Audit book by m asif chapter 17 reliance on others

Auditing – Study Notes Chapter 17 Reliance on Others CHAPTER SEVENTEEN RELIANCE ON OTHERS LO # LEARNING OBJCTIVE PART A – AUDIT OF GROUP FINANCIAL STATEMENTS LO WHAT IS A GROUP AUDITOR LO WHAT IS A COMPONENT LO TYPE OF WORK TO BE PERFORMED ON COMPONENT LO RESPONSIBILITIES IF WORK OF COMPONENT AUDITOR IS USED LO IMPACT OF USE OF WORK ON AUDITOR’S RESPONSIBILITIES PART B – USING THE WORK OF INTERNAL AUDITORS DEFINITION AND OBJECTIVES OF INTENRAL AUDIT FUNCTION LO COMPARISON OF INTERNAL AUDITOR WITH EXTERNAL AUDITOR AUDITOR’S RESPONSIBILITIES IF AUDITOR USES WORK OF AN INTERNAL AUDIT LO LO IMPACT OF USE OF WORK ON AUDITOR’S RESPONSIBILITIES LO PART C – USING THE WORK OF AN AUDITOR’ S EXPERT LO 10 AREAS WHERE WORK OF EXPERT CAN BE USED LO 11 DETERMINE WHETHER TO USE WORK OF AUDITOR’S EXPERT AUDITOR’S RESPONSIBILITIES IF AUDITOR USES WORK OF AN EXPERT EVALUATE THE COMPET ENCE, CAPA BILITIES AND OBJ ECTIVITY OF EXPERT EVALUATE APPROPRIATENESS/AD EQUACY OF WORK OF EXPERT AS AUDIT EVIDENCE LO 12 LO 13 LO 14 LO 15 CONCLUSION ON ADEQUACY OF WORK OF EXPERT LO 16 IMPACT OF USE OF WORK ON AUDITOR’S RESPONSIBILITIES REFERENCE Section (Chapter 13) Section (Chapter 13) Section (Chapter 13) Section (Chapter 13) Section (Chapter 13) Section (Chapter 13) Section (Chapter 13) Section (Chapter 13) Section (Chapter 13) Section (Chapter 13) Section (Chapter 13) Section (Chapter 13) Section (Chapter 13) Section (Chapter 13) Section (Chapter 13) Section (Chapter 13) Auditing – Study Notes Chapter 17 Reliance on Others PART A – AUDIT OF GROUP FINANCIAL STATEMENTS LO 1: WHAT IS A GROUP AUDITOR: Group Auditor: Group auditor is the audit firm responsible for the audit of the group financial statements Group auditor will also be the auditor of the parent company Problems in a Group Auditor:  Large number of components  Components may be with a different accounting year end  Components may be with a different currency  Specific adjustments relating to consolidation Responsibilities of Group Auditor:  Perform Acceptance and Continuance Procedures (i.e whether he will be able to obtain sufficient appropriate audit evidence on all components)  Obtain understanding of components (i.e which is significant and which is not) and consolidation process  Establishing overall group audit strategy, including o Determining materiality levels for components o Deciding type of work to be performed on component  Responsibilities if work of component auditor is used o Evaluate the competence, objectivity etc of component auditor o Communicate with component auditor LO 2: WHAT IS A COMPONENT: Component: A component is an entity or business activity, for which group or component management prepares financial information, that should be included in the group financial statements (e.g in case of subsidiaries, branches or combination of both) Significant component: Significant Component is a component identified by the group engagement team, that is: of individual financial significance to the group, or likely to include significant risk of material misstatement in the group financial statements (due to its specific nature or circumstances) LO 3: TYPE OF WORK TO BE PERFORMED ON COMPONENT: Nature of component Significant (on financial basis) Work to be performed Audit of whole component using component materiality Auditing – Study Notes Significant (on risk basis) Non-significant Chapter 17 Reliance on Others audit of whole component using component materiality or audit of one or more account balances or classes of transactions or audit procedures specific to assertions having significant risk (Procedure to be performed will depend on effect of risk.) Analytical procedures at group level If evidence cannot be obtained from analytical procedures, additional procedures (similar to significant components) may be performed on some of selected components (this selection will change every year) If a component is subject to an audit by law or regulation or other reason, auditor shall evaluate whether materiality level is appropriate If materiality level was low, additional procedures will be necessary LO 4: RESPONSIBILITIES IF WORK OF COMPONENT AUDITOR IS USED: A component auditor is an auditor who, at the request of the group auditor, performs work on the financial information of a component Obtaining understanding of component auditor: Group Engagement Team shall obtain understanding of following if it plans to use a component auditor: Whether component auditor understands and will comply with Independence requirements (and other ethical requirements) Whether component auditor has Professional Competence (e.g industry specific knowledge) Whether component auditor operates in a regulatory environment that actively oversees auditor Whether group engagement team will be able to be involved in the work of component auditor to the extent necessary to obtain sufficient appropriate audit evidence If group engagement team has serious concerns/issues about component auditor from above evaluation, it will not engage such component auditor However, if concerns are less than serious, group engagement team may engage component auditor but it will have to perform additional audit procedures by getting involved more extensively in the work of component auditor Involvement in work of component auditor: In case of a significant component, group engagement team shall be involved in component’s risk assessment to identify significant risk This involvement shall include, at minimum, following: o Discussing those business activities of component which are significant to the group o Discussing susceptibility of component to misstatement due to fraud or error o Reviewing component auditor’s documentation of identified significant risks for group financial statements For other components, extent of involvement will depend on understanding of component auditor Auditing – Study Notes Chapter 17 Reliance on Others Communication between Group Auditor and Component Auditor: Letter of Instructions Memorandum/Report of work performed (From group auditor to component auditor) (From component auditor to group auditor) –nature, timing and extent of work to be –List of uncorrected misstatements performed by component auditor –Material weakness in internal controls –Identified risk of material misstatement relevant to component auditor LO 5: IMPACT OF USE OF WORK ON AUDITOR’S RESPONSIBILITIES: Auditor (i.e Group Engagement Partner) has sole responsibility to express opinion on Financial Statements His responsibility is not reduced if he uses the work of component auditor He shall not refer to the work of component auditor in auditor’s report unless it is: a Required by Law or Regulation or b Necessary to explain nature of modification in auditor’s report If reference of component auditor is made in auditor’s report: a Auditor may need the permission of the component auditor before making such a reference and b Auditor shall state that such reference does not reduce auditor’s responsibility for audit opinion PART B – USING THE WORK OF INTERNAL AUDITORS LO 6: DEFINITION AND OBJECTIVES OF INTENRAL AUDIT FUNCTION: Internal Audit Function: Internal Audit Function is a function that performs activities to evaluate and improve entity’s Governance, Risk Management and Internal Control Following are objectives/scope/activities/benefits of internal audit function: Governance Activities Risk Management Activities Internal Control Activities Special Investigations Assisting Board of Directors in overseeing:  strategic direction of the entity and  obligations related to accountability of the entity  Identification of Risks  Management of Risks  Review of economy, efficiency and effectiveness of operating activities (called Value for Money audit)  Review of compliance with laws and regulations  Review of financial information (by performing tests of details)  Monitoring and Evaluation of Internal Control (by performing tests of controls on design, implementation and operating effectiveness of internal control)  Investigations when there is suspected fraud within the entity Auditing – Study Notes Chapter 17 Reliance on Others Disadvantages of internal audit department include:  Internal auditors are not independent of entity  Higher cost is involved in establishing internal audit department  There may be lack of qualification and experience in internal audit department LO 7: COMPARISON OF INTERNAL AUDITOR WITH EXTERNAL AUDITOR: Internal Auditor Relationship/Independence Employee of entity Appointment By BOD/Audit Committee Qualification Determined by BOD/Audit Committee Objective is to evaluate and improve Scope / Objectives / entity’s Governance, Risk Management and Activities Internal Control Scope/Objectives/ BOD/Audit Committee Activities determined by Reports To BOD/Audit Committee and his Reporting reports are restricted to them Format of Report Any (depending on circumstances) External Auditor Independent of entity By Members Determined by Law Objective is to express an opinion on financial statements and on additional matters required by law Determined by Laws and Regulations Reports to Members and his report is publically available Determined by Law Methods to ensure Independence of Internal Auditor: Internal auditors are not independent of company; however they should be independent of management To ensure this:  they should be reportable to audit committee and not to CFO  Scope of work of internal auditor should be decided by audit committee or internal auditor; and not by management or finance director etc  To avoid familiarity threat, Internal auditors should be rotated periodically e.g after every to years  Internal auditor should be appointed by BOD or audit committee; and not by management  Internal auditor should not be responsible for design or implementation of control; they should be responsible for monitoring and evaluation of control Areas where work of internal audit function can be used by external auditor:  Testing of the operating effectiveness of controls;  Substantive procedures involving limited judgment;  Observations of inventory counts;  Tracing transactions through the information system relevant to financial reporting;  Testing of compliance with regulatory requirements;  audits or reviews of the financial information of subsidiaries that are not significant components to the group Auditing – Study Notes Chapter 17 Reliance on Others LO 8: AUDITOR’S RESPONSIBILITIES IF AUDITOR US ES WORK OF AN INTERNAL AUDIT: If entity has an internal audit function whose activities are relevant to audit, external auditor shall perform following procedures before using/relying on the work of internal audit function: determine whether the work of the internal audit function can be used by evaluating competence, objectivity and approach of internal auditor (if work can be used) evaluate appropriateness/adequacy of internal auditor’s work as audit evidence Evaluating the Internal Audit Function: Evaluation Factors to consider while evaluating – Level of education and professional qualification – Training and experience of internal auditors Competence –Specific knowledge and skills relating to entity’s financial statements –Whether internal audit function is adequately resourced –Compliance with internal auditing standards relating to objectivity –Hiring/Firing authority of internal auditors should be with TCWG Objectivity –Organizational status (e.g whether it reports directly to TCWG) –Free from conflicting responsibilities (e.g no managerial work) –Whether internal auditors apply a systematic and disciplined approach –Quality of internal auditor’s working papers (covering risk assessments, work Approach programs, documentation and reporting) –Consistency of Conclusions with work performed –Quality Control Program for internal auditor Evaluating the adequacy of work of Internal Audit Function: Before using specific work of internal auditor, auditor shall determine adequacy of work by evaluating whether:  The work of the function has been properly planned, performed, reviewed and documented  Sufficient appropriate evidence has been obtained to draw reasonable conclusions, and  Conclusions reached are appropriate in the circumstances and reports prepared are consistent with the conclusions For this evaluating, auditor’s procedures may include:  Reperformance of some of the work  Review of internal audit function’s work programs and working papers  Observation of procedures performed by the internal audit function  Inquiries of individuals within the internal audit function Exact nature, timing and extent of testing of specific work depend on:  Scope and assessment of of internal audit function’s work  Risk of material misstatement  Significance of Judgments involved in work If auditor determines that the work of internal auditor is not adequate for auditor’s purposes, auditor may: − Perform additional audit procedures appropriate to the circumstances or − Agree with internal auditor on further work to be performed by internal auditor Auditing – Study Notes Chapter 17 Reliance on Others LO 9: IMPACT OF USE OF WORK ON AUDITOR’S RESPONSIBILITIES: Auditor (i.e external auditor) has sole responsibility to express opinion on Financial Statements His responsibility is not reduced if he uses the work of internal auditor He shall not refer to the work of internal auditor in auditor’s report in any circumstances Direct Assistance: Direct assistance is defined as the use of internal auditors to perform audit procedures under the direction, supervision and review of the external auditor ISAs prohibit direct assistance procedures that:  involve making significant judgements in the audit;  relate to higher assessed risks of material misstatement;  relate to work with which the internal auditors have been involved and which has already been, or will be, reported to management or TCWG by the internal audit function; or  relate to decisions the external auditor makes regarding the internal audit function and the use of its work or direct assistance Prior to using internal auditors to provide direct assistance, the external auditor shall:  Obtain written agreement from an authorized representative of the entity that the internal auditors will be allowed to follow the external auditor’s instructions, and that the entity will not intervene in the work the internal auditor performs for the external auditor; and  Obtain written agreement from the internal auditors that they will keep confidential specific matters as instructed by the external auditor and inform the external auditor of any threat to their objectivity Agreement: It may be useful for the external auditor to agree the following in advance with internal audit:  the timing of such work  the nature of the work performed  the extent of audit coverage  materiality and performance materiality  methods of item selection and sample sizes  documentation of work performed  review and reporting procedures Documentation: The external auditor is required to document:  threats to the objectivity of the internal auditors, and the level of competence of the internal auditors used to provide direct assistance;  The basis for the decision regarding the nature and extent of the work performed by the internal auditors;  Who reviewed the work performed and the date and extent of that review;  The written agreements obtained from an authorized representative of the entity and the internal auditors; and  The working papers prepared by the internal auditors who provided direct assistance on the audit engagement Auditing – Study Notes Chapter 17 Reliance on Others PART C – USING THE WORK OF AUDITOR’S EXPERT LO 10: AREAS WHERE WORK OF EXPERT CAN BE USED: Expert may be required by management/auditor when financial statement involve following: − Estimation of life and valuation of fixed assets − Valuation of specialized inventory − Analysis of complex or unusual tax compliance issues − IT Expertise − Legal Opinions LO 11: DETERMINE WHETHER TO USE WORK OF AUDITOR’S EXPERT: Auditor’s expert: An individual or organization possessing expertise in a field (other than accounting or auditing), whose work in that field is used by the auditor to assist the auditor in obtaining sufficient appropriate audit evidence Assessing the need for an expert: Considerations when deciding whether to use an auditor’s expert may include: Risk of material misstatement of the matter Subjectivity, significance and complexity of the matter Availability of alternative sources of evidence LO 12: AUDITOR’S RESPONSIBILITIES IF AUDITOR USES WORK OF AN EXPERT: Auditor shall perform following procedures if auditor uses work of an expert: 1) Evaluate the competence, capabilities and objectivity of expert 2) Obtain an understanding of the field of expert 3) Evaluate the appropriateness/adequacy of expert’s work as audit evidence 4) Agree terms with expert i.e  Nature and scope of work  The respective roles and responsibilities  Communication and Reporting  Confidentiality requirements LO 13: EVALUA TE THE COMPETENCE, CAPABILITIES AND OBJE CTIVITY OF EXPERT: The auditor shall evaluate whether the auditor’s expert has the necessary competence, capabilities and objectivity Competence, capability and objectivity of an expert may be assessed in following ways:  Personal experience of previous work with expert  Discussion with expert  Discussion with other professionals who have worked with expert  Books or papers published by expert  Knowledge of expert’s qualification, membership of professional bodies or other external recognition, license to practice Auditing – Study Notes Chapter 17 Reliance on Others LO 14: E VALUAT E APPROPRIATENESS/A DEQUACY OF WORK OF EXPERT AS AUDIT EVIDENCE: For this purpose, auditor shall evaluate: Relevance, completeness, and accuracy of significant source data (if expert’s work involves use of significant source data) Relevance and reasonableness of significant assumptions and methods (if expert’s work involves use of significant assumptions and methods) Reasonableness of expert’s findings and conclusions Consistency of these conclusions with other audit evidnece LO 15: CONCLUSION ON ADEQUACY OF WORK OF EXPERT: If auditor determines that the work of expert is not adequate for auditor’s purposes, auditor shall: − Agree with expert on further work to be performed by expert − Perform additional audit procedures appropriate to the circumstances − Consider the necessity to engage another expert LO 16: IMPACT OF USE OF WORK OF EXPERT ON AUDITOR’S RESPONSIBILITIES: Auditor has sole responsibility to express opinion on Financial Statements His responsibility is not reduced if he uses the work of expert He shall not refer to the work of expert in auditor’s report unless it is: a Required by Law or Regulation or b Necessary to explain nature of modification in auditor’s report If reference of expert is made in auditor’s report: a Auditor may need the permission of the expert before making such a reference and b Auditor shall state that such reference does not reduce auditor’s responsibility for audit opinion ... components, extent of involvement will depend on understanding of component auditor Auditing – Study Notes Chapter 17 Reliance on Others Communication between Group Auditor and Component Auditor:... risk basis) Non-significant Chapter 17 Reliance on Others audit of whole component using component materiality or audit of one or more account balances or classes of transactions or audit procedures... – Study Notes Chapter 17 Reliance on Others LO 9: IMPACT OF USE OF WORK ON AUDITOR’S RESPONSIBILITIES: Auditor (i.e external auditor) has sole responsibility to express opinion on Financial Statements