18audit and Assurance

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1.8Audit and Assurance
F8 - Audit and Assurance (Association of Chartered Certified Accountants)
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ACCA - AA
Audit and Assurance
Study Notes

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CONTENTS
Sr # Topics Page #
01 Using these Notes 01
02 About the Exam 02
03 Introduction 04
04 Assurance Engagements 06
05 Regulation of Auditors 11
06 Code of Ethics 18
07 Client Acceptance/Continuance, Agreeing Terms of Engagement 26
08 Planning 32
09 Internal Control Systems 49
10 Management assertions, Audit Procedures & Audit Evidence 71
11 Procedures on Specific Areas 82
12 Review 106
13 Opinion & Reporting 123
14 Audit Sampling 144
15 CAATs (including data analytics) 147
16 Fraud 151
17 Laws & Regulations 154
18 Audit Documentation 156
19 Quality Control 159
20 Corporate Governance 161
21 Internal Audit 168
22 Not for profit organizations-audit techniques 174


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Using These Notes

For each area of the syllabus, the notes cover:
- The key knowledge/technical areas
- The answer technique!

It is VERY important to understand that the nature of the AA exam is such that it cannot be passed without excessive
practice so these notes HAVE to be used in combination with past exams or the revision kit.

Use the LATEST revision kits from approved content providers.

The past papers on the ACCA website are not updated for changes in ISAs or IFRS.

When you are attempting questions from the latest revision kits, focus on ‘knowing’ the language used and
understanding the ‘answer technique’; remember, it’s not the English language which will help you get through the
exam‐ it is the ‘audit language’!

Lastly, ensure you read the Technical articles on the ACCA website; focus on the ones that have been published in
the last 12 months from you exam attempt.

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About the Exam
‐ All questions are compulsory. The exam will contain both computational and discursive elements.
‐ Some questions will adopt a scenario/case study approach.

Computer‐based exams
The total exam time is 3 hours. Prior to the start of the exam candidates are given an extra 10 minutes to read the
exam instructions.

Section A of the exam comprises three 10 mark case‐based questions. Each case has five objective test questions
worth 2 marks each.

Section B of the exam comprises one 30 mark question and two 20 mark questions.

Section B of the exam will predominantly examine one or more aspects of audit and assurance from planning and
risk assessment, internal control or audit evidence, although topics from other syllabus areas may also be included

Paper‐based exams
The total exam time is three hours and 15 minutes. Prior to the start of the exam candidates are given an extra
10 minutes to read the exam instructions.

Section A of the paper‐based exam comprises three questions containing five multiple choice questions.

Section B of the exam comprises one 30 mark question and two 20 mark questions.

Section B of the exam will predominantly examine one or more aspects of audit and assurance from planning and
risk assessment, internal control or audit evidence, although topics from other syllabus areas may also be included

Tools available in the CBE
- Calculator‐ can bring own!
- Scratch pad
- Screen splitter‐ can be moved
- Highlight: visible for all requirements
- Strikethrough: dealt with this information
- Cut and paste within the CR area
- Re‐set: ALL text removed. Be careful! Only if want to start again‐ warning message will come up. Can use
undo function to restore!

For Section B in CBEs
‐ Each question will have a number of requirements.
‐ Use word processing tools to construct the answer.
‐ A pre‐formatted response template might also be given (mainly for audit risks, control deficiencies and IESBA’s
ethical threats and safeguards)

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Which formatting options should a student use in CRs?
- Bold
- Underline
- Marks for content NOT how you are presenting it. No marks for formatting!
- Can insert table yourself if pre‐formatted not given

Reasons for an unsuccessful attempt
Very bad scripts
1. Very brief answers to most, if not all questions. In other words, some of the basic knowledge is known, but there
is little or no application of that knowledge to the scenario

2. Significant lack of understanding of audit procedures and the audit process. For example, where a question asks
for audit procedures to be listed and explained, a typical answer is ‘check the ledger’ providing no indication of
which ledger will be ‘checked’ or what the ledger is being checked for

3. Lack of exam practice. In a significant minority of scripts, it appears that candidates have not attempted any
mock exams prior to the ‘real’ exam. Poor exam technique is identified as:
 answering questions in a random sequence (for example, Question 1 Part (a), followed by Question 3 Part
(b), followed by Question 2 Part (c), and so on)
 spending far too much time on one question, leaving little or no time for the other questions
 not writing in the required style (eg providing the answer in one long paragraph rather than splitting the
answer up into individual points)
 focusing on theory only with no attempt to use the scenario.

Marginal scripts
1. Answering questions correctly, but not including a sufficient number of relevant points to obtain a pass
standard.

2. Having a good knowledge of auditing, but being unable to apply that knowledge to the scenarios provided in
the question.

3. Not answering all the questions.

Pass standard scripts
1. Are usually well presented, and make appropriate use of paragraphs, sentences and table formats where
appropriate.

2. Demonstrate that students are able to apply that knowledge to the question, clearly and succinctly. Audit
procedures are listed as well as explained.

3. All questions are attempted, even though some sections may not be answered that well. A few marks could
normally be obtained from a valid attempt; obviously, no marks are awarded if the question is not attempted
at all.
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Introduction

Audit in Layman Terms
An audit can be compared to an annual checkup with the doctor. Just as the patient must pass certain exams to
ensure a clean bill of health, a company’s financial “good health” standing relies on whether or not its financial
statements abide by generally acceptable standards and accounting principles. While audit does not guarantee
perfect financial statements, it does provide reasonable assurance that the statements are free of misstatements.
In this case, the doctor is the auditor, and the company is the patient.

Almost every organization, whether it is a privately held business, a publicly owned corporation, or a nonprofit
organization, must prepare financial reports. These reports are like the lifeline of a company and help owners and
managers make decisions and help provide the company’s financial status to shareholders, employees, regulators,
and the public.

There are two kinds of audits: internal and external.

An external audit is performed by an outside auditor who does not have any ties to the organization or its financial
statements. The outside auditor examines financial statements prepared by management for a fair presentation as
well as relevance and accuracy. Most importantly, an auditor tests whether or not a company is adhering to
professional standards and IAS/IFRS.

Internal Auditing: Companies perform internal audits to ensure that the company is meeting internal and external
goals. Internal goals include productivity, quality, compliance controls, consistency, and cost, while external goals
deal with customer satisfaction and market share. Auditors check to make sure transactions are executed with
management’s authorization. Also, access to assets must have management’s authorization. Generally speaking, an
internal auditor rates the company’s overall effectiveness.

Accountability, Stewardship and Agency
An audit of a company's accounts is needed because in companies, the owners of the business are often not the
same persons as the individuals who manage and control that business.
 The shareholders own the company.
 The company is managed and controlled by its directors.

The directors have a stewardship role. They look after the assets of the company and manage them on behalf of
the shareholders. In small companies the shareholders may be the same people as the directors. However, in most
large companies, the two groups are different.

The relationship between the shareholders of a company and the Board of Directors is also an application of the
general legal principle of agency. The concept of agency applies whenever one person or group of individuals acts
as an agent on behalf of someone else (the principal). The agent has a legal duty to act in the best interests of the
principal, and should be accountable to the principal for everything that he does as agent. As agents of the
shareholders, the board of directors should be accountable to the shareholders, in order for the directors to show
their accountability to the shareholders, it is a general principle of company law that the directors are required to
prepare annual financial statements, which are presented to the shareholders for their approval.

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Over time, the annual audit was developed as a way of adding credibility to the financial statements produced by
management. The statutory audit is now a key feature of Company Law throughout the world. An auditor reports
to the shareholders on the financial statements produced by a company's management.

Accountability
It often means answerability and responsibility. (Management is accountable to shareholders)

Stewardship
Stewardship is the responsibility for taking good care of resources on behalf of someone else. (Management acts as
steward of shareholders’ investments)

Agency
Agency is a relationship between a principal (who engages the agent) and another party, (who is engaged i.e. an
agent), where the second party (agent) is authorised to carry out the principal's instructions in the transactions with
a third party.

(Management is an Agent of Shareholders)

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Assurance Engagements AA Revision Notes
Assurance Engagements

The practitioner examines the subject matter made available by the responsible party, matches it to the suitable
criteria using evidence and reports to the intended users.

Elements of an assurance engagement
1. An assurance engagement will require a three‐party relationship comprising of:
a) The intended user who is the person who requires the assurance report.
b) The responsible party, which is the organisation responsible for preparing the subject matter to be
reviewed.
c) The practitioner (i.e. an accountant) who is the professional who will review the subject matter and provide
the assurance.

2. A second element which is required for an assurance engagement is suitable subject matter. The subject matter
is the data which the responsible party has prepared and which requires verification.

3. Thirdly this subject matter is then evaluated or assessed against suitable criteria in order for it to be assessed
and an opinion provided.

4. Fourth, the practitioner must ensure that they have gathered sufficient appropriate evidence in order to give
the required level of assurance.

5. Last, an assurance report provides the opinion which is given by the practitioner to the intended user

Types of Assurance Assignments

Reasonable assurance Limited assurance
An Assurance engagement in which the practitioner An assurance engagement in which the practitioner

reduces engagement risk to an acceptably low reduces engagement risk to a level that is acceptable
level in the circumstances of the engagement as in the circumstances of the engagement but where that
the basis for the practitioner’s conclusion. risk is greater than for a reasonable assurance
engagement
Example: External Audit Example: Review of financial statements

High level of assurance but NOT absolute or 100% Moderate level of assurance

A high but not absolute level of assurance is The practitioner gathers sufficient evidence to be
provided, this is known as reasonable assurance. satisfied that the subject matter is plausible; in this case
negative assurance is given whereby the practitioner
confirms that nothing has come to their attention which
indicates that the subject matter contains material
misstatements.

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Sufficient appropriate evidence is obtained as part Lesser testing‐focus on obvious errors only

of a systematic engagement process that includes: (Analytical testing and Enquiry)
- Obtaining an understanding of the engagement
circumstances No going concern review
- Assessing risks
- Responding to assessed risks The procedures undertaken are not nearly as
- Performing further procedures using a comprehensive as those in an audit, with procedures
combination of inspection, observation, such as analytical review and enquiry used extensively. In
external confirmation, re‐calculation, re‐ addition, the practitioner does not need to comply with
performance, analytical procedures and inquiry. ISAs as these only relate to external audits.
Positive conclusion‐ Wording: Negative conclusion‐Wording:
‘in our opinion the financial statements give (or do “nothing has come to light to suggest errors or problems
not give) a true and fair view of the state of the exist’'
company’s affairs’.
The assurance is therefore given on the absence of any
The phrases used to express the auditor’s opinion indication to the contrary.
are ‘give a true and fair view’ or ‘present fairly, in
all material respects’ which are equivalent terms
Review engagements are often undertaken as an
alternative to an audit, and involve a practitioner
reviewing financial data, such as six‐monthly figures. This
would involve the practitioner undertaking procedures
to state whether anything has come to their attention
which causes the practitioner to believe that the financial
data is not in accordance with the financial reporting
framework.

Assignments were no assurance is given
1. Agreed‐upon procedures: A report on factual findings is given but no assurance expressed. Users must judge for
themselves and drawn their own conclusions

2. Compilation engagement: Users of the compiled information gain benefit from the accountant’s involvement
but no assurance is expressed. It is used to collect, classify and summarise financial information. It means to
present data in a manageable and understandable form.

External audit

It is a review and assessment of the financial records to form an overall conclusion as to whether:
- The financial statements have been prepared using acceptable accounting policies, which have been
consistently applied.
- The financial statements comply with all the relevant regulations and statutory requirements.
- Adequate disclosure of all material matters relevant to the proper presentation of financial information has
been made.

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Objective of external audit engagements: “Opinion”: The auditor’s report contains a clear written expression of
opinion on the financial statements.

Important points to remember
• Auditors do not bear any responsibility for the preparation and presentation of the financial statements
• This is the responsibility of the directors
• There are many misconceptions about the role of the auditors, which are referred to as ‘the expectations gap’.
The expectations gap is the gap between what auditors do and what people think they (should) do
• Statutory audits
 Required by law for most companies
 Small and dormant companies may be exempt
 Various other bodies require an audit under law, including Building societies, Some charities
- Non‐statutory audits: Performed on various clubs, sole traders and partnerships because the owners want
them, not because it is legally needed

General principles of external audit engagements
According to the International Standards on Auditing, the general principles of an audit are:
1. Compliance with Code of Ethics (IFAC’s)
2. Performance of an audit in accordance with ISAs
3. Audit with professional skepticism
4. Professional judgment
5. Sufficient appropriate audit evidence

Implied portion of an External Audit Opinion (only mention if material problem arises)
 Returns have been received from all branches
 Accounts agree to underlying records
 Proper accounting records have been maintained
 Information and explanations have been received
 Directors loans and transactions have been disclosed

Important Terms

True and Fair presentation

Financial statements are produced by management which give a true and fair view of the entity’s results. The
auditor in reviewing these financial statements gives an opinion on the truth and fairness of them. Although there
is no definition in the International Standards on Auditing of true and fair it is generally considered to have the
following meaning:

True – Information is factual and conforms with reality in that there are no factual errors. In addition it is assumed
that to be true it must comply with accounting standards and any relevant legislation. Lastly true includes data
being correctly transferred from accounting records to the financial statements.

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Fair – Information is clear, impartial and unbiased, and also reflects plainly the commercial substance of the
transactions of the entity.

Those charged with governance – The person(s) with responsibility for overseeing the strategic direction of the
entity and obligations related to the accountability of the entity. This includes overseeing the financial reporting
process.

Management – The person(s) with executive responsibility for the conduct of the entity’s operations.

In some cases, all of those charged with governance are involved in managing the entity, for example, a small
business where a single owner manages the entity and no one else has a governance role

Engagement partner – The partner in the firm who is responsible for the audit engagement and its performance,
and for the auditor’s report that is issued on behalf of the firm, and who has the appropriate authority from a
professional, legal or regulatory body.

Professional judgment – The application of relevant training, knowledge and experience, within the context
provided by auditing, accounting and ethical standards, in making informed decisions about the courses of action
that are appropriate in the circumstances of the audit engagement.

Professional skepticism – An attitude that includes a questioning mind, being alert to conditions which may
indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence. Professional
skepticism includes being alert to, for example:
• Audit evidence that contradicts other audit evidence obtained.
• Information that brings into question the reliability of documents and responses to inquiries to be used as
audit evidence.
• Conditions that may indicate possible fraud.
• Circumstances that suggest the need for audit procedures in addition to those required by the ISAs.

Materiality
The objective of an audit of financial statements is to enable the auditor to express an opinion on whether the
financial statements are prepared in all material respects, with an identified financial reporting framework.
Information is material if its omission or misstatement could influence the economic decisions of users taken on
the basis of the financial statements.

The auditor must be concerned with identifying 'material' errors, omissions and misstatements. Both the amount
(quantity) and nature (quality) of misstatements need to be considered.

To put this into practice the auditor therefore has to set his own materiality levels – this will always be a matter
of judgement.

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Inherent Limitations of audit/ Reasons why absolute assurance cannot be given
1. Sampling – it is not practical for an auditor to test 100% of transactions and so they have to apply sampling
methodologies in selecting balances/transactions to test. Therefore, there could be an error in an item not
selected for testing by the auditor.
2. Subjectivity – financial statements include judgmental and subjective areas and therefore the auditor is required
to use their judgment in assessing whether the financial statements are true and fair.
3. Inherent limitations of internal control systems – an internal control system is operated by people and hence is
liable to human error. In addition, there is the possibility of controls override by management and of collusion
and fraud. It is impossible to remove all of these inherent limitations and as the auditor relies on the internal
control systems, this can reduce the usefulness of the audit.
4. Evidence is persuasive not conclusive – the opinion is based on audit evidence gathered; however, while this
evidence can indicate possible issues affecting the audit opinion, evidence involves estimates and judgments
and hence does not give a definite conclusion.
5. Even if everything reported on was examined and found to be satisfactory, there may be other items which
should have been included– the completeness problem.
6. Auditors plan their work to detect material errors and frauds only – so small frauds (or large frauds split into
many small amounts) may go unnoticed.

An external audit has a number of other issues which reduce its usefulness
1. Audit report format – the format of the opinion is determined by International Standards on Auditing. However,
the terminology used is not usually understood by non‐accountants. This means that users may not actually
understand the audit opinion given.
2. Historic information – the audit report is often issued sometime after the year end, and so the financial
information can be quite different to the current position. In the current marketplace where companies’
financial positions can change quite quickly, the audit opinion may no longer be relevant as it is out of date.
3. Auditors need to understand their clients in great depth if they are to understand how fraud could be carried
out and hidden. However, auditors cannot become too close to their clients or their independence will be called
into question.
4. Where auditors spot errors or fraud, their primary legal responsibility is to report this to management. Any
external reporting is hampered by rules on confidentiality.

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Regulation of Auditors AA Revision Notes
Regulation of Auditors

Regulation, monitoring and Supervision
Each country's regulation of external audits will differ. Most regimes do have certain common elements which we
examine in detail below.

Briefly these are as follows:
a) Education and work experience: the IFAC has issued guidance on this

b) Eligibility: there may well be statutory rules determining who can act as auditors. Membership of an appropriate
body is likely to be one criterion.

c) Supervision and monitoring: these activities initially came under particular scrutiny in a number of countries
during the 1990s and these activities are again under the spotlight following the recent global economic crisis.
Questions have been asked about why auditors have failed to identify impending corporate failures and whether
they were being regulated strongly enough. The supervision regime has come under particular scrutiny in
countries where regulation and supervision is done by the auditors' own professional body (self‐regulation).
Suggestions have been made in these countries that supervision ought to be by external government agencies.

Eligibility to Act as Auditor
To be allowed to perform external audits, an individual must go through an approval process. The individual must:
 Pass an approved set of examinations set by a Recognized Qualifying Body (RQB). Examples of an RQB include
the ACCA and the ICAEW;

 Become a member (and stay a member) of a Recognized Supervisory Body (RSB). The ACCA and the ICAEW are
also examples of RSBs.

In addition, the individual must not be either of:
 A director or employee of the client or any of its associated companies;

 A business partner or employee of a director or employee of the client, or any of its associated companies.

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Duties of an External Auditor
The auditor must consider the following;

Maintenance of adequate accounting records The auditor while performing his duties must check whether
proper and adequate accounting records have been
maintained and prepared.

Compliance with legislation It is the duty of an auditor to ensure that all the applicable
regulations have been complied with while preparing the
financial statements.

Verification of records The auditor’s duty is to examine, compare and verify the
accounting records and returns with the financial statements.
If the accounting records do not agree with the financial
statements or are incomplete, then it is the duty of the auditor
to report this fact to the shareholders.
Truth and fairness It is the primary duty of the auditor to prepare a report on the
financial statements examined by him and state whether, in his
opinion and to the best of his knowledge, the financial
statements provide:
 A true and fair state of affairs at the end of accounting
period, in the case of statement of financial position (SOFP)
and
 A true and fair view of the amount of profit or loss during
the accounting period, in the case of statement of
comprehensive income (SOCI).
Adequate disclosure Another duty of an auditor is to ensure that the financial
statements and all the other material disclosures are made in
accordance with the applicable statute. The auditor also needs
to verify whether all the payments and benefits accruing to
directors from the company are properly disclosed in the
accounts.

Rights of an external auditor
The regulatory framework, within which the auditors are required to perform, provides them with certain rights to
perform their duties effectively
(i) A right of access at all times to the books, accounts and vouchers of the company.
(ii) A right to require from officers of the company such information and explanations as they consider
necessary for the performance of their duties.
(iii) A right to attend any general meetings of the company and to receive all notices of and communications
relating to such meetings which any member of the company is entitled to receive.
(iv) A right to be heard at any general meeting on any part of the business of that meeting that concerns them
as auditors.
(v) A right, in the case of the auditors of a holding company, to request information and explanations from
subsidiaries of the holding company and their auditors.
(vi) Aright to make written representations when the company proposes to appoint auditors other than them.
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(vii) A right to requisition an extraordinary general meeting to consider any circumstances which members or
creditors ought to know about in connection with their resignation (which may be effected at any time by
giving written notice to the client setting out any such circumstances).

(viii) A right to give notice in writing requiring the holding of a general meeting for the purpose of laying the
accounts and report before the members.

Responsibilities of Directors
The directors and the auditors of a company are both appointed by the members of the company but their duties
are quite distinct.

Directors are appointed to fulfill the executive function of managing the company. In company law, company
directors also have specific responsibilities in relation to the accounting function.
(i) Directors are expected to safeguard the assets of the company.
(ii) The company is expected to keep accounting records sufficient to enable the directors to ensure that the
balance sheet and profit and loss account prepared under the Companies Act comply with the Act. In
practice, the directors will, in all but the smallest companies, delegate much accounting work to employees
of the company.
(iii) Directors are responsible for preventing errors, irregularities and fraud. This task should be addressed by
setting up appropriate controls within the company. There should be appropriate measures in place to
detect errors, irregularities and fraud which may occur. The auditors can only be expected to carry out their
work so as to have a reasonable expectation of detecting material errors and fraud which may have
occurred.
(iv) The directors must prepare financial statements for each financial year of the company. The annual
accounts are required to show a true and fair view of the state of affairs of the company at the balance
sheet date and of its profit or loss for the accounting period then ended, and to be properly prepared in
accordance with the Companies Act 1985.
(v) The directors are required to lay a copy of the annual accounts before the members in general meeting.
Under provisions introduced by the Companies Act 1989, a private company may exempt itself from this
requirement.
(vi) The directors must file a copy of the accounts with the Registrar of Companies within seven months of the
end of the accounting period in the case of public companies.

Appointment, Removal and Resignation of Auditors
There are various legal and professional requirements on appointment, resignation and removal of auditors which
must be followed.

Appointment of Auditors
 Usually, the external auditors are appointed by the shareholders at the annual general meeting (AGM) of the
company, and hold office until the next AGM. At the next AGM the auditors are re‐appointed by the
shareholders, or different auditors are appointed.

However, directors may be allowed to appoint auditors in the following circumstances, as a matter of practical
convenience:
 To fill a 'casual vacancy'; for example where the current auditor is no longer able to act
 To appoint the first auditor of a newly‐formed company.
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 An auditor appointed by the directors will normally hold office only until the next AGM, when they will have to
submit themselves for re‐appointment by the shareholders.
 If neither the shareholders of the company nor its directors have appointed auditors, company law may allow
for an appropriate government department to make the appointment.
 In principle, the remuneration of the auditor is set by whoever appoints him. However, in practice, where the
shareholders make the appointment, it is usual to delegate to the board of directors the power to set the
auditor's remuneration. The directors are likely to be more familiar than the shareholders with the nature and
scope of the work involved in the audit process, and so the appropriate level of fees for that work. (The board
of directors may delegate the task of recommending or approving the audit fee to the audit committee.)

Removal of Auditors
Key points
 Directors cannot remove the auditors themselves.
 Auditors can be removed by a simple majority at a general meeting.
 The auditors should be given notice of such a meeting
 They are allowed to speak at the general meeting
 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. They can request an Extraordinary
General Meeting (EGM) of the company to explain the circumstances of the resignation.

RESIGNATION: Sometimes it is necessary for the auditors to resign. If an auditor resigns, they should do so in writing
and they may wish to speak to the shareholders to explain their reasons

The procedures for the resignation of the current auditors will normally include the following:
– The resignation should be made to the company in writing. The company should submit this resignation letter
to the appropriate regulatory authority.
– The auditor should prepare a Statement of the Circumstances. This sets out the circumstances leading to the
resignation, if the auditor believes that these are relevant to the shareholders or creditors of the company. If
no such circumstances exist, the auditor should make a statement to this effect. This statement should be sent:
 By the auditor to the regulatory authority
 By the company to all persons entitled to receive a copy of the company's financial statements (principally
the shareholders).

FORCED REMOVAL: Sometimes, the Board of Directors or some shareholders may wish to remove the auditors. A
General Meeting must be called so that the shareholders can vote on the proposal (via an ordinary resolution). The
auditor will normally be allowed to attend such a meeting and make statements to the shareholders.

Alternatively, the auditor may require written statements to be circulated to the shareholders in advance of the
meeting.

Documentation should be filed with the appropriate regulatory authority
AUDITORS DO NOT WISH TO SEEK REAPPOINTMENT: Sometimes the auditors finish the annual audit and decide
they do not wish to audit the company in future years. As such, when the board asks them to accept nomination for
the following year, the auditors should politely decline and issue a Statement of Circumstances.

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International Standards on Auditing Standard Setting Procedure

International Federation of Accountants
The accounting profession believes in and practices both self‐regulation and self‐promotion. The profession
established and maintains the International Federation of Accountants (“IFAC”). IFAC is a global organisation
comprising of 155 members and associates (mostly national professional institutes) spread across 118 countries.
Membership stands at more than 2.5 million accountants that come from public practice, industry and commerce,
the public sector as well as education backgrounds.

International Standards on Auditing (ISAs) are issued by the International Auditing and Assurance Standards Board
(IAASB) and provide guidance on the performance of an audit.

ISAs only apply to the audit of historical financial information. They are written in the context of an audit of financial
statements by an independent auditor.

The ISAs contain basic principles and essential procedures together with related guidance in the form of explanatory
material and appendices. It is necessary to consider and understand the entire text of an ISA to understand and
apply the basic principles and essential procedures.

The basic principles and essential procedures of an ISA are to be applied in all cases. If in exceptional cases the
auditor deems it necessary to depart from an ISA to achieve the overall aim of the audit, then this departure must
be justified.

ISAs issued by the IAASB are not meant to override or supersede local auditing regulations. The reason for the wide
adoption is because of the fact that the IAASB has worked closely with many national standard setters. By following
the below diagrammed process the IAASB has managed to:
o Cooperate with national standard setters,
o Help minimise duplication of efforts and
o Gain support and acceptance of their standards during the early stages of their development

In addition, the IAASB also hosts an annual meeting with various national auditing standard setters to discuss and
debate proposed ISAs and drafts. In this way the board can reach a consensus with local standard setters at an early
stage of development for the ISAs.

Overall it can be said that the relationship that ISAs share with national standards is one of co‐existence. By working
closely with various local standard setters, the IAASB has helped to make adoption / integration of ISAs an almost
seamless process in many countries.

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The process of producing an ISA is as follows;

Research and consultation
A project task force is established to develop a draft standard or practice statement.
Transport debate
A proposed standard is discussed at a meeting, open to the public
Exposure for public comment
Exposure drafts are put on the IAASB’s website and widely distributed for comment for a
minimum of 120 days.
Consideration of comments
Any comments as a result of the exposure draft are considered at an open meeting of the
IAASB, and it is revised as necessary.
Affirmative approval
Approval is made by the affirmative vote of at least 2/3 of IAASB members.
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Application of ISAs to Small and Medium Sized Entities

Introduction
The IAASB is strongly of the view that an ‘audit is an audit’ and that users who receive audit reports expressing an
opinion have to have confidence in those opinions whether they are in relation to large or small entity financial
statements. However the IAASB have recognised the importance of those who audit small and medium sized entities
(SMEs) and in clarifying the ISAs was heavily influenced by their needs

Qualitative characteristics of a smaller entity
These are identified by ISA 200 as follows:
a) Concentration of ownership and management in a small number of individuals; and
b) One or more of the following:
i. Straightforward or uncomplicated transactions
ii. Simple record‐keeping
iii. Few lines of business and few products within business lines
iv. Few internal controls
v. Few levels of management with responsibility for a broad range of controls; or
vi. Few personnel, many having a wide range of duties

Considerations specific to SME entities
The structure of the ISAs means they are suitable for SMEs. Notably they include:
 A separate section for requirements to help readability and clarification of conditional requirements
 Requirements capable of being applied proportionately
 Additional guidance specific to SME audits

Small Company Audit Exemption
The majority of companies are required by national law to have an audit. A key exception to this requirement is that
given to small companies. Many EC countries have a small company exemption from audit that is based on the
turnover and total assets at the year‐end.

The main reasons for exempting small companies are:
– For owner‐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
– It may also not be cost beneficial for the small entities.

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Code of Ethics AA Revision Notes
Code of Ethics

As the auditor has to be ethical in his dealings with clients, ACCA publishes guidance for its members in its Code of
Ethics and Conduct. This guidance is given in the form of fundamental principles, guidance and explanatory notes.

The IESBA (International Ethics Standards Board for Accountants), a body of IFAC, also lays down fundamental
principles in its Code of Ethics for Professional Accountants. The fundamental principles of the two associations are
extremely similar.

Fundamental Principles
1. Integrity: Members should be straightforward and honest in all professional and business relationships.
Auditors should not knowingly be associated with reports, returns, communications or other information where
they believe that the information contains a materially false or misleading statement.
2. Objectivity: Members should not allow bias, conflicts of interest or undue influence of others to override
professional or business judgements.

3. Professional competence and due care: to maintain professional knowledge and skill at the level required to
ensure that a client receives competent professional services, and to act diligently and in accordance with
applicable technical and professional standards.

4. 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
There are, however, circumstances where auditors may disclose information to third parties without first
obtaining permission. These can be categorised as obligatory and voluntary disclosures.

Obligatory: Auditors are obliged to make disclosure where, for example, there is a statutory right or duty to
disclose, such as if the auditor suspects the client is involved in money laundering, terrorism or drug trafficking
in which case they must immediately notify the relevant authorities.
In addition, auditors must make disclosure if compelled by the process of law, for example under a court order
or summons, under which they are obliged to disclose information.

Voluntary
In certain circumstances auditors are free, as opposed to obliged, to disclose information without obtaining the
client’s permission first. These circumstances can be categorised into the four areas below:

Public interest – An auditor may disclose information which would otherwise be confidential if disclosure can
be justified in the ‘public interest’. This would be perhaps if those charged with governance are involved in
fraudulent activities;

Protect a member’s interest – Members/auditors may disclose information to defend themselves against a
negligence action, disciplinary proceedings or if suing for unpaid fees;

Authorised by statute/laws – There are cases of express statutory provision where disclosure of information to
a proper authority overrides the duty of confidentiality;
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Non‐governmental bodies – Auditors may be approached by non‐governmental bodies seeking information
concerning suspected acts of misconduct not amounting to a crime or civil wrong. Disclosure should only be
made to those bodies with statutory powers to compel disclosure.

5. Professional behaviour: Members should comply with relevant laws and regulations and should avoid any
action that discredits the profession.

Threats to compliance with the fundamental principles
There are five general sources of threat (explanation of the threats are given in the table with examples later):
1. Self‐interest threat (for example, having a financial interest in a client)
2. Self‐review threat (for example, auditing financial statements prepared by the firm)
3. Advocacy threat (for example, promoting shares in a listed entity when that entity is a financial statement audit
client)
4. Familiarity threat (for example, an audit team member having family at the client)
5. Intimidation threat (for example, threats of replacement due to disagreement)

The exam: Once you have identified a threat from the scenario, you will need to name the threat, explain WHY it is
a threat and tell the safeguard.
Important terms

QCR: Quality Control Review (independent partner review)‐ Having a professional accountant who was not involved
with the non‐assurance service review the non‐assurance work performed

Chinese walls: The use of separate engagement teams, with different engagement partners and team members

Public interest entities are:
(a) All listed entities; and
(b) Any entity:
(i) Defined by regulation or legislation as a public interest entity; or
(ii) For which the audit is required by regulation or legislation to be conducted in compliance with the
same independence requirements that apply to the audit of listed entities. Such regulation may be
circulated by any relevant regulator, including an audit regulator

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Self‐interest : the threat that a financial or other interest will inappropriately influence the professional
accountant’s judgment or behavior
Example Safeguard
A member of the assurance team or the firm having a Remove the individual from the audit team‐the self‐interest
direct financial interest in the assurance client. threat created would be so significant that no safeguards
could reduce the threat to an acceptable level.
Gifts and hospitality ‐ Nature, value and intent of offer to be considered
‐ Not allowed unless insignificant ( politely decline)

A firm having undue dependence on total fees from Listed clients:
a client. If gross recurring fee from one client greater than 15% of
the firm’s revenue for two consecutive years,
‐ Tell client’s TCWG
‐ Independent QCR or external QCR before OR after
issuing 2nd year’s opinion
Other clients:
‐ Reducing the dependency on the client;
‐ External quality control reviews; or
‐ Consulting a third party, such as a professional
regulatory body or a professional accountant, on key
audit judgments.

Recent Service with an Audit Client Remove from team if worked at the client in the year being
(if a member of the audit team has recently served an audited at a position to exert significant influence over the
employee of the audit client) subject matter.
A member of the assurance team(or the firm) having ‐ If material, not allowed (The threat created would be
a significant close business relationship so significant that no safeguards could reduce the
‐ Commercial relationship threat to an acceptable level.)
‐ Common financial interest
Examples: joint venture with the client or a
controlling owner/ director, formal marketing of
each other’s product, combine the services of the
firm with those being offered by client and market
the package

A firm entering into a contingent fee arrangement Politely decline the proposed contingent fee arrangement
relating to an assurance engagement. (relating to the
outcome of a transaction or the result of the services Inform the client that the fees will be based on the level of
performed by the firm) work required to obtain sufficient and appropriate audit
evidence.

Overdue fee‐might be regarded as being equivalent Discuss with those charged with governance the reasons
to a loan to the client (if fees due from an audit client why the payments have not been made.
remain unpaid for a long time, especially if a
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significant part is not paid before the issue of the Should agree a revised payment schedule which will result
audit report for the following year.) in the fees being settled before much more work is
performed for the current year audit.
Loans and guarantee If not under normal lending conditions, no safeguard
acceptable
If under normal lending conditions‐ review by network firm.

Serving as a Director or Officer of an Audit Client ‐ No allowed.
(Particular reference made by the code to the role of the
Company Secretary. If allowed under local laws or
professional rules, the duties and activities shall be limited
to those of a routine and administrative nature, such as
preparing minutes and maintaining statutory returns)
Recruitment services ( especially hiring of senior ‐ Listed clients: not allowed for directors or senior
management) positions related to f/s preparation
‐ Otherwise, final decision should be by the client and DO
NOT negotiate on the client’s behalf

Firm can undertake roles such as reviewing a shortlist of
other candidates. However, they must ensure that they are
not seen to undertake management decisions and so must
not make the final decision on who is
appointed
A member of the audit team entering into ‐ Remove the individual from the audit team
employment negotiations with the audit client. ‐ A review of any significant judgments made by that
individual while on the team.

Compensation and Evaluation Policies (when a A key audit partner shall not be evaluated on or
member of the audit team is evaluated on or compensated based on that partner’s success in selling non‐
compensated for selling non‐assurance services to assurance services to the partner’s audit client.
that audit client.)

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Self‐Review‐the threat that the auditor will not appropriately evaluate the results of a previous judgment made/or
service performed by him
Example Safeguard
Provision of other services to an audit client Listed Clients: Most non‐assurance services related to
(Note: other threats due to this are self‐interest financial reporting are not allowed.
because of the fee element and advocacy‐see below)
Other clients: Segregation of duties, Chinese walls, QCR
Temporary staff assignments‐The lending of staff by Should ideally not be made a part of the audit team.
a firm to an audit client
Generally acceptable if no management responsibility taken
up and the audit client shall be responsible for directing and
supervising the activities of the loaned staff

Recent Service with an Audit Client‐ a member of the Remove from team if worked at the client in the year being
audit team has recently served as a employee of the audited at a position to exert significant influence over the
audit client‐ The threat is that the member of the subject matter
audit team has to evaluate elements of the financial
statements for which he had prepared the accounting
records while with the client.

Familiarity: the threat that due to a long or close relationship with a client , the auditor will be too sympathetic to
their interests or too accepting of their work
Long Association of Senior Personnel with an Audit Listed clients:
Client ‐ 7 years plus 1 year of flexibility then a gap of two years
for audit partner
‐ In the 2 years gap period, not participate in the audit
or, provide quality control for the engagement, or
consult with the engagement team or the client
regarding technical or industry‐specific issues
‐
Other clients:
rotate members, QCR
Family and Personal Relationships Remove from team if the relationship is with a senior person
at the client with influence over the f/s.

Employment with an Audit Client Listed client: for partners, ok if twelve months have passed
(the director or a senior member of the audit client since the individual was Partner.
has been a member of the audit team or partner of Other safeguards
the firm in the past) – Modifying the audit plan;
– Any work already undertaken by that individual should
be independently reviewed.
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– Assigning individuals to the audit team who have

sufficient experience in relation to the individual who
has joined the client.
Advocacy: threat that the auditor will promote a client’s position to the point that the his objectivity is compromised
Legal services to audit client ( for example contract If they relate to resolving a dispute or litigation when the
support, litigation, mergers and acquisition legal amounts involved are material to the financial Statements:
advice and support to clients’ internal legal not allowed
departments)
Auditor asked to promote client/shares in a client or Not allowed ( politely decline)
asked to accompany the client to a meeting with the
bank.
Intimidation: the threat that the auditor will be deterred from acting objectively because of actual or perceived
pressures, including attempts to exercise undue influence over the auditor
Threat of dismissal or replacement of auditor/or his ‐ Tell client’s TCWG
close family member over a disagreement about the ‐ ensure that all audit engagements are conducted in
application of an accounting principle. An auditor accordance with International Standards on Auditing
feeling pressured to agree with the judgment of a ‐ Ensure you gather sufficient appropriate evidence
client employee because the employee has more
expertise on the matter in question.
A dominant personality at the client attempting to
influence the decision making process, for example
the application of an accounting principle.
A firm being pressured to reduce inappropriately the
extent of work performed in order to reduce fees.
Actual or Threatened Litigation(for example ‐ QCR
regarding a previous audit report)‐ When the firm ‐ If a team member involved, remove from team
and the client’s management are placed in ‐ Withdraw from engagement if very significant
adversarial positions by actual or threatened
litigation, affecting management’s willingness to
make complete disclosures
Fee dependence, close personal relationships, The safeguards for each will be the same as discussed
business relationships also cause intimidation earlier.
threats.

Conflict of Interest
(Firm competes with client or firm has a joint venture with a competitor of a client or the firm has competitors as
clients)

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.

A conflict of interest arises where an auditor acts for both a client company and for a competitor company of the
client. Where the acceptance/continuance of an engagement would, despite safeguards, materially prejudice the
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interests of any clients, the appointment should not be accepted/continued, or one of the appointments should be
discontinued.

Managing conflicts of interest
1. Full disclosure is important – both companies should be fully aware that the firm is acting for the other party.
2. Regular review of situation by an independent senior partner
3. Use of different partners and teams of staff for different engagements
4. Internal procedures within the firm :
o Procedures to prevent access to information, for example, strict physical separation of both teams,
confidential and secure data filing.
o Clear guidelines for members of each engagement team on issues of security and confidentiality. These
guidelines could be included within the audit engagement letters.
o Potentially the use of confidentiality agreements signed by employees and partners of the firm
5. Advising at least one or all clients to seek additional advice

Answer Technique

1. Identify the threat by using words from the scenario.
2. Write the name of the threat and explain it! For example, it is not enough to write this is ‘self‐interest’. Explain
HOW self‐interest will affect the auditor’s objectivity.
3. Write the safeguard.

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Independent Audit of Financial Statements

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Client Acceptance/Client Continuation AA Revision Notes
Client Acceptance/Client Continuation

Obtaining Audit Engagements

Advertising, Publicity and Obtaining Professional Work

Members:
• Should not obtain or seek work in an unprofessional manner
• Can advertise, but should have regard to relevant advertising codes and standards
• Should not make disparaging references to or comparisons with the work of others

Audit fee
• It is estimated according to charge out rates and work planned
• Lowballing is offering audit services at less than the market rate; undercutting others in a tender
• It can be an independence threat as such a fee is less than the work is worth
• However, audit does have a fluctuating market price and firms can reduce fees

Steps before accepting an audit client
Outgoing auditor‐ Professional Client‐ related issues Practitioner‐related issues
etiquette letter ( Audit firm)

The auditor should 1. Formalities(of removal of outgoing 1. Any issues which might arise
communicate with the outgoing auditor fulfilled) which could threaten compliance
auditor the client to assess if with ACCA’s Code of Ethics and
there are any ethical or 2. Reputation and integrity of the Conduct or any local legislation,
professional reasons why they client’s management assessed‐ If including independence and
should not accept appointment. necessary, the firm may want to conflict of interest with existing
obtain references if they do not clients. If issues arise, then their
They should obtain permission formally know the directors significance must be considered.
from the client’s management
to contact the outgoing auditor; 3. Consider the level of risk attached 2. Whether they are competent to
if this is not given, then the to the audit whether this is perform the work and whether
engagement should be refused. acceptable to the firm. As part of they would have appropriate
this, they should consider whether resources( especially human
The previous auditor must the expected audit fee is adequate resource and time!) available, as
obtain permission from the in relation to the risk auditing the well as any specialist skills or
client’s management to client knowledge required for the audit
respond; if not given, then the
auditor should refuse the Client screening
engagement. The purpose of client screening
procedures is to determine whether the
prospective client is suitable for the
firm.

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The firm should evaluate the potential
risk to the firm of acceptance.
When a client is deemed to represent a
high audit risk to the firm, the firm
should carefully consider the
implications arising should it fail in
meeting its objective of giving an
accurate audit opinion. If the firm is not
confident that the benefit to be derived
from accepting the appointment
outweighs the potential risks (including
financial and reputational risk of being
sued), then the firm should decline the
appointment.

Indicators of high risk clients include :
Poor performances, lack of finance, odd
accounting, unskilled finance director,
significant related party or unusual
transactions

Factors to consider:
- The state of the economic sector in
which the client operates (a
depressed sector may indicate
risk).
- The client’s previous audit history
(frequent changes of auditors,
and/or qualified reports, are
obviously bad news).
- The experience and qualifications
of the company’s management and
their attitude towards controls.
- The current operating and financial
position of the company.
- Directors’ understanding of
External Auditor’s role and their
own responsibilities
- The accounting policies used
- Evidence of client involvement in
fraudulent or illegal activities.
- Management permission or refusal
to allow auditors to examine
significant documents, such as the
minutes of directors’ meetings.

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Preconditions for an audit
ISA 210 Agreeing the Terms of Audit Engagements provides guidance to auditors on the steps they should take in
accepting a new audit or continuing on an existing audit engagement. It sets out a number of processes that the
auditor should perform including agreeing whether the preconditions are present, agreement of audit terms in an
engagement letter, recurring audits and changes in engagement terms.

Preconditions for an Audit
1. Determine whether the financial reporting framework to be applied in the preparation of the financial
statements is acceptable.

2. Obtain the agreement of management that it acknowledges and understands its responsibility:
(i) For the preparation of the financial statements in accordance with the applicable financial reporting
framework, including where relevant their fair presentation

(ii) For such internal control as management determines is necessary to enable the preparation of financial
statements that are free from material misstatement, whether due to fraud or error; and

(iii) To provide the auditor with:
a. Access to all information of which management is aware that is relevant to the preparation of the
financial statements such as records, documentation and other matters;
b. Additional information that the auditor may request from management for the purpose of the
audit***; and
c. Unrestricted access to persons within the entity from whom the auditor determines it necessary
to obtain audit evidence

***Additional information: Additional information that the auditor may request from management for the purpose
of the audit may include when applicable, matters related to other information in accordance with ISA 720 (Revised).
When the auditor expects to obtain other information after the date of the auditor’s report, the terms of the audit
engagement may also acknowledge the auditor’s responsibilities relating to such other information including, if
applicable, the actions that may be appropriate or necessary if the auditor concludes that a material misstatement
of the other information exists in other information obtained after the date of the auditor’s report.

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Agreeing Terms of Engagement

Engagement letter (compulsory for every new engagement; sent before the audit starts)

Purpose of an engagement letter
An engagement letter provides a written agreement of the terms of the audit engagement between the auditor and
management or those charged with governance.

It confirms that there is a common understanding between the auditor and management, or those charged with
governance, of the terms of the audit engagement helps to avoid misunderstandings with respect to the audit.

Contents of an engagement letter
Generally, an audit engagement letter includes the following matters:

1. Objective of the audit: e.g. statutory audit or internal audit
2. Scope of the audit: Elaboration of the scope of the audit, including reference to applicable legislation,
regulations, ISAs, and ethical and other pronouncements of professional bodies to which the auditor adheres.
3. Identification of the applicable financial reporting framework: e.g. IFRS or US GAAP
4. Time schedule: estimated time required for completion of audit
5. The requirement for the auditor to communicate key audit matters in the auditor’s report in accordance with
ISA 701
6. Deliverables: The form of any other communication of results of the audit engagement.e.g. Letters,
certificates or audit report.
7. The expectation that management will provide written representations
8. The basis on which fees are computed and any billing arrangements.
9. Permission to communicate with the previous accountant (by sending the etiquette letter)
10. Access to all the records, documentation and other information requested in connection with the audit, e.g.
customs documents to verify whether the goods are being held by customs
11. Management’s responsibility for establishing and maintaining effective internal controls, e.g. maintenance
of proper accounting records
12. The fact that because of the inherent limitations of an audit, together with the inherent limitations of internal
control, there is an unavoidable risk that some material misstatements may not be detected, even though the
audit is properly planned and performed in accordance with ISAs.
13. Arrangements regarding the planning and performance of the audit, including the composition of the
engagement team.
14. The expectation that management will provide access to all information of which management is aware that
is relevant to the preparation of the financial statements, including an expectation that management will
provide access to information relevant to disclosures.
15. The agreement of management to make available to the auditor draft financial statements including all
information relevant to their preparation, whether obtained from within or outside of the general and
subsidiary ledgers (including all information relevant to the preparation of disclosures), and the other
information,3 if any, in time to allow the auditor to complete the audit in accordance with the proposed
timetable.
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16. The agreement of management to inform the auditor of facts that may affect the financial statements, of which
management may become aware during the period from the date of the auditor’s report to the date the
financial statements are issued.
17. A request for management to acknowledge receipt of the audit engagement letter and to agree to the terms of
the engagement outlined therein.

Changes to engagement letters
Engagement letters for recurring/existing clients should be revised if any of the following factors are present:
- Any indication that the entity misunderstands the objective and scope of the audit, as this misunderstanding
would need to be clarified.
- Any revised or special terms of the audit engagement, as these would require inclusion in the engagement letter.
- A recent change of senior management or significant change in ownership. The letter is signed by a director on
behalf of those charged with governance; if there have been significant changes in management they need to
be made aware of what the audit engagement letter includes.
- A significant change in nature or size of the entity’s business. The approach taken by the auditor may need to
change to reflect the change in the entity and this should be clarified in the engagement letter.
- A change in legal or regulatory requirements. The engagement letter is a contract; hence if legal or regulatory
changes occur, then the contract could be out of date.
- A change in the financial reporting framework adopted in the preparation of the financial statements. The
engagement letter clarifies the role of auditors and those charged with governance, it identifies the reporting
framework of the financial statements and if this changes, then the letter requires updating.
- A change in other reporting requirements. Other reporting requirements may be stipulated in the engagement
letter; hence if these change, the letter should be updated.

What if Management Refuses to Sign the Engagement Letter?
Actions in respect of the engagement letter not being signed
– Discuss the matter again with the directors in an attempt to reach a suitable compromise.
– Remind the directors that statutory audits require the directors to make all the necessary information and
explanations available to the auditor.
– Explain that lack of information on the website will result in a limitation in scope of the audit work.
– Further explain that because the lack of evidence appears to relate to a material amount that the auditor’s
report will have to be modified with an ‘except for’ qualification due to the lack of information and the possibility
of misstatement of non‐current assets.
– Finally note that auditor may have to decline to work for the entity unless suitable terms of engagement can be
agree

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Audit Planning AA Revision Notes
Audit Planning
Importance of audit planning

1. It helps the auditor to devote appropriate attention to important areas of the audit.
2. It helps the auditor to identify and resolve potential problems on a timely basis.
3. It helps the auditor to properly organise and manage the audit engagement so that it is performed in an
effective and efficient manner.
4. It assists in the selection of engagement team members with appropriate levels of capabilities and competence
to respond to anticipated risks and the proper assignment of work to them.
5. It facilitates the direction and supervision of engagement team members and the review of their work.
6. It assists, where applicable, in the coordination of work done by experts
An exam focused overview
The Planning stage of audit- An overview

Planning
Audit Strategy Audit Plan

(Overall approach to audit) (Detailed implementation of strategy)
a) Understanding the client e) Description of risk assessment procedures
b) Audit Risk f) Description of further audit procedures
c) Materiality
d) Scope, timing, direction
a) Understanding the client: Industry, regulatory and other external factors; Nature of entity and accounting
policies; Objectives…strategies…related business risks!; Measurement and review of Financial performance
and Internal control.
b) Risk assessment
 Through the understanding gained
 Through Analytical procedures.
o Analytical procedures: evaluate financial information by analysing plausible relationships among
both financial and non-financial data.
o These procedures are conducted at the planning stage to assess the risk of material misstatement
in the financial statements. Examples are given below.
- Compare client’s F/S with prior periods
- Compare client’s F/S with budgets/forecasts
- Compare client’s F/S with similar industry information ( sales to accounts receivable ratio)
- Compare client’s F/S with auditor’s own expectations ( proof in total)
- Evaluate relationships among elements of F/S that are expected to have a predictable pattern
based on client’s previous experience
- Evaluate relationship between financial and non-financial data ( payroll cost to number of
employees, revenue to sales volume)
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Explanation of the term Audit Risk

Audit Risk: Is the risk that the auditor might give an incorrect opinion when the F/S are materially misstated. Audit
Risk has two components ( Risk of material misstatement in F/S and Detection Risk)
Audit Risk
Risk of material misstatement in the F/S Detection Risk

(Risk that the F/S might be materially misstated before the ( risk that the auditor’s procedures will not
audit) detect misstatements in the F/S)
Inherent Risk Control Risk Possible reasons for high detection risk
include:
( Risk that a class of ( risk that a material
transaction/account misstatement in a class of – inadequate planning
balance/disclosure is transaction/account – audit team related issues
misstated before balance/disclosure will not be – lack of professional scepticism
considering any prevented/detected/corrected by – inadequate supervision and review of
controls) the client’s internal control work
because controls are not – incorrect audit procedures
designed or implemented – improper sample selection
properly)
Important: If risk of material misstatements in financial statement is high, the auditor will need to reduce detection
risk in order to decrease audit risk.
c) Materiality: Misstatements, including omissions, are considered material if they are expected to influence
the economic decisions of users taken on the basis of the financial statements.
Auditor’s determination of materiality is a matter of professional judgment.

 Material by amount for F/S as a whole: The exam: 5% of PBT, 2% of Total Assets, 1% of Revenue
 Material by nature: related party transactions, Bank, items which affect debt covenants. Items which
affect statutory items ect.)
 Materiality may be revised at a later stage in audit ( for example if auditor gets new information, or if
there is a change in auditor’s understanding of the client)
 Performance materiality ( should be lower than the overall materiality level) The amount of
performance materiality is considered necessary to reduce to an appropriately low level the probability
that the aggregate of uncorrected and undetected misstatements is greater than materiality.
Important: Risk and materiality are inversely proportional!
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d) Scope:
 locations/branches
 financial reporting framework
 any industry specific regulation that apply
 need of experts
 reliance on internal auditor’s work
 use of service org by client (outsourced functions)
 use of computer aided audit techniques (CAATs) by the auditor
Timing:
 reporting deadlines
 meetings with the management/TCWG
 expected communication with the management
 team meetings
 review of audit work by audit partner.
Direction:
 Controls plus substantive or mainly substantive (to be explained later)
Answer Technique
Risk of material misstatement

1. Identify risk by using words from the scenario
2. If possible, write the relevant accounting treatment.
3. Explain the risk; ensure you mention WHICH are of the financial statements is at the risk of understatement or
overstatement or misstatement. The answer HAS to end by explaining chances of fraud/error in financial
statements ( could be in an amount or a disclosure)
Detection risk
1. Identify from the scenario
2. Explain HOW it would increase the chances of the AUDITOR not being able to detect material fraud/error.
Risk response
This is the area students struggle with the most.
This is simply the AUDITOR’s plan for the risk areas (i.e. what further work will the auditor do on the risky areas
identified above).
The plan could be ( some example)…

– The auditor will test the controls in this area
Or
– The auditor will perform substantive procedures like XXXXX later
Or
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– The auditor will have a look this at the review stage of audit by performing these XXXXXX procedures
Examples are given further along in the notes.
Details of the overview that has been covered above
Audit Strategy: An audit strategy sets the scope, timing and direction of the audit and guides the development of
the more detailed audit plan.
Audit plan: Once the overall strategy has been planned, detailed consideration can be given to each individual audit
objective and how it can be best met.
A.UNDERSTANDING THE CLIENT/ KNOWLEDGE OF THE BUSINESS

The auditor obtains an understanding of the entity, its control environment and its detailed internal controls:
 To identify and assess the risks of material misstatements in the financial statements and to provide a basis for
designing and implementing responses to these risks
 To determine the extent to which the auditor would rely on the internal control system.
 To assess whether the team is competent to perform the audit
 To understand relevant law and regulations impacting the entity
 To consider the reliability of various evidence sources.
Understanding to be gained about Understanding can be gained from
- Industry, regulatory and other external factors( for Prior year financial statements: Provides
example financial reporting framework, laws and information in relation to the size of the client
regulations, stakeholders, economic conditions like as well as the key accounting policies, disclosure
volatility of exchange rates, competition, level of notes and whether the audit opinion was
technology modified or not.
- Nature of entity and accounting policies ( legal structure,
ownership and governance, main sources of finance) Discussions with the previous auditors/access
- Objectives…strategies…related business risks! ( e.g. new to their files: Provides information on key issues
products/services, explansion, use of IT) identified during the prior year audit as well as
- Measurement and review of Financial performance ( the audit approach adopted.
measures important to the client, KPIs i.e. Key
Performance Indicators, budgets, targets) Prior year report to management: If this can be
- Internal control (gain an understanding about the design obtained from the previous auditors or from
and implementation of internal controls) management, it can provide information on the
internal control deficiencies noted last year. If
Miscellaneous these have not been rectified by management,
then they could arise in the current year audit
Identification of issues that arose in the prior year audit and as well and may impact the audit approach.
how these were resolved. Also whether any points brought
forward was noted for consideration for this year’s audit.
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Internal control deficiencies noted in the prior year; if these The client‘s accounting systems
have not been rectified by management then they could arise notes/procedural manuals: Provides
in the current year audit as well information on how each of the key accounting
systems operates and this will be used to
Significant changes in the entity as compared to prior years. identify areas of potential control risk and help
determine the audit approach.
Is the company using e-commerce?
Discussions with management: Provides
information in relation to the business, any
important issues which have arisen or changes
to accounting policies from the prior year.
Review of board minutes: Provides an overview

of key issues which have arisen during the year
and how those charged with governance have
addressed them.
Current year budgets and management

accounts: Provides relevant financial
information for the year to date. It will help the
auditor during the planning stage for
preliminary analytical review and risk
identification.
The client’s website: Recent press releases

from the company may provide background on
the business during the year as this will help in
identifying the key audit risks.
Financial statements of competitors: This will

provide information about the client ‘s
competitors, in relation to their financial results
and their accounting policies. This will be
important in assessing the client’s performance
in the year and also when undertaking the going
concern review.
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B. AUDIT RISK and Auditor Response
Examiner’s comments
Audit risk questions typically require a number of audit risks to be identified (½ marks each), explained (½ marks
each) and an auditor’s response to each risk (1 mark each).
To explain audit risk, candidates need to state the area of the accounts impacted with an assertion (e.g. cut off,
valuation etc.), or, a reference to under/over/misstated, or, a reference to inherent, control or detection risk.
Misstated is only awarded if it was clear that the balance could be either over or understated.
Candidates are reminded that audit risk questions may also require a calculation of relevant ratios that will allow
the auditor to identify the key areas of risk in the financial statements. If this is required, as it was in September
2015, it is noted that candidates should only provide one ratio per area of the financial statements (eg either
“inventory days” or “inventory turnover”), not include calculations of movements year on year (eg “revenue has
increased by x%), as while relevant in the discussion of risk, will not score the marks for calculating appropriate
ratios, and also come equipped with a calculator for the exam.
Importance of risk assessment

1. Assessing engagement risks at the planning stage, this will ensure that attention is focused early on the area’s
most likely to cause material misstatements.
2. It will help the auditor to fully understand the entity, which is vital for an effective audit.
3. Any unusual transactions or balances would also be identified early, so that these could be addressed in a timely
manner.
4. Assessing risks early should also result in an efficient audit. The team will only focus their time and effort on key
areas as opposed to balances or transactions that might be immaterial or unlikely to contain errors.
5. In addition assessing risk early should ensure that the most appropriate team is selected with more experienced
staff allocated to higher risk audits and high risk balances.
6. A thorough risk analysis should ultimately reduce the risk of an inappropriate audit opinion being given.
7. It should enable the auditor to have a good understanding of the risks of fraud, money laundering, etc.
8. Assessing risk should enable the auditor to assess whether the client is a going concern.
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Auditors use the audit risk model to direct audit resources to the performance of additional substantive procedures
in areas of the financial statement where audit risk is deemed to be high.
The formula for the audit risk model is:
Audit Risk = Risk of material misstatement in the financial statements x Detection Risk
Audit Risk Explained

Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are
materially misstated.
Audit risk is a function of two main components being the risks of material misstatement and detection risk. Risk of
material misstatement is made up of two components, inherent risk and control risk.
Risk of material misstatement in the financial statements explained

Risk of material misstatement is made up of a further two components, inherent risk and control risk.
Inherent risk
Inherent risk:
Definition: The susceptibility of an assertion about a class of transaction, account balance or disclosure to a
misstatement that could be material, either individually or when aggregated with other misstatements, before
consideration of any related controls.
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Inherent risk describes something about the nature of a business or its transactions that make it particularly
susceptible to material misstatements.
Inherent risk is affected by the nature of an entity and factors which can result in an increase include:
– Changes in the industry it operates in.
– Operations that are subject to a high degree of regulation.
– Going concern and liquidity issues including loss of significant customers.
– Developing or offering new products or services, or moving into new lines of business.
– Expanding into new locations.
– Application of new accounting standards.
– Accounting measurements that involve complex processes.
– Events or transactions that involve significant accounting estimates.
– Pending litigation and contingent liabilities.
Control risk
Definition: The risk that a misstatement that could occur in an assertion about a class of transaction, account balance
or disclosure and that could be material, either individually or when aggregated with other misstatements, will not
be prevented, or detected and corrected, on a timely basis by the entity’s internal control.
It is the risk that an organisation’s internal control systems do not adequately protect the organization either because
they have not been adequately designed and / or implemented.
The following factors can result in an increase in control risk:

– Lack of personnel with appropriate accounting and financial reporting skills.
– Changes in key personnel including departure of key management.
– Deficiencies in internal control, especially those not addressed by management.
– Changes in the information technology (IT) environment.
– Installation of significant new IT systems related to financial reporting.
It is important to appreciate that the auditor has no control over the extent of either inherent or control risk; these
are risks borne by the entity subject to audit. However, the auditor has to assess them in the process of determining
the extent of the detailed substantive procedures to be carried out.
Detection risk Explained

Definition: The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level will
not detect a misstatement that exists and that could be material, either individually or when aggregated with other
misstatements. Detection risk is affected by sampling and non-sampling risk.
Detection risk is all down to the auditors and is the risk that the auditor’s procedures fail to detect a material
misstatement.
Detection risk is affected by sampling and non-sampling risk and factors which can result in an increase include:
– Inadequate planning.
– Inappropriate assignment of personnel to the engagement team.
– Failing to apply professional scepticism.
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– Inadequate supervision and review of the audit work performed.

– Incorrect sampling techniques performed.
– Incorrect sample sizes
Detection risk include sampling risk and non-sampling risk (these are explained in detail with the topic of sampling-
below is an overview).
Sampling risk= sample is not representative of the population
Non-sampling risk = auditor’s procedures or the conclusion reached are incorrect.
Audit Risk = Inherent Risk x Control Risk x Detection risk
Needs to be High High Must be low!

at an
acceptably
low level
The audit risk model used by auditors, dictates that for a given level of audit risk, the acceptable level of detection
risk bears an inverse relationship to the assessment of the risk of material misstatement.
For example, on an audit assignment where the risk of material misstatement has been assessed as high, in order
to achieve a low level of audit risk, detection risk must be set as low.
In such circumstances the auditor would need to direct an appropriate level of resources to the testing of the
assertion in question. This will comprise adequate planning, proper assignment of personnel, the application of
professional scepticism and supervision and review of the audit work performed.
Analytical procedures
Analytical procedure is an audit procedure which seeks to provide evidence as to the completeness, accuracy and
validity of the information contained in the accounting records or in the financial statements.
The procedure consists of the systematic study and comparison of relationships among elements of financial
information and the investigation of significant fluctuations and variances from the expected relationship
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Steps involved in analytical procedures

1. Expectation: This step involves developing an expectation of what the financial information figures should be.
This can be agreed through comparisons of financial information or considerations of relationships (ratio
analysis).
2. Identification: This step involves identification of significant variations between the actual data with the
expected data.
3. Investigation of unusual variances: Once the variation has been computed, and if significant variations are
found, the auditor would consult the management in order to establish explanations for the variations revealed.
4. Performance of alternate procedures: If the auditor or the management does not find the variation reasonable,
then they investigate further and perform analytical procedures to satisfy themselves.
When performing an analytical procedure, the auditor compares numbers, ratios or even non-financial
information in order to identify unexpected trends or unexpected relationships, which may indicate the
existence of errors.
There are many different analytical procedures including the comparisons listed below
 Year on year (e.g. Revenue this year compared to revenue last year);
 to budget or forecast (e.g. Actual purchases compared to budgeted purchases);
 to predictions made by the auditors-proof in total (e.g. Auditors calculation of depreciation compared to client’s
calculation);
 To industry information (e.g. Client’s revenue compared to competitor’s revenue).
 Comparison/analysis of relationships between different elements of the financial statements ( for example gross
profit compared to sales)
 Comparison of financial info with non-financial info ( for e.g. Payroll expense matched to number of employees)
 Nonfinancial information. For example, sales revenue for a client from the hotel industry might be based on
available data as to room occupancy rates.
Analytical Procedures at the To assist the auditor in planning the nature, timing and extent of other audit
Planning stage procedures. Use at this stage should add to the firm’s understanding of the
business and identify risk areas to which audit resources should be targeted.
Analytical Procedures at At the detailed testing stage – in most instances analytical procedures should be
substantive testing stage used in conjunction with tests of detail to achieve a particular audit objective in
relation to specific financial statement assertions..
Analytical Procedures at the At the final review stage the auditor must design and perform analytical
Review stage procedures that assist him when forming an overall conclusion as to whether the
financial statements are consistent with the auditor’s understanding of the entity
and that all of the audit objectives with regard to the financial statements have
been met.
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Using Ratios
In the exam you may be asked to compute and interpret the key ratios used in analytical procedures at both the
audit planning stage and when collecting audit evidence. Ratios and comparisons can be used to identify where
the accounts might be wrong, and where additional auditing effort should be spent.
Calculating a ratio is easy, and usually is little more than dividing one number by another. Indeed, the calculations
are so basic that they can be programmed into a spreadsheet. The real skill comes in interpreting the results and
using that information to carry out a better audit. Saying that a ratio has increased because the top line in the
calculation has increased (or the bottom line decreased) is rather pointless: this is simply translating the calculation
into words.
Gross Profit Margin = Gross profit/Sales Revenue x 100
Operating profit margin =Operating profit/Sales Revenue x 100
Return on capital employed = Operating profit/ Capital employed x 100
Current Ratio= Current Assets/Current Liabilities
Quick ( or asset test) ratios =Current assets minus inventory/ current liabilities
Inventory holding period or Inventory days =Inventory/Cost of sales x 365
Receivable days/ Receivables collection period =Trade receivables/Sales x 365
Trade payable Days/Payables payment period =Trade payables/Cost of sales x 365
Gearing =Long-term loan finance/ equity finance x 100
The gearing ratio can also be defined in other ways, particularly by comparing long-term loan finance to total
finance. As gearing increases so does the risk that the interest can’t be paid. But it is difficult to define a ‘safe’
level of gearing. For example, a property company with properties leased to tenants will have fairly predictable
rental income. Such a company can probably safely sustain substantial borrowings (though it could be in trouble
if interest rates increased significantly). A company with volatile streams of income would have to keep its gearing
lower as it must ensure that interest can be paid during the lean times.
Interest cover = profit before interest/ interest
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Auditor’s Responses to Risk
An auditor’s response does not have to be a detailed audit procedure, rather an approach the audit team will take
to address the identified risk.
Having identified the audit risk candidates are often required to identify the relevant response to these risks. A
common mistake made by candidates is to provide a response that management would adopt rather than the
auditor.
In the past exams, in relation to the risk of valuation of receivables if a company has a number of receivables who
were struggling to pay, many candidates suggested that management needed to chase these outstanding customers.
This is not a response that the auditor would adopt, as they would be focused on testing valuation through after
date cash receipts or reviewing the aged receivables ledger.
Auditor’s responses should focus on how the team will obtain evidence to reduce the risks identified to an acceptable
level. Their objective is confirming whether the financial statement assertions have been adhered to, and whether
the financial statements are true and fair. Responses are not as detailed as audit procedures; instead they relate to
the approach the auditor will adopt to confirm whether the transactions or balances are materially misstated.
ISA 330 lists the following overall responses that may be used by auditors in order to address the assessed risks of
material misstatement at the financial statement level:
 Emphasizing to the audit team the need to maintain professional scepticism.

 Assigning more experienced staff, those with special skills, or using experts.
 Providing more supervision.
 Incorporating additional elements of unpredictability in the selection of further audit procedures to be
performed.
 Making general changes to the nature, timing or extent of audit procedures
Examples from past exams

Audit Risk Audit Response
The finance director Abrahams is planning to capitalize the full A breakdown of the development expenditure
$2.2 million of development expenditure incurred. However in should be reviewed and tested in detail to
order to be capitalized it must meet all of the criteria under IAS ensure that only projects which meet the
38 intangible Assets. The risk is that the criteria has not been capitalization criteria are included as an
and assets might be overstated. intangible asset, with the balance being
expensed.
In September Abrahams Co introduced a new accounting The new system will need to be documented in
system. This is a critical system for the accounts preparation full and testing should be performed over the
and if there were any errors that occurred during the transfer of data from the old to the new system.
changeover process, these could impact on the final amounts
in the trial balance.
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C.MATERIALITY
Definition: ‘Misstatements, including omissions, are considered to be material if they, individually or in the
aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the
financial statements.’
In assessing the level of materiality there are a number of areas that should be considered.
Firstly the auditor must consider both the amount (quantity) and the nature (quality) of any misstatements, or a
combination of both.
The quantity of the misstatement refers to the relative size of it and the quality refers to an amount that might be
low in value but due to its prominence could influence the user’s decision, for example, directors’ transactions.
In assessing materiality the auditor must consider that a number of errors each with a low value may when
aggregated amount to a material misstatement.
The assessment of what is material is ultimately a matter of the auditor’s professional judgement, and it is affected
by the auditor’s perception of the financial information needs of users of the financial statements and the perceived
level of risk; the higher the risk, the lower the level of overall materiality.
Materiality is often calculated using benchmarks such as 5% of profit before tax or 2% of total assets. These values
are useful as a starting point for assessing materiality.
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Auditors need to establish the materiality level for the financial statements as a whole, as well as assess performance
materiality levels, which are lower than the overall materiality.
Performance materiality is normally set at a level lower than overall materiality. It is used for testing individual
transactions, account balances and disclosures. The aim of performance materiality is to reduce the risk that the
total of errors in balances, transactions and disclosures does not in total exceed overall materiality.
Definition of performance materiality below:

‘Performance materiality means the amount or amounts set by the auditor at less than materiality for the financial
statements as a whole to reduce to an appropriately low level the probability that the aggregate of uncorrected and
undetected misstatements exceeds materiality for the financial statements as a whole. If applicable, performance
materiality also refers to the amount or amounts set by the auditor at less than the materiality level or levels for
particular classes of transactions, account balances or disclosures.’
Material by size (importance depends on value)-Quantitative factors

 1% of revenue;
 2% of total assets;
 10% of PBT.
Material by nature
Examples
 Bank balances
 Related party transactions ( including remuneration and personal expenses of directors)
 Fraud/ Unlawful transactions (e.g. illegal payments)
 Violation of regulatory requirements
 Incorrect selection or application of an accounting policy that has an immaterial effect on the current period
but is likely to have a material effect on future periods
 Failure to meet requirements of debt-covenants
 Key Performance Indicators of the company (e.g. converting loss into profit)
D.SCOPE.TIMING AND DIRECTION
Scope Timing
Deadlines for:
1. Financial reporting framework for the financial  Final reporting
statements.  Any interim report
2. Are there industry specific or other special  Meeting with Those charged with governance and
reporting requirements? Management to discuss important matters of
3. Are there other factors which influence the overall audit
approach to the audit?  Reports to management
 Multiple locations  Reports to those charged with governance.
 Need of expert
 Whether the entity has an internal audit The normal timetable for an audit includes:
function, and if so, in which areas and to what - An interim visit, usually at least three-quarters of
extent work of the function can be used. the way through the accounting year
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 Nature of business (considering need of - Attendance at inventory count

specialized knowledge). - Yearend confirmation letters
 Effect of information technology on the audit - The final audit shortly after the accounting year-
procedures end
This pattern will often be modified to suit the needs of

the particular business.
Direction
The ‘direction’ of the audit covers the overall approach and concerns such issues as:
1. Reliance on controls or a fully substantive approach.
2. Significant developments and changes in
 Industry (e.g. regulations and reporting requirements)
 Business (impact of IT, changes in processes, mergers, acquisitions)
 Financial Reporting Framework
 Others (e.g. legal environment)
3. With respect to risk
 Identification of areas of financial statements where there is higher risk.
 Impact of risk at financial statements level on direction, supervision and review.
4. With respect to materiality:; Setting materiality for planning purposes
5. With respect to Internal Controls
 Internal control deficiencies identified in previous audits and actions to address them.
 Appropriateness of design, implementation and operating effectiveness of internal control.
 Whether it is more efficient to rely on internal control.
Audit plan
An audit plan converts the audit strategy into a more detailed plan and includes the nature, timing and extent of
audit procedures to be performed by engagement team members in order to obtain sufficient appropriate audit
evidence to reduce audit risk to a low level.
Audit planning is a detailed recording of each procedure and process required to perform an audit.
Once the overall strategy has been determined, the auditor should prepare a detailed plan of the areas determined
in the audit strategy. Once the audit strategy has been decided, the next stage is to decide how it is going to be
carried out; an audit plan is necessary. The audit plan contains the nature, timing and extent of the procedures to
be performed.
The audit plan covers:

 Allocation of work and duties to the assistants
 Allocation of time and cost
 Formation of various teams
 Audit tests/procedures
 Data gathering techniques
 Types of audit evidence desired
The audit plan is developed in order to reduce audit risk to an acceptably low level.
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Interim vs Final Audit
Interim Audit
An interim audit refers to audit work that is conducted during the accounting year, at intervals, fixed or not. The
audit of the remaining part of the year will be done at the end of the accounting year.
The auditor uses the interim audit to carry out procedures which would be difficult to perform at the year end
because of time pressure. There is no requirement to undertake an interim audit; factors to consider when deciding
upon whether to have one include the size and complexity of the company along with the effectiveness of internal
controls.
Typical work carried out at the interim audit includes:

- Consideration of inherent risks facing the company. (Risk would be initially considered at the planning stage, but
is, in fact, reassessed at all audit stages.)
- Documenting and testing of internal controls
- Testing of profit and loss transactions for the year to date
- Identification of potential problems that may affect the final audit work.
Final audit
The final audit will take place after the year end and concludes with the auditor forming and expressing an opinion
on the financial statements for the whole year subject to audit. It is important to note that the final opinion takes
account of conclusions formed at both the interim and final audit.
Typical work carried out at the final examination includes:

- Follow up of items noted at the inventory count
- Obtaining confirmations from third parties, such as bankers and lawyers
- Analytical reviews of figures in the financial statements.
- substantive procedures of account balances and transactions
- Reviews of events after the reporting period
- Consideration of the going concern status of the organisation.
Advantages of interim audit

a) The errors are discovered at early stage
b) As the auditor visits the entity frequently, the chances of fraud being committed reduce.
c) Fraud, if committed, will be discovered at an early stage, which results in minimising the loss due to the fraud.
d) Most of the time, the audit staff is present at the client’s premises, which acts as a moral check and result in
minimising the chances of errors or fraud.
e) All the books and records of the client are always up-to-date.
f) As the audit is started earlier, more time is available for a detailed checking of accounts and hence this allows
for a comprehensive audit.
g) An interim audit minimises the work and time involved in conducting the audit at the end of the year and
therefore assures early completion of the audit reports.
h) If the auditor plans to rely on the internal controls, some extensive testing may be done at the interim period
only so that the workload at the end of the year will be reduced.
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Disadvantages of interim audit

a) There is always a danger that the audited figures may be altered either innocently or fraudulently. That is why
ISA 330 states that when audit evidence (relating to the operating effectiveness of internal controls or the
financial statement assertions), is obtained during the interim period, additional audit evidence (relating to the
effectiveness of internal controls or the financial statement assertions) must also be obtained for the remaining
period.
b) It is just a waste of time in small entities.
c) The cost would be high.
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Evaluating Internal Control AA Revision Notes
Evaluating Internal Control over Financial Reporting

Internal control questions typically require internal control deficiencies to be identified (½ marks each), explained
(½ marks each), a relevant recommendation to address the control (1 mark), and, often a test of control the
external auditor would perform to assess whether each of these controls, if implemented, is operating correctly
(1 mark).

Internal control questions may also require a covering letter to management to accompany the list of deficiencies
and recommendations.

Occasionally, as in September 2015, candidates may be asked to identify internal control strengths as well as
deficiencies.

Internal controls: Internal control represents the system or policies and procedures implemented by an
organization.

Internal control over financial reporting: The process designedimplemented maintained by TCWG to provide
reasonable assurance about the reliability of financial reporting, effectiveness of operations and compliance with
laws and regulations.

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Why does an auditor need to understand internal controls?
Internal controls assure management of the accuracy of the financial statements, that the operations of the entity
are conducted efficiently and that the entity has complied with all the laws and regulations which are applicable to
the entity.

The objectives of internal controls relevant to audit include:
1. Avoidance of fraud, errors, wastes and inefficiency
2. Maximum accuracy of all records, data and statements
3. Enables auditors to determine the degree of reliance they can place on the various systems. This will enable the
auditors to assess the correctness, truth and fairness of the financial statements.
4. Informing management about weaknesses detected in internal controls so that corrective action can be taken.
5. Enabling planning of the audit
6. Understanding the components of internal control: While planning the audit, the auditor understands the
various components of the internal control so as to:
o Identify the types of potential misstatements.
o Consider the factors that affect the risk of misstatement.
o Design effective substantive tests.

Components of internal control over financial reporting
ISA 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its
Environment considers the components of an entity’s internal control. It identifies the following components:
1. Control environment
2. Entity’s risk assessment process
3. Information system and communication
4. Control activities
5. Monitoring of controls

Understand client’s Control The control environment sets the tone of an organisation, influencing the control
Environment consciousness of its people. It includes the attitudes, awareness, and actions of
TCWG concerning the entity’s internal control and its importance in the entity.

The control environment has many elements such as:
a) Communication and enforcement of integrity and ethical values – essential
elements which influence the effectiveness of the design, administration and
monitoring of controls.
b) Commitment to competence – management’s consideration of the
competence levels for particular jobs and how those levels translate into
requisite skills and knowledge.
c) Management’s philosophy and operating style – management’s approach to
taking and managing business risks, and management’s attitudes and actions
towards financial reporting, information processing and accounting functions
and personnel.
d) Organisational structure – the framework within which an entity’s activities
for achieving its objectives are planned, executed, controlled and reviewed.
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e) Assignment of authority and responsibility – how authority and responsibility
for operating activities are assigned and how reporting relationships and
authorisation hierarchies are established.
f) Human resources policies and practices – recruitment, orientation, training,
evaluating, counselling, promoting, compensating and remedial actions.
g) Participation by TCWG (their independence from the management, their
experience, appropriateness of actions etc.)

Understand client’s Risk Auditor needs to understand the management’s process to identify and assess
Assessment Process risks in financial reporting. Auditor also needs to understand actions taken by the
management to address these risks.The auditor will then evaluate whether there
are deficiencies in the client’s risk assessment process.
Understand client’s Auditor will understand the process by which transactions and events are
Information systems relevant initiated, recorded, processed, corrected, transferred to general ledger and
to financial reporting reported in the financial statements.
Plus
communication Auditor will also understand how the client communicates financial reporting roles
and responsibilities as well as important matters relating to financial reporting.

Understand the Control Control activities are the policies and procedures which help ensure that
Activities management directives are carried out.

Auditor has to understand control activities to assess risk of material
misstatement in the financial statements and to design further procedures.
Examples of controls are:

Segregation of duties: assignment of roles/responsibilities to different people,
thereby reducing the risk of fraud and error occurring. The concept is that no
individual person should be responsible for more than one of the following duties:
(i) the authoristion of a transaction;
(ii) the recording of the transaction in the accounting records; and
(iii) the custody of the asset relating to the transaction.

Information processing: computer controls including general IT controls, which
cover a range of applications and support the overall IT environment and
application controls which operate on a cycle/business process level ( details given
separately)

Authorisation: approval of transactions by a suitably responsible official to ensure
transactions are genuine.

Physical controls: restricting access to physical assets such as cash, inventory and
plant and equipment, thereby reducing the risk of theft.

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Performance reviews: comparison or review of the performance of the business
by looking at areas such as budget v actual results.

Arithmetical controls: controls which check the arithmetical accuracy of
accounting records.

Account reconciliations: comparison of an account balance with another source;
often this source is from a third party, such as the bank, with differences being
investigated.

Understand client’s Auditor will understand how internal controls over financial reporting monitored
Monitoring process ( including whether there is an effective internal audit department)

Computer Controls

GENERAL CONTROLS (Apply to the whole system)
Controls on the information system environment which ensure proper development of applications.

Examples include
 Making regular back‐ups of data and storing them off‐site;
 Having an it help‐desk and it training for staff;
 Keeping computers in locked rooms;
 Having a disaster recovery plan;
 All computers have log in codes;
 Anti‐virus software and firewalls;
 Segregation of duties between programmers and users.
 Review of the data center or information processing facility should cover the adequacy of air conditioning
(temperature, humidity), power supply (uninterruptible power supplies, generators) and smoke detectors

APPLICATION CONTROLS
Application controls are those controls that relate to the transaction and standing data relating to a computer‐based
accounting system.

They are specific to a given application and their objectives are to ensure the completeness and accuracy of the
accounting records and the validity of entries made in those records.

An effective computer‐based system will ensure that there are adequate controls existing at the point of input,
processing and output stages of the computer processing cycle and over standing data contained in master files.

Application controls need to be ascertained, recorded and evaluated by the auditor as part of the process of
determining the risk of material misstatement in the audit client’s financial statements.

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Input controls
Data input controls ensure the accuracy, completeness, and timeliness of data during its conversion from its original
source into computer data, or entry into a computer application. Examples are given below:
– Format checks: These ensure that information is input in the correct form. For example, the requirement that
the date of a sales invoice be input in numeric format only – not numeric and alphanumeric.

– Range /Reasonableness checks: These ensure that input data is rejected or highlighted if it is outside pre‐set
parameters.For example, where an entity rarely, if ever, makes bulk‐buy purchases with a value in excess of
$50,000, a purchase invoice with an input value in excess of $50,000 is rejected for review and follow‐up.

– Compatibility/dependence checks: These ensure that data input from two or more fields is compatible. For
example, a sales invoice value should be compatible with the amount of sales tax charged on the invoice.

– Exception checks: These ensure that an exception report is produced highlighting unusual situations that have
arisen following the input of a specific item. For example, the carry forward of a negative value for inventory
held.

– Sequence checks: ensure that sequential input of documentation/data is maintained. These facilitate
completeness of processing by ensuring that documents processed out of sequence are rejected. For example,
where pre‐numbered goods received notes are issued to acknowledge the receipt of goods into physical
inventory, any input of notes out of sequence should be rejected.

– Control totals: These also facilitate completeness of processing by ensure that pre‐input, manually prepared
control totals are compared to control totals input. For example, the total of all the invoices, such as the gross
value, is manually calculated. The invoices are input, the system aggregates the total of the input invoices’ gross
value and this is compared to the control total. This helps to ensure completeness and accuracy of input.

– Existence checks: the system is set up so that certain key data must be entered, such as supplier name,
otherwise the invoice is rejected. This helps to ensure accuracy of input.

– Check digit verification: Check digits are used to protect against the transposition of data i.e. errors arising due
to accidental reversal of digits. This process uses algorithms to ensure that data input is accurate.

– Document counts: the number of invoices to be input are counted, the invoices are then entered one by one,
at the end the number of invoices input is checked against the document count. This helps to ensure
completeness of input.

– One for one checking: the invoices entered into the system are manually agreed back one by one to the original
purchase invoices. This helps to ensure completeness and accuracy of input.

Processing controls
Processing controls exist to ensure that all data input is processed correctly and that data files are appropriately
updated accurately in a timely manner.

For example, the balance carried forward on the bank account in a company’s general (nominal) ledger.
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Other processing controls should include the subsequent processing of data rejected at the point of input, for
example:
- A computer produced print‐out of rejected items.
- Formal written instructions notifying data processing personnel of the procedures to follow with regard to
rejected items.
- Appropriate investigation/follow up with regard to rejected items.
- Evidence that rejected errors have been corrected and re‐input.

Output controls
Output controls exist to ensure that all data is processed and that output is distributed only to prescribed authorised
users. While the degree of output controls will vary from one organisation to another (dependent on the
confidentiality of the information and size of the organisation), common controls comprise:
- Appropriate review and follow up of exception report information to ensure that there are no permanently
outstanding exception items.
- Careful scheduling of the processing of data to help facilitate the distribution of information to end users on a
timely basis.
- Ongoing monitoring by a responsible official, of the distribution of output, to ensure it is distributed in
accordance with authorised policy.

Term to remember: Standing Data
Standing data is the information that is held on computer files for long‐term use. It is called standing data as it tends
to change less frequently than other data. Examples of standing data would be:
• The rate of sales tax to be applied to sales invoices;
• The hourly pay rate for a factory worker to be used when calculating payroll;
• Employee bank account details.

Master file controls
The purpose of master file controls is to ensure the ongoing integrity of the standing data contained in the master
files. It is vitally important that stringent ‘security’ controls should be exercised over all master files. These include:
– Appropriate use of passwords, to restrict access to master file data
– The establishment of adequate procedures over the amendment of data, comprising appropriate segregation
of duties, and authority to amend being restricted to appropriate responsible individuals
– Regular checking of master file data to authorised data, by an independent responsible official

Limitations of internal control components
The internal control system, even if well‐designed and well‐implemented, does not completely eliminate the
possibility of fraud or error. No internal control system can be perfect due to its inherent limitations.
- Controls are far more expensive compared to the benefits from the system.
- Overriding of controls by the management.
- Control systems are not geared up to cater to non‐routine transactions.
- Possibility of human error.
- Possibility of fraud on account of collusion between employees.
- Possibility that, with a change in conditions, a control may not be modified and therefore may become
inadequate.
- Obsolescence of controls.

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Responsibilities of various parties regarding ICS
Management: design and implement and effective ICS. Check and ensure it is working effectively on a continuous
basis.

BOD: ensure that an effective ICS is designed, implemented and monitored by the management. Ensure ICS are
reviewed by internal and external auditors and their recommendations are implemented

Auditors: review and report on ICS and recommend changes

External auditor’s work regarding controls
Document/Evaluate Narratives
Narrative notes consist of a written description of the system; they would detail what
occurs in the system at each stage and would include any controls which operate at
each stage.

Advantages of this method include:
– They are simple to record; after discussion with staff members of Oregano, these
discussions are easily written up as notes.
– They can facilitate understanding by all members of the internal audit team,
especially more junior members who might find alternative methods too complex.

Disadvantages of this method include:
– Narrative notes may prove to be too cumbersome, especially if the sales and
distribution system is complex.
– This method can make it more difficult to identify missing internal controls as the
notes record the detail but do not identify control exceptions clearly.

Flowcharts
Flowcharts are a graphic illustration of the internal control system for the sales and
despatch system. Lines usually demonstrate the sequence of events and standard
symbols are used to signify controls or documents.

Advantages of this method include:
– It is easy to view the sales system in its entirety as it is all presented together in
one diagram.
– Due to the use of standard symbols for controls, they are easy to spot as are any
missing controls.
– Information is presented in a logical sequence.
– They ensure that a system is recorded in its entirety as all documents have to be
traced from beginning to end.
– Facilitates easy understanding of a system.
– Facilitates the highlights of strengths and weaknesses of a system.
– Serves as a permanent record of a system that can be subject to a minor
amendment on a year‐to‐year basis.
– They can be prepared quickly by staff with little experience.

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Disadvantages of this method include:
– They can sometimes be difficult to amend, as any amendments may require the
whole flowchart to be redrawn.
– There is still the need for narrative notes to accompany the flowchart and hence it
can be a time consuming method.
– Not generally suitable for recording systems with numerous unusual transactions.
– Only suitable for describing standard systems.
– Major amendment is not normally possible without redrawing.
– Time can be wasted by recording and checking areas that are of no audit
significance.
– They are not normally appropriate for recording systems where there are
subsystems or subroutines.

Questionnaires
Internal control questionnaires are used to assess whether controls exist which meet
specific objectives or prevent or detect errors and omissions.
- ICQ( designed to ask if certain controls are present)
- ICEQ (designed to ask if certain errors can be prevented‐i.e. test the effectiveness
of controls)

An Internal Control Questionnaire (ICQ) normally comprises a checklist of standard
controls that should exist in a specified functional area (for example sales and trade
receivables or purchases and trade payables). Questions about the existence of
specified controls are usually phrased to generate a ‘Yes’ or a ‘No’ answer, with an
affirmative answer confirming the existence of the control and a negative answer
indicating the absence of the control and a weakness in the system.

A problem associated with ICQs is that whilst they do identify areas where controls
appear to be weak, they do not provide evaluation of those weaknesses. For example,
whilst a ‘No’ answer may indicate weakness in controls, it is possible that other controls
in the system, of which the auditor is unaware, may compensate for the weakness.

Internal Evaluation Questionnaires (ICEQs) provide an alternative and improved means
of evaluating control systems, by asking key questions about those systems. Key
questions are phrased such that answers in the positive should alert the auditor to the
fact that there are deficiencies in the systems because systems objectives are not being
met. ICEQs are usually designed to include a list of points that the auditor should
consider before answering each key question.

The auditor issues the questionnaires to the client, who in turn gets it filled by the
appropriate employees. The feedback on the questionnaire enables the auditor to
assess the inherent limitations in the design of the internal controls.

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The ICEQs contain detailed questions relating to the functioning of internal controls.
They are to be answered by the clients. The answers to the questions are generally in
a narrative form.

Information relating to the following matters is included the ICQs and ICEQs:
– Segregation and rotation of duties
– Maintenance of records and documents
– Accountability for, and safeguarding of assets
– Procedure for authorisations

The feedback received on the questionnaires will then be tested by the auditors and
the weaknesses, if any, will be communicated in the form of a letter of weakness to the
client.

Advantages
Questionnaires are quick to prepare, which means they are a cost effective method for
recording the system.

They ensure that all controls present within the system are considered and recorded;
hence missing controls or deficiencies are clearly highlighted.

Questionnaires are simple to complete and therefore any members of the team can
complete them and they are easy to use and understand.

Disadvantages
It can be easy for the company to overstate the level of the controls present as they
are asked a series of questions relating to potential controls.

Without careful tailoring of the questionnaire to make it company specific, there is a
risk that controls may be misunderstood and unusual controls missed.

Test! Test of controls are performed to obtain audit evidence about 2 things:
1. Whether the ICS is designed suitably (to prevent, detect or correct material
misstatements)
2. Whether the ICS are operating properly ( test of controls)

Test of controls‐ examples
– inspection of documents (e.g. authorizations)
– enquiries about internal controls which leave no audit trail ( e.g. is the person who
is SUPPOSED to perform the function actually performing it or is someone else is
doing so)
– Re‐performance of control procedures ( e.g. reconciliations)
– examination of evidence of management views(e.g. minutes of meetings)
– Observation of controls
– Using TEST DATA(CAATs)

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If controls appear strong, they are tested to ensure they operated as described
throughout the year. If the results show they operated effectively, substantive testing
may be reduced.

Report control A letter on internal control (also referred to as a management letter or letter of
weaknesses to weakness) is a letter usually forwarded by an auditor to the senior management of a
management company.
The letter should normally be forwarded immediately following the completion of the
tests of control and before the commencement of substantive procedures.

The letter contains weaknesses identified in the entity’s system of internal control as
identified by the auditor when performing tests of control and the purpose of the letter
is to bring these weaknesses to the attention of management.

The weaknesses identified in the main body of the letter should be those which could
lead to fraud or material error in or omission from the company’s financial statements,
and will be classified as those relating to:
(i) The design of the systems of accounting and internal control.
(ii) The operation of the systems of accounting and internal control.

For both categories the implication(s) of the weakness (es) should be identified,
however minor control issues which the auditor would wish to bring to the attention
of the company’s senior management should be included in an appendix to the letter
of weakness or in a supplementary report.

Examples of matters the external auditor should consider in determining whether a
deficiency in internal controls is significant include:
– The likelihood of the deficiencies leading to material misstatements in the financial
statements in the future.
– The susceptibility to loss or fraud of the related asset or liability, the subjectivity
and complexity of determining estimated amounts.
– The financial statement amounts exposed to the deficiencies.
– The volume of activity that has occurred or could occur in the account balance or
class of transactions exposed to the deficiency or deficiencies.
– The cause and frequency of the exceptions detected as a result of the deficiencies
in the controls.

Decide extent of Internal control over financial reporting strong‐ decrease substantive testing
substantive testing
Internal control over financial reporting weak‐ inccrease substantive testing

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Answer Technique

For deficiencies in the design of the system (weaknesses in the way the system has been made):
- Identify weakness from the scenario
- Explain the impact of the weakness on the organization ( think of the problem it can casue for the business or
the recording in the Financial statements etc)

For Test of controls (to confirm the operating effectiveness of internal control)
- Remember: the idea of TOCs is to simply confirm that are the systems actually being implemented the way
auditors were told (so confirm the ‘stories’ you were told!)
- Identidy the control from the scenario
- Think of a way to test it to confirm it was actually being followed

The Sales System

Control objectives for sales and despatch system
- To ensure that orders are only accepted if goods are available to be processed for customers.
- To ensure that all orders are recorded completely and accurately.
- To ensure that goods are not supplied to poor credit risks.
- To ensure that goods are despatched for all orders on a timely basis.
- To ensure that goods are despatched correctly to customers and that they are of an adequate quality.
- To ensure that all goods despatched are correctly invoiced.
- To ensure completeness of income for goods despatched.
- To ensure that sales discounts are only provided to valid customers.
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Sales order ‐ All sales orders documented on a sequentially numbered multi‐part SALES ORDER FORM.

placed ‐ Confirm from the customer ( preferably in writing except on telephonic sales, a verbal
reconfirmation/ call recording should be acceptable)
‐ Inventory check
‐ One copy of the GDN is sent with the goods, one copy stays in the warehouse, stapled to
the relevant sales order, and one copy is sent to the invoicing department.
‐ New customer: credit checks, the obtaining of trade/bank references and the setting of
appropriate credit limits for customers
‐ Existing customer: credit limit check, Customer credit limits should be regularly reviewed
and updated based on the level of sales transactions and credit risk
‐ Any discounts committed to be authorized
‐ Follow up on unfulfilled orders‐ On a regular basis, a sequence check of orders should be
undertaken to identify any missing orders.
‐ Automated environment: access to master file limited to authorized individuals only

Goods ‐ Sequentially pre‐numbered Goods Dispatched Note
dispatched to ‐ Matched to the sales order‐ Upon despatch, the GDN should be matched to the order; a
the customer regular review of unmatched orders should be undertaken to identify any unfulfilled
orders.
‐ Signed by the warehouse manager after quantity and quality checks
‐ 3 copies( warehouse, customer, accounts/invoicing)
‐ Customer should sign the copies to acknowledge receipt of goods

Sales invoice ‐ Sequentially pre‐numbered invoices
raised and ‐ Matched to GDN
entered in the ‐ 3 copies ( accounts/invoicing, customer, sales day book clerk if applicable)
accounting ‐ Ensure the authorized price list is used to prepare the invoice
system ‐ Any discounts authorized
‐ Arithmetic checks on invoices
‐ Sequence check on GDNs to ensure all GDNs have been invoiced
‐ Sequence check on Invoices to ensure all invoices have been entered in the accounting
system
‐ Customer statements should be sent monthly to ensure any errors and disputed invoices
are quickly identified and resolved
‐ The sales ledger control account should be reconciled on a monthly basis to the individual
ledger to identify any errors. The reconciliations should be reviewed by a responsible
official and they should evidence their review.

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Payment received from the customer Goods returned by the customer
‐ Match payment to invoice ‐ Sequentially pre‐numbered credit note
‐ Check validity of any settlement discounts ‐ Signed by the manager
availed by the customer ‐ Matched to invoice
‐ Segregation of duties: receiving payment ‐ Prepare a report for reasons for returns and actions taken
and recording by the management.
‐ Encourage bank transfers
‐ A Bank Reconciliation Statement should be
prepared on a monthly basis

Other controls Aged receivables report: prepare monthly and reviewed by a senior official.

Exceptions reports created and reviewed (old receivables, credit limit exceeded etc.)
Amendments to master file data should be restricted so that only senior officials can make
changes.

The Purchase System

The main objectives in purchase transactions are:
– Procurement is made only when the requirements are genuine.
– Purchases are made at the most optimum prices and terms.
– Purchases meet the required quality standards and if substandard quality is accepted, must be at negotiated
terms.
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– Payments are made according to agreed terms.
– They are procured on time and the payments are made according to agreed terms.

Purchase ‐ Sequentially pre‐numbered
requisition ‐ Authorized to ensure only those goods are ordered which are required
‐ Monitor inventory level or Re‐order level set
‐ Inventory/ re‐order level checked before raising the requisition to ensure only order when
required.

Purchase ‐ Sequentially pre‐numbered and matched to requisition
order ‐ Authorized supplier list used and updated annually (this should take into account the price
of goods, their quality and the speed of delivery.)
‐ Authorized
‐ 3 copies ( supplier, order department, warehouse)
‐ Follow up on order placed but not yet received ( exception reports can be created in a
computerized environment) and sequence check can be performed for any unfulfilled
orders

Goods ‐ Sequentially pre‐numbered GRN
received ‐ Matched to purchase order
‐ Signed by the warehouse manager after quantity and quality checks
‐ 3 copies ( ordering department, warehouse for their records, account)

Invoice ‐ Match to GRN
received from ‐ File in an order (CANNOT be sequentially pre‐numbered) but should be numbered
supplier manually. This way, a sequence check can then be carried out to ensure all invoices have
been entered in the day book/ledger.
‐ Arithmetic checks
‐ Entered in the ledger /day book on a daily basis‐application controls (such as control total)
should be applied to ensure completeness and accuracy over the input of purchase
invoices.
‐ Stamp ‘entered’ when recorded
‐ Segregation of duties ( order placement, goods received and recording)
‐ Monthly reconciliation: PL to PLCA

Payment made Goods returned to the supplier
‐ Segregation of duties ( Purchase order, goods ‐ Sequentially pre‐numbered debit notes
received, payment ) ‐ Authorized
‐ Before approving invoices for payment, a senior ‐ Vendor‐wise analysis to identify consistent quality
official should match them to the audit trail ( esp. problems
the GRN)
‐ Bank transfer preferred
‐ If payment by cheque: senior individuals only plus
two signatories for high amounts
‐ Stamp invoice ‘paid’
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‐ Try and avail settlement discounts and pay

according to supplier’s terms to maintain supplier
goodwill
‐ Payment against specific invoices only ( avoid ‘on
account payment’)
‐ Supplier statement reconciliation with PL
‐ PL reconciliation with PLCA
‐ Monthly BRS

Examples of application Document counts – the number of invoices to be input are counted, the invoices are
controls to ensure the then entered one by one, at the end the number of invoices input is checked against
Completeness and the document count. This helps to ensure completeness of input.
accuracy of the input of
purchase invoices. Control totals – here the total of all the invoices, such as the gross value, is manually
calculated. The invoices are input, the system aggregates the total of the input
invoices’ gross value and this is compared to the control total. This helps to ensure
completeness and accuracy of input.

One for one checking – the invoices entered into the system are manually agreed
back one by one to the original purchase invoices. This helps to ensure completeness
and accuracy of input.

Check digits – this control helps to reduce the risk of transposition errors.
Mathematical calculations are performed by the system on a particular data field,
such as supplier number, a mathematical formula is run by the system, this checks
that the data entered into the system is accurate. This helps to ensure accuracy of
input.

Range checks – a pre‐determined maximum is input into the system for gross invoice
value, for example, $10,000; when invoices are input if the amount keyed in is
incorrectly entered as being above $10,000, the system will reject the invoice. This
helps to ensure accuracy of input.

Existence checks – the system is set up so that certain key data must be entered, such
as supplier name, otherwise the invoice is rejected. This helps to ensure accuracy of
input.

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The Payroll System

The main objective of a payroll is to ensure that:
– Wages and salaries are paid at the correct rates.
– Wages and salaries are paid to the right people.
– Wages and salaries are paid on time.

Key terms: 1. Clock cards/ timesheets 2.Payroll sheet 3.Pay slips 4.Bank Transfer List/payment list (instructions to
the bank)

Appointment/ leavers
‐ Appointments: All appointment of staff, whether temporary or permanent, should only be made by the human
resources department, separate from the payroll department

‐ There should be formal procedures requiring the interviews manager to provide detailed written notification to
a responsible official (for example the wages supervisor) of starters and leavers.

‐ Update ‘starters and leavers’ details on a timely basis. Procedures should ensure that ‘starters’ and ‘leavers’
details are added to or deleted from the master file immediately after starting or leaving the company’s
employment.

‐ All increases of pay should be proposed by the HR department and then formally agreed by the board of
directors.

‐ Standing data in the master file:
 ‘Read’ and ‘amend’ access to the master file should be available from specified terminals to responsible
officials who have a need and authorised cause to access the information.
 Maintain a log of access attempts (Controls should include a computer log which registers date and time
access to the master file by the various users. This should regularly be reviewed by a senior responsible
official of the company)
 Match standing data to the personnel filed periodically

At random intervals a more senior responsible official of the company (for example the company accountant), should
access the wages master file and check its contents to the manual records maintained, input documentation and
notifications from the interviews manager as appropriate.

Calculations
‐ Clock cards sequentially pre‐numbered (which details the employee number and name)
‐ Clock card machine supervised or in open view (Staff attendance machine kept near the security gate (to ensure
that there are no dummy attendances recorded).
‐ Head count by area supervisor ( attendance matched to actual employees present)
‐ Any overtime worked reviewed and then authorized. This should be evidenced by signature on the employees’
overtime sheets.
‐ Periodic verification of staff cards with personal files of employees (to ensure that there are no ghost
employees).
‐ Data input: Use application and general IT controls ( for example range checks, passwords)
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‐ Gross pay, deductions, net pay:
 Preferably automatically calculated by the payroll system.
 Calculations re checked on a sample basis‐ A senior member of the payroll team should recalculate the
gross to net pay workings for a sample of employees and compare their results to the output from the
payroll system.

Payments
‐ Pay slips to be sequentially pre‐numbered
‐ Segregation of duties ( payroll sheet, recording, payment)
‐ Salaries:
 Preferably through bank transfer
 Bank transfer list/payment list matched to payroll sheet prior to authorising the bank payment.
 When authorising the payments, the responsible official should on a sample basis perform checks from
payroll records to payment list and vice versa to confirm that payments are complete and only made to
bona fide employees.
 Bank transfer list/payment list preferably authorized by someone other than the person who authorized
payroll ( for example the Finance Director)
‐ Wages (cash)/Pay packets
 All cash wages should only be paid upon sight of the employee’s clock card and photographic identification
as this confirms proof of identity.
 Uncollected wage packets should be kept in a safe place/ deposited in the bank

Revenue and Capital Expenditure

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Capital expenditure is incurred when a business spends money either to buy fixed assets or to add to the value of
an existing fixed asset.

Revenue expenditure is that expenditure which is incurred to maintain the existing capacity of an asset so that it
can do its daily work. Examples of revenue expenditure are cost of raw material and other stores, salaries and wages,
repairs and maintenance, stationery and printing, advertisements, postage, telephone, travel expenses etc.

The main control objectives over revenue and capital expenditure are to ensure that:
 All expenditure is authorised.
 Proper segregation of capital and revenue expenses is made.
 Expenses are properly accounted for.

The transaction cycle for capital and revenue expenditure is quite similar for purchases. However, certain additional
control points, which are to be ensured, are mentioned below:
 Am authorized budget is prepared for all expenditure.
 Preparation of a report of capital budget versus actual expenditure.
 Preparation of a periodic variance report of those expenses that do not match the budget.
 Orders for capital items should be authorised by appropriate levels of management.
 A document may be prepared for showing the distinction between capital and revenue expenditure and for
providing guidance on which expenses to be capitalised.
 All vouchers of revenue expenditure need to have approval of maintenance manager.
 A senior person should check the accounting treatment for the expenses (especially repairs and maintenance).

Non‐Current Asset register

The purpose of a tangible non‐current assets register is to list details of all the non‐current assets owned by an entity,
in order to facilitate control over those assets. Typically, the register should record cost, depreciation and net book
value information of each asset along with identifying details. For example in the case of plant and machinery – gross
cost, annual depreciation rate, depreciation provision, net book value, date of acquisition, serial number and
description and location of asset.
 The register should be updated by individuals who are separated from the acquisition, custody and disposal of
assets.
 Periodical reconciliation of non‐current register with the general ledger to be done and any differences to be
investigated.
 Preparation of an exception report if the non‐current register does not match the non‐current assets account
maintained in accounts.
 Invoices should bear appropriate ledger code (distinguishing revenue items from capital expenditure) in order
to facilitate correct recording.
 Depreciation rates should be reasonable and authorised.
 Depreciation calculations should be checked
 NCA register should be used to confirm physical existence on a periodic basis
 To ensure completeness of recording, periodic checks should be made to ensure that assets in existence are
completely recorded in the register.

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Bank and Cash

The main objectives of cash and bank transactions are to ensure that:
 All money received is recorded.
 All money received is banked.
 Money is properly safeguarded.
 Payments are made to correct persons and properly recorded.

Controls over Cash receipts

‐ Regular review of internal control over cash receipts and payments should be conducted by the Internal Audit
Department

‐ On a daily basis, cash received should be matched with the sales made. This should be done for each till
separately

‐ Cash should be banked with proper security on a daily basis

‐ Match bank deposit slips with the cash and cheque receipt register.

‐ Access to the cash tills should be restricted to authorized individuals only

‐ Monthly bank reconciliation statements should be performed and differences to be investigated.These should
be reviewed by senior officials.

‐ Segregation of duties between the person receiving the money, the person depositing it in the bank and the
one making the payments.

‐ Receivables’ ledger reconciled with control account.

‐ Surprise cash counts by personnel other that the accounts department.

‐ Cash to be suitably insured for cash in hand, and cash in transit.

‐ Unused cheques to be kept under lock and key.

‐ Cheques books to be in the custody of a responsible person

‐ Minimum cash balance to be maintained needs to be decided. Whenever cash balance exceeds minimum
balance, excess balance deposited to be in the bank.

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Main controls on bank and cash
 Segregation of duties between the person receiving the money, the person depositing it in the bank and the
one making the payments.
 Match bank deposit slips with the cash and cheque receipt register.
 Daily cash receipts immediately recorded in the customers’ accounts.
 Cash receipt register reconciled daily with the customer accounts.
 Periodical management review of the register is to be conducted to ensure that cheques are promptly deposited
into the bank.
 Bank reconciliation to be prepared periodically and differences to be investigated.
 Receivables’ ledger reconciled with control account.
 Cash kept under the custody of the cashier. And there should be restricted access to cashier’s room
 Security personnel to accompany the cashier while depositing or withdrawing cash from the bank
 Minimum cash balance to be maintained needs to be decided.
 Whenever cash balance exceeds minimum balance, excess balance deposited to be in the bank.
 Surprise cash counts by personnel other that the accounts department.
 Cash to be suitably insured for cash in hand, and cash in transit.
 Unused cheques to be kept under lock and key.
 Cheques books to be in the custody of a responsible person

Writing the answers for deficiencies

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Test of controls
In the exam, you might be asked to:
‐ Identify and explain deficiencies in the system
‐ Recommend a control to address each of these deficiencies
‐ Describe a TEST OF CONTROL the external auditors would perform to assess if each of these controls, if
implemented, is operating effectively.

What is a Test of Control? An audit procedure designed to evaluate the operating effectiveness of controls in
preventing, or detecting and correcting, material misstatements at the assertion level.

Examples of test of controls ( also mentioned earlier):
– inspection of documents (e.g. authorizations)
– enquiries about internal controls which leave no audit trail ( e.g. is the person who is SUPPOSED to perform the
function actually performing it or is someone else is doing so)
– Reperformance of control procedures ( e.g. reconciliations)
– examination of evidence of management views(e.g. minutes of meetings)
– Observation of controls
– Using TEST DATA(CAATs)

If you are confused about how to word a TOC, start with “The auditor should….”

Example from a past exam
Deficiency Control Test of Control
Customer credit limits are set by Credit limits should be set by a The auditor should take a sample of
sales ledger clerks. senior member of the sales ledger new customers accepted in the year
department and not by sales ledger and review the authorisation of the
Sales ledger clerks are not clerks. These limits should be credit limit, and ensure that this was
sufficiently senior and so may set regularly reviewed by a responsible performed by a responsible official.
limits too high, leading to official.
irrecoverable debts, or too low, And/or
leading to a loss of sales.
The auditor should enquire of sales
ledger clerks as to who can set
credit limits.

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Another example from a past exam
Deficiency Control Test of Control
Supplier statement reconciliations Supplier statement reconciliations The auditor should review the file
are no longer performed. should be performed on a monthly of reconciliations to ensure that
basis for all suppliers and these they are being performed on a
This may result in errors in the should be reviewed by a responsible regular basis and that they have
recording of purchases and official. been reviewed by a responsible
payables not being identified in a official.
timely manner.

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Management Assertions AA Revision Notes
Management Assertions

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Management is responsible for the preparation of financial statements that give a true and fair view, but what does
this really mean?

For each item in the financial statements, management is making assertions.

The auditors need evidence that these financial statements are valid!

‘In representing that the financial statements are in accordance with the applicable financial reporting framework,
management implicitly or explicitly makes assertions regarding the recognition, measurement and presentation
of classes of transactions and events, account balances and disclosures’.

Consequently auditors use these assertions when considering the potential types of misstatements that may
occur and when designing and performing appropriate audit procedures.

Transactions include sales, purchases, and wages paid during the accounting period.

Account balances include all the asset, liabilities and equity interests included in the statement of financial position
at the period end.

ISA 315, Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its
Environment identifies the following assertions:
1. Assertions about classes of transactions and events and related disclosures for the period under audit
2. Assertions about account balances and related disclosures at the period end

Assertions about classes of transactions and events and related disclosures for the period under audit

1. Occurrence – the transactions and ‐ This means that the transactions recorded or disclosed actually
events that have been recorded or happened and relate to the entity. For example that a recorded
disclosed, have occurred, and such sale represents goods which were ordered by valid customers
transactions and events pertain to the and were despatched and invoiced in the period. An alternative
entity. way of putting this is that sales are genuine and are not
overstated.

‐ Relevant test – select a sample of entries from the sales
account in the nominal ledger and trace to the appropriate
sales invoice and supporting goods despatched notes and
customer orders.

2. Completeness – all transactions and ‐ No omission
events that should have been
recorded have been recorded and all ‐ Relevant test – select a sample of customer orders and check
related disclosures that should have to despatch notes and sales invoices and the posting to the
been included in the financial sales account in the nominal ledger.
statements have been included.

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Note the difference in the direction of the above test. In order to
test completeness the procedure should start from the underlying
documents and check to the entries in the relevant ledger to ensure
none have been missed. To test for occurrence the procedures will
go the other way and start with the entry in the ledger and check
back to the supporting documentation to ensure the transaction
actually happened.

3. Accuracy – amounts and other data ‐ This means that there have been no errors while preparing
relating to recorded transactions and documents or in posting transactions to ledgers. The new
events have been recorded reference to disclosures being appropriately measured and
appropriately, and related disclosures described means that the figures and explanations are not
have been appropriately measured misstated.
and described.
‐ Relevant test – calculation checks on invoices, payroll, etc, and
the review of control account reconciliations are designed to
provide assurance about accuracy.

4. Cut–off – transactions and events ‐ That transactions are recorded in the correct accounting
have been recorded in the correct period.
accounting period.
‐ Relevant test – recording last goods received notes and
despatch notes at the inventory count and tracing to purchase
and sales invoices to ensure that goods received before the
year–end are recorded in purchases at the year end and that
goods despatched are recorded in sales.
5. Classification – transactions and ‐ Transactions recorded in the appropriate accounts – for
events have been recorded in the example,the purchase of raw materials has not been posted to
proper accounts. repairs and maintenance.

‐ Relevant test – check purchase invoices postings to nominal
ledger accounts.

6. Presentation – transactions and ‐ This means that the descriptions and disclosures of transactions
events are appropriately aggregated are relevant and easy to understand. There is a new reference
or disaggregated and clearly to transactions being appropriately aggregated or
described, and related disclosures are disaggregated. Aggregation is the adding together of individual
relevant and understandable in the items. Disaggregation is the separation of an item, or an
context of the requirements of the aggregated group of items, into component parts. The notes to
applicable financial reporting the accounts are often used to disaggregate totals shown in the
framework. profit or loss account. Materiality needs to be considered when
judgements are made about the level of aggregation and
disaggregation
.
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‐ Relevant test – check the total employee benefits expense is
analysed in the notes to the financial statements under
separate headings– ie wages and salaries, pension costs, social
security contributions and taxes, etc.

Assertions about account balances and related disclosures at the period end

1. Existence – assets, liabilities and ‐ Means that assets and liabilities really do exist and there has
equity interests exist. been no overstatement – for example,by the inclusion of
fictitious receivables or inventory. This assertion is very closely
related to the occurrence assertion for transactions.

‐ Relevant tests – physical verification of non–current assets,
circularisation of receivables, payables and the bank letter.

2. Rights and obligations – the entity ‐ Means that the entity has a legal title or controls the rights to
holds or controls the rights to assets, an asset or has an obligation to repay a liability.
and liabilities are the obligations of
the entity ‐ Relevant tests – in the case of property, deeds of title can be
checked. Current assets are often checked to purchase invoices
although these are primarily used to confirm cost. Long term
liabilities such as loans can be checked to the relevant loan
agreement.

3. Completeness – all assets, liabilities ‐ That there are no omissions and assets and liabilities that
and equity interests that should have should be recorded and disclosed have been. In other words
been recorded have been there has been no understatement of assets or liabilities.
recorded and all related disclosures
that should have been included in the ‐ Relevant tests – A review of the repairs and expenditure
financial statements have been account can sometimes identify items that should have been
included. capitalised and have been omitted from non–current assets.
Reconciliation of payables ledger balances to suppliers’
statements is primarily designed to confirm completeness
although it also gives assurance about existence.

4. Accuracy, valuation and allocation ‐ Means that amounts at which assets, liabilities and equity
– assets, liabilities and equity interests interests are valued, recorded and disclosed are all appropriate.
have been included in the financial The reference to allocation refers to matters such as the
statements at appropriate amounts inclusion of appropriate overhead amounts into inventory
and any resulting valuation or valuation.
allocation adjustments have been
appropriately recorded and related ‐ Relevant tests – Vouching the cost of assets to purchase
disclosures have been appropriately invoices and checking depreciation rates and calculations.
measured and described.
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5. Classification – assets, liabilities and ‐ Means that assets, liabilities and equity interests are recorded

equity interests have been recorded in in the proper accounts.
the proper accounts.
‐ Relevant tests – the test for transactions of checking purchase
invoice postings to the appropriate accounts in the nominal
ledger will be relevant again. Also that research expenditure is
only classified as development expenditure if it meets the
criteria specified in IAS 38.

6. Presentation – assets, liabilities and ‐ This means that the descriptions and disclosures of assets and
equity interests re appropriately liabilities are relevant and easy to understand. The points made
aggregated or disaggregated and above aggregation and disaggregation of transactions also
clearly described, and related apply to assets, liabilities and equity interests.
disclosures are relevant and
understandable in the context of the ‐ Relevant tests – auditors often use disclosure checklists to
requirements of the applicable ensure that financial statement presentation complies with
financial reporting framework. accounting standards and relevant legislation. These cover all
items (transactions, assets, liabilities and equity interests) and
would include for example checking that disclosures relating to
non–current assets include cost, additions, disposals,
depreciation, etc.

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Methods for testing these assertions/
Procedures to obtain evidence/
Sources of evidence

Audit evidence verifies the correctness of the assertions contained in the financial statements. Audit evidence can
be obtained from different sources.

Inspection Inspection involves examining Example – the physical inspection of a freehold office
records or documents, whether building to verify existence of the building.
internal or external, in paper form,
electronic form, or other media, or a Example – the examination of a purchase invoice to
physical examination of an asset. vouch the validity of an entry in the trade creditors
ledger.
Observation Observation consists of looking at a Example – the observation of the counting of
process or procedure being inventory by an entity’s personnel to ensure that they
performed by others are counted in accordance with procedures
authorised by the management of the entity.

Example – the observation of the opening of the mail
of an entity to ensure that at least two employees are
present to receive and witness the receipt of monies
received by the entity.
Analytical Analytical procedures consist of Example – the calculation of the average
procedures evaluations of financial information remuneration (total wages and salaries divided by
through analysis of plausible total employees) paid to the employees of an entity,
relationships among both financial to assess the reasonableness of the reported wages
and non‐financial data. Analytical and salaries costs as compared to a previous
procedures also encompass such equivalent period.
investigation as is necessary of
identified fluctuations or Example – the calculation of an entity’s trade creditors
relationships that are inconsistent ratio to help assess the reasonableness of bad debt
with other relevant information or provisions, the effectiveness of credit control and the
that differ from expected values by a possibility of under/over statement of reported sales.
significant amount.

Assertions normally tested by the
analytical procedures are
Completeness, Accuracy, Valuation
and Classification

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Inquiry Inquiry consists of seeking Example‐ inquire of the management whether they
information of knowledgeable have opened/closed any bank accounts during the
persons, both financial and non‐ year.
financial, within the entity or outside
the entity.
External An external confirmation represents Example – direct confirmation of a trade receivables
confirmation audit evidence obtained by the balance – to verify the existence of a trade receivables
auditor as a direct written response balance.

to the auditor from a third party, in
paper form, electronic form or by Example – letter from a loan company, confirming the
other medium. balance outstanding on a loan – to verify the loan
liability of the company.

Example – a certificate from a specialist, confirming
the value of specific inventories held – to verify the
valuation of inventories.

Recalculation Recalculation consists of checking the Example – checking the accuracy of inventory
mathematical accuracy of documents calculations to verify the accuracy of the valuation of
or records. Recalculation may be reported inventory.
performed manually or electronically.

Re‐ Re‐performance involves the Example – Using computer assisted audit techniques
performance auditor’s independent execution of to re‐perform the ageing of accounts receivable
procedures or controls that were balances.
originally performed as part of the
entity’s internal control. Example – Re‐performing the extraction of a trial
balance from the company’s general ledger.

Example‐Re‐perform the year end bank reconciliation
to ensure the process was undertaken accurately.

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Sufficient Appropriate evidence

The term ‘audit evidence’ describes the information obtained by the auditors in arriving at the conclusions on which
the audit opinion is based.

Audit evidence comprises source documents and accounting records underlying the financial statements (subject to
audit) and corroborating information from other sources.

The auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which
to base the audit opinion.

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Sufficient Factors affecting sufficiency

(quantity of evidence)
1. Assessment of risk at the financial statement level and/or the individual
transaction level. As risk increases then more evidence is required.

2. The materiality of the item. More evidence will normally be collected on
material items whereas immaterial items may simply be reviewed to ensure
they appear correct.

3. The nature of the accounting and internal control systems. The auditor will
place more reliance on good accounting and internal control systems limiting
the amount of audit evidence required.

4. The auditor’s knowledge and experience of the business. Where the auditor
has good past knowledge of the business and trusts the integrity of staff then
less evidence will be required.

5. The findings of audit procedures. Where findings from related audit
procedures are satisfactory (e.g. tests of controls over receivables) then
substantive evidence will be collected.

6. The source and reliability of the information. Where evidence is obtained
from reliable sources (e.g. written evidence) then less evidence is required
than if the source was unreliable (e.g. verbal evidence).

Appropriate Reliability of evidence
(quality of evidence)
Following are the factors that influence the reliability of audit evidence:

1. Audit evidence is more reliable when it is obtained from independent sources
outside the entity.

2. Audit evidence that is generated internally is more reliable when the related
controls imposed by the entity are effective.

3. Audit evidence obtained directly by the auditor (for example, observation of
the application of a control) is more reliable than audit evidence obtained
indirectly or by inference (for example, inquiry about the application of a
control).

4. Audit evidence is more reliable when it exists in documentary form, whether
paper, electronic, or other medium.

5. Audit evidence provided by original documents is more reliable than audit
evidence provided by photocopies or facsimiles.

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6. Evidence created in the normal course of business is better than evidence
specially created to satisfy the auditor.

7. The best‐informed source of audit evidence will normally be management of
the company (although management’s lack of independence may reduce its
value as a source of such evidence).

8. Evidence about the future is particularly difficult to obtain and is less reliable
than evidence about past events.

Relevance of evidence: Audit evidence should be relevant to the area/ assertions
being tested.

Substantive procedure

Substantive procedure is an audit procedure which is designed to detect material misstatements at the assertion
level.

Substantive procedures (or substantive tests) are those activities performed by the auditor that gather evidence as
to the completeness, validity and / or accuracy of account balances and underlying classes of transactions and
related disclosures.

Substantive procedures comprise the following
a) Analytical procedures

b) Tests of details (of classes of transactions, account balances, and related disclosures)

a) Analytical procedures
Analytical procedures mean the analysis of significant ratios and trends. It also involves the investigation of
resulting fluctuations and inconsistent relationships. ISA 520 Analytical Procedures states that analytical
procedures may be applied as substantive procedures. For many areas of the audit the substantive procedures
will be a combination of tests of details and analytical procedures. The decision about which procedures to use
will be based on the auditor’s judgement about the expected effectiveness and efficiency of the available
procedures.

The auditor will need to consider :
‐ The suitability of analytical procedures to a particular assertion
‐ The reliability of the data from which the expected amounts or ratios are developed
‐ Whether the expectation is sufficiently precise to identify a material misstatement

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b) Test of detail
Test of detail is carried out for transactions and balances.

Details of transaction
These are tests to obtain evidence of individual debits and credits that make up an account to reach a conclusion
about the account.

The tests can be made through tracing and vouching of transactions.

Tracing: Supporting documents traced to records/account books

Vouching: Records/account books vouched/verified by matching to relevant supporting documents

Important!

Attempting Questions on Audit Evidence or Audit Procedure

Mini‐case studies might be given in the exam
Audit procedures are actions that auditors carry out during the audit. They are also known as ‘audit tests’ or ‘audit
work’.

Audit evidence is obtained by the auditor as a result of the audit procedure.
For example, ‘performing a circularisation of receivables/debtors’ is an audit procedure, whereas ‘replies from
customers’ is audit evidence.

Deciding on audit procedure
For each scenario:
1. Think about how the accountant would have:
 calculated the numbers in the financial statements,
 the source documents used and
 the systems followed, and then write about the documents etc., that one would expect to see.
2. Think about how to verify the other relevant facts in each case.
3. Consider the accounting/disclosure requirements of each scenario, and say how one can check if they are being
met.
Answer Technique

‐ Read the mini‐case carefully
‐ Pick up hints regarding which assertions are being talked about (for example, is there a completeness issue or
an accuracy issue?
‐ Think of procedures related to that assertion
‐ Tailor them to the scenario
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Procedures on Specific Areas AA Revision Notes
Procedures on Specific Areas

Substantive on Receivables Key risk: overstatement

Receivables circularization (3rd party confirmation of receivables)

Types of receivable confirmation letters
1. Positive confirmation: Receivable asked to agree or disagree with the stated balance or write the balance
owing.

2. Negative confirmation: Receivable asked to reply only if he disagrees with the balance. This type of confirmation
should only be used when:
 The audit client has a strong internal control system over sales and trade receivables.
 Other good corroborative evidence with regard to the existence of trade receivables has already been
obtained from other tests carried out.
 There are a large number of small balances.
 A substantial number of errors is not expected.

Method of sending confirmation letter
1. Obtain the receivables ledger and reconcile it to the control account
2. Select a sample of debtors to be circularized
3. Inform the client of the intended list.
4. Get the details of the debtors and prepare letters on client’s letterhead.
5. Get the letter signed by a senior person at the client.
6. Record names and amount circularized
7. Post/fax letters ensuring the replies are sent directly to the auditor.
8. Record replies received and test the ones not agreed.
9. For non‐replies:
- With the client’s permission, the team should arrange to send a follow up circularisation.
- If the receivable does not respond to the follow up, then with the client’s permission, the senior should
telephone the customer and ask whether they are able to respond in writing to the circularisation request.
- If there are still non‐responses, then the auditor should undertake alternative procedures to confirm
receivables. These procedures include verifying post year end receipts from that customer, verifying order
placement and dispatch documentation and carrying out bad debt procedures

10. For responses with differences:
i. The auditor should identify any disputed amounts, and identify whether these relate to timing differences
or whether there are possible errors in the records of the client.
ii. Any differences due to timing, such as cash in transit, should be matched with cash received after the
year end
iii. The receivables ledger should be reviewed to identify any possible mispostings as this could be a reason
for a response with a difference.
iv. If any balances have been flagged as disputed by the receivable, then these should be discussed with
management to identify whether a write down is necessary

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Substantive testing

Existence 1. Circularization of a sample of period end receivables (discussed above)
2. Verify audit trail from records to source document: Select a sample of year‐end
The receivable actually receivable balances and agree back to valid supporting documentation of GDN
exists and sales order to ensure existence
Accuracy, valuation, 1. Circularization of a sample of period end receivables (discussed above)
allocation 2. Invoice: inspect and recalculate
3. Recoverability procedures ( bad debts):
Receivables are included in  Select a significant sample of receivables and review whether there are
the financial statements at any after date cash receipts(ensure that a sample of slow moving/old
the correct amount receivable balances is also selected)
 Review the aged receivable ledger to identify any slow moving or old
receivable balances, discuss the status of these balances with the credit
controller to assess whether they are likely to pay
 Calculate average receivable days and compare this to prior year,
investigate any significant differences
 Review customer correspondence to identify any balances which are in
dispute or unlikely to be paid.
 Review board minutes to identify whether there are any significant
concerns in relation to payments by customers.

4. Allowance for doubtful debts:
 recalculate to ensure it is accurate
 ensure rationale/basis reasonable and in line with your understanding of
the client’s business
 written representation from management that the basis/assumptions are
reasonable and that the allowance is adequate.
 Inspect post year‐end sales returns/credit notes and consider whether an
additional allowance against receivables is required.

Rights & obligation 1. Circularization of a sample of period end receivables (discussed above)
2. Invoice: inspect to confirm right over the receivable
The receivable belongs to
the client
Completeness 1. Verify audit trail from source document to record:
 Select a sample of GDNs and agree to valid supporting documentation of
There has been no omission invoice.
in recording of receivables  Ensure these invoices have been entered in the day books and individual
ledgers.
 Ensure the individual ledger is reconciled with the control account)
2. Compare ratios/balances of this period to prior periods and budgets,
investigate any significant differences.
3. Ensure all disclosures relevant to receivables have been made.

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SALES/REVENUE
1. Select a sample of invoices:
a) Recalculate them to confirm their arithmetical accuracy.
b) Recalculate discounts to ensure accuracy.
c) Match rates/prices to standard price list to confirm accuracy

2. Completeness: Select a sample of trade customer orders placed and agree these to the despatch notes and sales
invoices through to inclusion in the sales ledger to ensure completeness of revenue.

3. Cut‐off: Note down the last GDN for the year. Take a sample of GDNs immediately before AND after the year
end and ensure they are recorded in the correct accounting period

4. Analytical procedure: Compare the overall level of revenue against prior years and budget and investigate any
significant fluctuations.

5. Analytical procedure: Calculate the gross profit margin for Heraklion Co and compare this to the prior year and
investigate any significant fluctuations.

6. Select a sample of credit notes raised, trace through to the original invoice and ensure invoice correctly removed
from sales.

Substantive testing: Inventory‐ Key risk: overstatement

Auditor’s work before the Inventory count
1. Review the prior year audit files to identify whether there were any particular warehouses/areas where
significant inventory issues arose last year
2. Discuss with management whether any of the warehouses this year are new, or have experienced significant
control issues.
3. Consider locations. Ensure all locations are covered OR decide locations the audit team members will attend,
basing this on materiality and risk of each site.
4. Obtain a copy of the proposed inventory count instructions, review them to identify any control deficiencies
and if any are noted, discuss them with management prior to the counts.
5. Arrange to verify any inventory held by 3rd party
6. Establish whether expert help is needed
7. If an internal audit department exists, discuss the procedures that they carried out and review their working
papers.

The following matters should be covered in the instructions for the physical inventory count:
1. There should be adequate supervisory controls, with one individual assuming overall responsibility for the
inventory count.
2. Employees involved in the inventory count should be independent of those working in the stores and
production areas
3. Counters should work in pairs with one counting inventory and the other recording and checking quantities
counted.
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4. Procedures should ensure that items are marked or tagged as ‘counted’ to avoid the possibility of double
counting or omission.
5. There should be adequate control over the issue and returning of inventory control sheets, possibly involving
the use of pre‐numbered sheets with returned sheets being agreed to issued sequences for completeness.
6. Inventory sheets should be completed in ink and signed by the relevant individuals involved in the counting
and recording process.
7. Movement of inventory during the count should be prohibited where possible and a special quarantine area
should be created in which to store any goods received.
8. In order to minimise disruption to the production process, raw materials together with parts and finished
goods inventories should be counted first with work‐in‐progress inventory being counted at the end of the
working day.
9. There should be stringent controls over cut‐off issues with careful note being made of the number of the last
goods received, goods returned and goods despatched and raw materials/parts issued notes prior to the
inventory count.
10. There should be adequate procedures to identify, count and record inventory that is slow moving or obsolete.

During Inventory Count
The purpose of an auditor’s attendance at a client’s year‐end inventory count is to assess the effectiveness of the
client’s inventory counting procedures in order to determine whether reliance can be placed upon them to provide
assurance about the existence and condition of inventory.

Auditor’s procedures during the count
1. Observe the counting teams to confirm whether the inventory count instructions mentioned above are being
followed correctly.
2. Perform a test of controls (i.e. test the system used for recording, issuing inventory etc.)
3. Confirm the procedures for identifying and segregating damaged goods are operating correctly, and assess
inventory for evidence of any damaged or slow moving items.
4. Test the counts that are being done by the client’s representative‐ Perform two‐way testing: Match physical
stock with stock records(completeness) and records with physical stock(existence
5. Check cut‐off arrangements‐ Identify and make a note of the last goods received notes and goods despatched
notes for the year end in order to perform cut‐off procedures.
6. Note any inventory that is set aside or specially marked, providing possible indicators that inventory is not
owned by the company
7. Enquire as to the possibility of consignment or third party inventories being held by the company and record
appropriate notes for subsequent follow up
8. Obtain a photocopy of the completed sequentially numbered inventory sheets for follow up testing on the final
audit.

After Inventory Count
1. Discuss any weaknesses discovered during count with the management
2. Match final inventory sheets with the photocopies that you did at the time of inventory count‐ Check to ensure
that all sheets and records used at the inventory count are included in the final inventory count sheets and
records.
3. Ensure that slow‐moving and obsolete inventory lines recorded at the inventory count are properly highlighted
in the sheets and records to be used in the valuation process.
4. Follow‐up on any other matters recorded in working papers at time of count
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Substantive procedures
Completeness During the inventory count, take a sample of physical inventory and ensure it is completed
recorded in the records/inventory ledger
Existence During the inventory count, select a sample of inventory from the ledger and verify its
physical existence.
Rights and obligation 1. Inspect invoices/supporting documents to confirm right
2. IF there is any inventory at the 3rd party, confirmed it is owned by the client by
circularizing the 3rd party.
3. IF there is consignment stock, the agreement will need to be inspected to confirm
when risks and rewards(control) are transferred.
Accuracy, Valuation. 1. Select a representative sample of goods in inventory at the year end, agree the cost
Allocation per the records to a recent purchase invoice and ensure that the cost is correctly
stated.
2. For a sample of manufactured items obtain cost sheets and confirm:
 raw material costs to recent purchase invoices
 labour costs to time sheets or wage records
 overheads allocated are of a production nature.
3. Net Realisable Value:
a) For a sample of inventory, review post year end sales to see if adjustments are
required
b) For unsold items, discuss with mngt to determine whether they are slow moving
and provision has been created
c) Review aged inventory reports and identify any slow moving goods, discuss with
management why these items have not been written down
d) Perform a review of the average inventory days for the current year and
compare to prior year inventory days .Discuss any significant variations with
management.
e) Compare the gross margin for current year with prior year. Fluctuations in gross
margin could be due to inventory valuation issues. Discuss significant variations
in the margin with management.
f) Follow up any damaged/obsolete items noted by the auditor at the inventory
counts attended, to ensure that the inventory records have been updated
correctly
g) Determine estimated costs to completion. These costs represent another
important element of net realisable value. Determine costs to be incurred in
marketing, selling and distributing directly related to the items in question.
h) Get a written representation from the management that inventory has been
correctly valued.
4. WIP
a) Cast the schedule of total WIP and agree to the trial balance and financial
statements.
b) Obtain the costing records for a sample of WIP and:
 Agree labour costs to payroll;
 Agree labour hours to time sheets;
 Recalculate the overhead absorption rate
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5. Procedures to confirm use of standard costs for inventory valuation
a) Discuss with management the basis of the standard costs applied to the inventory
valuation, and how often these are reviewed and updated.
b) Review the level of variances between standard and actual costs and discuss with
management how these are treated.
c) Obtain a breakdown of the standard costs and agree a sample of these costs to
actual invoices or wage records to assess their reasonableness.

Cut‐off Note down the last GDN and GRN for the year. Take a sample of GDNs and GRNs
immediately before AND after the year end and ensure they are recorded in the correct
accounting period

Inventory Held by Third Parties
Where the entity has inventory that is held by third parties and which is material to the financial statements, the
auditor shall obtain sufficient appropriate audit evidence by performing one or both of the following:

 Direct confirmation from the third party regarding quantities and condition (in accordance with ISA 505 External
confirmations)

 Inspection or other appropriate audit procedures (if third party's integrity and objectivity are doubtful, for
example)

The other appropriate audit procedures referred to above could include the following:

Procedures to confirm inventory held at third party locations
1. Send a letter requesting direct confirmation of inventory balances held at year end from the third party
regarding quantities and condition.

2. Attend the inventory count (if one is to be performed) at the third party warehouses to review the controls in
operation to ensure the completeness and existence of inventory.

3. Inspecting documentation in respect of third party inventory (eg warehouse receipts)

4. Requesting confirmation from other parties when inventory has been pledged as collateral

Audit procedures for continuous (perpetual) inventory counts
In order that the company’s auditors may rely on the company’s revised continuous inventory checking system, the
auditor should ensure that:
I. Inventory records are kept up to date.
II. All inventory lines are counted at least once a year with higher value and desirable lines being counted more
frequently.
III. The counting of inventory is carried out by suitably experienced independent individuals in a systematic and
orderly manner.
IV. All corrections to inventory records are authorised by a responsible official of the company.
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V. Any material discrepancies noted between inventory records and physical quantities are investigated
immediately and reported to management for immediate further follow up as appropriate.
VI. There are satisfactory procedures with regard to cut‐off and receipt/issue documentation at the time of
inventory counts.

Procedures
1. The audit team should attend at least one of the continuous (perpetual) inventory counts to review whether
the controls over the inventory count are adequate.
2. The audit team should confirm that all of the inventory lines have been counted or are due to be
3. counted at least once a year by reviewing the schedules of counts undertaken/due to be undertaken.
4. Review the adjustments made to the inventory records on a monthly basis to gain an understanding of the level
of differences arising on a month by month basis.
5. If significant differences consistently arise, this could indicate that the inventory records are not adequately
maintained. Discuss with management how they will ensure that year‐end inventory will not be under or
overstated.
6. Consider attending the inventory count at the year end to undertake test counts of inventory from records to
floor and from floor to records in order to confirm the existence and completeness of inventory.

Substantive testing: Property, Plant & Equipment Key risk: overstatement

Completeness 1. Take a sample of physical assets and ensure they are completely recorded in the NCA
Register
2. Re‐perform the NCA Register reconciliation to the General Ledger
3. Obtain a breakdown of additions, cast the list and agree included in the non‐current
assets register to confirm completeness of PPE.
4. Review the repairs and maintenance ledger to ensure capital expenditure has not been
accidently expensed off
Existence 1. Select a sample of assets from the NCA Register and inspect them to verify their physical
existence
2. Ensure disposed‐off assets have been removed from the NCA Register as they no longer
exist.
Rights & Obligation 1. Inspect the ownership documents (title deeds, registration documents etc) to ensure
they are in client’s names.
2. Review insurance policies to confirm the asset is in client’s name.
Accuracy, valuation, Additions during the year
allocation 1. Select a sample of additions and agree cost to supplier invoice to confirm valuation.
2. Ensure all additions were authorized by inspecting the minutes of the board meetings
3. Review the list of additions and confirm that they relate to capital expenditure items
rather than repairs and maintenance.

Disposals during the year
1. Disposal proceeds matched to supporting documents such as invoices and to cash book
and bank statement
2. Verify that the correct cost and depreciation has been removed from the records
3. Recalculate profit/loss on disposal agree to the statement of profit or loss
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4. Check authorising documentation to ensure that the disposal was appropriately
authorised
5. Examine the sales documentation relating to the disposal and ensure that the sale
details match those in the authorising documentation.

Revaluation
1. Obtain a schedule of assets revalued this year and cast to confirm completeness and
accuracy of the revaluation adjustment.
2. Ensure all similar assets have been revalued
3. Verify depreciation has been calculated on the revalued amount
4. Agree the valuation to the expert’s report
5. Inspect the valuer’s report to ensure the valuer was skilled and independent
6. Agree the revalued amounts for these assets are included correctly in the non‐current
assets register.
7. Review the financial statements disclosures of the revaluation to ensure they comply
with IAS 16

Depreciation
1. Review the depreciation policy of the company to ensure that it is consistent and
appropriate(this can be done by comparison with last year and with industry practice)
2. recalculate and re‐perform depreciation charge to ensure its accuracy.
3. assess depreciation method is reasonable:
 compare with last year
 compare with industry practice
 review NCA Register with Net Book Value of zero which are still in use
 review NCA Register for excessive profit/loss on disposal. Enquire from the
management the reason for this.
4. enquire from the management whether they consider the depreciation method to be
reasonable‐ obtain a ‘written representation’
5. Review the disclosure of the depreciation charges and policies in the draft financial
statements.

General
Review the disclosure of the additions and disposals in the draft financial statements and
ensure it is in line with IAS 16 Property, Plant and Equipment.

Repairs and Maintenance

1. Obtain a schedule of the expenditure and cast to ensure accuracy.
2. For those items treated as capital and included with property, plant and equipment, agree to purchase invoices
and ascertain whether they are in fact of a capital nature.
3. For items treated as repairs, agree to invoices to ensure they are not of a capital nature and that they have been
correctly expensed to the statement of profit or loss (income statement).

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Intangible assets

1. Obtain and cast a schedule of intangible assets, detailing opening balances, amount capitalised in the
current year, amortisation and closing balances.
2. Agree the opening balances to the prior year financial statements.
3. Agree the closing balances to the general ledger, trial balance and draft financial statements.
4. Recalculate the amortisation charge for a sample of intangible assets and confirm it is line with the
amortisation policy.

Research and Development
1. For those expensed as research, agree the costs incurred to invoices and supporting documentation and to
inclusion in profit or loss.
2. For those capitalised as development, agree costs incurred to invoices and confirm technically feasible by
discussion with development managers or review of feasibility reports.
3. Review market research reports to confirm client has the ability to sell the product once complete and probable
future economic benefits will arise.
4. Review the disclosures for intangible assets in the draft financial statements are in accordance with IAS 38
Intangible Assets.

An acquired brand/patents/license.
1. Review board minutes for evidence of discussion of the purchase of the acquired brand, and for its approval.
2. Agree the cost to the company’s cash book and bank statement.
3. Obtain the purchase agreement and confirm the rights of client in respect of the brand.
4. Discuss with management the estimated useful life of the brand and obtain an understanding of how the useful
life has been determined.
5. Recalculate the amortisation expense for the year and agree the charge to the financial statements
6. Confirm adequacy of disclosure in the notes to the financial statements.

Bank and cash

General 1. Agree the bank balance on the trial balance to
procedures - the year end bank balance on the computer system, and
- the balance on the financial statements.

2. Review the cash book and bank statements for any unusual items or large transfers
around the year end, as this could be evidence of window dressing.
3. Review the financial statements to ensure that the disclosure of cash and bank
balances are complete and accurate.

Bank confirmation Procedure for obtaining a bank letter
letter 1. The auditor will produce a confirmation letter in accordance with local audit
regulations and practices.
2. The letter will be sent to the client to sign and authorise disclosure and then it will be
forwarded on to the client’s bank. (Alternatively, the client may already have provided
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a standard authority for the bank to respond to a bank letter each year. In this case
separate authority would not be required.)

Ideally the letter should be sent before the end of the accounting period to enable the bank
to complete it on a timely basis e.g. at the year‐end.

3. The bank will complete the letter and send it back directly to the auditor.

Contents of a bank letter
The following matters should be confirmed in the confirmation from the company’s bank:
1. Titles and account numbers of all bank accounts held in the name, joint name or trade
name of client at the year end
2. Confirmation of balances held in those accounts at the year end
3. Full details of interest charged or received on accounts held during the year if not
specified on bank statements.
4. Details of overdrafts and loans repayable on demand together with details of other
loans and facilities.
5. Details of any assets of client which are held as security by the bank.
6. Details of any other assets held by the bank, for example share certificates, documents
of title or deed boxes.
7. Accounts with nil balance
8. Details of accounts closed in the last 12 months
9. A list of branches of the bank, or other banks, or associated companies where it is
known that a relationship has been established with the client.

Audit procedures on the bank letter include:
1. Agree the balances for each bank account to the relevant bank reconciliation and the
yearend balance in the financial statements.
2. Agree total interest charges on the letter to the interest expense account in the
general ledger.
3. For any details of loans, ensure repayment terms are correctly disclosed in the
financial statements between current and non‐current liabilities.

Period‐end Bank Obtain a copy of client’s bank reconciliation and perform the procedures below:
Reconciliation 1. Cast the reconciliation to check arithmetical accuracy
Statement (BRS) 2. Agree the bank balance to the trial balance.
3. Agree the reconciliation’s balance per the cash book to the year‐end cash book.
4. Agree the balance per the bank statement to an original year‐end bank statement and
also to the bank confirmation letter.
5. Trace all of the outstanding lodgments to the pre year‐end cash book, post year‐end
bank statement and also to paying‐in‐book per year end.
6. Trace all un‐presented cheques through to a pre year‐end cash book and post year‐
end statement. For any unusual amounts or significant delays obtain explanations
from management.
7. Examine any old un‐presented cheques to assess if they need to be written back into
the purchase ledger as they are no longer valid to be presented.
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Completeness 1. Agree all balances listed on the bank confirmation letter to client’s bank reconciliations
or the trial balance to ensure completeness of bank balances.

2. Examine the bank confirmation letter for details of any security provided by client as
this may require disclosure.

Cash
Generally cash balance is immaterial to the financial statements. However, cash is an area which is prone to fraud,
especially if the internal controls are not efficient. That is why cash verification is an important audit procedure for
internal auditors.

Physical verification of cash
Cash balances include the hard cash, unbanked cheques, credit card slips and IOUs. That is why all cash balances
need to be counted at the same time.

The audit working papers relating to the cash count will include the date of the count, time of the count, name and
signature of staff conducting the count and the name of the client’s staff available at the count.

Audit procedures for cash
The main audit work involved in verifying cash balances is a physical count.

Audit procedures include the following:
 The auditor should count cash at all locations simultaneously and in the presence of a company official.
(Simultaneous counting is necessary, to prevent the client from moving cash that has been counted at one
location to another location ready for the next count.)
 After the count the auditor should obtain a signed receipt for the amount of cash returned to the official,
 The auditor should check the cash balance obtained from the count against the client's cash records and cash
balance in the draft financial statements.
 Where appropriate, the auditor should also investigate the treatment of any money advances to employees (for
example, against wages or salary).

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Substantive testing: Trade Payables‐ Key risk: understatement

1. Reconcile payables ledger to the general ledger.
Completeness
2. Check reconciliation of supplier account statements to trade payable ledger balances,
prepared by client. Enquire into any abnormalities and carry out further
reconciliations as required.

3. Obtain year‐end supplier statements:
 Agree the balance on the statement to the individual account in client’s payables
ledger.
 Where necessary, reconcile the balances taking into account cash and invoices in
transit.

4. Compare trade payables individually and in total to prior, investigate any significant
difference, in particular any decrease for this year.

5. Calculate the trade payable days and compare to prior years, investigate any
significant difference.

6. Current supplier list matched to last year’s supplier list and explanations sought for
suppliers missing this year

7. Select population from purchase invoices received after the year‐end. Trace to
evidence of goods receipt and where goods received prior year‐end, ensure invoice
amount included in purchase accrual

8. Post year end payments reviewed. If they relate to purchases made before the year
end, ensure they were recorded as a liability at the year end!

9. Verify the Audit trail from source document to records (Take a sample of GRNs prior
to the end of the year and trace to purchase invoice. Ensure a liability has been
recorded)

Accuracy, 1. Supplier circularization(rare in practice)
Valuation,
Allocation 2. Verify supporting documentation ( Purchase order Goods Received Note, Invoice)

3. Supplier statements reconciled to individual supplier accounts ( as above)

Cut‐off 1. Select a sample of GRNs before the year end and after the year end and follow through
(purchases) to inclusion in the correct period’s payables balance, to ensure correct cut‐off.

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2. Review after date payments; if they relate to the year under audit, then follow
through to the purchase ledger listing to ensure they are recorded in the correct
period

Existence 1. Supplier circularization(rare in practice)

2. Verify the Audit trail from records to source documents ( individual ledger to purchase
invoice and Goods Received Note)

Substantive procedures for supplier statement reconciliations
1. Select a representative sample of year‐end supplier statements and agree the balance to the purchase ledger.
If the balance agrees, then no further work is required.
2. Where differences occur due to invoices in transit, confirm from goods received notes (GRN) whether the
receipt of goods was pre year end, if so confirm that this receipt is included in year‐end accruals.
3. Where differences occur due to cash in transit from client to the supplier, confirm from the cashbook and bank
statements that the cash was sent pre year end.
4. Discuss any further adjusting items with the purchase ledger supervisor to understand the nature of the
reconciling item, and whether it has been correctly accounted for.

Why supplier circularization is rare in practice
Third party evidence is a good source of audit evidence and a large proportion of the documentation available when
auditing trade payables is produced by third parties, for example, suppliers’ invoices, statements and
correspondence.

A trade payables circularisation may however be deemed appropriate where:
 Supplier statements are, for whatever reason, unavailable.
 Only faxed or photocopied supplier statements are available and there is some doubt as to their authenticity.
 The auditor or the company, suspect that fraudulent manipulation with regard to supplier payments is taking
place within the company.

Substantive testing: Accruals

1. Obtain or prepare a listing of accruals as at the end of the reporting period.

2. If the list is prepared by the client company, check the calculations and additions far arithmetical accuracy.
Check the amounts in the listing against the balances in the relevant main ledger expense accounts and ensure
that the amounts are the same.

3. Sample check computations of accruals by comparing to earlier relevant invoices and payment records.

4. Review the bank statement for post year end payments that may relate to services used before the year end.
Trace these items to the accruals listing.
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5. Compare the list of accruals to those for the previous period to obtain assurance as to the completeness of the
accruals.

6. Review the list of accruals for completeness, based on the auditor's knowledge of the business. The auditor will
review expense categories included in the income statement to identify areas of possible accruals and check to
list of accruals for inclusion.

7. Relate items on the list of accruals to other audit areas, such as the bank confirmation letter (which might
provide details of unpaid/accrued bank charges).

8. Test transactions around the accounting period end to determine whether amounts have been recognised in
the correct period.

Substantive testing: Payroll

Substantive Analytical procedures
1. Compare the total payroll expense to the prior year and investigate any significant differences.

2. Review monthly payroll charges, compare this to the prior year and budgets and discuss with management for
any significant variances.

3. Perform a proof in total of total wages and salaries, incorporating joiners and leavers and the annual pay
increase. Compare this to the actual wages and salaries in the financial statements and investigate any
significant differences.

Other procedures
1. Cast a sample of payroll records to confirm completeness and accuracy of the payroll expense.

2. For a sample of employees, recalculate the gross and net pay and agree to the payroll records to confirm
accuracy.

3. Re‐perform the calculation of statutory deductions to confirm whether correct deductions for this year have
been made in the payroll.

4. Select a sample of joiners and leavers, agree their start/leaving date to supporting documentation, recalculate
that their first/last pay packet was accurately calculated and recorded.

5. Agree the total net pay per the payroll records to the bank transfer listing of payments and to the cashbook.

6. Agree the individual wages and salaries per the payroll to the personnel records for a sample to confirm bona
fide employees.

7. Select a sample of weekly overtime sheets and trace to overtime payment in payroll records to confirm
completeness of overtime paid.

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Substantive testing: Accrual for income tax payable on employment income

1. Agree the year‐end income tax payable accrual to the payroll records to confirm accuracy.

2. Re‐perform the calculation of the accrual to confirm accuracy.

3. Agree the subsequent payment to the post year‐end cash book and bank statements to confirm completeness.

Substantive testing: Corporation tax

1. Agree the year end tax liability back to the year end tax computation.
2. Agree the year end tax liability to the post year end payment to the tax authorities.
3. Agree the corporation tax liability to the amount owed as per correspondence from the tax authorities.

Substantive testing: Long term loans

Completeness of new loans Review Board minutes for evidence of new loans being taken out in the year
during the year and ensure they have been recorded.

Inspect the bank statements for the year for evidence of a significant deposit,
which may be proceeds of a loan.

Loan balance ‐ Loan statement from the bank.
‐ Bank letter
‐amount of the loan ‐ Loan agreement
‐the rate of interest
chargeable
‐any security provided
‐repayment terms.

Finance cost ‐ Recalculate expected interest charges during the year and compare to the
client’s figure.

Other procedures ( ‐ Verify the amount of the loan outstanding at the balance sheet date and
presentation and disclosure) ensure that this is accurately stated and fully disclosed in the company’s
balance sheet. The amount of the loan outstanding should be disclosed as
repayable within 12 months and repayable after 12 months from the
balance sheet date.
‐ Check the note to the company’s financial statements to ensure that full
disclosure is made with regard to any security for the loan.

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1. If it’s an old loan with balance outstanding at the year end, agree the opening balance of the bank loan to the
prior year audit file and financial statements.

2. For any loan payments made during the year, agree the cash outflow to the cash book and bank statements.

3. Agree loan balances back to the loan statement from the bank.

4. Inspect the bank confirmation letter for details of loans and overdrafts and trace these amounts to the balance
sheet to ensure they have been recorded.

5. Review Board minutes for evidence of new loans being taken out in the year and ensure they have been
recorded.

6. Inspect the bank statements for the year for evidence of a significant deposit, which may be proceeds of a loan.

7. Recalculate expected interest charges during the year and compare to the client’s figure.

8. Verify the amount of the loan outstanding at the balance sheet date and ensure that this is accurately stated
and fully disclosed in the company’s balance sheet. The amount of the loan outstanding should be disclosed as
repayable within 12 months and repayable after 12 months from the balance sheet date.

9. Examine the loan agreement to verify the amount of the loan, the rate of interest chargeable, the security
provided and the repayment terms.

10. Review the loan agreement for details of covenants and recalculate to identify any breaches in these.

11. Agree closing balance of the loan to the trial balance and draft financial statements.

12. Review that the F/S disclosures are adequate, including any security provided and that the disclosure is in
accordance with accounting standards and local legislation.

Substantive testing: Accounting estimates

Accounting estimates are approximations. Approximations are often made in conditions of uncertainty regarding
the outcome of events.

When transactions involve precise amounts and are supported by specific documents, verification is relatively easier.
However, this comfort is not available in the case of accounting estimates. There is greater risk of material
misstatement. Therefore greater care is needed when auditing them.

The auditor should adopt one or a combination of the following approaches in the audit of an estimate:
– Review and test the process used by management to develop the estimate
– Use an independent estimate for comparison with that prepared by management
– Review subsequent events which confirm the estimate made.

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Exam focus: Provision for fines/penalties, provision for legal claims, provision for restructuring(detailed formal plan,
valid expectation raised in those affected, implementation of plan started/public announcement, DO NOT include
retraining/relocation, marketing expenses etc), provision for warranties, provision for redundancies, Fair Value

Review and test the process used by management to 1. Enquire of management how the accounting
develop the estimate estimate is made
2. Enquire of management data on which it is based‐
the data used should be accurate, complete and
assumptions reasonable.
3. Review the method of measurement used and
assess the reasonableness of assumptions made.
Use an independent estimate for comparison with that prepared by management. The estimate can be made
by the auditor OR obtained from an expert.
Review subsequent events which confirm the estimate made.
‐ Obtain written representations from management and, where appropriate, those charged with governance
whether they believe significant assumptions used in making accounting estimates are reasonable.
‐ Ensure disclosures relating to accounting estimates are adequate and complete.
‐ If applicable, compare with last year to evaluate reasonableness of the estimate.
‐ If applicable, compare last year’s estimated with actual result to evaluate reasonableness of the estimate.

Further explanation of the procedures above
1. Recalculate to ensure accuracy
2. Review process used by the management and controls over how the estimate was made.
3. Enquire of management how the accounting estimate is made and the data on which it is based‐the data used
should be accurate, complete and assumptions reasonable.
4. Review the method of measurement used and assess the reasonableness of assumptions made. Review the
judgments and decisions made by management in the making of accounting estimates to identify whether there
are indicators of possible management bias.
5. Test the operating effectiveness of the controls over how management made the accounting estimate.
6. Develop an expectation of the possible estimate or a range of amounts to evaluate management’s estimate.
7. Obtain written representations from management and, where appropriate, those charged with governance
whether they believe significant assumptions used in making accounting estimates are reasonable.
8. Review expert’s report if applicable
9. Determine whether events occurring up to the date of the auditor’s report (after the reporting period) provide
audit evidence regarding the accounting estimate.
10. To confirm the probability and amount of a provision(or the need of a contingent liability disclosure):
‐ Inspect pinutes of board meetings
‐ Inspect client’s Correspondence with any 3rd party
‐ Inspect Other documents (copy of claims, copy of laws etc)
‐ Enquire from a relevant 3rd party
11. Ensure disclosures relating to accounting estimates are adequate and complete
12. If applicable, compare with last year to evaluate reasonableness of the estimate.
13. If applicable, compare last year’s provision with actual result to evaluate reasonableness of the estimate.
14. Fair Value: Expert’s report

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Examples extracted from past exams‐ read through them rather than rote learning them!

Scenario: Law suit filed by a former (ex) employee for unfair dismissal‐ decision pending

Substantive procedures to confirm completeness of provisions or contingent liability:

o Discuss with management the nature of the dispute between the client and the former employee to ensure that
a full understanding of the issue is obtained and to assess whether an obligation exists.
o Review any correspondence with the former employee to assess if a reliable estimate of any potential payments
can be made.
o Write to the company’s lawyers to obtain their views as to the probability of the ex‐employeer’s claim being
successful.
o Review board minutes and any company correspondence to assess whether there is any evidence to support
the former employee’s claims of unfair dismissal.
o Obtain a written representation from the directors of client confirming their view of chances of a successful
claim.

Scenario: sales ledger department is being made redundant and a redundancy provision has been included in the
financial statements.

Substantive procedures to verify redundancy provision

o Discuss with the directors as to whether they have formally announced their intention to make the sales ledger
department redundant, to confirm that a present obligation exists at the year end.
o If announced before the year end, review supporting documentation to verify that the decision has been
formally announced.
o Review the board minutes to ascertain whether it is probable that the redundancy payments will be paid.
o Obtain a breakdown of the redundancy calculations by employee and cast it to ensure completeness.
o Recalculate the redundancy provision to confirm completeness and agree components of the calculation to
supporting documentation.
o Review the post year‐end period to identify whether any redundancy payments have been made, compare
actual payments to the amounts provided to assess whether the provision is reasonable.
o Obtain a written representation from management to confirm the completeness of the provision.
o Review the disclosure of the redundancy provision to ensure compliance with IAS 37 Provisions, Contingent
Liabilities and Contingent Assets.

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Scenario: Customers of a hotel have filed a law suit claiming they got food poisoning‐ directors do not feel
a provision is needed

1. Review the correspondence from the customers claiming food poisoning to assess whether client has a
present obligation as a result of a past event.
2. Send an enquiry letter to the lawyers of client to obtain their view as to the probability of the claim being
successful.
3. Review board minutes to understand whether the directors believe that the claim will be successful or
not.
4. Review the post year‐end period to assess whether any payments have been made to any of the
claimants.
5. Discuss with management as to whether they propose to include a contingent liability disclosure or not,
consider the reasonableness of this.
6. Obtain a written management representation confirming management’s view that the lawsuit is unlikely
to be successful and hence no provision is required.
7. Review the adequacy of any disclosures made in the financial statements.

Scenario: Reorganisation provision has been made

1. Review the board minutes where the decision to reorganise the business was taken, ascertain if this
decision was made pre year end.
2. Review the announcement to shareholders to confirm that this was announced before the year end.
3. Obtain a breakdown of the reorganisation provision and confirm that only direct expenditure from
restructuring is included.
4. Review the expenditure to confirm that there are no retraining costs included.
5. Cast the breakdown of the reorganisation provision to ensure correctly calculated.
6. For the costs included within the provision, agree to supporting documentation to confirm validity of
items included.
7. Obtain a written representation confirming management discussions in relation to the announcement of
the reorganisation.
8. Review the adequacy of the disclosures of the reorganisation in the financial statements to ensure they
are in accordance with IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

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Substantive testing: Capital and Other Issues

Share (equity) capital

1. Review board minutes to confirm the issue of additional share capital during the year.

2. Agree the issue of shares is permitted from a review of any statutory constitution agreements in place (Where
local law requires that companies should have an authorised share capital, the auditor should check that the
total authorised capital in the draft financial statements is consistent with the company's constitution)

3. Inspect the cash book and bank statements for evidence of cash receipts from the share issue.

4. Recalculate the split of proceeds between the nominal value of shares and premium on issue and agree correctly
recorded within share capital and share premium account.

5. Review the disclosure of the share issue in the draft financial statements and ensure it is in line with relevant
accounting standards and local legislation.

6. Check that the amount reported as issued share capital agrees with the amount recorded in the register of
members/shareholders, if the company has such a register. (In some countries there is a legal requirement to
maintain a register of members.)

Substantive procedures: reserves

The auditor‐will usually carry out tire following substantive procedures on reserves:
 Obtain an analysis of movements on all reserves during the period.
 Check the accuracy of these movements by checking supporting documentation.
 Ensure that any specific legal requirements relating to reserves have been complied with. (For example, check
that the entity has not breached legal restrictions on use of the share premium account.)
 Confirm that dividends have been deducted only from those reserves that are legally distributable (usually the
accumulated profits reserve/retained earnings).
 Check the authorisation for the amount of dividends paid by reviewing board minutes.
 Check the dividend calculations and check that the total dividends paid are consistent with the amount of issued
share capital at the relevant date.

Directors’ Emoluments

Emoluments include compensation paid for the services provided by the directors to the company and reward for
entrepreneurial contribution.

The various components of emoluments include:
 Basic salary
 Bonuses
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 Share options
 Pension contributions
 Other benefits (e.g. provision of a company car, rented accommodation, health insurance etc.)

Main procedures for directors’ bonus and remuneration
1. Obtain a schedule of the directors’ remuneration including any bonus paid and cast the addition of the schedule.
2. Agree the individual bonus payments to the payroll records.
3. Confirm the amount of each bonus paid by agreeing to the cash book and bank statements.
4. Review the board minutes to confirm whether any additional bonus payments relating to this year have been
agreed.
5. Obtain a written representation from management confirming the completeness of directors’ remuneration
including the bonus.
6. Review any disclosures made of the bonus and assess whether these are in compliance with local legislation

Other procedures:
‐ Verify the accuracy of the emoluments recorded by recalculating the amount of emoluments applicable to the
directors with the recommendations of the remuneration committee.
‐ For all performance related bonus, verify the correctness of the bonus by comparing the bonus with the
achievement of the performance related targets i.e. ensure that performance related bonus is supported with
appropriate achievement of targets.
‐ Loyalty bonuses are given when a person completes a certain number of years in a company. Verify the accuracy
of the payments made along with adherence to the conditions of the loyalty bonus.
‐ Verify the directors’ rent accounts for the directors’ accommodation and trace entries therein with the
approvals of the remuneration committee and also confirm the correctness of the values with the rent
agreement.
‐ Verify the directors’ health insurance accounts paid for the directors and trace entries therein with the approvals
of the remuneration committee and also confirm the correctness of the values with the insurance policies.

Relying on work of others

In certain cases, auditors may rely on the work of third parties when gathering their audit evidence.
• Experts such as: lawyers; valuation experts;

• The client’s internal auditors (who have reviewed the internal controls).

• Service organization ( who work has been outsourced to by client)

• Another firm of external auditors (who may for example be auditing an overseas subsidiary of our client).

Why?
- Avoid duplication of work
- Improve efficiency and effectiveness
- Improve trust of shareholders
- Reduce cost
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Reliance on the work of an expert
ISA 500 Audit Evidence requires auditors to evaluate the competence, capabilities including expertise and objectivity
of a management expert.
1. Are they suitably qualified? (member of a professional body or industry association)

2. Do they have the experience?

3. Are they independent of the client?

4. The auditor should meet with the expert and discuss with them their relevant expertise in order to understand
their field of expertise.

5. Evaluating the Adequacy of the Expert’s Work (the audit procedures carried out to evaluate the work done by
the expert!)
a) the relevance and reasonableness of that expert’s findings or conclusions, and their consistency with other
audit evidence
b) If that expert’s work involves use of significant assumptions and methods, the relevance and
reasonableness of those assumptions and methods in the circumstances
c) Adequacy and appropriateness of source data

Audit considerations relating to entities using service organisations
Service organisation: third‐party organisation providing services to user entities that are part of those entities’
information systems relevant to financial reporting

When any work is outsourced to the service organisation, the auditor should consider its impact on the internal
control of the entity.

If the auditor concludes that outsourcing to service organisation significantly affects the accounting and / or internal
control system of the entity, they should obtain sufficient understanding of the entity and its environment, including
the internal control.

This will help him in assessing the risk of material misstatement and designing and performing further audit
procedures

Factors auditors should consider in relation to client’s use of the service organisation include:

1. The audit team should gain an understanding of the services being provided by the service organisation ,
including the materiality of that area and the basis of the outsourcing contract.

2. They will need to assess the design and implementation of internal controls at the service organisation

3. The team may wish to visit the service organisation and undertake tests of controls to confirm the operating
effectiveness of the controls.

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4. If this is not possible, auditors should contact the service organisation’s auditors to request either a type 1
(report on description and design of controls) or type 2 report (on description, design and operating
effectiveness of controls).

5. The auditor is responsible for obtaining sufficient and appropriate evidence, therefore no reference may be
made in the audit report regarding the use of information from the service organisation’s auditors

Writing the Answers

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The Review Stage of Audit AA Revision Notes
The Review Stage of Audit

Subsequent Events Review
Exam Questions

- Adjusting or non‐adjusting?
- Auditor’s responsibilities
- Procedures
- Impact on opinion

Adjusting event: An event after the reporting period that provides further evidence of conditions that existed at the
end of the reporting period, including an event that indicates that the going concern assumption in relation to the
whole or part of the enterprise is not appropriate.

Non‐adjusting event: An event after the reporting period that is indicative of a condition that arose after the end of
the reporting period.

Events after the balance sheet date

ADJUSTING NON‐ADJUSTING

Provide additional evidence Concern conditions which did not
of conditions existing at the exist at the balance sheet date
balance sheet date

Adjust the financial Impacts going concern Does not impact going
statements to reflect the concern
event

Adjust the financial Do not adjust the
statements to present financial statements
on an alternative basis(
break‐up basis)

If important to users
understanding disclose
in a note:
nature of event
estimate of financial
effect
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Examples of adjusting events
→ The bankruptcy of a customer indicates that their debt was irrecoverable at the reporting date
→ The sale of inventory at less than cost indicates that it should have been valued at NRV in the accounts
→ The resolution after the reporting date of a court case giving rise to a liability
→ Invoices received in respect of goods or services received before the year end
→ Discovery of fraud or errors showing that financial statements were incorrect
→ Determination of employee bonuses
→ The tax rates applicable to the financial year are announced
→ The auditors submit their fee

Examples of non‐adjusting events
 Destruction of major assets in natural disasters
 A purchase or sale of a non‐current asset
 The announcement of plans to discontinue an operation
 Dividends declared on equity after the reporting date

Auditor’s responsibilities‐ISA 560

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For the purposes of ISA 560, subsequent events are those events that occur between the reporting date and the
date of approval of the financial statements and the signing of the auditor’s report.

Period between the year‐end date and the date the auditor’s report is signed

The auditor shall perform audit procedures designed to obtain sufficient appropriate audit evidence that all
events occurring between the date of the financial statements and the date of the auditor’s report that require
adjustment of, or disclosure in, the financial statements have been identified.

A. Review procedures management has established to ensure that subsequent events are identified.
B. Inspect: Read minutes of board meetings, shareholder meetings and audit committees that have taken place
since the year‐end.
C. Obtain and review the latest available interim financial statements and/or management accounts, budgets
and other related management reports.
D. Perform normal post balance sheet work( e.g. checking receipts from trade receivables after the yearend)
E. Enquire of the entity’s legal counsel concerning litigation and claims.
F. Enquire of management as to whether any subsequent events have occurred which might affect the financial
statements
G. Checking whether any events have occurred that could call into question the validity of the going concern
assumption

Facts discovered after the date of the auditor’s report but before the date the financial statements are issued.

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The auditor does not have any responsibility to perform audit procedures or make any enquiry regarding the
financial statements or subsequent events after the date of the auditor’s report.

In this period, it is the responsibility of management to inform the auditor of facts which may affect the financial
statements.

When the auditor becomes aware of a fact which may materially affect the financial statements, the matter
should be discussed with management.

If the financial statements are appropriately amended then a new audit report should be issued, and procedures
relating to subsequent events should be extended to the date of the new audit report.

If management do not amend the financial statements to reflect the subsequent event, in circumstances where
the auditor believes they should be amended, a qualified or adverse opinion of disagreement should be issued.

Facts discovered after the financial statements have been issued.

After the financial statements have been issued, the auditor has no obligation to perform any audit procedures
regarding such financial statements. However, if, after the financial statements have been issued, a fact becomes
known to the auditor that, had it been known to the auditor at the date of the auditor’s report, may have caused
the auditor to amend the auditor’s report, the auditor shall:

(a) Discuss the matter with management and, where appropriate, those charged with governance;

(b) Determine whether the financial statements need amendment; and, if so,

(c) Inquire how management intends to address the matter in the financial statements.

If management amends the financial statements, the auditor shall:

(a) Carry out the audit procedures necessary in the circumstances on the amendment.

(b) Review the steps taken by management to ensure that anyone in receipt of the previously issued financial
statements together with the auditor’s report thereon is informed of the situation.

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Event specific procedures

inspection or observation) and
 Confirm event( maybe through enquiry,

calculate impact on financial statements(if any or the need for a disclosure

 Discussion with the management ( any adjustments to be made, disclosure

to be given, impact on going concern etc.)

 Enquire: from any relevant 3rd party to get further evidence about the

event( insurance company,lawyers, customer etc )

 Review: minutes of the board meetings in which the event and its impact

was discussed

 correspondence with 3rd parties
Review: accounting records and any
involved

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Going concern review

The Exam

- Indicators ( words from the scenario and explain why it is an indicator; what problems it can cause in the future)
- Procedures
- Impact on audit opinion and audit report

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Under the ‘going concern assumption’, an entity is ordinarily viewed as continuing in business for the foreseeable
future (being to a date of at least, but not limited to, 12 months from the end of the reporting period); with
neither the intention nor the necessity of liquidation, cessation of trading or the seeking of protection from
creditors pursuant to laws or regulations.

Accordingly assets and liabilities are recorded on the basis that the entity will be able to realise its assets and
discharge its liabilities in the normal course of business.

Management’s responsibility

‐ assess ability of the company to continue in the foreseeable future
‐ disclose uncertainties that might affect the going concern status
‐ adjust F/s and disclose if financial statement not prepared on a going concern basis

It is the responsibility of management to make an assessment of whether the going concern presumption is
appropriate, or not, when they are preparing the financial statements.

Auditor’s responsibilities

1. They carry out appropriate audit procedures to determine whether the management’s assumption of going
concern is appropriate and ensure that the organisation’s management have been realistic in their use of the
going concern assumption
2. Report if not appropriate. In forming the audit opinion, the auditor should consider two issues: have the
financial statements been prepared using the appropriate going concern assumption, and is there adequate
disclosure of any material uncertainty regarding the going concern status.

Indicators of going concern problems

Financial Indicators
– Net liability or net current liability position.
– Fixed term borrowings approaching maturity without realistic prospects of renewal or repayment, or excessive
reliance on short‐term borrowings to finance long‐term assets.
– Adverse key financial ratios.
– Substantial operating losses.
– Arrears or discontinuance of dividends.
– Inability to pay payables on due dates.
– Difficulty in complying with the terms of loan agreements.
– Change from credit to cash‐on‐delivery transactions with suppliers.
– Inability to obtain financing for essential new product development or other essential investments.

Operating Indicators
– Loss of key management without replacement.
– Loss of major market, franchise, licence, or principal supplier.
– Labour difficulties or shortages of important supplies.
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Other Indicators
– Non‐compliance with capital or other statutory requirements.
– Pending legal proceedings against the entity that may, if successful result in judgements that could not be met.
– Changes in legislation or government policy.

Audit Procedures
DONOT produce a list of generic audit procedures, but instead identify and highlight the factors from the scenario
that may call into question the entity’s ability to continue as a going concern.

1. Evaluate the management’s assessment
o the process followed by management to make its assessment
o the assumptions on which the assessment is based
o management’s plans for future action
o whether management has taken into consideration all the facts that the auditor is aware of due to their
audit procedures
2. Reading minutes of shareholders’ meetings to identify any current, or potential, cash flow difficulties

3. Review post year end management accounts

4. Review cash flow forecast (sufficient cash to continue operations for next year?) In this evaluation the auditor
should pay particular attention to the\ reliability of the company’s systems for generating the cash flow
information, and whether the assumptions underlying the cash flow appear reasonable.

5. Confirming the existence, terms and adequacy of borrowing facilities

6. Review events after the period end to identify those that affect the entity’s ability to continue as a going concern

7. Review the terms of loan agreements and determining whether they have been breached

8. Requesting written representations from management and, where appropriate, those charged with
governance, regarding their plans for future action and the feasibility of these plans.

9. View correspondence with major customers, suppliers and banks for evidence of dispute

10. Legal/solicitor letter‐ inspect correspondence to understand possible consequences of legal action being
brought against the company.

11. Obtaining and reviewing reports of regulatory action

12. Other procedures relevant to question given should also be considered!

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Prepare this section AFTER revising Audit Opinion

Auditor’s conclusions
Use of going concern basis of accounting is Use of Going Concern Basis of Accounting Is Inappropriate
appropriate When the use of the going concern basis of accounting is not
but appropriate in the circumstances, management may be
a material uncertainty exists relating to events required, or may elect, to prepare the financial statements on
or conditions that may cast significant doubt on another basis (e.g., liquidation basis). The auditor may be able
the entity’s ability to continue as a going to perform an audit of those financial statements provided that
concern. the auditor determines that the other basis of accounting is
acceptable in the circumstances.
In auditor’s judgment, appropriate disclosure
of the nature and implications of the
uncertainty is necessary.

If adequate disclosure If adequate disclosure The financial The auditor may be able to express an
about the material about the material statements have been unmodified opinion on those financial
uncertainty is made in uncertainty is not prepared using the statements, provided there is
the financial made in the financial going concern basis of adequate disclosure therein about
statements, the statements, the accounting but, in the the basis of accounting on which the
auditor shall express auditor shall: auditor’s judgment, financial statements are prepared,
an unmodified Express a modified management’s use of but may consider it appropriate or
opinion and the opinion ( Qualified or the going concern necessary to include an Emphasis of
auditor’s report shall Adverse as basis of accounting in Matter paragraph
include a separate appropriate) the preparation of the
section under the financial statements is
heading “Material In the Basis for inappropriate, the
Uncertainty Related Opinion section of the auditor shall express
to Going Concern” report, state that a an adverse opinion
(a) Draw attention to material uncertainty
the note in the exists that may cast
financial statements doubt on entity’s
that discloses the ability to continue as a
matters going concern and
(b) State that these that F/ S do NOT
events or conditions adequately disclose
indicate that a this matter
material uncertainty
exists that may cast
significant doubt on
the entity’s ability to
continue as a going
concern and that the
auditor’s opinion is
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not modified in

respect of the matter.
Example
Material Uncertainty
Related to Going
Concern
We draw attention to
Note 6 in the financial
statements, which
indicates that the
Company
incurred a net loss of
ZZZ during the year
ended December 31,
20X1 and, as of that
date, the Company’s
current liabilities
exceeded its total
assets by YYY. As
stated in Note 6,
these events or
conditions, along with
other matters as set
forth in Note 6,
indicate that a
material uncertainty
exists that may cast
significant doubt on
the Company’s ability
to continue as a going
concern. Our opinion
is not modified in
respect of this matter.

REPORTING IN LINE WITH ISA 570, GOING CONCERN
Exam questions might ask the candidate to recognise indicators that an entity may not be a going concern, or require
candidates to arrive at an appropriate audit opinion depending on the circumstances presented in the scenario. It
may be the case that candidates are presented with a situation where the auditor has concluded that there are
material uncertainties relating to going concern and the directors have made appropriate disclosures in relation to
going concern and candidates must understand the new auditor reporting requirements in this respect.

Under ISA 570 (Revised), if the use of the going concern basis of accounting is appropriate but a material uncertainty
exists and management have included adequate disclosures relating to the material uncertainties the auditor will
continue to express an unmodified opinion, but the auditor must include a separate section under the heading
‘Material Uncertainty Related to Going Concern’ and:
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 draw attention to the note in the financial statements that discloses the matters giving rise to the material
uncertainty, and
 state that these events or conditions indicate that a material uncertainty exists which may cast significant
doubt on the entity’s ability to continue as a going concern and that the auditor’s opinion is not modified in
respect of the matter.

The section headed ‘Material Uncertainty Related to Going Concern’ is included immediately after the Basis for
Opinion paragraph but before the KAM section.

Over and above the new reporting requirements under ISA 570, candidates need to understand how issues identified
regarding going concern interact with the requirements of ISA 701. By their very nature, issues identified relating to
going concern are likely to be considered a key audit matter and hence need to be communicated in the auditor’s
report. Where the auditor has identified conditions which cast doubt over going concern, but audit evidence
confirms that no material uncertainty exists, this ‘close call’ can be disclosed in line with ISA 701. This is because
while the auditor may conclude that no material uncertainty exists, they may determine that one, or more, matters
relating to this conclusion are key audit matters. Examples include substantial operating losses, available borrowing
facilities and possible debt refinancing, or non‐compliance with loan agreements and related mitigating factors. In
summary if a confirmed material uncertainty exists it must be disclosed in accordance with ISA 570 and where there
is a ‘close call’ over going concern which has been determined by the auditor to be a KAM it will be disclosed in line
with ISA 701. This is illustrated in the following example:

Example – unmodified audit opinion but material uncertainty exists in relation to going concern and the
disclosures are adequate

Report on the Audit of the Financial Statements (extract)
Opinion: In our opinion, the accompanying financial statements present fairly, in all material respects, the financial
position of the Company as at 31 December 2015, and its financial performance and its cash flows for the year then
ended in accordance with International Financial Reporting Standards (IFRSs).

Basis for opinion: We conducted our audit in accordance with International Standards on Auditing (ISAs). Our
responsibilities under those standards are further described in the Auditor’s Responsibilities for the Audit of the
Financial Statements section of our report. We are independent of the Company in accordance with the ethical
requirements that are relevant to our audit of the financial statements in Far land, and we have fulfilled our other
ethical responsibilities in accordance with these requirements. We believe that the audit evidence we have obtained
is sufficient and appropriate to provide a basis for our opinion.

Material uncertainty related to going concern: We draw attention to Note 6 in the financial statements, which
indicates that the Company incurred a net loss of $125,000 during the year ended 31 December 2015 and, as of that
date, the Company’s current liabilities exceeded its total assets by $106,000. As stated in Note 6, these events or
conditions, along with other matters as set forth in Note 6, indicate that a material uncertainty exists that may cast
significant doubt on the Company’s ability to continue as a going concern. Our opinion is not modified in respect of
this matter.

Key audit matters: Key audit matters are those matters that, in our professional judgment, were of most significance
in our audit of the financial statements of the current period. These matters were addressed in the context of our
audit of the financial statements as a whole, and in forming our opinion thereon, and we do not provide a separate
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opinion on these matters. In addition to the matter described in the Material Uncertainty Related to Going
Concern section, we have determined the matters described below to be the key audit matters to be communicated
in our report.

[Include a description of each key audit matter]

Written representations/Management representation letter

Written representations are necessary information that the auditor requires in connection with the audit of the
entity’s financial statements. Accordingly, similar to responses to inquiries, written representations are audit
evidence.

The auditor needs to obtain written representations from management and, where appropriate, those charged with
governance that they believe they have fulfilled their responsibility for the preparation of the financial statements
and for the completeness of the information provided to the auditor.

Written representations are needed to support other audit evidence relevant to the financial statements or specific
assertions in the financial statements, if determined necessary by the auditor or required by other International
Standards on Auditing.
This may be necessary for judgemental areas where the auditor has to rely on management explanations.

Written representations can be used to confirm that management have communicated to the auditor all deficiencies
in internal controls of which management are aware.

Written representations are normally in the form of a letter, written by the company’s management and addressed
to the auditor. The letter is usually requested from management but can also be requested from the chief operating
officer or chief financial officer.

Throughout the fieldwork, the audit team will note any areas where representations may be required
During the final review stage, the auditors will produce a draft representation letter. The directors will review this
and then produce it on their letterhead.

It will be signed by the directors and dated as at the date the audit report is signed, but not after.

The ISAs require auditors to obtain written representations from management on matters material to the Financial
Statements where other sufficient, appropriate, audit evidence cannot reasonably be expected to exist.

Purpose of written representation
1. Acknowledging responsibility for the financial statements by management(ISA 580 requires that “the auditor
should obtain audit evidence that management acknowledges its responsibility for fair presentation of the
financial statements and for the completeness of the information provided to the auditor)
2. Acknowledging responsibility for other matters (ICS, related party transactions etc)
3. Used as audit evidence there is no sufficient appropriate evidence in existence on a matter which is material to
the financial statements.
4. Acknowledges representations previously made verbally by management
5. Minimises misunderstandings between management and auditor
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Reliability of written representations
– Representations from management are a source of assurance evidence.
– They cannot be used instead of other (better) evidence which the assurance providers expect to exist.
– HOWEVER, they may be the only available form of evidence in certain circumstances.
– They are relatively unreliable as evidence.
– Corroborative evidence will always be sought, but may not always be available.
– If a representation appears to be contradicted by other evidence: the circumstances should be investigated, and
the reliability of other representations made by management should be reconsidered.

Written representation letter contents
 No irregularities involving management or employees that could have a material effect on the financial
statements
 All books of account and supporting documentation have been made available to the auditors
 Information and disclosures with reference to related parties is complete
 Financial statements are free from material misstatements including omissions
 No non‐compliance with any statute or regulatory authority
 No plans that will materially alter the carrying value or classification of assets or liabilities in the financial
statements
 No plans to abandon any product lines that will result in any excess or obsolete inventory
 No events, unless already disclosed, after the end of the reporting period that need disclosure in the financial
statements.

SPECIFIC MATTERS

Included here is anything else that the auditor would like a representation on for example:
 that a certain debt is recoverable;
 all bank accounts have been disclosed;
 any plans to reorganise the business or discontinue product lines have already been disclosed.

Refusal to Provide Requested Written Representations
If management refuses to provide a written representation, then the auditor should again review the possibility of
obtaining sufficient audit evidence from alternative sources in connection with the matter or issue under review.
If the directors refuse to sign the representation letter, then the auditor has a number of options available to him:
(i) The auditor could discuss the matter with the directors and try to resolve their problems with the letter.
(ii) The auditor could write a representation letter for the directors, then send this to the directors and ask
them to sign it.
(iii) If the auditor considers that he has not received all the information and explanations required for his audit,
then the auditor’s report should be qualified.
(iv) Before taking these actions, the auditor should explain to the directors the consequences of not signing the
representation letter, to try to avoid a confrontation.

An auditor should reconsider the reliability of other representations.

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If the representation is not consistent with other audit evidence, the auditor should perform audit procedures to
attempt to resolve the matter. For this, the auditor should reassess the appropriateness of the risk of material
misstatement on account of this inconsistency. If required, the auditor should revise the nature, timing and extent
of further audit procedures.

Overall review of financial statements

Before the audit report is signed, the auditor needs to know that the work is finished and that all necessary issues
have been dealt with. The easiest way to do this is to use a series of checklists:
 The audit plan should be reviewed, to verify that all issues raised have been resolved.
 An Accounting Standards Checklist will be completed, forcing the auditor to consider every possible accounting
issue that could affect the client’s Financial Statements.
 Additional checklists may be necessary (e.g. Company Law) to make sure that any other issues have been fully
considered

All audit work should be subject to review. This is a basic quality control requirement of ISA 220, Quality Control for
an Audit of Financial Statements, and serves to ensure that sufficient appropriate audit evidence has been obtained
in respect of transactions and balances included in the financial statements.

In performing a file review, the reviewer should consider the sufficiency of evidence obtained and may need to
propose further audit procedures if evidence is found to be insufficient or contradictory. ISA 230, Audit
Documentation requires that documentation of the review process includes who reviewed the audit work completed
and the date and extent of such review.

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Typically, the auditor will present the client with a list of misstatements (often referred to as the ‘audit error
schedule’), quantifying the amount of each misstatement, and proposing the necessary adjustment to the financial
statements. The proposed adjustment may be in the form of a journal entry, an amendment to the presentation of
the financial statements, or a correction to a disclosure note. When management makes the necessary adjustments
to the financial statements, the auditor should confirm that the adjustments have been made correctly.

Procedures an auditor should perform include:

1. Reviewing the financial statements to ensure compliance with accounting standards and local legislation
disclosure. This is sometimes done via the use of a disclosure checklist.

2. Reviewing the disclosure of the accounting policies to ensure that they are in accordance with the accounting
treatment adopted in the financial statements, and that they are sufficiently disclosed.

3. Reviewing the financial statements to ensure they are consistent with the auditor’s knowledge of the business
and the results of their audit work.

4. Reviewing the financial statements to assess whether they adequately reflect the information and explanations
previously obtained and conclusions reached during the course of the audit.

5. Performing analytical procedures of the financial statements, under ISA 520 Analytical Procedures; this helps
the auditor to form an overall conclusion on the financial statements ( explained separately below)

6. Reviewing the aggregate of uncorrected misstatements to assess whether in aggregate a material misstatement
arises; if so discuss with management with regards to a potential adjustment.

7. As part of the overall review, the auditor should assess whether the audit evidence gathered by the team is
sufficient and appropriate to support the audit opinion.

Final analytical procedures

Before the audit report is signed, it is sensible to do some final analysis of the Financial Statements (e.g. ratio
analysis) – just to make sure that the auditor is confident in the audit opinion.

There are 2 main reasons for this final analysis:

The Financial Statements may have been adjusted during the audit as mistakes were found, so the final figures
may never have been analysed or been subject to ratio analysis.

The auditor will have learned more about the company during the audit, so is in a better position at the end of the
audit to analyse the figures and understand trends in ratios.

The analytical procedures performed at this stage of the audit are not different to those performed at the planning
stage – the auditor will perform ratio analysis, comparisons with prior period financial statements and other
techniques to confirm that trends are as expected, and to highlight unusual transactions and balances that may
indicate a risk of misstatement.
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The key issue is that, near the end of the audit, the auditor should have sufficient audit evidence to explain the
issues highlighted by analytical procedures, and should therefore be able to conclude as to the overall
reasonableness of the financial statements.

When the analytical procedures performed near the end of the audit reveal further previously unrecognised risk
of material misstatement, the auditor is required to revise the previously assessed risk of material misstatement
and modify the planned audit procedures accordingly. This means potentially performing further audit procedures
in relation to matters that are identified as high risk.

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Misstatements
Misstatements: A difference between the amounts, classification, presentation, or disclosure of a reported financial
statement item and the amount, classification, presentation, or disclosure that is required for the item to be in
accordance with the applicable financial reporting framework.

Misstatements can arise from error or fraud.

Uncorrected misstatements: Misstatements that the auditor has accumulated during the audit and that have not
been corrected.

There are three categories of misstatements:
i. Factual misstatements are misstatements about which there is no doubt.
ii. Judgemental misstatements are differences arising from the judgements of management concerning accounting
estimates that the auditor considers unreasonable, or the selection or application of accounting policies that
the auditor considers inappropriate.
iii. Projected misstatements are the auditor’s best estimate of misstatements in populations, involving the
projection of misstatements identified in audit samples to the entire populations from which the samples were
drawn.

The auditor has a responsibility to accumulate misstatements which arise over the course of the audit.

Identified misstatements should be considered during the course of the audit to assess whether the audit strategy
and plan should be revised.

The auditor will communicate the uncorrected misstatements and their implication on the auditor’s report to those
charged with governance.

The auditor will also request a written representation (including a summary of uncorrected misstatements) from
management and – where appropriate – those charged with governance as to whether they believe the effects of
uncorrected misstatements are immaterial, individually and in aggregate to the financial statements as a whole.

The auditor may find:
1. Individual material misstatements
2. Individual immaterial misstatements
3. Immaterial misstatements which become material when aggregated

In all 3 cases, they have to be reported to the management.

Examples of circumstances when misstatement is considered material when it lower than quantitative (material
by nature)
‐ Affects compliance with regulatory requirements;
‐ Affects compliance with debt covenants or other contractual requirements;
‐ Affects ratios used to evaluate the entity’s financial position, results of operations or cash flows;

Has the effect of increasing management compensation, for example, by ensuring that the requirements for the
award of bonuses or other incentives are satisfied;
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Audit Opinion & Audit Report AA Revision Notes
Audit Opinion & Audit Report

Questions historically in this area of the syllabus have required a discussion of the accounting treatment, a
materiality calculation, an assessment of the type of audit report modification and the impact on the auditor’s
report.

Candidates often find auditor’s reports a challenging part of the syllabus and in preparation for exams, it is
imperative that candidates can:
‐ Describe the different elements of the auditor’s report
‐ Determine the most appropriate type of audit opinion in a given scenario, often through an explanation of
why a certain opinion is appropriate which will test the application of the candidate’s knowledge
‐ Understand the issues that may arise during the course of an audit that could require an emphasis of matter
or other matter paragraph to be included in the audit report, and
‐ Identify key Audit Matters (KAM) that are required to be disclosed in an auditor’s report.

Candidates will not be expected to draft an auditor’s report but may be asked to present reasons for an
unmodified or a modified opinion, or the inclusion of an Emphasis of Matter paragraph.

Candidates attempting the exam may be required to identify and describe the elements of the auditor’s report
and therefore candidates should ensure that they have a sound understanding of the revised ISA 700, Forming an
Opinion and Reporting on Financial Statements.

Candidates may also be presented with extracts from an auditor’s report and be asked to critically appraise the
extracts, or challenge the proposed audit opinion.

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Explanation of the overview given above
Form of opinion

Unmodified opinion The auditor shall express an unmodified opinion when the auditor concludes that
the financial statements are prepared, in all material respects, in accordance with
the applicable financial reporting framework.
Modified opinion If the auditor:
‐qualified (a) concludes that, based on the audit evidence obtained, the financial statements
‐Adverse as a whole are not free from material misstatement; or
‐Disclaimer (b) is unable to obtain sufficient appropriate audit evidence to conclude that the
financial statements as a whole are free from material misstatement, the
auditor shall modify the opinion in the auditor’s report in accordance with ISA
705 (Revised).

To understand different types of opinions, the following terms need to be understood.
Misstatement: Discussed above

Inability to obtain appropriate and sufficient evidence: The auditor was not able to get sufficient appropriate audit
evidence on which to base the opinion. The auditor’s inability to obtain sufficient appropriate audit evidence is also
referred to as a limitation on the scope of the audit and could arise from:
o Circumstances beyond the entity’s control (e.g. accounting records destroyed)
o Circumstances relating to the nature or timing of the auditor’s work (e.g. the timing of the auditor’s appointment
prevents the observation of the physical inventory count).
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o Limitations imposed by management (e.g. management prevents the auditor from requesting external
confirmation of specific account balances).

Pervasive: This is a term used to describe the effects or possible effects on the financial statements of misstatements
or undetected misstatements (i.e. due to an inability to obtain sufficient appropriate audit evidence). There are three
types of pervasive effect:
o Those that are not confined to specific elements, accounts or items in the financial statements.
o Those that are confined to specific elements, accounts or items in the financial statements and represent or
could represent a substantial portion of the financial statements.
o Those that relate to disclosures which are fundamental to users understanding of the financial statements.

Unmodified Opinion Auditor concludes that the financial statements are prepared, in all material
respects, in accordance with the applicable financial reporting framework.

Wording
In our opinion, the financial statements present fairly, in all material respects, (or
give a true and fair view of) the financial position of ABC Company as of December
31, 20X1, and (of) its financial performance and its cash flows for the year then
ended in accordance with International Financial Reporting Standards.

Modified Opinion a) Qualified

a) Qualified Nature of matter: Material
b) Adverse
c) Disclaimer Reason: material misstatement or inability to obtain appropriate and sufficient
evidence (regarding an accounting policy, transaction, balance or disclosure etc)

Opinion: Qualified ‘Except for’

Wording:
QUALIFIED OPINION
In our opinion, except for the effects of the matter described in the Basis of
Qualified Opinion paragraph the financial statements present fairly, In all
material respects, (or give a true and fair view of) the financial position of ABC
Company as at December 31, 20X1 and (of) its financial performance and its cash
flows for the year then ended in accordance with International Financial Reporting
Standards.

BASIS FOR QUALIFIED OPINION
(Nature, amount , impact to be explained)
The company’s inventories are carried in the balance sheet at XXX. Management
has not stated inventories at the lower of cost and net realizable value but has
stated them solely at cost, which constitutes a departure from International
Financial Reporting Standards. The company’s records indicate that had
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management stated the inventories at the lower of cost and net realizable value,
an amount of XXX would have been required to write the inventories down to their
net realizable value. Accordingly, cost of sales would have been increased by XXX,
and income tax, net income and shareholders’ equity would have been reduced
by XXX, XXX and XXX, respectively.

b) Adverse
Nature of matter: Material and pervasive

Reason: Misstatement in the F/S

Opinion: Adverse

Wording:
ADVERSE OPINION
In our opinion, because of the significance of the matter discussed in the Basis of
Adverse Opinion paragraph, the consolidated financial statements do not present
fairly (or do not give a nature and fair view of) the financial position of ABC
Company and its subsidiaries as at December 31, 20X1 and (of) their financial
performance and their cash flows for the year then ended in accordance with
International Financial Reporting Standards.

BASIS FOR ADVERSE OPINION
c) Disclaimer

Nature of matter: Material and pervasive

Reason: Inability to obtain appropriate and sufficient evidence

Opinion: Disclaimer

Wording:
DISCLAIMER OF OPINION
Because of the significance, of the matters described in the Basis for Disclaimer of
Opinion paragraph, we have not been able to obtain sufficient appropriate audit
evidence to provide a basis for an audit opinion. Accordingly, we do not express
an opinion on the financial statements

BASIS FOR DISCLAIMER OF OPINION

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Emphasis of Matter paragraph

Emphasis of Matter paragraph :A paragraph included in the auditor’s report that refers to a matter appropriately
presented or disclosed in the financial statements that, in the auditor’s judgment, is of such importance that it is
fundamental to users’ understanding of the financial statements.

Emphasis of Matter Paragraphs in the Auditor’s Report

If the auditor considers it necessary to draw users’ attention to a matter presented or disclosed in the financial
statements that, in the auditor’s judgment, is of such importance that it is fundamental to users’ understanding of
the financial statements, the auditor shall include an Emphasis of Matter paragraph in the auditor’s report provided:

‐ The auditor would not be required to modify the opinion in accordance with ISA 705 (Revised) as a result of the
matter; and
‐ When ISA 701 applies, the matter has not been determined to be a key audit matter to be communicated in
the auditor’s report. (When ISA 701 applies, the use of Emphasis of Matter paragraphs is not a substitute for a
description of individual key audit matters.)

When the auditor includes an Emphasis of Matter paragraph in the auditor’s report, the auditor shall:

(a) Include the paragraph within a separate section of the auditor’s report with an appropriate heading that
includes the term “Emphasis of Matter”;

(b) Include in the paragraph a clear reference to the matter being emphasized and to where relevant disclosures
that fully describe the matter can be found in the financial statements. The paragraph shall refer only to
information presented or disclosed in the financial statements; and

(c) Indicate that the auditor’s opinion is not modified in respect of the matter emphasized.

Examples of circumstances where the auditor may consider it necessary to include an Emphasis of Matter
paragraph are
1. An uncertainty relating to the future outcome of exceptional litigation or regulatory action.
2. A significant subsequent event that occurs between the date of the financial statements and the date of the
auditor’s report.
3. Early application (where permitted) of a new accounting standard that has a material effect on the financial
statements.
4. A major catastrophe that has had, or continues to have, a significant effect on the entity’s financial position.
5. When a financial reporting framework prescribed by law or regulation would be unacceptable but for the fact
that it is prescribed by law or regulation.
6. When facts become known to the auditor after the date of the auditor’s report and the auditor provides a new
or amended auditor’s report (i.e., subsequent events).

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Other Matter paragraph

Other Matter paragraph – A paragraph included in the auditor’s report that refers to a matter other than those
presented or disclosed in the financial statements that, in the auditor’s judgment, is relevant to users’ understanding
of the audit, the auditor’s responsibilities or the auditor’s report.

If the auditor considers it necessary to communicate a matter other than those that are presented or disclosed in
the financial statements that, in the auditor’s judgment, is relevant to users’ understanding of the audit, the auditor’s
responsibilities or the auditor’s report, the auditor shall include an Other Matter paragraph in the auditor’s report,
provided:

(a) This is not prohibited by law or regulation; and

(b) When ISA 701 applies, the matter has not been determined to be a key audit matter to be communicated in the
auditor’s report.

When the auditor includes an Other Matter paragraph in the auditor’s report, the auditor shall include the paragraph
within a separate section with the heading “Other Matter,” or other appropriate heading.

Circumstances in Which an Other Matter Paragraph May Be Necessary

1. Relevant to Users’ Understanding of the Audit: In the rare circumstance where the auditor is unable to
withdraw from an engagement even though the possible effect of an inability to obtain sufficient appropriate
audit evidence due to a limitation on the scope of the audit imposed by management is pervasive,the auditor
may consider it necessary to include an Other Matter paragraph in the auditor’s report to explain why it is
not possible for the auditor to withdraw from the engagement.

2. Relevant to Users’ Understanding of the Auditor’s Responsibilities or the Auditor’s Report: Law, regulation
or generally accepted practice in a jurisdiction may require or permit the auditor to elaborate on matters that
provide further explanation of the auditor’s responsibilities in the audit of the financial statements or of the
auditor’s report thereon.

3. Reporting on more than one set of financial statements: An entity may prepare one set of financial
statements in accordance with a general purpose framework (e.g., the national framework) and another set
of financial statements in accordance with another general purpose framework (e.g., International Financial
Reporting Standards), and engage the auditor to report on both sets of financial statements. If the auditor
has determined that the frameworks are acceptable in the respective circumstances, the auditor may include
an Other Matter paragraph in the auditor’s report, referring to the fact that another set of financial
statements has been prepared by the same entity in accordance with another general purpose framework
and that the auditor has issued a report on those financial statements.

4. Prior Period Financial Statements Audited by a Predecessor Auditor . If the financial statements of the prior
period were audited by a predecessor auditor and the auditor is not prohibited by law or regulation from
referring to the predecessor auditor’s report on the corresponding figures and decides to do so, the auditor
shall state in an Other Matter paragraph in the auditor’s report:
a. That the financial statements of the prior period were audited by the predecessor auditor;
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b. The type of opinion expressed by the predecessor auditor and, if the opinion was modified, the reasons
therefore; and
c. The date of that report.

5. Prior Period Financial Statements Not Audited : If the prior period financial statements were not audited, the
auditor shall state in an Other Matter paragraph in the auditor’s report that the corresponding figures are
unaudited. Such a statement does not, however, relieve the auditor of the requirement to obtain sufficient
appropriate audit evidence that the opening balances do not contain misstatements that materially affect
the current period’s financial statements

Matters to be communicated to TCWG (Those Charged with Governance)

1. The auditor’s responsibilities in – A statement that the auditor is responsible for forming and
relation to the financial statements expressing an opinion on the financial statements.
– That the auditor’s work is carried out in accordance with ISAs and
in accordance with local laws and regulations.

2. Planned scope and timing of audit This would include
– The audit approach to assessing the risk of serious misstatement,
whether arising from fraud or error.
– The audit approach to the internal control system and whether
reliance will be placed on it.
– The timing of interim and final audits, including reporting
deadlines.

3. Significant findings from the audit This heading could include:
– Significant difficulties encountered during the audit, including
delays in obtaining information from management.
– Material weaknesses in internal control and recommendations for
improvement.
– Audit adjustments, whether or not recorded by the entity, that
have, or could have, a material effect on the entity’s financial
statements. For example, the bankruptcy of a material receivable
shortly after the year‐end that should result in an adjusting entry.

4. A statement on independence This would include:
issues affecting the audit ( for listed – That the audit firm has ensured that all members of the audit team
entities only) have complied with the ethical standards of ACCA.
– That appropriate safeguards are in place where a potential threat
to independence has been identified.

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The lists of examples listed under the above headings are not exhaustive and in practice many more specific matters
would be communicated to those charged with governance such as:

– Modifications to the audit report.

– Any management representation points requested.

– Cases of suspected/actual fraud.)

Key Audit Matters (KAM)

Key audit matters: Those matters that, in the auditor’s professional judgment, were of most significance in the audit
of the financial statements of the current period. Key audit matters are selected from matters communicated with
those charged with governance.

Objectives: The objectives of the auditor are to determine key audit matters and, having formed an opinion on the
financial statements, communicate those matters by describing them in the auditor’s report.

Determining KAM
The auditor shall determine, from the matters communicated with those charged with governance, those matters
that required significant auditor attention in performing the audit. In making this determination, the auditor shall
take into account the following:
1. Areas of higher assessed risk of material misstatement, or significant risks identified in accordance with ISA 315
(Revised).
2. Significant auditor judgments relating to areas in the financial statements that involved significant management
judgment, including accounting estimates that have been identified as having high estimation uncertainty.
3. The effect on the audit of significant events or transactions that occurred during the period.
4. Other considerations

COMMUNICATING KAM
Once the auditor has determined which matters will be included as KAM, the auditor must ensure that each matter
is appropriately described in the auditor’s report including a description of:
1. Why the matter was determined to be one of most significance and therefore a key audit matter, and
2. How the matter was addressed in the audit (which may include a description of the auditor’s approach, a brief
overview of procedures performed with an indication of their outcome and any other key observations in
respect of the matter).

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Audit Report‐an exam focused summary
Column A and B will be in all reports.

Column C explains the impact of various issues on the report‐this will be in addition to Column B and C.
Column A Column B Column C
Content Explanation Impact of various issues
1 Title The auditor’s report shall have a title that
clearly indicates that it is the report of an
independent auditor.
2 Addressee The auditor’s report shall be addressed, as
appropriate, based on the circumstances of
the engagement.

3 Opinion “we have audited..” In modified opinion:
‐ Name the client ‐ Heading changes to the name of
‐ Year end the modified opinion
‐ Components of F/s + accounting policies ‐ Wording of the opinion changes
“in our opinion”…..
4 Basis for Opinion ‐ Conducted audit according to ISAs Heading changes: Basis for
‐ Our responsibilities described in a Qualified/Adverse/Disclaimer Opinion
separate paragraph Nature, amount, impact and reference
‐ We are independent in accordance with to accounting standard given
IESBA code of ethics/local codes
‐ SAE gathered to provide a basis for the
opinion
Material uncertainty relating to going
concern” paragraph (if needed)

‐ draw attention to the note in the
financial statements that discloses
the matters giving rise to the
material uncertainty, and
‐ state that these events or
conditions indicate that a material
uncertainty exists which may cast
significant doubt on the entity’s
ability to continue as a going
concern and that the auditor’s
opinion is not modified in respect
of the matter.

Disclosure correctly given‐ ‘we draw
your attention to notes to the account
number 6 which relate to….”
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5 Key Audit Matters ‐ Provide further information about the

process that led to the opinion so When the auditor expresses a
related to matters included in the F/S disclaimer of opinion then the auditor’s
‐ Selected from matters communicated report should not include a KAM
to TCWG section.
‐ According to auditor’s judgment, the
MOST significant matters relating to the
audit

Key audit matters are those matters that, in
our professional judgment, were of most
significance in our audit of the financial
statements of the current period. These
matters were addressed in the context of our
audit of the financial statements as a whole,
and in forming our opinion thereon, and we
do not provide a separate opinion on these
matters.”

[Description of each key audit matter in
accordance with ISA 701.]

EOMP ( can be placed here or before
Key Audit Matters‐ auditor has to use
his judgment)
‐ Cannot be used for drawing
attention to a going concern
uncertainty disclosure as a
separate paragraph is now
required for this
‐ Should be headed as EOMP
‐ Reference of the disclosure needs
to be given ( Note # 7…)

OMP
‐ placed here ( always AFTER Key
audit matters)
‐ cannot be used for other
information issues as there is now
a separate paragraph for this.
‐ ‐none of the Key Audit Matters can
be mentioned here.
6 Other ‐ Management responsible for other Any uncorrected inconsistencies in
information information in the document containing Other Information will be explained
financial statements here. This paragraph will then be
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‐ Our opinion does not cover OI, no moved from here to underneath basis
assurance give on it for opinion paragraph.
‐ Our responsibility to read OI and find
inconsistencies with F/s‐
7 Responsibilities ‐ Preparation of F/S
of management ‐ Internal control over financial reporting
and TCWG ‐ Assess ability of the company to
continue as a going concern
‐ TCWG’s responsibility to oversee the
financial reporting process
8 Auditor’s ‐ Reasonable assurance that F/S free
responsibility for from material misstatements‐ not a
audit of F/S guarantee that all misstatements will be
detected
‐ Issue audit report
‐ Define material misstatement in this
para
‐ Mention use of professional judgment
and professional skepticism

‐ Identify and assess risk of material
misstatement due to fraud and error (
fraud could include collusion, forgery,
intentional omissions,
misrepresentation, override of internal
control)
‐ Obtain understanding of internal
control over financial reporting to
design audit procedures‐ no opinion
given
‐ Evaluate appropriateness of accounting
policies
‐ Evaluate reasonableness of accounting
estimated
‐ Conclude on appropriateness of
management’s use of going concern
basis‐also mention that future
events/conditions may still cause the
company to cease as going concern
‐ Evaluate overall presentation,
structure, content of F/S including
disclosures
‐ Communicate with TCWG
‐ ‘ from matters communicated with
TCWG, we determine the most
significant ones (KEY AUDIT MATTERS)
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9 Report on other In some jurisdictions, the auditor may have
legal and additional responsibilities to report on other
regulatory matters that are supplementary to the
requirements auditor’s responsibilities under the ISAs.

For example, the auditor may be asked to
report certain matters if they come to the
auditor’s attention during the course of the
audit of the financial statements.

Auditing standards in the specific jurisdiction
often provide guidance on the auditor’s
responsibilities with respect to specific
additional reporting responsibilities in that
jurisdiction
10 Engagement
partner’s name
11 Signatures
12 Auditor’s address
13 Date

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Audit Sampling AA Revision Notes
Audit Sampling

Audit sampling is the application of audit procedures to less than 100% of items within a population of audit
relevance, such that all sampling units have a chance of selection in order to provide the auditor with a reasonable
basis on which to draw conclusions about the entire population.

Audit sampling can be applied using either a statistical or a non‐statistical approach. It involves testing a smaller
number of items and using the results to draw a conclusion about the whole balance or class of transactions.

It is necessary for auditors to sample as it is impossible to select all items for testing as this would take the audit
team too long and it would cost too much.

In addition, auditors do not provide 100% assurance in their audit report about the financial statements, they only
provide reasonable assurance and hence it is not necessary to test every item within a population.

Audit sampling is also widely known to reduce the risk of ‘over‐auditing’ in certain areas, and enables a much more
efficient review of the working papers at the review stage of the audit.

In devising their samples, auditors must ensure that the sample selected is representative of the population. If the
sample is not representative of the population, the auditor will be unable to form a conclusion on the entire
population.

SAMPLING RISK
Sampling risk is the risk that the auditor’s conclusions based on a sample may be different from the conclusion if the
entire population were the subject of the same audit procedure.

ISA 530 recognises that sampling risk can lead to two types of erroneous conclusions:

1. The auditor concludes that controls are operating effectively, when in fact they are not. In substantive testing,
the auditor may conclude that a material misstatement does not exist, when in fact it does. These erroneous
conclusions will more than likely lead to an incorrect opinion being formed by the auditor.

2. The auditor concludes that controls are not operating effectively, when in fact they are. In terms of substantive
testing, the auditor may conclude that a material misstatement exists when, in fact, it does not.

NON SAMPLING RISK
Non‐sampling risk is the risk that the auditor forms the wrong conclusion, which is unrelated to sampling risk. An
example of such a situation would be where the auditor adopts inappropriate audit procedures, or does not
recognise a control deviation.

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METHODS OF SAMPLING

Random selection: This method of sampling ensures that all items within a population stand an equal chance of
selection by the use of random number tables or random number generators. The sampling units could be physical
items, such as sales invoices or monetary units.

Systematic selection: This is a method of selection in which the auditor selects items using a constant interval
between selections. The first item may be selected on a random or haphazard basis, and thereafter the sampling
interval is derived by the auditor, for example, by dividing the population by the sample size.

Haphazard selection: The auditor selects the sample without following a structured technique – the auditor would
avoid any conscious bias or predictability.

Block selection: This involves selection of a block(s) of contiguous items from within the population. Block selection
cannot ordinarily be used in audit sampling because most populations are structured such that items in a sequence
can be expected to have similar characteristics to each other, but different characteristics from items elsewhere in
the population.

Monetary Unit Sampling: This is a type of value‐weighted selection in which sample size, selection and evaluation
results in a conclusion in monetary amounts. This selection method ensures that each individual $1 in the population
has an equal chance of being selected.

STATISTICAL VERSUS NON‐STATISTICAL SAMPLING
‘Statistical’ sampling: ‘An approach to sampling that has the following characteristics:
i. Random selection of the sample items, and
ii. The use of probability theory to evaluate sample results, including measurement of sampling risk.’

The ISA goes on to specify that a sampling approach that does not possess the characteristics in (i) and (ii) above is
considered non‐statistical sampling.

The advantages of using statistical sampling rather than judgemental sampling (non‐statistical sampling) include:
(1) The size of the sample is determined objectively having regard to the degree of risk associated with the area
being tested.

(2) Bias is eliminated.

(3) Results of statistical sampling can be more easily justified as being representative of the population as a whole,
thus increasing the level of confidence in the results of testing the sample. As a consequence of this, the
conclusion drawn from the results of sample testing are more easily justified where an audit client disputes the
audit conclusions.

(4) In instances when there is a large population, the use of statistical sampling techniques may reduce the sample
size, and therefore the amount of audit work required, as compared to the sample size that would be selected
using judgement sampling methodology.

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When might sampling not be appropriate?

A sampling approach to testing would not be appropriate in the following circumstances:

i. Where there is a statutory requirement to disclose specific items in the financial statements, for example
directors’ remuneration.
ii. Where the population is very small and the results from sampling could not be relied on, for example when
conducting certain compliance tests.
iii. Where the population is small in number but comprises material individual balances or transactions, for
example property additions.
iv. Where the population is not homogenous and requires subdivision before sampling can be attempted, for
example purchase invoices and credit notes.
v. When the auditor is put ‘on enquiry’ for example when testing for fraud.
vi. Where the costs of sampling outweigh the benefits as compared to 100% testing.

EXTRAPOLATION: Extrapolation takes the result of a sample and projects that result over the whole population.
Imagine total sales are $10m. You select a sample of $1m (10% of the population) to test. If errors of $37k are found
in the sample, it could be inferred by extrapolation that there are errors of $370k in the total population.

Extrapolation can only be applied to statistical sampling.

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CAATs AA Revision Notes
COMPUTER ASSISTED AUDIT TECHNIQUES (CAATs)

Computer‐assisted audit techniques (CAATs) are those featuring the ‘application of auditing procedures using the
computer as an audit tool’

The extent to which an auditor may choose between using CAATs and manual techniques on a specific audit
engagement depends on the following factors:

 The cost effectiveness of using CAATs
 The availability of audit time
 The availability of the audit client’s computer facility
 The level of audit experience and expertise in using a specified CAAT
 The level of CAATs carried out by the audit client’s internal audit function and the extent to which the external
auditor can rely on this work

Test data Audit test data is used to test the existence and effectiveness of controls built into an
application program used by an audit client.

As such, dummy transactions are processed through the client’s computerised system. The
results of processing are then compared to the auditor’s expected results to determine
whether controls are operating efficiently and systems’ objectiveness are being achieved.

For example, two dummy bank payment transactions (one inside and one outside authorised
parameters) may be processed with the expectation that only the transaction processed
within the parameters is ‘accepted’ by the system. Clearly, if dummy transactions processed
do not produce the expected results in output, the auditor will need to consider the need for
increased substantive procedures in the area being reviewed.

Test data should contain valid data (to ensure the system processes it correctly) and invalid
data (to ensure system rejects it).

Live test data: data processed on the client’s system during a normal production run

Dead test data: data processed at a time when the normal production run is not taking place

Integrated test facility: the auditor may seek permission from the client to establish an
integrated test facility within the accounting system. This entails the establishment of a
dummy unit, for example, a dummy supplier account against which the auditor’s test data is
processed during normal processing runs.

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Audit Software The term ‘audit software’ describes the computer software used by auditors to assist them in
their work, when examining the operations of, and testing the output of a computer‐based
accounting system.

Computer programs designed to carry out tests of control and/or substantive procedures

This performs checks that auditors would otherwise need to do by hand.

Such programs may be classified as:

Packaged programs (off the shelf)
These consist of pre‐prepared generalised programs used by auditors and are not ‘client
specific’. They may be used to carry out numerous audit tasks, for example, to select a sample,
either statistically or judgementally, during arithmetic calculations and checking for gaps in
the processing of sequences.

Purpose written programs (bespoke)
These programs are usually ‘client specific’ and may be used to carry out tests of control or
substantive procedures. Audit software may be bought or developed, but in any event the
audit firm’s audit plan should ensure that provision is made to ensure that specified programs
are appropriate for a client’s system and the needs of the audit. Typically, they may be used
to re‐perform computerised control procedures (for example, cost of sales calculations) or
perhaps to carry out an aged analysis of trade receivable (debtor) balances.

Enquiry programs
These programs are integral to the client’s accounting system; however they may be adapted
for audit purposes. For example, where a system provides for the routine reporting on a
‘monthly’ basis of employee starters and leavers, this facility may be utilised by the auditor
when auditing salaries and wages in the client’s financial statements. Similarly, a facility to
report trade payable (creditor) long outstanding balances could be used by an auditor when
verifying the reported value of creditors

Uses of audit software

Highlighting of exceptions‐ For example, to identify exceptional wages payments outside of
stated parameters

Highlighting of trends‐ To highlight reported inventory movement both immediately before
and after reporting dates to identify possible manipulation of inventory figures

Performance of sequence checks‐ To verify completeness of sales reporting by ensuring that
all invoices have been recorded.

Calculation checks‐ To ensure that overhead costs are totalled correctly in the general ledger.

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Stratification of data – To subdivide the population of inventory lines with a view to examining
only material balances.

Selection of items for testing – To select trade receivables accounts for circularisation, to
verify the existence of trade receivables.

Detecting violation of system rules – For example, where other people besides the accountant
have been overriding overtime payments or employees amending their own gross wages.

The advantages of Computer‐Assisted Audit Techniques (CAATs) are that they:

1. Enable the auditor to test program controls – if CAATs were not used then those controls would not be testable.

2. Enable the auditor to test a greater number of items quickly and accurately. This will also increase the overall
confidence for the audit opinion.

3. Allow the auditor to test the actual accounting system and records rather than printouts which are only a copy
of those records and could be incorrect.

4. Are cost effective after they have been setup as long as the company does not change its systems.

5. Allow the results from using CAATs to be compared with ‘traditional’ testing – if the two sources of evidence
agree then this will increase overall audit confidence

DATA ANALYTICS
Data analytics (DA) is the process of examining data sets in order to draw conclusions about the information they
contain, increasingly with the aid of specialized systems and software.

With the increasing volume of data in business today, data analytics can be used as an audit technique to better
understand and analyze large volumes of data. Equipped with a more in‐depth knowledge of the entity’s business,
the auditor is able to focus on items of greater audit interest.

The International Auditing and Assurance Standards Board (IAASB) is currently evaluating whether and to what
extent data analytics should be integrated into the ISAs.

Data analytics enhances audit quality because the population tested is larger with the objective that 100 % of the
data is screened. As a result, auditors can generally derive a combination of quality and value from its use.

Data analytics provide an opportunity to maximize the effectiveness of the human element.

For example, technology solutions can reduce the amount of time dedicated to manual analysis, allowing more time
to be spent by the auditor on the more judgmental aspects of an analysis.

Data analytics increases the automation in the audit process which allows the auditor to increase his focus on the
more fundamental audit procedures and the more complex and risky areas of audit.
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The application of professional skepticism and professional judgment is improved when the auditor has a robust
understanding of the entity and its increasingly complex and high‐volume data environment.

This enhances the quality of the auditor’s risk assessment and response.

Data analytics presents an opportunity for more valuable and informed engagement and dialogue with those charged
with governance within the audited entity.

Data analytics can be applied throughout the phases of the audit, including:
• Plan the audit.
• Perform tests of operating effectiveness of control.
• Perform substantive procedures.
• Evaluate results.

Commonly performed data analytics routines
 Comparing the last time an item was bought with the last time it was sold, for cost/NRV purposes.
 Inventory ageing and how many days inventory is in stock by item.
 Receivables and payables ageing and the reduction in overdue debt over time by customer.
 Analyses of revenue trends split by product or region.
 Analyses of gross margins and sales, highlighting items with negative margins.
 Matches of orders to cash and purchases to payments.
 ‘Can do did do testing’ of user codes to test whether segregation of duties is appropriate, and whether any
inappropriate combinations of users have been involved in processing transactions.
 Detailed recalculations of depreciation on fixed assets by item, either using approximations (such as assuming
sales and purchases are mid‐month) or using the entire data set and exact dates.
 Analyses of capital expenditure v repairs and maintenance.
 Three‐way matches between purchase/sales orders, goods received/despatched documentation and invoices.

Test of controls using data analytics

Examples include the following tests of controls:
 Analysis of all paid invoices of the fiscal year: approval present? Timely? Correct person?
 Analysis of credit limits by customers: any exceeded?
 Analysis of access rights of users and possible changes throughout the fiscal year

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Fraud AA Revision Notes
Fraud

Fraud: ISA 240 (Redrafted) defines fraud as: ‘An intentional act by one or more individuals among management,
those charged with governance, employees, or third parties, involving the use of deception to obtain an unjust or
illegal advantage.’

Error: is an unintentional misstatement in financial statements, including the omission of an amount or a disclosure.

Two types of intentional misstatements are relevant to the auditor – misstatements resulting from fraudulent
financial reporting and misstatements resulting from misappropriation of assets.

Fraudulent financial reporting

Fraudulent financial reporting often involves management override of controls that otherwise may appear to be
operating effectively. Fraud can be committed by management overriding controls using such techniques as
intentionally:

 Recording fictitious journal entries, particularly close to the end of an accounting period, to manipulate
operating results or achieve other objectives.
 Inappropriately adjusting assumptions and changing judgments used to estimate account balances.
 Omitting, advancing or delaying recognition in the financial statements of events and transactions that have
occurred during the reporting period.
 Omitting, obscuring or misstating disclosures required by the applicable financial reporting framework, or
disclosures that are necessary to achieve fair presentation.
 Concealing facts that could affect the amounts recorded in the financial statements.
 Engaging in complex transactions that are structured to misrepresent the financial position or financial
performance of the entity
 Altering records and terms related to significant and unusual transactions

Misappropriation of assets involves the theft of an entity’s assets and is often perpetrated by employees in relatively
small and immaterial amounts. However, it can also involve management who are usually more able to disguise or
conceal misappropriations in ways that are difficult to detect. Misappropriation of assets can be accomplished in a
variety of ways including:

• Embezzling receipts (for example, misappropriating collections on accounts receivable or diverting receipts in
respect of written‐off accounts to personal bank accounts).
• Stealing physical assets or intellectual property (for example, stealing inventory for personal use or for sale,
stealing scrap for resale, colluding with a competitor by disclosing technological data in return for payment).
• Causing an entity to pay for goods and services not received (for example, payments to fictitious vendors,
kickbacks paid by vendors to the entity’s purchasing agents in return for inflating prices, payments to fictitious
employees).
• Using an entity’s assets for personal use (for example, using the entity’s assets as collateral for a personal loan
or a loan to a related party).

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Misappropriation of assets is often accompanied by false or misleading records or documents in order to conceal
the fact that the assets are missing or have been pledged without proper authorization.

External auditor‐responsibilities regarding fraud
The main focus of audit work is to ensure that the financial statements show a true and fair view. The detection of
fraud is therefore not the main focus of the external auditor’s work.

Learn!

1. In accordance with ISA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements,
external auditors are responsible for obtaining reasonable assurance that the financial statements taken as a
whole are free from material misstatement, whether caused by fraud or error.

2. In order to fulfil this responsibility, they are required to identify and assess the risks of material misstatement
of the financial statements due to fraud.

3. They need to obtain sufficient appropriate audit evidence regarding the assessed risks of material misstatement
due to fraud, through designing and implementing appropriate responses. In addition, auditors must respond
appropriately to fraud or suspected fraud identified during the audit.

4. When obtaining reasonable assurance, auditors are responsible for maintaining professional scepticism
throughout the audit, considering the potential for management override of controls and recognising the fact
that audit procedures which are effective in detecting error may not be effective in detecting fraud.

5. To ensure that the whole engagement team is aware of the risks and responsibilities for fraud and error, ISAs
require that a discussion is held within the team, placing particular emphasis on how and where the entity’s
financial statements may be susceptible to material misstatement due to faud, including how fraud might occur

6. In situations where the external auditor does detect fraud, then the auditor will need to consider the
implications for the entire audit. In other words, the external auditor has a responsibility to extend testing into
other areas because the risk of providing an incorrect audit opinion will have increased.

Groups to report fraud to
1. Report to audit committee: Disclose the situation to the audit committee as they are charged with maintaining
a high standard of governance in the company. The committee should be able to discuss the situation with the
directors and recommend that they take appropriate action
2. Report to members: If the financial statements do not show a true and fair view then the auditor needs to
report this fact to the members through their audit report.
3. Report to professional body: If the auditor is uncertain as to the correct course of action, advice may be
obtained from the auditor’s professional body.

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Internal auditor’s responsibilities regarding fraud

 Commenting on the process used by management to identify and classify the specific fraud and error risks to
which the entity is subject (and in some cases helping management develop and implement that process)
 Commenting on the appropriateness and effectiveness of actions taken by management to manage the risks
identified (and in some cases helping management develop appropriate actions by making recommendations)
 Periodically auditing or reviewing systems or operations to determine whether the risks of fraud and error are
being effectively managed
 Monitoring the incidence of fraud and error, investigating serious cases and making recommendations for
appropriate management responses.

In practice, the work of internal audit often focuses on the adequacy and effectiveness of internal control procedures
for the prevention, detection and reporting of fraud and error. It should be recognised, however, that many
significant frauds bypass normal internal control systems and that, in the case of management fraud in particular,
much higher level controls (those relating to the high level governance of the entity) need to be reviewed by internal
audit in order to establish the nature of the risks and to manage them effectively.

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Law and Regulations AA Revision Notes
Laws and Regulations

An important part of an external audit is the consideration by the auditor as to whether the client has complied with
laws and regulations.

Key points
Management’s responsibility: Management have a responsibility to ensure that the operations of The client are
conducted in accordance with the provisions of laws and regulations. This includes compliance with laws and
regulations that determine amounts and disclosures in financial statements, including tax liabilities and charges.

Auditor’s responsibility: Auditors are not responsible for preventing non‐compliance with laws and regulations,
and cannot be expected to detect non‐compliance with all laws and regulations.

They have a responsibility to obtain reasonable assurance that the financial statements are free from material
misstatement, whether caused by fraud or error.

Auditor’s responsibility differs in relation to the two different categories of laws and regulations identified below:

1. Laws and regulations which have a DIRECT effect on the determination of material amounts and disclosures
in financial statements. Here the auditor is responsible for obtaining sufficient appropriate audit evidence
regarding compliance.

2. Laws and regulations which DO NOT HAVE A DIRECT EFFECT on the determination of material amounts and
disclosures in financial statements, but may impact the entity’s ability to continue to trade. Here the auditor’s
responsibility is limited to specified audit procedures to help identify non‐compliance with those laws and
regulations that may have a material effect on the financial statements. This includes inquiring with
management whether the entity is in compliance with such laws and regulations, and inspecting
correspondence with relevant licensing or regulatory authorities.

The auditor also has a responsibility to remain alert, by maintaining professional scepticism, to the possibility that
other audit procedures may bring instances of identified or suspected non‐compliance with laws and regulations.

DIRECT AND INDIRECT LAWS AND REGULATIONS‐ IMPORTANT EXAPLANATION TO GO THROUGH
There are many laws and regulations that a reporting entity may have to comply with in order to continue in
business. For example, many entities (particularly in the UK) will have to comply with strict health and safety
legislation; a food manufacturer may have strict food hygiene legislation to comply with, and an accountancy firm
will have a code of ethics to follow from its professional body.

Such laws and regulations will have both a direct effect on the financial statements and an indirect effect.

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Law and Regulations AA Revision Notes
Laws and regulations that have a direct effect Laws and regulations that have an indirect effect on the
on the financial statements financial statements

Gather sufficient and appropriate audit The auditor will undertake procedures with the objective of
evidence that the entity has complied with identifying non‐compliance with such laws and regulations. ISA
such laws and regulations. For example, when 250 gives examples of:
auditing the payroll the auditor will be  Compliance with the terms of an operating license
concerned with gathering sufficient and  Compliance with regulatory solvency requirements, or
appropriate audit evidence to ensure that tax  Compliance with environmental regulations.
legislation has been correctly applied by the
entity because if it has not (there is risk that When designing procedures to help to identify non‐compliance
the entity could be fined for non‐compliance with laws and regulations, the auditor should obtain a general
and the fines could be material, either in understanding of:
isolation or when aggregated with other  The applicable legal and regulatory framework, and
misstatements. In addition, amounts within  How the entity complies with that framework.
the financial statements may also be
misstated as a result of the non‐compliance the auditor must maintain a degree of professional scepticism
with laws and regulations. and remain alert to the possibility that other audit procedures
applied may bring instances of non‐compliance or suspected
non‐compliance with laws and regulations to the auditor’s
attention, and such procedures could include:
 Reading minutes of board meetings
 Enquiring of management and/or legal advisers concerning
litigation or claims brought against the entity, and
 Undertaking substantive tests on classes of transactions,
account balances or disclosures.

REPORTING IDENTIFIED OR SUSPECTED NON‐COMPLIANCE WITH LAWS AND REGULATIONS
Where the auditor discovers non‐compliance with laws and regulations, the auditor must notify those charged with
governance.

However, care must be taken by the auditor because if the auditor suspects that those charged with governance are
involved, the auditor must then communicate with the next highest level of authority, which may include the audit
committee.

If a higher level of authority does not exist, the auditor will then consider the need to obtain legal advice.

The auditor must also consider whether the non‐compliance has a material effect on the financial statements and,
in turn, the impact the non‐compliance will have on their report.

There may be occasions when the auditor’s duty of confidentiality may be overridden by law or statute. This can be
the case when the auditor discovers non‐compliance with legislation such as drug trafficking or money laundering.

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Audit Documentation AA Revision Notes
Audit Documentation

Audit documentation’ means the record of audit procedures performed, relevant audit evidence obtained and the
conclusions the auditor reached.

Professional judgment is subjective. It needs to be supported by the facts and circumstances of the engagement or
by sufficient appropriate audit evidence.

Therefore, these matters need to be appropriately documented.

Need/ importance of documentation
1. Provides evidence of the auditor’s basis for a conclusion about the achievement of the overall objective of the
audit.
2. Provides evidence that the audit was planned and performed in accordance with ISAs and applicable legal and
regulatory requirements.
3. Assists the engagement team to plan and perform the audit.
4. Assists members of the engagement team responsible for supervision to direct, supervise and review the audit
work.
5. Enables the engagement team to be accountable for its work.
6. Retains a record of matters of continuing significance to future audits.

Contents of a working paper
1. Name of client – identifies the client being audited.
2. Year‐end date – identifies the year end to which the audit working papers relate.
3. Subject – identifies the area of the financial statements that is being audited, the topic area of the working
paper, such as receivables circularisation.
4. Working paper reference – provides a clear reference to identify the number of the working paper, for example,
R12 being the 12th working paper in the audit of receivables.
5. Preparer – identifies the name of the audit team member who prepared the working paper, so any queries can
be directed to the relevant person.
6. Date prepared – the date that the audit work was performed by the team member; this helps to identify what
was known at the time and what issues may have occurred subsequently.
7. Reviewer – the name of the audit team member who reviewed the working paper; this provides evidence that
the audit work was reviewed by an appropriate member of the team.
8. Date of review – the date the audit work was reviewed by the senior member of the team; this should be prior
to the date that the audit report was signed.
9. Objective of work/test – the aim of the work being performed, could be the related financial statement
assertion; this provides the context for why the audit procedure is being performed.
10. Details of work performed – the audit tests performed along with sufficient detail of items selected for testing.
11. Results of work performed – whether any exceptions arose in the audit work and if any further work is required.
12. Conclusion – the overall conclusion on the audit work performed, whether the area is true and fair.

Audit documentation may be recorded on paper or on electronic or other media.

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The working papers should be so prepared so as to enable an experienced auditor, with no previous connection
to the audit, to understand:
 The nature, timing and extent of the audit procedures performed to comply with the International Standard on
Auditing (ISA).
 The results of the audit procedures and audit evidence obtained.
 Significant matters resulting during the audit and the conclusions expressed thereon.

Types of audit files
The files in which all the working papers are put are termed audit files.

Permanent file papers (information of continuing importance)
The permanent file contains matters of continuing importance affecting the company or the audit. This generally
has future or long term use.
 Information concerning legal structure of entity (e.g., Memorandum and Articles of Association).
 Other documents of continuing importance:
o Terms of engagement;
o Minutes of important meetings;
o Debenture deeds;
o Title deeds and lease agreements;
o Royalty agreements.
 Descriptions of nature and history of client's business, locations and products.
 A list of client's investments (if any).
 Organisation charts, with extra details for finance department.
 Main accounting records, showing where kept and of what type (e.g., handwritten, computerised).
 Copies of previous financial statements and auditor's reports thereon.
 Previous reports to management (detailing weaknesses found in the accounting system.
 Client's other professional advisers.
 Client's insurance cover details.
 Significant ratios and trends.
 Accounting systems descriptions in flow chart and narrative form.
 Internal controls evaluation data: questionnaires and checklists.
 Principal accounting policies.

Current audit file papers (information of relevance to current year’s audit)

The current file which is broadly concerned with the accounts being audited. This generally serves an immediate
purpose. It generally contains the following papers:

Examples of the working papers ordinarily contained in a typical current audit file include:
‐ Evidence of the planning process including audit programmes and any changes thereto.
‐ Evidence of the auditor’s consideration of the work of internal auditing and conclusions reached.
‐ Analyses of transactions and balances.
‐ Analyses of significant ratios and trends.
‐ The identified and assessed risks of material misstatements at the financial statement and assertion level.
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‐ A record of the nature, timing and extent of audit procedures performed in response to risks at the assertion
level and the results of such procedures.
‐ Evidence that the work performed by assistants was supervised and reviewed
‐ An indication as to who performed the audit procedures and when they were performed.
‐ Details of audit procedures applied regarding components whose financial statements are audited by another
auditor.
‐ Copies of communications with other auditors, experts and other third parties.
‐ Copies of letters or notes concerning audit matters communicated to or discussed with management or those
charged with governance, including the terms of the engagement and material weaknesses in internal control.
‐ Letters of representation received from the entity.
‐ Conclusions reached by the auditor concerning significant aspects of the audit, including how exceptions and
unusual matters, if any, disclosed by the auditor’s procedures were resolved or treated.
‐ Copies of the financial statements and auditor’s report.

Controls required to ensure the safe custody of audit documentation

1. Maintain a log
2. Prevent unauthorised changes to the documentation
3. Protection from theft: passwords, access restrictions
4. Retention of working papers: minimum 5 years

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Quality Control AA Revision Notes
Quality Control for an Audit of Financial Statements

1 Leadership responsibility Engagement Partner
for quality

2 Ethical requirements Engagement Partner to ensure independence not compromised throughout the
audit

3 Acceptance/ continuance Matters to consider before accepting new clients/continuing with previous
of client clients

4 HR policies Engagement Partner should have skills, authority, time required for audit. He
should also ensure the team has relevant skills
5 Engagement performance a) Direction
‐ Set by Engagement Partner
‐ Set in the planning meeting
‐ Responsibilities assigned to team
‐ Objective of work to be done communicated
‐ Risks
‐ Team told how to deal with problems as they arise
b) Supervision

Main responsibility: Engagement Partner
The audit supervisor should keep track of the progress of the audit
engagement to ensure that the audit timetable is met and should ensure
that the audit manager and partner are kept updated of progress
‐ Should be continuous
‐ Ensure work according to planned approach (The competence and
capabilities of individual members of the engagement team should be
considered, including whether they have sufficient time to carry out
their work, whether they understand their instructions and whether
the work is being carried out in accordance with the planned approach
to the audit.)
‐ Ensure important matters told to seniors
‐ Ensure audit approach modified if needed ( based on any significant
matters that may arise during the audit)
‐ See if consultation is needed.
c) Consultation (use of experts) where needed
‐ From outside the team or outside the firm

d) Review
‐ Hierarchical review (consider whether work has been performed in
accordance with professional standards and other regulatory
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Quality Control AA Revision Notes
requirements and if the work performed supports the conclusions

reached and has been properly documented.)
‐ Check if objective of work has been achieved
‐ Ensure conclusions are supported by sufficient appropriate evidence

e) Engagement Quality Control Review (if needed)
‐ Reviewer will review significant judgments
‐ Reviewer will evaluate conclusions reached in making the audit report
‐ Reviewer will ensure consultations have been taken where needed
‐ The review of the proposed auditor’s report includes consideration of
the proposed wording to be included in the Key Audit Matters section(to
be studied later)

f) Documentation
‐ Maintain and retain all documentation ( working papers)
‐ Ensure confidentiality

6 Monitoring ‐ The firm should ensure quality control procedures are adequate and
complied with.

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Corporate Governance AA Revision Notes
Corporate Governance

Corporate governance is the system by which companies are directed and controlled.

Good corporate governance ensures that stakeholders with a relevant interest in the company are fully taken into
account.

According to the UK Corporate Governance Code the ‘purpose of corporate governance is to facilitate effective,
entrepreneurial and prudent management that can deliver the long‐term success of the company’.

Corporate governance considers the responsibilities of directors, how the board of directors should be run and
structured, the need for good internal controls and the relationship with external auditors.

It is important for companies to consider good corporate governance principles as often it is management or those
charged with governance who run the company, but the owners are the shareholders and they are not involved in
the running of the business.

For these shareholders their only opportunity to raise concerns is at the annual general meeting, which only occurs
once a year and often attendance is low.

Shareholders need to ensure that their needs are taken into account by management, and that there is a process in
place for them to be informed as to how the business is operating.

Corporate governance represents the set of policies and procedures that determine how an organisation is directed,
administered and controlled.

Although the contents of corporate governance will vary from organisation to organisation, almost all will have the
following components: Accountability, compliance, transparency and integrity

TCWG: Those “charged with governance” are defined as the persons who are “accountable for ensuring that the
entity achieves its objectives, with regard to reliability of financial reporting, effectiveness and efficiency of
operations, compliance with applicable laws, and reporting to interested parties.”

Although there is no universal rule, in most instances these persons will either be the board of directors and/or the
audit committee

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An Exam focused summary

Can be principles based or rules based

Board of Directors
The ENTIRE board responsible for F/S, fraud prevention and detection, ICS, ethics, compliance etc.

Executive Directors: Remuneration package ( Basic Salary, Benefits in kind, Performance linked elements in short
term as well as long term, Retirement benefits)

Non‐Executive Directors ( should be independent: No familiarity with the executive management, no financial
interest in company except a fixed fee for directors’ duties, not business relationship, not been an employee in
the recent past, can serve for maximum 9 years)

Appoint NEDs to protect SH interest. They also bring external expertise.
1. CEO and Chairman roles should be segregated ( Chairman should be an NED)

2. Balance in the board: equal number of EDs and NEDs excluding the independent Chairman

3. Variety of skills, cultural and gender diversity in the board

4. There should be FOUR sub‐committees of the board
a) Audit Committee
b) Remuneration Committee
c) Risk Committee
d) Nomination Committee

5. For ALL directors:
‐ Induction
‐ CPD
‐ Annual performance appraisal
‐ Re‐election ever 3 years ( retirement by rotation)

6. Regular board meetings (with agenda and minutes). No single individual should dominate discussions.

7. The company should have a sound system of internal control.

8. There should be adequate risk management in the company.

9. There should be an internal audit department

10. Transparency in the annual report is important.

11. Institutional shareholders should intervene in the company when needed.

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Provisions of international codes of corporate governance (such as OECD) that are most relevant to auditors.

The Principles cover six key areas of corporate governance:
1. Ensuring the basis for an effective corporate governance framework(should promote transparent and efficient
markets, be consistent with the rule of law and have a clear division of responsibilities among different
supervisory, regulatory and enforcement authorities)

2. The rights of shareholders and key ownership functions

3. The equitable treatment of shareholders

4. The role of stakeholders in corporate governance

5. Disclosure and transparency

6. The responsibilities of the board

Important terms in corporate governance

An executive director: an executive director is a director responsible for the administration of a company.
They are primarily responsible for carrying out the strategic plans and policies as established by the board of
directors.

A non‐executive director (NED): a non‐executive director is a director without day‐to‐day operational
responsibilities of the company.

Responsibilities of the board of directors in corporate governance
- Establish a code of corporate ethics
- Ensure that that the organisation establishes policies, procedures and controls to manage the potential risks
it will face
- Ensure compliance with laws and regulations
- Ensuring that an effective system of internal controls is in place and functioning
- Ensuring that a high quality and timely independent audit is conducted
- Establish and oversee the work of audit and remuneration committee

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The board of directors - The board should meet regularly.

- The roles of chairman and CEO should not be performed by the same individual.
The roles of chairman (NED) and chief executive(ED) are both very important and
carry significant responsibilities; hence this prevents too much power residing in
the hands of one individual.

- At least half of the board should be comprised of NEDs :There should be an
appropriate balance of executives and non‐executives (excluding the chairman),
to ensure that the board makes the correct objective decisions, which are in the
best interest of the stakeholders of the company, and no individual or group of
individuals dominates the board’s decision‐making

- Non‐executives need to be independent of the executive management so that
they can exercise judgment without bias or self interest

- All directors should receive induction training when they first join the board so
that they are fully aware of their responsibilities.

- The shareholders should review on a regular basis that the composition of the
board of directors is appropriate, and they do this by re‐electing directors every
three years ( retirement by rotation).

- The directors need to consider, on an annual basis, whether the company requires
an internal audit department. Internal audit helps the director in monitoring the
company.

- The performance of each board member should be appraised on an annual basis.

- There should be an on‐going process of board development through continuous
professional development (CPD) of all board members.

- Board sub‐committees with appropriate composition should be made ( Audit and
Remuneration committee should only have NEDs whereas Risk and Nomination
should have a majority of NEDs)

Director’s No director should be involved in setting their own remuneration as this may result in
remuneration excessive levels of pay being set.

Levels of remuneration should be sufficient to attract and retain the directors needed
to run the company successfully, but companies should avoid paying more than is
necessary for this purpose. A proportion of executive directors’ remuneration should
be structured so as to link rewards to corporate and individual performance.

Non‐executive directors’ pay should not be based on meeting company targets as
their pay should be independent of how the company performs.
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Accountability and The board should present a balanced and understandable assessment of the
audit company’s position and prospects.

Internal control The board should maintain a safe and registered system of internal control to
safeguard the shareholders’ investment and the company’s assets.

Audit committee and i. The board should establish an audit committee of at least three directors, all
auditors non‐executive, with written terms of reference which deal clearly with its
authority and duties.
ii. The audit committee should monitor and review the internal audit and the
reports prepared by the internal audit team.
iii. With regard to the external auditors, the audit committee should
– Recommend their appointment.
– Approve their remuneration and terms of engagement.
– Monitor and review their independence, objectivity and effectiveness.

Relations with All members of the board should be involved in ensuring that satisfactory dialogue
shareholders occurs with shareholders (for example all should attend meetings with shareholders).

Dialogue with institutional shareholders: Companies should be ready, where
practicable, to enter into a dialogue with institutional shareholders based on mutual
understanding of objectives.

Constructive use of the AGM: Boards should use the AGM to communicate with
private investors and encourage their participation.

Institutional investors Shareholder voting: Institutional shareholders have a responsibility to make careful
use of their votes.
Code provisions
i. Institutional shareholders should, on request, make available to their clients
the information on the proportion of resolutions on which votes were cast
and non‐discretionary proxies lodged.
ii. Institutional shareholders should take steps to ensure that their voting
intentions are being translated into practice.

Dialogue with companies: Institutional shareholders should be ready, where
practicable, to enter into a dialogue with companies based on the mutual
understanding of objectives.

Evaluation of governance disclosures:When evaluating companies’ governance
arrangements, particularly those relating to board structure and composition,
institutional investors should give due weight to all relevant factors drawn to their
attention.

pg. 165


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Roles of the Audit Committee

Composition: entirely NEDs‐at least one of them should have recent and relevant financial experience.

1. With regards to Financial statements, the Audit committee:
o Reviews integrity of financial statements (including reviewing significant judgments)
o Checks the clarity and completeness of the disclosures in the financial statements.
o Monitors formal announcement regarding financial performance

2. With regards to Internal audit, it
o monitors effectiveness of IA, review their plan and ensure their recommendations are actioned
o ensures IA is accountable to AC and preserve their independence + Chief Internal auditor has access to
Chairman
o approves appointment/termination of Chief Internal Auditor

3. With regards to External auditors, it
o Is responsible for oversight of the company’s relations with its external auditors.
o Recommends appointment, re‐appointment and removal of external auditor
o Recommends remuneration and terms of engagement of EA
o Reviews and monitors independence of EA
o Develops and implements policy on EA providing non‐audit services
o Reviews qualification and expertise of the EA

4. It reviews control systems (internal controls, internal financial controls, risk management)

5. It monitors compliance with laws and regulations

6. The audit committee should also review the procedures in place for whistle‐blowing within the company.

Advantages of audit committee
1. Improves Public confidence in the credibility and objectivity of the financial statements. (They can create a
climate of discipline and control and reduce the opportunity for fraud)
2. It will help to improve the quality of the financial reportingguidance to BOD
3. An audit committee can help to improve the internal control environment of the company. The audit committee
is able to devote more time and attention to areas such as internal controls.
4. Helps in risk management: The audit committee can also provide advice on risk management to the executive
directors.
5. The audit committee will be responsible for appointing the external auditors and this will strengthen the
auditors’ independence and contribute to a channel of communication and forum of issues.
6. The NEDs bring considerable external experience to the board as well as challenging the decisions of executive
directors and contributing to independent judgements.
7. Senior management in the accounting and finance function can raise concerns and discuss accounting issues
with the audit committee.
8. The independence of the internal audit department is improved The audit committee will assume responsibility
for appointing and liaising with the external audit firm, thus ensuring the independence of the external auditor
especially in cases of dispute with management.
pg. 166


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Limitations of audit committee

1. Although audit committees do oversee the work of auditors (both internal and external) they do not have the
authority to appoint or dismiss them. This limits the amount of power the committee has over the organisation’s
auditors.

2. Audit committees generally do not have as much technical expertise and knowledge as the auditors they are
overseeing.

3. Independent directors often do not have as thorough a knowledge of the organisation’s operations and
functioning as executive directors.

4. Most of the members of the audit committee are non‐executive directors. The board may feel that the audit
committee has been formed to limit its powers and allow outsiders to run the company.

5. The non‐executive directors have to be paid more for carrying out the responsibilities associated with the audit
committee. Hence, it increases the cost of the organisation.

pg. 167


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Internal Audit AA Revision Notes
Internal Audit
An independent appraisal activity established within an organization as a service to it. A control in itself which
functions by examining and evaluating the adequacy and effectiveness of other controls.
It functions by, amongst other things, examining, evaluating and reporting to management and the directors on the
adequacy and effectiveness of components of the accounting and internal control systems
(Internal Audit is NOT a regulatory requirement BUT is a corporate governance best practice guideline)
There is NO requirement for internal auditor to be professionally qualified.
INDEPENDENCE
Internal auditors should:

• Monitor and review controls, not design and implement them;
• Report to the audit committee
• Be free to decide on the nature and scope of their work;
• Be free to communicate fully with the external auditors.
Steps to conduct internal audit
1. Identify the risks which may occur if there are no controls in place
2. Identify controls in place
3. Evaluate whether the controls in place reduce the risk to an acceptable level, i.e. they are adequate.
4. Evaluate whether the controls are working effectively.
5. Report
Functions of Internal Audit
1. Reviewing adequacy and effectiveness of financial and operational internal control systems
2. Helping management with risk assessment
3. Examining operating and financial information (is it reliable, adequate, and timely? How is it identified and
communicated?)
4. Review of compliance with laws, regulations and other external requirements and with management policies
and directives and other internal requirements.
5. Special assignments- some examples

- Value for Money audit (VFM)
- Mystery shopping
- Financial audit
- Financial statement audit
- IT system audit
pg. 168

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- HR audit
- Undertake inventory counts
6. Internal audit’s role in preventing and detecting fraud and error

- Can help by assessing the main areas of fraud risk
- Can help by assessing the adequacy and effectiveness of control systems.
- Can undertake regular reviews of compliance of these controls.
- Where fraud is suspected, the internal audit department can undertake a detailed fraud investigation to
identify who is involved, likely sums stolen and gather evidence for any subsequent police investigation.
- The presence of an internal audit department can itself act as a fraud deterrent, as the risk of being
discovered means individuals are less likely to undertake fraudulent activities.
Factors determining need of internal audit
Before establishing an internal audit department, consider the following:
 Will it be cost-beneficial?
 Consider the size and complexity of operations as well as number of employees- is more monitoring needed due
to increased chances of fraud and error?
 Have key risks and processes changed? Internal audit can help in risk assessment and in reviewing controls.
 Problems with existing controls- is there a history of control deficiencies?
 Need of special assignments that normally internal audit carries out. The ability of current management to carry
out these assignments will need to be considered. If they do not have the ability, an IA department may be
needed.
What does corporate governance say about Internal Audit?

 IA should report to the Audit Committee. The AC will monitor if internal audit is effective. If there is no IA
department, the AC should determine whether there is need for one. In case they believe the internal audit
department is not required, it needs to explain the reason for this in the annual report.
 Assistance to the board of directors:
The IA department checks reports that are not audited by the external auditors.
It can help the board with regards to accounting and auditing standards when required.
IA can liaison with external auditors which can reduce the time and cost of external audit.
pg. 169

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Differences between external and internal audit

Internal Audit External Audit
Appointment process Determined by management; appointed Determined by statute; appointed by
by management. members. Formal auditing qualifications
are required.
Objective The main objective of internal audit is to The main objective of the external auditor
improve a company’s operations, is to express an opinion on the truth and
primarily in terms of validating the fairness of the financial statements, and
efficiency and effectiveness of the other jurisdiction specific requirements.
internal control systems of a company.
Report to Internal audit reports are normally External audit reports are provided to the
addressed to the board of directors, or shareholders of a company. The report is
other people charged with governance attached to the annual financial
such as the audit committee. Those statements of the company and is
reports are not publicly available, being therefore publicly available to the
confidential between the internal auditor shareholders and any reader of the
and the recipient. financial statements.
Scope The work of the internal auditor normally The work of the external auditor relates
relates to the operations of the only to the financial statements of the
organisation, including the transaction organisation.
processing systems and the systems to
produce the annual financial statements. However, the internal control systems of
The internal auditor may also provide the organisation will be tested as these
other reports to management, such as provide evidence on the completeness and
value for money audits which external accuracy of the financial statements.
auditors rarely become involved with.
Relationship with the In most organisations, the internal auditor The external auditor is appointed by the
organization is an employee of the organisation, which shareholders of an organisation, providing
may have an impact on the auditor’s some degree of independence from the
independence. However, in some company and management
organisations the internal audit function
is outsourced.
Planning and evidence No materiality Materiality
collection Procedural or risk based Risk based
Primarily internal sources of evidence Internal and external sources of evidence
IA and risk management

IA ensures risk management systems are operating effectively and that the strategies implemented for business risks
are operating effectively.
Business risk (risk that the company’s objectives are not met or strategy not executed properly or inappropriate
objectives and strategies were set).
pg. 170

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Limitations of IA
– Independence issues as employees so may be concerned about job security
– If it is not reporting to the ac, management can influence them (they will be checking the work of the people
they are reporting to).
Outsourcing Internal Audit

Advantages
- Greater expertise, specialist skills and access to better audit technology without extra cost available
- Cost:
- The risk of staff turnover is passed on to the firm
- Lesser cost of training staff and retaining permanent staff
- Can budget better.
- May be more independent
- Lesser management time consumed in administering the department
- IA will be immediately available (also good for short term)
- The contract can be set for an appropriate time scale
- Flexibility in terms of that the staff can be called in according to workload
Disadvantages
1. May not be independent if the same firm is offering external audit and internal audit
2. May be more expensive
3. The firm will not have in-depth knowledge of the company
4. Lesser control by the management over the standard of service
5. May have confidentiality issues
6. If the company has an existing IA department:
- they may face opposition from the other staff
- In-house skills will be lost
- Redundancy costs if these staff members cannot be re-allocated other roles
Internal Audit assignments- examples to read through

1. VFM audit: A value for money audit focuses on whether the best combination of services has been obtained for
the lowest level of resources. In performing a value for money audit there are three areas which an auditor will
commonly focus on being economy, efficiency and effectiveness, and these are known as the three Es.
Economy – Keeping the cost of resources used to a minimum.
Efficiency – The relationship between the output from goods and services and the resources used to produce
them.
Effectiveness – How well the organisation’s objectives have been achieved.
• Economy: attaining the appropriate quantity and quality of physical, human and financial resources at the
lowest cost
• Efficiency: this is a measure of the relationship between goods and services produced (outputs) and the
resources used to produce them (inputs)
• Effectiveness: how well an activity is achieving its policy objectives or other intended effects
pg. 171

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2. IT audit
An information technology audit is an examination of the controls within an information technology
infrastructure. This determines if the information systems are:
- Safeguarding assets,
- Maintaining data integrity and
- Operating effectively and efficiently to achieve the organisation’s goals or objectives.
3. Best value audit

A best value review involves the following:
- Reviewing whether the products / services meet the requirements of the customers
- Determining whether there is balance between the cost and quality of the service or not
- Comparing product / service with competitors to find out the best and the worst features in the products
of the entity so as to make improvements.
4. Financial audit
The scope of internal audit for financial functions may involve internal control topics such as the efficiency of
operations, the reliability of financial reporting, deterring and investigating fraud, identifying errors,
safeguarding assets and compliance with laws and regulations.
5. Operational audit (procurement, marketing, HR)
6. Mystery shopper reviews
7. Regulatory compliance review
EXTERNAL AUDIT RELIANCE ON INTERNAL AUDITWORK
Reliance on internal audit
ISA 610 Using the Work of Internal Auditors details the factors the external auditors should consider in order to place
reliance on the work of the internal audit (IA) department as follows:
1. Objectivity: They should consider the status of IA within the company and if they are independent of other
departments, in particular the finance department. In addition, consideration should be given as to who IA
reports to, whether this is directly to those charged with governance or to a finance director.
2. Technical competence: The technical competence of IA staff should be considered. Consideration should be
given to whether they are members of a professional body and have relevant qualifications and experience.
3. Due professional care: The external auditors should consider if the IA department have exercised due
professional care, the work would need to have been properly planned including detailed work programmes,
supervised, documented and reviewed.
4. Communication: In order to place reliance there needs to be effective communication between the internal
auditors and the external auditor. This is most likely to occur when the IA department is free to communicate
openly and regular meetings are held throughout the year.
pg. 172

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Areas where external auditor can rely on/use internal auditor’s work:
– External Auditors could look to rely on any internal control documentation produced by internal audit for
changes in the control environment.
– If the IA department has performed test of controls during the year, such as the payroll, sales and purchase
systems, then external auditors could review and possibly place reliance on this work. This may result in the
workload reducing and possibly a decrease in the external audit fee.
– IA department may have conducted a risk assessment which external auditors could use as part of their initial
planning process.
– External auditors would need to consider the risk of fraud and error and non-compliance with law and
regulations resulting in misstatements in the financial statements. This is also an area for IA to consider, hence
there is scope for the external auditor to review the work and testing performed by IA to assist in this risk
assessment.
– It is possible that the IA department may assist with year-end inventory counting and controls and so external
auditors can place some reliance on the work performed by them, however, they would still need to attend the
count and perform their own reduced testing.
pg. 173

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Not for Profit Organizations AA Revision Notes
Not for Profit Organizations
Examples: charities, housing associations, clubs. Local authorities/councils, government bodies.
Charities
Unlike publicly traded companies, charities are not required by the Securities and Exchange Commission to undergo
annual audits. Many not-for-profit organizations, however, are required to receive an audit if they accept certain
types of funding or earn a large amount of revenue. A positive audit opinion can increase donor and board member
confidence in the non-profit's operations. An audit may also be required by the regulators (the charity commission
for example).
The auditor should clarify who the addresses of the report will be along with the scope of the engagement.
Important features to remember:
 There are no external shareholders therefore no dividends

 Income likely to be from donations/grants.
 Likely additional reporting/accounting rules.
 Their activities may be restricted by regulators
 They are NOT forbidden from engaging in commercial activities
 3Es very important for them.
 Normally managed by a council made up entirely of volunteers ( like NEDs)
- Inherent risk can be high in not-for-profit organizations that must report certain results to continue
receiving grants.
- Non-profits that pay low wages may have trouble attracting qualified accountants
- Higher level of cash transactions.
- Income – completeness problem.
- Lack of predictability regarding future income/expenditure. (analytical procedures aren’t very useful here!)
- Potential restrictions regarding activities/use of income.
- Restricted number of employees so segregation of duties difficult
- Auditors should evaluate not only the number of people involved in the accounting process but the level of
supervision. If no one is approving junior-level accounting staff entries, mistakes are less likely to be caught.
- Volunteer staff: Risks regarding their competence, training, lack of trust
- Informal environment
- Trustees (the time they give to the org, skills, qualifications, frequency of meetings, independence from
each other)
- Auditors typically test a variety of accounts and transactions. They should pay special attention to revenue
accounts when auditing a nonprofit. Nonprofit entities have different sources of revenue than their for-
profit counterparts, and all employees may not be familiar with the revenue recognition rules for donations
and grants. Auditors should check to see if the nonprofit has adequate supporting documentation and
determine the correct timing of revenue recognition for grants that have strings attached. The auditors
should give special attention to:
- Completeness of income
- Misuse of funds/ misappropriation of assets
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Planning the audit

The planning procedures undertaken for not-for-profit organisations will differ very little from those for profit
making organisations.
However, the auditor should have specific regard to any laws, regulations or guidelines imposed on the entity by any
regulatory body.
The scope of the auditor's work will be detailed in the engagement letter.
Risk assessment
The auditor should, during the planning stage, fully assess the risks associated with the not for-profit organisation.
INHERENT RISK
Key factors to consider include:

- The complexity and extent of regulation
- The significance of donations and cash receipts
- Restrictions imposed by the objectives and powers given by the entity’s governing documents
- The sensitivity of certain key statistics such as proportion of resources used in administration
- The need to maintain adequate resources whilst avoiding the buildup of resources which could appear excessive
CONTROL RISK
Key factors to consider include:
- Competence, training and qualification of paid staff and volunteers
- Segregation of duties
- Reliability of accounting systems / computer systems
- Controls over compliance with laws and regulations
- Power of trustees
Audit evidence
When designing substantive procedures for not-for-profit organisations, the auditor should give special attention to
the possibility of:
 Understatement of income, including gifts in kind, cash donations and legacies
 Incorrect accounting treatment of lifetime subscriptions
 Overstatement of cash grants or expenses
 Misanalysis or misuse of funds
 Misstatement or omission of assets including donated properties
 Misallocation of expenses to disguise excessive administration expenditure
Reporting
For incorporated not-for-profit organisations, the reporting requirements of ISA 700 the independent auditor's
report on a complete set of general purpose financial statements apply.
Additionally, the reporting requirements of the governing body will need to be encompassed in the auditor's report.
For organisations not incorporated under statute, the auditor or review report will be determined in accordance
with the terms of appointment detailed in the letter of engagement.
pg. 175

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Common formats
Management letter
Weakness Implication (Possible effect) Recommendation
Report (with Cover letter)
Board of Directors
XYZ Co
Address line 1
Address line 2
Address line 3
8 August 20XX
Dear Sirs,
Audit of XYZ Co for year ended 30th September 20XX
Please find enclosed the report to management on……
This report is solely for the use of management and if you have any further questions, then please do
not hesitate to contact us.
Yours faithfully
An audit firm
pg. 176

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Formal business letter
ABC plc
Address line 1
Address line 2
Address line 3
Date
Dear Shareholders,
Subject
Do not start the letter right away. You need to have a formal introduction
Thank you
Yours sincerely
Mr. A
(Designation)
Memorandum
From:
To:
CC:
Date: DD/MM/YYYY
Subject: _____________________________:
Introduction
Explanation
Sincerely
AB
pg. 177

18audit and Assurance

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1.8Audit and Assurance

F8 - Audit and Assurance (Association of Chartered Certified Accountants)

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Audit and Assurance

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01 Using these Notes 01

02 About the Exam 02

07 Client Acceptance/Continuance, Agreeing Terms of Engagement 26

09 Internal Control Systems 49

10 Management assertions, Audit Procedures & Audit Evidence 71

11 Procedures on Specific Areas 82

13 Opinion & Reporting 123

14 Audit Sampling 144

15 CAATs (including data analytics) 147

17 Laws & Regulations 154

18 Audit Documentation 156

19 Quality Control 159

20 Corporate Governance 161

21 Internal Audit 168

22 Not for profit organizations-audit techniques 174

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An Assurance engagement in which the practitioner An assurance engagement in which the practitioner

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Sufficient appropriate evidence is obtained as part Lesser testing‐focus on obvious errors only

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– Assigning individuals to the audit team who have

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Audit Planning AA Revision Notes

Importance of audit planning

An exam focused overview

The Planning stage of audit- An overview

Audit Strategy Audit Plan

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Audit Planning AA Revision Notes