Lecture 4 & 5

Completing the audit and final review

1
Learning outcomes
 Describe the auditor’s final audit evaluation
processes in completing the audit
 Identify and evaluate the audit issues related to
contingent liabilities, commitments, subsequent
events
 Describe and draft audit procedures relating to
contingent liabilities, commitments, subsequent
events
 Describe the issues related to accounting estimates
and related parties
 Describe auditors responsibility relating to gong
concern
 Describe and draft audit procedures relating to
assessment of going concern
2
Final Review

Final evidential evaluation processes

Before deciding on the appropriate audit report to
be issued for the entity the auditor conducts a
number of audit steps and activities in the
completion stage of the audit. At this stage of the
audit, the audit steps performed are normally not
related directly to specific business process or
account balances

3
 Completing the Audit ( cont.)
Review of Working Papers
ISA 220 Quality Control for Audits of Historical Financial
Information emphasizes the need to review the work of the
engagement team, the review of working paper becomes an
important aspect of completing the audit. The engagement
partner or managers normally do this just before issuing the
audit report. The review is designed to satisfy the engagement
partners and managers that:
•the work provides sufficient appropriate evidence supporting the
financial report assertions;
•the audit report is fully supported by working papers;
•the working papers are in accordance with appropriate standards;
•important matters have been communicated to relevant parties;
•the senior has undertaken the supervisory role satisfactorily.
Completing the audit

 Final Analytical Procedures

 Contingent Liabilities
 Commitments
 Subsequent Events
 Related Parties Disclosures
 Going Concern and estimates
 Representation Letter
 Communication with
Management, Audit Committee
and Board of Directors

5
 Final Analytical Review

Review for Contingent Liabilities & Commitments

Review for Subsequent Events and related

parties
On Going Concern Considerations and accounting
estimates

Issue Management Letter and Representation Letter

Communicate with Audit Committee and Management

Evaluation of Final Audit Evidence and Results

Issue Auditor’s Report 6

 Final Analytical Procedures
 ISA 520
 Recalculation of ratios
 Analysis of ratios and trends
 To help the auditor assess the conclusions reached on
the financial statement components and evaluate the
overall financial statement presentation
 The auditor should apply analytical procedures at the
planning and overall review stages of the audit.
Analytical procedures may also be applied at other
stages.

7
 Final Analytical Procedures
 Reasonableness of ratio
 How the client fits within its own industry
 Critical issues and significant industry business risks
 Structure and profitability of the industry
 Make sense? In parallel with auditor’s knowledge and
understanding throughout the audit and past years
experiences

8
 Final Analytical
Procedures in Planning the
Audit
 The auditor should apply analytical procedures at
the planning stage to assist in understanding the
business and in identifying areas of potential risk.
Application of analytical procedures may indicate
aspects of the business of which the auditor was
unaware and will assist in determining the nature,
timing and extent of other audit procedures.
 
 Analytical procedures in planning the audit use both
financial and non-financial information, for example,
the relationship between sales and square footage of
selling space or volume of goods sold.
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 Analytical Procedures in the
Overall Review at the End of
the Audit
 The auditor should apply analytical procedures at or
near the end of the audit when forming an overall
conclusion as to whether the financial statements as
a whole are consistent with the auditor’s knowledge
of the business.
 The conclusions drawn from the results of such
procedures are intended to corroborate conclusions
formed during the audit of individual components or
elements of the financial statements and assist in
arriving at the overall conclusion as to the
reasonableness of the financial statements. However,
they may also identify areas requiring further
procedures.
10
 
Investigating Unusual Items
 When analytical procedures identify significant
fluctuations or relationships that are inconsistent with
other relevant information or that deviate from
predicted amounts, the auditor should investigate and
obtain adequate explanations and appropriate
corroborative evidence.
 Compare account being audited with prior-year
balances
 Identify unusual fluctuations from prior year
 Examine movement of related accounts
 Use internal management accounts
 Use of industry data
 Reasonableness tests
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 Final Analytical Review

Review for Contingent Liabilities & Commitments

Review for Subsequent Events

On Going Concern Considerations

Issue Management Letter and Representation Letter

Communicate with Audit Committee and Management

Evaluation of Final Audit Evidence and Results

Issue Auditor’s Report 12

Contingencies-MFRS 137
 Contingent Liability
 Contingent Assets
 Provisions

13
 Following terms are used in mfrs
137 
A provision is a liability of uncertain timing or amount.
A liability is a present obligation of the entity arising from past events, the settlement
of which is expected to result in an outflow from the entity of resources
embodying economic benefits.
An obligating event is an event that creates a legal or constructive obligation that
results in an entity having no realistic alternative to settling that obligation.
 A legal obligation is an obligation that derives from:
 (a)a contract (through its explicit or implicit terms);
 (b)legislation; or
 (c)other operation of law.
A constructive obligation is an obligation that derives from an entity’s actions where:
 (a)by an established published policiepattern of past practice, s or a sufficiently
specific current statement, the entity has indicated to other parties that it will
accept certain responsibilities; and
 b)as a result, the entity has created a valid expectation on the part of those other
parties that it will discharge those responsibilities. 14
Contingencies-Auditors’
objectives
 Evaluate the accounting treatment of
known contingent liabilities and to
identify, where practical, any
contingencies that have not been
identified by management (management
is responsible to identify & decide proper
accounting treatment)

15
 “Contingent Liabilities” (MFRS 137)
a) A possible obligation that arises from past
events and whose existence will be confirmed
only by the occurrence or non-occurrence of
one or more uncertain future events not
wholly within the control of the enterprise;
or
b) A present obligation that arises from past
events but is not recognize because:
i) It is not probable that an outflow of resources
embodying economic benefits will be required to
settle the obligation; or
ii) The amount of the obligation cannot be measured
with sufficient reliability 16
 Three Conditions for a
contingent liabilities

 There is a potential future payment to an outside party or the

impairment of an asset that resulted from existing condition.
 There is uncertainty about the amount of the future payment or
impairment
 The outcome will be resolved by some future event or events
Note: The uncertainty of the future payment can vary from
extremely likely to highly unlikely. MFRS 137 describe 3 levels
of likelihood

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 Contingent Liabilities
 An entity should not recognise a contingent
liability. An entity should disclose a contingent
liability, unless the possibility of an outflow of
resources embodying economic benefits is remote.
 Not recognized as liabilities (MFRS 137) because
 It has yet to be confirmed (possible obligations)
 Do not meet the recognition criteria of liabilities
(present obligations)
 To be disclosed as notes to financial statements

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Contingent Liabilities -
Disclosures
 Each class – a brief description of the
nature of the contingent liability
 An estimate of its financial effect
 An indication of the uncertainties or
timing of any outflow
 The possibility of any reimbursement

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Accounting treatment
Contingent liability-per MFRS 137
Likelihood or occurrence Accounting treatment
of event

Remote – slight chance No disclosure necessary

Reasonable possible – more than Footnote disclosure necessary

remote but less than probable

Probable – likely to happen/occur If the amount can be reasonably

estimated, provision to be made
If the amount cannot be
reasonably estimated,
20 note
disclosure is necessary
Example
 Legal Claim
 Corporate guarantee given to banks for credit
 Facilities granted to subsidiaries (unsecured)

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Accounting treatment
Contingent Assets-per MFRS 137
Likelihood or occurrence Accounting treatment
of event

Possible &Remote Ignore

Probable Footnote disclosure necessary

Virtually certain Recognise

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Audit procedures
 Management enquiries about unrecorded contingencies, via
letter of representation (written representation ISA 580)
 Review current & previous years; IRB report for potential
income tax dispute
 Review minutes of meetings for indication of lawsuits or
other contingencies
 Analyse legal expenses and invoices from lawyers for any
indication of potential law suit
 Obtain a letter from each major lawyers to know about the
status of pending litigation (legal confirmation ,see below)
 Review audit documentation for any information that may
indicate a potential contingency
 Examine letters of credit as of balance sheet date and obtain
confirmation of used and unused balances
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Contingent liabilities –
Inability to obtain sufficient appropriate
audit evidence (Limitation of Scope)

 If the client refuses to permit the auditors

to communicated with entity’s lawyers/
further enquire about the contingent
liability
 Qualified opinion or
A disclaimer of opinion

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Example of question on provision &
contingent liabilities

Introduction and client background

You are an audit senior in Staple and Co and you are commencing
the planning of the audit of -Smoothbrush Paints Co for the year
ending 31 August 2010.
Smoothbrush Paints Co is a paint manufacturer and has been
trading for over 50 years, it operates from one central site, which
includes the production facility, warehouse and administration
offices.
Smoothbrush sells all of its goods to large home improvement
stores, with 60% being to one large chain store Homewares.
The company has a one year contract to be the sole supplier of
paint to Homewares. It secured the contract through significantly
reducing prices and offering a four-month credit period, the
company’s normal credit period is one month.
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Example -continued

 Goods in/purchases
 In recent years, Smoothbrush has reduced the level of goods
directly manufactured and instead started to import paint from
South Asia. Approximately 60% is imported and 40% manufactured.
 Within the production facility is a large amount of old plant and
equipment that is now redundant and has minimal scrap value.
Purchase orders for overseas paint are made six months in advance
and goods can be in transit for up to two months. Smoothbrush
accounts for the inventory when it receives the goods.
 To avoid the disruption of a year end inventory count, Smoothbrush
has this year introduced a continuous/perpetual inventory counting
system. The warehouse has been divided into 12 areas and these
are each to be counted once over the year.

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Example -continued

 The counting team includes a member of the internal audit department

and a warehouse staff member. The following procedures have been
adopted;
 1. The team prints the inventory quantities and descriptions from the
system and these records are then compared to the inventory physically
present.
 2. Any discrepancies in relation to quantities are noted on the inventory
sheets, including any items not listed on the sheets but present in the
warehouse area.
 3. Any damaged or old items are noted and they are removed from the
inventory sheets.
 4. The sheets are then passed to the fi nance department for
adjustments to be made to the records when the count has fi nished.
 5. During the counts there will continue to be inventory movements
with goods arriving and leaving the warehouse.
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Example -continued

 At the year end it is proposed that the inventory will be based on the
underlying records. Traditionally Smoothbrush has maintained an inventory
provision based on 1% of the inventory value, but management feels that as
inventory is being reviewed more regularly it no longer needs this provision.
 Finance Director
 In May 2010 Smoothbrush had a dispute with its finance director (FD) and he
immediately left the company. The company has temporarily asked the
financial controller to take over the role while they recruit a permanent
replacement.
 The old FD has notified Smoothbrush that he intends to sue for unfair
dismissal. The company is not proposing to make any provision or disclosures
for this, as they are confident the claim has no merit.
 Required:
 Describe substantive procedures the auditor of Smoothbrush Paints Co should
perform at the year end in confirming the completeness of provisions or
contingent liabilities.
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Answers

 Substantive procedures to confirm completeness of provisions or contingent

liability
 – Discuss with management the nature of the dispute between Smoothbrush
and the former finance director (FD), to ensure that a full understanding of
the issue is obtained and to assess whether an obligation exists.
 – Review any correspondence with the former FD to assess if a reliable
estimate of any potential payments can be made.
 – Write to the company’s lawyers to obtain their views as to the probability of
the FD’s claim being successful.
 – Review board minutes and any company correspondence to assess whether
there is any evidence to support the former FD’s claims of unfair dismissal.
 – Obtain a written representation from the directors of Smoothbrush confi
rming their view that the former FD’s chances of a successful claim are
remote, and hence no provision or contingent liability is required.
 Credit will be awarded for any substantive procedures which test for
additional provisions or contingent liabilities of Smoothbrush

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 Completing the Audit – Legal
matters

ISA 501 suggests procedures that the auditor should follow in the
identification of such legal matters that will affect the entity:
• make appropriate inquiries of management including obtaining
representations
• review minutes of those charged with governance and
correspondence with the entity’s legal counsel
• examine legal expense accounts
• use any information obtained regarding the entity’s business
including information obtained from discussions with any in-
house legal department
Legal Confirmation
When the auditor has identified litigation or claims
against the entity or when the auditor believes that
such claim may exist, the auditor should seek direct
communication with the entity’s lawyers(ISA 501).Such
communication is in the form of a letter or request for
confirmation commonly referred to as legal
confirmation letter or a legal letter

31
 Commitments
 Long term contractual commitments during the year but
not yet materialized or “transacted”
 Auditors search for unknown commitments within each
auditable area
 Sales commitment, purchase of machinery, etc
 Reading contracts and correspondence files
 Inquiries to client’s solicitors
 Auditors may modify audit report to reflect lack of
evidence if no response from solicitors

32
Example

33
Audit review of subsequent events
(Facts discovered after the date of auditors’
report)

34
 Final Analytical Review

Review for Contingent Liabilities & Commitments

Review for Subsequent Events

On Going Concern Considerations

Issue Management Letter and Representation Letter

Communicate with Audit Committee and Management

Evaluation of Final Audit Evidence and Results

Issue Auditor’s Report 35

 Subsequent events
 ISA 560-Subsequent events are events occurring between the date of the
financial statements and the date of the auditor's report, and facts that
become known to the auditor after the date of the auditor's report.
 MFRS 110 –Events after the date of financial statements are those favourable
and unfavourable, that occur between the date of financial statements and
the date when the financial statements are authorised for issue

 MFRS 110 Events after the reporting period deals with the treatment in the
financial statements of events, both favourable and unfavourable, occurring
after the period-end. There are two types of event defined by IAS 10:
 Those that provide evidence of conditions that existed at the year-end date
(adjusting events)
 Those that are indicative of conditions that arose after the year-end date (non-
adjusting events)
 2 Types of subsequent events
 Adjusting events-Events that provide
additional evidence about conditions that
existed at the date of financial statements
and affect the estimates that are part of the
financial statement preparation process

 Non-adjusting events-Events that provide

evidence about conditions that did not exist
at the date of financial statements but arose
subsequent to that date

37
ISA 560 Subsequent Events
 The auditor should consider the effect of subsequent
events on the financial statements and on the auditor’s
report.

 The auditor should perform procedures designed to obtain

sufficient appropriate audit evidence that all events up to
the date of the auditor’s report that may require
adjustment of, or disclosure in, the financial statements
have been identified.

 When the auditor becomes aware of events which

materially affect the financial statements, the auditor
should consider whether such events are properly
accounted for and adequately disclosed in the financial
statements.
38
Review for Subsequent Events for
Audit of Financial Statements
Balance
Sheet Date
Type I Event Type II Event

Affects estimates Conditions did

that are part of not exist at the
financial balance sheet
statements. date.

Require adjustment of
Require financial
the financial
statement disclosure.
statements.
 Period Covered by
Subsequent Events Review

Client’s ending Audit Date client

balance sheet report issues financial
date date statements

31-12-08 15-03-09 30-03-09

Period to which Period for Period in which

review for processing subsequent
subsequent the financial discovery of
events applies statements facts is made
 Types of Subsequent Events

Those that have a direct effect on the

financial statements and require adjustment

Those that have no direct effect on the

financial statements but for which
disclosure is advisable
 Subsequent Events
Requiring Adjustment

• Declaration of bankruptcy by a customer with an

accounts receivable balance
• Settlement of a litigation at an amount different
from the amount recorded on the books

• Disposal of equipment not being used in

operations at a price below the current book value
• Sale of investments at a price below recorded cost
 Subsequent Events
Advisability of Disclosure
• Decline in the market value of securities
held for temporary investment or resale
• Issuance of bonds or equity securities
• Decline in the market value of inventory as
consequence of government action barring
further sale of a product
• Uninsured loss of inventories as a result
of fire
• A merger or an acquisition
 ISA 560 Subsequent events provides guidance to auditors in this area. The
objectives of the auditor are:
 To obtain sufficient appropriate audit evidence about whether events occurring
between the date of the financial statements and the date of the auditor’s report
that need adjustment or disclosure in the financial statements are properly
reflected in the financial statements.
 To respond appropriately to facts that become known to the auditor after the date
of the auditor’s report which may have caused the auditor to amend the auditor’s
report if they were known to the auditor at the date of the report.
 Procedures
 Auditors have a responsibility to review subsequent events before they
sign the auditor's report, and may have to take action if they become
aware of subsequent events between the date they sign the auditor's report
and the date the financial statements are issued.
 Audit Tests for

Subsequent Events
Review management procedures for identifying subsequent events to ensure that
such events are identified.
 Read minutes of general board/committee meetings and enquire about unusual
items.
 Review latest available interim financial statements and budgets, cash flow forecasts
and other management reports.
 Obtain evidence concerning any litigation or claims from the company's solicitors
(only with client permission).
 Obtain written representation that all events occurring subsequent to the period-end
which need adjustment or disclosure have been adjusted or disclosed
 Compare the latest available interim statements with the financial statements being
audited.
 Ascertain whether the interim statements were prepared on the same basis as the
audited financial statements.
 • Inquire whether any contingent liabilities or commitments existed at the balance
sheet date or the date of inquiry.
 • Inquire whether there was any significant change in the share capital, long-term
liabilities, or working capital to the date of inquiry.
 Facts discovered after the date of the
auditor's report but before the financial
statements are issued
 The financial statements are the management's responsibility. They should
therefore inform the auditors of any material subsequent events between the
date of the auditors' report and the date the financial statements are issued.
 The auditor does not have any obligation to perform procedures, or make
enquires regarding the financial statements, after the date of the report.
 However if the auditor becomes aware of a fact that had it been known to
the auditor at the date of the report may have caused the auditor to amend
the auditor’s report, the auditor shall:

 Discuss the matter with management and

those charged with governance.
 Determine whether the financial
statements need amendment.
 Ifamendment is required, inquire how
management intends to address the
matter in the financial statements.
 If amendment is required to the financial statements and management makes
the necessary changes, the auditor must carry out a number of procedures:

 Undertake any necessary audit

procedures on the changes made.
 Extend audit procedures for identifying
subsequent events that may require
adjustment of or disclosure in the
financial statements to the date of the
new auditor's report.
 Provide
a new auditor's report on the
amended financial statements.
 If management does not amend the financial statements:

 If the auditor’s report has not yet been

provided to the entity, the auditor shall
modify the opinion and then provide the
auditor’s report.
 If the auditor’s report has already been
provided to the entity, the auditor shall
notify management and those charged with
governance not to issue the financial
statements before the amendments are
made; but if the financial statements are
issued anyway, the auditor shall take action
to seek to prevent reliance on the
auditor’s report.
 Facts discovered after the financial
statements have been issued
 Auditors have no obligations to perform procedures or make
enquiries regarding the financial statements after they have
been issued.
 However if the auditor becomes aware of a fact that had it
been known to the auditor at the date of the report may have
caused the auditor to amend the auditor’s report, the auditor
shall:
 Discuss the matter with management and those charged
with governance.
 Determine whether the financial statements need
amendment.
 If amendment is required, inquire how management
intends to address the matter in the financial statements.
 If management amends the financial statements, the auditor shall carry out
procedures necessary on the amendment and review the steps taken by
management to ensure that anyone in receipt of the previously issued
financial statements is informed.
 The auditor shall also issue a new or amended auditor’s report which will
include an explanatory paragraph.
 If management does not take the necessary steps, the auditor shall notify
management and those charged with governance that the auditor will seek
to prevent future reliance on the report. If management still does not act,
the auditor shall take appropriate action to seek to prevent reliance on the
auditor’s report.
Example

53
Related parties

 ISA 550
 MFRS124

54
 Related Parties
 Related parties may enter into transaction which unrelated parties
may no enter into and at terms that may be different from those
between unrelated parties
 The definition of related party and the disclosure requirements are
dealt with MFRS 124
 Related parties of the reporting entities would include its parent,
subsidiaries, associates and its key management personnel and the
close family members of such individual.
 The accounting standard defines a related party transaction as “ a
transfer of resources ,services or obligation between related parties,
regardless of whether a price is charged”
Examples
 Purchases or sales of goods
 Purchases or sales of property and other capital assets
 Leasing and rental arrangements
 Provision of guarantees or collateral
55
 Introduction

The Context for ISA 550

Inherent difficulty in identifying undisclosed RPs/RPTs
E.g., management itself may be unaware of Related
parties (RPs) and (Related parties transactions)RPTs
(especially if framework does not require
disclosure)heightened risk of fraud
 RPs present greater opportunities for collusion,
concealment, or manipulation by management
 RPs involved in a number of corporate reporting
scandals in recent times
 Standard provides robust basis for identifying risks of
material misstatement from RPs
51
 Significant Features of New Standard

A Risk-Based Approach
Risk-based approach requires a thorough understanding of
RPs and RPTs to identify and assess risk
 Consider RPs in engagement team discussion
 Inquire into changes in RPs from prior period, nature of
RP relationships, and type and purpose of RPTs
 Understand controls to identify, account for, and disclose
RPs and RPTs; and to authorize and approve significant
RPTs
 Determine whether any of the assessed risks are
significant risks
 Respond appropriately to assessed risks risks
52
 Significant Features of New Standard
Identifying Undisclosed RPs or Significant RPTs
 Searching for unidentified or undisclosed RPs or
RPTs can be an onerous task
 Standard takes a robust but practicable approach
 Mandatory document inspection limited to a few
document types
 Bank and legal confirmations and minutes
 However, required to consider which other records or
documents should be inspected in the circumstances
 Required to remain alert to undisclosed RPs or RPTs

53
 Significant Features of New Standard
Significant Transactions Outside Normal Business
 Standard places specific focus on significant
transactions outside normal course of business
 As a means to help identify undisclosed RPs
 No requirement to search for these transactions but
understand how they are authorized and approved
 Probe into the transactions when identified
 Make specific inquiries of management
 Understand nature of the transactions
 Determine whether RPs are involved

54
 Significant Features of New Standard
Significant RPTs Outside Normal Business
 Treated as significant risks if RPTs are identified
 Understand controls over them
 Obtain substantive audit evidence about them
 Inspect supporting contracts or agreements
 Does business rationale of the RPTs suggest possibility of
fraud?
 Are their terms consistent with management’s explanations?
 Have they been appropriately accounted for and disclosed?
 Have they been appropriately authorized and approved?

55
 Practical Considerations
DISCLOSURE –MFRS124
Disclosure requirement under MFRS 124
-the name of the parent entity or the ultimate controlling party
-Related party transactions and balances on the nature of the relationship ,
description & amount of the transaction, Outstanding balance

57
 Related parties-Audit
procedures
Due to the nature of related party relationships, audit evidence for a
related party transaction may be limited .If availability of
appropriate audit evidence for related party transactions is limited,
the auditor may need to perform the audit procedures such as :
 Confirm with the related party, the terms and amount of the
transaction
 Discuss with the management the purpose and nature of the
transaction
 Inspect documentary evidence in the possession of the related party
 ISA 580 requires auditor to obtain written representation from
management
 Communicate significant RP matters with TCWG
 Refer To handout on additional procedures for related parties
62
Evaluate going concern
assumption

63
 Final Analytical Review

Review for Contingent Liabilities & Commitments

Review for Subsequent Events

On Going Concern Considerations and accounting

estimates

Issue Management Letter and Representation Letter

Communicate with Audit Committee and Management

Evaluation of Final Audit Evidence and Results

Issue Auditor’s Report 64

Things to do here
 Evaluate going concern (ISA 570 Revised)
 Obtain written representation letter (ISA
580)
 Other information in documents
containing audited financial statements
(ISA 720 Revised)

65
Going concern issues
 MFRS101 – Presentation of financial statements
require management to make an assessment of
the company’s ability to continue as a going
concern
 ISA 570(Revised) - Auditors are required to
consider any events which may cast significant
doubt on its client’s ability to continue as a
going concern, at least 1 year beyond the date
of financial statements
 Done as part of planning but revised as and
when more facts are obtained during the audit
66
 ISA 570 Revised -Going Concern
 When planning and performing audit procedures and in evaluating
the results thereof, the auditor should consider the appropriateness
of management’s use of the going concern basis of accounting in the
preparation of the financial statements.
 The auditor’s responsibility is to consider the appropriateness of
management’s use of the going concern basis of accounting in the
preparation of the financial statements, and consider whether there
are material uncertainties about the entity's ability to continue as a
going concern that need to be disclosed in the financial statements.
 The auditor considers the appropriateness of management’s use of
the going concern assumption even if the financial reporting
framework used in the preparation of the financial statements does
not include an explicit requirement for management to make a
specific assessment of the entity’s ability to continue as a going
concern.

67
 ISA 570 Revised Going
Concern
 The auditor cannot predict future events or
conditions that may cause an entity to cease
to continue as a going concern. Accordingly,
the absence of any reference to going
concern uncertainty in an auditor’s report
cannot be viewed as a guarantee as to the
entity’s ability to continue as a going
concern.

68
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.
 Indications of withdrawal of financial support by creditors.
 Negative operating cash flows indicated by historical or prospective
financial statements.
 Adverse key financial ratios.
 Substantial operating losses or significant deterioration in the value of
assets used to generate cash flows.
s.

69
FINANCIAL
INDICATORS(Continued)
  Arrears or discontinuance of dividends.
  Inability to pay creditors on due dates.
  Inability to comply 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 investment

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OPERATING

 Management intentions to liquidate the entity or to

cease operations.
 Loss of key management without replacement.
 Loss of a major market, key customer(s), franchise,
license, or principal supplier(s).
 Labor difficulties.
 Shortages of important supplies.
 Emergence of a highly successful competitor

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 OTHERS
 Non-compliance with capital or other statutory or regulatory
requirements, such as solvency or liquidity requirements for financial
institutions.
 Pending legal or regulatory proceedings against the entity that may, if
successful, result in claims that the entity is unlikely to be able to satisfy.
 Changes in law or regulation or government policy expected to
adversely affect the entity.
 Uninsured or underinsured catastrophes when they occur
The significance of such events or conditions often can be mitigated by
other factors. For example, the effect of an entity being unable to make
its normal debt repayments may be counter-balanced by management’s
plans to maintain adequate cash flows by alternative means, such as by
disposing of assets, rescheduling loan repayments, or obtaining additional

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Evaluating Management’s Assessment
 The auditor should evaluate management’s
assessment of the entity’s ability to continue as a
going concern.
 The auditor should consider the same period as that
used by management in making its assessment under
the financial reporting framework.
 If management’s assessment of the entity’s ability to
continue as a going concern covers less than twelve
months from the balance sheet date, the auditor
should ask management to extend its assessment
period to twelve months from the statement of
financial position.

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Period Beyond
Management’s Assessment
 The auditor should inquire of
management as to its knowledge of
events or conditions beyond the period
of assessment used by management that
may cast significant doubt on the
entity’s ability to continue as a going
concern.

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 ISA 570 Revised Going
Concern
■ When events or conditions have been identified which may
cast significant doubt on the entity’s ability to continue as a
going concern, the auditor should :-
(a) review management’s plans for future actions based on
its going concern assessment;

(b)  gather sufficient appropriate audit evidence to confirm

or dispel whether or not a material uncertainty exists
through carrying out procedures considered necessary,
including considering the effect of any plans of
management and other mitigating factors; and

(c) seek written representations from management

regarding its plans for future action. –ISA 580
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 Audit procedure for going
concern evaluation
Procedures that are relevant in this regard may include :-
 Analyzing and discussing cash flow, profit and other
relevant forecasts with management.
 Analyzing and discussing the entity’s latest available
interim financial statements.
 Reviewing the terms of debentures and loan agreements
and determining whether any have been breached.
 Reading minutes of the meetings of shareholders, the
board of directors and important committees for
reference to financing difficulties.

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 Audit procedure for going
concern evaluation
(cont)
 Inquiring of the entity’s lawyer regarding the existence of
litigation and claims and the reasonableness of
management’s assessments of their outcome and the
estimate of their financial implications.
 Confirming the existence, legality and enforceability of
arrangements to provide or maintain financial support with
related and third parties and assessing the financial ability
of such parties to provide additional funds.
 Considering the entity’s plans to deal with unfilled customer
orders.
 Reviewing events after period end to identify those that
either mitigate or otherwise affect the entity’s ability to
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continue as a going concern.
 How to report/ disclose?
 If adequate disclosure is made in the
financial statements, the auditor should
express an unmodified opinion but add a
para “Material Uncertainty Related to
Going Concern” that highlights the
existence of a material uncertainty
relating to the event or condition that may
cast significant doubt on the entity’s
ability to continue as a going concern and
draws attention to the note in the
financial statements that discloses the
matters set out in paragraph 78
 How to report/ disclose?
 Ifadequate disclosure is not made in the financial
statements, the auditor should express a qualified
or adverse opinion, as appropriate (ISA 700, "The
Auditor's Report on Financial Statements",
paragraphs 45-46). The report should include
specific reference to the fact that there is a
material uncertainty that may cast significant
doubt about the entity’s ability to continue as a
going concern.

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Going Concern Basis of Accounting Inappropriate
 If, in the auditor’s judgment, the entity will not be able
to continue as a going concern, the auditor should
express an adverse opinion if the financial statements
have been prepared on a going concern basis.

Management Unwilling to Make or Extend its

Assessment
If management is unwilling to make or extend its assessment
when requested to do so by the auditor, the auditor should
consider the need to modify the auditor’s report as a result
of the limitation on the scope of the auditor’s work

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Accounting estimates
 An
accounting estimate is an approximation of
amount of an item in the absence of a precise
meaning of measurement.
 Examples of an accounting estimate:
 Allowance to reduce inventories and accounts
receivable to their estimated realizable value
 Provision to allocate the cost of long term assets over
their estimated useful lives
 Accrued revenue
 Provision for loss from a lawsuit
 Losses on construction contracts in progress
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 Management is responsible for making
accounting estimates included in the financial
statements. These estimates are often made in
conditions of uncertainty regarding to the
outcomes of events and involve the use of
judgment
A formula based on past experiences is used to
calculate the estimates, and it should be
reviewed regularly by management.

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 Theauditor should gain an understanding of the
procedures and methods used by management to
make accounting estimates. The auditor should
adopt one or a combination of the following
approaches in the audit of an accounting
estimate:
(A) Review and test the process used by management
or the director to develop the estimates.
(B) Use an independent estimate for comparison with
the one prepared by the management or the directors.
(C) Review subsequent events which confirm the
estimate made.

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(A) Review and testing the procedure
 The auditors will carry out these steps:
 Evaluate the data and consider the
assumptions on which the estimate is
based
 Consider whether data is accurate,
complete and reliable
 Seek appropriate evidence from outside
client
 Check whether data is appropriately
analyzed and projected
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 Evaluate whether base used for
assumption is appropriate.
 Consider whether the formulae used
remain appropriate.
 Test calculations involved in the
estimate consideration.
 Compare previous estimates with actual
results.
 Consider management’s approval
procedures, confirming it is performed
by the appropriate level of management
and evidenced.
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(B) Use of independent estimates
 The auditors may seek evidence from sources
outside the entity. Such an estimate (made or
obtained by the auditors) may be compared with
the accounting estimates. The auditors should
evaluate the data and consider the assumptions
and test the calculation procedures used to
develop the independent estimates.

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(C) Review the subsequent events
 The auditors should review transactions or
events after the period end which may reduce
or even remove the need to test accounting
estimates
 If the auditors believe that differences between
the amount of an estimate supported by
evidence and the estimates calculated by
management is unreasonable the an adjustment
should be made.
 If the directors or management refuse to revise
the estimate, then the difference is considered
a misstatement.
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 Final Analytical Review

Review for Contingent Liabilities & Commitments

Review for Subsequent Events

On Going Concern Considerations and accounting

estimates

Issue Management Letter and Representation Letter

Communicate with Audit Committee and Management

Evaluation of Final Audit Evidence and Results

Issue Auditor’s Report 88

 ISA 580 Written
representation (Management
Representations)
 Theauditor should obtain appropriate
representations from management
 Content of ISA
 Acknowledgment by Management of its Responsibility
for the Financial Statements
 Representations by Management as Audit Evidence
 Documentation of Representations by Management
 Actionif Management Refuses to Provide
Representations
89
 Client’s management
representation letter
 To impress upon management its responsibilities for the
assertions in the financial statements
 To document the response from management to inquiries
about various aspects of the audit
 4 categories of specific matters
 Financial statements
 Completeness of information
 Recognition, management and disclosure
 Subsequent events
 Auditor should investigate any evidence of contradiction
in the written representation
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 Acknowledgment by Management
of its Responsibility for the
Financial Statements

The auditor should obtain evidence that

management acknowledges its responsibility for
the fair presentation of the financial statements
in accordance with the relevant financial
reporting framework, and has approved the
financial statements.

91
 Representations by Management
as Audit Evidence
 Audit evidence is the information used by the auditor in arriving at the
conclusions on which the auditor’s opinion is based. 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
 . Although written representations provide necessary audit evidence,
they do not provide sufficient appropriate audit evidence on their own
about any of the matters with which they deal. Furthermore, the fact
that management has provided reliable written representations does
not affect the nature or extent of other audit evidence that the
auditor obtains about the fulfilment of management’s responsibilities,
or about specific assertions.
 Cannot be regarded as reliable evidence and cannot be use to
substitute for other evidence. This type of evidence needs to be
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corroborated
Representations by Management
as Audit Evidence
 During the course of an audit, management makes many
representations to the auditor, either unsolicited or in
response to specific inquiries. When such representations
relate to matters which are material to the financial
statements, the auditor will need to:
 (a) seek corroborative audit evidence from sources inside or
outside the entity;
 (b) evaluate whether the representations made by management
appear reasonable and consistent with other audit evidence
obtained, including other representations; and
 (c) consider whether the individuals making the representations
can be expected to be well informed on the particular matters.

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 Basic Elements of a Management
Representation Letter
 When requesting a management representation letter,
the auditor would request that it be addressed to the
auditor, contain specified information and be
appropriately dated and signed.
 The date of the written representations shall be as near
as practicable to, or after, the date of the auditor’s
report on the financial statements if another letter is
required. The written representations shall be for all
financial statements and period(s) referred to in the
auditor’s report

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 Management from whom Written
Representations Requested
 The auditor shall request written representations from
management with appropriate responsibilities for the financial
statements and knowledge of the matters concerned.
 Written representations are requested from those responsible
for the preparation of the financial statements. Those
individuals may vary depending on the governance structure of
the entity, and relevant law or regulation; however,
management (rather than those charged with governance) is
often the responsible party.
 Written representations may therefore be requested from the
entity’s chief executive officer and chief financial officer, or
other equivalent persons in entities that do not use such titles.
In some circumstances, however, other parties, such as those
charged with governance, are also responsible for the
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preparation of the financial statements.
 Action if Management
Refuses to Provide
 If Representations
management refuses to provide a representation
that the auditor considers necessary, this
constitutes a scope limitation and the auditor
should express a qualified opinion or a disclaimer
of opinion. In such circumstances, the auditor
would evaluate any reliance placed on other
representations made by management during the
course of the audit and consider if the other
implications of the refusal may have any additional
effect on the auditor’s report.

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Requested Written Representations Not Provided
■ If management does not provide one or more of the requested
written representations, the auditor shall:
(a) Discuss the matter with management;
(b) Re-evaluate the integrity of management and evaluate the effect that this
may have on the reliability of representations (oral or written) and audit
evidence in general; and
(c) Take appropriate actions, including determining the possible effect on
the opinion in the auditor’s report in accordance with ISA 705(revised),
having regard to the requirement in paragraph 24 of this ISA.
■ The auditor shall disclaim an opinion on the financial statements in
accordance with ISA 705 (Revised) if:
(a) The auditor concludes that there is sufficient doubt about the integrity of
management such that the written representations are not reliable; or
(b) Management does not provide the written representations required
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 Final Analytical Review

Review for Contingent Liabilities & Commitments

Review for Subsequent Events

On Going Concern Considerations

Issue Management Letter and Representation Letter

Communicate with Audit Committee and Management

Evaluation of Final Audit Evidence and Results

Issue Auditor’s Report 98

Communicate with Audit
Committee and Management

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ISA 260 (Revised) Communications of Audit
Matters with Those Charged with Governance
 The auditor should communicate audit matters
of governance interest arising from the audit of
financial statements with those charged with
governance of an entity.
Relevant Persons
 The auditor should determine the relevant
persons who are charged with governance and
with whom audit matters of governance interest
are communicated.
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 Matters to be communicated (ISA 260 R)
■ The auditor shall communicate with those charged with governance the
responsibilities of the auditor in relation to the financial statement audit
■ The auditor shall communicate with those charged with governance an overview
of the planned scope and timing of the audit
■ Significant Findings from the Audit
 The auditor’s views about significant qualitative aspects of the entity’s
accounting practices, including accounting policies, accounting estimates and
financial statement disclosures
 Significant difficulties, if any, encountered during the audit
 Other matters, if any, arising from the audit that, in the auditor’s professional
judgment, are significant to the oversight of the financial reporting process.
■ In the case of listed entities, the auditor shall communicate with those charged
with governance: A statement that the engagement team and others in the firm
as appropriate, the firm and, when applicable, network firms have complied with
relevant ethical requirements regarding independence
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 Communication-Form and
Timing
 The auditor shall communicate in writing with those charged with
governance regarding significant findings from the audit if, in the
auditor’s professional judgment, oral communication would not be
adequate. Written communications need not include all matters that
arose during the course of the audit.
 The auditor shall communicate in writing with those charged with
governance regarding auditor independence when required by paragraph
17. Timing of Communications
 The auditor shall communicate with those charged with governance on
a timely basis.
 Where matters required by this ISA to be communicated are
communicated orally, the auditor shall include them in the audit
documentation, and when and to whom they were communicated.
Where matters have been communicated in writing, the auditor shall
102
retain a copy of the communication as part of the audit documentation.
COMMUNICATING DEFICIENCIES IN INTERNAL CONTROL TO THOSE
CHARGED WITH GOVERNANCE AND MANAGEMENT (ISA 265)
■ The objective of the auditor is to communicate appropriately to those charged
with governance and management deficiencies in internal control that the
auditor has identified during the audit and that, in the auditor’s professional
judgment, are of sufficient importance to merit their respective attentions.
a) Deficiency in internal control – This exists when:
(i) A control is designed, implemented or operated in such a way that it is unable
to prevent, or detect and correct, misstatements in the financial statements on a
timely basis; or
(ii) A control necessary to prevent, or detect and correct, misstatements in the
financial statements on a timely basis is missing.
(b) Significant deficiency in internal control – A deficiency or combination of
deficiencies in internal control that, in the auditor’s professional judgment, is
of sufficient importance to merit the attention of those charged with
governance

103
 ISA 265 (Requirements)
 The auditor shall determine whether, on the basis of the audit work
performed, the auditor has identified one or more deficiencies in
internal control. (Ref: Para. A1-A4)
 If the auditor has identified one or more deficiencies in internal
control, the auditor shall determine, on the basis of the audit work
performed, whether, individually or in combination, they constitute
significant deficiencies. (Ref: Para. A5-A11)
 The auditor shall communicate in writing significant deficiencies in
internal control identified during the audit to those charged with
governance on a timely basis.via management letter
 The auditor shall include in the written communication of significant
deficiencies in internal control: (a) A description of the deficiencies
and an explanation of their potential effects; and (Ref: Para. A28) (b)
Sufficient information to enable those charged with governance and
management to understand the context of the communication
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 Significant Deficiencies in Internal
Control
 The significance of a deficiency or a combination of deficiencies in
internal control depends not only on whether a misstatement has actually
occurred, but also on the likelihood that a misstatement could occur and
the potential magnitude of the misstatement. Significant deficiencies
may therefore exist even though the auditor has not identified
misstatements during the audit.
 Examples of matters that the auditor may consider in determining
whether a deficiency or combination of deficiencies in internal control
constitutes a significant deficiency 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, such as fair value accounting
estimates. • 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
105
deficiencies.
 Management letter
This letter intended to inform the client of auditor’s
recommendations for improving any part of the client’s
business.
Most recommendations focus on suggestions for more
efficient operations. Many audit firms write a management
letter for every audit to demonstrate to management that
the firm adds value to the business beyond the audit service
provided.
Their intent is to encourage a better relationship with the
management . A management letter is optional and
intended to help the client operate its business more
effectively.
Some auditors combine the management letter with the
letter about significant deficiencies of internal
106control
 Final Analytical Review

Review for Contingent Liabilities & Commitments

Review for Subsequent Events

On Going Concern Considerations

Issue Management Letter and Representation Letter

Communicate with Audit Committee and Management

Evaluation of Final Audit Evidence and Results

Issue Auditor’s Report 107

Evaluate results or final review of audit evidence means
■ Integrate the audit results into one overall conclusion
■ Whether all significant evidence have been adequately tested,
considering the circumstances of the overall audit engagement
■ Uses a “Completing the engagement” checklist

5 main aspects of evaluating results

■ Evidence supports auditor’s opinion
■ Financial statements disclosure
■ Audit documentation review and Quality control review
■ Independent review
■ Summary of audit evidence
108
 1.Evidence supports auditor’s
opinion
 Evaluatewhether accounts are fairly stated by
summarizing the uncovered misstatement
 Ifmaterial, auditors to propose to client to adjust the
accounts
 Sometimes difficult to adjust because true value may
not be known
 Uses a summary of possible adjustment schedule
 Ifauditors believe that there is sufficient evidence
that does not present the accounts fairly
 Client adjusts accounts to auditors’ satisfaction
 Either a qualified or adverse opinion is issued

109
2. Adequacy of accounts disclosure?
 Review disclosure at the end of audit is NOT the
only time the auditor carries out the review,
must be an ongoing process
 It is a final review
A checklist is used to guide auditor – Financial
Statement Disclosure Checklist

110
 3. Audit documentation review
 Reasons for audit documentation review
 To evaluate the performance of inexperienced
personnel
 To assure the firm’s standard of performance is
met
 To counteract the potential bias of auditors’
judgment
 To be done by someone experienced and
knowledgeable about the client and
circumstances
 Assistant => Senior => Manager => Partner
111
 Quality Control review
 For the audit of public listed companies, the
quality control standards (ISA 220 & ISQC 1)
require that an engagement quality control review
must be performed before the audit report is
issued
 Thisis in addition to the final review of audit
documentation by engagement partner
 The quality control reviewer is normally a partner
not associated or involved with the details of the
engagement

112
4 - Independent review

 For larger client, where it calls for an

independent reviewer who does not participate
in the engagement
 Auditteam must justify the evidence that it has
accumulated and conclusion it reaches

5 – Summary of Audit Evidence

113
Consideration for OTHERS
MFRS/IFRS and IAS

 Refer to ATTACHMENT ON SUMMARY OF ACCOUNTING

STANDARDS

114
END OF LECTURE 4 & 5

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