CAF-8 AUDIT WITH M.

BILAL QURESHI, ACA, FCCA

IMPACT OF ADVERSE MACRO ENVIRONMENT ON AUDIT
RELEVANT FOR SPRING 2023 ATTEMPT
Important Notes
1. Current issues are frequently tested in ICAP exam scenarios. For example in Autumn 2022 attempt,
import restrictions and going concern issues were tested in CAF-8 Audit exam.
2. Adverse macro environment is a current issue and in focus locally and globally. Amidst the recent
situation in Pakistan, this may be examined in CAF-8 Audit exam in the upcoming Spring 2023
attempt.
3. Before reading this document, you may generate your own ideas about the aspects that the auditor
needs to consider and thereafter you can reconcile those ideas with those given in the document.

4. This document has been prepared to provide a helicopter view on the financial reporting and
auditing implications of adverse macro environment.

Understanding entity 1. Understanding of changes in current business environment

and environment (ISA
2. Understanding of stresses / malfunctioning of company's internal controls
315)
3. New risks / key risks and changes therein including complex transactions
4. Increased skepticism - Challenge unusual trends / transactions etc.

Planning (ISA 300) Whether specialized audit knowledge needed and revisiting risk assessment
& planned procedures

Quality Control (ISA 1. Leadership responsibilities - renewed emphasis on skepticism given the
220) risk
2. Client acceptance/continuance - critical evaluation of integrity of
management
3. Engagement team - more experienced, competent team members to
address increased risk
4. Increased Direction, supervision, review, consultations

Business Risks from Threats in terms of PESTEL

Adverse macro factors
a. Business Failures
b. Reduced investor confidence
c. Economic slow down - reduced investments in PPE, inventories e.g.
high tech industries, reduced consumer spending
d. Increasing unemployment due to lay offs and restructurings
e. Reduced earnings and adverse performance measures

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CAF-8 AUDIT WITH M. BILAL QURESHI, ACA, FCCA
IMPACT OF ADVERSE MACRO ENVIRONMENT ON AUDIT
RELEVANT FOR SPRING 2023 ATTEMPT
Impact on Internal 1. Large layoffs, staff reductions, and notifications to employees of
controls effectiveness impending termination leading to:
a. lack time to complete tasks and consider decisions,
b. Increased workloads leads to reduced accuracy level
c. Limited Segregation of duties
d. IT personnel lay off leading to issues regarding transaction initiation,
processing, or recording or maintaining the integrity of information
generated by the IT system
2. Changes in business strategies, and integration of different businesses
may exceed the ability of a company’s financial systems to remain under
effective internal control.

3. Controls at business units whose divestment has been announced may

be disrupted.

4. Unfilled positions
a. key control procedures are no longer being performed/ performed
less frequently, or
b. Key controls performed by individuals lacking proper understanding
to identify and correct errors.

5. Changes to the control environment have altered internal control

effectiveness and potentially resulted in a material control weakness

6. Changes in internal control caused by past or pending layoffs or staff

reductions create an incentive / opportunity for fraudulent activities,
including misappropriation of assets

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CAF-8 AUDIT WITH M. BILAL QURESHI, ACA, FCCA
IMPACT OF ADVERSE MACRO ENVIRONMENT ON AUDIT
RELEVANT FOR SPRING 2023 ATTEMPT

Audit Risks

1. PPE & intangibles 1. Events triggering impairment considerations

2. Assumptions reasonableness and estimation uncertainty

2. Inventory write off Reduced demand, reduced selling prices, returns, contract cancellations

3. Revenue 1. Significant judgements / estimates - management bias

2. Special / side arrangements
3. Unusual seasonal trends or period-end “spikes” in revenue

4. Estimates 1. Assumptions and source data reasonableness

2. Fair valuations / useful lives not updated / revised

5. Deferred tax asset Deferred tax asset may not be recoverable due to recurring losses

6. Restructuring 1. Provision (Criteria per IAS 37 met or not, Extra costs included)
2. Disclosure - non-adjusting event

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CAF-8 AUDIT WITH M. BILAL QURESHI, ACA, FCCA
IMPACT OF ADVERSE MACRO ENVIRONMENT ON AUDIT
RELEVANT FOR SPRING 2023 ATTEMPT
7. Borrowings 1. Liabilities incorrectly classified as non-current instead of current in
following situations:
a. Debt Refinancing / rescheduling on long term basis executed post
year end and before FS approval.
b. Company has no discretion for refinancing / rollover of obligation.
c. Breach of loan arrangement on / before year end leading to debt
becoming immediately repayable even if lender agreed (before FS
approval) not to demand immediate repayment due to breach.

2. For loans classified as current liabilities, following non-adjusting

events not disclosed:
a. Refinancing on long term basis
b. Rectification of a breach of a long term loan arrangement
c. Grant of grace period by lender to rectify a breach for a long term loan

3. Incorrectly classifying a non-current liability as current liability IF

lender agreed by end of year end for a grace period of more than 12
months after reporting date

8. Receivables 1. Expected credit loss may be incorrect / optimistic

2. Disclosures of credit risk and default risk

9. New IFRS IFRS 9, 15 and 16 - requirements not properly complied such as ECL /
premature revenue recognition

10. Related party Increased pressures on management to maintain or achieve financial

transactions targets may heighten the risk of improper accounting or disclosure of related
party transactions.

11. Accounting Policy Higher risk of material misstatement at FS level to meet expectations / goals
/ method changes

12. Going Concern 1. Material uncertainty related to GC disclosures

2. Going concern basis may be inappropriate or inadequately disclosed
3. Significant events / GC close call situations not disclosed

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CAF-8 AUDIT WITH M. BILAL QURESHI, ACA, FCCA
IMPACT OF ADVERSE MACRO ENVIRONMENT ON AUDIT
RELEVANT FOR SPRING 2023 ATTEMPT
Fraud Risk Factors 1. Pressure on management from external parties such as analyst,
competitors, shareholders, lenders and stock market to perform well
including ratios linked to debt covenants.

2. Pressure on management from internal sources such as Board of

Directors to meet short term key performance indicators (KPIs).

3. Incentive for fraudulent financial reporting (FFR) where remuneration of

executives tied to earnings growth etc.

4. Complex business structures and transactions posing substance over

form questions and also leading to internal control issues and financial
reporting failures.

5. Liquidity crisis increases pressure for FFR.

6. Changes in internal control caused by past or pending layoffs or staff

reductions create an opportunity for fraudulent activities, including
misappropriation of assets.

7. Planned lay off provides incentive for misappropriation of assets.

8. Difficult economic times also increase the possibility that the economic
substance of certain transactions may be other than their legal form, or
that transactions may lack economic substance such as in case of RPT
providing opportunities for FFR.

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CAF-8 AUDIT WITH M. BILAL QURESHI, ACA, FCCA
IMPACT OF ADVERSE MACRO ENVIRONMENT ON AUDIT
RELEVANT FOR SPRING 2023 ATTEMPT

Going Concern issues Indicators to look for in case studies

1. Recurring operating losses
2. Working capital issues
3. Loan defaults due to financial difficulties
4. Denial of credit from suppliers
5. Dependence on the success of a particular product that is not selling
well
6. Legal proceedings,
7. Excessive reliance on external financing rather than funds generated
from operations.

8. Loss of a principal customer or supplier or license revocation

9. Destabilization of a trading partner or contract counterparty

Auditor's focus
1. Management plans and their effective implementation and company's
control over such plans
2. Assumptions realistic or not such as financing availability etc.
3. Liquidity challenges disclosed

Impact on Procedures 1. Overall / specific response when fraud risk identified.

2. When faced with a “gray” area, perform appropriate procedures to test
and corroborate management’s explanations and representations, and
consult with others as needed.
3. More reliable evidence needed including involvement of specialists and
experts.
4. Performing analytical procedures at a disaggregated level to identify
hidden patterns.

Communications Open & ongoing communications with management and TCWG, including
discussions about the quality of financial reporting and any pressure to
accept less than high-quality financial reporting

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CAF-8 AUDIT WITH M. BILAL QURESHI, ACA, FCCA
IMPACT OF ADVERSE MACRO ENVIRONMENT ON AUDIT
RELEVANT FOR SPRING 2023 ATTEMPT
Unusual transactions 1. Examples of unusual transactions
a. sales of assets outside the ordinary course of business
b. significant or unusual period-end revenues
c. introduction of new period end
d. sales promotion programs
e. disposal of a segment of a business

2. Focus areas for auditor

a. What is the business purpose and related financial benefits or
obligations?
b. Whether subject to effective controls.
c. Whether properly accounted for and disclosed
d. Whether any “special” or “side” arrangements exist that were not
considered in determining the appropriate accounting and disclosure
for the transactions.
e. Whether “non-standard” journal entries, including the adjusting
entries made at the end of the closing process, are subject to
appropriate review and oversight.

Evaluation of Both quantitative and qualitative factors should be considered, focusing on:
misstatements -
Materiality (may be 1. Individual & aggregate misstatements and their impact on key FSLIs,
lower due to increased totals, and ratios.
audit risk) 2. Whether misstatement increases management’s compensation via
bonuses or other incentives.
3. Whether misstatement hides change in earnings / other trends /
failure to meet analysts’ expectations.
4. A misstatement’s impact on compliance with financial statement-
related debt covenants.
5. A misstatement indicative of intentionally misleading financial
reporting or illegal acts.
6. A misstatement particularly important to a segment of the business.