AUDIT SKILLS Mo On Zim Notes

NATIONAL UNIVERSITY OF SCIENCE AND TECHNOLOGY
AUDIT SKILLS
CAC 2103
Majory Nyazema
10/1/2012
Table of Contents
CHAPTER 1 .......................................................................................................... 1
1.0 INTRODUCTION ................................................................................................................................... 1
1.1 THE CONCEPT OF AGENCY ............................................................................................................ 2
CHAPTER 2 .......................................................................................................... 5
2.0Definition of Auditing........................................................................................................................... 5
2.1 Why the need for audit services ................................................................................................... 7
2.1.1 Class discussion 1 .................................................................................................................. 7
2.2 NATURE OF AUDIT WORK ................................................................................................................... 8
2.3 FRAMEWORK FOR AUDITING AND RELATED SERVICES ...................................................................... 9
2.3.1 Attestation engagements...................................................................................................... 9
2.3.2 Assurance services .............................................................................................................. 10
2.3.3 Review Engagement............................................................................................................ 11
2.4 LEVEL OF ASSURANCE ....................................................................................................................... 12
2.5 EXPECTATIONS GAP .................................................................................................................... 14
2.6 CLASS DISCUSSION 2 ................................................................................................................... 15
CHAPTER 3 ........................................................................................................ 16
3.0 INTRODUCTION ........................................................................................................................... 16
3.1 OPERATIONAL AUDITS ................................................................................................................ 16
3.2 MANAGEMENT AUDITS............................................................................................................... 17
3.3 COMPREHENSIVE AUDIT ............................................................................................................. 17
3.4 FORENSIC AUDIT ......................................................................................................................... 17
3.5 GOVERNMENTAL AUDITS............................................................................................................ 17
3.6 INTERNAL AUDIT ......................................................................................................................... 17
3.7 EXTERNAL AUDIT ......................................................................................................................... 18
3.7.1 BENEFITS OF STATUTORY AUDITS ....................................................................................... 19
3.7.2 LIMITATIONS OF STATUTORY AUDITS................................................................................. 19
CHAPTER 4 ........................................................................................................ 21
4.0 CONDUCT OF AUDIT.................................................................................................................... 21
4.1 SETTING AUDITING STANDARDS ................................................................................................ 22
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4.1.1The International Federation of Accountants (IFAC) .................................................................. 22
4.1.2 International Auditing and Assurance Standards Board (IAASB). ....................................... 22
4.2 AUDITING STANDARDS ............................................................................................................... 22
4.3 THE RELATIONSHIP BETWEEN INTERNATIONAL AND NATIONAL STANDARDS AND REGULATION
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4.4 CLASS DISCUSION ........................................................................................................................ 27
CHAPTER 5 ........................................................................................................ 29
5.0 INTRODUCTION – THE NEED FOR PROFESSIONAL ETHICS ......................................................... 29
5.1 THE IFAC CODE OF ETHICS AND THE CONCEPTUAL FRAMEWORK ................................................... 30
5.2 THE FUNDAMENTAL PRINCIPLES ................................................................................................ 30
5.2.1 Ethical requirements (ISA 220.8-220.13) ............................................................................ 31
5.2.2 Class discussion ................................................................................................................... 32
5.2.3 Independence ..................................................................................................................... 33
5.3 THREATS AND SAFEGUARDS ....................................................................................................... 34
5.3.1 Identifying the threats ........................................................................................................ 34
5.3.2 Possible safeguards ............................................................................................................. 35
5.3.3 Specific threats to objectivity ............................................................................................. 36
5.3.4 Other proposals to improve independence ........................................................................ 62
5.4 OTHER ISSUES ............................................................................................................................. 62
CHAPTER 6 ........................................................................................................ 65
6.0 THE AUDITOR’S FUNDAMENTAL DUTIES .................................................................................... 65
6.1 WHO MAY ACT AS AUDITOR? .................................................................................................... 66
6.2 WHO MAY NOT ACT AS AUDITOR? ............................................................................................ 66
6.2.1 Excluded by law.......................................................................................................................... 66
6.3 Excluded by the ethics rules (See chapter 4 for more detail) ................................................. 67
6.3.1 Class discussion ................................................................................................................... 68
6.4 HOW ARE AUDITORS APPOINTED AND REMOVED? ......................................................................... 68
6.4.1 Who appoints the auditor? ........................................................................................................ 68
6.4.2 Removing the auditor ......................................................................................................... 69
6.5 THE AUDITOR’S RESPONSIBILITIES ON APPOINTMENT AND REMOVAL ........................................... 69
6.6 RESIGNATION OF AUDITORS ............................................................................................................. 70
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6.7 THE AUDITOR’S RIGHTS .............................................................................................................. 70
6.8 CLASS DISCUSSION 4 ................................................................................................................... 72
6.9 RESPONSIBILITY IN RESPECT TO FRAUD, ERROR AND ILLEGAL ACTS.......................................... 72
6.8.1 Fraud and error ....................................................................................................................... 72
6.9 MANAGEMENTS’ RESPONSIBILITIES ........................................................................................... 73
6.10 RESPONSIBILITIES OF THE EXTERNAL AUDITORS ....................................................................... 74
6.10.1 Other responsibilities and consequences ........................................................................... 75
6.11 SUMMARY OF RESPONSIBILITIES ................................................................................................ 76
6.12 PROFESSIONAL SKEPTICISM ........................................................................................................ 77
6.13 REPORTING OF FRAUD ................................................................................................................ 77
6.14 REMUNERATION OF AN AUDITOR .............................................................................................. 78
CHAPTER 7 ........................................................................................................ 81
7.0 INTRODUCTION ........................................................................................................................... 81
7.1 OBTAINING OF ENGAGEMENT ACCEPTANCE INFORMATION .................................................... 82
7.2 PRE-ENGAGEMENT ACTIVITIES ................................................................................................... 84
7.3 ENGAGEMENT LETTERS .............................................................................................................. 88
7.3.1 Purpose of the engagement letters: ................................................................................... 88
7.3.2 Principal contents of an engagement letter ....................................................................... 89
7.4 ASSIGNMENT OF ENGAGEMENT TEAMS .................................................................................... 90
7.5 ENGAGEMENT PERFORMANCE ................................................................................................... 90
CHAPTER 8 ........................................................................................................ 91
8.0 THE AUDIT OPINION.......................................................................................................................... 91
8.1 THE AUDITOR’S REPORT ON FINANCIAL STATEMENTS..................................................................... 92
8.1.1 Contents of an audit report ................................................................................................ 92
8.1.2 Example of a clean audit report .......................................................................................... 94
Research .............................................................................................................................................. 96
8.1.3 Audit reports .............................................................................................................................. 98
8.2 THE IMPACT OF AUDITORS’ REPORTS...................................................................................... 106
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CHAPTER 1
The development of audit and other assurance
engagements
1.0INTRODUCTION
Most of the large, international accounting (Big 4) firms were founded around the turn of the
20th century during the Industrial revolution. Incorporation had two implications:
 the creation of a distinction between the owners of the business and the business
itself, which may in turn lead to the business being run by managers who are distinct
from its owners
 the granting of limited liability status so that, if the business fails, the owners only
stand to lose a specific amount of money – hence the term ‘limited’.
A legal framework was therefore needed for how companies should be operated
 to protect business owners from unscrupulous managers

 to protect the business world and the public at large from owners taking unfair
advantage of limited liability status.
This in turn had two results:
 the legal requirement for accounts to be produced by management on a regular basis

to account to the shareholders for their stewardship of the business
 the recognition of the need for these accounts to be checked in some way by someone
independent of the managers – the auditor.
As such as European financiers sent representatives to check up on their investments, hence

the primary focus of their practice has been traditional accounting and auditing services.
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You must be aware from your studies that a company is a ‘separate legal entity’, which can sue
or be sued. Once this principle was established in law, it became very necessary for the
interests of the owners of the business to be safeguarded. Consequently the business owners
needed assurance that the professional managers (directors) whom they employed to run the
business had been doing so properly. Who better to give the shareholders that reassurance
than professionally qualified accountants who were independent of the business and who had
their own code of ethics and professional competence? The shareholders employed
accountants to provide them with a report on the accuracy of financial statements and so the
auditing profession came into being.
Stewardship is the responsibility to take good care of resources. This relationship, where one
person has a duty of care towards someone else is known as a ‘Fiduciary relationship’. A
fiduciary relationship is a relationship of ‘good faith’ such as that expected between the
directors of a company and the shareholders of the company. There is a ‘separation of
ownership and control’ in the sense that the shareholders own the company, while the
directors take the decisions. The directors must take their decisions in the interests of the
shareholders rather than in their own selfish personal interests.
Accountability means that people in positions of power can be held to account for their actions,
i.e. they can be compelled to explain their decisions and can be criticised or punished if they
have abused their position. Accountability is thus central to the concept of good corporate
governance – the process of ensuring that companies are well run – which the student will look
at in more detail in Corporate finance.
1.1 THE CONCEPT OF AGENCY

Agency relationships occur when one party, the principal, employs another party, the agent, to
perform a task on their behalf. In a company this works as follows:
 It is the shareholders of the company who own the shares in the company and thus
indirectly own the assets of the company.
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 The directors are accountable to the shareholders and to society at large for:
– making decisions on behalf of the company’s owners (the shareholders)
– using the assets of the company efficiently and effectively.
 The shareholders in turn have the right to remove the directors by voting in a general
meeting and are likely to do this if they are dissatisfied with the decisions taken.
 Additionally, if the directors have acted illegally while running the company, they can
be fined or even sent to jail.
Modern organisational theory views an organisation as comprising various interest groups

often called stakeholders. The relationships between the various stakeholders in a company are
often described in terms of agency theory. For example, directors can be seen as the agents of
shareholders, employees as the agents of directors and external auditors as agents of
shareholders.
The concepts of:
 stewardship
 fiduciary duty
 accountability are all very well.
The requirement for a company’s management to produce financial statements giving an

account of their stewardship of the company at regular intervals, certainly helps with the
accountability concept.
But what if the financial statements contain errors, or worse, are fraudulent? Clearly there was
a need for some kind of independent validation of the financial statements – there was a need
for independent audit.
There is a problem, however, in getting the balance right. If the auditors are expected to verify
that the financial statements are correct this:
 may prove to be very expensive because of the amount of work required
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 may prove to be unduly disruptive to the operation of the business.
Over time, therefore, the role of the auditor has been established as forming an independent
opinion about:
 the truth and fairness of the financial statements.
However, there is no official definition in the IAASB Glossary of Terms or in any individual ISA of
the meaning of ‘true and fair’.
‘Truth’ in accounting terms can be taken to mean not factually incorrect.
The word fair can have the following meanings:
 on the one hand clear, distinct and plain; and

 on the other impartial/unbiased, just and equitable.
Both can be considered relevant when fair is used in an accounting context.
• their compliance with legal and regulatory requirements.
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CHAPTER 2
Nature, purpose and scope of auditing
Chapter learning objectives
Upon completion of this chapter the student will be able to:
• explain the level of assurance provided by audit assignments
• explain the level of assurance provided by other review assignments
• explain the nature and development of audit and other assurance engagements
• discuss the concept of stewardship
• discuss the concept of accountability
• discuss the concept of agency
• explain the concept of materiality
• explain the concept of true and fair
• explain the concept of presentation and reasonable assurance.
2.0Definition of Auditing
Auditing is theindependent examination of and expression of an opinion on the financial

statements of an entity by a jury appointed auditor in pursuit of that appointment.
The words independent and opinion in this definition are of prime importance.
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Independent is essential and underlies the value of auditing. There are no certainties and there
are no certifications of correctness or accuracies.
Opinion really means that an auditor could look at his set of financial statements and disagree
with the opinion of another auditor
Alternatively, an audit can also be described as:

 a process by which an independent, qualified third party expresses an opinion as to
whether a set of financial statements of a company represents a true and fair view of its
financial affairs for an accounting period(s).
The determination of fair presentation relates to the financial statements taken as a whole.
Fair is based on the following financial information;
- Information on the financial position – Statement of financial Position
- Information on performance – Statement of comprehensive income and statement of
changes in equity
- Information on changes in the financial position- Statement of changes in Cashflows
 A systematic process of objectively obtaining and evaluating evidence regarding

assertions about economic actions and events to ascertain the degree of
correspondence between assertions and established criteria and then communicating
the results to interested users.
A closer look at the second definition reviews several ideas that are important to any type of
auditing engagement.
Systematic process: it is a logical and purposeful process based on a disciplined and structured
approach to reaching final decisions. It has a logical starting point, proceeds along established
guidelines and has a logical conclusion. It is not haphazard, unplanned or unstructured
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Obtaining and evaluating evidence: evidence consists of all types of influences that ultimately
guides auditors decisions and relates to assertions made by management and thus obtains
managements’ implicit assertions about economic actions and events (that the revenue
recorded on the income statement really occurred, that assets on the balance sheet actually
exists, that the liabilities recorded are complete e.t.c.) as well as assertions that the financial
statement disclosures are fairly presented.
The purpose of collecting and evaluating evidence is to ascertain the degree of correspondence
between assertions made by the information provider and established criteria i.e. the
applicable financial reporting framework. The auditors will ultimately communicate their
findings to interested parties
2.1 Why the need for audit services

There is always a need for investors to invest money in the business entities. To make it
attractive for individuals to invest in businesses, the general public need to feel assured that the
financial statements supplied by business entities contain reliable financial information. It is an
auditor who provides the required assurance.
The purpose of an audit is to enhance the degree of confidence that intended users can place in
the financial statements. This is achieved by the expression of an opinion by the auditor on
whether the financial statements are prepared in all material respects in accordance with an
applicable financial reporting framework. In short the purpose of assurance services is to:
• increase the confidence
• reduce the risk of the user of those services.
2.1.1 Class discussion 1

Not all businesses have to be audited. Who needs to be audited?
Sole traders, partnerships and small companies are not required to have an audit.
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The main reasons for exempting small companies are:
• forowner managed companies, those receiving the audit report are those running the
company (and hence preparing the accounts!)
• the advice/value which accountants can add to a small company is more likely to concern
other services, such as accounting and tax, rather than audit and which may also give rise to a
conflict of interest under the ethics rules
• the impact of misstatements in the accounts of small companies is unlikely to be material to

the wider economy
• given the above points, the audit fee and related disruption are seen as too great a cost for
any benefits the audit might bring.
Private companies may also be exempt from appointing an auditor under company law, see
Company’s act chapter 24:03 section150 sub-section1)if;
a) the number of members in such a company does not exceed ten, and
b) none of the members of such a company is
i. a public company
ii. a private company is a subsidiary of a public company
c) all members in such a company agree that an auditor shall not be appointed
2.2 NATURE OF AUDIT WORK

An auditor can be given an engagement for auditing services either in terms of statutory
requirements or on a voluntary basis.
Statutory audits are audits required in terms of an act, such as the Companies act Chapter
24:03. The statutory duties and responsibilities are spelled out in the act.
Non –statutory audits on the other hand are requested by clients but are not obligatory in
terms of the relevant legislation.
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2.3 FRAMEWORK FOR AUDITING AND RELATED SERVICES
As you proceed with your studies, you will find that auditors perform different tasks. There are
two main categories of engagements; audit engagements and related services engagements
which include attestation, review and assurance engagements
2.3.1 Attestation engagements

These are engagements in which a practitioner is engaged to issue a report on subject matter,
or an assertion about subject matter that is the responsibility of another party. It involves
reporting on an expanded set of financial information beyond financial statements or on a
specified element of financial statement information. No assurance is mentioned in the report.
Examples of attestation engagements

1. Agreed Upon procedures Engagements: e.g. verifying inventory quantities and
locations
2. Financial forecasts and projections: such as analysis of prospective or hypothetical
“what-if” financial statements for some period in the same future.
3. Reporting on pro-forma Financial information: such as retroactively analysing the
effect of a proposed or consummated transaction on the historical financial
statements “as if” that transaction had already occurred
4. An examination of an entity’s internal control over financial reporting that is
integrated with an audit of its financial statements: focused on the design and
operating effectiveness of an entity’s internal control over financial reporting
5. Compliance attestation: such as ascertaining a clients’ compliance with debt
covenants
6. Examination of management’s discussion and analysis: prepared in pursuant to the
rules and regulations of the Securities and Exchange Commission
7. Reporting on controls at a service organisation: such as organisations that provide
outsourced processes that are likely to be relevant to the user entities internal control
over financial reporting
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8. Compilation: consists of preparing financial statements from a client’s book and
records without performing any evidence-gathering work
2.3.2 Assurance services

While auditing refers specifically to expressing an opinion on financial statements and
attestation refers to expressing an opinion on an expanded set of financial information beyond
financial statements or a specified element of financial statement information, assurance
includes many areas of information, including non-financial information
Assurance services are expanded independent professional services that improve the quality of
information or its context for decision makers.
The major elements of assurance services are;
Independence: Auditors want to preserve their attestation and audit reputations and
competitive advantages by preserving integrity and objectivity when performing assurance
services
Professional services: all work is defined as professional for as long as it involves some element
of judgment based on education and experience
Improving the quality of information or its context: auditors can enhance quality by assuring
users about the reliability and relevance of information. Context is relevant in a different light.
For assurance services improving the context of information refers to how information is used
in decision-making
For decision making: these are consumers of the information
Examples of assurance engagements;
1. Enterprise risk management assessment
2. Information risk assessment and assurance’
3. Customer satisfaction surveys
4. Evaluation of investment management policies
5. Fraud and illegal acts prevention and deterrence
6. Accounts receivable review
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7. Comprehensive risk assessment reports
8. Performance measurement reports
9. Systems reliability reports
10. Reports on social and environmental issues (e.g. to validate an employer’s claims
about being an equal opportunities employer or a company’s claims about how
‘green’ it is)
11. Reviews of internal control
12. Vote counts
Other services
1. tax services ; public accountant or ca is asked to argue out a tax position for a client
2. advisory/ consultancy services but ca and pa are prohibited from performing client managerial
decisions
2.3.3 Review Engagement

A review engagement has all the attributes of an audit engagement; however, there are
important differences between a review engagement and an audit i.e.
• The practitioner is not carrying out an audit
• For an audit the user will always be the company’s shareholders, whereas for review
engagement, the user could be whoever commissions the work e.g.:
- a bank wanting to know whether to maintain existing or extend further credit facilities
- the directors of the predator company in a takeover situation.
- A review of financial statements
-
 limited evidence gathering work is performed which is narrower in scope than audit
The objective of a review engagement is to enable the auditor to state whether anything has
come to his/her attention which has caused him/her to believe that financial statements have
not been complied with an identified financial reporting framework in all material respects.
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2.4LEVELOF ASSURANCE
Since decision makers rely largely on information technology, a new need has arisen for various
forms of audit assurance. The degree of satisfaction obtained and therefore the level of
assurance that can be provided is determined the auditability of the financial information, the
nature and extent of the procedures which have been carried out and results obtained.
Irregardless of the scope of an auditors work, the Framework permits only three types of
assurance engagement to be performed:
i. A reasonable assurance engagement
In a reasonable assurance engagement, the auditor
• gathers sufficient appropriate evidence
(We will look at this in detail in the chapters on audit evidence and audit procedures, but for
now let us accept that it means that the practitioner has to do enough work to be able to draw
rational conclusions)
• concludes that the subject matter conforms in all material respectswith identified suitable
criteria.Information is material if its omission or misstatement could influence the economic
decisions of users taken on the basis of the financial statements.
(Materiality is another concept which we will consider in detail later. The important point for
you to understand is that the practitioner is not saying that everything is absolutely correct, but
that, broadly speaking, the information given is reliable.)
• gives his report in the form of 'positive assurance'.
This means that the report states that in the auditor’s opinion e.g.:
- Financial statements have been prepared in accordance with applicable legislation and
accounting standards
- The company’s employment policy in respect of disabled people isin accordance with
applicable legislation or guidance
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- The volume of greenhouse gasses emitting from the company’s factories is within targets
set by government.
A reasonable assurance engagement requires that:
• The subject matter is the responsibility of another party
• The subject matter is
– Identifiable
– In a form that can be subjected to evidence gathering procedures
– the practitioner is not aware of any reason for believing that a conclusion expressing a
reasonable level of assurance about the subject matter based on suitable criteria cannot be
expressed.
ii. No assurance
No assurance is expressed in the audit report
iii. A limited assurance engagement.
The auditor:
• gathers sufficient appropriate evidence to be satisfied that the subject matter is plausible in
the circumstances
• gives his report in the form of 'negative assurance'.
A negative assurance report takes the form:
'Nothing has come to our attention that causes us to believe that the financial statements are
not prepared, in all material respects, in accordance with an applicable financial reporting
framework'.
It is not possible to give an absolute level of assurance due to:
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• The lack of precision often associated with the subject matter – e.g. financial statements are
often subject to estimation and judgment
• The nature, timing and extent of procedures
• The fact that evidence is usually persuasive rather than conclusive
• The fact that evidence is gathered on a test basis.
The level of assurance given by a reasonable assurance engagement is high, whereas a limited
assurance engagement gives a moderate level of assurance.There is no precise definition of
what is meant by high or moderate in this context.
What is clear is that the confidence inspired in the user by the report produced after a
reasonable assurance engagement is designed to be greater than the outcome of a limited
assurance engagement.
It follows therefore that
• The procedures carried out will be more intensive
• The evidence gathered needs to be of higher qualityfor a reasonable assurance engagement

and this is reflected in the nature of the opinion given.
The contrast between the objective of the audit as a reasonable assurance engagement and the
expectation that it should lead to the discovery of all errors and fraud is a phenomenon known
as the ‘expectation gap’.
2.5 EXPECTATIONS GAP

Expectations of users are sometimes out of line with the service that auditors can provide in
practice, this is referred to as the ‘expectations gap.’ There are two components to the
expectations gap.
 The communications gap
This arises because;
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- users have unreasonable expectation that an unqualified audit report means that they can
safely invest in a company
- users often blame the auditors for company failures rather than the company directors
- users do not understand the exact nature of an audit and the responsibilities of the
auditor and thus have unreasonable expectations
You can clearly see that the communications gap arises because of unreasonable
expectations/perceptions of users.
 The performance gapwhich arises because;

- The auditor has tended to perceive his role as much narrower than expected by the users.
Users expect auditors to detect all fraud but auditors would consider this to be a feasible
role
- The auditor has focused on financial statements(mainly due to his responsibilities under
the companies act and auditing standards, whereas users require assurance on much
broader issues such as the environmental performance of a company
2.6 CLASS DISCUSSION 2

What is the difference between an audit,a review, attestation and assurance engagement?
Amount of work done decided by whom: Auditor, as much as he deems necessary to give
positive opinion/Reviewer, as much as he deems necessary to give negative opinion
Type of assurance engagements: Reasonable, (but not absolute) assurance/ Limited assurance
Level of assurance provided: High/ Moderate
Type of report provided: Positive assurance/ Negative assurance
Objective:
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CHAPTER 3
TYPES OF AUDITS
 Identify and define the different kinds of auditing engagements

 Identify the objectives of the various kinds of auditing services mentioned
 Note the difference between the different types of audits
3.0 INTRODUCTION
The auditing process is applied to a number of areas of financial and business activities. Seven different
kinds of auditing services are currently identified namely;
 Independent (external) audit

 Internal audit
 Operational audits
 Management audits
 Comprehensive audits
 Forensic audits
 Governmental audits
3.1 OPERATIONAL AUDITS

The purpose of this form of audit is to;
 appraise the effectiveness with which management objectives are being carried out;
 identify shortcomings and make recommendations to management
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3.2 MANAGEMENT AUDITS
This audit covers the evaluation of an entity’s management systems. An audit is carried out to
determine whether management systems are operating effectively and if not what risk entails
for the entity.
3.3 COMPREHENSIVE AUDIT

A combined operational and management audit is performed instead of an external audit. The aim of
this audit is therefore to;
 appraise the effectiveness with which management objectives are being carried out;
 appraise the effectiveness with which management systems are functioning
 identify shortcomings and make recommendations to management
3.4 FORENSIC AUDIT

In this form of auditing a combination of accounting, auditing and investigative expertise is used
to gather evidence of criminal conduct and its financial implications. A forensic auditor may also
be asked to assist with determination or refutation of possible claim for damages.
3.5 GOVERNMENTAL AUDITS

The auditor general performs audits on all governmental and state revenue and expenses and
reports to Parliament.
3.6 INTERNAL AUDIT

The Board of directors of the Institute of internal auditors (IIA) defines internal auditing and
states its objective as an independent, objective assurance and consulting activity designed to
add value and improve an organisation’s operations. It helps an organisation accomplish its
objectives by bringing a systematic, disciplined approach to evaluate and improve the
effectiveness of risk management and governance processes.
Internal auditors are employed by organisations such as banks, hospitals, local government
authorities, industrial companies and Chartered accountant firms that provide the internal
audit services.
Internal auditors provide assurance to the company’s management that:

• systems are operating effectively
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• internal controls are effective
• laid down procedures are being followed
• financial and other information being produced is sound and reliable
Internal auditors often do this by:

• carrying out assignments and
• producing reports of their findings
3.7 EXTERNAL AUDIT

In most developed countries, all publicly quoted companies and all large companies are
required by law to produce annual financial statements and have them audited by an external
auditor. The majority of the course outline is designed around this process.
Other organisations (e.g. small private companies, partnerships, etc.) may choose to be audited
even if there is no legal requirement.
The objective of an external audit engagement is to enable the auditor to express an opinion on
whether the financial statements
• Give a true and fair view (or present fairly in all material respects)
• are prepared, in all material respects, in accordance with an applicable financial reporting
framework.The financial reporting framework to be applied will vary from country to country.
The auditor should follow certain general principles in the conduct of an external audit.
• Compliance with applicable ethical principles, i.e. the IFAC Code of Ethics for Professional
Accountants and the ethical pronouncements of the auditor’s professional body
• Compliance with applicable auditing standards, i.e. the International Auditing and Assurance
Standards Board’s (IAASB’s) International Standards on Auditing (ISAs).
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• Planning and performing the audit with an attitude of professional skepticism that recognises
that the financial statements being audited may be materially misstated. For example, the
auditor should not simplyaccept an explanation about a matter given by management. The
auditor should seek further evidence about the matter that confirms or contradicts
management’s explanation.
As stated earlier in this chapter, an audit is designed to provide reasonable assurance that the
financial statements taken as a whole are free from material misstatement and give a true and
fair view.Auditors should attempt to ensure that the financial statements which are the subject
of the audit, present clearly and equitably the financial state of affairs of the enterprise. This
suggests that in order to achieve the statutory trueand fair view, it is necessary:
• To present certain information impartially
• That this data is shown in such a way that it is clearly understood by the user.
Limitations and benefits
3.7.1 BENEFITS OF STATUTORY AUDITS

• High quality, reliable information circulates the market (gives investors faith and
improves reputation of the market).
• Independent verification (management value having their business scrutinised).
• Reduces the risk of management bias, fraud and error (by acting as a deterrent).
• Enhances the creditability of the information (especially for raising finance and for the
tax authorities).
• Deficiencies may be highlighted in the management letter and suggestions for
improvements.
3.7.2 LIMITATIONS OF STATUTORY AUDITS

• Financial information includes subjective and judgmental matters.
• Inherent limitations of controls used as audit evidence.
 Representations from management may have to be relied upon as the only source of
evidence in some areas.
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• Evidence is persuasive not conclusive.
• Do not review 100% of the transactions.
 The fact that the auditors work is governed by his or her judgment especially with
regard to gathering evidence and drawing conclusions based on the evidence gathered
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CHAPTER 4
AUDITING IN ZIMBABWE AND
INTERNATIONAL PERSPCTIVE
• describe the regulatory environment within which statutory audits take place
• explain the development and status of International Standards onAuditing
• explain the relationship between International Standards onAuditing and national auditing standards
• discuss the reasons and mechanisms for the regulation of auditors
4.0 CONDUCT OF AUDIT

The conduct of audits is governed by three sets of rules:
•Codes of ethics
•Auditing Standards (ISAs)
•Company law.
In addition, Governments have increasingly tried to ensure that audits are conducted by people
who are suitably qualified and whose work is of satisfactory quality – a process known as Audit
Regulation.
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4.1 SETTING AUDITING STANDARDS
4.1.1The International Federation of Accountants (IFAC)

IFAC is the global organisation for the accountancy profession. It was formed in 1977 and is
based in New York. IFAC has more than 160 member bodies of accountants, representing 2.5
million accountants from 120 separate countries.
Through its boards and committees, IFAC aims to encourage best practice by the members of its
constituent bodies.IFAC’s overall mission is to serve the public interest, strengthen the worldwide
accountancy profession, and contribute to the development of strong international economies
by establishing and promoting adherence to high-quality professional standards.
It has developed a code of ethics for its members and through the IAASB it sets standards for audit and
other assurance engagements.
4.1.2 International Auditing and Assurance Standards Board (IAASB).

IAASB is a subsidiary of the International Federation of Accountants (IFAC). It sets the International
standards on auditing (ISAs) and standards for other types of assurance engagements in addition to
audits.There are more than 30 ISAs as shown below.IAASB publishes International Standard on Quality
Control (ISQC1) setting out quality control principles for all assurance engagements (including audits)
conducted under its standards.
4.2 AUDITING STANDARDS

AUDIT AND REVIEWS OF HISTORICAL FINANCIAL INFORMATION
INTERNATIONAL STANDARDS ON AUDITING (ISA’S)
GENERAL PRINCIPLES AND RESPONSIBILITIES (200 – 299)
ISA Title
200 The objective of and general principles governing an audit of financial
statements (Effective for periods beginning on or after June 15, 2006)
210 Terms of audit engagements
220 Quality control for audits of historical financial information
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230 Audit documentation
240 The auditor’s responsibility to consider fraud in an audit of financialstatements
250 Consideration of laws and regulations in an audit of financial statements
260 Communication of audit matters with those charged with governance
ASSESSMENT AND RESPONSE TO ASSESSED RISKS (300 – 499)

ISA Title
300 Planning an audit of financial statements
315 Understanding the entity and its environment and assessing the risk of material
misstatement
320 Audit materiality
330 The auditor’s procedures in response to assessed risks
402 Audit considerations relating to entities using service organizations
AUDIT EVIDENCE (500 – 599)

ISA Title
500 Audit evidence
501 Audit evidence – additional considerations for specific items
505 External confirmations
510 Initial engagements – opening balances
520 Analytical procedures
530 Audit sampling and other means of testing
540 Audit of accounting estimates
545 Auditing fair value measurements and disclosures
550 Related parties
560 Subsequent events
570 Going concern
580 Management representations
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USING WORK OF OTHERS (600 – 699)
ISA Title
600 Using the work of another auditor
610 Considering the work of internal audit
620 Using the work of an expert
AUDIT CONCLUSIONS AND REPORTING (700 – 799)

ISA Title
700 Independent auditors report on a complete set of general purpose financial
statements
701 Modifications to the independent auditors report
710 Comparatives
720 Other information in documents containing audited financial statements
SPECIALISED AREAS (800 – 899)

ISA Title
800 The auditor’s report on special purpose audit engagements
INTERNATIONAL AUDITING PRACTICE STATEMENTS (1000 – 1100)
IAPS Title
1000 Inter-bank confirmation procedures
1004 The relationship between banking supervisors and banks’ external auditors
1005 The special considerations in the audit of small entities
1006 Audits of the financial statements of banks
1010 The consideration of environmental matters in the audit of financial statements
1012 Auditing derivative financial instruments
1013 Electronic commerce –effect on the audit of financial statements
1014 Reporting by auditors on compliance with international financial reporting
standards
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INTERNATIONAL STANDARDS ON REVIEW ENGAGEMENTS (ISRE) (2000 – 2699)
ISRE Title
2400 Engagements to review financial statements (previously ISA 910)
2410 Review of interim financial information performed by the independentauditor of
the entity
ASSURANCE ENGAGEMENTS OTHER THAN AUDITS OR REVIEWS OF HISTORICAL

FINANCIAL STATEMENTS
INTERNATIONAL STANDARDS ON ASSURANCE ENGAGEMENT (ISAES) (3000 – 3699)
ISAE Title
3000 Assurance engagements other than audits or reviews of historical financial
information
3400 The examination of prospective financial information (previously ISA 810)
RELATED SERVICES
International standards on related services (ISRS) (4000 – 4699)
ISRS Title
4400 Engagements to perform agreed-upon procedures regarding financial
information (previously ISA 920)
4410 Engagements to compile financial statements (previously ISA 930)
PRE-ENGAGEMENT
ISA 210: Terms of audit engagement.
ISA 220: Quality control for audits of historical financial information.
ISA 300: Planning on audit of financial statements.
ISQC 1: Quality control for firms that perform audits and reviews of historical
financialinformation, and other assurance and related services engagements.
SAAPS 1: Quality control.
All audits carried out under the laws of member states of the EU have had to be conducted
under ISAs for all accounting periods beginning on or after 1January 2005.
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4.3 THE RELATIONSHIP BETWEEN INTERNATIONAL AND NATIONAL STANDARDS
AND REGULATION
Because IFAC is simply a grouping of accountancy bodies, it has no legal standing in individual
countries. Countries therefore need to have arrangements in place for:
• regulating the audit profession
• implementing auditing standards.
National Regulatory bodies:
• enforce the implementation of auditing standards
• have disciplinary powers to enforce quality of audit work
• have rights to inspect audit files to monitor audit quality.
There are two possible schemes for regulation at the national level:
• Self-regulation by the audit/accountancy profession
• Regulation by government or by some independent body set up by government for the

purpose.
National standard setters may set their own auditing standards or adopt and implement ISAs,
possibly after modifying them to suit national needs.
Following the decision by the EU to implement ISAs in all member states for all accounting
periods beginning on or after 1 January 2005, countries with their own standard setting bodies
such as the UK had to decide whether to modify their own standards to bring them into line
with ISA’s or adopt ISAs and modify them to suit national requirements.
In the UK the national standard setter – The Auditing Practices Board (APB) –decided to adopt
and modify ISAs.
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4.4 CLASS DISCUSION
1) Describe the role of the IFAC?(3 marks)
2) Describe how ISAs and national auditing standards influence each other. (2 marks)
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CHAPTER 5
PROFFESSIONAL ETHICS
 define and apply the fundamental principles of professional ethics of integrity, objectivity,
professional competence and due care, confidentiality and professional behaviour
 define and apply the conceptual framework
 discuss the sources of, and enforcement mechanisms associated with, Code of Ethics and
Conduct
 discuss the requirements of professional ethics and other requirements in relation to the
acceptance of new audit engagements
 discuss the process by which an auditor obtains an audit engagement
 Explain the importance and state their contents of engagement letters.
5.0 INTRODUCTION – THE NEED FOR PROFESSIONAL ETHICS

We have seen in chapter 1 that the purpose of assurance engagements is to increase the
confidence of end users by reducing their level of risk.It follows from this that the user needs to
trust the professional.
In the light of the various corporate scandals which have occurred in the past decade – Enron,
WorldCom, Lehman brothers etc. There is a need for a basis for this level of trust. The user
needs to believe that assurance practitioners act in accordance with a code of ethics, while the
practitioner needs a code of ethics to make sure that he or she is worthy of that level of trust.
29
In order to be trusted the auditor needs to be independent of their client. Independence is
defined in APB Ethical Standard 1 as ‘freedom fromsituations and relationships which make it
probable that a reasonable and informed third party would conclude that objectivity either is
impaired or could be impaired.’
5.1 THE IFAC CODE OF ETHICS AND THE CONCEPTUAL FRAMEWORK

IFAC has also issued a code of ethicswhich follows a conceptual framework which identifies:
- fundamental principles of ethical behaviour

- potential threats to ethical behaviour
- Possible safeguards which can be implemented to counter the threats.
A conceptual framework relies on principles rather than a rules based approach. That means
that the spirit of the code is followed rather than a strict set of rules. It is guidance so the actual
application will depend on the individual circumstances of a specific situation.
You should remember that sometimes the only viable safeguard is not to accept an assurance
engagement, or to resign from it.
The framework and principles would be of little use if they could not be enforced.Professional
bodies therefore reserve the right to discipline members who infringe the rules through a
process of disciplinary hearings which can result in:
– fines
– suspension of membership
– Withdrawal of membership.
5.2 THE FUNDAMENTAL PRINCIPLES

The firm should establish policies and procedures designed to provide it with reasonable
assurance that the firm and its personnel comply with relevant ethical requirements.
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5.2.1 Ethical requirements (ISA 220.8-220.13)
The engagement partner should consider whether members of the engagement team have
complied with ethical requirements (Part A& B of IFAC Code). The fundamental principles of
professional ethics as set out in the code are as follows:
- Integrity;
- Objectivity;
- Professional competence & due care;
- Confidentiality; and
- Professional behaviour
The formal definitions of the fundamental principles are as follows:
1. Objectivity
Members should not allow bias, conflicts of interest or undue influence of others to override
professional or business judgments.
2. Professional behaviour
Members should comply with relevant laws and regulations and should avoid any action that
discredits the profession.
3. Professional competence and due care
Members have a continuing duty to maintain professional knowledge and skill at a level
required to ensure that a client or employer receives competent professional service based on
current developments in practice, legislation and techniques.
Members should act diligently and in accordance with applicable technical and professional standards
when providing professional services.
4. Integrity
Members should be straightforward and honest in all professional and business relationships.
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5. Confidentiality
Members should respect the confidentiality of information acquired as a result of professional

and business relationships and should not disclose any such information to third parties
without proper and specific authority or unless there is a legal or professional right or duty to
disclose. Confidential information acquired as a result of professional and business
relationships should not be used for the personal advantage of members or third parties.
5.2.2 Class discussion

Some examples of the fundamental principles in action might be:
Objectivity
The owners of a private company have the opportunity to sell their shareholdings to a large
listed company and have asked for your advice. It looks like an excellent deal, but which will
almost certainly mean that your firm will lose the audit to a larger competitor. Your advice
might not be impartial – you may be tempted to advice against the deal in order to keep the
client.
Professional behaviour
This is possibly the most difficult principle to illustrate. Clearly you, as a professional, would not
indulge in illegal behaviour. But does it matter what you do in the evenings or on your lunch
break?
Professional competence and due care
A client is starting to expand into areas where there are complex tax issues. You have no direct
experience of this area, but you know that a larger firm in the town does have a number of
specialists in this field. You might be tempted to think that you can ‘get yourself up to
speedquite’ quickly.
Integrity
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You find out that one of your listed audit clients is shortly to be taken over, or has access to
technological advances which will give it a fantastic competitive advantage. You might be
tempted to buy some shares or encourage your friends to do so.
Confidentiality
You are tempted to share your knowledge of the takeover or technical advances mentioned
above, or even of the level of directors’ salaries, with your friends on a night out on the town.
5.2.3 Independence
Part B of the IFAC code includes a conceptual approach to independence for assurance
engagements and takes into consideration threats to independence, accepted safeguards and
public interest.
The firm should establish policies and procedures designed to provide it with reasonable
assurance that the firm, its personnel, and wherever applicable, others subject to
independence requirements (including experts contracted by the firm and network firm
personnel), maintain independence where required by the IFAC code and national ethical
requirements.
Such policies and procedures should enable the firm to;

a) Communicate its independence requirements to its personnel and where applicable
others subject to them,
b) Identify and evaluate circumstances and relationships that create threats to
independence and to take appropriate action to eliminate those threats or reduce them
to an appropriate level by applying safeguards or if considered appropriate withdraw
from the engagement.
At least annually, the firm should obtain written confirmation of compliance with its policies
and procedures on independence from all firm personnel required to be independent by the
IFAC code and national ethical requirements.
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Engagement partner should form a conclusion of compliance (ISA 220.12).
5.3 THREATS AND SAFEGUARDS

IFAC has developed a ‘principles approach’rather than a ‘rules based’ approach to ethical
professional behaviour.This has taken the form of identifying 5 potential threats to ethical
behaviour and the suggestion of a number of safeguards which might be appropriate, including
the possibility of ceasing to act for the client.
Throughout, the consideration is not simply the auditor’s view as to whether his or her integrity
is under real threat, but how the situation might appear to a third party.The auditor needs to
‘behave and be seen to behave’ in an ethical, professional manner.
5.3.1 Identifying the threats

In order to guard against the threats or perceived threats the firm needs procedures to enable
it to:
• identify possible threats
• evaluate the risk arising from the threat
• evaluate whether the necessary safeguards are in place
• take corrective action if necessary.
All the above considerations need to be made
- On acceptance of a new client.

- At the planning stage of any audit.
- At the completion stage of any audit.
- Whenever additional, non-audit services are provided to an audit client.
- If any event, or change in circumstances occurs which may mean that the firm’s
independence may be threatened.
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Examples of threats to objectivity include;
i. Self- interest- this being interested in the client financially or personally

ii. Self- review- Providing other services to the client and then also doing the Statutory
Audit – the auditor will then be reviewing their own work.
iii. Advocacy- When the auditor promotes the client or represents them
iv. Familiarity -Where the auditor is familiar with the client
v. Intimidation- Being harassed or bullied
vi. Management- Taking on a management role.
5.3.2 Possible safeguards

The procedures operated by the firm will normally consist of the following.
• ‘Fit and proper’ or ‘independence’ forms to be completed by all staff on a regular, usually
annual basis disclosing financial interests and other relevant factors.
• A checklist of procedures to be filled in when a new appointment is accepted covering such

issues as:
– proof of the client’s identity
– consideration of relationships with the firm, its staff, other clients etc.
• Consideration of independence issues when files are reviewed as part of the firm’s quality
control process.
• Appointment of a senior partner with responsibility for ethical issues.
5.3.2.1General safeguards
a. Safeguards created by the profession (these might include education, training and
experience requirements for entry into the profession, professional development
requirements, corporate governance regulations, professional standards, monitoring,
external review of work and reports).
b. The right to discipline through fines, suspension of membership or even withdrawal.
35
c. Safeguards in the work environment (such as oversight structures, ethics and conduct
programs, good recruitment procedures, strong internal controls, disciplinary
procedures, strong ethical leadership, policies and procedures to promote quality
control, culture of strong ethics in the organisation).
d. Safeguards created by individuals (complying with professional development
requirements, keeping records of contentious issues, keeping a broader perspective,
using a mentor, keeping in contact with professional bodies).
5.3.3 Specific threats to objectivity
5.3.3.1 Self-interest
THREAT WHY SAFEGUARD

Dependence on client • The auditor will have a fear of • Should not audit if the client
losing a lot of income therefore provides a large proportion of
will appease the client regular/recurring income to the
audit firm. Total gross recurring
fees should be no more than:
 Listed Co’s – 10% of the
Firms total fees (review
at 5%)
 Other Co's – 15% of the
Firms total fees (review
at 10%)
Lowballing •The auditor will keep the client • Setting an audit fee low to try
happy to ensure further work. and get more lucrative work is
Therefore will not disagree with frowned upon the fee must be
client based on pre-determined level
of work required
Loans, guarantees and overdue •The auditor will have fear of •No loans or guarantees allowed
36
fees not getting paid so will keep the to or from client, unless in
client happy to ensure payment normal course of business
•Significant overdue fees are
deemed a loan, hence not
allowed
Hospitality or other benefits •This could be deemed a bribe •Benefits should not be
and potentially the auditor may accepted unless modest.
lose professional skeptism Modest – means available to all
the company's staff at same
terms
•The Audit firm should establish
policies on gifts and hospitality
and should be communicated
Contingent fees •The auditor has an incentive, • Assurance work should not be
therefore may not be conducted on a contingent basis
independent (i.e. where you receive a
commission, or a % of fees is
payable upon a specific event
occurring)
• No safeguard – fee must be
based on pre-determined
amount
Financial/business can also lead •The auditor will wantthe •Close business, family or
to intimidation threat greatest returnfrom investment, personal relationship should
therefore may cover anything be avoided between the
that could devalue the interest
client and the assurance
firmi.e.
i. seeking to gain
employment with an
37
assurance client
Financial interest in shares e.t.c. ii. entering a joint venture /

arrangement with client
• Anyone involved with

assurance must NOT have
direct or indirect interest in a
client i.e. holding shares
• Rules apply to
– Assurance firm
– Any partner in the firm
– Person in a position to
influence engagement
– Immediate family
member of above
• Safeguards:
– Dispose of interest
– Remove individual from
the team
– Independent partner
review
– Internal QC procedures
in place (i.e. prohibited
shareholding list)
Cross selling •The auditor has an incentive, Assurance team should not be
therefore may not be remunerated on their success in
independent selling other services to the
client
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5.3.3.2 Self-review threats
Accounting services •If the auditor reviews their own • Should not do for LISTED
work they may miss errors, or be companies, unless it is an
more relaxed about doing the emergency
work. • For nonlisted clients –
•Also if they do find any errors permitted as long as safeguards
it's easier to cover them up and in place (applicable to all self-
not disclose in the fear of looking review threats)
incompetent • No management decisions are
made; client to prepare
judgmental area
• Separate personnel / terms /
partners
• Independent partner review
IT
• Should not design, provide or
implement IT systems which are
important to a significant part of
the accounting system or
undertake the role of
management
Valuation services • Should not provide valuation

services if they involve degree of
39
judgment and have a material
effect on the FS being audited
Tax services • Should not be undertaken if

audit firm seen to be taking on
management role or if they are
likely to have a material effect
on the Financial Statements
Corporate finance services • Acceptable, as long as not

making decisions
• Allowed to assist client raising
finance/developing corporate
strategies
Internal Audit Services • Should not be undertaken

where significant reliance
will be placed on the internal
audit A work by the auditors
from same firm
5.3.3.3 Familiarity
Participation in client The auditor may lose • Cannot be director, employee

affairs/family and personal professional skeptics, or have or a business partner if you are
relationships the fear of upsetting the client going to audit a client
• Must not take part in audit if
40
have been officer / employee in
that period, or in the last 2 years
• If the director / employee or
business partner is an immediate
family member of someone on
the audit team, that audit team
member
must be removed
• May be extended to other
close relationships within the
firm (not just those on the team)
Audit partners leaving to join the • Can join the client, but must
client sever all links with the assurance
firm (e.g. pension)
• Audit partner has to inform
the audit firm immediately and is
then removed from audit team
as soon as decision to join client
is made
• If partner becomes director or
key management and has
worked as partner on the audit
in prior 2 years the audit firm
must resign as auditors
• 2 year period must then
elapse before the firm can be
re-appointed as auditors
Acting for prolonged period • Listed clients – Engagement

partners can act for a maximum
of 5 years, should then have a
41
break of a minimum of 5 years
before resuming role
• Anyone who has acted as a
key audit partner for a period of
7 years should have a break of 2
years
• Senior staff on listed clients
should also not act for longer
than 7 years
• Nonlisted clients – No
compulsory rotation, but firm
carry out annual reviews to
ensure objectivity not
threatened, but is advised that
partners act for no longer than
10 years
5.3.3.4 Advocacy
Legal services When representing the client • Should not offer legal services
you automatically view the same to a client and defend them in
views as the client therefore may dispute or litigation which is
lose independence material to the FS
Corporate finance services • Should not advise on debt

restructuring as part of
Corporate finance – don't enter
negotiations with bank on
clients' behalf
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Contingent fees • Assurance work should not be
conducted on a contingent basis
(i.e. where you receive a
commission, or a % of fees is
payable upon a specific event
occurring)
• No safeguard – fee must be
based on pre-determined
amount
Dealing in clients shares • This could be seen as signal to

other investors if dealing in
clients shares
5.3.3.5 Intimidation
Close business, family and The auditor has the fear of • see SELFINTEREST
personal relationships upsetting the client, therefore
will agree with what they say
Litigation The client may harass or bully • If there is actual or

the auditor into giving an threatened litigation between
unqualified report client and assurance firm, the
firm should not continue to act
Assurance staff move to join • See SELF-REVIEW

clients
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5.3.3.6 Management
Undertaking any work which • An engagement partner or

involves making judgments employee of the assurance
and taking decisions that are firm should not serve on the
responsibility of management board of directors as they
would be involved with
decision making
• Performing other services
is also a management threat –
See SELF-REVIEW
• Safeguards; Informed
management
5.3.3.7 Quiz questions

1. List and explain – the fundamental principles of the IFAC Codes of Ethics?(2 marks)
2. List the threats to objectivity.(2 marks)
5.3.3.8 Assignments.
QUESTION 1 50 marks
The auditing firm known as Nel, Ngwena& Singh, where you are a manager, recently lost a
senior partner of theirs to one of their most prominent clients, the DevelopOne Limited Group.
DevelopOne Limited Group is a large property developer in Gauteng, listed on the JSE. Mr Kent,
the partner in question, had a very long relationship with DevelopOne Limited before joining
44
them as the financial director. In fact, he went to university with one of the founding members
of the company, Jay Smith. He was the senior partner in charge of the audit for the last eight
years and knows their business inside out. The directors of DevelopOne Limited approached
him during the previous financial year with the offer to become the financial director, after the
previous financial director immigrated to Australia. He apparently told his partners at Nel,
Ngwena& Singh that it was a very lucrative deal in terms of remuneration and that it also
included performance bonuses and share options. As part of the agreement to leave the
partnership, Mr Kent promised that he would try his utmost to ensure that Nel, Ngwena& Singh
remained the auditors of the DevelopOne Group. He kept this promise and the firm was
reappointed as auditors. In return, he insisted on keeping his office in the firm’s building in
Rivonia. He intends to do consultation work, especially in the field of Black Economic
Empowerment (BEE), from this office. His new employer is fully aware of the arrangement and
does not have a problem with it.
During the planning of the first audit of DevelopOne Limited and its subsidiaries, with a new
partner in charge, it came to the attention of the audit team that DevelopOne Limited
concluded a BEE deal in order to introduce new broad-based black ownership into the
company. The deal represents an opportunity to a BEE Consortium to obtain an interest in
DevelopOne Limited with the prospect for DevelopOne Limited to grow its business and in
doing so increase the value of the Consortium’s investment. Mr Kent was instrumental in
clinching and managing this deal.
The main features of the deal are as follows:
• The BEE Consortium will be a 30% shareholder of a newly formed subsidiary of DevelopOne
Limited, which will be called BeeOne (Property) Limited. DevelopOneLimited is the holder of
the other 70% of the shares.
• BeeOne (Property) Limited will buy a 15% stake in DevelopOne Limited and this transaction
will be funded by a loan from DevelopOne Limited. The loan will be interest-free for a period of
three years in order to assist the BeeOne shareholders to establish themselves financially.
45
• The BEE Consortium consists of two politicians and a number of up-and-coming black
business people.
• BeeOne (Property) Limited appoints Nel, Ngwena& Singh as auditors of the company.
• The Consortium is restrained from having an interest in a substantially similar BEE transaction
in the property sector. The Consortium, through the deal, will be entitled to nominate two new
directors for appointment to the Board of DevelopOne Limited. The Consortium has put
forward their names and although they are technically competent in their respective fields,
they are
totally inexperienced as directors.
Two other important transactions came to the attention of the audit team when inspecting the
minutes of directors meetings of DevelopOne Limited:
1. The company bought a piece of land situated next to one of their latest developments in
Sandton from Mrs Willow, the wife of the marketing director of DevelopOne, for a significantly
larger sum compared to current market prices. Mrs Willow works as an estate agent on a part-
time basis, but bought the property a few months ago with her own money. She was tipped off
by her husband that the company would probably be interested in the property, as it is
adjacent to one of their most popular apartment developments.
2. The company also bought a large piece of land just outside Dullstroom, for the purpose of
developing a golf estate. It was noted in the minutes that DevelopOne Limited paid more than
the market value of the adjacent land. While they were still considering the viability of the golf
estate project, the previous owner sold the land to another developer. As a result they had to
buy it from this developer when they eventually decided to go ahead with the project. This
developer is a private company that belongs to Mr Franken (the managing director of
DevelopOne Limited) and an old university friend, who each have a 50% share. They formed the
company many years ago to use should opportunities like these arise. Their sons are now
managing the company and identify investment opportunities on their behalf. The new partner
in charge of the audit identified an opportunity to increase the fee income received from the
46
DevelopOne Group. She convinced management that the firm should be part of an information
technology project to update the company’s internal controls. The project will specifically aim
to ensure that all transactions between the companies in the group are correctly valued and
properly recorded.
You also stumbled upon a piece of interesting information during a social event. One of your
friends, who work at the City Council as a city-planner, told you about a contentious rezoning
application that was approved by the Council. He mentioned the name of the DevelopOne
Group during the conversation.
At the next planning meeting with the management of DevelopOne Limited you enquired about
this issue and the client informed you that they are actually planning a party to celebrate the
rezoning approval. You and the partner in charge of the DevelopOne Group audit attended this
function in order to build client relationships. At the party you overheard Mr Willow remark to
Mr Franken how relieved he was that their “little investment” in the mayor’s holiday fund paid
off. It also became evident from various conversations, that DevelopOne Group desperately
needed this rezoning, as some of their transactions put some strain on the company’s financial
position. The excesses paid for the properties in Sandton and Dullstroom depleted their cash
reserves and additional finance had to be raised.
REQUIRED
(a) Identify all the ethical issues evident from the above scenario and, where appropriate, state
the possible actions or safeguards in terms of the Code of Professional Conduct. [17]
(b) Outline the responsibilities of directors for all of the above transactions in terms of the
Companies Act and the Corporate Laws Amendment Bill. [13]
(c) Briefly outline the King Report requirements for Mr Kent, in his capacity as a new director of
the DevelopOne Group.[5]
47
(d) Discuss whether BeeOne (Property) Limited can be regarded as a widely held company, as
defined in the Corporate Laws Amendment Bill and briefly explain the possible corporate
governance implications thereof.[9]
(e) Determine whether any reportable irregularity exists in this scenario.[6] [Total 50]
QUESTION 1 - SUGGESTED SOLUTION

(a) Ethical issues from the scenario including actions and safeguards (17)
Appointment of Mr Kent as financial director
• Auditors should not be too dependent on one client (too much fees). (1)
• Before his resignation, a familiarity threat existed between Mr Kent and the client he joined
(DevelopOne Limited), as a result of his long association with the client (eight years).
(Familiarity threat – university friend) (1)
• Mr Kent a CA (SA) is a former partner and now financial director of a client. This poses a
threat to independence of the firm, in the form of self-interest, familiarity and intimidation
threats. (1)
• In this case significant connections remain between the individual and firm: Mr Kent still has
an office at the firm, Nel, Ngwena& Singh and also ensured that his former firm retained the
audit of his new employer. (2)
• Mr Kent is also is in a position to exert direct and significant influence over the subject matter
of the audit. (1)
• The significance of the threats created will depend upon the following:
- The position the individual has taken at the client – financial director can directly affect audit;
(1)
- The amount of any involvement the individual will have with the assurance team- he will be
involved in many audit queries; (1)
- The length of time that has passed since the individual was a member of the assurance team
or firm- no time passed since previous audit; (1)
- The former position of the individual within the assurance team or firm –he was the partner
responsible for the audit for the last eight years. (1)
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• The threats to independence are therefore significant and the following actions or safeguards
can be considered: (1)
- Assigning an assurance team to the subsequent engagement that is of sufficient experience in
relation to the individual who has joined the client. (1)
- Review of the work by a person who is not a member of the assurance team/quality control
review. (1)
- The individual does not continue to participate in the firm’s business and professional
activities – Mr Kent should vacate the office he still has at the firm. (1)
- Nel, Ngwena& Singh should resign as auditors of the company. (1)
Provision of IT Systems services to audit clients:
• The provision of services that involve the design and implementation of financial information
technology, that are used to generate information that forms part of the client’s financial
statements, may create a self-review threat. (1)
• Usually the self-review threat is too significant to allow the provision of such services, unless
the following safeguards are put in place: (1)
- The DevelopOne Group acknowledges responsibility for establishing and monitoring a system
of internal controls. (1)
- The DevelopOne Group assigns a competent senior employee with the responsibility to make
all the relevant management decisions with respect to the design and implementation. (1)
- A responsible person within the DevelopOne Group evaluates the adequacy and results of the
design and implementation of the system. (1)
- The DevelopOne Group assumes full responsibility for the operation of the system and the
data used or generated by the system. (1)
- These services should preferable be provided by personnel not involved in the audit. (1)
• Auditors aware of bribe - reconsider continued involvement with client. (1)
[Total 23, Maximum 17]
(b) Responsibilities of directors in terms of the Companies Act, amendments andcommon law
(13)
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• Section 89: Subsidiary may only have a maximum of 10% share in holding
company. (1)
Financial Assistance:
• The interest-free loan to BeeOne (Pty) Ltd to purchase a 15% interest in DevelopOne Limited
qualifies as financial assistance. (1)
• Section 38(1) of the Corporate Laws Amendment Act does not prohibit a company from giving
financial assistance for the purchase for shares of that company or its holding company, if: (1)
(a) The company’s board is satisfied that:
(i) subsequent to the transaction, the consolidated assets of the company fairly valued will be
more than its consolidated liabilities; and
(ii)subsequent to providing the assistance, and for the duration of the transaction, the company
will be able to pay its debts as they become due in the ordinary course of business; and
(b) The terms upon which the assistance is to be given is sanctioned by a special resolution of
its members.
• For the purposes of above the directors must consider any contingent liabilities which may
arise to the company, including any contingent liabilities which may result from giving the
assistance.
(Quoting from Act = max 2)
In this case the two transactions in Sandton and Dullstroom put a definite financial strain on the
company. (1)
It is also evident from the fact that the company needed to pay a bribe in order to secure the
rezoning and the additional finance that had to be raised as a result of the cash flow
difficulties.(1)
The viability of these two transactions has not been proven, and the company could suffer
future losses. Will the company therefore be able to pay its debts as they become due? (1)
It is therefore not a certainty that Section 38 (1) was complied with. (1)
Possible reckless trading by the directors (section 424).(1)
Interests in contracts:
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In terms of Section 234, directors have to declare their direct/indirect material interest in a
contract of the company. (1)
In this case Mr Franken clearly has an interest in the contract to buy the property in Dullstroom
from the private company, as he is a 50% shareholder in that company. (1)
The fact that the property in Sandton was bought from the estate agent, Mrs Willow, the
spouse of Mr Willow, indicates that he abused his position as director and used confidential
information to his own benefit and for the benefit of someone closely associated with him,
namely his wife. (1)
The company had to pay a premium for the property in Sandton as a result of the abuse of
confidential information. (1)
Mr Willow and Mr Franken both clearly have interests in the two transactions in Sandton and
Dullstroom, which they should have declared. (1)
Companies Act requirements

It must be declared in the form of a written notice to the directors of the company, which
indicated the nature and extent of the interests (i.e. containing full particulars thereof). (1)
The declaration has to be made:
• Before or at the meeting on which the contract will be dealt with; or (1)
• On the next director’s meeting, stating the reason why it was previously impossible. (1)
The director who has the interest is not allowed to vote on that specific contract. (1)
He can also not form part of the quorum. (1)
The declaration must be minuted. (1)
The interests should be recorded in the Register of director’s interests. (1)
(Co Act requirements max - 4)
(c) King requirements for new directors (5)
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• Mr Kent should have attended a formal orientation program as an incoming director joining a
board for the first time. Due to his previous relationship as the external auditor of DevelopOne
Limited, Mr Kent would probably have sufficient knowledge on the group and its operations. (2)
• Background checks should be performed on Mr Kent to ensure that he is not disqualified from
being a director. (2)
• In the event that Mr Kent’s board experience was regarded as insufficient, he should have
been educated. (1)
with regard to his: - duties, - responsibilities, - powers; and - potential liabilities. (2)
(d) Can BeeOne Pty Ltd be regarded a widely held company and corporate governance
implications. (9)
Can it be regarded as widely held?
• A company is a widely held company if: (Section 1h)
i. its articles provide for an unrestricted transfer of its shares;
ii. it is permitted by its articles to offer shares to the public;
iii. it decides by special resolution to be a widely held company; or
iv. it is subsidiary of a company described above. (2)
DevelopOne Limited is a listed company. A listed company is regarded as widely held, as it
offers its shares to the public. (1)
BeeOne (Pty) Ltd is a subsidiary of DevelopOne Limited and therefore in my opinion
qualifies to be widely held. (1)
Corporate governance implications:
The implications are mentioned in Section 269A of the Corporate Laws amendment Act: (1)
• In every financial year in which a company is a widely held company, its boardof directors
shall appoint an audit committee for the following financial year. (1)
• This shall not apply to a company if the audit committee of a holding companywill perform
the functions on behalf of that company. (1)
• An audit committee must have at least two members. (1)
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• It should consist only of non-executive directors of the company who must actindependently.
(1)
• The audit committee must perform certain prescribed functions in terms of Section 270A, for
instance the pre-approval of certain non-audit services. (1)
In this case BeeOne (Pty) Ltd would have to appoint an appropriate audit committee or the
audit committee of DevelopOne Limited could perform the functions on its behalf. (1)
BeeOne (Pty) Ltd would also have to adhere to King II requirements. (1)
(e) Reportable irregularity and auditor’s actions (6)
Bribe
To determine whether a reportable irregularity exists the following questions should
be asked:
(a) Is this an act of a person responsible for the management of the entity? (1)
Yes, it seems that the managing director (MD) and marketing director were involved and the
MD is a person responsible for management of an entity. (1)
(b) Is this an unlawful act or an omission? (1)
Yes, payment to secure approval for business (rezoning) not otherwise due may be unlawful,
because it may be regarded as a bribe. (1)
(c) Which conditions does this meet (material financial loss; fraudulent or amounting to theft;
material breach of any fiduciary duty)? (1)
This unlawful act, if authorised by the Board of Directors, would amount to a material breach of
a fiduciary duty owed to the entity in ensuring that its affairs are conducted within the law. It
could also lead to future penalties, loss of business and negative publicity for the company. (2)
(d)Is this a reportable irregularity? Yes, it is a reportable irregularity. (1)
Interest in contract
To determine whether a reportable irregularity exists, the following questions should be asked:
(a) Is this an act of a person responsible for the management of the entity? (1)
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Yes, the marketing director (Sandton) and the managing director (Dullstroom) were involved
and they are responsible for the management of the entity. (1)
(c) Is this an unlawful act or an omission? (1) Yes, not declaring your interest in a contract is
contrary to the Companies Act. (1)
(c) Which conditions does this meet (material financial loss; fraudulent or amounting to theft;
material breach of any fiduciary duty)? (1)
These unlawful acts amount to a material breach of fiduciary duties owed to the entity/
material financial loss – paid more than market value. (2)
(d)Is this a reportable irregularity? Yes, it is. (1)
Total 8 Maximum 6
QUESTION 2
You are a manager in the audit firm of NUST & Co; and this is the first time you have worked on
one of the firm's established clients, Pink Co. The main activity of Pink Co is providing
investment advice to individuals regarding saving for retirement, purchase of shares and
securities and investing in tax efficient savings schemes. Pink is regulated by the relevant
Securities Commission of Zimbabwe.
You have been asked to start the audit planning for Pink Co, by Mrs Good, a partner in NUST&
Co. Mrs Good has been the engagement partner for Pink Co, for the previous six years and so
has a sound knowledge of the client. Mrs Good has informed you that she would like her son
Simon to be part of the audit team this year; Simon is currently studying for his first set of
fundamentals papers for Chartered Accountant qualification, CTA. Mrs Good also informs you
that Mr Supper, the audit senior, received investment advice from Pink Co during the year and
intends to do the same next year.
In an initial meeting with the finance director of Pink Co, you learn that;
 the audit team will not be entertained on Pink Co's yacht this year as this could appear to be
an attempt to influence the opinion of the audit. Instead, Pink Co has arranged a day at the
horse races costing less than two fifths of the expense of using the yacht and hopes this will
beacceptable.
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 NUST& Co have done some consultive work previously and the invoice is still outstanding.
Required:
a. i) Explain the ethical threats which may affect the auditor ofPink Co.(6 marks)
ii) For each ethical threat, discuss how the effect of the threat can be mitigated.(6 marks)
[12 marks]
QUESTION 3
Ingwe Wine Wholesalers Limited (Ingwe), a JSE listed company, is one of the largest distributors
of South African wines. The company has most of the large retail stores and restaurant groups
in South Africa on its customer list. Ingwe specialises in the bulk purchasing of wines from South
Africa’s finest wine estates and then repackages and distributes these wines to its clients.
Accounting system
Ingwe currently uses stand-alone legacy application systems. As the company grew these
systems increased and today Ingwe has more than 20 different application systems, each
managing its own data files. This fragmented approach in the way its systems were developed,
causes delays in obtaining and combining information and is extremely difficult to manage.
Over the last few months, management noted their concern that the information regarding
sales and inventory in the sales and inventory data files has become more and more
inconsistent. Various incidents of inventory shortages, inventory items with negative values
being sold and incorrect invoicing (including the existence of invoices with negative values)
have also been reported.
Management has since taken a strategic decision to implement a comprehensive Enterprise

Resource Planning (ERP) system with a single relational database. The conversion process,
which was delayed until the new financial year, has started two weeks ago. All sales to its
customers are on credit only and customers are only invoiced once an order has been delivered
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and the bill of lading has been signed. Orders are received by the sales department staff that
then enters the details of the goods to be dispatched into the system.
The system calculates the invoice value and, if the customer does not exceed the credit criteria,
the system prints a set of delivery notes on the printer in the dispatch department. The
dispatch department prepares the delivery and delivers it directly to the customer. When goods
are dispatched, the dispatch department staffs records the transactions on the system. The
system prints a sales invoice and records it to the sales summary. The sales invoice is then sent
to the customer and the quantity of inventory dispatched is then also deducted from the
inventory records. The credit criteria above is designed to determine whether the customer,
with this purchase, has exceeded the credit limit, whether there are any significant old, unpaid
invoices reflected in the sales summary, or whether the credit controller has put a customer
“stop” (i.e. no dispatches of goods are allowed to the customer) on the account. On the request
of the sales department, the credit controller can over-ride the system’s controls.
Ingwe uses an open-invoice system. Under this approach, invoices are recorded individually
rather than being summarised or grouped by customer. No accounts receivable subsidiary
ledger therefore exists. Total accounts receivable is calculated by simply calculating the total of
the open (unpaid) invoices. Invoices are closed when payment is received. To calculate the
outstanding balance per customer, invoices are grouped by customer number and added.
As part of its social responsibility drive, Ingwe launched the Khulumani project five years ago to
assist new emerging wine farmers with the distribution of their products. The project entails
the purchasing, distribution and sale of these wines subject to the following clause in the sales
agreements: All wines purchased as part of the Khulumani project can be returned to the
supplier at cost price by Ingwe if not sold within a specific timeframe from date of purchase. The
specific timeframe was negotiated on an individual basis with every wine farmer. These returns
are referred to as non-suitable wines. Pre-numbered debit notes are prepared in respect of all
returns. The winery must sign a copy of the debit note upon return of the wines to the winery.
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This signed copy, together with the winery’s credit note, is used to record the return in the
purchase returns journal. The totals of the purchase returns journal are posted to the
appropriate purchase accounts and to creditors on a monthly basis.
Research into the Khulumani project showed that 5% of all purchases are returned to the
relevant winery within a month. This reduces to 3% and 1% respectively for purchases of two
and three months old. All purchases are normally either returned or sold after three months.
The debtors for non-suitable wines at year-end were calculated based on these research
results.
Corporate governance
The Board of Directors recently attended a workshop on directors’ responsibilities and the
importance thereof. They realised that they have to improve Ingwe’s corporate governance and
as a first step they formed an audit committee. MrLindiwe, MrPhumzile and MrManto will be
the members of this committee, with MrPhumzile as chairperson. The audit committee’s first
meeting is scheduled for after the completion of the 30 September 20X7 year-end audit. All
directors’ remuneration is approved by the Board of Directors.
Auditors
Mpanda Auditors Limited has been Ingwe’s auditors for the past five years. MrJackey is an
information technology specialist with only an information technology degree. He was
previously employed by Ingwe as its Chief Information Officer (CIO) until July 20X7 after which
he joined Mpanda Auditors Limited. His employment contract with Mpanda Auditors stipulates
that he will become a shareholder and director within six months. He has been allocated the
role of audit manager on the audit of Ingwe Wine Wholesalers Limited for the financial year
ended 30 September 20X7 due to his knowledge and experience of the company. You, as a
third year trainee accountant, with specialist information technology experience, are the in
charge auditor on the engagement. An extract of the 30 September 20X7 trial balance is
attached as Annexure A.
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Ingwe has also requested the auditors to perform a comprehensive review of the information
related to sales in order to investigate management’s concerns regarding sales and inventory
information. You have a generalised audit software (GAS) package with full data extraction and
analysis capabilities at your disposal to assist in the review. The file structure of all files related
to sales transactions is attached as Annexure B.
Ingwe Wine Wholesalers Limited and Mpanda Auditors Limited are governed, inter alia, by
the following laws and regulations:
• The Companies Act, as amended (inclusive of the Corporate Laws Amendment Act);
• The Report of the King Committee on Corporate Governance, 2002 (King II);
• The Auditing Profession Act;
• The South African Institute of Chartered Accountants’ (SAICA) Code of Professional
Conduct; and
• The Independent Regulatory Board of Auditors’ (IRBA) Disciplinary Rules.
Required:
1. Discuss Ingwe Wine Wholesalers Limited’s non-compliance with the requirements of the
abovementioned laws and regulations applicable to the company. (13)
2. Discuss Mpanda Auditors Limited’s non-compliance with the requirements of the
abovementioned laws and regulations applicable to the company. (13)
3. List the responsibilities of the newly appointed audit committee according to the above-
mentioned laws and regulations, as applicable. (8)
SUGGESTED SOLUTION
1. NON-COMPLIANCE BY INGWE TO THE RELEVANT LAWS AND REGULATIONS

1.1 Non-compliance to the King II report in the following instances:
1.1.1 Board composition:
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• Ingwe’s Board of directors consists of both executive and nonexecutive directors, but the non-
executive directors are not the majority. (2)
• Ingwe only has an audit committee, but the report recommends that every company should
at least have an audit and a remuneration committee. (1)
1.1.2 Directors’ remuneration:
• The directors’ remuneration is approved by the Board of Directors. (1)
• The Board of Directors’ should appoint a remuneration committee which; (1)
• consist of independent non-executive directors; (1)
• determines the remuneration of the executive directors; and (1)
• recommends the fees to be paid to the non-executive directors; (1)
• for approval by the Board of Directors and at a general shareholders’ meeting prior to
payment. (1)
1.1.3 Audit committee:
• Ingwe only recently appointed the audit committee/the audit committee’s first meeting is
only scheduled after the completion of the audit. (1)
• The audit committee currently consists of two executive directors and one non-executive
director. (1)
• The King II report recommends that the committee should consist of a majority of
independent non-executive directors. (1)
• The chairperson of the audit committee (MrPhumzile) is an executive director and the King II
report recommends that the chairperson of the audit committee should be a non-executive
director. (2)
1.2 Non-compliance in terms of the Companies Act (Corporate Laws Amendment Act):
1.2.1 Audit committee
• Every public interest company should have an audit committee, consisting of only
independent non-executive directors. (1)
• The audit committee currently consists of two executive directors and one non-executive
director. (1)
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1.2.2 Non-audit services:
• The request to the auditors to perform a comprehensive engagement on the information
related to sales in order to investigate
management’s concerns could be seen as non-audit services. (1)
• All non-audit services must be approved by the audit committee of a public interest company.
(2)
1.3 Also consider any other relevant matter. [Total 16, Maximum 13]
2. NON-COMPLIANCE BY MPANDA TO THE REQUIREMENTS OF THE RELEVANT LAWS

AND REGULATIONS
2.1 Auditing Profession Act (APA):
• MrJackey is not a registered auditor and he only has an Information Technology degree. It will
therefore at least be a few years before he will be qualified to become a registered auditor. (2)
• Only registered auditors are allowed to be shareholders and directors of company registered
as a registered auditor. (2)
2.2 Code of Conduct:

• The audit engagement manager was the Chief Information Officer of Ingwe/ previously
employed by the audit client. (1)
• The fundamental principal of objectivity, integrity and professional competence is threatened.
(1)
• MrJackey is in charge of the audit of the financial information, some of which he would have
been directly responsible for. This creates a self-review threat to his independence. (2)
• A familiarity threat is also created as MrJackey was previously employed by the client. (1)
• It is also possible that he lacks the professional competency to manage the engagement as he
is an information technology specialist and not an auditor. (2)
• Mpanda Auditors has been Ingwe’s auditors for five years. This could also create a familiarity
threat. (2)
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• Mpanda Auditors has been requested to perform certain non-audit services, which could
create a self-interest thread. (2)
2.3 Disciplinary Rules:

• A contravention of the Auditing Profession Act (appointment of MrJackey as director and
shareholder); and (1)
• failing to perform work with reasonable care and skill (allocating the engagement manager
roll on Ingwe’s audit to a person with no auditing experience and training/allocating the roll of
in-charge auditor to a third year trainee); (1)
• will be regarded as improper conduct by Mpanda Auditors Limited. (1)also consider any other
relevant matter. [Total 18, Maximum 13]
3. RESPONSIBILITIES OF THE NEWLY APPOINTED AUDIT COMMITTEE

3.1 In terms of King II report the audit committee should review:
• the functioning of the internal control system; (1)
• the functioning of the internal audit department; (1)
• the risk areas of the company’s operations to be covered in the scope of the internal and
external auditors; (1)
• the reliability and accuracy of the financial information provided to management and other
users of financial information; (1)
• any accounting or auditing concerns identified as a result of the internal or external audits;
and (1)
• the company’s compliance with legal and regulatory provisions, its articles of association,
code of conduct, by-laws and the rules established by the board. (1)
3.2 Section 270A of the Corporate Laws Amendment Act requires the audit committee
of a Public Interest company to:
• nominate the individual for appointment as auditor; (1)
• determine the fees to be paid to the auditor; (1)
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• determine and pre-approve the nature and extent of any non-audit services which the
auditors may provide; (1)
• report in the financial statements on how it has carried out its functions and on whether it is
satisfied with the independence of the auditor; and (2)
• receive and deal with complaints e.g. on accounting practices, internal control, etc. (1)
5.3.4 Other proposals to improve independence

• Compulsory rotation of audit firms (already happens in some countries).
• A ban on the provision of certain (maybe all) other services.
• A State Auditing Board to audit all major companies.
• Government to appoint auditors of listed companies.
5.4 OTHER ISSUES

i. Opinion Shopping
Whilst shareholders appoint auditors, the Directors typically seek out a potential firm for the
shareholders to vote on. The Board might be tempted to interview several firms until it found
one that accepted its accounting methods.
Any firm of auditors aware that a potential client is engaged in this process should not accept
nomination.
ii. Confidentiality
External auditors are in a unique position of having a legal right of access to all information
about their clients. It goes without saying that the client must be able to trust the auditor not to
disclose anything about their business to anyone as it could be detrimental to their operations.
As a basic rule, members of an audit team should not disclose any information to those outside
of the audit team, whether or not they work for the same firm. There is little point using
different teams for different work assignments if staff from different teams are disclosing
information to each other!
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Information should only be disclosed under certain circumstances.
• If the client has given their consent.
• If there is an obligation to disclose, e.g. if the client is suspected of money laundering,

terrorism, drug trafficking.
• If it is required by a regulatory body, e.g. Securities Commission of Zimbabwe, ZSE.
• If a court order has been obtained.
• If a member has to defend himself in court or at a disciplinary hearing.
• If it is in the public interest, though this is difficult to prove and the audit must proceed with
caution if thinking of disclosing information for this reason. Such examples could include fraud,
environmental pollution, or simply companies acting against the public good.
Legal advice should be sought beforehand to avoid the risk of being sued. Matters to consider
before disclosing information in the public interest are whether that matter is likely to be
repeated and how serious the effects of the client’s actions are.
Where an auditor feels the need to disclose information, they should consider disclosing to the
company’s Audit Committee (or Board of Directors, if there is no Audit Committee).
In certain circumstances auditors may be required by law to disclose information. For example,
where money laundering is suspected, UK auditors must disclose their suspicions to the Serious
Organised Crime Agency (SOCA).
There is no duty for the auditor to disclose information (e.g. to customers, suppliers, tax
authorities), they should only do so if a court order has been obtained.
iii. Conflicts of interest
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Members should place their clients’ interests before their own and should not accept or
continue engagements which threaten to give rise to conflicts of interest between the firm and
the client. Any advice given should be in the best interests of the client. Where clients’ interests
conflict (for example, clients in the same line of business), the firm’s work should be arranged
to avoid the interests of one being adversely affected by those of another.
The steps to be taken by the auditor are:
1. once a conflict is noted, you should advise both clients of the situation
2. reassure the client that adequate safeguards will be implemented, e.g. separate
engagement leaders for each, separate teams, ‘Chinese walls’ to prevent the transfer of
client information between teams and a second partner review
3. suggest they seek additional independent advice
4. if adequate safeguards can’t be implemented, the auditor should resign.
Safeguards can help to avoid or manage a problem situation, but problems are often hard to
foresee as the auditor may have no knowledge that two clients are related in some way until a
problem comes to light.
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CHAPTER 6
THE STATUTORY AUDITOR
• explain the statutory regulations governing the appointment, removal and resignation of auditors
• discuss the need for auditors to communicate with those charged with governance
• discuss the responsibilities external auditors for the prevention and detection of fraud and error
6.0 THE AUDITOR’S FUNDAMENTAL DUTIES

Duties include to:
• form an opinion on whether the financial statements give a true and fair view and are
prepared in accordance with applicable reporting framework
• issue an audit report.
Matters implicit in the audit report i.e. will not be included in the audit report unless there is a
problem hence commonly referred to as “exception reporting” and which the auditors
therefore have a duty to check are as follows.
• Proper Returns received from branches not visited by the auditor.
• The company's financial statements agree with the underlying accounting records.
• Proper accounting records have been kept.
• All necessary Information and explanations have been obtained.
• Information issued with the financial statements is consistent with the financial statements.
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• Other information required by law, if not included in the financial statements, is included in
the auditors’ report. For e.g. in Britain this includes information about directors’ pay and
benefits and any amounts owed by the directors to the company.
6.1 WHO MAY ACT AS AUDITOR?

To be eligible to act as auditor, a person must be:
• a member of a Recognised Supervisory Body (RSB), e.g. ICAZ and be allowed by the rules of
that body to be an auditor
• someone directly authorised by the state.
Individuals who are authorised to conduct audit work may be:
• sole practitioners
• partners in a partnership
• members of an LLP
• directors of an audit company.
To be eligible to act as auditor, a firm must be:
• controlled by members of a suitably authorised supervisory body or
• a firm directly authorised by the state.
6.2 WHO MAY NOT ACT AS AUDITOR?
6.2.1 Excluded by law

The law in most countries excludes those involved with managing the company and those who
have business or personal connections with them.
For example, in
Zimbabwe
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According to the Company’s act chapter 24:03 (152) (1), none of the following persons shall be
qualified for appointment as auditors of a company-
a) An officer or servant of the company

b) A person who is a partner of an officer or servant of the company
c) A person who is an employer or an employee of an officer or servant of the company
d) A body corporate
e) A person who is an officer or servant of a body corporate which is an officer of the
company
f) A person who by himself or his partner or his employee, regularly performs the duties of
secretary or bookkeeper of the company
Britain the following are excluded by company law:
• an officer (Director or secretary) of the company
• an employee of the company
• a business partner or employee of the above.
6.3 Excluded by the ethics rules (See chapter 4 for more detail)
The IFAC and the APB Ethics Standards require Auditors to consider whether their objectivity
and independence might be questioned by external parties because of:
• business relationships
• personal relationships
• long association with the client
• fee dependency
• non audit services provided.
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6.3.1 Class discussion
Who may and who may not be the auditor – some examples
• Mr Blue is a very experienced accountant and business consultant. He has a degree but no
professional qualifications. He is not allowed to act as an auditor.
• Ms. Green is a qualified CA but has always worked in the accounting and finance departments
of large companies. She is not allowed to act as an auditor.
• Mr Red is a partner in an accounting practice and is authorised by the ICAZ to conduct audits.
He may be allowed to act as an auditor.
• Mr Red’s brother runs a successful company in the town and asks Mr Red to become his
auditor. Mr Red must refuse because the relationship with his brother would bring his
independence into question.
• Mr Red is also a nonexecutive director of a large local company NUST Ltd. Neither he, his
firm, his partners, nor any members of his staff, may act as auditor for NUST Ltd.
6.4 HOW ARE AUDITORS APPOINTED AND REMOVED?
6.4.1 Who appoints the auditor?

In most jurisdictions:
• the members (shareholders) of the company
• directors can appoint the first auditor and fill a ‘casual vacancy’ (see Company’s act chapter 24:03
section 150 sub-section1 and sub-section 5)
But, needs members’ approval at next Annual General Meeting (AGM). However, in some countries the
auditors may be appointed by the directors as a matter of course.
Research
Under what circumstances can an auditor be appointed by the state?
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6.4.1.1Tenure of office
• Appointment runs from the end of the AGM until the end of the next AGM. (see Company’s act
chapter 24:03 section150 sub-section2).Where no AGM – automatic annual reappointment unless a
shareholder objects (small companies can elect to dispense with the requirement for an AGM).
• For a private company they will no longer have to hold an annual general meeting if an elective
6.4.2 Removing the auditor

Arrangements for appointing and removing the auditor have to be structured in such a way
that:
• the auditor has sufficiently secure tenure of office, to maintain independence of management
• auditors can be removed if there are doubts about their continuing abilities to carry out their
duties effectively.
To enable this balance to be maintained, the removal of auditors can usually be achieved by a
simple majority at a general meeting of the company, but with some safeguards such as a
specified notice period, to prevent the resolution to remove the auditors being ‘sprung’ on the
meeting.
6.5 THE AUDITOR’S RESPONSIBILITIES ON APPOINTMENT AND REMOVAL

On appointment
• Obtain clearance from the client to write to the existing auditor (if denied, appointment
should be declined).
• Write to the existing auditor asking if there are any reasons why the appointment should not
be accepted
On removal/resignation
• Deposit at the company’s registered office a statement of the circumstances connected with
the removal/resignation or
• A statement that there are no such circumstances
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• Deal promptly with requests for clearance from new auditors.
6.6RESIGNATION OF AUDITORS
In practice, if the auditors and management find it difficult to work together, the auditors will
usually resign. To prevent the circumstances of the resignation being hidden from the
company’s members, the auditors have to submit a statement of the circumstances
surrounding their resignation.
Auditors can resign. There two main reasons why they may wish to do so. These are;
1. The obvious reasons:

-the company have grown too large for the firm,
-the fees is inadequate
2. Where the auditor concludes tha because of fraud or other irregularity the accounts do
not show a true and fair view and there is no immediate opportunity to report to
members
Duties of the resigning auditor:
An auditor may resign by depositing a notice in writing to that effect accompanied by the
statement of circumstances.
The company must then send the copy of the notice to every member of the company due to
attend an extra-ordinary meeting within 21 days
***The statement of circumstances rule apply to any situation where an auditor leaves office
6.7 THE AUDITOR’S RIGHTS

During the audit/continued appointment:
• Access to the company’s books and records (see Company’s act chapter24:03 section 154sub-
section 1)
• To receive information and explanations deemed necessary for the audit.
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• To receive notice of and attend any general meeting of members of the company (see
Company’s act chapter24:03 section 154 sub- section 3).
• To be heard at such meetings on matters of concern to the auditor. (see Company’s act
chapter24:03 section 154 sub-section 3)
On resignation
• To request an Extraordinary General Meeting (EGM) of the company to explain the

circumstances of the resignation.
• To require the company to circulate the notice of circumstances relating to the resignation.
Companies act section 151 requires that special notice (28 days) for a resolution at a
company’s annual general meeting appointing as auditor a person other than a retiring auditor
or providing expressly that a retiring auditor shall not be reappointed.
Notice must also be given to the respective auditor, removal of an auditor cannot be done
behind the auditors back
The auditor, proposed to be removed, may make with respect to the intended resolution,
representations in writing to the company and request their notification to members. Thus the
auditor who does not wish to be removed can state his case and require it to be sent to
members
The company must then do two things(assuming representations are received well in time),
state the fact that representations were received in any notice of the resolution and send a
copy to every member of the company to whom notice of the meeting has been sent or will be
sent
The auditor has a general right to speak at that meeting on the subject of his intended removal
and if representations have not been sent to the members he has the right to have them read
out at the meeting
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**The object of these rules is not to prevent the auditors being removed, if the members wish
to remove him, but to ensure that he/she has adequate opportunity to put his case to the
members before they vote on the resolution
6.8 CLASS DISCUSSION 4

1) List the statutory duties of the auditor?(3 marks)
2) Who may act as auditor of a company? (2 marks)
3) Who may not act as the auditor of a company? (3 marks)
4) Who may appoint the first auditors of a company?(1 mark)
5) What action should a company take if the auditor resigns prior to completion of his term of
office? (1 mark) [10 marks]
6.9 RESPONSIBILITY IN RESPECT TO FRAUD, ERROR AND ILLEGAL ACTS

The distinction between the responsibilities of a company’s management and its external
auditors is reasonably clear cut. However, as we have already seen, misconceptions, particularly
about the role of audit, in the minds of the public, can lead to a phenomenon known as the
'expectation gap'.
6.8.1 Fraud and error

Major scandals that have affected the accounting profession in recent times have usually been
as a result of fraud. Therefore, in order to maintain confidence in the profession it is important
for the auditors and the directors to understand their role in the prevention and detection of
fraud.
ISA 240: The Auditor’s Responsibility to Consider Fraud in an Audit of Financial Statements gives
the definition of:
Fraud – as ‘an intentional act involving the use of deception to obtain an unjust or illegal
advantage’.
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Error – as ‘an unintentional mistake’ and could include accidental misapplication of accounting
policies, oversights or misinterpretation of the facts.
Both affect the accuracy of the financial statements and as such are a concern for the external
auditor. Fraud can be further split into two types:
i. fraudulent financial reporting – deliberately misstating the accounts to make the

company look better/worse than it actually is
Examples include:
- Manipulation, falsification or alteration of records and/or documents

- Suppression or omission of the effects of transactions from documents or records
- Recording of transactions without substance, in other words creating false documents or
invoices and
- Misapplication of accounting policies
ii. misappropriation of assets – the theft of the company’s assets such as cash or
inventory.
Examples include;
- teaming and lading, which is the practice of banking cheques to cover cash received
6.9 MANAGEMENTS’ RESPONSIBILITIES

As we have seen in chapter 1, a company’s board of directors is responsible for operating the
company in the interests of shareholders and other stakeholders. To do this it needs to ensure
that all the mechanisms for good corporate governance are in place such as Financial reporting.
The primary responsibility for the detection and prevention of fraud and errors rests with
management.
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Management is responsible for preparing financial statements which give a true and fair view of
the company’s results for the period under review and its financial position at the year end.In
order to do this, the directors are required to:
• Install an effective accounting system

• Select suitable accounting policies and apply them consistently.
• Make judgments and estimates that are reasonable and prudent.
• Design and implement internal controls relevant to the preparation of financial statements
and to prevent and detect fraud or error.
• Ensure that employees understand relevant codes of conduct
6.10 RESPONSIBILITIES OF THE EXTERNAL AUDITORS

The auditors’ main responsibility is to form an opinion on whether the company’s financial statements
give a true and fair view.
In some jurisdictions the external auditors have further reporting responsibilities, e.g.
• The auditors of listed companies in the UK report on certain aspects of the disclosures of directors’
remuneration.
• Auditors in the Republic of Ireland report on certain aspects of the adequacy of a company’s capital.
What the auditors are not responsible for
They are not responsible for:
- Preparing the financial statements.

- Choosing accounting policies.
- Implementing systems and controls.
- Establishing the mechanisms for ensuring that good standards of corporate governance
are maintained.
Under ISA 240, the auditors are required to consider the risks of material misstatement in the
financial statements due to fraud when planning and performing their audit. If their work
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confirms that, or is unable to conclude whether, the financial statements are materially
misstated as a result of fraud, the auditors need to consider the implications for their audit.
There is no requirement in the auditing standards for the auditor to detect any fraud or errors,
though they are required based on the risk assessment, the auditor should design audit
procedures to obtain reasonable assurance that misstatements arising from fraud and error
that are material to the financial statements taken as a whole are detected
The external auditor is responsible for identifying material misstatements in the financial
statements in order to ensure that they give a true and fair view. By definition then, the
external auditor is responsible for detecting any material fraud that may have occurred as
this will lead to a material misstatement.
However, they have no specific responsibility with regard to immaterial fraud. As with
immaterial errors, if they identify them they will be reported to those charged with governance,
but there is no duty to identify them.
The auditor cannot guarantee that the financial statements are free of all fraud and error
because of the inherent limitations of the audit, for example the use of sampling. The risks in
respect of fraud are higher than those for error because of the possibility of concealment and
collusion between staff.
In order to have a chance of detecting fraud the auditor must maintain an attitude of
professional skepticism when performing their work which involves keeping an open mind to
the possibility of fraud occurring.
6.10.1 Other responsibilities and consequences

As we shall see further on, the external auditors are responsible for:
- planning their work

- gathering sufficient appropriate audit evidence
so that the risk that they may come to the wrong conclusion is reduced to an appropriately low
level. As a consequence they are interested in:
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- the quality of accounting systems from which the financial statements are produced
- the internal controls operated by the company to ensure that its financial information is
as complete and accurate as possible
- the standards of corporate governance including the effectiveness of the internal audit
function
Because all of these factors will reduce the risk of misstatement in the financial statements. But
the establishment and maintenance of these things is the responsibility of the company and its
management, not its auditors.
6.11 SUMMARY OF RESPONSIBILITIES

‘Audit matters of governance’ include:
• Effects of significant accounting policies.
• Potential financial effect of risks/uncertainties.
• Material audit adjustments.
• Disagreements with management concerning the financial statements.
• Expected modifications to the audit report.
• Internal control weaknesses including fraud.
AUDITTING INSIGHT
Sarbanes-Oxley Act was passed in 2002 in an attempt to address a number of weaknesses found
in corporate financial reporting in the wake of accounting scandals. One of its most important
provisions (Section 302) states that key company officials must certify the financial statements.
Certification means that the company’s CEO and CFO must sign a statement indicating that;
i. They have read the financial statements
ii. They are not aware of any false or misleading statements(or any key omitted disclosures)
iii. They believe that the financial statements presentation accurate picture of the company’s
financial condition.
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6.12 PROFESSIONAL SKEPTICISM
This refers to an auditor’s responsibility not to accept management assertions without
corroboration, a responsibility to ask management to “prove it” (with evidence). Skepticism is a
manifestation of objectivity, holding no special concern for preconceived conclusions on any
side of any issue. Skepticism is not being cynical, scornful or hypercritical. The properly skeptical
asks these questions;
i. What do I need to know?

ii. How well do I know it?
iii. Does it make sense?
iv. What can go wrong?
A potential conflict of interests always exists between the auditors and the management of the
enterprise under the audit. Management wants to present the company in the best possible
light, while auditors must ensure that the information about the company’s financial condition
is presented fairly.
Having recognized this potential conflict, auditors must be professional in their relationships
with management, not adversarial or confrontational.
6.13 REPORTING OF FRAUD

The external auditor needs to be careful of their duty of confidentiality to their client, therefore
before reporting to any external party, it is advisable to seek legal advice unless there is a legal
requirement to report e.g. money laundering regulations.
If fraud is identified, auditor’s responsibilities include:
- reporting it to the audit committee, if one exists, or

- reporting it to the highest level of management, or
- reporting it to the shareholders if the fraud is being committed by the highest level of
management and no audit committee is in place.
The directors' responsibilities
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The directors have a primary responsibility for the prevention and detection of fraud.
As we have seen the directors’ fiduciary responsibilities include:
- safeguarding the company’s assets and

- implementing an effective system of internal control.
If they have been effective in meeting these responsibilities fraud and error should not occur.
The directors should be aware of the potential for fraud and this should feature as an element
of the risk assessment and corporate governance procedures. The audit committee should
review these procedures to ensure that they are in place and working effectively. This will
normally be done in conjunction with the internal auditors.Internal auditors may be given an
assignment:
- to assess the likelihood of fraud, or if a fraud has been discovered,

- to assess its consequences and
- to make recommendations for prevention in the future.
6.14 REMUNERATION OF AN AUDITOR

Under section 150:6 the remuneration of an auditor of a company shall be fixed by the
company in a general meeting or in such a manner as the company in a general meeting may
determine.
AUDITING INSIGHT
When Lehman Brothers filed for bankruptcy in September 2008, it was reportedly the largest
bankruptcy in U.S history. How could such a large firm seem to collapse so suddenly? Auditors
at Ernst & Young have been identified, along with other investment banks and senior Lehman
executives, for having played a role in the firm’s demise. In fact, the Atttorny’s general of New
York filed a civil fraud law suit against EY in December 2010 and is claiming that the
accounting firm helped to disguise the financial condition of Lehman for at least seven years e.g
the lawsuit describes a “cozy” relationship between Lehman’s CFO’s were former EY
employees during much of the seven year period when the transactions occurred and Ernest and
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Young charged Lehman’s $150 million in audit fees over a seven period of time. (“Ernest
accused of Lehman Whitewash”
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CHAPTER 7
THE ENGAGEMENT(APPOINTMENT)
PROCEDURES.
7.0 INTRODUCTION
Obtaining
engagement
Advertising Direct client request Tendering
Before accepting the auditor/audit firm should consider potential issues
RISK ANALYSIS ETHICAL ISSUES LEGAL ISSUES PRACTICAL ISSUES
May not want to -If replacing an Directors -Staff

accept client if auditor, there is need
perceived risk is too -Casual basis -Location
to ask permission to
high by evaluating:
contact existing -1st appointment -Timing
-Management auditor, then wait for
integrity clearance. Members
-Past performance -If there is no -Ordinary resolution,

of business response consider the (21 days at AGM)
-Internal controls new appointment
Secretary of state
whether good/bad carefully
-Rare,only when no
-Complexity of
transactions auditor has been
appointed in time
-unusual
transactions
When engagement accepted then ‘engagement letter’ should be drafted after all
considerations
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The most common way of obtaining an audit engagement is by recommendation. It is not
uncommon for up to 90% of a firm’s new business to come from its existing client base.
However, the second most common way of obtaining new work is by submitting a successful
tender, after being invited to participate in what is frequently referred to as a ‘beauty
parade’.‘Tendering’ is the process of quoting a fee for work before the work is carried out.
In addition to the risk associated with any other new client the specific risks of being involved
with the tender include:
• wasted time – if the audit tender is not accepted
• setting an uncommercially low fee in order to win the contract leading to lowballing
• making unrealistic claims or promises in order to win the contract.
7.1 OBTAINING OF ENGAGEMENT ACCEPTANCE INFORMATION

The firm should establish policies and procedures for the acceptance and continuance of client
relationships and specific engagements, designed to provide it with reasonable assurance that
it will only undertake or continue relationships and engagements where it;
a) Has considered the integrity of the client and does not have information that would lead
it to conclude that the client lacks integrity
b) Is competent to perform the engagement and has the capabilities, time and resources
to do so and;
c) Can comply with ethical requirements
An auditing client that has integrity generally results in a problem free engagement. Conversely
despite conducting an audit in line with the generally accepted auditing standards, it is difficult
for an auditor/ audit firm to avoid appearing “guilty by association” with a client that lacks
integrity.
With regard to the integrity of client, matters that a firm should consider include for example;
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 The identity and the business reputation of the client’s principal owners, management,
related parties and those charged with its governance
 The nature of the clients, operations, including business practices
 Information concerning the attitude of the client’s principal owners, management,
related parties and those charged with its governance towards such matters as
aggressive interpretation of accounting standards and the internal control environment
 Indications of an appropriate limitation of scope of work
 Indications that the client might be involved in criminal activities
 The reasons for the proposed appointment of the firm and non-reappointment of the
previous firm
Information will be obtained through performance of risk assessment proceduresconsisting of:

- Inquires of management and others inside and outside the entity.
- Observation and inspection.
- Analytical review.
• New clients
To reduce the risk of accepting a problem client, auditing standards require a prospective
auditor to collect information from a wide range of sources for instance:
- Communication with predecessor auditors.
Basic information should be collected directly from the predecessor regarding issues that
reflect directly on the integrity of management. The audit client must of course grant its
approval before the communication can occur between the prospective auditor and the
predecessor auditor.
In addition to client acceptance and continuance policies and procedures generally include
Obtaining and reviewing financial information about the prospective client-annual reports,
interim statements, registration statements e.t.c.
- Enquiry of client personnel (boards, audit committees and management),
- Enquiry from third parties e.g. bankers, layers, analyst, etc.
- Enquiry from other auditors with similar clients in the industry.
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- Press and media coverage of the client.
- Background searches of relevant databases e.g. detailed criminal background checks for
senior managers
• Existing clients
Consider only changes that might affect the ability to continue as their auditors (Dynamic
Auditing, Section 1, 2 and 3).
Retention reviews may be done annually or on occurrence of major events such aschanges in
management, directors, ownership, legal counsel, financial condition, litigation status, nature of
client’s business or scope of audit engagement
7.2 PRE-ENGAGEMENT ACTIVITIES

Before beginning to work on an audit, the auditor must complete a number of required pre-
engagement activities that help to determine whether to accept a new client or agree to work
with an existing client.
The Engagement partner should take responsibility for the overall quality on each
auditengagement and by this setting an example to all the other members of the engagement
team through all stages of the audit engagement (ISA 220.6-220.7).
1. Perform a client investigation:
The process activities are clearly focused on understanding and managing audit risk. Evaluate
the acceptance of new clients and continuance as auditors for the existing clients (ISA 220.14-
220.18).
Consider risks and exposure involved in the process of decision-making to accept a client/not
(Legal liability, reputational damage, etc.).
Consider;
• Independence.( In fact and appearance)
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Auditors must maintain independence in mental attitude i.e. auditors are expected to be
unbiased and impartial with respect to financial statements and other information they audit.
This state of mind is referred to as “independent in fact”.
It is not only important for auditors to be unbiased but they must also appear to be
unbiased.‘Independence in appearance’ relates to others’ perceptions of auditors
independence.
The firm and the engagement team are required to be independent in order to complywith the
ethical requirements prior to accepting a new client or to continuing to providestatutory audit
services to an existing client. (Refer to ISA 200, par A16.)
• Integrity of the client.

Integrity of principal owners, key management and those charged with governance (ISA 220,
par 8).
• Changes in the entity for existing clients.
• Information obtained from communication with the predecessor auditor.
• Financial responsibility of the client.
• Legal procedures prior the engagement.
• Conflict of interest
• The entity’s business standing risk
• Information obtained from communication with the predecessor auditor.
• Ability to pay the audit fees.
• If there is a vacancy to appoint auditors (Sec 91 of the Companies Act).
2. Determine skills and competence requirements for the engagement.

After having performed the client investigation, the audit/firm should consider whether the
engagement would require special attention or involve unusual risks. Engagement should only
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be taken if the audit firm has the skills, competence, necessary staff and experience to provide
an effective and efficient audit.
Matters to consider:
i. The number of audit team members in relation to the size of the client.
ii. Firm personnel’s knowledge base of the relevant industry/subject matters.
iii. Firm personnel experience of relevant regularity/reporting requirements or the ability to
gain the necessary skills and knowledge effectively.
iv. Experience of the audit team members, especially that of management (audit seniors).
v. Does the firm have sufficient personnel with necessary skills and competencies?
vi. Use of an expert and/or other third parties, are experts are available, if needed?
ISA 610: Using the work of internal auditors (par 8-9; par A4-A5).
ISA 620: Using the work of an auditor’s expert (par 7; 9; 12-13; par A10-A13, A32-
A40)
vii. Can the audit deadline be met?
viii. ISA 600: Special considerations – Audits of group financial statements (including the work
of component auditors) (par 12-14; par A10-A21).
ix. Compliance with quality control as per SAAPS1 and ISQC1.
When you are required to discuss factors that you will consider prior to accepting
theengagement, in addressing quality control, we recommend that you write the
followingsentence in addressing compliance with quality control:
‘The audit firm would have to consider whether it could comply with SAAP1 and ISQC1
inensuring quality of the audit.
3. Terms and conditions of the audit engagement
Procedures performed with regard to acceptance of a new client/continuance with engagement

clients should bedocumented. Issue an engagement letter to those charged with governance
highlighting the following:
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1. Management and auditor’s responsibility.
2. Duty to report to IRBA any reportable irregularity.
CLASS DICCUSSION
The audit partner assigned to the audit of ABC Ltd is married to the CEO of ABC Ltd. The CEO of
ABC Ltd receives a bonus based on profits.
Required:
Discuss ethical concerns prior to accepting ABC Ltd as a statutory client.
If your answer was only one of the following it will be incomplete, resulting in loss of marks:
• There is a threat to independence and therefore the audit partner should not be part ofthe
audit of ABC Ltd.
OR
• There is a familiarity threat and therefore the audit partner should not be part of theaudit of
ABC Ltd.
We recommend that you present your answer in the following manner:
Ethical requirements
• There is a familiarity threat as the audit partner is married to the CEO.
• There is self-interest threat as the audit partner has a financial interest in ABC Ltd asshe is
married to the CEO.
• There is intimidation threat, audit team might be reluctant to ask challenging questionin a
fear to upset the audit partner’s spouse.
• Based on the above, the threat to independence is seen as significant.
• It will be appropriate for the audit partner to not be involved in the audit of ABC Ltd.
Please note that the threats in the above answer are explained by linking them to
theinformation in the scenario whereas in the top part of the answer the threats were
notlinked to the information in the scenario.
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7.3 ENGAGEMENT LETTERS
Professional standards require auditors to reach mutual understanding with clients concerning
engagement requirements and expectations and to document this understanding in the form of
a written letter.
Once the terms of the engagement have been established they have to beconfirmedthrough
the engagement letter.When a new client is accepted or when an existing client continues from
year to year an engagement letter should be prepared.
The engagement letter will be sent before the audit, but for an existing auditor continuing to
work for the same client the auditor must issue a new engagement letter if the scope or
context of the assignment changes after initial appointment or there is a change in
circumstances.
It specifies the nature of the contract between the audit firm and the client.
It minimises the risk of any misunderstanding of the auditor’s role.
It should be reviewed every year to ensure that it is up to date but does not need to be
reissued every year unless there are changes to the terms of the engagement. Many firms of
auditors choose to send a new letter every year, to emphasise its importance to clients.(ISA
200.10-200.11).
7.3.1 Purpose of the engagement letters:

The engagement letter actually acts as a contract. It serves as a means for reducing risk of
misunderstandings with the client and as ameans of avoiding legal liability for claims thatthe
auditors did not perform the work promised.
• Sets out the type of engagement and for instance audit engagement and other services.
• Avoid/minimise misunderstanding between client and auditor.
 Records the following:- auditors acceptance
- objectives of the engagement
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- managements’responsibilities
auditors’ responsibilities
- scope
- format of any reports.
• Sent and agree the terms with client and sign, preferably before the commencement of
the engagement.
Content, vary from client to client (ISA 200.6-200.8).
7.3.2 Principal contents of an engagement letter

The letter should outline the clients’ statutory duties(e.g. to prepare accounting records) and
the auditors statutory duties (e.g. to report) and professional (e.g. to follow the auditing
standards) responsibilities. The sections may include;
 The boards’ responsibilities

 The auditors responsibilities
 The scope of the auditor’s work - auditing standards
-accounting system review
-collection of audit evidence
-tests and reliance on internal controls
 The sending of a letter of weakness to the management
 Any special factors: - relations with internal audit
- audit divisions
- any overseas location problems
- other auditors if any
-significant reliance on supervision of directors
 The need for a letter of representation from management
 Irregularities and fraud
- the director’s primary responsibility
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-the auditors planning of his audit to have a reasonable expectation of
discovering material misstatements in the accounts
-non-reliance on the auditor to uncover irregularities and frauds
 Any agreement for the provision of other services e.g. tax, advisory, accounting
 The fees and the basis on which they are charged
 A request for written acknowledgement of the letter and that it creates
obligations
7.4 ASSIGNMENT OF ENGAGEMENT TEAMS

The firm should assign responsibility for each engagement to an engagement partner.
The engagement partner should ensure that the engagement team has the appropriate
capabilities, competence and time to perform the audit engagement in accordance with
professional standards (ISA 220.19-220.20).
Research
List 6 items you would see in an engagement letter. (3 marks)
7.5 ENGAGEMENT PERFORMANCE

The engagement partner should take responsibility for the direction, supervision and
performance of the audit engagement in compliance with the professional standard, regulatory
and requirements (ISA 220.21-220.40).
ISQC1requires the firm to establish policies and procedures designed to provide it with
reasonable assurance that the policies and procedures relating to the system of quality control
are relevant, adequate, operating effectively and complied within practice (ISA 220.41-220-42).
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CHAPTER 8
THE EXPRESSION OF THE AUDIT OPINION

• describe and analyse the format and content of unmodified and modified audit reports
• discuss the type of opinion provided in statutory audits.
8.0 THE AUDIT OPINION

A company’s auditor must report their opinions to shareholders/members on two primary
matters:
1. Whether the financial statements give a true and fair view (or present fairly in all
material respects).
2. Whether the financial statements have been properly prepared in accordance with
relevant rules, e.g. – International Accounting Standards,
– a particular country’s legal requirements.
These considerations are assessed on the basis of the audit work carried out and the evidence
obtained from this.In addition, certain other matters may have to be reported by exception.
These matters, which are also referred to as implied reporting, are laid down by a country’s
laws.
These matters are:
- where Returns are not received from all branches of the company
- where Accounting records are inconsistent with the Financial statements
- where Proper accounting records have not been kept
- where all Information and explanations were not received
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- whereDirector transactions with the company are missing from Financial Statements.
**The above can be remembered using the mnemonic RAPID.
Reporting by exception is not the same as a qualification; however, as the matters dealt with
are usually legal requirements, non-compliance will probably lead to a qualification anyway. For
instance, if all informations and explanations have not been received, there will most likely be a
limitation of scope. This term is explained later in the chapter.
8.1 THE AUDITOR’S REPORT ON FINANCIAL STATEMENTS

ISA 700The Auditor's Report on Financial Statements, explains the basic principles of audit
reporting and identifies the elements of the auditor’s report.
8.1.1 Contents of an audit report

ISA 700 describes the elements that make up the audit report as:
 Title
The title should be ‘appropriate’. The use of ‘Independent Auditor’s Report’ distinguishes this
report from any other report produced internally or by other non-statutory auditors.
 Addressee
The report should be addressed to the intended user of the report which is usually the
shareholders, board of directors or other party defined in the engagement or local regulations.
This varies from country to country, but is usually addressed to the members of the company.
This is to prevent other parties relying on the report when it is not intended for their use.
 Introductory paragraph
Identifies the financial statements which have been audited (see below), by name or by the use
of page numbers, and stating the period they cover. This is in order to distinguish such
information from other documents that have not been subject to audit (e.g. the Directors’
Report).
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 Statement of responsibilities of management
- Preparation of the financial statements which show a true and fair view or
present fairly in all material respects and in accordance with the applicable
financial framework.
- Designing and implementing an effective internal control system.
- Applying appropriate accounting policies.
- Making reasonable accounting estimates.
 Statement of responsibilities of the auditors
- Express opinion.
- Assess the risk of material misstatement.
- The fact that the audit was planned and performed to obtain reasonable
assurance about whether the financial statements are free from material
misstatement.
- Consider internal control as a basis for preparing financial statements without
responsibility for implementing it.
- Obtain sufficient, appropriate audit evidence on which to base the opinion.
 Scope Paragraph
- The standards under which the audit was conducted i.e. ISAs.
- A summary of audit processes and procedures in general terms e.g. examining
on a test basis, evidence to support the financial statement amounts and
disclosures.
- Evaluate the appropriateness of accounting policies.
- Evaluate the overall presentation of the financial statements.
 Opinion
- This covers the primary statements and associated notes referred to in the introductory
paragraph (even though only the first two are referred to explicitly).
- Truth and fairness (or presented fairly in all material respects).
- Preparation in accordance with the financial reporting framework – applicable
legislation and accounting standards.
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- If applicable, any other matters required under a country’s regulations. Such a statement would
be made at the end of the opinion paragraph.
 Auditor’s signature
- This should include reference to the auditor's status as a Registered Auditor.
- The report may be signed by the firm, by the auditor individually or both.
- Normally the firm’s signature is given as the firm as a whole assumes responsibility
for the audit.
 Date of report
- The audit report must be signed after the directors have approved the financial
statements and preferably on the same day.
- It is not necessary that the final typewritten copies of financial statements are
available for signature – draft copies may be signed, provided the draft documents
are sufficiently clear to enable a proper overall assessment of presentation to be
made.
 Auditor’s address
The audit report should name a specific location, which is normally the city where the auditor
maintains the office that has responsibility for the audit.
8.1.2 Example of a clean audit report

Title INDEPENDENT AUDITOR’S REPORT
Addressee (APPROPRIATE ADDRESSEE)
Report on the financial statements
Introductory paragraph
We have audited the accompanying financial statements of the XXX Company, which comprise
the statement of financial position as at 31 December, 20XX, and the income statement,
statement of changes in equity and statement of cash flow for the year then ended, and a
summary of significant accounting policies and explanatory notes.
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Management responsibilityfor the financial statements
Management is responsible for the preparation and fair presentation of these financial
statements in accordance with International Financial Reporting Standards (IFRS’s). This
responsibility includes, designing, implementing and maintaining internal control relevant to
the preparation and fair presentation of financial statements that are free from material
misstatement, whether due to fraud or error; selecting and applying appropriate accounting
policies; and making accounting estimates that are reasonable in the circumstances.
Auditor's responsibility
Our responsibility is to express an opinion on these financial statements based on our audit.
Scope paragraph
We conducted our audit in accordance with International Standards on Auditing. Those

Standards require that we comply with ethical requirements and plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and
disclosures in the financial statements. The procedures selected depend on the auditor’s
judgment, including the assessment of the risks of material misstatement of the financial
statements, whether due to fraud or error. In making those risk assessments, the auditor
considers internal control relevant to the entity’s preparation and fair presentation of the
financial statements in order to design audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the effectiveness of the
entity’s internal control. An audit also includes evaluating the appropriateness of accounting
policies used and the reasonableness of accounting estimates made by management, as well as
evaluating the overall financial statement presentation.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a
basis for our audit opinion.
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Opinion
In our opinion, the financial statements give a true and fair view of (or ‘present fairly, in all
material respects',) the financial position of the Company as of31 December, 20XX, and of its
financial performance and its cash flows for the year then ended in accordance with
International Financial Reporting Standards.
Other reporting responsibility
Report on other Legal and Regulatory
[Form and content of this section of the auditor’s report will vary depending on the nature of
the auditor’s other reporting responsibilities.]
Auditor signature
Date of the auditor’s report
Research
1. List the main contents of an unmodified audit report?(3 marks)
 An unqualified audit report should include the following.
• A title identifying the person or persons to whom the report is addressed.
• An introductory paragraph identifying the financial statements audited and the respective
responsibilities of directors and auditors.
• Management’s responsibilities in respect of the financial statements.
• The auditors’ responsibilities in forming their audit opinion.
• The scope paragraph detailing the nature of the audit e.g. ISA's followed, limitation of audit
testing.
• The auditors’ opinion on the financial statements.
• The manuscript or printed signature of the auditors.
• The date of the auditors’ report.
• The auditors’ address.
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2. What opinion does the auditor give in an unmodified audit report?(2 marks)
 Whether or not the financial statements are ‘true and fair’, or ‘present fairly’ the financial
position and performance.
 Whether or not the financial statements have been properly prepared in accordance with the
financial reporting framework and statutory requirements where appropriate
3. When should the audit report be signed?(1 mark)
 The audit report should be signed after the directors have signed the financial
statements (preferably same day).
4. Who should sign the audit report and what further information about the signatory should
be provided?(1 mark)
 The auditor’s signature should refer to Registered Auditor status and be signed either
by the firm or the auditor individually.
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8.1.3 Audit reports
AUDIT REPORT
If auditor agrees the FS are true If auditor is unable to state the true and
And fair they would give an fair or disagrees with some

aspects of the FS, a
MODIFIED REPORT IS
UNMODIFIED/UNQUALIFIED
REQUIRED
/CLEAN AUDIT REPORT
There are two possibilities
The opinion would be;
when this kind of report is
-“do give a true and fair view”, given
or present in material
respects”,
-“do comply with applicable

reporting framework”
-do not give the auditor any

need to report other matters
under exception reporting rules
UNQUALIFIED AUDIT REPORT

QUALIFIED AUDIT
If the auditor agrees with the REPORT
financial statements but would like
to draw readers’ attention to
something through an ‘emphasis of
matter paragraph’
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8.1.3.1 The ‘emphasis of matter’ paragraph
The emphasis of matter paragraph is placed after the opinion paragraph.The paragraph is given
a separate heading.
The auditor makes it clear in the paragraph that the opinion is not qualified.
The sections of the report prior to the paragraph are unchanged. Where possible, the potential
financial effect on the financial statements should be quantified.
Where there are particular circumstances surrounding the financial statements and they are fully
disclosed, the auditors may wish to draw the reader’s attention to them in the audit report e.g.
• significant uncertainties whose outcome depends on future events
• going concern problems
• material misstatements in prior period figures
• the financial statements have been prepared on a break up basis not a going concern.
Examples of emphasis of matters
‘Without qualifying our opinion we draw attention to Note X to the financial statements. The
Company is the defendant in a lawsuit alleging infringement of certain patent rights and
claiming royalties and punitive damages. The Company has filed a counter action, and
preliminary hearings and discovery proceedings on both actions are in progress. The ultimate
outcome of the matter cannot presently be determined, and no provision for any liability that
may result has been made in the financial statements.’
Effect on the audit report
The result of these matters on the audit report is shown below. Note the circumstances given at the top
of the example reports that will give you an indication of when each type will be appropriate.
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8.1.3.2 Qualified audit report
QUALIFIED REPORTS
If the auditor has been unable to obtain There is a disagreement with management
Evidence which should have been regarding;
available then a -acceptability of the accounting policies
-the method of their application
-accounting treatment adopted for

particular transactions or
- the adequacy of FS disclosures
LIMITATION OF SCOPE DISAGREEMENT
Material Material& pervasive Material Material& pervasive
ISA 700 uses the phrase “material and pervasive” we know that unless the matter is material, it
will not cause the report to be qualified at all. So the nature of the qualification depends on the
degree of effect that the auditor considers it may have on the financial statements.
To be considered pervasive, it must affect the view given by the financial statements as a
whole. As such;
- If the circumstance is a limitation of scope it will leave the auditor unable to form an
opinion at all
- If it is a disagreement, it will be of such significance that the financial statements do not
give a true and fair view
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Class discussion
i. Example: Limitation of scope – material but not pervasive
Previous paragraphs as per standard report
Auditor’s responsibility
Our responsibility is to express an opinion on these financial statements based on our audit.
Except as discussed in the following paragraph, we conducted our audit in accordance with …
We did not observe the counting of the physical inventories as of 31 December 20XX, since that
date was prior to the time we were initially engaged as auditors for the Company. Owing to the
nature of the company’s records, we were unable to satisfy ourselves as to inventory quantities
by other audit procedures.
Opinion
In our opinion, except for the effects of such adjustments, if any, as might have been
determined to be necessary had we been able to satisfy ourselves as to physical inventory
quantities, the financialstatements give a true and …
Example :Limitation of scope – pervasive therefore a disclaimer
‘We were engaged to audit the accompanying financial statements of the XXX Company, which
comprise the statement of financial position as of 31 December, 20XX and the income
statement, the statement of changes in equity and the cash flow statement for the year then
ended, and a summary of the significant accounting policies and other explanatory notes.
Management responsibility paragraph as per standard report (omit the sentence stating the
responsibility of the auditor).
(The paragraph discussing the scope of the audit would either be omitted or amended
according to the circumstances.)
(Add a paragraph discussing the scope limitation as follows.)
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We were not able to observe all physical inventories and confirm accounts receivable due to
limitations placed on the scope of our work by the Company.Because of the significance of the
matters discussed in the preceding paragraph, we do not express an opinion on the financial
statements.’
Example :Disagreement – material but not pervasive
Previous paragraphs as per standard report ...Opinion
As discussed in Note X to the financial statements, no depreciation has been provided in the
financial statements which practice, in our opinion, is not in accordance with International
Financial Reporting Standards. The provision for the year ended 31 December, 20XX, should be
XXX based on the straight-line method of depreciation using annual rates of 5% for the building
and 20% for the equipment. Accordingly, the non-current assets should be reduced by
accumulated depreciation of XXX and the loss for the year and accumulated deficit should be
increased by XXX and XXX, respectively.
In our opinion, except for the effect on the financial statements of the matter referred to in the
preceding paragraph, the financial statements give a true and ...’
Iv. Example: Disagreement – pervasive therefore adverse opinion
Previous paragraphs as per standard report … Opinion paragraph
‘In our opinion, because of the effects of the matters discussed in the preceding paragraph(s),
the financial statements do not give a true and fair view of (or do not “present fairly”) the
financial position of the Company as of 31 December, 20XX, and of its financialperformance and
its cash flows for the year then ended in accordance withInternational Financial Reporting
Standards.’
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As you can see, there is a potentially difficult decision process to go through when deciding
what kind of modified audit report may be appropriate.
Question approach
1) Ask yourself what the directors have disclosed in the financial statements.
2) Ask yourself, do we as the auditors agree or have we obtained sufficient evidence to give
a clean audit report.
3) Give opinion.
4) State why.
Assignment
Taylor (Profit before tax $750,000)
On 5 January 2009 a customer sued the company for personal damages arising from an
unexpected defect in one of its products. Shortly before the year end the company made an
out-of-court settlement with the customer, which is not material of $10,000, although this
agreement is not reflected in the financial statements as at 31 December 2008. Further, the
matter was reported to the press and was extensively reported. Subsequently, the matter
became known and the company's legal advisers have now informed you that further claims
have been received following the publicity, although they are unable to place afigure on the
potential liability arising from such claims which have not yet been received. The company had
referred to the claims in a note to the financial statements stating, however, that no provision
had been made to cover them because the claims were not expected to be material.
Discuss the effect on the audit report.(10 marks)
Out of court settlement
The out of court settlement is not material (10K/950K) is less than 5%, therefore there will be
no impact on the audit report (a clean audit report will be given). 1 mark
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If we look at this transaction on its own the financial statements will show a true and fair view
(materially). 1 mark
Further claims
Materiality is questionable here, if we agree with the directors and its not material then again
there would give a clean audit report. 1 mark
If the two issues became material in total then I would ask the director to amend the financial
statements, if the director did so, and the auditor reviewed updates and agreed the updates
were accurate then an unmodified report would be given.1 mark
Remembering clean audit report, unmodified report is the opinion the financial statements
show a true and fair view (they represent the same thing).
If the directors used the going concern basis but we as the auditors feel the business will not
continue for the foreseeable future we as the auditors would disagree, as it should be on a
break up basis. 1 mark
The effect on the opinion would be adverse.
If the directors prepared the financial statements on a break up basis and the auditor agreed
we would give a modified, unqualified report, emphasis of matter. 1 mark
Drawing the attention of this matter to the readers. 1 mark
If the directors have prepared the financial statement on a going concern basis and the going
concern status is uncertain, as long as the issue was adequately disclosed the effect on the
audit report would be unqualified, with an emphasis of matter paragraph. 1 mark
If the directors didn't adequately disclose then this would be one disagreement therefore the
effect on the audit report would be qualified except for. 1 mark
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RESEARCH
List four types of qualified audit report?(2 marks)
 Limitation of scope
 Except for audit report?
 Disclaimer
 Disagreement
1. Give an example of when each type of report would be appropriate.(4 marks)
Examples of the above could be:
Limitation in scope – material No inventory count carried out at a branch.
– pervasive Destruction of accounting records.
Disagreement – material Difference of opinion between directors and auditor as to

whether to provide for a doubtful debt.
– pervasive Inappropriate basis of preparation used e.g. if the going

concern basis has been used when the break up basis
should have been used.
2. What is an ‘emphasis of matter’ paragraph?(3 marks)
An ‘emphasis of matter’ highlights a matter affecting the financial statements and draws the
reader’s attention to a note that more fully explains the position.
An emphasis of matter does not constitute a qualified opinion. It is usually situated after the
opinion paragraph and states that the opinion is not qualified with regard to that matter. It is
used when there is a significant uncertainty or going concern issue that has been fully disclosed
in the notes to the financial statements and the outcome of the issue is dependent on events
yet to happen.
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8.2 THE IMPACT OF AUDITORS’ REPORTS
• The unqualified report is a summary of the auditor’s work and conclusions. It adds
credibility to the contents of the financial statements.
• Clearly, if the audit report has any impact, the management should be reluctant to get
themselves into a position where a qualification is required.
• If the subject matter of the qualification is a disagreement, then a large or public
company faces possible/probable investigation resulting in a company reissuing its
accounts with the ultimate sanction that it can take the company to court if it does not
comply with government’s wishes.
• If the subject matter is a limitation of scope, the company may find itself in financial
difficulties. Trade payables may be reluctant to supply goods on credit terms and the
bank may call in any overdraft. It should be appreciated that overdrafts are technically
repayable on demand.
• The severity of these potential effects helps to ensure that the auditor decides very
carefully whether a qualification is required and ensures that management take the
‘threat’ of qualification seriously.
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NATIONAL UNIVERSITY OF SCIENCE AND TECHNOLOGY

 to protect business owners from unscrupulous managers

This in turn had two results:

 the legal requirement for accounts to be produced by management on a regular basis

As such as European financiers sent representatives to check up on their investments, hence

1.1 THE CONCEPT OF AGENCY

– making decisions on behalf of the company’s owners (the shareholders)

– using the assets of the company efficiently and effectively.

Modern organisational theory views an organisation as comprising various interest groups

The concepts of:

The requirement for a company’s management to produce financial statements giving an

 may prove to be very expensive because of the amount of work required

 the truth and fairness of the financial statements.

‘Truth’ in accounting terms can be taken to mean not factually incorrect.

The word fair can have the following meanings:

 on the one hand clear, distinct and plain; and

Both can be considered relevant when fair is used in an accounting context.

• their compliance with legal and regulatory requirements.

Chapter learning objectives

Upon completion of this chapter the student will be able to:

• explain the level of assurance provided by audit assignments

• explain the level of assurance provided by other review assignments

• discuss the concept of stewardship

• discuss the concept of accountability

• discuss the concept of agency

• explain the concept of materiality

• explain the concept of true and fair

• explain the concept of presentation and reasonable assurance.

Auditing is theindependent examination of and expression of an opinion on the financial

Alternatively, an audit can also be described as:

 A systematic process of objectively obtaining and evaluating evidence regarding

2.1 Why the need for audit services

• reduce the risk of the user of those services.

2.1.1 Class discussion 1

• the impact of misstatements in the accounts of small companies is unlikely to be material to

2.2 NATURE OF AUDIT WORK

2.3.1 Attestation engagements

Examples of attestation engagements

2.3.2 Assurance services

2.3.3 Review Engagement

• The practitioner is not carrying out an audit

i. A reasonable assurance engagement

In a reasonable assurance engagement, the auditor

• gathers sufficient appropriate evidence

• gives his report in the form of 'positive assurance'.

A reasonable assurance engagement requires that:

• The subject matter is the responsibility of another party

• The subject matter is

– In a form that can be subjected to evidence gathering procedures

No assurance is expressed in the audit report

iii. A limited assurance engagement.

• gives his report in the form of 'negative assurance'.

A negative assurance report takes the form:

It is not possible to give an absolute level of assurance due to:

• The nature, timing and extent of procedures

• The fact that evidence is usually persuasive rather than conclusive

• The fact that evidence is gathered on a test basis.

It follows therefore that

• The procedures carried out will be more intensive

• The evidence gathered needs to be of higher qualityfor a reasonable assurance engagement

2.5 EXPECTATIONS GAP

 The communications gap

This arises because;