Elements of an assurance engagement

1. An assurance engagement will require a three-party relationship comprising of:

a) The intended user who is the person who requires the assurance report.
b) The responsible party, which is the organisation responsible for preparing the subject
matter to be reviewed.
c) The practitioner (i.e. an accountant) who is the professional who will review the subject
matter and provide the assurance.

2. is required for an assurance engagement is suitable subject matter ie data from the company..

3. Thirdly this subject matter is then evaluated or assessed against suitable criteria in order for it to be
assessed and an opinion provided.

4. Fourth, the practitioner must ensure that they have gathered sufficient appropriate evidence in order to
5. Last, an assurance report provides the opinion which is given by the practitioner to the intended user

Types of assurance assignments

Reasonable assurance Limited assurance

Example: External Audit Example: Review of financial statements

High level of assurance but NOT absolute or 100% Moderate level of assurance

A high but not absolute level of assurance is The practitioner gathers sufficient evidence to be satisfied
provided, this is known as reasonable assurance. that the subject matter is plausible; in this case negative
assurance is given whereby the practitioner confirms that
nothing has come to their attention which indicates that
the subject matter contains material misstatements.

More testing (Analytical tests, test of controls and Lesser testing-focus on obvious errors only
substantive testing) (Analytical testing and Enquiry)

Going concern review carried out No going concern review

The procedures undertaken are not nearly as

comprehensive as those in an audit, with procedures such
as analytical review and enquiry used extensively. In
addition, the practitioner does not need to comply with
ISAs as these only relate to external audits.

Dynamic Publishers 1
Positive conclusion- Wording: Negative conclusion-Wording:
‘in our opinion the financial statements give (or do “nothing has come to light to suggest errors or problems
not give) a true and fair view of the state of the exist’'
company’s affairs’.
The assurance is therefore given on the absence of any
indication to the contrary.

Review engagements are often undertaken as an

alternative to an audit, and involve a practitioner
reviewing financial data, such as six-monthly figures. This
would involve the practitioner undertaking procedures to
state whether anything has come to their attention which
causes the practitioner to believe that the financial data
is not in accordance with the financial reporting
framework.

Assignments were no assurance is given

1. Agreed-upon procedures : A report on factual findings is given but no assurance expressed. Users must
judge for themselves and drawn their own conclusions

2. Compilation engagement: Users of the compiled information gain benefit from the accountant’s
involvement but no assurance is expressed. It is used to collect, classify and summarise financial
information. It means to present data in a manageable and understandable form.

External audit

It is a review and assessment of the financial records to form an overall conclusion as to whether:
- The financial statements have been prepared using acceptable accounting policies, which have been
consistently applied.
- The financial statements comply with all the relevant regulations and statutory requirements.
- Adequate disclosure of all material matters relevant to the proper presentation of financial information
has been made.

Objective of external audit engagements: “Opinion”: The auditor’s report contains a clear written expression of
opinion on the financial statements.

Dynamic Publishers 2
General principles of external audit engagements

According to the International Standards on Auditing, the general principles of an audit are:
1. Compliance with Code of Ethics (IFAC’s)
2. Performance of an audit in accordance with ISAs
3. Audit with professional skepticism
4. Professional judgment
5. Sufficient appropriate audit evidence

True and Fair presentation

True – Information is factual and conforms with reality in that there are no factual errors. In addition it is
assumed that to be true it must comply with accounting standards and any relevant legislation. Lastly true
includes data being correctly transferred from accounting records to the financial statements.

Fair – Information is clear, impartial and unbiased, and also reflects plainly the commercial substance of the
transactions of the entity.
Inherent Limitations of audit/ Reasons why absolute assurance cannot be given

1. Sampling – it is not practical for an auditor to test 100% of transactions

2. Subjectivity – financial statements include judgmental and subjective areas
3. Inherent limitations of internal control systems – an internal control system is operated by people and
hence is liable to human error.
4. Evidence is persuasive not conclusive .
5. There may be other items which should have been included– the completeness problem.
An external audit has a number of other issues which reduce its usefulness

1. Audit report format – the format of the opinion is determined by International Standards on Auditing.
However, the terminology used is not usually understood by non-accountants. This means that users may
not actually understand the audit opinion given.
2. Historic information – the audit report is often issued some time after the year end, and so the financial
information can be quite different to the current position. In the current marketplace where companies’
financial positions can change quite quickly, the audit opinion may no longer be relevant as it is out of
date.
3. Auditors need to understand their clients in great depth if they are to understand how fraud could be
carried out and hidden. However, auditors cannot become too close to their clients or their independence
will be called into question.
4. Where auditors spot errors or fraud, their primary legal responsibility is to report this to management.
Any external reporting is hampered by rules on confidentiality.
.
The auditor’s duties

Dynamic Publishers 3
Fundamental duties are to:
- form an opinion on whether the financial statements give a true and fair view and are prepared
in accordance with applicable reporting framework - issue an audit report.

Duty to check and ensure: Adequate accounting records, Compliance with legislation, Truth and fairness,
Adequacy of financial statements disclosures

The auditor’s rights

1. Right of access at all times to the company’s books, accounts and vouchers.
2. Right to require from an officer of the company such information or explanations as they think
necessary for the performance of their duties as auditors.
3. Right to receive all communications relating to written resolutions.
4. Right to receive all notices of, and other communications relating to, any general meeting which a
member of the company is entitled to receive.
5. Right to attend any general meeting of the company.
6. Right to be heard at any general meeting which an auditor attends on any part of the business of the
meeting which concerns them as auditor.

Appointment of auditors

Only a member of a recognised supervisory body is eligible to be appointed as an auditor. The person to be
appointed as the auditor is required to hold a professional accountancy qualification.
1. Appointed by shareholders
2. Appointment runs from the end of the Annual General Meeting (AGM) until the end of the next AGM.
3. On appointment , need to get ‘clearance’ from outgoing auditor
For entities in which a share is owned by the state, the auditor is appointed by the Secretary of State or
Ministry of Finance (or a person authorised by the Ministry of Finance)

Removal of auditors

1. RESIGNATION: Sometimes it is necessary for the auditors to resign. If an auditor resigns, they should do so
in writing and they may wish to speak to the shareholders to explain their reasons
2. FORCED REMOVAL: Sometimes, the Board of Directors or some shareholders may wish to remove the
auditors. A General Meeting must be called so that the shareholders can vote on the proposal (via an ordinary
resolution).
3. AUDITORS DO NOT WISHTO SEEK REAPPOINTMENT: Sometimes the auditors finish the annual audit and
decide they do not wish to audit the company in future years. As such,when the board asks them to accept

Dynamic Publishers 4
nomination for the following year, the auditors should politely decline and issue a Statement of
Circumstances.

Key points

 Directors cannot remove the auditors themselves.

 Auditors Can be removed by a simple majority at a general meeting.
 The auditors should be given notice of such a meeting
 They are allowed to speak at the general meeting
 Deposit at the company’s registered office a statement of the circumstances connected with the
removal/resignation or a statement that there are no such circumstances. They can request an
Extraordinary General Meeting (EGM) of the company to explain the circumstances of the resignation.

Audit exemption for small companies

The main reasons for exempting small companies are:

- for owner-managed companies, those receiving the audit report are those running the company
(and hence preparing the accounts!)
- the advice/value which accountants can add to a small company is more likely to concern other
services, such as accounting and tax, rather than audit and which may also give rise to a conflict of
interest under the ethics rules
- the impact of misstatements in the accounts of small companies is unlikely to be material to the
wider economy
- it may also not be cost beneficial for the small entities.

Client acceptance/continuance

Dynamic Publishers 5
Steps before accepting an audit client
Outgoing auditor- Professional Client- related issues Practitioner-related issues (
etiquette letter Audit firm)

The auditor should communicate 1.Formalities(of removal of outgoing auditor 1.Any issues which might arise
with the outgoing auditor the client fulfilled) which could threaten
to assess if there are any ethical or compliance with ACCA’s Code
professional reasons why they 2.Reputation and integrity of the client’s of Ethics and Conduct or any
should not accept appointment. management assessed- If necessary, the firm local legislation, including
may want to obtain references if they do not independence and conflict of
They should obtain permission formally know the directors interest with existing clients. If
from the client’s management to issues arise, then their
contact the outgoing auditor; if this 3. Consider the level of risk attached to the significance must be
is not given, then the engagement audit whether this is acceptable to the firm. considered.
should be refused. As part of this, they should consider whether
the expected audit fee is adequate in 2.Whether they are competent
The previous auditor must obtain relation to the risk auditing the client to perform the work and
permission from the client’s whether they would have
management to respond; if not appropriate resources(
given, then the auditor should Client screening especially human resource and
refuse the engagement. time!) available, as well as any
specialist skills or knowledge
The purpose of client screening procedures is
required for
to determine whether the prospective client
the audit
is suitable for the firm.

The firm should evaluate the potential risk to

the firm of acceptance.
When a client is deemed to represent a high
audit risk to the firm, the firm should
carefully consider the implications arising
should it fail in meeting its objective of giving
an accurate audit opinion. If the firm is not
confident that the benefit to be derived from
accepting the appointment outweighs the
potential risks (including financial and
reputational risk of being sued), then the
firm should decline the appointment.

Factors to consider:
- The state of the economic sector in
which the client operates (a
depressed sector may indicate
risk).

Dynamic Publishers 6
- The client’s previous audit
history (frequent changes of
auditors, and/or qualified
reports, are obviously bad
news).
- The experience and
qualifications of the company’s
management and their attitude
towards controls.
- The current operating and
financial position of the
company.
- Directors’ understanding of
External Auditor’s role and their
own responsibilities
- The accounting policies used

- Evidence of client involvement

in fraudulent or illegal activities.

- Management permission or
refusal to allow auditors to
examine significant documents,
such as the minutes of
directors’ meetings.

Preconditions for an audit

ISA 210 Agreeing the Terms of Audit Engagements provides guidance to auditors on the steps they should take
in accepting a new audit or continuing on an existing audit engagement. It sets out a number of processes that
the auditor should perform including agreeing whether the preconditions are present, agreement of audit terms
in an engagement letter, recurring audits and changes in engagement terms.

To assess whether the preconditions for an audit are present the auditor must
1. determine whether the financial reporting framework to be applied in the preparation of the
financial statements is acceptable.
2. assess the nature of the entity, the nature and purpose of the financial statements and whether
law or regulations prescribes the applicable reporting framework.
3. obtain the agreement of management that it acknowledges and understands its responsibility
for the following:
 Preparation of the financial statements in accordance with the applicable
financial reporting framework

Dynamic Publishers 7
 For internal controls
 To provide the auditor with access to all relevant information for the
preparation of the financial statements

Agreeing the terms of engagement

Engagement letter ( compulsory for every new engagement ; sent before the audit starts)

Purpose of an engagement letter

An engagement letter provides a written agreement of the terms of the audit engagement between the auditor
and management or those charged with governance.

Contents of an engagement letter

Matters to be included in an audit engagement letter:

– The objective and scope of the audit;
– The responsibilities of the auditor;
– The responsibilities of management;
– Identification of the financial reporting framework for the preparation of the financial statements;
– Expected form and content of any reports to be issued;
– Elaboration of the scope of the audit with reference to legislation;
– The form of any other communication of results of the audit engagement;
– The fact that some material misstatements may not be detected;
– Arrangements regarding the planning and performance of the audit, including the composition of the audit
team;
– The expectation that management will provide written representations;
– The basis on which fees are computed and any billing arrangements;

Changes to engagement letters

Engagement letters for recurring/existing clients should be revised if any of the following factors are present:

- Any indication that the entity misunderstands the objective and scope of the audit, as this
misunderstanding would need to be clarified.
- Any revised or special terms of the audit engagement, as these would require inclusion in the
engagement letter.

Dynamic Publishers 8
- A recent change of senior management or significant change in ownership. The letter is signed by a
director on behalf of those charged with governance; if there have been significant changes in
management they need to be made aware of what the audit engagement letter includes.
- A significant change in nature or size of the entity’s business. The approach taken by the auditor
may need to change to reflect the change in the entity and this should be clarified in the
engagement letter.
- A change in legal or regulatory requirements. The engagement letter is a contract; hence if legal or
regulatory changes occur, then the contract could be out of date.
- A change in the financial reporting framework adopted in the preparation of the financial
statements. The engagement letter clarifies the role of auditors and those charged with governance,
it identifies the reporting framework of the financial statements and if this changes, then the letter
requires updating.
- A change in other reporting requirements. Other reporting requirements may be stipulated in the
engagement letter; hence if these change, the letter should be updated.

What if management refuses to sign the engagement letter?

1. Identify the reason. Discuss the matter with the directors in an attempt to reach a suitable
compromise.

2. Try to reach a suitable compromise keeping in mind your duties and responsibilities 3. Refuse
the engagement if matter still not resolved

Audit planning ( Audit Strategy and Audit Plan)

Importance of audit planning

1. It helps the auditor to devote appropriate attention to important areas of the audit.
2. It helps the auditor to identify and resolve potential problems on a timely basis.
3. It helps the auditor to properly organise and manage the audit engagement so that it is performed in an
effective and efficient manner.
4. It assists in the selection of engagement team members with appropriate levels of capabilities and
competence to respond to anticipated risks and the proper assignment of work to them.
5. It facilitates the direction and supervision of engagement team members and the review of their work.
6. It assists, where applicable, in the coordination of work done by experts

Dynamic Publishers 9
Audit Strategy: An audit strategy sets the scope, timing and direction of the audit and guides the development
of the more detailed audit plan.

Audit plan: Once the overall strategy has been planned, detailed consideration can be given to each individual
audit objective and how it can be best met.

A.UNDERSTANDING THE CLIENT/ KNOWLEDGE OF THE BUSINESS

The auditor obtains an understanding of the entity, its control environment and its detailed internal controls: 
to identify and assess the risks of material misstatements in the financial statements and to
provide a basis for designing and implementing responses to these risks
 to determine the extent to which the auditor would rely on the internal control
system.
 to assess whether the team is competent to perform the audit  To understand
relevant law and regulations impacting the entity  To consider the reliability of
various evidence sources.

Understanding to be gained about Understanding can be gained from

- Industry, regulatory and other external factors( Prior year financial statements: Provides
for example financial reporting framework, laws information in relation to the size of the client
and regulations, stakeholders, economic conditions as well as the key accounting policies,
disclosure notes and whether the audit opinion
like volatility of exchange rates, competition, level
was modified or not.
of technology
Discussions with the previous auditors/access
- Nature of entity and accounting policies ( legal to their files: Provides information on key
structure, ownership and governance, main issues identified during the prior year audit as
sources of finance) well as the audit approach adopted.

- Objectives…strategies…related business risks!

Dynamic Publishers 10
Prior year report to management: If this can
be obtained from the previous auditors or from
- Measurement and review of Financial management, it can provide information on
performance ( measures important to the client, the internal control deficiencies noted last
KPIs, budgets, targets) year. If these have not been rectified by
management, then they could arise in the
- Internal control (gain an understanding about the current year audit as well and may impact the
audit approach.
design and implementation of internal controls)

Miscellaneous The client ‘s accounting systems

notes/procedural manuals: Provides
information on how each of the key accounting
Identification of issues that arose in the prior year audit and
systems operates and this will be used to
how these were resolved. Also whether any points brought identify areas of potential control risk and help
forward was noted for consideration for this year’s audit. determine the audit approach.

Internal control deficiencies noted in the prior year; if these Discussions with management: Provides
have not been rectified by management then they could arise information in relation to the business, any
in the current year audit as well important issues which have arisen or changes
to accounting policies from the prior year.
Significant changes in the entity as compared to prior years.
Review of board minutes: Provides an
Is the company using e-commerce? overview of key issues which have arisen
during the year and how those charged with
governance have addressed them.

Current year budgets and management

accounts: Provides relevant financial
information for the year to date. It will help the
auditor during the planning stage for
preliminary analytical review and risk
identification.

The client’s website: Recent press releases

from the company may provide background on
the business during the year as this will help in
identifying the key audit risks.

Financial statements of competitors: This will

provide information about the client ‘s
competitors, in relation to their financial
results and their accounting policies. This will
be important in assessing the client’s
performance in the year and also when
undertaking the going concern review.

Dynamic Publishers 11
B. AUDIT RISK and Risk Response

Importance of risk assessment

1. Assessing engagement risks at the planning stage, this will ensure that attention is focused early on the
areas most likely to cause material misstatements.

2. It will help the auditor to fully understand the entity, which is vital for an effective audit.

3. Any unusual transactions or balances would also be identified early, so that these could be addressed in
a timely manner.

4. Assessing risks early should also result in an efficient audit.

5. In addition assessing risk early should ensure that the most appropriate team is selected with more
experienced staff allocated to higher risk audits and high risk balances.

6. Assessing risk should enable the auditor to assess whether the client is a going concern.

Audit Risk

Auditors use the audit risk model to direct audit resources to the performance of additional substantive
procedures in areas of the financial statement where audit risk is deemed to be high.

The formula for the audit risk model is:

Audit Risk = Risk of material misstatement in the financial statements x Detection Risk

Audit Risk Explained

Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are
materially misstated.

Audit risk is a function of two main components being the risks of material misstatement and detection risk. Risk
of material misstatement is made up of two components, inherent risk and control risk.

Risk of material misstatement in the financial statements explained

Risk of material misstatement is made up of a further two components, inherent risk and control risk. Inherent
risk

Dynamic Publishers 12
Inherent risk:

Definition: The susceptibility of an assertion about a class of transaction, account balance or disclosure to a
misstatement that could be material, either individually or when aggregated with other misstatements, before
consideration of any related controls.

Inherent risk describes something about the nature of a business or its transactions that make it particularly
susceptible to material misstatements.

Inherent risk is affected by the nature of an entity and factors which can result in an increase include:
– Changes in the industry it operates in.
– Operations that are subject to a high degree of regulation.
– Going concern and liquidity issues including loss of significant customers.
– Developing or offering new products or services, or moving into new lines of business.
– Expanding into new locations.
– Application of new accounting standards.
– Accounting measurements that involve complex processes.
– Events or transactions that involve significant accounting estimates.
– Pending litigation and contingent liabilities.

Control risk

Definition: The risk that a misstatement that could occur in an assertion about a class of transaction, account
balance or disclosure and that could be material, either individually or when aggregated with other
misstatements, will not be prevented, or detected and corrected, on a timely basis by the entity’s internal
control.

It is the risk that an organisation’s internal control systems do not adequately protect the organization either
because they have not been adequately designed and / or implemented.

The following factors can result in an increase in control risk:

– Lack of personnel with appropriate accounting and financial reporting skills.
– Changes in key personnel including departure of key management.
– Deficiencies in internal control, especially those not addressed by management.
– Changes in the information technology (IT) environment.
– Installation of significant new IT systems related to financial reporting.

Dynamic Publishers 13
It is important to appreciate that the auditor has no control over the extent of either inherent or control risk;
these are risks borne by the entity subject to audit. However, the auditor has to assess them in the process of
determining the extent of the detailed substantive procedures to be carried out.

Detection risk Explained

Definition: The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level
will not detect a misstatement that exists and that could be material, either individually or when aggregated
with other misstatements.

Detection risk is all down to the auditors and is the risk that the auditor’s procedures fail to detect a material
misstatement.

Detection risk is affected by sampling and non-sampling risk and factors which can result in an increase include:
– Inadequate planning.
– Inappropriate assignment of personnel to the engagement team.
– Failing to apply professional scepticism.
– Inadequate supervision and review of the audit work performed.
– Incorrect sampling techniques performed.
– Incorrect sample sizes

Detection risk include sampling risk and non-sampling risk ( these are explained in detail with the topic of
sampling- below is an overview).

Sampling risk= sample is not representative of the population

Non-sampling risk = auditor’s procedures or the conclusion reached are incorrect.

Audit Risk = Inherent Risk x Control Risk x Detection risk

Needs to be at High High Must be low!

an acceptably
low level

Dynamic Publishers 14
The audit risk model used by auditors, dictates that for a given level of audit risk, the acceptable level of
detection risk bears an inverse relationship to the assessment of the risk of material misstatement.

For example, on an audit assignment where the risk of material misstatement has been assessed as high, in
order to achieve a low level of audit risk, detection risk must be set as low.

In such circumstances the auditor would need to direct an appropriate level of resources to the testing of the
assertion in question. This will comprise adequate planning, proper assignment of personnel, the application of
professional scepticism and supervision and review of the audit work performed.

Analytical procedures

Analytical procedure is an audit procedure which seeks to provide evidence as to the completeness, accuracy
and validity of the information contained in the accounting records or in the financial statements.

The procedure consists of the systematic study and comparison of relationships among elements of financial
information and the investigation of significant fluctuations and variances from the expected relationship

Steps involved in analytical procedures

1. Expectation:This step involves developing an expectation of what the financial information figures
should be. This can be agreed through comparisons of financial information or considerations of relationships
(ratio analysis).

2. Identification:This step involves identification of significant variations between the actual data with the
expected data.
3. Investigation of unusual variances: Once the variation has been computed, and if significant variations
are found, the auditor would consult the management in order to establish explanations for the variations
revealed.

4. Performance of alternate procedures: If the auditor or the management does not find the variation
reasonable, then they investigate further and perform analytical procedures to satisfy themselves.

When performing an analytical procedure, the auditor compares numbers, ratios or even non-financial
information in order to identify unexpected trends or unexpected relationships,which may indicate the
existence of errors.

There are many different analytical procedures including the comparisons listed below
• year on year (e.g. revenue this year compared to revenue last year);
• to budget or forecast (e.g. actual purchases compared to budgeted purchases);
• to predictions made by the auditors-proof in total (e.g. auditors calculation of depreciation compared
to client’s calculation);

Dynamic Publishers 15
• to industry information (e.g. client’s revenue compared to competitor’s revenue).
• Comparison/analysis of relationships between different elements of the financial statements ( for
example gross profit compared to sales)
• Comparison of financial info with non-financial info ( for e.g. payroll expense matched to number of
employees)
• Nonfinancial information. For example, sales revenue for a client from the hotel industry might be
based on available data as to room occupancy rates.
Analytical Procedures at to assist the auditor in planning the nature, timing and extent of other audit
the Planning stage procedures. Use at this stage should add to the firm’s understanding of the
business and identify risk areas to which audit resources should be
targeted.
Analytical Procedures at at the detailed testing stage – in most instances analytical procedures should be
substantive testing stage used in conjunction with tests of detail to achieve a particular audit objective in
relation to specific financial statement assertions..

Analytical Procedures at At the final review stage the auditor must design and perform analytical
the Review stage procedures that assist him when forming an overall conclusion as to whether the
financial statements are consistent with the auditor’s understanding of the entity
and that all of the audit objectives with regard to the financial statements have
been met.

Using Ratios

Gross Profit Margin = Gross profit/Sales Revenue x 100

Operating profit margin =Operating profit/Sales Revenue x 100

Return on capital employed = Operating profit/ Capital employed x 100

Current Ratio= Current Assets/Current Liabilities

Quick ( or asset test) ratios =Current assets minus inventory/ current liabilities

Inventory days =Inventory/Cost of sales x 365

Receivable days/ Receivables collection period =Trade receivables/Sales x 365

Trade payable Days/Payables payment period =Trade payables/Cost of sales x 365

Dynamic Publishers 16
Gearing =Long-term loan finance/ equity finance x 100
The gearing ratio can also be defined in other ways, particularly by comparing long-term loan finance to total
finance. As gearing increases so does the risk that the interest can’t be paid. But it is difficult to define a ‘safe’
level of gearing. For example, a property company with properties leased to tenants will have fairly predictable
rental income. Such a company can probably safely sustain substantial borrowings (though it could be in trouble
if interest rates increased significantly). A company with volatile streams of income would have to keep its
gearing lower as it must ensure that interest can be paid during the lean times.

Interest cover = profit before interest/ interest

Responses to Risk

C.MATERIALITY

Definition: ‘Misstatements, including omissions, are considered to be material if they, individually or in the
aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the
financial statements.’

In assessing the level of materiality there are a number of areas that should be considered.

Firstly the auditor must consider both the amount (quantity) and the nature (quality) of any misstatements, or a
combination of both.

The quantity of the misstatement refers to the relative size of it and the quality refers to an amount that might
be low in value but due to its prominence could influence the user’s decision, for example, directors’
transactions.

In assessing materiality the auditor must consider that a number of errors each with a low value may when
aggregated amount to a material misstatement. .

Definition of performance materiality below:

‘Performance materiality means the amount or amounts set by the auditor at less than materiality for the
financial statements as a whole to reduce to an appropriately low level the probability that the aggregate of
uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole. If
applicable, performance materiality also refers to the amount or amounts set by the auditor at less than the
materiality level or levels for particular classes of transactions, account balances or disclosures.’

Dynamic Publishers 17
Material by size (importance depends on value)-Quantitative factors
 1% of revenue; 
2% of total assets; 
10% of PBT.

Material by nature
Examples
 Bank balances
 Related party transactions ( including remuneration and personal expenses of directors)
 Fraud/ Unlawful transactions (e.g. illegal payments)
 -Violation of regulatory requirements
 Incorrect selection or application of an accounting policy that has an immaterial effect on the current period
but is likely to have a material effect on future periods
 Failure to meet requirements of debt-covenants
 Key Performance Indicators of the company (e.g. converting loss into profit)

Audit plan

An audit plan converts the audit strategy into a more detailed plan and includes the nature, timing and extent
of audit procedures to be performed by engagement team members in order to obtain sufficient appropriate
audit evidence to reduce audit risk to a low level.

Audit planning is a detailed recording of each procedure and process required to perform an audit. Once the
overall strategy has been determined, the auditor should prepare a detailed plan of the areas determined in
the audit strategy. Once the audit strategy has been decided, the next stage is to decide how it is going to be
carried out; an audit plan is necessary. The audit plan contains the nature, timing and extent of the procedures
to be performed.

The audit plan covers:

• Allocation of work and duties to the assistants
• Allocation of time and cost
• Formation of various teams
• Audit tests/procedures
• Data gathering techniques
• Types of audit evidence desired
The audit plan is developed in order to reduce audit risk to an acceptably low level.

Dynamic Publishers 18
Interim vs Final Audit

Interim Audit

An interim audit refers to audit work that is conducted during the accounting year, at intervals, fixed or not. The
audit of the remaining part of the year will be done at the end of the accounting year. There is no requirement
to undertake an interim audit

Typical work carried out at the interim audit includes:

- consideration of inherent risks facing the company. ( Risk would be initially considered at the
planning stage, but is, in fact, reassessed at all audit stages.)
- documenting and testing of internal controls
- testing of profit and loss transactions for the year to date
- identification of potential problems that may affect the final audit work.

Final audit

The final audit will take place after the year end and concludes with the auditor forming and expressing an
opinion on the financial statements for the whole year subject to audit. It is important to note that the final
opinion takes account of conclusions formed at both the interim and final audit.

Typical work carried out at the final examination includes:

- Follow up of items noted at the inventory count
- Obtaining confirmations from third parties, such as bankers and lawyers - Analytical reviews of
figures in the financial statements.
- substantive procedures of account balances and transactions
- Reviews of events after the reporting period
- Consideration of the going concern status of the organisation.

Advantages of interim audit

a) The errors are discovered at early stage

b) As the auditor visits the entity frequently, the chances of fraud being committed reduce.
c) Fraud, if committed, will be discovered at an early stage, which results in minimising the loss due to the
fraud.
d) Most of the time, the audit staff is present at the client’s premises, which acts as a moral check and
result in minimising the chances of errors or fraud.
e) All the books and records of the client are always up-to-date.
f) As the audit is started earlier, more time is available for a detailed checking of accounts and hence this
allows for a comprehensive audit.

Dynamic Publishers 19
g) An interim audit minimises the work and time involved in conducting the audit at the end of the year
and therefore assures early completion of the audit reports.
h) If the auditor plans to rely on the internal controls, some extensive testing may be done at the interim
period only so that the workload at the end of the year will be reduced.

Disadvantages of interim audit

a) There is always a danger that the audited figures may be altered either innocently or
fraudulently. That is why ISA 330 states that when audit evidence (relating to the operating
effectiveness of internal controls or the financial statement assertions), is obtained during the
interim period, additional audit evidence (relating to the effectiveness of internal controls or the
financial statement assertions) must also be obtained for the remaining period.
b) It is just a waste of time in small entities.
c) The cost would be high.

Internal control Systems

Internal controls: Internal control represents the system or policies and procedures implemented by an
organization.

Why does an auditor need to understand internal controls?

Internal controls assure management of the accuracy of the financial statements, that the operations of the
entity are conducted efficiently and that the entity has complied with all the laws and regulations which are
applicable to the entity.

The objectives of internal controls relevant to audit include:

1. Avoidance of fraud, errors, wastes and inefficiency

2. Maximum accuracy of all records, data and statements
3. Enables auditors to determine the degree of reliance they can place on the various systems. This will
enable the auditors to assess the correctness, truth and fairness of the financial statements.
4. Informing management about weaknesses detected in internal controls so that corrective action can be
taken.
5. Enabling planning of the audit
6. Understanding the components of internal control: While planning the audit, the auditor understands
the various components of the internal control so as to:
o identify the types of potential misstatements. o consider
the factors that affect the risk of misstatement. o design
effective substantive tests.

Dynamic Publishers 20
Components of internal control systems (5 in total)

Internal control components

ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its
Environment considers the components of an entity’s internal control. It identifies the following components:
1. Control environment
2. Entity’s risk assessment process
3. Information system and communication
4. Control activities
5. Monitoring of controls

1 Control environment The control environment sets the tone of an organisation, influencing the
control consciousness of its people. It includes the attitudes, awareness, and
actions of TCWG concerning the entity’s internal control and its importance in
the entity.

The control environment has many elements such as:

a) Communication and enforcement of integrity and ethical
values – essential elements which influence the effectiveness
of the design, administration and monitoring of controls.
b) Commitment to competence – management’s consideration
of the competence levels for particular jobs and how those
levels translate into requisite skills and knowledge.
c) Management’s philosophy and operating style –
management’s approach to taking and managing business
risks, and management’s attitudes and actions towards
financial reporting, information processing and accounting
functions and personnel.
d) Organisational structure – the framework within which an
entity’s activities for achieving its objectives are planned,
executed, controlled and reviewed.
e) Assignment of authority and responsibility – how authority
and responsibility for operating activities are assigned and
how reporting relationships and authorisation hierarchies are
established.
f) Human resources policies and practices – recruitment,
orientation, training, evaluating, counselling, promoting,
compensating and remedial actions.

Dynamic Publishers 21
2 Entity’s risk assessment For financial reporting purposes, the entity’s risk assessment process includes:
process - how management identifies business risks relevant to the
preparation of financial statements
- how it estimates their significance
- how it assesses the likelihood of their occurrence, and decides
upon actions to respond to and manage them and the results
thereof.

3 Information system, The information system relevant to financial reporting, which includes the
(including the related accounting system, consists of the procedures and records designed and
business processes, established to initiate, record, process, and report entity transactions (as well
relevant to financial as events and conditions) and to maintain accountability for the related assets,
reporting), and liabilities, and equity.
communication
4 Control activities relevant Control activities are the policies and procedures which help ensure that
to the audit management directives are carried out. Control activities, whether within
information technology or manual systems, have various objectives and are
applied at various organisational and functional levels.

Dynamic Publishers 22
Examples of controls are:

Segregation of duties :assignment of roles/responsibilities to different people,

thereby reducing the risk of fraud and error occurring. The concept is that no
individual person should be responsible for more than one of the following
duties:
(i) the authoristion of a transaction;
(ii) the recording of the transaction in the accounting records; and
(iii) the custody of the asset relating to the transaction.

Information processing: computer controls including general IT controls,

which cover a range of applications and support the overall IT environment
and application controls which operate on a cycle/business process level (
details given separately)

Authorisation: approval of transactions by a suitably responsible official to

ensure transactions are genuine.

Physical controls : restricting access to physical assets such as cash, inventory

and plant and equipment, thereby reducing the risk of theft.

Performance reviews : comparison or review of the performance of the

business by looking at areas such as budget v actual results.

Arithmetical controls: controls which check the arithmetical accuracy of

accounting records.

Account reconciliations : comparison of an account balance with another

source; often this source is from a third party, such as the bank, with
differences being investigated.

5 Monitoring of controls It is the process to assess the effectiveness of internal control performance
over time. It involves assessing the effectiveness of controls on a timely basis
and taking necessary remedial actions. Management accomplishes the
monitoring of controls through ongoing activities, separate evaluations, or a
combination of the two..

Dynamic Publishers 23
Computer Controls
GENERAL CONTROLS(Apply to the whole system)

Controls on the information system environment which ensure proper development of applications.

Examples include

• making regular back-ups of data and storing them off-site;

• having an IT help-desk and IT training for staff;
• keeping computers in locked rooms;
• having a disaster recovery plan;

APPLICATION CONTROLS

Application controls are those controls that relate to the transaction and standing data relating to a
computerbased accounting system.

They are specific to a given application and their objectives are to ensure the completeness and accuracy of the
accounting records and the validity of entries made in those records.

Input controls

Data input controls ensure the accuracy, completeness, and timeliness of data during its conversion from its
original source into computer data, or entry into a computer application. Examples are given below:

- Format checks: These ensure that information is input in the correct form. For example, the
requirement that the date of a sales invoice be input in numeric format only – not numeric and
alphanumeric.

- Range /Reasonableness checks: These ensure that input data is rejected or highlighted if it is
outside pre-set parameters.For example, where an entity rarely, if ever, makes bulk-buy purchases
with a value in excess of $50,000, a purchase invoice with an input value in excess of $50,000 is
rejected for review and follow-up.

- Compatibility/dependence checks: These ensure that data input from two or more fields is
compatible. For example, a sales invoice value should be compatible with the amount of sales tax
charged on the invoice.

- Exception checks: These ensure that an exception report is produced highlighting unusual situations
that have arisen following the input of a specific item. For example, the carry forward of a negative
value for inventory held.

- Sequence checks: ensure that sequential input of documentation/data is maintained.

Dynamic Publishers 24
- Control totals: These also facilitate completeness of processing by ensure that pre-input, manually
prepared control totals are compared to control totals input.
- Existence checks : the system is set up so that certain key data must be entered, such as supplier
name, otherwise the invoice is rejected. This helps to ensure accuracy of input.

- Check digit verification: Check digits are used to protect against the transposition of data i.e. errors
arising due to accidental reversal of digits. This process uses algorithms to ensure that data input is
accurate.

- Document counts :the number of invoices to be input are counted, the invoices are then entered
one by one, at the end the number of invoices input is checked against the document count. This
helps to ensure completeness of input.

- One for one checking: the invoices entered into the system are manually agreed back one by one to
the original purchase invoices. This helps to ensure completeness and accuracy of input.

Processing controls

Processing controls exist to ensure that all data input is processed correctly and that data files are appropriately
updated accurately in a timely manner.
For example, the balance carried forward on the bank account in a company’s general (nominal) ledger. Other
processing controls should include the subsequent processing of data rejected at the point of input, for
example:
- A computer produced print-out of rejected items.
- Formal written instructions notifying data processing personnel of the procedures to follow with regard
to rejected items.
- Appropriate investigation/follow up with regard to rejected items.
- Evidence that rejected errors have been corrected and re-input.

Output controls

Output controls exist to ensure that all data is processed and that output is distributed only to prescribed
authorised users. While the degree of output controls will vary from one organisation to another (dependent on
the confidentiality of the information and size of the organisation), common controls comprise:
- Appropriate review and follow up of exception report information to ensure that there are no
permanently outstanding exception items.
- Careful scheduling of the processing of data to help facilitate the distribution of information to end
users on a timely basis.

Term to remember: Standing Data

Dynamic Publishers 25
Standing data is the information that is held on computer files for long-term use. It is called standing data as it
tends to change less frequently than other data. Examples of standing data would be:
• the rate of sales tax to be applied to sales invoices;
• the hourly pay rate for a factory worker to be used when calculating payroll;
• employee bank account details.

Master file controls

The purpose of master file controls is to ensure the ongoing integrity of the standing data contained in the
master files. It is vitally important that stringent ‘security’ controls should be exercised over all master files.
These include:
-appropriate use of passwords, to restrict access to master file data
-the establishment of adequate procedures over the amendment of data, comprising appropriate segregation of
duties, and authority to amend being restricted to appropriate responsible individuals -regular checking of
master file data to authorised data, by an independent responsible official

Limitations of internal control components

The internal control system, even if well-designed and well-implemented, does not completely eliminate the
possibility of fraud or error. No internal control system can be perfect due to its inherent limitations.

- Controls are far more expensive compared to the benefits from the system.
- Overriding of controls by the management.
- Control systems are not geared up to cater to non-routine transactions.
- Possibility of human error.
- Possibility of fraud on account of collusion between employees.

Dynamic Publishers 26
External auditor’s work regarding controls
Document/Evaluate Narratives

Narrative notes consist of a written description of the system; they would detail what
occurs in the system at each stage and would include any controls which operate at
each stage.

Advantages of this method include:

– They are simple to record; after discussion with staff members of Oregano,
these discussions are easily written up as notes.
– They can facilitate understanding by all members of the internal audit team,
especially more junior members who might find alternative methods too complex.

Disadvantages of this method include:

– Narrative notes may prove to be too cumbersome, especially if the sales and
distribution system is complex.
– This method can make it more difficult to identify missing internal controls as
the notes record the detail but do not identify control exceptions clearly.

Flowcharts

Flowcharts are a graphic illustration of the internal control system for the sales and
despatch system. Lines usually demonstrate the sequence of events and standard
symbols are used to signify controls or documents.

Advantages of this method include:

– It is easy to view the sales system in its entirety as it is all presented together in
one diagram.
– Due to the use of standard symbols for controls, they are easy to spot as are any
missing controls.
Information is presented in a logical sequence.
– They ensure that a system is recorded in its entirety as all documents have to be
traced from beginning to end.
– Facilitates easy understanding of a system.
– Facilitates the highlights of strengths and weaknesses of a system.

Dynamic Publishers 27
– Serves as a permanent record of a system that can be subject to a minor
amendment on a year-to-year basis.
– They can be prepared quickly by staff with little experience.

Disadvantages of this method include:

– They can sometimes be difficult to amend, as any amendments may require the
whole flowchart to be redrawn.
– There is still the need for narrative notes to accompany the flowchart and hence
it can be a time consuming method.
– Not generally suitable for recording systems with numerous unusual
transactions.
– Only suitable for describing standard systems.
– Major amendment is not normally possible without redrawing.
– Time can be wasted by recording and checking areas that are of no audit
significance. – They are not normally appropriate for recording systems where there are
subsystems or subroutines.

Questionnaires
Internal control questionnaires are used to assess whether controls exist which meet
specific objectives or prevent or detect errors and omissions.

- ICQ( designed to ask if certain controls are present)

- ICEQ (designed to ask if certain errors can be prevented-i.e. test the
effectiveness of controls)

An Internal Control Questionnaire (ICQ) normally comprises a checklist of standard

controls that should exist in a specified functional area (for example sales and trade
receivables or purchases and trade payables). Questions about the existence of specified
controls are usually phrased to generate a ‘Yes’ or a ‘No’ answer, with an affirmative
answer confirming the existence of the control and a negative answer indicating the
absence of the control and a weakness in the system.

A problem associated with ICQs is that whilst they do identify areas where controls
appear to be weak, they do not provide evaluation of those weaknesses. For example,
whilst a ‘No’ answer may indicate weakness in controls, it is possible that other controls
in the system, of which the auditor is unaware, may compensate for the weakness.

Internal Evaluation Questionnaires (ICEQs) provide an alternative and improved means

of evaluating control systems, by asking key questions about those systems. Key
questions are phrased such that answers in the positive should alert the auditor to the
fact that there are deficiencies in the systems because systems objectives are not being
met. ICEQs are usually designed to include a list of points that the auditor should
consider before answering each key question.

Dynamic Publishers 28
The auditor issues the questionnaires to the client, who in turn gets it filled by the
appropriate employees. The feedback on the questionnaire enables the auditor to
assess the inherent limitations in the design of the internal controls.

Dynamic Publishers 29
The ICEQs contain detailed questions relating to the functioning of internal controls.
They are to be answered by the clients. The answers to the questions are generally in a
narrative form.
Information relating to the following matters is included the ICQs and ICEQs:
_ segregation and rotation of duties
_ maintenance of records and documents
_ accountability for, and safeguarding of assets
_ procedure for authorisations

The feedback received on the questionnaires will then be tested by the auditors and the
weaknesses, if any, will be communicated in the form of a letter of weakness to the
client.

Advantages
Questionnaires are quick to prepare, which means they are a cost effective method for
recording the system.
They ensure that all controls present within the system are considered and recorded;
hence missing controls or deficiencies are clearly highlighted.
Questionnaires are simple to complete and therefore any members of the team can
complete them and they are easy to use and understand.

Disadvantages
It can be easy for the company to overstate the level of the controls present as they are
asked a series of questions relating to potential controls.
Without careful tailoring of the questionnaire to make it company specific, there is a risk
that controls may be misunderstood and unusual controls missed.

Dynamic Publishers 30
Test!
Test of controls are performed to obtain audit evidence about 2 things:

1. Whether the ICS is designed suitably (to prevent, detect or correct material
misstatements)
2. Whether the ICS are operating properly ( test of controls)
Test of controls- examples

inspection of documents (e.g. authorizations)

enquiries about internal controls which leave no audit trail ( e.g. is the person who is
SUPPOSED to perform the function actually performing it or is someone else is doing
so)
Re-performance of control procedures ( e.g. reconciliations)
examination of evidence of management views(e.g. minutes of meetings)
Observation of controls
Using TEST DATA(CAATs)

If controls appear strong, they are tested to ensure they operated as described
throughout the year. If the results show they operated effectively, substantive testing
may be reduced.

Dynamic Publishers 31
Report control A letter on internal control (also referred to as a management letter or letter of
weaknesses to weakness) is a letter usually forwarded by an auditor to the senior management of a
management company.
The letter should normally be forwarded immediately following the completion of the
tests of control and before the commencement of substantive procedures.

The letter contains weaknesses identified in the entity’s system of internal control as
identified by the auditor when performing tests of control and the purpose of the letter
is to bring these weaknesses to the attention of management.

The weaknesses identified in the main body of the letter should be those which could
lead to fraud or material error in or omission from the company’s financial statements,
and will be classified as those relating to:
(i) the design of the systems of accounting and internal control.
(ii) the operation of the systems of accounting and internal control.
For both categories the implication(s) of the weakness(es) should be identified, however
minor control issues which the auditor would wish to bring to the attention of the
company’s senior management should be included in an appendix to the letter of
weakness or in a supplementary report.

Decide extent of Internal control over financial reporting strong- decrease substantive testing
substantive testing
Internal control over financial reporting weak- inccrease substantive testing

Dynamic Publishers 32
The Sales System

Control objectives for sales and despatch system

- To ensure that orders are only accepted if goods are available to be processed for customers.
- To ensure that all orders are recorded completely and accurately.
- To ensure that goods are not supplied to poor credit risks.
- To ensure that goods are despatched for all orders on a timely basis.
- To ensure that goods are despatched correctly to customers and that they are of an adequate quality.
- To ensure that all goods despatched are correctly invoiced.
- To ensure completeness of income for goods despatched.
- To ensure that sales discounts are only provided to valid customers.

Sales order - All sales orders documented on a sequentially numbered multi-part SALES ORDER FORM.
placed
- Confirm from the customer ( preferably in writing except on telephonic sales, a verbal
reconfirmation/ call recording should be acceptable)
- Inventory check

- One copy of the GDN is sent with the goods, one copy stays in the warehouse, stapled to
the relevant sales order, and one copy is sent to the invoicing department.
- New customer: credit checks, the obtaining of trade/bank references and the setting of
appropriate credit limits for customers
- Existing customer: credit limit check, Customer credit limits should be regularly reviewed
and updated based on the level of sales transactions and credit risk
- Any discounts committed to be authorized

- Follow up on unfulfilled orders- On a regular basis, a sequence check of orders should be

undertaken to identify any missing orders.
- Automated environment: access to master file limited to authorized individuals only

Goods - Sequentially pre-numbered Goods Dispatched Note

dispatched to - Matched to the sales order- Upon despatch, the GDN should be matched to the order; a
the customer regular review of unmatched orders should be undertaken to identify any unfulfilled
orders.
- Signed by the warehouse manager after quantity and quality checks
- 3 copies( warehouse, customer, accounts/invoicing)

- Customer should sign the copies to acknowledge receipt of goods

Dynamic Publishers 33
Sales invoice - Sequentially pre-numbered invoices
raised and - Matched to GDN
entered in the - 3 copies ( accounts/invoicing, customer, sales day book clerk if applicable)
accounting - Ensure the authorized price list is used to prepare the invoice
system - Any discounts authorized
- Arithmetic checks on invoices
- Sequence check on GDNs to ensure all GDNs have been invoiced
- Sequence check on Invoices to ensure all invoices have been entered in the accounting
system
- Customer statements should be sent monthly to ensure any errors and disputed invoices
are quickly identified and resolved
- The sales ledger control account should be reconciled on a monthly basis to the individual
ledger to identify any errors. The reconciliations should be reviewed by a responsible
official and they should evidence their review.

Payment received from the customer Goods returned by the customer

- Match payment to invoice - Sequentially pre-numbered credit note

- Check validity of any settlement - Signed by the manager
discounts availed by the customer - Matched to invoice
- Segregation of duties: receiving payment - Prepare a report for reasons for returns and actions
and recording taken by the management.
- Encourage bank transfers
- A Bank Reconciliation Statement should
be prepared on a monthly basis

Other controls Aged receivables report: prepare monthly and reviewed by a senior official
Exceptions reports created and reviewed ( old receivables, credit limit exceeded etc.)
Amendments to master file data should be restricted so that only senior officials can make
changes.

The Purchase System

The main objectives in purchase transactions are:

– Procurement is made only when the requirements are genuine.
– Purchases are made at the most optimum prices and terms.
– Purchases meet the required quality standards and if substandard quality is accepted, must be at negotiated
terms.
– Payments are made according to agreed terms.
– They are procured on time and the payments are made according to agreed terms.

Dynamic Publishers 34
Purchase - Sequentially pre-numbered
requisition - Authorized to ensure only those goods are ordered which are required
- Monitor inventory level or Re-order level set

- Inventory/ re-order level checked before raising the requisition to ensure only order
when required.

Purchase - Sequentially pre-numbered and matched to requisition

order - Authorized supplier list used and updated annually (this should take into account the
price of goods, their quality and the speed of delivery.)
- Authorized

- 3 copies ( supplier, order department, warehouse)

- Follow up on order placed but not yet received ( exception reports can be created in a
computerized environment) and sequence check can be performed for any unfulfilled
orders

Goods - Sequentially pre-numbered GRN Matched

received - to purchase order
- Signed by the warehouse manager after quantity and quality checks

- 3 copies ( ordering department, warehouse for their records, account)

Invoice - Match to GRN

received from - File in an order ( CANNOT be Sequentially pre-numbered) but should be numbered
supplier manually. This way, a sequence check can then be carried out to ensure all invoices have
been entered in the day book/ledger.
- Arithmetic checks

- Entered in the ledger /day book on a daily basis-application controls( such as control
total) should be applied to ensure completeness and accuracy over the input of
purchase invoices.
- Stamp ‘entered’ when recorded

- Segregation of duties ( order placement, goods received and recording)

- Monthly reconciliation: PL to PLCA

Dynamic Publishers 35
Payment made Goods returned to the supplier

- Segregation of duties ( Purchase order, goods received, - . Sequentially pre-numbered debit

payment ) notes
- Before approving invoices for payment, a senior official - Authorized
should match them to the audit trail ( esp. the GRN) - Vendor-wise analysis to identify
- Bank transfer preferred consistent quality problems
- If payment by cheque: senior individuals only plus two
signatories for high amounts
- Stamp invoice ‘paid’
- Try and avail settlement discounts and pay according to
supplier’s terms to maintain supplier goodwill
- Payment against specific invoices only ( avoid ‘on account
payment’)
- Supplier statement reconciliation with PL
- PL reconciliation with PLCA
- Monthly BRS

Dynamic Publishers 36
Examples of application Document counts – the number of invoices to be input are counted, the invoices are
controls to ensure the then entered one by one, at the end the number of invoices input is checked against
the document count. This helps to ensure completeness of input.
Completeness and
accuracy of the input of Control totals – here the total of all the invoices, such as the gross value, is manually
purchase invoices. calculated. The invoices are input, the system aggregates the total of the input
invoices’ gross value and this is compared to the control total. This helps to ensure
completeness and accuracy of input.

One for one checking – the invoices entered into the system are manually agreed
back one by one to the original purchase invoices. This helps to ensure completeness
and accuracy of input.

Check digits – this control helps to reduce the risk of transposition errors.
Mathematical calculations are performed by the system on a particular data field,
such as supplier number, a mathematical formula is run by the system, this checks
that the data entered into the system is accurate. This helps to ensure accuracy of
input.

Range checks – a pre-determined maximum is input into the system for gross invoice
value, for example, $10,000; when invoices are input if the amount keyed in is
incorrectly entered as being above $10,000, the system will reject the invoice. This
helps to ensure accuracy of input.

Existence checks – the system is set up so that certain key data must be entered,
such as supplier name, otherwise the invoice is rejected. This helps to ensure
accuracy of input.

The Payroll System

The main objective of a payroll is to ensure that:

– Wages and salaries are paid at the correct rates.
– Wages and salaries are paid to the right people.
– Wages and salaries are paid on time.

Key terms: 1. Clock cards/ timesheets 2.Payroll sheet 3.Pay slips 4.Bank Transfer List/payment list (instructions
to the bank)

Appointment/ leavers

- Appointments: All appointment of staff, whether temporary or permanent, should only be made by the
human resources department, separate from the payroll department

Dynamic Publishers 37
- There should be formal procedures requiring the interviews manager to provide detailed written
notification to a responsible official (for example the wages supervisor) of starters and leavers.

- Update ‘starters and leavers’ details on a timely basis. Procedures should ensure that ‘starters’ and
‘leavers’ details are added to or deleted from the master file immediately after starting or leaving the
company’s employment.

- All increases of pay should be proposed by the HR department and then formally agreed by the board of
directors.

- Standing data in the master file:

• ‘Read’ and ‘amend’ access to the master file should be available from specified terminals
to responsible officials who have a need and authorised cause to access the information.
• Maintain a log of access attempts (Controls should include a computer log which registers
date and time access to the master file by the various users. This should regularly be
reviewed by a senior responsible official of the company)
• Match standing data to the personnel filed periodically

At random intervals a more senior responsible official of the company (for example the company accountant),
should access the wages master file and check its contents to the manual records maintained, input
documentation and notifications from the interviews manager as appropriate.

Calculations

- Clock cards sequentially pre-numbered (which details the employee number and name)

- Clock card machine supervised or in open view (Staff attendance machine kept near the security gate (to
ensure that there are no dummy attendances recorded).

- Head count by area supervisor ( attendance matched to actual employees present)

- Any overtime worked reviewed and then authorized. This should be evidenced by signature on the
employees’ overtime sheets.

Dynamic Publishers 38
- Periodic verification of staff cards with personal files of employees (to ensure that there are no ghost
employees).

- Data input: Use application and general IT controls ( for example range checks, passwords)

- Gross pay, deductions, net pay:

• Preferably automatically calculated by the payroll system.
• Calculations re checked on a sample basis- A senior member of the payroll team should
recalculate the gross to net pay workings for a sample of employees and compare their results
to the output from the payroll system.

Payments

- Pay slips to be sequentially pre-numbered

- Segregation of duties ( payroll sheet, recording, payment)

- Salaries:
• Preferably through bank transfer
• Bank transfer list/payment list matched to payroll sheet prior to authorising the bank payment.
• When authorising the payments, the responsible official should on a sample basis perform
checks from payroll records to payment list and vice versa to confirm that payments are
complete and only made to bona fide employees.
• Bank transfer list/payment list preferably authorized by someone other than the person who
authorized payroll ( for example the Finance Director)

- Wages (cash)/Pay packets

• All cash wages should only be paid upon sight of the employee’s clock card and
photographic identification as this confirms proof of identity.
• Uncollected wage packets should be kept in a safe place/ deposited in the bank

Revenue and Capital Expenditure

Capital expenditure is incurred when a business spends money either to buy fixed assets or to add to the value
of an existing fixed asset.

Revenue expenditure is that expenditure which is incurred to maintain the existing capacity of an asset so that it
can do its daily work. Examples of revenue expenditure are cost of raw material and other stores, salaries and

Dynamic Publishers 39
wages, repairs and maintenance, stationery and printing, advertisements, postage, telephone, travel expenses
etc.

The main control objectives over revenue and capital expenditure are to ensure that:
 All expenditure is authorised.
 Proper segregation of capital and revenue expenses is made.
 Expenses are properly accounted for.

The transaction cycle for capital and revenue expenditure is quite similar for purchases. However, certain
additional control points, which are to be ensured, are mentioned below:
 Am authorized budget is prepared for all expenditure.
 Preparation of a report of capital budget versus actual expenditure.
 Preparation of a periodic variance report of those expenses that do not match the budget.
 Orders for capital items should be authorised by appropriate levels of management.
 A document may be prepared for showing the distinction between capital and revenue expenditure and for
providing guidance on which expenses to be capitalised.
 All vouchers of revenue expenditure need to have approval of maintenance manager.
 A senior person should check the accounting treatment for the expenses (especially repairs and
maintenance).

Non-Current Asset register

The purpose of a tangible non-current assets register is to list details of all the non-current assets owned by an
entity, in order to facilitate control over those assets. Typically, the register should record cost, depreciation and
net book value information of each asset along with identifying details. For example in the case of plant and
machinery – gross cost, annual depreciation rate, depreciation provision, net book value, date of acquisition,
serial number and description and location of asset.

 The register should be updated by individuals who are separated from the acquisition, custody and
disposal of assets.
 Periodical reconciliation of non-current register with the general ledger to be done and any differences
to be investigated.
 Preparation of an exception report if the non-current register does not match the non-current assets
account maintained in accounts.
 Invoices should bear appropriate ledger code (distinguishing revenue items from capital expenditure) in
order to facilitate correct recording.
 Depreciation rates should be reasonable and authorised.
 Depreciation calculations should be checked
 NCA register should be used to confirm physical existence on a periodic basis
 To ensure completeness of recording, periodic checks should be made to ensure that assets in existence
are completely recorded in the register.

Dynamic Publishers 40
Bank and Cash
The main objectives of cash and bank transactions are to ensure that:
 All money received is recorded.
 All money received is banked.
 Money is properly safeguarded.
 Payments are made to correct persons and properly recorded.

Main controls on bank and cash

 Segregation of duties between the person receiving the money, the person depositing it in the bank and the
one making the payments.
 Match bank deposit slips with the cash and cheque receipt register.
 Daily cash receipts immediately recorded in the customers’ accounts.
 Cash receipt register reconciled daily with the customer accounts.
 Periodical management review of the register is to be conducted to ensure that cheques are promptly
deposited into the bank.
 Bank reconciliation to be prepared periodically and differences to be investigated.
 Receivables’ ledger reconciled with control account.
 Cash kept under the custody of the cashier. And there should be restricted access to cashier’s room 
Security personnel to accompany the cashier while depositing or withdrawing cash from the bank 
Minimum cash balance to be maintained needs to be decided.
 Whenever cash balance exceeds minimum balance, excess balance deposited to be in the bank.
 Surprise cash counts by personnel other that the accounts department.
 Cash to be suitably insured for cash in hand, and cash in transit.
 Unused cheques to be kept under lock and key.
 Cheques books to be in the custody of a responsible person

Test of controls

What is a Test of Control? An audit procedure designed to evaluate the operating effectiveness of controls in
preventing, or detecting and correcting, material misstatements at the assertion level.

Examples of test of controls( also mentioned earlier):

inspection of documents (e.g. authorizations)

enquiries about internal controls which leave no audit trail ( e.g. is the person who is SUPPOSED to perform
the function actually performing it or is someone else is doing so)
Reperformance of control procedures ( e.g. reconciliations)
examination of evidence of management views(e.g. minutes of meetings)

Dynamic Publishers 41
Observation of controls
Using TEST DATA(CAATs)

If you are confused about how to word a TOC, start with “The auditor should….”

Management assertions, Audit procedures and Audit evidence

Management is responsible for the preparation of financial statements that give a true and fair view, but what
does this really mean?

For each item in the financial statements, management is making assertions.

A note of caution: ISA 315 has been recently revised. The solutions of the past exams may not reflect these
revisions at the moment. Students are requested to be careful when practicing past exams. The revised
summary is given below.

Assertions about classes of transactions and events and related disclosures for the period under audit

- This means that the transactions recorded or disclosed

1. Occurrence – the transactions and actually happened and relate to the entity. For example that
events that have been recorded a recorded sale represents goods which were ordered by
or disclosed, have occurred, and valid customers and were despatched and invoiced in the
such transactions and events period. An alternative way of putting this is that sales are
pertain to the entity. genuine and are not overstated.

- Relevant test – select a sample of entries from the sales

account in the nominal ledger and trace to the appropriate
sales invoice and supporting goods despatched notes and
customer orders.

Dynamic Publishers 42
2. Completeness – all transactions and - No omission
events that should have been
recorded have been recorded and - Relevant test – select a sample of customer orders and
all related disclosures that should check to despatch notes and sales invoices and the posting
have been included in the to the sales account in the nominal ledger.
financial statements have been
included.
Note the difference in the direction of the above test. In order to
test completeness the procedure should start from the underlying
documents and check to the entries in the relevant ledger to ensure
none have been missed. To test for occurrence the procedures will
go the other way and start with the entry in the ledger and check
back to the supporting documentation to ensure the transaction
actually happened.

3. Accuracy – amounts and other data - This means that there have been no errors while preparing
relating to recorded transactions documents or in posting transactions to ledgers. The new
and events have been recorded reference to disclosures being appropriately measured and
appropriately, and related described means that the figures and explanations are not
disclosures have been misstated.
appropriately measured and
described. - Relevant test – calculation checks on invoices, payroll, etc,
and the review of control account reconciliations are
designed to provide assurance about accuracy.

4. Cut–off – transactions and events - That transactions are recorded in the correct accounting
have been recorded in the correct period.
accounting period.
- Relevant test – recording last goods received notes and
despatch notes at the inventory count and tracing to
purchase and sales invoices to ensure that goods received
before the year–end are recorded in purchases at the year
end and that goods despatched are recorded in sales.

5. Classification – transactions and - Transactions recorded in the

events have been recorded in the appropriate accounts – for
proper accounts. example,the purchase of raw
materials has not been posted to
repairs and maintenance.

- Relevant test – check purchase invoices postings to nominal ledger accounts.

6. Presentation – transactions and - This means that the descriptions and disclosures of events are
appropriately transactions are relevant and easy to understand. There is a aggregated or disaggregated
and new reference to transactions being appropriately clearly described, and related

Dynamic Publishers 43
aggregated or disaggregated. Aggregation is the adding disclosures are relevant and together
of individual items. Disaggregation is the understandable in the context of separation of an item, or
an aggregated group of items, into the requirements of the component parts. The notes to the
accounts are often used applicable financial reporting to disaggregate totals shown in the profit or loss
account.
framework. Materiality needs to be considered when judgements are made about the level of
aggregation and disaggregation
.
- Relevant test – check the total employee benefits expense
is analysed in the notes to the financial statements under
separate headings– ie wages and salaries, pension costs,
social security contributions and taxes, etc.

Assertions about account balances and related disclosures at the period end

1. Existence – assets, liabilities and - Means that assets and liabilities really do exist and there
equity interests exist. has been no overstatement – for example,by the inclusion
of fictitious receivables or inventory. This assertion is very
closely related to the occurrence assertion for transactions.

- Relevant tests – physical verification of non–current assets,

circularisation of receivables, payables and the bank letter.

2. Rights and obligations – the entity - Means that the entity has a legal title or controls the rights
holds or controls the rights to to an asset or has an obligation to repay a liability.
assets, and liabilities are the
obligations of the entity - Relevant tests – in the case of property, deeds of title can
be checked. Current assets are often checked to purchase
invoices although these are primarily used to confirm cost.
Long term liabilities such as loans can be checked to the
relevant loan agreement.

Dynamic Publishers 44
3. Completeness – all assets, liabilities - That there are no omissions and assets and liabilities that
and equity interests that should should be recorded and disclosed have been. In other words
have been recorded have been there has been no understatement of assets or liabilities.
recorded and all related
disclosures that should have been Relevant tests – A review of the repairs and expenditure
included in the financial - account can sometimes identify items that should have
statements have been included. been capitalised and have been omitted from non–current
assets. Reconciliation of payables ledger balances to
suppliers’ statements is primarily designed to confirm
completeness although it also gives assurance about
existence.

4. Accuracy, valuation and allocation - Means that amounts at which assets, liabilities and equity
– assets, liabilities and equity interests are valued, recorded and disclosed are all
interests have been included in appropriate. The reference to allocation refers to matters
the financial statements at such as the inclusion of appropriate overhead amounts into
appropriate amounts and any inventory valuation.
resulting valuation or allocation
- Relevant tests – Vouching the cost of assets to purchase
adjustments have been
invoices and checking depreciation rates and calculations.
appropriately recorded and
related disclosures have been
appropriately measured and
described.

- Means that assets, liabilities and equity interests are

recorded in the proper accounts.
5. Classification – assets, liabilities and
equity interests have been Relevant tests – the test for transactions of checking
-
recorded in the proper accounts.
purchase invoice postings to the appropriate accounts in the
nominal ledger will be relevant again. Also that research
expenditure is only classified as development expenditure if
it meets the criteria specified in IAS 38.

6. Presentation – assets, liabilities and - This means that the descriptions and disclosures of assets
equity interests re appropriately and liabilities are relevant and easy to understand. The
aggregated or disaggregated and points made above aggregation and disaggregation of
clearly described, and related transactions also apply to assets, liabilities and equity
disclosures are relevant and interests.
understandable in the context of
the requirements of the - Relevant tests – auditors often use disclosure checklists to
applicable financial reporting ensure that financial statement presentation complies with
framework. accounting standards and relevant legislation. These cover
all items (transactions, assets, liabilities and equity interests)
and would include for example checking that disclosures

Dynamic Publishers 45
relating to non–current assets include cost, additions,
disposals, depreciation, etc.

Methods for testing these assertions/Procedures to obtain evidence/sources of evidence

Audit evidence verifies the correctness of the assertions contained in the financial statements. Audit evidence
can be obtained from different sources.

Inspection Inspection involves examining records Example – the physical inspection of a freehold office
or documents, whether internal or building to verify existence of the building.
external, in paper form, electronic
form, or other media, or a physical Example – the examination of a purchase invoice to
examination of an asset. vouch the validity of an entry in the trade creditors
ledger.
Observation Observation consists of looking at a Example – the observation of the counting of inventory
process or procedure being by an entity’s personnel to ensure that they are
performed by others counted in accordance with procedures authorised by
the management of the entity.

Example – the observation of the opening of the mail

of an entity to ensure that at least two employees are
present to receive and witness the receipt of monies
received by the entity.

Dynamic Publishers 46
Analytical Analytical procedures consist of Example – the calculation of the average remuneration
procedures evaluations of financial information (total wages and salaries divided by total employees)
through analysis of plausible paid to the employees of an entity, to assess the
relationships among both financial reasonableness of the reported wages and salaries
and non-financial data. Analytical costs as compared to a previous equivalent period.
procedures also encompass such
investigation as is necessary of Example – the calculation of an entity’s trade creditors
identified fluctuations or relationships ratio to help assess the reasonableness of bad debt
that are inconsistent with other provisions, the effectiveness of credit control and the
relevant information or that differ possibility of under/over statement of reported sales.
from expected values by a significant
amount.

Assertions normally tested by the

analytical procedures are
Completeness, Accuracy, Valuation
and Classification

Inquiry Inquiry consists of seeking

information of knowledgeable
persons, both financial and
nonfinancial, within the entity or
outside the entity.

External An external confirmation represents Example – direct confirmation of a trade receivables

confirmation audit evidence obtained by the balance – to verify the existence of a trade receivables
auditor as a direct written response balance.
to the auditor from a third party, in
paper form, electronic form or by Example – letter from a loan company, confirming the
other medium. balance outstanding on a loan – to verify the loan
liability of the company.

Example – a certificate from a specialist, confirming

the value of specific inventories held – to verify the
valuation of inventories.

Recalculation Recalculation consists of checking the Example – checking the accuracy of inventory
mathematical accuracy of documents calculations to verify the accuracy of the valuation of
or records. Recalculation may be reported inventory.
performed manually or electronically.

Dynamic Publishers 47
Re- Re-performance involves the Example – Using computer assisted audit techniques to
performance auditor’s independent execution of re-perform the ageing of accounts receivable balances.
procedures or controls that were
originally performed as part of the Example – Reperforming the extraction of a trial
entity’s internal control. balance from the company’s general ledger.

Sufficient Appropriate evidence

The term ‘audit evidence’ describes the information obtained by the auditors in arriving at the conclusions on
which the audit opinion is based.

Audit evidence comprises source documents and accounting records underlying the financial statements (subject
to audit) and corroborating information from other sources.

The auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on
which to base the audit opinion.

Sufficient Factors affecting sufficiency

(quantity of evidence)
1. Assessment of risk at the financial statement level and/or the individual
transaction level. As risk increases then more evidence is required.

2. The materiality of the item. More evidence will normally be collected on

material items whereas immaterial items may simply be reviewed to ensure
they appear correct.

3. The nature of the accounting and internal control systems. The auditor
will place more reliance on good accounting and internal control systems
limiting the amount of audit evidence required.

4. The auditor’s knowledge and experience of the business. Where the

auditor has good past knowledge of the business and trusts the integrity
of staff then less evidence will be required.

5. The findings of audit procedures. Where findings from related audit

procedures are satisfactory (e.g. tests of controls over receivables) then
substantive evidence will be collected.

6. The source and reliability of the information. Where evidence is obtained

from reliable sources (e.g. written evidence) then less evidence is required
than if the source was unreliable (e.g. verbal evidence).

Dynamic Publishers 48
Appropriate Reliability of evidence
(quality of evidence)
Following are the factors that influence the reliability of audit evidence:

1. Audit evidence is more reliable when it is obtained from independent

sources outside the entity.
2. Audit evidence that is generated internally is more reliable when the
related controls imposed by the entity are effective.
3. Audit evidence obtained directly by the auditor (for example, observation
of the application of a control) is more reliable than audit evidence
obtained indirectly or by inference (for example, inquiry about the
application of a control).
4. Audit evidence is more reliable when it exists in documentary form,
whether paper, electronic, or other medium.
5. Audit evidence provided by original documents is more reliable than audit
evidence provided by photocopies or facsimiles.
6. Evidence created in the normal course of business is better than evidence
specially created to satisfy the auditor.
7. The best-informed source of audit evidence will normally be management
of the company (although management’s lack of independence may
reduce its value as a source of such evidence).
8. Evidence about the future is particularly diffi cult to obtain and is less
reliable than evidence about past events.

Relevance of evidence: Audit evidence should be relevant to the area/ assertions

being tested.

Dynamic Publishers 49
Substantive procedure

Substantive procedure is an audit procedure which is designed to detect material misstatements at the assertion
level.

Substantive procedures (or substantive tests) are those activities performed by the auditor that gather evidence
as to the completeness, validity and / or accuracy of account balances and underlying classes of transactions and
related disclosures.

Substantive procedures comprise the following a)

Analytical procedures
b) Tests of details (of classes of transactions, account balances, and related disclosures) a)
Analytical procedures
Analytical procedures mean the analysis of significant ratios and trends. It also involves the investigation of
resulting fluctuations and inconsistent relationships.

b) Test of detail
Test of detail is carried out for transactions and balances.
Details of transaction
These are tests to obtain evidence of individual debits and credits that make up an account to reach a conclusion
about the account.
The tests can be made through tracing and vouching of transactions.

Tracing: Supporting documents traced to records/account books

Vouching: Records/account books vouched/verified by matching to relevant supporting documents
PROCEDURES on specific areas

Substantive on Receivables Key risk: overstatement

Receivables circularization (3rd party confirmation of receivables)

Types of receivable confirmation letters

1. Positive confirmation: Receivable asked to agree or disagree with the stated balance or write the
balance owing.
Dynamic Publishers 50
2. Negative confirmation: Receivable asked to reply only if he disagrees with the balance. This type of
confirmation should only be used when:
• The audit client has a strong internal control system over sales and trade
receivables.
• Other good corroborative evidence with regard to the existence of trade
receivables has already been obtained from other tests carried out.
• There are a large number of small balances.
• A substantial number of errors is not expected.

Method of sending confirmation letter

1. Obtain the receivables ledger and reconcile it to the control account 2.
Select a sample of debtors to be circularized
3. Inform the client of the intended list.
4. Get the details of the debtors and prepare letters on client’s letterhead.
5. Get the letter signed by a senior person at the client.
6. Record names and amount circularized
7. Post/fax letters ensuring the replies are sent directly to the auditor.
8. Record replies received and test the ones not agreed.
9. For non-replies:
- with the client’s permission, the team should arrange to send a follow up
circularisation.
- If the receivable does not respond to the follow up, then with the client’s
permission, the senior should telephone the customer and ask whether they are
able to respond in writing to the circularisation request.
- – If there are still non-responses, then the auditor should undertake alternative
procedures to confirm receivables. These procedures include verifying post year end
receipts from that customer, verifying order placement and dispatch documentation
and carrying out bad debt procedures

10. – For responses with differences:

i. the auditor should identify any disputed amounts, and identify whether these relate to
timing differences or whether there are possible errors in the records of the client.
ii. Any differences due to timing, such as cash in transit, should be matched with cash
received after the year end
iii. The receivables ledger should be reviewed to identify any possible mispostings as this
could be a reason for a response with a difference.
iv. If any balances have been flagged as disputed by the receivable, then these should be
discussed with management to identify whether a write down is necessary

Dynamic Publishers 51
Substantive testing

Existence 1. Circularization of a sample of period end receivables (discussed above)

The receivable actually 2. Verify audit trail from records to source document: Select a sample of
exists yearend receivable balances and agree back to valid supporting
documentation of GDN and sales order to ensure existence

Accuracy, valuation, 1. Circularization of a sample of period end receivables (discussed above)

allocation
2. Invoice: inspect and recalculate
Receivables are included
in the financial 3. Recoverability procedures ( bad debts):
statements at the
• Select a significant sample of receivables and review whether there
correct amount
are any after date cash receipts(ensure that a sample of slow
moving/old receivable balances is also selected)

• Review the aged receivable ledger to identify any slow moving or old
receivable balances, discuss the status of these balances with the
credit controller to assess whether they are likely to pay

• Calculate average receivable days and compare this to prior year,

investigate any significant differences

• Review customer correspondence to identify any balances which are

in dispute or unlikely to be paid.

• Review board minutes to identify whether there are any significant

concerns in relation to payments by customers.

Dynamic Publishers 52
4. Allowance for doubtful debts:

• recalculate to ensure it is accurate

• ensure rationale/basis reasonable and in line with your

understanding of the client’s business

• written representation from management that the

basis/assumptions are reasonable and that the allowance is
adequate.

• -Inspect post year-end sales returns/credit notes and consider

whether an additional allowance against receivables is required.

Rights & obligation 1. Circularization of a sample of period end receivables (discussed above)

The receivable belongs 2. Invoice: inspect to confirm right over the receivable
to the client
Completeness 1. Verify audit trail from source document to record:

There has been no  Select a sample of GDNs and agree to valid supporting
omission in recording of documentation of invoice.
receivables
 Ensure these invoices have been entered in the day books and
individual ledgers.

 Ensure the individual ledger is reconciled with the control

account)
2.
Compare ratios/balances of this period to prior periods and budgets,
investigate any significant differences.

3. Ensure all disclosures relevant to receivables have been made.

Dynamic Publishers 53
Substantive testing- Sales Revenue

1. Arithmetical accuracy of invoices checked

2. Recalculate discounts to ensure accuracy

3. Compare the overall level of revenue against prior years and budget and investigate any significant
fluctuations.

4. For a sample of invoices match rates to standard price list to confirm accuracy

5. Select a sample of credit notes raised, trace through to the original invoice and ensure invoice correctly
removed from sales.

6. Completeness as above: Select a sample of trade customer orders placed and agree these to the
despatch notes and sales invoices through to inclusion in the sales ledger to ensure completeness of
revenue.

7. Cut-off: Note down the last GDN for the year. Take a sample of GDNs immediately before AND after
the year end and ensure they are recorded in the correct accounting period

Substantive testing: Inventory- Key risk: overstatement

Inventory count

Before Inventory Count

1. Review the prior year audit files to identify whether there were any particular warehouses/areas where
significant inventory issues arose last year
2. Discuss with management whether any of the warehouses this year are new, or have experienced
significant control issues.
3. Consider locations. Ensure all locations are covered OR decide locations the audit team members will
attend, basing this on materiality and risk of each site.
4. Obtain a copy of the proposed inventory count instructions, review them to identify any control
deficiencies and if any are noted, discuss them with management prior to the counts.
5. Arrange to verify any inventory held by 3rd party
6. Establish whether expert help is needed
7. If an internal audit department exists, discuss the procedures that they carried out and review their
working papers.

Dynamic Publishers 54
The following matters should be covered in the instructions for the physical inventory count:

1. There should be adequate supervisory controls, with one individual assuming overall responsibility for
the inventory count.
2. Employees involved in the inventory count should be independent of those working in the stores and
production areas
3. Counters should work in pairs with one counting inventory and the other recording and checking
quantities counted.
4. Procedures should ensure that items are marked or tagged as ‘counted’ to avoid the possibility of double
counting or omission.
5. There should be adequate control over the issue and returning of inventory control sheets, possibly
involving the use of pre-numbered sheets with returned sheets being agreed to issued sequences for
completeness.
6. Inventory sheets should be completed in ink and signed by the relevant individuals involved in the
counting and recording process.
7. Movement of inventory during the count should be prohibited where possible and a special quarantine
area should be created in which to store any goods received.
8. In order to minimise disruption to the production process, raw materials together with parts and finished
goods inventories should be counted first with work-in-progress inventory being counted at the end of
the working day.
9. There should be stringent controls over cut-off issues with careful note being made of the number of the
last goods received, goods returned and goods despatched and raw materials/parts issued notes prior to
the inventory count.
10. There should be adequate procedures to identify, count and record inventory that is slow moving or
obsolete.

During Inventory Count

The purpose of an auditor’s attendance at a client’s year-end inventory count is to assess the effectiveness of the
client’s inventory counting procedures in order to determine whether reliance can be placed upon them to
provide assurance about the existence and condition of inventory.

Auditor’s procedures during the count

1. Observe the counting teams to confirm whether the inventory count instructions mentioned above are
being followed correctly.
2. Perform a test of controls (i.e. test the system used for recording, issuing inventory etc.)
3. Confirm the procedures for identifying and segregating damaged goods are operating correctly, and
assess inventory for evidence of any damaged or slow moving items.
4. Test the counts that are being done by the client’s representative- Perform two-way testing: Match
physical stock with stock records(completeness) and records with physical stock(existence
5. Check cut-off arrangements- Identify and make a note of the last goods received notes and goods
despatched notes for the year end in order to perform cut-off procedures.
Dynamic Publishers 55
6. Note any inventory that is set aside or specially marked, providing possible indicators that inventory is
not owned by the company
7. Enquire as to the possibility of consignment or third party inventories being held by the company and
record appropriate notes for subsequent follow up
8. Obtain a photocopy of the completed sequentially numbered inventory sheets for follow up testing on
the final audit.

After Inventory Count

1. Discuss any weaknesses discovered during count with the management

2. Match final inventory sheets with the photocopies that you did at the time of inventory count- Check to
ensure that all sheets and records used at the inventory count are included in the final inventory count
sheets and records.
3. Ensure that slow-moving and obsolete inventory lines recorded at the inventory count are properly
highlighted in the sheets and records to be used in the valuation process.
4. Follow-up on any other matters recorded in working papers at time of count

Substantive procedures

Completeness During the inventory count, take a sample of physical inventory and ensure it is
completed recorded in the records/inventory ledger
Existence During the inventory count, select a sample of inventory from the ledger and verify its
physical existence.
Rights and obligation 1. Inspect invoices/supporting documents to confirm right
2.
IF there is any inventory at the 3rd party, confirmed it is owned by the client by
circularizing the 3rd party.

3. IF there is consignment stock, the agreement will need to be inspected to

confirm when risks and rewards(control) are transferred.

Accuracy, Valuation. 1. Select a representative sample of goods in inventory at the year end, agree
Allocation the cost per the records to a recent purchase invoice and ensure that the cost
is correctly stated.

Dynamic Publishers 56
2. For a sample of manufactured items obtain cost sheets and confirm:

• raw material costs to recent purchase invoices

labour costs to time sheets or wage records
• overheads allocated are of a production nature.

3.
Net Realisable Value:

a) For a sample of inventory, review post year end sales to see if

adjustments are required

b) For unsold items, discuss with mngt to determine whether they are
slow moving and provision has been created

c) Review aged inventory reports and identify any slow moving goods,
discuss with management why these items have not been written
down

d) Perform a review of the average inventory days for the current year
and compare to prior year inventory days .Discuss any significant
variations with management.

e) Compare the gross margin for current year with prior year.
Fluctuations in gross margin could be due to inventory valuation
issues. Discuss significant variations in the margin with management.

f) Follow up any damaged/obsolete items noted by the auditor at the

inventory counts attended, to ensure that the inventory records have
been updated correctly

g)
Determine estimated costs to completion. These costs represent
another important element of net realisable value. Determine costs to
be incurred in marketing, selling and distributing directly related to the
items in question.

h)
Get a written representation from the management that inventory has
been correctly valued.

Dynamic Publishers 57
4. WIP

a) Cast the schedule of total WIP and agree to the trial balance and financial
statements.

b) Obtain the costing records for a sample of WIP and:

• Agree labour costs to payroll;

• Agree labour hours to time sheets;
• Recalculate the overhead absorption rate

5. Procedures to confirm use of standard costs for inventory valuation

a) Discuss with management the basis of the standard costs applied to the
inventory valuation, and how often these are reviewed and updated.
b) Review the level of variances between standard and actual costs and discuss
with management how these are treated.
c) Obtain a breakdown of the standard costs and agree a sample of these costs to
actual invoices or wage records to assess their reasonableness.

Cut-off Note down the last GDN and GRN for the year. Take a sample of GDNs and GRNs
immediately before AND after the year end and ensure they are recorded in the
correct accounting period

Inventory Held by Third Parties

Where the entity has inventory that is held by third parties and which is material to the financial statements, the
auditor shall obtain sufficient appropriate audit evidence by performing one or both of the following:

• Direct confirmation from the third party regarding quantities and condition (in accordance with ISA 505
External confirmations)

• Inspection or other appropriate audit procedures (if third party's integrity and objectivity are doubtful, for
example)

The other appropriate audit procedures referred to above could include the following:

Procedures to confirm inventory held at third party locations

1. Send a letter requesting direct confirmation of inventory balances held at year end from the third party
regarding quantities and condition.

Dynamic Publishers 58
2. Attend the inventory count (if one is to be performed) at the third party warehouses to review the
controls in operation to ensure the completeness and existence of inventory.

3. Inspecting documentation in respect of third party inventory (eg warehouse receipts)

4. Requesting confirmation from other parties when inventory has been pledged as collateral

Audit procedures for continuous (perpetual) inventory counts

In order that the company’s auditors may rely on the company’s revised continuous inventory checking system,
the auditor should ensure that:

I. Inventory records are kept up to date.

II. All inventory lines are counted at least once a year with higher value and desirable lines being counted
more frequently.
III. The counting of inventory is carried out by suitably experienced independent individuals in a systematic
and orderly manner.
IV. All corrections to inventory records are authorised by a responsible official of the company.
V. Any material discrepancies noted between inventory records and physical quantities are investigated
immediately and reported to management for immediate further follow up as appropriate.
VI. There are satisfactory procedures with regard to cut-off and receipt/issue documentation at the time of
inventory counts.

Procedures

1. The audit team should attend at least one of the continuous (perpetual) inventory counts to review
whether the controls over the inventory count are adequate.
2. The audit team should confirm that all of the inventory lines have been counted or are due to be 3.
counted at least once a year by reviewing the schedules of counts undertaken/due to be undertaken.
4. Review the adjustments made to the inventory records on a monthly basis to gain an understanding of
the level of differences arising on a month by month basis.
5. If significant differences consistently arise, this could indicate that the inventory records are not
adequately maintained. Discuss with management how they will ensure that year-end inventory will not
be under or overstated.
6. Consider attending the inventory count at the year end to undertake test counts of inventory from
records to floor and from floor to records in order to confirm the existence and completeness of
inventory.

Substantive testing: Property, Plant & Equipment Key risk: overstatement

Dynamic Publishers 59
Completeness 1. Take a sample of physical assets and ensure they are completely recorded in the
NCA Register

2. Re-perform the NCA Register reconciliation to the General Ledger

3.
Obtain a breakdown of additions, cast the list and agree included in the
noncurrent assets register to confirm completeness of PPE.

4. Review the repairs and maintenance ledger to ensure capital expenditure has
not been accidently expensed off

Existence 1. Select a sample of assets from the NCA Register and inspect them to verify their
physical existence

2. Ensure disposed-off assets have been removed from the NCA Register as they
no longer exist.

Rights & Obligation 1. Inspect the ownership documents (title deeds, registration documents etc) to
ensure they are in client’s names.

2. Review insurance policies to confirm the asset is in client’s name.

Accuracy, valuation, Additions during the year

allocation
1. Obtain A breakdown of additions, cast the lust

2. Select a sample of additions and agree cost to supplier invoice to confirm

valuation.

3. Ensure all additions were authorized by inspecting the minutes of the board
meetings

4. Review the list of additions and confirm that they relate to capital expenditure
items rather than repairs and maintenance.

Disposals during the year

1. Disposal proceeds matched to supporting documents such as invoices and to

cash book and bank statement

2. To confirm occurrence, select a sample and agree sale proceeds to sup. Docs to
comfirm occurence

Dynamic Publishers 60
3. Verify that the correct cost and depreciation has been removed from the
records

4. Recalculate profit/loss on disposal agree to the statement of profit or loss

Dynamic Publishers 61
4. Check authorising documentation to ensure that the disposal was appropriately
authorised

5. Examine the sales documentation relating to the disposal and ensure that the
sale details match those in the authorising documentation.

Revaluation

1. Obtain a schedule of assets revalued this year and cast to confirm completeness
and accuracy of the revaluation adjustment.

2. Ensure all similar assets have been revalued

3. Verify depreciation has been calculated on the revalued amount

4. Agree the valuation to the expert’s report

5. Inspect the valuer’s report to ensure the valuer was skilled and independent

6. Agree the revalued amounts for these assets are included correctly in the
noncurrent assets register.

7. Review the financial statements disclosures of the revaluation to ensure they

comply with IAS 16

Depreciation

1. Review the depreciation policy of the company to ensure that it is consistent

and appropriate(this can be done by comparison with last year and with
industry practice)

2. recalculate and re-perform depreciation charge to ensure its accuracy.

3. assess depreciation method is reasonable:

compare with last year

compare with industry practice

review NCA Register with Net Book Value of zero which are
still in use

review NCA Register for excessive profit/loss on disposal.

Enquire from the management the reason for this.

Dynamic Publishers 62
4. enquire from the management whether they consider the depreciation method
to be reasonable- obtain a ‘written representation’

5. Review the disclosure of the depreciation charges and policies in the draft
financial statements.

General

Review the disclosure of the additions and disposals in the draft financial statements
and ensure it is in line with IAS 16 Property, Plant and Equipment.

Repairs and Maintenance

1. Obtain a schedule of the expenditure and cast to ensure accuracy.

2. For those items treated as capital and included with property, plant and equipment, agree to purchase
invoices and ascertain whether they are in fact of a capital nature.
3. For capital items, agree to the non-current assets register to ensure that they are correctly included.
4. For capital items, recalculate the depreciation charged to ensure it has been appropriately time
apportioned.
5. For items treated as repairs, agree to invoices to ensure they are not of a capital nature and that they
have been correctly expensed to the statement of profit or loss (income statement).

Research and development

1. Obtain and cast a schedule of intangible assets, detailing opening balances, amount capitalised in the
current year, amortisation and closing balances.
2. Agree the opening balances to the prior year financial statements.
3. Agree the closing balances to the general ledger, trial balance and draft financial statements.
4. Recalculate the amortisation charge for a sample of intangible assets and confirm it is line with the
amortisation policy.
5. For those expensed as research, agree the costs incurred to invoices and supporting documentation
and to inclusion in profit or loss.
6. For those capitalised as development, agree costs incurred to invoices and confirm technically feasible
by discussion with development managers or review of feasibility reports.
7. Review market research reports to confirm client has the ability to sell the product once complete and
probable future economic benefits will arise.
8. Review the disclosures for intangible assets in the draft financial statements are in accordance with IAS
38 Intangible Assets.

Dynamic Publishers 63
An acquired brand

1. Review board minutes for evidence of discussion of the purchase of the acquired brand, and for its
approval.
2. Agree the cost to the company’s cash book and bank statement.
3. Obtain the purchase agreement and confirm the rights of client in respect of the brand.
4. Discuss with management the estimated useful life of the brand and obtain an understanding of how
the useful life has been determined.
5. Recalculate the amortisation expense for the year and agree the charge to the financial statements
6. Confirm adequacy of disclosure in the notes to the financial statements.

Bank and cash

General 1. Agree the bank balance on the trial balance to

procedures - the year end bank balance on the computer system, and -
the balance on the financial statements.

2. Review the cash book and bank statements for any unusual items or large transfers
around the year end, as this could be evidence of window dressing.
3. Review the financial statements to ensure that the disclosure of cash and bank
balances are complete and accurate.

Dynamic Publishers 64
Bank confirmation Procedure for obtaining a bank letter
letter
1. The auditor will produce a confirmation letter in accordance with local audit
regulations and practices.
2. The letter will be sent to the client to sign and authorise disclosure and then it will
be forwarded on to the client’s bank. (Alternatively, the client may already have
provided a standard authority for the bank to respond to a bank letter each year.
In this case separate authority would not be required.)

Ideally the letter should be sent before the end of the accounting period to enable the bank
to complete it on a timely basis e.g. at the year-end.

3. The bank will complete the letter and send it back directly to the auditor.

1.

Audit procedures on the bank letter include:

1. Agree the balances for each bank account to the relevant bank reconciliation and the
yearend balance in the financial statements.
2. Agree total interest charges on the letter to the interest expense account in the
general ledger.
3. For any details of loans, ensure repayment terms are correctly disclosed in the
financial statements between current and non-current liabilities.

Dynamic Publishers 65
Period-end Bank Obtain a copy of client’s bank reconciliation and perform the procedures below:
Reconciliation
Statement (BRS)
1. Cast the reconciliation to check arithmetical accuracy
2. Agree the bank balance to the trial balance.
3. Agree the reconciliation’s balance per the cash book to the year-end cash book.
4. Agree the balance per the bank statement to an original year-end bank statement
and also to the bank confirmation letter.
5. Trace all of the outstanding lodgments to the pre year-end cash book, post yearend
bank statement and also to paying-in-book per year end.
6. Trace all un-presented cheques through to a pre year-end cash book and post
yearend statement. For any unusual amounts or significant delays obtain
explanations from management.
7. Examine any old un-presented cheques to assess if they need to be written back into
the purchase ledger as they are no longer valid to be presented.

Completeness 10. Agree all balances listed on the bank confirmation letter to client’s bank
reconciliations or the trial balance to ensure completeness of bank balances.
11. Examine the bank confirmation letter for details of any security provided by client as
this may require disclosure.

Cash
Generally cash balance is immaterial to the financial statements. However, cash is an area which is prone to fraud,
especially if the internal controls are not efficient. That is why cash verification is an important audit procedure
for internal auditors.

Physical verification of cash

Cash balances include the hard cash, unbanked cheques, credit card slips and IOUs. That is why all cash balances
need to be counted at the same time.
The audit working papers relating to the cash count will include the date of the count, time of the count, name
and signature of staff conducting the count and the name of the client’s staff available at the count.

Audit procedures for cash

The main audit work involved in verifying cash balances is a physical count.
Audit procedures include the following:

Dynamic Publishers 66
• The auditor should count cash at all locations simultaneously and in the presence of a company official.
(Simultaneous counting is necessary, to prevent the client from moving cash that has been counted at one
location to another location ready for the next count.)
• After the count the auditor should obtain a signed receipt for the amount of cash returned to the official,
• The auditor should check the cash balance obtained from the count against the client's cash records and cash
balance in the draft financial statements.
• Where appropriate, the auditor should also investigate the treatment of any money advances to employees
(for example, against wages or salary).

Attempt questions to check your understanding:

March/June Hybrid 2016-Q2

June 2015-Q6bii
June 2013-Q1d

Substantive testing: Trade Payables- Key risk: understatement

Reconcile payables ledger to the general ledger.

Completeness 1.
2. Check reconciliation of supplier account statements to trade payable ledger
balances, prepared by client. Enquire into any abnormalities and carry out further
reconciliations as required.

Obtain year-end supplier statements:

3.  Agree the balance on the statement to the individual account in client’s
payables ledger.
 Where necessary, reconcile the balances taking into account cash and
invoices in transit.
Compare trade payables individually and in total to prior, investigate any significant
4. difference, in particular any decrease for this year.

Dynamic Publishers 67
5.
Calculate the trade payable days and compare to prior years, investigate any
significant difference.
6.
Current supplier list matched to last year’s supplier list and explanations sought for
suppliers missing this year
7. Select population from purchase invoices received after the year-end. Trace to
evidence of goods receipt and where goods received prior year-end, ensure invoice
amount included in purchase accrual

Post year end payments reviewed. If they relate to purchases made before the year
8. end, ensure they were recorded as a liability at the year end!

9. Verify the Audit trail from source document to records (Take a sample of GRNs prior
to the end of the year and trace to purchase invoice. Ensure a liability has been
recorded)

Accuracy, 1. Supplier circularization(rare in practice)

Valuation,
Allocation 2. Verify supporting documentation ( Purchase order Goods Received Note, Invoice)
Supplier statements reconciled to individual supplier accounts ( as above)
3.

Cut-off 1. Select a sample of GRNs before the year end and after the year end and follow
(purchases) through to inclusion in the correct period’s payables balance, to ensure correct
cutoff.

2. Review after date payments; if they relate to the year under audit, then follow
through to the purchase ledger listing to ensure they are recorded in the correct
period

Existence 1. Supplier circularization(rare in practice)

2. Verify the Audit trail from records to source documents ( individual ledger to
purchase invoice and Goods Received Note)

Substantive procedures for supplier statement reconciliations

Dynamic Publishers 68
1. Select a representative sample of year-end supplier statements and agree the balance to the purchase
ledger. If the balance agrees, then no further work is required.
2. Where differences occur due to invoices in transit, confirm from goods received notes (GRN) whether
the receipt of goods was pre year end, if so confirm that this receipt is included in year-end accruals.
3. Where differences occur due to cash in transit from client to the supplier, confirm from the cashbook
and bank statements that the cash was sent pre year end.
4. Discuss any further adjusting items with the purchase ledger supervisor to understand the nature of the
reconciling item, and whether it has been correctly accounted for.

Why supplier circularization is rare in practice

Third party evidence is a good source of audit evidence and a large proportion of the documentation available
when auditing trade payables is produced by third parties, for example, suppliers’ invoices, statements and
correspondence.

A trade payables circularisation may however be deemed appropriate where:

supplier statements are, for whatever reason, unavailable.

only faxed or photocopied supplier statements are available and there is some doubt as to their
authenticity.
the auditor or the company, suspect that fraudulent manipulation with regard to supplier payments is
taking place within the company.

Substantive testing: Accruals

1. Obtain or prepare a listing of accruals as at the end of the reporting period.

2. If the list is prepared by the client company, check the calculations and additions far arithmetical
accuracy. Check the amounts in the listing against the balances in the relevant main ledger expense
accounts and ensure that the amounts are the same.

3. Sample check computations of accruals by comparing to earlier relevant invoices and payment
records.

4. Review the bank statement for post year end payments that may relate to services used before the
year end. Trace these items to the accruals listing.

5. Compare the list of accruals to those for the previous period to obtain assurance as to the
completeness of the accruals.
Dynamic Publishers 69
6. Review the list of accruals for completeness, based on the auditor's knowledge of the business. The
auditor will review expense categories included in the income statement to identify areas of
possible accruals and check to list of accruals for inclusion.

7. Relate items on the list of accruals to other audit areas, such as the bank confirmation letter (which
might provide details of unpaid/accrued bank charges).

8. Test transactions around the accounting period end to determine whether amounts have been
recognised in the correct period.

Substantive testing: Payroll

Substantive Analytical procedures

1. Compare the total payroll expense to the prior year and investigate any significant differences.

2. Review monthly payroll charges, compare this to the prior year and budgets and discuss with
management for any significant variances.

3. Perform a proof in total of total wages and salaries, incorporating joiners and leavers and the annual pay
increase. Compare this to the actual wages and salaries in the financial statements and investigate any
significant differences.

Other procedures

1. Cast a sample of payroll records to confirm completeness and accuracy of the payroll expense.

2. For a sample of employees, recalculate the gross and net pay and agree to the payroll records to
confirm accuracy.

3. Re-perform the calculation of statutory deductions to confirm whether correct deductions for this year
have been made in the payroll.

4. Select a sample of joiners and leavers, agree their start/leaving date to supporting documentation,
recalculate that their first/last pay packet was accurately calculated and recorded.

5. Agree the total net pay per the payroll records to the bank transfer listing of payments and to the
cashbook.

6. Agree the individual wages and salaries per the payroll to the personnel records for a sample to confirm
bona fide employees.

Dynamic Publishers 70
7. Select a sample of weekly overtime sheets and trace to overtime payment in payroll records to confirm
completeness of overtime paid.

Substantive testing: Accrual for income tax payable on employment income

1. Agree the year-end income tax payable accrual to the payroll records to confirm accuracy.

2. Re-perform the calculation of the accrual to confirm accuracy.

3. Agree the subsequent payment to the post year-end cash book and bank statements to confirm
completeness.

Substantive testing: Corporation tax

1. Agree the year end tax liability back to the year end tax computation.
2. Agree the year end tax liability to the post year end payment to the tax authorities.
3. Agree the corporation tax liability to the amount owed as per correspondence from the tax authorities.

Substantive testing: Long term loans

1. Agree loan balances back to the loan statement from the bank.

2. Inspect the bank confirmation letter for details of loans and overdrafts and trace these amounts to the
balance sheet to ensure they have been recorded.

3. Review Board minutes for evidence of new loans being taken out in the year and ensure they have been
recorded.

4. Inspect the bank statements for the year for evidence of a significant deposit, which may be proceeds of
a loan.

5. Recalculate expected interest charges during the year and compare to the client’s figure.

6. Verify the amount of the loan outstanding at the balance sheet date and ensure that this is accurately
stated and fully disclosed in the company’s balance sheet. The amount of the loan outstanding should
be disclosed as repayable within 12 months and repayable after 12 months from the balance sheet date.

7. Examine the loan agreement to verify the amount of the loan, the rate of interest chargeable, the
security provided and the repayment terms.

Dynamic Publishers 71
8. Check the note to the company’s financial statements to ensure that full disclosure is made with regard
to any security for the loan.

Substantive testing: Accounting estimates

Accounting estimates are approximations. Approximations are often made in conditions of uncertainty regarding
the outcome of events.

When transactions involve precise amounts and are supported by specific documents, verification is relatively
easier. However, this comfort is not available in the case of accounting estimates. There is greater risk of
material misstatement. Therefore greater care is needed when auditing them.

The auditor should adopt one or a combination of the following approaches in the audit of an estimate:
– review and test the process used by management to develop the estimate – use
an independent estimate for comparison with that prepared by management –
review subsequent events which confirm the estimate made.

F8 focus: Provision for fines/penalties, provision for legal claims, provision for restructuring(detailed formal plan,
valid expectation raised in those affected, implementation of plan started/public announcement, DO NOT include
retraining/relocation,marketing expenses etc), provision for warranties, provision for redundancies, Fair Value

General procedures

1. Recalculate to ensure accuracy

2. Review process used by the management and controls over how the estimate was made.

3. Enquire of management how the accounting estimate is made and the data on which it is based-the
data used should be accurate, complete and assumptions reasonable.

4. Review the method of measurement used and assess the reasonableness of assumptions made. Review
the judgments and decisions made by management in the making of accounting estimates to identify
whether there are indicators of possible management bias.

5. Test the operating effectiveness of the controls over how management made the accounting estimate.

6. Develop an expectation of the possible estimate or a range of amounts to evaluate management’s

estimate.

Dynamic Publishers 72
7. – Obtain written representations from management and, where appropriate, those charged with
governance whether they believe significant assumptions used in making accounting estimates are
reasonable.

8. Review expert’s report if applicable

9. Determine whether events occurring up to the date of the auditor’s report (after the reporting period)
provide audit evidence regarding the accounting estimate.

10. To confirm the probability and amount of a provision(or the need of a contingent liability disclosure):
- Inspect pinutes of board meetings
- Inspect client’s Correspondence with any 3rd party
- Inspect Other documents (copy of claims, copy of laws etc) - Enquire from a relevant 3rd party

11. Ensure disclosures relating to accounting estimates are adequate and complete

12. If applicable, compare with last year to evaluate reasonableness of the estimate.

13. If applicable, compare last year’s provision with actual result to evaluate reasonableness of the
estimate.

14. Fair Value: Expert’s report

Examples extracted from past exams- read through them rather than rote learning them!

Scenario: Law suit filed by a former (ex) employee for unfair dismissal- decision pending

Substantive procedures to confirm completeness of provisions or contingent liability:

o Discuss with management the nature of the dispute between the client and the former employee
to ensure that a full understanding of the issue is obtained and to assess whether an
obligation exists.
o Review any correspondence with the former employee to assess if a reliable estimate of
any potential payments can be made. o Write to the company’s lawyers to obtain their
views as to the probability of the exemployeer’s claim being successful.
o Review board minutes and any company correspondence to assess whether there is any
evidence to support the former employee’s claims of unfair dismissal.
o Obtain a written representation from the directors of client confirming their view of
chances of a successful claim.

Dynamic Publishers 73
Scenario: sales ledger department is being made redundant and a redundancy provision has been
included in the financial statements.

Substantive procedures to verify redundancy provision

o Discuss with the directors as to whether they have formally announced their intention to make the
sales ledger department redundant, to confirm that a present obligation exists at the year
end.
o If announced before the year end, review supporting documentation to verify that the
decision has been formally announced.
o Review the board minutes to ascertain whether it is probable that the redundancy
payments will be paid.
o Obtain a breakdown of the redundancy calculations by employee and cast it to ensure
completeness.
o Recalculate the redundancy provision to confirm completeness and agree components of
the calculation to supporting documentation.
o Review the post year-end period to identify whether any redundancy payments have
been made, compare actual payments to the amounts provided to assess whether the
provision is reasonable.
o Obtain a written representation from management to confirm the completeness of the
provision.
o Review the disclosure of the redundancy provision to ensure compliance with IAS 37
Provisions, Contingent Liabilities and Contingent Assets.

Scenario: Customers of a hotel have filed a law suit claiming they got food poisoning- directors do
not feel a provision is needed

1. Review the correspondence from the customers claiming food poisoning to assess whether
client has a present obligation as a result of a past event.
2. Send an enquiry letter to the lawyers of client to obtain their view as to the probability of the
claim being successful.
3. Review board minutes to understand whether the directors believe that the claim will be
successful or not.
4. Review the post year-end period to assess whether any payments have been made to any of the
claimants.
5. Discuss with management as to whether they propose to include a contingent liability disclosure
or not, consider the reasonableness of this.
6. Obtain a written management representation confirming management’s view that the lawsuit is
unlikely to be successful and hence no provision is required.
7. Review the adequacy of any disclosures made in the financial statements.

Dynamic Publishers 74
Scenario: Reorganisation provision has been made

1. Review the board minutes where the decision to reorganise the business was taken, ascertain if
this decision was made pre year end.
2. Review the announcement to shareholders to confirm that this was announced before the year
end.
3. Obtain a breakdown of the reorganisation provision and confirm that only direct expenditure
from restructuring is included.
4. Review the expenditure to confirm that there are no retraining costs included.
5. Cast the breakdown of the reorganisation provision to ensure correctly calculated.
6. For the costs included within the provision, agree to supporting documentation to confirm
validity of items included.
7. Obtain a written representation confirming management discussions in relation to the
announcement of the reorganisation.
8. Review the adequacy of the disclosures of the reorganisation in the financial statements to
ensure they are in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent
Assets.

Substantive testing: Capital and Other Issues

Substantive procedures: share capital issued

1. Review board minutes to confirm the issue of additional share capital during the year.

2. Agree the issue of shares is permitted from a review of any statutory constitution agreements in place
(Where local law requires that companies should have an authorised share capital, the auditor should
check that the total authorised capital in the draft financial statements is consistent with the company's
constitution)

3. Inspect the cash book and bank statements for evidence of cash receipts from the share issue.

4. Recalculate the split of proceeds between the nominal value of shares and premium on issue and agree
correctly recorded within share capital and share premium account.

Dynamic Publishers 75
5. Review the disclosure of the share issue in the draft financial statements and ensure it is in line with
relevant accounting standards and local legislation.

6. Check that the amount reported as issued share capital agrees with the amount recorded in the register
of members/shareholders, if the company has such a register. (In some countries there is a legal
requirement to maintain a register of members.)

Substantive procedures: reserves

The auditor-will usually carry out tire following substantive procedures on reserves:
• Obtain an analysis of movements on all reserves during the period.
• Check the accuracy of these movements by checking supporting documentation.
• Ensure that any specific legal requirements relating to reserves have been complied with. (For example,
check that the entity has not breached legal restrictions on use of the share premium account.)
• Confirm that dividends have been deducted only from those reserves that are legally distributable (usually
the accumulated profits reserve/retained earnings).
• Check the authorisation for the amount of dividends paid by reviewing board minutes.
• Check the dividend calculations and check that the total dividends paid are consistent with the amount of
issued share capital at the relevant date.

Directors’ Emoluments
Emoluments include compensation paid for the services provided by the directors to the company and reward for
entrepreneurial contribution.

The various components of emoluments include:

Basic salary
Bonuses
Share options
Pension contributions
Other benefits (e.g. provision of a company car, rented accommodation, health insurance etc.)

Main procedures for directors’ bonus and remuneration

1. Obtain a schedule of the directors’ remuneration including any bonus paid and cast the addition of the
schedule.

2. Agree the individual bonus payments to the payroll records.

3. Confirm the amount of each bonus paid by agreeing to the cash book and bank statements.

Dynamic Publishers 76
4. Review the board minutes to confirm whether any additional bonus payments relating to this year have
been agreed.

5. Obtain a written representation from management confirming the completeness of directors’

remuneration including the bonus.

6. Review any disclosures made of the bonus and assess whether these are in compliance with local
legislation

Other procedures:

 Verify the accuracy of the emoluments recorded by recalculating the amount of emoluments applicable to
the directors with the recommendations of the remuneration committee.

 For all performance related bonus, verify the correctness of the bonus by comparing the bonus with the
achievement of the performance related targets i.e. ensure that performance related bonus is supported with
appropriate achievement of targets.

 Loyalty bonuses are given when a person completes a certain number of years in a company. Verify the
accuracy of the payments made along with adherence to the conditions of the loyalty bonus.

 Verify the directors’ rent accounts for the directors’ accommodation and trace entries therein with the
approvals of the remuneration committee and also confirm the correctness of the values with the rent
agreement.

 Verify the directors’ health insurance accounts paid for the directors and trace entries therein with the
approvals of the remuneration committee and also confirm the correctness of the values with the insurance
policies.

Relying on work of others

In certain cases, auditors may rely on the work of third parties when gathering their audit evidence.

• Experts such as: lawyers; valuation experts;

• The client’s internal auditors (who have reviewed the internal controls).

• Service organization ( who work has been outsourced to by client)

• Another firm of external auditors (who may for example be auditing an overseas subsidiary of our client).

Why?
- Avoid duplication of work
Dynamic Publishers 77
- Improve efficiency and effectiveness
- Improve trust of shareholders
- Reduce cost

Reliance on the work of a management expert

ISA 500 Audit Evidence requires auditors to evaluate the competence, capabilities including expertise and
objectivity of a management expert.

1. Are they suitably qualified? (member of a professional body or industry association)

2. Do they have the experience?

3. Are they independent of the client?

4. The auditor should meet with the expert and discuss with them their relevant expertise in order to
understand their field of expertise.

5. Evaluating the Adequacy of the Auditor’s Expert’s Work(the audit procedures carried out to evaluate
the work done by the expert!)
a) the relevance and reasonableness of that expert’s findings or conclusions, and their consistency
with other audit evidence
b) If that expert’s work involves use of significant assumptions and methods, the relevance and
reasonableness of those assumptions and methods in the circumstances
c) Adequacy and appropriateness of source data

Audit considerations relating to entities using service organisations

When any work is outsourced to the service organisation, the auditor should consider its impact on the internal
control of the entity.

If the auditor concludes that outsourcing to service organisation significantly affects the accounting and / or
internal control system of the entity, they should obtain sufficient understanding of the entity and its
environment, including the internal control.

This will help him in assessing the risk of material misstatement and designing and performing further audit
procedures

Dynamic Publishers 78
Factors auditors should consider in relation to client’s use of the service organisation include:

1. The audit team should gain an understanding of the services being provided by the service organisation ,
including the materiality of that area and the basis of the outsourcing contract.

2. They will need to assess the design and implementation of internal controls at the service organisation

3. The team may wish to visit the service organisation and undertake tests of controls to confirm the
operating effectiveness of the controls.

4. If this is not possible, auditors should contact the service organisation’s auditors to request either a type
1 (report on description and design of controls) or type 2 report (on description, design and operating
effectiveness of controls).

5. The auditor is responsible for obtaining sufficient and appropriate evidence, therefore no reference may
be made in the audit report regarding the use of information from the service organisation’s auditors

Review

Subsequent events

Adjusting event: An event after the reporting period that provides further evidence of conditions that existed at
the end of the reporting period, including an event that indicates that the going concern assumption in relation to
the whole or part of the enterprise is not appropriate.

Non-adjusting event: An event after the reporting period that is indicative of a condition that arose after the end
of the reporting period.

Events after the balance sheet date

ADJUSTING NON-ADJUSTING

Provide additional evidence of Concern conditions which did not exist

conditions existing at the at the balance sheet date
balance sheet date

Dynamic Publishers 79
Adjust the financial statements Impacts going concern Does not impact going
to reflect the concern
event

Adjust the financial Do not adjust the

statements to present financial statements
on an alternative basis(
break-up basis)

If important to users
understanding disclose
in a note:
nature of event
estimate of financial
effect

Auditor’s responsibilities-ISA 560

For the purposes of ISA 560, subsequent events are those events that occur between the reporting date and the
date of approval of the financial statements and the signing of the auditor’s report.

Dynamic Publishers 80
Period between the year-end date and the date the auditor’s report is signed

The auditor shall perform audit procedures designed to obtain sufficient appropriate audit evidence that all
events occurring between the date of the financial statements and the date of the auditor’s report that require
adjustment of, or disclosure in, the financial statements have been identified.

A. Review procedures management has established to ensure that subsequent events are identified.

B. Inspect: Read minutes of board meetings, shareholder meetings and audit committees that have
taken place since the year-end.

C. Obtain and review the latest available interim financial statements and/or management accounts,
budgets and other related management reports.

D. Perform normal post balance sheet work( e.g. checking receipts from trade receivables after the
yearend)

E. Enquire of the entity’s legal counsel concerning litigation and claims.

F. Enquire of management as to whether any subsequent events have occurred which might affect the
financial statements

G. Checking whether any events have occurred that could call into question the validity of the going
concern assumption

The auditor is not, however, expected to perform additional audit procedures on matters to which previously
applied audit procedures have provided satisfactory conclusions.

Period between the date the auditor’s report is signed and the date the financial statements are issued The
auditor has no obligation to perform any audit procedures regarding the financial statements after the date of
the auditor’s report.

However, if a fact becomes known to the auditor that, had it been known to the auditor at the date of the
auditor’s report, may have caused him to amend the auditor’s report, the auditor shall: discuss the matter with
management, determine whether the financial statements need amendment and, if so, inquire how
management intends to address the matter in the financial statements.

If management amends the financial statements, the auditor shall carry out the necessary audit procedures,
extend the subsequent events testing to the date of the new auditor’s report, and provide a new auditor’s report
on the amended financial statements.

Dynamic Publishers 81
In situations where management refuses to make amendments to the financial statements, the auditor must
take all steps required to avoid reliance by third parties on the auditor’s report. The auditor should also consider
the need to resign from the audit.

Event specific procedures

Confirm event( maybe through enquiry, inspection or

observation) and calculate impact on financial statements(if
any or the need for a disclosure

Discussion with the management ( any adjustments to be

made, disclosure to be given, impact on going concern etc.)

rd
Enquire: from any relevant 3 party to get further evidence
about the event( insurance company,lawyers, customer etc )

Review: minutes of the board meetings in which the event

and its impact was discussed

Review: accounting records and any correspondence with

rd
3 parties involved

Going concern review

Under the ‘going concern assumption’, an entity is ordinarily viewed as continuing in business for the foreseeable
future (being to a date of at least, but not limited to, 12 months from the end of the reporting period); with
neither the intention nor the necessity of liquidation, cessation of trading or the seeking of protection from
creditors pursuant to laws or regulations.

Accordingly assets and liabilities are recorded on the basis that the entity will be able to realise its assets and
discharge its liabilities in the normal course of business.

Management’s responsibility

- assess ability of the company to continue in the foreseeable future

Dynamic Publishers 82
- disclose uncertainties that might affect the going concern status
- adjust F/s and disclose if financial statement not prepared on a going concern basis

It is the responsibility of management to make an assessment of whether the going concern presumption is
appropriate, or not, when they are preparing the financial statements.

Auditor’s responsibilities

1. They carry out appropriate audit procedures to determine whether the management’s assumption of
going concern is appropriate and ensure that the organisation’s management have been realistic in
their use of the going concern assumption
2. Report if not appropriate. In forming the audit opinion, the auditor should consider two issues: have the
financial statements been prepared using the appropriate going concern assumption, and is there
adequate disclosure of any material uncertainty regarding the going concern status. Indicators of going
concern problems

Financial Indicators
– Net liability or net current liability position.
– Fixed term borrowings approaching maturity without realistic prospects of renewal or repayment, or excessive
reliance on short-term borrowings to finance long-term assets.
– Adverse key financial ratios.
– Substantial operating losses.
– Arrears or discontinuance of dividends.
– Inability to pay payables on due dates.
– Difficulty in complying with the terms of loan agreements.
– Change from credit to cash-on-delivery transactions with suppliers.
– Inability to obtain financing for essential new product development or other essential investments.

Operating Indicators
– Loss of key management without replacement.
– Loss of major market, franchise, licence, or principal supplier.
– Labour difficulties or shortages of important supplies.

Other Indicators
– Non-compliance with capital or other statutory requirements.
– Pending legal proceedings against the entity that may, if successful result in judgements that could not be met.
– Changes in legislation or government policy.

Audit Procedures

Dynamic Publishers 83
DONOT produce a list of generic audit procedures, but instead identify and highlight the factors from the
scenario that may call into question the entity’s ability to continue as a going concern.

1. Evaluate the management’s assessment

o the process followed by management to make its assessment o

the assumptions on which the assessment is based o

management’s plans for future action

o whether management has taken into consideration all the facts

that the auditor is aware of due to their audit procedures

2. Reading minutes of shareholders’ meetings to identify any current, or potential, cash flow
difficulties

3. Review post year end management accounts

4. Review cash flow forecast (sufficient cash to continue operations for next year?) In this
evaluation the auditor should pay particular attention to the\ reliability of the company’s
systems for generating the cash flow information, and whether the assumptions underlying the
cash flow appear reasonable.

5. Confirming the existence, terms and adequacy of borrowing facilities

6. Review events after the period end to identify those that affect the entity’s ability to continue as
a going concern

7. Review the terms of loan agreements and determining whether they have been breached

8. Requesting written representations from management and, where appropriate, those charged
with governance, regarding their plans for future action and the feasibility of these plans.

9. View correspondence with major customers, suppliers and banks for evidence of dispute

10. Legal/solicitor letter- inspect correspondence to understand possible consequences of legal

action being brought against the company.

11. Obtaining and reviewing reports of regulatory action

12. Other procedures relevant to question given should also be considered!

Dynamic Publishers 84
Prepare this section AFTER revising Audit Opinion

REPORTING IN LINE WITH ISA 570, GOING CONCERN

Exam questions might ask the candidate to recognise indicators that an entity may not be a going concern, or
require candidates to arrive at an appropriate audit opinion depending on the circumstances presented in the
scenario. It may be the case that candidates are presented with a situation where the auditor has concluded that
there are material uncertainties relating to going concern and the directors have made appropriate disclosures in
relation to going concern and candidates must understand the new auditor reporting requirements in this
respect.
Under ISA 570 (Revised), if the use of the going concern basis of accounting is appropriate but a material
uncertainty exists and management have included adequate disclosures relating to the material uncertainties the
auditor will continue to express an unmodified opinion, but the auditor must include a separate section under
the heading ‘Material Uncertainty Related to Going Concern’ and:
• draw attention to the note in the financial statements that discloses the matters giving rise to the material
uncertainty, and
• state that these events or conditions indicate that a material uncertainty exists which may cast significant
doubt on the entity’s ability to continue as a going concern and that the auditor’s opinion is not modified in
respect of the matter.

The section headed ‘Material Uncertainty Related to Going Concern’ is included immediately after the Basis for
Opinion paragraph but before the KAM section.

Over and above the new reporting requirements under ISA 570, candidates need to understand how issues
identified regarding going concern interact with the requirements of ISA 701. By their very nature, issues
identified relating to going concern are likely to be considered a key audit matter and hence need to be
communicated in the auditor’s report. Where the auditor has identified conditions which cast doubt over going
concern, but audit evidence confirms that no material uncertainty exists, this ‘close call’ can be disclosed in line
with ISA 701. This is because while the auditor may conclude that no material uncertainty exists, they may
determine that one, or more, matters relating to this conclusion are key audit matters. Examples include
substantial operating losses, available borrowing facilities and possible debt refinancing, or non-compliance with
loan agreements and related mitigating factors.
In summary if a confirmed material uncertainty exists it must be disclosed in accordance with ISA 570 and where
there is a ‘close call’ over going concern which has been determined by the auditor to be a KAM it will be
disclosed in line with ISA 701. This is illustrated in the following example:
Example – unmodified audit opinion but material uncertainty exists in relation to going concern and the
disclosures are adequate

Report on the Audit of the Financial Statements (extract)

Dynamic Publishers 85
Opinion
In our opinion, the accompanying financial statements present fairly, in all material respects, the financial
position of the Company as at 31 December 2015, and its financial performance and its cash flows for the year
then ended in accordance with International Financial Reporting Standards (IFRSs).

Basis for opinion

We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under
those standards are further described in theAuditor’s Responsibilities for the Audit of the Financial Statements
section of our report. We are independent of the Company in accordance with the ethical requirements that are
relevant to our audit of the financial statements in Farland, and we have fulfilled our other ethical responsibilities
in accordance with these requirements. We believe that the audit evidence we have obtained is sufficient and
appropriate to provide a basis for our opinion.

Material uncertainty related to going concern

We draw attention to Note 6 in the financial statements, which indicates that the Company incurred a net loss of
$125,000 during the year ended 31 December 2015 and, as of that date, the Company’s current liabilities
exceeded its total assets by $106,000. As stated in Note 6, these events or conditions, along with other matters
as set forth in Note 6, indicate that a material uncertainty exists that may cast significant doubt on the
Company’s ability to continue as a going concern. Our opinion is not modified in respect of this matter.

Key audit matters

Key audit matters are those matters that, in our professional judgment, were of most significance in our audit of
the financial statements of the current period. These matters were addressed in the context of our audit of the
financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate opinion
on these matters. In addition to the matter described in the Material Uncertainty Related to Going Concern
section, we have determined the matters described below to be the key audit matters to be communicated
in our report.
[Include a description of each key audit matter]

Written representations/Management representation letter

Written representations are necessary information that the auditor requires in connection with the audit of the
entity’s financial statements. Accordingly, similar to responses to inquiries, written representations are audit
evidence.

The auditor needs to obtain written representations from management and, where appropriate, those charged
with governance that they believe they have fulfilled their responsibility for the preparation of the financial
statements and for the completeness of the information provided to the auditor.

Written representations are normally in the form of a letter, written by the company’s management and
addressed to the auditor. The letter is usually requested from management but can also be requested from the
chief operating officer or chief financial officer.

Dynamic Publishers 86
Throughout the fieldwork, the audit team will note any areas where representations may be required During
the final review stage, the auditors will produce a draft representation letter. The directors will review this
and then produce it on their letterhead.

It will be signed by the directors and dated as at the date the audit report is signed, but not after.

The ISAs require auditors to obtain written representations from management on matters material to the
Financial Statements where other sufficient, appropriate, audit evidence cannot reasonably be expected to exist.

Purpose of written representation

1. Acknowledging responsibility for the financial statements by management(ISA 580 requires that
“the auditor should obtain audit evidence that management acknowledges its responsibility for
fair presentation of the financial statements and for the completeness of the information
provided to the auditor)
2. Acknowledging responsibility for other matters (ICS, related party transactions etc)
3. Used as audit evidence there is no sufficient appropriate evidence in existence on a matter
which is material to the financial statements.
4. Acknowledges representations previously made verbally by management
5. Minimises misunderstandings between management and auditor

Reliability of written representations

– Representations from management are a source of assurance evidence.
– They cannot be used instead of other (better) evidence which the assurance providers expect to exist.
– HOWEVER, they may be the only available form of evidence in certain circumstances.
– They are relatively unreliable as evidence.
– Corroborative evidence will always be sought, but may not always be available.
– If a representation appears to be contradicted by other evidence:the circumstances should be investigated,
andthe reliability of other representations made by managementshould be reconsidered.

Written representation letter contents

No irregularities involving management or employees that could have a material effect on the financial
statements
All books of account and supporting documentation have been made available to the auditors
Information and disclosures with reference to related parties is complete
Financial statements are free from material misstatements including omissions
No non-compliance with any statute or regulatory authority

Dynamic Publishers 87
No plans that will materially alter the carrying value or classification of assets or liabilities in the financial
statements
No plans to abandon any product lines that will result in any excess or obsolete inventory
No events, unless already disclosed, after the end of the reporting period that need disclosure in the
financial statements.

SPECIFIC MATTERS

Included here is anything else that the auditor would like a representation on for example:
that a certain debt is recoverable;
all bank accounts have been disclosed;
any plans to reorganise the business or discontinue product lines have already been disclosed.

Refusal to Provide Requested Written Representations

If management refuses to provide a written representation, then the auditor should again review the possibility
of obtaining sufficient audit evidence from alternative sources in connection with the matter or issue under
review.

If the directors refuse to sign the representation letter, then the auditor has a number of options available to
him:
(i) The auditor could discuss the matter with the directors and try to resolve their problems with the letter.
(ii) The auditor could write a representation letter for the directors, then send this to the directors and ask
them to sign it.
(iii) If the auditor considers that he has not received all the information and explanations required for his
audit, then the auditor’s report should be qualified.
(iv) Before taking these actions, the auditor should explain to the directors the consequences of not signing
the representation letter, to try to avoid a confrontation.

An auditor should reconsider the reliability of other representations.

If the representation is not consistent with other audit evidence, the auditor should perform audit procedures to
attempt to resolve the matter. For this, the auditor should reassess the appropriateness of the risk of material
misstatement on account of this inconsistency. If required, the auditor should revise the nature, timing and extent
of further audit procedures.

Overall review of financial statements

Procedures an auditor should perform include:

1. Reviewing the financial statements to ensure compliance with accounting standards and local legislation
disclosure. This is sometimes done via the use of a disclosure checklist.

Dynamic Publishers 88
2. Reviewing the disclosure of the accounting policies to ensure that they are in accordance with the
accounting treatment adopted in the financial statements, and that they are sufficiently disclosed.

3. Reviewing the financial statements to ensure they are consistent with the auditor’s knowledge of the
business and the results of their audit work.

4. Reviewing the financial statements to assess whether they adequately reflect the information and
explanations previously obtained and conclusions reached during the course of the audit.

5. Performing analytical procedures of the financial statements, under ISA 520 Analytical Procedures; this
helps the auditor to form an overall conclusion on the financial statements ( explained separately
below)

6. Reviewing the aggregate of uncorrected misstatements to assess whether in aggregate a material

misstatement arises; if so discuss with management with regards to a potential adjustment.

7. As part of the overall review, the auditor should assess whether the audit evidence gathered by the
team is sufficient and appropriate to support the audit opinion.

Final analytical procedures

Before the audit report is signed, it is sensible to do some final analysis of the Financial Statements (e.g. ratio
analysis) – just to make sure that the auditor is confident in the audit opinion.

There are 2 main reasons for this final analysis:

The Financial Statements may have been adjusted during the audit as mistakes were found, so the final figures
may never have been analysed or been subject to ratio analysis.

The auditor will have learned more about the company during the audit, so is in a better position at the end of
the audit to analyse the figures and understand trends in ratios.

The analytical procedures performed at this stage of the audit are not different to those performed at the
planning stage – the auditor will perform ratio analysis, comparisons with prior period financial statements and
other techniques to confirm that trends are as expected, and to highlight unusual transactions and balances that
may indicate a risk of misstatement.

Dynamic Publishers 89
The key issue is that, near the end of the audit, the auditor should have sufficient audit evidence to explain the
issues highlighted by analytical procedures, and should therefore be able to conclude as to the overall
reasonableness of the financial statements.
When the analytical procedures performed near the end of the audit reveal further previously unrecognised risk
of material misstatement, the auditor is required to revise the previously assessed risk of material misstatement
and modify the planned audit procedures accordingly. This means potentially performing further audit
procedures in relation to matters that are identified as high risk.

Misstatements

Misstatements: A difference between the amount, classification, presentation, or disclosure of a reported

financial statement item and the amount, classification, presentation, or disclosure that is required for the item
to be in accordance with the applicable financial reporting framework.

Misstatements can arise from error or fraud.

Uncorrected misstatements: Misstatements that the auditor has accumulated during the audit and that have not
been corrected.

There are three categories of misstatements:

i. Factual misstatements are misstatements about which there is no doubt.
ii. Judgemental misstatements are differences arising from the judgements of management concerning
accounting estimates that the auditor considers unreasonable, or the selection or application of
accounting policies that the auditor considers inappropriate.
iii. Projected misstatements are the auditor’s best estimate of misstatements in populations, involving the
projection of misstatements identified in audit samples to the entire populations from which the
samples were drawn.

The auditor has a responsibility to accumulate misstatements which arise over the course of the audit.

Identified misstatements should be considered during the course of the audit to assess whether the audit
strategy and plan should be revised.

The auditor will communicate the uncorrected misstatements and their implication on the auditor’s report to
those charged with governance.

The auditor will also request a written representation (including a summary of uncorrected misstatements) from
management and – where appropriate – those charged with governance as to whether they believe the effects
of uncorrected misstatements are immaterial, individually and in aggregate to the financial statements as a
whole.

The auditor may find:

Dynamic Publishers 90
1. Individual material misstatements
2. Individual immaterial misstatements
3. Immaterial misstatements which become material when aggregated

In all 3 cases, they have to be reported to the management.

Examples of circumstances when misstatement is considered material when it lower than quantitative
(material by nature)

- Affects compliance with regulatory requirements;

- Affects compliance with debt covenants or other contractual requirements;
- Affects ratios used to evaluate the entity’s financial position, results of operations or cash flows;
- Has the effect of increasing management compensation, for example, by ensuring that the
requirements for the award of bonuses or other incentives are satisfied;

Audit Opinion

To understand different types of opinions, the following terms need to be understood.

Misstatement: Discussed above

Inability to obtain appropriate and sufficient evidence: The auditor was not able to get sufficient
appropriate audit evidence on which to base the opinion. The auditor’s inability to obtain sufficient
appropriate audit evidence is also referred to as a limitation on the scope of the audit and could arise from:

o Circumstances beyond the entity’s control (e.g. accounting records destroyed) o

Circumstances relating to the nature or timing of the auditor’s work (e.g. the timing of the
auditor’s appointment prevents the observation of the physical inventory count).
o Limitations imposed by management (e.g. management prevents the auditor from
requesting external confirmation of specific account balances).

Pervasive: This is a term used to describe the effects or possible effects on the financial statements of
misstatements or undetected misstatements (i.e. due to an inability to obtain sufficient appropriate audit
evidence). There are three types of pervasive effect:

o Those that are not confined to specific elements, accounts or items in the financial
statements.

Dynamic Publishers 91
o Those that are confined to specific elements, accounts or items in the financial statements
and represent or could represent a substantial portion of the financial statements.
o Those that relate to disclosures which are fundamental to users understanding of the
financial statements.

Unmodified Opinion Auditor concludes that the financial statements are prepared, in all material
respects, in accordance with the applicable financial reporting framework.

Wording

In our opinion, the financial statements present fairly, in all material respects,
(or give a true and fair view of) the financial position of ABC Company as of
December 31, 20X1, and (of) its financial performance and its cash flows for the
year then ended in accordance with International Financial Reporting
Standards.

Modified Opinion a)Qualified

Dynamic Publishers 92
a) Qualified Nature of matter: Material
b) Adverse
c) Disclaimer Reason: material misstatement or inability to obtain appropriate and
sufficient evidence (regarding an accounting policy, transaction, balance or
disclosure etc)

Opinion: Qualified ‘Except for’

Wording:

QUALIFIED OPINION
In our opinion, except for the effects of the matter described in the Basis of
Qualified Opinion paragraph the financial statements present fairly, In all
material respects, (or give a true and fair view of) the financial position of ABC
Company as at December 31, 20X1 and (of) its financial performance and its
cash flows for the year then ended in accordance with International Financial
Reporting Standards.

BASIS FOR QUALIFIED OPINION

(Nature, amount , impact to be explained)
The company’s inventories are carried in the balance sheet at XXX.
Management has not stated inventories at the lower of cost and net realizable
value but has stated them solely at cost, which constitutes a departure from
International Financial Reporting Standards. The company’s records indicate
that had management stated the inventories at the lower of cost and net
realizable value, an amount of XXX would have been required to write the
inventories down to their net realizable value. Accordingly, cost of sales would
have been increased by XXX, and income tax, net income and shareholders’
equity would have been reduced by XXX, XXX and XXX, respectively.

b) Adverse

Dynamic Publishers 93
Nature of matter: Material and pervasive

Reason: Misstatement in the F/S

Opinion: Adverse

Wording:

ADVERSE OPINION
In our opinion, because of the significance of the matter discussed in the Basis
of Adverse Opinion paragraph, the consolidated financial statements do not
present fairly (or do not give a nature and fair view of) the financial position of
ABC Company and its subsidiaries as at December 31, 20X1 and (of) their
financial performance and their cash flows for the year then ended in
accordance with International Financial Reporting Standards.

BASIS FOR ADVERSE OPINION

(Nature, amount , impact to be explained)
c)Disclaimer

Nature of matter: Material and pervasive

Reason: Inability to obtain appropriate and sufficient evidence

Opinion: Disclaimer

Wording:

DISCLAIMER OF OPINION
Because of the significance, of the matters described in the Basis for
Disclaimer of Opinion paragraph, we have not been able to obtain sufficient
appropriate audit evidence to provide a basis for an audit opinion.
Accordingly, we do not express an opinion on the financial statements

BASIS FOR DISCLAIMER OF OPINION

(Nature, amount , impact to be explained)

Dynamic Publishers 94
Emphasis of Matter paragraph

A paragraph included in the auditor’s report that refers to a matter appropriately presented or disclosed in the
financial statements that, in the auditor’s judgment, is of such importance that it is fundamental to users’
understanding of the financial statements.

Circumstances in Which an Emphasis of Matter Paragraph May Be Necessary

When a financial reporting framework prescribed by law or regulation would be unacceptable but for the
fact that it is prescribed by law or regulation.

When facts become known to the auditor after the date of the auditor’s report and the auditor provides a
new or amended auditor’s report (i.e., subsequent events)

An uncertainty relating to the future outcome of exceptional litigation or regulatory action.

Early application (where permitted) of a new accounting standard that has a material effect on the
financial statements.

It cannot be given for a matter determined to be a key audit matter to be communicated in the auditor’s report
(the use of Emphasis of Matter paragraphs is not a substitute for a description of individual key audit matters.)

When the auditor includes an Emphasis of Matter paragraph in the auditor’s report, the auditor shall:

(a) Include the paragraph within a separate section of the auditor’s report with an appropriate heading that
includes the term “Emphasis of Matter”;

(b) Include in the paragraph a clear reference to the matter being emphasized and to where relevant disclosures
that fully describe the matter can be found in the financial statements. The paragraph shall refer only to
information presented or disclosed in the financial statements; and

(c) Indicate that the auditor’s opinion is not modified in respect of the matter emphasized.

Dynamic Publishers 95
Other Matter paragraph

A paragraph included in the auditor’s report that refers to a matter other than those presented or disclosed in
the financial statements that, in the auditor’s judgment, is relevant to users’ understanding of the audit, the
auditor’s responsibilities or the auditor’s report

Examples of circumstances in which an Other Matter Paragraph may be necessary

Prior Period Financial Statements Audited by a Predecessor Auditor

Prior Period Financial Statements Not Audited

Restriction on distribution or use of the auditor’s report

Modification in auditor report for comparative financial statement.This is when reporting on prior period
financial statements in connection with the current period’s audit, if the auditor’s opinion on such prior
period financial statements differs from the opinion the auditor previously expressed (ISA 710).

It cannot be given for a matter determined to be a key audit matter to be communicated in the auditor’s report

When the auditor includes an Other Matter paragraph in the auditor’s report, the auditor shall include the
paragraph within a separate section with the heading “Other Matter,” or other appropriate heading.

Dynamic Publishers 96
Matters to be communicated to TCWG
1. The auditor’s responsibilities in – A statement that the auditor is responsible for forming and
relation to the financial expressing an opinion on the financial statements.
statements – That the auditor’s work is carried out in accordance with ISAs
and in accordance with local laws and regulations.

2. Planned scope and timing of This would include

audit – The audit approach to assessing the risk of serious
misstatement, whether arising from fraud or error.
– The audit approach to the internal control system and whether
reliance will be placed on it.
– The timing of interim and final audits, including reporting
deadlines.

3. Significant findings from the This heading could include:

audit – Significant difficulties encountered during the audit, including
delays in obtaining information from management.
– Material weaknesses in internal control and recommendations
for improvement.
– Audit adjustments, whether or not recorded by the entity, that
have, or could have, a material effect on the entity’s financial
statements. For example, the bankruptcy of a material receivable
shortly after the year-end that should result in an adjusting entry.

4. A statement on independence This would include:

issues affecting the audit ( for – That the audit firm has ensured that all members of the audit
listed entities only) team have complied with the ethical standards of ACCA.
– That appropriate safeguards are in place where a potential
threat to independence has been identified.

The lists of examples listed under the above headings are not exhaustive and in practice many more specific
matters would be communicated to those charged with governance such as:

– Modifications to the audit report.

– Any management representation points requested.

– Cases of suspected/actual fraud.)

Dynamic Publishers 97
APPLICATION OF ISA 701 WHEN A QUALIFIED OR ADVERSE OPINION IS ISSUED

ISA 705 (Revised), Modifications to the Opinion in the Independent Auditor’s Report outlines the requirements
when the auditor concludes that the audit opinion should be modified. ISA 705 (Revised) requires that the
auditor includes a Basis for Qualified/Adverse Opinion section in the auditor’s report. When the auditor
expresses a qualified or adverse opinion, the requirement to communicate other KAM is still relevant and hence
will still apply.

When the auditor issues an adverse opinion it means that the financial statements do not give a true and fair
view (or present fairly) because the auditor has concluded that misstatements, individually and in aggregate, are
both material and pervasive to the financial statements.
Depending on the significance of the matter(s) which has resulted in the auditor expressing an adverse audit
opinion, the auditor might determine that no other matters are KAM. In this situation, the auditor will deal with
the matter(s) in accordance with applicable ISAs and include a reference to the Basis for Qualified/Adverse
Opinion or the Material Uncertainty Related to Going Concern section(s) in the KAM section of the report as
illustrated below.

Example – Qualified ‘except for’ opinion issued but no key audit matters
The audit of Turquoise Industries Co has been completed and the auditor discovered a material amount of
research expenditure which had been capitalised as an intangible asset in contravention of IAS 38 Intangible
Assets. The finance director refused to derecognise the research expenditure as an intangible asset and include
it in profit or loss and the auditor therefore issued a qualified ‘except for’ opinion on the basis of disagreement
with the entity’s accounting treatment for research expenditure.

The auditor has concluded that there are no KAM which require to be communicated in the audit report. The
KAM section of the report will therefore be as follows:

Key audit matters

Except for the matter described in the Basis for Qualified Opinion section, we have determined that there are no
key audit matters to communicate in our report.
When the auditor has expressed an adverse opinion on the financial statements and communicates KAM, it is
important that the descriptions of such KAM do not imply that the financial statements as a whole are more
credible in light of the adverse opinion.

DISCLAIMER OF OPINION ISSUED

Dynamic Publishers 98
A disclaimer of opinion is issued when the auditor is unable to form an opinion on the financial statements. ISA
705 states that when the auditor expresses a disclaimer of opinion then the auditor’s report should not include
a KAM section.

A note of caution: Forming an opinion and Reporting and communicating Key Audit Matters have been recently
revised. The solutions of the past exams may not reflect these revisions at the moment. Students are
requested to be careful when practicing past exams. The notes above used should be used when practicing.

Audit sampling

Audit sampling is the application of audit procedures to less than 100% of items within a population of audit
relevance, such that all sampling units have a chance of selection in order to provide the auditor with a
reasonable basis on which to draw conclusions about the entire population.

SAMPLING RISK
Sampling risk is the risk that the auditor’s conclusions based on a sample may be different from the conclusion if
the entire population were the subject of the same audit procedure.

ISA 530 recognises that sampling risk can lead to two types of erroneous conclusions:

1. The auditor concludes that controls are operating effectively, when in fact they are not. In substantive
testing, the auditor may conclude that a material misstatement does not exist, when in fact it does. These
erroneous conclusions will more than likely lead to an incorrect opinion being formed by the auditor.

2. The auditor concludes that controls are not operating effectively, when in fact they are. In terms of
substantive testing, the auditor may conclude that a material misstatement exists when, in fact, it does not.

NON SAMPLING RISK

Non-sampling risk is the risk that the auditor forms the wrong conclusion, which is unrelated to sampling risk. An
example of such a situation would be where the auditor adopts inappropriate audit procedures, or does not
recognise a control deviation.

METHODS OF SAMPLING

Random selection: This method of sampling ensures that all items within a population stand an equal chance of
selection by the use of random number tables or random number generators. The sampling units could be
physical items, such as sales invoices or monetary units.

Dynamic Publishers 99
Systematic selection: This is a method of selection in which the auditor selects items using a constant interval
between selections. The first item may be selected on a random or haphazard basis, and thereafter the sampling
interval is derived by the auditor, for example, by dividing the population by the sample size.

Haphazard selection: The auditor selects the sample without following a structured technique – the auditor
would avoid any conscious bias or predictability.

Block selection: This involves selection of a block(s) of contiguous items from within the population. Block
selection cannot ordinarily be used in audit sampling because most populations are structured such that items in
a sequence can be expected to have similar characteristics to each other, but different characteristics from
items elsewhere in the population.

Monetary Unit Sampling: This is a type of value-weighted selection in which sample size, selection and
evaluation results in a conclusion in monetary amounts. This selection method ensures that each individual $1 in
the population has an equal chance of being selected.

STATISTICAL VERSUS NON-STATISTICAL SAMPLING

‘Statistical’ sampling: ‘An approach to sampling that has the following characteristics:

i. Random selection of the sample items, and ii. The use of probability theory to evaluate sample
results, including measurement of sampling risk.’

The ISA goes on to specify that a sampling approach that does not possess the characteristics in (i) and (ii) above
is considered non-statistical sampling.

The advantages of using statistical sampling rather than judgemental sampling (non-statistical sampling) include:
(1) The size of the sample is determined objectively having regard to the degree of risk associated with the area
being tested.
(2) Bias is eliminated.
(3) Results of statistical sampling can be more easily justified as being representative of the population as a
whole, thus increasing the level of confidence in the results of testing the sample. As a consequence of this,
the conclusion drawn from the results of sample testing are more easily justified where an audit client
disputes the audit conclusions.
(4) In instances when there is a large population, the use of statistical sampling techniques may reduce the
sample size, and therefore the amount of audit work required, as compared to the sample size that would
be selected using judgement sampling methodology.

When might sampling not be appropriate

Dynamic Publishers 100

A sampling approach to testing would not be appropriate in the following circumstances:
(i) Where there is a statutory requirement to disclose specific items in the financial statements, for example
directors’ remuneration.
(ii) Where the population is very small and the results from sampling could not be relied on, for example when
conducting certain compliance tests.
(iii) Where the population is small in number but comprises material individual balances or transactions, for
example property additions.
(iv) Where the population is not homogenous and requires subdivision before sampling can be attempted, for
example purchase invoices and credit notes.
(v) When the auditor is put ‘on enquiry’ for example when testing for fraud.
(vi) Where the costs of sampling outweigh the benefits as compared to 100% testing.

EXTRAPOLATION: Extrapolation takes the result of a sample and projects that result over the whole population.
Imagine total sales are $10m. You select a sample of $1m (10% of the population) to test. If errors of $37k are
found in the sample, it could be inferred by extrapolation that there are errors of $370k in the total population.
Extrapolation can only be applied to statistical sampling.

COMPUTER ASSISTED AUDIT TECHNIQUES (CAATs)

Computer-assisted audit techniques (CAATs) are those featuring the ‘application of auditing procedures using
the computer as an audit tool’

The extent to which an auditor may choose between using CAATs and manual techniques on a specific audit
engagement depends on the following factors:

--the cost effectiveness of using CAATs

--the availability of audit time

--the availability of the audit client’s computer facility

--the level of audit experience and expertise in using a specified CAAT

--the level of CAATs carried out by the audit client’s internal audit function and the extent to which the external
auditor can rely on this work

Dynamic Publishers 101

Test data Audit test data is used to test the existence and effectiveness of controls built into
an application program used by an audit client.

As such, dummy transactions are processed through the client’s computerised system. The
results of processing are then compared to the auditor’s expected results to determine
whether controls are operating efficiently and systems’ objectiveness are being achieved.

For example, two dummy bank payment transactions (one inside and one outside
authorised parameters) may be processed with the expectation that only the transaction
processed within the parameters is ‘accepted’ by the system. Clearly, if dummy
transactions processed do not produce the expected results in output, the auditor will
need to consider the need for increased substantive procedures in the area being
reviewed.

Test data should contain valid data ( to ensure the system processes it correctly) and
invalid data (to ensure system rejects it).

Live test data: data processed on the client’s system during a normal production run

Dead test data: data processed at a time when the normal production run is not taking place

Integrated test facility: the auditor may seek permission from the client to establish an
integrated test facility within the accounting system. This entails the establishment of a
dummy unit, for example, a dummy supplier account against which the auditor’s test data
is processed during normal processing runs.

Audit Software The term ‘audit software’ describes the computer software used by auditors to assist them
in their work, when examining the operations of, and testing the output of a computer-
based accounting system.

Computer programs designed to carry out tests of control and/or substantive procedures

This performs checks that auditors would otherwise need to do by hand.

Such programs may be classified as:

Packaged programs (off the shelf)

These consist of pre-prepared generalised programs used by auditors and are not ‘client
specific’. They may be used to carry out numerous audit tasks, for example, to select a
sample, either statistically or judgementally, during arithmetic calculations and checking
for gaps in the processing of sequences.

Dynamic Publishers 102

Dynamic Publishers 103
Purpose written programs (bespoke)
These programs are usually ‘client specific’ and may be used to carry out tests of control or
substantive procedures. Audit software may be bought or developed, but in any event the
audit firm’s audit plan should ensure that provision is made to ensure that specified
programs are appropriate for a client’s system and the needs of the audit. Typically, they
may be used to re-perform computerised control procedures (for example, cost of sales
calculations) or perhaps to carry out an aged analysis of trade receivable (debtor)
balances.

Enquiry programs
These programs are integral to the client’s accounting system; however they may be
adapted for audit purposes. For example, where a system provides for the routine
reporting on a ‘monthly’ basis of employee starters and leavers, this facility may be
utilised by the auditor when auditing salaries and wages in the client’s financial
statements. Similarly, a facility to report trade payable (creditor) long outstanding
balances could be used by an auditor when verifying the reported value of creditors

Uses of audit software

Highlighting of exceptions- For example, to identify exceptional wages payments outside of

stated parameters

Highlighting of trends- To highlight reported inventory movement both immediately

before and after reporting dates to identify possible manipulation of inventory figures

Performance of sequence checks- To verify completeness of sales reporting by ensuring

that all invoices have been recorded.

Calculation checks- To ensure that overhead costs are totalled correctly in the general
ledger.

Stratification of data – To subdivide the population of inventory lines with a view to

examining only material balances.

Selection of items for testing – To select trade receivables accounts for circularisation, to
verify the existence of trade receivables.

Detecting violation of system rules – For example, where other people besides the
accountant have been overriding overtime payments or employees amending their own
gross wages.

Dynamic Publishers 104

The advantages of Computer-Assisted Audit Techniques (CAATs) are that they:
1. Enable the auditor to test program controls – if CAATs were not used then those controls would not be
testable.

2. Enable the auditor to test a greater number of items quickly and accurately. This will also increase the
overall confidence for the audit opinion.

3. Allow the auditor to test the actual accounting system and records rather than printouts which are only
a copy of those records and could be incorrect.

4. Are cost effective after they have been setup as long as the company does not change its systems.

5. Allow the results from using CAATs to be compared with ‘traditional’ testing – if the two sources of
evidence agree then this will increase overall audit confidence.

Responsibilities regarding fraud

External auditor-responsibilities regarding fraud

The main focus of audit work is to ensure that the financial statements show a true and fair view. The detection
of fraud is therefore not the main focus of the external auditor’s work.

Learn!

1. In accordance with ISA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements,
external auditors are responsible for obtaining reasonable assurance that the financial statements taken as a
whole are free from material misstatement, whether caused by fraud or error.

2.In order to fulfil this responsibility, they are required to identify and assess the risks of material misstatement
of the financial statements due to fraud.

3.They need to obtain sufficient appropriate audit evidence regarding the assessed risks of material
misstatement due to fraud, through designing and implementing appropriate responses. In addition, auditors
must respond appropriately to fraud or suspected fraud identified during the audit.

4.When obtaining reasonable assurance, auditors are responsible for maintaining professional scepticism
throughout the audit, considering the potential for management override of controls and recognising the fact
that audit procedures which are effective in detecting error may not be effective in detecting fraud.

Dynamic Publishers 105

5.To ensure that the whole engagement team is aware of the risks and responsibilities for fraud and error, ISAs
require that a discussion is held within the team, placing particular emphasis on how and where the entity’s
financial statements may be susceptible to material misstatement due to faud, including how fraud might occur

6.In situations where the external auditor does detect fraud, then the auditor will need to consider the
implications for the entire audit. In other words, the external auditor has a responsibility to extend testing into
other areas because the risk of providing an incorrect audit opinion will have increased.

Groups to report fraud to

1. Report to audit committee: Disclose the situation to the audit committee as they are charged with
maintaining a high standard of governance in the company. The committee should be able to discuss the
situation with the directors and recommend that they take appropriate action
2. Report to members: If the financial statements do not show a true and fair view then the auditor needs
to report this fact to the members through their audit report.
3. Report to professional body: If the auditor is uncertain as to the correct course of action, advice may be
obtained from the auditor’s professional body.

Internal auditor’s responsibilities regarding fraud

• Commenting on the process used by management to identify and classify the specific fraud and error
risks to which the entity is subject (and in some cases helping management develop and implement that
process)
• commenting on the appropriateness and effectiveness of actions taken by management to manage the
risks identified (and in some cases helping management develop appropriate actions by making
recommendations)
• periodically auditing or reviewing systems or operations to determine whether the risks of fraud and
error are being effectively managed
• monitoring the incidence of fraud and error, investigating serious cases and making recommendations
for appropriate management responses.

In practice, the work of internal audit often focuses on the adequacy and effectiveness of internal control
procedures for the prevention, detection and reporting of fraud and error. It should be recognised, however, that
many significant frauds bypass normal internal control systems and that, in the case of management fraud in
particular, much higher level controls (those relating to the high level governance of the entity) need to be
reviewed by internal audit in order to establish the nature of the risks and to manage them effectively.

Laws and Regulations

Dynamic Publishers 106

An important part of an external audit is the consideration by the auditor as to whether the client has complied
with laws and regulations.

Key points
Management’s responsibility: Management have a responsibility to ensure that the operations of The client are
conducted in accordance with the provisions of laws and regulations. This includes compliance with laws and
regulations that determine amounts and disclosures in financial statements, including tax liabilities and charges.

Auditor’s responsibility: Auditors are not responsible for preventing non-compliance with laws and regulations,
and cannot be expected to detect non-compliance with all laws and regulations. They have a responsibility to
obtain reasonable assurance that the financial statements are free from material misstatement, whether
caused by fraud or error.

Auditor’s responsibility differs in relation to the two different categories of laws and regulations identified
below:

1. Laws and regulations which have a DIRECT effect on the determination of material amounts and
disclosures in financial statements. Here the auditor is responsible for obtaining sufficient appropriate
audit evidence regarding compliance.

2. Laws and regulations which DO NOT HAVE A DIRECT EFFECT on the determination of material amounts
and disclosures in financial statements, but may impact the entity’s ability to continue to trade. Here the
auditor’s responsibility is limited to specified audit procedures to help identify non-compliance with
those laws and regulations that may have a material effect on the financial statements. This includes
inquiring with management whether the entity is in compliance with such laws and regulations, and
inspecting correspondence with relevant licensing or regulatory authorities.

The auditor also has a responsibility to remain alert, by maintaining professional scepticism, to the possibility
that other audit procedures may bring instances of identified or suspected non-compliance with laws and
regulations.

DIRECT AND INDIRECT LAWS AND REGULATIONS- IMPORTANT EXAPLANATION TO GO THROUGH

There are many laws and regulations that a reporting entity may have to comply with in order to continue in
business. For example, many entities (particularly in the UK) will have to comply with strict health and safety
legislation; a food manufacturer may have strict food hygiene legislation to comply with, and an accountancy
firm will have a code of ethics to follow from its professional body.

Such laws and regulations will have both a direct effect on the financial statements and an indirect effect.

laws and regulations that have a direct laws and regulations that have an indirect effect on the effect on the
financial statements financial statements

Gather sufficient and appropriate audit The auditor will undertake procedures with the objective of evidence
that the entity has complied with identifying non-compliance with such laws and regulations. ISA such
laws and regulations. For example, 250 gives examples of:

Dynamic Publishers 107

when auditing the payroll the auditor will be compliance with the terms of an operating license
concerned with gathering sufficient and compliance with regulatory solvency requirements, or
appropriate audit evidence to ensure that tax compliance with environmental regulations.
• legislation has been correctly applied by the entity
because if it has not (there is risk that the entity
could be fined for non-compliance When
designing procedures to help to identify non-
compliance and the fines could be material, either in
with laws and regulations, the auditor should
obtain a general isolation or when aggregated with
other understanding of: misstatements. In addition,
amounts within the applicable legal and
regulatory framework, and the financial statements
may also be how the entity complies with
that framework.
misstated as a result of the non-compliance with
laws and regulations.
the auditor must maintain a degree of professional scepticism
and remain alert to the possibility that other audit procedures
applied may bring instances of non-compliance or suspected
non-compliance with laws and regulations to the auditor’s
attention, and such procedures could include:
• reading minutes of board meetings
• enquiring of management and/or legal advisers
concerning litigation or claims brought against the
entity, and
• undertaking substantive tests on classes of transactions,
account balances or disclosures.

REPORTING IDENTIFIED OR SUSPECTED NON-COMPLIANCE WITH LAWS AND REGULATIONS

Where the auditor discovers non-compliance with laws and regulations, the auditor must notify those charged
with governance.
However, care must be taken by the auditor because if the auditor suspects that those charged with governance
are involved, the auditor must then communicate with the next highest level of authority, which may include
the audit committee.
If a higher level of authority does not exist, the auditor will then consider the need to obtain legal advice.
The auditor must also consider whether the non-compliance has a material effect on the financial statements
and, in turn, the impact the non-compliance will have on their report.

Dynamic Publishers 108

There may be occasions when the auditor’s duty of confidentiality may be overridden by law or statute. This can
be the case when the auditor discovers non-compliance with legislation such as drug trafficking or money
laundering.

Audit Documentation

Audit documentation’ means the record of audit procedures performed, relevant audit evidence obtained and
the conclusions the auditor reached.
Professional judgment is subjective.

Need/ importance of documentation

1. Provides evidence of the auditor’s basis for a conclusion about the achievement of the overall objective
of the audit.
2. Provides evidence that the audit was planned and performed in accordance with ISAs and applicable
legal and regulatory requirements.
3. Assists the engagement team to plan and perform the audit.
4. Enables the engagement team to be accountable for its work.
5. Retains a record of matters of continuing significance to future audits.

Contents of a working paper

1. Name of client – identifies the client being audited.
2. Year-end date – identifies the year end to which the audit working papers relate.
3. Subject – identifies the area of the financial statements that is being audited, the topic area of the
working paper, such as receivables circularisation.
4. Working paper reference – provides a clear reference to identify the number of the working paper, for
example, R12 being the 12th working paper in the audit of receivables.
5. Preparer – identifies the name of the audit team member who prepared the working paper, so any
queries can be directed to the relevant person.
6. Date prepared – the date that the audit work was performed by the team member; this helps to
identify what was known at the time and what issues may have occurred subsequently.
7. Reviewer – the name of the audit team member who reviewed the working paper; this provides
evidence that the audit work was reviewed by an appropriate member of the team.

The working papers should be so prepared so as to enable an experienced auditor, with no previous
connection to the audit, to understand:
-The nature, timing and extent of the audit procedures performed to comply with the International Standard on
Auditing (ISA).
-The results of the audit procedures and audit evidence obtained.
-Significant matters resulting during the audit and the conclusions expressed thereon.

Dynamic Publishers 109

Types of audit files

The files in which all the working papers are put are termed audit files.

Permanent file papers

The permanent file contains matters of continuing importance affecting the company or the audit. This generally
has future or long term use.

• Information concerning legal structure of entity (e.g., Memorandum and Articles of Association).
• Other documents of continuing importance:
o terms of engagement; o
minutes of important meetings;
o debenture deeds; o title
deeds and lease agreements; o
royalty agreements.
• Descriptions of nature and history of client's business, locations and products.
• A list of client's investments (if any).
• Organisation charts, with extra details for finance department.
• Main accounting records, showing where kept and of what type (e.g., handwritten, computerised).
• Copies of previous financial statements and auditor's reports thereon.
• Previous reports to management (detailing weaknesses found in the accounting system.
• Client's other professional advisers.
• Client's insurance cover details.
• Significant ratios and trends.
• Accounting systems descriptions in flow chart and narrative form (see later).
• Internal controls evaluation data: questionnaires and checklists (see later).

2. Current audit file papers

The current file which is broadly concerned with the accounts being audited. This generally serves an immediate
purpose. It generally contains the following papers:

Examples of the working papers ordinarily contained in a typical current audit file include:

- Evidence of the planning process including audit programmes and any changes thereto.
- Evidence of the auditor’s consideration of the work of internal auditing and conclusions reached. -
Analyses of transactions and balances.
- Analyses of significant ratios and trends.
- The identified and assessed risks of material misstatements at the financial statement and assertion
level.
- A record of the nature, timing and extent of audit procedures performed in response to risks at the
assertion level and the results of such procedures.
- Evidence that the work performed by assistants was supervised and reviewed
- An indication as to who performed the audit procedures and when they were performed.
Dynamic Publishers 110
- Details of audit procedures applied regarding components whose financial statements are audited by
another auditor.
- Copies of communications with other auditors, experts and other third parties.
- Copies of letters or notes concerning audit matters communicated to or discussed with management or
those charged with governance, including the terms of the engagement and material weaknesses in
internal control.
- Letters of representation received from the entity.
- Conclusions reached by the auditor concerning significant aspects of the audit, including how
exceptions and unusual matters, if any, disclosed by the auditor’s procedures were resolved or treated.
- Copies of the financial statements and auditor’s report.

Corporate governance

Corporate governance is the system by which companies are directed and controlled. According to the UK
Corporate Governance Code the ‘purpose of corporate governance is to facilitate effective, entrepreneurial and
prudent management that can deliver the long-term success of the company’.

Although the contents of corporate governance will vary from organisation to organisation, almost all will have
the following components: Accountability, compliance, transparency and integrity

TCWG: Those “charged with governance” are defined as the persons who are “accountable for ensuring that
the entity achieves its objectives, with regard to reliability of financial reporting, effectiveness and efficiency of
operations, compliance with applicable laws, and reporting to interested parties.”

Although there is no universal rule, in most instances these persons will either be the board of directors and/or
the audit committee

Provisions of international codes of corporate governance (such as OECD) that are most relevant to auditors.

The Principles cover six key areas of corporate governance:

1. Ensuring the basis for an effective corporate governance framework(should promote transparent and
efficient markets, be consistent with the rule of law and have a clear division of responsibilities among
different supervisory, regulatory and enforcement authorities)
2. The rights of shareholders and key ownership functions
3. The equitable treatment of shareholders
4. The role of stakeholders in corporate governance
5. Disclosure and transparency
6. The responsibilities of the board

Dynamic Publishers 111

Important terms in corporate governance

An executive director: an executive director is a director responsible for the administration of a company. They
are primarily responsible for carrying out the strategic plans and policies as established by the board of
directors.

A non-executive director (NED): a non-executive director is a director without day-to-day operational

responsibilities of the company.

Responsibilities of the board of directors in corporate governance - establish a code of corporate ethics -
ensure that that the organisation establishes policies, procedures and controls to manage the potential
risks it will face
- ensure compliance with laws and regulations - ensuring that an effective system of internal controls is
in place and functioning - ensuring that a high quality and timely independent audit is conducted
- establish and oversee the work of audit and remuneration committee

The board of directors - The board should meet regularly.

- The roles of chairman and CEO should not be performed by the same
individual. The roles of chairman (NED) and chief executive(ED) are both very
important and carry significant responsibilities; hence this prevents too much
power residing in the hands of one individual.
- At least half of the board should be comprised of NEDs :There should be an
appropriate balance of executives and non-executives (excluding the
chairman), to ensure that the board makes the correct objective decisions,
which are in the best interest of the stakeholders of the company, and no
individual or group of individuals dominates the board’s decision-making
- Non-executives need to be independent of the executive management so that
they can exercise judgment without bias or self interest
- All directors should receive induction training when they first join the board so
that they are fully aware of their responsibilities.
- The shareholders should review on a regular basis that the composition of the
board of directors is appropriate, and they do this by re-electing directors.
- The directors need to consider, on an annual basis, whether the company
requires an internal audit department. Internal audit helps the director in
monitoring the company.
- The performance of each board member should be appraised on an annual
basis.
- There should be an on-going process of board development through
continuous professional development (CPD) of all board members.
- Board sub-committees with appropriate composition should be made ( Audit
and Remuneration committee should only have NEDs whereas Risk and
Nomination should have a majority of NEDs)

Dynamic Publishers 112

Director’s No director should be involved in setting their own remuneration as this may result in
remuneration excessive levels of pay being set.

Levels of remuneration should be sufficient to attract and retain the directors needed
to run the company successfully, but companies should avoid paying more than is
necessary for this purpose. A proportion of executive directors’ remuneration should
be structured so as to link rewards to corporate and individual performance.

Non-executive directors’ pay should not be based on meeting company targets as

their pay should be independent of how the company performs.

Accountability and The board should present a balanced and understandable assessment of the
audit company’s position and prospects.

Internal control The board should maintain a safe and registered system of internal control to
safeguard the shareholders’ investment and the company’s assets.

Audit committee and i. The board should establish an audit committee of at least three directors, all
auditors nonexecutive, with written terms of reference which deal clearly with its authority
and duties. ii. The audit committee should monitor and review the internal audit and
the reports prepared by the internal audit team. iii. With regard to the external
auditors, the audit committee should -Recommend their appointment.
-Approve their remuneration and terms of engagement.
-Monitor and review their independence, objectivity and effectiveness.

Relations with Dialogue with institutional shareholders: Companies should be ready, where
shareholders practicable, to enter into a dialogue with institutional shareholders based on mutual
understanding of objectives.
Constructive use of the AGM: Boards should use the AGM to communicate with
private investors and encourage their participation.

Dynamic Publishers 113

Institutional investors Shareholder voting: Institutional shareholders have a responsibility to make careful
use of their votes.
Code provisions
i. Institutional shareholders should, on request, make available to their clients
the information on the proportion of resolutions on which votes were cast and
nondiscretionary proxies lodged.
ii. Institutional shareholders should take steps to ensure that their voting
intentions are being translated into practice.

Dialogue with companies: Institutional shareholders should be ready, where

practicable, to enter into a dialogue with companies based on the mutual
understanding of objectives.

Evaluation of governance disclosures:When evaluating companies’ governance

arrangements, particularly those relating to board structure and composition,
institutional investors should give due weight to all relevant factors drawn to their
attention.

Roles of the Audit Committee

Composition: entirely NEDs-at least one of them should have recent and relevant financial experience.

1. With regards to Financial statements, the Audit committee: o reviews integrity of financial
statements (including reviewing significant judgments) o checks the clarity and completeness of the
disclosures in the financial statements.
o monitors formal announcement regarding financial performance

2. With regards to Internal audit, it o monitors effectiveness of IA, review their plan and ensure their
recommendations are actioned
o ensures IA is accountable to AC and preserve their independence + Chief Internal
auditor has access to Chairman o approves appointment/termination of Chief
Internal Auditor

3. With regards to External auditors, it

o Is responsible for oversight of the company’s relations with its external
auditors. o Recommends appointment, re-appointment and removal of
external auditor o Recommends remuneration and terms of engagement of
EA o Reviews and monitors independence of EA
o Develops and implements policy on EA providing non-audit services o
Reviews qualification and expertise of the EA

Dynamic Publishers 114

4. It reviews control systems (internal controls, internal financial controls, risk management)

5. It monitors compliance with laws and regulations

6. The audit committee should also review the procedures in place for whistle-blowing within the
company.

Advantages of audit committee

1. Improves Public confidence in the credibility and objectivity of the financial statements. (They can
create a climate of discipline and control and reduce the opportunity for fraud)
2. It will help to improve the quality of the financial reportingguidance to BOD
3. An audit committee can help to improve the internal control environment of the company. The audit
committee is able to devote more time and attention to areas such as internal controls.
4. Helps in risk management: The audit committee can also provide advice on risk management to the
executive directors.
5. The audit committee will be responsible for appointing the external auditors and this will strengthen the
auditors’ independence and contribute to a channel of communication and forum of issues.
6. The NEDs bring considerable external experience to the board as well as challenging the decisions of
executive directors and contributing to independent judgements.

Limitations of audit committee

1. Although audit committees do oversee the work of auditors (both internal and external) they do not
have the authority to appoint or dismiss them. This limits the amount of power the committee has over
the organisation’s auditors.
2. Audit committees generally do not have as much technical expertise and knowledge as the auditors
they are overseeing.
3. Independent directors often do not have as thorough a knowledge of the organisation’s operations and
functioning as executive directors.
4. Most of the members of the audit committee are non-executive directors. The board may feel that the
audit committee has been formed to limit its powers and allow outsiders to run the company.
5. The non-executive directors have to be paid more for carrying out the responsibilities associated with
the audit committee. Hence, it increases the cost of the organisation.

Internal audit

An independent appraisal activity established within an organization as a service to it. A control in itself which
functions by examining and evaluating the adequacy and effectiveness of other controls

Steps to conduct internal audit

1. Identify the risks which may occur if there are no controls in place
2. Identify controls in place
Dynamic Publishers 115
3. Evaluate whether the controls in place reduce the risk to an acceptable level, i.e. they are adequate.
4. Evaluate whether the controls are working effectively.
5. Report

Functions

1. Reviewing accounting and internal control systems

2. Helping with risk assessment
3. Reviewing 3Es (economy, efficiency & effectiveness) of operations
4. Examining operating and financial information
5. Review of compliance with laws, regulations and other external requirements and with management
policies and directives and other internal requirements.
6. Carrying out special investigations (e.g. into suspected fraud)

Factors determining need of internal audit

 Cost benefit analysis

 Complexity of operations
 Scale of operations
 Changes in key risks and processes
 Problems with existing controls
 Ability of current management to carry out assignments which would normally be carried out by
internal auditors
 Need of special assignments that normally internal audit carries out (IT audits for example)

What does corporate governance say about Internal Audit?

• IA should report to the Audit Committee. The AC will monitor if internal audit is effective. If there is no
IA department, the AC should determine whether there is need for one. In case they believe the internal
audit department is not required, it needs to explain the reason for this in the annual report.

• Assistance to the board of directors:

The IA department checks reports that are not audited by the external auditors.

It can help the board with regards to accounting and auditing standards when required.

IA can liaison with external auditors which can reduce the time and cost of external audit.
Differences between external and internal audit
Internal Audit External Audit

Appointment process Determined by management; appointed by Determined by statute; appointed

management. by members. Formal auditing
qualifications are required.

Dynamic Publishers 116

Objective The main objective of internal audit is to improve The main objective of the external
a company’s operations, primarily in terms of auditor is to express an opinion on
validating the efficiency and effectiveness of the the truth and fairness of the
internal control systems of a company. financial statements, and other
jurisdiction specific requirements.

Report to Internal audit reports are normally addressed to External audit reports are provided
the board of directors, or other people charged to the shareholders of a company.
with governance such as the The report is attached to the annual
audit committee. Those reports are not publicly financial statements of the company
available, being confidential between the internal and is therefore publicly available to
auditor and the recipient. the shareholders and any reader of
the financial statements.

Scope The work of the internal auditor normally relates The work of the external auditor
to the operations of the organisation, including relates only to the financial
the transaction processing systems and the statements of the organisation.
systems to produce the annual financial
statements. The internal auditor may also However, the internal control
provide other reports to management, such as systems of the organisation will be
value for money audits which external auditors tested as these provide evidence on
rarely become involved with. the completeness and accuracy of
the financial statements.

Relationship with the In most organisations, the internal auditor is an The external auditor is appointed by
organization employee of the organisation, which may have an the shareholders of an organisation,
impact on the auditor’s independence. However, providing some degree of
in some organisations the internal audit function independence from the company
is outsourced. and management
Planning and evidence No materiality Materiality
collection
Procedural or risk based Risk based

Primarily internal sources of evidence Internal and external sources of

evidence

IA and risk management

IA ensures risk management systems are operating effectively and that the strategies implemented for business
risks are operating effectively.

Business risk (risk that the company’s objectives are not met or strategy not executed properly or inappropriate
objectives and strategies were set).

Dynamic Publishers 117

IA and fraud

- Assess the adequacy and effectiveness of controls.

- Be alert to suspicious activities
- Report suspicious activities
- Carry out special investigations if asked

Limitations of IA

- independence issues as employees so may be concerned about job security

- if it is not reporting to the AC, management can influence them (they will be checking the work of
the people they are reporting to).

Outsourcing Internal Audit

Advantages

- Greater expertise, specialist skills and access to better audit technology without extra cost available
- The risk of staff turnover is passed on to the firm
- Lesser cost of training staff and retaining permanent staff
- May be more independent
- Lesser management time consumed in administering the department
- IA will be immediately available (also good for short term)
- The contract can be set for an appropriate time scale
- Flexibility in terms of that the staff can be called in according to workload

Disadvantages

- May not be independent if the same firm is offering external audit and internal audit
- May be more expensive
- The firm will not have in-depth knowledge of the company
- Lesser control by the management over the standard of service
- May have confidentiality issues
- If the company has an existing IA department which is to be made redundant, they may face
opposition from the other staff

Internal Audit assignments- examples to read through

1. VFM audit : A value for money audit focuses on whether the best combination of services has been
obtained for the lowest level of resources.

Dynamic Publishers 118

In performing a value for money audit there are three areas which an auditor will commonly focus on being
economy, efficiency and effectiveness, and these are known as the three Es.

Economy – Keeping the cost of resources used to a minimum.

Efficiency – The relationship between the output from goods and services and the resources used to produce
them.
Effectiveness – How well the organisation’s objectives have been achieved.

Deficiencies of value for money audit

There is no universal measure for outputs. For example, the output of a customer care executive in a call centre
can be measured by the number of calls attended by him. However, the output of a machine will be in terms of
the units manufactured.
Objectives of audit and measure of efficiency vary with the type of work being audited. For example, the
objective of a customer care executive is to satisfy the queries of a customer in the minimum time.
Hence, their efficiency would be determined on that basis. However, the objective of a machine is to produce
the maximum output with minimum resources.
Quality might be sacrificed to achieve economy and efficiency.For example, the customer care executive may
end the call without giving adequate answers to the queries posed by the customer. The servicing of the
machine may be delayed to avoid the machine’s downtime.
It is not easy to measure effectiveness. For example, the effectiveness of a customer care executive will
improve if they give detailed replies to the queries of the customers. However, it would result in low call
turnover and other customers would have to wait for a long time before their phone call is attended. Therefore
the measurement of effectiveness of this function is subjective, and not easy.

2. IT audit

An information technology audit is an examination of the controls within an information technology

infrastructure. This determines if the information systems are:
--safeguarding assets,
--maintaining data integrity and
--operating effectively and efficiently to achieve the organisation’s goals or objectives.

3. Best value audit

A best value review involves the following:
--Reviewing whether the products / services meet the requirements of the customers
--Determining whether there is balance between the cost and quality of the service or not
--Comparing product / service with competitors to find out the best and the worst features in the products of
the entity so as to make improvements.
4. Financial audit

The scope of internal audit for financial functions may involve internal control topics such as the efficiency of
operations, the reliability of financial reporting, deterring and investigating fraud, identifying errors,
safeguarding assets and compliance with laws and regulations.

5. Operational audit (procurement, marketing, HR)

6. Mystery shopper reviews

Dynamic Publishers 119
7. Regulatory compliance review

INDEPENDENCE
Internal auditors should:
• monitor and review controls, not design and implement them;
• report to the audit committee if possible, not the finance director; • be free to decide
on the nature and scope of their work; • be free to communicate fully with the external
auditors.

EXTERNAL AUDIT RELIANCE ON INTERNAL AUDITWORK

Reliance on internal audit

ISA 610 Using the Work of Internal Auditors details the factors the external auditors should consider in order to
place reliance on the work of the internal audit (IA) department as follows:

1. Objectivity: They should consider the status of IA within the company and if they are independent of
other departments, in particular the finance department. In addition, consideration should be given as
to who IA reports to, whether this is directly to those charged with governance or to a finance director.
2. Technical competence: The technical competence of IA staff should be considered. Consideration
should be given to whether they are members of a professional body and have relevant qualifications
and experience.
3. Due professional care: The external auditors should consider if the IA department have exercised due
professional care, the work would need to have been properly planned including detailed work
programmes, supervised, documented and reviewed.
4. Communication: In order to place reliance there needs to be effective communication between the
internal auditors and the external auditor. This is most likely to occur when the IA department is free to
communicate openly and regular meetings are held throughout the year.

Fundamental principles of ethics

1. Integrity: Members should be straightforward and honest in all professional and business relationships.

2. Objectivity: Members should not allow bias, conflicts of interest or undue influence of others to
override professional or business judgements.

3. Professional competence and due care: to maintain professional knowledge and skill at the level
required to ensure that a client receives competent professional services, and to act diligently and in
accordance with applicable technical and professional standards.

Dynamic Publishers 120

4. Confidentiality : Members should respect the confidentiality of information acquired as a result of
professional and business relationships and should not disclose any such information to third parties
without proper and specific authority
There are, however, circumstances where auditors may disclose information to third parties without
first obtaining permission.
These can be categorised as obligatory and voluntary disclosures.

Obligatory: Auditors are obliged to make disclosure where, for example, there is a statutory right or
duty to disclose, such as if the auditor suspects the client is involved in money laundering, terrorism or
drug trafficking in which case they must immediately notify the relevant authorities.
In addition, auditors must make disclosure if compelled by the process of law, for example under a court
order or summons, under which they are obliged to disclose information.

Voluntary
In certain circumstances auditors are free, as opposed to obliged, to disclose information without
obtaining the client’s permission first. These circumstances can be categorised into the four areas
below:

Public interest – An auditor may disclose information which would otherwise be confidential if
disclosure can be justified in the ‘public interest’. This would be perhaps if those charged with
governance are involved in fraudulent activities;

Protect a member’s interest – Members/auditors may disclose information to defend themselves

against a negligence action, disciplinary proceedings or if suing for unpaid fees;

Authorised by statute/laws – There are cases of express statutory provision where disclosure of
information to a proper authority overrides the duty of confidentiality;

Non-governmental bodies – Auditors may be approached by non-governmental bodies seeking

information concerning suspected acts of misconduct not amounting to a crime or civil wrong.
Disclosure should only be made to those bodies with statutory powers to compel disclosure.

5. Professional behaviour: Members should comply with relevant laws and regulations and should avoid
any action that discredits the profession.

Threats

Once you have identified a threat from the scenario, you will need to name the threat, explain WHY it is a threat
and tell the safeguard.

QCR: Quality Control Review ( independent partner review)- Having a professional accountant who was not
involved with the non-assurance service review the non-assurance work performed

Chinese walls: The use of separate engagement teams, with different engagement partners and team members

Dynamic Publishers 121

This is a snapshot for basic revision- the assumption is that you have already read
through them in detail.

Self-interest : the threat that a financial or other interest will inappropriately influence the professional
accountant’s judgment or behaviour

Example Safeguard

A member of the assurance team or the firm having a Remove the individual from the audit team-the
direct financial interest in the assurance client. self-interest threat created would be so significant
that no safeguards could reduce the threat to an
acceptable level.
Gifts and hospitality - Nature, value and intent of offer to be
considered
- Not allowed unless insignificant ( politely
decline)

A firm having undue dependence on total fees from a Public interest(listed) clients:
client.
If gross recurring fee from one client greater than
15% of the firm’s revenue for two consecutive
years,

- Tell client’s TCWG

- Independent QCR or external QCR before
OR after issuing 2nd year’s opinion

Recent Service with an Audit Client Remove from team if worked at the client in the
year being audited at a position to exert significant
(if a member of the audit team has recently served an influence over the subject matter
employee of the audit client)

Dynamic Publishers 122

A member of the assurance team(or the firm) having - If material, not allowed (The threat created
a significant close business relationship would be so significant that no safeguards
- Commercial relationship could reduce the threat to an acceptable
- Common financial interest level.)
Examples: joint venture with the client or a
controlling owner/ director, formal marketing of
each other’s product, combine the services of the
firm with those being offered by client and market
the package

A firm entering into a contingent fee arrangement Politely decline the proposed contingent fee
relating to an assurance engagement. (relating to the arrangement
outcome of a transaction or the result of the services
performed by the firm) Inform the client that the fees will be based on the
level of work required to obtain sufficient and
appropriate audit evidence.
Overdue fee-might be regarded as being equivalent Discuss with those charged with governance the
to a loan to the client reasons why the payments have not been made.

(if fees due from an audit client remain unpaid for a Should agree a revised payment schedule which
long time, especially if a significant part is not paid will result in the fees being settled before much
before the issue of the audit report for the following more work is performed for the current year audit.
year.)

Loans and guarantee Okay if in normal course of business under normal

lending conditions- otherwise not allowed.

Serving as a Director or Officer of an Audit Client - No allowed.

(Particular reference made by the code to the role
of the Company Secretary. If allowed under local
laws or professional rules, the duties and activities
shall be limited to those of a routine and
administrative nature, such as preparing minutes
and maintaining statutory returns)

Dynamic Publishers 123

Recruitment services ( especially hiring of senior Listed client: not allowed for directors or senior
management) positions related to f/s preparation

Firm can undertake roles such as reviewing a

shortlist of other candidates. However, they must
ensure that they are not seen to undertake
management decisions and so must not make the
final decision on who is appointed

A member of the audit team entering into - Remove the individual from the audit team
employment negotiations with the audit client. - A review of any significant judgments made
by that individual while on the team.
Compensation and Evaluation Policies (when a - Not allowed
member of the audit team is evaluated on or
compensated for selling non-assurance services to
that audit client.)

Self-Review-the threat that the auditor will not appropriately evaluate the results of a previous judgment
made/or service performed by him

Example Safeguard

Provision of other services to an audit client Listed Clients: Most non-assurance services related
to financial reporting are not allowed.
(Note: other threats due to this are self-interest
because of the fee element and advocacy-see below) Other clients: Segregation of duties, Chinese walls,
QCR

Temporary staff assignments-The lending of staff by Should ideally not be made a part of the audit
a firm to an audit client team

Generally acceptable if no management

responsibility taken up and the audit client shall be
responsible for directing and supervising the activities
of the loaned staff

Dynamic Publishers 124

Recent Service with an Audit Client- a member of Remove from team if worked at the client in the
the audit team has recently served as a employee of year being audited at a position to exert significant
the audit client- The threat is that the member of the influence over the subject matter
audit team has to evaluate elements of the financial
statements for which he had prepared the accounting
records while with the client.

Familiarity: the threat that due to a long or close relationship with a client , the auditor will be too
sympathetic to their interests or too accepting of their work

Long Association of Senior Personnel with an Audit Listed clients:

Client
- 7 years plus 1 year of flexibility then a gap
of two years for audit partner
- In the 2 years gap period, not participate in
the audit or, provide quality control for the
engagement, or consult with the
engagement team or the client regarding
technical or industry-specific issues
-
Other clients:

rotate members, QCR

Family and Personal Relationships Remove from team if the relationship is with a
senior person at the client with influence over the
f/s.

Dynamic Publishers 125

Employment with an Audit Client Listed client: for partners, ok if twelve months have
passed since the individual was Partner.
(the director or a senior member of the audit client
has been a member of the audit team or partner of Other safeguards
the firm in the past)
-Modifying the audit plan;

-any work already undertaken by that individual

should be independently reviewed.

-Assigning individuals to the audit team who have

sufficient experience in relation to the individual
who has joined the client.

Advocacy: threat that the auditor will promote a client’s position to the point that the his objectivity is
compromised

Legal services to audit client ( for example contract If they relate to resolving a dispute or litigation
support, litigation, mergers and acquisition legal when the amounts involved are material to the
advice and support to clients’ internal legal financial Statements: not allowed
departments)

Auditor asked to promote client/shares in a client or Not allowed ( politely decline)

asked to accompany the client to a meeting with the
bank

Intimidation: the threat that the auditor will be deterred from acting objectively because of actual or
perceived pressures, including attempts to exercise undue influence over the auditor

Threat of dismissal or replacement of auditor/or his

close family member over a disagreement about the
application of an accounting principle.

- Tell client’s TCWG

A dominant personality at the client attempting to
influence the decision making process, for example - ensure that all audit engagements are
the application of an accounting principle. conducted in accordance with International
Standards on Auditing
A firm being pressured to reduce inappropriately the - Ensure you gather sufficient appropriate
extent of work performed in order to reduce fees. evidence

Dynamic Publishers 126

An auditor feeling pressured to agree with the
judgment of a client employee because the employee
has more expertise on the matter in question.

Actual or Threatened Litigation(for example - QCR

regarding a previous audit report)- When the firm and - If a team member involved, remove from
the client’s management are placed in adversarial team
positions by actual or threatened litigation, affecting - Withdraw from engagement if very
management’s willingness to make complete significant
disclosures

Fee dependence, close personal relationships, The safeguards for each will be the same as
business relationships also cause intimidation threats. discussed earlier.

Conflict of Interest

Members should place their clients’ interests before their own and should not accept or continue engagements
which threaten to give rise to conflicts of interest between the firm and the client. Any advice given should be in
the best interests of the client.

A conflict of interest arises where an auditor acts for both a client company and for a competitor company of the
client. Where the acceptance/continuance of an engagement would, despite safeguards, materially prejudice the
interests of any clients, the appointment should not be accepted/continued, or one of the appointments should
be discontinued.

Managing conflicts of interest

1. Full disclosure is important – both companies should be fully aware that the firm is acting for the
other party.
2. Regular review of situation by an independent senior partner
3. Use of different partners and teams of staff for different engagements 4. Internal procedures within
the firm :
o Procedures to prevent access to information, for example, strict physical
separation of both teams, confidential and secure data filing.
o Clear guidelines for members of each engagement team on issues of security and
confidentiality. These guidelines could be included within the audit engagement
letters.
o Potentially the use of confidentiality agreements signed by employees and
partners of the firm
Dynamic Publishers 127
5. Advising at least one or all clients to seek additional advice

Not for profit organizations

Important features to remember:

 There are no external shareholders therefore no dividends  Income likely to be from
donations/grants.
 Likely additional reporting/accounting rules.
 Their activities may be restricted by regulators
 They are Not forbidden from engaging in commercial activities  3Es very important for them.
 Normally managed by a council made up entirely of volunteers ( like NEDs)

Examples: charities , housing associations, clubs. local authorities/councils, government bodies.

Charities
Risks
- Higher level of cash transactions.
- Income – completeness problem.
- Lack of predictability regarding future income/expenditure. (analytical procedures aren’t very useful
here!)
- Complexity of external regulations.
- Complexity of taxation regulations.
- Potential restrictions re: activities/use of income.
Control risks

- Restricted number of employees so segregation of duties difficult

- Volunteer staff-competence, training, lack of trust
- Informal environment
- Trustees (the time they give to the org, skills, qualifications, frequency of meetings, independence from
each other)

Obtain understanding of an entity and its By obtaining and examining constitution, by-laws,
environment rules and regulations.

Risk assessment Generally control risk is high

Planning Generally need to perform extensive substantive

procedures

Dynamic Publishers 128

Determine adequacy and effectiveness of controls Generally less effective ( run by non-professionals
plus controls might not be cost beneficial)

Audit evidence gathering procedures Extensive substantive testing.

Dynamic Publishers 129