Auditing and Assurance 1

Assignment one

Describe in your own words the different phases of the audit of historical financial statement.
Provide specific examples in your answers. (Use the International Auditing Standard
uploaded in Moodle as a guide to complete your assignment apart from your other sources.)

1.  Client acceptance & continuance. (10 marks)

Client acceptance refers to an audit firm's decision to begin performing audit work for a
company with which it has not been associated in the past while client continuance refers to
the decision to continue performing audit work for a company that is an ongoing client. APES
320 and ASQC 1 requires an audit firm, as part of its quality control, to establish policies for
investigating potential clients and acceptance of an engagement and periodically reviewing
continuance of clients. Policies and procedures for client’s acceptance and continuance are
important as an audit firm will want to avoid association with a client whose management lacks
integrity. The seven steps involved in Client acceptance & continuance are as follows:

Client related
1. Reputation and integrity
2. Level of risk
3. Expected audit fees
Firm-related
4. Code of ethics and conduct
5. Competence
6. Resources
Other
7. Professional etiquette letter

Example:

A client with its ethical practices brought to question may produce unreliable financial reports
or other information that the firm could use for its assurance engagement. As the quality of the
firm’s work is directly influenced by the quality of the provided information, the auditor may
risks issuing an inappropriate report, thereby hampering the firm’s reputation and even its
viability. Well-calibrated client acceptance and continuance assessment is a vital safeguard
against possible damage associated with poor quality clients.

2.  Audit planning (15 marks)

As per Auditing and Assurance Standard 1, Basic Principles Governing an Audit, Audit Planning is
one of the basic principles. Accordingly, it states that an auditor should plan his work to enable
him to conduct an effective audit in an efficient and timely manner. Plans should be based on
knowledge of the client’s business. Plans should be made to cover, among other things:
 a) Acquiring knowledge of the client’s accounting systems, policies and internal control
procedures;
b) Establishing the expected degree of reliance to be placed on internal control;
c) Determining and programming the nature, timing, and extent of the audit procedures to
be performed
d) Coordinating the work to be performed.

Example:
Company XYZ has come to audit its financial reports. In planning his audit, the auditor will
consider factors such as complexity of the audit, the environment in which the entity operates,
his previous experience with the client and knowledge of the client’s business. The auditor may
wish to discuss elements of his overall plan and certain audit procedures with the client to
improve the efficiency of the audit and to coordinate audit procedures with work of the client’s
personnel. The overall audit plan and the audit program, however, remain the auditor’s
responsibility.

3.  Identifying Risks (15 marks)

The auditor should perform risk assessment procedures that are sufficient to provide a reasonable
basis for identifying and assessing the risks of material misstatement, whether due to error or
fraud, and designing further audit procedures. Risks of material misstatement can arise from a
variety of sources, including external factors, such as conditions in the company's industry and
environment, and company-specific factors, such as the nature of the company, its activities, and
internal control over financial reporting.

For example

External or company-specific factors can affect the judgments involved in determining

accounting estimates or create pressures to manipulate the financial statements to achieve certain
financial targets.

Thus, the audit procedures that are necessary to identify and appropriately assess the risks of
material misstatement include consideration of both external factors and company-specific
factors. This standard discusses the following risk assessment procedures:

1) Obtaining an understanding of the company and its environment.

2) Obtaining an understanding of internal control over financial reporting.

3) Considering information from the client acceptance and retention evaluation, audit
planning activities, past audits, and other engagements performed for the company
Performing analytical procedures
 4) Conducting a discussion among engagement team members regarding the risks of
material misstatement

5) Inquiring of the audit committee, management, and others within the company about the
risks of material misstatement

4. Test of control (15 marks)

A test of controls is an audit procedure to test the effectiveness of a control used by a client
entity to prevent or detect material misstatements. Depending on the results of this test, auditors
may choose to rely upon a client's system of controls as part of their auditing activities.
However, if the test reveals that controls are weak, the auditors will enhance their use of
substantive testing, which usually increases the cost of an audit. The following are general
classifications of tests of controls:

 Re-performance - Auditors may initiate a new transaction, to see which controls are used
by the client and the effectiveness of those controls.
 Observation - Auditors may observe a business process in action, and in particular the
control elements of the process.
 Inspection - Auditors may examine business documents for approval signatures, stamps,
or review check marks, which indicate that controls have been performed.

If the inspection approach is used, a test of controls is typically conducted for a sample of
documents related to transactions that occurred throughout the year. Doing so provides evidence
that the system of controls has operated in a reliable manner throughout the reporting period.

If the auditors encounter an error in a test of controls, they will expand the sample size and
conduct further testing. If additional errors are found, they will consider whether there is a
systematic controls problem that renders the controls ineffective, or if the errors appear to be
isolated instances that do not reflect upon the overall effectiveness of the control in question.

Example:

The auditor is engaged with the audit of the financial statements of ABC and the audit work will
start very soon. Normally, before performing the substantive test or go to fieldwork, the auditor
required to perform audit planning and get it approved by the audit partner. At the planning
stage, auditors will have to document many areas that required by the standard and one of those
areas is testing the internal control.

5.  Substantive procedures (15 marks)

A substantive procedure is a process, step, or test that creates conclusive evidence regarding
the completeness, existence, disclosure, rights, or valuation (the five audit assertions) of assets
and/or accounts on the financial statements. To qualify as a substantive procedure, enough
documentation must be collected so that another competent auditor could conduct the same
procedure on the same documents and make the same conclusion.
Most of the work auditors do is aimed at conducting substantive procedures. If you've ever
worked at an organization that has been audited by external or internal auditors, you likely
remember the requests for documentation, reports, and other original information. While this
may not be the most fun if you are the one being audited, it is important to remember that the
auditors are hired by someone in authority to provide an objective assessment of the
completeness, existence, disclosure, rights, or valuation of some asset or account.

Examples

Anytime an auditor performs a procedure that results in obtaining documentation to support a

conclusion they've made, they are conducting a substantive procedure. Depending on the asset
or account being audited, these procedures may be different.

6.   Opinion formulation (10 marks)

An auditor's opinion is a certification that accompanies financial statements. It is based on an

audit of the procedures and records used to produce the statements and delivers an opinion as
to whether material misstatements exist in the financial statements. An auditor's opinion may
also be called an accountant's opinion.

 Unqualified Opinion Audit - An unqualified opinion is also known as a clean opinion. The
auditor reports an unqualified opinion if the financial statements are presumed to be free
from material misstatements. In addition, an unqualified opinion is given over the internal
controls of an entity if management has claimed responsibility for its establishment and
maintenance, and the auditor has performed fieldwork to test its effectiveness.
Example:
let’s assume that Company XYZ is a publicly traded company. After the year-end, Company
XYZ hires Auditor ABC to conduct an audit of its financial statements, practices and controls
for the previous fiscal year. Auditor ABC discovers no material errors in Company XYZ’s
accounting practices. As a result, Auditor ABC issues an unqualified opinion, which appears
in the form of a letter that accompanies Company XYZ’s financial statements.

 Qualified Audit - A qualified opinion is given when a company’s financial records have not
followed GAAP in all financial transactions. Although the wording of qualified opinion is very
similar to an unqualified opinion, the auditor provides an additional paragraph including
deviations from GAAP in the financial statements and points out why the auditor report is
not unqualified. A qualified opinion may be given due to either a limitation in the scope of
the audit or an accounting method that did not follow GAAP. However, the deviation from
GAAP is not pervasive and does not misstate the financial position of the company as a
whole.
Example:
The auditor noticed that inventory of ABC Company faces a write-down due to
obsolescence. However, the company refuses to write down the inventory. In such a
 scenario, a GAAP departure reservation is made. Since only the inventory and cost of goods
sold accounts are wrong, a qualified opinion due to a GAAP departure would be issued.

 Adverse Opinion - The most unfavorable opinion a business may receive is an adverse
opinion. An adverse opinion indicates financial records are not in accordance with GAAP
and are grossly misstated. An adverse opinion may be an indicator of fraud, and public
entities that receive an adverse opinion are forced to correct their financial statements and
have the financial statements re-audited. Investors, lenders, and other financial institutions
do not typically accept financial statements with adverse opinions as part of their debt
covenants.

Example:
The auditor believes ABC Company faces a going concern and is unable to survive another
year. ABC Company disagrees and prepares its financial statements on a historical cost basis
instead of on a liquidation basis. In such a scenario, a GAAP departure reservation is made.
Since ABC Company prepared its financial statements on a historical cost basis, the majority
of the company’s accounts are incorrect. An adverse opinion due to a GAAP departure
would be issued

 Disclaimer of Opinion - In the event that the auditor is unable to complete the audit report
due to absence of financial records or insufficient cooperation from management, the
auditor issues a disclaimer of opinion. This is an indication that no opinion over the financial
statements was able to be determined. A disclaimer of opinion is not an opinion itself.

Example:
The auditor is looking to review the company’s minutes’ book, which contains important
information regarding the board of directors meeting and the audit committee. ABC
Company does not permit the auditor to review the minute’s book. In such a scenario, a
disclaimer of opinion reservation is made. Since the auditor is unable to access the minute’s
book, a majority of the company’s accounts cannot be verified. A disclaimer of opinion due
to a scope limitation would be issued

7.    Audit completion of files. (10 Marks)

The auditor shall assemble the audit documentation in an audit file and complete the
administrative process of assembling the final audit file on a timely basis after the date of the
auditor’s report. After the assembly of the final audit file has been completed, the auditor shall
not delete or discard audit documentation of any nature before the end of its retention period. In
circumstances other than those envisaged in paragraph 13 ISA, where the auditor finds it
necessary to modify existing audit documentation or add new audit documentation after the
assembly of the final audit file has been completed, the auditor shall, regardless of the nature of
the modifications or additions, document the specific reasons for making them; and when and by
whom they were made and reviewed.
Example:

Internal control documents that auditor prepare in Microsoft words, Microsoft excel or other
application is the example of audit documentation. Another best example that describes audit
documentation would be the working paper that auditor prepares to document and test
depreciation expenses.

References
Corporate Finance Institute. (n.d.). Auditor Opinions: Corporate Finance Institute. Retrieved from
Corporate Finance Institute:
https://corporatefinanceinstitute.com/resources/knowledge/accounting/auditor-opinions/

Finance Slide. (2018, August 14). Overview of the audit opinion formulation process: Finance Slide.
Retrieved from FinanceSlide: http://financeslide.blogspot.com/2016/09/overview-of-audit-
opinion-formulation.html

International Standard on Auditing (ISA) 230. (2009). INTERNATIONAL STANDARD ON AUDITING 230.

InvestingAnswers. (2009, October 1). Unqualified Opinion. Retrieved from InvestingAnswers:

InvestingAnswers: https://investinganswers.com/dictionary/u/unqualified-opinion

Investopidea. (2019, June 16). Auiting: Investopidea. Retrieved from Investopidea:

https://www.investopedia.com/

Wiki Accounting. (n.d.). Audit Test of Controls: Definition, Explanation, and Example: Wiki Accounting.
Retrieved from Wiki Accounting: https://www.wikiaccounting.com/audit-internal-control-
testing/