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Regulatory Environment

International Regulatory Frameworks
The Need for Standards and Regulations

Regulation is needed to ensure that auditors are acting in the public

These 'regulations' come in 4 ways
1. Ethics
2. Standards
3. Regulations
4. Statutory

The international regulatory framework for audit and assurance services encompasses:
International Federation of Accountants (IFAC) pronouncements

Corporate Governance

Audit Committees

Know the Structure, Role & Benefits / Drawbacks

Structure of the Committee
At least one member of the committee should have recent and relevant financial experience.

There should be at least 3 non executive directors. In the case of smaller companies, this may be 2.

Role of the committee
1. To improve the quality of financial reporting
2. To increase the confidence of the public in the financial statements.
3. Assist directors in meeting their responsibilities in respect of financial reporting.
4. Provide a channel to external auditors to report concerns or issues.
5. Review the company’s system of internal controls.
6. Strengthen the position of internal audit by providing greater independence from management.
7. Appointment of external auditor.

Advantages of a committee
Independent Reporting
Provides internal audit with an independent reporting mechanism. Without this management may be tempted to hide
unfavourable reports.

Frees up Executive time
Leaves top executives free to manage by providing expertise on financial reporting

Corporate Governance monitored
Ensures that corporate governance requirements are brought to attention of the board

Appropriate Internal Controls
Should ensure that an appropriate system of internal control is maintained.

Better Communication

Better communication between the directors, external audit and management is facilitated.

Strengthens external audit independence
Strengthens independence of external audit as their appointment is now not made by the board.

Disadvantages of Committee
1. Executive directors may perceive it as a threat to their authority.
2. Finding non executive directors with appropriate expertise may be difficult.
3. Additional costs will be involved.
4. Too much detail may be thrust upon non executive directors.

Communication with the audit committee

Why does the external auditor speak first to the Audit Committee?
1. To ensure independence between the board and the audit firm.
The audit committee consists of independent NEDs, who can therefore take an objective view of the audit report.

2. The audit committee has more time to review the audit report and other communications (eg management letters) than the board.
The auditor should therefore benefit from their reports being reviewed carefully

3. The audit committee can ensure that any recommendations from the auditor are implemented.
The NEDs can pressurise the board to taking action on auditor recommendations

4. The audit committee also has more time to review the effectiveness and efficiency of the work of the external auditor than the
The committee can therefore make recommendations on the re-appointment of the auditor, or recommend a different firm if this
is appropriate

Public Interest Oversights Board

A profession has a responsibility to the public

Public Interest Oversight Boards
1. Oversees IFAC's auditing and assurance
2. Believes standards should be high quality, clear and usable
3. Ensures auditors act independently of personal interests, and be responsive to emerging needs of standard users
4. Promote compliance with IFAC standards by the member bodies of IFAC around the world

Money Laundering
Money Laundering Basics

Cashing up
A business taking large amounts of small change each week (e.g. a convenience store) needs to deposit that money in a bank. If
its deposits vary greatly for no obvious reason this can draw suspicion; but if the transactions are regular and roughly the same
the suspicion is easily discounted. This is the basis of all money laundering, a track record of depositing clean money before
slipping through dirty money.
In the United States, for example, cash transactions and deposits of more than $10,000 must be reported by the cashier (the
bank etc) as "significant cash transactions" to the Financial Crimes Enforcement Network FinCEN, with any other suspicious
financial activity identified as "suspicious activity reports" (SARs).
In other jurisdictions suspicion-based requirements may be placed on financial services employees and firms to report suspicious

A record of a haircut must ostensibly be accepted as prima facie evidence. For example. perform some service (not provide physical goods). it is quite reasonable to think that a hairstylist is paid in cash and. as accountants operate in the regulated sector and are therefore required to report suspicions of money laundering . and have a business that reasonably would accept cash as a matter of course. To avoid suspicion. In 1990 FATF issued recommendations to combat the misuse of financial systems to launder drug money. But all bank employees are trained to be constantly on the lookout for transactions that seem to be trying to get around reporting requirements. which promotes policies globally to combat money laundering and terrorist financing. purely for the purpose of accepting money from them. does not know their bank details. but the receipt for the computer. shell companies should deal directly with the public. The UK examples are: Possessing or concealing the proceeds of any crime Attempting or helping to commit the above offence Failure by a person in the regulated sector to inform the appropriate party of a suspicion that someone is money laundering Making a disclosure which is likely to prejudice an investigation into money laundering (tipping off) The last two offences are the ones that accountants may find themselves affected by even inadvertently. Captive business Another method is to start a business whose cash inflow cannot be monitored. including: • customer due diligence and record​keeping • reporting of suspicious transactions to an appropriate authority • international co​operation including extradition of suspects.activity to the authorities. International efforts to combat money laundering The Financial Action Task Force (FATF) is an international body. exists — that for the haircut probably does not. even if she knows her customer's names. whereas the hairstylist does not have to produce the cut hair. and funnel the small change into it and pay taxes on it. even if inflated. Dealing directly with the public in cash gives a plausible reason for not having a record of customers. It is of course also possible to invent customers. There are various criminal offences connected with money laundering. Service businesses have the advantage of the anonymity of resources — but the disadvantage that they must deal in cash. The recommendations include: • making money laundering a criminal offence measures to be taken by businesses and professions to prevent money laundering. A business that sells computers has to account for the computers. These recommendations have become the benchmark against which a country’s rules are assessed.

providing a legitimate cover for their sources of income. The term is widely defined to include: . ultimately. source. Money laundering is thus the process by which criminals attempt to conceal the true origin and ownership of the proceeds generated by illegal means. or destination of illegally gained money. It is taking any action with property of any form which is either wholly or in part the proceeds of a crime that will disguise the fact that that property is the proceeds of a crime or obscure the beneficial ownership of said property. allowing them to maintain control over the proceeds audio pause audio clipAttachment play Tweet Like RCAtweets Defences to charges of money laundering: A report had been made to the appropriate party There was an intention to make a report and a reasonable excuse (likely to include fear of physical violence or other menaces) for not having done so Acquiring or using property for adequate consideration in good faith Money laundering is creating the appearance that money obtained from crimes originated from a legitimate source. In UK law the common law definition is wider. It basically means any financial transaction which generates an asset or a value as the result of an illegal act. which may involve actions such as tax evasion or false accounting. In US law it is the practice of engaging in financial transactions to conceal the identity.

Concealing .1.the proceeds of any crime International Efforts on Money Laundering The Financial Action Task Force on Money Laundering (FATF) is an international body which sets standards. and develops policies to combat money laundering and terrorist financing It currently has 35 member countries/territories and observers such as the World Bank and International Monetary Fund).. Dealing with in any way 3. Possessing 2. Their recommendations are endorsed by more than 180 countries and are the international anti-money laundering standard against which national anti-money laundering systems are assessed The recommendations cover Policies and coordination Money laundering and confiscation Terrorist financing and financing of proliferation ....

. Tipping off 7. No ongoing client due diligence 5. 1. Not appointing a Money Laundering Reporting Officer (MLRO) 2. 3. and – reporting of suspicious transactions and compliance to an external financial intelligence unit (FIU).More specifically these deal with: 1. Measures needed in systems for combating money laundering. International co-operation including mutual legal assistance and extradition Scope of Money Laundering Principal Offences of Money Laundering. Tax evasion . Not verifying identity of all new clients 4. Failure to report a suspicion of ML 6. The scope of the criminal offence of money laundering 2. Not having risk management procedures and internal controls complying with anti-ML legislation 3. These are the common ones under UK legislation but generally apply worldwide and hence in the exam. Measures to prevent money laundering including: – customer due diligence (CDD) and record-keeping.. including transparency of legal persons and arrangements 4.

g. . this must be reported to the appropriate authority Also not being suspicious is not a defence if it is clear that a reasonable person should have been suspicious The fear of tipping off should not prevent the professional accountant from discussing money laundering matters with clients on a non-specific basis. Not doing so.. when requested. may amount to tipping off. If the client asks the accountant to commit a suspected ML offence. How Accountants May Be Protected All partners are potentially liable on a joint and several basis for breaches of the firm's obligations General Defences Defences to money laundering offences include: Reporting to the MLRO Intending to report BUT there was a reasonable excuse for not doing so (fear of violence) We thought the client's actions were in good faith (and it's a reasonable assumption) How Accountants Prevent Money Laundering Accountants have money laundering obligations. not carrying out a client's instructions that is effectively a money laundering operation).Tipping-off This is when an individual who is suspicious. discloses that suspicion to the suspect In fact even non-disclosure/action may
be considered tipping off (e.

Their expected patterns of business Their business model Where their funds come from Money Laundering Reporting Officer . Have internal suspicion reporting procedures 7.. Have record keeping systems for all transactions 5. Educate and train all staff in the main requirements of the legislation Client Acceptance Procedures should include Identification procedures Know your Client information including. Keep systems for initial verification and continued monitoring of clients' identities 6.The following will prevent their organisations being used for money laundering purposes 1.. Establish a top-down anti-money laundering culture 2. Appoint a money laundering reporting officer (MLRO) 4. Have risk management procedures & internal controls 3.

If the MLRO is away then a deputy must be appointed (as reports must be made as soon as practicable) 2. Responsibilities Include Internal reports of money laundering Deciding if sufficient grounds for suspicion Preparing the external report to present to the appropriate authority Key liaison individual with the authorities Advising the engagement individual/team on how to continue their work and interact with the client Training on ML matters Designing anti-ML systems Reporting Duties Professional accountants must report money laundering to the appropriate authority (e. Sole practitioners do not need to appoint an MLRO 3.g. Police). Some Points about Reporting It is a criminal offence not to report Regardless of the amount or seriousness .Basically should have a suitable level of seniority and 
experience 1. MLRO.

. address etc) Role of each person (eg Suspect) Any references seen (eg Bank account) Details of suspicious transaction Location of any laundered property Resignation You should consider resigning where. It is in your commercial interests to do so It is professionally and ethically responsible to do so .There is no obligation to quantify the certainty of suspicion There is no automatic need to cease working for a particular client where a report has been filed Doing so may even be tipping off! An external report should be made to the authorities It should include the following Name of the reporting business Identification information of each person (DOB.

items to look for when detecting money laundering These risk factors could include Secrecy with a transaction . Again.Just be careful to avoid tipping off. experience and responsibility 2. Dedicated Resources An MLRO in place The MLRO has appropriate knowledge. legal advice should be sought if in doubt What are suspicious transactions? Large cash deposits Unexplained foreign transactions Transactions with no business explanation Anti-Money Laundering Programme The MLRO is responsible for setting up the anti-money laundering programme The following is required 1. Written Policies and Procedures The procedures should use available technology and identify risk factors .

Transactions through several jurisdictions or financial institutions without any apparent purpose Using central bank or government-owned banks as the source of funds A rapid increase/decrease in a balance. A frequent clearing out of an account for purposes other than maximising the value of the funds held in the account 3. Timely Escalation and Resolution Timely reports Appropriate reviews of the report Identify the outcome / resolution of matters 5. particularly those that have contact with customers should be covered A comparison of the account holder's identity to the government lists of known or suspected terrorists 4. Comprehensive Coverage All aspects of a company's business. Sufficient Training and Education Integral to the whole programme Courses on how to recognise suspicious activity and what to do next 7. Regular Review of the Program To make sure it is working as designed Accompanied by a formal assessment / report . Explicit Management Support Senior management should set the tone Their support clearly visible to all employees 6. not explained by fluctuations in the underlying market value of investments held Frequent or excessive use of funds/wire transfers in or out of an account Repeated deposits or withdrawals just below the monitoring and reporting threshold on or around the same day A pattern that after a deposit or wire transfer the same (or similar) amount is wired to another financial institution (especially one that is offshore).

ACCA factsheet 145 on Money Laundering The offences Failing to disclose or report money laundering Tipping off Prejudicing an investigation Systems and Controls Identify complex / unusually large transactions Prevent use of anonymity granting products Perform customer due diligence Appoint mlro Customer record keeping for 5 years ML compliance monitoring Make employees aware of ML regulations Risk-Based approach Target efforts where risk is highest Watch for unusual transactions Keep customer due diligence up to date Customer Due Diligence Test riskiness of client to see amount of DD Always at the start of a business relationship When there's unusual transaction When suspicious To new and old clients on a risk sensitive basis Identify beneficial owner Monitor throughout relationship Reporting Suspicious activity reports Have an MLRO to report to Failure to report is an offence When reports made. they are protected Report as soon as possible MLRO Significant responsibility Senior person Absences covered Learn more list The fact sheet in full baby! .

Is an ethical framework better than rules? Here's some reasons why a framework is good. Needs auditor to consider his situation actively .Good luck with it. A framework works better in changing environments Laws and regulations Responsibilities of management and auditors Management is responsible for ensuring that the company complies with laws and regulations Auditors are responsible for concluding FS free from mistatements caused by non-compliance with laws and regulations having a general understanding of the legal and regulatory framework within which the company operates applying professional scepticism . Every situation is different 4. and if you get to the end.. 1. give yourself a medal Ethical Framework or Rules Current Issue . Ensures there are no loopholes by interpreting rules too narrowly 3..not just a checklist 2.

A culture of honesty and ethical behaviour 4. publicising and following a Code of Conduct 7. Prevention AND detection of fraud and error 2. Strong risk management and internal control 3. Monitoring legal requirements 6. Training Non-Compliance Discovery There are indicators that Non-compliance may have occurred .obtaining a general understanding of applicable laws and regulations understanding how the entity complies with those laws and regulations identifying instances of non-compliance being aware of the impact of breaches of regulations on the assertions Responsibilities of Management (and Those Charged With Governance) 1. Compliance with applicable laws and regulations 5. Developing.

Consider impact on other areas of the audit . charges etc Potential disclosures needed Decide if so serious that true and fair view is questioned Procedures when possible noncompliance is discovered These are: 1. Excessive sales commissions 5. Lack of adequate audit trail Consequences of Non-Compliance Provision for fines. Fines or penalties 3. Discuss with own lawyer 5. Discuss with management 3. Unusual bank transfers 7. Purchasing at not market price 6. Payments without exchange control documentation 8. Discuss with their lawyer 4.These are 1. Government Investigations 2. Unspecified payments for to related parties or (government) employees 4. Document findings 2.

Consider if you can now rely on other management representations How to Report on Non-Compliance Auditors should tell directors of any non-compliance immediately This should happen without delay. as set out below: THOSE CHARGED WITH GOVERNANCE If the auditors suspect non-compliance with laws and regulations Communicate to audit committee Consider the need for legal advice SHAREHOLDERS Only if it causes FS to not give a true and fair view or there is a fundamental uncertainty Report in usual way (See reporting section) REGULATORY AUTHORITIES . and make appropriate reports.6.

Legal responsibilities? 4. Non-compliance affect on relationship with client 3. Any alternatives? WHEN TO WITHDRAW Management refuses to remedy the situation Significant doubts about the competence or integrity of management When withdrawing the auditor must Discuss the reasons for WITHDRAWING with the appropriate level of management Consider any professional or legal requirements to report his withdrawal . Are management implicated? 2.REGULATORY AUTHORITIES Auditor decides if there's a responsibility to report to parties outside the entity When to Withdraw From the Engagement This is a last resort There are many factors to consider 1.

Confidentiality Don't disclose any confidential information to third parties without proper and specific authority You can. Professional Competence & Due Care Keep up your professional knowledge and skill so as to give a competent professional service.Professional and Ethical Considerations Code of Ethics for Professional Accountants Fundamental Principles The 5 fundamental principles of the ACCA Code of Ethics must be followed The 5 Fundamental principles and what they mean 1. if there is a legal or professional right or duty to disclose Obviously never use it for personal advantage of yourself or third parties . however. Integrity Be straightforward and honest in all professional relationships 2. using current developments and techniques Act diligently and within appropriate standards when providing professional services 4. Objectivity No bias or conflict of interest influencing your business judgements 3.

1.groovy baby. Or an audit firm prepared the financial statements and then acted as auditor. Professional behaviour A professional accountant should act in a manner consistent with the good reputation of the profession Refrain from any conduct which might bring discredit to the profession In the exam question you may have to apply these to a case study .5. This is a threat to objectivity and independence. Self-interest Here the auditor may have a financial (or other) interest in a matter. Threats An auditor must be independent and be seen to be independent Categories of Threat Auditors need to be fully aware of situations that may damage their independence. Self-review Here the auditor reviews a judgement she has taken herself. Therefore the auditor may not act with objectivity and independence. 2.. .

so should be avoided. Close business relationships A material joint venture with a client is a self-interest threat. and act as an ‘advocate’. The interest should either be disposed of. All other loans or guarantees are a self. 4. Examples of Threats Financial Interest Here look for the nature of the interest and the degree of control the accountant has over it . This is a threat to objectivity and independence. 5. No member of the assurance team (or immediate family) should hold a financial interest in a client. Advocacy Here the auditor is expected to defend or justify the position of the client. Loans and guarantees If the client is a bank (or similar) and the loan is on normal commercial terms then there is no threat to independence. Intimidation Here the auditor can't act independently as she is scared due to intimidatory threats such as the threat to take away the work unless they do as the client wishes. for example due to a long association over many years in carrying out the annual audit.3. or the team member removed from the engagement. Buying things from a client is fine if on normal commercial terms and in the normal course of business.obviously the more control the higher the risk. Family and personal relationships . Familiarity Here the auditor and client have a too close relationship.interest threat and should be avoided.

What is vital is that they are not involved in making management decisions. An audit engagement partner and/or quality control reviewer shouldn't work on the same client for more than seven years and should not be returned to the engagement for at least two years after being rotated off the team.Think here about the seniority of the assurance staff and the closeness of the relationship. like a company secretary. Serving on the board of assurance clients Auditors should not do this. In the exam you need to look at the nature of the role and the length of time that he has been doing it when deciding which staff members to involve in assurance work. Gifts and hospitality . there is a significant self-interest threat. Recent employment with client The threat can be reduced by getting an independent third party to review the audit file. Long association of senior personnel with assurance clients This may cause a familiarity threat. If the family member is able to exert significant influence over the subject matter then the threat to independence can only be avoided by removing the individual from the assurance team. Overdue fees should be avoided as they are practically a loan. Although if it's only routine administrative services. If a member thinks they might soon be employed by the client (having applied for a job there) then this should be disclosed by the member immediately. then it may be ok. Fees If the client fees are a large proportion of a firm’s total fees. ACCA rules state that recurring fees paid by one client or a related group of clients should not exceed 15% of the income of the audit practice (10% if the client is listed). In larger firms an individual office may exceed these limits as long as responsibility for signing off the audit file should be passed to a different office.

Only accept if not significant to either party Consider the following: Could the value affect objectivity? Was the hospitality when the auditors should have been working? Were remaining members of the team properly supervised? Ensure the member checked with more senior people in the firm to check if it was allowed .otherwise it is a disciplinary offence also. Actual and threatened litigation If actual litigation then resign from the engagement. Safeguards Safeguarding independence is the responsibility of the audit firm & the profession .

So things that the profession do to help safeguard against ethical threats are: 1. Using audit committees . an audit firm should have the following procedures in place: Training To an appropriate level for the role Quality control procedures This ensures that independence is considered in all work performed by the audit firm. this means a rotation of the engagement partner and senior staff. Consultation So issues can be discussed internally and procedures are laid out to facilitate this Ethical Codes of conduct Internal Controls The Profession The profession should take disciplinary action as appropriate.Audit Firm Level A culture of independence should be created. The profession regularly suggest new practices and procedures designed to improve auditor independence. In addition. Regular rotation of auditors made compulsory 2.

or has reason to suspect that.. Treason Terrorism Drug trafficking . Corporate Governance and of course auditing standards The Individual An individual auditor can limit ethical threats by.3. a client has committed. ACCA Exams and CPD :) 4.and staying up to date Keeping in contactwith fellow professionals To informally discuss issues and problems Independent Mentor used to discuss individual threats Confidentiality Never disclose unless consent has been given or you're obliged to Recognised exceptions to the duty of confidentiality Sometimes disclosure is required and sometimes it is voluntary Obligatory disclosure when the auditor knows. Complying with CPD regulations ..

Money laundering More exceptions Voluntary disclosure This is permitted in the following circumstances: 1. See what established procedures there are for dealing with it otherwise. Public Interest For example . 1.. Fundamental Principles Are they affected? 4. defending yourself against an accusation of negligence 2. Protecting Member Interests For example. Consider ethical Issues 3.Informing tax authorities of non-compliance by a client company with tax regulations Resolving Ethical Issues When the auditor is suspicious of an ethical threat.. Assess the facts 2. Legal Process The courts may require documents 3. action must be taken Follow these steps. .

5. Look for alternative measures such as an external regulator, or worst case scenario, resigning!

Conceptual Framework

Works on principles, not listing every reason why auditors may not do
the right thing

The conceptual framework works like this..
1. Identify the threat that may cause a fundamental principle to be broken
2. The fundamental principle how likely is it to be broken?
3. Limit the risk if the threat is more than negligible - to an acceptable level

There are 3 types of safeguard
which can limit the risk

Training & Education Gaining experience at work, passing your exams :) & CPD on ethical matters

Legislation On things such as who is fit and proper to become an auditor

Corporate Governance regulations These often set out best practice for some ethical situations

CPD Keeping up to date with auditing standards and developments

Networks Keeping in contact with other professionals to discuss matters informally or contacting ACCA for guidance

Independent Mentor A formal relationship with another auditor to discuss ethical threats on a confidential basis

Codes of Conduct created and followed by the firm with controls and procedures in place

Ethical Standards Relating to audit engagements such as discussions with audit committees and staff rotation policies

Typical threats

The auditor is tempted to gain a personal or family benefit rather than
give an appropriate service

Holding Shares in a client
Don't! Here look for the nature of the interest and the degree of control the accountant has over it - obviously the more
control the higher the risk
No member of the assurance team (or immediate family) should hold a financial interest in a client.
The interest should either be disposed of, or the team member removed from the engagement

Significant Income from client
Limit the amount 10% of total fees if listed
15% of total fees if unlisted
In larger firms an individual office may exceed these limits as long as responsibility for signing off the audit file should be
passed to a different office.
Overdue fees should be avoided as they are practically a loan

Separate business venture with client

Don't! Although buying things from a client is fine if on normal commercial terms and in the normal course of business

Giving a loan to the client
This may include unpaid audit fees


Getting a loan from a client
If the client is a bank (or similar) and the loan is on normal commercial terms then there is no threat to independence.
All other loans or guarantees are a self- interest threat and should be avoided

Setting a very low fee either to attract new clients or ensure further work
Auditors should not set fees in this way, the fee must be based on a pre-determined level of work required

Hospitality and Benefits
Any such items given to the auditor by a client could be seen to be a bribe
So do not accept

Contingent Fees
Where auditors fees are contingent on another event happening.
Audit Fees are not to be determined in this way

Accounting Services
If an auditor prepares the accounts it is 100% sure that they will be reviewing their own work. They may be tempted to hide
errors to save face.
So the Auditor must not undertake accounting services for a client, if they are a LISTED company.
No management decisions should be made in other companies and a different team should provide each service.

Professional Scepticism

A healthy scepticism is a fundamental part of any audit

We need to see more scepticism
Not a total distrust it requires an enquiring mind that is open to the possibility that something may be wrong
Is it supported by evidence
Is it consistent with what is known from elsewhere?

Are assumptions reasonable? In today's world, impairment testing is commonplace and works on assumptions
The auditor needs to not only see a record of what the assumptions are, but also challenge them and understand how they
affect the conclusions the client has come to.
Too often it seems that the auditor is looking for reasons why assumptions can be supported, without also considering facts
that might suggest they are not appropriate - too optimistic, for example.

Is there sufficient evidence? If an auditing standard requires a certain presumption - for example, of a significant risk of
fraud in the case of revenue recognition - does the auditor too easily find reasons for overriding the presumption?

Professional Scepticism and Judgement

When planning and performing an audit, the auditor should adopt an
attitude of professional scepticism

What is the quality of this evidence Factors to help with the judgement are.. So he has to judge. When is there sufficient evidence? 2. 1.It is “An attitude that includes a questioning mind.. The seriousness of the risk The materiality of the item . they must not simply believe everything management tells them The exercise professional judgement in planning and performing an audit The auditor will need to exercise professional judgement on both the quantity and the quality of evidence. being alert to conditions which may indicate possible misstatement due to error or fraud. and a critical assessment of audit evidence” In other words..

.involving the use of deception to obtain an unjust or illegal advantage Three main areas of fraud exist: Corruption Misappropriation of assets Financial statement fraud Error ...The strength of internal controls The sampling method used (see later) Fraud and Error Definitions Fraud An intentional act.

An unintentional misstatement in financial statements, including the omission of an amount or a disclosure

Examples are:
A mistake in gathering data from which FS are prepared

An incorrect accounting estimate due to an oversight

A mistake in applying accounting principles


An intentional misstatement to mislead users
If a material error is identified, but not corrected it becomes an irregularity

Investigating Misstatements

If a misstatement is discovered, the audit impact needs to be considered

This is done by:
1. looking at the circumstances of the offence
2. Gathering information about the FS effect

2. Gathering information about the FS effect
3. If material, additional procedures should be carried out
4. Communicated to those charged with governance
Find out their action to rectify it and whether it is likely to happen again

Management and Auditor Responsibilities

Management Responsibilities

These are:
1. Safeguards created to avoid fraud and error using internal controls
2. Internal audit is responsible for monitoring and implementing these

Auditor Responsibilities

If fraud or error leads to amaterial misstatement, the auditor is responsible for detecting it

At the Planning Stage
The auditor must consider the risk of material misstatement due to fraud and error when planning and performing their audit

If fraud is discovered
Report it to the audit committee or
Highest level of management (if not involved in the fraud), or
Shareholders if the fraud is by those in senior management

Reporting Fraud and Error

Fraud and error must be reported to management or the audit
committee ASAP

What about reporting to shareholders?
By including a paragraph in the audit report

What if it's in the public interest?
Report to a 3rd party (eg. Regulator)
Especially if management involved

Audit Approach

Audit teams members should discuss the risk of fraud at planning stage

Further Procedures:
1. Ask Management what their assessment of the risk is
2. Ask Management what their processes are for identifying and dealing with these risks
3. Ask Management how they communicate this process to staff
4. Ask management if any actual or suspected fraud has occurred

Professional Liability
When are Auditors Liable to their Client?

The auditor has a contract with her client

This means that the contract can be broken by the auditor and so become liable
This begins when it can be shown that the auditor didn't use "reasonable skill and care"

How can you show "Due skill and care"? Applying IFRS and ISA's correctly Following ethical standards Following engagement letter terms Using properly trained and competent staff Being Sued for Negligence This means 3 tests need to be proven: 1. Duty of Care owed This is obvious for an audit client (though not necessarily for 3rd Parties) 2.. Breach of that Duty such as. Client suffered a Financial Loss The client wouldn't have made this loss otherwise Client 3rd party Duty of care exists? Automatic Needs proving Breached? Needs proving Needs proving Loss made? Needs proving Needs proving . Incorrect Opinion ISA's not followed correctly 3.

For the current year only 3.needs shareholder approval It must be: 1. Made clear as part of any tender process When are Auditors Liable to 3rd Parties? . Fair and reasonable 2.LIMITING LIABILITY TO YOUR CLIENT Reducing liability for statutory audit work is normally not allowable However there are options: Limited Liability Partnerships A separate legal entity the LLP itself is liable to the full extent of its assets The liability of the members will be however limited to the investment made in the LLP Negligent Partner will still be sued personally .but non-negligent partners are protected Limited Liability Agreements Here companies limit auditor liability by contract .

the auditor reports to the class and not to assist individuals . 1. The 3rd party suffered financial loss as a result CONSEQUENCES A shareholder stands no different from any other investing member of the public to whom the auditor owes no duty Shareholders are seen as a class.A duty of care must be owed to a 3rd party . Foreseeability of damage to the 3rd party 2. The auditor ought to have known that 3rd parties relied upon her opinion 3. The auditor acted negligently 2.and it needs proving! Client 3rd party Duty of care exists? Automatic Needs proving Breached? Needs proving Needs proving Loss made? Needs proving Needs proving This involves looking at: 1. A relationship of "proximity" with the 3rd party 3.. It's fair. just and reasonable to impose such a duty on the accountants Another way of looking at this is.

Show that audits are performed on a test basis only A statement that the opinion gives reasonable NOT absolute assurance that FS are free from material misstatement In the Engagement letter Responsibilities of management and the auditor The nature. scope and purpose of an audit There are many disclaimers protecting the auditor and reducing the amount of reliance that users can place on these reports. Management misunderstand that it is THEIR responsibility to detect fraud 4.The Expectation Gap Difference between client's expectations and actual audit work performed What causes the 'Expectation Gap' 1. However. Management misunderstanding their responsibilities 2. auditors are exposed to the threat of liability from bad clients and without any protection may not accept many . Management think that the auditors are liable for any errors How is the 'Expectation Gap' narrowed? In the Audit report Responsibilities of management and the auditor. Management misunderstanding the scope of the audit 3.

Listed entity An entity whose shares (or debt) are quoted on a stock exchange 8. with experience and authority to objectively evaluate the significant judgments & conclusions 4. Firm A sole practitioner.engagements Practice Management Quality Control Definitions for Quality Control learn the meaning of the following terms: 1. Engagement Quality Control Review Provides an objective evaluation. Engagement Quality Control Reviewer Someone not part of the engagement team. Monitoring . Engagement team All partners and staff performing the engagement. partnership or corporation of professional accountants 6. of any significant judgments & conclusions It is for listed entity audits and any where the firm thinks such a review is required 3. before signing the report. Engagement partner The partner responsible for the audit engagement. plus anyone engaged by to do audit work This excludes external experts 5. legal or regulatory body 2. performance and report Also she has the appropriate authority from a professional. Inspection These provide evidence of compliance with the firm’s quality control policies 7.

Human Resources 5. Ethics 2. Leadership 4. Client Relationships 3. At the FIRM level International Standard on Quality Control 1 (ISQC 1) – Quality Control for firms that perform audits and reviews 2.An ongoing evaluation of the firm’s quality control It includes periodic inspections of a selection of completed engagements Principles & Purpose Firms need to be sure that the audits they perform meet quality standards This is to decrease the risks of: Litigation against us for professional litigation Incorrect Audit opinion and hence an increased investor confidence in the financial statements There are 2 standards on Quality Control 1. Engagement Performance . At the individual AUDIT level ISA 220 – Quality Control for audits of historical financial information ISQC 1 (firm level) ISQC 1 identifies six building blocks of a firm’s system of quality control: 1.

and (b) Reports issued by the firm or engagement partners are appropriate in the circumstances 1. Resources must be available to support quality 2. Elements of a QC system This follows on from the previous section Firm Level Quality Control The objective of the firm is to establish and maintain a system of quality control to provide it with reasonable assurance that: (a) The firm and its personnel comply with professional standards and applicable legal and regulatory requirements. play audio pause audio clipAttachment play Tweet Like RCAtweets . See you there. Leadership An internal culture focused on quality is key This means training. hotpants.6. Commercial considerations never override quality Pay & Benefits must reflect commitment to quality.. appraisal & mission statements... Monitoring We will look at the above in more detail in the next section.

play audio pause audio clipAttachment play Tweet Like RCAtweets 5. have knowledge of the client Contentious areas must be consulted on in a cost effective way A timetable for suitable reviews Ensure independence and any issues addressed Time pressure All audits should be planned to ensure that adequate time can be spent to obtain sufficient appropriate audit evidence to support the audit opinion. education/training.3. 6. Engagement Issues .Review Review has the purpose of identifying previously unrecognised problems and examining them along with the rest of the work carried out.Planning Discuss known risks with the client and document Staff suitably qualified and experienced. Any breaches to monitoring system dealt with 9.Supervision Staff supervised and assessed to control the work flow. Engagement Issues . Monitoring Ensure new developments in standards and regulations are implemented Ensure CPD is kept up to date. monitoring and dealing with non-compliance . Any problems tackled immediately and consultation on any deviations from the original plan. independence Emphasise through leadership. Ethical Requirements Have procedures to comply with ethical requirements eg. Human Resources All staff to have the capabilities & competence to ensure quality. 7. Appraisals and development regularly 4. Engagement Issues . Is the amount of evidence gathered sufficient or is further work required? Quality control can be achieved during the review stage by: 1) Learn lessons from mistakes made 2) Appraisal staff immediately after assignments to praise &/or constructively criticise 8.

It will be designed to identify problems in procedures and poor practice. prompt notification by employees Ensure that firm is notified of breaches of ethical requirements promptly Types Of Review Hot Reviews A ‘hot’ review is carried out before the audit report is signed.Have procedures to identify independence threats eg. Performed by a suitably independent reviewer such as a senior manager (not part of the management team). Listed company engagements must have a hot review as well as those of public interest or with significant risks. . Have misstatements been correctly dealt with? Do working papers support the conclusions reached? Is the final engagement report justified in the circumstances? Cold Reviews A ‘cold’ review is a review carried out after the audit report is signed. it reviews the quality of the judgements made such as: Is the firm independent? Are risk assessment judgements justified? Use of work outside the audit team.

The objectives of the work to be performed 3. Supervision and Performance Directing the engagement team means telling them about: 1. Their ethical responsibilities Their need to plan and perform an audit with professional skepticism 2. Problems that may arise 6.The cold review should make recommendations for improvements. Engagement Performance Direction. The detailed approach to the performance of the engagement Supervision includes: Seeing if the team has enough time and competence to do their job Also whether they understand their instructions Addressing significant matters arising during the audit and modifying the plan appropriately Identifying matters for consultation with experienced engagement team members . The nature of the entity’s business 4. Risk-related issues 5.

Reviews include: Ensuring that work of less experienced team members is reviewed by more experienced ones Ensuring that significant matters have been raised for further consideration Appropriate consultations have happened The work performed supports the conclusions reached and is appropriately documented The Engagement Partner’s Review of Work Performed This involves timely reviews of the following: 1. Documentation of the review may be completed after the auditor’s report (as part of the assembly of the final audit file) . Critical areas of judgment 2. Significant risks Engagement Quality Control Review Note the following: It helps to see if sufficient appropriate evidence has been obtained It is done throughout the audit so significant matters are promptly resolved before the date of the auditor’s report.

similar audits 2. Ability to apply professional judgment 6. and experience with. Understanding of. Understanding of professional standards and regulations 3. Understanding of the firm’s quality control policies Individual level of Quality Control .The extent of the review depends on: 1) The complexity of the audit 2) If the entity is listed and 3) The risk of an inappropriate auditor’s report Assigning the Audit Team You need to consider the team's competence and capabilities This means looking at their: 1. Knowledge of the client's industry 5. IT expertise and any specialist accounting / auditing 4.

by looking at photographic identification such as passports and driving licences ➢ Consider whether the commercial activity makes business sense (i. Money laundering (client identification) procedures. Other procedures on client acceptance should include: 1. Consideration of any conflict of interest 3.e. it is not just a ‘front’ for illegal activities) ➢ Obtain evidence of the company’s registered address e.g. The engagement partner should assess that the audit team. Additionally. for example: . ➢ Establish the identity of the entity and its business activity e. for example.Individual Level Quality Control ISA 220 Quality Control for Audits of Historical Financial Information specifies the following quality control procedures that should be applied by the engagement team in individual audit assignments. Engagement team Procedures should be followed to ensure that the engagement team collectively has the skills.g. by obtaining a certificate of incorporation ➢ If the client is an individual.g. competence and time to perform the audit engagement. Obtaining professional clearance from previous auditors 2. whether all members of the team are independent of the client. obtain official documentation including a name and address. the engagement partner should conclude whether all acceptance procedures have been followed. for example. The engagement partner should consider whether members of the audit team have complied with ethical requirements. Client acceptance procedures There should be full documentation. and conclusion on. e. that the audit firm has considered the integrity of the principal owners and key management of the client. ethical and client acceptance issues in each audit assignment. by obtaining headed letter paper ➢ Establish the current list of principal shareholders and directors.

The nature of the client’s business 4. Has experience of audit engagements of a similar nature and complexity 3. Procedures such as an engagement planning meeting should be undertaken to ensure that the team understands: 1. . Attention should be focused on ensuring that members of the audit team are carrying out their work in accordance with the planned approach to the engagement. How to deal with any problems that may arise. The objectives of the work they are to perform 3. Significant matters should be brought to the attention of senior members of the audit team. Has the ability to apply professional judgement 4. Their responsibilities 2. Review The review process is one of the key quality control procedures. Any problems that arise during the audit should be rectified as soon as possible. and Supervision Supervision should be continuous during the engagement. Has the appropriate level of technical knowledge 2. Understands professional standards. The planning meeting should be led by the partner and should include all people involved with the audit. and regulatory and legal requirements. Risk related issues 5.1. There should be a discussion of the key issues identified at the planning stage. Direction The engagement team should be directed by the engagement partner.

All work performed must be reviewed by a more senior member of the audit team. Reviewers should consider for example whether: 1. and 2. This is a procedure whereby the matter is discussed with a professional outside the engagement team. Advertising Acceptable Advertising They should inform and not try to impress Generally they should not reflect badly on the member. Work has been performed in accordance with professional standards 2. and sometimes outside the audit firm. Consultation Finally the engagement partner should arrange consultation on difficult or contentious matters. The results of the consultation. The issue on which the consultation was sought. The objectives of the procedures performed have been achieved 3. the ACCA or the accounting profession as a whole Acceptable publicity includes: Appointments and awards . Work supports conclusions drawn and is appropriately documented. Consultations must be documented to show: 1.

decent & truthful Names & Descriptions Members may be called Chartered Certified Accountants. Mislead 5. lectures. Bring ACCA into disrepute 2.. At least half the partners or directors are ACCA members They control at least 51% of the voting rights . Discredit the services offered by others 3.Seeking employment or professional business Professional directories Books. media appearances Training courses and seminars Advertisements and promotional material must not: 1.. but not companies The firm may describe itself as ‘Chartered Certified Accountants’ if. interviews. article. Be legal. Claim superiority 4.

hourly) must be clearly stated Any reference to fees must not mislead the reader about the precise range of services and time commitment that it relates to You can compare your fee to others if..If all partners in the firm are ACCA members they may state this on their stationery If some partners are members of another accountancy body however. .g. this must be made clear Use of ACCA logo Acceptable if: At least 1 partner is an ACCA member The logo is separate from the firm logo Fees The basis of calculation (e.

It is for the same service 2. It is an objective comparison 3. It doesn't create confusion Percentage discounts may be offered but must not detract from the firm or the profession Assurance Engagement Fees Not calculated on a % or contingency basis Due to self-interest and advocacy threats Non-Assurance Engagement Fees Contingent fee possible only if possible range and variability of the fee is small Approval by the audit committee may be needed Setting Fees The following needs considering: 1. The risk of taking on the work & costs incurred . It doesn't discredit the other 4. How important the work is to client 4. Time needed 3. Level of expertise needed 2.1.

Low-Balling This is setting the initial audit fee low in order to win the client Ethical Issues: Client needs to stay to recover the initial losses so independence is impaired Possibly unprofessional because many smaller practices can't compete Tendering This is when an audit firm is approached by a prospective client to bid for their audit Audit Firm Considerations: How did the client get to know about them? Why has the firm been approached particularly? .

An assessment of the requirements of the prospective client 3. Deadlines and information needed 5. Fee and how it has been calculated 2.What is the scope of the audit? How risky is the audit to the firm? Does the firm have the necessary resources Tender documents contents: 1. Outline of the firm and our staff Professional Appointments Accepting a new engagement Auditors should screen clients to ensure they are not high risk . Our approach to the requirements 4.

Are management trustworthy? Other Areas to help gain an understanding are: The market and its competition Legislation and regulation Regulatory framework Ownership of the entity Nature of products/services and markets Location of production facilities and factories Key customers and suppliers Capital investment activities Accounting policies and industry specific guidance Financing structure . Has the client had a history of changing auditor regularly or had qualified audit reports in the past? 4.e. An auditor is required under ISA 315 to gain an understanding of their client.The risk to the auditor is ‘reputation risk’ i. Do client directors understand their role and are they able to carry it out? 5. What is the nature of the industry in which they are involved – is it depressed? 3. Is the client involved in any fraudulent/illegal activities? 2. that they will be associated with a poorly regarded client. Auditors should screen clients to ensure they are not high risk Questions to ask will be: 1.

asking for any reasons why we should not accept appointment 3.. adverts should not bring the ACCA into disrepute. Get permission to contact the outgoing auditor 2. However. Procedures when offered a role These include: 1. Contact the old auditor. Check we have the competence & resources to do it Pre-Conditions for an Audit Auditors should only accept a new audit engagement when it has been confirmed that the preconditions for an audit are present. discredit the services of others. be misleading. or fall short of regulatory or legislative requirements. Is the FR framework acceptable? .Financing structure Significant changes in the entity on prior year Auditors may advertise their services. Check we are sufficiently Independent 4.

Get Information The potential client will inform the auditor of what is expected. The auditor shall not accept the proposed audit engagement New engagement process Tendering for audit work Things to consider. 1.. also..Consider the entity & the purpose of the FS Perhaps. Proposal The auditor may then draw up a proposal containing: . Fee A fee will be quoted for a piece of audit work before it is carried out under a tendering process The auditor must not lowball as we have seen above.. nor may they make unrealistic claims or promises to win the contract 2. future plans of the company and any problems with current auditor 3. laws say which FR framework should be used Do Management accept their responsibilities? For preparing FS For internal controls For giving the auditor all relevant information they request If the preconditions for an audit are not present. the timetable.

professionalism. relevance. Outline of audit firm and personnel Ability of firm to perform the audit Pre-conditions Is the Financial framework used acceptable? (Consider the type of business and relevant laws and the uses of the financial statements) Client Decision The client will decide on the basis of clarity. How audit firm proposes to satisfy requirements Any assumptions made. purpose and legal requirements of an audit. reputation.Proposed audit fee Nature. Assessment of the requirements of the client. Proposed audit methodology. timeliness of delivery and originality which firm will conduct the audit Engagement letter An engagement letter is a letter from the auditor to the client indicating various matters concerning the engagement The engagement letter is sent before the audit to the client confirming their acceptance of the audit .

Managements’ responsibility for the Financial Statements. but as a rule most will include: The Objective of the audit. materiality and risk Business Risk .Contents ISA 210 Terms of Engagement gives guidance as to their content. The scope of the audit including reference to legislation and professional standards. The form of report to be used Use of the work of internal audit Reference to inherent limitations of an audit Access to information to be allowed Deadlines and confidentiality Expectations of management representations Fees Complaints procedures Audit of Historical Financial Information Planning.

The risk that the business won't meet its objectives The objective is normally profit maximisation So we are looking for problems which may impact on the business To look for Risks. The Company will need to assess the likelihood of such restrictions. the new government may impose restrictions. You could use PESTEL Business risk identification is literally putting yourself in the shoes of the management. Economic risks Social and taste changes Technological changes Environmental issues Legal issues . The current government may be unstable and if there is a change of government. Political risks e..g..

Poor controls leading to errors) Business risks can lead to going concern problems. This too would be a FS risk (wrong basis of accounting) Materiality ISA 320 defines information as material if ‘its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements.Financial Statement Risk Simply the risk that the FS are materially misstated (before any audit procedures) The risk comes from potential errors or deliberate misstatements Business v Financial Risk Business risks will affect the FS if not addressed by management Business risks can lead to errors on specific areas of the FS (eg. Technological change leading to obsolete stock) Business risk can have a more general effect on FS (eg.’ .

Material items could be large transactions or significant events.
Materiality is important to the auditor because if a material item is incorrect, the financial statements will not show a ‘true and
fair view.’

Materiality Levels

The auditor will decide materiality levels and design their audit procedures to ensure that the risk of material misstatements is
reduced to an acceptable level.
Generally, materiality will be set with reference to the financial statements such as:
0.5 – 1% of turnover
5 – 10% of profits reported
1 – 2 % of gross assets
Judgement will be used by the auditor in charge and will depend on the type of business and the risks it faces.

2. Considerations
The relative size of the item

This might be something that's low in value but could still affect users' decisions e.g.. Directors wages

Tolerable Error
This is when the auditor accepts the error

For example finding one error out of 100 tested, might be ignored

The tolerable level will be decided at planning stage

Performance Materiality

This is lower than normal materiality
The idea is that this will try to prevent all those small, undetected errors do not aggregate to become material

There are now 2 standards to consider..
1. ISA 320 Audit Materiality

2. ISA 450 Evaluation of Misstatements Identified During the Audit

As we know, materiality is calculated at the planning stage
But it might not stay at that amount - oh no baby
Things happen that make the auditor change the level
Such things are often immaterial in quantity but material by their nature

The company you are auditing makes a $5,000 profit.
The materiality is set at $10,000
You notice that an invoice for $6,000 has been incorrectly placed into next year.
This would be material as it changes the look of the whole accounts (changing a profit into loss)

The new standard recognises that there could well be instances where certain classes of transactions, account balances or
disclosures might be affected by misstatements which are less than the materiality level for the financial statements as a
whole, but which may well influence the decisions of the user of those financial statements regardless of the fact they are
below materiality – this is where performance materiality is to be applied.
Specifically, the clarified ISA 320 suggests performance materiality be applied to areas such as related party transactions
and directors’ remuneration.

Evaluation of Misstatements

Material Misstatements normally lead to qualifying the audit report

Misstatements aren't just monetary figures, they could also be incorrect classification or disclosures

Evaluating Misstatements
1. Get a list of misstatements found
2. Discuss these with management at the end of the audit
3. Management will normally correct these
4. Any remaining material misstatements will cause the auditor to qualify the report

Aggregation of Immaterial Errors
Immaterial errors could aggregate to become material

These will be brought to the attention of management

If management amend material errors, then the auditor will issue an unqualified audit report

If management refuse to adjust the errors then the auditor must persuade them to do so or issue a qualified audit report

All misstatements found must be communicated to those charged with governance
This is to ensure that no management bias exists in the decision taken on what constitutes an ‘immaterial misstatement’
Management must also provide written representations that all uncorrected errors are immaterial

Components of Audit Risk

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

Stated another way, this is the risk that there is a material misstatement in the financial statements, but the auditor misses it
and says that they present a true and fair view.

Formula for audit risk is:
Inherent Risk x

Inherent Risk

Control Risk x

Detection Risk

an invoice is raised by one person and the cheque is written by another and authorise by someone else.This will be considered at the planning meeting as it depends on the auditors’ knowledge of the business Examples are. Control Risk This is the risk of material misstatement due to inadequate internal controls within the business. The auditor may take expert advice on the valuation of inventory. The auditor will make a judgement as to the suitability and strength of internal controls – we will examine how this is done at a later stage. If this control is weak or not in place. more physical checks of the existence and condition of assets will have to be carried out. The auditor may feel that there are insufficient controls in place to mitigate this risk which may lead to limitation of scope. Fast moving Industry In fast moving industries such as IT or fashion there may be a risk that the inventory held by the business becomes obsolete.. No segregation of duties Segregation of duties is where different tasks in a process are performed by different people e.g.. A cash based business This is often a problem as there must be very strong controls in place if a business is a cash based one. . No controls over access to assets If employees have unfettered access to the assets of the business with no restrictions.. Examples are. the auditor may have to increase the sample size to ensure the financial statements present a true and fair view. this will increase the risk of theft or damage to those assets If the auditor finds this to be the case.. or they may review post year-end sales to ensure the goods are sold for more than they are valued at in the financial statements.

If these controls are not in place the auditor will have to understand the system to assess the ease of which it can be manipulated and check for anomalous trends using analytical review. Detection Risk This is the risk that the work carried out by the auditor does not uncover a material misstatement that exists. Detection risk can be split into sampling & non-sampling risk Non-sampling risks The auditor did not sufficiently investigate a significant balance The procedures used may have been inappropriate or misinterpreted Sampling risk ‘arises from the possibility that the auditor’s conclusion. based on a sample may be different from the conclusion reached if the entire population were subjected to the same audit procedure’. Affecting Audit Risk The auditor cannot affect inherent risk or control risk as these are internal (called Entity Risk) . This is another way of saying that the sample selected by the auditor was not representative of the data. Detection risk may be increased by things such as inexperienced audit staff or tight deadlines to complete the audit.No controls over access to IT If a business does not use passwords and other protection to protect its’ computer systems this can lead to data loss or manipulation without authorisation.

then to minimise overall audit risk. Why Plan an Audit? Plan the audit so that the engagement will be performed in an effective manner Time spent planning the audit to ensure it is carried out efficiently will reduce the time taken and thus the cost.The auditor therefore concentrates on detection risk once they have assessed the control and inherent risk. they are working efficiently and that work is focused on material areas of risk and potential problem areas. The auditor will want to ensure that the correct team is in place to conduct the audit. The planning process will also assess and thus reduce risk. Consider the elements of Audit risk and how they relate in our formula: Inherent Risk x Control Risk x Detection Risk If Inherent & Control risk are judged to be high. . The auditor will have to increase the amount of tests or the number of samples to ensure that there is less chance of a material misstatement being overlooked or missed. the auditor must attempt to minimise detection risk.

Deadlines & Timing The timing of the audit will set out any deadlines applicable and the dates of the interim and final audit visits. The auditor must ensure that the strategy selected is appropriate Geography If there are any geographical or other factors which may affect the audit. In addition there may be some substantive tests carried out. The strategy decided upon will be tailored to the client and the nature of their business and their structure.Planning Activities Risk Assessment We will look in detail later at risk assessment. timing and direction of the audit. The interim audit is conducted before the final audit to evaluate controls and document the systems in place. The scope of the audit will be determined by the reporting framework applied as well as any industry specific requirements. The attendance at the stock count will be carried out at this time and perhaps the receivables circularisation. but at this point we should be aware that the identification of risk will determine the entire audit process. they will be considered here. Audit Strategy The audit strategy sets out the scope. . The final audit will involve the bulk of the audit work and it may be possible to concentrate on the statement of financial position figures if sufficient work has been carried out during the interim audit.

Contents of the Plan There are several stages in the planning process: As follows Ensure understanding of the business Undertake analytical review Assess the risks involved with the business Establish materiality levels Establish tolerable error for material errors Decide the audit approach Ensure auditor independence Decide the budget and staff requirements Timetable the audit & set deadlines Permanent file The permanent file kept by the audit firm will bring forward a lot of the knowledge of the business. but this must be kept up .

and there will be a completion section which will review the audit. In between there will be a sub-section for each balance sheet item (e. purchases) with the work done outlined and evidence documented Analytical Procedures in Planning Analytical procedures consist of ‘evaluations of financial information through analysis of plausible relationships among both financial and nonfinancial data’ At the planning stage they help you understand the business and its environment Because you compare figures to the industry and to previous years Any items which go against the expected relationships help you assess the risk of material misstatement . The planning section of the file will cover all of the areas above.g. Current File The current file contains the evidence and documents relevant to the current year.g. Non Current Assets) and for each income statement item ( date.

Calculate the procedure and the difference to the prediction in step 1 4. and to understand any accounting or auditing ramifications of the new data Types of analytical procedures Trend analysis The analysis of changes in an account over time Ratio analysis The comparison of relationships using financial and non.How to perform Analytical Procedures A step by step guide 1. Many accounting adjustments missed as only done at Y/E . or both to actual results Limitations when used for Planning data Reasonableness testing Comparing expectations based on financial data. This could be gross profit as a % of revenue (based on previous years and industry averages) 2. based on a relationship Eg. non-financial data. Define what a significant difference is We call this the threshold below which we see any difference as just a tolerable 'error' 3. Predict a figure.these aren't reliable if business is seasonal 3. look at what impact this would have on the original expectations as if this data had been considered in the first place. If done before Y/E extrapolations used . Investigate the difference Differences indicate an increased likelihood of misstatements If caused by factors previously overlooked. Often budgets and forecasts needed 2.

4. this will require the auditor to assess: The following. Industry conditions Principle business strategies Competitors Laws and regulations Technology Stakeholders Financing Acquisitions and disposals Related parties Competence of management Accounting policies .. Even more difficult for smaller companies who don't have good management accounts How to get Initial Understanding Firstly the auditor needs to understand the entity’s environment. Often uses less rigorous management accounts 5.

1. External sources such as credit reference agencies. balances and disclosures to see if sufficient evidence on them has been collected . Information provided by the client. Analytical procedures should be undertaken at this stage to establish an understanding of the financial statements and draw attention to anomalies.’ The minutes of this meeting should be documented as evidence of its occurrence.From a number of sources. 4.. 3. We will look more closely at analytical procedures later. Internal to the audit firm such as last years’ file. The auditor’s personal experience and knowledge ISA 315 requires a planning meeting where ‘the members of the engagement team should discuss the susceptibility of the entity’s financial statements to material misstatements. Evidence The Assertions Explained Assertions are used for transactions. 2.

The assertions help assess risks They help the auditor consider potential misstatements and so design audit procedures for those particular risks. Completeness 3. Valuation and allocation Disclosures Assertions 1. Completeness 4. Classification and understandability 4. Accuracy 4. Rights and obligations 3. Accuracy and valuation . Classification Y/E Balances Assertions 1. Completeness 3. Cut-off 5. Transactions Assertions 1. Occurrence 2. Occurrence 2. Existence 2.

contracts. Inquiry This means getting information from people inside or outside the entity.Using Assertions So the assertions need testing to see if they're true This is done by 1. This enables the auditor to verify the existence (though not ownership) of them 2. play audio pause audio clipAttachment play Tweet Like RCAtweets . It also includes physical examination of the assets. It can be a formal written or an oral inquiry 4. Inspection This means a physical examination Things to inspect include: documentation. records and minutes. Observation This means watching others perform a procedure Examples include observation of Payment of wages Inventory counts Opening mail It gives assurance that official procedures are followed 3.

E. Observation 5. For example. comparing the rent charge from one period to the next and see if other evidence such as number of rental properties corroborates the increase or decrease Procedures for obtaining evidence Just remember A.5. confirming accounts receivables by circularising the debtors 6. Analytical Procedures This is the analysis of ratios and trends It includes investigating fluctuations between current and previous performance and check whether other information is consistent with such relationship. Re-calcUlation / Re-performance . 1.I. Re-Performance This can be recalculating figures or re-counting stock etc 7. Confirmation This means corroborating evidence from third parties with the internal evidence For example. Analytical Procedures 2. Enquiry 3.. Inspection 4.O and U So here's a reminder..

Procedure Meaning Control test Substantive test Analytical procedure Exploring relationships between data Comparing yearly gross margins Enquiry Getting confirmation from a 3rd party Replies from a debtors circular Inspection Examining records Signature as evidence Observation Looking at a process Watching staff complete their attendance sheet Recalculation Checking mathematical accuracy Getting title deeds to a property Adding individual sales in the sdb to check the totals Analytical procedures Substantive procedures help detect material misstatement or fraud at the assertion level There are two categories of substantive procedures . *Analytical procedures generally provide less reliable evidence than the tests of detail AP's are used at different times in the audit whereas tests of detail are only applied in the substantive testing stage Analytical procedures are compulsory at two stages of the audit under ISA 520: 1.analytical procedures* and tests of detail. The planning stage & .

Receivables/Payables/Inventory Days 2. The review stage Analytical procedures use calculations such as financial ratios to generate an expectation of what a figure is likely to be and then comparing this to the actual figure in the accounts. The financial ratios used by the auditor will fall into 3 general categories: Profitability/Return 1. Operational Gearing Whether or not the auditor relies on analytical procedures as substantive procedures . Gross Margin 2. Quick Ratio Gearing 1. ROCE Liquidity/Efficiency 1. Current Ratio 3. They can be used to highlight unusual figures in order to focus the audit on them or to establish that a trend has continued. Net Margin 3. Financial Gearing 2.2.

No misstatements in them 2.depends on four factors: Suitability Analytical procedures will not be suitable for every assertion Reliability The auditor may only rely on data generated from a system with strong controls Degree of Precision Some figures will not have a recognisable trend over time or be comparable Acceptable Variation Variations having an immaterial impact on the financial statements will not hold as much interest to the auditor as those that do Initial Engagement Opening Balances Get evidence that: 1. Accounting policies consistent If not then the comparative needs restating and disclosed . Prior period c/f correctly Or restated if necessary 3.

If previous report modified . Check post Y/E cash for confirming opening receivables / payables 2.for competence and independence 2. Get 3rd party confirmation on other assets and liabilities Prior period . Review their working papers .Prior Period Not Audited? Procedures: 1. Do stock count and "roll back" to opening balance 3. Check FS & audit report for information relevant to opening balances 3.check it has been rectified now Audit Report Possible Effects Can't get enough evidence about opening balances? "Except for" or "Disclaimer" Opening balances or disclosures incorrect "Except for" or "Adverse" .Different Auditor Audit procedures: 1.

Subsidiaries 2. is under common control with entity 3. Associate 3. Key management 5. has significant influence over the entity Types of related party These therefore include: 1. A post-employment benefit plan for the benefit of employees Not necessarily related parties Two entities with a director in common Two joint venturers Providers of finance .IAS 24 Related Parties A party is said to be related to an entity if any of the following three situations occur: The 3 situations are: 1. Close family member of above (like my beautiful daughter pictured in her new school uniform aaahhh) 6. Controls / is controlled by entity 2. Joint venture 4.

which though may be at arms length. Similarly they need to be aware of the volume of business with a related party. should the related party connection break then the volume of business disappear also Disclosures General The name of the entity’s parent and. supplier etc Stakeholders need to know that all transactions are at arms length and if not then be fully aware. if different.A big customer. this includes: Amount of outstanding balances Bad and doubtful debt information Key management personnel compensation should be broken down by: short-term employee benefits post-employment benefits other long-term benefits termination benefits . the ultimate controlling party The nature of the related party relationship Information about the transactions and outstanding balances necessary for an understanding of the relationship on the financial statements As a minimum.

Need to ensure RPs identified. Need to recognise possible fraud risk factors 2.share-based payment Group and Individual accounts 1. Individual accounts Disclose related party transactions / outstanding balances of parent.. Group accounts The intragroup transactions and balances would have been eliminated Auditing Related Parties Understanding RP relationships and transactions is vital This is because: 1. accounted for and disclosed Auditors need to.g. venturer or investor 2. Know the indicators of RP existence (not identified by managers) e. complex structures Records/documents that may indicate related parties . Need to show fair presentation 3.

P/Y working papers for names of known RPs 2. Confirm terms. Shareholder records/share register 3. Records of investments and senior management pension plans 5. Income tax returns 4. lawyers) 4. conditions and amounts with the RPs 2. Confirm or discuss with relevant independent persons (e. Review RPs FS for related party disclosures made If transactions are OUTSIDE normal course of business . banks.g. Internal auditors' reports Examples include: An unusually high turnover of senior management The use of business intermediaries for significant transactions Evidence of the RPs excessive participation in selecting accounting policies Auditing IDENTIFIED Related Parties 1. accounting for and disclosing RPs Understand the risk of management override of RPs controls Review 1.See the importance management place on identifying. Inspect evidence of appropriate authorisation 3.

Ask why management controls failed to recognise them 4. management's integrity etc) Tell Those charged with governance about: Management failure to disclose information Disagreement with management regarding RP accounting and disclosure Non-compliance with laws and regulations Difficulties in identifying the party that ultimately controls the entity Effect on Auditor's Opinion . Perform appropriate substantive audit procedures 5.Evaluate business rational Do management explanations make sense Accounting and disclosure is in accordance with the reporting framework Authorisation is appropriate What if we find an RP that management didn't tell us about? 1. Get management to identify all transactions with the RP 3.evaluate the implications for the audit (e. Tell the engagement team 2. If intentional .g. Reconsider risk of other RPs not told about & perform additional procedures 6.

Management give identifying RP low importance 2. Often it's effective and efficient to do so 3. Examples of this are specialist inventory. 1. property valuation and complex work in progress. Disagreement if disclosures are inadequate 2. The absence of disclosure requirements under the applicable financial reporting framework Why Rely on Experts? ISA 600 deals with the use of the work of an expert by the auditor The auditor may not have the expertise to make judgements on all aspects of a clients’ business and may seek help in the form of an expert.1.. Why rely on experts? 1. Limitation of scope if insufficient information Limitation of Scope if. Auditors do not have to be experts in everything 2. Intentional disregard to controls because disclosures would be sensitive 4. Poor management understanding of RP accounting and disclosures needed 5.. They need to where they lack the skills . Lack of appropriate oversight by those charged with governance 3.

but works for a subsidiary of the entity then the auditor may consider them to be not sufficiently independent Before any work is performed by the expert the auditor should agree in writing: 1. market based price? This is based on their qualifications and their experience If an expert in the inventory of the entity being audited is consulted on valuation of inventory. scope and objectives 2. Confidentiality of expert After the work . Roles and responsibilities 3.Auditor ensures it is appropriate This means considering: Consistency with other evidence Any significant assumptions made The accuracy of source data . Nature of communication 4.How much to rely on experts? Auditor needs to make judgements on: Their Independence. Nature. Objectivity and Competence Enquiries: Competence Is a member of a recognised professional body? How long has the expert been a member of the recognised body? How much experience does the expert have? Objectivity Does the expert have any financial interest in the company? Does the expert have any personal relationship with any director in the company? Is the fee paid for the service reasonable and a fair.

to come to that opinion Why Rely on Internal Audit? The external auditor must determine whether it is likely to be adequate for the purposes of the audit: So we look at: Whether the internal audit staff are sufficiently independent to retain objectivity The qualifications and technical competence of the internal audit staff The professionalism of the staff and the standing of internal audit within the organisation Are internal audit constrained in any way by management? If these considerations are fulfilled the auditor may assess the reliability of the work carried out by internal audit by . if sufficient and reliable.No reference in the Audit Report The auditor should make no reference to the use of the work of others in the audit report It is the auditors’ opinion in the report and the work of others is simply one type of evidence that may be used.

Auditing specific items IFRS 8 Determining Reporting segments IFRS 8 Determining Reporting segments Identifying Business and Geographical Segments An entity must look to its organisational structure and internal reporting system to identify reportable segments.ensuring: Internal audit working papers are well documented and have been reviewed Evidence gained by internal audit is sufficient and appropriate Any conclusions drawn are reasonable and valid Management have acted on recommendations made by internal audit If all of the above is satisfied the auditor may choose to place reliance on some of the work of internal audit. the segmentation used for internal reports for the board should be the same for external reports Only if internal segments are not along either product/service or geographical lines is further disaggregation appropriate. In fact. Remember that although they may use some of the work of internal audit as evidence. the responsibility for the final opinion will always lie with the external auditor. .

Assets are 10% or more of the total assets of all segments.Primary and Secondary Segments For most entities one basis of segmentation is primary and the other is secondary (with considerably less disclosure required for secondary segments) To decide which is primary. whether profit or loss. whichever is greater in absolute amount. Which Segments Are Reportable? Segments with a majority of external sales and for which: 1. additional segments should be identified as reportable segments until at least 75% of total revenue is included in reportable segments. Segment result. Very small segments Segments deemed too small for separate reporting may be combined with each other. If neither combined nor separately reported. Total revenue is 10% or more of the total revenue. 75% External revenue test If total external revenue of all reportable segments identified is less than 75% of the total consolidated revenue. they may be separately reported. but they may not be combined with other significant segments for which information is reported internally. . or 2. if related. the entity should see whether business or geographical factors most affect the risk and returns. is 10% or more of the combined result of all segments in profit or the combined result of all segments in loss. they must be included as an unallocated reconciling item. or 3. Alternatively. This should be helped by looking at entity’s internal organisational and management structure and its system of internal financial reporting to senior management.

reportable segments. The Earwax extractor passes all 3 tests 3. the selling segment is combined with the buying segment. Other Products These are not separate segments and can only be added together if the nature of the products are similar. However we need to check whether the 2 reported segments meet the 75% external revenue test: . but need not be.000 14.000 Which segments should be reported upon? Let’s look at the 3 reportable segment tests: 10% of combined revenue = 1. If not separately reported.000 2.050 20. it fails the assets test.010 10% of profits = 165 10% of losses = 10 10% of assets = 3.000 30 (100) 3.100 So. as are their customer type and distribution method.000 20 600 8. it fails the profits test as a loss of 100 is less than 165 (165 is higher than 10). It is still a reportable segment though as only 1 test needs to be passed 2.Internal based segments Vertically integrated segments (those that earn a majority of their revenue from intersegment transactions) may be. So ordinarily these would not be disclosed.000 50 1.000 Other Products 5.000 The Earwax extractor 3. Illustration Product External Revenue Internal Revenue Profit Assets Liabilities The Nose picker 2. 1.000 3. The Nose picker only passes the revenue test.

Similar production process 3. Operating Segments can be aggregated together only if. Similar regulations Inventory and construction contracts Inventory Value at Lower of cost and net realisable value . Currently only 5. they have similar economic characteristics such as: 1. the related revenue and expenses must also be allocated. Therefore additional operating segments (other products) may be added until the 75% threshold is reached What Accounting Policies Should a Segment Follow? Segment accounting policies must be the same as those used in the consolidated financial statements. Similar distribution methods 5. If assets used jointly by two or more segments are allocated to segments. Similar product / service 2.000 out of 10..4. Similar sort of customer 4.000 (50%).

Does a management carry out test checks? 3.Remember to take future costs away from selling price and NOT add to costs Questions relating to the physical inventory count: 1. Is a complete set of stocksheets available covering all categories of inventory? Construction Contracts Show % complete (in sales and cost of sales) Calculated one of 3 ways 1. Are all items marked when counted? 2. Value of work done method Value of work done / Total Price of contract Loss making contracts 1. Are stocksheets pre-numbered and prepared in ink? 4. Losses must be shown IMMEDIATELY by placing more costs in current year . Costs to date method Costs to date / Total costs 2.

technology. and function for their ultimate purpose or use Accounting treatment Basically uses the accruals concept Sales .and you will be told which to use :) Agreed value of work method Work done so far / Contract price total Cost Method Costs to date / Total costs .% complete How do you calculate % complete? There are 2 ways .% complete IAS 11 defines a construction contract as: a contract specifically negotiated for the construction of an asset or a combination of assets that are closely interrelated or interdependent in terms of their design.Contracts where not sure it is going to be profitable or not 1. Therefore show nil profit Construction Contracts . Make revenue just equal costs spent to date 2.% complete Costs .

000 = 70% So sales would be 700 Costs would be (70% x 800) = 560 Solution .Costs method 600 / 800 = 75% So sales would be (75% x 1000) = 750 Costs would be 600 Changes in Accounting Policy .000 Estimated total costs 800 Costs to date 600 Agreed value of work done 700 Progress billings invoiced 600 Calculate the stage of completion using:.Illustration of % complete Contract Price 1. the agreed value of work method b.agreed value of work done 700 / 1. the cost method Solution .a.

then they must also show any related tax. In this case. This is normally not a problem as both the accounts and taxman often charge amounts in the same period The problem occurs when they don’t. deferred tax is all about matching. as financial reporters we must make sure we match the income and related expense. We saw how the accounts may show income when the performance occurs. If the accounts show the income. So this was a case of the accounts showing ‘more income’ then the tax man in the current year (he will tax it the following year when the money is received). So we had to bring in ‘more tax’ ourselves by creating a deferred tax liability Hopefully you can see then that the opposite also applies: Difference Tax effect Deferred Tax More expense in I/S less tax needed Asset .Changes in accounting policy Change comparatives also Changes in accounting estimates Just change this year and not comparatives Deferred tax basics The basic idea So as we saw in the introductory section. while the taxman only taxes it (tax base) when the money is received.

Evaluate the assumptions used in the forecast against business understanding.Double entry Dr Deferred tax asset Cr Tax (I/S) In fact. Ie The accounts are showing more income. 2. 5. the following table all applies: Difference Tax effect Difference 1 More Income More tax Liability 2 Less income Less tax Asset 3 More expense Less tax Asset 4 Less expense More tax Liability Remember this ​more income etc​is from the point of view of IFRS. If it is going to take a number of years to generate such profits. Obtain a copy of current tax computation and deferred tax calculations and agree figures to any relevant tax correspondence and/or underlying accounting records. 3. Obtain forecasts of profitability and agree that there is sufficient forecast taxable profit available for the losses to be offset against. as the taxman does not tax it until next year Principal audit procedures – recoverability of deferred tax asset 1. verify that there is no restriction on the ability of Company to carry the losses forward and to use the losses against future taxable profits. Develop an independent expectation of the estimate to corroborate the reasonableness of management’s estimate. . Using tax correspondence. 4. it may be that the recognition of the asset should be restricted. 6. In particular consider assumptions regarding the growth rate of taxable profit in light of the underlying detrimental trend in profit before tax. Assess the time period it will take to generate sufficient profits to utilise the tax losses.

and agreement of all figures to the draft financial statements 6. Confirmation that the additions to PPE are disclosed in the required note to the financial statements . A breakdown of the components of the amount capitalised costs to ensure all items are eligible for capitalisation. 2. Recalculation of the borrowing cost.g.Cost This is recorded initially and then fixed Costs to include are: All directly attributable costs (e. A copy of the approved budget for any capital expenditure plan 4. P&P) All future OBLIGATED costs (at Present value) Borrowing costs (if takes a reasonable length of time to construct) Future obligated costs Dr Cost Cr Liability The liability must then be unwound Dr Interest (I/S) Cr Liability Auditing PPE additions 1. Documentation to verify when constructed assets are complete and ready for use 5. depreciation charge and carrying value of the extension at the year end. Agreement of a sample of the capitalised costs to supporting documentation 3.Non Current Assets .

Depreciation Quite straightforward but a reminder. no changing of comparatives) A change in depreciation policy is actually only a change in accounting estimate not policy So again changes only made prospectively On a revaluation .Non-current Assets .Revaluation .check that all accumulated depreciation on that asset has been cleared to zero Non-current Assets .RV) / UEL Reducing Balance NBV x depreciation rate The RV and UEL should be kept up to date each year Any changes made prospectively (i. 2 main methods Straight Line (Cost .e..

Impairments Impair if Recoverable amount is lower than carrying value Recoverable amount .Increase goes to OCI and RR Basic double entry steps: Dr Accumulated depreciation Cr Revaluation Reserve Dr Cost Cr Revaluation reserve An impairment downwards after a revaluation Dr the revaluation reserve first then Dr the Income statement Keep the revaluations up to date So change only when necessary (not always every year) Non-current Assets .

is higher of. All other non current assets pro rata to their carrying values Leases .Introduction There are 2 types of lease . Value in Use The PV of future cash flows FV less Costs to sell Only check for impairment when theres been an indicator eg Damage Loss of key employees MV fall Fall in interest rates Order for impairment 1. a finance lease is where the LESSEE takes the majority of the risks and rewards of the underlying asset Therefore with a finance lease the lessee would show the asset on their SFP (and the related finance lease liability) When classifying look for substance rather than the form .an Operating and a Finance lease In simple terms... Goodwill 2.

Finance Lease Indicators The lessee gets ownership of the asset at the end of the lease term The lessee can buy the asset at such a low price that it is reasonably certain that the option will be exercised. Land = Operating lease (unless title passes to the lessee at the end of the lease term) . and Only the lessee can use the asset as it is so specialised Other possible finance lease indicators If the lessee cancels the lease. he has to pay the lessor’s losses The lessee gets any residual value gains/losses and The lessee can lease for a secondary period at a cheap rent Land & Buildings Normally separately classified The minimum lease payments are allocated between the land and buildings elements in proportion to their relative fair values. The lease term is for the major part of the economic life The PV of the lease payments is substantially the fair value of the leased asset.

Buildings = Operating or finance lease (by applying the classification criteria in IAS 17) The classification of leases is a key issue in corporate reporting. The level of perceived risk may increase.have we actually sold it? Have we got rid of the risk and rewards? Well if we finance lease it back .it means we keep the risks and rewards . future borrowing will be harder to come by and current loan covenants may be breached. Sale and Leaseback If we sell an item and lease it back . . From a lessees point of view. Any apparent profit (FV . loan covenants may be compromised and an entity’s future borrowing capacity may be in effect . UK studies have revealed that average operating lease commitments are over ten times that of reported finance lease obligations.CV) should be deferred and amortised over the lease term.we have transferred the risks and rewards so an effective sale has been made Finance Lease Back Do not recognise a profit or loss on the disposal and continue to recognise the asset in the statement of financial position. Interest cover will also decrease As the SFP shows more liability.we have NOT sold it If we operating lease it back . classifying as a finance lease will increase gearing and decrease ROCE (as there’s more capital employed due to the finance lease liability).

Then show the operating lease rentals and that’s it.just show it in the income statement. we hold it in the SFP and take it to the income statement over the length of the operating lease. Step 3 • Amortise the profit on sale as income over the lease term Dr. This should have the effect of making the lease rentals in the income statement show at the true market rate Not normal sales .Accounting treatment The accounting entries are: 1. Step 2 • Recognise the finance lease asset Dr Asset and the associated liability Cr Finance lease liability at the lower of FV and PV of MLP as usual 3. A normal sale is where the sale price = Fair Value Not normal sales . If Operating lease rentals > market rate So here we do not take the profit to the income statement immediately but take the extra above FV and take it to the SFP and hold it there.Selling Price greater than Fair Value Again you must ask yourself why did we receive more? If theres no reason then be happy and show the whole profit in the income statement immediately.Selling Price less than Fair Value If Operating lease rentals < market rate So we simply take the “loss” and instead of hitting the income statement with it immediately. Deferred Income Cr. Income statement Operating Lease Back A normal sale If it’s a ‘normal’ profit then there’s no problem . This should have the effect of reducing the future operating lease rentals to the market rate . We then take it to the income statement over the length of the lease. Step 1 • Derecognise the carrying amount of the asset now sold Cr Asset • Recognise the sales proceeds Dr Cash • Calculate the profit on sale (proceeds less carrying amount) Cr Deferred Income 2.

Classification of the lease . signed by the lessor A copy of insurance documents where appropriate Physical inspection of the property complex Confirmation of the fair value of the property complex. possibly using an auditor’s expert. Agreement of the cash proceeds to bank statement and cash book. 3. Minutes of a discussion with management regarding the accounting treatment and including an auditor’s request to amend the financial statements. Revenue recognition WHEN do we actually show this revenue in the accounts? . if not. the audit firm should consider the implication for the auditor’s opinion 5.for the Exam 1. State a correct accounting it FL or OL? 2. In future accounting periods. depreciation should be calculated based on the NEW carrying value of the asset allocated over the remaining life and the deferred income should be amortised over the same period. An adjustment should be made and.Audit procedures . Is the effect of the error material to FS? 4. A schedule showing the adjustment required in the financial statements. Audit Evidence A copy of the lease.

revenue from sale of goods can only be recognised when the majority of the risks and rewards have been transferred and you have no more managerial control. enter into a separate agreement to repurchase the goods at a later date. These can be reliably measured 3. No managerial control Breaking Down a transaction For example. that amount is deferred and recognised as revenue over the period during which the service is performed.2 tests need to be passed 1. (Majority of) Risks and rewards transferred 4. You need to pass 4 tests to recognise revenue from the sale of goods: 1. Sale of Services These are recognised as the service completes and again only when the revenue is probable and reliably measurable: . These benefits can be measured reliably Sale of Goods In addition to 1 and 2 above. at the same time. the two transactions are dealt with together. Aggregating separate transactions For example. Probable Future Benefits 2. in such a case. an entity may sell goods and. It is probable that future economic benefits will flow to the entity 2. thus negating the substantive effect of the transaction. when the selling price of a product includes an identifiable amount for subsequent servicing.

royalties and dividends.So the revenue from a service is recognised when: 1. provided that it is probable that the economic benefits will flow to the enterprise and the amount of revenue can be measured reliably. revenue should be recognised as follows: Interest Use the effective interest method as set out in IAS 39 Royalties On an accruals basis in accordance with the substance of the relevant agreement Dividends When the shareholder’s right to receive payment is established Auditing Revenue Auditing Consignment Stock . Percentage Complete 2. Reliable Measure of Economic Benefits Interest. Probable Economic Benefits 3.Procedures Revenue may only be recognised when risks and rewards of the goods has been transferred and no more managerial control Inspect sales contracts and confirm terms Review the terms to see if client retains risk exposure and managerial involvement with the goods Send a direct circularisation to selected external vendors for inventory balances at the year end Enquire as to the % of goods usually returned . Royalties. and Dividends For interest.

Results of auditor’s test counts of inventory at a selection of vendors’ premises to ensure the existence of goods held on consignment Fair Value Audit .

audit There re 2 types .Government Grants .Revenue and Capital The debit is always cash so we only have to know where we put the credit.. Revenue Grant Cr I/S (other income or reduce expense) Capital Grant Cr Cost of asset or Cr Deferred Income Revenue Grant For I/S items such as wages etc Dr Cash Cr Other income (or expense) Capital Grant .

.For NCA such as machines and buildings 1. Option 2 Dr Cash Cr Deferred Income This will have the effect of keeping full depreciation on the income statement and the full asset and liability on the SFP Then. Dr Deferred Income Cr Income statement (over life of asset) This will have the effect of reducing the liability and the expense on the income statement An Example Option 1 Asset $100 with 10yrs estimated useful life Received grant of $50 Accounting for a grant received: DR Cash $50 CR Asset $50 At the Y/E Depreciation charge: DR Depreciation expense (I/S) (100-50)/10yrs = $5 CR Accumulate depreciation $5 Option 2 Asset $100 with 10yrs estimated useful life Received grant of $50 Accounting for a grant received: DR Cash $50 CR Deferred income $50 At the Y/E Depreciation charge: DR Depreciation expense (I/S) 100/10yrs = $10 CR Accumulate depreciation $10 Release of deferred income: .. Option 1 Dr Cash Cr Cost of asset This will have the effect of reducing depreciation on the income statement and the asset on the SFP 2.

Government advice 2. paid vacation and sick leave. any benefits payable within a year after the work is done. (such as wages.DR Deferred income 50/10yrs =$5 CR I/S $5 Government grants can only be recognised when it is probable that all terms will be reached What isn't a government grant? 1.the most obvious being wages but there are. Tax breaks from the government Pensions Introduction Objective of IAS 19 Companies give their employees benefits . bonuses etc) should be recognised when the work is done not when paid for . Preferred government supplier 3. sick leave and free or subsidised goods given to employees Short-term Employee Benefits As we mentioned above. other things they may offer such as pensions IAS 19 says that the benefit should be shown when earned rather than when paid Employee benefits include paid holiday. of course.

and because they’re groovy employers.Profit-sharing and Bonus Payments Recognise when there is an obligation to make such payments and a reliable estimate of the expected cost can be made Illustration Grazydays PLC give their employees 6 weeks of paid holiday each year. any holiday not taken can be carried forward to the next year. Accounting Treatment Any untaken holiday entitlement should be recognised as a liability in the current year even though it wouldn’t be taken until the next year Types of Post-employment Benefit Plans There are two types: 1. Defined Contribution plan In this one the company just promises to pay fixed contributions into a pension fund for the employee and has no further obligations The contribution payable is recognised in the income statement for that period If contributions are not payable until after a year they must be discounted 2.Terms . Defined Benefit plan This is a post-employment benefit that gives the company an obligation to pay a defined pension to its employees who have left The SFP Figure The present value of the obligation less FV of assets (in the pension fund) Defined Benefit Scheme .

the fund will not always exactly match the pension liability. The assets make an EXPECTED return. Actuarial gains/losses These occur due to differences between previous estimates and what actually occurred These are recognised in the OCI 2. They should be recognised immediately if already vested or not 3. The idea is that the company puts money into the fund. Of course. Plan curtailments or settlements Curtailments are reductions in benefits or the number of employees covered by the pension Any gain/loss is recognised when the curtailment occurs. Past service cost Dr Income statement Cr Pension Liability This is a change in the pension plan resulting in a higher pension obligation for employee service in prior periods. the fund spends that money on assets. . The company hopes this return will pay off the employees future pensions when they leave the company.this is “A post-employment benefit that creates a constructive obligation to the enterprise’s employees” The SFP shows the pension fund as it stands at the year end in terms of the present value of the obligation less FV of assets Let’s dig a little deeper to make some sense out of this. Therefore there will either be a surplus or deficit on the SFP Let’s look at some terms before we put it all together: 1.Terms Defined benefit plan As we said in the intro .Defined Benefit Scheme .

Interest cost The unwinding on the discount of the pension liability Dr Interest Cr Pension Liability 6. Benefits paid These are the actual pensions paid out to former will have net interest received If a fund has more liabilities than assets (a deficit) . Expected return on plan assets This is the the fund can buy assets to generate an expected return Dr Pension Asset Cr Cash 8. dividends and other revenue from the pension assets and is now to be based on the return from AA-rated corporate bonds This means companies cannot set expected returns according to the assets actually held by the plan. Paying the pensions means we reduce the liability. They use the same discount rate. seeing as the potential higher return will no longer be reflected in the accounts. so we reduce the pension asset also Dr Pension Liability Cr Pension Asset . So if a fund has more assets than liabilities (a surplus) . Contributions to Pension fund This is simply the money that the company puts in to the fund . but we use the pension fund to do it. The reason behind this is to improve transparency and consistency Dr Pension Asset Cr Interest received The Interest cost and EROA are netted off against each will have net interest paid 7. Current service cost Increase in pension liability due to benefits earned by employee service in the period Dr Income statement Cr Pension Liability 5. it could encourage them to invest in more secure vehicles than is currently the case.

In such cases. any asset recognised in the balance sheet should be the lower of: . “Demonstrably committed” means a detailed formal plan without realistic possibility of withdrawal. deferral of past service cost may not result in a refund to the entity or a reduction in future contributions to the pension fund. Discount down if payable in more than a year Equity Compensation Benefits No recognition for stock options issued to employees as compensation. So. It may be that there are net assets but not all can be recovered through refunds / contributing less in the future. bonuses) A simplified application of the model described above for other long-term employee benefits: All past service cost is recognised immediately Termination Benefits (eg. Terminating the employment of employees before the normal retirement date. so a gain is prohibited in these circumstances.Other Long-term Benefits (eg Profit shares. Providing benefits in order to encourage voluntary redundancy. Redundancy) Amount payable only recognised when committed to either: 1. or 2. Nor does it require disclosure of the fair values of stock options or other share-based payment IAS 19 ‘Asset Ceiling’ This stops gains being shown just because Past service costs (unvested) have been deferred.

the net total calculated. Can a reliable estimate can be made of the amount of the obligation . Is there a present obligation (legal or constructive) as a result of a past event 2. and (ii) the present value of any economic benefits available in the form of refunds from the plan or reductions in future contributions to the plan. 1.. Is it probable that an outflow of resources embodying economic benefits will be required to settle the obligation 3. and the net total of: (i) past service costs not recognised as an expense. as you know exactly how much that is and when it is to be paid However it is still a potential liability To create a provision though Dr Expense Cr Provision the potential liability must be probable In fact 3 tests need to be passed. An asset may arise where a defined benefit plan has been overfunded or in certain cases where actuarial gains are recognised Provisions A provision is a liability of uncertain timing or amount All this means is that it is not a creditor.

settlement of a lawsuit Measured at the most likely amount Large populations of events Eg. environmental clean-up. Provisions for one-off events Eg. What amount of provision should be made? (88% x 0) + (7% x 24. Past experience suggests: 88% of the goods sold will have no defects 7% will have minor defects 5% will have major defects If minor defects were detected in all products sold.000. restructuring.000) = $11. If major defects were detected in all products sold. the cost of repairs will be $24.680 Contingent Assets . the cost would be $200. warranties.000) + (5% x 200. customer refunds Measured at a probability-weighted expected value A company sells goods with a warranty for the cost of repairs required in the first 2 months after purchase.000.Measurement of a Provision The amount recognised as a provision should be the best estimate of the expenditure required to settle the present obligation at the end of the reporting period.

it must be harder to show a potential asset in your accounts than it is a potential liability This is achieved by changing the probability test For a potential (contingent) asset . it is not a potential liability.create an asset in the accounts IAS 24 Related Parties A party is said to be related to an entity if any of the following three situations occur: . but a potential asset The principle of PRUDENCE is important here.Create a provision Probability test for Contingent Assets Remote chance of receiving .Do nothing Probable chance of receiving .Disclosure Virtually certain of receiving .Do nothing Possible chance of receiving .it needs to be virtually certain (rather than just probable) Probability test for Contingent Liabilities Remote chance of paying out .Do nothing Possible chance of paying out .Here.Disclosure Probable chance of paying out .

is under common control with entity 3. Joint venture 4. A post-employment benefit plan for the benefit of employees Not necessarily related parties Two entities with a director in common Two joint venturers Providers of finance A big customer. supplier etc . Key management 5. Close family member of above (like my beautiful daughter pictured in her new school uniform aaahhh) 6. Associate 3. Controls / is controlled by entity 2. Subsidiaries 2.The 3 situations are: 1. has significant influence over the entity Types of related party These therefore include: 1.

if different. the ultimate controlling party The nature of the related party relationship Information about the transactions and outstanding balances necessary for an understanding of the relationship on the financial statements As a minimum. which though may be at arms length. should the related party connection break then the volume of business disappear also Disclosures General The name of the entity’s parent and.Stakeholders need to know that all transactions are at arms length and if not then be fully aware. Similarly they need to be aware of the volume of business with a related party. this includes: Amount of outstanding balances Bad and doubtful debt information Key management personnel compensation should be broken down by: short-term employee benefits post-employment benefits other long-term benefits termination benefits share-based payment Group and Individual accounts .

venturer or investor 2. Group accounts The intragroup transactions and balances would have been eliminated IAS 33 EPS Introduction EPS is a much used PERFORMANCE appraisal measure It is calculated as: PAT . Individual accounts Disclose related party transactions / outstanding balances of parent.Preference dividends / Number of shares It is not only an important measure in its own right but also as a component in the price earnings (P/E) ratio (see below) .1.

Introduction There are 3 types of Share based payment.Diluted EPS This is saying that the basic EPS might get worse due to things that are ALREADY in issue such as: Convertible Loan This will mean more shares when converted Share options This will mean more shares wen exercised Who has to report an EPS? PLCs Group accounts where the parent has shares similarly traded/being issued EPS to be presented in the income statement Share Based Payments . 1.. Equity-settled share-based payment This is where the company pays shares in return for goods and/or services received .. These are.

Transactions with a choice of settlement A choice of cash or shares paid in return for goods and services received depends on choice made Vesting period Often share based payments are not immediate but payable in say 3 years. HOWEVER.Dr Expense Cr Equity 2. Cash-settled share-based payment This is where cash is paid in return for goods and services received.the actual cash amount though is based on the share price These are also called SARs (Share Appreciation Rights) Dr Expense Cr Liability 3.. The expense is spread over these 3 years and this is called the vesting period How much to recognise? So we have decided that share based payments (either shares or cash based on share price) should go into the accounts (Dr expense Cr Equity or Liability) We now have to look at the value to put on these Option 1: Direct method Use the FV of the goods or services received .

if the FV of these cannot be reliably measured then you should go for option 2 . You cannot put a value on the work done by employees . option 2 is the most common. Option 2 Equity Settled An entity grants 100 share options on its $1 shares to each of its 500 employees on 1 January Year 1. the entity estimates on 1 January that 100 employees will leave during the threeyear period and therefore forfeit their rights to share options.Option 2: Indirect method Use the FV of the shares issued by the company Equity settled .share options are equity settled (so Dr Expense Cr Equity) .the FV of the goods/services.FV of shares issued. This is because share based payments are often associated with paying employees. Strangely enough.Update FV of shares each year IFRS 2 suggests you choose option 1 . The following actually occurs: – 20 employees leave during Year 1 and the estimate of total employee departures over the three-year period is revised to 70 employees – 25 employees leave during Year 2 and the estimate of total employee departures over the three-year period is revised to 60 employees – 10 employees leave during Year 3 Solution Step 1: Decide if this is a cash or equity settled SBP . However. Each grant is conditional upon the employee working for the entity over the next three years.except for the value of what you pay them ie. The fair value of each share option as at 1 January Year 1 is $10 On the basis of a weighted average probability.Use FV of shares @ grant date Cash settled .

000 Year 3: Dr Expense 151.700 Cr Liability 208.300 = 150.352.700 3 445 x 100 x 14 x 3/3 .000 Cr Equity 150.300 Year 2: Dr Expense 208.300 Cr Equity 143.623.300 =’s just we’ve spread it over the 3 years vesting period Cash settled illustration Same question with additional information of share price at the end of each year: Year 1 10 Year 2 12 Year 3 14 Solution As this is cash settled then the double entry becomes Dr Expense Cr Liability and we do not keep the value of the option @ grant date but change it as we pass through the vesting period 1 430 x 100 x 10 x 1/3 = 143.700 Notice that if you add these up it comes to 445.300 Year 2: Dr Expense 150. This is exactly our final liability (445 x 100 x $14 x 3/3) .300 Cr Liability Year 3: Dr Expense 271.Step 2: Decide whether to value directly or indirectly .000 x 3/3 .000 = 271.000 Year 3 445 x 100 x $10 x 3/3 .300 Year 2 440 x 100 x $10 x 2/3 .700 Cr Equity 2 440 x 100 x 12 x 2/3 . This is exactly our final liability (445 x 100 x $10 x 3/3) .it’s just we’ve spread it over the 3 years vesting period Auditing SBP .700 So you can see that the “costs” and so the entries into the accounts would be: Year 1: Dr Expense 143.000 Notice that if you add these up it comes to 623.300 = 208.000 So you can see that the “costs” and so the entries into the accounts would be: Year 1: Dr Expense 143.000.these are for employees so indirectly Step 3: Calculate how many employees (and their share options each) are expected to be issued at the end of the vesting period Year 1 430 Employees expected to be left at end (500-70) x 100 (share options each) x $10 (FV @ GRANT date) x 1/3 (time through vesting period) = 143.000 Cr Liability 271.

Recalculate the expense and check that the fair value has been correctly spread over the stated vesting period. and evaluate whether the specialist report is a reliable source of evidence. 2. If no market value available for FV Then we need to audit the model used as follows: Review assumptions used. Agree fair value of share options to specialist’s report and calculation. 3. Obtain and review a forecast of staffing levels or employee turnover rates for the duration of the vesting period. Obtain management calculation of the expense and agree the following from the calculation to the contractual terms of the scheme: – Number of employees and executives granted options – Number of options granted per employee – The official grant date of the share options – Vesting period for the scheme – Required performance conditions attached to the options. and scrutinise the assumptions used to predict level of staff turnover.option pricing model) used by management to estimate the fair value of the share options at the grant date Consider the appropriateness of the model Consider using an expert to provide evidence as to the validity of the fair value used Check the sensitivity of the calculations to a change in the assumptions used in the valuation . Agree that the fair value calculated is at the grant date. 4. Obtain written representation from management confirming that the assumptions used in measuring the expense are reasonable. 6. and inputs into the the model (eg.Principal audit procedures – measurement of share-based payment expense Those are: 1. 5.

it’s an identifiable non-monetary asset without physical substance. It is the lack of identifiability which prevents internally generated goodwill being recognised . It is SEPARABLE. just one or the other is enough) . are not separable and do not arise from legal rights A taxi licence can be an intangible asset as they are controlled. such as a licence. according to IAS 38. whats identifiable mean?? Well it just means the asset is one of 2 things: 1. Examples Employees can never be recognised as an asset. It is not separable and does not arise from contractual or other legal rights. patent or trademark.What is an intangible asset What is an Intangible asset? Well. It arises from contractual or other legal rights. Whooah there partner. meaning it can be sold or rented to another party on its own (rather than as part of a business) or 2. they are not under the control of the employer. can be sold/exchanged/transferred and arise from a legal right (The intangible doesn’t have to be separable AND arise from a legal right.

Inspect minutes of a discussion with management regarding amortisation / non-amortisation and recalculate where necessary 4.use the FV of that item NCI .use the figure given If it's future payment . Look at forecast sales records to determine the future economic benefit to be derived Auditing Goodwill Learn the 3 components of goodwill FV of Consideration If it's cash easy . confirming the length / type / cost of asset this figure down If it's a contingent item (dependent on something happening) . Inspect legal documents.Auditing Intangible Assets Audit procedures & Evidence needed as follows Basic procedures are: 1. Agree cash paid to the bank statement and the cash book 3.

If payment occurs after year end confirm that a current liability is recognised on the individual company and consolidated statement of financial position (balance sheet). and reflects current market assessment of the time value of money 7. 3. Agreement of the monetary value and payment dates of the consideration per the client schedule to legal documentation signed by vendor and acquirer.g.One of two choices Proportionate value of FV of S's NA FV of S as a whole This means goodwill share is only given to NCI in the FV method FV of NA acquired Include intangibles and contingent liabilities that are not on S's accounts normally If the values are provisional . e. 2. 4. Agree % of ownership. Inspect the bank statement and cash book whether the payment was paid. Board minutes approving the payment. Obtain due diligence report and agree net assets valuation if appropriate Step Acquisitions Step Acquisitions .there is 1 year from date of acquisition to change this figure Audit evidence 1. 5. 6. Agreement that the discount rate used is pre-tax. using Companies House search/register of significant shareholdings 8. Recomputation of discounting calculations applied to deferred and contingent consideration.

The Consideration figure in the goodwill working would now be 940 (140 + 800) Further acquisition after control is achieved If there are further acquisitions after control .so no profit is calculated. At this date we must: Revalue the original 10% from 100 to 140 The 40 gain goes to the income statement (and retained earnings) Also we would now start consolidating S (as we now control it). At this date. the original 10% now has a FV of 140 How would this be accounted for? The key date of when controlled is achieved is year 2.When Control is achieved is the key date.this is deemed to be a purchase from the other owners (NCI) . Consolidation only occurs when control is eventually achieved When Control is achieved this occurs: Remeasure all previous holdings to FV Any gain or loss to income statement Illustration P acquired 10% of S in year 1 for 100 P acquired a further 60% of S in year 2 for 800. Simply Here you will need to do the following calculation: ..

2 years later its NA are 150 and H acquires another 20% for 80 Calculate decrease in NCI and movement in parents equity for the latest acquisition FV of consideration 80 Decrease in NCI (30) Difference .goes to Equity of the Parent x/(x) Illustration H acquired 60% S for 100 in year 4 when the FV of its NA was 90. Proportionate NCI method used.FV of consideration (for the extra % bought) x Decrease in NCI (x) Difference .goes to Equity of the Parent 50 NCI .

Now. It has halved. So NCI has gone down by 30.@ Acquisition 36 (40% x 90) Post acquisition 24 (40% x (150-90)) Impairment (0) TOTAL AT DATE OF DISPOSAL 60 SO NCI was 60 (representing 40%). Group accounting audit Always think of the basics Acquisition in year I/S pro rate inclusion of sub Calculate GW Pro rata NCI in the year Think about component auditors Materiality will now increase . this means NCI will go from 40% to 20%. by acquiring a further 20% from the NCI.

g. 80% to 60% Any profit goes to equity NOT I/S Full Disposal eg 60% to 30% Any profit goes to I/S The sub is taken out completely from group accounts (NA. GW. from 60% to 80% Any "profit" goes to equity NOT I/S Partial Disposal eg. NCI) Is replaced by an associate at FV Investment property .Ensure sub uses same accounting policies and same year end as parent Analytical procedures may be enough for the audit of this acquisition (if its in the same industry as us) New related party transactions (with the sub) Further acquisition? e.

Instead it is just an investment for them It stands alone and makes the company some cash: 1. but rather held for investment surprise here . So each property is revalued and the difference is added to the asset and the other side goes to the income statement What if the property is ours but only under an Operating Lease? This is fine but the property must be measured using the FV model (see later) IAS 40 lists the following as examples of investment property: Land held for long-term capital appreciation rather than short-term sale Land held for a currently undetermined future use A building owned by the entity (or held under a finance lease) and leased to a third party under an operating lease A building which is vacant but is held to be leased out under an operating lease Property being constructed or developed for future use as an investment property The following are NOT investment property . From Capital appreciation . From Rental Income .So here we are dealing with a situation where a company owns a building (or land) but doesn’t use it . No problemo 2. Much better is a market based fair value.As the asset is not used. then historic cost becomes particularly unuseful (you could argue).throw it in the income statement.

.Categories There's only 2 categories.Property intended for sale in the ordinary course of business (IAS 2) Property being constructed or developed on behalf of third parties (IAS 11) Owner-occupied property (IAS 16) Property leased to another entity under a finance lease (IAS 17) An investment property should be recognised when: It is probable that the future economic benefits will flow. Yay! . and The cost of the investment property can be measured reliably. property transfer taxes) This does not include Start up costs Financial liabilities . Initially measured at cost . for example transaction costs (professional fees. FVTPL and Amortised cost. This includes: ​Purchase price Directly attributable costs.

Fair Value Through Profit and Loss This includes financial liabilities incurred for trading purposes and also derivatives 2.. Amortised Cost If financial liabilities are not measured at FVTPL (see below) we want to look at HOW MUCH to bring the liabilities in at.we always recognise it at Fair Value INITIALLY. we’ve looked at recognising (bring into the accounts for those of you who are a sandwich short of a picnic*) . Basically there are 2 categories of Financial Liability. We already dealt with this on a tricky convertible loan. It is how we treat them afterwards where the category matters (and remember here we are just dealing with the initial measurement) Accounting Treatment of Financial Liabilities (Overview) Initially At Year-End Any gain/loss FVTPL Fair Value Fair Value Income Statement Amortised Cost Fair Value Amortised Cost . Trust me this section is much easier.. 2 Categories 1. they are measured at amortised cost The good news is that whatever the category the financial liability falls into .

000 x 0. Possible Naughty Bits Premium on redemption This is just another way of paying interest.the question is .how do you measure the FV of a loan?? Well again the answer is simple . Always presume the market rate is the same as the effective rate you’re paying unless told otherwise by El Examinero.751 751 Interest 100 x 2.WHERE THE EFFECTIVE RATE YOU PAY IS THE SAME AS THE MARKET RATE THEN THE FV IS THE PRINCIPAL so no need to do the 2 steps.So .and you’ve done it already with compound instruments.486 249 Total 1. All you do is those 2 steps: STEP 1: Take all your actual future cash payments STEP 2: DIscount them down at the market rate If the market rate is the same as the rate you actually pay then this is no problem and you don’t really have to follow those 2 steps as you will just come back to the capital amount…let me explain 10% 1.000 Payable Loan 3 years Capital 1. Except you pay it at the end (on redemption) .000 So the conclusion is .

Accounting Treatment So we have these 3 categories.000 not 4% x 950 *A quaint old English saying .with a 10% premium on redemption.000) payable at the end.000 payable loan . the INITIAL FV of the loan was is just another way of paying interest .because we haven’t yet taken into account the extra 100 (10% x 1.000 payable loan with a 5% discount on issue So again the interest rate is not 4%.000). So the examiner will tell you what the effective rate actually is .meaning you’re an idiot :p Financial assets .except this time you pay it at the start eg 4% is actually 950 NB You still pay interest of 4% x 1. This means that the EFFECTIVE interest rate is more than 4% . because it ignores the extra interest you pay at the beginning of 50 (5% x 4% 1. Category Initial Measurement Year-end Measurement Difference goes where? FVTPL FV FV Profit and Loss FVTOCI FV FV OCI Amortised Cost FV Amortised Cost - . although you presume that the effective rate is the same as the market rate (7% say).let’s say 8% (not enough info in the question to calculate this) The crucial point here is that you presume the effective rate is the same as the market rate so the initial FV is still 1. So the effective rate is let’s say 7% (again we cannot calculate this and will just be given in the exam) The crucial point here is that the discount is paid immediately.000 but is immediately reduced by the 50 discount .. So.000 Discount on Issue Exactly the same as above .

Revalue to FV 2. Difference to OCI Amortised cost accounting treatment 1. Revalue to FV 2.Initially both are measured at FV Now let's look at what happens at the year-end. Re-calculate using the amortised cost table (see below) Amortised Cost Table 8% 100 receivable loan (effective rate 10% due to a premium on redemption) Opening Balance Interest (effective rate) (CashReceived) Closing balance 100 10 (8) 102 . Difference to I/S FVTOCI accounting treatment 1. FVTPL accounting treatment 1..

within 12 months of classification as held for sale The asset is being actively marketed for sale at a sales price reasonable in relation to its fair value Abandoned Assets The assets need to be disposed of through sale. Therefore.Assets Held for Sale Key Issues When is an asset held for sale? Management is committed to a plan to sell The asset is available for immediate sale An active programme to locate a buyer is initiated The sale is highly probable. operations that are expected to be wound down or abandoned would not meet the definition. Therefore assets to be abandoned would still be depreciated. Measurement Immediately before the initial classification The carrying amount of the asset will be measured in accordance with applicable IFRSs. Generally. bring depreciation up to date .

After classification as held for sale Measured at the lower of carrying amount and fair value less costs to sell An Impairment? Any impairment loss must be recognised in profit or loss. Subsidiaries already consolidated now held for sale The parent must continue to consolidate such a subsidiary until it is actually disposed of. It is not excluded from consolidation and is reported as an asset held for sale under IFRS 5.(if cost model followed) or revalue (if revaluation policy followed). Subsequent increase in Fair Value? This basically happens at the year end if the asset still has not been sold A gain is recognised in the p&l up to the amount of all previous impairment losses. even for assets previously carried at revalued amounts. Non-depreciation Non-current assets or disposal groups that are classified as held for sale shall not be depreciated Balance sheet presentation Presented separately on the face of the balance sheet in current assets Subsidiaries Held for Disposal IFRS 5 applies to accounting for an investment in a subsidiary held only with a view to its subsequent disposal in the near future. Revalued assets will need to deduct costs to sell from their fair value and this will result in an immediate charge to profit or loss. So subsidiaries held for sale are accounted for initially and subsequently at FV-CTS of all the net assets not just the amount to be disposed of .

including a review of post year-end board minutes and a review of significant cash transactions.Auditing Held for Sale Audit procedures & Evidence needed as follows Procedures Include: 1. to confirm if any properties are sold in the period after the year end 6. Inspect board minute at which the disposal of the properties was agreed by management 2. Ensure active programme to locate a buyer. Inspect any minutes of meetings held with prospective purchasers of any of the properties. to confirm no depreciation once reclassified as held for sale IAS 10 Events After The Reporting Period Events can be adjusting or non-adjusting If the event gives us more information about the condition at the year end then we adjust If not then we don't . Subsequent events review. instructions given to real estate agency 3. Written representation from management on the opinion that the assets will be sold within a year 5. or copies of correspondence with them 4. for example. Review client’s depreciation calculations.

rather they are . Property gets impaired 3 weeks after SFP date (This implies that the property was impaired at the SFP date also) Non-Adjusting Events . but before the accounts are authorised and published. should we change the accounts or not? The most important thing to remember is that the accounts are prepared to the SFP date. 1. it may be that more information ABOUT the conditions at the SFP date have come about afterwards and so we should adjust the accounts. Sometimes we do not adjust though… Adjusting Events The event (which occurred after the SFP date) provides evidence of conditions that existed at the period end Examples are.When is the "After the Reporting date" period? It is anytime between period end and the date the accounts are authorised for issue Ok and why is it important? Well it may well be that many of the figures in the accounts are estimates at the period end However. Not afterwards.these are disclosed only These are events (after the SFP date) that occurred which do not give evidence of conditions at the year end. So we are trying to show what was the situation at the SFP date.. Stock is sold at a loss 2 weeks after SFP date 3. However.. Debtor goes bad 5 days after SFP date (This is evidence that debtor was bad at SFP date also) 2. what if we get more information about these estimates etc afterwards.

Difference goes to reserves NOT I/S Single company eg Dealing with foreign transactions 1. Property impaired due to a fall in market values generally post year end (This is evidence that the property value was fine at the year end . Stock is sold at a loss because they were damaged post year end (This is evidence that they were fine at the year end .g. Retranslate I/S at average or actual rate no adjustment) 2. Difference between buying and paying rate .indicative of conditions AFTER the SFP date 1. Retranslate SFP at year end rate 2. Foreign subsidiary no adjustment required) Non-adjusting event which affects Going Concern Adjust the accounts to a break up basis regardless if the event was a non-adjusting event Foreign exchange effects Understand these from a single and group company viewpoint Group Companies e.

Difference between buying and paying rate 2. Difference goes to I/S Borrowing Costs Part 1 Borrowing Costs Part 1 Let’s say you need to get a loan to construct the asset of your dreams . Remember that directly attributable costs get added to the cost of an asset per IAS 16 . construction or production of a qualifying asset form part of the cost of that does iAS 23 agree and add interest to the cost of the asset? Well this is what it says: Where the loan is specifically for building a substantial asset. the interest is to be added to the cost of the asset (as opposed to going to the income statement as an expense as normal) This means the cost of an asset includes ALL costs to get it ready for use or sale Basic Idea Borrowing costs that are directly attributable to the acquisition. loans.1. Other borrowing costs are recognised as an expense.well the interest on the loan then is a directly attributable cost. Retranslate all foreign monetary balances (cash. debtors etc) at year end rate 4. . Difference between selling and receiving rate 3.

. Assets measured at fair value. Inventories and Intangibles You don’t have to add the interest to the cost of the following assets: 1. This means up to the point when just the finalising touches are left NB Stop capitalising when AVAILABLE for use. Expenditure begins for the asset 2. Activities begin on building the asset eg. It has to take quite a while to build do could be PPE. Borrowing costs begin on the loan 3. This means it can’t be anything that is available for use when you buy it. This tends to be when the construction is finished If the asset is completed in parts then the interest capitalisation is stopped on the completion of each part. getting planning etc So just having an asset for development without anything happening is not enough to qualify for capitalisation When will capitalisation stop? Well. Plans drawn up. when virtually all the activities work is complete. Inventories that are manufactured or produced in large quantities on a repetitive basis even if they take a substantial period of time to get ready for use or sale. 2. Investment Properties.So what is a “Qualifying asset?” It is one which needs a substantial amount of time to get ready for use or sale. When should we start adding the interest to the cost of the asset? Capitalisation starts when all three of the following conditions are met: 1.

eg.If the part can only be sold when all the other parts have been completed. and the basis of that opinion Review the claim itself to confirm the amount Inspect the board minutes for evidence of discussion of the claim. then stop capitalising when the last part is completed. Bank holidays etc Auditing Provisions Audit procedures & Evidence needed as follows Procedures would include: Obtain written evidence from legal advisors that in their opinion amounts are probable to be paid. to obtain an understanding as to the reason for the claim and whether it has been disputed Auditing Insurance claims (Contingent Assets) Obtain a copy of the insurance claim made and confirm the amount claimed Enquire as to the basis of the amount claimed . Be careful though . What about if the activities stop temporarily? Well you should stop capitalising when activities stop for an extended period During this time borrowing costs go to the profit or loss.If the temporary delay is a necessary part of the construction process then you can still capitalise.

g. Review board minutes for discussion of on-going warranty claims. Review correspondence with customers during the year to gain an understanding of claims already in progress at the year end 4. Perform analytical procedures to compare the level of warranty provision year on year. the insurance company disputing the claim Auditing Warranty Provisions ISA 540 Audit of Accounting Estimates requires that auditors should obtain sufficient audit evidence as to whether an accounting estimate is reasonable and that disclosure is appropriate. and compare actual to budgeted provisions. Review and test the process used by management to develop the estimate 2. Audit procedures 1. and attempt to receive written confirmation of the likelihood of any payment being made Review correspondence between the client and the insurance provider. e..Review any supporting documentation such as management accounts showing lost income for the period of halted production Scrutinise the terms of the insurance policy. and for approval of the amount provided . Review contracts or orders for the terms of the warranty to gain an understanding of the obligation 3. Re-calculate the warranty provision 6. Agree the percentage applied in the calculation to the stated accounting policy of the Client 7. 5. to determine whether covered Seek permission to contact the insurance provider to enquire as to the status of the claim. looking for confirmation of any amounts to be paid Contact client lawyers to enquire if there have been any legal repercussions arising from the insurance claim.

An example of development is a car manufacturer undertaking the design. devices. Dr Intangible non-current assets (SOFP) Cr Bank/Payables . Development Development is the application of research findings or other knowledge to a plan or design for the production of new or substantially improved materials. no future economic benefit can be expected to flow to the entity.Development cost Research and Development Definitions Research Research is original and planned investigation undertaken with the prospect of gaining new scientific or technical knowledge and understanding. or services. systems. products. 2. processes. and therefore. construction. and testing of a pre-production model. at this early stage. Accounting Treatment of Research and Development 1. before the start of commercial production or use. The company is researching the unknown. and will never be capitalised as an intangible asset. An example of research could be a company in the pharmaceuticals industry undertaking activities or tests aimed at obtaining new knowledge to develop a new vaccine. Research costs IAS 38 states that all expenditure incurred at the research stage should be written off to the income statement as an expense when incurred. Development costs Should be capitalised as an intangible assets if meet the following criteria.

Under IAS 38. Evaluate whether the development costs meet the recognition criteria (PIRATE) Review Analytical procedures at review stage These are compulsory at review and at planning stage Analytical procedures are also an effective tool for gathering evidence throughout the audit. an intangible asset must demonstrate all of the following criteria: P robable future economic benefits I ntention to complete and use or sell the asset R esources (technical. they highlight unexpected movements These can then be focussed on during the audit . and comparing to actuals. financial and other resources) are adequate and available to complete and use the asset A bility to use or sell the asset T echnical feasibility of completing the intangible asset (so that it will be available for use or sale) E xpenditure can be measured reliably Audit procedures: 1. By using expectations. Are the development costs material? 2.

Reliability: The auditor may only rely on data generated from a system with strong controls 3. Suitability: Analytical procedures will not be suitable for every assertion 2. Gearing Financial gearing Operational gearing Whether or not the auditor relies on analytical procedures as substantive procedures depends on 4 factors: 1. Degree of Precision: Some figures will not have a recognisable trend over time or be comparable. Profitability Gross margin Net margin ROCE 2. Acceptable Variation: Variations having an immaterial impact on the financial statements will not hold as much interest to the auditor as those that do. Comparatives . Liquidity Receivables/Payables/Inventory Days Current ratio Quick ratio 3. 4.These can then be focussed on during the audit The financial ratios fall into 3 general categories: 1.

Adverse opinion on comparative Prior period financial statements were audited by another auditor .Modify this year's report Misstatement in comparative found but not restated .use "other matter" paragraph to explain this . Basically just ensure: 1) They agree with the previous period 2) Accounting policies are consistent applied in the two periods What if a material misstatement is found in the comparative? Perform appropriate additional procedures Comparatives and the Audit Report The audit opinion should not normally refer to the corresponding figures Unless the following apply: Qualified opinion last time remains unresolved .Comparatives must be presented in accordance with the applicable financial reporting framework Audit work on comparatives is far less than current year figures.

the Chairman’s report and the employees report are not covered by the audit.Prior period financial statements were not audited .use "other matter" paragraph to explain this Comparative Issue Resolved "Other matter" paragraph if material to this year Comparative Issue NOT Resolved Modify Report Other Information The other information in the accounts such as the Directors report.qualify the audit report due to disagreement If OTHER INFO is wrong .and management refuse to amend . Material inconsistency If FS are wrong .an EOM paragraph only is needed Misstatement of fact If management refuse to amend then an EOM paragraph is needed FS problem not resolved "Except for" paragraph or "Adverse" opinion Other information NOT corrected "Other matter" paragraph or seek legal advice . the auditor must review such information and highlight any material inconsistency with the audited financial statements or material misstatements of fact.and management refuse to amend . However.

ensure that the matter was resolved 2.Initial Engagements This is when an Auditor takes on a new engagement Things to Consider: 1. Previous audit qualified? If so. Any audit adjustments in previous year? Ensure made in the client’s accounting system as well as the final accounts 3. but if these are unsatisfactory then substantive procedures may be required Auditor responsibility for Subsequent Events . Were the accounts audited last year? Carry out some work to ensure happy with the opening position By consulting with management and reviewing the systems in place the auditor may not have to carry out substantive procedures.


Purpose of a Subsequent Events Review Auditors are responsible for their audit work from Y/E to issuing of FS This duty is both Active and Passive And ranges from Active Duty Between the Y/E and signing the FS To search for all material events Passive Duty Between the signing and issue date .

budgets and cash flow forecast Review of post Y/E board minutes Review how management assess subsequent events and ask if any have been found Obtain a management representation letter confirming this Check post Y/E cash received to ensure: 1) Receivables are received and 2) NRV of inventory is as expected Going Concern Disclosures and Reporting Going Concern Disclosures .To act if they become aware of anything that may affect their audit opinion Subsequent events are events which occur after the balance sheet date The auditor must perform a subsequent events review This involves: Review post Y/E management accounts.

If GC is appropriate No need to mention GC in their report If GC not appropriate Qualify the audit report (unless management agree to alter the financial statements ) Insufficient Disclosure Qualify the audit report (unless management agree to alter the disclosures) If NOT on Going Concern basis Always refer to it in their report in an ‘emphasis of matter’ paragraph Going Concern Responsibilities FS are prepared on a going concern basis unless inappropriate to do so Going concern is defined under IAS 1 as the assumption that the company will continue in operational existence for the foreseeable future .

future profitability and repayment of debt .Some Key Issues: 1. Foreseeable Future This isn't defined :( but is generally accepted to be at least one year into the future and further if specific business reasons make it appropriate 2. Break up basis This is when GC basis is not appropriate This values assets at their sale value and inventory at NRV Director's Responsibility They must assess going concern They should use a suitable basis on which to base the going concern They should use information on sources of finance. Use of Judgement GC involves the use of judgement on the basis of the information available at the time 3.

Auditors Responsibility They must assess the appropriateness of the going concern assumption If there are going concern issues.If the directors have any material uncertainties as to the going concern of the business they must disclose them in the financial statements. the auditor must ensure that sufficient disclosures are made Management Responsibility Assess if can carry on for foreseeable future At least 12 months Auditor Responsibility Going Concern Review & Indicators Decide if management are right to use going concern status Should uncertainties be disclosed .

are they reasonable Conduct analytical review of the FS to check for worsening performance Review correspondence with solicitors to ensure no likely actions or cases Review correspondence with banks to provide evidence of continued good relations Indicators of Going Concern Technology changes in the industry Suppliers unwilling to provide credit terms Banks withdrawing loan facilities Management plans for risky diversification Cash-flow problems post year end or large cash outflows Deterioration in key ratios . management accounts and budgets Review management assumptions .Going concern is vital as the FS must show a ‘true and fair view’ The auditor will undertake a number of procedures in the going concern review: Look at the economic conditions of the industry at that time Contact providers of finance to check they're happy to continue Assess management intentions for the future Review post Y/E cash flow statements.

VAT or supplier invoices Sales of major assets without prior warning Loss of key customer or supplier Group Audits Should we accept the job? Group accounts are audited by a principal auditor with subsidiaries being audited by other auditors What are "Components"? Subsidiaries Associates So what are the problems? Principle auditor may rely on the work of component auditors Complex groups mean a complex audit .Loss of Key staff Legal action against the company Late payment of staff salaries. PAYE payments.

appropriate evidence to form an opinion on the consolidated financial statements. non-coterminous year. Materiality assessment If an acquisition in year . perhaps having up to 50 subsidiaries. Group structure The group structure must be ascertained to identify the entities that should be consolidated 2.Consolidation adjustments must comply with the specific accounting standards applicable So what are the considerations before accepting a role as principal auditor Materiality of the portion to be audited Degree of Knowledge of the components Risk of material misstatement of the components Any additional procedures required on components Relationship with other auditors The principal auditor will have to gather sufficient. In complex groups. this is no easy task Planning a group audit Think materiality.Preliminary materiality will be much higher than in the prior year . and changes in structure etc Here's a nice little proforma to use in the exam 1.

Additions in year Step Acquisition . liabs.FV of NA acquired Check FV is used not book value Check the FV of these items are correct (independently valued.Use the FV Check assumptions used and discount rate for this 5. Goodwill . Disposals Partial disposal Ensure that the difference between amount received and the NCI increase goes only to reserves and not I/S Full disposal Ensure all assets. goodwill and NCI relating to the sub have been removed and any profit on disposal is shown in the I/S 9.Consideration Any shares issued . Group Transactions & Balances . Goodwill Audit any goodwill arising on acquisitions Audit any impairment test at the balance sheet date 4.use their MV Any amounts in the future .General SFP . work of others etc) 6.The materiality of each subsidiary should be assessed (in terms of the group) This will help decide: Which to visit & Which to do just analytical procedures on 3.Use the PV Check discount rate and recalculate the PV Any contingent consideration .Ensure assets and liabs of Parent and subs added together but Associate not (separate line) I/S . Groups .Ensure any mid year acquisitions and disposals are accounted for pro-rata 7.check the first acquisition has been revalued Further Acquisition Ensure that the difference between amount paid and the NCI decrease goes only to reserves and not I/S Goodwill See above 8. Goodwill .

Associates Check accounted for correctly using the equity method Cost + Post acquisition reserves on the SFP Share of PAT on the I/S . Accounting policies Material accounting policies should comply with the rest of the group. Timetable Key dates should be planned for: Agreement of inter-company balances and transactions Submission of proforma statements to Parent Completion of the consolidation package Tax review of group accounts Subsequent events review Completion of audit fieldwork by other auditors Final clearance on accounts of subsidiaries Parent's final clearance of consolidated financial statements 14. Analytical procedures Acquiring subs with similar activities may extend the scope of analytical procedures available. Foreign Subs SFP Ensure assets and Liabs are translated at the year end closing rate I/S Ensure the transactions are translated at the average or actual rate Goodwill Ensure it is retranslated at the year end Forex differences Ensure these go a translation reserve and not the Income statement 15. Other auditors (See separate section) 12.A list of all the companies in the group included in group audit instructions (to ensure that intra-group transactions and balances are eliminated) on consolidation 10. So a group accounting policy for adjustment on consolidation may be needed 13. This could have the effect of increasing audit efficiency 11.

Their competence. The strategy of the other auditor The principal auditor should also.The work of component auditors The principal auditor should evaluate the component auditor. 1. if going to rely on his work She will look at.. Perform risk assessment on components Evaluate business risk of components Evaluate susceptibility of other auditors to error Attend the closing meetings of component audit Review of component files Evaluate whether further substantive testing should be performed at a component level . The findings of the other auditor 4. qualifications and experience 2. The procedures carried out to obtain sufficient.. appropriate evidence that the work of the other auditor is adequate 3.

is considered to be a going concern So often the parent might have to guarantee this for other subs. for example. as a single entity. The period of support may be limited (eg one year) Sufficient other evidence concerning the appropriateness of the going concern assumption must therefore be obtained where a later repayment of material debts is foreseen 5.Support letters When the parent undertaking (or a fellow subsidiary) is able and willing to provide support Group accounts are prepared on a going concern basis when a group. The ability of the parent to support the company should also be confirmed. Many banks routinely require a letter of reassurance from a parent company stating that the parent would financially or otherwise support a subsidiary with cashflow or other operational problems As audit evidence: 1.. This letter of support should normally be approved by a board minute of the parent company 3. by examining the group’s cash flow forecast 4. Formal confirmation is a ‘comfort letter’ confirming the parent ’s intention to keep the subsidiary in operational existence 2. The fact of support and the period to which it is restricted should be noted in the Sub's FS Horizontal groups Horizontal groups of entities under common control increase audit risk as .

However.fraud is often hidden via complex group structures Auditors need to understand and confirm the economic purpose of entities within business empires Difficulties faced by auditors include: 1. 2. not understanding the substance of transactions with entities under common control 3. the implications of transfer pricing (eg failure to identify profits unrealised at the business empire level) 5. a lack of access to relevant confidential information held by others 6. the complexity of business empires across multiple jurisdictions with different auditors may deter auditors from liaising with other auditors (especially where legal or professional confidentiality considerations prevent this) Joint Audits Where more than one firm is appointed and are both responsible for the opinion . failing to detect related party transactions and control relationships. excessively creative tax planning 4. relying on representations made in good faith by those whom the auditors believe manage the company when control rests elsewhere Audit work is inevitably increased if an auditor is put upon inquiry to investigate dubious transactions and arrangements.

making the litigation process more complex However. to calculate materiality. blame each other. assuring the quality of the opinion given Quality Both auditors can discuss contentious issues together Often a ‘fresh pair of eyes’ helps. as the firms should both be covered by professional indemnity insurance. It should be easier to challenge management and therefore ensure that the auditors’ position is taken seriously Disadvantages More expensive for the client From a cost/benefit point of view there is clearly no point in paying twice for one opinion to be provided. sample sizes etc One firm’s methods may dominate. . Despite the audit workload being shared. however. both firms will have a high cost for being involved in the audit in terms of senior manager and partner time Different audit approaches Problems could arise in deciding which firm’s method to use.There are several advantages and disadvantages in a joint audit being performed Advantages Efficiency The subs auditor will have a good understanding of the business / controls etc so working together will help the principal auditor catch up quicker This is a key issue. as the principal auditor needs a thorough understanding of the subsidiary also for risk assessment Resources A joint audit allows sufficient resources to be allocated to the subs audit. for example. eliminating the benefit of a joint audit being conducted Working Together There may be problems for the two audit firms to work together harmoniously Joint Liability Both firms are jointly liable They could. it could be argued that joint liability is not necessarily a drawback.

is the group too?? It basically depends if the group auditor thinks it is material or not If so .then no effect Examples: Group auditor can't get full access to sub Disclaimer of Opinion in component Except for paragraph in group Subs inventory is incorrectly valued It is material to the group also Qualified "except for" in component Qualified "except for" in group .then the group accounts are qualified too If not .Modified Audit Reports So what if the subsidiary report is qualified .

Confirm % owned through a review of shareholder register. Obtain the due diligence report prepared by the external provider and confirm the estimated fair value of net assets at acquisition 7. including its amount. and details of any contingent consideration. and the factors on which payment depends 3. Inspect the purchase agreement. date potentially payable.Going concern doubts over the sub It is material to the group also Emphasis of matter paragraph in component Emphasis of matter paragraph in group Going concern doubts over the sub It is NOT material to the group though Emphasis of matter paragraph in component No modification in group Auditing Goodwill Audit procedures & Evidence needed as follows: Basic procedures include: 1. and by agreement to legal documentation 4. Agree any cash paid to cash book and bank statements 5. confirm the consideration paid. Review the board minutes for discussion regarding the purchase 6. Obtain the legal purchase agreement and confirm the date of the acquisition 2. Recalculate goodwill .

It is a high level of assurance It is Positive Assurance (This means that in their opinion the subject has been prepared in accordance with the criteria required) An example is the external audit Limited Assurance is where there's sufficient evidence that the subject matter is plausible in the circumstances It is a moderate level of assurance It is a Negative Assurance (This means that in their opinion there is nothing to suggest that the subject has not been prepared .Other Assignments Audit-related services Levels of Assurance Reasonable Assurance is where there is sufficient evidence that the subject matter agrees to certain criteria.

g. the auditor reviews the financial statements using less evidence than required by an audit It is not an line with the relevant criteria) An example is a review engagement Here. Directors. The report will not be to the shareholders but to the body that commissioned the review e. Remember! A Review Engagement gives Negative Assurance An Audit Report gives Positive Assurance Absolute assurance will never be provided by an assurance engagement whether audit or review Non-Audit Engagements There are three main types of non-audit engagements They are more likely to arise with small companies. and only a general awareness is needed . Bank.

1. nor a review is being carried out and that the report should not be . 2.They are. A report for a bank as to the validity of the receivables balance The report will only be for the client The engagement letter shows the purpose & procedures to be applied and the form of any report.. Review Engagements Offer limited assurance Used by smaller companies who do not require an audit but may want to apply for finance The assurance given is negative assurance Involves a lot less work than an audit Agree the terms with the client and send an engagement letter Look at the systems in place and how judgements made by management affect the items under review Assess materiality & procedures to be used Analytical Review (year on year figures) + forecasts as well as establish relationships between balances Assess the entities accounting practices and how information is recorded during the review and examine minutes of important meetings to establish any facts which may affect the financial statements. Agreed Upon Procedures In certain situations the auditor may not be asked to express an opinion. It should also make clear that neither an audit. but merely to present the results of a set of procedures The client draws their own conclusions from the data presented by the auditor.. Eg.

ACCOUNTANT Date Address Due Diligence There is little specific guidance on due diligence reviews. On the basis of information provided by management we have compiled. nor a review is being carried out and that the report should not be distributed 3. Management is responsible for these financial statements. So. We have not audited or reviewed them and accordingly express no opinion thereon.It should also make clear that neither an audit. despite this being an increasingly common form of assurance Normally someone buying a company wants info about the target organisation. the assurance provider tries to verify any management representations and offer practical recommendations regarding the . Compilation Engagements This is where the accountant is asked to compile financial information for presentation to the client An example is the compilation of FS from a client’s books and records No opinion is issued Eg. in accordance with the International Standard on Related Services (or refer to relevant national standards or practices) applicable to compilation agreements. the balance sheet of Jamima Ltd at 31 March 20XX and statements of income and cash-flows for the year ended then.

Credibility An external investigation is independent & impartial view. Acquisition planning Look for commercial effects of the acquisition. 7. Identification of assets and liabilities Especially internally generated intangibles such as customer databases and brand names (these won't show on the SFP) 4. employees and third parties Purpose of a Due diligence review 1. Several years prior financial statements Management accounts Profit and cash flow forecasts Any business plans recently prepared Discussions with management. synergies & economies of scale Also acquisition expenses to pay such as redundancies and change management 6. Verification of specific management reps 3. Management involvement Reduces time spent by the directors on fact finding. leaving more time to focus on strategic matters to do with the acquisition and on running the existing group. . Information Gathering about a target company so the buyer knows everything Essentially the aim is to uncover any ‘skeletons in the closet’ before a decision regarding the acquisition is made. enhancing the credibility of the amount paid for the investment. or suppliers contract terms 5. Operational issues Risk can come from issues such as high staff turnover.acquisition process Scope of a due diligence assignment compared to an audit Fact finding from a WIDER range of sources Such as. Eg. 2..

such as a lease. 4. and any other key management personnel’s contracts of employment – these will be needed to see if there are any contractual settlement terms if the contract of employment is terminated after the acquisition. Prior-year audited financial statements. 2. An organisational structure should be obtained .NO aim to provide assurance that financial data is free from material misstatement No detailed audit procedures will be performed unless there are specific issues which cause concern More AP used More forward looking No detailed tests of control Information requested for Due diligence review 1. The most recent management accounts for the current year should be analysed. 6. identify the members of management and key personnel and their roles 3.FS will also provide useful information regarding contingent liabilities. Details of any legal arrangement. accounting policies. and the value of assets. the liquidity position of the company. Forecasts and budgets for future periods Key performance indicators Key performance indicators . and management accounts for this financial year . Directors.

Evidence available Problems for the Assurance Provider Getting precise definitions of KPI targets Poor KPI data capturing systems Manipulation of results / spin However.Many companies now publish some key performance indicators (KPIs) in the FS The increased tendency to disclose such data is often in response to shareholder expectations Types 1. Reporting Purpose 4. Financial such as ratios based on the financial statements 2. Calculation method 3. an assurance report provided on the KPIs should add credibility to the published data if sufficient evidence is available Review of Interim Financial Information . Non-financial such as targets on social and environmental matters The Assurance approach 1. Definition 2.

g.Review of Interim Financial Information Some companies are required to report interim results after six months of their financial year This will usually be an income statement and certain balance sheet items Level of Assurance Given: Negative The objective is to see if anything has come to the auditor's attention that suggests that the information is not in accordance with an identified financial reporting framework The auditor: 1) Makes inquiries 2) Performs analytical and other review procedures The review will NOT include: Tests of accounting records through inspection. Create an Engagement Letter . test of controls) Planning an Interim Review 1. observation or confirmation Obtaining corroborative evidence in response to enquiries Other typical audit tests (e.

Procedures: Read minutes Consider effect of any past report modifications In group audits. Inquire about. Understanding the Entity As the review will be carried out by the auditor..Objective and scope of the review Management's responsibility for: 1) Internal Controls 2) Making records available 3) Written representations Level of Assurance (Negative) Style of Report 2. this means updating the understanding from the year-end audit and the last interim review Identify potential material misstatement Identify their likelihood Select the inquiries. communicate with component auditors 4. Changes in accounting policy Any relevant unusual circumstances Assumptions relating to FV valuations Related Party Transactions Contingent liability details Fraud / Non-compliance events . analytical and other review procedures 3.

Analytical procedures including. Agree terms 2.g. by source of revenue. Going Concern Management assessment of GC changed? Any significant factors since Y/E to affect GC? Discuss with management if GC doubts Consider adequacy of GC disclosures Prospective Financial Information This is financial information based about possible future events and actions PFI work is highly subjective in its nature. by product line.. and its preparation requires the exercise of considerable judgement Before accepting a PFI engagement: 1. Actual interim to expected and prior interim results Actual interim to budget and actual financial results Comparison to similar company's interim results Compare key items (e. by location 6.5. expenses) by month. Get knowledge of the business 3. revenue. Clarify the time period it relates to .

. Forecasts up to one year ahead 2. 1. Their acceptance of their responsibility for the PFI Assurance given Given the subjective and speculative nature of the PFI. Projections up to five years ahead Forecasts .Get written management reps on. so only negative assurance can be given Negative Assurance Services Prospective Financial Information Definition of PFI Prospective financial information is ‘future information’ It covers: 1. Its intended use 2. an opinion cannot be given on whether the results shown in the report will be achieved. The completeness of their significant assumptions 3.

Who will use the information? .are based on expected future events Projections are based on hypothetical assumptions A Hypothetical Illustration is based on assumptions about uncertain future events and undecided management actions Targets are based on assumptions about future performance Accepting a PFI engagement There are matters to consider before accepting an engagement These are: 1.

What assumptions have been made? Best-estimates and assumptions may have little basis and will lead to higher risk 3. How long is the period covered? Short term forecasts are more reliable than long term 5.Internal or External? If it's 3rd parties for investment decisions . What elements are included in the information? The auditor must understand the information 4.more risky for the auditor 2. Will the information be for general or limited distribution Procedures and Assurance on PFI The assurance given is limited and negative usually So they will state that ‘nothing has come to their attention’ to suggest the assumptions are not a reasonable basis for the forecast Examination Procedures .

Is it prepared on a consistent basis with historical financial statements. Are calculations correct? 4. Basis of opinion An opinion as to whether the PFI is properly prepared on the basis of the assumptions and is presented in accordance with the relevant financial reporting framework. date & address 2. . Agree the cash figure to bank statement or bank reconciliation The procedures are often restricted to enquiry and analytical review PFI Report A PFI report will include: The following: 1. Is information properly prepared on the basis of the assumptions 5. Assess management assumptions 2.Verifying PFI will be based around analytical procedures and assessing the validity of the assumptions Possible procedures: 1. Reference to standards or laws 3. using appropriate accounting policies 3. Title.

Expression of assurance (negative) 8. Reference to the purpose and distribution of the report The PFI is based on hypothetical assumptions. auditing. Identification of the PFI contents 5. Appropriate caveats (on achievability of results) 9.4. A financial investigation where the evidence may be use in court generally Covers. and investigative skills to examine a company’s financial statements.. state that there are hypothetical assumptions about future events and management's actions that are not necessarily expected to occur Forensic audits Forensic Definitions Forensic Accounting Forensic accounting uses accounting. Forensic Investigations & Forensic Auditing . Accountants name etc Such a report would: State if anything has come to the auditor's attention to believe that the assumptions do not provide a reasonable basis for the PFI Give opinion that it's prepared on the basis of the assumptions and is presented in accordance with the relevant financial reporting framework State that actual results are likely to be different from the PFI & and the variation could be material in the case of a projection. 7. the events and figures contained in the PFI may not necessarily occur as expected. Statement of management’s responsibility for preparation of the PFI 6.

Gather evidence .Forensic Investigations A forensic investigation is a process whereby a forensic accountant carries out procedures to gather evidence.Determine the identity of the perpetrator(s) and . Decide if a fraud has actually taken place 2. which could ultimately be used in legal proceedings or to settle disputes. Eg. Objectives of a Forensic Investigation 1. Consider how the fraud could have taken place Eg. Determine the type of fraud 2. Produce evidence which is sufficient and relevant enough to be used to assist legal proceedings Steps in investigating a suspected fraud 1. and ultimately to assist in their prosecution 3. Discover the perpetrator(s) of the fraud.The monetary value of the fraud. usually focused on the quantification of a financial loss. fraud or money laundering cases Forensic Auditing Forensic auditing uses audit procedures within a forensic investigation to find facts and gather evidence. Usually by circumventing internal controls 3. Quantify the financial loss 4. .

concluding on the identity of the fraudster(s) and . An advice can be provided to management Application of Forensic Auditing Different practical contexts could appear in the exam Such as: Insurance claims Possibly to quantify losses Fraud Such as tax evasion . and – Any attempt made by the alleged to conceal the crime.Discussions with management. . . Produce a report for the management .Interviewing employees of the company.The use of computer-assisted auditing techniques (CAATs). This report is also likely to be presented as part of evidence during court proceedings. An interview with the suspect(s) 5. – The ability of the alleged fraudster to conduct the fraud. Evidence must be sufficient and relevant.Gathering evidence includes: – The motive for the fraud.summarising all findings . 4.where we trace funds etc Professional negligence To quantify damages .the amount of financial loss suffered. . 6.An examination of accounting records and other documentation. and .

To be an expert witness. This can create an ethical threat . the auditor must be suitably qualified and experienced Forensic auditing and Ethics Forensic auditors are often in contact with criminals.lets see this in light of the fundamental principles Threats: Advocacy threat Try not to feel pressured into promoting the interests of the client Self Review Ensure that they possess the specialist knowledge and skills to undertake the work required Confidentiality but reveal all relevant information required to the court In order to maintain the reputation of the profession.The auditor may assist in legal proceedings as an expert witness. the auditor should be sure to act in a professional manner at all times ..

Internal Audit Service
Internal v External Audit

Let's look at the difference in roles between internal and external audit

Objective & Planning
Internal Audit
Dictated by management - planning follows this
However, good corporate governance would allow IA a degree of independence over objectives

External Audit
Ensure accounts free from material misstatement and prepared in line with reporting framework.
Planned in accordance with ISAs
Work planned by themselves

Internal Audit
The amount / type gathered would depend upon the objective set
Eg It may just be a check that assets exist, with no concern over their value

External Audit
Governed by IAS 330 - gather evidence to address misstatement risk
The risk would have been analysed during planning and in the light of subsequent evidence

Internal Audit
Determined by the nature of the assignment

External Audit
Determined by statute & ISAs 700/5/6
Communicate to stakeholders

Scope and limitations of Internal Audit

The scope is to give assurances on...

Items such as
1. Effectiveness of systems
2. Effectiveness of Internal Controls
3. Whether manuals are followed
4. Whether internally produced info is reliable
5. Compliance with OECD

Oooh nice... What about limitations though?
Reporting System
Reporting to the Finance Director - who is responsible for some of the info being reported on!

Report to Audit Committee instead

Scope of Work
Could be decided by executive directors and thus influenced away from their particular areas (the cheeky monkeys)

Scope decided by chief internal auditor or audit committee

Audit Work
Auditing their own work (Self review threat)

Chief internal auditor doesn’t establish any controls herself
(see how modern metrosexual I am... ;)

Lengths of Service
Too long in IA and there may well be a familiarity threat

Rotation of work into different areas
So being an IA is basically just a crazy, roller-coaster of a life..

Appointment of Chief Internal Auditor
Don't let the CEO do it....!


Appointed by the whole of the board or Audit committee

Outsourcing internal audit

A firm may decide to outsource its internal audit function as this may
seem like better value for money

Advantages of Outsourcing
1. The provider will have specialist staff.
2. Cost of employing and training full time staff is avoided.
3. Outsourcing provides an immediate internal audit department.
4. The time scale is flexible with the contract lasting just for the appropriate time.
5. Independence may be improved.
6. Audit methodology and technologies will be up to date.

If Internal and External audit are provided by the same firm (prohibited under ethics rules in UK) then there may be a
conflict of interest.

objectives and attitudes. Lack of understanding of firms culture. responsibilities and reporting procedures 4. Blurring of the distinction between internal and external audit function. Outsourcing Outsourcing v Insourcing The use of external suppliers for finished products &services Outsourcing is when an external specialist organisation (also known as a service organisation) is used to carry out functions which would normally be performed within the entity. . The cost of outsourcing may be so high as to encourage the firm not to have an internal audit function at all. Setting and reviewing performance measures 2. Minimising/Managing risks of Outsourcing 1.Independence may not be ensured by outsourcing due to threat of management not renewing the contract. Clear agreement on scope. The standard of service provided cannot be controlled. Ensure external audit and internal audit are two separate functions. Quality reviews and working paper reviews 3.

Service organisations usually operate in one of two ways: 1. there are challenges and difficulties that come with this kind of change. Here the reporting entity will maintain internal records relating to the outsourced function. short-term solution . Payroll When to insource High strategic importance process Eg. or acts as a custodian of assets. Where value is added The current economic environment presents an excellent opportunity to further utilise outsourcing as a way to reduce their manufacturing and design costs. The service organisation fully maintains the outsourced function (keeps accounting records and internal records) 2. The most successful situations are those where the customer understands that outsourcing is as much a cultural change as a strategic one for their organization The bottom line is that even in the best of economic times. Insourcing is making the finished products & services yourself When to outsource Low strategic importance processes Eg. It is not a quick. the decision to outsource should be made based on a careful cost/benefit analysis. The service organisation executes transactions only at the request of the entity.

com Should I outsource the materials writing and videos? I'm HOPING you're screaming "Nooooooooo!!!!" The reason being that the whole competitive advantage of aCOWtancy. what about the design of the site? Well I personally think design is of enormous strategic importance (like the materials and videos etc). Why? Well here my strength is in teaching accountancy and not in the design and usability of websites.this is one process I wouldn't outsource . I know a fair bit about these topics and i study them daily but it is sooooo important to me that I want to be the best in the world at it. Miki. However. So i outsource it to people who I believe are the best in the world. take a bow .. videos (amongst a million other things :P) In all seriousness . Dan..because the suppliers competences don't match my needs However.Should a Process be bought? Should we outsource? The idea is here that some processes may be best not performed in house but rather bought in from outside ie Outsourced Let's think of is the simplicity of the materials. here I do outsource some. Naomi.

though it is no panacea. there are challenges and difficulties that come with this kind of change. Improved customer care 3. It is not a quick. the decision to outsource should be made based on a careful cost/benefit analysis. Cost savings 2. A niche business to business producers’ core competencies are very different than those of a provider that's set up to produce large volumes of a consumer-oriented product The current economic environment presents an excellent opportunity to further utilise outsourcing as a way to reduce their manufacturing and design costs.Some processes are more suited too to outsourcing than others eg Standardised processes (you're not losing a competitve advantage then) Never forget though also the external v internal costs of processing. Is it cheaper or more expensive to have the process outsourced Business Process Outsourcing Under the right circumstances outsourcing can certainly provide significant opportunities for savings. Allows management to focus on core competencies Problems of BPO 1. Sony announced plans recently to close 10 percent of its plants worldwide and shift more manufacturing to outsourcing Different companies will have different expectations for their outsourcing partners. The most successful situations are those where the customer understands that outsourcing is as much a cultural change as a strategic one for their organisation The bottom line is that even in the best of economic times. More outsourcing suppliers leads to fragmentation and a less cohesive business . short-term solution Advantages of BPO 1.

Obtain an understanding of the nature and significance of the services provided by the service organisation Service limited to recording and processing? Client does all the authorising Client uses own control policies and procedures Service provider is accountable Client relies on their control policies Audit risk is now higher . Potential problems with access and confidentiality Although the service organisation should co-operate with us as it is in their interests 2. Security problems procedures required . Performance measuring problems Auditing an outsourced function The auditor has no direct contractual relationship with the service organisation Planning 1. Managing of the outsourcers 4.

accuracy. Existence of third party reports about the operation and effectiveness of the service organisation's accounting and control systems.Things to Consider 1. Information available in user and technical manuals 8.on their controls Contact or visit the service organisation (via the user entity) to obtain specific information Engage the services of another auditor Reports Auditor Reports Structure of an Unmodified Audit Report . Evidence when client can't get sufficient evidence Use the service organisations auditor's reports . Material financial statements assertions affected ? 4. validity). Consider the effect of business failure on the client entity 7. Nature of services provided and relationship between client and service organisation Regulations involved? 2. Extent to which client's accounting and internal control systems interact with service organisations 5. Client's internal controls (to ensure completeness. Service organisation's capability and financial standing. Are they the same as if processing were done "in house"? 6. Contractual terms Oral or legal contract? 3.

. for whom the report is produced. Statement of responsibilities of Auditor The audit was planned and assessed the risk of material misstatement considering internal controls and obtaining sufficient appropriate evidence That the auditor will express an opinion 5. 1. . Opinion Do the statements present a true and fair view? Are they prepared according to applicable GAAP and legislation? 7.e. Addressee The shareholders i. the processes and the test basis as well as the appropriateness of policies and disclosures 6. Application of accounting policies and estimates as well as responsibilities for systems and controls 4.ISA 700 sets out the elements of an audit report: The headings are as follows. Scope Paragraph Standards under which the audit was conducted. Auditors signature Auditor or firm is registered and authorised to conduct the audit. Title Identifies the report as an ‘Independent Auditors Report’ 2. Statement of responsibilities of Management Management have prepared financial statements in accordance with GAAP and representing a true and fair view. 3.

Date of the Report Signed after approved by directors – on the same day. Advantages: – Potential to limit liability exposure – Clarifies extent of auditor’s responsibility – Reduces expectation gap – Manages audit firm’s risk exposure 2. 9. and that no responsibility is accepted or assumed to third parties. Auditors address Liability disclaimer paragraph It is not a requirement of auditing standards but it has become increasingly common for audit firms to include a disclaimer paragraph within the audit report. Disadvantages: – Each legal case assessed individually – no evidence that a disclaimer would offer protection in all cases – May lead to reduction in audit quality Audit Opinion Modified Audit Reports If the auditor disagrees with some aspect of the financial statements or is unable to state that they provide a true and fair view.8. 1. then a modified audit report will be issued . It states the fact that the auditor’s report is intended solely for the use of the company’s member.

Insufficient Evidence Disagreement A qualified report for the reason of disagreement will be issued if the auditor disagrees with the application of accounting policies. Qualified Reports There are two reasons that an auditor may qualify an audit report: 1. The matter referred to will be fully disclosed in the accounts and the auditor is simply drawing the users’ attention to it. treatment of a particular item or the adequacy of disclosures . Disagreement 2. but agrees with the financial statements an ‘emphasis of matter’ paragraph will be included in the audit report. The paragraph will make it clear that the opinion is not qualified and will be given a separate heading after the opinion paragraph. A qualified audit report Emphasis of matter If the auditor wishes to draw attention to a particular matter. An unqualified audit report with an ‘emphasis of matter paragraph’ 2. the policies used.There are two types of modified audit report: 1.

The insufficient evidence can be either: Material or Material & Pervasive Material . Insufficient Evidence If the auditor is unable to form an opinion. the financial statements give a true and fair view. “Except for” paragraph In this situation the auditor will qualify the audit with an ‘except for’ paragraph i. Material and Pervasive ."Except for" paragraph . but disagrees with that particular element of them. Adverse opinion In such a situation an adverse opinion is issued i.e."Except for" Paragraph This will mean that the auditor agrees with the rest of the financial statements. the financial statements do not give a true and fair view.The disagreement can be either: Material or Material & Pervasive A material disagreement .e. then the report will be qualified for Insufficient Evidence Insufficient Evidence will be due to being unable to obtain sufficient evidence which should have been available.Adverse Opinion A disagreement which is material and pervasive is of such significance that the financial statements do not give a true and fair view. except for the effect on the financial statements of the matter referred to in the preceding paragraph. In our opinion.

A material insufficient evidence will mean that the auditor agrees with the rest of the financial statements. the financial statements give a true and fair view Material & Pervasive . In our opinion.. except for the matter referred to in the preceding paragraph. the auditors do not express an opinion on the financial statements EOM and Other Matter Compared There are 2 types of modified but not qualified reports.e.Disclaimer of opinion Insufficient evidence which is material and pervasive is of such significance that auditor is unable to state whether the financial statements give a true and fair view Disclaimer of Opinion In such a situation a disclaimer of opinion is issued i. Emphasis of Matter This refers specifically to matters in the FS Other Matters This refers to anything else the auditor may wish to bring to the users attenion .e. but is unable to agree with that particular element of them “Except for” Paragraph In this situation the auditor will qualify the audit with an ‘except for’ paragraph i.

Emphasis of matter Other matter What is it? Draws attention to fundamental issue in the fs Draws attention to another issue users need to know about Where does it go? After the opinion paragraph After the opinion paragraph & eom paragraph Headed how? Emphasis of matter Other matter Key points? Highlights the matter in the FS by reference to its page or note number The effect on the auditor's responsibilities Effect on opinion? None None Example Uncertainty regarding a contingent liability Auditor wishes to resign but legally cannot Management Reports Management Letters The aim of the letter to management is to ensure the audit runs smoothly and to highlight weaknesses and problems Matters which should be included are: .

Any efficiencies which could be made 4. The report to management takes the form of either a formal report or a letter Communication with those charged with governance Communicate matters of audit importance Management letter . Failures by staff to adhere to proper procedures 3. Weaknesses in internal controls 2.see above Specific internal control issues . Any other specific issues Often times the auditor does not sufficiently communicate these matters and such problems include: No outline of weaknesses in internal controls or assessment of potential effects No assessment of the cost of implementation of recommendations Lack of recognition of clients experience in running their own business ‘Rubbing management up the wrong way’ with wide ranging suggestions.1.