideall a list o# 'uestions designed to ascertain and identi# controls that indicate areas o# strength and weaknesses A t pical &CE might take the #ormat bellow: Internal Control questionnaire ) sales cycle 6re ared by2 Date2 Reviewed by2 Date2 Client2 Control ob3ective2 (aut"ori3ation prompt and accurate recording etc) >uestionnaire Je s Ordering ' Are pre3numbered order #orms used and checked #or completeness4 * Are all orders checked #or creditworthiness o# the customer and availabilit be#ore acceptance4 - Are all orders periodicall checked #or cross re#erencing to invoices4 Dis atch ' Are all goods checked to order prior to dispatch4 * &s dispatch documentation pre3numbered and periodicall checked #or completeness4 - Are all dispatch notes cross3 re#erenced to invoices4 K o 0omment s 9efer to.

D"*

Internal Control :valuation >uestionnaires .IC:>s/

&n recent ears man auditing #irms have developed and implemented an evaluation techni'ue more concerned with accessing whether speci#ic errors -or #rauds. are possible rather than establishing whether certain desirable controls are present! The characteristic o# these 'uestions is that the concentrate on the signi#icant errors or omissions that could occur at each phase o# the appropriate c cle i# controls are weak

02B

A t pical &CEE might take the #orm below: Internal Control :valuation >uestionnaire ) $ales cycle Prepared b : Reviewed by2 Client2 Control ob,ectives: $as above% Hate: Date2

>uestionnaire Invoicing Is it ossible for invoices to be raised but not recorded, ' Are invoices pre3numbered and checked periodicall #or completeness4 * Are invoices batched and totaled prior to input4 - &s a sale ledger maintained and reconciled to the control accounts4 Is it ossible for invoices to be raised for incorrect rices or quantities, ' Are invoices raised with re#erence to authori9ed price list4 * Are invoices checked to order and dispatch documentation be#ore being raised4 - Are invoices reviewed be#ore dispatch4 Je s K o 0ommen t 9efer to.

D"-

#dvantages and disadvantages of questionnaires

IC>s2 advantages &# dra#ted thoroughl $ can ensure all controls are considered! The are 'uick to prepare! The are eas to use and control! IC>s2 disadvantages The client ma be able to overstate controls! The ma contain a large number or irrelevant controls! The ma not include unusual controls$ which are nevertheless e##ective in a particular circumstance! The can give the impression that all controls are o# e'ual weight! &n man s stems one <: answer -#or e%ample lack o# segregation o# duties. will cancel out a string o# 5E* answers! 02D

IC:>s2 advantages "ecause the are dra#ted in terms o# ob,ectives rather than speci#ic controls$ the are easier to appl to a variet o# s stems than &CEs! Answering &CEEs should enable auditors to identi# the ke controls$ which the are most likel to test during control testing! &CEEs can highlight areas o# weakness where e%tensive substantive testing will be re'uired! IC:>s2 disadvantage The can be dra#ted vaguel $ hence misunderstood and important controls not identi#ied!

G"(

Design, 8aintenance and 8onitoring Internal Controls

The auditor needs to pa particular attention to the manner in which the s stems o# internal controls have been designed and whether these controls have operated effectively throughout the period under review! Here$ we shall concentrate on the design o# internal controls and the tests of controls the auditor is e%pected to per#orm on the ma3or transaction cycles" The transaction c cles we deal with here are sales, urchases and salaries!

G"'

The sales system

The tests o# controls in the sales s stem will be based around: *elling -authori9ation.$ Foods outwards -custod . and Accounting -recording. G"'"' #ims .ob3ectives/ of controls #ims Foods and services are onl supplied to customers with good credit ratings Customers are encouraged to pa promptl :rders are recorded correctl :rders are #ul#illed All dispatches o# goods are recorded All goods and services sold are correctl invoiced All invoices raised relate to goods and services supplied b the business Credit note are onl given #or valid reasons All sales that have been invoiced are recorded in the general and sales ledger 06>

#rea Ordering and granting of credit

Dis atch and invoicing

Recording, accounting M

credit control

All credit notes that have been issued are recorded in the general and sales ledgers All entries in the sales ledger are made to the correct sales ledger accounts Cut3o## is applied correctl to the sales ledger Potentiall doubt#ul debts are identi#ied

G"'"*

Controls Controls *egregation o# duties$ credit control$ invoicing and inventor dispatch Authori9ation o# credit terms to customers vi. Re#erences)credit checks obtained vii. Authori9ation b senior sta## viii. Regular review Authori9ation #or changes in other customer data vii. Change o# address supported b letterhead viii. Heletion re'uests supported b evidence balances cleared)customer in li'uidation :rders onl accepted #rom customers who have no credit problems *e'uential numbering o# blank pre3printed order documents Correct prices 'uoted to customers +atching o# customers orders with production orders and dispatch notes and 'uer ing o# orders not matched Healing with customer 'ueries Authorisation o# dispatch o# goods i. Hispatch onl on sales order ii. Hispatch onl to authori9ed order iii. *pecial authori9ation o# dispatches o# goods #ree o# charge or on special terms E%amination o# goods outwards as to 'uantit $ 'ualit and condition Recording o# goods outwards Agreement o# goods outwards records to customer orders$ dispatch notes and invoices Pre3numbering o# dispatch notes and deliver notes and regular checks on se'uence

#rea Ordering and a roval rocess

Dis atches and invoice re aration

061

Recording and credit roblems #rea

Condition o# returns checked Recording o# goods returned on goods returned notes Preparation o# invoices and credit notes iv. Authori9ation o# selling prices)use o# price lists v. Authori9ation o# credit notes vi. Checks on prices$ 'uantities$ e%tensions and totals on invoices and credit notes vii. *e'uential numbering o# blank invoices)credit notes and regular se'uence checks *ignature o# deliver notes b customers &nventor records updated +atching o# sales invoices with dispatch and deliver notes and sales orders Regular review #or dispatch notes not matched b invoices

*egregation o# duties: recording sales$ maintaining customer accounts and preparing statements Recording o# sales invoices se'uence and control over spoilt invoices +atching o# cash receipts with invoices Retention o# customer remittance advices *eparate recording sales returns$ price ad,ustments etc Cut3o## procedures to ensure goods dispatched and not invoiced -or vice versa. are properl dealt with in the correct period Regular preparation o# trade accounts receivable statements Checking o# trade accounts receivable statements *a#eguarding o# trade accounts receivable statements so that the cannot be altered be#ore dispatch Controls Review and #ollow3up o# overdue accounts Authori9ation o# writing o## o# bad debts Reconciliation o# sales ledger control account Anal tical review o# sales ledger and pro#it margins

G"'"- Test of controls


#rea :rdering and granting o# credit Test of controls Check that re#erences are being obtained #or all new customers Check that orders are onl accepted #rom customers who are within their credit terms and credit limits Check that all new accounts on the sales ledger have been authorised b senior sta## 060

Hispatches and invoices

Area

Check that customer orders are being matched with production orders and dispatch notes! Peri# details o# trade sales or goods dispatched notes with sales invoices checking vi. Euantities vii. Prices charged with o##icial price lists viii. Trade discounts have been properl dealt with i%. Calculations and additions %. Entries in sales da book are correctl anal sed %i. PAT$ where chargeable$ has been properl dealt with! %ii. Postings to sales ledger Peri# details o# trade sales with entries in inventor records Peri# non3routine sales -scrap$ non current assets etc. with: iv. Appropriate supporting evidence v. Approval b authori9ed o##icials vi. Entries in plant register Peri# credit notes with: iii. Correspondence or other supporting evidence iv. Approval b authori9ed o##icials v. Entries in inventor records vi. Entries in goods returned records vii. Calculations and additions viii. Entries in da book$ checking these are correctl anal sed i%. Postings to sales ledger Test numerical se'uence o# dispatch notes and en'uiries

Test of controls Test numerical se'uence o# invoices and credit notes$ en'uire into missing numbers and inspect copies o# those cancelled Test numerical se'uence o# order #orms and en'uire into missing numbers Check that dispatches o# goods #ree o# charge or on special terms have been authori9ed b management Recording o# and accounting #or sales *ales da book Check entries with invoices and credit notes respectivel Check additions and cross casts Check postings to sales ledger control account Check postings to sales ledger *ales ledger 062

B D 1> 11 10 12 16 18

Check entries in a sample o# accounts to sales da book Check additions and balances carried down <ote and en'uire into entries Check that control accounts have been regularl reconciled to total o# sales ledger balances *crutini9e accounts to see i# credit limits have been observed Check that trade accounts receivable statements are prepared and sent out regularl Check that overdue accounts have been #ollowed up Check that all bad debts written o## have been authori9ed b management

G"*

The urchases and e@ enses system

The tests o# controls in the purchases s stem will be based around: "u ing -authori9ation. Foods inwards -custod . Accounting -recording. G"*"' #ims .ob3ectives/ of controls #ims All orders #or goods and services received are properl authori9ed$ and are #or goods and services that are actuall received and are #or the compan :rders are onl made to authori9ed suppliers :rders are made at competitive tenders All goods and services received are used #or the organi9ations purposes$ and not private purposes Foods and services are onl accepted i# the have been ordered$ and the order has been authori9ed All goods and services received are accuratel recorded Giabilities are recogni9ed #or all goods and services that have been received All credits to which business is due are claimed and received Receipt o# goods and services is necessar to establish a liabilit to be recorded! All e%penditure is #or goods that are received All e%penditure is authori9ed

#rea :rdering

Receipt and invoices

Accounting

066

G"*"* Controls #rea :rdering

All e%penditure that is made is recorded correctl in the general and purchase ledger All credit notes that are received are recorded in the general and purchase ledger All entries in the purchase ledger are made to the correct purchase ledger accounts Cut3o## is applied correctl to the purchase ledger

Foods M invoices received

Controls *egregation o# duties= re'uisition and ordering Central polic #or choice o# suppliers Evidence re'uired o# re'uirements #or purchase be#ore purchase authori9ed -re3order 'uantities and re3order levels. :rder #orms prepared onl when a pre3numbered purchase re'uisition has been received Authori9ation o# order #orms Pre3numbered order #orms *a#eguarding o# blank order #orms Review #or orders not received or invoiced +onitoring supplier terms and taking advantage o# #avourable conditions -bulk order$ discount.! E%amination o# goods inwards i. Eualit ii. Eualit iii. Condition Recording arrival and acceptance o# goods -pre3numbered goods received notes. Comparison o# goods received notes with purchase orders Re#erencing o# suppliers invoices$ numerical se'uence and supplier re#erence Checking o# suppliers invoices i. Prices$ 'uantities$ accurac o# calculation ii. Comparison with order and goods received Recording return o# goods -pre3numbered goods returned notes. Procedures #or obtaining credit #rom suppliers *egregation o# duties= accounting and checking #unctions Prompt recording o# purchases and purchase returns in da books and ledger Regular maintenance o# purchase ledger Comparison o# supplier statements with purchase ledger balances

Accounting #or purchases

068

G"*"Tests of controls

Authori9ation o# pa ments i. Authorit limits ii. Con#irmation that goods have been received$ accord with purchase order$ and are properl priced and invoiced Review o# allocation o# e%penditure Reconciliation o# purchase ledger control account to total o# purchase ledger balances Cut3o## accrual o# goods received notes not matched b purchases at ear end

A most important test o# control is #or auditors to check that all invoices are supported b authori9ed purchase invoices and purchase orders! The o##icials who approve the invoices should be operating within laid3down authorit limits!

06;

#rea Recei ts of goods and invoices

Test of controls Check invoices #or goods$ raw materials are: i. *upported b goods received notes and inspection notes ii. Entered in inventor records iii. Priced correctl b checking to 'uotations$ price lists to see the price is in order iv. Properl re#erence with a number and supplier code v. Correctl coded b t pe o# e%penditure Trace entr in record o# goods returned etc and see credit note dul received #rom supplier$ #or invoices not passed due to de#ects or discrepanc ! (or invoices o# all t pes: i. Check calculations and additions ii. Check entries in purchase da book and veri# that the are correctl anal sed iii. Check posting to purchase ledger (or credit notes: i. Peri# the correctness o# credit received with correspondence ii. Check entries in inventor records iii. Check entries record o# returns iv. Check entries in purchases da book and veri# that the are correctl anal sed v. Check postings to purchase ledger Check #or returns that credit notes are dul received #rom suppliers Test numerical se'uence and en'uire into missing numbers o#: i. Purchase re'uisitions ii. Foods received notes iii. *uppliers invoices iv. Purchase orders v. Foods returned notes :btain e%planation #or items which have been outstanding #or a long time: i. Inmatched purchase re'uisitions ii. Purchase orders iii. Foods received notes -i# invoices not received. iv. Inprocessed invoices

06?

Recording of urchases

Peri# that invoices and credit notes recorded in the purchase da book are: i. &nitialed #or prices$ calculations and e%tensions ii. Cross re#erenced to purchase orders$ goods received notes etc iii. Authori9ation #or pa ment Check additions Check postings to general ledger accounts and control account Check postings to purchase ledger 6urchase ledger (or sample o# accounts recorded in the purchase ledger i. Test check entries back into books o# prime entr ii. Test check additions and balances #orward iii. <ote and en'uire into all contra entries Con#irm control account balancing has been regularl carried out during the ear E%amine control account #or unusual entries

G"-

The wages system

The ke controls over wages cover: Hocumentation and authori9ation o# sta## changes Calculation o# wages and salaries Pa ment o# wages Authori9ation o# deductions G"-"' #ims .ob3ectives/ of control #ims Emplo ees are onl paid #or work that the have done Fross pa has been calculated correctl and authori9ed Fross and net pa and deductions are accuratel recorded on the pa roll /ages and salaries paid are recorded correctl in the bank and cash records /ages and salaries are correctl recorded in the general ledger The correct emplo ees are paid All deductions have been calculated correctl and are authori9ed The correct amounts are paid to the ta%ation authorities

#rea $etting of wages and salaries Recording of wages and salaries

6ayment of wages and salaries Deductions

06B

G"-"*

Controls

/hile in practice separate arrangements are generall made #or dealing with wages and salaries$ the considerations involved are broadl similar and #or convenience the two aspects are here treated together! #rea 7eneral arrangements Controls Responsibilit #or the preparation o# pa sheets should be delegated to a suitable person$ and ade'uate sta## appointed to assist him! The e%tent to which the sta## responsible #or preparing wages and salaries ma per#orm other duties should be clearl de#ined! &n this connection #ull advantage should be taken where possible o# the division o# duties$ and checks available where automatic wage accounting s stem are in use! *ta##ing and segregation o# duties +aintenance o# personnel records and regular checking o# wages and salaries to details in personnel records Authori9ation: i. Engagement and discharge o# emplo ees ii. Change in pa rates iii. :vertime iv. <on3statutor deductions -#or e%ample pension contributions. v. Advances o# pa Recording o# changes in personnel pa rates Recording o# hours worked b timesheets$ clocking in and out arrangements Review o# hours worked Recording o# advances o# pa Holida pa arrangements Answering 'ueries Review o# wages against budget *egregation o# duties i. Cash sheet preparation ii. (illing pa packets iii. Histribution o# wages Authori9ation o# wage che'ue cashed Custod o# cash i. Encashment o# che'ue ii. *ecurit o# pa packets iii. *ecurit o# transit iv. *ecurit and prompt banking o# unclaimed wages Peri#ication o# identit

$etting of wages and salaries

6ayment of cash wages

06D

6ayment of salaries

+ages and salaries

Deductions from ay

Recording o# distribution Preparation and authori9ation o# che'ues and bank trans#er lists Comparison o# che'ues and bank trans#er list with pa roll +aintenance and reconciliation o# wages and salaries bank account "ases #or compilation o# pa roll Preparation$ checking and approval o# pa roll Healing with non3routine matters +aintenance o# separate emplo ees records$ with which pa lists ma be compared as necessar Reconciliation o# total pa and deductions between one pa da and the ne%t *urprise cash counts Agreement p# gross earnings and total ta% deducted with ta%ation returns!

G"-"-

Tests of controls

Appropriate arrangements should be made #or dealing with statutor and other authori9ed deductions #rom pa $ such as ta%ation$ pension #und contributions and savings held in trust! A primar consideration is the establishment o# ade'uate controls over the records and authori9ing deductions!

08>

#rea $etting of wages and salaries

Test of controls Auditors should check that the wages and salar summar is approved #or pa ment! The should con#irm that procedures are operating #or authori9ing changes in rates o# pa $ overtime$ and holida pa A particular concern will be ,oiners and leavers! Auditors will need to obtain evidence that sta## onl start being paid when the ,oin the compan $ and are removed #rom the pa roll when the leave the compan ! The should check that the engagement o# new emplo ees and discharges have been con#irmed in writing! Auditors will also wish to check calculations o# wages and salaries! This test should be designed to check that the client is carr ing out checks on calculations and also to provide substantive assurance that wages and salaries are being calculated correctl ! (or wages$ this will involve checking calculation o# gross pa with: Authori9ed rates o# pa Production records! *ee that production bonuses have been authori9ed and properl calculated Clock cards$ time sheets or other evidence o# hours worked! Peri# that overtime has been authori9ed (or salaries$ auditors should veri# that gross salaries and bonuses are in accordance with personnel records$ letters o# engagement etc and that increases in pa have been properl authori9ed!

Recording of wages and salaries

Deductions

Additions and cross3 casts o# summar A ke control auditors will be concerned with will be the reconciliation o# Postings o# summar to general -including accounts. wages and salaries! (or wages$ thereledger should have beencontrol reconciliations Casts o# net cash column to cash book with: (or The salaries the include checking previous weeks pa roll #or a number o# weeks)months: Additions o# pa roll sheets Clock cards)time sheets),ob cards Costing Totals o# salaries to summar anal ses$ sheets production budgets Additions and cross3casts o# summar The total salaries should be reconciled with the previous week)month or standard Postings pa o# summar to general ledger -including control accounts. the roll! &n should con#irm that important calculations have been addition$ Total o# auditors net pa column to cash book checked b the clients and re3per#orm calculations Auditors should check the calculationsthose o# ta%ation and non3statutor These include checking #or wages #or a number o# weeks: deductions! o# pa roll the sheets (or Additions PA5E and <AP*A should carr out the #ollowing tests: *crutini9e the control Totals o# wages sheetsaccounts selected maintained to summar to see appropriate deductions have been made Check that pa ments to ta%ation bodies are correct The should check other deductions to appropriate records! (or voluntar 081

deductions$ the should see the authorit completed b the relevant emplo ees!

>uestion
&*A 57? Lnderstanding t"e entity and its environment and assessing t"e risks of material misstatement deals with the whole area o# controls! A proper understanding o# internal controls is essential to auditors in order that the understand the business and are able to e##ectivel plan and e%ecute tests o# controls and an appropriate level o# substantive procedures! 5ou are the auditor o# a small manu#acturing compan $ Cambe9i$ that pa s its sta## in cash and b bank trans#er and maintains its pa roll on a small stand3alone computer! Required: -a. (or the pa roll department at Cambe9i$ describe the: i. internal control objectives that should be in place= ii. &nternal control environment and internal control activities that should be in place to achieve the internal control ob,ectives! -b. (or the pa roll charges and pa roll balances -including cash. in the #inancial statements o# Cambe9i: i. describe the e%ternal auditor audit objectives= ii. Gist the tests of control and substantive procedures that will be applied in order to achieve the audit ob,ectives identi#ied in -b. -i. above!

#nswer
.a/ .i/ &nternal control ob,ectives Control ob,ectives include policies and procedures designed b management to: 1! Achieve the orderl and e##icient running o# the business including adherence to internal policies 1 this would include the regular$ accurate processing and recording o# pa roll pa ments! 0! *a#eguard assets 1 this would include the ph sical sa#eguarding o# cash and sa#eguarding mone held in bank accounts b means o# other controls! 2! Prevent and detect #raud and error 1 #raud and error would include incorrect pa ments or deductions #rom the pa roll and pa ments o# incorrect amounts #or ta% and social insurance$ pa ments #or work not per#ormed and pa ments to dumm emplo ees$ #or e%ample! 6! Achieve accurac and completeness o# the accounting records and timel preparation o# reliable #inancial in#ormation= this would include making correct

080

pa ments and deductions #rom the pa roll$ correct pa ments #or ta% and social insurance$ and making pa ments #or work per#ormed onl -not to dumm emplo ees$ #or e%ample.$ in order that 'uarterl or hal#3 earl accounts can be prepared -possibl .$ but in an case in order that annual accounts can be prepared within the time limits #or small companies! .ii/ &nternal control environment and control activities The control environment relates to: 1! +anagements overall st le in encouraging awareness o# the need #or good controls$ #or e%ample: 0! The e%istence o# organisational controls such as review o# the pa roll b an independent person such as the managing director$ and the rotation o# pa roll duties amongst sta## responsible #or processing it 1 this helps achieve all o# the ob,ectives set out above! 2! *egregation o# duties and supervisor controls to avoid the misappropriation o# cash -or allegations thereo#. and to avoid #raudulent collusion to create$ #or e%ample$ dumm emplo ees or to make in#lated pa ments 1 this prevents the loss o# assets and)or inaccurate records! &nternal control activities include: 6! Gimiting direct ph sical access to the cash$ such as the use o# a securit #irm to deliver cash$ locking doors to areas where cash is held$ keeping cash in a #ire3 proo# sa#e and the protection o# the computer b password controls 1 this will help sa#eguard assets and ensure the completeness and accurac o# the records and #inancial statements! 8! Controls over computerised applications$ checking the arithmetical accurac o# documents and the maintenance o# control accounts 1 this can be achieved b $ #or e%ample$ the use o# timesheets or clock cards$ the use o# reliable so#tware with programmed controls #or the calculation o# deductions$ and the use o# batch and hash totals #or in#ormation that is input into the computer s stem 1 this helps achieve the orderl and e##icient running o# the business and the accurac and completeness o# records and #inancial statements! ;! Approval and control o# documents$ such as the authorisation o# the pa roll itsel#$ and authorisation #or the bank to make trans#ers and to deliver cash! .b/ Audit ob,ectives$ tests o# control and substantive procedures

082

Ob3ectives E%istence: o# assets and liabilities such as cash on hand and in bank$ and o# the liabilit to pa sta## and the associated ta% and social insurance liabilities!

Tests of control and substantive rocedures Testing controls over the securit o# cash to ensure that the are operating e##ectivel throughout the relevant period! Per#orming cash counts$ with reconciliations to the records and observing cash pa ments to sta##$ ensuring that appropriate signatures are obtained and that unclaimed cash is promptl re3banked$ #or e%ample! +aking checks on the ph sical e%istence o# sta## to ensure that the related e%penses and liabilities are genuine! Checking a#ter date pa ments to sta## and #or ta% and social insurance contributions!

Ob3ectives :ccurrence: pa roll transactions occurred during the relevant accounting period Completeness: there are no unrecorded assets or liabilities -such as those noted under 7e%istence$ above. or transactions -such as pa roll pa ments. or undisclosed items

Tests of control and substantive rocedures Per#orming cut3o## tests to ensure that pa roll costs incurred during the period have been recorded during the period b e%amining entries in the pa roll records ,ust a#ter the period 1end and checking back to source documentation$ such as timesheets or clock cards! Per#orming starters and leavers tests to ensure that sta## are not paid be#ore the ,oin the compan and are not paid a#ter the leave 1 this involves checking the pa roll #or two separate periods e%amining entries relating to starters and leavers in the intervening period! +anuall checking the accurac o# pa roll calculations to ensure that correct pa ments and deductions with approved pa rates and approved deduction rates #or ta% and social insurance!

086

-such as unrecorded pa roll liabilities.! +easurement: transactions such as pa roll pa ments are recorded at the correct amounts and are recorded in the correct period Presentation and disclosure: an item is disclosed and described in accordance with accounting standards and legislation

Reviewing evidence o# authori9ation controls to ensure that the pa roll has alread been checked! As #or completeness above$ and checking to ensure that the pa roll has been properl authori9ed and reviewed! Checking entries relating to hours or overtime worked in the pa roll to source documentations! Reviewing the #inancial statements with the aid o# disclosure check lists to ensure that disclosure re'uirements have been met! Reviewing the overall presentation o# pa roll transactions and balances!

H"(

$maller entities

*egregation o# duties is a particularl important control in smaller entities!

H"'

8inimum business controls

The control s stems in smaller entities are o#ten not as sophisticated as those in larger entities! The particular area that can be a concern #or smaller entities with #ew sta## is segregation o# duties! &t can be impossible to ade'uatel share duties between sta## when there is onl one or two sta##! Having established earlier that proprietor involvement is a ke internal control in the small enterprise$ we need ne%t to be rather more precise and identi# the t pes o# control relevant to each principal accounting area! These controls can be re#erred to as 4minimum business controls5" &t is important to appreciate that such controls will not$ and cannot$ be evaluated and relied on b the auditors as in a 7s stems audit approach$ but the do provide overall com#ort to the auditors$ particularl when determining whether to seek to rel on management assurances as to the completeness o# the accounting records! The #ollowing checklist provides illustrative e%amples o# minimum control standards! #rea 8ail >uestion &s all mail received opened b the proprietor4 &# the proprietor does not himsel# open the mail$ is it opened b a person not connected with accounts and read b him be#ore it is

088

distributed to the sta##4 Recei ts %an!ing 6ayments Are all che'ues and postal orders received b post counted b the proprietor be#ore the are passed to the cashier4 Are all che'ues and postal orders crossed to the compan s branch o# its bankers 7Kot negotiable G accounts payee only$ Are cash sales and credit sale receipts over the counter controlled b locked cash register tapes which onl the proprietor can open4 Hoes the proprietor reconcile the cash register totals with the cash sales receipts dail 4 &s the person per#orming the duties o# cashier barred an responsibilit concerning the sales$ purchase or nominal ledgers4 &s all cash received banked intact at intervals o# not more than three da s4 Hoes the proprietor reconcile all monies received with the cop pa ing3slips at regular intervals4 Are all pa ments e%cept sundr e%penses made b che'ue4 Hoes the proprietor sign all the che'ues4 Are all che'ues signed b the proprietor onl a#ter he has satis#ied himsel# that: i. He has approved and cancelled all vouchers supporting the pa ment4 ii. All che'ues are crossed not negotiable and account pa ee onl 4 iii. All pett cash e%penses are accounted #or4 Are pett cash e%penses controlled b the imprest s stem4 Hoes the proprietor review all e%penses and initial the pett cash be#ore reimbursing the cashier4 Are bank statements and paid che'ues sent direct to the proprietor and opened onl b him4 Hoes the proprietor scrutini9e all paid che'ues to ensure that he has signed them all be#ore he passes them to the cashier4 Hoes the proprietor: i. Prepare bank reconciliation each month4 :r ii. Review in detail a reconciliation produced b the cashier4

%an! statements

08;

Orders

Recei t of goods

+ages

Receivables

7oods outwards

Are all purchase orders issued: i. *eriall numbered b the printer4 ii. Pre3printed duplicate order #orms4 Hoes the proprietor approve all orders4 Are deliver notes: Checked with goods4 Compared with the cop order4 Compared with the invoice4 &s a separate che'ue drawn #or the e%act amount to pa wages and ta%4 Hoes the proprietor either prepare or e%amine the wages records be#ore signing the che'ue4 Hoes the proprietor initial the wages records a#ter his e%amination4 Hoes the proprietor oversee the distribution o# the wages packets or does he distribute them himsel#4 &# credit is grated to customers does the proprietor: i. Authori9e ever e%tension o# credit to a customer4 ii. Approve credit limits #or each customer4 Hoes the proprietor authori9e all: i. /rite o##s o# bad debts4 ii. *ales returns and allowances4 iii. Hiscounts other than routine cash discounts4 Hoes the proprietor receive a monthl list o# trade accounts receivable$ showing the age o# the debts4 Are all authori9ations b the proprietor evidenced b his inials4 Are pre3numbered dispatch notes prepared #or all goods leaving the premises4 Are all dispatch notes: i. Accounted #or4 ii. Cross re#erenced with invoices and credit notes4 &s the proprietor satis#ied that all goods leaving the premises have been accounted #or4

Hoes the proprietor scrutini9e inventor regularl to: Keep abreast o# what is in inventor 4 Hiscover obsolete items4 Hiscover damaged articles4 Ensure that inventor levels are kept under control4 Although the above t pes o# control are desirable and #easible$ the are nevertheless relativel in#ormal! Conse'uentl evidence o# their per#ormance tends to be lacking and the ma indeed be overridden$ as there is no check on the proprietor himsel#!

Inventory

08?

Cha ter Roundu


The auditor must understand the accounting s stem and control environment in order to determine the audit approach! There are alwa s inherent limitations to internal controls! The auditors must assess the ade'uac o# the s stems as a basis #or the #inancial statements and must identi# risks o# material misstatements! &# the auditors believe the s stem o# controls is strong$ the choose to test controls to assess whether the can rel on the controls having operated e##ectivel ! There are special considerations #or the auditors when a s stem is computeri9ed! The auditors must keep a record o# the clients s stem which must be updated each ear! The test o# controls in the sales s stem will be based around: -a. *elling -authori9ation. -b. Foods outwards -custod . -c. Accounting -recording. The tests o# controls in the purchases s stem will be based around: -a. "u ing -authori9ation. -b. Foods inwards -custod . -c. Accounting -recording. Ke controls over wages cover: -a. Hocumentation and authori9ation o# sta## changes -b. Calculation o# wages and salaries -c. Pa ment o# wages -d. Authori9ation o# deductions *egregation o# duties is a particularl important control in smaller entities!

Now try question '( in the e@am question ban! at the bac! of the manual

CHAPTER 11: Audit o# (inancial *tatements

08B

To ic &ist &ncome E%penses Assets Giabilities Hisclosures

INTRODUCTION
The audit o# #inancial statements was covered in paper G1! This chapter covers issues pertaining to the use o# relevant accounting standards$ laws and regulations and audit risk though risk and materialit #orms part o# the overall re'uirement in an audit o# #inancial statements! The issues that are presented in this chapter will be more comple% than those ou did in paper G!6 and 'uestions will be scenario based or case stud ! However$ the basic principles pertaining to the audit o# #inancial statements applied in this chapter will look more on relevant accounting standards$ laws and regulations and audit risk! &n order to gather su##icient appropriate audit evidence during the audit o# #inancial statement$ ou need to appreciate the relevant auditing and accounting standards #or a particular audit and bearing in mind that ou are tr ing to prove management assertions covered in chapter B audit evidence! These include e@istence, com leteness, valuation, rights and obligations, occurrence, measurement, resentation and disclosure"

'"(

Income

&n the audit o# #inancial statements$ it is important that the auditor checks whether the revenue has been properl recogniEed as per &A* 1B! He should also #ocus his attention on its measurement has a ke assertion to be audited!

'"'

Revenue recognition as er I#$ 'H

&A* 1B prescribes the accounting treatment #or revenue arising #rom the #ollowing speci#ic transactions and events: The sale o# goods= The rendering o# services= and The use b others o# entit assets ielding interest$ ro alties and dividends!

&t does not deal with revenue arising #rom transactions covered b other *tandards 08D

-E!g! revenue arising #rom lease agreements dealt with in &A* 1? ;eases.! Definition2 Revenue is the gross in#low o# economic bene#its during the period arising in the course o# the ordinar activities o# an enterprise when those in#lows results in increases in e'uit $ other than increases relating to contributions #rom e'uit participants! 9air value is the amount #or which an asset could be e%changed$ or a liabilit settled$ between knowledgeable$ willing parties in an arms length transaction! #ccounting treatment Revenue is measured at the #air value o# the consideration received or receivable! The consideration is usuall cash! &# the in#low o# cash is signi#icantl de#erred$ and there is no interest or a below3market rate o# interest$ the #air value o# the consideration is determined b discounting e%pected #uture receipts! &# dissimilar goods or services are e%changed -as in barter transactions.$ revenue is the #air value o# the goods or services received or$ i# this is not reliabl measurable$ the #air value o# the goods or services given up! $ale of goods Revenue from sale of goods2 Revenue #rom the sale o# goods is recogni9ed when: *igni#icant risks and rewards o# ownership are trans#erred to the bu er The seller has no continuing managerial involvement or control over the goods The amount o# revenue can be measured reliabl &t is probable that economic bene#its will #low to the seller= and The costs o# the transaction -including #uture costs. can be measured reliabl ! Revenue from rendering of service2 Revenue #rom rendering services is recogni9ed b re#erence to the stage o# completion i# the #ollowing conditions are satis#ied: The amount o# revenue can be measured reliabl &t is probable that economic bene#its will #low to the service provider The stage o# completion o# the transaction can be measured reliabl = and The costs o# the transaction -including #uture costs. can be measured reliabl !
&# the outcome cannot be measured reliabl $ revenue is recogni9ed onl to the e%tent o# the e%penses recogni9ed that are recoverable!

Interest, royalties and dividends2

0;>

Definitions2 Interest is the charge #or the use o# cash or cash e'uivalents or amounts due to the enterprise! Royalties are charges #or the use o# long3term assets o# the enterprise$ e!g! patents$ computer so#tware and trademarks! Dividends are distributions o# pro#it to holders o# e'uit investments$ in proportion with their holdings$ o# each relevant class o# capital! Gike an other revenue$ it must be probable that economic bene#its are going to #low to the enterprise and can be measured reliabl ! However$ it must be recogni9ed on the #ollowing bases: &nterest: time proportion basis using the e##ective interest method! Ro alties: accrual basis in accordance with the substance o# the relevant agreement Hividends: when shareholders gain rights to receive pa ments is established!

Disclosure Accounting polic note Amount o# each signi#icant categor o# revenue Amount o# revenue #rom e%change o# goods)services Contingent gains)losses$ warrant costs &t must be appreciated that anal tical review is the common method used to audit revenue! This is because revenue can easil be predictable and there#ore anal tical review becomes a good base where su##icient in#ormation is available and there is some logical relationship among the items being audited! However$ depending on the t pe o# revenue being audited$ revenue audit ma be comple% especiall #or audits undertaken in the construction and engineering industries! (or such t pes o# industries$ auditing revenue recognition ma #orm part o# the construction contracts audit and ou ma consider the #ollowing procedures: Consider whether the basis #or recognition is reasonable Agree turnover recogni9ed to relevant documents -#or e%ample$ work certi#icates or contracts.

'"*

7overnment grants and assistance

Fovernment grants and assistance are accounted #or under &A* 0>! The ma be grants relating to the assets or income! The ob,ective o# &A* 0> is to prescribe the accounting #or$ and disclosure o#$ government grants and other #orms o# government assistance! &A* 0> applies to all government grants and other #orms o# government assistance! However$ it does not cover government assistance that is provided in the #orm o# bene#its in determining ta%able income! "elow is a summar o# the standard!

0;1

I#$ *( Definitions 7overnment assistance 1 action b government designed to provide an economic bene#it speci#ic to an enterprise or range o# enterprise 'uali# ing under certain criteria! 7overnment grants 1 assistance b government in the #orm o# trans#ers o# resources to an enterprise in return #or past or #uture compliance with certain conditions relating to the operating activities o# the enterprise! The e%clude those #orms o# government assistance which cannot have a value placed upon them and transaction with government which cannot be distinguished #rom the normal trading transactions o# the enterprise! 7rants relating to assets 1 government grants whose primar condition is that an enterprise 'uali# ing #or them should purchase$ construct or otherwise ac'uire long3term assets! *ubsidiar conditions ma also be attached restricting the t pe or location o# the assets or the periods during which the are to be ac'uired or held! 7rants5 relating to income 1 government grants other than those relating to assets! 9orgivable loans 1 Goans$ which the lender undertakes to$ waive repa ment o# certain prescribed conditions! #ccounting treatment A government grant is recogni9ed onl when there is reasonable assurance that -a. the enterprise will compl with an conditions attached to the grant and -b. the grant will be received! S&A* 0>!?T The grant is recogni9ed as income over the period necessar to match them with the related costs$ #or which the are intended to compensate$ on a s stematic basis$ and are usuall accounted #or at #air value$ although recording both the asset and the grant at a nominal amount is also permitted! S&A* 0>!02T Frants are recogni9ed under the income approach= recogni9e grants as income to match them with related costs that the have been received to compensate! Frants #or depreciable assets must be recogni9ed as income on the same basis as the asset is depreciated! Frants #or non3depreciable assets should be recogni9ed as income over the periods in which the cost o# meeting the obligation incurred! A grant ma be split into parts and allocate on di##erent bases where there are a series o# conditions attached! /here related costs have alread been incurred$ the grant ma be recogni9ed as income in #ull immediatel ! A grant in the #orm o# non3monetar asset ma be valued at #air value or a nominal value! Frants relating to assets ma be presented in the balance sheet either as a separate credit or deducted in arriving at the carr ing value o# the asset!

0;0

Frants relating to income ma be presented in the income statement either as a separate credit or deducted #rom the related e%pense! Repa ment o# government grants should be accounted #or as a revision o# an account estimate!

Disclosure of 7overnment 7rants The #ollowing must be disclosed: S&A* 0>!2DT


Accounting polic adopted #or grants$ including method o# balance sheet presentation <ature and e%tent o# grants recogni9ed in the #inancial statements In#ul#illed conditions and contingencies attaching to recogni9ed grants

To audit them the auditor should do the #ollowing: :btain documentation relating to the grant and ensure that it should be classi#ied as revenue The value ma be agreed to the same documentation -#or e%ample$ a letter outlining the details o# the grant$ or a cop o# an application #orm sent b the client. The receipt o# the grant can be agreed to bank statements!

Capital grants can be more di##icult to audit! The #ollowing audit procedures can be carried out! Consider whether the basis o# accounting is comparable to the previous ear Hiscuss the basis o# accounting with the directors to ensure that the method used is the best method! Ensure that an changes in accounting methods are disclosed!

A grant receivable as compensation #or costs alread incurred or #or immediate #inancial support$ with no #uture related costs$ should be recogni9ed as income in the period in which it is receivable! S&A* 0>!0>T A grant relating to assets ma be presented in one o# two wa s: S&A* 0>!06T -a. As de#erred income$ or -b. " deducting the grant #rom the assetUs carr ing amount! A grant relating to income ma be reported separatel as Uother incomeU or deducted #rom the related e%pense! S&A* 0>!0DT &# a grant becomes repa able$ it should be treated as a change in estimate! /here the original grant related to income$ the repa ment should be applied #irst against an related unamortised de#erred credit$ and an e%cess should be dealt with as an e%pense! /here the original grant related to an asset$ the repa ment should be treated as increasing the

0;2

carr ing amount o# the asset or reducing the de#erred income balance! The cumulative depreciation$ which would have been charged had the grant not been received$ should be charged as an e%pense! S&A* 0>!20T 7overnment #ssistance Fovernment grants do not include government assistance whose value cannot be reasonabl measured$ such as technical or marketing advice! S&A* 0>!26T Hisclosure o# the bene#its is re'uired! S&A* 0>!2D-b.T

>uestion2
Cinc Gtd is a mining compan that has ,ust started mining some precious stone in the <orthern part o# Cambia! A concession was entered into with the +inistr o# +ines to mine precious stones #or a period o# 1> ears starting 0>>6! &ts #irst #inancial statements were done #or the ear ended 21 Hecember 0>>8 #or a period o# 18 months! Cinc Gtd suppliers and customer are mainl #rom Asia where the demand #or precious stones is high! A total revenue o# I* V0> million is e%pected during the 18 months period$ all arising #rom credit sales made to its customers in Asia! Foods are dispatched ever 'uarter to Asia in credit! &n order to #inance its activities$ Cinc Gtd had to borrow I* V6> million #rom a commercial bank with an B3 ear re3pa ment period and re3pa ments o# both the principle and interest is e%pected to start a#ter a ear o# trading! However$ Cinc Gtd had also taken advantage o# the available government grant to small scale enterprises venturing into mining and an amount o# I* V8 million was applied #or and granted in order to allow Cinc Gtd to purchase a bulldo9er! Cinc Gtd shareholders supported the above move because o# the e%pected high return though the business risk is also high! Required2 As a newl 'uali#ied auditor$ state the main procedures that ou would carr out to audit the income in the #inancial statements o# Cinc Gtd #or the ear ended 21 Hecember 0>>8!

7uidance2
There are a number o# areas that need to be considered in the audit o# income #rom the scenario$ #or instance$ sales #rom precious stones$ and government grant! Consider there#ore the re'uirements o# &A* 1B!

0;6

$olution2
Revenue is the gross in#low o# economic bene#its during the period arising in the course o# the ordinar activities o# an enterprise when those in#lows result in increases in e'uit $ other than increases relating to contributions #rom e'uit participants! &A* 1B gives guidance on how revenue should be recogni9ed #rom speci#ic transactions or events that are carried out b an enterprise! The #ollowing procedures would be carried out: $ales from recious stones2 The audit o# sales can better be done through anal tical review procedures especiall where there is su##icient in#ormation on which to base the anal sis! *ince Cinc Gtd has not been in business #or a long time$ anal tical reviews ma not be ver use#ul! However$ in this particular case$ it would be important to determine as to whether signi#icant risk and rewards o# ownership o# goods and services are trans#erred! /e need to consider at what point ownership and risks are trans#erred to the Asian customer be#ore revenue can be recogni9ed in the books o# accounts! Check at what point signi#icant risks and rewards o# ownership o# goods and services have been trans#erred! Check whether Cinc Gtd has no continuit managerial involvement over goods Check whether revenue has been measured reliabl Ensure that economic bene#its will #low to the enterprise

7overnment grants2 Fovernment grants are in #orm o# government assistance through the trans#er o# resources to an enterprise in return #or past or #uture compliance with certain conditions relating to operating activities o# the enterprise! The grant o# I* V8 million is in #orm o# an asset! &A* 0> re'uires that grants relating to assets like the one in 'uestion should either be used #or the purchase$ construction or ac'uire a long3term asset! &n this particular case$ the re'uirement is that a bulldo9er will be purchased to be held b Cinc Gtd and be used #or mining purposes! The #ollowing procedures would be carried out: Check whether conditions pertaining to government grants have been complied with in terms o# receipt and waiver! /hether the grant has been recogni9ed as a depreciable asset and that income is recogni9ed on the same basis as the asset is depreciated! /here a grant is re'uired to be split into parts and allocated on di##erent bases$ ensure that a series o# conditions are abided to!

0;8

Ensure that the asset is presented in the balance sheet either as a separate credit or deducted in arriving at the carr ing value o# the asset! Check whether proper disclosures have been made!

9inancing income .loan/2 Pouch the amount received through the cashbook and corresponding records!

Eventuall $ this will be recogni9ed as a liabilit thereb creating a legal obligation to trans#er economic bene#its at speci#ied periods o# times!

*"(

:@ enses ) %orrowing costs

Ob3ective of I#$ *The ob,ective o# &A* 02 is to prescribe the accounting treatment #or borrowing costs! "orrowing costs include interest on bank overdra#ts and borrowings$ amorti9ation o# discounts or premiums on borrowings$ amorti9ation o# ancillar costs incurred in the arrangement o# borrowings$ #inance charges on #inance leases and e%change di##erences on #oreign currenc borrowings where the are regarded as an ad,ustment to interest costs!

*"'

%orrowing costs2

&A* 02 gives guidance on how to account #or borrowing costs and deals with the treatment o# borrowing costs$ o#ten associated with the construction o# sel#3constructed assets$ but which also can be applied to an asset purchased that takes time to get read #or use)sale! Here we look at borrowing costs as per re'uirement in &A* 02! These ma either be written o## the income or capitali9ed as part o# an asset! Definition: %orrowing costs 1 is interest and other costs incurred b an enterprise in connection with the borrowing o# #unds! S&A* 02!6T &nterest includes amorti9ation o# discount)premium on debt! :ther costs include amorti9ation o# debt issue costs and certain #oreign e%change di##erences that are regarded as an ad,ustment o# interest cost! S&A* 02!8T "orrowing cost does not include actual or imputed cost o# e'uit capital$ including an pre#erred capital not classi#ied as a liabilit pursuant to &A* 20 S&A* 02!1T >ualified assets 1 A 'uali# ing asset is an asset that takes a substantial period o# time to get read #or its intended use! S&A* 02!8T That could be propert $ plant$ and e'uipment and investment propert during the construction period$ intangible assets during the development period$ or Wmade3to3orderW inventories! S&A* 02!;T

0;;

#ccounting treatment2 %enchmar! treatment 1 recogni9e borrowing costs as an e%pense in the period incurred! #llowed alternative treatment 1 borrowing costs ma be capitali9ed as part o# the cost o# the asset i# the are directl attributed to ac'uisition$ construction or production! :ther borrowing costs must be e%pensed! "orrowing costs eligible #or capitali9ation are those that would have been avoided otherwise! Ise ,udgement where a range o# debt instruments is held #or general #inance! Amount o# borrowing costs available #or capitali9ation is actual borrowing costs incurred less an investment income #rom temporar investment o# those borrowings! (or borrowings obtained generall $ appl the capitali9ation rate to the e%penditure on the asset -weighted average borrowing costs.! &t must not e%ceed actual borrowing costs! Capitali9ation is suspended is active development is interrupted #or e%tended periods= -temporar dela s or technical)administrative work will not cause suspension.! Capitali9ation ceases -normall . when ph sical construction o# the asset is completed$ capitali9ation should cease when each stage or part is completed! /here the carr ing amount o# the asset #alls below cost$ it must be written down)o##

Disclosure NI#$ *-"*IO Accounting polic adopted Amount o# borrowing costs capitali9ed during the period! Capitali9ation rate used to determine borrowing costs eligible #or capitali9ation!

&t must be appreciated that the cost o# borrowing is interest and is disclosed in the income statement! &nterest can o#ten be audited b using anal tical review procedures as it has a predictable relationship with loans! Alternativel $ it can be veri#ied to pa ments records such as bank statements and loan agreements documents! &t #ollows there#ore that where borrowing costs are capitali9ed$ the auditor should carr out the #ollowing tests: Agree #igures in respect o# interest pa ments made to statements #rom lenders and )or banks statements! Ensure interest is directl attributed to construction!

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#ssets

0;?

The auditors dut is to veri# all the assets that have been recogni9ed in the balance sheet and that there are no other assets that have not been recogni9ed in the balance sheet! The ke assertions to consider in relation to assets are e@istence$ com leteness$ valuation and rights and obligations" "elow we look at a number o# assets and procedures to be carried out in line with &A* 0$ &A* 11$ &A* 2;$ &A* 2B and &A* 6>!

-"'

Tangible non?current assets

(or tangible and intangible assets$ auditors should ensure that both are sub,ected to an annual impairment review in addition to the usual veri#ication done! &n order #or ou to appreciate this impairment review #or audit purposes$ it is important that ou revise what the indicators o# impairment are #rom our accounting paper 2!1! Aspects relating to tangible non3current assets were covered in our studies o# paper 0!6 Auditing! The #ollowing 'uestion below will assist ou appreciate #urther how to audit tangible non3current assets! &A* 2; states that non current assets -tangible and intangible. should be recorded in the #inancial statements at no more than their recoverable amount! &n certain circumstances$ assets should be sub,ected to an impairment review! The auditors approach towards impairment should be as #ollows: 6lanning2 Assess whether impairment reviews might be necessar #rom knowledge o# the business! Testing: :btain the clients workings o# the impairment loss Consider whether the are reasonable Recalculate$ to ensure the are arithmeticall correct &# possible$ veri# new value to documentation$ #or e%ample valuers report! Disclosure2 &mpairment losses recogni9ed in the income statement &mpairment losses reversed in the income statements /hich line item-s. o# the income statement!

-"*

Intangible non?current assets

The accounting guidance on intangible assets is given in &A* 2B &ntangible assets and &(R* 2 "usiness combinations! The t pes o# assets that ma #all under the intangible assets include patents$ licences and trademarks$ development costs and goodwill! However$ &A* 2B does not cover assets such as #inancial assets$ mineral rights and e%ploration and development costs incurred b mining and oil and gas companies etc! &t must be appreciated that all intangibles must be sub,ected to an impairment review!

0;B

According to &A* 2B$ an intangible asset is an identi#iable non3monetar asset without ph sical substance! &t ma be held #or using in the production and suppl o# goods and services or #or rental to others or #or administrative purposes! The asset must be: Controlled b the enterprise as a result o# events in the past$ and *omething #rom which the enterprise e%pects some #uture economic bene#its to #low!

Thus the three critical attributes o# an intangible asset are identi#iabilit $ control and #uture economic bene#its! (or e%ample$ items that ma be considered as intangible assets ma include computers so#tware$ patents$ cop rights$ motion picture #ilms$ customer lists$ #ranchises and #ishing rights$ mortgage servicing rights$ import 'uotas$ customer and supplier relationship and marketing rights! An item should not be recogni9ed as an intangible asset$ however$ unless it #ull meets the de#inition in the proposed standards! As such internall generated goodwill ma not be recogni9ed as an asset! The auditor should carr out the #ollowing procedures: Com leteness Prepare anal sis o# movements on cost and amorti9ation accounts Rights and obligations :btain con#ormation o# all patents and trademarks held b a patent agent Peri# pa ment o# annual renewal #ees ;aluation Review special valuations o# intangible assets$ considering the 'uali#ication o# the valuer$ scope o# work and assumptions and methods used! Con#irm carried down balances represent continuing value$ which are proper charges to #uture operations! #dditions .rights and obligations, valuation and com leteness/ &nspect purchase agreements$ assignments and supporting documentation #or intangible assets ac'uired in period! Con#irm purchases have been authori9ed Peri# amounts capitali9ed o# patents developed b the compan with supporting costing records! #mortiEation Review amorti9ation b checking computation and con#irming that rates used are reasonable! 0;D

Income from intangibles Review sales returns and statistics to veri# the reasonableness o# income derived #rom patents$ trademarks$ licences etc! E%amine audited accounts o# third part sales covered b a patent$ licence or trademark owned b the compan ! Recognition Recogni9e intangible assets onl i# it is probable that the #uture economic bene#its that are attributable to the asset will #low to the enterprise and the cost o# the asset can be measured reliabl ! -"*"' 7oodwill

The #ollowing ke tests can be carried out Agree consideration to a sale agreement Con#irm valuation o# assets ac'uired is reasonable Check that purchased goodwill is calculated correctl -it should re#lect the di##erence between the #air value o# the consideration given and the aggregate o# the #air values o# the separate net assets ac'uired. Check that goodwill does not include non3purchased goodwill &mpairment test 1 ensure management have carried out annual impairment review and assess whether their conclusions are reasonable Ensure valuation o# goodwill is reasonable b reviewing prior ears accounts and discussion with the directors! -"*"* Develo ment costs

There are special circumstances that ma prompt development costs to be included in the balance sheet! These are outline in &A* 2B &ntangible assets! &A* 2B de#ines research and development as #ollows: Research 1 is original and planned investigation undertaken with the prospect o# gaining new scienti#ic or technical knowledge and understanding! Develo ment 1 is the application o# research #indings or other knowledge to a plan or design #or the production o# new or substantiall improved materials$ devices$ products$ processes$ s stems or services prior to the commencement o# commercial production or use! :@ enditure on research is re'uired to be written o## in the ear o# e%penditure! However$ &A* 2B states that the development costs o# a pro,ect should be recogni9ed as an asset onl when all o# the #ollowing criteria are met! Completion o# the asset will be technicall #easible The business intends to complete the asset and use or sell it 0?>

The business will be able to use or sell the asset! The business can demonstrate how #uture economic bene#its will be generated$ either b demonstrating a market e%ists or the internal use#ulness o# the asset! Ade'uate technical$ #inancial and other resources will be available to complete the development and use or sell the intangible asset! E%penditure attributable to the development o# the asset can be measured reliabl ! Feneral overhead e%penditure$ costs o# ine##iciencies and operating losses$ and e%penditure o# training sta## to operate the asset should not be capitali9ed! Amorti9ation o# development e%penditure should not e%ceed 0> ears and an appropriate method should be used!

*ummar on how development e%penditure ma be capitali9ed and matched against #uture revenues: $ *eparate pro,ects! : E%penditure clearl identi#iable! C Commerciall viable! T Technicall #easible! O :verall pro#it e%pected! R Resources e%ist or are capable o# being raised! Audit evidence re'uired to con#irm the above ma include: (or $ and : 3 /ork completed at interim audit on accounting s stems (or C 3 Results o# market research both internal and e%ternal (or T 3 E%perts report! &nternal letter o# representation (or O 3 Pro#it #orecasts b management$ i!e! reasonableness (or R 3 Gi'uidit )long term solvenc ! Relationship with bankers)markets The development costs o# a pro,ect recogni9ed as an asset should not e%ceed the amount that is likel to be recovered #rom related #uture bene#its$ a#ter deducting #urther development costs$ related production costs$ and selling and administrative costs directl incurred in marketing the product! &n all other circumstances$ development costs should be written o## in the ear o# e%penditure! The ke test to be carried out in line with &A* 2B: Check the accounting records to con#irm that the pro,ect is clearl de#ined and that related e%penditure can be separatel identi#ied$ and certi#ied to invoices$ timesheets! Con#irm #easibilit and viabilit b e%amining market research reports$ #easibilit studies$ budgets and #orecasts and consult clients technical e%perts! Review budget revenues and costs b e%amining results to date$ production #orecasts$ advance orders and discussions with directors!

0?1

Review calculations o# #uture cash #lows to ensure that resources e%ist to complete the pro,ect Review previousl de#erred e%penditure to ensure &A* 2B criteria are still ,usti#ied! Check that amorti9ation has been charged on a s stematic basis and commences with production!

&n most cases$ companies ma write o## research and development e%penditure in the pro#it and loss without capitali9ation! &n this particular case the auditor need to veri# that the charge to the pro#it and loss is com lete, accurate and valid" -"*"%rands, mastheads, ublishing titles etc

The recognition o# brands in the income statement would depend on whether the brands are internall generated or not! This is in accordance with &A* 2B that #orbids the capitali9ation o# internall generated assets! However$ i# the brand was purchased then the auditor should test check the value o# the brand based on the sales documentation! &n this particular case$ the brand is not part o# the internall generated goodwill or an other internall generated asset!

-"- Investments
/hen auditing investments$ the auditor needs to consider both income and asset! &nvestment will be considered under the #ollowing #our distinct items indicated below: -"-"' &nvestment in companies$ whether listed or unlisted$ non3current assets or e'uit &ncome arising #rom the above investments &nvestment in subsidiar and associated companies &nvestment properties! Internal control considerations

Ke controls are: Authori9ation over investment dealings -normall #rom higher level management. *egregation o# duties b keeping the recording and custod roles separate= those with the responsibilit #or custod not to have access to cash where the investment is pledged as collateral! -"-"* :@istence and rights and obligations

*tockbrokers should not be entrusted with the sa#e custod o# share certi#icates on a continuing basis since the have read access to the *tock E%change! Auditors should not there#ore rel on a certi#icate #rom a broker stating that he holds the compan securities!

0?0

$ubstantive tests E%amine certi#icate o# titles to investments listed in investment records and con#irm that the are: o "ona #ide complete title documents o &n the clients name o (ree #rom an charge or lien E%amine con#irmation #rom third part investment custodians such as banks and check investment are in clients name and #ree #rom charge! &nspect certi#icate o# title which are held b third parties who are not bona #ide custodians &nspect bank trans#ers and letters o# trust to con#irm client owns shares in name o# nominee Review minutes and other statutor books #or evidence o# charging and pledging Peri# purchases to agreements$ contract notes and correspondence Con#irm purchases where authori9ed Check with appropriate #inancial data supplier appropriate #inancial statements that all reported capital changes have been correctl accounted #or during the period! Peri# disposals with contract notes$ sales agreements correspondence etc! Check whether investment disposals have been authori9ed! Con#irm that pro#it or loss on sale o# investments has been correctl calculated taking into account o#: o "onus issue o# shares o Consistent basis o# identi# ing cost o# investment sold o Rights issues o Accrued interest o Ta%ation ;aluation

-"-"-

The auditor should establish and ensure that the valuation o# investments has been correctl applied and is consistent with previous ears cost or market value! $ubstantive tests2 Con#irm the value o# listed investment b re#erence to stock e%change listings or the 'uotations published in the #inancial press! The middle market value should be used! Review accounts o# unlisted investments and calculate the net assets value o# the shares and value the investment on a ield basis and ensure that the valuation o# the investment is reasonable! Check that there is no substantial #all in value o# the investments has taken place since the balance sheet date! 0?2

Consider whether there are an restrictions on remittance o# income and ensure these are properl disclosed! Check whether current assets investments are included at the lower o# cost or net reali9able value! Investment income

-"-"0

The basis o# recogni9ing investment income ma var #rom compan to compan particularl #or dividends$ #or e%ample Credit taken onl when received Credit taken when declared Credit taken onl a#ter rati#ication o# the dividend b the investees shareholders in general meeting A consistent basis must be applied #rom ear to ear! Com leteness, occurrence and measurement Check that all income due has been received$ b re#erence to *tubbs or e%tel cards #or listed investments$ and #inancial statements #or unlisted investments! Review investment income account #or irregular or unusual entries$ or those not apparentl pertaining to investments held! Consider investment paid and bought during the ear! Ensure that the basis o# recogni9ing income is consistent with previous ears! Compare investment income with prior ear and e%plain an signi#icant #luctuations Consider whether there are likel to be an restrictions on reali9ation o# the investment or remittance o# an income due and ensure these are properl disclosed in the #inancial statements!

-"0 Investment ro erty


&nvestment propert is covered in &A* 6> and #actors to consider should be treated in accordance with this standard! Definition &nvestment propert is propert -land or a building$ or part o# a building or both. held -b the owner or b the lessee under a #inance lease or$ under certain conditions$ an operating lease. to earn rentals or #or capital appreciation or both$ rather than #or S&A* 6>!8T Ise in the production or suppl o# goods or services or #or administrative purposes$ or *ale in the ordinar course o# business!

0?6

E%amples o# investment propert S&A* 6>!BT Gand held #or long3term capital appreciation Gand held #or undecided #uture use "uilding leased out under an operating lease Pacant building held to be leased out under an operating lease! The #ollowing non3investment propert and applicable standards are di##erentiated #rom investment propert ! Propert held #or use in the production or suppl o# goods and services or #or administrative purposes! Propert held #or sale in the ordinar course o# the business or in the process o# construction o# development #or such sale 1 &A* 0 &nventories Propert being constructed or developed on behal# o# third parties 1 &A* 11 Construction contracts :wner3occupied propert 1 &A* 1; Propert $ plant and e'uipment$ including propert held #or #uture use as owner3occupied propert $ propert held #or #uture development and subse'uent use as owner3occupied propert $ propert occupied b emplo ees and owner3occupied propert awaiting disposal! Propert being constructed or developed #or #uture use as investment propert 1 &A* 1; applies until construction or development is complete$ then treat as investment propert Propert leased to another entit under a #inance lease!

Disclosure2 9or both 9air ;alue 8odel and Cost 8odel NI#$ 0("G1O /hether the #air value or the cost model is used &# the #air value model is used$ whether propert interests held under operating leases are classi#ied and accounted #or as investment propert The methods and signi#icant assumptions applied in determining the #air value o# investment propert ! The e%tent to which the #air value o# investment propert is based on a valuation b a 'uali#ied independent valuer= i# there has been no such valuation$ that #act must be disclosed! The amounts recogni9ed in pro#it or loss #or: o Rental income #rom investment propert o Hirect operating e%penses -including repairs and maintenance. arising #rom investment propert that generated rental income during the period o Hirect operating e%penses -including repairs and maintenance. arising #rom investment propert that did not generate rental income during the period! Restrictions on the realisabilit o# investment propert or the remittance o# income and proceeds o# disposal! Contractual obligations to purchase$ construct or develop investment propert or #or repair$ maintenance or enhancements! 0?8

$ubstantive tests Peri# rental agreement$ ensuring that occupier is not a connected compan and that the rent has been negotiated at arms length -#air value.! &# the building has been recentl built$ check architects certi#icates to ensure that construction work has been completed! (or valuation purposes$ &A* 6> re'uires that investment propert either be held at cost or at #air value! This appro%imates to open market value! The auditor should be able to veri# this b re#erence to a valuers certi#icate$ as pro#essional valuers are encouraged under &A* 6>! (or cost o# the investment propert $ the auditor should check purchase invoices or i# sel# constructed the costing records or pa roll #or the cost o# salaries and wages! Ensure that recognition and measurement has been done in accordance with &A* 6>! (or disclosure$ the auditor should review the disclosure made in the #inancial statements to ensure that the have been made properl in accordance with &A* 6>!

-"1 Inventories
The ke assertions #or inventories are e@istence$ com leteness$ valuation and rights and obligations" (or standard costing purposes$ the auditor must assess whether the valuation is properl done! &A* 0 states that inventories should be measured at the lower o# cost and net reali9able value! Costs include costs o# purchase$ conversion and other incurred in bringing inventories to present location and condition! This standard was ade'uatel covered in paper 0!6 Auditing$ there#ore a 'uestion would assist to remind ou o# what is e%pected in the audit o# inventories!

-"D Construction contracts


&A* 11 states that a construction contract is one speci#icall negotiated #or the construction o# an asset or a combination or assets that are closel interdependent in terms o# their design$ technolog and #unction or their ultimate purpose or use! The accounting treatment is as #ollows: Recogni9e contract revenue as revenue in the accounting period in which the work is per#ormed! Recogni9e contract costs as an e%pense in the accounting period in which the work to which the relate i# per#ormed! An e%pected e%cess o# total contract costs over total contract revenue should be recogni9ed as an e%pense immediatel !

0?;

An costs incurred$ which relate to #uture activit should be recogni9ed as an asset i# it is probable that the will be recovered -o#ten called contract work in progress$ that is$ amount due #rom the customer.! /here amounts have been recogni9ed as contract revenue$ but their collectabilit #rom the customer becomes doubt#ul$ such amounts should be recogni9ed as an e%pense not a deduction #rom revenue!

The auditor should ensure that revenue and e%penses have been correctl recogni9ed and that an assets recogni9ed #or cost incurred in relation to #uture activit are recoverable! 6rocedures are as follows2 Peri# revenue #igures to certi#ication o# work completed in ear$ or i# unavailable$ work completed to date e%cluding revenue recogni9ed in prior ears! Peri# cost #igures to invoices and ensure that the relate to current period! Ensure that capitali9ed costs relating to #uture activit relate to #uture activit b reviewing invoices and work schedules! Review contracts to ensure that capitali9ed costs are recoverable Indertake bad debts review recogni9ed and ensure that an debt$ which is not collectable$ has been treated as an e%pense!

0"(

&iabilities

The relevant #inancial statement assertions #or liabilities are completeness$ rights and obligations and e%istence! The can also be tested #or understatement! A number o# summari9ed standards are looked at in order to assist in the audit o# selected liabilities that ma give the auditor some di##iculties!

0"'

&eases

The classi#ication o# leases can have a material e##ect on the #inancial statements and the auditor need to ensure that leases have been properl classi#ied$ recogni9ed and disclosed! &n doing so the re'uirements the auditor should consider &A* 1? Geases! Ob3ective of I#$ 'G The ob,ective o# &A* 1? -Revised 1DD?. is to prescribe$ #or lessees and lessors$ the appropriate accounting policies and disclosures to appl in relation to #inance and operating leases! &A* 1? applies to all leases other than lease agreements #or minerals$ oil$ natural gas$ and similar regenerative resources and licensing agreements #or #ilms$ videos$ pla s$ manuscripts$ patents$ cop rights$ and similar items! However$ &A* 1? does not appl as the basis o# measurement #or the #ollowing leased assets: 0??

Propert held b lessees that is accounted #or as investment propert #or which the lessee uses the #air value model set out in &A* 6> &nvestment propert provided b lessors under operating leases "iological assets held b lessees under #inance leases "iological assets provided b lessors under operating leases!

&A* 1? de#ines a lease as an agreement whereb the lessor conve s to the lessee in return #or a pa ment or series o# pa ment the right to use an asset #or an agreed period o# time! Two t pes o# leases are identi#ied! 9inance lease 1 a lease that substantiall trans#ers all the risks and rewards incident to ownership o# an asset! Title ma or ma not eventuall be trans#erred! O erating lease 1 a lease other than a #inance lease! &A* 1? re'uires that a #inance lease should be recorded in the balance sheet o# a lessee as an asset and as an obligation to pa #uture lease pa ments! At the inception o# the lease the sum to be recorded both as an asset and as a liabilit should be the #air value o# the leased propert or$ i# lower$ at the present value o# the minimum lease pa ments! The later are derived b discounting them at the interest rate implicit in the lease! &A* 1? also re'uires that the rentals under the operating lease should be written o## as an e%pense on a straight3line basis over the lease term even i# the pa ments are not made on such a basis$ unless another s stematic and rational basis is ,usti#ied b the circumstances! 5ou can see that the classi#ication o# the lease is likel to have a material e##ect on the #inancial statements! &# the lease is a #inance lease$ the balance sheet will show substantial assets and liabilities! The net e##ect will be minimal$ but the #ace o# the balance sheet will be materiall di##erent to i# it was an operating lease! &t is important that the auditor ensures that the classi#ication -which wiil #all under the assertion e%istence. is correct! :ther important assertions are valuation and rights and obligations! #udit rocedures2 Classi#ication and rights and obligations :btain a cop o# a lease agreement Review a lease agreement to ensure that the lease has been correctl classi#ied according to &A* 1? Paluation :btain a cop o# the clients workings in relation to #inance leases

0?B

Check the additions and calculations o# the workings Ensure that the interest has been accounted #or in accordance with &A* 1? Recalculate the interest Agree the opening position Agree an new assets to lease agreements Peri# lease pa ments in the ear to the bank statements Agree pa ments to the bank statements -#or an operating lease.

Hisclosure The auditor should ensure that both #inance leases and operating leases have been properl disclosed in the #inancial statements!

0"*

Deferred ta@ation

He#erred ta%ation is addressed in &A* 10 &ncome ta%es and the ,ob o# the auditor is to check the movements on the de#erred ta% provision! &ts main ob,ective is to prescribe the accounting treatment #or income ta%es! &A* 10 gives the #ollowing de#initions: Deferred ta@ liabilities are the amounts o# income ta%es pa able in #uture periods in respect o# ta%able temporar di##erences! Deferred ta@ assets are the amounts o# income ta%es recoverable in #uture periods in respect o#: Heductible temporar di##erences The carr #orward o# unused ta% losses The carr #orward o# unused ta% credits

Tem orary differences are di##erence between the carr ing amount o# an asset or liabilit in the balance sheet and its ta% base! Temporar di##erence ma be either: Ta@able tem orary differences, which are temporar di##erences that will result in ta%able amounts in determining ta%able pro#it -ta% loss. o# #uture periods when the carr ing o# the asset or liabilit is covered or settled! Deductible tem orary difference$ which are temporar di##erences that will result in amounts that are deductible in determining ta%able pro#it -ta% loss. o# #uture periods when the carr ing amount o# the asset or liabilit is recovered or settled!

The ta% base o# an asset or liabilit is the amount attributed to that asset or liabilit #or ta% purposes! All ta%able temporar di##erences given rise to a de#erred ta% liabilit 0?D

All deductible temporar di##erences give rise to a de#erred ta% asset! Deferred ta@ is the ta@ attributable to timing differences" /here a compan 7saves ta% in the current period b having accelerated capital allowances$ a provision #or the ta% charge is made in the balance sheet! The provision is made because over the course o# the assets li#e$ the ta% allowances will reduce until the depreciation charged in the accounts is higher than the allowances! This will result in ta%able pro#it being higher than reported pro#it and the compan will be su##ering higher ta% in this period! The provision ma or ma not be material depending on the entit s #uture plans and there#ore the e%tent to which it is estimated that ta% liabilities will cr stalli9e! &n determining the de#erred ta% amount$ there is a degree o# estimation involved and the auditor should look out #or manipulation o# the amount b the directors! Disclosure .among others/ Current ta% assets and ta% liabilit He#erred ta% assets and liabilities Ta% e%penses relating to pro#it or loss #rom ordinar activities Ta% relating to e%traordinar items Changes in ta% rates Ta% relating to discontinuit operations Hetails o# de#erred ta% assets

The #ollowing audit procedures could be carried out: :btain a cop o# the de#erred ta% workings and the corporation ta% computation Check the arithmetical accurac o# the de#erred ta% working Agree the #igures used to calculate timing di##erences to those on the ta% computation and the #inancial statements Hiscuss the assumptions made about #uture events with the directors and)or the ta% specialists to ensure that the are reasonable Consider the assumptions made in the light o# our knowledge o# the business and an other evidence gathered during the course o# the audit to ensure reasonableness! Agree the opening position on the de#erred ta% account to the prior to the prior ear #inancial statements! Review the basis o# the provision to ensure: o &t is in line with accounting practice under &A* 10 o &t is suitabl comparable to practice in practice in previous ears$ and an changes in accounting polic have been disclosed!

0"-

6rovisions and contingencies


0B>

Provisions are accounted #or as a liabilit $ contingencies are disclosed$ so auditors must ensure the have been classi#ied correctl according to &A* 2?! Provisions are accounting #or under &A* 2? Provisions$ contingent liabilities and contingent assets! &A* 2? gives the #ollowing de#initions: A provision is a liabilit o# uncertain timing or amount! A liabilit is a present obligation o# the enterprise arising #rom past events$ the settlement o# which is e%pected to result in an out#low #rom the enterprise o# resources embod ing economic bene#its! An obligation event is an event that creates a legal or constructive obligation that results in an enterprise having no realistic alternative to settling that obligation! A legal obligation is an obligation that derives #rom: A contract -trough its e%plicit or implicit terms. Gegislation or :ther operation o# law

A constructive obligation is an obligation that derives #rom an enterprises actions where " an established pattern o# past practice$ published policies and su##icientl speci#ic current statement$ the enterprise has indicated to other parties that it will accept certain responsibilities$ and As a result$ the enterprise has created a valid e%pectation on the part o# those other parties that it will discharge those responsibilities! A contingent liabilit is: A possible obligation that arises #rom past events and whose e%istence will be con#irmed onl b the occurrence or non occurrence o# one or more uncertain #uture events not wholl within the control o# the enterprise$ or A present obligation that arises #rom past events but is not recogni9ed because: o &t is not probable that an out#low o# resources embod ing economic bene#its will be re'uired to settle the obligation$ or o The amount o# the obligation cannot be measured with su##icient reliabilit !

A contingent asset is a possible asset that arises #rom past events and whose e%istence will be con#irmed onl b the occurrence or non3occurrence o# one or more uncertain #uture events not wholl within the control o# the enterprise! Inder &A* 2?$ an entit should not recogni9e a contingent asset or a contingent asset or a contingent liabilit ! However$ i# it becomes probable that an out#low o# #uture economic bene#its will be re'uired #or a previous contingent liabilit $ a provision should be

0B1

recogni9ed! A contingent asset should not be accounted #or unless its reali9ation is virtuall certain= i# an in#low o# economic bene#its has become probable$ the asset should be disclosed!

1"(

Disclosures

The auditor should ensure that all disclosures in the #inancial statements are #airl stated! "elow we look at a number o# disclosures!

1"'

$egment re orting

The ob,ective o# &A* 16 is to establish principles #or reporting #inancial in#ormation b line o# business and b geographical area! &t applies to entities whose e'uit or debt securities are publicl traded and to enterprises in the process o# issuing securities to the public! &A* 16 gives the #ollowing de#initions and guidance! A business segment is a distinguishable component o# an enterprise that is engaged in providing a single product or service or a group o# related products or service and that is sub,ect to risks and returns that are di##erent #rom those o# other business segments! (actors thats should be considered in determining whether products and services are related include: The nature o# the products or services! The nature o# the production processes The t pe or class o# customer #or the products or services The methods used to distribute the products or provide the services &# applicable$ the nature o# the regulator environment #or e%ample$ banking$ insurance or public utilities! A geogra hical segment is a distinguishable component o# an enterprise that is engaged in providing products or services within a particular economic environment and that is sub,ect to risks and returns that are di##erent #rom those o# components operating in other economic environments! (actors that should be considered in identi# ing geographical segment include: *imilarit o# economic and political conditions Relationships between operations in di##erent geographical areas! Pro%imit o# operations *pecial risks associated with operations in a particular area E%change control regulations The underl ing currenc risks

0B0

A re ortable segment is a business segment or a geographical segment identi#ied based on the #oregoing de#initions #or which segment in#ormation is re'uired to be disclosed b &A* 16 $egmental revenue is revenue that also includes inter3segment revenue that is directl attributed or reasonabl allocable to a segment this includes interest and dividend income and related securities gains onl i# the segment is a #inancial segment! The disclosure re'uirements o# &A* 16 are 'uite long and complicated but ou should know them #rom our advanced accounting paper 0!1 However$ the #ollowing audit procedure would be necessar : :btain a client schedule o# turnover workings Hiscuss with management the basis #or the segmentation Peri# a sample o# items to backing documentation to ensure disclosure is correct! Hisclosure is re'uired o# the t pes o# products and services included in each reported business segment and o# the composition o# each reported geographical segment$ both primar and secondar ! S&A* 16!B1T

1"*

:arnings er share

&A* 22 ob,ective is to prescribe principles #or the determination and presentation o# earnings per share -EP*. amounts in order to improve per#ormance comparisons between di##erent enterprises in the same period and between di##erent accounting periods #or the same enterprise! &t applies to securities that are publicl traded or that are in the process o# issuing securities to the public! &A* 22 deals with disclosures relating to earnings per share #or the ear! Earnings per share are de#ined as the pro#it in pence attributable to each share! Though earnings per share ma not be material in itsel#$ investors consider it ke #or investment purposes thus it becomes material b its nature! The auditor must consider three issues when dealing with earnings per share: /hether it should be disclosed on a comparable basis to the prior ear$ and have an changes in accounting polic been disclosed$ and /hether it has been calculated accuratel &# both parent and consolidated statements are presented in a single report$ EP* is re'uired onl #or the consolidated statements!

Thus the #ollowing audit procedures ma be appropriate: :btain a cop o# the clients workings #or earnings per share! Compare the calculations with the prior ear calculations to ensure that the basis is comparable

0B2

Hiscuss the basis with the directors i# it has changed to ascertain i# it is the best #or the accounts this ear and whether the change has been ade'uatel disclosed Recalculate to ensure that it is correct! &# some new shares where issued check whether EP* has been diluted and whether the EP* has been properl calculated and presented!

Disclosure NI#$ --"G(O2 The amounts used as the numerators in calculating basic and diluted EP*$ and a reconciliation o# those amounts to pro#it or loss attributable to the parent entit #or the period! The weighted average number o# ordinar shares used as the denominator in calculating basic and diluted EP*$ and a reconciliation o# these denominators to each other! &nstruments that could potentiall dilute basic earnings per share in the #uture A description o# those ordinar share transactions or potential ordinar share transactions that occur a#ter the balance sheet date and that would have changed signi#icantl the number o# ordinar shares or potential ordinar shares outstanding at the end o# the period i# those transactions had occurred be#ore the end o# the reporting period!

1"-

Disclosures relating to discontinued o erations and cash flow statements

The &(R* 8 re'uires that discontinued operations be disclosed on the #ace o# the income statement or in the notes! This is due to the #act that the discontinued operations ma be inherentl material and ma a##ect the #ocus o# operations in relation to management polic ! The si9e o# the discontinued operations ma also be material thus the need to disclose! The discontinued operations ma also be o# concern to the shareholders and the implications! The auditor must there#ore be aware o# the implications o# &(R* 8 #or the #inancial statements that he is going to audit! The auditor should be aware o# operations that have discontinued in the ear under review or will be discontinued in the ne%t period #or lanning purposes and to assist him in assessing the going concern o# the entit ! This is also important at the review stage and the auditor should ensure that su##icient disclosure has been made on the #ace o# the #inancial statements or in the notes! The discontinuing o# certain operations ma cast doubt on the abilit o# the entit to continue in the #oreseeable #uture! The #ollowing procedures need to be undertaken b the auditor! Ensure that the re'uirements o# &(R* 8 have been complied with! This can be achieved through discussions with management! Review board minutes to ascertain the activities that have been discontinued Review the working pertaining to discontinued operations and determine their reasonableness and disclosure in the #inancial statements! 0B6

Trace the discontinued operations through the relevant records to prove their authenticit !

>uestion2
Tip3Top is a #irm o# chartered accountants that is involved in a number o# audits through out Cambia! Apart #rom the audits$ Tip3Top also carries out a number o# consultanc work in management and business advisor services$ which includes ta% planning! Tip3 Top will be carr ing out an audit o# Te%a Compan that deals in cotton and #abric material #or the #irst time though Te%a has been a long3standing client o# Tip3Top in the areas o# consultanc ! However$ Tip 1 Top has ,ust #inished carr ing out a review o# some #orecasted #inancial statements #or Te%a$ which Te%a was re'uired to present to the bank! As an audit senior$ ou have been asked to plan #or the #orthcoming audit o# #inancial statements #or the period ending 21 Hecember 0>>6! This is a #irst audit the compan is undertaking #or Te%a Compan other than the consultanc that the have been doing! The #ollowing dra#t balance sheet #or 0>>8 has been provided! *((1 K>>> #ssets: <on current assets Tangible non current asset &nvestments Current assets &nventor Receivables "ank Prepa ments &iabilities and shareholders funds2 Current liabilities Trade pa ables "ank overdra#t "ank loan Gong3term liabilities "ank loan He#erred ta% *hareholders #unds *hare capital 0B8 1$D>> 2$6>> B$8>> 12$B>> 06$;10 1>$>>> 0>> 1$B>> 3 3 1$B>> 21$818 1>$>>> 0>> K>>> 0>$1>> 0>$>>> 1$>>> 2$>>> 3 10 6$>10 00,''* D>> 1$?>> 8>> 18 2$118 *I,1'1 K>>> *((0 K>>> 00$6>> 6$>>>

*hare premium Revaluation reserves Pro#it and Goss *I,1'1 Required2

0$>>> 6$>>> -1>$8>>. 00,''*

0$>>> 3 -1;$>>>.

Provide comments on some issues arising #rom the above balance sheet #or planning purposes #or the ear3end 21 Hecember 0>>6 to include the issues relating to risk and materialit $ accounting and audit evidence issues and an other limitations o# the review ou have undertaken to date! And highlight an #urther in#ormation that ou intend to seek!

#nswer2
+atters arising #orm preliminar review: 7oing concern There is a worsening cash position over the ears and the compan seems to be e%periencing going concern problems as e%hibited b the #ollowing indicators: "ank overdra#ts= e%cessive current liabilities over current assets= substantial increase in receivables and the bank re'uiring #uture pro#it #orecast that our #irm has been veri# ing! The reduction in the loss indicates that pro#it has been earned though it does not appear that sales are being converted into cash! Pro#it #orecasts$ correspondence with the bank clearl con#irm this in#ormation! However #urther in#ormation could be obtained #rom the advisor department on issues pertaining to the companies strateg or business plan! /e ma also need to know wh the bank re'uires pro#it #orecast and also review the work that we did on the same! The auditor also needs to pa attention to the #ollowing items in the balance sheet$ namel de#erred ta%$ increased investment and the revaluation that has taken place! Deferred ta@ 1 it could be seen #rom the balance sheet that there is no movement in de#erred ta% liabilit ! The de#erred ta% does not seem to be supported b the asset port#olio and revaluation in the ear! /e need there#ore to check whether the re'uirements o# &A* 10 have been adhered to in terms o# calculations and disclosure re'uirements! Increase in investment 1 investments have increased b a bigger b over 8>> O and we need to consider whether the have been correctl accounted #or! &nvestment in shares will re'uire to veri# share certi#icates and valuation certi#icates as audit evidence! However$ care need to be taken on the huge increase in investments to ensure that the increase does not represent a holding in another compan that would re'uire the results being consolidated into group results!

0B;

Revaluation 1 more need to be discovered on the revaluation amount in the balance sheet due to the #act that the non3current assets #igure in the balance sheet as decreased! /e need to ensure that revaluations have been accounted #or correctl ! 8ateriality as ects 1 it would also be important to consider the materialit o# some o# the #igures in the balance sheet! (or instance$ the de#erred ta% amount ma have adverse e##ects i# the amount is overstated ,ust like i# the non current assets were overstated a negative position would worsen! However$ the current review has some limitations as indicated below: The review has ,ust taken the balance sheet position onl without the income statement! There#ore we can onl guess at #actors on the income statement$ which have had some implications #or the balance sheet! &t being the #irst audit to be undertaken #or Te%a$ it implies that we are not ver #amiliar with the client thus ver little knowledge to appl to this review! &n this case then the partner needs to have a chat with Te%a management or heads o# departments as a wa o# understanding the client and discuss issues pertaining to going concern o# the compan ! /e also need to consider issues o# independence due to the #act that we o##er Te%a other services other than audits! There is a danger that as a #irm we might loose ob,ectivit in respect o# this audit!

Cha ter roundu 2


Revenue recognition is an e@tremely im ortant issue and measurement is the !ey assertion to be audited" %orrowing costs may at times be ca italiEed In the audit of assets, the !ey assertions to consider are e@istence, com leteness, valuation and rights and obligations" Fowever, the auditor should ensure that both tangible and intangible assets are sub3ected to an annual im airment review" 9or the audit of investments, consider both investment income and assets" In the audit of liabilities, the !ey assertions to consider are com leteness, rights and obligations and e@istence" Test liabilities for understatement" The classification of a lease can have a material effect on the financial statements" In the audit of deferred ta@, the auditor should chec! the movements" 6rovisions must be ro erly accounted for in accordance with I#$ -G" Their classification would be im ortant In all cases, the auditor should ensure that disclosure has been adhered to"

Now try >'' from the :@am >uestion %an! at the bac! of the manual

0B?

6#RT C OTF:R $:R;IC:$

0BB

CF#6T:R '*2 Internal #udit Other #ssurance :ngagements


To ic &ist
&nternal audit :ther internal audit issues :utsourcing :utsourcing speci#ic #unctions &mpact o# outsourcing on an audit Audit related services and assurance services Compilations Assurance engagements +aterialit and assurance engagement risk Risk assessment Per#ormance measurements * stem reliabilit Electronic commence

INTRODUCTION2
Having looked mostl on e%ternal audit$ it is important that we address issues pertaining to internal audit! &nternal auditing was also covered in paper G!6 auditing! &n this

0BD

particular chapter$ we #ocus more on its role in corporate governance and the provision o# ob,ective assurance on control and risk management! :ther areas included are outsourcing$ which has become ke in internal audit and business undertakings! The chapter also considers audit related services such as review$ agreed u on rocedures and com ilations" :thers covered are assurance engagements$ ris! assessments, value for money and systems reliability" *ome issues on e?commerce have also been considered!

'"(

Internal audit

As alread indicated$ this sub,ect was covered in paper G!6 Auditing! This chapter revises some areas covered and e%tends #urther the knowledge obtained b looking at other areas such as outsourcing that ma be considered as an alternative to having a #ull3#ledged internal audit department! 3e!inition0 &nternal auditing is an appraisal or monitoring activit established within an entit as a service to the entit ! &t #unctions b amongst other things$ e%amining$ evaluating and reporting to management and directors on the accurac and e##ectiveness o# components o# the accounting and internal control s stems!

Other definitions2
A s stematic$ ob,ective appraisal b internal auditors o# the diverse operations and controls within an organi9ation to determine whether #inancial and operating in#ormation is accurate and reliable$ risks to organi9ations are identi#ied and minimi9ed$ e%ternal regulations and acceptable internal policies and procedures are #ollowed$ satis#actor standards are met$ resources are used e##icientl and economicall and the organi9ations ob,ectives are e##ectivel achieved! &nternal audit is a #unction$ provided either b the emplo ees o# the entit or sourced #rom an e%ternal organi9ation to assist management in achieving corporate ob,ectives! The di##erence between internal and e%ternal auditing can be seen in this wa : An e%ternal audit is an e%ercise whose ob,ective is to enable auditors to e%press an opinion as to whether the #inancial statements give a true and #air view -or presents #airl in all material respect. o# the entit s a##airs at the period end and o# its pro#it and loss #or the period then ended and have been properl prepared in accordance with the applicable reporting #ramework! The e%ternal audit #ocuses more on #inancial statements as opposed to internal audit that #ocuses more on the operations o# the entire business! The #ollowing table highlights the di##erences between internal and e%ternal audit!

0D>

Reason
Re orting

Relating to Relationshi with the com any

Internal audit &nternal audit activities are designed to add value and improve an organi9ations operations &nternal auditors report to the board o# directors$ or other people charged with governance$ such as the audit committee! Relates to the operations o# the organi9ation &nternal auditors are emplo ees o# the organi9ation although sometimes internal audit can be outsourced

:@ternal audit An e%ercise to enable auditors to e%press an opinion on the #inancial statements! The e%ternal auditors report to the shareholders$ or members o# a compan on the truth and #airness o# the accounts! Relates to the #inancial statements concerned more with #inancial records! E%ternal auditors are independent o# the compan and its management! The shareholders appoint them!

:@ercise2 &n order #or ou to appreciate the principle di##erences between the internal and e%ternal auditors$ re#lect back and provide answers to the #ollowing #actors: Eligibilit *ecurit o# appointment and +ain ob,ectives and limitations on the scope o# their work! Also tr and e%plain how e%ternal auditors would evaluate speci#ic work carried out b internal auditors!

'"'

Role of internal audit in cor orate governance

Corporate governance is simpl the wa b which those vested with the responsibilities direct and control the operations o# the organi9ation! &t covers among other things the Cadbur Report$ Freenbur Report$ Hampel and Turnbull report$ the *tock E%change Re'uirements$ King & and && report and the recent *arbanes3:%le Act 0>>0! According to Hampel and Turnbull reports internal audit should assist management in the assessment o# risks and internal controls! The Turnbull report in particular highlights the role internal audit can have in providing ob,ective assurance and advice on risk and control! The Turnbull report sets out some ke guidelines #or the board as #ollows: Have a de#ined process #or the review o# e##ectiveness o# internal controls Review regular reports on internal controls Consider the risks and how the have been managed!

0D1

Check the ade'uac o# the action taken to remed weaknesses and incidences Consider the ade'uac o# monitoring Conduct an annual assessment o# risks and the e##ectiveness o# internal control! +ake a statement on this process in the annual report!

The third paragraph o# the Turnbull guidelines re#ers to the risk! All companies #ace risks arising #rom their operational activities! Risks arise in di##erent areas! *uch as: Risk that the compan will go bankrupt Risks arising #rom regulation and law Risks arising #rom publicit

Turnbull re'uires that risks be managed! This takes as to another role #or internal audit #unction!

'"*

Ris! management

Risk awareness and management should not onl be the role o# management but also that o# ever one in the organi9ation! This role is also e%tended to internal audit as a wa o# ensuring that risk continue to be monitored as a wa o# integrating risk management within a compan $ and the reporting o# results to the board to enable them to report to shareholders! &nternal auditors have relationship with other people: 8anagement 1 b whom the are emplo ed and ma report to! #udit committee 1 to whom the report :@ternal auditors 1 who ma make use o# their work!

'"-

Reliance on the wor! of internal auditors by e@ternal auditors"

I$# D(( 1 Considering the wor! of internal auditors The e%ternal auditor ma make use o# the work o# internal audit! The &*A states that the e%ternal auditor must give consideration #irst to the scope and organi9ation o# the internal audit department and then evaluate the speci#ic audit work the are interested in! the e%ternal auditor should also look at the technical com etence and due rofessional care e%ercised b the internal auditors! However$ the #ollowing #actors must be considered among others: Pro#icienc and training o# the people who have undertaken the work Gevel o# supervision$ review and documentation o# the work o# assistants *u##icienc and appropriateness o# evidence to draw conclusions Appropriateness o# conclusion drawn Consistenc o# an reports prepared with the work per#ormed

0D0

/hether the work necessitates amendment to the e%ternal audit programme!

'"0

Internal auditors and ris! management

The Turnbull guidance on internal auditors role in relation to risk management is an important re'uirement #or directors! The directors need to ensure that risks are identi#ied$ monitored and controlled in their organi9ation! The process o# risk assessment in a compan is important to both investors and managers! Thus directors)management$ internal audit and e%ternal auditors must be involved in the process o# risk assessment! Turnbull states that the need #or internal auditors would depend on the scale$ diversity and com le@ity o# the compan s activities$ the number of em loyees and cost?benefit considerations" However in a climate where the need #or risk management assessment is stressed more$ the need #or internal audit would be more! The #actors below ma indicate the need #or internal audit #unction: The changes in the underlying systems or reporting processes and organi9ation structures Changes in ma3or ris!s arising #rom changes in some e%ternal #actors such as regulator re'uirements Changes in ke risks arising #rom changes in internal rocesses Problems with internal control s stems An increased number o# une@ lained or unacceptable events!

However$ directors usuall delegate to individual managers in various departments! The risk should be identi#ied and assessed$ and a polic is taken in respect o# each o# them! &n this case$ risks ma be dealt with either b one o# the #ollowing: Accept risk -i# it is low impact and likelihood. Reduce risk -b setting up a s stem o# internal control. Avoid risk -b not entering the market$ not accepting contracts. Trans#er risk -b taking out insurance.

/ith their skills in business s stems$ internal auditors are ideall placed to monitor this process and add value to it! The can do the #ollowing: Five advice on the best design o# s stems and monitor their operations "e involved in a process that continuall improves internal control s stems Provide assurance on s stems set up on each department!

*"(

Other internal audit issues"

0D2

*"'

Internal audit and assurance engagement"

An assurance engagement is an assignment in which a practitioner e%presses a conclusion designed to enhance the degree o# con#idence o# the intended users other than the responsible part about the outcome o# the evaluation or measurement o# a sub,ect matter against criteria! &nternal audit was also de#ined as an independent appraisal #unction established within the organi9ation to e%amine$ evaluate and report on the activities! Foing b the de#initions above$ it is clear that internal audit is an assurance #unction and as such the internal auditors$ like accountants undertake assurance engagements through the evaluation and measurement o# per#ormance o# certain aspects o# the compan against pre3ordained criteria! However$ internal audit can also be compare to agreed 1 upon procedures assignments that #orm part o# non3assurance engagement!

*"*

O erational and com liance audits"

O erational audits are audits o# the operational processes o# the organi9ation and check not onl compliance with controls but also the e##ectiveness o# controls as part o# the risk management process! Com liance audits are audit checks intended to determine whether the actions o# emplo ees are in accordance with compan polic or law and regulations! &n order #or this t pe o# audit to be carried out$ the audit need to have knowledge o# the compan polic and carr ing out tests to ensure that compan polic is being #ollowed in practice! As such$ compliance audits tend to #all into the categor o# internal audit providing assurance services! +anagement emplo s internal auditors in order #or them to give them assurance that certain criteria have been met! However$ the work is not assurance in the strict sense o# &*AE 2>>$ because internal audit are not reall checking assertions o# the emplo ees o# the compan ! The are checking that procedures have been complied with! :perational audits are di##erent #rom compliance audits in that the scope is more e%tensive! As part o# an operational audit$ the internal audit department might undertake a compliance audit$ but the scope also includes an assessment o# the e##ectiveness o# the procedures that are being audited! Thus operational audits are more like agreed upon procedures engagement!

*"-

8ulti?site o erations

/hen organi9ations have various sites o# operations like those who operate chain stores$ s stems o# operations ma be the same! Though the ob,ective o# multi3site operations might be the same with those in a single site operation$ results might di##er or var across the di##erent locations! &n this case the internal auditor has to take a di##erent approach$ below we look at some possible approaches to multi3site operations audits! .a/ Com liance based audit a roach 0D6

/ith this t pe o# audit$ a master audit programme is drawn up which is used to check the compliance o# the branches with the set o# procedures$ a#ter which the results #rom the branches are compared! There are two possible wa s o# undertaking the compliance3based approach: .b/ Cyclical 1 this approach is based on visiting all the sites within a given time #rame work! Ris! based a roach 1 this alternative determines which branches are to be visited based on the risk attached to them! roach

6rocess based audit a

/ith this t pe o# audit$ the audit is planned so that speci#ic ke processes are audited! &n a detailed operation$ #or e%ample$ this could involve the important process o# cash handling being audited! Two wa s ma be involved as #ollows: Cyclical 1 aims to audit all processes in a business within a set time#rame! Ris! base 1 the process to be audited are determined with re#erence to the risk attached to them!

*"-"' 6ractical consideration The #ollowing practical issues ma be considered when auditing in a multi site operations: /hich sites to visit How o#ten to visit sites /hether to conduct routine or surprise visits and what mi% o# these t pes o# visit

-"(

Outsourcing

&t has become common nowada s #or some companies to outsource internal audit services and other #unctions! "elow we look at wh outsource$ what to outsource and merits and demerits o# outsourcing! /e also look at what #unctions to outsource such as internal audit and #inance and accounting #unctions and the impact o# outsourcing on an audit!

-"'

+hy outsource,

Outsourcing is the contracting out o# certain #unctions! A business can outsource a small part o# the #unction$ or the entire #unction$ or practicall all its #unctions! &t is the process o# purchasing ke #unctions #rom an outside supplier! &n other words$ it is contracting3out certain #unctions$ #or e%ample internal audit or in#ormation technolog ! This is as opposed to insourcing that entails the organi9ation decides to retain a centrali9ed department #or the ke #unction$ but brings e%perts in #rom an e%ternal market on a short term basis to account #or < ea!= and <though= periods! E%ternal auditors ma be asked 0D8

to provide an internal audit #unction as a wa o# outsourcing although this ma lead to independence problems! There are three general reasons #or outsourcing: (inancial e##icienc Change management *trateg -"'"' 9inancial efficiency2

:utsourcing certain #unctions such as internal audit or in#ormation technolog is considered to be cheaper than operating a #ull3#ledged department! However$ it is important to calculate costs #or both outsourcing and insourcing to prove either! :utsourcing a #unction can lead to greater cost control over that #unction as a result o# the #unction being sub,ected to a contractual #ee rather than a continuous one arising #rom maintaining the #unction in3house! This aspect o# outsourcing might substantiall improve budgeting and cost control$ though shedding o## sta## ma make outsourcing a di##icult legal and human issue! Among other things that outsourcing can do are: &t ma considerabl reduce the number o# emplo ees #or whom the business is responsible thus serving costs in #orm o# salaries$ ta%$ pension etc! The shape o# the entit s #inancial statements can have a #undamental e##ect$ particularl a #unction with a high capital invest is being outsourced such as in#ormation technolog ! &n some cases$ it ma be possible to sell the compan s assets to the service provider$ producing a cash in,ection$ or reduced initial #ees! -"'"* Change management2

:utsourcing can be a wa o# managing change in a compan ! (or e%ample$ i# the compan decides to change its so#tware$ outsourcing the so#tware provision might mean that all sta## training in the new s stem is incorporated into the service! :utsourcing a #unction such as #inance might #acilitate the smooth running o# a merger o# two #irms who have di##erent accounting s stems! -"'"$trategy2

A business might use outsourcing as a strateg to re3#ocus on the core competencies$ or a trust to improve technical services! &t can be a wa o# entering the market in the most low risk wa ! (or e%ample$ a previous low3tech business wanting to merge in e3commerce could outsource its web site development and maintenance!

0D;

-"*

+hat to Outsource

&n most cases$ what is outsourced ma be a #unction$ which is not perceived to be part o# ke competencies! Core competencies are those$ which #orm part o# the #undamental principles on which the compan was #ounded! An e%ample would assist in appreciating what to outsource! )cenario0 TeleCam is a Cambian owned mobile telephone service provider$ owned b Havid Names! Hue to the demise o# Havid$ the compan has not been doing well especiall that other mobile telephone providers have come into the market! A son to Havid$ Peter is thinking o# there options! To merge with another mobile telephone service provider or accept a takeover proposed b Top Cell or continue operating! /ith a recent in,ection o# cash #rom a loan #rom H"C$ Peter has decided to continue operating! TeleCam has a work #orce o# 18> emplo ees and technical computeri9ed processes and operates on its own comple% in the industrial area! TeleCam has the #ollowing departments and #unctions: An accounts department with 1> emplo ees! This has grown over ears and 0 o# the emplo ees are speciali9ed in pa roll duties! The accounts department has a computer s stem$ which is separate #rom the computer s stems used in operations! &n operations$ there are several divisions namel $ design$ sales and marketing! The compan has a part time human resource manager who deals with sta## matters and recruitment! :ther workers include$ o##ice cleaners and o##ice orderl #or mail deliveries who has been with the #irm since inception!

&earning rocess2
&n the e%ample o# the TeleCam$ there are several areas management could consider outsourcing! "elow we look at some o# the potential areas #or outsourcing! The core competenc o# the compan is the provision o# mobile telephone services! This entails that a number o# areas could be considered #or outsourcing or potential areas o# outsourcing$ which ma #all outside the core competenc such as: Accounting Human resources Cleaning$ and +ail deliver

0D?

(rom the above areas$ cleaning and mail deliver would be the least risk to outsource because the do not directl impact on the operations o# the business! The are common outsourced #unctions in ever da li#e o# the companies! The accounting #unction is also a potential area #or outsourcing since it is not part o# the core competenc ! However within accounting there could be other areas that could be considered such as: Pension #unctions Ta% related #unctions The entire pa roll #unction &nvoicing Credit control

However$ when considering the e%tent to which the compan wants to adopt outsourcing$ it is important to consider the risk involved and the control which management want to maintain over the #unction! (or instance$ there is less risk involved in outsourcing a part o# the pa roll #unction than in outsourcing the entire #inance #unction! *ub3dividing can also be done when considering outsourcing o# other #unctions$ e!g! Fuman Resource can be sub divided into wel#are$ health and *a#et $ recruitment and)or the entire department Information Technology can also be sub3divided into maintenance$ pro,ect management$ <etwork +anagement$ and)or the entire &T #unction (urthermore$ looking at the core competenc o# TeleCam$ sub dividing it ma prompt the need to outsource! TeleCam ma concentrate on the network coverage and outsource the design o# products and sales and marketing &n another case$ Peter ma create a virtual organi9ation$ so that the provision o# mobile telephone services is done b another mobile telephone service provider and simpl retains control! This ma entail outsourcing all the business #unctions$ e!g! in the airline industr $ all planes could be contracted out to another person together with maintenance and the crew to #l them!

-"-

#dvantages and disadvantages of outsourcing

The #ollowing general advantages and disadvantages o# outsourcing can be considered: #dvantages of outsourcing2 Cost 1 it is o#ten cheaper to contract out a service than it is to conduct it in house! &t ma also signi#icantl import cost control

0DB

$ ecialist services 1 outsourcing results in specialists being used to provide the service when that would not have been the case i# the #unction were per#ormed in house! Indemnity 1 the service organi9ation ma provide indemnit in the event o# problem arising! &# problems arise in house$ there is no such com#ort 9one! Cash flow 1 obtaining a service through a contract ma assist with the cash #low as the contract will represent a #lat #ee$ as opposed to the cost o# providing a service in house that ma #luctuate!

Disadvantages2 The compan is likel to lose control over the #unction itsel#$ although not over cost! The initial cost o# outsourcing ma be substantial$ i# #or instance$ outsourcing entails closing that department or portion o# the business in pre#erence #or outsourcing! Potential redundancies ma dissuade companies #rom considering outsourcing! +ore time ma be needed to manage the contract to ensure that the service provided is appropriate and in accordance with the contract! Court action ma arise due to limitations in the liabilit o# the contractor$ leading to problems i# the contract is not per#ormed well! /ith all the disadvantages above$ costs might outweigh the bene#its$ even though in theor outsourcing should reduce costs!

0"(
0"'

Outsourcing s ecific functions


Internal audit2

&nternal audit is not a core competenc and can be easil outsourced! However$ it should be appreciated that it is a valuable service to management! The corporate codes such as Turnbull$ Freen bur $ King & and King && reports have made a lot o# emphasis on the importance o# internal audit in assessing controls and monitoring risks! However$ setting up internal audit #unction has its own problems such as: Cost o# recruiting sta## though one o## Hi##icult o# recruiting sta## o# su##icient skill and 'uali#ications #or the compan s pre#erence or need! The #act that management are not accounting specialist and there#ore might struggle to direct the new department in their duties! The time #rame between setting up the department and seeing the results o# having the department!

0DD

The #act that the work re'uired ma not be enough to ,usti# engaging #ulltime sta##! The #act that a variet o# skills and seniorit level are re'uired$ but onl one member o# #ull time sta## can be ,usti#ied!

#dvantages2 :utsourcing can overcome the #ollowing problems: *ta## need not be recruited as the service provider has good 'ualit sta##! The service provider has specialist skills and can assess what management re'uires them to do! :utsourcing can provide an immediate internal audit The service contractor can be #or an appropriate time scale$ e!g! a week :utsourcing can be used on a short term basis to o Provide immediate service o Ga a basis o# a permanent #unction$ b setting policies and #unctions! o Prepare the directors #or the implications o# having an internal audit #unction o Assist the director in recruiting the permanent #unction Disadvantages2 :utsourcing entails that e%ternal auditors provide the internal audit services! This can raise problems as indicated below: &n the event that the compan uses the same audit #irm #or e%ternal audit services$ complications ma arise #or the e%ternal auditors /hen the cost o# outsourcing is ver high$ it ma make the directors see no need o# creating an in house internal audit #unction!

0"*

Outsourcing finance and accounting functions

&n the sections above$ a number o# advantages and disadvantages have been outlined! "elow we look at #urther advantages and disadvantages #or some o# the #unctions considered #or outsourcing: 0"*"' Data rocessing2

Disadvantages2 Gogistical di##iculties ma arise in outsourcing data processing due to high level o# paper involved such as invoices$ goods received notes etc! this in#ormation will need to be passed over to the service organi9ation! The compan ma also not have control o# the ke accounting documents and records! &t is a legal re'uirement that the director maintain this in#ormation! Though

2>>

the ma delegate the practicalities$ the responsibilit still remains with them to maintain the records! 0"*"* 6ension2

#dvantages2 This is a speciali9ed area and would need a specialist to operate the compan s pension provision! Disadvantages2 Pensions are closel related to the pa roll and the compan will need to share sensitive in#ormation with the pension provider$ which ma make the situation complicated! 0"*"- Information Technology2 #dvantage2 :utsourcing &T as a part or all the #unction enables the compan to keep pace with rapid changes in technologies or technological advances To tap the e%pertise o# the work o# &T specialists a #ield where man people #ind di##iculties! :utsourcing can provide a use#ul sa#et net o# a technical help line or indemnit in the event o# computer disaster! &t ma bring about added value in new wa s o# doing business that have been identi#ied such as e3commerce!

0"*"0 Due diligence2 #dvantage: Hue diligence can bring about e%pertise! Eualit can be e%pected #rom its service contractor and can seek legal compensation #rom them in the event o# negligence! 0"*"1 Ta@es2 #dvantage2 E%pertise can be brought in Disadvantage: /hile the work can be outsourced$ the responsibilit cannot! The ta% authorit normall deals with responsible persons and not the agent!

1"(

Im act of outsourcing on an audit

&*A 6>0 Audit Considerations relating to entities using service organi9ation ,usti#ies the impact o# outsourcing on an e%ternal audit! 2>1

A service organi9ation is an organi9ation that provides services to another organi9ation! As alread said on outsourcing$ some companies ma choose to outsource activities necessar to the running o# their business to service organi9ations! E%ample o# such activities that could be outsourced are: &n#ormation processing +aintenance o# accounting records (acilities management Asset management &nitiation or e%ecution o# transactions on behal# o# the other entit ! Pa roll management

As part o# the audit evidence$ the auditor needs to obtain su##icient appropriate audit evidence to e%press an opinion on the #inancial statements! Their approach should there#ore be that #or parts outsourced to a service organi9ation$ such as maintenance o# accounting records$ su##icient evidence is obtained!

1"'

Considerations of the client5s auditor

A service organi9ation ma establish and e%ecute policies and procedures that a##ect a client organi9ations accounting and internal control s stems! These policies and procedures are ph sicall and operationall separate #rom the client organi9ation! -a. /hen the services provided b a service organi9ation are limited to recording and processing client transactions and the client retains authori9ation and maintenance o# accountabilit $ the client ma be able to implement e##ective policies and procedures within its organi9ation! /hen the service organi9ation e%ecutes the client transactions and maintains accountabilit $ the client ma deem it necessar to rel on policies and procedures at the service organi9ation! #UDIT CON$ID:R#TION$ R:&#TIN7 TO :NTITI:$ U$IN7 $:R;IC: OR7#NIB#TION$

-b.

I$# 0(*

&*A establish standards and provide guidance to an auditor where the entit uses a service organi9ation! &t also describes the service organi9ation auditors reports$ which ma be obtained b the entit s auditors!

I$# 0(*"*
The auditor should consider how an entity5s use of a service organiEation affects the entity5s internal control so as to identify and assess the ris! of material misstatement and to design and erform further audit rocedures"

I$# 0(*"-

2>0

# client may use a service organiEation such as one that e@ecutes transactions and maintains related accountability or records transactions and rocesses related data .for e@am le, a com uter systems service organiEation/" If the entity uses a service organiEation, certain olicies, rocedures and records maintained by the service organiEation may be relevant to the audit of the financial statements of the client" I$# 0(*"1 In obtaining an understanding of the entity5s and its environment the auditor should determine the significance of service organiEation activities to the client and the relevance to the audit" In doing so, the client auditor would need to consider the following as a ro riate2

The nature of the services rovided by the service organiEation The terms of contract and the relationshi between the client and the service organiEation" The e@tent to which the entity5s internal controls interact with the systems at the service organiEation" The entity5s internal control relevant to the service organiEation activities" $uch as2 o Those that are a lied to the transactions rocesses by the service organiEation o Fow the entity identifies and manages ris! related to the use of the service organiEations" The service organiEation5s ca ability and financial strength, including the ossible effect of the failure of the service organiEation on the client" Information about the service organiEation such as that reflected in user and technical manuals Information available on general controls and com uter systems controls relevant to client5s a lications"

I$# 0(*"D The client auditor should also consider the e@istence of third arty re orts from the service organiEation auditor, internal auditors or regulatory agencies as a means of roviding information about the accounting and internal control systems of the service organiEation and about its o erations and effectiveness" The understanding obtained ma lead the auditor to decide that the control risk assessment o# the risk o# material misstatement will not be a##ected b controls at the service organi9ation= i# so$ #urther consideration o# this &*A is unnecessar ! I$# 0(*"G If the client auditor concludes that the activities of the service organiEation are significant to the entity and relevant to the audit, the auditor should obtain a

2>2

sufficient understanding of the entity and its environment, including its internal control, to identify and assess the ris!s of material misstatement and design further rocedures in res onse to the assessed ris!" I$# 0(*"H If information is insufficient, the client auditor should consider as!ing the service organiEation to have its auditor erform such rocedures as to su ly the necessary information or the need to visit the service organiEation to obtain the information" a client auditor wishing to visit a service organiEation may advice the client to request the service organiEation to give the client auditor access to the necessary information" I$# 0(*"I If the client auditor uses the re ort of a service organiEation auditor, the auditor should consider ma!ing inquiries concerning that auditor5s rofessional com etence in the conte@t of the s ecific assignment underta!en by the service organiEation auditor"

1"*

$ervice organiEation auditor5s re orts

I$# 0(*"'' +hen using a service organiEation auditor5s re ort, the client auditor should consider the nature of and content of that re ort" The re ort of the service organiEation auditor will ordinarily be one of two ty es2 .a/ .b/ Re ort on suitability of design" This is the basic re ort" Re ort on suitability of design and o erating effectiveness" This will contain the same as a re ort on design, lus an o inion by the service organiEation auditor that the accounting and internal control systems are o erating effectively based on the results from the tests of control"

I$# 0(*"'The client auditor should consider the sco e of the wor! erformed by the service organiEation auditor and should assess the usefulness and a ro riateness of re orts issued by the service organiEation auditor" +hile re orts on design may be useful to a client auditor in gaining the understanding of the accounting and internal control systems, an auditor would not use such re orts as a basis for reducing the assessment of control ris!" %y contrast a re ort on o erating effectiveness may rovide such a basis since tests of control have been erformed" The client auditor should consider whether the controls tested by the service organiEation auditor are relevant to the client5s

2>6

transactions and whether the service organiEation auditor5s tests of control and the results are adequate" I$# 0(*"'D 9or those s ecific tests of control and results that are relevant, a client auditor should consider whether the nature, timing and e@tent of such tests rovide sufficient a ro riate audit evidence about the o erating effectiveness of the internal controls to su ort the auditor5s assessed ris!s of material misstatement" The auditor o# a service organi9ation ma be engaged to per#orm substantive procedures that are o# use to a client auditor! *uch engagements ma involve the per#ormance o# procedures agreed upon b the client and its auditor and b the service organi9ation and its auditor!

1"-

Re orting2

E%ternal auditors will be a##ected when outsourced #unctions impact on the #inancial statements! &nternal audit will be interested in outsourced #unctions$ which a##ect the business! &nternal audit will also be interested in the contractual arrangements made with the service organi9ation! The ma want to pa a visit to the organi9ation and undertake a review o# its s stems to ensure that the are su##icient #or the business needs! I$# 0(*"'H /hen the auditor uses a report #rom the auditor o# a service organi9ation$ no re#erence should be made in the entit s auditors report to the auditors report on the service organi9ation!

>uestion2
A" Gtd has made losses #or the two ears ending 0>>0 and 0>>2! Huring a meeting to discuss among other cost reduction$ which has been identi#ied as one o# the problems making the compan to incur losses$ it has been decided that certain services provided to the compan such as pa roll$ clearing and mail deliver be outsourced to other service providers! +anagement is convinced be ond doubt that this plan is going to work! However$ since outsourcing is a new concept$ which most companies and emplo ees have not understood properl $ ou have been asked to do the #ollowing: -a. -b. -c. E%plain the meaning o# the word outsourcing and distinguish it #rom insourcing" "rie#l outline the risks and bene#its o# outsourcing the pa roll$ clearing services and mail deliver #unctions! /hat are some o# the issues that ou would consider in planning the audit o# a compan whose services have been outsourced$ like in -b. above!

2>8

#nswer2
-a. Outsourcing is a term used when a compan contracts out some services to the outside provider thereb allowing them to provide e%pert service-s. and in turn make a pa ment! This is normall given to e%perts$ in this case$ e%perts in pa roll$ clearing and mail deliver ! /hereas insourcing relates to maintaining a specialist #unction in house #rom where other #unctions can bu e%ternal e%pertise on a short3term basis as and when need arise! (or e%ample$ services can be insourced #rom a consultanc department within the organi9ation to which pa ment is made as opposed to an outside consulting #irm! Pa roll is a di##icult area o# accounting that needs e%pertise on areas such as ta%ation! &t is also another area where #raud is eminent in most companies! Though an e%ternal service provider can provide the e%pertise$ it is likel to be susceptible to #rauds and lack o# con#identialit ! Emplo ees ma not be happ to provide in#ormation to e%ternal people pertaining to their salaries and other personal details such as bank details! The trans#er o# data is another area where control need to be enhanced so that accurate data is provided to avoid #raudulent behaviour! /here the department is small with #ew personnel working there$ it could be a good idea to outsource the service in order to relin'uish personnel some o# the duties$ thereb allowing them to be more e##icient on the remaining ones! *egregation o# duties ma also be enhanced! (or clearing services$ this ma not posse much challenge as long as a proper timetable is outlined as to when the clearing should be done especiall in o##ices! Eualit can be enhanced due to e%pertise being provided and some costs ma be reduced since pa ments to the outsourced compan are a one o##! However$ it would also be important to institute su##icient controls to sa#eguard the assets o# the compan #rom pil#erage and misuse! Certain assets could miss and blame either the owner o# the o##ice or the clearing compan ! Con#identialit should also be emphasi9ed and protect all documents #rom being taken and used #or purposes not intended! (or mail deliver $ there could be a risk o# mails$ cash and important documents missing! The compan should streamline a good s stem o# mail collection! +issing o# mails especiall pertaining to important documents ma ,eopardi9e the #unctioning o# the compan ! A register needs to be put in place so that all the mails$ cash and documents received are recorded properl ! :## course some o# the bene#its include reduced administrative activities! -c. The auditor should determine whether the outsourced #unction is relevant to the audit! &n re#erence to -b. above$ the audit should pa attention to the e%penditure arising #rom the services provided! (or instance$ the wage bill is the total pa roll bill in line with the compan s budget!

-b.

2>;

As part o# planning$ it would be important that the auditor obtains contract schedules #or all the services that have been outsourced! This ma bring about certain vital in#ormation as the auditor tries to ,usti# e%penditure lines pertaining to outsourced contracts and terms outline therein! The audit should assess as to whether he would need the records pertaining to outsourced services especiall where the outsourced compan maintains these records! &# he has to$ then arrangements should be made to #acilitate accessibilit ! The auditor should also be in a position to assess the risk o# material misstatement arising #rom outsourced services! Are the material to warrant consideration in the determination o# risks pertaining to #igures in the #inancial statements4 The auditor ma also consider things like the reputation o# the service provider and the e##ectiveness o# the past controls in relation to present controls arising #rom outsourced services!

D"(

#udit related services and assurance services

Audit related services ma be assurance services in #orm o# reviews or non3assurance services in #orm o# agreed upon procedures and compilations!

D"'

Ob3ective of a review engagement

The ob,ective o# a review engagement is to enable an auditor to state whether on the basis o# procedures$ which do not provide all the evidence that would be re'uired in an audit$ an thing has come to the auditors attention that causes the auditor to believe that the #inancial statements are not prepared in all material respect in accordance with an identi#ied #inancial reporting #ramework!

D"'"'

Reviews2

The review engagements can be in line with the assurance engagement alread looked at in chapter 1! "elow we look at two t pes o# engagements$ which ma #all in this conte%t! An attestation engagement where the accountant declares that a given premise is either correct or not! A direct re orting engagement$ where the accountant reports on issues that have come to his attention during the course o# his review!

:@am le2 Attestation engagements! Auditors ma sometimes be asked to review interim #inancial in#ormation! &n such an engagement$ the auditor is being asked to attest assertions made$ such as: 2>?

The accounting policies used are consistent with those used in the prior ear #inancial statements! <o material modi#ications to the interim #inancial in#ormation as it has been presented are re'uired!

:@am le2 Hirect reporting engagements A good e%ample is a @due diligenceA engagements! This is where an accountant is asked to review the accounts and s stems o# a target compan in the event o# a prospective business purchase! &n such an event$ the accountant is asked to simpl report on issues arising! &n review engagements$ the auditor will rel more heavil on procedures such as in'uir and anal tical review than on more detailed substantive testing! The reasons #or this are as #ollows: He is seeking a lower level o# assurance than #or an audit$ so these #orm o# evidence seeking are su##icient due to risk being lower! *uch techni'ues provide indicators to direct work to risk areas and #rom which to draw conclusions$ and the are 'uick and there#ore$ cost e##ective!

&nternational *tandards on review engagements -&*RE. 06>> is to establish standards and provide guidance on the auditors pro#essional responsibilities when an engagement to review #inancial statements is undertaken and on the #orm and content o# the report that the auditor issues in connection with such a review! I$R: *0(("D The auditor should lan and erform the review with an attitude of rofessional s!e tism recogniEing that circumstances may e@ist, which cause the financial statements to be materially misstated" As part o# the review engagement$ the auditor should compl with the Code o# Ethics #or Pro#essional Accountants issued b the &nternational #ederation o# Accountants! These ma include independence$ integrit $ ob,ectivit $ pro#essional competence and due care$ con#identialit $ pro#essional behaviour$ and technical standards! I$R: *0(("G 9or the ur ose of e@ ressing negative assurance in the review re ort, the auditor should obtain sufficient a ro riate evidence rimarily through inquiry and analytical rocedures to be able to draw conclusions"

2>B

I$R: *0(("H The rocedures required to conduct a review of financial statements should be determined by the auditors having regard to the requirements of this I$R:, relevant rofessional bodies, legislation, regulation and, where a ro riate, the terms of the review engagement and re orting requirements" +an o# the re'uirements o# the &*RE are similar to the engagements o# an audit because review is e%tremel similar to an audit! D"'"* 6lanning

I$R: *0(("'-A'0 The auditor should lan the wor! so that an effective engagement will be erformed" In lanning a review of financial statements, the auditor should obtain or u date the !nowledge of the business including consideration of the entity5s organiEation, accounting systems, o erating characteristics and the nature of its assets, liabilities, revenues and e@ enses" Planning ma include obtain knowledge o# the business$ some materialit re'uirements$ and the need to use the work o# e%perts or per#ormed b others! &t ma also involve documenting matters$ which are important in providing evidence to support the review report$ and evidence that the review was carried out in accordance with &*RE! Evidence collecting procedures ma re'uire documenting all3important matters that the auditor has come across$ appl ing ,udgement in determining nature$ timing and e%tent o# procedures and make en'uiries about subse'uent events and carr out some e%tended procedures i# material misstatements are suspected! D"'"- Re orting2 An e%ternal review is an e%ercise similar to an audit$ which is designed to give a reduced degree o# assurance concerning the proper preparation o# a set o# #inancial statements! I$R: *0(("*-A*0 The review re ort should contain a clear written e@ ression of negative assurance" The auditor should review and assess the conclusion drawn from the evidence obtained as the basis for the e@ ression of negative assurance" %ased on the wor! erformed, the auditor should assess whether any information obtained during the review indicates that the financial statements do not give a true and fair view .or are not resented fairly, in all material res ect/ in accordance with the identified financial re orting framewor!" The &*RE gives as part o# the appendi% various illustrations such as 2>D

Hetailed procedures that ma be per#ormed in an engagement to review #inancial statements! (orm o# un'uali#ied review report Review reports other than un'uali#ied Adverse report #or a departure #rom &nternational Accounting standards!

"elow an un'uali#ied review report has been reproduced! <egative assurance is assurance o# something in the absence o# an evidence arising to the contrar ! &n e##ect this means the auditor is sa ing$ <I believe that this is reasonable because I have no reason to believe otherwise= The I$R: gives the following form of unqualified review re ort2 Review report toJJJJJ! /e have reviewed the accompan ing balance sheet o# A"C Compan at Hecember 21$ 0>LL$ and the related statements o# income and e%penditure and cash #low #or the ear then ended! These #inancial statements are a responsibilit o# the compan s management! :ur responsibilit is to issues a report on these #inancial statements based on our review! /e conducted our review in accordance with the &*RE 06>> -or re#er to relevant national standards or practices. applicable to review engagements! This standard re'uires that we plan and per#orm the review to obtain moderate assurance as to whether the #inancial statements are #ree #rom material misstatements! A review is limited primaril to in'uiries o# compan personnel and anal tical procedures applied to #inancial data and thus provide less assurance than an audit! /e have not per#ormed an audit= accordingl $ we do not e%press an opinion! "ased on our review$ nothing has come to our attention that causes us to believe that the accompan ing #inancial statements do not give a true and #air view -or not present #airl in all material respects. in accordance with international accounting standards

Date
#ddress" &# there are an matters that have come to the attention o# the auditor$ the auditor should describe those matters and the ma have the #ollowing e##ects! Im act2 +aterial :ffect on re ort E%press a 'uali#ied opinion o# negative assurance

21>

Pervasive

E%press an adverse opinion that the #inancial statement do not give a true and #air view!

Again i# there are an limitations in scope o# the work he intended to carr out #or the review$ he should describe the limitation and the ma have the #ollowing e##ects! Im act: :ffect on re ort

+aterial to one area! E%press a 'uali#ied opinion o# negative assurance due to amendments$ which might re'uire i# the limitation did not e%ist! Pervasive! D"'"0 Ho not provide an assurance

#greed u on rocedures

Agreed upon procedures assignments are discussed in &*R* 66>> Engagements to per#orm agreed upon procedures regarding #inancial in#ormation! The purpose o# the standards is to establish standards and provide guidance on the auditors pro#essional responsibilities when an engagement to per#orm agreed3upon procedures regarding #inancial in#ormation is undertaken and on the #orm and content o# the report that the auditor issues in connection with such an engagement! Ob3ective of an #greed ) u on rocedures :ngagement This is an engagement to per#orm agreed upon procedures and an auditor is engaged to carr out those procedures o# an audit nature to which the auditor and the entit and an appropriate third parties have agreed and to report on #actual #indings! The recipient o# the report must #orm their own conclusions #rom the report b the auditors! The report is restricted to those parties that have agreed to the procedures to be per#ormed since others$ unaware o# the reasons #or the procedures ma misinterpret the results! D"'"1 #cce ting a ointment

I$R$ 00(("I The auditor should ensure that re resentatives of the entity and ordinarily other s ecified arties who will receive co ies of the re ort of factual findings that there is a clear understanding regarding the agreed rocedures and the conditions of the engagement" The auditor should carr out procedures to come up with the plan that would assist in carr ing out the assignment$ document matters$ which are important in providing evidence to support the report o# #actual #indings$ and evidence that the engagement was carried out in accordance with the standard! Re orting

211

I$R$ 00(("'H The re ort of factual finding should contain .a/ .b/ .c/ .d/ .e/ .f/ .g/ .h/ .i/ .3/ .!/ .l/ .m/ Title #ddressee .ordinarily the client who engaged the auditor to erform the agreed?u on rocedures/ Identification of s ecific financial or non?financial to which the agreed u on rocedures has been a lied" # statement that the rocedures erformed were those agreed with the reci ient # statement that the engagement was erformed in accordance with the international standards on auditing a licable to agreed u on rocedure engagements, or with relevant national standards or ractices" +hen relevant a statement that the auditor is not inde endent of the entity Identification if the ur ose for which the agreed u on rocedures were erformed # listing of s ecific rocedures erformed # descri tion of the auditor5s factual findings including sufficient details of errors and e@ce tions found" $tatements that the rocedures erformed do not constitute either an audit or a review and as such no assurance is e@ ressed" # statement that had the auditor erformed additional rocedures an audit or a review other matters might have come to light that would have been re orted" # statement that the re ort is restricted to those arties that have agreed to the rocedures to be erformed" # statement .when a licable/ that the re ort only relates to the elements, accounts items or financial and non?financial information s ecified and that it does not e@tend to the entity5s financial statements ta!en as a whole" Date of the re ort #uditor5s address #uditor5s signature"

.n/ .o/ . /

G"(

Com ilations"

This is an engagement where the accountant is engaged to use accounting e%pertise as opposed to auditing e%pertise to collect$ clari# and summari9e #inancial in#ormation! The accountant is e%pected to compile in#ormation such as: Preparing #inancial statements Preparing ta% returns etc! The in#ormation to be compiled does not have to be #inancial in#ormation!

210

The &nternational guidance on compilations engagements i# #ound in &*R* 661> Engagements to compile #inancial statements! The most relevant piece o# guidance that it contains #or us is the guidance on reporting$ which is reproduced below:

G"'

Re orting

The in#ormation compiled b the accountant should contain a re#erence to the #act that it has been audited! I$R$ 00'("H Re ort on com ilation engagements should contain the following2 .a/ .b/ .c/ .d/ .e/ .f/ .g/ Title and addressee # statement that the engagement was erformed in accordance with the I$# a licable to com ilation engagement, or with the national standards and ractices" +hen relevant that the accountant is not inde endent of the entity" Identification in the financial information noting that it is based on information rovided by management" # statement that neither an audit nor a review had been carried out and that accordingly no assurance is e@ ressed on the financial information" # statement that neither an audit nor a review has been carried out and that accordingly no assurance is e@ ressed on the financial information" # aragra h when considered necessary, drawing attention to the disclosure of material de artures from the identified financial re orting framewor!"

H"(

#ssurance engagements2

Assurance services improve the 'ualit o# decision3making #or users o# in#ormation!

H"'

:lements of an assurance engagement"

As alread de#ined in chapter one$ an assurance engagement is one where a pro#essional accountant evaluates or measure a sub,ect matter that is the responsibilit o# another part against a suitable criteria$ and e%presses an opinion which provides the individual user with a level o# assurance about the sub,ect matter! &n this particular case we #ocus our attention on &nternational standards on assurance engagements -&*AE. 2>>> Assurance engagements other than audits or reviews o# historical #inancial in#ormation! 212

H"*

#ssurance given"

The &*AE 2>>> re#ers to two t pes o# engagements: reasonable assurance engagements and limited assurance engagements" &t is important to remember that$ absolute assurance can never be given on an assurance engagement due the inherent limitations o# such engagements! This emphasi9es the point that assurance engagements ma give reasonable assurance or limited assurance!

H"-

#cce ting and continuing a

ointment

Assurance engagements should onl be accepted i# the #irm meets the re'uirements o# the Codes o# Ethics and &*EC 1$ which re'uires that practitioners ensure the compl with the codes o# ethics and the 'ualit control standards -&*EC 1. with regard to the assignment! &n addition$ the standard speci#ies the #ollowing: I$#: -((("HAI The ractitioners should acce t .or continue where a licable/ an assurance engagement only if, on the basis of a reliminary !nowledge of the engagement circumstances, nothing comes to the attention of the ractitioner to indicate that the requirements of the code or of the I$#:s would not be satisfied" The ractitioner should acce t .or continue where a licable/ an assurance engagement only if the ractitioner is satisfied that those ersons who are to erform the engagement collectively ossess the necessary rofessional com etencies" I$#: -((("G The ractitioner should acce t .or continue where a licable/ an assurance engagement only if the sub3ect matter is the res onsibility of a arty other than the intended user or the ractitioner" &n the absence o# an acknowledgement o# responsibilit $ the practitioner considers: -a. /hether it is appropriate to accept the engagement! Accepting it ma be appropriate when$ #or e%ample$ other sources$ such as legislation or a contract$ indicate responsibilit $ and -b. &# the engagement is accepted$ whether to disclose these circumstances in the assurance report!

H"0

#greeing on the terms of the engagement"

I$#: -((("'( The ractitioner should agree on the terms of the engagement with the engagement arty" 216

To avoid misunderstanding$ it is important that the agreed terms are contained in an engagement letter or other suitable #orms o# contracts! However$ i# the engagement part is not the responsible part $ the nature and content o# an engagement letter or contract ma var ! I$#: -((("'' # ractitioner should consider the a ro riateness of a request made before the com letion of an assurance engagement to a limited assurance engagement or from a reasonable assurance engagement to a limited assurance engagement, and should not agree to a change without reasonable 3ustification"

H"1

6lanning and erforming the engagement"

I$#: -((("'* The practitioner should plan the engagement so that it will be per#ormed e##ectivel ! This involves developing: An overall strateg #or the scope$ emphasis$ timing and conduct o# the engagement and a detailed engagement plan! Ade'uate planning helps to devote appropriate attention to important areas o# the engagement$ identi# potential problems on a timel basis and properl organi9e and manage the engagement in order #or it to be per#ormed in an e##ective and e##icient manner! +atters to be considered: The terms o# the engagement The characteristics o# the sub,ect matter and identi#ied criteria The engagement process and possible sources o# evidence The practitioners understanding o# the entit and its environment -risks o# material misstatement &denti#ication o# intended user and their needs$ and consideration o# materialit ! Component o# assurance engagement risk Personnel and e%pertise re'uired -including the potential use o# e%pertise. I$#: -((("'1 The practitioner should obtain an understanding o# the sub,ect matter and other engagement circumstances$ su##icient to identi# and assess the risks o# sub,ect matter in#ormation being materiall misstatement$ and su##icient to design and per#orm #urther evidence gathered procedures!

218

H"D

# ro riateness of the sub3ect matter and suitability of the criteria

I$#: -((("'H The practitioner should assess the appropriateness o# the sub,ect matter! I$#: -((("'I The practitioner should assess the suitabilit o# the criteria to evaluate or measure the sub,ect matter!

I"(

8ateriality and assurance engagement ris!

I$#: -((("**A*0 The ractitioner should consider materiality and assurance engagement ris! when lanning and erforming an assurance engagement" The ractitioner should reduce assurance engagement ris! to an acce table low level in the circumstance of the engagement"

I"'

Using the wor! of an e@ ert

I$#: -((("*DA-(A-* +hen the wor! of an e@ ert is used, in the collection and evaluation of evidence, the ractitioner and the e@ ert should on a combined basisC ossess adequate s!ills and !nowledge regarding the sub3ect matter and the criteria for the ractitioner to determine that sufficient a ro riate evidence had been obtained" The ractitioner should be involved in the management and understanding the wor! for which an e@ ert is used, to an e@tent that is, sufficient to enable the ractitioner to acce t res onsibility for the conclusion on the sub3ect matter information" The ractitioner should obtain sufficient a ro riate audit evidence that the e@ ert5s wor! is adequate for the ur ose of the assurance engagement" Obtaining :vidence I$#: -((("-The ractitioner should obtain sufficient a base the conclusion" 21; ro riate audit evidence on which to

*u##icienc is the measure o# 'uantit o# evidence! Appropriateness is the measure o# the 'ualit o# evidence$ i!e! its relevance and its reliabilit ! And as part o# the audit evidence$ the practitioner should obtain representations #rom the responsible part as appropriate!

Considering $ubsequent :vents


I$#: -((("0' The ractitioner should consider the effect on the sub3ect matter information and on the assurance re ort of events u to the date of the assurance re ort" Documentation2 I$#: -((("0* The ractitioner should document matters that are significant in roviding evidence that su orts the assurance re ort and that the engagement was erformed in a Re orting I$#: -((("01A0D The ractitioner should conclude whether sufficient a ro riate evidence has been obtained to su ort the conclusion e@ ressed on the assurance re ort" The assurance re ort should be in writing and should contain a clear e@ ression of the ractitioner5s conclusion about the sub3ect matter information"

References for a client


*ometimes an auditor ma be asked #or a re#erence concerning a client particularl in relation to his abilit to service a loan! /here no additional work is re'uired to provide a re#erence$ the #ollowing matters should be considered: &nherent uncertaint o# #uture income and e%penditure The di##icult o# reporting on present solvenc The possibilit o# a dut o# care arising That clari#ication ma be re'uired

However$ the accountant might be able to provide certain in#ormation without di##icult :

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The length o# time the have acted #or the client The results declared to the ta%ation authorities over part ears A statement o# a level o# negative assurance given in part per#ormance

'("( Ris! assessment


&nvestors and managers should consider risk assessment as an important area #or assurance services! There are other risk categories that could be considered! However #or business managers and investors business risk ma take a center stage! &t can be broken down into three -2. elements namel : (inancial risk :perational risk$ and Compliance risk!

/ithin these risks$ there are a number o# speci#ic risks within these elements$ as shown below:

%usiness Ris!

9inancial Ris! &n#ormation

O erational ris! &n#ormation Technolog

Com liance ris! Environmental

'("'

Need for assurance

The risk that a compan enters into has a direct im act on the risk o# the investment that an one purchasing shares in a compan or loaning mone to a compan is making! &nterested stakeholders$ particularl investors need assurance that the risk taken b the compan in e##ect with their investment is acceptable to them and that the returns that the receive are in accordance with that level o# risk! The need #or assurance about the risks the compan enters into has led to the importance o# the issue o# corporate governance and internal control e##ectiveness! :ther stakeholders will also be interested in the e##ectiveness o# risk management in a compan such as creditors and emplo ees! This is because the ultimate risk is that a business might #ail! 21B

'("* 6ossible assurance criteria"


The criteria b which risk assessment is evaluated will depend on the speci#ic needs o# the compan and users! However$ some possibilities are: The re'uirements o# the Turnbull guidelines +anagements polic on risk management

&t should be noted that there are no universall recogni9ed criteria suitable #or evaluating the e##ectiveness o# an entit s risk evaluation! Assurance is likel to be limited to whether evaluation is carried out rather than the 'ualit o# the evaluation!

'("- Res onsibility for ris! assessment"


There are three sets o# people who can be involved in risk assessment in a compan $ namel : Hirectors)+anagement &nternal audit E%ternal audit!

&t is important that ou distinguish between the risk assessment carried out b the auditors and the directors! The directors are responsible #or assessing and then managing the risks arising to the business$ that is$ the business risk! As part o# their audit$ the auditors assess audit risk! Audit risk is the risk that the auditors make an inappropriate opinion on #inancial statements! The auditors ma consider business risk as part o# their audit risk assessment! However$ the auditors are not responsible #or risk management o# their clients!

'("0 #ssessing ris!


Risk assessment ma be done using methods such as */:T or PE*T anal sis! &n practice$ risk identi#ication is likel to be done in all the various departments o# a business! These risks could include #or e%ample Contractual risks -important customers not agreeing to give contractual terms. :perational risks -scarce raw material$ risks arising through storage and use. Ph sical risks -#or e%ample$ health and sa#et compliance. Product distribution -logistics$ networks$ outlets. Regulation -di##erent ,urisdictions$ internet trading. Reputation -brands and sta## pro#ile. 21D

The directors o# a compan need to determine guidelines #or assessing risk! Risks might be assessed in terms o# signi#icance$ capacit to be managed and likelihood! +athematicall $ risk can be assessed or anal 9ed 'ualitativel using a grid as the e%ample below!

6robabilityAim act matri@


&ow li!elihood &ow im act Figh li!elihood &ow im act &ow Figh &ow Figh &ow li!elihood Figh im act Figh li!elihood Figh im act

'("1

Res onses to ris!

A number o# responses can be taken b management to address the risk! Risk acceptance -particularl i# it is low likelihood! Gow impact. Risk reduction -b setting up a s stem o# internal control to prevent the risk arising. Risk avoidance -b not entering that market or not accepting certain contract. Risk trans#erence -b taking out insurance. &# management chooses to accept risk$ the must set risk thresholds$ that is$ determine levels o# risk where the will stop accepting risk and choose one o# the other strategies! These thresholds are important because i# directors or management are reckless with regard to risk the ma be breaching their #iduciar duties!

'("D

#ssurance

E%ternal accountants ma be able to provide assurance that management polic is being adhered to that insurance is su##icient or that a management polic e%ists!

>uestion2
5ou are the auditor o# Hamlet &nc$ a compan that operates health and #itness clubs in ma,or cities throughout the countr o# Itopia! The shares are owned b the #our

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e%ecutive directors who have the long3term ob,ective o# growing the business and eventuall #loating it on the stock market! The compan operates in a competitive market$ and the directors have adopted a strateg o# undercutting the competition to increase membership and turnover! Huring the current ear$ the compan has bought out the owners o# seven clubs in small towns and has embarked on a programme o# re#urbishment! The directors e'uit in the business has been #unded b mortgaging their homes$ and the remaining capital is #unded b bank borrowings! The managing director is ver enthusiastic about adopting new ideas and sound business practices! He has recentl read a newspaper article$ which stated: 7&t is good practice #or an organi9ation to undertake a business risk assessment e%ercise at least annuall ! He does not know what business risk assessment entails$ and has asked ou to e%plain! He would also like to know how the compan should undertake a business risk assessment e%ercise! Required2 Prepare brie#ing notes in preparation #or a meeting with the managing director which: -a. -b. E%plain the ob,ectives o# a business risk assessment e%ercise$ and describe the attributes re'uired #or e##ective business risk management= Provide e%amples o# signi#icant business risks to which Hamlet &nc is e%posed!

#nswer2
NOT:$ 9OR 8::TIN7 +ITF 8D O9 F#8&:T INC -a. A risk assessment #or a compan is a wa o# assessing what threats there are to that compan in continuing in business$ and deciding how to best manage those risks! The ob,ective is to ascertain what the greatest risks are to the compan $ and then to #ind wa s to mitigate those risks! The e%ercise is to look at all aspects o# the business$ e!g! customers$ competitors$ suppliers$ and emplo ees$ to establish what those risks are! " per#orming this e%ercise regularl $ the compan will be in a better position to react to threats to the compan ! :ffective ris! management

201

&t is important that all risks 1 both internal and e%ternal 3 are considered! There#ore$ it is important to get the views o# as man people as possible 1 directors$ managers$ emplo ees$ service providers -ie auditors$ bankers.! :nce identi#ied$ the risks should be given a risk rating in order to establish which are the greatest and which are the least according to their likelihood and impact! Those risks that are considered the greatest should be concentrated on! The compan should then consider these risks$ and decide what should be done to e##ectivel manage them! This could involve rethinking the compan s strateg in order to negate these risks$ or #inding new$ less risk wa s o# raising #inance! An e##ective s stem o# internal control is important in the processes o# identi# ing and managing risks! E##ective risk management also involves establishing a risk culture within the compan $ so that all emplo ees are continuall evaluating the risks o# their actions! &n this wa $ ever one will be identi# ing risks on an ongoing basis and thinking o# wa s to reduce these risks! -b. Hamlet &nc has a polic o# undercutting competitors to gain business! The risks o# this strateg are that it opens up the compan to getting involved in a price war with its competitors and$ i# this happens$ the margins o# the business could be eroded too #ar #or the compan to maintain its pro#its! " continuing this polic $ the standards o# the health clubs could #all in order to reduce costs$ and members could be lost! Another risk to the compan is the chosen method o# e%pansion! The previous polic o# the compan was to operate in ma,or cities$ but it has embarked on a process o# bu ing clubs in small towns! This is a risk polic because operating clubs in small towns could be markedl di##erent #rom in large cities! Inless Hamlet &nc is aware o# these di##erences= it ma not operate these new clubs e##ectivel $ and could lose business! " re#urbishing these clubs$ the compan leaves itsel# open to two main risks! The #irst is that the capital investment re'uired ma not be recovered in the short3 term$ placing a strain on the compan s resources! *econdl $ while the clubs are out o# action$ members ma be #orced to go elsewhere and so membership numbers could su##er! The compan has bank borrowings to #und working capital! This suggests that the compan is not generating su##icient operating cash #low! The risk here is that i# the e%pansion polic continues at the same pace$ the compan could get into serious debt$ which it could not #inance! The compan has a regional spread o# branches$ which makes it more di##icult to control! This ma lead to #raud arising or a high error rate in in#ormation s stems!

200

''"( 6erformance measurement


Assurance can also be given on issues o# per#ormance measurement in companies! Per#ormance measurement includes a series o# measures within the compan designed to ensure that people who work in the compan are accountable to management #or their per#ormance! &t is also to do with achievement o# results on set activities! The #ollowing bene#its can be cited #or per#ormance measurement Clari#ies the ob,ectives o# the organi9ation Hevelops agreed measures o# activit Fives greater understanding o# processes (acilitates the setting o# targets #or the organi9ation and its managers Promotes the accountabilit o# the organi9ation to its stakeholders

-This supports the #act that assurance on per#ormance measurement can be given.

''"'

Traditional erformance measures

''"'"' 9inancial2 (inancial ratios give indicators about pro#itabilit $ li'uidit $ gearing and investment! /hilst these measures are relevant to shareholders$ the are measures which investors would e%pect companies to calculate as a matter o# course$ and also to calculate them correctl ! There#ore there should be no need #or assurance services in these areas! However$ #inancial per#ormance could be assessed in #urther details in per#ormance measures generall kept #or internal use! Hetails behind #igures in #inancial statements$ #or e%ample$ sales b product$ sales b region and sales b division! Timeliness o# in#ormation whether in#ormation is received 'uickl enough to make good investment decisions! Comparisons between the per#ormance o# the compan and its competitors or its budgets$ or its historic per#ormance!

''"'"* O eration2 Clearl $ indicators o# operational per#ormance will var with each business! +easures could include: *ales per sales person <umber o# new products launched each ear

This issue o# per#ormance is measured on what will be the ke drivers o# operation #or that particular business! 202

''"* ;alue for money audits2


Palue #or mone audit is sometimes pre#erred to #inancial audits due to its #ocus on determining the value that management could have reali9ed #rom the services that the received! This is a service that could be undertaken b internal audit! This sub,ect matter was discussed at a lower paper! However$ we shall revise the main re'uirements in this paragraph! Palue #or mone audits #ocus on whether organi9ations have achieved the #ollowing: :conomy entails attaining the appropriate 'uantit and 'ualit o# ph sical$ human and #inancial resources -inputs. at lowest cost! An activit would not be economic$ i#$ #or e%ample$ there was oversta##ing or #ailure to purchase materials o# re'uisite 'ualit at the lowest available price! Gower cost ma mean #or instance$ i# ou wash more clean plates per pound o# paste! :fficiency entails the relationship between goods and services produced -output. and the resources used to produce them! An e##icient operation produces the ma%imum output #or an given product or service provided$ e!g! more clean plates per s'uirt! :ffectiveness entails how well an activit is achieving its polic ob,ectives or other intended e##ects$ e!g! plates as clean as the should be! ''"*"' 8easurement of value for money2 Econom $ e##icienc and e##ectiveness can be studied and measured with re#erence to the #ollowing!

206

In uts &nputs means mone or resources$ i!e! labour$ material$ time and so on consumed$ and their cost! (or e%ample$ a P(+ audit into state secondar education would look at the e##icienc and econom o# the use o# resources #or education -the use o# school teachers$ school buildings$ e'uipment$ cash. and whether the resources are being used #or their purpose! /hat is the pupil)teacher ration and are trained teachers being #ull used to teach the sub,ects the have been trained #or4

:conomy Econom is concerned with the cost o# inputs$ and it is achieved b obtaining those inputs at the lowest acceptable cost! Econom does not mean straight #orward cost cutting$ because resources must be ac'uired which are o# a suitable 'ualit to provide the service to the desired standard! Cost cutting should not sacri#ice 'ualit to the e%tent that service standards #all to an unacceptable level! Econom b bu ing poor 'ualit material$ labour or e'uipment is a #alse econom !

Out uts
:utputs mean the results o# an activit $ measurable as the services actuall produced$ and the 'ualit o# services! &n the case o# a P(+ audit o# secondar education$ outputs would be measured as number o# pupils taught and the number o# sub,ects taught per pupil= how man e%amination papers are taken and what is the pass rate4

:fficiency
E##icienc means the #ollowing: +a%imi9ing output #or a given input$ #or e%ample ma%imi9ing the number o# transactions handled per emplo ee or per V1 spent! Achieving the minimum input #or a given output!

Im acts
&mpacts are the e##ects that the outputs o# an activit or programme have in terms o# achieving polic ob,ectives! Polic ob,ectives might be to provide a minimum level o# education to all children up to the age o# 1;$ and to make education relevant #or the childrens #uture ,obs and careers! This might be measured b the ratio o# ,obs vacant to unemplo ed school leavers!

:ffectiveness
E##ectiveness means ensuring that the outputs o# a service or programme have the desired impacts= in other words$ #inding out whether the succeed in achieving ob,ectives$ and i# so$ to what e%tent! &n pro#it making organi9ations$ ob,ectives can be e%pressed #inanciall in terms o# target pro#it or return! &n non3pro#it organi9ations$ e##ectiveness cannot be measured this wa $ because the organi9ation has non3#inancial ob,ectives! The e##ectiveness o# per#ormance in <(P organi9ations could be measured in terms o# whether targeted non3#inancial ob,ectives have been achieved!

208

''"- Need for assurance2


''"-"' 6ur ose of assurance2 6erformance measurements2 9inancial ratios2 The ke stakeholders who are likel to be interested in this t pe o# in#ormation are shareholders! The are interested in the return that the get #rom their investment! The sort o# criteria$ which the are interested in$ are there#ore likel to be industrial averages and percentages o# historic per#ormance! O erational ratios2 shareholders ma also be interested in operational ratios! However$ a part who is more likel to be interested in such in#ormation is a customer who demands a 'ualit service! &n terms o# criteria$ the customer is going to be interested in comparisons with competitors$ so industr averages are likel to #eature again! 1alue !or money0 in a pro!it target company, shareholders might be interested in value !or money. 4o ever, they are more li"ely to be interested in the !inancial indicators above. In non/pro!it target company, value !or money can be e&tremely important. Interested parties might be trustees and donors. In this case criteria ould be objectives set ithin the system.

$cenario2
The +inistr o# (inance and <ational Planning has ,ust received a management letter #rom the :##ice o# the Auditor Feneral! The auditors have been auditing the 0>>6 #inancial ear ended 21 Hecember$ and has highlighted a number o# issues pertaining to various departments! :ne main issue that has been raised is that mone was not properl spent in line with budget appropriations! However$ the minister #eels that a lot o# changes in the service provision have taken place to ,usti# the said e%penditure! :ne chie# accountant commented to sa <what was carried out was a financial audit, if they had underta!en a ;98 audit, a better insight would have been observed by the auditors" There are a number of indicators that su orts the minister5s observation=" As the accountant in 'uestion$ ou have been asked to shade more light on P(+ and more speci#icall to address the #ollowing: -a. -b. *ome speci#ic e%amples o# methods o# anal sis$ which ma be emplo ed in value #or mone audits! E%plain the use o# per#ormance indicators and the advantages and limitations o# using these indicators in a value #or mone audit in the public sector! 5ou are also re'uired to include three e%amples o# per#ormance indicators in our e%planation!

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Res onse2

-a.

P(+ and per#ormance audits are interchangeable concepts that mean one and the same! The are all more to do with the econom $ e##icienc and e##ectiveness commonl known as the 2Es! The #ollowing methods could be emplo ed: -i. 5ou can carr out the stud o# the 2 Es with re#erence to in uts" &nputs can be said to be mone or resources that assist in carr ing out the activities in a particular programme! (or e%ample$ the cost o# 'ualit education to pupils can be investigated b looking at the cost o# pa ing teachers and other materials to be used in the provision o# the service! &n#ormation can also be anal 9ed according to the out uts" :utputs related to the results o# the programmes that have been implemented! The results could be measured either in terms o# t pe$ 'uantit or 'ualit ! &n the above e%ample o# 'ualit education provision$ outputs could mean pupils trained with e%ceptional passes$ 'ualit o# service provided etc! A stud o# the im acts on the programme! This is the e##ect that the outputs o# a programme ma have on the achievement o# polic ob,ectives! (rom the e%ample given above$ we can sa that$ to what e%tent the 'ualit education was provided$ the number o# people trained and whether the outcomes o# the pro,ect are in tandem with the original aims o# setting up the programme!

-ii.

-iii.

This said$ it is acknowledged that in practice$ the assessment o# inputs$ outputs and impact on the programmes carried out in the public sector could be ver di##icult! However$ P(+ audits provide a sanctit wa o# assessing the per#ormance o# programmes in the public service!

-c.

Per#ormance indicators indicate how a department or team would measure its per#ormance in each ke task or per#ormance area! (or e%ample in government$ when we talk about cost control$ the per#ormance indicator would be the e%penditure variances! (or non3pro#it making organi9ations such as government$ it is ver di##icult to measure per#ormance and in turn establish indicators that would signi# the achievement o# the set ob,ectives! This is as opposed to the private sector where competition and establishment o# a market niche in order to make a pro#it is an important re'uirement! Though outputs in #orm o# 'uantit and 'ualit could be used as part o# per#ormance indicators$ the provide insu##icient evidence o# how well the programme has impacted on the department #or instance! However$ per#ormance standards such as ardsticks could be used in order to maintain proper levels o# per#ormance in each ke task or per#ormance area!

20?

Though di##icult$ per#ormance can be measured in the #ollowing wa s: -i. -ii. -iii. /hat progress has been made in achieving appropriate ob,ectives$ #or instance$ improved #unding #or povert eradication! /hat progress has been made to improve the e##icienc o# operations such as work done in relation to the number o# emplo ees involved4 Control over spending$ #or instance minimi9ing costs on motor vehicles procured or spending that do not add value to the e##ective achievement o# ob,ectives!

A number o# problems could be associated with per#ormance indicators! Parious stakeholders who are interested in seeing to it that public institutions are per#orming well such as ta% pa ers$ parliament$ customers etc are so e%pectant and aim to see that clear indicators are set and achieved! The are entitled to proper e%planations and results achieved! However$ the #ollowing di##iculties need to be appreciated: &t is di##icult to establish cause and e##ect especiall where several activities interact but contribute to achieving a desired result and where one activit contributes to more than one ob,ective! (or e%ample$ to what e%tent does e%penditure on street lighting contribute to road sa#et as opposed to the reduction o# street crime4 Per#ormance indicators i# simple$ ma be misleading *ome o# the members who receive per#ormance indicators set in an organi9ation ma not clearl understand the clear operations or activities o# the organi9ation$ thus not able to put them into a proper conte%t!

However$ where per#ormance indicators are set$ regardless o# their clarit $ the #ollowing can be achieved: &ncreased accountabilit o# those running the organi9ation to those using it and pa ing #or it! At least managers working on them have got targets to aim at! Per#ormance indicators set ma not be absolute!

'*"( $ystems reliability


Reliabilit o# internal control is important #or #inancial statements and general business operations!

20B

'*"'

Reliable information

The re'uirement #or assurance services is driven b a re'uirement #or reliable in#ormation! This in#ormation about business is o#ten produced b the s stems o# a business! Hence it is a prere'uisite o# 'ualit business in#ormation that a business has 'ualit s stems! A #undamental stage o# the traditional audit is the assessment o# #inancial s stems to ensure that the are capable o# producing #inancial statements! The concept can be e%tended be ond #inancial statements to all the s stems o# the business #rom which in#ormation can be derived! *takeholders$ customers and suppliers and other interested parties are interested in in#ormation #rom the business based on s stems that the can rel on! Reliable s stems enhance e##icienc in the compan operations! "usiness s stems can either be manual or computeri9ed! Computeri9ed s stems are even more important in modern times since companies can trade electronicall !

'*"*

Internal control systems

Providing assurance in the e##ectiveness o# internal control is an important issues! &nternal controls are an area o# particular importance in line with corporate governance re'uirements$ notabl the Turnbull report! This reports concentrates on risks #acing companies$ and the need #or directors to manage that risk! Providing assurance on internal controls Assurance can be provided on: -a. -b. -c. The design o# internal control s stems The operation o# the internal controls in accordance with the design Risk identi#ication

Process o# internal control The AP" recogni9es the #ollowing process in relation to internal controls

Identify business ob3ectives

#ssess ris!s that will threaten those ob3ectives

Design internal controls to manage those ris!s

O erate the internal controls in accordance with their design"

20D

&n order to carr out an engagement in relation to the internal controls the practitioners will re'uire su##icient knowledge o# the business that the can identi# and understand the events$ transactions and practices which impact on the s stem o# internal controls! Providing assurance on the operation o# the s stem Providing assurance on the operation o# the s stem can be done properl i# the entit has a detailed description o# the design o# their s stem o# internal control! The report arises #rom such an assignment need not be e%tensive$ but is likel to be narrative! This is because practitioners are likel to include such issues as: '*"*"' &solated control #ailures :bservation about the abilities o# sta## involved in operating the s stem o# control! Potential weakness observed which were not contemplated within the design 6roviding assurance on the design and o eration of the system

&n such an engagement$ practitioners will consider: The design o# the s stem addressing a set o# identi#ied risks The operation o# the s stem

&t will also involve signi#icant discussions with management at the outset to establish matters such as: The desired balance between prevention and detection controls! The balance between costs and bene#its The importance o# speci#ic control ob,ectives The outcome o# these discussions will necessaril be included in the assurance report$ to provide a conte%t #or their conclusion! The #ollowing things will also be included in the report! The applicable risks An #ramework #or design used b either the directors or the practitioners A description o# the design o# the s stem o# internal control

The level o# assurance given b the practitioner all depends on several #actors including the nature o# the entit $ the knowledge o# the business the practitioner possesses and the scope o# the engagement! &t is likel that the report in this instance would be 'uite long! '*"*"* 6roviding assurance on the a system" licable ris! and design and o eration of the

22>

This engagement would include consideration o# all the three stages o# the internal controls process identi#ied above! The identi#ication o# risk is likel to involve a high degree o# ,udgement as there are no universall recogni9ed criteria suitable #or evaluating the e##ectiveness o# an entit s risk evaluation! This means that practitioners are unlikel to be able to provide a high level o# assurance in this area! The practitioner should #irst identi# the entit s business ob,ectives and should consider the #ollowing: The completeness o# the applicable identi#ied risks The probabilit o# a risk cr stalli9ing The materialit o# the likel impact o# the risk The time period over which cr stalli9ation is anticipated!

&n their report$ the practitioners would have to outline the business ob,ectives o# the entit $ a description o# the risk identi#ication process and the applicable risks! '*"*"- Inherent limitations &nternal control s stems have inherent limitations$ a ke one o# which is the chance o# sta## colluding in #raud to override the s stem! An assurance report on internal controls s stems should include a mention o# these inherent limitations$ in order to prevent an unnecessar e%pectation gap! '*"*"0 Re orts The nature o# the individual reports has been touched on above! However$ it is di##icult to issue a standard report #or assurance services$ which are largel depended on the scope and nature o# the individual assignment!

'*"- Com uter systems2


&n these times o# in#ormation technolog $ most businesses now use computer s stems to run their businesses and #inancial in#ormation is processed on a computer s stem! A number o# controls there#ore which directors are re'uired to put into place to sa#eguard the assets o# the shareholders are incorporated into computer s stems!

Revision
&t is possible to build controls into computeri9ed processing! A balance must be struck between the degree o# control and the re'uirement #or a user3#riendl s stem! Controls can be classi#ied into: *ecurit controls &ntegrit controls Contingenc controls 221

&ntegrit controls can be sub divided into two areas: -a. -b. Hata integrit is preserved when data is the same as it is in source documents and has not been accidentall or intentionall altered$ destro ed or disclosed! * stems integrit re#ers to s stem operating con#orming to the design speci#ication despite attempts -deliberate or accidental. to make it behave incorrectl !

/hen auditors undertake their assessment and testing o# controls$ #or the purpose o# the statutor audit$ the #ocus is on the general and application controls o# the s stem$ which relates to securit and policies #or data input! However$ it is also important #or stakeholders in the compan that the s stem used$ which will o#ten impact on operation as well as #inancial in#ormation operates reliabl and that risks are mitigated against! The ke risks are: The s stem being put at risk b a virus or some rather #ault or breakdown which spreads across the s stem! The s stem being invaded b an unauthori9ed user who could then a##ect the smooth operation o# the s stem :btain commercial sensitive in#ormation!

A contingenc plan would be necessar in the event that the above risks occurs$ the s stem is not a##ected! However$ it is important to know that the original s stem is as reliable as could be e%pected and whether it is the best s stem that the compan could be using at a given cost! The compan ma also seek some assurance #rom the service provider though this assurance ma not be all that relied upon due to the vested interest o# the supplier! This then makes the directors to seek the services o# the auditors or another #irm o# accountants to undertake work to ascertain i# the assertions o# the service provider are correct! &# a #irm o# accountants were to consider taking on an assurance engagement$ the should ensure that the had su##icient skill to undertake the procedures re'uired to ascertain i# the assurances were correct! The should have to ensure that the have an &T specialist on a team! '*"-"' $ystem audit" A s stem audit is undertaken in order to generall assess the internal controls e##ectiveness! The auditor assesses the 'ualit and e##ectiveness o# the accounting s stem$ be it manual or computeri9ed!

220

Auditors could accept an assurance engagement to undertake this task outside o# the audit and to report speci#icall on #indings! The #ollowing are the ke areas to concentrate on to establish how reliable the s stems are: +anagement polic *egregation o# duties *ecurit

These are important control consideration in a computer environment! Hetails in the above areas are as indicated below: +anagement polic Hoes management have a written statement o# polic with regard to computer s stems4 &s it compatible with management polic in other areas4 &s it adhered to4 &s it su##icient and e##ective4 &s it updated when the s stems are updated4 Hoes it relate to the current s stem4 '*"-"* $egregation of duties &s their ade'uate segregation o# duties with regard to data input4 Are there ade'uate s stems controls -e!g! pass word. to en#orce segregation o# duties4 '*"-"- $ecurity &s there a securit polic in place4 o Ph sical securit -looked doors)windows. o Access securit -passwords. o Hata securit -virus shield. &s it adhered to4 &s it su##icient and e##ective4

'*"0 Re orting
Reports are important to management so that the could utili9e in#ormation the contain on the e##ectiveness o# their control s stems and s stems reliabilit generall $ especiall where the operations o# the compan are likel to rel heavil i# not completel on computer s stems! (ailure o# the s stem ma lead to problems such as <o production being possible 222

<o invoicing being possible &nvoicing being duplicated or omitted!

Reliabilit o# the compan s s stem is also important to other stakeholders such as customers and suppliers! This is because these people would not want to deal with a compan who makes mistakes and cannot operate properl ! Thus in order #or management to be sure that the s stems are reliable assurance should be obtained concerning the in#ormation it receives!

'-"( :lectronic commerce


E3commerce is a #ast moving area o# business and companies engaged in e3commerce should appreciate what is involved and its use! The #ollowing terms are normall used in e3commerce or business traded in a computer environment: Internet 1 a global network connecting millions o# computers! The +orld +ide +eb -///. is a s stem o# &nternet servers that support speciall #ormatted documents! A group o# documents accessed #rom the same base web site is known as a website! :lectronic data Interchange -EH&. is a #orm o# computer3to3computer data trans#er! &n#ormation can be trans#erred in electronic #orm$ avoiding the need #or the in#ormation to be re3inputted somewhere else! :lectronic 8ail -E3+ail. is a s stem o# communicating with other connected computer or via the &nternet in written #orm! :lectronic Commerce -E3Commerce. 1 means conducting business electronicall via a communication link! As an accountant$ it is important that ou appreciate the language or terms used in e3 commerce! However$ it is also important that ou appreciate the risk involved in order to determine the e%tent o# involvement in e3commerce! The greater the involvement$ the higher the risk and vice3versa!

226

:@tent of involvement2
IN;O&;:8:NT RI$J Information rovision2 A website can be used as a marketing device$ to provide in#ormation to potential customers$ and to enable them to re'uest #urther LO in#ormation through the e3mail W Transactions with e@isting customers 1 E%isting customers can be given the opportunit to track current contracts or initiate others over the website! #ccess to new customer 1 a website can be used as a place where new customers ma initiate transactions with the compan ! New business models3 a website can be used to diversi# into speci#ic web3 based products #or e%ample$ items that are @downloadableA! High There are a variet o# business risks speci#ic to a compan involved in e3commerce! *ome are indicated below: Risk o# non3compliance with law$ issues o# where the domain is #or legal purposes! Contractual issues arising 1 are legall binding agreements #ormed over the &nternet! Risk o# technological #ailure -crashes. resulting in business interruption! Hi##iculties in determining accounting policies -particularl relating to revenue. &mpact o# technolog on going concern assumption$ e%tent o# risk o# business #ailure! *ecurit risks

&mplications o# these risks should be considered when undertaking statutor audits!

'-"' Internal controls"


(or companies engaged in e3commerce$ reliabilit o# computer s stems is ke and most stakeholders will be interested in such reliable s stems! Controls over transaction integrit would be o# great importance as the s stem will capture transactions and automaticall process them! &t is also important that the transactions are processed completel through the accounting s stem! The website ma not be integrated completel

228

with the underl ing accounting s stem! Thus the assurance services over the design and operation o# s stems will be o# great importance!

'-"* $ecurity
The issue o# securit #or companies engaged in e3commerce cannot be over emphasi9ed! &t is ver important #or the business to acknowledge in order to avoid risk o# #raud being perpetuated against the compan i# the transactions are carried out through the website rather than in person! &t is important #or customers inputting sensitive data! '-"*"' &ac! of trust &n e3commerce engagements$ trust should take the center stage! &t should be appreciated that in most cultures$ customers grant their trust to business parties that have a ph sical presence such as buildings$ #acilities and people to talk to as opposed to where the ph sical presence is not availed! &nternet merchants need to elicit consumer trust when the level o# perceived risk in a transaction is high! However$ research has #ound that once consumers have built up trust in an internal merchant such concerns are reduced! &ssues such as #ear o# invasion o# privac and abuse o# customer in#ormation such as credit cards$ because the stop people even considering the &nternet as a shopping medium! There#ore parties involved in e3commerce need to have con#idence that an communication set gets to its target destination unchanged$ and without being read b an one else!

'-"- +eb assurance"


&n most cases$ people would be #ree to browse through the web on line but less happ to make purchases due to lack o# knowledge about the compan the were dealing with! This lead to concerns about: Processing o# the transaction Ise o# the personal in#ormation that must be given to complete the sale! Poor business practices b the compan -late deliver )errors in order etc.

/eb assurance seeks to remove this barrier b providing assurance to the users o# the service! An e%ample o# an assurance service developed in relation to e3commerce is web Trust! An assurance engagement under the /eb Trust would involve looking at the assertions o# the compan relating to the concerns above$ and seeking evidence as to whether what the sa about their service is true and whether their s stems compl with pre3determined

22;

criteria! :nce it is proved that the accountant has assurance that the s stem compl and representations made about the service is #air$ the website can be /eb Trust Accredited!

CF#6T:R ROUNDU6
Internal audit lays a ivotal role in cor orate governance" Its relationshi with e@ternal audit is also cardinal" The role of internal audit in ris! management is an im ortant requirement in an organiEation" Ris!s need to be identified and res onded to a ro riately" There are other internal audit issues that could be considered in relation to assurance engagements, o erational and com liance audits and multi?site o erations Outsourcing has become a common way of roviding services to organiEations and a number of reasons are given why outsourcing should be done, what to outsource and the im act that outsourcing has on an audit" #udit related services may be assurance .review/ or not .agreed u on rocedures and com ilations/ #ssurance services im rove the quality of decision ma!ing for users of information #ssurance services may give reasonable assurance or limited assurance Ris! assessment is im ortant to investors and managers and therefore is an im ortant area for assurance services" 6erformance measurement is another im ortant issue for com anies where assurance can be given Reliability of systems of internal control is im ortant for financial statements and general business o erations : ) Commerce is a fast growing area of business"

22?

CF#6T:R '-2 $ocial and :nvironmental issues

Item list *ocial and environmental issues Environmental matters Environmental audits *ocial audits INTRODUCTION &n this chapter we address some issues pertaining to social and environmental issues that ma have a bearing on a compan or organi9ation and their impact)e##ect on the #inancial statements and audit opinion thereon! The have to do more with compliance to the best code o# conduct e%pected b an organi9ation when it comes to these issues! Their implications on companies and how the could be measured have also been addressed! *ection 0 addresses environmental matters in relation to their im act on financial statements and what the auditor need to consider as part o# his dut ! *ection 2 we speci#icall #ocus on environmental audit and we address the auditors concerns and other considerations and #inall social audits in section 6!

'"(

$ocial and :nvironmental issues

The environment is an ongoing source o# concern though not much has been said about it! The environment is amongst the other stakeholders that a compan has and includes emplo ees$ societ $ directors$ creditors and shareholders! Human activit causes pollution$ climate change and other environmental problems! These problems must be solved in order to preserve the earth #or ourselves and #or our children! /orldwide recognition o# the importance o# environmental polic has increased during the last decades o# the twent 3#irst centur ! &t has led to man local and regional environmental accords on man t pes o# environmental issues! This calls #or a rigorous campaign worldwide aimed at making companies responsible #or environmental issues that a##ect societ and also to determine the knock on impact it has on the various stakeholders! The #ollowing issues impact on the public: 22B

+an induced climatic changes The green house e##ects A need #or waste management A need to avoid polluting the earth$ water and air A need #or rec cling A need #or a sa#e and clean environment!

*ocial and environmental audits are designed to ascertain whether the organi9ation is compl ing with codes o# best practice or internal guidelines or is #ul#illing the wider re'uirements o# being a good corporate citi9en! &n relation to the above issues$ the 'uestion that should be asked is that 7to what e%tent do companies respond to them4 &n some compan s annual reports and accounts$ companies ma make it clear that the have good social policies in areas like emplo ment$ remuneration or treatment o# disabled persons and care #or societ ! &n some circles$ the have talked about child labour and poor remunerations! All these issues need to ,og the auditor when carr ing out an audit o# such a compan ! Addressing these issues is 'uite challenging$ as the cannot lead to misstatements in the #inancial statements!

'"'

Im lications of $ocial and :nvironmental issues"

Here we look at the implications that social and environmental issues can have on the compan and its management! +anagement has the responsibilit to prepare and produce accounts that represents their assertions and whatever management does provide the needed direction or misdirection to the compan at large! As alread indicated above$ a compan has various stakeholders namel the emplo ees$ societ $ and the environment! &t is there#ore important to appreciate the interactive nature o# the compan and the stakeholders! &t is also a well know #act that social and environmental issues might present a signi#icant risk to the compan and thus a##ect the corporate governance re'uirements! (or instance$ the Turnbull guidance states that management is responsible #or internal controls and internal controls should provide a sound s stem to mitigate against risks o# the business! This is the risk that the business might #ail and can lead to possible misstatements in the #inancial statements! +anagement should there#ore put in place speci#ic internal controls as part o# their duties under corporate governance! (or instance: There must be measures designed to ensure that environmental legislation is complied with such as preventive clothing$ disposal o# waste$ pollution and emissions in all #orms etc! A human resource polic to ensure that emplo ment legislation is complied with Policies pertaining to social and environmental values that should be incorporated into the corporate cultural o# the organi9ation! Policies that ensure that the standards as re'uired and regulated b the Environment Council o# Cambia and an other national and international standards are adhered to! 22D

'"*

Fow $ocial and :nvironmental erformance could be measured"

+easuring social and environmental per#ormance can be a di##icult thing to attain! However auditors can provide assurance services b giving opinions as to whether directors assertions about per#ormance are #air! The common wa o# measuring per#ormance is b setting targets and sustainable per#ormance indicators! The targets and indicators can then be appraised or assessed in order to determine whether meaning#ul achievements have been met! +easuring per#ormance ma also depend on the issues at hand! (or the purpose o# illustrating these issues as a case stud #or $hell has been used" Case study2 $hell *hell is a multi3national group o# companies that deal in oil$ gas and chemicals! There are various issues$ which make social and environmental issues important in this compan : The deal in the earths natural resources Their business is heavil environmentall legislated The emplo a signi#icant number o# people *ome emplo ees work in risk environments The operate in areas o# the world where Human Rights are not given su##icient priorit

Targets2 &n response to the social and environmental issues raised above$ *hell has set targets o# social and environmental per#ormance which the evaluate and report on to shareholders on an annual basis! The #ollowing are targets$ which the compan has set: :nvironmental2 $ocial: Cero emplo ee #atalities in work related incidents <ot e%ploit children in an countr where child labour e%ists b emplo ing children under the legal age o# emplo ment and dealing with other companies who emplo children illegall Pursue e'ual opportunities #or men and women in all countries that this is legall possible! 26> Reduce emissions o# carbon dio%ide #rom re#iner activit Continue to develop cleaner #uels Reduce emissions o# nitrogen o%ides #rom burning #uel in operations Reduce spills o# crude oil$ oil and chemicals

$ustainable rinci les2 The compan has also set general sustainabilit principles$ which all sta## should appl in dail business: Respect and sa#eguard people Engage and work with stakeholders +inimi9e impact on the environment Ise resources e##icientl +a%imi9e pro#itabilit +a%imi9e bene#its to the communit

Re orting2 The compan reports on all these issues to its shareholders and wherever possible! The #acts included in the report are veri#ied b independent veri#iers! (rom the case stud above it can be seen that some indicators can easil be veri#ied whereas some ma not! (or instance$ emissions$ spills$ elimination o# work related #atalities and emplo ment o# children could be measured! However some targets are not speci#ic enough to be measured$ e!g! developing cleaner #uels cannot be easil identi#ied until when it is done! The general principles can e'uall be di##icult to measure!

*"(

:nvironmental matters

Environmental matters can constitute considerable risks to some audit clients and could also lead to the risk o# material misstatement in #inancial statements! The &nternational Auditing Practice *tatement 1>1> 3 the consideration o# Environmental +atters in the Audit o# (inancial *tatements provides guidance on the audit o# #inancial statements! &t recogni9es that environmental matters can be comple% and ma there#ore re'uire additional consideration b auditors! The statement provides practical assistance to auditors b describing the #ollowing: The auditors main consideration in an audit o# #inancial statements with respect to environmental matters= E%amples o# possible impact o# environmental matters on #inancial statements= and Fuidance that the auditor ma consider when e%ercising pro#essional ,udgment in this conte%t to determine the nature$ timing and e%tent o# audit procedures with respect to: o o o o Knowledge o# the business -&*A 21>. Risk assessment and internal control -&*A 6>>. Consideration o# law and regulations -&*A 08>. :ther substantive procedures -&*A ;0> and some other. 261

The guidance in C above re#lects the t pical se'uence o# the audit process! Having ac'uired a su##icient knowledge o# the business the auditor assesses the risk o# a material misstatement in the #inancial statements! This assessment includes consideration o# environmental laws and regulations that ma pertain to the entit $ and provides a basis #or the auditor to decide whether there is a need to pa attention to environmental matters in the course o# the audit o# #inancial statements! (orthwith$ &PA* 1>1> gives su##icient guidance on the applicabilit o# the above standards!

*"' The auditor5s main considerations with res ect to environmental matters
Nust like an other audit$ the ob,ective o# an audit o# #inancial statements is %=to enable t"e auditor to e)press an opinion !"et"er t"e financial statements are prepared in all material respects in accordance !it" an identified financial reporting frame!ork* (ISA 200)# The opinion that is given relates to the #inancial statements as a whole and not to an speci#ic aspect! /hen planning and per#orming audit procedure and in evaluating and reporting the results thereo#$ the auditor should recogni9e that noncompliance b the entit with law and regulations ma materiall a##ect the #inancial statements though an audit cannot be e%pected to detect noncompliance with all laws and regulations as per &*A 08>! &n particular$ with respect to the entit s compliance with environmental laws and regulations$ the auditors purpose is not to plan the audit to detect possible breaches o# environmental laws and regulations= nor are the auditors procedures su##icient or the ade'uac o# its controls over environmental matters! /hile assessing inherent risk at the #inancial statement level and through the use o# pro#essional ,udgment to evaluate #actors relevant to this assessment$ the auditor ma also include assessing the risk o# material misstatement o# the #inancial statements due to environmental matters! The auditor uses pro#essional ,udgement to determine the nature$ timing and e%tent o# the speci#ic procedures considered necessar in order to obtain su##icient appropriate audit evidence that the #inancial statements are not materiall misstated! &# the auditors do not have the pro#essional competence to per#orm these procedures$ technical advice ma be sought #rom specialists$ such as law ers$ engineers$ or other environmental e%perts!

*"* :nvironmental matters and their im act on the financial statements

260

The practice statement gives the #ollowing e%amples on environmental matters a##ecting the #inancial statements: The introduction o# environmental laws and regulations ma involve an impairment o# assets and conse'uentl a need to write down their carr ing value! (ailure to compl with legal re'uirements concerning environmental matters$ such as emissions or waste disposal$ or changes to legislation with retrospective e##ect$ ma re'uire accrual o# remediation$ compensation or legal costs! *ome entities$ #or e%ample in the e%traction industries$ chemicals manu#acturers or waste management companies ma incur environmental obligations as a direct b 3product o# their core business! Constructive obligations that stem #rom a voluntar initiative$ #or e%ample an entit ma have identi#ied contamination o# land$ although under no obligation$ it ma have decided to remed the contamination$ because o# its concern #or its long3term reputation and its relationship with the communit ! An entit ma need to disclose in the notes the e%istence o# a contingent liabilit where the e%pense relating to environmental matters cannot be reasonabl estimated! &n e%treme situations$ noncompliance with certain environmental laws and regulations ma a##ect the continuance o# an entit as a going concern and conse'uentl ma a##ect the disclosure and the basis o# preparing o# the #inancial statements!

-"(

:nvironmental audit

Environmental audits are becoming increasingl common in certain industries! Environmental audits have a wide variet o# meanings and the can be per#ormed b e%ternal and internal e%perts including internal auditors at the discretion o# the entit s management! These audits are there#ore carried out in order to assess how well the organi9ation per#orms in sa#eguarding the environment in which it operates$ and whether the compan complies with its environmental policies!

-"'

The auditor5s concerns


/hether the board and management have a good understanding o# the environment$ its impact and related legislation o# the organi9ations activities in such areas as$ buildings$ transport$ products$ packaging and waste! /hether the board and management have adopted ade'uate policies and procedures to ensure compliance with relevant standards and laws and that the policies are ade'uatel communicated! /hether the organi9ation is able to assess progress in an economic and e##icientl !

262

"oard and management is able to report on environmental activities in a true and #air and complete reporting

The auditor should carr out the #ollowing steps: :btain a cop o# the organi9ations environmental polic Assess whether the polic is likel to achieve ob,ectives b meeting various legal re'uirements and environmental standards as spelt out b the Environmental Council o# Cambia$ and ensure that customers and suppliers are satis#ied! Test implementation and adherence to the polic through discussions$ observations and carr ing out walk3through tests where possible!

-"*

Other consideration2
+aterial environmental matters can present ma,or risks to some clients and can lead to possible misstatements in the #inancial statements Responsibilit #or environmental matters$ their recognition$ measurement and disclosure$ is with the management! The main possibilities #or misstatement in #inancial statements include: o The introduction o# environmental laws and regulations which ma involve impairment o# assets o (ailure to compl with legal re'uirements ma re'uire accrual o# remediation$ compensation or legal costs! o (ines$ damages and legal costs ma need to be accrued #or violation! o *ome companies ma incur environmental obligations as a direct result o# their core operations! o Constructive obligations ma occur #rom publicl stated environmental policies! These ma not be legal obligations but ma be ,ust a binding! o Contingent liabilities ma need to be disclosed in some circumstances! o &nitiatives to abate environmental damages ma cost a great deal but ma not enhance the value o# #i%ed assets! o Picarious liabilit ma reside in a client as a result o# the environmental damage caused b a previous owner o# a site! &n some e%treme cases$ environmental matters can lead to abandonment o# going concern in whole or in part! An e%ample o# this is i# a compan was obliged to cease production o# some environmentall polluting product altogether!

0"(

$ocial audits2

The process o# checking whether an organi9ation has achieved target ma #all within a social audit that a compan carries out! *ocial audits will involve:

266

Establishing whether a compan has a rationale #or engaging in sociall possible activit ! &denti# ing that all current environmental programmes are congruent with the mission o# the compan ! Assessing ob,ectives and priorities related to these programmes! Evaluating compan investment in such programmes past$ present and #uture!

/hether or not a social audit is used depends on the degree to which social responsibilit is part o# the corporate philosoph ! A cultural awareness must be achieved within an organi9ation in order to implement environmental polic $ which re'uires "oard and sta## approval! The targets and indicators are as indicated in a case stud #or $hell"

Cha ter round u 2


There is need to address social and environmental issues that a compan ma be e%posed to! This e%hibits the organi9ations care #or the environment and societ thus cementing the relationship that ma subsist between management and other stakeholders! *ocial and environmental policies need to be established and measured in order to determine their per#ormance! &n looking at social and environmental issues$ a number o# standards and practice statements ma be used as a means o# accomplishing best practice! *ocial and environmental audits can be carried out depending on the degree to which both social and environmental responsibilities are parts o# corporate philosoph !

Now try question '- from the e@am question ban! at the bac! of the manual

268

6#RT D R:6ORTIN7

26;

CF#6T:R '02 Re orts


To ic &ist 1 <ature and t pes o# auditors report 0 Communication with those charged with governance 2 *pecial Purpose audit reports

INTRODUCTION
At this stage o# our studies$ ou will be #amiliar with the e%ternal Audit opinion! &# this is not the case$ be#ore ou read an o# this chapter$ ou must go back to our paper 0!6 stud te%t and revise the basic features o# the report$ the various qualifications that can be made$ the conce t of true and fair view and the statutor re'uirements in relation to the audit opinion! 5ou should also bear in mind the new audit report in &*A ?>> 1 an e%ample is given in this chapter! At paper 2!2 level$ students are e%pected not onl to know what the audit opinion is and how it is presented! The are re'uired to draw audit opinions and also criticall appraise an audit opinion #ormed b another person! &n this chapter we shall look at the #orm o# the audit report! /e shall also look at occasions when a special audit report is re'uired and we shall also look at the Auditors re'uirements in relation to reporting to those charged with governance! /e have alread looked at the issue o# reporting assignments other than audit assignments in part C o# this stud te%t!

'"( Nature and Ty es of auditors5 re ort


Auditors e%press an opinion on #inancial statements based on the work the have done$ the evidence obtained and conclusions drawn in relation to the evidence!

'"'

Unqualified auditors5 re ort

&*A ?>> Auditors Report on (inancial *tatements provides guidance on the #orm and content o# the auditors report issued as a result o# an audit! The auditor should review and assess the conclusions drawn #rom the audit evidence obtained as the basis #or the e%pression o# an opinion on the #inancial statements! &# in the auditors opinion the #inancial statements show a true and fair view then an un'uali#ied audit report is issued!

26?

True: &n#ormation is #actual and con#orms with realit $ not #alse! &n addition the in#ormation con#orms with re'uired standards and law! The accounts have been correctl e%tracted #rom the books and records! 9air: &n#ormation is #ree #rom discrimination and bias and in compliance with e%pected standards and rules! The accounts should re#lect the commercial substance o# the compan underl ing transactions! The auditors report includes the #ollowing basic elements: Title Addressee :pening or introductor paragraph *cope paragraph -describing the nature o# an audit. :pinion paragraph -containing an e%pression o# opinion on the #inancial statements. Hate o# the report Auditors address Auditors signature! "elow is an e%ample o# un'uali#ied auditors report #rom the standard IK,/B/K,/K' AL,I'O9$S 9/BO9' (ABB9OB9IA'/ A,,9/SS//) &e "ave audited t"e accompanying financial statements of t"e A40 0ompany as of ,ecember 57 20M7 and t"e related statements of income and cas" flo!s for t"e year t"en ended# '"ese financial statements are t"e responsibility of t"e 0ompany$s management# Our responsibility is to e)press an opinion on t"ese financial statements based on our audit# &e conducted our audit in accordance !it" International Standards on Auditing (or refer to relevant national standards or practices)# '"ose Standards re(uire t"at !e plan and perform t"e audit to obtain reasonable assurance about !"et"er t"e financial statements are free of material misstatement# An audit includes e)amining on a test basis evidence supporting t"e amounts and disclosures in t"e financial statements# An audit also includes assessing t"e accounting principles used and significant estimates made by management as !ell as evaluating t"e overall financial statement presentation# &e believe t"at our audit provides a reasonable basis for our opinion# In our opinion t"e financial statements give a true and fair vie! of (or present fairly in all material respects) t"e financial position of t"e 0ompany as of ,ecember 57 20M7 and of t"e results of its operations and its cas" flo!s for t"e year t"en ended in accordance !it" International Accounting Standards

26B

(,ate of t"e auditor$s report) (Auditor$s signature) (Auditor$s address)

'"'"' :m hasis of matter aragra h


*ometimes an auditor ma wish to issue an un'uali#ied audit report containing an em hasis of matter aragra h to highlight a particular matter! An e%ample o# this is when the #inancial statements are a##ected b a #undamental uncertaint $ #or e%ample$ over the recoverabilit o# a receivable balance or the potential incurring o# liabilit such as a #ine! &# the #inancial statements contain su##icient disclosure about the matter$ then the auditor will not need to modi# his opinion$ but ma wish to draw attention to the matter and the disclosure in his report! An e%ample o# the audit report with an emphasis o# matter paragraph is shown below: IK,/B/K,/K' AL,I'O9$S 9/BO9' (ABB9OB9IA'/ A,,9/SS//) &e "ave audited t"e accompanying financial statements of t"e A40 0ompany as of ,ecember 57 20M7 and t"e related statements of income and cas" flo!s for t"e year t"en ended# '"ese financial statements are t"e responsibility of t"e 0ompany$s management# Our responsibility is to e)press an opinion on t"ese financial statements based on our audit# &e conducted our audit in accordance !it" International Standards on Auditing (or refer to relevant national standards or practices)# '"ose Standards re(uire t"at !e plan and perform t"e audit to obtain reasonable assurance about !"et"er t"e financial statements are free of material misstatement# An audit includes e)amining on a test basis evidence supporting t"e amounts and disclosures in t"e financial statements# An audit also includes assessing t"e accounting principles used and significant estimates made by management as !ell as evaluating t"e overall financial statement presentation# &e believe t"at our audit provides a reasonable basis for our opinion# In our opinion t"e financial statements give a true and fair vie! of (or present fairly in all material respects) t"e financial position of t"e 0ompany as of ,ecember 57 20M7 and of t"e results of its operations and its cas" flo!s for t"e year t"en ended in accordance !it" International Accounting Standards &it"out (ualifying our opinion !e dra! attention to Kote M to t"e financial statements# '"e 0ompany is t"e defendant in a la!suit alleging infringement of certain patent rig"ts

26D

and claiming royalties and punitive damages# '"e company "as filed a counter and preliminary "earing and discovery proceedings on bot" actions are in progress# '"e ultimate outcome of t"e matter cannot presently be determined and no provision for liability t"at may result "as been made in t"e financial statements (,ate of t"e auditor$s report) (Auditor$s signature) (Auditor$s address)

>uestion2
Comment on the limitations that shareholders ma perceive to e%ist in the standard unmodi#ied auditors report as described in &*A ?>> 7The Auditors Report on (inancial *tatements!

#nswer2
Perceived limitations in the standard unmodified auditor5s re ort2 &t is di##icult #or a private shareholder to understand its meaning because it assumes knowledge o# the audit process= and is ,argoni9ed! (or e%ample$ it does not sa what 7*tandards -on Auditing. are! An individual 7*tandard could be a document on an entire topic$ or ,ust a paragraph o# bold print! Also$ *tandards are re#erred to be#ore what constitutes an audit is e%plained! Terms which might be regarded as ,argon include: 7reasonable assurance= 7material= 7misstatement= 7test basis= 7accounting principles= and 7True and #air view! Although some o# these terms are de#ined in Auditing *tandards -e!g! 7materialit .$ others are not -e!g! 7true and #air view.! Even relativel in#ormed shareholders do not appreciate that 7reasonable assurance is merel a high level o# assurance and not an absolute guarantee! The #inancial statement to which the auditors report re#ers is o#ten onl a small part o# a much larger document -an Annual Report.! /hat is it all #or4 How much is re'uired b statute4 /hat are the auditors responsibilities #or it4 The auditors responsibilit $ as stated$ 7to e%press an opinion !!! based on our audit$ perhaps does not sound like much! :ne o# the perceived limitations o# using standard wording -generall . is that it is something routine which does not re#lect the e%ercise o# pro#essional ,udgement!

28>

&nstitutional shareholders ma believe that the rigid #ormat o# a standard auditors report is a constraint on the auditor being able to sa what the reall mean!

7#2

8odified auditor5s re ort

+odi#ied audit reports arise when auditors do not believe that the can give a true and #air view! &*A ?>1 deals with situations where the auditor cannot issue an un'uali#ied opinion! An auditors report is considered to be modi#ied in the #ollowing situations: -a. +atters that do not a##ect the auditors opinion -b. +atters that do a##ect the auditors opinion: Euali#ied opinion Hisclaimer o# opinion Adverse opinion '"*"' 8atters that do not affect the auditor5s o inion

&*A ?>> distinguishes between going concern matters and other matters" An e%tract o# an emphasis o# the matter paragraph relating to going concern -&*A 8?>. is reproduced below! &it"out (ualifying our opinion !e dra! attention to note M in t"e financial statements# '"e 0ompany incurred a net loss of NMM during t"e year ended 57 ,ecember 20M7 and of t"at date t"e company$s current liabilities e)ceeded its current assets by NMM and its total liabilities e)ceeded its total assets by NMM# '"ese conditions along !it" ot"er matters as set fort" in note M indicate t"e e)istence of a material uncertainty !"ic" may cast significant doubt about t"e company$s ability to continue as a going concern#$ An e%ample o# an emphasis o# matter paragraph relating to signi#icant uncertaint other than a going concern problem is reproduced in paragraph 1!1!1 above! '"*"* 8atters that do affect the auditor5s o inion

An auditor ma not be able to e%press an un'uali#ied opinion when either o# the #ollowing circumstances e%ists and$ in the auditors ,udgement$ the e##ect o# the matter is or ma be material to the #inancial statements -a. There is a limitation of sco e o# the auditors work -b. There is a disagreement with management regarding the acceptabilit o# the accounting policies selected$ the method o# their application or the ade'uac o# #inancial statements disclosure! A limitation o# scope ma lead to either a: Euali#ied opinion or Hisclaimer o# opinion 281

A disagreement ma lead to either: A 'uali#ied opinion or An adverse opinion # qualified o inion 1 should be e%pressed when the auditor concludes that an un'uali#ied opinion cannot be e%pressed but that the e##ect o# an disagreement with management$ or limitation on sco e is not so material and pervasive as to re'uire an adverse opinion or a disclaimer o# opinion A 'uali#ied opinion should be e%pressed as being 7e%cept #or the e##ects o# the matter to which the 'uali#ication relates! An e%ample o# an audit report including a 'uali#ied opinion due to limitation o# scope is shown below IK,/B/K,/K' AL,I'O9$S 9/BO9' (ABB9OB9IA'/ A,,9/SS//) &e "ave audited t"e accompanying financial statements of t"e A40 0ompany as of ,ecember 57 20M7 and t"e related statements of income and cas" flo!s for t"e year t"en ended# '"ese financial statements are t"e responsibility of t"e 0ompany$s management# Our responsibility is to e)press an opinion on t"ese financial statements based on our audit# &e conducted our audit in accordance !it" International Standards on Auditing (or refer to relevant national standards or practices)# '"ose Standards re(uire t"at !e plan and perform t"e audit to obtain reasonable assurance about !"et"er t"e financial statements are free of material misstatement# An audit includes e)amining on a test basis evidence supporting t"e amounts and disclosures in t"e financial statements# An audit also includes assessing t"e accounting principles used and significant estimates made by management as !ell as evaluating t"e overall financial statement presentation# &e believe t"at our audit provides a reasonable basis for our opinion# &e did not observe t"e counting of t"e p"ysical inventories as of ,ecember 57 20M7 since t"at date !as prior to t"e time !e !ere initially engaged as auditors for t"e company# O!ing to t"e nature of t"e company$s records !e !ere unable to satisfy ourselves as to inventory (uantities by ot"er audit procedures# In our opinion e)cept for t"e effect of suc" adjustments if any as mig"t "ave been determined to be necessary "ad !e been able to satisfy ourselves as to p"ysical inventory (uantities t"e financial statements give a true and fair vie! of (or present fairly in all material respects) t"e financial position of t"e company as of ,ecember 57 20M7 and

280

t"e results of its operations and its cas" flo!s for t"e year t"en ended in accordance !it" (ISA s or relevant national standards) and comply !it" (relevant statues or la!)# (,ate of t"e auditor$s report) (Auditor$s signature) (Auditor$s address) A disclaimer of o inion 1 should be e%pressed when the possible e##ect o# a limitation on scope is so material and pervasive that the auditor has not been able to obtain su##icient appropriate audit evidence and accordingl is unable to e%press an opinion on the #inancial statements! "elow is an e%ample o# an audit report with a disclaimer o# opinion IK,/B/K,/K' AL,I'O9$S 9/BO9' (ABB9OB9IA'/ A,,9/SS//) &e "ave audited t"e accompanying financial statements of t"e A40 0ompany as of ,ecember 57 20M7 and t"e related statements of income and cas" flo!s for t"e year t"en ended# '"ese financial statements are t"e responsibility of t"e 0ompany$s management# Our responsibility is to e)press an opinion on t"ese financial statements based on our audit# &e conducted our audit in accordance !it" International Standards on Auditing (or refer to relevant national standards or practices)# '"ose Standards re(uire t"at !e plan and perform t"e audit to obtain reasonable assurance about !"et"er t"e financial statements are free of material misstatement# An audit includes e)amining on a test basis evidence supporting t"e amounts and disclosures in t"e financial statements# An audit also includes assessing t"e accounting principles used and significant estimates made by management as !ell as evaluating t"e overall financial statement presentation# &e believe t"at our audit provides a reasonable basis for our opinion# &e did not observe t"e counting of t"e p"ysical inventories as of ,ecember 57 20M7 since t"at date !as prior to t"e time !e !ere initially engaged as auditors for t"e company# O!ing to t"e nature of t"e company$s records !e !ere unable to satisfy ourselves as to inventory (uantities by ot"er audit procedures# &e !ere not able to observe all p"ysical inventories and confirm accounts receivable due to limitations placed on t"e scope of our !ork by t"e company# 4ecause of t"e significance of t"e matters discussed in t"e preceding paragrap" !e do not e)press an opinion on t"e financial statements# (,ate of t"e auditor$s report)

282

(Auditor$s signature) (Auditor$s address) A 'uali#ied audit opinion due to disagreement over accounting method is shown below IK,/B/K,/K' AL,I'O9$S 9/BO9' (ABB9OB9IA'/ A,,9/SS//) &e "ave audited t"e accompanying financial statements of t"e A40 0ompany as of ,ecember 57 20M7 and t"e related statements of income and cas" flo!s for t"e year t"en ended# '"ese financial statements are t"e responsibility of t"e 0ompany$s management# Our responsibility is to e)press an opinion on t"ese financial statements based on our audit# &e conducted our audit in accordance !it" International Standards on Auditing (or refer to relevant national standards or practices)# '"ose Standards re(uire t"at !e plan and perform t"e audit to obtain reasonable assurance about !"et"er t"e financial statements are free of material misstatement# An audit includes e)amining on a test basis evidence supporting t"e amounts and disclosures in t"e financial statements# An audit also includes assessing t"e accounting principles used and significant estimates made by management as !ell as evaluating t"e overall financial statement presentation# &e believe t"at our audit provides a reasonable basis for our opinion# As discussed in Kote M to t"e financial statements no depreciation "as been provided in t"e financial statements !"ic" practice in our opinion is not in accordance !it" International Accounting Standards# '"e provision for t"e year ended ,ecember 57 20M7 s"ould be NMM based on t"e straig"tG line met"od of depreciation using annual rates of ?Ofor building and 20Ofor e(uipment# Accordingly t"e long A term assets s"ould be reduced by accumulated depreciation of NMM and t"e loss for t"e year and t"e accumulated deficit s"ould be increased by NMM and NMM respectively# In our opinion e)cept for t"e effect on t"e financial statements of t"e matter referred to in t"e preceding paragrap" t"e financial statements give a true and fair vie! (or present fairly in all material respects) t"e financial position of t"e company as of ,ecember 57 20M7 and of t"e results of its operations and its cas" flo!s for t"e year t"en ended in accordance !it" (IASs o r relevant national standards) and comply !it" (relevant statues or la!)# (,ate of t"e auditor$s report) (Auditor$s signature) $Auditor?s address%

286

#n adverse o inion 1 should be e%pressed when the e##ect o# a disagreement is so material pervasive to the #inancial statements that the auditor concludes that a 'uali#ication o# the report is not ade'uate to disclose the misleading or incomplete nature o# the #inancial statements! "elow is an e%ample o# auditors report with an adverse audit o inion IK,/B/K,/K' AL,I'O9$S 9/BO9' (ABB9OB9IA'/ A,,9/SS//) &e "ave audited t"e accompanying financial statements of t"e A40 0ompany as of ,ecember 57 20M7 and t"e related statements of income and cas" flo!s for t"e year t"en ended# '"ese financial statements are t"e responsibility of t"e 0ompany$s management# Our responsibility is to e)press an opinion on t"ese financial statements based on our audit# &e conducted our audit in accordance !it" International Standards on Auditing (or refer to relevant national standards or practices)# '"ose Standards re(uire t"at !e plan and perform t"e audit to obtain reasonable assurance about !"et"er t"e financial statements are free of material misstatement# An audit includes e)amining on a test basis evidence supporting t"e amounts and disclosures in t"e financial statements# An audit also includes assessing t"e accounting principles used and significant estimates made by management as !ell as evaluating t"e overall financial statement presentation# &e believe t"at our audit provides a reasonable basis for our opinion# In our opinion because of t"e effects of t"e matter discussed in t"e preceding paragrap"(s) t"e financial statements do not give a true and fair vie! of (or do not present fairly$) t"e financial position of t"e 0ompany as of ,ecember 57 20M7 and of t"e results of its operations and its cas" flo!s for t"e year t"en ended in accordance !it"=) and do not comply !it" =)# (,ate of t"e auditor$s report) (Auditor$s signature) (Auditor$s address)

>uestion2
5ou are an audit manager in +upeta M *ons$ a #irm o# Chartered Certi#ied Accountants! :ne o# our audit clients$ "ookhouse$ is a te%tbook publisher! "ookhouse is planning to e%pand through the ac'uisition o# a number o# small publishers o# other media such as video tapes and CHs! The #inance director o# "ookhouse has been reviewing the #inancial statements o# potential targets! He has come across an auditors report dated 1D Nanuar 0>L;$ on #inancial statements #or the ear ended 2> *eptember 0>L6$ which does not have the standard wording o# an unmodi#ied report! The #inance director has now

288

approached ou #or an e%planation o# its meaning! The scope and opinion paragraphs are as #ollows:

$co e /e conducted our audit in accordance with &nternational *tandards on Auditing! Those *tandards re'uire that we plan and per#orm the audit to obtain reasonable assurance about whether the #inancial statements are #ree o# material misstatement! An audit includes e%amining$ on a test basis$ evidence supporting the amounts and disclosures in the #inancial statements! However$ the evidence available to us identi#ied certain transactions which had not been included in the previous ears records and as a result had been omitted #rom the #inancial statements #or the ear ended 2> *eptember 0>L2! Ad,ustments have been made and are disclosed in <ote 00! An audit also includes assessing the accounting principles used and signi#icant estimates made b management$ as well as evaluating the overall #inancial statement presentation! /e believe that our audit provides a reasonable basis #or our opinion! O inion &n our opinion the #inancial statements give a true and #air view o# the #inancial position o# the Compan as o# 2> *eptember 0>L6 and o# the loss on its operations and its cash #lows #or the ear then ended in accordance with &nternational Accounting *tandards! 7The compan s liabilities e%ceed its assets at 2> *eptember 0>L6 creating an adverse situation which management believes is reversible over the coming twelve months! +anagement #urther believes that the compan is capable o# continuing to trade #or twelve months #rom the date o# this report!71D Nanuar 0>L;! Required2 Identify and e@ lain the shortcomings of this re ort"

#nswer2
:@ lanation of shortcomings2 Has there been a limitation on scope4 The 7however !!! in the middle o# the e%planation o# the scope o# the audit suggests that what #ollows is some sort o# reservation about what has ,ust been stated! &n a scope paragraph this would be e%pected to be a description o# a limitation on scope! However$ a limitation on scope is normall introduced with the wording 7e%cept as discussed -below.$ we conducted our audit in accordance with !!!!

28;

The matter described concerns additional evidence having been discovered during the current ear audit -to 2> *eptember 0>L2. which suggests a lack o# evidence in respect o# the prior ear! &t is unclear #rom the wording 7the evidence available to us whether: The evidence has been made available to the auditor #or the #irst time -e!g! it was previousl withheld.= or The auditor is claiming credit #or having discovered new evidence!

*plitting the description o# what an audit includes -between the #irst and third paragraphs. adds #urther con#usion! :m hasis of matter An emphasis o# matter is suggested b : The inclusion o# additional in#ormation into the scope paragraph= and The cross3re#erence to a note in the #inancial statements!

&t is not clear whether <ote 00 relates to transactions in the previous paragraph or something unrelated! The addition o# an emphasis o# matter paragraph does not a##ect the auditors opinion! /hen emphasi9ing a matter it is pre#erable to: &nclude such a paragraph a#ter the opinion paragraph= and *tate that the auditors opinion is not 'uali#ied with respect to it!

The re#erence to <ote 00 is be#ore the opinion paragraph and$ although it would be reasonabl in#erred$ there is no positive con#irmation that the auditors opinion is not 'uali#ied! 7oing concern The opinion paragraph introduces doubts about going concern b re#erring to 7the loss on its operations! The last paragraph$ being a#ter the opinion paragraph$ appears to be o# the nature o# an emphasis o# matter -as e%plained above. o# a #undamental uncertaint e%cept that: There is no cross3re#erence to a note= and There is no statement that the auditors opinion is not 'uali#ied with respect to it! &# the absence o# a cross3re#erence is because there is no disclosure -o# the signi#icant doubts cast on the entit s abilit to continue as a going concern. the audit opinion should be modi#ied on grounds o# disagreement over inade'uate disclosure -i!e! 7e%cept #or.!

28?

Although the opinion paragraph is un'uali#ied$ the use o# the word 7adverse in the last paragraph could potentiall be con#used with an 7adverse opinion! Fiven the apparent circumstances -i!e! ad,ustments in relation to prior ear$ operating losses$ net liabilities$ lack o# disclosure.$ it is conceivable that an adverse opinion ma be appropriate -i!e! the #inancial statements do not give a true and #air view.! The opinion paragraph should be a statement o# the auditors opinion -belie#. 1 but the last paragraph makes two re#erences to managements belie#s! There is no a##irmation that the auditor concurs with those belie#s nor e%pression o# disagreement that the are un#ounded! TimelinessAdate of re ort The auditors report is dated 1D Nanuar 0>L; on the #inancial statements #or an accounting period ended 2> *eptember 0>L6 1 i!e! nearl 18 months a#ter the balance sheet! The report should be dated as at the completion date o# the audit -&*A ?>>.! The reader is there#ore in#ormed that the auditor has considered the e##ect in the #inancial statements and on the report o# events and transactions o# which the auditor became aware o# and that occurred up to that date! (or e%ample$ the entit has not ceased to trade or been li'uidated in 0>L8! The lateness should concern the reader because the reason #or it is not e%plained -e!g! whether due to lack o# evidence or serious doubts about going concern.! 6rior eriod im lications The omission o# transactions #rom the prior ears records could: "e due to a cuto## error -e!g! omission o# purchase invoices.= &ndicate #raudulent reporting -e!g! deliberate suppression o# liabilities #rom being recorded.= Have resulted in the understatement o# an accounting estimate!

/hatever the circumstance the matter is presumabl material$ otherwise the auditors report should not re#er to it! &# the evidence available this ear was not available last ear$ but should have been reasonabl e%pected to be available$ the scope o# the prior ear audit would have been limited! This should have resulted in a modi#ied opinion in the prior ears auditors report! &# the matter has properl been resolved the current report does not ordinaril re#er to it 1 but an emphasis o# matter paragraph ma deal with the situation i# it is material to the current period -&*A ?1> 7Comparatives.! &t is not stated whether the ad,ustments have been made to the prior ears #inancial statements as re#lected in the corresponding #igures$ or in the current periods #inancial statements! The absence o# an 7e%cept #or opinion means that the auditor concurs with the ad,ustments having been made! 28B

The o ening balance of retained earnings should only have been ad3usted .and com arative information restated/ if the matter amounted to a fundamental error .I#$ H 4Net 6rofit or &oss for the 6eriod, 9undamental :rrors and Changes in #ccounting 6olicies5/" Tutorial note2 The onl other circumstance in which opening balances are ad,usted is when there is a change in accounting polic 1 which is not relevant here!

Conclusions Tutorial note2 The Euestion is set in the conte%t o# a client asking #or clari#ication o# the meaning o# the auditors report and appropriate marks will be awarded #or drawing a conclusion on the preceding anal sis! The auditors report draws attention to two apparentl unrelated matters: the prior ears #inancial statements and the going concern basis! Although the prior period matter ma have been correctl dealt with as an emphasis o# matter$ a clearer description o# the problem and a statement where the ad,ustments have been made would have assisted the reader! Also$ it should have been a#ter the opinion paragraph and a statement made that the opinion was not 'uali#ied in this respect! /hatever the going concern issue$ it is inappropriatel dealt with!

*"(

Communications with those charged with 7overnance

Auditors must report relevant audit matters with those charged with governance and will sometimes produce a report to management detailing control weaknesses observed during the audit

*"'

Re ort to those charged with governance

I$# *D( Communication of audit matters with those charged with governance gives guidance in this area" 7overnance 1 is the term used to describe the role o# persons entrusted with the supervision$ control and direction o# the entit ! Those charged with governance ordinaril are accountable #or ensuring that the entit achieves its ob,ectives$ #inancial reporting and reporting to interested parties! Those charged with governance include management onl when it per#orms such #unctions! I$# *D("*

28D

The auditor should communicate matters of governance interest arising from the audit of financial statements with those charged with governance of any entity The sco e of the I$# is limited to matters that come to the auditor5 attention as a result of the audit, the auditors are not required to design rocedures to identify matters of governance interest"

I$# *D("1 The auditor should determine the relevant ersons who are charged with governance and with whom audit matters of governance interest are communicated" The auditors may communicate with the whole board, the su ervisory board or the audit committee de ending on the governance structure of the organiEation" To avoid misunderstandings, the engagement letter should e@ lain that auditors will only communicate matters that come to their attention as a result of the erformance of the audit" It should state that the auditors are not required to design rocedures for the ur ose of identifying matters of governance interest" The letter may also2 Describe the form which any communications on governance will ta!e Identify the relevant ersons with whom such communications will be made Identify any s ecific matters of governance interest which it has agreed are to be communicated" I$# *D("'' The auditor should consider matters of governance interest that arise from the audit of the financial statements and communicate them with those charged with governance" 8atters should include2 The general a roach or overall sco e of the audit, including limitations or additional requirements $election of, or changes in, significant accounting olicies The otential effect on the financial statements of any significant ris!s and e@ osure, for e@am le ending litigation, that are required to be disclosed in the accounts $ignificant audit ad3ustments 8aterial uncertainties affecting the organiEation5s ability to continue as a going concern $ignificant disagreements with management

2;>

:@ ected modifications to the audit re ort Other significant matters such as material wea!nesses in internal control, questions regarding management integrity, and fraud involving management Other matters mentioned in terms of engagement

I$# *D("'The auditor should consider audit matters of governance interest on a timely basis 8atters may be communicated orally or in writing, but they should be recorded in the audit wor!ing a ers, however discussed" #uditors should ma!e clear that the audit is not designed to identify all relevant matters connected with governance #uditors should have regard to local laws and regulations, and local guidance on confidentiality when communicating with management"

*"*

Re orting to management

Auditors ma also issue a report on control weaknesses to management! This usuall takes the #ormat 4wea!ness, im lication, recommendation"5

*"-

Investigations and $ ecial #udit Re orts

Auditors ma issue special reports on components o# #inancial statements$ compliance with contractual agreements summar #inancial statements$ revised accounts and distribution #ollowing an audit 'uali#ication!

-"(

$ ecial ur ose audit re orts

Auditors ma issue special reports on components o# #inancial statements$ compliance with contractual agreements$ summari9ed #inancial statements$ distributions #ollowing 'uali#ication and revised accounts

-"'

Re orts on Com onents of financial statements

The auditor ma be re'uested to e%press an opinion on one or more components o# #inancial statements$ #or e%ample$ accounts receivable$ inventor $ an emplo ees bonus calculation or a provision #or income ta%es! This t pe o# engagement ma be undertaken as a separate engagement or in con,unction with an audit o# the entit s #inancial

2;1

statements! However$ this t pe o# engagement does not result in a report on the #inancial statements taken as a whole and$ accordingl $ the auditor would e%press an opinion onl as to whether the component audited is prepared$ in all material respects$ in accordance with the identi#ied basis o# accounting! I$# H(("'0A'1 The auditor should consider the conce t of materiality in relation to the com onent of financial statements being re orted u on" To avoid giving the user the im ression that the re ort relates to the entire financial statements, the auditor would advise the client that the auditor5s re ort on a com onent of financial statements is not to accom any the financial statements of the entity" I$# H(("'D The auditors report on a component o# #inancial statements should include a statement that indicates the basis o# accounting in accordance with which the component is presented or re#ers to an agreement that speci#ies the basis! The opinion should state whether the component is prepared$ in all material respects$ in accordance with the identi#ied basis o# accounting!

-"* Com liance with Contractual #greements


The auditor ma be re'uested to report on an entit s compliance with certain aspects o# contractual agreements$ such as loan agreements! *uch agreements ordinaril re'uire the entit to compl with a variet o# covenants involving such matters as pa ments o# interest$ maintenance o# predetermined #inancial ratios$ restriction o# dividend pa ments and the use o# the proceeds o# sales o# propert ! I$# H(("'IA*( Engagements to e%press an opinion as to an entit s compliance with contractual agreements should be undertaken onl when the overall aspects o# compliance relate to accounting and #inancial matters within the scope o# the auditors pro#essional competence! However$ when there are particular matters #orming part o# the engagement that are outside the auditors e%pertise$ the auditor would consider using the work o# an e%pert! The report should state whether$ in the auditors opinion$ the entit has complied with the particular provisions o# the agreement!

-"- $ummariEed financial statements

2;0

An entit ma prepare #inancial statements summari9ing its annual audited #inancial statements #or the purpose o# in#orming user groups interested in the highlights onl o# the entit s #inancial position and the results o# its operations" I$# H(("*'A*1 Unless the auditor has e@ ressed an audit o inion on the financial statements from which the summariEed financial statements were derived, the auditor should not re ort on summariEed financial statements" The auditors report on summari9ed #inancial statements should include the #ollowing basic elements ordinaril in the #ollowing la out: (a) 'itle+ (b) Addressee+ (c) An identification of t"e audited financial statements from !"ic" t"e summari3ed financial statements !ere derived+ (d) A reference to t"e date of t"e audit report on t"e unabridged financial statements and t"e type of opinion given in t"at report+ (e) An opinion as to !"et"er t"e information in t"e summari3ed financial statements is consistent !it" t"e audited financial statements from !"ic" it !as derived# &"en t"e auditor "as issued a modified opinion on t"e unabridged financial statements yet is satisfied !it" t"e presentation of t"e summari3ed financial statements t"e auditor$s report s"ould state t"at alt"oug" consistent !it" t"e unabridged financial statements t"e summari3ed financial statements !ere derived from financial statements on !"ic" a modified auditor$s report !as issued+ (f) A statement or reference to t"e note !it"in t"e summari3ed financial statements !"ic" indicates t"at for a better understanding of an entity$s financial performance and position and of t"e scope of t"e audit performed t"e summari3ed financial statements s"ould be read in conjunction !it" t"e unabridged financial statements and t"e auditor$s report t"ereon+ (g) ,ate of t"e report+ (") Auditor$s address+ and (i) Auditor$s signature# :@am le of Re ort on $ummariEed 9inancial $tatements is as follows2

2;2

AL,I'O9$S 9/BO9' 'O##### &e "ave audited t"e financial statements of A40 0ompany for t"e year ended ,ecember 57 20M0 from !"ic" t"e summari3ed financial statements !ere derived in accordance !it" International Standards on Auditing (or refer to relevant national standards or practices)# In our report dated 2arc" 70 20M7 !e e)pressed an un(ualified opinion on t"e financial statements from !"ic" t"e summari3ed financial statements !ere derived# In our opinion t"e accompanying summari3ed financial statements are consistent in all material respects !it" t"e financial statements from !"ic" t"ey !ere derived# 1or a better understanding of t"e 0ompany$s financial position and t"e results of its operations for t"e period and of t"e scope of our audit t"e summari3ed financial statements s"ould be read in conjunction !it" t"e financial statements from !"ic" t"e summari3ed financial statements !ere derived and our audit report t"ereon# ,ate Address

-"0 Distribution following an audit qualification


&n some countries it ma be a case that companies whose accounts have been 'uali#ied b the auditor ma make a distribution -pa a dividend. onl under certain circumstances! The 'uestion whether a compan has pro#its #rom which to pa a dividend is determined b re#erence to local)national compan legislation! &# the auditors have modi#ied their report on the accounts the ma have also stated -in writing. whether$ in their opinion$ the sub,ect matter o# their 'uali#ication -i# it relates to statutor accounting re'uirements. is made in determining whether the dividend ma be paid!

-"1

Revised accounts

Annual accounts ma be #ound a#ter their la ing or delivering$ to be de#ective! &n some countries it ma be possible to revise such de#ective accounts$ in some$ such revision ma be compulsor and others revision ma not be permitted! The use o# hindsight is likel to be limited in determining whether accounts #ailed to compl with &*As$ local legislation or standards to events that took place be#ore the accounts were approved! This means that estimated #igures in the accounts need onl be corrected i# the #acts on which the estimates were made are #undamentall wrong -as opposed to a change in accounting polic chosen to calculate the estimate or change in the intentions and #orecasts o# management.! The revision o# accounts ma be undertaken b :

2;6

Revision by re lacement, replacing the original with new set o# accounts or report$ or Revision by su lementary note

&n both cases$ it is assumed that accounts should be prepared as i# prepared and then approved b management as at the date o# the original annual accounts$ which means that the e%tent o# an revision is limited to that resulting #rom #acts which were known or discovered at the original date o# approval +anagement should include a statement in prominent place in the revised accounts which gives #ull details o# the revision! As #ar as the duties o# auditors are concerned$ a#ter the date on which the have signed the audit report on the original accounts$ the auditors have no dut to search #or evidence o# #urther matters which ma a##ect the accounts to which the report relates! However$ i# such matter comes to their attention$ the should discuss an appropriate revision with management! &# management are unwilling to revise the accounts then the auditor should take legal advice! The #ollowing speci#ic procedures should be undertaken: -a. Review the original audit plan in light o# the anal sis o# the matter leading to revision and the e%tent to which additional audit evidence is re'uired should be considered -b. Reassess the various matters o# ,udgement involved in the preparation o# the original accounts! -c. :btain evidence speci#ic to the ad,ustments made to the original accounts -d. Review period a#ter the date on which the original accounts were approved -e. Review the revised accounts to a su##icient e%tent$ in con,unction with the conclusions drawn #rom the other audit evidence obtained$ to give the auditors a reasonable basis #or their opinion on the accounts -#. Consider an legal and regulator conse'uences o# the revision! :@am le of the auditors5 re ort on revised accounts is given below$ based on &*A ?>> -opinion paragraph onl ! In our opinion t"e revised financial statements give a true and fair vie! (or present fairly in all material respects$) as at t"e date t"e original financial statements !ere approved of t"e financial position of t"e company as of ,ecember 57 20M7 and of t"e results of its operations and its cas" flo!s for t"e year t"en ended in accordance !it" (relevant national legislation)# In our opinion t"e original financial statements for t"e year to ,ecember 57 20M7 failed to comply !it" (relevant national standards or legislation)#

2;8

,ate Address

AL,I'O9

Chapter roundup
Auditors e%press an opinion on #inancial statements based on the work the have done$ the evidence obtained and conclusions drawn in relation to that evidence! A standard #ormat is used to promote understandabilit because the audit report is widel available to both accustomed users and users who are not accustomed to audit and audit language! The availabilit o# reports has been increased b the trend to publish #inancial statements on companies websites! Auditors ma issue special reports on o *ummar #inancial statements o Revised accounts o Histributions #ollowing an audit 'uali#ication Auditors must report relevant audit matters to those charged with governance and will also sometimes produce a report to management detailing control weaknesses observed during the audit!

2;;

>U:$TION$ #ND #N$+:R$ $:CTION


This section is broken down into two parts!
Part :ne consists o# 'uestions #or each o# the chapters addressed in the manual Part two consists o# answers to each o# the 'uestions in Part one above!

/e suggest that #irst ou do 'uestions that are provided at the end o# each chapter$ and then ou can attempt the corresponding 'uestion provided in Part :ne o# this section! The 'uestions are arranged in line with the manual set up! The manual is in #our parts! Part A is about the (ramework$ Part " Process$ Part C :ther *ervices and Part H Reporting! Euestions have been prepared in line with these Parts! &n other words$ #or each chapter that is provided in the manual$ there is an e%amination 'uestion set! However$ knowledge across whole parts is vital because it makes ou appreciated a wide range o# in#ormation as ou tackle the 'uestions!

2;?

>uestion '2 #$$UR#NC: 6RO;I$ION


Pro#essional accountants are now operating in a dynamic, turbulent and com le@ environment that demands for greater accountability, ethics and trans arent both in the public and private sectors! There has been a number o# #raudulent acts to which companies such as Enron$ /orld Com$ Agri#lora and other big corporations have been e%posed to despite the assurance that were given b the auditors! Parious stakeholders and the public in general have 'uestioned these acts knowing ver much that pro#essional accountants have the dut to rovide assurance on a variet o# sub,ect matters b e%pressing a conclusion regarding the quality and reliability o# in#ormation that the provide to their clients! However$ there are a number o# implications o# assurance rovision that ma hinder various stakeholders appreciate the assurance given b the accountants! Required2 Hiscuss the above statement and the various implications o# assurance provision #or the accountanc pro#essional in line with the &(ACs &nternational (ramework #or Assurance Engagements!

>uestion *2 L:T#
5ou are the audit manager in 5eta$ a #irm o# Chartered Certi#ied Accountants! 5our speci#ic responsibilities include advising the senior audit partner on the acceptance o# new assignments! The #ollowing matters have arisen in connection with three prospective client companies: -a. 5our #irm as been nominated to act as auditor to Peterson$ a private limited compan ! 5ou have been waiting #or a response to our letter o# 7pro#essional en'uir to Petersons auditor$ Carol M Co$ #or several weeks! 5our recent attempt to call the current engagement partner Names Chali$ in Carol M Co have been met with response #rom Namess personal assistant that @+r Chali is not available! 1 mar!s 5eta has been approach b the management o# Teka$ a compan listed on a recogni9ed stock e%change$ to advise on a take3over bid which the propose to

-b.

2;B

make! The target compan $ Flobal$ is an audit client o# our #irm! However$ Teka is not! 1 mar!s -c. A #ormer collegue in 5eta$ Tom Tom#we$ is now emplo ed b another audit #irm$ *wap! 5eta and *wap and three other #irms have recentl tendered #or the audit o# Tadori$ a limited liabilit compan ! Tedori is e%pected to announce the success#ul #irm ne%t week! 5esterda at a social gathering$ Tom con#ined to ou that *wap 7lowballed on their tender #or the audit as the e%pect to be able to provide Tadori with lucrative other services! 1 mar!s

Required: Comment on the pro#essional issues raised b each o# the above matters and the steps$ i# an $ that 5eta should now take! Total2 '1 8ar!s/

>uestion -2 8#&#JI
+alaki (isheries is a medium si9ed entit operating in Cambia and managed b its owners! The entit was bought out #rom Pol *torage$ a large listed compan si% ears ago! The share capital is owned b #our directors! :ne o# the original directors$ "ob (isher has recentl passed awa and his shares and his place on the board have been taken up b his son$ Tedd (isher! A large loan #rom the bank$ which helped to #inance the purchase$ was paid o## in the previous period! This ear$ the directors have negotiated another loan #rom the bank to help #inance an e%pansion into Hemocratic Republic o# Congo! 5ou work #or a #irm o# chartered certi#ied accountants called * M K! * M K became involved with +alaki at the time o# the bu out when the provided advice to two o# the current directors! The have been involved with the business ever since$ acting in the capacit o# ta% advisers$ management consultants and personal ta% advisers #or all directors! The have also been involved in some special pro,ects #or +alaki$ taking part in an investigation due to a suspected #raud two ears a#ter the +":$ and putting together pro,ections and budgets #or the potential e%pansion! * M K were invited to tender initiall #or the audit$ but their tender had the highest #ee$ and "ob (isher who was the managing director that time strongl believed that an audit was a statutor necessit which the compan should obtain as cheapl as possible! The audit was given to a small #irm o# auditors$ " M " but * M K were engaged to provide what "ob (isher alwa s termed$ 7the use#ul stu## 1 worth pa ing #or!

2;D

The #ee income #rom +alaki has been considerable over the ears! Two ears ago$ when the work was done on the e%pansion$ it represented 0>O o# the income o# the #irm #or that ear! The increase in si9e o# the business since the e%pansion has led to the current auditors$ " M "$ resigning! Rather than going through another tender$ the directors have decided to o##er the audit to their business advisers$ * M K$ as the believe that it provides s nerg to combine the two roles$ and that s nerg ma result in a lower overall cost to the compan o# accountanc and related services! * M * have accepted their audit work! The #irst audit is due to start in three weeks time! At a recent board meeting$ attended b the partner who has been in charge o# the work provided b +alaki$ and his colleague$ who has been appointed as the audit engagement partner$ the directors discussed plans to #loat the compan on the stock e%change in the #oreseeable #uture! Required2 -a. -b. E%plain the current ethical and legal considerations in connection with accepting appointment as an auditor! D mar!s Hiscuss whether the conduct o# * M * has been ethical in its dealings with +alaki during the course o# their relationship! '( mar!s E%plain whether our answer to part -b. would have been di##erent i# +alaki had been a public interest compan ! - mar!s * M * have appointed an audit engagement partner who has not previousl been involved with the client to the audit o# +alaki! /hat other 'ualit control procedures and policies should * M * have in place in relation to the audit o# +alaki to sa#eguard audit 'ualit 4 D mar!s .Total2 *1 mar!s/

-c.
-d.

>uestion 02 6RO9:$$ION#& R:$6ON$I%I&ITL #ND &I#%I&ITL


+uch publicit has been given to recent developments which have implications #or the respective responsibilities and liabilities o# management and auditors$ both internal and e%ternal$ relating to: -a. -b. -c. The e%ternal audit opinion= D mar!s

Reporting assurance on the e##ectiveness o# internal #inancial controls= 1 mar!s +anagement representation letters D mar!s

2?>

Required2 Comments on responsibilities in each o# the above areas and discuss the impact o# recent developments on the pro#essional liabilit o# e%ternal auditors! .Total2 '1 mar!s/

>uestion 12 CF#T$
A Cambian leading #irm o# pro#essional accountants CHAT*$ operate in a dynamic and com etitive environment o# auditing$ accounting and knowledge management and have been looking at wa s o# being more efficient, economic and effective as well as demonstrating achievement o# best ractice to demonstrate leading edge deliver ! The consultanc arm o# CHAT* undertook a high level review o# current working practices across the organi9ation as a means to establishing their per#ormance in the usage of IT as a tool to enhance their competitive edge! The #ollowing #indings came to light! CHAT* has not used &T as a tool to enhance per#ormance o# their responsibilities! There has been a minimum automation o# activities and low level usage o# computers! There are no 'ualit control mechanisms put in place aimed at minimi9ing various short comings /hile working papers are vital in the documentation o# audit work$ the are inconsistent and incomplete to #acilitate an in#ormed opinion!

5ou have been emplo ed b the auditing section o# CHAT* and have been asked to come up with a paper setting out proposals #or addressing these #indings within the audit #irm! 5ou are re'uired to prepare a paper with the #ollowing details: -a. -b. -c. E%plain the bene#its o# the use o# in#ormation technolog and recommend wa s that CHAT* can best use automation in their auditing service! '( mar!s Hescribe the importance o# 'ualit control and propose a 'ualit control strateg and procedures that should be implemented within CHAT* '( mar!s E%plain the risk o# inade'uate working papers and describe the criteria that should be implemented b CHAT* #or working papers to address such risks! 1 mar!s .Total2 *1 mar!s/

>uestion D2 COR6OR#T: 7O;:RN#NC: $T#ND#RD$


2?1

&# there is need #or a uni#orm set o# international accounting standards and international auditing standards$ there is also a need #or global corporate governance standards! Required2 Hiscuss and reach a conclusion! '1 mar!s

>uestion G2 FLDR#$6ORT
H drasports$ a limited liabilit compan and national leisure group$ has si%teen centres around the countr and a head o##ice! (acilities at each centre are o# a standard design which incorporates a heated swimming pool$ sauna$ air conditioned g m and #itness studio with supervised childcare! Each centre is managed on a da 3to3da basis$ b a centre manager$ in accordance with compan policies! The centre manager is also responsible #or preparing and submitting monthl accounting returns to head o##ice! Each centre is re'uired to have a licence #rom the local authorit to operate! Gicences are granted #or periods between two and #ive ears and are renewable sub,ect to satis#actor reports #rom local authorit inspectors! The average annual cost o# a licence is K6>>$ >>>! +embers pa a K1>$>>> ,oining #ee$ plus either K8$>>> per month #or 7peak membership or K2$>>> per month #or 7o## peak$ pa able 'uarterl in advance! All #ees are stated to be non 1 re#undable! The centre at Perne was closed #rom Nul to *eptember 0>>2 a#ter a chemical spill in the sauna caused a serious accident! Although the centre was re 1 opened$ H drasports has recommended to all centre managers that sauna #acilities be suspended until #urther notice! &n response to complaints to local authorities about its childcare #acilities$ H drasports has issued centre managers with revised guidelines #or minimum levels o# supervision! Centre managers are #inding it di##icult to meet new guidelines and have suggested that childcare #acilities should be withdrawn! *ta## lateness is a recurring problem and a ma,or cause o# 7earl bird customer dissatis#action with sessions which are scheduled to star at >?!>>! new emplo ees are generall attracted to the industr in the short term #or its non3cash bene#its$ including #ree use o# the #acilities 1 but leave when the re'uire increased #inancial rewards! Training sta## to be 'uali#ied li#e3guards is costl and time consuming and retention rates are poor! Turnover o# centre manager is also high$ due to the constraints imposed on them b compan polic ! Three o# the centres are e%pected to have run at a loss #or the ear ending 21 Hecember 0>>2 due to #alling membership! H drasports has invested heavil in a h drotherap pool 2?0

at one o# these centres$ with the aim o# attracting retired members with more leisure time! The building contract has alread billed twice as much and taken three times as long as budgeted #or the work! The pool is now e%pected to open in (ebruar 0>>6! Cash #low di##iculties in the current ear have put back the planned replacement o# g m e'uipment #or most o# the centres! &nsurance premiums #or liabilit to emplo ees and the public have increased b nearl 68O! H drasports has met the additional e%pense b reducing its insurance cover on its plant and e'uipment #rom a replacement cost basis to a net reali9able value basis! Required2 -a.-i. &denti# and e%plain the business risks which should be assessed b the management o# H drasports! H mar!s -ii. Also e%plain how each o# the business risks identi#ied in -i. ma be linked to #inancial statement risk! H mar!s -b. Hescribe the principal audit work to be per#ormed in respect o# the carr ing amount o# the #ollowing items in the balance sheet o# H drasports as at 21 Hecember 0>>2: -i. He#erred income= and -ii. H drotherap pool! - mar!s - mar!s

-c. *uggest per#ormance indicators that could be set to increase the centre managers awareness o# h drasports social and environmental responsibilities and the evidence which should be available to provide assurance on their accurac ! H mar!s

.Total2 -( mar!s/ >uestion H2 6&#$CO


5ou are the manager responsible #or the audit o# Plasco Co$ a private limited compan engaged in the manu#acture o# plastic products! The dra#t #inancial statements #or the ear ended 21 +arch 0>>; show revenue o# K6?X6 million -0>>8 1 K62XD million.$ pro#it be#ore ta%ation o# K0 million -0>>8 1 K0X6 million. and total assets o# K22XB million -0>>8 1 K08X? million.! The #ollowing issues arising during the #inal audit have been noted on a schedule o# points #or our attention: .a/ &n April 0>>8$ Plasco bought the right to use a land#ill site #or a period o# 18 ears #or K1X1 million! Plasco e%pects that the amount o# waste that it will need to dump will increase annuall and that the site will be completel #illed a#ter ,ust 1> ears! Plasco has charged the #ollowing amounts to the income statement #or the ear to 21 +arch 0>>;: 2?2

1 K0>$ >>> licence amortisation calculated on a sum3o#3digits basis to increase the charge over the use#ul li#e o# the site= and 1 K1>>$ >>> annual provision #or restoring the land in 18 ears time! .I mar!s/ .b/ A sale o# industrial e'uipment to *uper +etal Co in +a 0>>8 resulted in a loss on disposal o# K>X2 million that has been separatel disclosed on the #ace o# the income statement! The e'uipment cost K1X0 million when it was purchased in April 1DD; and was being depreciated on a straight3line basis over 0> ears! .D mar!s/ &n April 0>>;$ Plasco was banned b the local government #rom empt ing waste water into a river because the water did not meet minimum standards o# cleanliness! Plasco has made a provision o# K>XD million #or the technological upgrading o# its water puri# ing process and included K68$>>> #or the penalties imposed in 7other provisions! .1 mar!s/

.c/

Required2 9or each of the above issues2 .i/ Comment on the matters that you should considerC and .ii/ $tate the audit evidence that you should e@ ect to find, in underta!ing your review of the audit wor!ing a ers and financial statements of 6lasco Co for the year ended -' 8arch *((D" <:TE: The mark allocation is shown against each o# the three issues! .Total2 *( mar!s/

>uestion I2 6O+:R :N:R7L


5ou are the manager responsible #or the audit o# Power Energ $ an energ generation compan ! The dra#t #inancial statements #or the ear ended 21 march 0>>6 show revenue o# K0B? billion -0>>2 1 K0;0 billion.$ pro#it be#ore ta%ation o# K?!0 billion -0>>2 1 K02 billion. and total assets o# K 060 billion -0>>2 1 K001 billion.! The #ollowing issues arising during the #inal audit have been noted on a schedule o# points #or our attention: -a. Huring the ear Power Energ put its technical sta## through a new training program! :n the basis that this e%penditure has been incurred solel #or the purpose o# generating #uture economic bene#its the chie# e%ecutive is adamant that the costs$ amounting to K6!2 billion be capitali9ed as an intangible asset! G 8ar!s

2?6

-b.

Huring the ear Power Energ assembled a laborator on land which had been granted to it 08 ears b the local authorit in 1DD8! Inder the terms o# the grant the laborator must be dismantled and the site decontaminated when the grant term e%pires! This is e%pected to cost K1!B billion in 0>0> and an annual provision o# K1!0 billion is being made! G mar!s Power Energ receives signi#icant #unding #rom government sources and is re'uired to report monthl on its #inancial per#ormance and position! Ever month end a ,ournal entr is made$ 7Hebit *undr 1 account)Credit *undr 0 account! There is no narrative but the chie# accountant e%plained that the ,ournal is approved b the chie# e%ecutive to ensure that reported debt ratios sta within government speci#ied limits! The entries are then reversed at the beginning o# the #ollowing month! The net movement on these accounts over the ear to 21 +arch 0>>6 was K2>> million! D mar!s

-c.

Required: (or each o# the above issues: -i. -ii. Comment on the matters that ou should consider= and *tate the audit evidence that ou should e%pect to #ind$

&n undertaking our review o# the audit working papers and #inancial statements o# Power Energ #or the ear ended 21 +arch 0>>6! .Total2 *( mar!s/

>uestion '(2
8UND#+#N7# BOO 7#RD:N$ The principal activit o# +undawanga Coo Fardens -+CF. is the conservation o# animals! Appro%imatel B>O o# the 9oos income comes #rom admission$ mone spent in the #ood and retail outlets and animal sponsorship! The remainder comprises donations and investment income! Admission #ees include da visitor entrance #ees -gate. and annual membership #ees! Ha tickets ma be pre3booked b credit cards using telephone booking 7hotline and via the 9oos website! Reduced #ees are available -e!g! students$ senior citi9ens and #amilies.! Animal sponsors bene#it #rom the advertisement o# their names at the sponsored animals enclosure! "CFs management has identi#ied the #ollowing applicable risks that re'uire #urther consideration and are to be activel managed: -i. Reduction in admission income through #ailure to invest in new e%hibits and breeding programs to attract visitors= 2?8

-ii. -iii.

Animal sponsorships ma not be invoiced due to incomplete data trans#er between the sponsoring and invoicing departments= Corporate sponsorships ma not be charged #or at approved rates 1 either in error or due to arrangements with the companies! &n particular$ the sponsorship department ma not noti# the invoicing department o# reciprocal arrangements$ whereb sponsoring companies provide "CF with advertising -e!g! in compan maga9ines and manual reports.= Cash received at the entrance gate ticket o##ices -kiosks. ma not be passed to cashiers in the accounts departments -e!g! through the#t.= The ticket booking and issuing s stem ma not be available= Honation o# animals to the collection -e!g! #rom Customs and E%cise sei9ures and rare breeds enthusiasts. ma not be recorded!

-iv. -v. -vi.

Required2 -a. -b. -c. Hescribe suitable internal controls to manage each o# the applicable risks! '* mar!s E%plain the #inancial statements risks arising #rom the applicable risks! D mar!s Comment on the #actors to be considered when planning the e%tent o# substantive anal tical procedures to be per#ormed on "CFs income! G mar!s .Total2 *1 mar!s/

>uestion ''2
L#T:$ 5our #irm has success#ull tendered #or the audit o# 5ates Co$ a private national haulage and distribution compan with over 0$>>> emplo ees! This long3established compan provides re#rigerated$ bulk and heav haulage transport services to time3sensitive deliver schedules! 5ou have obtained the #ollowing #inancial in#ormation #rom 5ates: (or the ear to 2> Nune 0>>; 0>>8 &ncome statement Revenue -<ote 1. Hra#t Km 1;1X8 Actual Km 166X6

2?;

+aterials e%pense -<ote 0. *ta## costs Hepreciation and amorti9ation :ther e%penses (inance costs Total e%penses Pro#it)-loss. be#ore ta%ation %alance sheet &ntangible assets -<ote 2. Tangible assets -<ote 6. Propert Pehicles and transport e'uipment :ther e'uipment &nventories Trade receivables -<ote 8. Cash and cash e'uivalents Total assets 6rovisions Restructuring -<ote ;. Ta% provision Giabilities (inance lease liabilities -<ote ?. Trade pa ables :ther liabilities -<ote B. Total liabilities

111111 BBX> 6>X; BX8 1DX; 0XD 111111 111111 18DX; 111111 111111 1XD 111111 111111 ?X0 88X1 1;X6 ?X6 >X; 12X? 2X6 111111 111111 1>2XB 1111111 1 DX? 2X> 8X6 12XB BX8 111111 111111 6>X6 111111 111111

11111 ?6X? 28X; DX8 02X0 0X0 168X0 ->XB.

;X0 8?XB 1;X> DX2 >X8 12X6 0XB 1>;X> 11111 1>XB 2X2 6X6 12X1 ?XD 2DX8

Notes -1. Revenue is net o# rebates to ma,or customers that increase with the volume o# consignments transported! Rebates are calculated on cumulative sales #or the #inancial ear and awarded 'uarterl in arrears!

2??

-0. -2.

+aterials e%pense includes #uel$ repair materials$ transportation and vehicle maintenance costs! Purchased intangible assets$ including so#tware and industrial licences$ are accounted #or using the cost model! &nternall generated intangible assets$ mainl so#tware developed #or customers to generate consignment documents$ are initiall recogni9ed at cost i# the asset recognition criteria are satis#ied!

-6.

+ovements on tangible non3current assets have been dra#ted as #ollows:


Propert Pehicles M Transport e'uipment :ther e'uipment Total

Historical cost :pening balance at 1 Nul 0>>8 Additions Hisposals Closing balance at 2> Nune 0>>;

Vm ?8X? 1X6 -0X8. 11111 111111 ?6X; 11111

Vm 08X; 0X? -0X;. 11111 08X? 11111 DX; 1XD -0X0. 11111 DX2 11111 1;X6 11111 1;X>

Vm Vm 1?XB 11DX1 1X1 8X0 -1X6. -;X8. 11111 1?X8 11?XB 11111 BX8 0X8 ->XD. 11111 1>X1 11111 2;X> ;XB -2XD. 2BXD

111111 Hepreciation and impairment losses :pening balance at 1 Nul 0>>8 1?XD Hepreciation and impairment loss 0X6 Hisposals ->XB. 11111 111111 Closing balance at 2> Nune 0>>; 1DX8 11111 111111 Carr ing amount at 2> Nune 0>>; 88X1 11111 Carr ing amount at 2> Nune 0>>8 8?XB

?X6 ?BXD 111111 11111 DX2 B2X1

Hepreciation is charged using the straight3line method assuming the #ollowing use#ul lives: 5ears Propert ; to ;> Pehicles and transport e'uipment 2 to B 2?B

:ther e'uipment -8. -;. -?. -B.

2 to 18

Trade receivables are carried at their principal amount$ less allowances #or impairment! The restructuring provision relates to emplo ee termination and other obligations arising on the closure and relocation o# distribution depots in Hecember 0>>6! (inance leases are capitali9ed at the date o# inception o# the lease at #air value or the present value o# the minimum lease pa ments$ i# less! :ther liabilities include amounts due to emplo ees #or accrued wages and salaries$ overtime$ sick leave$ maternit pa and bonuses!

Required2 &n respect o# the #inancial statements audit o# 5ates Co #or the ear ending 2> Nune 0>>;: -a. -b. -c. -d. Calculate preliminar materialit and ,usti# the suitabilit o# our assessment! .D mar!s/ &denti# and e%plain the #inancial statement risks to be taken into account in planning the #inal audit! .'* mar!s/ E%plain the e%tent to which ou should plan to place reliance on anal tical procedures as audit evidence! .D mar!s/ "rie#l describe the principal audit work to be per#ormed in respect o# the carr ing amount o# the #ollowing items in the balance sheet: -i. trade receivables= and -ii. Pehicles! .- mar!s/ .- mar!s/ .Total2 -( mar!s/

>uestion '*2
OTF:R #$$UR#NC:$ Audit practitioners have recentl initiated substantive changes in the audit approach! &t appears to be the strateg that audit #irms are moving awa #rom audit o# #inancial statements and more to the provision o# assurance on #inancial data$ s stems and controls in those s stems! Auditors are #ocusing on providing 7business assurance and 7business risk which gives clients wider assurance than the traditional audit has o##ered! Auditors are reviewing the business #rom a process standpoint utili9ing benchmarking$ per#ormance measurements and best control practices as the ke criteria! &t seems that the audit is moving more to the anal sis o# business risk and the alignment o# the audit much to the management perspective! A wider range o# risk assessment services is now part o# the audit service which clients can subscribe to! The provision o# internal audit services is becoming an increasingl

2?D

larger part o# the 7business assurance service o##ered b auditors! &t seems that the audit is becoming a management consultanc e%ercise with internal audit$ e%ternal audit and consultanc assignments being seen as complementar services! Required2 -a. Hiscuss the implications o# the e%ternal auditor providing an internal audit service to a client$ e%plaining the current ethical guidance on the provision o# other services to clients! '( mar!s E%plain the principal e##ects o# the e%ternal auditor providing wider assurance to the client! D mar!s Criticall evaluate the move b large auditing #irms to providing 7business risk and assurance services rather than the traditional audit services #or investors and creditors! 0 mar!s"

-b. -c.

>U:$TION '-2 :N;IRON8:NT#& I$$U:$ The importance o# the environment is increasingl recogni9ed! Environmental issues o#ten have implications #or business and cannot be ignored b auditors! Auditors need a general awareness o# the risk that environmental issues ma have an impact on the #inancial statements! Required2 Hiscuss the above statement! >U:$TION '02 8UT:ND: -a. -b. E%plain the auditors responsibilities #or the appropriateness o# the going concern assumption as a basis #or the preparation o# #inancial statements! .1 mar!s/ 5ou are a manager in a 'ualit control review department o# *C:RE$ a #irm o# Chartered Certi#ied Accountants! 5ou are currentl responsible #or reviewing the appropriateness o# our #irms proposed auditors reports on #inancial statements! The dra#t #inancial statements o# +utende group #or the ear ended 21 Hecember 0>>1 disclose the #ollowing: '1 mar!s

2B>

Note ' $ignificant event Huring the ear$ +utende sold a signi#icant amount o# its business and certain assets -plant and e'uipment and inventor . and commenced a s stematic winding down o# its operations! The groups remaining assets -including propert $ trade receivables and cash. were su##icient to meet the groups liabilities$ as at 21 Hecember 0>>1! Note * #ccounting olicies The consolidated #inancial statements have been prepared in accordance with &nternational Accounting *tandards -&A*. under the historical cost convention! As described in note 1$ the group has commenced the winding down o# its operations and remaining assets have been restated to their net reali9able values! There are no other disclosures relating to the going concern assumption although the 7signi#icant event is re#erred to in the directors report under the heading 7principal activities and trading review! +utende ceased to trade in April 0>>0 The auditors report on +utendes #inancial statements #or the ear ended 21 Hecember 0>>> was unmodi#ied! Required2 Comment on the suitabilit or otherwise o# an unmodi#ied auditors report #or +utende #or the ear ended 21 Hecember 0>>1! 5our answer should discuss the appropriateness o# alternative audit opinions! .'( mar!s/

$olution '2 #ssurance rovision


Tutorial: This 'uestion is about assurance provision that is provided b auditors! 5ou need to appreciate what t pe o# assurance services are provided b auditors and how these services impact on the users o# in#ormation! The d namic$ turbulent and comple% environment mentioned signi#ies the high demand e%pected and o# course the #actors that ma impact on the assurance provision! This is a discursive 'uestion and ou need to e%plore various issues on assurance provision in relation to the 'uestion! Know what &(ACs &nternational (ramework #or Assurance Engagements sa s -&*A 1>>.! Conclude our discussion to intimate our perception o# the issue at hand! 9ramewor!

2B1

The &(ACs &nternational (ramework #or Assurance states that the ob,ective o# an assurance engagement is #or a pro#essional accountant to evaluate or measure a sub,ect matter that is the responsibilit o# another part against identi#ied suitable criteria$ and to e%press a conclusion that provides the intended user with a level o# assurance about the sub,ect matter! An assurance service is there#ore @an agreement in which a practitioner e%presses a conclusion designed to enhance the degree o# con#idence o# the intended users other than the responsible part about the outcome o# the evaluation or measurement o# a sub,ect matter against criteria! Information availability As indicated in the statement$ the d namic$ turbulent and comple% environment has made the users and the public to demand #or assurance services on man kinds o# in#ormation provided to them! This is in addition to the traditional wa o# providing assurance on #inancial statement as to whether the #inancial statements give a true and #air view or presents #airl in all material statements! &n this global world$ in#ormation is more widel available and people and organi9ations are re'uired to be more accountable to those who have a stake in them! Communication has enhanced tremendousl through the use o# internet and other internet connective! "oth the private and public sectors are able to access in#ormation as this in#ormation is readil available and kept on public register! Companies and organi9ations publish in#ormation in #orm o# annual reports= environmental reports= social reports= value #or mone reports and corporate governance reports! 6rofessional #ccountants &n line with &nternational *tandards on Auditing -&*A. 1>> 1 Assurance Engagements$ assurance engagements per#ormed b pro#essional accountants are intended to enhance the credibilit o# in#ormation about a sub,ect matter b evaluating whether the sub,ect con#irms in all material respect with the criteria$ thereb improving the likelihood that the in#ormation will meet the needs o# an intended user! " virtual o# being Pro#essional Accountants$ users are e%pectant that valuable in#ormation will be provided considering that the possess certain 'uali#ications and e%pertise to give an independent opinion as a wa o# meeting public e%pectations! #ssurance services Assurance services can be in the #orm o# assertion based engagements where the accountant declares that a given premise or assertion is either correct or not such as a statutor audit! The other one is a direct re orting engagement, where the accountants reports on issues that have come to his attention during his evaluation! However$ the standard states that #or it to be an assurance engagement$ it would depend on whether it e%hibits that a three part relationship involving ractitioner$ res onsible arty and intended user! There must also be a sub,ect matter$ suitable criteria$ su##icient appropriate evidence and whether the assurance report is in appropriate #orm! &evels of assurance &t is also important to not that a level o# absolute assurance cannot be given in such engagements due to limitations inherent in the process! Two levels o# assurance can be

2B0

identi#ied namel = reasonable level of assurance where the practitioner would conclude that the sub,ect matter materiall con#orms with the criteria such as a statutor audit! A limited level of assurance where the practitioner has no reason to believe that the sub,ect matter does not con#orm with the criteria! However$ there are a number o# implications o# assurance services that pro#essional accountants o##er! On audit2 Audit #irms need to make mone in order to sustain there operations ,ust like an other #irms! This means that the increase in #ee income #rom assurance services ma replace #ee income lost due to a dwindling audit re'uirement! &t ma also cause the e%isting #ees to #all due to less audit work being re'uired in the light o# assurance work alread undertaken! On s!ills2 The diversit o# the services to be provided entails that pro#essional accountants need to have a wider range o# skills and to be all round business pro#essionals$ e%perts in both #inance and other areas! On liability2 Assurance services other than audit are o#ten based in areas o# risk to the business! The potential liabilit o# accountants is likel to increase thus the need to ensure that pro#essional accountants limit their liabilit in respect o# users! The should also identi# ver clearl in contract to whom the e%tend liabilit ! On ublic erce tion2 Hue to the in#ormation availabilit and the e%tended range o# services that audit #irms provide$ there is potential #or increasing the e%pectations gap which e%ists between what the auditors are re'uired to do in respect o# the statutor audit and what the public thinks that the do! Assurance services ma also be misunderstood and seen as audit repackaged! As a result$ this could lead to assurance services su##ering the same distrust in terms o# value #or mone and necessit ! Conclusion &t could be envisaged #rom the discussion that with the availabilit o# a wider range o# in#ormation$ both reasonable and limited levels o# assurance need to be provided! This re'uires the independent veri#ication o# the in#ormation demanded and provided b the stakeholders! &t is in this sense that 'uali#ied$ independent people are re'uired to give this assurance! The various implications on assurance services pin points on some important issues that impact on the assurance given! $olution *2 L:T#

2B2

Tutorial2 this 'uestion addresses the 'uestion o# client con#identialit $ con#licts o# interest and the practice o# low balling to obtain other services! /hilst the knowledge o# the Rules is essential$ what this 'uestion is looking #or is our abilit to appl them in practical manner and reach a satis#actor solution! There ma be alternatives$ so consider all the options available be#ore reaching a conclusion! -a. 46rofessional inquiry5 Brofessional issues raised Carol has a pro#essional dut o# con#identialit to its clients$ Peterson! &# Carols lack o# response is due to Peterson not having given them permission to respond$ 5eta should not accept the appointment! However$ in this case$ Names Chali should have: 3 3 noti#ied Petersons management o# the communication received #rom 5eta= and written to 5eta to decline to give in#ormation and state is reasons!

Carol ma have suspicions o# some unlaw#ul act -e!g! de#rauding the ta%ation authorit .$ but no proo#$ which the do not wish to conve to 5eta in a written communication! However$ Carol has had the opportunit o# oral discussion with 5eta to conve a matter which ma provide grounds #or the nomination being declined b 5eta! Steps by Jeta :btain written representation #rom Petersons management$ that Carol M co has been given Petersons written permission to respond to 5etas communication! *end a #urther letter to Carol b a recorded deliver service -i!e! re'uiring a signature. which states that i# a repl is not received in the ne%t seven da s -sa . 5eta will assume that there are no matters o# which the should be aware and so proceed to accept the appointment! -Advise also that unless a response is received$ a written compliant will be made to the relevant pro#essional bod .! +ake a written compliant to the disciplinar committee o# the pro#essional bod o# which Names Chali is a member 1 so that his unpro#essional conduct can be investigated!

.b/

Ta!e ) over bid Brofessional issues raised 5eta has a pro#essional dut o# con#identialit to its e%isting audit client$ Flobal! 2B6

Flobal ma ask 5eta to give a corporate #inance advice on Tekas take3 over bid which would be incidental to the audit relationship! Providing 5eta can maintain and demonstrate integrit and ob,ectivit through out$ there would be no ob,ection to 5eta providing such an additional service$ to advance their e%isting clients base! &t is o#ten in the compan s best interests to have #inancial advice provided b their auditors$ and there is nothing ethicall improper in this! *o it seems unusual that Teka should have approached 5eta$ rather than their current auditors! ACCAs Rules o# Pro#essional Conduct and as adopted b C&CA consider that it would not be improper #or an audit #irm to audit two parties$ even i# the take3over is contested$ and that to cease to act could damage the clients interests! However$ the situation is di##erent here in that 5eta is not Tekas auditor! 5eta should take all reasonable steps to avoid con#licts o# interest arising #rom new engagements and the possession o# con#idential in#ormation! 5eta cannot there#ore resign #rom Flobal in order to undertake the advisor role #or Teka! -A relationship which has ended onl in the last two ears is still likel to constitute a con#lict.!

Steps by Jeta .c/ As it is clear that a material con#lict o# interest e%ists$ 5eta should decline to act as adviser to Teka! Advise Flobals management that Tekas approach has been declined!

&owballing Brofessional issues raised# 4&owballing is a practice in which auditors compete #or clients b reducing their #ees #or statutor audits! Gower audit #ees are compensated b the auditor carr ing out more lucrative non3audit work -e!g! consultanc and ta% advice. The #act that *wap has 'uoted a lower #ee than the other tendering #irms -i# that is the case. is not improper providing that the prospective client$ Tadori$ is not misled about: 3 3 the precise range o# services that the 'uoted #ee is intended to cover= and the likel level o# #ees #or an other work undertaken!

Although an admission to lowballing 7setting the earl price in an arrangement at a low amount to secure business with the intent later to raise the price ma sound improper$ it does not breach current ethical guidance providing Tadori understandings the situation! *o$ #or e%ample$ *wap could o##er Tadori a 7#ree

2B8

#irst 1 ear audit$ provided Tadori appreciates what the cost o# the #uture audits would be! The risk is that i# the non3audit work does not materiali9e$ *wap ma be under pressure to cut corners or resort to irregular practices -e!g! the #alsi#ication o# audit working papers. in order to 7keep within budget! &# a situation o# negligence -sa . were then to arise$ *wap could be #ound guilt o# incompetence! As the provision o# other services is under scrutin and becoming increasingl restricted this risk is likel to be high! (or e%ample$ non3audit services which are prohibited in the I* include bookkeeping$ #inancial in#ormation s stems design and implementation$ valuation services$ actuarial services$ internal audit -outsourced.$ human resource services #or e%ecutive positions$ investment and legal services! *wap ma not be ,ust lowballing on the #irst ear audit #ee$ but in the longer term! Perhaps indicating that #uture increases might onl be in line with in#lation! &n this case$ i# rather than compromise the 'ualit o# the audit$ *wap were to substantiall increase Tadoris audit #ees$ a#ee dispute could arise! &n this event Tadori could re#use to pa the higher #ee! &t might be di##icult then #or *wap to take the matter to arbitration i# Tadori was misled! $te s by Leta $olution -2 8#&#JI .a/ Current ethical and legal requirements to acce ting an audit :thical requirements2 &t is a re'uirement that auditors ensure that there are no ethical barriers pertaining the acceptance o# an appointment! Amongst the ethical re'uirements are the #ollowing$ which ma a##ect the independence o# the audit #irm:

There are no steps which 5eta can take to prevent Tadori #rom awarding the tender to whichever #irm it chooses! &# *wap is success#ul in being awarded the tender$ 5eta should consider its own polic on pricing in #uture competitive tendering situation!

The auditor should ensure that he is rofessionally qualified to act as one both legall and ethicall ! &n terms o# ethics$ the #ollowing issues are relevant! o Hoes an one in the audit #irm own shares in +alaki4

2B;

o &s the nature o# the relationship between the auditor and the client more personal than business4 o /ould the audit #ee constitute too high a percentage o# gross practice income4 o &s there a con#lict o# interest with e%isting clients4 Ensure the e@isting resources are adequate b looking at the availabilit o# time$ sta##$ technical e%pertise etc References should be obtained b making independent en'uiries i# the directors are not personall known to the audit #irm! To communicate with outgoing auditors en'uiring whether there are reasons or circumstances behind the change which the new auditors ought to know! &t is also a wa o# showing courtes to the outgoing auditors!

&egal requirements2 The auditor must also ensure that the outgoing auditors removal or resignation was conducted in the correct manner$ once the have accepted appointment!

.b/

+hether $ M J dealings with 8ala!i is ethical Arising #rom the scenario$ * M * has the #ollowing dealings with +alaki and its directors! Advice given during the management bu out Ta%ation advice -compan and directors. +anagement consultanc *pecial pro,ects$ comprising: o (raud investigation o E%pansion$ budgets and investigation The 'uestion tells us that this has resulted in signi#icant #ee income #or * M K! it mentions one statistic$ that in the ear o# the e%pansion investigation$ the #ee income was 0>O o# the #ull o##ice income! $ M J have now been asked to provide audit services to the compan in addition to other services the provide! The have agreed to take on the audit o# the compan ! The 'uestion does not speci# whether * M K discussed this with the previous auditors$ " M "! $tandard of conduct2 Ip until the point where * M K were asked to become auditors o# the #orm #or the second time$ there were no ethical issues arising!

2B?

Accountants are entitled to provide an number o# services to audit clients$ unless one o# the services is a specialist service to which the ACCAs rules on independence appl ! The services discussed above do not constitute an such specialist services! A #irm o# accountants ma take on the combined roles o# ta% advice$ management advice$ and specialist investigations$ with no ethical issues! Inde endence2 The most recent step in the relationship between * M K and +alaki is that the directors o# +alaki have asked the #irm to provide audit services to the compan ! However$ audit is one o# the specialist services which accountants provide which the pro#essional bodies issue specialist rules about! This is because the conduct o# audit is regulated b the pro#essional bodies$ this responsibilit being devolved to them b the law! ACCAs Rules o# Pro#essional conduct re'uires that an auditor is$ and is seen to be$ independent! The auditor must be ob,ective in his dealing with audit clients! The speciali9ed guidance states that provision o# additional services to audit clients ma result in ob,ectivit being impaired! ACCAs rules also state that #ee income derived #rom private compan audit clients should not constitute more than 18O o# their income! This is to protect the independence o# the audit #irm$ who might otherwise become #inanciall depended on the client$ to the point where the are no longer ob,ective! # lication to $ M J and 8ala!i2

The #act that * M K alread undertake so much work #or +alaki represents a signi#icant barrier to them being able to maintain ob,ectivit on the audit! /hen asked to take on the audit$ the partners should have considered whether it was appropriate to take on the audit in addition to the other audit work! The 'uestion does not establish whether this as been done or not! However$ the #irm has clearl taken some steps to preserve some independence #or the audit service! The #irm has appointed a di##erent partner to be audit engagement partner in addition to the partner who has dealt with the client previousl ! This indicates that the have considered the issue and decided that there is no barrier to independence! Another ke #actor to consider is the level o# #ees that the auditor gain #rom the client are high$ and that in one ear$ when a special assignment was taken on$ the represented 0>O o# the #ee income! This does not necessaril mean that the #ee income including the audit #ee will be in e%cess o# the 18O barrier$ but it certainl suggests that it is possible! As a minimum$ it suggests that it ma no longer be appropriate to undertake the special assignments!

2BB

Conclusion2 &t is impossible to conclude precisel whether * M K were acting unethicall in accepting the audit work! However$ the indication is strong that the #irm is not independent in relation to the audit due to high level o# other services and the #ees that the bring in! this is despite e##orts which has been made to preserve independence$ notabl appointing a di##erent audit engagement partner! .c/ Im lications for a ublic interest com any A public interest compan is one which #or some reason -si9e or nature. is in the public e e! &# the above situation was #ound in a public interest compan $ the conclusion would be made more strongl that the situation was an ethical problem! However$ no services are supplied to +alaki which per se are not allowed in a public compan situation! * M K should take note that the compan is considering #loatation! This will mean that it becomes a public interest compan ! .d/ >uality control rocedures and olicies The audit engagement partner is a ke #eature in 'ualit control processes in relation to individual audits! &t is important #or the audit engagement partner who has been appointed to both consider and document his considerations o# the ethical issues raised in the answer to part -b.$ above! He must be assured that he is independent with regard to the audit! *peci#icall with regard to the assignment$ he must ensure that the audit is directed$ supervised and reviewed in an appropriate manner! He ma delegate much o# these tasks to an audit manager$ who will be responsible #or undertaking planning meetings with the audit team and liaising with them on site$ perhaps undertaking an on site review o# their work! However$ the audit engagement partner cannot delegate the responsibilit #or drawing the audit conclusion$ and must ensure that he has reviewed the audit #ile to ensure that he draws the correct conclusion$ and that su##icient work has been undertaken to support that conclusion! The engagement partner must consider the engagement risk attached to the assignment$ and consider the need #or a hot review prior to the issues o# the audit opinion! &# +alaki does become publicl listed$ such a hot review would be essential! The audit engagement partner is responsible in the #irst instance #or ensuring that an disputes in the audit team arising over issues relating to the +alaki audit are

2BD

resolved appropriatel ! The #irm should have clear guidelines as to how such dispute should be resolved! Gastl $ the #irm should have a practice o# monitoring audits undertaken #or 'ualit ! &t is likel that the audit o# +alaki should be monitored b the #irm team this ear #or several reasons: i"e" it is the first year of a new audit and it is a substantial client" &t is a client which had signi#icant ethical issues to consider in relation to accepting the audit$ and there#ore the audit -engagement. risk is higher on this audit than others!

$olution 02
6rofessional res onsibilities and liability2 .a/ :@ternal audit o inion res onsibilities2 &t is primaril the responsibilit o# management #or the proper preparation and presentation o# #inancial statements! The #act is clearl stated in the auditors report! The auditors statutor dut is to report$ e%pressl $ an opinion on a <true and fair view5 .or resents fairly in all material res ects/" There is also an e%pressl statement as to whether or not all in#ormation and e%planations necessar #or the audit purposes have been received! The auditors report is addressed to the shareholders and it has long been established that the auditor is liable to shareholders in cases o# negligence! There are a number o# cases that could be sited here and include: Gondon and Feneral "ank Gtd -1BD8.= Re Kingston Cotton +ill -1BD;.= Re Thomas Ferrard M *on Gtd -1D;?.! Cases on liabilit to third parties have #ocused on the 'uestion o# whether a dut o# care is owed and the issue o# #orseeabilit -e!g! Donoghue ; $tevenson -1D20.= Candler v Crane Chrismas -1D81.= Fedley %yrne v Feller M 6artner -1D;2.= K:% 9astener v 8ar!s %loom -1DB1.= Twoma@ &td v Dic!son$ 8c9arlane M Robinson -1DB2.= #& $andi %anque v Clar!e 6i@ley -1DBD..! However$ the case o# Caparo &ndustries plc v Hickman and others -1DD>. narrowed the scope o# liabilit b introducing a condition o# 7pro%imit o# relationshipA into dut o# care! Recent develo ments &n the I*$ the *arbanes3:%le Act$ introduced in the wake o# the Enron and /orldcom scandal$ re'uires the principal e%ecutive and #inance o##icers -CE:s and C(:s. to certi# that accounts o# *EC3 registered companies:

2D>

Ho not contain an untrue statements or omit an thing that would be necessar #or the report not to be misleading= and (airl present the compan s #inancial position and results!

*uch a demonstration o# managements responsibilit ma assist auditors in claiming that the are not liable in cases where management is #raudulent! As a deterrent$ will#ul breach o# this provision can result in I*V 8 million -K0>$ >>>$>>>$>>>. #ine or 0> ears imprisonment -or both.! &n the "annerman case$ a *cottish court held that auditor could be held to have a dut o# care to a third part -in this case a lending bank. i# the knew$ or ought to know that the bank would rel on audited accounts and the did not disclaim liabilit ! The 7new or ought to have known principle is the same as in pre3Caparo cases above! /hat is di##erent about the "annerman case is that the auditors #ailure to disclaim liabilit was what supported the e%istence o# the dut o# care!

Im act on rofessional liability The auditors responsibilit to conduct an audit in accordance with auditing standards in unchanged! However$ liabilit to third parties is clearl increased i# the auditor does not disclaim such liabilit ! This is not to be con#used with=

A disclaimer o# liabilit to shareholders= or The disclaimer o# an audit opinion in accordance with &*A ?>> the Auditors Report on #inancial *tatements!

Auditors wishing to manage the risk o# liabilit to third parties are advised to include a separate disclaimer o# such responsibilit $ at the same time stating that the auditors report is to the shareholders and that audit work is undertaken solel #or that purpose! .b/ Internal financial controls Res onsibilities Risk management is a primar responsibilit o# management whose #iduciar duties include the sa#eguard o# assets and ensuring the completeness and accurac o# #inancial records! &nternal audit provides ob,ective assurance and advice to boards$ especiall the non3e%ecutive directors$ on the e##ectiveness o# the risk management processes and the wa s in which risks are managed and controlled!

2D1

&n accordance with e%isting auditing standards$ the e%ternal auditor is re'uired to make a preliminar assessment o# internal controls and to test them i# seeking to place reliance on them as audit evidence! Develo ments There has been much debate concerning reporting$ in the public interest$ statements b directors o# listed companies! IK Gisted Rules -#or e%ample. re'uire that auditor review the e##ectiveness o# managements s stems o# internal control! However$ auditors are not re'uired to provide assurance on internal control -as suggested b 7The Combined Code.! The spectacular collapses o# "arings "ank)Enron)Agri#lora clearl demonstrates the need #or management to have risk management practices and e##ective internal #inancial controls! &t is unlikel that auditors can report on such matters in 7short #orm! The ,udgements involved and the lack o# generall accepted suitable criteria will re'uire a length narrative report to avoid misunderstandings in communicating conclusions! Post Enron legislation in the I*$ the *arbanes 1:%le Act$ now re'uires that CE:s and C(:s certi# that:

The are responsible #or internal controls and have reported on their e##ectiveness= and All signi#icant control weaknesses and management #rauds have been reported to the auditors and the audit committee!

Auditors are re'uired to report on managements report on internal control e##ectiveness! Im act on rofessional liability Reporting on the 7e##ectiveness o# #inancial internal controls is perceived to increase auditors liabilit i# the auditor #ails to identi# signi#icant risks or potential weaknesses in the design and operation o# a s stem o# internal #inancial controls! &n particular$ allegations o# negligence ma be directed to the auditors because o# a lack o# understanding that absolute assurance is not possible due to inherent limitations o# internal control -e!g! human error$ collusion$ and management override.! .c/ 8anagement re resentation letters Res onsibilities +anagement representation letters provide written evidence that management acknowledges its collective responsibilit #or the preparation o# the #inancial

2D0

statements and that the have approved them! Auditors have a pro#essional responsibilit to gather su##icient evidence to support their audit opinion$ including obtaining written representations when appropriate! &*A 8B> +anagement Representations re'uires that:

/ritten representation be obtained when su##icient appropriate evidence cannot reasonabl be e%pected to e%ist= The reliabilit o# representations be reconsidered i# contracted= &# management re#uses to provide representation the implications #or the auditors report can be considered!

Also auditors are re'uired to consider whether the individual making the representation can be e%pected to be well in#ormed on the particular matters! Recent develo ments The High Court decision in the "arrings case raised some ke issues in relation to the protection which management representations a##ord to auditors! A director having little knowledge or understanding o# <ick Geesons activities -although he was nominall his boss.$ made representations that there had been no irregularities and that the #inancial statements were #ree o# material errors and omissions! The ,udge said that the e%ternal auditors -H M T. de#ence against the claim #or damages which the #aced$ that the director was recklessl #raudulent$ would have succeeded i# #raudulent misrepresentation could have been established! &n some ,urisdictions it is a criminal o##ence #or an o##icer o# a compan to knowingl or recklessl make misleading or #alse statements to the compan s auditors! &t is alread clear in &*A 8B> that management representation cannot be a substitute #or evidence that auditors e%pect to be available and that uncorroborated representations do not normall constitute su##icient audit evidence! The "arrings ,udgement does not contradict the basic principles and essential procedures contained in &*A 8B>! However$ it has highlighted the need #or emphasis o# the guidance in this area! To add substance to auditors considering whether individuals are well3in#ormed on the matters about which the are making representations$ it is recommended that management include a speci#ic representation that the can properl make their representations! Im act on rofessional liability &# more cases o# criminal charges are brought against o##icers$ as a deterrent to making deceptive statements$ the reliabilit o# management representations as

2D2

audit evidence should be increased! Pro#essional liabilit is thereb reduced i# there are #ewer cases brought or proved against the auditor!

$olution 12
Tutorial2 <ote that this 'uestion re'uires ou to give a practical application o# best practice! &n so doing$ ou should highlight the e##ective use o# technolog and its impact on practice management! The 'uestion also re'uires ou to make appropriate recommendations and su##icient e%planation with supporting e%amples! Tr b all means to relate our answer to CHAT* situation! 5ou should be able to articulate the 'ualit control re'uirements and as it relate to &*A 00> and &*EC 1 and state the 'ualit control procedures that ou think could assist CHAT* to per#orm well! (inall $ discuss the issues pertaining to working paper and the compliance e%pected in line with &*A 02> 1 Hocumentation! .a/ %enefits of technology2 Technolog brings about a number o# signi#icant bene#its and the automation o# CHAT* audit services will entail: &t will increase pro#essionalism o# CHAT* and enhance the image o# CHAT* audit services both internall and e%ternall with clients! &t will demonstrate the use o# best practice techni'ues and compliance with appropriate standards #or auditing! &t will improve e##icienc and should result in cost savings$ in particular through standard documentation$ rapid sharing o# in#ormation and automatic generation o# plans$ programmes$ schedules and working papers! &t will enable more e##ective$ risk #ocused audit work b targeting scare resources and b allowing auditors to #ocus on thinking about risks$ controls and accounts!

Recommended uses of technology by CF#T$ Computeri9ed audit working papers using either a word processing package to generate and store working papers and reports$ through audit programmes generators or through a standard audit package that automaticall generates a consistent standard #or working papers and reporting! *preadsheet packages #or generating working papers and #or calculations$ testing and anal tical review! <ormall a PC will include a standard work processing and spreadsheet package! This should be consistent with CHAT* standard to enable read trans#er between departments! These would results in the #ollowing=

2D6

3 increased e##icienc $ e##ectiveness$ risk #ocus and pro#essionalism 3 /ill lead to more consistent and complete working papers! Risk anal sis so#tware used to identi# $ calculate and evaluate risks within a compan or department to result in= 3 &ncreased risk #ocused targeted audits$ pro#essionalism and improved public relations! Communication including electronic email between clients via the internet and e%cellent internal communication where auditors are working across site or even in di##erent countries! 3 &ncrease e##icienc and use o# time$ speedier response times! Knowledge management and sharing o# in#ormation! Access to the internet will strengthen planning and background research$ with the availabilit o# regulations and rules governing auditing and accounting$ increasingl holding audit reports and other relevant material! 3 +ore e##ective auditing$ pro#essionalism Planning and resource management so#tware$ including time recording s stems$ scheduling and skills records! 3 /ill allow more targeted planning$ with appropriate skills allocated and at the right time (lowcharting and diagrammatic so#tware #or generating documentation o# s stems! 3 There are a number o# relativel low cost #lowcharting so#tware that can be purchased and used b CHAT*$ that will provide more consistent and e##ective documentation$ that can be readil edited and updated! Again a CHAT* standard would be sensible! Computer assisted audit techni'ues will also allow CHAT* to leverage &T to better a##ect with more e##ective sampling and testing! &n particular trial balance processors and interrogation so#tware that: strati#ies and anal ses #iles$ produces e%ceptional reports$ compares in#ormation across computer #iles$ detects gaps or duplicate entries$ re3per#orms calculations!

.b/

>uality control2 Eualit control is not ,ust a bene#it to CHAT* but is an essential re'uirement! &*A 00> and &*EC 1 re'uire that all #irms implement 'ualit control policies and procedures both at a #irm and individual level! The should be communicated to all sta## and monitored to ensure the are compiled with! The 'ualit control procedures should provide the #ollowing additional bene#its: Ensure the pro#essional re'uirements are met &denti# an improvements including training and development o# sta## *upporting$ accepting and supporting clients :verall however the bene#its are more that the provide protection against the risk o# loss o# client$ #inancial loss and compensation and reputation damage!

2D8

The 'ualit control procedures #or CHAT* should: Ensure compliance with ethical guidance and &*As "e documented in the audit manual$ along with the documentation o# their methodolog and ongoing mechanisms #or review and compliance should be put in place! -i. Eualit control procedures #or CHAT* audit services Pro#essional re'uirements All sta## should compl with relevant pro#essional codes o# conduct and the CHAT* code o# conduct$ ensuring honest $ ob,ectivit $ con#identialit and integrit ! This should be identi#ied as important to CHAT* at the recruitment stage and rea##irmed through guidance on #or e%ample accepting gi#ts$ dealing with clients! *kills and competence Ensuring the appropriate skills and competence o# sta## is important! All sta## should be pro#essionall 'uali#ied or be stud ing #or an appropriate 'uali#ication! *kills will be assessed through the recruitment process and be monitored as part o# the per#ormance appraisal processes! Training and development o# sta## will be carried out to ensure that appropriate skills and development o# sta## will be carried out to ensure that appropriate skills and competence levels are achieved and that sta## keep up3to3date with best practice Acceptance and retention o# clients *tandards acceptance procedures are in place and an problems that ma impact retention o# clients should be identi#ied$ documented and evaluated! Assignment Assignments should be per#ormed in accordance with standardi9ed documentation! Assignment review and control procedures will ensure that individual audits are completed to a high standard$ using the right skills and resulting in a report that re#lects the underl ing #acts! Helegation There should be su##icient direction$ supervision and review o# work at all levels so that work per#ormed meets appropriate standards o# 'ualit ! *upervisors will receive appropriate training in the conduct o#

2D;

this supervision and be appraised against the relevant management competencies! Consultation &nternal and e%ternal consultation will be carried out to ensure that CHAT* achieve and maintain leading edge deliver ! +onitoring :nce these procedures are implemented$ an annual review o# their ade'uac and e##ectiveness should be undertaken$ with updates to the procedures as re'uired! :ther methods o# monitoring will include peer reviews o# work carried out! -ii. Eualit control procedures #or individual audits Hirection and supervision o# sta## An organi9ation chart with ,ob descriptions set out the structure$ organi9ation and responsibilities o# sta##! These will be maintained and updated as appropriate! The audit plan and resource)time allocation schedule will be used e##ectivel to ensure that all team members are clear o# the assignments to be undertaken and when! Time will be built in #or supervision o# the work and all sta## should #eel the cn consult supervisors i# the encounter di##icult situations on which the need advice! Records o# assignments per#ormed and skills gained will be kept to ensure that an accurate skills database can be held and that assignment evaluations can be carried out! Review o# work per#ormed All audit work should be documented in a timel and consistent wa $ in accordance with CHAT* audit standards! Proper review procedures should be in place! All working papers must be independentl reviewed to ensure that work has been per#ormed in accordance with the audit plan$ that the appropriate risks have been identi#ied and that the evidence supports the conclusions! "e#ore the audit report is #inali9ed$ the manager or partner should review the audit #ile and #inal accounts! -c/ Ris!s of inadequate wor!ing a ers 2D?

&# working papers are inade'uate: An inappropriate audit report ma be given Potential problems or risks #or investigation ma not be documented! Audits ma not be targeted e##ectivel or carried out in accordance with plans! CHAT* ma not be able to support conclusions made and could be sub,ect to action through legal action$ loss o# client$ damage to reputation and adverse publicit ! Audit work need to be re3per#ormed i# not documented ade'uatel and #or subse'uent ear reviews important background in#ormation ma not be available$ resulting in ine##iciencies$ additional cost and damage to client 1 CHAT* relationship! These risks could be minimi9ed b compl ing with &*A 02> Hocumentation! CHAT* working papers should be maintained in accordance with audit standards and meet the #ollowing criteria! Hocument matter important to support the report and record reasoning to support ,udgement and conclusions made *u##icientl complete and detailed to provide an overall understanding o# the audit! Kept up to date during an audit *u##icientl detained and complete to enable an auditor to pick up the work and understand the work carried out and conclusions reached! +aintained in a con#idential manner Reviewed in accordance with 'ualit control procedures!

$olution D2
Introduction The :ECH -:rgani9ation #or Economic Cooperation and Hevelopment. and /orld "ank are activel involved in initiatives to promote corporate governance -e!g! holding an annual #orum on the sub,ect.! &n 1DDD$ the :ECH issued a set o# corporate governance principles which although non binding$ re#lect the concept o#:

The risk o# shareholders The e'uitable treatment o# stakeholders The role o# stakeholders Hisclosure and transparenc and "oard responsibilities!

2DB

These principles are now being promoted as a #ramework #or dialogue and consultation with emerging and transition economies with the aim o# improving corporate governance practices! (urther in Nune 0>>>$ :ECH issued governance guidelines #or multinationals that provide 7voluntar principles and standards #or responsible business consistent with applicable laws! The &nternational (orum on Accountanc Hevelopment -&(AH. is an initiative o# &(AC and the /orld "ank! &ts vision is to achieve a rational #ramework o# reporting on the per#ormance o# economic entities$ which serves the ob,ectives o# issuers and users across the world! This vision calls #or$ inter alia$ improving corporate governance practices using the :ECH Principles o# Corporate Fovernance as a point o# re#erence! Need for I#$s The need #or a uni#orm set o# international accounting standards to provide #or the transparenc and consistenc o# #inancial reporting is evident in that &:*C: -the international :rgani9ation o# *ecurities Commissions. endorsed 2> &nternational Accounting *tandards #or cross3border listings! Although these are not et global standards$ it is envisaged that &A*s will become the international standards and will not re'uire reconciliation to I* FAAP! Need for I$#s The auditing pro#ession pla s a ke role in both national and international regulation and the development o# transparent international standards on auditing -&*As. provides a high level o# assurance on the reliabilit o# #inancial reporting! &*As and &nternational Audit Practice *tatements &AP*s. have been #ormulated b &(AC through its international Auditing Practice Committee -&APC.! A signi#icant number o# &(AC members use the &*A as a basis #or developing their own national standards! &APC is now working with &:*C: #or endorsement o# &*As! Need for cor orate governance standards Corporate governance ma be de#ined as 7the ethical corporate behaviour b directors or others charged with governance in the creation o# wealth #or all stakeholders! &t is how these persons:

Provides stewardship over the business o# an entit to achieve corporate ob,ectives= "alance the corporate ob,ectives with the e%pectations o# societ = and Provide accountabilit to stakeholders!

The need #or governance has increased as primar stakeholders have become more removed #rom management and the control o# the entities the own! The use o# outside directors in governance roles has been shown to provide protection to entit stakeholders!

2DD

The growth o# global capital markets and the signi#icant #raud which are being perpetrated in these markets has put this need on a global scale! Corporate governance can counter #inancial statements #raud$ corruption and mone laundering! &# investors are to invest$ stamping out corruption -#or e%ample. is important! An in#rastructure is there#ore needed #or regulation$ corporate governance disclosure and transparenc ! The importance o# the role o# corporate governance is re#lected in the &APCs &*A 0;>! Auditors are re'uired to communicate audit matters o# governance interest to those charged with corporate governance on a timel basis! That the &*A re'uires the auditor to identi# those responsible #or governance$ when the entit has not$ emphasi9es the need #or governance s stems to be established! &t has widel been reported that had corporate governance and public governance e%isted in *outheast Asia$ then the economic crisis that occurred in 1DD? ma have been avoided!

#rguments for global cor orate governance standards Corporate governance on a national basis is appropriate when investing and #inancing companies is on a national basis! However$ a set o# global rules should be applicable$ as a minimum to entities listing shares or obtaining #inancing in the public capital markets outside o# their national boundaries! Re'uiring companies who participate in global capital markets to #ollow global rules will provide greater protection to global investors! Corporate governance will still be re'uired at a national level! The use o# global shares b global business enterprises increases the need #or corporate governance rules to be global! Flobal shares -i!e! the same #orm o# shares #or listing in a home countr and a non3home countr . enable virtuall seamless cross3border trading! As their use become more widespread$ global stakeholder will need higher 'ualit global accounting$ auditing and corporate governance standards! Regulators are national and not international$ so international consistenc is needed to avoid regulation arbitrage! Flobal standards are necessar because national and international standards will not converge o# their own volition! Gocal subsidiaries o# international groups tend to be content to compl with lower local standards and not adopt the higher standards o# their parents location! Companies in some countries such as &ndia$ have been advised not to globali9e until there is a good #ramework #or corporate governance! &t is there#ore asserted that global

6>>

standards are ke to developing countries prospects #or sustainabl mobili9e capital #or economic growth! Heveloping countries can #urther bene#it b initiating the models and s stems o# another$ rather than incurring the costs o# developing their own models! There does not have to be a 7one si9e #its all approach to global standards because there are universall recogni9ed standards that can provide benchmarks -e!g! responsibilit $ accountabilit $ #airness and transparenc .! &# universal principles o# transparenc and ob,ectivit can support international accounting and auditing #rameworks$ then a global corporate governance model can cater #or di##erent legal structures and cultural identities! :ECHs voluntar code provides a point o# re#erence #or multinational which are encouraged to:

Contribute to economic$ social and environmental progress Respect the human rights o# those a##ected b their activities Encourage local capacit building encourage human capital #ormation -e!g! b creating emplo ment opportunities and through training programs. Re#rain #rom seeking)accepting e%emption #rom environmental$ health and sa#et $ e'ual opportunities and labour legislation$ etc *upport and uphold good corporate governance -principles and practices. Abstain #rom improper involvement in local political activities!

#rguments against global cor orate governance standards" Hevelopment o# corporate governance and its implementation needs to be at a national level because regulators are national and it is not appropriate$ given the need to respect diverse cultures and legal structures$ to prescribe a global standard! (or e%ample:

Concern in the I* is #or increasing shareholders value Continental Europes economic philosoph is creating emplo ment &n Napan companies work with the government towards the national strateg

+an people #ear that global corporate governance standards ma attempt to impose an Anglo3American business model on developing countries! Corporate governance and the composition o# boards should suit the local business environment to encourage economic success! &APC has established as a principle that auditors determine the relevant persons who are charged with governance responsibilities! However$ that there ma be no such persons suggested that the need #or governance is not et proven at a national level! Flobal standards are necessar because the emerge eventuall b a natural process o# convergence! (or e%ample$ &nternational (inancial Reporting *tandards -&(R*. have been issued b the &nternational Accounting *tandards "oard in place o# separate &nternational Accounting *tandards -&A*s. and IK (inancial Reporting *tandards -(R*s. since the end o# 0>>1!

6>1

&nternational standards are not global standards! &# accounting and auditing standards have onl reached an international level$ then the need #or corporate governance standards at the present time is onl international 1not global! Conclusion A global corporate governance #ramework is essential #or high 'ualit reporting and auditing standards to be interpreted$ used and en#orced consistentl throughout the world! Alternativel $ accounting standards have been implemented on a nation b nation basis be#ore the international acceptance b &:*C: o# international Accounting *tandards! Auditing standards are #ollowing suit! The :ECH principles are ver general and$ as the need #or global corporate governance standards is apparent$ the initiatives to create them will continue to emerge!

$olution G2
Tutorial2 this 'uestion is about business risk! This ma make the compan to overstate the assets and understate the liabilities! The knowledge o# &A* 1; and 02 is cardinal in answering part -b. o# the 'uestion! This will clearl allow ou to de#ine what an asset is$ their recognition and measurement criteria! Part -c. re'uires ou to emplo techni'ues pertaining to environmental issues and the impact on societ ! Part a -i. and a -ii. can be tackled simultaneousl ! -a. .i/ %usiness ris!s The standard design o# #acilities increases operational risk as an di##iculties encountered in one #acilit will be compounded b the number o# other #acilities -potentiall all. that are similarl a##ected! This is illustrated b the closure o# the sauna Note: standard design ma also reduce risk as it results in a higher 'ualit product! Centrali9ed control through compan polic is resulting in ine##icient and ine##ective operations as managers cannot respond on a timel basis to local needs .ii/ 9inancial $tatements ris! The carr ing amount o# the associated non3current assets -i!e! e'uipment$ #i%tures and #ittings. is likel to be overstated as the are likel to be impaired i# the are not in use!

+anagement circumvention or override o# control procedures laid down b head o##ice ma result in s stem weaknesses! &# errors arising are not detected and corrected the risk o# misstatement

6>0

"usiness reporting risk is likel to be increased b centre managers preparing monthl accounting returns! :perational risk ma be increased i# centre managers cannot #ul#ill their da 1to3da responsibilities -e!g! relating to customer satis#action$ human resources$ health and sa#et .! Advanced pa ments contribute to business reporting and #inancial -cash #low. risk! Cash received must be available to meet the costs o# providing #uture services!

H drasports cannot operate a centre i# a licence is suspended$ withdrawn or not renewed -e!g! through #ailing a local authorit inspection or #ailing to appl #or renewal.

Closure ma result in customers #inding alternative #acilities with permanent loss o# #ee revenue Earl bird customer dissatis#action similarl increases operational risk!

*erious accidents ma prompt investigation b local authorit 1 resulting in penalties$ #ines and )or withdrawal o# licence to operate!

Although #ees are non3 re#undable$ suspension 6>2

in the #inancial statements in increased! &n#ormation processing risk is increased as accounting in#ormation #lowing into the #inancial statements ma not be properl captured$ input$ processed or output b the centre manager &nherent risk$ o# errors arising in monthl branch returns is high! Revenue ma be overstated i# an accurate cuto## is not achieved! &n particular$ there is an estimate risk in determining the amount o# de#erred income at the balance sheet date! An error o# principle ma also arise i# H drasports revenue recognition polic does not compl with &A* 1B Revenue! An error o# principle arises i# licences are not capitali9ed as intangible assets -but instead written o## as e%penses when incurred.! &ntangible assets should be reviewed #or impairment at each balance sheet date -e!g! #or centre which are closed.! (ailure risk -i!e! that H drasports will not continue to operate as a going concern. is increased! This creates disclosure risk i# the disclosures relating to going concern as the basis o# accounting do not meet the re'uirements o# &A* 1 1 Presentation o# #inancial statements! &# licences are withdrawn$ the intangible asset -amount prepaid. should be written o## to the e%tent that monies are not re#undable! The likelihood o# contingent -i# not actual. liabilities increases disclosure risk! Provisions ma be understated at

o# a #acilit -e!g! sauna. ma result in customers asking #or partial re#und! &n particular H drasports ma have an obligation to re#und #ees paid in advance when centres are closed -e!g! the Perne centre #rom Nul 1 *eptember 0>>2.! Permanent loss o# customers re'uiring childcare #acilities increases operating risk! Compliance risk is increased i# the new guidelines are not met! *imilarl $ inabilit to retain li#eguards increases operational risk that pools cannot open -due to health and sa#et regulations.! Compliance risk is increased b the possibilit that pools ma operate without a li#e guard being on dut ! High sta## turnover indicates increased operational risk -poor human resources management$ ine##icienc in working practices$ reduced capacit etc.! Gimitations on centre managers levels o# authorit ma not be commensurate with their responsibilities! Empowerment risk arises i# managers are not properl led -and i# the $ in turn$ do not properl lead their centre sta##.! +ore centres ma become loss making i# the reasons #or #ailing membership are not addressed! The H drotherap pool cannot operate until construction is completed and completion ma be threatened b cash #low di##iculties! Cash #low di##iculties increase li'uidit )#inancial risk :bsolete g m e'uipment increases operational risk as customer satis#action decreases and health and sa#et risks are increased!

21 Hecember 0>>2 i# H drasports has a legal obligation to re#und #ees where it has #ailed to provide services! Hisclosure risk is increased i# #ines)penalties arising are material and not disclosed!

*ta## costs ma be overstated as the risk that pa ments ma be made to leavers is increased! An lack o# integrit ma increase the risk o# management and)or emplo ee #raud$ illegal acts and unauthori9ed use o# compan assets! &n particular the assertion o# e%istence o# assets ma be at risk -resulting in overstatement. Goss making centres should be tested #or impairment as cash generated units! The value o# the asset in construction should be written down i# it is impaired -even though it has not et been brought into use. *ee above re#erence #or going concern and disclosure risk! Hepreciation ma be overstated i# H drasports continues to calculate depreciation on #ull depreciated assets! Hisclosure #or capital commitments -e!g! to replace e'uipment. in the #inancial statements ma be inappropriate i# H drasports does not have #unds to #inance such commitments!

6>6

The reduction in insurance cover reduces the recoverable amount o# assets in the event o# loss through #ire -#or e%ample. inabilit to replace lost)damaged assets increases operational risk! :perational risk is increased i# the substantial increase in liabilit insurance premiums is a re#lection o# an increase in the level o# claims being made!

*ee above re#erence to going concern and disclosure risk!

Hisclosure risk is increased in relation to contigent assets -#or reimbursement under insurance policies.

-b.

Principal audit work -i.

He#erred income Agreeing H drasports anal sis o# ,oining #ee and peak)o##3peak membership #ees on a sample basis! &nitial ,oining #ees should not be de#erred but recogni9ed when received! Reconciling membership income to #ees paid! &# customers can renew their membership without pa ment there should be no de#erral o# income -unless the debt #or unpaid #ees is also recogni9ed.! Assessing the collectibilit o# unpaid #ees -i# an . b reviewing a#ter date receipts and correspondence with members! Recomputing the de#erred income element o# #ees received in the three months be#ore the balance sheet date! Comparison o# ear end balance with prior ear and investigation o# variance! H drotherap pool Peri# the initial cost o# this constructed asset will include an e%amination o#: o The contract with the builder o Contractors billings= and o *tage pa ment H drasports is likel to be advised b its own e%pert -a 'uantit surve or. on how the contract is progressing! Audit work will include a review o# the e%perts assessment o# stage o# completion as at the balance sheet date$ estimated costs to completion$ etc! Ph sical inspection o# the construction at the ear end to con#irm work to date and assess the reasonableness o# stage o# completion! "orrowing costs associated with this substantial -heav . investment should be agreed to #inance terms and pa ments! The calculation o# an amount capitali9ed should be recomputed to con#irm accurac ! The basis o# capitali9ation$ i# an should be agreed to compl with &A* 02 "orrowing costs -e!g! interest accruing during an suspension o# building work should be capitali9ed.!

-ii.

6>8

As the construction as alread cost twice as much as budgeted$ its value in use -when brought into use. ma be less than cost! +anagements assessment o# possible impairment -o# the H drotherap pool and the centre. should be criticall appraised! 6erformance indicators ) socialAenvironmental res onsibility

-c.

8ember satisfaction <umber o# people on membership waiting list -i# an . <umber o# re#erral)recommendations to club members b e%isting members Proportion o# renewed memberships Actual members: 1>> O capacit membership -sub3anal sed between 7peak and 7o##3peak! 8embershi dissatisfaction Proportion o# members re'uesting re#unds per month)'uarter! Proportion o# membership 7lapsing $taff Average number o# sta## emplo ed per month <umber o# starters)leavers per month *ta## turnover)average duration o# emplo ment <umber o# training courses #or li#eguard per annum! 6redictability <umber o# late openings -sa more than 8$ 18 and 2> minutes a#ter advertised opening times. <umber o# da s closure per month) ear o# each #acilit -i!e! pool$ crYche$ sauna$ g m and centre. $afety &ncidents reports documenting the date$ time and nature o# each incident$ the e%tent o# damage and )or personal in,ur $ and action taken! <umber o# accident #ree da s! :ther societ Gocal communit involvement -e!g! #acilities o##ered to schools and clubs at discount rates during 7o## peak time.! Range o# #acilities o##ered speci#icall to pensioners$ mothers and babies$ disabled patrons$ etc! Participation in the wider communit -e!g! providing #acilities to support sponsored charit events.! :nvironment

6>;

<umber o# instances o# non3compliance with legislation)regulations -e!g! on chemical spills. Energ e##icienc -e!g! in maintaining pool at a given temperature throughout the ear. &ncentives #or environment #riendliness such as discouraging use o# cars)promoting use o# bic cles -e!g! b providing secure lock ups #or c cles and restricted car parking #acilities.!

:vidence Tutorial note: As there is a wide range o# measures o# operational per#ormance which candidates could suggest$ there is alwa s a wider range o# possible sources o# audit evidence! As the same evidence ma contribute to providing assurance on more than one measure the are not tabulated here$ to avoid duplication! However$ candidates ma ,usti#iabl adopt a tabular la out!

+embership registers clearl distinguishing between new and renewed members$ also showing lapsed memberships! Pool)g m timetables 1 showing sessions set aside #or 7over ;>s$ 7ladies onl $ schools$ clubs$ special events$ etc! *ta## training courses and costs *ta## timesheets 1 showing arrival)departure times and adherence to sta## rotas! Hocuments supporting additions to)deletions #rom pa roll standing data -e!g! new ,oiner)leaver noti#ications.! Engineers inspection reports 1 con#irming g m e'uipment$ etc is in satis#actor working order! Also engineer and sa#et check manuals and the maintenance program! Gevels o# e%penditure on repairs and maintenance! Energ saving e'uipment)measures -e!g! insulated pool covering.! *a#et drill reports -e!g! alarm tests$ pool evacuations.! Accident report register 1 showing date$ nature o# incident$ personal in,ur sustained -i# an .$ action taken -e!g! emergenc services called in. An penalties)#ines imposed b the local authorities and the reasons #or them! Copies o# reports o# local authorit investigations! The #re'uenc and nature o# insurance claims -e!g! to settle claims o# in,ur to members and)or sta##!

$olution H2
6&#$CO CO &TD Tutorial note2 Kone of t"e issues "ave any bearing on turnover# '"erefore any materiality calculations assessed on turnover are inappropriate and !ill not be a!arded marks#

6>?

.a/ &andfill site .i/ +atters K1X1m cost o# the right represents 2X2O o# total assets and is there#ore material! The right should be amorti9ed over its use#ul li#e that is ,ust 1> ears$ rather than the 183 ear period #or which the right has been granted! This is in accordance with &A* 2B which states that use#ul right o# an intangible asset that arises #rom contractual or other legal rights should not e%ceed the period o# the rights$ but ma be shorter depending on the period over which the entit e%pects to use the asset$ which in this case is 1> ears! Tutorial note2 9ecalculation on t"e stated basis (see audit evidence) s"o!s t"at a 70Gyear amortisation "as been correctly used#

The amortisation charge represents 1O o# pro#it be#ore ta% -P"T. and is not material! The amortisation method used should re#lect the pattern in which the #uture economic bene#its o# the right are e%pected to be consumed b Plasco! The amorti9ation charge method used should re#lect the pattern in which the assets #uture economic bene#its are consumed! Inless such a pattern cannot be predicted reliabl $ then a straight3line method should be used! -&A* 2B 7intangible assets.! Ising an increasing sum3o#3digits will 7end3load the amortisation charge -i!e! least charge in the #irst ear$ highest charge in the last ear.! However$ &A* 2B simpl states that the amorti9ation method used #or an intangible asset with a #inite use#ul li#e should be reviewed at each #inancial ear3end!

Tutorial note2 Over t"e first "alf of t"e asset$s life depreciation !ill be lo!er t"an under t"e straig"tGline basis (and "ig"er over t"e second "alf of t"e asset$s life)#

:n a straight line basis the annual amortisation charge would be K>X11m$ an increase o# KD>$ >>>! Although this di##erence is ,ust below materialit -6X8O P"T. the cumulative e##ect -o# undercharging amortisation. will become material! Also$ when account is taken o# the understatement o# cost -see below.$ the undercharging o# amortisation will be material! The sum3o#3digits method might be suitable as an appro%imation to the unit3o#3 production method i# Plasco has evidence to show that use o# the land#ill site will increase annuall ! However$ in the absence o# such evidence$ the audit opinion should be 'uali#ied 7e%cept #or disagreement with the amortisation method -resulting in intangible asset overstatement)amortisation e%pense understatement.! The annual restoration provision represents 8O o# P"T and >X2O o# total assets! Although this is onl borderline material -in terms o# pro#it.$ there will be a cumulative impact! Annual provisioning is contrar to an E%posure dra#t issued in Nune 0>>8 proposes amendments to &A* 2? 7Provisions$ contingent liabilities and contingent assets!

6>B

The estimate o# the #uture restoration cost is -presumabl . K1X8m -i!e! K>X1 Z 18.! The present value o# this amount should have been provided in #ull in the current ear and included in the cost o# the right! Thus the amortisation being charged on the cost o# the right -including the restoration cost. is currentl understated -on an basis.!

Tutorial note2 A 7?Gyear discount factor at 70O (say) is 0P25># :7P?m Z 0P25> is appro)imately :0P5Em# '"e resulting present value (of t"e future cost) !ould be added to t"e cost of t"e rig"t# Amortisation over 70 years on a straig"tGline basis !ould t"en be increased by :5E 000 increasing t"e difference bet!een amorti3ation c"arged and t"at !"ic" s"ould be c"arged# '"e lo!er t"e discount rate t"e greater t"e understatement of amortisation e)pense# 'otal amount e)pensed (:720) is less t"an !"at s"ould "ave been e)pensed (say :78E amortisation Q :5E un!inding of discount)# -o!ever t"is is not material#

/hether Plasco will wait until the right is about to e%pire be#ore restoring the land or might restore earlier -i# the site is completel #illed in 1> ears.!

.ii/ #udit evidence /ritten agreement #or purchase o# right and contractual terms therein -e!g! to make restoration in 18 ears time.! Cash book)bank statement entries in April 0>>8 #or K1X1m pa ment! Ph sical inspection o# the land#ill site to con#irm Plascos use o# it! Annual dump budget)pro,ection over ne%t 1> ears and comparison with sum3o#3 digits proportions! Amount actuall dumped in the ear -per dump records. compared with budget and as a percentage)proportion o# the total available! Recalculation o# current ears amortisation based on sum3o#3digits! That is$ K1X1m [ 88 \ K0>$ >>>! Tutorial note2 The sum/o!/digits !rom > to >- may be calculated long/hand or using the !ormula n$nA>%B, i.e. $>- P >>%B, C DD.

The basis o# the calculation o# the estimated restoration costs and principal assumptions made! &# estimated b a 'uantit surve or)other e%pert then a cop o# the e%perts report! /ritten management representation con#irming the planned timing o# the restoration in 18 ears -or sooner.!

.b/ $ale of industrial machinery .i/ +atters The industrial machiner was in use #or nine ears -#rom April 1DD;. and would have had a carr ing value o# K;;>$>>> at 21 +arch 0>>8 -11)0> Z K1X0m 1 assuming nil residual value and a #ull ears depreciation charge in the ear o#

6>D

ac'uisition and none in the ear o# disposal.! Hisposal proceeds were there#ore onl K2;>$>>>! The K>X2m loss represents 18O o# P"T -#or the ear to 21 +arch 0>>;. and is there#ore material! The machiner was material to the balance sheet at 21 +arch 0>>8 representing 0X;O o# total assets -K>X;;)]08X? Z 1>>.! A separate disclosure o# a material loss on disposal$ on the #ace o# the income statement in accordance with &A* 1; 7Propert $ plant and e'uipment! The reason #or the sale! (or e%ample$ whether the machiner was: 1 surplus to operating re'uirements -i!e! not being replaced.= or 1 being replaced with newer machiner -thereb contributing to the KBX1m increase -22XB 1 08X?. in total assets.! The reason #or the loss on sale! (or e%ample$ whether: 1 the sale was at an under3value -e!g! to a related part .= 1 the machiner had a bad maintenance histor -or was otherwise impaired.= 1 the use#ul li#e o# the machiner is less than 0> ears= 1 there is an de#erred consideration not et recorded= 1 an non3cash disposal proceeds have been overlooked -e!g! i# another asset was ac'uired in a part3e%change.! &# the use#ul li#e was less than 0> ears$ tangible non3 current asset ma be materiall overstated in respect o# other items o# machiner that are still in use and being depreciated on the same basis! &# the sale was to a related part then additional disclosure should be re'uired in a note to the #inancial statements #or the ear to 21 +arch 0>>; -&A* 06 7Related part disclosures.!

Tutorial note2 Since t"ere are no specific pointers to a related party transaction (9B') t"is point is not e)panded on#

/hether the sale was identi#ied in the prior ear audits post balance sheet event review! &# so: 1 the disclosure made in the prior ears #inancial statements -&A* 1> 7Events a#ter the balance sheet date.= 1 whether an impairment loss was recognised at 21 +arch 0>>8! &# not$ and the machiner was impaired at 21 +arch 0>>8$ a prior period ad,ustment should be made -&A* 1$ 7Reporting #inancial per#ormance.! An impairment loss o# K>X2m would have been material to prior ear pro#it -10X8O.!

Tutorial note2 Lnless t"is !as a 9B' or t"e impairment arose after 57 2arc" 200? a prior period adjustment s"ould be made#

(ailure to account #or a prior period ad,ustment -i# an . would result in modi#ication o# the audit opinion 7e%cept #or non3compliance with &A* 1 -in the current ear. and &A* 1> -in the prior period.! #udit evidence

.ii/

61>

Carr ing amount -K>X;;m as above. agreed to the tangible asset register balances at 21 +arch 0>>8 and recalculation o# the loss on disposal! Cost and accumulated depreciation removed #rom the asset register in the ear to 21 +arch 0>>;! Receipt o# proceeds per cash book agreed to bank statement! *ales invoice trans#erring title to *upper +etal Co! A review o# maintenance e%penses and records -e!g! to con#irm reason #or loss on sale.! Post balance sheet event review on prior ear audit working papers #ile! +anagement representation con#irming that *upper +etal Co is not a related part -provided that there is no evidence to suggest otherwise.!

.c/ %an on em tying waste water .i/ 8atter


K>XDm provision #or upgrading the process represents 68O P"T and is ver material! This provision is also material to the balance sheet -0X?O o# total assets.! The provision #or penalties is immaterial -0X0O P"T and >X1O total assets.! The ban is an ad,usting post balance sheet event in respect o# the penalties -&A* 1>.! &t provides evidence that at the balance sheet date Plasco was in contravention o# local authorit standards! There#ore it is correct -in accordance with &A* 2?. that a provision has been made #or the penalties! As the matter is not material inclusion in 7other provisions is appropriate! However$ even i# Plasco has a legal obligation to meet minimum standards$ there is no obligation #or upgrading the puri# ing process at 21 +arch 0>>; and the K>XDm provision should be written back! &# the provision #or upgrading is not written back the audit opinion should be 'uali#ied 7e%cept #or -disagreement.! Plasco does not even have a contingent liabilit #or upgrading the process because there is no present obligation to do so! The obligation is to stop empt ing unclean water into the river! <or is there a possible obligation whose e%istence will be con#irmed b an uncertain #uture event not wholl within Plascos control!

Tutorial note2 0onsider for e)ample t"at Blasco "as alternatives !"olly !it"in its control# 1or e)ample it could ignore t"e ban and incur fines or relocateFclose t"is particular plantFoperation or per"aps dispose of t"e !ater by alternative means#

The need #or a technological upgrade ma be an indicator o# impairment! +anagement should have carried out an impairment test on the carr ing value o# the water puri# ing process and recognised an impairment loss in the pro#it #or the ear to 21 +arch 0>>;! +anagements intention to upgrade the process is more appropriate to an environmental responsibilit report -i# an .! /hether there is an other in#ormation in documents containing #inancial statements!

611

.ii/ #udit evidence


Penalt notices o# #ines received to con#irm amounts and period)dates covered! A#ter3date pa ment o# #ines agreed to the cash book! A cop o# the ban and an supporting report on the local authorit #indings! +inutes o# board meetings at which the ban was discussed con#irming managements intentions -e!g! to upgrade the process.!

Tutorial note2 This may be disclosed in the directors? report andBor as a non/ adjusting post balance sheet event.

An tenders received)costings #or upgrading!

Tutorial note2 '"is !ill be relevant if for e)ample capital commitment aut"orised (by t"e board) but not contracted for at t"e year end are disclosed in t"e notes to t"e financial statements#

Ph sical inspection o# the empt ing point at the river to con#irm that Plasco is not still empt ing waste water into it -unless the upgrading has taken place.!

$olution I2
6O+:R :N:R7L Tutorial: (or this t pe o# 'uestions$ alwa s consider the materialit o# the matters$ the nature o# evidence available$ the relevant accounting standards and how the audit opinion ma be a##ected! (or part -a. the matters relate to issues in respect o# recognition$ measurement and disclosure having regard to circumstances described and the relevant accounting standards! (or part -b. ou should bring to mind the #inancial statements assertions to be tested in order to identi# relevant audit evidence re'uired! .a/ Ca italiEation of staff training costs -i.

+atters arising K6!2 billion represents less than 1!BO o# total assets and there#ore is not$ in isolation$ material to the balance sheet! &t does$ however$ represent nearl ;>O o# pro#it be#ore ta%ation and is there#ore material! &# K6!2 billion were to be e%pensed pro#it be#ore ta% would #all to K0!D billion$ which is onl an eighth -i!e! 10!8O. o# pro#it$ reported in the prior ear!

610

However true it ma be that mone is spent in the hope o# #uture bene#its= sta## training costs does not usuall meet the de#inition o# an asset as there is insu##icient control over them -&A* 2B &ntangible Assets.! The cannot there#ore be intangible assets! Control might be claimed i# power had legal rights over the sta## training$ to use and obtain #uture bene#its e%pected #rom them! However$ whilst this might appl to #ew individuals it would not appl to its entire technical sta##! /hether an o# the K6!2 billion is a cost which can be de#erred! (or e%ample$ pre3pa ments #or an part o# the training program not run until a#ter the ear end! :r training 7manuals -bound volumes or so#tware programs. which can be used over a #uture period o# time! The chie# e%ecutives grounds$ i# an $ #or re#using to change the #inancial statements once it is e%plained to him that the audit opinion will be 'uali#ied 7e%cept #or i# it does not do so!

-ii.

Audit evidence A break down o# K6!2 billion 1 anal 9ed between e%ternal and internal training costs! Test checking the largest invoices #or e%ternal training Ph sical inspection o# training manuals -or other training program related asset. The standards terms o# the contracts with technical sta## -con#irming that Power Energ does not have su##icient control over them.! Hetails o# leavers 1 supporting the argument to the chie# e%ecutive that #uture bene#its are not protected as Power cannot prevent technical sta## #rom taking up alternative emplo ment elsewhere!

-b.

Provision #or decommissioning -i.

+atters The provision made is one 1 #i#teenth o# the total e%pected cost and represents appro%imatel 1?O o# pro#it be#ore ta% -P"T. which is material$ but onl one3hal# o# total assets which is material! Fiven that materialit is based on P"T is e%aggerated$ because it is small compared to the prior ear$ on balance it is not material! However$ the total amount to be provided$ the present value o# K1B million$ will be material -the undiscounted amount is appro%imatel ?!8O o# total assets.! Power Energ has a legal obligation to incur K1B billion in dismantling)decontamination costs as a result o# having assembled a

612

laborator during the ear! The present value o# this should be recogni9ed$ in #ull$ as a liabilit -&A* 2? Provision$ Contingent Giabilities and Contingent Assets. and as part o# the cost o# the laborator -&A* 1; Propert $ Plant and E'uipment.! The capitali9ation o# this #uture costs is the carr ing amount o# the asset would increase the depreciation charge #or the ear b one3#i#teenth o# the present value$ which would be less than K1!0 billion! The chie# e%ecutives grounds$ i# an $ #or re#using to change the #inancial statements once it is e%plained to him that the audit opinion will be 'uali#ied 7e%cept #or i# he does not do so! Audit evidence

-ii.

Terms o# local authorit grant as documented in the permanent audit #ile! Ph sical inspection o# the site at the balance sheet date$ to con#irm that the laborator was assembled during the ear and the obligation #or settlement in 0>0> thereb created! "reak down and calculation o# the K1B billion cost 1 whether estimated b Powers management or an independent consultant! Assumptions made in estimating the #uture cost -e!g! concerning degree o# contamination.! An appropriate discount rate 1 to calculate the ad,ustment that management should make -or 'uanti# the impact o# disagreement i# the #inancial statements are not ad,usted.!

-c.

+onthl ad,ustment -i.

+atter The net movement #or the ear$ K2>> million represents onl 6O o# pro#it be#ore ta% and is there#ore immaterial -and negligible to the balance sheet.! However$ although the net amount is immaterial$ consideration should be given not onl to the amounts o# the ad,ustments made but their nature! The ,ournal entries have no economic substance 1 the are a manipulation o# #inancial reporting in#ormation! The #act that the ,ournals are reversed does not mitigate the #act that the ad,ustments appear to have been made solel to misrepresent reported debt ratios! The are there#ore #alse and$ being intentional and deceit#ul -to obtain)maintain a #inancial advantage. constitutes #raud! The ad,ustments have clear characteristics o# being #raudulent ,ournal entries: o +ade to unusual accounts 1 7*undr 1 and 7*undr 0! o Approved b an individual who t picall would not be involved in making ,ournal entries -the chie# e%ecutive. o Recorded at period end with no description!

616

-ii.

Audit evidence Gist o# all such ,ournals entries made -and reversed. during the ear! Terms and conditions o# government #unding -#rom permanent audit #ile #or on going #inance and new contracts entered into during the ear.! Recalculation o# what the debt ratios should have been$ without the ad,ustments$ and whether these indicate a breach o# conditions! +anagement representation signed b the chie# e%ecutive$ that there are no other transactions o# a similar nature which have not been brought to the attention o# the auditor! How the matter was addressed b the prior ear audit in respect o# the prior ear #inancial statements!

:verall The chie# e%ecutive clearl has a position o# in#luence within Power Energ ! Pro#it is materiall overstated b the capitali9ation o# sta## training costs! &# he re#uses to ad,ust the #inancial statements when re'uested to do so this would be a #urther instance to #raudulent reporting and the appropriateness o# reporting this to relevant government authorities -as well as 'uali# ing the audit opinion. should be considered! $olution '(2 8UND#+#N7# BOO 7#RD:N Tutorial: in part -a. applicable risks are those risks that are normall identi#ied as being material and cannot be insured against! &n part -b. the #inancial statements risks are the business risks that result in the risk that assets and liabilities will be misstated in the #inancial statements or that the business will #ail! Part -c. re'uires a knowledge and application o# &*A 80> Anal tical Procedures to planning the e%tent o# substantive procedures in the conte%t o# +CF income! .a/ -i. Internal controls Gack o# investment

+onthl review and monitoring o#: o Admission #ees o <umber o# da s visitors o Annual membership taken out -anal sed between new and renewed. o Gapsed membership o *ponsorship waiting lists -animals without sponsors and sponsors waiting #or suitable animals.

618

Approval o# annual budgets which plan #or ade'uate investment to attract visitors! +onthl comparison o# actual e%penditure on new e%hibits and breeding programs against budget 1 to see e%tent to which the e%pected level o# investment in development is being made!

-ii.

&ncomplete data trans#er

+onthl reconciliation o# actual -invoiced. sponsorship income to that e%pected -based on number o# sponsorships$ b t pe$ per sponsor department records. and investigate o# short#alls! +onitoring o# instances o# incomplete)inaccurate data trans#er 1 how identi#ied$ reason #or occurrence$ amounts involved$ how recti#ied!

-ii.

<on3charges

+onitoring o# sponsorship income generated -i!e! actual. to that available -e!g! pro,ected.$ b class o# animals$ and investigation o# short#all! Comparison o# "CFs advertising e%penditure against budget -to identi# potential #or unrecorded costs.!

-iv.

+isappropriated cash Two people could ma each ticket kiosk at all times! A dut log should be kept -date$ time$ sta## member. The kiosk must not be le#t unattended while cash is held there! All cash received #rom visitors should be counted and recorded and a receipt given! Cash and a cop o# the receipt should be trans#erred$ securel $ to cashiers! The e%istence o# CCTP at the kiosks should be made evident$ to act as a deterrent! Hail reconciliation o# cash takings to gate -i!e! number o# da visitors. and investigation o# an apparent short#all! A separate admission gate a#ter the kiosk checks that entrants have been issued a ticket! An auditable cash register s stem to control cash drawers at ticket booths! Transactions must be traceable in multiple #orms o# tender -cash$ credit cards. +ultiple cash drawer inserts enabling 'uick and eas shi#t changes! An automated audit trail o# all movements in and out o# each drawer! * stems not available

-v.

"ackup$ recover ) contingenc plans must be in place to ensure that +CF can take bookings and issue tickets even when the electron s stem is not available!

61;

&n particular$ the backup s stem should be tested periodicall to ensure that credit card bookings can be taken and correct discounts processed #or concessionar ticket and group bookings! Preventive arrangements to ensure that an 7down time is kept to a mini mum! (or e%ample$ ac'uiring highl reliable s stems components and #re'uentl housekeeping)maintenance!

-vi.

Inrecorded donations

Periodic inspection o# animals and comparison with books records -e!g! #i%ed assets registers #or larger spices and inventor records #or smaller species.! Comparing new animals identi#ied b veterinar records to additions to inventor records -or asset register.!

.b/

9inancial statements ris!s -i. A going concern -#ailure. risk arises #rom lack o# investment! An signi#icant doubts about going concern must be suitabl disclosed in the notes to the #inancial statements! Hisclosure risk arises i# the re'uirements o# &A* 1 Presentation o# (inancial *tatements are not met! A reduction in admission income ma result in asset impairment! +CFs management should per#orm impairment test on the carr ing amount o# the large e%hibits$ in accordance with &A* 2; &mpairment o# Assets! &ncome ma be materiall understated due to: -i. &ncomplete data trans#er resulting in invoices not being raised -ii. Inrecorded sponsorships arising #rom advertising arrangements! +CFs advertising costs will be understated i# their barter #or sponsorship is not recorded! &# material there is a risk o# non compliance with #inancial reporting re'uirements -*&C 21 Revenue 1 "arter Transactions &nvolving Advertising *ervices.! Cash asset)admission income will be understated in respect o# cash which does not reach the accounts department! &# some o# this cash is not stolen but rather appropriated #or use in the business -e!g! in meeting da 1 to 1 da cash e%penses. then costs would be understated also! The #inancial statements risk is greater i# income is lost through un ticketed entr -as it will be more di##icult to 'uanti# than i# misappropriation occurs a#ter ticket have been issued.! There ma be no #inancial statement risk! (or e%ample$ i# +CF were to admit people #or #ree there would be no admission #ees to be recorded #or that da ! Alternativel in the absence o# an ade'uate back up s stem$ the risk o# unrecorded cash)income identi#ied in -iv. ma be e%acerbated! Asset -and reserves. will be understated in donated animals are not initiall recogni9ed at #air value -&A* 1; Propert $ Plant and E'uipment.

-ii.

-iii.

-iv.

-v.

-vi.

61?

.c/

$ubstantive analytical rocedures ) factors to be considered

#udit ob3ectives 1 The principal audit ob,ective relating to income is to ensure the completeness o# recording! Anal tical procedures can be e##ective in providing assurance in this area$ especiall where it is ine##icient to per#orm tests o# control or detailed substantive tests! <ature o# entit 1 +CFs income will be seasonal$ with more visitors in #ine weather$ at weekends$ during school holida s and on national holida s! The relationship between income and weather)dates will provide a basis #or making comparisons ear3on3 ear! The greater the degree o# disaggregating o# in#ormation$ the greater the e%tent and reliance on substantive anal tical procedures! (or e%ample$ sponsorship income will be clearl distinguished #rom ticket income! Also$ income #rom sales o# #ood and retail will be separatel identi#iable #rom admissions! Availabilit o# in#ormation 1 non #inancial in#ormation$ as well as #inancial in#ormation$ should be available on which to base predictions! (or e%ample$ recorded admission #ees can be veri#ied on departure -e!g! through turnstiles.! Reliabilit o# in#ormation 1 7gates will be more reliable i# ph sical barriers are independentl supervised to ensure that visitors cannot otherwise gain admittance! Relevance o# in#ormation 1 budgets will be more reliable i# based on realistic rather than ideal targets -e!g! achieving ?>O rather than 1>>O sponsorship.! *ource o# in#ormation available 1 #or veri#ication o# completeness o# recorded sponsorship income there will be non3#inancial records #or the animals! E%ternal sources o# in#ormation might include weather reports and local newspapers reports o# ma,or donations$ sponsorships$ etc! Comparabilit o# in#ormation 1 as the nature o# +CF is 'uite speciali9ed there ma be no broad industr data available! There#ore most o# the comparisons will be with prior period in#ormation! E%pectation o# relationships 1 as well as seasonal relationships$ there will be an e%pectation that the higher the gate the higher the income #rom #ood and retail! +aterialit 1 as income is the item most material to the income statement$ audit evidence regarding its completeness should not be con#ined solel to anal tical procedures$ #or e%ample$ tests o# detail on the sponsorship o# the larger animals might be e%pected! :ther audit procedures aimed at the same audit ob,ective 1 +CF will have trade receivable in respect o# sponsorships -invoiced. on which other procedures can be carried out! (ro e%ample$ review o# credit period taken! However$ there will not be amounts due #ro admission #ees and retail sales -cash.

61B

Accurac o# predictions 1 #ood and retail sales are likel to have established margins 1 there#ore the completeness o# recorded income #rom these sources ma be predicted more accuratel than sponsorships -sa . where there are no directl attributable costs to be veri#ied! &nherent and control risk assessments 1 as much o# the income is cash$ inherent risk is assessed as high! However$ i# controls over the issues o# tickets are strong$ more reliance ma be placed on anal tical procedures than i# control risk in this area was assessed as high! Tests o# control 1 i# +CFs controls over recording non3#inancial in#ormation -e!g! gate. are strong then more reliance can be placed on anal tical procedures using this in#ormation!

$oution ''2 L#T:$ &TD .a/ Preliminar materialit Turnover 0>>; 0>>8 Pro#it be#ore ta%ation 0>>; 0>>8 Total assets 0>>; 0>>8 1)0O K>XBm K>X?m 8O K>X1m <)A 1O K1X>m K1X1m 1O K1X;m K1X6m 1>O K>X0m <)A 0O K0X1m K0X1m

A suitable range #or preliminar materialit is K1X>m 1 K1X;m! Tutorial note0 As t"e financial statements are presented to a precision of :0P7m it is meaningless to suggest a preliminary materiality to a greater level of precision since t"is suggests a level of accuracy t"at !ill not be ac"ieved# <ustification &t is not meaning#ul to base preliminar materialit on a small pro#it -or a loss. as this will result in over3auditing o# the #inancial statements!

61D

+ore than K1X;m turnover is material to the pro#it and loss account$ there#ore preliminar materialit is likel to be set so as not to e%ceed this amount! Gess than K>XBm is not material to turnover -or the balance sheet. so preliminar materialit should not be less than this amount! A suitable preliminar materialit level is most likel to be one that lies within the overlap o# the ranges calculated #or turnover and total assets! K1m -1O o# total assets. represents >X;O turnover! This would be a prudent estimate o# materialit -resulting in a higher level o# audit work.! K1X;m -1O o# turnover. represents 1X8O o# total assets! Preliminar materialit might be set at this end o# the range had this been a recurring audit! However$ as this is a #irst audit -and caution would generall result in over3auditing. preliminar materialit is likel to be lower! Total assets have #allen -marginall . since the prior ear$ whereas turnover has increased -b 11XBO.! As dra#t #igures #or the balance sheet appear more stable than #or the pro#it and loss account$ preliminar materialit is more likel to be set in relation to balance sheet amounts! The 0>>; #inancial statements are dra#t #or an une%pired period o# time! There#ore greater errors should be e%pected than i# the were actual! *o$ relativel $ sample si9es #or audit testing should be increased -i!e! preliminar materialit should be set at a relativel lower level.!

.b/ 9inancial statement ris!s Tutorial note2 Kote t"e timeframe# 1inancial statements for t"e year to 50 <une 200E are draft# 0ertain misstatements may t"erefore e)ist due to yearGend procedures not yet "aving taken place# SalesF (,ebtors) *ales have increased b 11XBO --1;1X8 1 166X6.)166X6 Z 1>>.! :verstatement could arise i# rebates due to customers have not et been accounted #or in #ull -as the are calculated in arrears.! &# rebates have still to be accounted #or trade debtors will be similarl overstated! 2aterials e)pense +aterials e%pense has increased b 1?XBO --BBX> 1 ?6X?.)?6X? Z 1>>.! This is more than the increase in sales! This could be legitimate -e!g! i# #uel costs have increased signi#icantl .! However$ the increase could indicate misclassi#ication o#: 1 Revenue e%penditure -see #all in other e%penses below.= 1 Capital e%penditure -e!g! on overhauls or ma,or re#urbishment. as revenue= 1 (inance lease pa ments as operating lease! ,epreciationFamorti3ation This has #allen b 1>X8O --BX8 1 DX8.)DX8 Z 1>>.! This could be valid -e!g! i# 5ates has signi#icant assets alread #ull depreciated or the asset base is lower since last ears restructuring.! However$ there is a risk o# understatement i#$ #or e%ample: 1 not all assets have been depreciated -or depreciated at the wrong rates$ or onl #or 11 months o# the ear.=

60>

1 1

cost o# #i%ed assets is understated -e!g! due to #ailure to recognise capital e%penditure.1= &mpairment losses have not been recognised -as compared with the prior ear.!

Tutorial note2 ,epreciation on ve"icles and transport e(uipment represents only RO of cost# If all items !ere being depreciated on a straig"tGline basis over eig"t years t"is s"ould be 72P?O# '"e depreciation on ot"er e(uipment looks more reasonable as it amounts to 78O !"ic" !ould be consistent !it" an average age of ve"icles of seven years (i#e# in t"e middle of t"e range 5A75 years)# Ot"er e)penses These have #allen b 18X8O --1DX; 1 02X0.)02X0 Z 1>>.! The ma have #allen -e!g! #ollowing the restructuring. or ma be understated due to: 1 e%penses being misclassi#ied as materials e%pense= 1 Inderestimation o# accrued e%penses -especiall as the #inancial reporting period has not et e%pired.!

Intangibles &ntangible assets have increased b ]1m -1;O on the prior ear.! Although this ma onl ,ust be material to the #inancial statements as a whole -see -a.. this is the net movement$ there#ore additions could be material! &nternall 3generated intangibles will be overstated i#: 1 the do not have a readil ascertainable market value -(R* 1> 7Foodwill and intangible assets.= 1 An impairment in the ear has not et been written o## in accordance with (R* 11 7&mpairment o# #i%ed assets and goodwill! Tutorial note2 '"e rule is muc" more restrictive t"an satisfying asset recognition criteria$# 'angible assets The net book value o# buildings -at cost. has #allen b 8O$ vehicles are virtuall unchanged -increased b ,ust 0X8O. and other e'uipment -though the least material categor . has #allen b 0>X6O! Pehicles and e'uipment ma be overstated i#: 1 disposals have not been recorded= 1 depreciation has been undercharged -e!g! not #or a whole ear.= 1 &mpairments have not et been accounted #or! Inderstatement will arise i# #inance leases are treated as operating leases! ,ebtors

601

Trade debtors have increased b ,ust 0X0O -although sales increased b 11XBO. and ma be understated due to a cuto## error resulting in overstatement o# cash receipts! There is a risk o# overstatement i# su##icient allowances have not been made #or the impairment o# individuall signi#icant balances and #or the remainder assessed on a port#olio or group basis!

9estructuring provision The restructuring provision that was made last ear has #allen)been utilised b 1>X0O! There is a risk o# overstatement i# the provision is underutilised)not needed #or the purpose #or which it was established! 1inance lease liabilities Although #inance lease liabilities have increased -b ]1m. there is a greater risk o# understatement than overstatement i# leased assets are not recognised on the balance sheet -i!e! capitalised.! Hisclosure risk arises i# the re'uirements o# **AP 01 7Accounting #or leases and hire purchase contracts -e!g! in respect o# minimum lease pa ments. are not met!

'rade creditors These have increased b onl 8X2O compared with the 1?XBO increase in materials e%pense! There is a risk o# understatement as noti#ications -e!g! suppliers invoices. o# liabilities outstanding at 2> Nune 0>>; ma have still to be received -the month o# Nune being an une%pired period.! Tutorial note2 '"is may be unlikely as ot"er e)penses "ave fallen also# Ot"er (employee) liabilities These ma be understated as the have increased b onl ?X8O although sta## costs have increased b 16O! (or e%ample$ balances owing in respect o# outstanding holida entitlements at the ear end ma not et be accuratel estimated! Tutorial note2 0redit !ill be given to ot"er financial statements risks specific to t"e scenario# 1or e)ample timeGsensitive delivery sc"edules$ mig"t give rise to penalties or claims t"at could result in understated provisions or undisclosed contingent liabilities# Also given t"at t"is is a ne! audit and t"e result "as c"anged significantly (from loss to profit) mig"t suggest a risk of misstatement in t"e opening balances (and "ence comparative information)# .c/ :@tent of reliance on analytical rocedures as audit evidence

600

Tutorial note2 In t"e re(uirement = reliance = as audit evidence$ is a direction to consider only substantive analytical procedures# Ans!er points concerning planning and revie! stages !ere not asked for and earn no marks#

Although there is likel to be less reliance on anal tical procedures than i# this had been an e%isting audit client$ the #act that this is a new assignment does not preclude placing some reliance on such procedures! Anal tical procedures will not be relied on in respect o# material items that re'uire 1>>O testing! (or e%ample$ additions to buildings are likel to represent a ver small number o# transactions! Anal tical procedures alone ma provide su##icient audit evidence on line items that are not individuall material! (or e%ample$ stock -less than 1)0O turnover and less than 1O total assets. ma be shown to be materiall correctl stated through anal tical procedures on consumable stores -i!e! #uel$ lubricants$ materials #or servicing vehicles etc.! *ubstantive anal tical procedures are best suited to large volume transactions -e!g! sales$ materials e%pense$ and sta## costs.! &# controls over the completeness$ accurac and validit o# recording transactions in these areas are e##ective then substantive anal tical procedures showing that there are no une%pected #luctuations should reduce the need #or substantive detailed tests! The e%tent o# planned use will be dependent on the relationships e%pected between variables -e!g! between items o# #inancial in#ormation and between items o# #inancial and non3#inancial in#ormation.! (or e%ample$ i# material costs rise due to an increase in the level o# business then a commensurate increase in sales and sta## costs might be e%pected also! 7Proo#s in total -or reasonableness tests. provide substantive evidence that items o# pro#it and loss are not materiall misstated! &n the case o# 5ates these might be applied to sta## costs -number o# emplo ees in each categor Z wage)salar rates$ grossed up #or social securit $ etc. and #inance e%pense -interest rate Z average monthl overdra#t balance.! However$ such tests ma have limited application$ i# an $ i# the population is not homogenous and cannot be subdivided! (or e%ample$ all the categories o# #i%ed asset have a wide range o# use#ul li#e! There#ore it would be di##icult)meaningless to appl an 7average depreciation rate to all assets in the class to substantiate the total depreciation e%pense #or the ear! -Although it might highlight a risk o# potential over or understatement re'uiring #urther investigation!. *ubstantive anal tical procedures are more likel to be used i# there is relevant in#ormation available that is being used b 5ates! (or e%ample$ as #uel costs will be signi#icant$ 5ates ma monitor consumption -e!g! miles per gallon -+PF..! Anal tical procedures ma supplement alternative procedures that provide evidence regarding the same assertion! (or e%ample$ the review o# a#ter3date pa ments to con#irm the completeness o# trade creditors ma be supplemented b calculations o# average pa ment period on a monthl basis!

602

Tutorial note2 0redit !ill be given for ot"er relevant points dra!n from t"e scenario# 1or e)ample t"e restructuring during t"e previous year is likely to "ave caused fluctuations t"at may result in less reliance being placed on analytical procedures# .d/ 6rinci al audit wor! .i/ Trade debtors Review o# agreements to determine the volume rebates terms! (or e%ample$ 1 the O discounts= 1 the volumes to which the appl = 1 the period over which the accumulate= 1 settlement method -e!g! b credit note or other o##3set or repa ment.! Hirect positive con#irmation o# a value3weighted sample o# balances -i!e! larger amounts. to identi# potential overstatement -e!g! due to discounts earned not being awarded.! +onitoring o# a#ter3date cash receipts and matching against amounts due as short#alls ma indicate disputed amounts! Review o# a#ter3date credit notes to ensure ade'uate allowance -accrual. is made #or discounts earned in the ear to 2> Nune 0>>;! Credit risk anal sis o# individuall signi#icant balances and assessment o# impairment losses -where carr ing value is less than the present value o# the estimated cash #lows discounted at the e##ective interest rate.!

.ii/ Pehicles Agreeing opening ledger balances o# cost and accumulated depreciation -and impairment losses. to the #i%ed asset register to con#irm the comparative amounts! Ph sicall inspecting a sample o# vehicles -selected #rom the asset register. to con#irm e%istence and condition -#or evidence o# impairment.! &# anal tical procedures use management in#ormation on mileage records this should be checked -e!g! against milometer. at the same time! Agreeing additions to purchase invoices to con#irm cost! Reviewing the terms o# all lease contracts entered into during the ear to ensure that #inance leases have been capitali9ed! Agreeing the depreciation rates applied to #inance lease assets to those applied to similar purchased assets! Reviewing repairs and maintenance accounts -included in materials e%pense. to ensure that there are no material items o# capital nature that have been e%pensed -i!e! a test #or completeness.!

$olution ''2
OTF:R #$$UR#NC:

606

-a.

Current ACCA guidance on the provision o# other services to clients is ver similar to &(AC guidance which applies in an international basis! The review taken internationall b &(AC is that man companies would be restricted i# the were unable to obtain the other services available #rom their auditors$ provided these services do not inter#ere with the e%ercise o# managerial #unctions and auditors independence! &t would seem that &(AC guidance allows e%ternal auditors to act as internal auditors o# clients! The view taken b the ACCA guidance is as #ollows:

The ACCA guidance states that ob,ectivit ma be threatened b the provision o# non3audit services! Care must be taken not to give e%ecutive advice or to become part o# the clients active management! (irms should not provide accountanc services to public limited compan clients! &# accounting records are prepared #or a client$ then the client must accept res onsibility for the records! There is no speci#ic prohibition #rom an e%ternal auditor undertaking the internal audit #unction!

*peci#ic problems which could occur include the #ollowing: The difficulty of re orting wea!nesses in internal controls in s stems designed b emplo ees o# the auditor acting as internal auditors o# the client! The erceived difficulties in testing wor! carried out b internal auditors who are colleagues o# e%ternal auditors &nternal audit programmes designed to reduce the wor! o# e%ternal auditors! The danger o# breaching #CC# rules o# conduct i# the internal audit department is deemed to be part o# the management o# the client! (ee pressure arising #rom the increase in #ees #or providing an internal audit service leading to breaching the #ee guidelines! #udit ris! assessed b the e%ternal auditor! The presumption is that control risk would reduce because o# the involvement o# the e%ternal auditor in the provision o# internal audit services!

-b.

The e##ects would be as #ollows: &ncreased risk o# liabilit claims Additional costs to the auditor incurred in emplo ing suitable sta## to provide wider assurance! An impact upon #ees charged to clients Possible increased e%pectations o# audit clients

608

-c.

The di##icult in #ormulating and wording an appropriate audit report which could re'uire legislative changes!

The new approach could be seen as a 7repackaging o# e%isting services where auditors concentrate upon providing services which add value to the audit #ee in the e es o# the client! "asic audit work ma be #orgone as it is perceived as adding ver little! The di##icult o# this approach is that auditors are increasing #aced with litigation claims and should there#ore provide more basic assurance based on lower materialit thresholds! &t ma be that auditors came to view the roles o# audit committees and internal audit departments as crucial in reducing control risk! &t is dangerous to assume that internal audit is a consultanc e%ercise aimed at adding value because traditional audit assurance will be lost and overall levels o# audit risk will rise!

$olution '*2
:N;IRON8:NT :nvironmental issues2 The last ten ears has seen an escalation in the issue o# new environmental legislation and regulations in response to the e##ects which economic activities have on a worlds natural resources! &n man countries$ such legislation now encompasses environmental protection$ water industries and resources$ clear air$ town and countr planning and pollution prevention and control! &n Cambia$ the environmental council o# Cambia pla s a pivotal roles in issues o# environmental and not #orgetting the town planning and the various Councils! Although there is wide spread publicit relating to environmental issues concerning large industries like the mines$ the #inancial statements o# small and medium si9ed enterprises are not e%empt #rom the potential impact o# such issues! The si9e o# an entit has no direct bearing on whether environmental matters are likel to be signi#icant to its operations! *mall operations$ in principle$ are likel to cause environmental damage as large operations!

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&ncreasing pressure on commercial activities to tackle environmental issues have arisen #rom man sources$ including: 3 3 3 3 3 lobb groups #inancial institutions -e!g! banks are more cautious not to risk their reputation b pa ing insu##icient attention to environmental issues in making lending decisions.! suppl chain greening -e!g! large organi9ations implementing environmental standards e%pecting there suppliers to do likewise.= government action -e!g! ta%es on emissions and land #illing though in Cambia a penalt charge ma be levied.! the accounting$ auditing and legal pro#ession -e!g! &(AC has issued an e%posure dra#t 7The Consideration o# Environmental +atters in the Audit o# (inancial *tatements.!

Im lications for business The signi#icance o# environmental matters to the #inancial statements normall depends on the nature o# the reporting entit s operations:

*ome entities ma incur environmental obligations as a direct result o# their core business e!g! e%tractive industries$ chemical manu#acturers and waste management companies! (or such organi9ations$ compliance with environmental law and regulations should be central to the business! :ther entities ma be a##ected b market issues as compliance o# products -e!g! those containing C(Cs. with environmental legislation and customer perception o# environmental #riendliness!

:perational processes that are likel to increase the signi#icance o# environmental risk include those that cause air)water)ground pollution$ use ha9ardous substances or generate ha9ardous waste! "usiness ma also be a##ected b the location o# their operations -e!g! i# holding an interest inland or buildings that have been contaminated b previous occupants.! The value o# propert is likel to be a##ected i# t is on or near a contaminated site! :rgani9ations ma incur the cost o# clear3up operations even though the are not responsible #or environmental pollution! "usinesses ma also be a##ected indirectl b environmental issues i# the are dependent on a ma,or customer or supplier whose business is under threat #rom environmental pressures! As it is a principal o# corporate governance that management should maintain a sound s stem o# internal control -to sa#eguard the shareholders investments and the compan s assets.$ a compan e%posed to signi#icant environmental risks might be e%pected to operate an environmental management s stem -E+*.!

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+hy they cannot be ignored by auditors The auditors duties with regard to the growing bod o# environmental laws and regulations is the same as #or an other laws and regulations where non3compliance ma materiall a##ect the #inancial statements -&A* 08>. &n particular auditors must be alert to the possibilit o# the nature o# a clients business having potentiall harm#ul environmental impacts -past$ present and #uture.! As part o# their assessment o# risk and internal controls$ auditors will also re'uire in#ormation concerning e%isting and proposed regulations and #ines or penalties incurred! (or e%ample$ the auditor o# a compan engaged in waste disposal must be conversant with the terms o# licences under which the compan is permitted to dispose o# ha9ardous substance! /here an organi9ation has been sub,ected to an environmental audit$ the #inancial auditor should review the environmental audit #indings -e!g! as published in the environmental per#ormance report. and consider whether the risk o# material error in the #inancial statements is increased! Im act on financial statements" At the #inancial statements level$ environmental risks encompass: 3 the risk o# non compliance with laws)regulations 3 the risk o# compliance costs arising 3 the possible e##ects o# customers pre#erences! Environmental issues ma have a direct impact on the #ollowing: 3 3 3 3 3 3 3 3 provisions$ e!g! #or site restoration Contingent liabilities e!g! arising #rom pending legal action actual liabilities e!g! #ines and penalties involved non3current asset values e!g! propert situated on or near a contaminated site inventor valuation Capital or revenue e%penditure on clean up operations product redesign costs! going concern e!g! where new or more stringent environmental legislation -such as that on emission. threaten products viabilit $ or where withdrawal o# an operating licence is 7li#e threatening!

Conclusion2 Clearl auditors cannot ignore the implications o# environmental issues on the #inancial statements o# their audit clients! A 7general awareness o# the risks is however$ a minimum re'uirement! /here #inancial statements embod management assertions concerning environmental matters -e!g! the e%istence o# the environmental liabilit $ the occurrence o# environmental e%penditure$ the evaluation o# an environmentall impaired

60B

asset$ the completeness o# #ines and penalties.$ the auditor must go much #urther in obtaining evidence to corroborate those assertions! $olution '-2 8UT:ND: .a/ #uditor5s res onsibilities ) a ro riateness of going concern assum tion"

The auditor should consider: The appropriateness o# managements use o# the going concern assumption -This is a #undamental principle in the preparation o# the #inancial statements. when planning and per#orming audit procedures and in evaluating the results thereo#= and /hether events or conditions ma cast signi#icant doubt on the entit s abilit to continue as a going concern -and sta alert to evidence o# such events or conditions.! &n particular the auditor should evaluate managements assessment o# the appropriateness o# the going concern assumption #or a period o# at least 10 months! /hen there are signi#icant doubts about the appropriateness o# the assumption$ managements plan #or #uture actions should be reviewed! *u##icient evidence should be gathered to con#irm or dispel whether or not material uncertaint e%ists! This ma necessitate the per#ormance o# additional speci#ic audit procedures -e!g! e%amination o# cash #lows and prospective #inancial in#ormation.! /ritten management representations should be sought con#irming managements plans and #uture actions! /here the going concern is appropriate but a material uncertaint e%ists the auditor must assess the ade'uac o# managements disclosure -o# events)conditions and managements plans. in the #inancial statements! &# disclosure is:

Ade'uate$ the audit opinion should be un'uali#ied opinion with an emphasis o# matter paragraph &nade'uate$ the auditor should e%press a 'uali#ied or adverse opinion -as appropriate.!

&# the assumption is ,udged inappropriate the auditor should e%press an adverse opinion i# the #inancial statements have been drawn up on a going concern basis -irrespective o# an disclosure made.! .b/ Comment on suitability .of unmodified auditor5s re ort

60D

An unmodi#ied opinion means that the #inancial statements gives a true and #air view -or are presented #airl $ in all material respects. in accordance with the #inancial reporting #ramework and compl with statutor re'uirements! Foing concern is an underl ing assumption o# the &A*Cs (ramework 0! Hence it is assumed unless an alternative basis o# preparation is disclosed! As +utende has li'uidated certain assets and commenced a s stematic winding down o# its operations$ it appears to have ceased trading and is not a going concern! Tutorial note2 There is neither uncertaint $ nor signi#icant doubt! There is su##icient evidence that 7de #acto +utende is not a going concern! There#ore 7e%cept #or or a disclaimer o# opinion -on grounds o# limitation on scope. would not be appropriate! There are two possibilities= +utendes #inancial statements have been prepared either:

:n a going concern basis or :n an alternative authoritative basis!

'"e frame!ork for t"e preparation and presentation of financial statements# &n either case$ an un'uali#ied opinion is inappropriate as the basis o# preparation has not been disclosed -and some 'uali#ication must be called #or with regard to this omission.! (inancial statements prepared on a going concern basis! This is likel to be appropriate as all remaining assets and liabilities might be e%pected to be settled in the ne%t 10 months and should be classi#ied as current! An adverse opinion should be e%pressed -&*A 8?>.! However$ the valuation o# assets and liabilities ma not be signi#icantl a##ected -e!g! i# trade receivables and pa ables are stated at the amounts e%pected to be settled in the normal course o# business.! (inancial statements prepared on an alternative authoritative basis! An alternative -e!g! 7break3up. basis #or the preparation and presentation o# the #inancial statements appears to be appropriate -as trading has ceased.! However$ the basis o# preparation is not disclosed and$ in the absence o# disclosure to the contrar $ users o# +utendes #inancial statements might assume that the have been prepared on a going concern basis!

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*core7s auditors report should there#ore be 'uali#ied 7e%cept #or on grounds o# inade'uate disclosure! &n conclusion$ as *core should agree with the basis o# preparing$ +utendes directors should be advised to disclose the basis in the notes to the #inancial statements! *cores opinion would then be un'uali#ied$ perhaps with an emphasis o# matter paragraph to draw users attention to the basis o# preparation note!

621

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