145 Keys for FAU Exam PDF

145 KEYs for Exam A Summary Note  Table of Contents I. Overview of FAU 1. Exam Format 2. Syllabus 3. Examinable Documents 4. Detailed Study Guide 5. Examiner’s Report II. Section A: Business Environment...

145 KEYs for Exam A Summary Note  Table of Contents I. Overview of FAU 1. Exam Format 2. Syllabus 3. Examinable Documents 4. Detailed Study Guide 5. Examiner’s Report II. Section A: Business Environment and Audit Framework III. Section B: Audit Planning and Risk Assessment IV. Section C: Internal Control V. Section D: Audit Evidence and Procedures VI. Section E: Audit Completion VII. Reference  Overview of FAU 1. Exam Format The syllabus is assessed by a two hour computer-based examination. Questions will assess all parts of the syllabus. The examination will consist of two sections. Section A will contain 15 two mark objective test questions. Section B will contain 8 questions. These will include 2 questions which are 15 marks each, 2 questions which are 10 marks each and 4 questions which are 5 marks each. 2. Syllabus 3. Examinable Documents 4. Detailed Study Guide https://docs.google.com/spreadsheets/d/1FKMkfvDRNEWOMfqtuPu1wIjm20yNHd WK6EEQlfGubfQ/edit?usp=sharing 5. Examiner’s Report https://drive.google.com/drive/folders/1Ujh3xYzXwCchutQn5IZe-t1HYQk_xCC2?us p=sharing  Section A Business Environment and Audit Framework Key 1: Auditors are appointed by the members of the company (shareholders) to scrutinise independently the financial statements and to report to the members on whether the financial statements show a ‘true and fair’ view of the company’s affairs and its results. Auditors’ conclusions are published with the financial statements in the auditor’s report. Key 2: Advantages of an audit: Independent scrutiny and a report on the financial statements. Greater credibility (believability) of the financial statements. This could help in raising finance. Professional expertise applied to the financial statements. Especially important when directors and shareholders do not have financial experience. Review of the company’s internal control system (the accounting system used by the company) and recommendations for improvement. Disadvantages of an audit: Cost: auditors charge for their work. Time and disruption. Auditors have to ask employees questions and have to find documents. This distracts staff from their day-to-day tasks A feeling of not being trusted. Auditors are always looking for independent evidence and cannot rely on employees' or management's word alone. This can make staff feel that they are not trusted. Key 3: True: Information is factual and conforms with reality such that it is not false. The financial statements have been correctly extracted from the books or records. Fair: Information is free from discrimination and bias, and complies with expected standards and rules. The financial statements should reflect the commercial substance of the company’s underlying transactions. Key 4: Reasonable assurance is defined as a high but not absolute level of assurance. The auditors can only provide reasonable assurance because: The auditors do not test every transactions The auditors use professional judgement The audit evidence is persuasive rather than conclusive The inherent limitations of internal control Key 5: Auditors’ rights include (ARA): Access to the company’s records. This includes not only the accounting records but also documents such as contracts, correspondence and board minutes. Receive all information and explanations they require. Attend (and receive notice about) general meetings and the right to speak at general meetings on relevant matters. The duties of the auditors: (PORT) Report whether the financial statements have been properly prepared Report whether other matters in company legislation have been followed State why they have been removed or resigned Report whether the financial statements shows a true and fair view The auditors must report RAPIDLY (Report only by exception): Adequate returns received from branches not visited Accounting records consistent with the FS Proper accounting records kept Information required by the auditor has been received Key 6: Upon either resignation or removal, the auditor must give written notice accompanied by a 'statement of circumstances' to the company’s registered office. Auditors cannot be removed by the board. They can only be removed by the members. This gives the auditors much greater strength should they disagree with the directors on some audit point: the directors cannot simply find more amenable auditors. However, directors can have great influence over the members and might recommend removal of the auditors even though the auditors are doing a good job. Therefore, the auditors are entitled to make representations to the members at a general meeting, arguing why they should not be removed. Key 7: Internal auditing is an independent, objective assurance and consulting activity designed to add value and improve an organization’s operation. It helps an organization accomplish its objectives by bringing a systematic and disciplined approach to evaluate and improve the effectiveness of risk management, control, and governance processes. Key 8: Scope of internal audit function is determined by the management but it may cover the following areas: Review of the accounting and internal control system Examination of financial and operational information Review of the economy, effectiveness, and efficiency of operations Review of compliance with laws and regulations Review of the safeguarding of assets Review the implementation of the corporate objectives Special investigations into particular areas such as frauds Key 9: Although the work of internal audit may be used for the purposes of the external audit, it is important to note that the external auditor has sole responsibility for the audit opinion expressed on the financial statements. Criteria to evaluate whether the work of internal audit function can be used by the external auditors: Whether the internal audit is objective The level of competence of the function  Whether the internal audit function applies a systematic and disciplined approach Key 10: Before using the work of internal audit, the external auditors need to evaluate and perform the audit procedures on the entirety of the work they plan to use. The evaluation includes the following: Whether the work was properly planned, performed, supervised, reviewed, and documented. Whether sufficient appropriate evidence was obtained to allow the internal auditors to draw reasonable conclusions Whether the conclusions reached are appropriate in the circumstances and the reports prepared are consistent with the results of the work done. Try this! Key 11: Professional scepticism is an attitude that includes a questioning mind, being alert to conditions which may indicate the possible misstatement due to fraud or error and a critical assessment of the audit evidence. Key 12: Three things must exist for a company and third party to bring a successful claim against auditors: Duty of care: there is always a case if the contract is in place. Negligence: In a situation a duty of care existed, the auditors were negligent in the performance of that duty, judged by accepted professional standards. Damage: the client has resulted monetary loss as a result of negligence on the part of the auditors Note: Auditors do not have an automatic liability to the third parties unless they know that the third parties will rely on the audited financial statements (exceptional circumstances at a duty of care arises). However, The auditor is entitled to try to disclaim liability to those people, for example, by writing to them and stating that the audit report is only for the purposes of the shareholders and that they do not admit legal liability to anyone else. Try this! Key 13: ISAs are produced by IAASB, a technical committee of IFAC. ISAs do not override national or local regulations. Key 14: All members and students of the ACCA must follow the provisions of the Code of Ethics and Conduct ('the Code'). Failure to comply with the Code can lead to fines, to members being excluded from membership, or to students being removed from the student register. Key 15: Fundamental principles: Integrity: Members should be straightforward and honest in business and professional relationships Objectivity: Members should not allow bias, conflicts of interest or undue influence to interfere with their professional or business judgment. Professional competence and due care: Members must keep up-to-date with legislation, accounting standards, auditing standards and so on. Members must ensure that enough time, resources and care are devoted to tasks so that they are carried out correctly. Professional behavior: Members must comply with laws and regulations and avoid any action that would discredit their profession. Confidentiality: Members must not disclose the confidential information to third parties without proper or specific authority or unless there is a legal or professional right or duty to disclose. Key 16: The auditors must be and must be seen to be independent. Independence of mind is the state of mind that permits the provision of an opinion without being affected by influences that compromise professional judgement, allowing an individual to act with integrity, and exercise objectivity and professional scepticism. Independence in appearance is the avoidance of facts or circumstances that are so significant a reasonable and informed third party, having knowledge of all relevant information, including any safeguards applied, would reasonably conclude a firm’s or member of the assurance team, integrity, objectivity, or professional scepticism had been compromised. Key 17: Self-Interest Self-review Advocacy Threat Familiarity Threat Intimidation Threat Key 18: Confidential information can be disclosed only in the following circumstances: Consent has been obtained from the client, employer, or other proper source Public duty to disclose Legal or professional right to disclose Try this! Key 19: Before accepting the appointment After accepting the appointment (PROC) (remove ex, we are new, let’s engaged) Professionally qualified to act Outgoing auditors’ removal or resignation Resources and risk has been properly conducted. Obtain the references New auditors’ appointment is valid Communication with the outgoing/present Submit a letter of engagement to the auditors client. Key 20: In order to establish whether the preconditions of an audit are present, the auditors are required to: 1. Determine whether the applicable financial reporting framework is acceptable 2. Obtain an acknowledgement from the management about its responsibility as following: a. For the preparation of financial statements b. For internal control relevant to the preparation of financial statements c. Provide an auditor with an access to all information required by the auditors in relation to the financial statements. If these preconditions are not present, the auditor must discuss with the management. If the engagement cannot be resolved, the appointment must not be accepted. Key 21: The purpose of the engagement letter is to avoid misunderstandings between the auditor and the client/management. The form and content of the engagement letter Must include the following: The scope and objective of the audit The responsibilities of management The responsibilities of auditors Identification of the applicable financial reporting framework to be used in the preparation of financial statements The expected form and content of any reports to be issued by the auditor A statement that there may be circumstances where the actual form and content may differ from what was expected Note: Audit fee may be included in the engagement letter but not a Must On recurring audit, the auditor must assess whether the term of engagement needs to be revised and whether there is a need to remind the entity of the existing terms. Try this!  Section B Audit Planning and Risk Assessment Key 22: Audit evidence is all of the information used by the auditor in arriving at the conclusion on which the auditor’s opinion is based. Audit evidence includes the information contained in the accounting records underlying the financial statements and information obtained from other sources, such as confirmations from third parties. Key 23: The auditors should evaluate all audit evidence in terms of its sufficiency and appropriateness. Sufficiency (ST): is the measure of the quantity of the audit evidence. Appropriateness (AL): is the measure of the quality of the audit evidence. Key 24: The auditor’s judgement over sufficiency and appropriateness is influenced by the following factors: Risk assessment Materiality Experience gained from previous audits The source and reliability of information Key 25: Generalisation in assessing the reliability of the audit evidence (AWESO-ME): Evidence obtained directly by auditors is more reliable than that obtained by the entity/client. Written representations are more reliable than oral representations Audit evidence from external sources is more reliable than that obtained from the entity’s records Audit evidence obtained from the entity’s records is more reliable when the related accounting and internal control system is strong. Original documents are more reliable than photocopies, and emails. Key 26: Systems-based approach/combined approach: is an approach to audit which seeks to place reliance on the accounting systems of an entity. This is used when the internal control system is strong. Both tests of controls and substantive procedures are used. Direct verification approach/substantive procedure approach/vouching approach: is an approach to audit which does not place reliance on systems, where the auditor only verifies individual transactions and balances in the financial statements. This is used when the internal control system is weak/poor. Only substantive procedures are used. Key 27: Tests of controls are audit procedures designed to evaluate the operating effectiveness of controls in preventing, detecting, and correcting material misstatements at the assertion level. Substantive procedures are audit procedures designed to detect material misstatements at the assertion level. They comprise analytical procedures and tests of details. Key 28: Financial statement assertions are representations by management, explicit or otherwise, that are embodied in the financial statements and used by the auditor to consider the different types of potential misstatements that may occur. Note: Completeness cannot be confirmed if the internal control system is very weak. Key 29: Audit Procedures (A,E,I,O,U) Analytical procedures: an evaluation of financial information made by studying plausible relationships between both financial data and non-financial data. e.g. comparing the current period gross margin with prior years External confirmation: seeking confirmation from another source of details in client’s accounting records. e.g. send the receivable confirmation letter Inquiry: seeking information from client or external sources about operation of controls or how certain items have been treated in the accounting records. E.g. ask payable clerk on how they record the purchase invoice Inspection: examining records or documents, whether internal or external, in paper form, electronic form, or other media, or physical examination of an asset. E.g. inspect the purchase invoice which has been posted onto payable ledger.  Observation: involves watching a procedure being performed. E.g. Observe the inventory count done by the client. Recalculation: confirming the arithmetic accuracy of a client’s records. E.g. recalculate the depreciation charged related to non-current assets. Reperformance: auditor’s independent execution of procedures of controls that were originally performed as part of the entity’s internal control. E.g reperform year-end bank reconciliation Key 30: The auditor is required to determine the materiality level for the financial statements as a whole as well as performance materiality at the planning stage. The calculation or estimation of materiality should be based on the auditor’s experience and judgement. The materiality chosen should be reviewed throughout the audit. Key 31: Information is material if its omission or misstatement could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements. Key 32: Materiality assessment will help the auditor to decide: How many and what items to examine Whether to use sampling techniques What level of error is likely to lead to modified audit opinion Key 33: Materiality benchmarking may be appropriate in the calculator of the materiality for the financial statements as a whole: Value % Revenue 0.5 - 1 Gross profit 0.5 - 1 Profit before tax 5 Profit after tax 5 - 10 Total assets 1-2 Net assets 2-5 Key 34: Performance materiality is the amount 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. This is to account for aggregation risk. Materiality level is affected by the following: The nature and extent of misstatements identified in prior audits The auditor’s understanding of the entity Result of risk assessment procedures Materiality has both quantitative and qualitative aspects. Key 35: Key 36: Audit risk is the risk that the auditor expresses an inappropriate opinion when the financial statements are materially misstated. Audit risk is a function of the risk of material misstatements and detection risk. Key 37: Inherent risk is the susceptibility of an assertion to a misstatement that could be material individually or when aggregated with other misstatements before consideration of any related internal controls. Control risk is the risk that the entity’s internal control will not prevent, detect and correct the material misstatements that could occur in an assertion and that could be material individually or when aggregated with other misstatements. Detection risk is the risk that the auditor’s procedures will not detect a misstatement that exists in an assertion that could be material, individually or when aggregated with other misstatements. Detection risk has two subsets: Sampling risk: the risk that the auditor’s conclusion based on a sample may be different from the conclusion that would be reached if the entire population were subject to the same audit procedures. Non-sampling risk: the risk that the auditor reaches an erroneous conclusion for any reason not related to sampling risk, for example, the use of inappropriate audit procedures or misinterpretation of audit evidence and failure to recognise a misstatement or deviation. Note: the detection risk has an inverse relationship with the risk of material misstatement (IR*CR) Key 38: Professional scepticism needs to be maintained throughout the audit to reduce the risks of overlooking unusual transactions, over-generalising when drawing conclusions, and using inappropriate assumptions in determining the nature, timing and extent of audit procedures and evaluating the results of them. Key 39: Professional judgement is the application of relevant training, knowledge and experience in making informed decisions about the courses of action that are appropriate in the circumstances of the audit engagement. Key 40: Professional judgement is important when assessing: Materiality and audit risk Nature, timing, and extent of audit procedures Evaluation of whether sufficient appropriate audit evidence has been obtained Evaluating management’s judgements in applying the applicable financial reporting framework Drawing conclusions based on the audit evidence obtained Try this! Key 41: Audit strategy sets the scope, timing and direction of the audit and guides the development of the more detailed audit plan. Audit strategy includes the following: The timetable for reporting, key dates and statutory obligations Reporting framework and scope of the audit Initial materiality levels Preliminary risk assessment Audit team members and skills required Arrangements for directing, supervising, and reviewing the work of audit team members Consider the need for the services of experts Location of client premises and travel/accommodation requirements Key 42: Audit plan converts the audit strategy into a more detailed plan and includes the nature, timing, and extent of the audit procedures to be performed by engagement team members. Key 43: Objectives of audit planning: Appropriate attention is devoted to important areas of the audit Potential problems are identified on a timely basis Work is completed effectively and efficiently Appropriate staff are engaged on the audit team, and the proper tasks are assigned to the members of the audit team Assisting with direction and supervision of the audit team and review of their work Assisting with the coordination of the work done by experts Key 44: When planning the audit, the partner or manager must decide how many staff are to be allocated to the assignment, how experienced and whether any of them will require any special knowledge, skill or experience. The engagement partner is responsible for ensuring that: An appropriate level of professional scepticism is applied by audit staff in the conduct of the audit. There is proper communication both within the audit team and the client staff. Key 45: Auditor’s expert is a person or firm possessing special skill, knowledge, and experience in a particular field other than accounting or auditing, whose work in that field is used by the auditor to assist the auditor in obtaining sufficient appropriate audit evidence. A management’s expert is a person or firm possessing special skill, knowledge, and experience in a particular field other than accounting or auditing, whose work in that field is used by the entity to assist the entity in preparing the financial statements. Key 46: It the management’s expert is used as an audit evidence, the auditors shall: Evaluate the competence, capabilities, and objectivity of that expert Obtain an understanding of the work of that expert Evaluate the appropriateness of that expert’s work as audit evidence for the relevant assertion When considering whether to use the work of an auditor’s expert, the auditors should review: Whether management has used a management’s expert in preparing the financial statements The nature and significance of the matter, including its complexity The risk of material misstatement in the matter The availability of alternative source of audit evidence Key 47: Information needed to evaluate the competence, capabilities, and objectivity of the expert: Personal experience with previous work of that expert Discussions with that expert Discussion with other auditors or other people who are familiar with that expert’s work Knowledge of that expert’s qualifications, membership of a professional body or industry association, license to practice, or other form of external recognition Published papers or books written by that expert The auditor’s firm’s quality control policies and procedures Key 48: Auditors are required to evaluate the adequacy of the expert’s work: The source data used The assumptions and methods used The results of the expert’s work in the light of auditor’s knowledge of the business and the result of other audit procedures Key 49: The auditor must not refer to the work of an auditor’s expert in an auditor’s report containing an unmodified report. However, if it is a modified report, the auditor may refer to the work of the expert to explain the nature of the modification. This should also obtain a permission from the expert. Key 50: Computer-assisted audit techniques are applications of auditing procedures to be applied using the computer as an audit tool. They consist of audit software and test data. Key 51: Auditing around the computer: Does not look at the specific underlying working of the system A sample of inputs will be traced to outputs and vice versa Need very little of IT technical expert Only suitable if there is a clear audit trail, simple system, and up-to-date documentation Auditing through the computer: Requires more specific IT audit skills Examine the detailed processing routines of the computer Key 52: Advantages of using CAATs: Large volumes of transactions can be tested Tasks which are manually impossible can be carried out using computer Cost effective in the long term if the client do not change the system Repetitive work can be eliminated Knowledge of the client’s system can be improved Results from CAATs can be compared with results from traditional testing, so increase the overall confidence. Disadvantages of using CAATs: Time consuming and expensive to set up the software Audit staff training is needed to ensure sufficient level of IT knowledge to apply CAATs Not all client systems will be compatible with the software used with CAATs Risk that live client data is corrupted and lost during the use of CAATs Information in real time systems is constantly changing Testing can be limited due to data held on the system Key 53: Audit software consists of computer programs used by the auditors to interrogate a client’s computer files. It may consist of generalised audit software or custom audit software. This is used for substantive procedures. Key 54: Advantages of using audit software: Audit software can perform calculations and comparisons more quickly than those done manually Large volumes of transactions can be tested Cost effective in the long term if the client do not change the system Audit software may allow the actual computer files to be tested directly from the audit program Disadvantages of using audit software: The costs of designing tests using audit software can be substantial as a great deal of planning time will be needed to gain an in-depth understanding of the client’s system The audit cost in general may increase because experienced and specially trained staff will be required If errors are made in the design of the audit software, audit time and cost can be wasted Risk that disrupts the client’s system during the living running of the client’s systems. Key 55: Test data is data submitted by the auditors for processing by the client’s computer system to test that the system processes the data as expected. This is used for testing the specific controls in computer programs of the client. Advantages of test data: Provide evidence that the client’s system is working effectively by testing the program controls Once the basic test data has been designed, less time and costs are incurred until the client’s systems change. Disadvantages of test data: Any resulting corruption of data files has to be corrected. It may be difficult to remove it. Only test the operation of the system at a single point of time Initial time and cost can be high and the client may change their system in subsequent years. Key 56: 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. Key 57: Statistical sampling has two characteristics: Random selection of items The use of probability theory to evaluate the sample results Key 58: Population is the entire set of data from which a sample is selected and about which an auditor wishes to draw conclusions. Sampling units are the individual items constituting a population. Tolerable misstatement is a monetary amount set by the auditor in respect of which the auditor seeks to obtain an appropriate level of assurance that the monetary amount set by the auditor is not exceeded by the actual misstatement in the population. Tolerable rate of deviation is a rate of deviation from prescribed internal control procedures set by the auditor in respect of which the auditor seeks to obtain an appropriate level of assurance that the rate of deviation set by the auditor is not exceeded by the actual rate of deviation in the population. Key 59: Statistical sampling Non-statistical sampling 1. Random selection 1. Haphazard selection 2. Systematic selection 2. Block or Sequence Selection 3. Monetary Unit Sampling Random selection involves using random number tables or computerised generators to select the sample. Systematic selection involves selecting items using a constant interval between selections and the first interval having a random start. Haphazard selection is where an auditor himself selects items subjectively without any structured techniques. Sequence or block selection involves selecting a sample on certain items with particular characteristics. Key 60: Factor influencing sample size for test of controls Key 61: Factor influencing the sample size for test of details Key 62: Misstatement is a difference between the amount, 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, and can arise due to either fraud or error. Key 63: Advantages of statistical sampling: Definite level of confidence that the whole population conforms to the sample result within a stated precision limit Sample size is objectively determined The results of tests can be expressed in precise mathematical terms Bias is eliminated Disadvantages of statistical sampling: The technique may be applied blindly without prior consideration of the suitability of the statistical sampling for the audit task to be performed. Unsuspected patterns in sample selection may invalidate the conclusions The selection exercise can be time consuming The degree of tolerance of acceptable error must be predetermined The auditors may fail to appreciate the further action necessary based on the results obtained from statistical sampling-based test Key 64: Audit documentation is the record of the audit procedures, relevant audit evidence obtained and the conclusion reached in connection with the performance of the audit. Key 65: The reasons why it is necessary for auditors to record all their work in working papers are: The reporting partner needs to be able to satisfy himself that the work delegated by him has been properly performed. Working papers will provide details of audit problems encountered, evidence of work performed, and conclusions drawn in arriving at the audit opinion Assist in the planning and control of the future audits The preperation of working papers encourages the auditors to adopt a methodical approach to their audit work, which in turn is likely to improve the quality of that work Key 66: The auditor must prepare the audit documentation that is sufficient to enable an experienced auditor having no previous connection with the audit to understand: The nature, timing, and extent of the audit procedures performed to comply with the ISAs and applicable legal and regulatory requirements The results of the audit procedures performed and the audit evidence obtained  Significant matters arising during the audit, the conclusions reach, and significant professional judgements made in reaching those conclusions Key 67: Working papers should be headed with: The name of the client The year-end date The file reference of the working paper The name of the person preparing the working paper The date of the working paper prepared The subject of the working paper The name of the person reviewing the working paper The date of the working paper reviewed Key 68: Permanent audit files contain information of continuing importance to the audit. Example of permanent audit files: Engagement letters New client questionnaires The memorandum and articles Other legal documents Details of the history of the client’s business Board minutes of continuing relevance Previous years’ signed account, analytical procedures, and management letters Accounting systems notes Key 69: Current audit files contain information which is relevant to the current year’s audit. Example of current audit files: Financial statements Management accounts details Account checklists Audit planning memorandum Time budgets and summaries Review notes Management letter Representation letter Communications with third parties such as experts or other auditors Key 70: Audit work performed should be reviewed by personnel of appropriate experience to consider whether: The work has been performed in accordance with the audit plan The work performed and the results obtained have been adequately documented Any significant matters have been resolved The objectives of the audit procedures have been achieved The conclusions expressed are consistent with the results of the work performed and support the audit opinion Key 71: Pre-issuance reviews are independent reviews carried out by another audit partner prior to signing of the auditor's report. Post-issuance reviews are independent reviews carried out by another audit partner in the firm after the auditor’s report has been issued. Key 72: Advantages of standardised working papers: Provide a quality control by requiring a consistent approach to all audits and ensuing that essential procedures are not overlooked Preparation and review is more efficient Help junior staff to become familiar with standard procedures Disadvantages of standardised working papers: It may be inappropriate to follow set procedures for a particular client It discourage the exercise of professional judgement It leads to lack of appreciation of the audit objectives and fail to appreciate the implications of the errors found Key 73: Advantages of automated working papers: The risk of errors is reduced The working papers will be neater and easier to review The time saved will be substantial Working papers can be transmitted for review remotely  Section C Internal Control Key 74: Internal control is a process designed, implemented and maintained by those charged with governance, management, and other personnel to provide reasonable assurance about the achievement of the entity’s objectives with regards to reliability of financial reporting, the effectiveness and efficiency of operations, and compliance with applicable laws and regulations. Key 75: Elements of internal controls include: (CRIME) Control environment Risk assessment process of the entity Information system Monitoring of the controls Existence and effectiveness of control activities Key 76: Control environment includes the governance and management functions and attitudes, awareness, and actions of those charged with governance and management concerning the entity’s internal control and its importance in the entity. COCHAMP - Control Environment Key 77: The entity’s risk assessment process is an element of the control environment which encompasses the entity’s process for identifying business risks relevant to financial reporting objectives and deciding about the actions to take to address those risks. Key 78: Information system relevant to financial reporting is a component of internal control that includes the financial reporting system, and consists of the procedures and records established to initiate, record, process, and report entity transactions and to maintain accountability for the related assets, liabilities, and equity. Key 79: Control activities are those policies and procedures in addition to the control environment which are established to achieve the entity’s specific objectives. Control activities include: (SIPPA) Segregation of duties  Information processing Physical control Performance review Authorisation Key 80: Monitoring of controls is a process to assess the effectiveness of internal control performance over time. It involves assessing the effectiveness of controls on a timely basis and taking necessary remedial actions. Key 81: Application controls are manual or automated procedures that typically operate at a business process level. Application controls can be preventative or detective in nature and are designed to ensure the integrity of the accounting records. General IT controls are policies and procedures that relate to many applications and support the effective functioning of applications by helping to ensure the continued proper operations of information systems. General controls include controls over data centre and network operations, system software acquisitions, change and maintenance, access security, and application system acquisitions, development and maintenance. Key 82: Inherent limitations of the internal control: Potential of human error The possibility of controls being by-passed or overridden The cost of controls outweighing their benefits Controls tending to be designed to cope with routine and not non-routine transactions Collusion of two or more people or management Key 83: Auditors can use a number of methods to record, document, or evaluate accounting and control systems: Narrative notes Flowcharts ICQs (ask if the controls exist) ICEQs (ask if the controls fulfill key objectives) Key 84: Advantages Disadvantages Narrative notes Simple to record Difficult to identify Facilitate understanding by missing controls the junior Flowcharts Quick to prepare Only suitable for Easy to understand, follow standard systems and review Difficult to amend Easy to identify control the chart deficiencies Time consuming in drawing the chart ICQs All controls are considered The control may be Quick to prepare overstated by the Easy to use and control client They may contain a large number of irrelevant controls They may not include unusual controls ICEQs Easier to apply to a variety They may be of systems than ICQs misunderstood due Easy to identify key controls to vague answers for testing Important controls They may highlight key may not be control deficiencies identified. Key 85: The principal purposes of a letter on internal control are: To enable the auditors to highlight deficiencies in the accounting records, systems and controls which they have identified during the course of their audit and which may lead to material errors To provide management with constructive advice on various aspects of the business which the auditors may have identified during the course of the audit To highlight matters that may have an effect on future audits Try this! Key 86: Sale/Receivable System Key 87: Purchase/payable system Key 88: Payroll/wage system Try this Key 89: Inventory system Key 90: Non-current assets Non-current liabilities Try this!  Section D Audit Evidence and Procedures Key 91: Analytical procedures can be used at all stages of the audit but must be used at planning and final review. Analytical procedures: Must be used at the planning stage as risk assessment procedures to understand the client and its environment May be used as a substantive procedure to provide evidence for the various financial statement assertions Must be used as part of the final review of the financial statements to see if the financial statements are consistent with the auditor’s knowledge of the business Key 92: A number of factors which auditors should consider when using analytical procedures as substantive procedures: The suitability of using substantive analytical procedures given the assertion: It is suitable for large volumes of transactions that tend to be predictable over time. The reliability of the data, whether internal or external, from which the expectation of recorded amounts or ratios is developed Whether the expectation is sufficiently precise to identify a material misstatement at the desired level of assurance The amount of any difference of recorded amounts from expected values that is acceptable. Key 93: Purposes of analytical procedures are: To identify relationship between financial data or between financial and non-financial data To identify consistencies and patterns or significant fluctuations and unexpected relationships To assist in increasing auditor’s understanding of the business To highlight risky areas and provide alternative means of audit assurance to extensive tests of details Key 94: Audit of accounting estimates: Obtain audit evidence from events occurring up to the date of the auditor’s report Test how management made the accounting estimate and the significance assumptions and data on which it is based Develop an auditor's point estimate or range to determine whether the estimate is reasonable Use an independent estimate Key 95: Main reasons why inventory is one of the most difficult areas of the audit: Closing inventory does not normally form part of the double entry bookkeeping system Inventory existence must generally be verified by attending the inventory count and follow-up procedure Control over inventory count can be difficult to achieve if it is taking place in a number of locations Cut-off may be difficult to test because it may be necessary to move inventory during the inventory count Valuation of inventory can be subjective such as assessment of the valuation of slow-moving, obsolete and damaged items, and assessment of valuation of work-in-progress. Key 96: Responsibility of auditors over the inventory count: Evaluate management’s instructions and procedures for recording and controlling the results of physical inventory count Observe the performance of the inventory count procedures Inspect the condition of inventory Perform test counts The best time to perform the inventory count from the auditor's perspective is at Year-end. Key 97: If the perpetual inventory is used, the auditors will verify that management: Ensures that all inventory lines are counted at least once a year Maintains adequate inventory records that are up-to-date. Has satisfactory procedures for inventory counts and test counting Investigates and corrects all material differences Key 98: The auditors should also: Attend one of the inventory counts Follow-up the inventory count attended to compare quantities counted by the auditors with the inventory count, obtain and verify explanations for any differences, and ensure that the client has reconciled count records with book inventory records. Review the year’s inventory counts to confirm the extent of counting, the treatment of discrepancies and overall accuracy of the records Compare the listing of inventory with detailed inventory records Key 99: Audit procedure before inventory count Key 100: Review of Inventory count instructions Key 101: Procedures during the inventory count: Key 102: Procedures after the inventory count: Trace items that were test counted to final inventory sheets to confirm the completeness and accuracy of the final inventory sheets Verify that all count records have been included in the final inventory sheets to confirm the completeness of the final inventory sheets Verity that final inventory sheets are supported by count records to confirm the existence of inventory recorded in the final inventory sheets. Obtain a list of the adjustments made to the continuous inventory records to vouch that they have been adjusted to the amounts physically counted or measured Trace the invoices relating to the last goods received note and last goods despatched note to the accounting records in order to verify that invoices have been recorded in the correct accounting period and therefore ensure the cut-off is accurate Review replies from third parties about the inventories held by or for them to confirm that all inventory owned by client is included in the inventory total Confirm the client's final valuation of inventory has been correctly calculated to confirm accuracy. Follow up queries and notify management of any problems Key 103: Audit procedures on inventory cut-off: Record all movement notes relating to the period Observe whether correct cut-off procedures are being followed in the despatch and receiving areas Discuss procedures with company staff performing the count to ensure they are understood Determine from management whether finished goods will be transferred to the warehouse on the day of the count Match up goods received notes with purchase invoices to ensure that liability has been recorded in the correct accounting period. Match up goods dispatched note with sale invoices to ensure that income/revenue has been recorded in the correct accounting period. Match up the requisition notes to the work in progress figures for the receiving department to ensure correctly recorded. Key 104: Audit tests for cost attributable production: Agree the valuation of raw materials to invoices and price lists to confirm accuracy Confirm appropriate basis of valuation is being is being used to ensure that this is in accordance with IAS2 Confirm correct quantities are being used when calculating raw material value in work in progress and finished goods to confirm valuation Agree the labour costs to wage records to determine whether the labour cost included is reasonable Review standard labour costs in the light of actual costs and production Agree labour hours to time summaries to confirm that the number of hours allocated to production is reasonable Review the proportion of overheads to the cost of inventory Key 105: Audit tests for inventory valuation: Review and test the client’s system for identifying slow-moving, obsolete or damaged inventory to determine its effectiveness in identifying items which may need to be written down to net realisable value. Follow up any such items that were identified at the inventory count, ensuring that the client has made adequate provision to write down the items to net realisable value. Examine inventory records to identify slow-moving items Examine the prices at which finished goods have been sold after the end of year to ascertain whether any finished goods items need to be reduced below cost. Review quantities of goods sold after the year end to determine that inventory at the year end has been realised Try this! Key 106: Non-current assets Completeness: Obtain or prepare a summary of tangible non-current assets and reconcile with the opening position Compare non-current assets in the non-current asset register with non-current assets in the general ledger and obtain explanations for differences to confirm completeness of the general ledger balance Match a sample of assets which physically to the non-current asset register to conform completeness of the assets recorded in the non-current asset register Reconcile the schedule of non-current assets with the general ledger Existence: Obtain a copy of the non-current asset register or schedule of non-current assets and inspect the physical assets Rights and obligations: Verify title to land and building to obtain evidence of ownership by inspecting the title deeds, land registry certificates or leases Obtain a certificate from bankers/solicitors to determine whether there is any restriction in ownership rights Inspect registration documents for vehicles held verifying that they are in the client’s name Confirm all vehicles used for the client’s business Review the purchase invoices to check if the non-current assets were bought under company’s name Review the board meeting minutes for the evidence of authorisation of capital expenditure Valuation and allocation: Verify valuation to valuation certificate Consider reasonableness of valuation by the valuer Confirm revaluation surplus has been correctly calculated Inspect the condition of non-current assets in use whether they need to be written down to recoverable amount Review insurance policies in force for all categories of tangible non-current assets and consider adequacy of their insured value and review expiry dates Consider the reasonableness of depreciation rates Recalculate the depreciation charged for a sample of assets in each category For revalued assets, ensure that the depreciation charge is based on revalued amount by recalculating it for a sample of revalued assets Compare ratio of depreciation to non-current assets with previous years and depreciation policy rates Confirm that no further depreciation is allowed on fully depreciated assets to ensure that the depreciation expense is not overstated Key 107: Additions: Obtain a breakdown of additions, cast the list and agree to the non-current asset register to confirm completeness of assets. Select a sample of additions and agree cost to supplier invoice to confirm valuation. Verify rights and obligations by agreeing the addition of plant and equipment to a supplier invoice in the name of the client.  Review the list of additions and confirm that they relate to capital expenditure items rather than repairs and maintenance. Review board minutes to ensure that significant capital expenditure purchases have been authorised by the board. For a sample of additions recorded in P&E physically verify them on the factory floor to confirm existence. Key 108: Disposals: Obtain a breakdown of disposals, cast the list and agree all assets removed from the non-current asset register to confirm existence. Select a sample of disposals and agree sale proceeds to supporting documentation such as sundry sales invoices. Recalculate the profit/loss on disposal and agree to the income statement. Key 109: Investments Try this! Key 110: Accounts Receivable Assertion: Accuracy, valuation and allocation Review the after date cash receipts and follow through to pre year-end receivable balances. Inspect the aged receivables report to identify any slow moving balances, discuss these with the credit control manager to assess whether an allowance or write down is necessary. For any slow moving/aged balances review customer correspondence to assess whether there are any invoices in dispute. Review board minutes of Dashing Co to assess whether there are any material disputed receivables. Assertion: Completeness Select a sample of goods despatched notes from before the year end, agree to sales invoices and to inclusion in the sales ledger and year-end receivables ledger. Agree the total of individual sales ledger accounts to the aged receivables listing and to the trial balance. Obtain the prior year aged receivables listing and for significant balances compare to the current year receivables listing for inclusion and amount due. Discuss with management any missing receivables or significantly lower balances. Review the sales ledger for any credit balances and discuss with management whether these should be reclassified as payables. Assertion: Right and Obligations Review bank confirmations and loan agreements for any evidence that receivables have been assigned as security for amounts owed by the client. Review board minutes for evidence that legal title to receivables has been sold onto a third party such as a factor. For a sample of receivables, agree the balance recorded on the sales ledger to the original name of the customer on a sales order or a contract. Key 111: The objective of receivable confirmation is to provide evidence to satisfy the objective of confirming whether the customers exist and owe bona fide amounts to the company. This is to confirm existence and rights and obligations. Timing: the confirmation should take place immediately after the year end. It may be acceptable to carry out before the year end considering the strong internal control. Key 112: The auditor maintains control over external confirmation requests as following: Decide what needs to be confirmed Selects the appropriate party from the whom the confirmation will be requested Designs the confirmation request Sends the request However, the client must authorise third parties to provide the information requested by the auditor. Key 113: Positive confirmation is a request that the confirming party respond directly to the auditor indicating whether the confirming party agrees or disagrees with the information in the request. Negative confirmation is a request that the confirming party respond directly to the auditor only if the confirming party disagrees with the information provided in the request. Key 114: The negative confirmation method may be used if: Risk of material misstatement is low The client has good internal control The population consists of a large number of small, homogenous account balances A very low exception rte is expected The auditor is not aware of circumstances or conditions that would cause recipients of negative confirmation requests to disregard such requests Key 115: Class of account requires special attention: Old unpaid accounts Accounts written off during the period under review Accounts with credit balances Accounts settled by round sum payments Dormant accounts Accounts with nil balances Accounts with large balances Accounts from top customers Accounts to which credit notes have been posted close to the year end Accounts containing unusual transactions Key 116: An exception is a response that indicates a difference between information requested to be confirmed or contained in the entity’s records, and information provided by the confirming party. Key 117: Alternative procedures if there is no response from the confirmation: Verity receipt of cash after date to determine whether debt has subsequently been settled Verify valid purchase orders if any to confirm that the debt relates to genuine orders Examine the account to see if the balance outstanding represents specific invoices and confirm their validity to confirm that the debt relates to genuine sale made. Obtain explanations for invoices remaining unpaid after subsequent ones have been paid Confirm whether the balance on the account is growing Test the company’s control over the issue of credit notes and the write off of irrecoverable debts Key 118: Additional procedures where confirmation is carried out before the year end: Review and reconcile entries on the sales ledger control account for the intervening period Verify sale entries from the control account by agreeing to sales day book entries, copy sale invoices and despatch notes to obtain evidence that they relate to genuine sales Confirm that appropriate credit entries have been made for goods returned notes and other evidence of returns/allowances to the sale ledger control account Select a sample from the cash received records and ensure that receipts have been credited to the control account to ensure that receivables are not overstated Review the list of balances at the confirmation date and year rend and investigate any unexpected movements Carry out analytical procedures by comparing accounts receivable ratios at the confirmation date to the year end. Carry out period end cut-off tests in addition to any performed at the date of the confirmation Key 119: Audit test of irrecoverable debts: Confirm necessity/adequacy of write-offs of specific receivables by review of correspondence, receivables collection agencies’s letters, liquidation statements. Examine customer files on overdue receivables and assess whether allowance is required in the circumstances  Review the customer files/correspondence from lawyers/receivables’ confirmation results for evidence of potential irrecoverable amounts Examine credit notes issued after the year end for allowances that should be made against the current period balances Review accuracy of aged receivables analysis by comparing analysis with dates on invoices Key 120: Revenue Compare the overall level of revenue against prior years and budget and investigate any significant fluctuations. Obtain a schedule of sales for the year broken down into the major categories of toys manufactured and compare this to the prior year breakdown and for any unusual movements, discuss with management. Calculate the gross margin for Tinkerbell and compare this to the prior year and investigate any significant fluctuations. Select a sample of sales invoices for larger customers and recalculate the discounts allowed to ensure that these are accurate. Recalculate for a sample of invoices that the sales tax has been correctly applied to the sales invoice. Select a sample of customer orders and agree these to the despatch notes and sales invoices through to inclusion in the sales ledger to ensure completeness of revenue. Select a sample of despatch notes both pre and post the year end, follow these through to sales invoices in the correct accounting period to ensure that cut-off has been correctly applied. Select a sample of credit notes issued after the year end and follow through to the sales invoice to ensure the returns were recorded in the proper period. Key 121: Standard request for information (information that would be disclosed by the banks): Key 122: Bank Balance: Obtain the company’s bank reconciliation and check the additions to ensure arithmetical accuracy. Obtain a bank confirmation letter from the company’s bankers. Verify the balance per the bank statement to an original year end bank statement and also to the bank confirmation letter. Verify the reconciliation’s balance per the cash book to the year end cash book. Trace all of the outstanding lodgements to the pre year end cash book, post year end bank statement and also to paying-in-book pre year end. Examine any old unpresented cheques to assess if they need to be written back into the purchase ledger as they are no longer valid to be presented. Trace all unpresented 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. Agree all balances listed on the bank confirmation letter to the company’s bank reconciliations or the trial balance to ensure completeness of bank balances. 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. Examine the bank confirmation letter for details of any security provided by the company or any legal right of set-off as this may require disclosure. Key 123: Payable confirmation is not generally done because the supplier’s statements and invoices already constitute strong and reliable evidence and they are part of the standardized documentation of the cycle. Key 124: Accounts payable confirmation letters may be necessary in the following circumstances: Suppliers’ statements are not available or incomplete Internal controls are weak It is thought that the client is deliberately trying to understate the account payable The accounts appear to be abnormal and irregular Key 125: Assertion: Completeness Obtain accounts payable listing and perform casting and cross-casting to the general ledger to ensure their balances are matched. Select a sample of suppliers’ statements and reconcile them to the accounting records.  Test for unrecorded liabilities by examining the transactions after year-end and those of unrecorded invoices. Assertion: Existence and Valuation Select a sample of payable accounts and vouch them to the supporting documents, such as purchase orders and suppliers’ invoices. Select a sample of payable accounts and reconcile them to the suppliers’ statements Perform accounts payable confirmation on a sample of suppliers Calculate the operating profit and gross profit margins and compare them to last year and budget and investigate any significant differences. Review monthly purchases and other expenses to identify any significant fluctuations and discuss with management. Discuss with management whether there have been any changes in the key suppliers used and compare this to the purchase ledger to assess completeness and accuracy of purchases. Recalculate the accuracy of a sample of purchase invoice totals and related taxes and ensure expense has been included in the correct nominal code. Recalculate the prepayments and accruals charged at the year end to ensure the accuracy of the expense charge included in the statement of profit or loss. Select a sample of post year-end expense invoices and ensure that any expenses relating to the current year have been included. Select a sample of payments from the cash book and trace to expense account to ensure the expense has been included and classified correctly. Select a sample of goods received notes (GRNs) from throughout the year; agree them to purchase invoices and the purchase day book to ensure the completeness of purchases. Select a sample of GRNs just before and after the year end; agree to the purchase day book to ensure the expense is recorded in the correct accounting period. Key 126: Substantive test for accruals: Verify that accruals are fairly calculated and verify by reference to subsequent payment and supporting documentation Review the statement of profit or loss and other comprehensive income and prior period’s figures and consider liabilities inherent in the trade to ensure that all likely accruals have been provided  Scrutinise payments made after period end to ascertain whether any payments made should be accrued Test transactions around the year end to determine whether amounts have been recognised in the correct financial period Consider basis for round sum accruals and ensure that it is consistent with prior periods Ascertain why any payments on accounts are being made and ensure that the full liability is provided Ensure that all disclosures relevant to liabilities have been made in the draft financial statements Key 127: Substantive tests for non-current liabilities: Obtain/prepare schedule of loans outstanding at the period end date showing for each loan: name of lender, date of loan, maturity date, interest rate, balance at the end of the period, and any security. Compare opening balances to previous year’s working papers to confirm that these have been carried forward accurately Compare balances to the general ledger and investigate any differences Agree name of lender to register of debenture holders or equivalent Trace additions and repayments to entries in the cash book to confirm the accuracy of the closing balance Confirm repayments are in accordance with loan agreement to determine whether there may be any unrecognized penalties Verify that borrowing limits imposed either by the company’s constitution or by other agreement are not exceeded Examine signed Board minutes relating the new borrowing/repayment to ensure that transactions are authorised Obtain direct confirmation from lenders of the amounts outstanding, accrued interest and what security they hold Verify interest charged for the period and the adequacy of accrued interest to confirm that interest is not misstated Review restrictive covenants and provisions relating to default. Review minutes and cash book to confirm that all loans have been recorded Review draft financial statements to ensure that disclosures for non-current liabilities are correct and in accordance with accounting standards. Any elements repayable within one year should be classified as current liabilities. Key 128: Audit tests for provisions and contingencies: Make appropriate inquiries of management including obtaining written representations Review minutes of those charged with governance and correspondence with the entity’s legal counsel Examine legal expense account Use any information obtained regarding the entity’s business including information obtained from discussion with any inhouse legal department Obtain details of all provisions which have been included in the financial statements and all contingencies that have been disclosed Obtain a detailed analysis of all provisions showing opening balances, movements and closing balances Determine for each material provision whether the company has a present obligations as a result of past events by ○ Review correspondence relating to the item ○ Discussion with directors Determine for each material provision whether it is probably that a transfer of economic benefits will be required to settle obligations Recalculate all provisions made to confirm accuracy Compare the amount provided with any payments after the period end and with amount paid in the past for the similar items to obtain evidence for valuation Confirm that contingent liability is disclosed in the financial statements if it is not possible to estimate the amount of the provision Consider the nature of the client’s business to determine whether other provisions may be required Consider adequacy of disclosure in accordance with the accounting standards Try this!  Section E Audit Completion Key 129: The auditors must perform and document an overall review of the financial statements before reaching an opinion. This review should include a review of accounting policies and a review of consistency and reasonableness. Key 130: 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. Examinable in FAU: only events occurring between the end of the reporting period and the date of the auditor’s report. Key 131: Adjusting events are those that provide further evidence of conditions that existed at the end of the reporting period. Key 132: Non-adjusting events are those that are indicative of conditions that arose after the end of the reporting period. Key 133: The auditor shall perform 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. The auditor shall also obtain written representations confirming that all subsequent events have been adjusted or disclosed. Key 134: Under the going concern basis of accounting, the financial statements are prepared on the assumption that the entity is a going concern and will continue its operations for the foreseeable future. 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. Key 135: The auditor’s responsibility is to obtain sufficient appropriate audit evidence regarding: The appropriateness of the management’s use of going concern basis of accounting in the preparation of financial statements The existence of a material uncertainty about the entity’s ability to continue as a going concern that needs to be disclosed in the financial statement Key 136: Key 137: If management’s assessment covers a period of less than 12 months from the end of the reporting period, the auditor should ask management to extend its assessment period to 12 months from the end of the reporting period. Key 138: Key 139: Key 140: Written representations are written statements by management provided to auditor to confirm certain matters to support other audit evidence. When the auditors receive such representations, they should: Seek corroborative audit evidence from sources inside or outside the entity Evaluate whether the representations made by management appear reasonable and are consistent with other audit evidence obtained including other representations Consider whether the individuals making representations can be expected to be well-informed on the particular matter Key 141: A representation letter should: Be addressed to the auditors Contain specified information Be appropriately dated and signed by those with specific relevant knowledge Key 142: If management does not provide one or more of the requested written representations, the auditor shall: Discuss the matter with management Reevaluate the integrity of management and evaluate the effect that this may have on this reliability of representations and audit evidence in general Take appropriate actions including possible effect on the opinion in the auditor’s report. Key 143: Elements of the auditor’s report: 1. Title 2. Addressee 3. Opinion paragraph 4. Basis for opinion 5. Emphasis of matter paragraph 6. Key audit matters 7. Other information 8. Management’s responsibilities 9. Auditor’s responsibilities 10. Other reporting responsibilities 11. Name of the engagement partner 12. Auditor’s signature 13. Auditor’s address 14. Date of the report Key 144: Pervasiveness is a term used to describe the effects or possible effects on the financial statements of misstatements or undetected misstatements. Key 145: Impact on audit opinion: VII. Reference Textbooks 1. BPP Learning Media, Interactive Tex on FAU Foundation in Audit* 2. BPP Learning Media, Practice & Revision Kit Paper FAU Foundation in Audit*