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F8 AOF Lecture Note - 7.2023
F8 AOF Lecture Note - 7.2023
Lecture note
ACCA F8
LECTURE NOTE
4.2023
Ngo Nhu Vinh, PhD, FCCA
Nguyen Thu Hao, MA, FCCA
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AOF ACCA Paper F8 – Audit and Assurance
Lecture note
2. ASSURANCE ENGAGEMENTS 6
1. MATERIALITY 23
2. INTRODUCTION TO RISK 25
5. FRAUDS 34
1. AUDIT PLANNING 36
2. AUDIT DOCUMENTATION 40
4. ASSERTION 46
5. AUDIT PROCEDURES 47
4. CONTROL OBJECTIVES, CONTROL PROCEDURES AND TEST OF CONTROL FOR MAIN CYCLE 59
1. AUDIT PROCEDURES 79
3. INVENTORY 89
INTRODUCTION 113
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Lecture note
Fair Information is free from discrimination and bias and in compliance with
expected standards and rules. The accounts should reflect the commercial
substance of the company's underlying transactions.
An audit gives the reader reasonable assurance on the truth and fairness of the financial
statements. The audit report does not guarantee that the financial statements are correct, but
that they are true and fair within a reasonable margin of error.
Audits give reasonable assurance that the accounts are free from material misstatement.
Definition of materiality
Materiality is an expression of the relative significance or importance of a particular matter
in the context of the financial statements as a whole.
A matter is material if its omission or misstatement would reasonably be expected to
influence the economic decisions of users taken on the basis of the financial statements.
Materiality depends on the size of the item or error judged in the particular circumstances of
its omission or misstatement.
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Accountability is the quality or state of being accountable; that is, being required or
expected to justify actions and decisions. It suggests an obligation or willingness to accept
responsibility for one's actions.
[Accountability means holding those in charge accountable for their actions. In the context
of a company, it means holding the directors who manage the company responsible for
explaining their actions to the shareholders who own the company.]
Stewardship means taking care of another person’s property or investment.
[Stewardship is when a person is responsible for taking care of something on behalf of
another. Directors are responsible for the management of the shareholders property.]
Agents are people employed or used to provide a particular service. In the case of a
company, the people being used to provide the service of managing the business also have
the second role of trying to maximize their personal wealth in their own right
[Agency is where an agent acts on behalf of a principle to perform tasks for them. In the
context of a company, the directors are the agents of the shareholders (principles) who
entrust them to manage the running of the business.]
This separation of ownership and management is often referred to as the ‘Agency Problem’
or “Agency Relationship Problem”
Applying these three terms together, we can say:
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Directors of all companies are required to produce financial statements annually which give
a true and fair view of the affairs of the company and its profit and loss for the period. They
are also encouraged to communicate with shareholders on matters relating to directors’ pay
and benefits, going concern and management of risks. An assurance engagement may help
to confirm that the information presents a fair picture.
An audit provides assurance to the shareholders and other stakeholders of a company on the
financial statements because it is independent and impartial.
2. ASSURANCE ENGAGEMENTS
An assurance engagement is one in which a practitioner expresses a conclusion designed to
enhance the degree of confidence of the intended users other than the responsible party about
the subject matter information (that is, the outcome of the evaluation or measurement of a
subject matter against criteria).
Assurance means the auditors’ satisfaction as to the reliability of the assertion made by one
party for use by another party.
An assurance engagement performed by a practitioner will consist of the following FIVE
elements:
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Lecture note
The level of assurance is determined by the nature of procedures performed and their results.
REVIEW ENGAGEMENTS
(= a type of assurance engagement but not the same as audit)
The objective of a review engagement is to enable a practitioner to state whether, on the
basis of procedures which do not provide all the evidence that would be required in an audit,
anything has come to the practitioner’s attention that causes the auditor to believe that the
financial statements are not prepared, in all material respects, in accordance with an
applicable financial reporting framework.
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Lecture note
The International Standards on Auditing (ISAs) are produced by the International Auditing
and Assurance Standards Board (IAASB), a technical standing committee of IFAC.
An explanation of the workings of the IAASB and the authority of ISAs are laid out in the
Preface to the International Standards on Quality Control, Auditing, Review, Other
Assurance and Related Services.
- ISAs are to be paid in the audit of historical financial information
- In exceptional circumstances, an auditor may judge it necessary to depart from an ISA
in order to more effectively achieve the objective of an audit. When such a situation
arises, the auditor should be prepared to justify the departure.
- ISAs do not override the local regulations governing the audit of financial or other
information in a particular country, but:
When the ISAs conform with local The audit of financial or other information in that
regulations on a particular subject country in accordance with local regulations will
automatically comply with the ISA regarding that
subject.
When local regulations differ Member bodies should comply with the obligations
from, or conflict with, ISAs on a of members set forth in the IFAC Constitution as
particular subject regards these ISAs (ie encourage changes in local
regulations to comply with ISAs).
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Transparent debate
A proposed standard is discussed at a meeting, open to the public
Consideration of comments
Any comments as a result of the exposure draft are considered at an open meeting
of the IAASB, and it is revised as necessary for a minimum of 120 days.
Affirmative approval
Approval is made by the affirmative vote of at least 2/3 of IAASB members. of the
IAASB, and it is revised as necessary for a minimum of 120 days.
STATUS OF ISA
International Standards on Auditing (ISAs) are issued by the International Auditing and
Assurance Standards Board (IAASB) and provide guidance on the performance of an audit.
ISAs only apply to the audit of historical financial information. They are written in the
context of an audit of financial statements by an independent auditor.
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The ISAs contain basis principles and essential procedures together with related guidance in
the form of explanatory material and appendices. It is necessary to consider and understand
the entire text of an ISA to understand and apply the basic principles and essential
procedures.
The basic principles and essential procedures of an ISA are to be applied in all cases. If in
exceptional cases the auditor deems it necessary to depart from an ISA to achieve the overall
aim of the audit, then this departure must be justified.
CURRENT ISAs
(no need to remember, just be aware)
Preface to International Standards on Quality Control, Auditing Review, Other
Assurance and Related Services
Glossary of terms
International Standards on Quality Control
1 Quality control for firms that perform audits and reviews of historical
financial information, and other assurance and related services
engagements
Framework for Assurance Engagements
International Standards on Auditing
200 Overall objectives of the independent auditor and the conduct of an audit
in accordance with International Standards on Auditing
210 Agreeing the terms of audit engagements
220 Quality Control for an Audit of Historical Financial Statements
230 Audit documentation
240 The auditor's responsibilities relating to fraud in an audit of financial
statements
250 Consideration of laws and regulations in an audit of financial statements
260 Communication with those charged with governance
265 Communicating deficiencies in internal control to those charged with
governance and management
300 Planning an audit of financial statements
315 Identifying and assessing the risks of material misstatement through
understanding the entity and its environment
320 Materiality in planning and performing an audit
330 The auditor's responses to assessed risks
402 Audit considerations relating to an entity using a service organisation
450 Evaluation of misstatements identified during the audit
500 Audit evidence
501 Audit evidence – specific considerations for selected items
505 External confirmations
510 Initial audit engagements – opening balances
520 Analytical procedures
530 Audit sampling
540 Auditing accounting estimates, including fair value accounting estimates,
and related disclosures
550 Related parties
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The ACCA’s Code of ethics and conduct aligns with the IFAC’s Code of ethics for
professional accountants and sets out the 5 fundamental principles of principles of
professional ethics and provides a conceptual framework for applying them.
Professional Members should comply with relevant laws and regulations and
behaviour avoid any action that discredits the profession.
CONFIDENTIALITY
General rules
Information obtained during an audit is normally held to be confidential; that is it will not
be disclosed to a third party.
However, client information may be disclosed where:
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However, these rules are general principles only; more detailed guidance is also available to
accountants, as explained below.
Objectivity is a state of mind but in certain roles, the preservation of objectivity has to be
shown by the maintenance of independence from those influences which could impair
objectivity.
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The auditor is impartial and independent of management, so that he can give an objective
view on the financial statements of an entity. The onus is always on the auditor not only to
be ethical but also to be seen to be ethical.
WHAT IS INDEPENDENCE?
Self-interest The auditors’ own personal interest, e.g. the auditors may fear
the loss of fees.
Self-review When carrying out the audit, the auditors, review work that their
own firm has undertaken previously, e.g. preparing accounts or
making a valuation.
Familiarity If the auditors are involved with the client for a long time, they
may become unduly sympathetic towards directors and
management and thus too inclined to trust their unsupported
word.
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a. FINANCIAL INTERESTS
[Key term]: A financial interest exists Appropriate safeguards:
where an audit firm has a financial interest - Disposing of the interest
in a client's affairs, for example, the audit - Removing the individual from the
firm owns shares in the client, or is a team if required
trustee of a trust that holds shares in the - Keeping the client's audit
client. committee informed of the
situation
- Using an independent partner to
The following parties are not allowed to
review work carried out if
own a direct financial interest or an
necessary
indirect material financial interest in a
client: Audit firms should have quality control
procedures requiring staff to disclose
- The assurance firm
relevant financial interests for themselves
- A member of the assurance team
and close family members. They should
- An immediate family member of a
also foster a culture of voluntary disclosure
member of the assurance team
on an ongoing basis so that any potential
problems are identified in a timely manner.
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f. OVERDUE FEES
Where there are overdue fees, the auditor Audit firm should discuss with those
runs the risk of making a loan to client. charged with governance or the possibility
of resining if overdue fees is not paid.
g. PERCENTAGE OR CONTINGENT
FEES A firm should not enter into any fee
[Key term]: Contingent fees are fees arrangement for an audit or assurance
calculated on a predetermined basis engagement under which the amount of the
relating to the outcome or result of a fee is contingent on the result of the
transaction or the result of the work assurance work or on items that are the
performed subject matter of the assurance
engagement.
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When a firm quotes a significantly lower - Maintaining records such that the
fee level for an audit service than would firm is able to demonstrate that
have been charged by the predecessor firm, appropriate staff and time are
there is a significant self-interest threat allocated to the engagement
- Complying with all applicable
auditing standards, guidelines and
quality control procedures
k. RECRUITMENT
Recruiting senior management for an audit Audit providers must not make
client, particularly those able to affect the management decisions for the client.
subject matter of an audit engagement, Their involvement could be limited to
creates a self-interest threat for the audit
reviewing a shortlist of candidates,
firm providing that the client has drawn up the
criteria by which they are to be selected.
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b. PREPARING ACCOUNTING
RECORDS AND FINANCIAL Appropriate safeguards:
STATEMENTS
- Using staff members other than
Auditors may routinely assist management assurance team members to carry
with the preparation of financial out work
statements and give advice about - Obtaining client approval for work
accounting treatments and journal entries undertaken
Firms should not prepare accounts or
financial statements for listed or public
interest clients.
For any client, assurance firm are not
allowed to:
- Determine or change journal
entries without client approval
- Authorize or approve transactions
- Prepare source documents
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d. CORPORATE FINANCE
Assurance firms are not allowed to Appropriate safeguards:
promote, deal in or underwrite an - using different teams of staff and
assurance client's shares. They are also not - ensuring that no management
allowed to commit an assurance client to decisions are taken on behalf of the
the terms of a transaction or consummate a client.
transaction on the client's behalf.
Other corporate finance services, such as
assisting a client in defining corporate
strategies, assisting in identifying possible
sources of capital and providing
structuring advice, may be acceptable
providing that safeguards are used.
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Factors to consider:
- The materiality of the litigation
- The nature of the assurance
engagement
- Whether the litigation relates to a
prior assurance engagement
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The concept of materiality is applied by the auditor both in planning and performing the
audit, and in evaluating the effect of identified misstatements on the audit and of
uncorrected misstatements, if any, on the financial statements and in forming the opinion
in the auditor’s report.
ISA 320.5
Auditors often calculate the following values (benchmark) and take an average or weighted
average of all the figures as the materiality level:
Value Percentage
Revenue 0.5%
Total asset 1%
Amount and First the auditor must consider both the amount (quantity) and the nature
nature of (quality) of any misstatements, or a combination of both.
misstatements The quantity of the misstatement refers to the relative size of it and the
quality refers to an amount that might be low in value but due to its
prominence could influence the user’s decision, for example, directors’
transaction.
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Calculating As per ISA 320, materiality is often calculated using benchmarks such as
materiality 5% of profit before tax or 1% of total revenue or total expenses. These
value are useful as starting point for assessing materiality.
Not material In assessing materiality, the auditor must consider that a number of errors
individually but each with a low value may, when aggregated, amount to a material
material misstatement.
aggregated
Performance materiality
Performance materiality is the amount or amounts set by the auditor at less than
materiality for the financial statements as a whole to reduce to an appropriately low level
the probability that the aggregate of uncorrected and undetected misstatements exceeds
materiality for the financial statements as a whole.
Performance materiality also refers to the amount or amounts set by the auditor at less
than the materiality level or levels for particular classes of transactions, account balances
or disclosures.
Performance materiality is normally set at a level lower than overall materiality. It is used
for testing individual transactions, account balances and disclosures.
The aim of performance materiality is to reduce the risk that the total of errors in balances,
transactions, and disclosures does not in total exceed overall materiality.
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2. INTRODUCTION TO RISK
Audit risk
Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the
financial statements are materially misstated.
Inherent risk is the risk that items will be misstated due to the
characteristics of those items, such as the fact they are estimates or that
they are important items in the accounts. The auditors must use their
professional judgment and all available knowledge to assess inherent
risk. If no such information or knowledge is available then the inherent
risk is high.
Inherent risk is affected by the nature of the entity; for example, the
industry it is in and the regulations it falls under, and also the nature of
the strategies it adopts
Control risk Control risk is the risk that a material misstatement that could occur in
an assertion and that could be material, individually or when aggregated
with other misstatements, will not be prevented or detected and
corrected on a timely basis by the entity's internal control.
Detection Detection risk is the risk that the procedures performed by the auditor
risk to reduce audit risk to an acceptably low level will not detect a
misstatement that exists and that could be material, either individually
or when aggregated with other misstatements.
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AR = IR x CR x DR
Explain
IR x CR x DR = AR
High x High x ? = Acceptable (constant)
Medium x Low x ? = Acceptable (constant)
The AR must always be acceptable to the auditor. AR can be considered as a constant.
REMEMBER: An Auditor has control over DR but not IR and CR!
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- To identify and assess the risks of material misstatement in the financial statements
- To enable the auditor to design and perform further audit procedures
- To provide a frame of reference for exercising audit judgement, for example, when
setting audit materiality
Industry factors
- The market and competition, including demand, capacity, and price competition.
- Product technology relating to the entity’s products.
- Customer relationship
- Energy supply and cost
Regulatory Factors
- Accounting principles and industry-specific practices
- Legislation and regulation that significantly affect the entity’s operations,
including direct supervisory activities
- Government policies currently affecting the conduct of the entity’s business, such
as monetary, including foreign exchange controls, fiscal, financial incentives (for
example, government aid programs), and tariffs or trade restrictions policies
External factors
- General economic conditions
- Interest rates and availability of financing,
- Inflation or currency revaluation
(b) Nature of the entity: to enable the auditor to understand the classes of transaction,
account balances, and disclosures to be expected in financial statement
Its operations
- Nature of revenue sources, products or services, and markets, including
involvement in electronic commerce such as Internet sales and marketing
activities.
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(c) The entity’s selection and application of accounting policies, including the reasons
for changes thereto.
The auditor shall evaluate whether the entity’s accounting policies are appropritate for its
business and consistent with the applicable financial reporting framework and accounting
policies used in the relevant industry.
Matters to consider include:
- The methods the entity uses to account for significant and unusual transactions
- Changes in the entity’s accounting policies
- Financial reporting standards and laws and regulations that are new to the entity and
when and how the entity will adopt such requirements.
(d) The entity’s objectives and strategies, and those related business risks that may
result in risks of material misstatement.
Matters to consider include:
- New products and services: a potential related business risk might be, for example,
that there is increased product liability
- Expansion of the business: a potential related business risk might be, for example,
that there the demand has not been accurately estimated
- Regulatory requirements: a potential related business risk might be, for example, that
there is increased legal exposure
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Apart from the accounts department, the auditors may need to make enquiries to:
- Those charged with governance: give insight to the environment in which the
financial statements are prepared.
- In-house legal counsel: Help with understanding matters such as outstanding
litigation or compliance with laws and regulation
- Sales and marketing: Give information about marketing strategies, sales trends
- Internal audit: Give information about the internal control system
- Production personnel: Give information about the production process
Analytical procedures
Analytical procedures consist of the analysis of significant ratios and trends including the
resulting investigations of fluctuations and relationships that are inconsistent with other
relevant information or which deviate from predictable amounts.
Analytical procedures is a mean of understanding the business and identifying audit risk. It
may be used as substantive procedures to obtain audit evidence.
Analytical procedures include:
(a) The consideration of comparisons with:
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Substantive
Test of controls
- professional scepticism procedures
- additional or more
experienced staff
- Supervision
- general changes to the Substantive
analytical Test of
nature, timing or extent of
procedure detailed
audit procedures
TEST OF CONTROL
Definition
Tests of controls are an audit procedure designed to evaluate the operating effectiveness
of controls in preventing, or detecting and correcting, material misstatements at the
assertion level.
- When the auditor’s assessment of risks of material misstatement at the assertion level
includes an expectation that the controls are operating effectively (that is, the auditor
intends to rely on the operating effectiveness of controls in determining the nature, timing
and extent of substantive procedures); or
- When the substantive procedures alone cannot provide sufficient appropriate audit
evidence at the assertion level
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SUBSTANTIVE PROCEDURES
Definition
The auditor must always carry out substantive procedures on material items
A
E
I
O
U
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The final audit is the main period of audit testing, when work is focused on the final
financial statements.
Interim audits are audits undertaken prior to the final audit, often during the period under
review. The auditor is likely to carry out tests of control at interim audits.
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5. FRAUDS
What is fraud?
What is error?
Error is a material misstatement cause by mistake.
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In conducting an audit of financial statements, the overall objectives of the auditor are:
(a) To obtain reasonable assurance about whether the financial statements as a whole are
free from material misstatement, whether due to fraud or error, thereby enabling the
auditor to express an opinion on whether the financial statements are prepared, in all
material respects, in accordance with an applicable financial reporting framework; and
(b) To report on the financial statements, and communicate as required by the ISAs, in
accordance with the auditor’s findings.
(ISA 200.11)
In order to archive the overall objective, auditor need to plan and perform the audit with
professional skepticism and apply professional judgment.
What is Professional skepticism?
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ISA 300 Planning an audit of financial statements which states that the auditor shall plan
the audit so that the engagement is performed in an effective manner.
Audits are planned to:
- Help the auditor devote appropriate attention to important areas of the audit
- Help the auditor identify and resolve potential problems on a timely basis
- Help the auditor properly organize and manage the audit so it is performed in an
effective manner
- Assist in the selection of appropriate team members and assignment of work to them
- Facilitate the direction, supervision and review of work
formulate translate
Auditors Audit strategy Audit plan
AUDIT STRATEGY
The audit strategy sets the scope, timing and direction of the audit, and guides the
development of the more detailed audit plan.
Matter to consider in establishing an overall audit strategy
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✓ Determination of materiality
✓ Areas identified with higher risk of material misstatement
✓ Results of previous audits
✓ Need to maintain professional skepticism
Significant factors,
preliminary engagement ✓ Evidence of management's commitment to design,
activities, and knowledge implementation and maintenance of sound internal control
gained on other ✓ Volume of transactions
engagements
✓ Significant business developments
✓ Significant industry developments
✓ Significant changes in financial reporting framework
✓ Other significant recent developments
What are the items which should be included in overall audit strategy?
AUDIT PLAN
The audit plan converts the audit strategy into a more detailed plan and includes the nature,
timing and extent of audit procedures to be performed by engagement team members in
order to obtain sufficient appropriate audit evidence to reduce audit risk to an acceptably
low level.
What are the items which should be included in the audit plan?
(a) A description of the nature, timing and extent of planned risk assessment procedures
sufficient to assesses the risk of material misstatement.
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This would include assessment of IR and CR at both the entity and assertion level. An
important element of the plan would be the understanding and assessment of the
control environment of the organisation
(b) A description of the nature, timing and extent of planned further audit procedures
at the assertion level for each material class of transactions, account balance and
disclosure
This would include an explanation of the decision whether to test the operating
effectiveness of controls (an important decision is whether reliance is to be placed on
controls) and on the nature, timing and extent of planned substantive procedures (this
would depend on the decision as to the level of control risk)
(c) Audit procedures required to be carried out for the engagement to comply with the
ISAs, for example, the use of external confirmations to obtain sufficient appropriate
evidence at the assertion level
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2. AUDIT DOCUMENTATION
ISA 230 Audit documentation
(a) It provides evidence of the auditor's basis for a conclusion about the achievement of
the overall objective.
(b) It provides evidence that the audit was planned and performed in accordance with
ISAs and other legal and regulatory requirements.
(c) It assists the engagement team to plan and perform the audit.
(d) It assists team members responsible for supervision to direct, supervise and review
audit work.
(e) It enables the team to be accountable for its work.
(f) It allows a record of matters of continuing significance to be retained.
(g) It enables the conduct of quality control reviews and inspections (both internal and
external)
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Objective Aim:
of work
- Sample selection
- Work done
- Source of information
Work done: - Key to any audit risks
- Appropriate cross-referencing
- Results
- Analysis of errors or other significant
Results: observations
- Conclusions
- Key points Conclusions:
Reviewer
Reviewed by: T Cooper
Date: 15 Feb 20X7
Date reviewed
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- Engagement letters
- New client questionnaires
- The memorandum and articles
- Other legal documents such as prospectuses, leases, leases and sales agreement
- Details of the history of the client’s business
- Board minutes of continuing relevance
- Previous years’ signed accounts, analytical review and management letters
- Accounting system notes, previous year’s control questionnaires
- Financial statements
- Accounts checklists
- Management accounts details
- Reconciliations of management and financial accounts
- A summary of unadjusted errors
- Report to partner including details of significant events and errors
- Review notes
- Audit planning memorandum
- Time budgets and summaries
- Letter of representation
- Management letter
- Notes of board minutes
- Communications with third parties such as experts or other auditors
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ACCA RECOMMENDATION: Auditors should retain their working papers for at least 7
years before destroying them.
Working papers are the property of the auditors
Auditors must follow ethical guidance on the confidentiality of audit working papers.
They may release the working papers to the entity, as long as disclosure does not
undermine “the independence or validity of the audit processes”.
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Audit evidence is all the information used by the auditor in arriving at the conclusions on
which the auditor's opinion is based.
Sufficiency Appropriateness
• The measure of the quantity of • The measure of the quality of
audit evidence audit evidence;
• The quantity of audit evidence • That is, its relevance and its
required is affected by the auditor reliability in providing support for
assessment of the risks of material the conclusions on which the
and also by the quality of such auditor's opinion is based
audit evidence
- Assessment of risk at the financial statement level and/or the individual transaction
level. As risk increases then more evidence is required.
- The materiality of the item. More evidence will normally be collected on material
items whereas immaterial items may simply be reviewed to ensure they appear
correct.
- The nature of the accounting and internal control systems. The auditor will place
more reliance on good accounting and internal control systems limiting the amount
of audit evidence required.
- The auditor’s knowledge and experience of the business. Where the auditor has good
past knowledge of the business and trusts the integrity of staff then less evidence will
be required.
- The findings of audit procedures. Where findings from related audit procedures are
satisfactory (e.g. tests of controls over receivables) then substantive evidence will be
collected.
- The source and reliability of the information. Where evidence is obtained from
reliable sources (e.g. written evidence) then less evidence is required than if the
source was unreliable (e.g. verbal evidence).
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External Audit evidence from external sources is more reliable than that obtained
from the entity's records because it is from an independent source.
Auditor Evidence obtained directly by auditors is more reliable than that obtained
indirectly or by inference.
Entity (ICS Evidence obtained from the entity's records is more reliable when the
strength) related control system operates effectively.
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4. ASSERTION
Financial statement assertions
Assertions are representations by management, explicit or otherwise, that are embodied in
the financial statements, as used by the auditor to consider the different types of potential
misstatements that may occur.
The use of assertions by auditor
Assertions used by the auditor when auditing the class of transactions or balance
Occurrence Transactions and events that have been recorded or disclosed have
occurred, and such transactions and events pertain to the entity
Completeness All transactions and events that should have been recorded have been
recorded
Accuracy Amounts and other data relating to recorded transactions and events
have been recorded appropriately
Cut-off Transactions and events have been recorded in the correct reporting
period
Classification Transactions and events have been recorded in the proper accounts
Rights and The entity holds or controls the rights to assets, and liabilities are the
obligations obligations of the entity.
Completeness All assets, liabilities and equity interests that should have been
recorded have been recorded.
Valuation and Assets, liabilities and equity interests are included in the financial
allocation statements at appropriate amounts and any resulting valuation or
allocation adjustments are appropriately recorded.
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5. AUDIT PROCEDURES
What is purpose of audit procedures?
The auditor obtains audit evidence by undertaking audit procedures to do the following:
- Obtain an understanding of the entity and its environment to assess the risks of
material misstatement at the financial statement and assertion levels (risk assessment
procedures)
- Test the operating effectiveness of controls in preventing, or detecting and correcting,
material misstatements at the assertion level (tests of controls)
- - Detect material misstatements at the assertion level (substantive procedures).
Inspection of - This is the examination of documents and records, both internal and
documentatio external, in paper, electronic or other forms.
n or records - This procedure provides evidence of varying reliability, depending on
the nature, source and effectiveness of controls over production (if
internal).
- Inspection can provide evidence of existence (e.g. a document
constituting a financial instrument), but not necessarily about
ownership or value.
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CONTROL ENVIRONMENT
What is control environment?
Control environment includes the governance and management functions and the attitudes,
awareness and actions of those charged with governance and management concerning the
entity's internal control and its importance in the entity.
What should the auditor consider when obtaining understanding of the control
environment?
Communication
and enforcement ✓ Essential elements which influence the effectiveness of the design,
of integrity and administration and monitoring of controls
ethical values
Organizational ✓ The framework within which an entity's activities for achieving its
structure objectives are planned, executed, controlled and reviewed
Human resource
✓ Recruitment, orientation, training, evaluating, counselling,
policies and
promoting, compensation and remedial actions
practices
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The auditor shall obtain an understanding of whether the entity has a process for:
- Identifying business risks relevant to financial reporting objectives
- Estimating the significance of the risk
- Assessing the likelihood of their occurrence
- Deciding on actions to address those risk
If the entity has established such a process, the auditor shall obtain an understanding of it.
If there is not a process, the auditor shall discuss with management whether relevant
business risks have been identified and how they have been addressed.
ISA 315.15
Entity should have a process for:
- Identifying business risks that impact financial reporting objectives
- Estimating the significance of the risks identifies
- Assessing the likelihood of occurrence
- Deciding relevant actions to address the risks
CONTROL ACTIVITIES
Control activities are those policies and procedures in addition to the control environment
which are established to achieve the entity’s specific objectives.
Control activities include those activities designed to prevent or to detect and correct
errors.
Specific control activities can be summarized into the following 5 types:
- Authorization
- Performance review
- Information processing
- Physical controls
- Segregation of duties
Examples of specific control activities
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Controls over
We shall look at computer controls later in this Information
computerized
chapter. processing
applications
Checking the
arithmetical For example, checking to see if individual invoices Information
accuracy of have been added up correctly. processing
records
Comparing the
results of cash,
For example, in a physical count of petty cash, the
security and Performance
balance shown in the cash book should be the same as
inventory counts review
the amount held.
with accounting
records
Comparing
internal data For example, comparing records of goods dispatched
Performance
with external to customers with customers' acknowledgement of
review
sources of goods that have been received.
information
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to assets and e.g. ensuring that the inventory stores locked are
records unless store personnel are there.
MONITORING OF CONTROLS
Monitoring of controls is a process to assess the effectiveness of internal control
performance over time. It includes assessing the design and operation of controls on a timely
basis and taking necessary corrective actions modified for changes in conditions.
If the entity has an internal audit function, the auditor shall obtain an understanding of the
nature of its responsibilities and how it fits in the organizational structure and the activities
performed / to be performed.
Any internal control system can only provide the directors with reasonable assurance
that their objectives are reached, because of inherent limitations. These include:
(1) The costs of control not outweighing their benefits
(2) The potential for human error
(3) Collusion between employees
(4) The possibility of controls being bypassed or overridden by management
(5) Controls being designed to cope with routine and not non-routine transactions
These factors demonstrate why auditors cannot obtain all their evidence from tests of the
systems of internal control. The key factors in the limitations of control systems are human
error and potential for fraud. The safeguard of segregation of duties can help deter fraud.
However, if employees decide to perpetrate frauds by collusion, or management commits
fraud by overriding systems, the accounting system will not be able to prevent such frauds.
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In obtaining an understanding of internal control, the auditor must understand the design
of the internal control and the implementation of that control.
There may be occasions where substantive procedures alone are not sufficient to address
the risks arising. Where such risks exist, auditors shall evaluate the design and determine
the implementation of the controls; that is, by controls testing. This is most likely to be
the case in a system which is highly computerized and which does not require much
manual intervention.
Advantages Disadvantages
They are relatively simple to record Describing something in narrative notes can be a lot
and can facilitate understanding by more time consuming than, say, representing it as a
all audit team members. simple flowchart, particularly where the system
follows a logical flow.
They can be used for any system They are awkward to update if written manually.
due to the method's flexibility.
Editing in future years can be It can be difficult to identify missing internal controls
relatively easy if they are because notes record the detail of systems but may not
computerized. identify control exceptions clearly.
FLOW CHARTS
Flowcharts can take many forms, but in general are graphic illustrations of the physical flow
of information through the accounting system. Flowlines represent the sequences of
processes, and other symbols represent the inputs and outputs to a process.
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Advantages Disadvantages
After a little experience they can be prepared They are most suitable for describing
quickly. standard systems. Procedures for dealing
with unusual transactions will normally have
to be recorded using narrative notes.
They generally ensure that the system is Time can sometimes be wasted by charting
recorded in its entirety, as all document flows areas that are of no audit significance.
have to be traced from beginning to end. Any
'loose ends' will be apparent from a cursory
examination.
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QUESIONAIRE
Advantages Disadvantages
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TEST OF CONTROL
Definition
Tests of control are tests performed to obtain audit evidence about the effectiveness of
the:
- Design of the accounting and internal control systems, ie whether they are suitably
designed to prevent, or detect and correct, material misstatement at the assertion level;
and
- Operation of the internal controls throughout the period.
(a) Inspection of documents supporting controls or events to gain audit evidence that
internal controls have operated properly, e.g. verifying that a transaction has been
authorized
(b) Enquiries about internal controls which leave no audit trail, e.g. determining who
actually performs each function, not merely who is supposed to perform it
(c) Re-performance of control procedures, e.g. reconciliation of bank accounts, to
ensure they were correctly performed by the entity
(d) Examination of evidence of management views, e.g. minutes of management
meetings
(e) Observation of controls to consider the manner in which the control is being operated
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Risks
identified/ Controls Controls Test of
Assertion objective procedures control
related
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PURCHASE SYSTEM
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• Approved purchase
order for each receipt of
goods.
• • Staff receiving goods • Observe receipt of goods by
check them to the staff to confirm whether the
purchase order. check is done.
• Stores clerks sign for • Inspect a sample to confirm
goods received. whether stores staff undertake
• Purchase orders and this check.
GRNs are matched with • Examine supporting
the suppliers' invoices. documentation to ensure it has
• Supplier statements been matched for a sample of
independently reviewed invoices.
and reconciled to trade • Review procedures for
payable records. reconciling supplier statements
and re-perform a sample of
reconciliations.
• To ensure that • Purchase orders and • For a sample of purchase orders
all purchase GRNs are matched with in the year ensure each has been
transactions the suppliers' invoices. matched to a related invoice that
that occurred was subsequently recorded.
have been
recorded. • Periodic accounting for • Review entity's procedures for
pre-numbered GRNs accounting for pre- numbered
and purchase orders. documents and inspect a sample
• Independent check of of GRNs for sequential
amount recorded in the numbering.
purchase journal. • Examine application controls.
• Supplier statements • Examine documentation for
independently reviewed evidence of this check.
and reconciled to trade • Review procedures for
payable records. reconciling supplier statements
and reperform a sample of
reconciliations.
• To ensure that • Purchase orders and • Examine supporting
recorded GRNs are matched with documentation to ensure it has
purchases the suppliers' invoices. been matched for a sample of
represent the invoices.
liabilities of
the entity.
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INVENTORY SYSTEM
Inventory controls are designed to ensure safe custody. Such controls include restriction of
access, documentation and authorisation of movements, regular independent inventory
counting and review of inventory.
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CASH SYSTEM
Cash payments
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Cash receipts
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PAYROLL SYSTEM
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Authorization • To ensure that • Orders for capital items • Review policies and
expenditure is should be authorized by procedures in place.
properly appropriate levels of
authorized. management.
• Orders should be • Examine a sample of
requisitioned on orders for appropriate
appropriate (different to authorisation.
revenue) documentation.
• Invoices should be • Inspect invoices to
approved by the person verify the invoice has
who authorised the been appropriately
order. approved.
• Invoices should be • Inspect invoices to
marked with the verify the invoice has
appropriate general the correct general
ledger code. ledger code marked
on it.
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Recall
Audit procedures comprise of:
- Test of control
- Substantive procedures, in which:
+ Substantive analytical procedures
+ Tests of detail (of transaction, account balance and disclosures)
‘Analytical procedures’ actually means the evaluation of financial and other information,
and the review of plausible relationships in that information. The review also includes
identifying fluctuations and relationships that do not appear consistent with other relevant
information or results.
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Analytical procedures are used at the beginning of the audit to help the auditor obtain an
understanding of the entity and assess the risk of material misstatement. Audit procedures
can then be directed to these ‘risky’ areas.
Analytical procedures as substantive procedures
Analytical procedures can be used as substantive procedures in determining the risk of
material misstatement at the assertion level during work on the income statement and
statement of financial position (balance sheet).
Analytical procedures in the overall review at the end of the audit
Analytical procedures help the auditor at the end of the audit in forming an overall
conclusion as to whether the financial statements as a whole are consistent with the
auditor’s understanding of the entity.
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Rights and obligations (a) Reviewing invoices for proof that item belongs to the company
(b) Confirmations with third parties
Classification and (a) Confirming compliance with law and accounting standards
understandability (b) Reviewing notes for understandability
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RECEIVABLES
What are key ASSERTIONS relating to the audit of RECEIVABLES?
Confirmation of receivables
➢ Objectives of confirmation
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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.
The verification of trade receivables by direct confirmation is the normal means of
providing audit evidence to satisfy the objective of testing whether customers exist and
owe bona fide amounts to the company (existence and rights and obligations)
Positive The customer is requested to confirm the accuracy of the balance shown or
state in what respect they are in disagreement.
It is preferable as it is designed to encourage definite replies from those
customer.
Negative The customer is requested to reply only if the amount stated is disputed.
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➢ Follow-up procedures
What should auditor do after sending confirmation?
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1. Compare receivables turnover and receivables days with the previous year and/or
with industry data.
2. Compare the aged analysis of receivables from the aged trial balance with the
previous year.
3. Review the adequacy of the allowance for uncollectable accounts through discussion
with management.
4. Compare the irrecoverable debt expense as a % of sales with the previous year and/or
with industry data.
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➢ Test of detailed
1. Agree the balance from the individual sales ledger accounts to the aged
receivables' listing and vice versa.
2. Match the total of the aged receivables' listing to the sales ledger control
account.
3. Cast and cross-cast the aged trial balance before selecting any samples to test.
4. Trace a sample of shipping documentation to sales invoices and into the sales
and receivables ledger.
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SALES
What are key ASSERTIONS relating to the audit of SALES?
Occurrence: All sales transactions recorded have occurred and relate to the entity
Completeness: All sales transactions that should have been recorded have been recorded
Accuracy: Amounts relating to transactions have been recorded appropriately
Cut-off: All transactions have been recorded in the correct period
Classification: All transactions are recorded properly
- For a sample of sales transactions recorded in the ledger, vouch the sales invoice back
to customer orders and despatch documentation.
➢ Completeness
- Compare the gross profit percentage by product line with the previous year and
industry data.
- Trace a sample of shipping documentation to sales invoices and into the sales ledger.
➢ Accuracy
- 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.
➢ Cut-off
- Perform analytical procedures on sales returns, comparing the ratio of sales returns to
sales.
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- For a sample of sales invoices around the year end, inspect the dates and compare with
the dates of despatch 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.
- Review material after-date invoices, credit notes and adjustments and ensure that they
are recorded correctly in the relevant financial period.
➢ Classification
- Take a sample of sales invoices and examine for proper classification into revenue
accounts.
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3. INVENTORY
What are the key ASSERTIONS relating to INVENTORY?
Cost is defined by IAS 2 as comprising all costs of purchase and other costs incurred in
bringing inventory to its present location and condition.
Net realisable value is 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.
We need to value inventory at the lower of cost or NRV. So if the NRV is less than cost, we
will have to adjust the inventory from cost to write it down to NRV (lower figure), and the
difference we charge to P&L as a loss.
- 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 percentage to the previous year or industry data.
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➢ Existence
- Observe the physical inventory count (see more in section “attendance at the
inventory count”)
- Verify that any inventory held for third parties is not included in the year-end
inventory figure by 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 yearend
inventory figure by reviewing the inventory listing.
- 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.
- Manufactured goods (RM + DL + OH)
- For materials, agree the valuation of raw materials to invoices and price lists.
- For labour costs, agree costs to wage records.
- Compare the actual manufacturing overhead costs with budgeted or standard
manufacturing overhead costs
- Testing for NRV
- Make enquiries 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.
- Compare the gross profit % to the previous year or industry data.
- Compare inventory days to the previous year and industry average
➢ 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.
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ISA 501.4:
“If inventory is material to the financial statement, the auditor shall obtain sufficient
appropriate audit evidence regarding the existence and condition of inventory by:
(a) Attendance at physical inventory counting, unless impracticable, to:
i. Evaluate management's instructions and procedures for recording and controlling the
result of the entity’s physical inventory counting;
ii. Observe the performance of management’s count procedures
iii. Inspect the inventory; and
iv. Perform test counts; and
(b) perform audit procedures over the entity's final inventory records to determine
whether they accurately reflect actual inventory count results”
Physical inventory From the viewpoint of the auditor, this is often the best method.
counts at the year end
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• Attend one of the inventory counts (to observe and confirm that instructions are being
adhered to).
• Follow up the inventory counts attended to compare quantities counted by the auditors
with the inventory records, obtaining and verifying explanations for any differences, and
checking that the client has reconciled count records with book inventory records.
• Review the year's inventory counts to confirm the extent of counting, the treatment of
discrepancies and the overall accuracy of records (if matters are not satisfactory, auditors
will only be able to gain sufficient assurance by a full count at the year-end).
• Assuming a full count is not necessary at the year end, compare the listing of inventory
with the detailed inventory records, and carry out other procedures (cut-off,
analytical review) to gain further comfort.
• The audit work when continuous inventory counting is used focuses on tests of controls
rather than substantive audit work. Nevertheless, the auditor will also need to do some
further substantive audit work on completeness and existence at the year end.
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Before the physical inventory count, the auditors should ensure audit coverage of the
count is appropriate, and that the client’s count instructions have been reviewed
Procedures
Get the client to send over their stock take instruction (or inventory count instructions)
and we need to review the instruction to ensure:
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Procedures:
- Observe whether the client's staffs 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; the auditors should obtain information about the
inventory's condition, age, usage and, in the case of work-in-progress, its stage of
completion to ensure that it is later valued appropriately.
- 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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- 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.
• When carrying out test counts the auditors should select items from the count records
and from the physical inventory and check one to the other, to confirm the accuracy of
the count records.
• The auditors should concentrate on high value inventory. If the results of the test counts
are not satisfactory, the auditors may request that inventory be recounted.
➢ After the inventory count (AFTER)
After the count, the auditor should check that final inventory sheets have been properly
compiled from count records and that book inventory has been appropriately adjusted.
After the count, the matters recorded in the auditors' working papers at the time of the
count or measurement should be followed up.
Procedures:
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ISA 501.8
“If inventory under the custody and control of a third party is material to the financial
statements, the auditor shall obtain sufficient appropriate audit evidence regarding the
existence and condition of that inventory by performing one or both of the following:
(a) Request confirmation from the third party as to the quantities and condition of
inventory held on behalf of the entity.
(b) Perform inspection or other audit procedures appropriate in the circumstances.”
Other 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 (eg warehouse receipts)
- Requesting confirmation from other parties when inventory has been pledged as
collateral
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What are audit procedures to audit Trade payables, other payables and Accruals?
➢ Completeness
Payables (Creditors)
- 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 enquiries 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.
- Perform a confirmation of accounts payables choosing the low or zero balance
suppliers
- Compare the current year balances for trade accounts payables and accruals with the
previous year
- Compare the payables turnover and payables days to the previous year and industry
data.
- complete the disclosure checklist to ensure that all the disclosures relevant to liabilities
have been made
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➢ Accuracy
- 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 with the previous year
to confirm reasonableness, and also calculating payables' turnover and comparing with
the previous year
- 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.
- Compare the current year balances for trade accounts payables and accruals with the
previous year.
- Compare the amounts owed to a sample of individual suppliers in the trade accounts
payables listing with amounts owed to these suppliers in the previous year.
Cut-off:
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- 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.
• Selection of only large balances or those with many transactions will not yield an
appropriate sample as understatement of liabilities is being tested for. The auditor
should consider the volume of business (look for active suppliers to audit) during the
year. Low or zero balances will be included in the sample.
• If the balance agrees exactly, no further work needs to be carried out.
• Where the differences arise, these need to be categorised as either in transit items or
other items. In-transit items will be either goods or cash
- If the difference relates to goods-in-transit, ascertain whether the goods were received
before the year end by reference to the GRN and that they are included in year-end
inventory and purchase accruals. If not, a cut-off error has occurred and should be
investigated. If the goods were received after the year end, the difference with the
suppliers' accounts is correct.
- Similarly, cash-in-transit would arise where the payment to the supplier was made by
cheque before the year end but was not received by them until after the year end. The
date the cheque was raised and its subsequent clearing through the bank account after
the year end should be verified by inspecting the cash book and the post year end bank
statements
However, if the cheque clears after the year-end date, it may indicate that the cheque,
though raised before the year end, was not sent to the supplier until after the year end.
The relevant amount should be added back to year-end accounts payable and to the
end of year bank balance.
Differences which do not arise from in-transit items need to be investigated and
appropriate adjustments made where necessary. These differences may have arisen
due to disputed invoices or invoices have been held back in order to reduce the level
of year-end account payables.
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Where, as a result of past events, there may be an outflow of resources embodying future
economic benefits in settlement of (a) a present obligation or (b) a possible obligation
whose existence will be confirmed by the occurrence or non-occurrence of one or more
uncertain future events not wholly within the entity’s control, and
Where, as a result of past events, there is a possible asset whose existence will be
confirmed by the occurrence or non-occurrence of one or more uncertain future events
not wholly within the entity’s control, and
the inflow of economic the inflow of economic the inflow is not probable,
benefits is virtually certain, benefits is probable but
not virtually certain,
The asset is not contingent. It No asset is recognised but No asset is recognised and
is a normal asset that we can disclosures are required. no disclosure is required.
recognised.
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• 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
– Discussion with the directors. Have they created a valid expectation in other parties that
they will discharge the obligation?
• 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 in respect of
the item 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 their views (where relevant)
– Discussing the position of similar past provisions with the directors. Were these
provisions eventually settled?
– Considering the likelihood of reimbursement
• 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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Occurrence: All purchase transactions recorded have occurred and relate to the entity.
Completeness: All purchase transactions that should have been recorded have been
recorded
Accuracy: Amounts relating to transactions have been recorded appropriately
Cut-off: Purchase transactions have been recorded in the correct period
Classification: Purchase transactions are recorded properly
➢ Audit procedures
- 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. Where differences from expectations are
discovered they should be investigated.
- Enquire of management whether there are any unsettled claims or obligations
arising before the year end and ensure these are provided for (to give evidence
over the completeness of the charge in the related expense category in the
statement of profit or loss)
- 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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• For each director, obtain a schedule of emoluments for the year, split between wages,
bonuses, benefits, pension contributions and other emoluments.
• Check 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?).
• 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.
• Obtain and review returns to tax authorities made by the company on behalf of the
directors 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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• The audit of bank balances will need to cover completeness, existence, rights and
obligations and valuation. All of these assertions can be audited directly by obtaining
third-party confirmations from the client's banks and reconciling these with the
accounting records, having regard to cut-off.
• The audit objectives linking these assertions are as follows
- Recorded cash balances exist at the year-end (existence).
- Recorded cash balances include the effects of all transactions that occurred
(completeness).
- Year-end transfers are recorded in the correct period (cut-off).
- Recorded balances are realizable at the amounts stated (valuation and allocation).
- The entity has legal title to all cash balances shown at the year-end (rights and
obligations)
• This audit evidence is valuable because it comes directly from an independent
source.
ISA 505 External confirmations:
• Prepare and dispatch of requests and receipt of replies
- Control over the content and dispatch of confirmation requests is the responsibility of
the auditors.
- However, it will be necessary for the request to be authorized by the client entity
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- Replies should be returned directly to the auditors and to facilitate such a reply, a pre-
addressed envelope should be enclosed with the request
• Content of a bank confirmation request:
The information to be requested:
- Balances due to or from the client entity on current, deposit, loan and other accounts
- Nil balances on accounts, and accounts which were closed in the 12 months prior to
the chosen confirmation date
- other information, such as the maturity and interest terms on loans and overdrafts,
unused facilities, lines of credit/standby facilities, any offset or other rights or
encumbrances, and details of any collateral given or received.
- contingent liabilities, such as those arising on guarantees, comfort letters and bills
- any securities and other items in safe custody on behalf of the client
• Obtain company’s current bank account reconciliation and check the additions to
ensure arithmetical accuracy.
• Obtain a bank confirmation letter from company’s bankers for all of its accounts.
• For the current account, agree the balance per bank statement to an original year-end
bank statement and also to the bank confirmation letter.
• Agree the reconciliation’s balance per the cash book to the year-end cash book.
• Trace all of the outstanding deposits (uncredited deposits) to the pre year-end cash
book, post year-end bank statement and also to paying-in-book pre year end.
• Trace all unpresented cheques through to a pre year-end cash book and post year-end
statement. For any unusual amounts or significant delays obtain explanations from
management.
• Examine any old unpresented cheques to assess if they need to be written bank into
the purchase ledger as they are no longer valid to be presented.
• Agree all balances listed on the bank confirmation letter to company’s bank
reconciliations or the trial balance to ensure completeness of bank balances.
• Review the cash book and bankstatements for any unusual items or large transfers
around the year end, as this could be evidence of window dressing.
• Examine the bank confirmation letter for details of any security provided by Fox or
any legal right of set-off as this may require disclosure.
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• Review the financial statements to ensure that the disclosure of cash and bank balances
are complete and accurate.
Audit of cash
➢ Auditors will be concerned that the cash exists, is complete, and belongs to the
company (rights and obligations) and is stated at the correct value.
➢ Where the auditors determine that cash balances are potentially material they
may conduct a cash count, ideally at the period end.
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Existence Recorded assets represent those physically exist and 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 The entity has rights to the assets purchased and those recorded at the
obligations year end
➢ Audit procedures
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+ Accumulated depreciation
+ Net book value
- 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.
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
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+ Previous years
+ Depreciation policy rates
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SECTION 7: REPORTING
LEARNING OBJECTIVE
Objectives of lecture
By the end of this lecture you should be able to:
• Explain the purpose of, auditor's responsibilities regarding, and procedures
involved in a subsequent events review.
• Explain the responsibilities of auditors and management regarding going concern,
and the procedures to be applied in performing going concern reviews.
• Discuss the purpose of, quality of and procedure for obtaining written
representations.
• Explain the auditor's responsibilities in relation to opening balances and
comparative information.
• Understand the appropriate actions in respect of misstatements.
• Explain the significance of uncorrected misstatements, and describe auditor's
procedures in the overall review of the financial statements.
• Describe and analyse the format and content of unmodified audit reports.
• Describe and analyse the format and content of modified audit reports.
• Describe the format and content of emphasis of matter and other matter
paragraphs.
• Explain when each audit opinion is appropriate.
• Explain the different audit reports in respect of issues surrounding going concern.
INTRODUCTION
After the auditor has completed their substantive testing there are still many procedures that
need to be performed before they can sign the audit report.
The completion phase normally includes the following tasks: the consideration of opening
balances and comparatives; a subsequent event reviews; a going concern reviews; obtaining
written representations from management; consideration of misstatements; overall review;
Auditor will issue their audit report which is containing audit opinion; Auditor will issue
management letter, which communicating with those charge with governance regarding
internal control weaknesses.
The audit report is the final product of the audit process.
7.1. THE CONSIDERATION OF OPENING BALANCES AND COMPARATIVES
7.1.1. Auditing opening balances
If the audit engagement continuing from previous years, there is no problem. But if this is
the fist-year audit client, auditor will concern about the reliablity of the previous year’s
financial statements and quality of previous auditors (predecessor auditor).
ISA 510 Initial Engagements – Opening Balances requires that when auditors take on a new
client, they must ensure that:
- opening balances do not contain material misstatements
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- prior period closing balances have been correctly brought forward or, where
appropriate, restated
- appropriate accounting policies have been consistently applied, or changes
adequately disclosed.
There are several considerations to be made:
- Were the previous financial statements audited?
- If the previous financial statements were audited, was the opinion modified?
- If the previous opinion was modified, has the matter been resolved since then?
- Were any adjustments made as a result of the audit? If so, has the client adjusted
their accounting ledgers as well as the financial statements?
- Where the prior period was audited by another auditor or unaudited, the auditors will
need to perform additional work in order to satisfy themselves regarding the opening
position. Such work would include:
+ Consulting the client’s management.
+ Reviewing records and accounting and control procedures in the preceding
period.
+ Consulting with the previous auditor and reviewing (with their permission) their
working papers and relevant representation letters.
+ Substantive testing of any opening balances where the above procedures are
unsatisfactory.
+ Some evidence of the opening position will also usually be gained from the audit
work performed in the current period.
In order to have the information necessary, the auditor should request that management
authorize the predecessor auditor to respond fully to inquiries from the auditor, and allow a
review of the prior year’s documentation.
The predecessor auditor may request a consent and acknowledgment letter from the entity
to document this authorization.
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Lecture note
Attached is the form of the letter we will furnish [name of successor CPA firm] regarding the use of the
audit documentation.
Very truly yours,
[Predecessor Auditor]
By: ______________________
Accepted:
ABC Enterprises
By: ______________________
Date: ____________
[Joanne M.Flood, 2016, Practitioner’s guide to GAAS]
The predecessor auditor may also request written confirmation of the auditor’s agreement
regarding the use of the audit documentation.
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[Predecessor Auditor]
By: __________________
Accepted:
[Successor Auditor]
By: __________________
Date: ___________
[Joanne M.Flood, 2016, Practitioner’s guide to GAAS]
The predecessor’s report should not reference as the basis, in part, for the auditor’s opinion.
If there is a material misstatements regarding prior financial statements, auditors should:
- correct to prior financial statemements: the auditor should ask management to inform
the predecessor auditor and arrange for a meeting of the three parties to try to resolve
the matter.
- Consider withdrawal or disclaim an opinion : if management refuse to inform the
processor auditor that the financial statements may need revision, or the auditor may
not be satisfied with the resolution
If auditors are unable to to obtain sufficient evidence regarding opening balances, the auditor
should disclaim an opinion or express a qualified opinion.
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Because of the significance of the matter described in the Basis for Disclaimer of Opinion paragraph, we
have not been able to obtain suf fi cient appropriate audit evidence to provide a basis for an audit opinion
on the results of operations and cash fl ows for the year ended December 31, 20X1.
Accordingly, we do not express an opinion on the results of operations and cash fl ows for the year ended
December 31, 20X1.
Opinion on the Financial Position
In our opinion, the balance sheet presents fairly, in all material respects, the financial position of ABC
Company as of December 31, 20X1, in accordance with accounting principles generally accepted in the
United States of America.
….
[Joanne M.Flood, 2016, Practitioner’s guide to GAAS]
The auditor should express a qualified or adverse opinion if the auditor concludes:
- That the opening balances contain a material misstatement that affects the current
statements and the effect is not appropriately accounted for or adequately disclosed
- That a change in accounting policies is not consistently applied or accounted for or
adequately presented or disclosed as to opening balances
If the prior period opinion included a modi fi cation relevant and material to the current
financial statements, the auditor should modify the current opinion in accordance with
Section
7.1.2. Auditing comprehensive data
ISA 710 Comparative Information – Corresponding Figures and Comparative Financial
Statements requires that comparative figures comply with the identified financial reporting
framework and that they are free from material misstatement.
IAS 1 Presentation of financial statements requires that financial statements show
comparatives.
Two categories of comparatives exist:
- corresponding figures where preceding period figures are included as an integral part
of the current period financial statements; and
- comparative financial statements where preceding period amounts are included for
comparison with the current period.
Audit procedures in respect of corresponding figures should be significantly less than for
the current period and are limited to ensuring that corresponding figures have been correctly
reported and appropriately classified. This involves evaluating whether:
- accounting policies are consistently applied; and
- corresponding figures agree to the prior period financial statements
Sufficient appropriate evidence should be gathered to ensure that comparative financial
statements meet the requirements of an applicable financial reporting framework. This
involves evaluating whether:
- accounting policies are consistently applied; and
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Events after the reporting date are categorised as either being an adjusting event and a non-
adjusting event. Adjusting events are incorporated into the financial statements as if they
existed at the reported date. Non-adjusting events are not incorporated into the financial
statements, although they may be disclosed.
Adjusting events: An adjusting event provides evidence of conditions that existed at the
reporting date. Examples: Resolution of a court case; Bankruptcy of a major customer;
Evidence of the NRV of inventories; Dicovery of fraud or errors
Non-adjusting event: A non-adjusting event provides evidence of conditions that arose
after the reporting date. For examples: Destruction of major assets after the reporting date
by fire or flood; Major share transactions; Announcing a plan to discontinue an operation;
Major purchases of assets.; Dividends proposed/ declared after the end of reporting period;
Entering into significant commitments or contingent liabilities; Commencing a court case
arising out of events after the reporting period.
7.2.2. The auditor and subsequent events
There will be a gap of time between the auditor finishing the audit and the financial
statements being published and issued to shareholders. Subsequent events are events
occurring between the company’s reporting date and the date of the auditor’s report, and
facts that become known to the auditor after the date of the audit report.
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- If the directors do not amend the financial statements accordingly then the auditor
should consider withdrawing the audit report.
- If management do not allow this (e.g. continue to distribute the financial statements
with the original audit report) then the auditor should take action to prevent
reliance on the audit report which could include the following:
+ Seek legal advice
+ Use the right to speak at the AGM
+ Consider resignation and call an EGM
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IAS1 states that an entity should prepare its financial statements on a going concern basis,
unless management intends to liquidate the entity or to cease trading or the directors have
no realistic alternative but to do so.
Where the assumption is made that the company will cease trading, the financial statements
are prepared using the breakup basis under which:
- The basis of preparation and the reason why the entity is not regarded as a going
concern are disclosed
- There are no long term assets or liabilities
- Assets are recorded at likely sale values
- Inventory and receivables are likely to require more provisions
- Additional liabilities may arise (severance costs for staff, the costs of closing down
facilities, etc.).
Where there is any significant doubt over the future of a company, the directors should
include disclosures in the financial statements explaining:
- the nature of and circumstances surrounding the doubts
- the possible effect on the company
Where the directors have been unable to assess going concern in the usual way (e.g. for less
than one year beyond the date on which they sign the financial statements), this fact should
be disclosed.
Where the financial statements are prepared on a basis other than the going concern basis,
the basis used should be disclosed.
7.3..2. Responsibilities of directors re GC
It is the directors’ responsibility to assess the company’s ability to continue as a going
concern when they are preparing the financial statements.
If they are aware of any material uncertainties which may affect this assessment, then IAS
1 requires them to disclose such uncertainties in the financial statements.
When the directors are performing their assessment they should take into account a number
of relevant factors such as:
- current and expected profitability
- debt repayment
- sources (and potential sources) of financing.
7.3..3. Problems with auditing going concern
When auditing going concern, the following is significant matters that the auditor should
pay attention:
- Consideration of the ‘foreseeable future’ involves making a judgement about future
events, which are inherently uncertain.
- Uncertainty increases with time and judgements can only be made on the basis of
information available at any point – subsequent events can overturn that judgement.
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PART 2
Liquidate assets
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Management Forecasts
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i. New borrowings
j. Income taxes
reporting framework on specific matters e.g. assets pledged as collateral; Confirmation that
any internal control deficiencies communicated to auditors.
7.4.2. Reliability of written representations
Representations from management are a source of audit evidence. They cannot be used
instead of other (better) evidence which the assurance providers expect to exist. But, they
may be the only available form of evidence in certain circumstances. They are relatively
unreliable as evidence (client generated). Together with represenation from management,
corroborative evidence will always be sought, but may not always be available. If a
representation appears to be contradicted by other evidence: the circumstances should be
investigated, and the reliability of other representations made by management should be
reconsidered.
7.4.3. If management won’t provide a written representation
In some situations, management might outright refuse to produce a written representation or
they do not provide representation on one or more areas requested by the auditor. Then, the
auditor should discuss the matters with management; re-consider the integrity of the
company management – this may have an impact on the reliability of other audit evidence
given. The auditor may consider the impact on the auditor report (more detail next lecture).
If the representation is inconsistent with other evidence obtained or if management refuse to
sign the written representation. The auditor should modify the audit opinion due to an
inability to obtain sufficient appropriate evidence.
[Entity Letterhead]
[To Auditor]
[Date]
This representation letter is provided in connection with your audit of the fi nancial statements of
ABC Company, which comprise the balance sheet as of December 31, 20XX, and the related statements of
income, changes in stockholders’ equity, and cash fl ows for the year then ended, and the related notes to
the financial statements, for the purpose of expressing an opinion on whether the fi nancial statements are
presented fairly, in all material respects, in accordance with accounting principles generally accepted in the
United States (US GAAP).
Certain representations in this letter are described as being limited to matters that are material. Items are
considered material, regardless of size, if they involve an omission or misstatement of accounting
information that, in the light of surrounding circumstances, makes it probable that the judgment of a
reasonable person relying on the information would be changed or influenced by the omission or
misstatement.
Except where otherwise stated below, immaterial matters less than $[insert amount] collectively are not
considered to be exceptions that require disclosure for the purpose of the following representa-tions. This
amount is not necessarily indicative of amounts that would require adjustment to or disclosure in the fi
nancial statements.
We con fi rm that, [to the best of our knowledge and belief, having made such inquiries as we considered
necessary for the purpose of appropriately informing ourselves] [as of (date of auditor’s report)]:
Financial Statements
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• We have ful fi lled our responsibilities, as set out in the terms of the audit engagement dated [insert date],
for the preparation and fair presentation of the fi nancial statements in accordance with US GAAP.
• We acknowledge our responsibility for the design, implementation, and maintenance of internal control
relevant to the preparation and fair presentation of fi nancial statements that are free from material
misstatement, whether due to fraud or error.
• We acknowledge our responsibility for the design, implementation, and maintenance of internal control to
prevent and detect fraud.
• Signifi cant assumptions used by us in making accounting estimates, including those measured at fair
value, are reasonable.
• Related-party relationships and transactions have been appropriately accounted for and disclosed in
accordance with the requirements of US GAAP.
• All events subsequent to the date of the fi nancial statements and for which US GAAP requires adjustment
or disclosure have been adjusted or disclosed.
• The effects of uncorrected misstatements are immaterial, both individually and in the aggregate, to the fi
nancial statements as a whole. A list of the uncorrected misstatements is attached to the representation letter.
• The effects of all known actual or possible litigation and claims have been accounted for and disclosed in
accordance with US GAAP.
[Any other matters that the auditor may consider appropriate.]
Information Provided
• We have provided you with:
• Access to all information of which we are aware that is relevant to the preparation and fair presentation of
the fi nancial statements such as records, documentation, and other matters;
• Additional information that you have requested from us for the purpose of the audit; and
• Unrestricted access to persons within the entity from whom you determined it necessary to obtain audit
evidence.
• All transactions have been recorded in the accounting records and are re fl ected in the fi nancial statements.
• We have disclosed to you the results of our assessment of the risk that the fi nancial statements may be
materially misstated as a result of fraud.
• We have [no knowledge of any] [disclosed to you all information that we are aware of regarding] fraud or
suspected fraud that affects the entity and involves:
• Management;
• Employees who have signi fi cant roles in internal control; or
• Others when the fraud could have a material effect on the fi nancial statements.
• We have [no knowledge of any] [disclosed to you all information that we are aware of regarding]
allegations of fraud, or suspected fraud, affecting the entity’s fi nancial statements communicated by
employees, former employees, analysts, regulators or others.
• We have disclosed to you all known instances of noncompliance or suspected noncompliance with laws
and regulations whose effects should be considered when preparing fi nancial statements.
• We [have disclosed to you all known actual or possible] [are not aware of any pending or threatened]
litigation, claims, and assessments whose effects should be considered when preparing the fi nancial
statements [and we have not consulted legal counsel concerning litigation, claims, or assessments].
• We have disclosed to you the identity of the entity’s related parties and all the related-party relationships
and transactions of which we are aware.
[Any other matters that the auditor may consider necessary.]
____________________________________
[Name of Chief Executive Officer and Title]
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____________________________________
[Name of Chief Financial Officer and Title]
[Joanne M.Flood, 2016, Practitioner’s guide to GAAS]
General
The effect of a new We have not completed the process of evaluating the effect that will result
accounting principle is from adopting the guidance in Financial Accounting Standards Board
not known. (FASB) Accounting Standards Update 20YY-XX, as discussed in Note [X].
The company is therefore unable to disclose the effect that adopting the
guidance in FASB Accounting Standards Update 20YY-XX will have on its
fi nancial position and the results of operations when such guidance is
adopted.
Financial circumstances Note [X] to the fi nancial statements discloses all of the matters of which we
are strained, with are aware that are relevant to the company’s ability to continue as a going
disclosure of concern, including signi fi cant conditions and events and management’s
management’s intentions plans.
and the entity’s ability to
continue as a going
concern.
The possibility exists that We have reviewed long-lived assets and certain identi fi able intangibles to
the value of specific signi be held and used for impairment whenever events or changes in
fi cant long-lived assets circumstances have indicated that the carrying amount of the assets might
or certain identifiable not be recoverable and have appropriately recorded the adjustment.
intangibles may be
impaired.
The entity has a variable Variable interest entities (VIEs) and potential VIEs and transactions with
interest in another entity. VIEs and potential VIEs have been properly recorded and disclosed in the
financial statements in accordance with GAAP.
We have considered both implicit and explicit variable interests in (1)
determining whether potential VIEs should be considered VIEs, (2)
calculating expected losses and residual returns, and (3) determining which
party, if any, is the primary beneficiary.
We have provided you with lists of all identified variable interests in (1)
VIEs, (2) potential VIEs that we considered but judged not to be VIEs, and
(3) entities that were afforded the scope exceptions of Financial Accounting
Standards Board (FASB) Accounting Standards Codification TM (ASC)
810, Consolidation.
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We have advised you of all transactions with identified VIEs, potential VIEs,
or entities afforded the scope exceptions of FASB ASC 810.
We have made available all relevant information about fi nancial interests
and contractual arrangements with related parties, de facto agents, and other
entities, including but not limited to their governing documents, equity and
debt instruments, contracts, leases, guarantee arrangements, and other fi
nancial contracts and arrangements.
The information we provided about fi nancial interests and contractual
arrangements with related parties, de facto agents and other entities includes
information about all transactions, unwritten understandings, agreement
modi fi cations, and written and oral side agreements.
Our computations of expected losses and expected residual returns of entities
that are VIEs and potential VIEs are based on the best information available
and include all reasonably possible outcomes.
Regarding entities in which the company has variable interests (implicit and
explicit), we have provided all information about events and changes in
circumstances that could potentially cause reconsideration about whether the
entities are VIEs or whether the company is the primary beneficiary or has a
significant variable interest in the entity.
We have made and continue to make exhaustive efforts to obtain information
about entities in which the company has an implicit or explicit interest but
that were excluded from complete analysis under FASB ASC 810 due to
lack of essential information to determine one or more of the following:
whether the entity is a VIE, whether the company is the primary beneficiary,
or the accounting required to consolidate the entity.
The work of a specialist We agree with the findings of specialists in evaluating the [describe
has been used by the assertion] and have adequately considered the quali fi cations of the
entity. specialist in determining the amounts and disclosures used in the fi nancial
statements and underlying accounting records. We did not give or cause any
instructions to be given to specialists with respect to the values or amounts
derived in an attempt to bias their work, and we are not otherwise aware of
any matters that have had an effect on the independence or objectivity of the
specialists.
Financial Instruments Debt securities that have been classi fi ed as held-to-maturity have been so
Management intends to classi fi ed due to the company’s intent to hold such securities to maturity
and has the ability to hold and the company’s ability to do so. All other debt securities have been classi
to maturity debt securities fi ed as available-for-sale or trading.
classi fi ed as held-to-
maturity.
Management considers We consider the decline in value of debt or equity securities classi fi ed as
the decline in value of either available-for-sale or held-to-maturity to be temporary.
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Lecture note
Management has The methods and signi fi cant assumptions used to determine fair values of
determined the fair value fi nancial instruments are as follows: [describe methods and significant
of signi fi cant fi nancial assumptions used to determine fair values of financial instruments]. The
instruments that do not methods and signi ficant assumptions used result in a measure of fair value
have readily appropriate for fi nancial statement measurement and disclosure purposes.
determinable market
values.
Financial instruments The following information about financial instruments with off-balance-
with off-balance-sheet sheet risk and financial instruments with concentrations of credit risk has
risk and financial been properly disclosed in the fi nancial statements:
instruments with
1. The extent, nature, and terms of financial instruments with off-balance-
concentrations of credit
sheet risk
risk exist.
2. The amount of credit risk of fi nancial instru-ments with off-balance-sheet
risk and infor-mation about the collateral supporting such fi nancial
instruments
3. Signi fi cant concentrations of credit risk aris-ing from all fi nancial
instruments and infor-mation about the collateral supporting such fi nancial
instruments
Investments [For investments in common stock that are either nonmarketable or of which
the entity has a 20% or greater ownership interest, select the appropriate
Unusual considerations
representation from the following:]
are involved in
determining the The equity method is used to account for the company’s investment in the
application of equity common stock of [investee] because the company has the ability to exercise
accounting. signi fi cant in fl uence over the investee’s operating and fi nancial policies.
The cost method is used to account for the company’s investment in the
common stock of [investee] because the company does not have the ability
to exercise signi fi cant in fl uence over the investee’s operating and fi nancial
policies.
The entity had loans to Loans to executive of fi cers have been properly accounted for and disclosed.
executive of fi cers,
nonaccrued loans or zero
interest rate loans.
Liabilities The company has excluded short-term obligations totaling $[amount] from
current liabilities because it intends to re fi nance the obligations on a long-
Debt
term basis. [Complete with appropriate wording detailing how amounts will
Short-term debt could be be refinanced as follows:]
re fi nanced on a long-
The company has issued a long-term obligation [debt security] after the date
term basis and
of the balance sheet but prior to the issuance of the financial statements for
management intends to
the purpose of re fi nancing the short-term obligations on a long-term basis.
do so.
The company has the ability to consummate there financing, by using the fi
nancing agreement referred to in Note [X] to the fi nancial statements.
……
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Lecture note
The overall review should be performed by the Engagement Partner –s/he will sign the audit
opinion and takes ultimate responsibility for the audit.
Reviews are also significant for a firm's appraisal system and development of staff.
Additionally they are an important element of any monitoring system, implemented to
identify and rectify deficiencies that could lead to poor quality work.
7.6.1. Financial statements review
To do this review, the auditor consider the important questions: Do the Financial statements
comply with the relevant framework, Law, GAAP, Other relevant regulations; is information
within annual report consistent with FSs; Do the financial statements make senses.
7.6.2. Audit evidence review
The audit evidence gathered must support the opinion given. The following questions are
significant to be considered: Was sufficient and appropriate evidence gathered; Was the
audit work performed in accordance with relevant laws / standards; What issues were there;
Were these resolved; Have matters been noted that may impact future year audits; Was the
original audit plan followed; Was is changed to allow for changing circumstances; Has the
file been reviewed appropriately.
7.6.3. Other completion procedures
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AOF ACCA Paper F8 – Audit and Assurance
Lecture note
Those work include: Final analytical review performed; Auditor independence assessed;
May require second partner review (only if required); Subsequent events review; Going
concern review; Obtain management representations
7.7. AUDIT REPORT
At the end of the audit, there are lots of reports to be signed.
- Management will sign the final management representation letter.
- The auditor will issue their audit report, containing the audit opinion.
Audit report is very important. If someone can demonstrate that the auditor owed them a
duty of care and they suffered loss by relying on the financial statements, they could sue
the auditor. Or as a member of the association (ACCA, ICAEW or VACPA), the auditor
could also face disciplinary proceedings, fines and penalties.
7.7.1. Elements of audit reports
Title The title should indicate that the report is by an independent auditor
to confirm all the relevant ethical standards regarding
independence have been met. These help readers to identify the
auditor’s report and to easily distinguish it from reports that might
be issued by others.
Auditor’s opinion The auditor’s report shall include a section with the heading
“Opinion”
If the auditor concludes that the financial statement give a true and
fair view, the auditor shall express an unmodified opinion which
states that the financial statements give true and fair view or present
fairly, in all material aspects, in accordance with the applicable
financial reporting framework.
Basis for opinion The basis for opinion section will (i) state that the audit was
conducted in accordance with the ISAs, (ii) includes a statement
that the auditor has fulfilled their ethical responsibilities and (iii)
states whether the auditor believes that the audit evidence obtained
is sufficient and appropriate to provide a basis for the audit opinion.
Going concern Where the auditor considers a material uncertainty related to going
concern exists, this should be described in a separate paragraph
headed ‘Material uncertainty related to going concern’. (ISA 570)
Key audit matters For the audit of listed entities, or where required by law and
regulation, the auditor should include a ‘Key audit matter’ section.
This section describes the matters that, in the auditor’s professional
judgment, are the most significant to the audit. (ISA 701)
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Lecture note
Other For the audit of listed entities or any other entity where the auditor
information has obtained other information, an ‘Other information’ section
(ISA 720) section should include:
• A statement that management is responsible for the other
information
• An identification of the other information obtained before
the date of the auditor’s report
• A statement that the auditor’s opinion does not cover the
other information
• A description of the auditor’s responsibilities for reading,
considering and reporting on other information, and
• Where other information has been obtained, either a
statement that the auditor has nothing to report, or a
description of any uncorrected material misstatement.
Auditor’s The auditor’s report shall include a section with the heading
responsibilities ‘Auditor’s responsibilities for the audit of financial statements’.
for the audit of The report shall state that the objectives of the auditor are to obtain
the financial reasonable assurance whether the financial statements as a whole
statements
are free from material misstatement, whether due to fraud or error,
and to issue an auditor’s report that includes the auditor’s opinion.
The report should state that the auditor’s responsibilities are:
• To exercise professional judgment and maintains
professional skepticism throughout the audit.
• To identify and assess the risks of material misstatement of
the financial statements and design and perform procedures
in response to those risks
• To obtain an understanding of internal control relevant to
the audit in order to design audit procedures but not to
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AOF ACCA Paper F8 – Audit and Assurance
Lecture note
Other reporting If the auditor is required by law to report on any other matters, this
responsibilities must be done in an additional paragraph below the opinion
paragraph which is titled 'Report on other legal and regulatory
requirements' or otherwise as appropriate.
Name of the The name of the audit engagement partner is included in the
engagement auditor’s report for audits of complete sets of general purpose
partner financial statements of listed entities.
Auditor’s The report shall contain the auditor’s signature, whether this is the
signature auditor’s own name or the audit firm’s name.
An auditor’s report shall state the auditor’s name.
Auditor’s address The location where the auditor practices must be included. This is
usually the city where the auditor has his office.
Date of the report The report shall be dated. This informs the reader that the auditor
has considered the effect on the financial statements and on his
report of events or transactions about which he became aware that
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AOF ACCA Paper F8 – Audit and Assurance
Lecture note
occurred up to that date. The date should not be earlier than the date
on which the auditor has obtained sufficient appropriate audit
evidence on which to base the opinion on the financial statements.
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Lecture note
title
INDEPENDENT AUDITOR’S REPORT
addressee
To the shareholders of ABC Company [or Other Appropriate Address]
Report on the Audit of the Financial Statements
audit opinion
Opinion
We have audited the financial statements of ABC Company (the Company) set out on pages 10 to 40, which
comprise the statement of financial position as at December 31, 20X1, and the statement of profit or loss
and other comprehensive income, statement of changes in equity and statement of cash flows for the year
then ended, and notes to the financial statements, including a summary of significant accounting policies.
In our opinion, the financial statements give a true and fair view of the financial position of the Company
as at 31 December, 20X1, and of its financial performance and its cash flows for the year then ended in
accordance with International Financial Reporting Standards (IFRSs) issued by the International
Accounting Standards Board and have been properly prepared in compliance with the Companies Act.
Basis for Opinion basic for opinion
We conducted out audit in accordance with International Standards on Auditing (ISAs) issued by the IFAC.
Our responsibilities under those standards are further described in the Auditor’s Responsibilities for the
Audit of the Financial Statements section of our report. We are independent of the Company in accordance
with the IFAC’s Code of Ethics for Professional Accountants (the Code), and we have fulfilled our other
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AOF ACCA Paper F8 – Audit and Assurance
Lecture note
ethical responsibilities in accordance with the Code. We believe that the audit evidence we have obtained
is sufficient and appropriate to provide a basis for our opinion.
Key Audit Matters listed => key risk
of material
Key audit matters are those matters that, in our professional judgment, were of most significant in our audit
of the financial statements ofmisstatement
the current period. These matters were addressed in the context of our audit
of the financial statements as & how to
a whole, andrespond
in forming our opinion thereon, and we do not provide a separate
opinion on these matters. to risk assessed
[Description of each key audit matter in accordance with ISA 701, which applies to audits of the financial
statements of listed entities.]
Other information
The directors are responsible for the other information. The other information comprises the [information
included in the X report, but does not include the financial statements and our auditor’s report thereon.]
Our opinion on the financial statements does not cover the other information and we do not express any
form of assurance conclusion thereon.
In connection with our audit of the financial statements, our responsibilities is to read the other information
and, in doing so, consider whether the other information is materially inconsistent with the financial
statements or our knowledge obtained in the audit or otherwise appears to be materially misstated. If, based
on the work we have performed, we conclude that there is a material misstatement of this other information;
we are required to report that fact. We have nothing to report in this regard.
Responsibilities of Management and Those Charged with Governance for the Financial Statements
The directors are responsible for the preparation of the financial statements that give a true and fair view in
accordance with IFRSs issued by the IASB and the (Country’s) Companies Act, and for such internal control
as the directors determine is necessary to enable the preparation of financial statements that are free from
material misstatement, whether due to fraud or error.
In preparing the financial statements, the directors are responsible for assessing the Company’s ability to
continue as a going concern, disclosing, as applicable, matters related to going concern and using the going
concern basis of accounting unless management either intends to liquidate the Company or to cease
operations, or has no realistic alternative but to do so.
Those charged with governance are responsible for overseeing the Company’s financial reporting process.
Auditor’s Responsibilities for the Audit of the Financial Statements
Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free
from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our
opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in
accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise
from fraud or error and are considered material if, individually or in the aggregate, they could reasonably
be expected to influence the economic decisions of users taken on the basis of these financial statements.
As part of an audit in accordance with ISAs, we exercise professional judgment and maintain professional
skepticism throughout the audit. We also:
Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or
error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is
sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material
misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion,
forgery, international omissions, misrepresentations, or the override of internal control.
Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of
the Company’s internal control.
Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates
and related disclosures made by management.
Conclude on the appropriateness of management’s use of the going concern basis of accounting and, based
on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that
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Lecture note
may cast significant doubt on the Company’s ability to continue as a going concern. If we conclude that a
material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures
in the financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions
are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or
conditions may cause the Company to cease to continue as a going concern.
Evaluate the overall presentation, structure and content of the financial statements, including the disclosures,
and whether the financial statements represent the underlying transactions and events in a manner that
achieves fair presentation.
We communicate with those charged with governance regarding, among other matters, the planned scope
and timing of the audit and significant audit findings, including any significant deficiencies in internal
control that we identify during our audit.
We also provide those charged with governance with a statement that we have complied with relevant ethical
requirement regarding independence, and to communicate with them all relationships and other matters
that may reasonably be thought to bear on our independence, and where applicable, related safeguards.
From the matters communicated with those charged with governance, we determine those matters that were
of most significance in the audit of the financial statements of the current period and are therefore the key
audit matters. We describe these matters in our auditor’s report unless law or regulation precludes public
disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should not
be communicated in our report because the adverse consequences of doing so would reasonably be expected
to outweigh the public interest benefits of such communication.
Report on Other Legal and Regulatory Requirements
[The form and content of this section of the auditor’s report would vary depending on the nature of the
auditor’s other reporting responsibilities prescribed by local law or regulation. The matters addressed by
other law or regulation (referred to as “other reporting responsibilities”) shall be addressed within this
section.
The engagement partner on the audit resulting in this independent auditor’s report is [name].
XYZ & Co
[Auditor Address]
[Date]
[Joanne M.Flood, 2016, Practitioner’s guide to GAAS]
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Lecture note
This paragraph is used to highlight a matter included in the financial statements which has
been correctly disclosed but which is fundamental to the understanding of the users of the
financial statements. This should be included in the audit report after the opinion (T&F),
headed up ‘Emphasis of Matter’. EOM should describes the matter, and states that the audit
opinion is not modified in this respect. For example: An item of significant uncertainty such
as the outcome of a major legal claim that has been adequately disclosed in the financial
statements. The auditor should not use EOM for for going concern (material uncertainty
over GC paragraph used instead – see later).
ILLUSTRATION 3:
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.
ILLUSTRATION 3:
Other Matter
In our report dated March 1, 20X1, we expressed an opinion that the 20X0 financial statements did not
fairly present the fi nancial position, results of operations, and cash fl ows of ABC Company in
accordance with accounting principles generally accepted in the United States of America because of two
departures from such principles: (1) ABC Company carried its property, plant, and equipment at appraisal
values, and provided for depreciation on the basis of such values, and (2) ABC Company did not provide
for deferred income taxes with respect to differences between income for financial reporting purposes and
taxable income. As described in Note X, the Company has changed its method of accounting for these
items and restated its 20X0 fi nancial statements to conform with accounting principles generally accepted
in the United States of America. Accordingly, our present opinion on the restated 20X0 fi nancial
statements, as presented herein, is different from that expressed in our previous report.
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Lecture note
- Adverse opinion: “In our opinion, because of the significance of the matter described
in the Basis for Adverse Opinion paragraph, the financial statements do not give a true
and fair view...”
- Disclaimer of opinion: “Because of the significance of the possible impact of the
uncertainties, described in the Basis for Disclaimer of Opinion paragraph, we do not
express an opinion on the financial statements...”
ILLUSTRATION 4:
Qualified Opinion
In our opinion, except for the effects of the matter described in the Basis for Qualified Opinion paragraph,
the financial statements give a true and fair view of the state of the Company’s affairs as at 31 December
31 20X1, and of its [profit][loss] and its cash flows for the year then ended in accordance with
International Financial Reporting Standards and have been properly prepared in accordance with the
Company Act.
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.
ILLUSTRATION 5:
Qualified Opinion
In our opinion, except for the possible effects of the matter described in the Basis for Qualified Opinion
paragraph, the financial statements give a true and fair view of the state of the Company’s affairs as at 31
December 20X1, and of its [profit][loss] and cash flows for the year then ended in accordance with
International Financial Reporting Standards and have been properly prepared in accordance with the
Companies Act.
Basis for Qualified Opinion
ABC Limited’s investment in DEF Limited, a foreign associate acquired during the year and accounted
for by the equity method, is carried at xxx on the [balance sheet] [statement of financial position] as at 31
December 20X1, and ABC’s share of DEF’s net income of xxx is included in ABC’s income for the year
then ended. We were unable to obtain sufficient appropriate audit evidence about the carrying amount of
ABC’s investment in DEF as at 31 December 20X1 and ABC’s share of DEF’s net income for the year
because we were denied access to the financial information, management, and the auditors of DEF.
Consequently, we were unable to determine whether any adjustments to these amounts were necessary.
ILLUSTRATION 6:
Adverse Opinion
In our opinion, because of the significance of the matter discussed in the Basis for Adverse Opinion
paragraph, the consolidated financial statements do not give a true and fair view of the state of affairs of the
Company and of the Group as at 31 December 20X1, and of the Group’s [profit][loss] and cash flows for
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Lecture note
the year then ended in accordance with International Financial Reporting Standards. In all other respects, in
our opinion the consolidated financial statements have been properly prepared in accordance with the
Companies Act.
Basis for Adverse Opinion
As explained in Note X, the Company has not consolidated the financial statements of subsidiary DEF
Limited it acquired during 20X1 because it has not yet been able to ascertain the fair values of certain of
the subsidiary’s material assets and liabilities at the acquisition date. This investment is therefore
accounted for on cost basis. Under the International Financial Reporting Standards, the subsidiary should
have been consolidated because it is controlled by the Company. Had DEF been consolidated, many
elements in the financial statements would have been materially affected. The effects on the consolidated
financial statements of the failure to consolidate have not been determined.
ILLUSTRATION 7:
Disclaimer of Opinion
Because of the significance of the matter 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. In all other respects, in our opinion
the financial statements have been properly prepared in accordance with the Company Act.
Basis for Disclaimer of Opinion
The Company’s investment in its joint venture DEF (Country X) Limited is carried at xxx on the
Company’s [balance sheet][statement of financial position], which represents over 90% of the Company’s
net assets as at 31 December 20X1. We were not allowed access to the management and the auditors of
DEF, including DEF’s auditors’ audit documentation. As a result, we were unable to determine whether
any adjustments were necessary in respect of the Company’s proportional share of DEF’s assets that it
controls jointly, its proportional share of DEF’s liabilities for which it is jointly responsible, its
proportional share of DEF’s income and expenses for the year, and the elements making up the statement
of changes in equity and [cash flow statement][statement of cash flow].
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Lecture note
Different types of errors result in different opinions being given. When considering the
errors, auditor should refer to the accounting standards to make assessment. There are 2
types of error.
- Disagreement: The auditor disagrees with the directors over accounting treatment or
disclosure resulting in the financial statements being misstated. For example, A
customer has gone into liquidation and cannot pay, so receivables are overstated.
- Limitation of scope: The auditor is unable to obtain sufficient appropriate audit
evidence over a balance/(s) in the financial statements. For example, A military coup
overseas means the auditor cannot attend the inventory account at the location where
the client holds most of its stock.
Step 2: Consider the seriousness of the problem: The seriousness of the problem can be
divided into 3 types
- Immaterial: Something that is below the materiality threshold would not impact the
users of the financial statements.
- Material: Something that is material would impact the users of the financial
statements. Things are material by nature (e.g. director’s transactions) or by size ( ½–
1% of revenue, 1–2% of gross assets, 5–10% of profit before tax)
- Pervasive or not: ISA 705 defines a pervasive matter as one which is not isolated; or
represents a substantial proportion of the financial statements; or is fundamental to the
users’ understanding.
Step 3: Determine appropriate opinion
The audit opinion that the auditor gives will depend on the type of error, and the
seriousness of the matter. The auditor can follow this decision rule to determine the
appropriate audit opinion.
Limitation of
Disagreement
Scope
concern is not certain and there are doubts over the GC status, the company must disclose
that fact clearly in the financial statements.
Material uncertainty related to going concern
- Under ISA 570 (Revised), if the use of the going concern basis of accounting is
appropriate but a material uncertainty exists and management have included adequate
disclosures relating to the material uncertainties the auditor will continue to express an
unmodified opinion, but the auditor must include a separate section under the heading
‘Material Uncertainty Related to Going Concern’
- This draws attention to the note in the financial statements that discloses the matters
giving rise to the material uncertainty, and
- States that these events or conditions indicate that a material uncertainty exists which
may cast significant doubt on the entity’s ability to continue as a going concern and that
the auditor’s opinion is not modified in respect of the matter.
The following issues may raise regarding going concern (“GC”)
Scenario 1: Company is a GC and has used GC basis: In this case, the auditor should
give unmodified opinion that financial statements give a true and fair view.
Scenario 2: Company is not a GC and the financial statements have been prepared on
the break-up basis: The auditor will issue an unmodified opinion. A goig concern issue is
important the understanding of the users of the financial statements and therefore the auditor
will include a material uncertainty related to going concern paragraph
Scenario 3: Company is not a GC and the financial statements have NOT been
prepared on the break-up basis: This is a disagreement. It is considered material by nature
and is pervasive to the users understanding of the financial statements. The auditor will issue
an adverse opinion.
Scenario 5: Company may not be a GC and the uncertainty has been adequately
disclosed: Issue an unmodified opinion and will include a material uncertainty related to
GC paragraph.
Scenario 6: Company may not be a GC and the uncertainty has NOT been adequately
disclosed: If the auditor consider this problem is material but not pervasive and therefore
the auditor will issue a modified ‘except for’ opinion. If the auditor considered this issue is
material and pervasive, the auditor will issue an adverse opinion.
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Lecture note
management requires that above their normal audit work, auditor should note deficiencies
in the internal control system and report these in the management letter.
Management letter is a report to those charge with governance and management which
normally include the observations of auditor which identifies the weakness point of internal
control, the possible consequences which could result from those weakness and the auditor’s
recommendation for improvement.
A report to management generally include: a covering letter and a appendix showing the
control deficiencies, implication and recommendation.
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Lecture note
…… …… ……
147