LEARNING UNIT 3

F I N A N C I A L S TAT E M E N T A U D I T
HOW DO YOU DECIDE WHETHER AN
ORGANISATION SHOULD HAVE AN AUDIT OR A
REVIEW?

The need for auditing is as a response to the needs of

society, therefore of public interest.
Criteria:
• The public interest score
• Who compiles the financial statements (Internally or
Eternal)
PUBLIC INTEREST
• Employment
• Pension funds
S • Direct/indirect
u shareholding
r • Trading
Busines • Loans

Society v • Purchasing a
i
v s house
• Purchasing a
vehicle
a • Education
l
 BEFORE 2008 COMPANIES ACT
• All companies, large or small, public or private = audit
• Close corporations = no audit
BUT!!!!!
CC’s were often bigger than small companies, but did not need an audit

Reasoning:
• CC’s are run by owners
• No split between ownership and management
• If you manage your own CC, you don’t need to report on the
custodianship of your own money to yourself
COMPANIES ACT 2008
• Decision is no longer based only on business type, but on the level of
PUBLIC INTEREST in the entity.
• All companies must calculate their public interest score for each
financial year.
Your public interest score is the sum of:
• A number of points equal to the average number of employees during
the financial year
• One point for every R1million (or portion thereof) of turnover
• One point for every R1million (or portion thereof) of 3rd party liability
at year end
• One point for every individual who directly or indirectly has a
WHO COMPILES THE AFS?
• Internally
• Externally

Therefore:
• High Public interest score + AFS compiled internally = external audit
• Low Public interest score + AFS compiled externally = review
 AN AUDIT OR A REVIEW?
Public interest Company CC and owner managed companies
score

Less than 100 Review No assurance engagement

required
100 – 349 Audit if AFS are internally Audit if AFS are internally
compiled compiled

Review if AFS are externally No assurance required if AFS are

compiled externally compiled
350 and above Audit regardless of who compiles Audit regardless of who compiles
the AFS the AFS
 ABC Ltd Number of points

Turnover R97.4m 98

Employees at start of year 132

Employees at end of year 116

Average employees 124 124

Amount owed to short term and long R14.8m 15

term creditors

Individuals (all shareholders) with a 15 15

direct or indirect interest in the
company’s shares

Public interest sore 252

 XYZ Number of points

Turnover R23.1m 24

Employees at start of year 37

(New=15; Retired=1) End of the year 51

Average employees 44 44

Amount owed to short term and long R7m 7

term creditors

Individuals (all shareholders) with a 10 10

direct or indirect interest in the
company’s shares

Public interest sore 85

 AN AUDIT OR A REVIEW?
Some companies must be audited regardless of
their Public interest score:
• Public companies and State Owned Entities
(SOE)
• Companies which hold assets exceeding R5
million in the normal course of their primary
activities in a fiduciary capacity for persons not
related to the company
 FINANCIAL STATEMENT AUDITING
• Split between ownership and management
Need for independent party to express an opinion (3-party relationship)
• A matter of public interest to protect investors and economic system
• Companies Act
ISA 200: Note (a) Objectives of the auditor:
• Reasonable assurance that financial statements as a whole are free from
material misstatement and are prepared in accordance with an applicable
financial reporting framework (e.g IFRS)
• Report on the AFS and communicate findings as required by ISA
 FINANCIAL STATEMENT AUDITING
Note (b) What the auditor’s opinion is not:
• Assurance of future viability
• Assurance of the efficiency with which management conducted the
affairs of the entity

Note (c) It is not the objective of the audit:

• To discover or prevent fraud
• To ensure compliance with the law
ROLES OF VARIOUS PARTIES
 ROLES OF VARIOUS PARTIES
Shareholders:
• Provide finance for the business
• Appoint directors to manage the business
• Appoint auditors
• Receive AFS from directors and a report from the auditors
Directors:
• Run the company and report results of stewardship to shareholders
• Prepare AFS in terms of applicable financial reporting framework (IFRS)
Auditors:
• Gather sufficient appropriate evidence to be in a position to give an independent
opinion on AFS if they present fairly the financial position in terms of ………
• Report the audit opinion to the shareholders
 ROLE OF THE COMPANIES ACT
Section 30 of the Companies Act:
• Compulsory for all public companies to be audited
• Gives the Minister the power to make regulations which require private
companies to be audited (public interest score)
The Companies Act also:
• Regulates the appointment of auditors and directors, as well as disqualifying
certain individuals
• Places an obligation on directors (prepare AFS, stipulate some content, give
legal backing for the reporting standards)
• Give the auditor the right of access to the company’s records
• Requires public companies to appoint an audit committee and lays down the
functions of the audit committee
 ROLE OF THE AUDITING PROFESSION
ACT 2005 (AP ACT)
• Only registered auditors may perform an audit of an entity’s financial
statements
• The individual who is responsible for the audit is identified and named the
“designated auditor”
• The Act lays down the broad conditions for conducting an audit . The act places
a duty on the auditor to report any reportable irregularity uncovered at an audit
client to the IRBA
 BROAD CONDITIONS LAID DOWN BY
THE AP ACT 2005
An auditor may only express an unqualified audit opinion if:
• Carried out free of restriction
• In compliance with applicable auditing pronouncements
• Existence of all assets and liabilities
• Proper accounting records in an official language
• If the auditor obtained all information, vouchers and other documents, that he
feels is necessary to perform his audit properly
• No occasion to report a reportable irregularity to the IRBA
• Complied with all the laws relating to the audit
• Is satisfied as to the fairness of the statements
ROLE OF INTERNATIONAL STANDARDS ON AUDITING
ISA provide:
• Standards that the auditor must attain
• Guidance on how to do it
ISA do not provide:
• Detailed lists of audit procedures
ISA cover the entire audit process:
• Preliminary activities
• Planning
• Gathering sufficient appropriate evidence
• Deciding on an appropriate audit opinion
• Reporting the opinion
 ROLE OF ASSERTIONS
Assertions:
• Laid down in ISA 315
• Claims and presentations made by the directors about the
company’s assets, equity, liabilities, transactions and
events, and disclosures
Different types of assertions:
Assertions about classes of transactions and events
Assertions about account balances and related disclosures
at the period end
 ASSERTIONS: CLASSES OF TRANSACTIONS AND
EVENTS
(Items in your P&L Account/ Income Statement)
OCCURRENCE – transactions and events which have been recorded or
disclosed, have occurred and pertain to the entity
COMPLETENESS - all transactions and events, which should have been
recorded, have been recorded, and all related disclosures that should have been
included in the FS have been included
CUT OFF – transactions and events have been recorded in the correct
accounting period
ACCURACY – amounts and other data relating to recorded transactions and
events have been recorded appropriately, and related disclosures have been
appropriately measured and described
 ASSERTIONS: CLASSES OF TRANSACTIONS AND
EVENTS
PRESENTATION – transactions and events are:
• appropriately aggregated or disaggregated
• and clearly described,
• and related disclosures are relevant and understandable in the context of the
applicable financial reporting framework
 ASSERTIONS: ACCOUNT BALANCES AND
RELATED DISCLOSURES AT THE END OF PERIOD
(Items in your Statement of Financial position/ Balance Sheet)
EXISTENCE – assets, liabilities and equity interest exist
RIGHTS AND OBLIGATIONS – the entity holds or controls the rights to
assets, and liabilities are the obligations of the entity
COMPLETENESS– all assets, liabilities and equity interests that should have
been recorded, have been recorded, and all related disclosures that should have
been included in the FS have been included
ACCURACY, VALUATION AND ALLOCATION – assets, liabilities and
equity interests have been included in the FS at appropriate amounts and any
resulting valuation or allocation adjustments (depreciation, obsolescence) are
appropriately recorded, and related disclosures have been appropriately
measured and described
 ASSERTIONS: ACCOUNT BALANCES AND
RELATED DISCLOSURES AT THE END OF PERIOD
CLASSIFICATION – assets, liabilities and equity interests have been recorded
in the proper accounts
PRESENTATION – assets, liabilities and equity interests are:
• appropriately aggregated or disaggregated
• and clearly described,
• and related disclosures are relevant and understandable in the context of the
applicable financial reporting framework
 EXAMPLE: WHAT ARE THE DIRECTORS ACTUALLY
SAYING/CLAIMING(ASSERTIONS) WITH THE FOLLOWING ITEM:
TRADE ACCOUNTS RECEIVABLE R2 782 924?
EXISTENCE: The debtors really existed, there are no fictitious debtors included
RIGHTS: the company has a right to the amounts owed by the debtors
COMPLETENESS: all debtors are included in the amount, and all related disclosures
have been made
ACCURACY, VALUATION AND ALLOCATION: the amount is appropriate
represents the amount that we can reasonably expect to collect from the debtors after
we made allowance for the bad debts
CLASSIFICATION: accounts receivable have been recorded in the correct accounts
PRESENTATION: accounts receivable have been appropriately
aggregated/disaggregated and clearly described and related disclosures are relevant
and understandable
 WHAT IS THE AUDITOR’S ROLE WITH REGARD TO
ASSERTIONS?
Assess the risk that there could be material misstatements (Consider the
likelihood of material misstatements of each assertion)
Conduct procedures to gather sufficient appropriate evidence to form an
opinion as to whether the account balances are presented fairly
 ROLE OF PROFESSIONAL SCEPTICISM
What is professional scepticism?
It is an attitude:
• Should be adopted by all members of the engagement team
• Questioning mind
• Be alert to conditions which may indicate possible misstatement due to error or
fraud
• Assess audit evidence critically
• Do not be led around by the nose, don’t accept everything you are told or
shown
• Remain unconvinced until you have suitable evidence to support a fact
 ROLE OF PROFESSIONAL SCEPTICISM
What should the auditor be alert to?
• Contradicting evidence
• Information that makes you question the reliablity of documents, responses to
inquiries
• Conditions that may indicate fraud

What if I’m not that type of person?

• It is not a choice, it is a requirement.

Still remain polite, dignified and professional, not rude, dismissive

 ROLE OF PROFESSIONAL JUDGEMENT
• Auditing is not a set of clear defined procedures carried out on clear-cut facts
and figures
• Different circumstances (no one size fits all)
• Consider and respond to uncertainties and options

What is professional judgement?

• Application of the relevant training, knowledge and experience
• Within the context of auditing, accounting and ethical standards
• In making informed decisions about the courses of action and options that are
appropriate in the circumstances of the audit
 ROLE OF PROFESSIONAL JUDGEMENT
• ISA 200 – auditor has to exercise professional judgement in planning
and performing audits of FS

Examples:
• Evaluating the integrity of the client’s management
• Deciding on materiality levels
• Identifying and assessing risk
• Evaluating whether sufficient appropriate evidence has been gathered
• Drawing conclusions on the evidence obtained and
• Deciding on the appropriate audit opinion to give
 AUDITING POSTULATES
Things assumed as a basis for reasoning
Postulates provide a basis for thinking about problems and arriving
at solutions
It is a starting point
A fundamental condition
 POSTULATES
No necessary conflict of interest exists between the auditor and
management/employees of the enterprise under audit (both client and auditor
have the same objective with regard to fair presentation)
• Common desire
• Assume that management do not want to manipulate the FS
• What if management doesn’t want to have fair presentation?

Questionable
• Traditionally the auditor would be able to rely on management’s integrity
• Recently due to increase in fraud, the auditor has to evaluate management
integrity with professional scepticism
 POSTULATES
An auditor must act exclusively as auditor in order to be able to offer an
independent and objective opinion on the fair presentation of financial
information
• Can only rely on opinion if it is free of any bias, therefore independent
• Has to be independent, and be SEEN as being independent
• Other services?
• Audit committee duty, to approve other service that the auditor
provides
 POSTULATES
The professional status of the independent auditor imposes
commensurate professional obligations
• Auditor has qualities, knowledge and capabilities that sets him/her
apart
• Status brings expectations
• Status brings responsibilities
• Due care, service before personal interest, efficiency, competence
 POSTULATES
Financial data is verifiable
It is possible to verify
• What if it is not possible? It would not be possible to do the audit
• Opinion is based on the level of assurance gained through verification
 POSTULATES
Internal controls reduce the probability of errors and irregularities
• What is internal control? Policies and procedures which a business puts
in place to ensure that its recorded transactions are valid, accurate,
complete & complies with the laws.
• Control makes it possible, not probable (control environment, division
of duties, proper authorisation, etc.)
• The better the control, the better the chances of FS that are truthful
• What if there are no effective control? Auditors are forced to refrain
from offering an opinion, or conduct detailed audit examinations.
 POSTULATES
Application of generally accepted accounting practice results in fair
presentation
• If you follow the framework it will result in fair presentation
• Fairness cannot rely on your personal preference, you need an
objective, generally accepted standard
• Evidence of proper application of the framework = fair presentation
has been achieved
 POSTULATES
That which held true in the past will hold true in the future (in the
absence of any contrary evidence)
• Things generally stay the same
• Historical information e.g. Bad debts
• Integrity of directors?
• Factual historical evidence is more powerful that speculations.
• But things CAN change
 POSTULATES
The financial statements submitted to the auditor for verification are free
of collusive and other unusual irregularities
• Start with the assumption that the FS do not contain misstatements due
to collusion or other irregularities
• Without evidence to the contrary
 assume that management took the necessary steps to prevent collusion
 Members of management did not collude
• Corporate governance and professional scepticism
• Assume the opposite?
LEARNING UNIT 3

THANK YOU!!!