f8 III

Chapter 12 • Tangible non-current assets
Non-current assets • Intangible non-current assets
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Syllabus learning outcomes
Explain the audit objectives and the audit procedures to obtain sufficient
appropriate evidence in relation to:
Tangible and intangible non-current assets
(i) Evidence in relation to non-current assets, and
(ii) Depreciation
(iii) Profit/loss on disposal
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Overview
Non-current assets
Evidence on statement
of profit or loss entries
• Depreciation
• Gains/losses on
Tangible Intangible disposals
non-current assets non-current assets • Impairments
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Chronology of an audit
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Tangible non-current assets 1
Audit objectives for tangible non-current assets

Financial statement assertion Audit objective
Existence and occurrence – Additions represent assets acquired in the year and
disposal represent assets sold or scrapped in the year
– Recorded assets represent those in use at the year-end
Completeness – All additions and disposals that occurred in the year have
been recorded
– Balances represent assets in use at the year-end
Rights and obligations – The entity has rights to the assets purchased and those
recorded at the year-end
Accuracy, valuation and allocation – Non-current assets are correctly stated at cost less
accumulated depreciation
– Additions and disposals are correctly recorded
Classification – Tangible assets have been recorded in the correct
accounts, and expenses which are not of a capital nature
are taken to profit or loss‘
Presentation – Disclosures relating to cost, additions and disposals,
depreciation policies, useful lives and assets held under
finance leases are adequate and in accordance with
accounting standards
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• The following slides set out audit procedures for tangible non-current
assets.
• Remember, these are substantive audit procedures.
• DO NOT confuse these with tests of controls, which were covered in
Chapter 10!
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Substantive audit procedures to test COMPLETENESS

• Obtain or prepare a summary of tangible non-current assets showing
how gross book value, accumulated depreciation and net book value
reconcile with the opening position.
• Compare non-current assets in the general ledger with the non-
current assets register and obtain explanations for differences.
• For a sample of assets which physically exist agree that they are
recorded in the non-current asset register.
• If a non-current asset register is not kept, obtain a schedule showing
the original costs and present depreciated value of non-current
assets.
• Reconcile the schedule of non-current assets with the general ledger.
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Substantive audit procedures to test EXISTENCE

• Confirm that the company physically inspects all items in the non-
current asset register each year.
• Inspect assets, concentrating on high value items and additions in-
year. Confirm that items inspected exist, are in use, are in good
condition, have correct serial numbers.
• Review records of income-yielding assets.
• Reconcile opening and closing vehicles by numbers as well as
amount.
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Substantive audit procedures to test RIGHTS AND OBLIGATIONS

• Verify title to land and buildings by inspection of title deeds, Land
Registry certificates, lease agreements.
• Obtain a certificate from solicitors/bankers stating purpose for which
the deeds are being held (custody only), stating deeds are free from
mortgage or lien.
• Inspect registration documents for vehicles held, confirming that they
are in client's name.
• Confirm all vehicles are used for the client's business.
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• Examine documents of title for other assets (including purchase
invoices, architects' certificates, contracts, hire purchase or lease
agreements).
• Review for evidence of charges in statutory books and by company
search.
• Review leases of leasehold properties to ensure that company has
fulfilled covenants therein.
• Examine invoices received after year-end, orders and board minutes
for evidence of capital commitments.
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Substantive audit procedures to test VALUATION

• Verify valuation to valuation certificate.
• Consider reasonableness of valuation, reviewing experience of
valuer, scope of work done, methods and assumptions used, whether
valuation bases are in line with accounting standards.
• Reperform calculation of revaluation surplus.
• Confirm whether valuations of all assets that have been revalued
have been updated regularly (full valuation every five years and an
interim valuation in year 3 generally) by asking the Finance Director
and inspecting the previous financial statements.
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Substantive audit procedures to test VALUATION continued

• Inspect draft financial statements to check that client has recognised
in the statement of profit or loss revaluation losses unless there is a
credit balance in respect of that asset in equity, in which case it
should be debited to equity to cancel the credit. All revaluation gains
should be credited to equity.
• Review insurance policies in force for all categories of tangible non-
current assets and consider the adequacy of their insured values and
verify expiry dates.
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Substantive audit procedures to test DEPRECIATION (part of

accuracy, valuation and allocation)
• Review depreciation rates applied in relation to asset lives, residual
values, replacement policy, past experience of gains and losses on
disposal, consistency with prior year's accounting policy, possible
obsolescence.
• Review non-current assets register to ensure that depreciation has
been charged on all assets with a limited useful life.
• For revalued assets, ensure that the charge for depreciation is based
on the revalued amount by recalculating it for a sample of revalued
assets.
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Substantive audit procedures to test DEPRECIATION continued

• Re-perform calculation of depreciation (proof in total test) to ensure it
is correct and appears reasonable.
• Compare ratios of depreciation to non-current assets (by category)
with previous years, depreciation policy rates.
• Scrutinise draft accounts to ensure that depreciation policies and
rates are disclosed adequately.
• For a sample of fully depreciated assets, inspect the non-current
assets register to ensure no further depreciation has been charged.
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Substantive audit procedures to test ADDITIONS (part of accuracy,

valuation and allocation)
• Verify additions by inspection of architects' certificates, solicitors'
completion statements, suppliers' invoices and other relevant
documentation.
• Review capitalisation of expenditure by examining for non-current
assets additions and items in relevant expense categories (repairs,
motor expenses, sundry expenses) to ensure that capital/revenue
distinction is correctly drawn and capitalisation is in line with
consistently applied company policy.
• Inspect non-current asset accounts for a sample of purchases to
ensure they have been properly allocated.
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Substantive audit procedures to test ADDITIONS continued

• Ensure that appropriate claims have been made for grants, and
grants received and receivable have been received, by inspecting
claims documentation and bank statements.
• Verify that additions have been recorded by scrutinising the non-
current asset register and general ledger.
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Substantive audit procedures to test SELF-CONSTRUCTED

ASSETS (part of accuracy, valuation and allocation)
• Verify material and labour costs and overheads to invoices, wage
records etc.
• Ensure expenditure has been analysed correctly and properly
charged to capital by inspecting a sample of invoices and other
relevant documentation relating to self-constructed assets.
• Review costs to ensure that no profit element has been included.
• Review accounts to ensure that finance costs have been capitalised
or not capitalised on a consistent basis, and costs capitalised in
period do not exceed total finance costs for period.
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Substantive audit procedures to test DISPOSALS (part of accuracy,

valuation and allocation)
• Verify disposals with supporting documentation, checking transfer of
title, sales price and dates of completion and payment.
• Recalculate profit or loss on disposal to ensure it is correct and has
been correctly reflected in the financial statements.
• Consider whether proceeds are reasonable.
• If the asset was used as security, ensure release from security has
been correctly made by inspection of documentation.
• Review board meeting minutes to confirm that disposals made during
the period were authorised and bona fide.
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Intangible non-current assets 1
Key financial statement assertions

• Existence
• Accuracy, valuation and allocation
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REMEMBER!
1. Only purchased goodwill or intangibles with a readily
ascertainable market value can be capitalised.
2. For research and development costs, research costs should be

expensed.
3. PIRATE criteria for development costs to be capitalised.
4. The audit of amortisation will be similar to the audit of

depreciation.
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Development expenditure
• Probable future economic benefits
• Intention to complete and use/sell asset
• Resources adequate and available to complete and use/sell asset
• Ability to use/sell the asset
• Technical feasibility of completing asset for use/sale
• Expenditure can be measured reliably
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Substantive audit procedures for goodwill

• Agree sales consideration to sales agreement by inspection.
• Consider whether asset valuation is reasonable.
• Review impairment review and discuss with management.
• Assess whether valuation of goodwill is reasonable/impaired or not
by discussion with management.
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Substantive audit procedures for research and development

• Confirm that capitalised development costs conform to IAS 38 criteria
by inspecting details of projects and discussions with technical
managers.
• Confirm feasibility and viability of projects by inspection of budgets
and discussions with project managers and technical staff.
• Recalculate amortisation for capitalised costs to ensure it commences
with production and is reasonable.
• Inspect invoices to verify material expenditure incurred on research
and development projects.
• Verify wages costs to supporting documentation such as time sheets.
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Substantive audit procedures for research and development

continued
• Review the accounting records to ensure that the expenditure can be
readily measured, eg separate cost centre or nominal ledger code.
• Consider probability of future economic benefits (ie commercial
viability) and ability to sell or use the asset in relation to market
research results, advance orders, budgets and forecasts.
• Review budgeted costs and revenues for reasonableness.
• Review cash flow forecasts to ensure that adequate resources exist to
complete the project.
• Obtain written representations from management of their intention to
complete and use the asset.
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Substantive audit procedures for other intangibles

• Agree purchased intangibles to purchase documentation agreement
by inspection.
• Inspect specialist valuations of intangibles for reasonableness.
• Review amortisation calculations and recalculate to verify accuracy
and reasonableness.
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Exam link 1
• Questions on non-current assets are likely to come up in a

scenario context and ask you to provide audit procedures to test
certain financial statement assertions.
• The June 2012 exam tested the audit of additions and disposals of
plant and equipment using substantive procedures.
• In the June 2013 exam, the requirement asked for procedures
used to get audit evidence and then for examples relevant to
property, plant and equipment.
• Part B of the 2015 Specimen Paper included a 10-mark
requirement for substantive procedures in relation to a revaluation
of land and buildings and the valuation of work-in-progress.
• There was also a scenario-linked objective test question on non-
current assets in Part A of the 2015 Specimen Paper.
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Exam link 2
• Audit evidence in the form of substantive procedures has been

tested in every sitting under the current F8 examiner and therefore
it is most important that you firstly understand the difference
between substantive procedures and tests of controls, and
secondly the financial statement assertions and how these can be
tested.
• When you suggest audit procedures (be they substantive tests or
tests of controls) it is VITAL that they are sufficiently detailed
otherwise you will not score full marks.
• For example, stating 'Discuss with management' or 'Check for
existence' are too vague. Would a real auditor be able to go away
and complete the audit of an account area with tests such as
these?
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Exam link 3
• As a general rule, when asked for audit procedures, do not use

'Check …' or 'Ensure …'.
• You must use action verbs such as 'Inspect …', 'Discuss …',
'Observe …' , 'Recalculate …' – remember the methods which
auditors use to get audit evidence, which were discussed in
Chapter 8.
• Generally, you should assume one mark for each well explained
audit procedure.
• Questions on audit risk and responses may require you to apply
the knowledge you have gained from this chapter.
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Question: 2015 Specimen Paper (Sec A, Question 7)
Balotelli Beach Hotel Co (Balotelli) operates a hotel providing

accommodation, leisure facilities and restaurants. You are an audit
senior of Mario & Co and are currently conducting the audit of
Balotelli for the year ended 31 December 20X4. During the course of
the audit a number of events and issues have been brought to your
attention:
Non-current assets and depreciation
Balotelli incurred significant capital expenditure during the year
updating the leisure facilities at several of the company’s hotels.
Depreciation is charged monthly on all assets on a straight line basis
(SL) and it is company policy to charge a full month’s depreciation in
the month of acquisition and none in the month of disposal.
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Question: 2015 Specimen Paper (Sec A, Q7) cont'd
Which of the following audit procedures are appropriate to test the
VALUATION assertion for non-current assets?
(1) Ensure disposals are correctly accounted for and recalculate gain/loss on
disposal
(2) Recalculate the depreciation charge for a sample of assets ensuring that it
is being applied consistently and in accordance with IAS 16 Property, Plant
and Equipment
(3) Review the repairs and maintenance expense accounts for evidence of
items of a capital nature
(4) Review board minutes for evidence of disposals during the year and verify
that these are appropriately reflected in the non-current assets register
A 1 and 2
B 1, 3 and 4
C 2, 3 and 4
D 2 and 3 only
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Answer: 2015 Specimen Paper (Sec A, Q7)
• Test 4 is a test for existence and test 3 is for completeness. All

other tests are relevant for valuation. Option A is correct.
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Question: 2015 Specimen Paper (Sec B, Q6b)
[See slides 631 to 633 for the question scenario.]
Required:
(b) Describe substantive procedures Suarez & Co should perform at
the year end to confirm plant and equipment additions. (2 marks)
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Approach: 2015 Specimen Paper (Sec B, Q6b)
• Note that the question states 'plant and equipment' so make sure
you do not include tests relating to property.
• You are asked for substantive procedures so do not include any
tests of controls.
• There are two marks available in total. This suggests you will be
able to score one mark per each well-explained audit procedure.
• Make sure your tests are sufficiently precise and detailed as
vague answers will not score very well.
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Answer: 2015 Specimen Paper (Sec B, Q6b)
• Inspect a sample of additions to ensure that they physically exist.

• Cast the list of additions of plant and equipment and match the
total back to the total in the non-current assets register and the
draft financial statements to ensure it is correctly stated.
• Recalculate the depreciation charge for the year for a sample of
additions to ensure it is correct and in line with the depreciation
policy for plant and equipment.
• Inspect purchase documentation for a sample of additions to verify
whether it is in the name of Baggio to confirm rights and
obligations.
• Inspect board meeting minutes during the year to ensure that
capital expenditure on new plant and equipment was authorised
appropriately by the board of Baggio.
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Question: December 2010 Question 4c
Required:
(c) Describe two substantive procedures the external auditor of
Bluesberry should adopt to verify each of the following assertions
in relation to an entity's property, plant and equipment:
(i) Accuracy, valuation and allocation
(ii) Completeness
(iii) Rights and obligations (6 marks)
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Approach: December 2010 Question 4c
• This question is testing your understanding of the financial

statement assertions so it is really important that you understand
these and how to test for them.
• There are six marks available in total so assume that there are
two marks for each assertion. This suggests you will be able to
score one mark per each well-explained audit procedure.
• Make sure you only provide audit procedures for the assertions
specifically asked for – don't include tests for existence, for
example.
• You are specifically asked for two procedures for each assertion
so don't do more than this as you won't get any credit for doing so.
• Note: The answer has more than two procedures for each
assertion as it is for illustrative purposes only.
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Answer: December 2010 Question 4c
Accuracy, valuation and allocation

• Obtain a schedule of property, plant and equipment and for a
sample of these, confirm the amount capitalised to the purchase
invoices to confirm valuation.
• For any properties revalued during the year, confirm the revalued
amount to the valuation report and assess the valuer in terms of
scope, objectivity, assumptions, qualifications etc.
• Perform a proof in total test for depreciation, using the
depreciation policy and rates for property, plant and equipment,
and compare this to the actual charge for the year to confirm
whether the charge appears reasonable.
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Answer: December 2010 Question 4c (cont'd)
Completeness
• For a sample of property, plant and equipment selected by
physical inspection, trace these back to the non-current assets
register to confirm that they have been included on the register.
• Perform a review of expenditure accounts (repairs, maintenance
etc) and select sample for further testing. Obtain invoices relating
to these to ensure the costs have been correctly expensed rather
than capitalised.
• Re-perform the reconciliation of the non-current assets register to
the general ledger, investigating fully any differences.
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Answer: December 2010 Question 4c (cont'd)
Rights and obligations

• Obtain a schedule of property, plant and equipment and for a
sample of these, confirm the amount capitalised to the purchase
invoices to confirm they were purchased by Bluesberry.
• Inspect title deeds of property to ensure that it belongs to
Bluesberry.
• For leased assets, review lease agreements to verify whether they
should be treated as finance leases or operating leases.
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• Introduction to auditing
Chapter 13 inventory
Inventory • Accounting for inventory
• Audit procedures for inventory
• The physical inventory count
• Cut-off
• Valuation
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Inventory
(i) Inventory counting procedures in relation to year-end and continuous
inventory systems
(ii) Cut-off
(iii) Auditor's attendance at inventory counting
(iv) Direct confirmation of inventory held by third parties
(v) Valuation
(vi) Other evidence in relation to inventory
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Overview
Inventory
Inventory counting Other evidence

Cut-off
procedures • Valuation
• Year end
• Continuous
inventory
Auditor's attendance 3rd party

at inventory count confirmations
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Introduction to auditing inventory
Audit objectives for tangible non-current assets
Financial statement assertion Audit objective
Existence and occurrence – Recorded purchases and sales represent inventories bought
and sold
– Inventory on the statement of financial position physically exists
Completeness – All purchases and sales are recorded
– All inventory at year-end is included on the statement of financial
position
Rights and obligations – The entity has rights to inventory recorded in the period and at
the year-end
Accuracy, valuation and – Costs are accurately determined in accordance with accounting
allocation standards
– Inventory is recorded at year-end at the lower of cost and net
realisable value
Classification – Inventory is recorded in the proper accounts
Cut-off – All purchases and sales of inventories are recorded in the
correct period
Presentation – Inventory is properly classified in the accounts
(classification and – Disclosures relating to classification and valuation are adequate
understandability, and in accordance with accounting standards
completeness, accuracy and
valuation)
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Accounting for inventory
• IAS 2 Inventories
• Inventory should be valued at the lower of cost and net realisable
value.
• Cost: all costs of purchase and other costs incurred in bringing
inventory to its present location and condition.
• Net realisable value: the estimated selling price in the ordinary
course of business, less the estimated costs of completion and the
estimated costs necessary to make the sale.
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Audit procedures for inventory 1
Substantive audit procedures to test COMPLETENESS

• Complete the disclosure checklist to ensure that all the disclosures
relevant to inventory have been made.
• Trace test counts to the detailed inventory listing.
• Where inventory is held in third party locations, physically inspect this
inventory or review confirmations received from the third party and
match to the general ledger.
• Compare the gross profit % to the previous year or industry data.
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Substantive audit procedures to test EXISTENCE

• Observe the physical inventory count.
The inventory count is covered in detail in later slides.
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• Verify that any inventory held for third parties is not included in the
year-end inventory figure by observing whether it is being
appropriately segregated during the inventory count.
• For any 'bill-and-hold' inventory (ie where the inventory has been sold
but is being held by the entity until the customer requires it), identify
such inventory and ensure that it is segregated during the inventory
count so that it is not included in the year-end inventory figure.
• Confirm that any inventory held at third party locations is included in
the year-end inventory figure by reviewing the inventory listing.
• Review loan agreements and board meeting minutes for evidence
that inventory has been pledged or assigned.
• Inquire of management about any warranty obligations.
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Substantive audit procedures to test ACCURACY, VALUATION AND

ALLOCATION
• Obtain a copy of the inventory listing and agree the totals to the
general ledger.
• Cast the inventory listing to ensure it is mathematically correct.
• Vouch a sample of inventory items to suppliers' invoices to ensure it is
correctly valued.
• Where standard costing is used, test a sample of inventory to ensure
it is correctly valued.
• For materials, agree the valuation of raw materials to invoices and
price lists.
• Confirm that an appropriate basis of valuation (eg FIFO) is being used
by discussing with management.
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ALLOCATION continued
• For labour costs, agree costs to wage records.
• Review standard labour costs in the light of actual costs and
production.
• Reconcile labour hours to time summaries.
• Make inquiries of management to ascertain any slow-moving or
obsolete inventory that should be written down.
• Examine prices at which finished goods have been sold after the
year-end to ascertain whether any finished goods need to be written
down.
• If significant levels of finished goods remain unsold for an unusual
period of time, discuss with management and consider the need to
make allowance.
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• Compare the gross profit % to the previous year or industry data.
• Compare raw material, finished goods and total inventory turnover to
the previous year and industry averages.
• Compare inventory days to the previous year and industry average.
• Compare the current year standard costs to the previous year after
considering current conditions.
• Compare actual manufacturing overhead costs with budgeted or
standard manufacturing overhead costs.
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• Obtain a copy of the inventory listing and cast it, and test the
mathematical extensions of quantity multiplied by price.
• Trace test counts back to the inventory listing.
• If the entity has adjusted the general ledger to agree with the physical
inventory count amounts, agree the two amounts.
• Where a continuous (perpetual) inventory system is maintained,
agree the total on the inventory listing to the continuous
inventory records, using CAATs.
• Read the notes to the financial statements to ensure that the
information is accurate and properly presented at the appropriate
amounts.
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Substantive audit procedures to test CUT-OFF

• Note the numbers of the last GDNs and GRNs before the year-
end and the first GDNs and GRNs after the year-end and check that
these have been included in the correct financial year by reviewing
the ledger.
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Substantive audit procedures to test CLASSIFICATION

• Review the inventory listing to ensure that inventory has been
properly classified between raw materials, work-in-progress and
finished goods.
• Read the notes to the accounts relating to inventory to ensure they
are understandable.
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The physical inventory count 1
• ISA 501 Audit evidence – specific considerations for selected items

• Inventory count provides evidence of existence and condition of
inventory.
• If inventory is material:
— Evaluate management's instructions
— Observe performance of count procedures
— Inspect inventory
— Perform test counts
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Inventory counting methods

1. Physical counts at year-end
2. Physical counts before or after the year-end
3. Perpetual (continuous) inventory counting
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Perpetual (continuous) inventory

Auditors need to verify that management:
• Ensures that all inventory lines are counted at least once a year
• Maintains adequate inventory records that are kept up-to-date
• Has satisfactory procedures for inventory counts and test-counting
• Investigates and corrects all material differences
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Before the count

• Review prior year's arrangements.
• Discuss arrangements with management.
• Assess key factors (risk, material items, location etc).
• Review inventory count instructions (organisation, counting,
recording).
• Plan procedures (representative selection, high value items, inventory
held by third parties, need for an expert).
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During the count

• Observe whether the client's staff are following instructions as this
will help to ensure the count is complete and accurate.
• Perform test counts to ensure procedures and internal controls are
working properly, and to gain evidence over existence and
completeness of inventory.
• Ensure that the procedures for identifying damaged, obsolete and
slow-moving inventory operate properly by observation.
• Confirm that inventory held on behalf of third parties is separately
identified and accounted for so that inventory is not overstated.
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During the count continued

• Conclude whether the count has been properly carried out and is
sufficiently reliable as a basis for determining the existence of
inventories.
• Consider whether any amendment is necessary to subsequent audit
procedures.
• Gain an overall impression of the levels and values of inventories held
so that the auditors may, in due course, judge whether the figure for
inventory appearing in the financial statements is reasonable.
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After the count

• Trace items that were test counted to final inventory sheets.
• Observe whether all count records have been included in final
inventory sheets.
• Inspect final inventory sheets to ensure they are supported by count
records.
• Ensure that continuous inventory records have been adjusted to the
amounts physically counted or measured, and that differences have
been investigated.
• Confirm cut-off by using details of the last serial number of goods
inwards and outwards notes and details of movements during the
count.
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After the count continued

• Review replies from third parties about inventory held by or for them.
• Confirm the client's final valuation of inventory has been calculated
correctly.
• Follow up queries and notify problems to management.
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Inventory held by third parties

If inventory held by third parties is material:
• Direct confirmation per ISA 505 External confirmations
• Inspection or other appropriate audit procedures
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Inventory held by third parties continued

Other appropriate audit procedures:
• Attending, or arranging for another auditor to attend, the third party's
inventory count
• Obtaining another auditor's report on the adequacy of the third party's
internal control for ensuring that inventory is properly counted and
adequately safeguarded
• Inspecting documentation in respect of third party inventory
• Requesting confirmation from other parties when inventory has been
pledged as collateral
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Cut-off 1
• There should ideally be no movements during the inventory count

• Receipts and dispatched should be suspended during the count
• If it is not possible to suspend all deliveries, these should be kept
separate from other inventory and carefully documented
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Cut-off 2
Year-end
Before After
GRN GRN
Purchase
Purchase
Included in? Included in?
— Purchases — Purchases X
— Payables — Payables X
— Inventories — Inventories X
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Cut-off 3
Year-end
Before After
GDN GDN
Included in? Included in?

Sales
Sales
— Sales — Sales X
— Receivables — Receivables X
— Inventories X — Inventories
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Valuation 1
• Inventory must be valued at the lower of cost and net realisable value.
• Auditors need to understand how cost is determined.
• Cost should include an appropriate proportion of overheads.
• As there are many ways to determine cost, management should be
using a method consistently and a method that gives a fair
approximation to cost.
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Valuation 2
Valuation of raw materials and brought-in components

• Use suppliers' invoices
• If standard costs used, check the basis of standards, compare with
actual costs and confirm that variances are being treated
appropriately
Valuation of work-in-progress and finished goods

• Use analytical procedures
• Reasonableness check
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Valuation 3
Cost versus net realisable value

NRV < cost when:
• An increase in costs or a fall in selling price
• Physical deterioration
• Obsolescence of products
• A marketing decision to manufacture and sell products at a loss
• Errors in production or purchasing
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Exam link 1
• Questions on inventory are likely to come up in a scenario context

and ask you to provide audit procedures to test certain financial
statement assertions.
• Requirements may tend to focus on a particular financial
statement assertion and the substantive audit procedures to test
that assertion.
• The examining team has commented time after time that
candidates do not provide enough detail in audit procedures or fail
to provide tests for the specific assertion in the question or just
provide a list of generic tests without regard to the scenario they
are presented with.
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Exam link 2
• Audit evidence in the form of substantive procedures has been

tested in every sitting under the current F8 examining team and
therefore it is most important that you firstly understand the
difference between substantive procedures and tests of controls,
and secondly the financial statement assertions and how these
can be tested.
• When you suggest audit procedures (be they substantive tests or
tests of controls) it is VITAL that they are sufficiently detailed
otherwise you will not score full marks.
• For example, stating 'Discuss with management' or 'Check for
existence' are too vague. Would a real auditor be able to go away
and complete the audit of an account area with tests such as
these?
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Exam link 3
• As a general rule, when asked for audit procedures, do not use

'Check …' or 'Ensure …'.
• You must use action verbs such as 'Inspect …', 'Discuss …',
'Observe …' , 'Recalculate …' – remember the methods which
auditors use to get audit evidence, which were discussed in
Chapter 8.
• Try to use the approach VERB-DOCUMENT-REASON in your
audit procedures, for example “Vouch the cost of inventory to the
original invoice to determine whether cost is accurately stated.”
• Questions on audit risk and responses may require you to apply
the knowledge you have gained from this chapter.
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Chapter 14 • Introduction
Receivables • Audit procedures for

receivables
• The receivables' confirmation
• Sales
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Explain the audit objectives and the audit procedures to obtain

sufficient appropriate evidence in relation to:
Receivables
(i) Direct confirmation of accounts receivable
(ii) Other evidence in relation to receivables and prepayments
(iii) Completeness and occurrence of sales
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Overview
Receivables
Statement of financial position: receivables and prepayments

Statement of profit or loss: revenue, irrecoverable debts expense
Direct
Other evidence
confirmation
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Introduction 1
• Receivables may be a material balance on a company's statement of

financial position.
• They are usually audited using tests of details and analytical
procedures.
• Sales can be tested at the same time as receivables.
• Existence, completeness and accuracy, valuation and allocation are
key financial statement assertions for receivables.
• Occurrence, completeness and accuracy are key financial statement
assertions for sales.
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Introduction 2
Audit objectives for receivables
Assertions about – All sales transactions recorded have occurred and relate to
classes of the entity (occurrence)
transactions and – All sales transactions that should have been recorded have
related disclosures been recorded (completeness)
– Amounts relating to transactions have been recorded
appropriately (accuracy)
– All transactions have been recorded in the correct period
(cut-off)
– All transactions are recorded properly (classification)
– All disclosed events and transactions relating to receivables
have occurred and pertain to the entity (occurrence, rights
and obligations)
– All disclosures required have been included (completeness)
– Financial information is appropriately presented and
described and disclosures clearly expressed (presentation)
– Financial and other information is disclosed fairly and at
appropriate amounts (presentation)
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Introduction 3
Audit objectives for receivables

Assertions about – Recorded receivables exist (existence)
account balances at – The entity controls the rights to receivables and related
the period-end and accounts (rights and obligations)
related disclosures – All receivables that should have been recorded have been
recorded (completeness)
– Receivables are included in the accounts at the correct
amounts (accuracy, valuation and allocation)
– All disclosures required have been included (presentation)
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Audit procedures for receivables 1
• The following slides set out audit procedures for receivables.

Chapter 10!
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Substantive procedures to test the COMPLETENESS of receivables

• Agree the balance from the individual sales ledger accounts to the
aged receivables' listing and vice versa.
• Match the total of the aged receivables' listing to the sales ledger
control account.
• Cast and cross-cast the aged trial balance before selecting any
samples to test.
• Trace a sample of shipping documentation to sales invoices and into
the sales and receivables' ledger.
relevant to receivables have been made.
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Substantive procedures to test the COMPLETENESS of receivables

continued
• Compare the gross profit % by product line with the previous year and
industry data.
• Compare the level of prepayments to the previous year to ensure the
figure is materially correct and complete.
• Review detailed statement of financial position to ensure all likely
prepayments have been included.
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Substantive procedures to test the EXISTENCE of receivables

• Perform a receivables' confirmation on a sample of year-end trade
receivables.
• Follow up all balance disagreements and non-replies to the
receivables' confirmation.
• Perform alternative procedures for any exceptions and non-
replies to the receivables' confirmation such as:
— Reviewing after-date cash receipts by inspecting bank statements
and cash receipts' documentation.
— Examining the customer's account and customer correspondence
to assess whether the balance outstanding represents specific
invoices and confirm their validity.
— Examining the underlying documentation (purchase order, dispatch
documentation, duplicate sales invoice etc).
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Substantive procedures to test the EXISTENCE of receivables

continued
— Inquiring from management explanations for invoices remaining
unpaid after subsequent ones have been paid.
— Observing whether the balance on the account is growing and if so,
finding out why by discussions with management.
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Substantive procedures to test the RIGHTS AND OBLIGATIONS of

receivables
• Inspect the bank confirmation letter for any liens on receivables.
• Inquire with management to ascertain whether any receivables have
been sold (eg to factors).
• Inspect loan agreements and board meeting minutes for any evidence
of receivables being sold (eg to factors).
• Determine, through discussion with management, whether any
receivables have been pledged, assigned or discounted and whether
such items require disclosure in the financial statements.
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Substantive procedures to test the ACCURACY, VALUATION AND

ALLOCATION of receivables
• Compare receivables' turnover and receivables' days to the previous
year and/or to industry data.
• Compare the aged analysis of receivables from the aged trial balance
to the previous year.
• Review the adequacy of the allowance for uncollectable accounts
through discussion with management.
• Compare the irrecoverable receivable expense as a % of sales to the
previous year and/or to industry data.
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ALLOCATION of receivables continued
• Compare the allowance for uncollectable accounts as a % of
receivables or credit sales to the previous year and/or to industry
data.
• Confirm adequacy of allowance by reviewing correspondence with
customers and solicitors.
• Examine credit notes issued after year-end for allowances that should
be made against current period balances.
• Examine large customer accounts individually and compare to the
previous year's balances.
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ALLOCATION of receivables continued
• For a sample of old debts on the aged trial balance, obtain further
information regarding their recoverability by discussions with
management and inspection of customer correspondence.
• For a sample of prepayments from the prepayments' listing,
recalculate the amount prepaid to ensure that it has been accurately
calculated.
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Substantive procedures to test the CLASSIFICATION of receivables

• Review the aged analysis of receivables for any large credits, non-
trade receivables and long-term receivables and consider whether
such items require separate disclosure.
• Read the disclosure notes relevant to receivables in the draft financial
statements and review of understandability.
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Substantive procedures to test the ACCURACY of sales

• For a sample of sales invoices, compare the prices and terms to the
authorised price list and terms of trade documentation.
• Test whether discounts have been properly applied by recalculating
them for a sample of invoices.
• Test the correct calculation of tax on a sample of invoices.
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Substantive procedures to test the CUT-OFF of sales

• For a sample of sales invoices around the year-end, inspect the dates
and compare with the dates of dispatch and the dates recorded in the
ledger for application of correct cut-off.
• For sales returns, select a sample of returns documentation around
the year-end and trace to the related credit entries.
• Perform analytical procedures on sales returns, comparing the ratio of
sales returns to sales.
• Review material after-date invoices, credit notes and adjustments and
ensure they are recorded correctly in the relevant financial period.
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Substantive procedures to test the OCCURRENCE of sales

• For a sample of sales transactions recorded in the ledger, vouch the
sales invoice back to customer orders and dispatch documentation.
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The receivables' confirmation 1
• The receivables' confirmation provides third party audit evidence

about amounts outstanding at the year-end.
• It is therefore an excellent source of audit evidence in terms of
sufficiency and appropriateness.
• It provides audit evidence about existence and rights and obligations.
• It does not provide audit evidence about valuation!
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• External confirmations are audit evidence obtained as a direct written

response to the auditor from a third party in paper form or by
electronic or other medium.
• ISA 505 External confirmations
• Confirmation is essentially an act of the client, who alone can
authorise third parties to divulge information to the auditors.
• There are two methods: positive and negative.
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What should the auditor do if the client does not give permission for
receivables' confirmations?
• Inquire about management's refusal to give permission.
• Seek audit evidence about the validity and reasonableness of the
reasons for refusal.
• Evaluate the implications of the refusal on the audit.
• Perform alternative substantive procedures to get audit evidence.
• Communicate with those charged with governance and consider
implications for the auditor's report if the reasons seem unreasonable
or cannot get sufficient, appropriate audit evidence from other
sources.
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Positive confirmation
• A positive confirmation request is one in which the confirming party
responds directly to the auditor indicating whether they agree or
disagree with the information in the request or provides the requested
information.
Negative confirmation
• A negative confirmation request is one in which the confirming
party responds directly to the auditor only if they disagree with the
information in the request.
The positive method is generally preferable.
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The negative method is only used if all of the following apply:

• The risk of material misstatement has been assessed as low.
• The auditor has obtained sufficient appropriate audit evidence on the
operating effectiveness of relevant controls.
• The population consists of a large number of small, homogeneous
account balances.
• A very low exception rate is expected.
• The auditor is not aware of circumstances or conditions that would
cause customers to disregard the requests.
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Points to note about the receivables' confirmation

• The letters are normally prepared by the client's staff on the client's
paper and signed by the client.
• Therefore the auditor must maintain strict control over this process to
mitigate the risk of fraudulent manipulation.
• A copy of the statement is included with the letter.
• Customers must send replies direct to the auditor in a pre-paid
envelope.
• Undelivered items should be returned to the auditor's office, not the
client's office, for follow-up.
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Specimen positive confirmation request letter
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How does the auditor select a sample of receivables for

confirmation?
The following should be included in the sample:
• Old, unpaid accounts

• Accounts written-off during the period under review
• Accounts with credit balances
• Accounts settled by round sum payments
• Accounts with nil balances
• Accounts which have been paid by the date of the examination
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What should the auditor do if a reply is not received?

A non-response is a failure of the confirming party to respond, or fully
respond, to a positive confirmation request, or a confirmation request
returned undelivered.
The auditor can:
• Send an additional confirmation request if a reply has not been
received within a reasonable time.
• Phone the customer (with the client's permission) to request a reply.
The auditor may have to do alternative audit work to gain evidence about
these balances such as reviewing after-date cash, shipping
documentation and sales.
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What happens if the response shows a different amount to that in

the client's records?
An exception is a response that shows a difference between the
information requested to be confirmed, or contained in the entity's
records, and information provided by the confirming party.
The auditor will need to do further work where responses give rise to
exceptions.
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Reasons for exceptions

• Disagreement of balances
• Cut-off issues
• Monies received posted to the wrong account or a cash-in-transit
account
• Netting off balances by customers who are also suppliers
• Fraud (teeming and lading, stealing monies, incorrect postings)
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Question: ABC Co
You have obtained the following results from three receivables

balances selected for external confirmation during the audit of ABC
Co.
Detail the tests you would perform on each of these responses.
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Answer: ABC Co
Customer 1
• The cash in transit should be traced to the cash receipts book post
year-end. I would expect it to be received within a few days of the
year-end.
• I would also trace the cash to the bank paying-in slip. Again, this
should be stamped by the bank post year-end.
Customer 2
• The goods in transit should be traced to a GDN dated prior to the
year-end.
• If inventory records exist the dispatch could be traced to the
records to confirm that it was sent prior to the year-end.
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Answer: ABC Co (cont'd)
Customer 3
• The reason for the dispute and my client's views on it should be
obtained from the correspondence file between Customer 3 and
my client.
• Credit notes post year-end should be scrutinised to determine
whether a credit was given for the disputed goods.
• Cash receipts should be reviewed post year-end to determine
whether Customer 3 paid the full balance.
• If the amount is outstanding at the audit date, discuss
recoverability with the credit controller.
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Sales 1
• Sales and receivables are often tested together.

• Sales are likely to be a material figure in the statement of profit or
loss.
• Completeness and occurrence are key financial statement assertions
for sales.
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Sales 2
• Analytical review is a key substantive procedure when testing the

completeness of sales.
• Compare level of sales, month by month, to previous year.
• Review effect on sales value of changes in quantity sold, prices and
products.
• Review level of goods returned, sales allowances and discounts.
• Efficiency of labour expressed in sales or profit per employee.
• Analyse changes in gross profit margin.
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Exam link
• When asked for substantive procedures to test receivables, make

sure your answer doesn't just talk about the receivables'
confirmation! Other tests also need to be done, such as a review
of after-date cash and analytical procedures.
• Remember, the receivables' confirmation does not provide audit
evidence about the valuation assertion!
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Question: 2014 Specimen Paper (Sec B, Q4b)
Torres Leisure Club Co (Torres) operates a chain of health and
fitness clubs. Its year end was 31 October 20X4. You are the audit
manager and the year-end audit is due to commence shortly. The
following matter has been brought to your attention. Torres's trade
receivables have historically been low, as most members pay
monthly in advance. However, during the year, a number of
companies have taken up group memberships at Torres and hence
the receivables balance is now material. The audit senior has
undertaken a receivables circularisation for the balances at the year
end; however, there are a number who have not responded and a
number of responses with differences.
Required:
Describe substantive procedures you would perform to obtain
sufficient and appropriate audit evidence in relation to Torres's trade
receivables. (6 marks)
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• Send an additional confirmation request if a reply for the non

responses has not been received within a reasonable time.
• Where the customer does not respond to this follow-up, phone the
customer with the client's permission to request a written
response.
• If a reply is still not received, review after date cash receipts to
assess the recoverability of year end balances.
• For exceptions, review the receivables ledger to identify possible
mispostings.
• For balances that are disputed, determine whether they relate to
timing differences or possible errors in Torres' records.
• Agree timing differences (ie cash in transit) to post year-end cash
receipts in the cash book.
• Discuss disputed balances with the finance director to assess
whether any write downs are required.
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Question: June 2015 (Section B, Question 6b)
Hawthorn Enterprises Co (Hawthorn) manufactures and distributes

fashion clothing to retail stores. Its year end was 31 March 2015. You
are the audit manager and the year-end audit is due to commence
shortly. The following matter has been brought to your attention.
Receivables
Hawthorn’s receivables ledger has increased considerably during the
year, and the year-end balance is $2.3 million compared to $1.4
million last year. The finance director of Hawthorn has requested that
a receivables circularisation is not carried out as a number of their
customers complained last year about the inconvenience involved in
responding. The engagement partner has agreed to this request, and
tasked you with identifying alternative procedures to confirm the
existence and valuation of receivables.
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Question: June 2015 (Section B, Q6b) cont'd
Required:
Describe substantive procedures you would perform to obtain
sufficient and appropriate audit evidence in relation to the above.
(5 marks)
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Approach: June 2015 (Section B, Question 6b)
• This question is about what audit work to do if your receivables'

confirmation cannot be carried out.
• We are not looking to perform a receivables’ confirmation, so do
not write down the process for carrying out a receivables'
confirmation in your answer!
• There are five marks available so assume there is one mark for
each well-explained audit procedure.
• You need to both read the requirement carefully AND ensure your
answers apply to the scenario described.
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Answer: December 2012 Question 4b(ii)
Substantive procedures for receivables

• 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.
• Select a significant sample of receivables and review whether
there are any after date cash receipts, ensure that a sample of
slow moving/old receivable balances is also selected.
• 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.
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Answer: December 2012 Question 4b(ii)
Substantive procedures for receivables (cont.)

• Calculate average receivable days and compare this to prior year,
investigate any significant differences.
• Inspect post year-end sales returns/credit notes and consider
whether an additional allowance against receivables is required.
• Select a sample of goods despatched notes (GDN) before and
just after the year end and follow through to the sales ledger to
ensure they are recorded in the correct accounting period.
• Select a sample of year-end receivable balances and agree back
to valid supporting documentation of GDN and sales order to
ensure existence.
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Chapter 15 • Introduction
Cash and bank • Bank

• Cash
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Bank and cash
(i) Bank confirmation reports used in obtaining evidence in relation to
bank and cash
(ii) Other evidence in relation to bank
(iii) Other evidence in relation to cash
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Overview
Bank and cash
Bank confirmation Other evidence

letters • Bank reconciliations
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Introduction 1
What is 'cash' in the financial statements?

Cash-in-hand and cash on deposit in bank accounts.
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Introduction 2
Audit objectives for cash

Financial statement Audit objective
assertion
Existence Recorded cash balances exist at the period-end
Completeness Recorded cash balances include the effects of all
transactions that have occurred
Rights and obligations The entity has legal title to all cash balances shown
at the period-end
Accuracy, valuation and Recorded cash balances are realisable at the
allocation amounts stated
Presentation (classification Disclosures relating to cash are adequate and in
and understandability, accordance with accounting standards and
occurrence and rights and legislation
obligations, accuracy and
valuation, completeness)
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Bank 1
• The year-end bank balance figure is usually confirmed by a direct

confirmation with the bank holding the account.
• This is a third party source of evidence and so provides the auditor
with excellent audit evidence in terms of sufficiency and
appropriateness.
• The bank confirmation covers the assertions of completeness,
existence, rights and obligations and valuation.
• ISA 505 External confirmations
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Bank 2
Approaches to the bank confirmation request

1. Listing balances and other information, and requesting confirmation
of their accuracy and completeness
2. Requesting details of balances and other information, which can
then be compared with the requesting client's records
Auditors need to decide which of these approaches is the most

appropriate. However, responses need to be sought for all confirmation
requests.
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Bank 3
• Control over content and dispatch of confirmation requests is the

auditor's responsibility but…
• The request must be authorised by the client.
• Replies must be sent directly to the auditor so a pre-addressed
envelope should be enclosed.
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Bank 4
Items included in the confirmation request

• Balances due to or from the client on current, deposit, loan and other
accounts
• Nil balances on accounts
• Accounts closed in the 12 months prior to confirmation date
• Maturity and interest terms on loans and overdrafts
• Unused facilities
• Lines of credit/standby facilities
• Any offset or other rights and encumbrances
• Details of any collateral given or received
• Contingent liabilities
• Securities held by the bank
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Bank 5
Bank confirmation procedure

• The banks will require explicit written authority from their client to
disclose the information requested.
• The auditors' request must refer to the client's letter of authority
and the date thereof.
• Alternatively it may be countersigned by the client or it may be
accompanied by a specific letter of authority.
• In the case of joint accounts, letters of authority signed by all
parties will be necessary.
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Bank 6
Bank confirmation procedure continued

• Such letters of authority may either give permission to the bank to
disclose information for a specific request or grant permission for an
indeterminate length of time.
• The request should reach the branch manager at least one month
in advance of the client's year-end and should state both that year-
end and the previous year-end date.
• The auditors should themselves check that the bank response
covers all the information in the standard and other responses.
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Bank 7
Window-dressing
• The bank balance is open to the risk of window-dressing so cut-off
must be audited carefully.
• Management may try to overstate liquidity by keeping the cash book
open to take credit for remittances actually received after the year-end
(overstate cash and understate receivables), or recording cheques
paid in the period which are not actually dispatched until after the
period-end (understate cash and overstate liabilities).
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Bank 8
• The following slides set out audit procedures for bank.

Chapter 10!
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Bank 9
Substantive procedures to test bank

• Obtain standard bank confirmations from each bank with which the
client conducted business during the audit period.
• Re-perform arithmetic of bank reconciliation.
• Trace cheques shown as outstanding from the bank reconciliation
to the cash book prior to the year-end and to the after-date bank
statements and obtain explanations for any large or unusual items not
cleared at the time of the audit.
• Compare cash book(s) and bank statements in detail for the last
month of the year, and match items outstanding at the reconciliation
date to bank statements.
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Bank 10
Substantive procedures to test bank continued

• Review bank reconciliation previous to the year-end bank
reconciliation and test whether all items are cleared in the last period
or taken forward to the year-end bank reconciliation.
• Obtain satisfactory explanations for all items in the cash book for
which there are no corresponding entries in the bank statement and
vice versa by discussion with finance staff.
• Verify contra items appearing in the cash books or bank statements
with original entry.
• Verify by inspecting paying-in slips that uncleared bankings are paid
in prior to the year-end.
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Bank 11

• Examine all lodgements in respect of which payment has been
refused by the bank; ensure that they are cleared on representation or
that other appropriate steps have to be taken to effect recovery of the
amount due.
• Verify balances per the cash book according to the bank reconciliation
by inspecting cash book, bank statements and general ledger.
• Verify the bank balances with reply to standard bank letter and with
the bank statements.
• Inspect the cash book and bank statements before and after the year-
end for exceptional entries or transfers which have a material effect
on the balance shown to be in-hand.
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Bank 12

• Identify whether any accounts are secured on the assets of the
company by discussion with management.
• Consider whether there is a legal right of set-off of overdrafts against
positive bank balances.
• Determine whether the bank accounts are subject to any
restrictions by inquiries with management.
• Review draft accounts to ensure that disclosures for bank are
complete and accurate and in accordance with accounting standards.
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Tackling the exam
• If the exam asks for audit procedures to verify bank balances,

remember that although the bank confirmation letter is important,
there are other procedures that need to be carried out.
• The F8 examining team has previously commented that
candidates lose out on marks for not focusing enough on
procedures other than obtaining the bank confirmation.
• Remember that the bank confirmation letter shows the balance
held by the client at the bank per the bank's records. So this must
be reconciled to the balance on the client's records.
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Cash 1
• Most businesses hold cash. This presents a fraud risk as cash is

easily misappropriated.
• In some types of industry, such as retail, cash held may be a
considerable amount.
• In other businesses, it may be a small amount such as petty cash
floats.
• The best way for the external auditor to audit cash in hand is to carry
out a cash count.
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Cash 2
Cash balances comprise:

• Notes and coins
• Unbanked cheques received
• IOUs
• Credit card slips
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Cash 3
The cash count has three phases:

• Planning
• Count
• Follow-up procedures
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Cash 4
Planning the cash count

• All cash balances should be counted at the same time.
• Need to establish locations where cash is held.
• Need to establish time of count.
• Need to know names of audit staff and client staff attending the
counts.
• Where a location is not visited, it may be appropriate to get a letter
confirming the balance from the client.
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Cash 5
Cash count
• All cash/petty cash books should be written up to date in ink (or
other permanent form) at the time of the count.
• All balances must be counted at the same time.
• All negotiable securities must be available and counted at the time the
cash balances are counted.
• At no time should the auditors be left alone with the cash and
negotiable securities.
• All cash and securities counted must be recorded on working
papers subsequently filed on the current audit file.
• Reconciliations should be prepared where applicable (for example,
imprest petty cash float).
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Cash 6
Substantive procedures to test cash

Cash count
• Count cash balances held and agree to petty cash book or other
record. Count all balances simultaneously and all counting to be done
in the presence of the individuals responsible.
• Enquire into any IOUs or cashed cheques outstanding for a long
period of time.
• Obtain certificates of cash-in-hand from responsible officials.
• Confirm that bank and cash balances as reconciled above are
correctly stated in the financial statements.
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Cash 7
Substantive procedures to test cash continued

Follow-up procedures
• Obtain certificates of cash-in-hand as appropriate.
• Verify unbanked cheques/cash receipts have subsequently been paid
in and agree to the bank reconciliation by inspection of the relevant
documentation.
• Ensure IOUs and cheques cashed for employees have been
reimbursed.
• Review whether IOUs or cashed cheques outstanding for
unreasonable periods of time have been provided for.
• Verify the balances as counted are reflected in the accounts (subject
to any agreed amendments because of shortages and so on) by
inspection of draft financial statements.
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Question: June 2013 Question 1d
Required:
Describe substantive procedures the auditor should perform to
confirm the bank and cash balance of Fox Industries Co at the year
end. (7 marks)
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Approach: June 2013 Question 1d
• There are seven marks available here so assume that there is one
mark awarded per well-explained audit procedure.
• Note that substantive procedures are required so do not mention
tests of controls in your answer!
• You are asked for audit procedures on bank and cash so do not
just focus on the bank balance.
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Answer: June 2013 Question 1d
Bank balance
• Send a bank confirmation request to the bank(s) holding the
current and savings accounts of Fox Industries Co so that the
year-end bank balance can be verified.
• Review the year-end reconciliation of the bank balance per the
general ledger against the bank balance per the bank letter.
• Re-perform the year-end bank reconciliation for each account and
investigate any differences fully.
• Agree the balance per the draft financial statements to the general
ledger and the bank reconciliations.
• Review draft financial statements to confirm that all amounts and
relevant disclosures relating to cash have been correctly stated.
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Answer: June 2013 Question 1d (cont'd)
Bank balance continued

• Trace cheques shown as outstanding from the bank reconciliation
to the cash book prior to the year-end and to the after-date bank
statements and obtain explanations for any large or unusual items
not cleared at the time of the audit.
• Compare cash book(s) and bank statements in detail for the last
month of the year, and match items outstanding at the
reconciliation date to bank statements.
• Obtain satisfactory explanations for all items in the cash book for
which there are no corresponding entries in the bank statement
and vice versa by discussion with finance staff.
• Verify contra items appearing in the cash books or bank
statements with original entry.
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Bank balance continued

• Verify by inspecting paying-in slips that uncleared bankings are
paid in prior to the year-end.
• Verify balances per the cash book according to the bank
reconciliation by inspecting cash book, bank statements and
general ledger.
• Verify the bank balances with the reply to standard bank letter and
with the bank statements.
• Inspect the cash book and bank statements before and after the
year-end for exceptional entries or transfers which have a material
effect on the balance shown to be in-hand.
• Identify whether any accounts are secured on the assets of the
company by discussion with management.
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Cash balance
• Count year-end cash balances and match to cash records such as
the petty cash book.
• Obtain certificates of cash-in-hand from responsible officers.
• Review draft financial statements to confirm that all amounts and
relevant disclosures relating to cash have been correctly stated.
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• Introduction
Chapter 16
• Procedures for trade payables,
Liabilities, capital accruals and expenses
and directors' • Non-current liabilities
emoluments • Provisions and contingencies
• Capital and other issues
• Directors' emoluments
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Syllabus learning outcomes 1
Payables and accruals
(i) Supplier statement reconciliations and direct confirmation of
accounts payable
(ii) Obtain evidence in relation to payables and accruals, and
(iii) Purchases and other expenses
Non-current liabilities, provisions and contingencies

(i) Evidence in relation to non-current liabilities
(ii) Provisions and contingencies
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Share capital, reserves and directors' emoluments
(i) Evidence in relation to share capital, reserves and directors'
emoluments
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Overview
Liabilities, capital and

directors' emoluments
• Payables and • Non-current liabilities • Share capital

accruals • Provisions and • Reserves
• Purchases and contingencies • Directors'
expenses • Finance costs emoluments
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Introduction 1
Audit objectives for liabilities, capital and directors' emoluments
Assertions – All purchase transactions recorded have occurred and relate to the
about classes entity (occurrence)
of – All purchase transactions that should have been recorded have been
transactions recorded (completeness)
and related
– Amounts relating to transactions have been recorded appropriately
disclosures (accuracy, valuation and allocation)
– Purchase transactions have been recorded in the correct period
(cut-off)
– Purchase transactions are recorded properly in the accounts
(classification)
– All disclosed events and transactions relating to liabilities have
occurred and relate to the entity (presentation)
– Financial information is appropriately presented and described and
disclosures clearly expressed (presentation)
– Financial information is disclosed fairly and at appropriate amounts
(presentation)
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Introduction 1 (continued)
Audit objectives for liabilities, capital and directors' emoluments
Assertions – Trade payables and accrued expenses are valid liabilities
about period- (existence)
end account – Trade payables and accrued expenses are the obligations of the
balances and entity (rights and obligations)
related
– All liabilities have been recorded (completeness)
disclosures
– All liabilities are included in the accounts at appropriate amounts
(accuracy, valuation and allocation)
– Financial information is appropriately presented and described and
disclosures clearly expressed (presentation)
– Financial information is disclosed fairly and at appropriate amounts
(presentation)
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Procedures for trade payables, accruals and expenses 1
• Accounts payables are likely to be a material figure in the statement

of financial position.
• When auditing trade payables, accruals and expenses, the auditor
must focus on understatement ie completeness.
• Cut-off testing is therefore a key audit test.
• Purchases are often tested in conjunction with trade payables.
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Substantive procedures to test COMPLETENESS

• Obtain a listing of trade accounts payables and agree the total to the
general ledger by casting and cross-casting.
• Test for unrecorded liabilities by inquiries of management on how
unrecorded liabilities and accruals are identified and examining post
year-end transactions.
• Obtain selected suppliers' statements and reconcile these to the
relevant suppliers' accounts.
• Examine files of unmatched purchase orders and supplier invoices for
any unrecorded liabilities.
• Perform a confirmation of accounts payables for a sample.
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Substantive procedures to test COMPLETENESS continued

relevant to liabilities have been made.
• Compare the current year balances for trade accounts payables and
accruals to the previous year.
• Compare the amounts owed to a sample of individual suppliers in the
trade accounts payable listing to amounts owed to these suppliers in
the previous year.
• Compare the payables' turnover and payables' days to the previous
year and industry data.
• Reperform casts of payroll records to confirm completeness and
accuracy.
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Substantive procedures to test COMPLETENESS continued

• Confirm payment of net pay per payroll records to cheque or bank
transfer summary.
• Agree net pay per cashbook to payroll.
• Inspect payroll for unusual items and investigate them further by
discussion with management.
• Perform proof-in-total (analytical procedures) on payroll and compare
to figure in draft financial statements to assess reasonableness.
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Substantive procedures to test EXISTENCE

• Vouch selected amounts from the trade accounts payables listing and
accruals listing to supporting documentation such as purchase orders
and suppliers' invoices.
• Obtain selected suppliers' statements and reconcile these to the
relevant suppliers' accounts.
• Perform a confirmation of accounts payables for a sample.
• Perform analytical procedures comparing current year balances to the
previous year to confirm reasonableness, and also calculating
payables' turnover and comparing to the previous year.
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Substantive procedures to test RIGHTS AND OBLIGATIONS

• Vouch a sample of balances to supporting documentation such as
purchase orders and suppliers' invoices to obtain audit evidence
regarding rights and obligations.
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Substantive procedures to test ACCURACY, VALUATION AND ALLOCATION

• Trace selected samples from the trade accounts payables' listing and
accruals listing to the supporting documentation (purchase orders, minutes
authorising expenditure, suppliers' invoices etc).
• Obtain selected suppliers' statements and reconcile these to the relevant
suppliers' accounts.
• For a sample of accruals, recalculate the amount of the accrual to ensure
the amount accrued is correct.
• Compare the current year balances for trade accounts payables and accruals
to the previous year.
• Compare the amounts owed to a sample of individual suppliers in the trade
accounts payables' listing to amounts owed to these suppliers in the previous
year.
• Compare the payables' turnover and payables' days to the previous year
and industry data.
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Substantive procedures to test ACCURACY, VALUATION AND

• Recalculate the mathematical accuracy of a sample of suppliers'
invoices to confirm the amounts are correct.
• Recast calculation of remuneration.
• Re-perform calculation of statutory deductions to confirm whether
correct.
• Confirm validity of other deductions by agreeing to supporting
documentation.
• Recast calculation of other deductions.
• Read disclosure notes to ensure information is accurate and properly
presented at the appropriate amounts.
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Substantive procedures to test CUT-OFF

• For a sample of vouchers, compare the dates with the dates they
were recorded in the ledger for application of correct cut-off.
• Test transactions around the year-end to determine whether amounts
have been recognised in the correct financial period.
• Perform analytical procedures on purchase returns, comparing the
purchase returns as a % of sales or cost of sales to the previous year.
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Substantive procedures to test OCCURRENCE

• For a sample of vouchers, inspect supporting documentation such as
authorised purchase orders.
• Agree individual remuneration per payroll to personnel records,
records of hours worked, salary agreements etc.
• Confirm existence of employees on payroll by meeting them,
attending wages payout, inspecting personnel and tax records, and
confirmation from managers.
• Agree benefits on payroll to supporting correspondence.
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Substantive procedures to test CLASSIFICATION AND

UNDERSTANDABILITY
• Review the trade accounts payables listing to identify any large debits
(which should be reclassified as receivables or deposits) or long-term
liabilities which should be disclosed separately.
• Read the disclosure notes relevant to liabilities in the draft financial
statements and review for understandability.
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Substantive procedures to test PURCHASES AND OTHER

EXPENSES
• Inspect a sample of purchase invoices to ensure they agree to the
amount posted to the general ledger.
• Compare expenses making up administrative expenses to the prior
year charge and to expectations on a line-by-line basis. Investigate
any differences from expectations.
• Inquire of management whether there are any unsettled claims or
obligations arising before the year-end and ensure these are provided
for.
• Recalculate accruals and prepayments to gain evidence that other
expenses are not over or understated.
• Compare gross profit margin with the previous year, the gross margin
per the budget and expectations. Investigate any unexpected
fluctuations.
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Substantive procedures to test WAGES COST

• Reconcile the gross costs on the payroll to the wages cost in the
financial statements.
• Re-perform casts of payroll records to confirm completeness and
accuracy of costs used as a basis for the journals to the accounts.
• Confirm payment of net pay per payroll records to cheque or bank
transfer summary.
• Inspect payroll for unusual items and investigate them further by
discussion with management.
• Perform proof-in-total (analytical procedures) on payroll by multiplying
estimated average wage (last year's figures x expected increases) by
average number of employees.
• Re-perform calculations of statutory deductions to establish whether
valid deductions have been included in the payroll expense.
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The suppliers' confirmation

• If the client's internal controls are weak, suppliers' statements may not
be available so a suppliers' confirmation may be undertaken
• This provides evidence of completeness
• Where internal controls are good, the confirmation will focus on large
balances
• Where internal controls are weak, the confirmation will focus on
regular suppliers with small/zero balances, other accounts, and large
balances
• Positive confirmation (blank or zero-balance confirmation)
• Does not state balance owed – the supplier has to fill the amount in
and return it, with a detailed statement of the account
• Amount must be reconciled with entity's records
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Exam link
• Trade payables and accruals are likely to be tested in a question

on audit evidence, asking for substantive audit procedures to
cover specific assertions
• This area has been tested on a regular basis, including in June
2014
• Remember the key point about audit procedures – they need to
be precise and test for the financial statement assertion asked for
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Non-current liabilities 1
Examples of non-current liabilities

• Debentures
• Loan inventory
• Loans repayable > 1 year after year-end
Key financial statement assertions

• Completeness
• Accuracy
• Classification and understandability
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Substantive procedures
• Obtain/prepare schedule of loans outstanding at the year-end date
showing, for each loan: name of lender, date of loan, maturity
date, interest date, interest rate, balance at the end of the period and
security.
• Compare opening balances to previous year's papers.
• Test the clerical accuracy of the analysis.
• Compare balances to the general ledger.
• Agree name of lender etc to register of debenture holders or
equivalent (if kept).
• Trace additions and repayments to entries in the cash book.
• Confirm repayments are in accordance with loan agreement.
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Substantive procedures continued

• Examine cancelled cheques and memoranda of satisfaction for loans
repaid.
• Verify that borrowing limits imposed by agreements are not exceeded.
• Examine signed Board minutes relating to new borrowings and
repayments.
• Obtain direct confirmation from lenders of the amounts outstanding,
accrued interest and what security they hold.
• Verify interest charged for the period is in accordance with statements
and supporting agreements, and consistent with known interest rates.
Consider the adequacy of accrued interest.
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Substantive procedures continued

• Confirm assets charged have been entered in the register of charges
and notified to the Registrar.
• Review restrictive covenants and provisions relating to default: review
any correspondence relating to the loan, review confirmation replies
for non-compliance, if a default appears to exist determine its effect
and schedule findings.
• Review minutes, cash book to confirm that all loans have been
recorded.
• Review draft accounts to ensure that disclosures for non-current
liabilities are correct and in accordance with accounting standards.
Any elements repayable within one year should be classified under
current liabilities.
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Provisions and contingencies 1
• Provisions and contingencies involve the judgement of management,

which makes them difficult to audit.
• You need to use your financial reporting knowledge from Paper F3
regarding IAS 37 Provisions, contingent liabilities and contingent
assets.
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• Examples of contingencies
— Guarantees
— Discounted bills of exchange
— Uncalled liabilities on shares or loan inventory
— Lawsuits or claims pending
— Options to purchase assets
• ISA 501 Audit evidence – specific considerations for selected items
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Audit procedures to identify possible litigations and claims

• Make appropriate inquiries of management and others including in-
house legal advisers.
• Review minutes of meetings of those charged with governance and
correspondence between the entity and its external legal advisers.
• Review legal expense accounts.
• Use any information obtained regarding the entity's business including
information obtained from discussions with any in-house legal
department.
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Audit procedures when litigations and claims have been identified

• Seek direct confirmation with lawyers through a letter of inquiry
• Letter of inquiry: general inquiry or specific inquiry
• Prepared by management and sent by auditor
• Lawyer to communicate directly with the auditor
• Written representations also required from management regarding
litigations and claims
• In certain circumstances, auditors may have to meet with lawyers
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For each material provision:

• Determine whether the company has a present obligation as a result
of a past event at the year end date.
• Determine whether it is probable that an outflow of resources will be
required to settle the obligation.
• Determine whether provisions represent the best estimate of liability.
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Audit procedures to test provisions

• Obtain details of all provisions which have been included in the
accounts and all contingencies that have been disclosed.
• Obtain a detailed analysis of all provisions showing opening balances,
movements and closing balances.
• Determine for each material provision whether the company has a
present obligation as a result of past events by review of
correspondence relating to the item and discussion with directors.
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Audit procedures to test provisions continued

• Determine for each material provision whether it is probable that a
transfer of economic benefits will be required to settle the obligation
by:
— Checking whether any payments have been made in the post
year-end period by reviewing after-date cash
— Review of correspondence with solicitors, banks, customers,
insurance company and suppliers both pre and post year-end
— Sending a letter to the solicitor to obtain his views (where
relevant)
— Discussing the position of similar past provisions with the directors
— Considering the likelihood of reimbursement
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Audit procedures to test provisions continued

• Recalculate all provisions made.
• Compare the amount provided with any post year-
end payments and with any amount paid in the past for similar items.
• In the event that it is not possible to estimate the amount of the
provision, check that a contingent liability is disclosed in the accounts.
• Consider the nature of the client's business. Would you expect to see
any other provisions eg warranties?
• Consider the adequacy of disclosure of provisions, contingent assets
and contingent liabilities in accordance with IAS 37.
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Exam link: Provisions and contingencies
• F8 students are often confused between contingent liabilities and
provisions so it is best to revisit your F3 notes in this area to clarify
the difference between the two.
• The best way to prepare is to first make sure you are comfortable
with the accounting side and then to practise past exam/exam-
standard questions where this topic is tested.
• Past exam questions on this area can be found in recent exam
sittings: December 2011 (Q1d, Q5b), June 2012 (Q4b), December
2012 (Q4b) and the 2014 and 2016 Specimen Exams.
• The 2014 Specimen Exam used the same scenario as the 2016
Specimen Exam. It is the 2014 version of the question – a Section
B written requirement – that we will look at now.
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Question: 2014 Specimen Paper (Sec B, Question 2b)
Balotelli Beach Hotel Co (Balotelli) operates a hotel providing

accommodation, leisure facilities and restaurants. Its year end was
31 October 20X4. You are the audit senior of Mario & Co and are
currently preparing the audit programmes for the year end audit of
Balotelli. You are reviewing the notes of last week's meeting between
the audit manager and finance director where two material issues
were discussed.
Food poisoning
Balotelli's directors received correspondence in September from a
group of customers who attended a wedding at the hotel. They have
alleged that they suffered severe food poisoning from food eaten at
the hotel and are claiming substantial damages. Balotelli's lawyers
have received the claim and believe that the lawsuit against the
company is unlikely to be successful.
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Question: 2014 Specimen Paper (Sec B, Q2b) cont'd
Required:
Describe substantive procedures to obtain sufficient and appropriate
audit evidence in relation to the above issue. (4 marks)
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Answer: 2014 Specimen Paper (Sec B, Question 2b)
• Review correspondence regarding the claim for damages to

assess whether the view of the claim being unsuccessful is
reasonable.
• Review the post year end period to confirm whether any payments
regarding the claim have been made.
• Contact Balotelli's lawyers, with the client's permission, to obtain
their view as to the success of the claim.
• Review the board minutes for evidence of the directors'
expectations of the claim's outcome.
• Obtain a written representation from Balotelli's directors confirming
management's view that the claim is unlikely to be successful.
• Review the financial statements to ensure that adequate
disclosure has been made of the issue as a contingent liability if
provision is not required.
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Capital and other issues
• The main area of concern with share capital and reserves is

compliance with law.
• Audit work will focus on share equity capital, the issue of shares, the
transfer of shares, dividends and reserves.
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Directors' emoluments 1
What are directors' emoluments?

• Salaries
• Fees
• Bonuses
• Pension contributions and retirement benefits
• Non-cash benefits
• Compensation for loss of office
Directors' emoluments are material by nature!
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Why are directors' emoluments important?

IAS 24 Related party disclosures is not in this syllabus, but it is useful to
look at its requirements here.
• IAS 24 requires that compensation payments to key management
personnel be disclosed
• Key management will include the board of directors
• Compensation includes items such as wages, paid annual leave,
profit-sharing, bonuses plus post-employment and long-term benefits
such as pensions and termination benefits
The auditor must ensure that the requirements of International
Accounting Standards and local legislation are met.
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Audit plan to test directors' emoluments

• For each director, obtain a schedule of emoluments for the year, split
between wages, bonuses, benefits, pension contributions and other
emoluments.
• Recast the addition of the schedule and ensure the totals are in
agreement with the disclosure in the financial statements.
• Ask each individual director to confirm the emoluments listed are
complete and in line with their expectations.
• Compare the emoluments with both the previous year's emoluments
and with expectations, taking into account the knowledge obtained
during the audit (for example if you know a director has left during
the year, is there any compensation for loss of office expected?).
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Audit plan to test directors' emoluments continued

• Agree salaries, fees, bonuses and pension contributions to payroll
records for the individual directors and check the amounts paid on the
bank statements agree with the payroll records.
• Review the directors' contracts and ensure emoluments are
consistent with the terms of these contracts.
• Review board meeting minutes and meetings of any remuneration
committee for evidence of any bonuses, fees or other emoluments not
disclosed.
• Review the cash book for any unusual transactions which suggest
undisclosed directors emoluments.
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Audit plan to test directors' emoluments continued

• Obtain and review returns to tax authorities made on behalf of the
directors by the company which detail non-cash benefits. Ensure
these are consistent with the benefits disclosed in the financial
statements.
• Consider the adequacy of disclosure of directors' emoluments in
accordance with applicable accounting standards and local
legislation, including the separate disclosure of amounts due to or
from directors in respect of directors' emoluments.
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Question: Directors' emoluments
You are responsible for auditing the directors' emoluments of ABC Co

and have been provided with the information below.
Termination Incentive
Salary Bonuses payments payments Total
$ $ $ $ $
Director A 120,000 90,000 – – 210,000
Director B 80,000 50,000 – – 130,000
Director C 50,000 5,000 15,000 – 70,000
Director D 20,000 5,000 – 10,000 35,000
270,000 150,000 15,000 10,000 445,000
State what audit tests you would perform.
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Answer: Directors' emoluments
Salary:
• Vouch salary amounts to monthly payroll records and bank statements to
ensure the amounts are accurate.
• For Directors C and D, obtain their leaving/start dates from the HR
department and vouch this to board meeting minutes. Recalculate their
salaries on a pro-rata basis to ensure they are accurately recorded.
Bonuses:
• Vouch the level of bonuses awarded to board meeting minutes, payroll
records and bank statements to ensure they have been authorised and
are accurately recorded.
• Discuss with management the reasons why Director C was awarded a
bonus despite leaving the company during the year. Support any
explanations with written documentation where possible (for example
Director C's contract).
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Answer: Directors' emoluments (cont'd)
Termination payments/incentive payments:

• Review the employment contracts for Directors C and D to verify
that there is a clause outlining that these payments are applicable.
• Vouch the level of these payments to board meeting minutes,
payroll records and bank statements.
General:
• Re-cast the schedule to ensure the note is accurate.
• Review the disclosure to ensure that it is in accordance with
applicable law and accounting standards.
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Chapter 17 • Objectives of not-for-profit
organisations
Not-for-profit
• Audit planning
organisations
• Audit evidence
• Audit reporting
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• Apply audit techniques to not-for-profit organisations.
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Overview
Not-for-profit organisations
Types of not-for-profit
organisations
Comparison with audit of Application of audit

for-profit organisations techniques
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Objectives of not-for-profit organisations 1
• Firstly, what are not-for-profit organisations?

• The first thing that springs to mind is charities
• However, there are many other kinds of not-for-profit organisations
• Charities, clubs, schools, hospitals etc
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Let's look now at the objectives of some key not-for-profit organisations.
Charities
To carry out the charitable purpose
Schools
To provide education
Hospitals
To provide healthcare
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Real World Example: Oxfam
Oxfam is an international confederation of 17 organisations that are

networked together in more than 90 countries.
Its objective is to build a future free from the injustice of poverty.
www.oxfam.org
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Real World Example: Cedars-Sinai hospital 1
Cedars-Sinai hospital in Los Angeles, USA, is one of the most

famous hospitals in the world.
It is the largest non-profit academic medical centre in the western
USA.
Let's look at its mission statement in the next two slides.
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'Cedars-Sinai Health System, a non-profit, independent healthcare

organisation, is committed to:
• Leadership and excellence in delivering quality healthcare
services
• Expanding the horizons of medical knowledge through biomedical
research
• Educating and training physicians and other healthcare
professionals
• Striving to improve the health status of our community'
from www.cedars-sinai.edu
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'Quality patient care is our priority. Providing excellent clinical and

service quality, offering compassionate care, and supporting research
and medical education are essential to our mission. This mission is
founded in the ethical and cultural precepts of the Judaic tradition,
which inspires devotion to the art and science of healing, and to the
care we give to our patients and staff.'
from www.cedars-sinai.edu
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Exam link
Question 4 of the December 2010 exam was a scenario question

based around a hospital.
Students were asked to identify strengths in the hospital's operating
environment, before making recommendations about how further
improvements might be made to provide value for money.
In questions like these it is vital that you spot clues given in the
scenario about what is important to the organisation.
This question also shows that you need to be able to link different
areas of the syllabus – in this instance applying your knowledge of
value for money and internal control in the context of a not-for-profit
organisation that is funded by taxpayers.
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• Many not-for-profit organisations are legislated for

• The acts which relate to them may specify how they report their
results
• Not-for-profit organisations may be:
— Companies
— Co-operatives
— Industrial or provident societies
— Trusts
— Clubs
— Associations
— Government departments
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• In the UK, there are SORPs (Statements of Recommended Practice)

in place for some entities such as charities and local authorities
• These supplement accounting standards and other legal requirements
• Different countries may have similar guidance in place for not-for-
profit organisations
• Let's look at the UK charities SORP in more detail…
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UK SORP Accounting and Reporting by Charities

• A statement of financial activities (SOFA) that shows all resources
made available to the charity and all expenditure incurred, and
reconciles all changes in its funds
• Where the charity is required to prepare accounts in accordance with
the Companies Act, or similar legislation, or where the governing
instrument so requires, a summary income and expenditure account
(in addition to the SOFA) in certain circumstances
• A balance sheet (the equivalent of a statement of financial position)
that shows the assets, liabilities and funds of the charity
• A cash flow statement, where required by accounting standards
• Notes
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An audit of a not-for-profit organisation may differ from a for-profit audit

due to:
• Its objectives and the impact on operations and reporting
• The purpose for which an audit is required
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When carrying out an audit of a not-for-profit organisation, the auditor

must establish:
• Whether a statutory audit is required
• If a statutory audit it not required, what the objectives of the
engagement are
• What the engagement is to report on
• To whom the report should be addressed
• What form the report should take
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Audit planning 1
When planning the audit of a not-for-profit organisation, the auditor

should consider the following factors:
• The scope of the audit
• Recent recommendations of the regulatory bodies
• The acceptability of accounting policies adopted
• Changes in circumstances in the sector in which the organisation
operates
• Past experience of the effectiveness of the organisation's accounting
system
• Key audit areas
• The amount of detail included in the financial statements on which
the auditors are required to report
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Audit planning 2
Audit risk
Let's look at some of the audit risks that might be relevant to the audit of
a not-for-profit organisation.
We will consider inherent risk and control risk.
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Audit planning 3
Inherent risk
• Complexity and extent of regulation
• Significance of donations and cash receipts
• Difficulties in establishing ownership and timing of voluntary income
where funds are raised by non-controlled bodies
• Lack of predictable income or precisely identifiable relationship
between expenditure and income
• Uncertainty of future income
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Audit planning 4
Inherent risks that may be relevant to charities

• Restrictions imposed by the objectives and powers given by charities'
governing documents
• Importance of restricted funds
• Extent and nature of trading activities must be compatible with
charitable status
• Complexity of tax rules
• Sensitivity of certain key statistics, eg proportion of resources used in
administration
• Need to maintain adequate resources for future expenditure while
avoiding the build up of reserves which could appear excessive
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Audit planning 5
Control risk
• Amount of time committed by directors/trustees to the organisation's
affairs
• Skills and qualifications of directors/trustees
• Frequency and regularity of board/trustee meetings
• Form and content of board/trustee meetings
• Independence of trustees from each other
• Division of duties between management/trustees
• Degree of involvement in the organisation's transactions by individual
directors/trustees
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Audit planning 6
Control risk continued

• Segregation of duties
• Supervision by management/trustees of activities of staff where
segregation of duties is not practical
• Competence, training and qualifications of paid staff and volunteers
• Board/trustee involvement in recruitment, appointment and
supervision of senior executives
• Access of trustees to independent professional advice where
necessary
• Budgetary controls
• Communication of results to board/trustees on a regular basis
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Audit planning 7
Internal controls over cash – collection boxes and tins

• Numerical control over collection boxes and tins
• Sealing of boxes and tins so that any opening prior to counting is
apparent
• Regular collection and recording of proceeds from collection boxes
and tins
• Dual control over counting and recording of proceeds
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Audit planning 8
Internal controls over cash – postal receipts

• Unopened mail kept securely
• Dual control over mail opening
• Immediate recording of donations on opening of mail or receipt
• Agreement of bank paying-in slips to record of receipts by an
independent person
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Audit planning 9
Internal controls over cash – deeds of covenant

• Regular checks and follow-up procedures to ensure due amounts are
received
• Regular checks to ensure all tax repayments have been obtained
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Audit planning 10
Internal controls over cash – legacies

• Comprehensive correspondence files maintained for each legacy
• Regular reports and follow-up procedures for outstanding legacies
Internal controls over cash – donations-in-kind

Separation of recording, storage and sale of inventory (charity shops)
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Audit planning 11
Internal controls over other income – fundraising activities

• Records maintained for each fundraising event
• Other appropriate controls over receipts
• Controls maintained over expenses as for administrative expenses
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Audit planning 12
Internal controls over other income – central and local government

grants and loans
• Regular checks that all sources of income or funds are fully utilised
and appropriate claims made
• Ensuring income or funds are correctly applied by adequate
monitoring
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Audit planning 13
Internal controls over use of resources – restricted funds

• Separate records maintained of relevant income, expenditure and
assets
• Terms controlling application of funds
• Oversight of application of fund monies by independent personnel or
trustees
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Audit planning 14
Internal controls over use of resources – grants to beneficiaries

• Records maintained of requests for material grants received and their
treatment
• Appropriate checks made on applications and applicants for grants,
and that amounts paid are in accordance with legislation
• Records maintained of all grant decisions, checking that proper
authority exists, that adequate documentation is presented to
decision-making meetings, and that any conflicts of interest are
recorded
• Controls to ensure grants made are properly spent by the recipient for
the specified purpose
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Question: Paws for Thought
Paws for Thought is a local charity whose objectives are to provide

care for lost and stray dogs and to eventually find them good homes.
The charity houses the dogs in a purpose-built kennel building which
also includes the administrative office and a vet.
The charity relies on donations from the public and runs three charity
shops in the area, which are overseen by one manager (who divides
her time between the three shops and the administrative offices). The
shop staff consist entirely of volunteers.
Each shop contains a collection box by the till. These are usually left
in the shop overnight but occasionally the manager takes them home
where she counts the cash collected in them.
The manager often does not have time to bank the cash takings from
the shops on a daily basis so she takes these home too as the shops
do not have safes.
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Question: Paws for Thought (cont'd)
The director of the charity is the vet who looks after the dogs. As she
is very busy tending to the dogs, she has little time to spend on
administrative activities and tends to delegate this to the one
administrative assistant employed and the shop manager.
Recently, the vet has been talking to an accountant friend of her's
who suggested that she ought to take a greater interest in the
financial side of the charity as there may be scope to improve how
the charity is run.
Imagine that you are the external auditor of Paws for Thought. What
audit risks can you identify from this scenario?
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Approach: Paws for Thought
If this were an exam question, the best approach would be to go

through the scenario line-by-line to identify the risk factors and then
explain how these would affect the financial statements.
Here are some ideas:
• Lack of segregation of duties
• Lack of supervision and monitoring of activities by director
• Poor controls over collection boxes
• Poor controls over cash takings in shops
• Shops have predominantly volunteer staff
• Too much control given to one member of staff (manager)
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Audit evidence 1
• There are special considerations for the audit of not-for-profit

organisations, especially where there are informal arrangements in
place.
• Obtaining sufficient, appropriate audit evidence may be an issue for
auditors.
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Audit evidence 2
The auditor must be alert to the following:

• Understatement or incompleteness of the recording of all income
including gifts in kind, cash donations and legacies
• Overstatement of cash grants or expenses
• Misanalysis or misuse in the application of funds, including the misuse
of taxpayers funds if the entity is government funded
• Misstatement or omission of assets including donated properties and
investments
• The existence of restricted or uncontrollable funds in foreign or
independent branches
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Audit evidence 3
Completeness of income issues

• Loss of income through fraud
• Recognition of government funding
• Recognition of income from professional fund raisers
• Recognition of income from branches, associates or subsidiaries
• Income from informal fundraising groups
• Income from grants
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Audit evidence 4
Issues to consider during overall review

• Appropriateness of accounting policies
• Consistent application of accounting policies
• Disclosure of accounting policies
• Do the financial statements present fairly the state of affairs and
results for the period under review?
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Audit evidence 5
Particular issues to consider during overall review

• Disclosure of income from fundraising activities (net or gross)
• Accounting for income and expenses (cash or accruals)
• Capitalisation of expenditure on non-current assets
• Apportionment of administrative expenses
• Recognition of income from donations and legacies
• Whether the going concern basis is appropriate
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Audit reporting 1
• For not-for profit organisations that require a statutory auditor's report,

auditors should issue an auditor's report in accordance with ISA 700
Forming an opinion and reporting on financial statements.
• We look at standard auditor's reports in detail in Chapter 19.
• There may be additional statutory reporting requirements for not-for-
profit organisations.
• If a not-for-profit organisation is having an audit for the benefit of its
members or trustees, or the organisation is government-funded or
heavily regulated, the standard auditor's report may not be applicable.
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Audit reporting 2
The following issues need to be included:

• The addressees of the report
• What the report relates to
• The scope of the engagement
• The respective responsibilities of auditors and management/trustees/
directors
• The work done
• The opinion drawn
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Tackling the exam 1
• The audit of not-for-profit organisations can be tested in both

Section A and Section B.
• Do not panic if presented with a client that is a charity or a hospital
or other not-for-profit organisation.
• Use the clues in the scenario to help you plan your answer.
• Remember that not-for-profit organisations will have their own
particular issues in relation to auditing.
• Remember also that the issues relating to the audit of small
entities might also apply to the audit of not-for-profit organisations.
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Tackling the exam 2
• The following articles from Student Accountant on not-for-profit

organisations may be useful and can be accessed via the ACCA's
website:
http://www.accaglobal.com/content/dam/acca/global/PDF-
students/2012s/3244839_09.pdf
http://www.accaglobal.com/content/dam/acca/global/pdf/sa_oct09
_souster.pdf
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Chapter 18 • Subsequent events
Audit review and • Going concern
finalisation • Written representations

• Overall review of financial
statements
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• Explain the purpose of a subsequent events review.

• Explain the responsibilities of auditors regarding subsequent events.
• Discuss the procedures to be undertaken in performing a subsequent
events review.
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• Define and discuss the significance of the concept of going concern.

• Explain the importance of and the need for going concern reviews.
• Explain the respective responsibilities of auditors and management
regarding going concern.
• Identify and explain potential indicators that an entity is not a going
concern.
• Discuss the procedures to be applied in performing going concern
reviews.
• Discuss the disclosure requirements in relation to going concern
issues.
• Discuss the reporting implications of the findings of going concern
reviews.
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• Explain the purpose of and procedure for obtaining written

representations.
• Discuss the quality and reliability of written representations as audit
evidence.
• Discuss the circumstances where written representations are
necessary and the matters on which representations are commonly
obtained.
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• Discuss the importance of the overall review of evidence obtained.

• Describe the procedures an auditor should perform in conducting their
overall review of financial statements.
• Explain the significance of uncorrected misstatements.
• Evaluate the effect of dealing with uncorrected misstatements.
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Overview
Overall review of evidence
Audit review and

finalisation
Uncorrected misstatements
Written
Subsequent events Going concern
representations
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Subsequent events 1
Subsequent events are events occurring between the date of the

financial statements and the date of the auditor's report, and facts that
become known to the auditor after the date of the auditor's report.
Two types
• Adjusting events: events that provide evidence of conditions that
existed at the year-end date
• Non-adjusting events: events that are indicative of conditions that
arose after the year-end date
ISA 560 Subsequent events

IAS 10 Events after the reporting period
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Subsequent events 2
Examples of adjusting and non-adjusting events
Adjusting events Non-adjusting events

Settlement of a court case Dividends declared after the year-end
Sales of inventory after year-end Fire causing destruction of major
providing evidence of its NRV at year- plant
end
Fraud or error showing the financial Announcement of a major
statements are incorrect restructuring
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Subsequent events 3
Between the year-end and the date of the auditor's report

The auditor must obtain sufficient appropriate audit evidence that all
events up to the date of the auditor's report that require adjustment or
disclosure have been identified.
Audit evidence
• Inquiries of management
• Inspection of board meeting minutes and latest interim financial
statements
• Review of procedures to identify subsequent events
• Inquiries with client's lawyers re litigation claims
• Written representations
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Subsequent events 4
Between the date of the auditor's report and issue of financial

statements
No obligation to perform procedures BUT if become aware of a fact that
would have caused an amendment to the auditor's report if it had been
known at the date of the auditor's report:
• Discuss matter with management and those charged with governance
• Determine whether financial statements need amending
• If amendment required, discuss with management how they intend to
address the matter in the financial statements
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Subsequent events 5
If amendment is required:
Management make the amendment Management do not make the

amendment
• Perform necessary audit • Modify the opinion (if auditor's
procedures on the changes. report not yet provided) and then
• Extend audit procedures for provide the auditor's report.
identifying subsequent events to • Notify management and those
the date of new auditor's report. charged with governance not to
• Provide a new auditor's report. issue the financial statements (if
auditor's report already provided).
• If financial statements issued, take
action to seek to prevent reliance
on the auditor's report.
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Subsequent events 6
Facts discovered after the financial statements have been issued

No obligations to perform procedures BUT if become aware of a fact that
would have caused an amendment to the auditor's report if it had been
known at the date of the auditor's report:
• Discuss matter with management and those charged with governance
• Determine whether financial statements need amending
• If amendment required, discuss with management how they intend to
address the matter in the financial statements
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Subsequent events 7
If amendment is required:
Management make the amendment Management do not make the

amendment
• Perform necessary audit • Notify management and those
procedures on the changes. charged with governance that the
• Review procedures to ensure that auditor will seek to prevent future
anyone in receipt of previously reliance on the auditor's report.
issued financial statements is • If still no progress, take action to
informed. seek to prevent reliance on the
• Issue a new auditor's report with auditor's report.
an explanatory paragraph.
• Extend audit procedures to date of
new auditor's report.
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Subsequent events 8
Summary
Audit field work
Year Auditor's F/S AGM

end report issued
date issued
Active duty Passive duty
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Exam link
• Subsequent events are likely to be tested in a question on the

auditor's report in the context of two or three mini scenarios.
• However, you could also be tested on your knowledge skills with a
question in section A.
• The following article from Student Accountant (April 2011) is
recommended reading on subsequent events:
students/2012s/sa_apr11_f8_subs_events.pdf
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Question: 2016 Specimen Paper (Sec A, Question 12)
Cannavaro.com is a website design company whose year end was

31 December 20X4. The audit is almost complete and the financial
statements are due to be signed shortly. Profit before tax for the year
is $3.8 million and revenue is $11.2 million.
The company has only required an audit for the last two years and
the board of directors has asked your firm to provide more detail in
relation to the form and content of the auditor’s report.
During the audit it has come to light that a key customer, Pirlo Co,
with a receivables balance at the year end of $285,000, has just
notified Cannavaro.com that they are experiencing cash flow
difficulties and so are unable to make any payments for the
foreseeable future. The finance director has notified the audit team
that he will write this balance off as an irrecoverable debt in the 20X5
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The audit assistant assigned to the audit of Cannavaro.com wants a

better understanding of the effect subsequent events have on the
audit and has made the following statements:
(1)All material subsequent events require the numbers in the
financial statements to be adjusted
(2)A non-adjusting event is a subsequent event for which NO
amendments to the current year financial statements are required
(3)The auditor’s responsibilities for subsequent events which occur
prior to the audit report being signed are different from their
responsibilities after the audit report has been issued
(4)The auditor should request a written representation confirming that
all relevant subsequent events have been disclosed
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Which of the statements above in relation to subsequent events

are true?
A 1 and 3
B 2, 3 and 4
C 1, 2 and 4
D 3 and 4
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Statement 1 is false as not all subsequent events will require an

adjustment to the numbers within the financial statements.
IAS 10 Events after the Reporting Period makes a distinction
between an adjusting and non-adjusting event. Only material
adjusting events would require an amendment to the figures within
the financial statements.
Statement 2 is false as while a non-adjusting event would not require
a change to the numbers within the financial statements, IAS 10 may
require a disclosure to be made. If the non-adjusting event is
material, non-disclosure could still result in a modification to the audit
report.
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Statement 3 is true as the auditor is required to carry out procedures

up to the date of the audit report to gain sufficient appropriate audit
evidence that all relevant subsequent events have been identified
and dealt with appropriately. After the audit report is issued, the
auditor does not need to actively look for subsequent events but is
only required to respond to subsequent events which they become
aware of.
Statement 4 is true as ISA 560 Subsequent Events requires the
auditor to obtain written confirmation from management/those
charged with governance that all subsequent events have been
identified and dealt with in accordance with the appropriate reporting
framework.
D is therefore correct.
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Question: June 2013 Question 5b
Panda Co manufactures chemicals and has a factory and four offsite

storage locations for finished goods. Panda Co's year end was 30
April 20X3. The final audit is almost complete and the financial
statements and audit report are due to be signed next week.
Revenue for the year is $55 million and profit before taxation is $5.6
million.
The following two events have occurred subsequent to the year end.
No amendments or disclosures have been made in the financial
statements.
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Question: June 2013 Question 5b (cont'd)
Event 1 – Defective chemicals

Panda Co undertakes extensive quality control checks prior to
despatch of any chemicals. Testing on 3 May 20X3 found that a batch
of chemicals produced in April was defective. The cost of this batch
was $0.85 million. In its current condition it can be sold at a scrap
value of $0.1 million. The costs of correcting the defect are too
significant for Panda Co's management to consider this an alternative
option.
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Event 2 – Explosion
An explosion occurred at the smallest of the four offsite storage
locations on 20 May 20X3. This resulted in some damage to
inventory and property, plant and equipment. Panda Co's
management have investigated the cause of the explosion and
believe that they are unlikely to be able to claim on their insurance.
Management of Panda Co has estimated that the value of damaged
inventory and property, plant and equipment was $0.9 million and it
now has no scrap value.
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Required:
For each of the two events above:
(i) Explain whether the financial statements require amendment.
(ii) Describe audit procedures that should be performed in order to
form a conclusion on any required amendment.
(12 marks)
Note. The total marks will be split equally between each event.
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Approach: June 2013 Question 5b
• There are 12 marks available in total, so six for each event.

Assuming that parts (i) and (ii) are also equally weighted, there will
be three marks for a discussion on whether the financial
statements need amending and three marks on audit procedures.
• You are provided with figures for revenue and profit before tax –
you MUST use them in assessing whether the events are material
or not!
• The first thing to do is consider whether the event is an adjusting
event or a non-adjusting event, so you need to use your financial
reporting knowledge from F3 here.
• Then look at whether it is material or not.
• In part (ii), remember that where you are asked for audit
procedures, they must be sufficiently detailed and avoid
vagueness, otherwise you will not be awarded any/full marks.
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Answer: June 2013 Question 5b
Event 1 – Defective Chemicals

A batch of chemicals produced before the year-end, costing $0.85m
to produce, has been found to be defective after the year-end. Its
scrap value is $0.1m. Inventory should be valued at the lower of cost
and net realisable value in accordance with IAS 2 Inventories. This is
an adjusting event in accordance with IAS 10 Events after the
reporting period. As it stands, the inventory is overstated by $0.75m.
This represents 13.4% of profit before tax and 1.4% of revenue and is
therefore material to the financial statements.
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Answer: June 2013 Question 5b (cont'd)
Audit procedures to be performed:

• Obtain a schedule to confirm the cost value of the defective batch
of $0.85m and documentary proof of the scrap value of $0.1m.
• Discuss with management whether this is the only defective batch
or whether there are likely to be other batches affected.
• Review quality control reports to assess the likelihood of other
batches being affected and discuss results of testing with technical
team members at Panda.
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Event 2 – Explosion
The amount of inventory and property, plant and equipment damaged
is estimated to be $0.9m. It has no scrap value. Inventory and
property, plant and equipment are therefore overstated by $0.9m.
This represents 16.1% of profit before tax and 1.6% of revenue, and
is therefore material. The explosion represents a non-adjusting event
in accordance with IAS 10 Events after the reporting period. It
therefore does not require adjustment in the financial statements but
should be disclosed as it is material.
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Audit procedures to be performed:

• Obtain a schedule of the inventory and property, plant and
equipment damaged in the explosion to verify the value of $0.9m.
• Visit the site where the explosion took place to assess damage.
• Discuss with directors the need to make disclosure in the financial
statements and review any draft disclosure note drafted.
• Inspect insurance agreement to assess whether any claim can be
made on the insurance.
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Going concern 1
• Financial statements should be prepared on a going concern basis

unless management either intends to liquidate the entity or has no
realistic alternative but to do so.
• Going concern means the entity is viewed as continuing in business
for the foreseeable future.
• If the going concern basis is not appropriate the financial statements
must be prepared on a break-up basis.
• ISA 570 Going concern
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Going concern 2
Financial indicators of going concern problems
Negative operating Substantial sales of

cash flows non-current assets
Net liabilities
Borrowing facilities not Financial Inability to pay

agreed creditors when due
Arrears or
Adverse key financial Operating losses discontinuance of
ratios Change from credit to dividends
cash-on-delivery with
suppliers
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Going concern 3
Operating indicators of going concern problems

Management
intentions to liquidate
or cease operating
Loss of key Labour difficulties
staff without
replacement Highly successful
Operating
competitor
Loss of major market,

key customers, licence Shortages of important
or suppliers Excessive supplies
dependence on a few
product lines
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Going concern 4
Other indicators of going concern problems
Uninsured or underinsured catastrophes
Other
Non-compliance with Changes in legislation

regulations
Pending legal proceedings
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Going concern 5
Management's responsibility re going concern

• To make an assessment of the entity's ability to continue as a going
concern, which should cover 12 months from the reporting date
Auditor's responsibility re going concern

• To obtain sufficient appropriate audit evidence regarding the
appropriateness of management's use of the going concern
assumption
• To conclude whether a material uncertainty exists related to events or
conditions that may cast significant doubt on the entity's ability to
continue as a going concern
• To determine the implications for the auditor's report
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Going concern 6
Audit procedures relating to going concern

• Analyse and discuss cash flow, profit and other relevant forecasts with
management.
• Analyse and discuss the entity's latest available interim financial
statements (or management accounts).
• Review the terms of debentures and loan agreements and determine
whether they have been breached.
• Read minutes of the meetings of shareholders, the board of directors
and important committees for reference to financing difficulties.
• Inquire of the entity's lawyer regarding litigation and claims.
• Confirm the existence, legality and enforceability of arrangements to
provide or maintain financial support with related third parties.
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Going concern 7
Audit procedures relating to going concern continued

• Assess the financial ability of such parties to provide additional funds.
• Consider the entity's position concerning unfulfilled customer orders.
• Review events after the period-end for items affecting the entity's
ability to continue as a going concern.
• Confirm the existence, terms and adequacy of borrowing facilities.
• Obtain and review reports of regulatory actions.
• Determine the adequacy of support for any planned disposals of
assets.
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Going concern 8
Impact on the auditor's report

• The auditor's work on going concern is very important as there can be
a significant impact on the auditor's report.
• We will look at audit reporting in more detail in Chapter 19.
• The next slide provides a summary table of how the auditor's report
can be affected by issues relating to going concern.
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Going concern 9
Summary of impact on auditor's report

Scenario Impact on auditor's report
Going concern assumption Unmodified opinion with Material

appropriate but material uncertainty Uncertainty Related to Going Concern
which is adequately disclosed paragraph
Going concern assumption Modified opinion (qualified opinion or
appropriate but material uncertainty adverse opinion)
which is not adequately disclosed
Use of going concern assumption Modified opinion (adverse opinion)
inappropriate
Management unwilling to make or Modified opinion (qualified opinion or

extend its assessment disclaimer of opinion)
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Tackling the exam
Students often find the reporting aspect of going concern a confusing

area. The September 2012 edition of Student Accountant has an
excellent article on going concern and how this can be examined in
paper F8:
students/2012s/sa_sept12_f8_goingconcern.pdf
However, note that ISA 570 has been revised recently, changing the
audit reporting requirements. The article stated that where the going
concern assumption is appropriate but there is a material uncertainty
which is adequately disclosed, the matter should be described in an
emphasis of matter paragraph. This should now be described in a
separate section of the auditor’s report, headed material uncertainty
related to going concern.
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Question: Going concern
The following issues have arisen during two of your firm's audits:
(i) The directors of Difficult Times Co have prepared the financial
statements on the going concern basis but the auditor does not
believe that the company is a going concern. The directors refuse
to amend the financial statements.
(ii) The directors of Trading's Hard Co have made the appropriate
disclosures relating to material uncertainties related to going
concern in the financial statements. The auditor has a significant
level of concern regarding the going concern basis but is happy
with the disclosure and does not disagree with the use of the
going concern basis.
Describe the impact on the auditor's report for each company.
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Answer: Going concern
(i) The directors of Difficult Times Co have prepared the financial

statements on the going concern basis but the auditors do not
feel that this is appropriate.
This is certainly material and likely to be material and pervasive
as going concern is fundamental to the basis on which the
financial statements are prepared.
An adverse opinion would therefore be required.
A basis for adverse opinion paragraph would need to be included
explaining the material misstatement in relation to the
inappropriate use of the going concern basis and the effect on
the financial statements.
The opinion paragraph would show an adverse opinion stating
that the financial statements do not present fairly – due to
material misstatement.
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Answer: Going concern (cont'd)
(ii) The directors of Trading's Hard Co have made appropriate

disclosures of material uncertainties related to going concern in
the financial statements and the auditor is happy with this
disclosure.
The audit opinion will therefore be unmodified.
Significant concern still exists however and so, due to the
importance of the issue, the auditor will include a material
uncertainty related to going concern.
This section must contain a clear reference to the disclosures in
the financial statements and state that the auditor's opinion is not
modified in respect of this matter.
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Exam link
• Going concern is likely to be tested as part of a mini-scenario

question in Section A.
• You might also be presented with a Section B question on audit
risk where the information in the scenario suggests that the
company may not be able to continue as a going concern (for
example, because of high operating costs, increased borrowing
sought etc).
• Question 5 of the June 2010 exam and the June 2012 exam are
excellent questions to practise as they cover knowledge,
indicators of going concern problems, audit procedures and the
auditor's report.
• The following question from the 2014 Specimen Exam does not
conform to the current exam style, but it is still good practice.
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You are the audit senior of Holtby & Co and are planning the audit of
Walters Co (Walters) for the year ended 31 December 20X4. The
company produces printers and has been a client of your firm for two
years; your audit manager has already had a planning meeting with
the finance director. He has provided you with the following notes of
his meeting and financial statement extracts.
Walter's management were disappointed with the 20X3 results and
so in 20X4 undertook a number of strategies to improve the trading
results. This included the introduction of a generous sales-related
bonus scheme for their salesmen and a high profile advertising
campaign. In addition, as market conditions are difficult for their
customers, they have extended the credit period given to them.
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The finance director of Walters has reviewed the inventory valuation

policy and has included additional overheads incurred this year as he
considers them to be production related.
The finance director has calculated a few key ratios for Walters; the
gross profit margin has increased from 44.4% to 52.2% and
receivables days have increased from 61 days to 71 days. He is
happy with the 20X4 results and feels that they are a good reflection
of the improved trading levels.
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Financial statement extracts for the year ended 31 December

DRAFT ACTUAL
20X4 20X3
$m $m
Revenue 23.0 18.0
Cost of sales (11.0) (10.0)
Gross profit 12.0 8.0
Operating expenses (7.5) (4.0)
Profit before interest and taxation 4.5 4.0
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Financial statement extracts for the year ended 31 December

DRAFT ACTUAL
20X4 20X3
$m $m
Inventory 2.1 1.6
Receivables 4.5 3.0
Cash - 2.3
Trade payables 1.6 1.2
Overdraft 0.9 -
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Required:
Describe the procedures that the auditor of Walters Co should
perform in assessing whether or not the company is a going concern.
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• Analyse cash flow forecasts prepared by Walters Co and assess whether

assumptions used in their preparation appear reasonable.
• Analyse post-year end sales and order book to assess the
reasonableness of the revenue figures in the cash flow forecast.
• Compare post year end management accounts to the cash flow forecast.
• Review current overdraft agreements to ensure covenants have not been
breached.
• Perform audit procedures in respect of subsequent events to identify
matters that might affect the going concern assumption.
• Make inquiries with Walters Co's lawyers regarding any on-going or
potential litigation claims against the company.
• Inspect board minutes to identify potential issues that may impact on the
company's ability to continue as a going concern.
• Obtain a written representation from management regarding the
company's ability to continue as a going concern.
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Written representations 1
Written representations are written statements by management

provided to the auditor to confirm certain matters or to support other audit
evidence.
ISA 580 Written representations
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Written representations about management's responsibilities

• Management has fulfilled its responsibility for the preparation and
presentation of the financial statements as set out in the terms of the
audit engagement and whether the financial statements are prepared
and presented in accordance with the applicable financial reporting
framework.
• Management has provided the auditor with all relevant information
agreed in the terms of the audit engagement and that all transactions
have been recorded and are reflected in the financial statements.
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Other written representations

• Whether the selection and application of accounting policies are
appropriate
• Plans or intentions that may affect the carrying value or classification
of assets and liabilities
• Liabilities, both actual and contingent
• Title to, or control over, assets, liens or encumbrances on assets and
assets pledged as collateral
• Aspects of laws, regulations and contractual agreements that may
affect the financial statements, including non-compliance
• All deficiencies in internal control that management is aware of have
been communicated to the auditor
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Other representations continued

• Written representations about specific assertions in the financial
statements
• Significant assumptions used in making accounting estimates are
reasonable
• All subsequent events requiring adjustment or disclosure have been
adjusted or disclosed
• The effects of uncorrected misstatements are immaterial, both
individually and in aggregate
• Management has disclosed the results of management's assessment
of the risk that the financial statements may be materially misstated
as a result of fraud
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Other representations continued

• Management has disclosed all information in relation to fraud or
suspected fraud involving management, employees with significant
roles in internal control, and others where fraud could have a material
effect on the financial statements
• Management has disclosed all information in relation to allegations of
fraud or suspected fraud communicated by employees, former
employees, analysts, regulators or others
• Management has disclosed all instances of non-compliance or
suspected non-compliance with laws or regulations
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Remember!
• Written representations on their own do not provide sufficient
appropriate audit evidence
• Written representations support other audit evidence
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Main elements of a representation letter from management

• Addressed to the auditors
• Contains specified information
• Appropriately dated
• Approved by those with specific knowledge
• Signed by senior financial officer
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Exam link
• Written representations could be tested as part of a mini-scenario

question in Section A
• Don't forget also that in evidence and risk questions, you might
suggest obtaining written representations from management
regarding specific issues
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Overall review of financial statements 1
• Auditors must carry out an overall review of the draft financial

statements using analytical procedures.
• ISA 520 Analytical procedures
• A senior member of the audit team must do this.
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Analytical review should cover:

• Important accounting ratios
• Related items
• Changes in products/customers
• Price and mix changes
• Wages changes
• Variances
• Trends in production and sales
• Changes in material and labour content of production
• Other expenditure in the statement of profit or loss
• Variations caused by industry or economy factors
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Treatment of misstatements
A misstatement is 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. It can arise from error or fraud.
An uncorrected misstatement is a misstatement accumulated during
the audit by the auditor which has not been corrected.
ISA 450 Evaluation of misstatements identified during the audit
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Misstatements
• Factual misstatements
• Judgemental misstatements
• Projected misstatements
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• All misstatements accumulated during the audit (unless clearly trivial)

must be communicated to management on a timely basis with a
request to correct them.
• The auditor must consider whether the aggregate of uncorrected
misstatements is material.
• Uncorrected misstatements and their effect must be communicated to
those charged with governance, with material uncorrected
misstatements being identified individually. A request must be made
for correction.
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Exam link
• Overall review is likely to be tested in the context of an auditor's

report question in Section A.
• The 2016 Specimen Exam tested the overall review of financial
statements in two objective test questions linked to a mini-
scenario, for a total of 4 marks.
• Remember, if a misstatement is immaterial, you must state that it
should be added to the schedule of uncorrected misstatements as
per the requirements of ISA 450.
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Question: 2016 Specimen Paper (Sec A, Q13 and 14)
Cannavaro.com is a website design company whose year end was

31 December 20X4. The audit is almost complete and the financial
statements are due to be signed shortly. Profit before tax for the year
is $3 8 million and revenue is $11 2 million.
The company has only required an audit for the last two years and
the board of directors has asked your firm to provide more detail in
relation to the form and content of the auditor’s report.
During the audit it has come to light that a key customer, Pirlo Co,
with a receivables balance at the year end of $285,000, has just
notified Cannavaro.com that they are experiencing cash flow
difficulties and so are unable to make any payments for the
foreseeable future. The finance director has notified the audit team
that he will write this balance off as an irrecoverable debt in the 20X5
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Question: 2016 Specimen Paper (Sec A, Q13)
13 The audit engagement partner has asked you to make an initial

assessment of the materiality of the issue with the outstanding
receivables balance with Pirlo Co and to consider the overall impact
on the financial statements.
Which of the following correctly summarises the effect of the
outstanding balance with Pirlo Co?
Material Financial statement impact
A No Revenue is overstated
B No Gross profit is understated
C Yes Profit is overstated
D Yes Going concern principle is in doubt
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C
The outstanding balance with Pirlo Co is likely to be irrecoverable as
the customer is experiencing financial difficulties.
The balance is material at 7 4% of profit before tax and 2 5% of
revenue.
Currently profit and assets are overstated by $285,000. Therefore the
correct option is C.
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The audit engagement partner requires you to perform additional procedures

in order to conclude on the level of any adjustment needed in relation to the
outstanding balance with Pirlo Co.
Which TWO of the following audit procedures should be performed to
form a conclusion as to whether the financial statements require
amendment?
(1) Discuss with management the reasons for not amending the financial
statements
(2) Review the cash book post year end for receipts from Pirlo Co
(3) Send a request to Pirlo Co to confirm the outstanding balance
(4) Agree the outstanding balance to invoices and sales orders
A 1 and 2
B 1 and 4
C 2 and 3
D 2 and 4
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A
Writing to the customer/agreeing to invoices, while valid procedures
during the audit to verify the existence of an outstanding balance,
would not allow the auditor to assess the recoverability of the balance
which is the key issue in determining whether an adjustment is
required. Therefore options 3 and 4 are incorrect.
Post year-end cash testing is the best way for the auditor to assess if
the balance is recoverable wholly or in part and therefore the cash
book should be reviewed for any receipts which will change the
assessment of the debt after the year end. The issue should also be
discussed with management to understand their reasons for not
wanting to amend the financial statements as this may be due to a
change in circumstances.
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Chapter 19 • The auditor's report on financial
statements
Reports
• Reports to management
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• Identify and describe the basic elements contained in the auditor's

report.
• Explain unmodified audit opinions in the auditor's report.
• Explain modified audit opinions in the auditor's report.
• Describe the format and content of emphasis of matter and other
matter paragraphs.
• Discuss the requirements and methods of reporting significant
deficiencies in internal control to management and those charged with
governance.
• Explain, in a format suitable for inclusion in a report to management,
significant deficiencies within an internal control system and provide
recommendations for overcoming these deficiencies to management.
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Overview
Opening balances and

Reports
comparatives
Auditor's reports
Standard report Changes to the

'unmodified opinion' audit reports
Unmodified opinions with Modified on matters that do

additional communication affect the auditor's opinion
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Overview continued
Unmodified opinions with Modified on matters that do

additional communication affect the auditor's opinion
Emphasis of Key Other

Material
matter Audit Matters matter
uncertainty
paragraph paragraph
related to
'Without
going concern
qualifying
paragraph
our opinion
…' Insufficient or inappropriate Material
(Eg 6) audit evidence misstatement
Material but Material and Material but Material and

not pervasive pervasive not pervasive pervasive
Qualified Disclaimer Qualified Adverse
'except for' of opinion 'except for' '…do not give
(Eg 4) 'do not express (Eg 2) a true and fair
an opinion' view'
(Eg 5) (Eg 3)
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The auditor's report on financial statements 1
• At the end of the external audit, the auditor produces a report which
sets out the opinion on the truth and fairness of the financial
statements.
• Are the financial statements prepared, in all material respects, in
accordance with the applicable financial reporting framework?
• ISA 700 Forming an opinion and reporting on financial statements
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Unmodified opinions
An unmodified opinion is the opinion expressed by the auditor when the
auditor concludes that the financial statements are prepared, in all
material respects, in accordance with the applicable financial reporting
framework.
This is good!
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Unmodified opinions
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 ended in accordance with International
Financial Reporting Standards.
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Basic elements of the auditor's report

• Title
• Addressee
• Opinion paragraph
• Basis for opinion
• Key audit matters paragraph (where relevant)
• Material uncertainty related to going concern paragraph (where
relevant)
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Basic elements of the auditor's report continued

• Other information paragraph
• Responsibilities for the financial statements
• Auditor's responsibility
• Other reporting responsibilities
• Auditor's signature
• Date of the auditor's report
• Auditor's address
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New elements of the auditor’s report

• Material uncertainty related to going concern (see Chapter 18)
• Key audit matters
− For listed entity audits and other audits where ISA 701 applies
− Describes matters of most significance in the audit of the financial
statements of the current period
− The aim is to enhance users’ understanding of the audit process
• Other information
− Describes other information obtained during the audit
− Clarifies that the audit opinion does not cover other information
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New elements of the auditor’s report continued

• Emphasis of matter paragraph
− Draws users’ attention to matters which are fundamental to
understanding the financial statements
− Must not be a matter that is covered in the Going concern or Key
audit matters paragraphs
New structure for reporting the audit opinion: the Opinion

paragraph comes before the Basis for Opinion!
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• The next few slides are going to discuss situations where the opinion
is not modified (ie the financial statements show a true and fair view)
BUT the report itself is modified.
• This can be because the report includes an emphasis of matter
paragraph or an other matter paragraph.
• ISA 706 Emphasis of matter paragraphs and other matter paragraphs
in the independent auditor's report
• It is important that you understand that although an opinion may be
unmodified, the report will be modified by the inclusion of an
emphasis of matter paragraph or other matter paragraph.
• So you can have a modified report with a modified opinion or you can
have a modified report but an unmodified opinion (due to an emphasis
of matter paragraph or an other matter paragraph).
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Emphasis of matter paragraphs

Refers to a matter appropriately presented or disclosed in the financial
statements that, in the auditor's judgement, is of such importance that it
is fundamental to users' understanding of the financial statements.
Examples
• Uncertainty relating to future outcome of exceptional litigation or
regulatory action
• Early application of a new accounting standard that has a pervasive
effect on the financial statements
• Major catastrophe that has had/continues to have a significant effect
on the entity's financial position
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What is the content of an emphasis of matter paragraph?

• Comes either before or after Key Audit Matters
• Clear reference to matter being emphasised
• Location of relevant disclosures in the financial statements
• Must state that the auditor's opinion is not modified in respect of the
matter being emphasised
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Example emphasis of matter paragraph
Emphasis of Matter
We draw attention to Note X to the financial statements which describes
the uncertainty related to the outcome of the lawsuit filed against the
company by XYZ Company. Our opinion is not qualified in respect of this
matter.
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Other matter paragraphs

Refers to a matter other than those presented or disclosed in the
financial statements that, in the auditor's judgement, is relevant to users'
understanding of the audit, the auditor's responsibilities or the auditor's
report.
Example
• Prior period financial statements not audited
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What is the content of an other matter paragraph?

• Describes other matter not presented and disclosed in the financial
statements that is relevant to users' understanding of the audit, the
auditor's responsibilities or the auditor's report
• Does not include information that the auditor is prohibited from
providing by law and regulations or other standards, or information
required to be provided by management
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Certain ISAs contain requirements for emphasis of matter or other matter

paragraphs in specific circumstances.
Emphasis of matter paragraph Other matter paragraph

ISA 210 Agreeing the terms of audit ISA 560 Subsequent events
engagements
ISA 560 Subsequent events ISA 710 Comparative information –
corresponding figures and comparative
financial statements
ISA 800 (outside the scope of F8)
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Exam link 1
• Emphasis of matter paragraphs and other matter paragraphs

seem to be a difficult area for students.
• Remember that there are specific circumstances when these
paragraphs are used.
• Students tend to suggest they need to be used when they are not
appropriate at all!
• Emphasis of matter paragraphs and other matter paragraphs
could be examined in section A as an objective test question
linked to a mini-scenario, as seen in the 2016 specimen paper.
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Modified audit opinions 1
• But what happens if the auditor cannot issue an unmodified opinion

on the financial statements?
• That is, the auditor cannot say that the financial statements, present
fairly, in all material respects …?
• In this case, the auditor has to issue a modified opinion on the
• This is not good!
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Types of modified opinions

• ISA 705 Modifications to the opinion in the independent auditor's
report
• Three possible types of modified opinion:
— Qualified opinion
— Adverse opinion
— Disclaimer of opinion
• How does the auditor know which type of modified opinion to use?
Let's find out…
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The type of modified opinion depends on:

• The nature of the matter giving rise to the modification (material
misstatement or lack of sufficient, appropriate audit evidence)
• The auditor's judgement about the pervasiveness of the
effects/possible effects of the matter on the financial statements
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But first we need to understand what pervasiveness is.

Pervasiveness describes the effects/possible effects on the financial
statements of misstatements or undetected misstatements (due to an
inability to obtain sufficient appropriate audit evidence).
Three types:
1. Those that are not confined to specific elements, accounts or items
in the financial statements
2. 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
3. Those that relate to disclosures which are fundamental to users'
understanding of the financial statements
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A modified opinion is required when:

• The auditor concludes that the financial statements as a whole are
not free from material misstatements or
• The auditor cannot obtain sufficient appropriate audit evidence to
conclude that the financial statements as a whole are free from
material misstatement.
It is very important that you understand this. The following slides

show examples of the different types of modified opinion.
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Qualified opinion due to material misstatement
Qualified Opinion
In our opinion, except for the effects of the matter described in the Basis
for 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.
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Qualified opinion due to material misstatement continued

Basis for qualified opinion
The company's inventories are carried in the statement of financial
position at xxx. Management has not stated inventories at the lower of
cost and net realisable 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 realisable value, an amount of
xxx would have been required to write the inventories down to their net
realisable 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.
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Adverse opinion due to material misstatement with a pervasive

effect
Adverse Opinion
In our opinion, because of the significance of the matter discussed in the
Basis for Adverse Opinion paragraph, the financial statements do not
present fairly (or do not 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.
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Adverse opinion due to material misstatement with a pervasive

effect continued
Basis for adverse opinion
The company has included houses built for re-sale (including related
land) at a cost of $X as non-current assets and depreciated them at a
rate of X%, resulting in depreciation of $X. Under International Financial
Reporting Standards, these should have been included as inventory in
the financial statements and no depreciation should have been provided
in respect of these. The carrying value of the houses represent 90% of
the company's total assets and the company's records indicate that
…[explanation of the effect on amounts presented in the financial
statements].
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Qualified opinion due to inability to obtain sufficient appropriate

audit evidence
Qualified Opinion
In our opinion, except for the possible effects of the matter described in
the Basis for 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.
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Qualified opinion due to inability to obtain sufficient appropriate

audit evidence continued
Basis for Qualified Opinion
With respect to inventory having a carrying amount of $X the audit
evidence available to us was limited because we did not observe
physical inventory as at 31 December 20X1, since that date was prior to
our appointment as auditor of the company. Owing to the nature of the
company's records, we were unable to obtain sufficient appropriate audit
evidence regarding the inventory quantities by using other audit
procedures.
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Disclaimer of opinion due to inability to obtain sufficient

appropriate audit evidence about multiple elements of the financial
statements continued
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.
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Disclaimer of opinion due to inability to obtain sufficient

appropriate audit evidence about multiple elements of the financial
statements continued
Basis for Disclaimer of Opinion
We were not appointed as auditors of the company until after December
31, 20X1 and thus did not observe the counting of physical inventories at
the beginning and end of the year. We were unable to satisfy ourselves
by alternative means concerning the inventory quantities held at
December 31, 20X0 and 20X1 which are stated in the statement of
financial position at xxx and xxx, respectively. In addition, the introduction
of a new computerised accounts receivable system in September 20X1
resulted in numerous errors in accounts receivable.
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Summary table
Nature of circumstances Material but not pervasive Material and pervasive
Financial statement QUALIFIED ADVERSE OPINION

are materially OPINION
misstated
Auditor unable to QUALIFIED DISCLAIMER
obtain sufficient OPINION OPINION
appropriate audit
evidence
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Question: Modified opinions
Consider the following three situations and decide whether a

modified opinion is required or not. If you decide a modified opinion is
necessary, explain what sort of modified opinion would be most
appropriate.
Additional information
Net assets: $250,000
Revenue: $455,000
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Question: Modified opinions (cont'd)
Situation 1
A major customer has gone bankrupt shortly after the year-end. At
the year-end, $25,500 was owing from this customer but the directors
will not amend the financial statements as a result of the customer
becoming bankrupt.
Situation 2
An accrual worth $1,560, representing an amount due to a new
supplier, has been omitted from the year-end statement of financial
position in error. No other errors on accruals or trade payables have
been found.
Situation 3
A small fire at head office has resulted in the loss of some records,
most of which relate to inventory. Inventory is one of the biggest
figures in the statement of financial position at year-end.
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Approach: Modified opinions
You have been provided with some information about net assets and
revenue in this question. You must use it to assess whether the
issues in the question are material or not as this will directly impact
the effect on the auditor's opinion.
In an exam question, if you are provided with figures for net
assets/revenue/profit before tax etc, you must ensure you use them –
it is not enough to say that something is material without comparing it
to the information you have been given in the question.
The first thing to do, therefore, is a quick calculation to see whether
the issue is material or not.
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Answer: Modified opinions
Situation 1: Major customer going bankrupt

1. A major customer going bankrupt after the year-end is indicative
of an adjusting event. In this case, it would seem unlikely that the
balance owing will be recovered.
2. $25,500 represents 10.2% of net assets and 5.6% of revenue so
it is a material amount.
3. As the directors are refusing to amend the financial statements,
this would constitute a material misstatement as they should
write the balance off.
4. The impact on the auditor's opinion would therefore be a
qualified opinion ('except for') due to material misstatement.
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Answer: Modified opinions (cont'd)
Situation 2: Accrual omitted

1. An accrual worth $1,560 has been omitted from the accruals
balance on the statement of financial position but no other errors
have been found by the auditor, suggesting this is a one-off.
2. $1,560 represents 0.62% of net assets and 0.34% of revenue so
it is clearly not material.
3. Although the amount is not material, it should be added to the
schedule of uncorrected misstatements which in total, may
represent a material amount which may lead to the financial
statements requiring amendment.
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Answer: Modified opinions (cont'd)
Situation 3: Fire destroying inventory records

1. A fire has destroyed inventory records and inventory is a material
balance.
2. Unless the auditors can obtain the evidence relating to the
destroyed records from elsewhere, it is likely that this will have an
impact on the auditor's opinion.
3. The auditor's opinion will probably be modified due to the inability
to obtain sufficient appropriate audit evidence. Without further
information, we cannot say whether the opinion will be qualified
('except for') or a disclaimer of opinion.
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Exam link 1
• Auditor's reports are a common source of confusion for students.

• However, they are highly likely to be tested as this is a key
syllabus area.
• The current F8 examining team has examined auditor's reports in
every sitting so far.
• The best way to improve your confidence in this area is to practise
as many past exam questions or exam-standard questions as you
can.
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[Please refer to slide 968 for the full question scenario]
The finance director has asked you to outline the appropriate audit opinions which
will be provided depending on whether the company decides to amend or not
amend the 20X4 financial statements for the issue identified regarding the
recoverability of the balance with Pirlo Co.
Which of the following options correctly summarises the audit opinions
which will be issued depending on whether or not the 20X4 financial
statements are amended?
Financial statements amended Financial statements not amended
A Unmodified Unmodified with emphasis of matter
B Unmodified with emphasis of matter Qualified ‘except for’
C Unmodified Adverse
D Unmodified Qualified ‘except for’
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The debt with Pirlo Co should be provided for and is material to the
financial statements at 7 4% of profit before tax and 2 5% of revenue.
This represents a material misstatement which is material but not
pervasive. As such, if no adjustment is made the auditor will be
required to provide a qualified ‘except for’ opinion. If the required
change is made, then no material misstatement exists and therefore
the auditor will be able to issue an unmodified opinion.
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Other information 1
We now look at other information in documents containing audited

ISA 720 The auditor's responsibilities relating to other information in
documents containing audited financial statements
Other information is financial and non-financial information, other than
the financial statements and the auditor's report, which is included, either
by law, regulation or custom, in a document containing audited financial
statements.
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Other information 2
Examples of other information

• A report by management or those charged with governance on
operations
• Financial summaries or highlights
• Employment data
• Planned capital expenditures
• Financial ratios
• Names of officers and directors
• Selected quarterly data
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Other information 3
So what are the auditor's responsibilities for other information?

They must read the other information to identify any material
misstatements.
A misstatement of the other information exists when the other
information is incorrectly stated or otherwise misleading (including
because it omits or obscures information necessary for a proper
understanding of a matter disclosed in the other information).
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Other information 4
Material inconsistency found
Amendment required in Action to take if management refuses

Financial statements • Modified opinion
Other information • Communicate to those charged with
governance and
• Include an Other information paragraph
in the auditor’s report OR
• Withhold auditor's report OR
• Withdraw from engagement
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Other information 5
Material misstatement found in other information
Initial actions to take Action to take if management refuses

to amend other information
• Discuss with management • Inform those charged with
• If still relevant, ask governance
management to consult an • Appropriate further action eg
independent third party (eg consulting auditor's lawyer
lawyer) and consider advice
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The auditor's report on financial statements
Implied information
• Adequate accounting records have been kept.
• The accounts agree with the records.
• The auditors have received all necessary information.
• All directors' transactions have been disclosed.
• The directors' report is consistent with the accounts.
The expectations gap

The difference between the apparent public perceptions of the
responsibilities of auditors on the one hand and the legal and
professional reality on the other
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You are the audit manager of Villa & Co and you are currently
reviewing the audit files for several of your clients for which the audit
fieldwork is complete. The audit seniors have raised the following
issues:
Czech Co
Czech Co is a pharmaceutical company and has incurred research
expenditure of $2.1m and development expenditure of $3.2m during
the year, this has all been capitalised as an intangible asset. Profit
before tax is $26.3m.
Dawson Co
Dawson Co's computerised wages program is backed up daily,
however for a period of two months the wages records and the back-
ups have been corrupted, and therefore cannot be accessed. Wages
and salaries for these two months are $1.1m. Profit before tax is
$10m.
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Required:
For each of the clients above:
(i) Discuss the issue, including an assessment of whether it is
material; and (4 marks)
(ii) Describe the impact on the audit report if the issue remains
unresolved. (4 marks)
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Approach: 2014 Specimen Paper (Sec B, Q3b)
This style of written question will no longer come up in your F8

exams. However, it offers good applied knowledge practice.
When asked about the impact of an issue on the auditor’s report,
make sure you always calculate and discuss materiality.
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Czech Co
IAS 38 Intangible Assets states that research expenditure must
always be expensed. Development expenditure can only be
capitalised if it meets certain criteria.
Czech has incorrectly capitalised $2.1m of research expenditure.
This represents 7.9% of profit before tax and is therefore material.
The development costs capitalised of $3.2m represent 12.2% of profit
before tax and are also material. If these do not meet the criteria for
capitalisation, they should be expensed.
If the directors refuse to expense the research costs, the auditor's
opinion will be modified with a qualified opinion as the issue is
material but not pervasive. This will also apply if the development
costs have been incorrectly capitalised.
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Answer: 2014 Specimen Exam (Sec B, Q3b) cont'd
Dawson Co
The wages costs of $1.1m for the two months in question represent
11% of profit before tax and are therefore material.
The auditors should seek alternative audit procedures to verify the
wage costs for the two months.
If the auditors cannot obtain sufficient appropriate audit evidence for
the wages cost then the audit opinion will be qualified 'except for' as
this is a material but not pervasive issue.
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Reports to management 1
• The report to management is a by-product of the external audit.

• It may also be known as a management letter or letter on internal
control.
• The purpose of a report to management is to set out significant
deficiencies in internal control, the implications of those deficiencies,
and possible recommendations to mitigate the deficiencies.
• A report to management may be sent after both the interim audit and
the final audit visits.
• Such reports are for internal use and are not in the public domain.
• ISA 265 Communicating deficiencies in internal control to those
charged with governance and management
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Reports to management 2
Drafting the report to management

• Do not include language which conflicts with the opinion in the
auditor's report.
• State the accounting and internal control system were considered
only to the extent necessary to determine auditing procedures to
report on the financial statements, and not to determine the adequacy
of internal control for management purposes or to provide assurances
on the accounting and internal control system.
• State it discusses only deficiencies in internal control which have
come to the auditor's attention as a result of the audit and that other
deficiencies in internal control may exist.
• Include a statement that the report is provided for use only by
management (or another specific named party).
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Exam link 1
• Questions on the report to management are highly likely to come

up in a scenario context and we looked at these in detail in
Chapter 10.
• In such questions, do not include a covering letter unless you are
specifically asked for one.
• Always set your answer out in a tabular format so that you can link
the deficiencies with the implications and suggested
recommendations.
• Reports to management could also be tested in a knowledge-
based requirement on reporting to those charged with
governance, focussing on ISAs 260 and 265.
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Exam link 2
If you are asked for a covering letter, make sure it includes:

• An address and date
• A short introduction explaining the purpose and content of the
report to management
• A closing paragraph that states the report only sets out those
significant deficiencies identified during the audit and that more
extensive procedures on internal control may have resulted in
more deficiencies being identified
• A statement that the report is solely for management's use
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Copyright notice
All rights reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted, in any form or by any means,
electronic, mechanical, photocopying, recording or otherwise, without the prior written permission of BPP Learning Media Ltd.
The contents of these slides are intended as a guide and not professional advice. Although every effort has been made to ensure that the contents
of this book are correct at the time of going to press, BPP Learning Media makes no warranty that the information in this book is accurate or
complete and accept no liability for any loss or damage suffered by any person acting or refraining from acting as a result of the material in this
book.
The publishers are grateful to the IASB for permission to reproduce extracts from the International Financial Reporting Standards including all
International Accounting Standards, SIC and IFRIC Interpretations (the Standards). The Standards together with their accompanying documents
are issued by:
The International Accounting Standards Board (IASB)
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Email: info@ifrs.org Web: www.ifrs.org
Disclaimer: The IASB, the International Financial Reporting Standards (IFRS) Foundation, the authors and the publishers do not accept
responsibility for any loss caused by acting or refraining from acting in reliance on the material in this publication, whether such loss is caused by
negligence or otherwise to the maximum extent permitted by law.
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Chapter 12 • Tangible non-current assets

Non-current assets • Intangible non-current assets

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Audit objectives for tangible non-current assets

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Substantive audit procedures to test COMPLETENESS

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Substantive audit procedures to test EXISTENCE

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Substantive audit procedures to test RIGHTS AND OBLIGATIONS

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Substantive audit procedures to test RIGHTS AND OBLIGATIONS

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Substantive audit procedures to test VALUATION

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Substantive audit procedures to test VALUATION continued

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Substantive audit procedures to test DEPRECIATION (part of

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Substantive audit procedures to test DEPRECIATION continued

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Substantive audit procedures to test ADDITIONS (part of accuracy,

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Substantive audit procedures to test ADDITIONS continued

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Substantive audit procedures to test SELF-CONSTRUCTED

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Substantive audit procedures to test DISPOSALS (part of accuracy,

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Key financial statement assertions

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2. For research and development costs, research costs should be

3. PIRATE criteria for development costs to be capitalised.

4. The audit of amortisation will be similar to the audit of

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Substantive audit procedures for goodwill

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Substantive audit procedures for research and development

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Substantive audit procedures for research and development

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Substantive audit procedures for other intangibles

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• Questions on non-current assets are likely to come up in a

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• Audit evidence in the form of substantive procedures has been

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• As a general rule, when asked for audit procedures, do not use

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Balotelli Beach Hotel Co (Balotelli) operates a hotel providing

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• Test 4 is a test for existence and test 3 is for completeness. All

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[See slides 631 to 633 for the question scenario.]

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• Inspect a sample of additions to ensure that they physically exist.

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