ents and internal audit . .

618 Assurance engagem h tthere is in this case (1) a practitione · (·

em t a l h . ... ' ,,nth· .
1tdoesse . rty (the loca aut onty\ (Ill) int - d 1s 1n.st•
sible pa h h en eel <\11
(\"i). a responthe coastal path. Wd' et er dyou
.b
would . Users l:t,I•
accept th , , \'l1 J{1¼ .
visitors to t rs that we iscusse a ove: e e lttn ).
~oo~~o n~~
depe . tter identifiable, capable of consistent 11)~n1
, Is the sub1ect ma ;.,st identified, suitable criteria and • eva\uation
ement agau, . . c tn a for l)r
measur edures for gathenng evidence to sup rn. that
. ted to proc . h' Pon th ean
sub1ec t" Toe subject matter m t is case is c\ea \ at eva\ b~
suremen · • · r Ythe ll ' llar
or mea h l cal authority mformmg potential visitors Of oeurn i1)n
issued by t e ~ ns and that it is safe to use provided that t~e Path ent
d ·ts attractio . b . notice .
an i f se Toe assertion a out safety 1s dearly sub· is ta~e
of the ease o u . Ject matt n
. er
information. . .
. . t be used are suitable and are ava1\able to int
, Toe cntena O . • h encleu
ill remember that cntena s ould have the io\\ .
users -You w l 1· . . owing
. t·cs- relevance, comp eteness, re 1ab1hty, neutrart1
charactens i . . ld b • . . Yanct
ity Toe cntena cou e qmte sub1ecttve in s0
understandabil · . rn.e e
th is well marked and accurately delineated is a q _ases.
That the pa f h b" d Uest1o
W ell as the existence o t e ir s and other physical f n
of fact, as . h b. . eatur
the path is easy to use 1s somew at su 1ective but th es.
Whether . Wh d ' f ' . e quest1
may be problematic. at oes sa e mean m this co t on
of safetY . h' h b d f" d . n ext') y
ave to determine if t is as een e me m the docume · ou
would h . h .. nt. For
. t there might be requirements t at V\Sltors keep to the d 1.
ms ance, .f. d h ld b e 1neateu
path, that children below a specidie . ahge s ou he acc?mpanied by
an adult, that livestock be treate wit respect, t at suitable footwear
be worn over the more difficult stretches and that such stretches are
clearly indicated.
• Sufficient appropriate evidence to support the practitioner's conclusion
is available. As suggested above, some of the statements in the docume
might be quite easy to confirm. ~isual inspec~ion would be enough to n1
prove that the path is clearly delineated, for mstance.The birds might
be more difficult as they tend to fly around, but talking with \oca\ bird-
watching groups would confirm their existence and what times of the vear
they would be best seen. The question of safety is more difficult to pr;ve.
particularly as some times of the year might be safer than others. \n the
winter or any rainy season or at times when tides are high, the path might
be more difficult to walk, and, if so, the document should state this fact.
You might be able to obtain sufficient evidence by visual inspection at
different times of the year or talking to local walking groups to pro\'e that
the subject matter information is generally valid.
Regarding the form of conclusion - positive or negative - this depends on
whether the evidence gathered was sufficient and appropriate or not. \'ou
~ight decide that there are so many variable factors that you could 0~1~
give a negative form of opinion. The variable factors would include dittermi
conditions at different times of the year the nearness to the sea, the fact thal
'
ease Of access :'ould depend on the local authority keeping the path c\eara
and that a contmuous eye has to be kept on material washed up fromth' se ·
your couclusion report might describe the evidence that you had sought. but
your conelusion
·
on safety might be along the lines of: 'Nothing has com,w

-
 Assurance engagements 619

attention that would lead us to believe that the statements on safety made
0 ~\nelocal auth~rit~ in the document are not reliable.' .
ti) flte last question ts about your ability to prepa_re an e~g~gem_e~t report 1f
were doubts about your independence of mmd. This 1s a difficult ques-
t~ereto answer. It depends on whether you had been involved in the detail
u00 eating the policy to the extent that you were exercising management
of ~jons. If this were the case, it would be difficult for you to prepare an
ftl!l endent report. It might be advisable for you to pass the assurance
d
io e~ement to a fellow partner not involved in the advisory activity. At
eog:xtreme, another firm might be better placed to carry out the assurance
tbe eroent. If, on the other hand, you had not been involved in the detail
eogag !icy form ulation, but had confined yourself to broad issues such as
of P0uate pubhc1ty,
· ·
re ducrng
· env1ronmenta
· 1 pollution
· and considering the
:::eiy of the path for all users, you might be able to give an independent
rance report.
ass U

I CASE STUDY 15.2 \ ;s

Gilling Limited Ferry income 100 000

Gilling Limited is a company based in a coastal village. It Refreshment income 25 000
wns a pleasure boat and dunng May to October each Less refreshment costs - 8 500
0
ar uses it to take visitors to an island some five miles 16 500
~~shore, known for its histmical interest, ancient light- 116 500
house and for seals and puffins, some 70 000 pairs of
which nest there each year in spring and early summer. Wages of ferrymen 25 000
The boat carries a maximum of 82 passengers and leaves Wages of administrator 5 500
its home port daily, at varying times depending on the Fuel 1 000
tide, and provided at least 12 passengers are aboard.
There are two crewmen, one of whom serves refresh- Insurance 10 000
ments to passengers. The fare is f 14 (£ 12 for certain Annual refurbishment and 4 000
classes of people) and £6 for accompanied children. The certification
trip to and from the island takes one hour each way and Sundry admin 3 000
passengers spend three hours ashore. There is a small
Licence 2 000
museum on the island, next to the seabird research sta-
tion, but there are no other facilities, apart from clearly Harbour dues 2 000
marked paths. The administrator and ferrymen are part- Depreciation of ferry 5 000
time, being employed also in a local boatyard. The com- Operating profit 57 500
pany is licensed by the local authority and pays an annual
59 000
licence fee of £2000.
The company cannot meet demand in June, July and Less interest expense - 15 000
August and has decided to acquire another (second- Profit after interest 44 000
hand boat), similar to the one the company is already
running, for £150 000 and has prepared the following The company has applied to its bank for a loan of
forecast profit and loss account for the second boat. The £100 000 to be repaid over a period of ten years and has
company has applied to the local authority for a further provided the bank with the forecast financial statements
licence. set out above.
 internal audit
ernents and
620 Assurance engag

ACTIVITY 15.1 2
Identify the principal business risks that might b
1
company of this nature and suggest measures t e faced b
. ht adopt to reduce their impact. · hat the co Ya
mtg . . 111pa11
2 Describe the m_adJ?r
. won the vah 1ty o
m;:~er;
you would consider Whe
e orecast profit and 1 . . n forni ·
Y

vie oss acco 'tig.

3 In your opinion w~uld the engagement be an assu Unt. ,,
engagement as defmed on page 595? ranee
lain whether you would be able to give a re
4 Exp h b k . asonab1
i:.... ·ted assurance
tot e an on the figures in th f e or
uu,1 e Oree
financial statements. ast

. •pal business risks facing Gilling Limited includ e:

1 The pnnc1
The risk that passengers or crew may suffer injury du . .
( )
a mbarking or disembarking, with resulting claims or 1nng trips or .
e ·1 dh oss of in
utation, because of fa1 ure to a ere to health and cornpa
rep . f h. . k safety . nv
tion. To reduce the im~act o t is ns ' passengers should be 1eg1s1a.·
are of safety regulations and emergency procedures C rnade
aW . . . · rew h
be trained to take appropnate
.
act10n m the event of em
d I . eroen
s ould
to distribute life jackets m an or er y fash10n. There sho le,d cy and
u be suffi.
cient life jackets on boar , me1ud"mg th ose suitable
d . . for ch.Id
1
boat should have signalling and radio equipment on boa d ren. The
authorities c~n be m · formed of probl ems on a timely
· r There
basis. so coaStal
should be stnct control of numbers on board and a registe f
r o nam
taken at point of payment. es
(b) The risk that bad weather may. prevent . h
sailing or cause peopl
e not
to visit the village or tak e a tnp m t e company's boats. The com.
pany will not be able to change the weather, but it should have a
system of informing customers on a timely basis if the trip is not to
take place. If landing on the island is not possible because of heavv
swell, the crew might be trained to run the boat round the island. ·
pointing out nesting sites and other interesting features.
(c) The risk that other operators might enter the market. The companv
does seem to be profitable and there will always be a risk that com-
petitors will enter the market. The best strategy for the company
might be to make the trips as interesting and informative as possible.
There seems to be little in the way of facilities on the island, and it
may be better that it stays like that, but the company might arrange
for seabird research personnel or museum staff to give talks about
birds nesting on and visiting the island, and some of the history of
the island. As far as the second boat is concerned, managern~nt
might consider alternative destinations if demand for trips to the
island turn out to be less popular than expected.
(d) The risk that crewmen might be lost to other activities alung. th l·

.....
coast. Clearly, the company should pay personnel well :111d g.l\l'
r n,;ght b
a eas u res th e faced • em
em.training to enh
a Iocal boat ance th e1r
. work Assu
at th by e in the boatyard ~~r1 and it may b:t se~ms that staff ranee engagements
'ti e co <l 1
b ~onsider ll1p<l ti ey have
. left or are . a
k
sic .ke the pl ace [desirable to tra· work
o crewmen . n other peo- part
fit and I0SsWhen fOr . Y e nsk that the ope rating
. I' , either beca use
1t be an accou il11ti n orroed of the terms o f theicence
I' maY not b
assur llt. "' a ure that they are adhered t icence T c renewed· we are not
' but the e
ance
d safety
• procedures 0 · he terms
mentio . ompany should mak e
might·
'. give area pect1ons and overha u I. ned above and annualinclude the health
rgures . sonab1 t step might be to co . or more regular
In the f e or
Oree ast ns1der th
, an d to do this by estim t' e reasonab\ene
ed mix of passengers. Let:ng the full-capacit ssi~f the projected
reveal an average nux · of fulls assume
. that d'1scuss1on
Y . come ·on h an
ults 10 per cent and ac payin g adults 65 s wit manage-
•nited lllclude·
· tal income from full co~panied children 25 per cent, concession-
capacity trips would be: per cent. On this basis
iffer injur ·
ir g claim:o~~ring trips Adults Concessions Children "Total
to health o ss of or in 65%
and colll Pe ntages 10% 25%
assengers sh safety le .Pany 53 8 82
cy proced ouJd be g1sJa. ijurn~rs one trip 21
lh ures C 111acte I £14 £1 2 £6
, e event of . rew sh i:are
£742 £96 £1 26 £964
/rJ..ion. Ther emergenc ouJct
b- s . e should y anct 184
. UitabJe forch · besuffi £177 376
upment on b ildren. Th .
. oarct e
JD a tunely basis ~o coastal e income projected by the compan 15
. li
ard and a re g1ster
. · ofhere capacity on this
. basis - which looky s ghtly_ above 56 per
f cent
f . of
~
s conservative on th
names d enqwre
P000 of management how they had l ul e ace it.
ul d f' ca c ated the figure
. an you m~y ~nd that they have assumed the boat would be
iling or cause e i~_.,,
:8 at lower capacity m May, September and O t b Th O
1pany's b p ople not ,f al · I c er. e same
1
oats. T he c Or: an yttca work would be carried out on the refreshment .mcome
:r, but it should h om- company b as. assumed. a gross
. margin on· refreshments of 66 per cent,
·
. . ave a
b as1s
. 1f the trip ts
• not to u sh ould.d1scuss this '_"It~ m~n~gement. You are to\d that the boat
oss1ble because of heav pany wishes to acq~rre is s~milar to the existing boat and you will
boat round the island Y ~e to compare the pro1ected figures with the actual figures for the
ing features. ' · egboat.
important point that you should discuss with management is
1e market. The company
ether the second boat will need any refurbishment to bring it up to the
'i\'ays be a risk that com- d roquired by the local authority and health and safety regulations.
tegy for the company 8$k the company to prepare a cash flow forecast to accom-
1 informative as possible. the forecast profit and loss account, as this might reveal that , initially
es on the island, and it ast, the company might need to borrow more than £100 000. On the
10mpany might arrange asis 0£ the forecast profit and loss account, the company would seem
lli to give talks about 11>,have a projected positive operating cash flow in the year ol £49 000
rme of the history of (profit £44 000 plus depreciation £5000). You would need to review the
projected costs carefully to ensure none are missed, and in calculating
med, .management
cash flow, calculate tax charge, the amounts that the directors' remu-
land for trips to the
neration might be, and dividends expected by shareholders. particular
ed. attention should be paid to annual refurbishment and certification.
th
rctivities along_ e
wel well and give
 ements and internal audit
622 Assurance engag boats are no longer new, annual refurbish
Asthe . . dt rnent .
e toxic em1ss10ns, an o meet ever more . might .
to reduc stn 11 e 1nei
safety requirements. g nt hea11ull~'
em to be an assurance engagement Gi·ii· han}~~
3 It does se . · 1ng Li . ~
'ble party. The bank 1s clearly the prirne u rn1tect .
respons1 . ser alth is th
th er interested parties as well - the local ' oUgh e
may be o . autho · th
fety authorities, the pubhc. The subject rnatte . nty, th" ere
and sa h • r 1s th ~h
f btaining finance to allow t e runnmg of a second b e feasib·e_alth
? o tter information is the forecast
1ect ma h fl
profit and los oat. 'he llity
s accou sUb
our way - a forecast cas ow statement th nt , a ·
You have Y
. by management that the forecasts are a fair
, e sub· nll 1•
Jeq of r
assert100 Th . . repre a
. . ted profits and cash flows. e cntena are tho sentati n
ant1c1pa ( se ele on
Cas ts that will enable the bank and the other p lllents or
th e fore otenr 1 of
involved) to make soundly based decisions and th a1 User .
they get 1 ' ey d s,r
have characteristics of relevance, comp eteness, reliability, n o have
dability. We can agree that the forecast profit eutrality to
understan . anct lo an
sh flow statements are relevant. You might argue th ss acco d
and ca . 1 . . h . at co unt
ness Would be achieved .by. me us10n m t e subject. matter of theillplete.
assumptl·ons made by Gdlmg - such as numbers . . .hkely to use th illai·or
report will have added a degree of rehab1hty and the e boat.
Your . .h h use ofk
·ng principles consistent wit t ose used by the com nv
acco Untl .. Pany1· 01 n
pastwill add neutrality and understandab1hty. . There is a practn. . nthe
10
this case you_ and you have collected evidence to enable you ; er, in
10
an assurance report. repare
4 Forecast financial statements and cash•flow statements .
are int
enctect
bl
to 1·uuminate the future. The pro hem 1s uncertainty ..
about th f
e uture
Although the future is not clear, t e practitioner can test the r ·
. d . . . 1 easonab1
ness of the assumptions m eternumng mcome evels and costs e.
. . .1 d . anct the
can ensure that the accountmg pnnc1p es use are acceptable and h I'
. t at
calculations are accurate. In your report Y?U can desc~1be the criteria
and discuss important elements of .the subject matter information. y00
would explain the nature of the evidence that you have examined b .
. d' l 1 . . . Ut It
is doubtful that you could give an au 1t- eve op1mon. In other word f
. . d s. or
this kind of engagement only Iumte ~ssurance would be possible and l'ou
would give a negative form of expression. ·

INTERNAL AUDIT
See page 287 in Chapter 7.
From time to time we have mentioned internal audit and this is an appropriate
point to discuss its function and its work in greater detail. Internal audito11
may not be practitioners in the terms of the amended Assurance Framework
or ISAE 3000 (revised) we discussed above, and management may be the
single user of their services, but we shall find that internal auditors provide
assurance to management on a range of matters of interest to the company.
In addi~ion, because their work frequently covers areas of interest toe~ter_-
nal auditors, the latter may use their work in achieving their own obiecuves.
We made the same point earlier with regard to the work of the quality
standards function.
 Internal audit 623

ACTIVITY 15.13
What do you think is the . d th
uality standards functio co~mo~ ~eature of internal aud~l an . e
~ q ble the auditor to I n, identified in Chapter 7, which might
l,I ena re yon their work?

·mportant feature of inte 1 . .

1 ·
;\n. indepen dence f rom day-to
rnad audit and the quality standards
. function
ld h •
is thetr . . - ay management. The auditor wou ave
10 decide if the~ were truly independent, but we did suggest in Figure 7.6 that See page 287 .
quality sta~darhs personnel ~hould be independent of the computer depart-
makmg t em more reliable fr .
Jllent, . _om management's point of view.
We shall now turn t~ a discussion of the work of internal auditors and
?e
whY it might appropn~t~ fo~ auditors to rely on the function. Here is the
definition of mternal auditing issued by the Chartered Institute of Internal
Auditors:
Internal auditing is an indepe~dent, objective assurance and consulting activ-
ity desig~ed ~o add valu~ an~ imp_rove an organization's operations. It helps
an orgamzation accomphs~ its 0 bJectJves by bringing a systematic, disciplined
approach to evaluate and improve the effectiveness of risk management, control.
and governance processes.

This definition has some common elements with external auditing. Thus,
there is a reference _to _i~dependence and also to assurance, risk and govern-
ce all terms of s1gmflcance to external auditing. However, the definition
an ' · d'ff
would seem to suggest two ma1or I erences between internal and external
audit:
1 The internal audit function, as its name suggests, is established within the
organization and reports to the board and senior management who are
within the organization's governance structure. Its independence should
be judged with this in mind.
2 A prime objective is to improve an organization's operations.
External auditors do, as we have seen, often provide services to manage-
ment designed to improve the organization's operations in the context of the
business risk approach, but this is as a by-product of the audit process rather
than a main objective.
The aim of statutory auditing is to establish whether financial statements
have been drawn up in compliance with regulatory requirements, some of
them legal, others professional and others required by regulatory bodies
such as the Stock Exchange. For this reason the statutory audit process is
sometimes described as 'compliance auditing'. Internal auditing, however,
although still concerning itself with compliance auditing, is moving into
other fields where it acts as an 'arm of management' in obtaining greater
efficiency and effectiveness in all operations of the organization. We shall
see later that the increasingly wide range of work performed by internal We discussed corporate
auditors has made some commentators suggest that the internal audit governance 1n Chapter 2 and
function might play an important role in the way that companies govern discuss it further 1n Chapters 16
themselves. and 19.

1~