ACCA paper f8 auditiing and assurance F8AA(IntRQB as d08

REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) Answer AUDITORS AND AUDITING STANDARDS (a) Development, role, and authority of ISAs ISAs set out the basic principles and essential procedures that auditors should follow in the conduct of an audit of financial statements Auditing Standards are in bold type The grey type found in ISAs provides guidance on the application of ISAs Each Standard contains objectives and requirements (“shall”) with related guidance (introductory, explanatory, application, definitions and other material, including appendices) The entire text of a Standard must be understood in order to apply the requirements of that Standard A current project is underway to redraft all ISAs – not to revise but to rewrite in plainer language and an improved structure The differentiation between bold and plain text has been removed The structure of the redrafted standard will show the objective and requirements of the standard and will be supported by application and other explanatory material – all of which should be considered as an integral part of the standard International Standards on Auditing are set by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants (IFAC) The IAASB is made up of representatives (in practice, commerce, research and academic) of the profession who are members of IFAC ISAs and other documents issued by the IAASB are developed using a process of exposure and consultation in order to obtain consensus and wide-spread acceptance of standards Consultation is with interested parties outside the profession, as well as within the profession itself 1001 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK Project is proposed and input sought If approved, project assigned to a Task Force Research carried out and Exposure Draft prepared ED placed on IFAC website and widely distributed for comment to member bodies, interested parties and general public Comments received are considered, ED revised and re-issued if substantive changes made Revised ED approved and issued as a Standard Projects are identified by the members of the IAASB, the Consultancy Advisory Group, the Forum of Firms, national auditing standard setting bodies and IFAC members The Consultancy Advisory Group gives representatives of the business community and international organisations the opportunity to contribute to the development of international auditing guidance Members of the Group represent organisations that have an interest in international auditing The Task Force carries out the basic research and development of an Exposure Draft (ED) This may be done as a joint project with a national auditing standard setting body ISAs apply to all audits of financial statements that are expressed in “true and fair”, “fair presentation”, or similar terms Each of the objectives within a Standard must be considered within the context of the overall objective of the audit as a whole If an objective cannot be achieved, the auditor must use their judgement to evaluate the impact on their ability to achieve the overall audit objective By their very nature, ISAs require auditors to use their professional judgement when applying them In exceptional circumstances, a professional accountant may judge it necessary to depart from a basic principle or essential procedure of a Standard (and Practice Statement) to achieve more effectively the objective of the engagement When such a situation arises, the professional accountant should be prepared to justify the departure 1002 REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) (b) The role of the ACCA in the regulation of auditors Auditors are regulated differently in different countries In some countries governments regulate auditors directly, or through government organisations (eg the Public Accounting Oversight Board in the USA established by the Sarbannes-Oxley Act) In other countries the profession is self-regulating In most cases, there is some combination of self-regulation and government regulation In the UK, the monitoring of the quality of the audit function carried out by listed company auditors is conducted by the Professional Oversight Board for Accountancy (POBA) of the Financial Reporting Council (FRC) The FRC is the UK’s independent regulator for corporate reporting and governance and is responsible for: setting, monitoring and enforcing accounting and auditing standards statutory oversight and regulation of auditors overseeing the regulatory activities of the professional accountancy bodies promoting high standards of corporate governance operating an independent investigation and discipline scheme for public interest (eg listed) cases Inspection of auditors under the monitoring of the POBA is carried out by the Audit Inspection Unit (AIU) Such inspection incorporates a very thorough quality control review including reviews of audit working papers and audit procedures The regulation and inspection of auditors for non-listed companies is carried out directly by the professional bodies, eg the ACCA Professional bodies such as the ACCA, seek to uphold professional standards, to investigate complaints against auditors, and to assist auditors in the performance of their duties They have both investigative powers and sanctions against auditors who not comply with professional standards These include fines, exclusion from membership, and the withdrawal of the licence to audit (audit registration) Members of the ACCA are bound by its “Rules of Professional Conduct” The ACCA encourages high professional standards by setting academic requirements for those wishing to study for the examinations, by setting the examinations and by requiring additional experience of those who wish to practice as auditors This includes passing both Auditing papers (F8 and P7) in the ACCA examinations In addition, all members of the IFAC (this includes the ACCA) are required to continue their development throughout their careers (CPD) (c) How ISAs and national standards influence each other In a global market-place it is increasingly important that Auditing Standards are harmonised across the world, particularly for multinational companies It is also important that Auditing Standards are applied consistently Over the last ten years, standard setters in those countries where the profession is mature have sought to harmonise their own standards with International Standards, and to influence International Standards 1003 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK In many countries, all new national Auditing Standards contain a statement to the effect that compliance with the national standard will ensure compliance with the relevant International Standard in all material respects, if that is the case, or it will explain the difference(s) The requirements of the Standards not override local regulations governing audit and assurance in a particular country If local regulations have been followed and ISAs (and Practice Statements) that are applicable to the engagement have not been applied in their entirety, then compliance with ISAs cannot be stated as fact It is not always possible for local Auditing Standards to be the same as International Standards because of local legal requirements Nevertheless, a number of countries have accepted International Standards in their entirety, or have accepted them subject to some minor local variations International Standards are thus extremely useful for countries where the profession is not strong and where government does not seek to detail Auditing Standards, and where there are few resources to develop local standards Standard setters in countries where the profession is mature make a significant contribution to the development of ISAs by providing representatives to sit on IFAC Committees and working parties and by providing the resource to help draft standards National standard setters comment on consultation papers and exposure drafts issued by the IAPC and help summarise responses on certain projects ISAs only have force internationally if they have the support of those countries who lead the profession internationally It is therefore essential for both national standard setters and international standard setters to take account of each other’s work Answer JUMPER & CO Memo From: To: Subject: Date: A Manager, Tela & Co Jumper & Co Corporate Governance in the SGCC Company dd/mm/yyyy As requested, I write to explain where your client SGCC does not appear to be following appropriate corporate governance codes and to recommend changes to ensure that the principles of good corporate governance are being followed Chief Executive Officer (CEO) and Chairman Mr Sheppard is both CEO and chairman of SGCC Corporate governance indicates that the person responsible for running the company (the CEO) and the person responsible for controlling the board (the chairman) should be different people This is to ensure that no one individual has unrestricted powers of decision I recommend that Mr Sheppard is either the CEO or the chairman and that a second individual is appointed to the other post to ensure that Mr Sheppard does not have too much power in SGCC Composition of board The current board ratio of executive to non-executive directors is 5:2 This means that the executive directors can dominate the board proceedings Corporate governance codes suggest that there should be 1004 REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) a balance of executive and non-executive directors so this cannot happen A minimum of three nonexecutive directors are also normally recommended, although reports such as Cadbury note this may be difficult to achieve I recommend that the number of executive and non-executive directors is equal to help ensure no one group dominates the board This will mean appointing more non-executive directors to SGCC Director appointment At present, Mr Sheppard appoints directors to the board, giving him absolute authority over who is appointed This makes the appointment procedure and qualities directors are being appointed against difficult to determine Corporate governance suggests that appointment procedures should be transparent so that the suitability of directors for board positions can be clearly seen I recommend that an appointments committee is established comprising three non-executive directors to ensure there is no bias in board appointments Formal job descriptions should also be published making the appointment process more transparent Review of board performance It is correct that the performance of senior managers is reviewed, but this principle should also be applied to the board While Mr Sheppard may undertake some review, this is not transparent and it is not clear what targets the board either met or did not meet I recommend that performance targets are set for each director and actual performance assessed against these on a regular basis Reasons for underperformance should also be ascertained and where appropriate, changes made to the composition of the board Board pay At present, board members’ pay is set by Mr Sheppard This process breaches principles of good governance because the remuneration structure is not transparent and Mr Sheppard sets his own pay Mr Sheppard could easily be setting remuneration levels based on his own judgements without any objective criteria I recommend that a remuneration committee is established comprising three non-executive directors They will set remuneration levels for the board, taking into account current salary levels and the performance of board members Remuneration should also be linked to performance, to encourage a high standard of work Internal control The system of internal control in SGCC does not appear to be reviewed correctly While external auditors will review the control system, this review is based on their audit requirement and cannot be relied on to test the overall effectiveness of the system The system may therefore still contain weaknesses and errors I recommend that some more formal review of internal control is carried out, perhaps by establishing an internal audit department, as noted below The relationship with the company’s auditors must also be reviewed so that the work of the board and the auditors regarding internal control is understood by both parties 1005 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK Internal audit SGCC does not have an internal audit department Given the lack of formal review of internal control in the company, this is surprising Good corporate governance implies that the control system is monitored and that an internal audit department is established to carry out this task I recommend that an internal audit department is established, reporting initially to the audit committee who will monitor internal control and then summarise reports for the board Financial statements There appears to be acceptable disclosure in the financial statements regarding the past results of the company However, the board should also provide an indication of how the company will perform in the future, by a forecast review of operations or similar statement This is partly to enable investors to assess the value of their investment in the company I therefore recommend that the annual accounts of SGCC include some indication of the future operations of the company Audit committee There is no mention in the report of an audit committee Good corporate governance implies that there is some formal method of monitoring external auditors as well as checking that the reports from the external auditors are given appropriate attention in the company I recommend that an audit committee is established – made up from non-executive directors The committee will receive reports from the external and internal auditors (as mentioned above) and ensure that the board takes appropriate action on these reports I hope this information is useful Please contact me again if you require any further assistance Sincerely Ann C Outent Note to candidates: An alternative and allowable answer format was to answer sections (a), (b) and (c) of the question separately Taking this approach would also allow other valid points in part (b) such as inability to obtain a stock exchange listing 1006 REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) Answer CORPORATE GOVERNANCE Memo From: To: Subject: Date: Chief Internal Auditor Board of ZX Role of Audit Committee dd/mm/yyyy (a) Areas where the internal audit department can assist the directors with the implementation of good corporate governance in an organisation include: Board reports Reviewing reports to the board and reports produced by the board to ensure that they present a balanced and understandable assessment of the company’s position and prospects The internal audit department will have good knowledge of the operations of the company as well as access to accounting information The department can effectively “audit” board reports to ensure they are accurate and understandable Internal controls The board need to maintain a sound system of internal control The internal audit department will be able to review existing controls and recommend improvements to ensure this objective is met Application of ISA and IFRS The board need to have a policy for applying appropriate International Statements on Auditing (ISA) and International Financial Reporting Standards (IFRS) to the organisation Internal audit will certainly be aware of new auditing standards and will have the technical expertise (especially where internal auditors are professionally qualified) to identify changes required by accounting standards Amendments to control systems for new auditing standards and financial accounting systems for new accounting standards can therefore be recommended Communication with external auditors Under corporate governance regulations, communications with external auditors will normally be via the audit committee, although the board must maintain an appropriate relationship with the external auditors However, internal and external auditors can also work together to ensure that the internal control system is sufficient; possibly by external audit delegating work to internal audit, and each auditor reviewing the work of the other auditor The board will therefore receive reports from both sets of auditors which will be accurate because they have been properly checked Communication to the board The internal auditor can also check that appropriate information is provided to the board from the external auditor ISA 260 Communications of audit matters with those charged with governance provides a list of matters which should be communicated to the board and the internal auditor can work with the external auditor to ensure that this information is provided 1007 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK (b) The advantages of an audit committee include: Public confidence Providing increasing public confidence in the creditability and objectivity of published financial information This will be particularly important for ZX if listing arrangements go ahead While an internal audit department is not normally necessary for incorporated companies, the provision of that department will provide additional confidence in the accuracy of the financial statements and hopefully make ZX an attractive investment Financial reporting Supports the directors in fulfilling their financial reporting obligations The directors have to prepare financial statements for ZX The committee can assist by checking the financial statements to ensure that they comply with appropriate reporting requirements This is especially important where the board not have detailed knowledge of accounting requirements Communication Enhancing the role of ZX’s external auditors by providing an appropriate channel of communication Use of the audit committee will enable the external auditor to discuss issues with the financial statements with the internal auditor, prior to providing a final summary of key points to the board “Friend” of the Board The audit committee may also act as a “critical friend” to the board by monitoring the work of the board and providing helpful guidance, where corporate governance requirements not appear to be being met The audit committee should have detailed knowledge of corporate governance as part of its monitoring function of the company and can share this with the board who may not have the time to obtain detailed information The disadvantages of an audit committee include: Lack of understanding of function As the directors in ZX not have much knowledge of corporate governance, they may see the additional involvement of the audit committee as a threat to their authority or taking away some of their responsibilities This memo has hopefully outlined the advantages of an audit committee in supporting the work of the directors, removing this as a problem Role of non-executive directors As the audit committee will be made up mainly from non-executive directors, the board may see this as a means of decreasing their power and possibly letting other people run the company Again, the audit committee must be seen as fulfilling a supporting role for the main board It will utilise the special knowledge of account production and internal controls from the external auditor and business non-executives to provide appropriate review of information being given to the board Cost The audit committee will increase the expenditure of the company as the non-executive directors will require some remuneration due to their additional responsibilities While this cannot be avoided, the benefits of the committee in terms of providing assistance to the board and raising the profile of ZX ready for possible listing must not be forgotten 1008 REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) Answer FRAUD AND COMPLIANCE SEMINAR (a) Missing share certificates The auditors must treat this matter as extremely serious Not only has a senior executive perpetrated an illegal act, he has also been guilty of deliberately attempting to mislead the auditors The auditors must report the matter immediately to the audit committee, if there is one, or otherwise to the full board of directors (ISA 240) A criminal offence has been committed in the theft of the shares and in attempting to mislead the auditors The auditors would expect appropriate action to be taken Any further course of action depends on the action taken by the directors If the directors not take appropriate action, such as reporting the matter to the police, the auditors must consider the desirability of continued association with the company Failure to take action would make the directors a party to the wrongdoing involving, as it does, money for which they have a responsibility to the shareholders In most jurisdictions the auditors not normally have any responsibility for reporting the matter to third parties except in the public interest or where there is some direct legal duty imposed on auditors Their duty of confidentiality prevents their taking further action However, on resigning, they can take the opportunity to reveal their concerns in any communication accompanying their resignation They may also respond appropriately to professional enquiries from auditors nominated to replace them However, they need to obtain legal advice on the form of such communication to avoid the risk of action for breach of confidence by the company or even defamation by the finance director If the directors take appropriate action, the auditors must consider their position with respect to the current audit engagement The finance director is a key person with respect to representations on which the auditors would have relied Now that the credibility of that officer is in doubt, the necessary level of professional scepticism becomes much greater Such an official has the authority to override almost any control and is in a position to conceal such actions The control environment must be regarded as being wholly ineffective and inherent risk assessed as high Extended substantive procedures will now need to be performed in all areas that could have been manipulated by the chief financial officer Providing sufficient appropriate evidence is available then there would be no effect on the auditors’ report It is possible, under the circumstances, that the auditors may be unable to reassure themselves that further misstatements are not present In this case they would need to issue an “except for – scope limitation” qualified auditors’ report (b) Product safety The auditors have no duty to search for all instances of non-compliance with all applicable laws and regulations However, in addition to laws and regulations directly pertaining to financial reporting, the auditors also have a duty (ISA 250) to become familiar with any particular laws and regulations breaches of which might result in the company no longer being a going concern Moreover, in this case, they have already become aware of the possible breach Their suspicions are aroused and they are under a duty to investigate the matter further 1009 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK The finance director may be right in claiming the matter is of no consequence, but the fact of attempting to conceal the evidence from the proper authorities must arouse suspicions that the matter is serious The auditors need to obtain independent expert advice on the implications of the matter If the company denies access to an independent expert the auditors may consider, at the very least, issuing an “except for – scope limitation” qualified auditors’ report If the expert confirms suspicions and the effect is potentially material, at the very least the auditors would require full provision to be made, failing which an “except for – disagreement” qualified auditors’ report would be necessary (ISA 250) If the auditors’ suspicions are confirmed and the effect is material, the auditors would normally report the matter to the board of directors and to the audit committee, if the company has one In this case, however, the board is implicated in the attempt to cover up the evidence, so the auditors would report solely to the audit committee Again legal advice needs to be sought on whether the actions of the board are illegal If so, then they may consider it desirable to resign from the audit Moreover, consideration must be given to the consequences of the continued supply of unsafe goods It is likely the auditors have a case for alerting the appropriate authorities in the public interest which overrides their duty of confidentiality to the client – legal advice must be sought before doing so (c) Understatement of royalties This suspected fraud differs in being perpetrated by the company and not by employees against the company The auditors’ duty of confidentiality to the company prevents them from communicating their suspicions to the authors However, the company has a liability under the terms of the royalty agreements which must be provided for until extinguished by the statute of limitations or other limitation on the rights of creditors to sue for amounts due The auditors would possibly seek legal advice on whether the company’s action was illegal, such as a conspiracy to defraud the authors or false accounting to obtain a pecuniary advantage If the directors’ actions are illegal the auditors would expect the directors to pay the amounts due in full If the directors refuse, the auditors should consider resigning If the action is not illegal, it is certainly unethical, and the audit will be affected in two ways Firstly, if the amounts are material and the company fails to make adequate provisions within the financial statements, the auditors must issue an “except for – disagreement” qualified auditors’ report (ISA 240) Secondly, the auditors will need to revise their assessment of inherent risk at the entity level They would need to increase the tolerable level of detection risk and perform a higher level of substantive procedures than previously would have been considered necessary (ISA 240) (d) Unclaimed wages If there is no immediately apparent explanation, such as an employee on long-term sick leave, the circumstances arouse suspicions that the employee is fictitious – possibly a former employee whose resignation the supervisor has deliberately withheld from the personnel department If the amount is wholly immaterial, the auditor has no duty to investigate the matter further However, the auditor does have a duty to communicate suspicions promptly to an appropriate level of management and to see that the matter is properly investigated (ISA 240) If the auditor is not satisfied that a proper investigation is performed, it is possible that the level of management to which the suspicions are communicated is also implicated in the fraud The matter becomes more serious and must be reported to the audit committee or board of directors 1010 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK Answer 64 CREMORNE (a) Inventory valuation The chief financial officer’s view that the write down should be reflected after the end of the reporting period is irrelevant As at the end of the reporting period the material could not be used in road construction and, as such, its value, at the lower of cost and net realisable value, was $2 million The issue of the report failed to change the situation The value of inventory and operating profit should, therefore, be reduced by the amount of the write down to net realisable value, being $5 million This amount is material being in excess of 10% of operating profit If Cremorne fails to adjust its financial statements, the effect on the auditor’s report would be an “except for” qualified opinion as the matter affects only inventory valuation and is, therefore, not pervasive The cause of the qualification is a disagreement with management and the auditor’s report would describe the nature of the disagreement and quantify the effect on the financial statements The opinion paragraph would then express a qualified opinion using the phrase “In our opinion, except for” and then refer to the matters described (b) Depreciation IAS 16 Property, Plant and Equipment requires that useful lives of assets be reviewed regularly and the depreciation adjusted where there is found to be a change in useful life The chief financial officer’s claim that technological obsolescence need not be taken into consideration is not consistent with IAS 16 Depreciation for the current financial year should be adjusted so as to write off the written down value of computer controlled earth movers over their revised useful life Year of purchase Cost $000 Depreciation to 1/10/07 $000 Written down value 1/10/07 $000 Remaining useful life in years including 2008 Required depreciation charge for 2008 based on an overall life of years $000 Depreciation provided 2008 $000 2005 5,000 1,500 3,500 1,750 500 1,250 2008 8,000 8,000 1,600 800 800 Adjustment required $000 2,050 The depreciation charge should be increased by $2,050,000 which would have the effect of reducing the written down value of plant and equipment and of profit from operations by that amount If there were no other uncorrected errors I would probably accept the amount as not being sufficiently material to justify issuing a modified audit opinion if the financial statements were not adjusted It is just over 5% of operating profit but depreciation is based on an estimate of the useful economic lives of the assets As such it is not a precise amount and, on a qualitative basis, does not indicate the financial statements are necessarily materially misstated If there were other detected but uncorrected errors in the financial statements then, no matter how small these other errors might be, it would probably be appropriate to qualify my opinion on the financial statements along the same lines as in the case of inventory valuation 1154 REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) (c) Contingent liability A threat to claim for damages might be regarded as remote but the actual issue of a claim must be taken seriously If successful, the claim would certainly be material being in excess of the year’s profit There certainly appears to be some substance to the claim and the existence of the lawsuit should be disclosed in the note on contingent liabilities This note needs to be reasonably comprehensive as to the basis for the claim, the amounts involved, and the company’s grounds for not making a provision If the company does not disclose the existence of the lawsuit a qualified opinion is required as the amount is significant but not pervasive The nature of the qualification is a disagreement with management as to the adequacy of disclosure The auditor’s report should describe the nature of the disagreement including details of the contingency The opinion paragraph would then commence with the phrase “In our opinion, except for’ followed by a reference to the description of the disagreement A further concern is that the existence of the lawsuit might constitute a significant uncertainty Even if the company properly disclosed the contingent liability, it should be referred to in the auditor’s report after the opinion, as an emphasis of matter Answer 65 THETA (a) Scope paragraph (extract) The evidence available to us was limited because many of the company’s accounting records were destroyed by fire in January 2008 The financial statements therefore include significant amounts based on estimates In these circumstances there were no satisfactory audit procedures that we could adopt to obtain all the information and explanations we consider necessary Opinion paragraph Limitation on scope – Disclaimer of Opinion “Because of the significance of the limitation on the evidence available to us, we not express an opinion2 on the financial statements.” (b) Reasons for audit opinion The fire has resulted in limitations in audit work and evidence necessary to form an opinion cannot be obtained It is a matter of fact that accounting records adequate for audit purposes have not been kept and all information and explanations necessary for audit purposes have not been received Disclaimer The effect of the limitation is so material and pervasive that it is not possible to express an opinion on the financial statements An “except for” opinion could be appropriate, ie “except for the effects of such adjustments, if any, that might have been determined to be necessary had we been able to satisfy ourselves as to ” The choice of opinion (ie disclaimer v “except for”) must be justified in part (b) 1155 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK For example, significant estimates include net book values of tangible non-current assets, inventory valuations, recoverable amounts of trade receivables, provisions for unrecorded liabilities, revenue and cost of sales Alternatively – Except for The effect of the limitation is not so material and pervasive as to require a disclaimer of opinion For example, the extent of reconstruction facilitated and analytical procedures performed is such that uncertainty only remains in respect of unrecorded liabilities (say) (c) Forms of modified audit opinion (i) Emphasis of matter An emphasis of matter is clearly distinguishable from other modifications (eg qualified opinions) in that it doe not affect the auditor’s opinion An emphasis of matter paragraph highlights a matter affecting the financial statements which is discussed in note to the financial statements, for example, going concern The paragraph is included after the opinion paragraph “Without qualifying our opinion (above) we draw attention to Note X…” (ii) Qualified opinion An “except for” opinion is expressed when the auditor cannot express an unqualified opinion but the effect of the matter (disagreement or limitation on scope) is not so material and pervasive as to require an adverse opinion or disclaimer of opinion (iii) Disclaimer of opinion An auditor is unable to express (ie “disclaims”) an opinion when the effect of a limitation on scope is so material and pervasive that the auditor has been unable to obtain sufficient appropriate audit evidence (which may be reasonably expected to be available) (iv) Adverse opinion The effect of a disagreement is so material and pervasive that the auditor concludes that a qualification is not adequate to disclose the misleading or incomplete nature of the financial statements Distinctions There are three issues which distinguish the form of modified reports 1156 EITHER the matter does not affect the auditor’s opinion (ie (i)) or it does (ie (ii), (iii) and (iv)) REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) If the audit opinion is affected, then: EITHER there is sufficient appropriate evidence on a matter for the auditor to disagree with the amount, treatment or disclosure in the financial statements (as in (iv)); OR there is insufficient evidence due to scope limitation (in (iii)) EITHER the matter is “so material and pervasive” (as in (iii) & (iv)) resulting in “Because of the significance of…” (extreme opinions); OR not so material and pervasive (as in (ii)) resulting in an “except for” opinion Answer 66 ABC COMPANY (a) Audit and review engagements Audit reports are dealt with by ISA 700 “The Independent Auditor’s Report on a Complete Set of General Purpose Financial Statements” and review reports are dealt with by ISRE 2400 “Engagements to Review Financial Statements” (i) Audit engagements: work performed and assurance provided Audit engagements provide a moderate level of positive assurance to the user They require the auditor to: Obtain a detailed understanding of the entity, its environment and its internal control sufficient to identify and assess the risks of financial misstatement Obtain detailed audit evidence in respect of the financial statement assertions by means of tests of internal controls and/or detailed substantive testing, and to corroborate explanations received Perform a review of the going concern status of the company (ii) Review engagements: work performed and assurance provided Review engagements provide a limited level of assurance that may be expressed as negative assurance They consist principally of analytical procedures and inquiries made by the reviewer The reviewer is not required to understand the accounting and internal control system, nor is he required to corroborate explanations, perform detailed tests on material financial statement assertions or to conduct a going concern review (iii) Addressee Audit reports are generally addressed to the shareholders or other owners of companies, review reports are addressed to directors or other management This is because most audit engagements are statutory audit engagements (where the auditor reports to shareholders on the financial statements prepared by directors) Statutory audit reports, particularly those of large companies, are often made available to the general public because they are filed with the financial statements at a public registry or are otherwise made available to potential investors and other interested stakeholders 1157 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK Review reports are generally not made available to the general public They are generally private engagements between directors and reviewers and sometimes a third party, such as a bank, who may wish to see a report for a specific purpose (iv) Responsibility for the financial information The responsibility for the preparation of financial information in both audit and review engagements is always that of directors, regardless of who has actually prepared the information This is stated in both review and audit reports because it is easy to assume that the auditor or reviewer has prepared the information and is responsible for it It is particularly important to state this in audit reports because legislation often makes directors responsible for the statutory financial statements (v) The opinion given The two opinions provided by an audit engagement relate to the “true and fair” status of the information or to its “fair presentation in all material respects” and to proper preparation in accordance with an identified financial reporting framework, such as International Accounting Standards The opinion given in the review report is not that the financial statements give a “true and fair view” (a positive opinion), but that nothing has come to the reviewer’s attention to indicate that they not (a negative opinion) The different level of assurance provided is commensurate with the different level of work performed, as indicated above There is no precise definition of the meaning of “true and fair” or “fair presentation in all material respects” (b) Direct and assertion engagements Direct engagements require professional accountants (eg auditors) to report directly on financial statements or other information that is the responsibility of a third party, such as directors A review engagement (eg to review a set of financial statements to see if they comply with IFRS) is a typical example of a direct engagement Assertion engagements involve professional accountants reporting on assertions made by directors on financial or other information For example, directors may make an assertion on financial internal controls to the effect that they have reviewed them, and have found them to be working effectively Auditors then report on the directors’ assertion, rather than on the internal controls themselves Auditors or reviewers will look at the processes that directors have been through in order to make the assertion and report their findings An audit of a set of financial statements can be taken as a typical benchmark for an assertion engagement 1158 REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) Answer 67 ISA 570 REVISED (a) Meaning of “going concern basis” Assets are recorded on the basis that the company will be able to realise or recover them at or above recorded amounts in the normal course of business Liabilities are recognised and recorded on the basis that they will be discharged in the normal course of business The IASB’s Framework defines the going concern concept as meaning that the enterprise will continue in operational existence for the foreseeable future This means that the financial statements are prepared on the assumption that there is no intention or necessity to liquidate or curtail significantly the scale of operation (b) Procedures for obtaining sufficient evidence Tutorial note: Evidence should be obtained sufficient to confirm or dispel whether or not material uncertainty exists A review of forecast and budget information produced by a company, and the reliability of the systems in place for producing this information This would include a review of the key assumptions underlying the forecasts and budgets, and a comparison actual results against budgets A review of the evidence relating to the adequacy and period of borrowing facilities The auditor may need to obtain written information from banks or other third parties in order to be able to assess the degree of their commitment (and the legality and enforceability of financial support) A review of the inherent risk assigned to the audit client The sensitivity of forecasts and budgets to variable factors both within the directors’ control and outside their control will be scrutinised, including relevant economic factors A review of the directors’ plans for overcoming any problems their company is having or resolving any matters giving rise to doubts about the appropriateness of the going concern basis The auditor should consider the basis on which they have been prepared, whether they are realistic and whether the plans are likely to resolve the company’s problems A consideration of any professional advice obtained by the directors as to the extent of the company’s difficulties and the practicalities of overcoming them It may be necessary for the directors to obtain legal advice on: − − the consequences of the company continuing to trade while it is known by the directors not to be a going concern; or the existence of litigation and claims A review of the financial records including the order book, directors’ minutes and an analytical review of the financial statements Reviewing the terms of loan and overdraft agreements and determining whether they have been breached (eg late payments, exceeding limits) 1159 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK The nature and scope of the auditor’s procedures will depend upon the circumstances of the client The extent of the procedures will be determined by the extent of the resources it requires to continue as a going concern (c) Factors which might cast doubt on the going concern status of a company Tutorial note: The Q only called for factors The following is not an exhastive list of the examples of the financial, operating and other events or conditions that may cast doubt on the going concern assumption Financial An excess of liabilities over assets and/or adverse key financial ratios Default on terms of loan agreements or inability to pay other creditors on due dates Significant impairment in the value of assets used to generate cash flows or substantial operating losses Significant liquidity or cash flow problems indicated by negative operating cash flows in historical or prospective financial statements Denial of normal terms of credit by suppliers or other indications of withdrawal of financial support by suppliers (eg change from credit terms to cash-on-delivery) Major debt repayment falling due where refinancing is necessary to the company’s continued existence and there are no realistic prospects of renewal or repayment Arrears or discontinuance of dividends Inability to raise finance for essential investment, new product development, etc Operational Internal matters such as: − − − loss of key management without replacement; labour difficulties; or excessive dependence upon a few product lines where the market is depressed External matters such as: Other − − − loss of key suppliers, customers or major markets; shortages of essential supplier; or technical developments which render a key product obsolete Major litigation in which an adverse judgement would result in claims that are unlikely to be satisfied, imperilling the company’s continued existence Non-compliance with statute, environmental legislation, etc Adverse effects of changes in legislation or government policy 1160 REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) (d) Auditor’s responsibilities Before the issue of ISA 570 Going Concern, professional requirements concerning going concern had a passive air about them Where the auditor was satisfied that the financial statements had been prepared on a going concern basis, no mention of any matters relating to the going concern status would normally be required in the auditor’s report The current guidance in ISA 570 goes somewhat further There is now a duty on the part of the auditor to plan and perform procedures specifically designed to identify material matters which might cast doubt upon the going concern status of the company It would be possible to extend the auditor’s responsibilities still further For example ISA 570 does not stipulate a strict time period beyond the end of the reporting period over which the auditor should satisfy himself that the company will remain in operation It would be possible for a revised ISA 570 to insist that the auditor’s report specifically includes a statement that the auditor’s opinion is that the company will remain in operational existence for at least the following twelve months, unless stated otherwise This requirement would highlight the issue of going concern more than is currently the case Answer 68 CORSCO (a) External auditor responsibilities – going concern ISA 570 Going Concern deals with this issue Auditors are required to consider the going concern status of companies and any disclosures regarding going concern in forming their audit opinion Companies that are listed on stock exchanges may be required to make additional disclosures in relation to going concern issues Auditors are required to assess the adequacy of the means (the processes) by which directors have satisfied themselves that the going concern basis is appropriate and that adequate disclosures have been made Auditors conduct an initial analysis at the planning stage of the audit as well as assessments at later stages Auditors should make enquiries of the directors and examine appropriate documentation supporting the company’s going concern status such as budgets and cash flow forecasts Auditors consider whether the period to which directors have paid particular attention is adequate This should normally be at least 12 months from the end of the reporting period Auditors also enquire of management as to their knowledge of events or conditions beyond this period that may cast significant doubt on the entity’s ability to continue as a going concern Auditors need to consider the appropriateness of assumptions which directors have made, the sensitivity of assumptions to external and internal changes, any obligations, guarantees or undertakings arranged with other entities, the existence and adequacy of borrowing facilities and the directors’ plans to deal with any going concern problems Auditors are required to document the extent of any concerns, taking account of matters that have come to their attention during the course of the audit and in particular, financial, operational, or other indicators of going concern problems that are present 1161 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK Indicators of going concern issues would include trading losses, impairment of assets, net liabilities, defaults on loans, liquidity problems, an inability to refinance loans where necessary, fundamental changes in the markets or technology having an adverse effect on the company, loss of management, staff, customers or suppliers, or major litigation, for example Auditors should consider the need to obtain written management representations Auditors should consider the adequacy of any disclosures in the financial statements (b) Possible audit reports and circumstances Where the auditors consider that there is a significant level of concern about the entity’s ability to continue as a going concern (but not disagree with the going concern basis), and where adequate disclosures of the situation are made, they modify (but not qualify) their opinion by including an “emphasis of matter” paragraph highlighting the existence of a material uncertainty as to the going concern status of the entity and drawing attention to the relevant note in the financial statements Where adequate disclosures are not made, a qualified or adverse opinion will be issued Where the period to which directors have paid particular attention is less than 12 months from the end of the reporting period, the auditors should consider the need to modify the audit report as a result of a limitation in the scope of the audit Where the auditors disagree with the preparation of the financial statements on the going concern basis, they should issue an adverse opinion This is very rare because auditors rarely have sufficient evidence to be sure If the auditors are unable to form an opinion on the going concern status of a company because of a limitation in the scope of the audit, they will issue an “except for” opinion, or “disclaimer of” opinion – but this is unusual (c) Report issued to Corsco In the case of Corsco, there are some indicators of going concern problems However, the company may still be a going concern and the fact that the company has been approached by take-over bidders does not necessarily mean that there is a going concern problem (possibly quite the opposite) The audit opinion issued on Corsco in the current year is not likely to make reference to the going concern status of the company, as in previous years The situation has not deteriorated significantly in the current year and it will be difficult for auditors to justify any change in their opinion from previous years (d) Difficulties associated with reporting on going concern If the auditors of Corsco were to report on a going concern problem, the mere act of reporting might of itself create a going concern problem (a “self-fulfilling prophecy”) This is particularly the case with large “blue-chip” companies where the issue of an audit report that is modified in any way is unusual and might well cause the company’s share price to drop, thus precipitating a going concern problem 1162 REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) This means that it is very difficult for companies such as Corsco and their auditors to send out any clear signal to the markets without running the risk of creating a panic However, recent events show that the consequences of companies and auditors failing to report where severe financial difficulties are encountered can be disastrous for both the company (its employees and shareholders) and auditors alike Auditors are failing in their professional duties if they not report on going concern problems of which they are aware; however, situations involving large companies are rarely clear cut and auditors who propose to make any changes at all to the audit report are likely to encounter fierce resistance from management who may genuinely believe that to make such a report would be wrong In the company’s annual financial statements, it is not the place of the auditor of Corsco to substitute his judgement for that of directors However, where large companies involved in complex financing arrangements are concerned, auditors may have to fight hard against vested and powerful interests if they disagree with the directors’ judgements and decide to make reference to the matter in the auditor’s report An auditor making reference to going concern issues in an audit report in such circumstances may lose the audit (and any other work) and may run a significant risk of litigation Answer 69 OCTBALL (a) Benefits of outsourcing to NFA Expertise available The NFA partnership will be able to provide the necessary expertise for internal audit work They may be able to provide a broader range of expertise as they serve many different clients therefore staff may be available for specialist work that Octball could not afford to employ Buy-in skills as necessary If internal audit is only required for specific functions or particular jobs each year then the expertise can be purchased as required Taking this approach will minimise in-house costs Independence/Qualifications No information is provided on the qualification of staff in NFA, although as an independent firm it is likely that care will be taken that staff remain independent and have the appropriate qualifications in order that they can provide an appropriate high level of service Audit techniques – training Outsourcing will remove the need for training internal staff Effectively training will be provided for “free” as the outsourcing firm will be responsible for keeping staff up-to-date with new auditing techniques and processes 1163 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK Problems with outsourcing to NFA Fee pressure NFA may experience some fee pressure, but only in respect of maintaining cost effectiveness of the internal audit department The relationship needs to be managed carefully to ensure that NFA not decrease the quality of their work due to insufficient fees Knowledge The NFA partnership will not have any prior knowledge of Octball This will be a disadvantage as this will mean the partnership will need time to ascertain the accounting systems and controls etc in Octball before commencing work However, provision of an independent view may identify control weaknesses etc that the current internal audit department have missed Location The NFA partnership may not be able to provide this service to Octball as they are a local firm and therefore the issue of travel and working away from home would remain Continuity of service – staffing As provision of audit services is the NFA partnership’s main activity, they should also be able to budget for client requirements although this cannot be guaranteed as staff may still leave However, as a larger internal auditing firm, they will be able to offer staff better career progression which should assist staff retention (b) Items to be considered by T&M Independence T&M need to ensure that independence can be maintained in a number of areas: Independence regarding recommending systems or preparing working papers and subsequent checking of those systems or working papers While the internal audit department may need to carry out these functions, T&M must ensure that separate staff are used to provide the internal and external audit functions Staff from T&M will be expected to follow the ethical guidance of ACCA which means that steps will be taken to avoid conflicts of interest or other independence issues such as close personal relationships building up with staff in Octball Any real or perceived threats to independence will lower the overall trust that can be placed on internal audit reports produced by T&M Training As a firm of auditors, T&M will automatically provide training for its staff as part of the inhouse compliance with association regulations (e.g compulsory CPD was introduced from January 2005) T&M will need to ensure that staff providing the internal audit function to Octball are aware of relevant guidance for internal auditors 1164 REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) Skills T&M must ensure that they have staff with the necessary skills and sufficient time to undertake the internal audit work in Octball Skills may not be an issue because staff in T&M will already understand audit procedures Fee pressure There may be fee pressure on T&M, either to maintain the cost effectiveness of the internal audit department, or to maintain the competitiveness of the audit fee itself in order to keep the internal audit work Knowledge As external auditors, T&M will already have knowledge of Octball This will assist in establishing the internal audit department as systems documentation will already be available and the audit firm will already be aware of potential weaknesses in the control systems (c) Controls to maintain the standard of the internal audit department If T&M are appointed, ensure that the internal and external audit is managed by different departments in the firm Setting and review of performance measures such as cost, areas reviewed etc with explanations obtained for any significant variances Use of appropriate audit methodology, including clear documentation of audit work carried out, adequate review, and appropriate conclusions drawn Review of working papers by myself, ensuring adherence to International Standards on Auditing where appropriate and any in-house standards on auditing The work plan for internal audit is agreed prior to work commencing and this is followed by the outsourcing company Answer 70 ZPM (a) Factors to consider when evaluating and testing the work of the internal auditor include: A check that the work is performed by persons having adequate technical training and proficiency as internal auditors, by ensuring appropriate training programmes are in place and the auditor has appropriate qualifications Ensuring that the work of assistants is properly supervised, reviewed and documented by reviewing the procedure manuals of internal audit and the audit working papers produced Determining that sufficient and appropriate audit evidence is obtained to afford a reasonable basis for the conclusions reached, again by reviewing the internal auditor’s working papers Checking that the conclusions reached are appropriate in the circumstances and that any reports prepared are consistent with the results of the work performed by reviewing the work performed and the reports produced 1165 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK Ensuring any exceptions or unusual matters disclosed by internal audit are properly resolved by the external auditor and management (b) (i) Objectives of internal audit Year end inventory count The main aim of the year end inventory count is to ensure that the figure for inventory in the financial statements is accurate The objective of the internal audit department is to check the accuracy of the inventory count to ensure that the physical goods inventory is correctly stated on the inventory sheets This objective is achieved by checking the control system over counting inventory Internal audit work will involve ensuring that all inventory is counted, teams of two people are counting inventory, and then performing test counts to determine the accuracy of the test counts Internal controls over procurement systems The internal auditor will be ensuring that the procurement system is achieving its key objectives and operating according to company guidelines Specific aims will include: Ensuring purchases are authorised Quantity discounts are obtained Inventory received is recorded on goods received notes or similar Reviewing operations of the marketing department The internal auditor will review the work of the marketing department with aims such as ensuring that the process is being managed effectively and information is available to the marketing manager as required Where deficiencies in the information provided are noted, then an internal audit report will highlight those deficiencies and make recommendations for improvement to the information systems The objectives of internal audit in this case are more to ensuring the efficiency of operations rather than any specific financial objective (ii) Objectives of the external auditor Year end inventory count The external auditor also needs to ensure that the figure for inventory is materially correct for the financial statements Part of the work of the external auditor is to attend the physical inventory count to ensure that the quantities and condition of inventory is correctly recorded Given that ZPM does not appear to have any perishable inventory, the main objective will be to ensure correct recording of inventory quantity Internal controls over procurement systems The external auditor will test the procurement system with the overall objective of determining that the purchases and payables figures in the financial statements are correct The objectives of testing will be to ensure that the control system over procurement is operating efficiently, and ensure complete and accurate recording of purchases and payables liabilities If errors are found then this implies that the financial statements could also contain errors 1166 REVISION QUESTION BANK – AUDIT AND ASSURANCE (Int) (F8) Reviewing operations of the marketing department As the operations of the marketing department not normally impact on the financial statements, the external auditor may not actually review this function (iii) Reliance by the external auditor Year end inventory count ZPM has 103 stores – which is likely to mean that the external auditor will not be able to attend the inventory count in all stores, simply due to lack of staff However, if inventory count procedures are the same at all stores, then reliance can be placed on the internal auditor to attend some stores and check that the internal control systems are being correctly applied in those stores This reliance does not mean that the external auditor does not carry out any work; the external auditor will compare results from stores tested with those of the internal auditor Results should be about the same; any differences in terms of errors found will be investigated, and reasons for those differences obtained Internal controls over procurement systems The external auditor may rely on the work of the internal auditor regarding the procurement systems, where the work of the internal auditor is relevant to the financial statements Some areas such as ensuring quantity discounts are obtained are less important than ensuring completeness of recording of liabilities Again, the external auditor must perform some work on the procurement systems; the presence of an internal auditor simply means that the work can be reduced Reviewing operations of the marketing department Given that the external auditor does not need to review the operations of the marketing department then no formal reliance is needed on the work of the internal auditor However, internal audit reports may be reviewed to determine, for example, the effectiveness of advertising spend etc to help determine the going concern situation of the company In the case of ZPM, the effectiveness of advertising new stores could be reviewed 1167 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK 1168 ... October 2007 and May 2008) as it is probable that the company’s control procedures were inadequate As the cashier was “recording cash received and preparing the bank reconciliation” as well as “having... International Standards, and to influence International Standards 1003 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION BANK In many countries, all new national Auditing Standards contain a... professional skepticism, notwithstanding the auditors’ past experience of the honesty and integrity of management and those charged with governance 1011 AUDIT AND ASSURANCE (Int) (F8) – REVISION QUESTION