ACCA Audit and Assurance (AA) Pocket Notes PDF

ACCA Audit and assurance (AA) Pocket Notes Audit and assurance (AA) The text in this material and any others British library made available by any Kaplan Group cataloguing-in-publication...

ACCA Audit and assurance (AA) Pocket Notes Audit and assurance (AA) The text in this material and any others British library made available by any Kaplan Group cataloguing-in-publication company does not amount to advice on a data particular matter and should not be taken as such. No reliance should be placed on A catalogue record for this book is available the content as the basis for any investment from the British Library. or other decision or in connection with Published by: any advice given to third parties. Please Kaplan Publishing UK consult your appropriate professional Unit 2 The Business Centre adviser as necessary. Kaplan Publishing Molly Millars Lane Limited, all other Kaplan group companies, Wokingham the International Accounting Standards Berkshire Board, and the IFRS Foundation expressly RG41 2QZ disclaim all liability to any person in respect of any losses or other claims, whether ISBN: 978-1-78740-124-2 direct, indirect, incidental, consequential or otherwise arising in relation to the use of © Kaplan Financial Limited, 2018 such materials. Printed and bound in Great Printed and bound in Great Britain. Britain. P.2 KAPLAN PUBLISHING  Audit and assurance (AA) Acknowledgements This Product includes propriety content of the Trade Marks International Accounting Standards Board which is overseen by the IFRS Foundation, The IFRS Foundation logo, the IASB logo, and is used with the express permission the IFRS for SMEs logo, the “Hexagon of the IFRS Foundation under licence. All Device”, “IFRS Foundation”, “eIFRS”, “IAS”, rights reserved. 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KAPLAN PUBLISHING P.3 Audit and assurance (AA) Contents Chapter 1: Introduction to assurance...............................................................................................1 Chapter 2: Rules and regulation....................................................................................................... 7 Chapter 3: Corporate governance.................................................................................................. 13 Chapter 4: Ethics and acceptance.................................................................................................19 Chapter 5: Risk...............................................................................................................................31 Chapter 6: Planning........................................................................................................................41 Chapter 7: Evidence.......................................................................................................................51 Chapter 8: Systems and controls................................................................................................... 63 Chapter 9: Internal audit................................................................................................................. 77 Chapter 10: Procedures...................................................................................................................83 Chapter 11: Completion and review.................................................................................................95 Chapter 12: Reporting....................................................................................................................105 References.................................................................................................................................... R.1 Index......................................................................................................................................I.1 This document references IFRS® Standards and IAS® Standards, which are authored by the International Accounting Standards Board (the Board), and published in the 2017 IFRS Standards Red Book. P.4 KAPLAN PUBLISHING  Audit and assurance (AA) Exam format Number of marks Section A: 3 x 10 mark objective test case study questions 30 Section B: 1 x 30 mark question 30 2 x 20 mark questions 40 –––––– 100 –––––– Computer-based examination 3 hours and 20 minutes - 110 marks of exam content: 100 marks + 10 marks of seeded questions. Seeded questions are included in the exam for quality assurance and security purposes. Paper-based examination 3 hours and 15 minutes - 100 marks of exam content. Paper exams do not have any of the time saving efficiencies which can be incorporated in a computer exam, therefore students are allocated more time for the same 100 marks. KAPLAN PUBLISHING P.5 Audit and assurance (AA) Aim of the paper The keys to success in To develop knowledge and understanding Paper F8 of the process of carrying out the assurance Answer the question engagement and its application in the context of the professional regulatory framework. Read the question extremely carefully, paying attention to the verbs telling you what to do, and to the mark allocation. You must make (at least) one point in your answer for every mark available. P.6 KAPLAN PUBLISHING  Audit and assurance (AA) Don’t overrun your time allocation Think before you start writing You must be absolutely strict with yourself Take time to understand what the question with your time allocation for each question. is really asking. Certain words read in In the exam room, write down the times isolation may lead you to misinterpret the for each question, and force yourself to requirement. finish your attempt within the time available. You also need to make sure that you identify Such discipline may not be fun, but it is the the whole requirement. Some questions are approach that will earn you most marks in actually more than one requirement. For the exam. example: “Identify and explain the control deficiencies in the question and recommend solutions to overcome them.” KAPLAN PUBLISHING P.7 Audit and assurance (AA) Quality and accuracy are of the utmost importance to us so if you spot an error in any of our products, please send an email to [email protected] with full details, or follow the link to the feedback form in MyKaplan. Our Quality Co-ordinator will work with our technical team to verify the error and take action to ensure it is corrected in future editions. P.8 KAPLAN PUBLISHING chapter 1 Introduction to assurance In this chapter Assurance services. Accountability, stewardship and agency. 1 Introduction to assurance Assurance services Purpose of assurance is to increase the confidence of the user in the subject matter being relied upon. Practitioner e.g. auditor (performs an independent examination of the subject matter against the suitable criteria and provides a written assurance report) 3 Party Involvement Intended user e.g. shareholders (user of the subject matter) Responsible party e.g. directors (preparer of the subject matter) Subject Matter The information being examined e.g. financial statements Suitable Criteria Subject matter is judged against the criteria e.g. IFRS Evidence Sufficient and appropriate to provide a basis for the conclusion Written Assurance Report Expressing a conclusion or opinion 2 KAPLAN PUBLISHING KA  Chapter 1 The Framework permits only two types of assurance engagement to be performed: Reasonable assurance engagements Limited assurance engagement The practitioner: The practitioner: Gathers sufficient appropriate evidence Gathers sufficient appropriate evidence to  Does enough work to be able to be satisfied that the subject matter is draw reasonable, but not absolute, plausible in the circumstances conclusions Gives a report in the form of a negative  Concludes that the subject matter statement of conclusion (“nothing has conforms in all material respects with come to our attention”) identified suitable criteria  Gives a report in the form of a positive statement of opinion EXAMPLES Review of financial statements (International Standard on Review Engagements 2400). EXAMPLE Risk assessment reports.  Statutory audit. Performance measurement reports. Systems reliability reports. Reports on social and environmental issues reviews of internal control. G KAPLAN PUBLISHING 3 Introduction to assurance Accountability, stewardship and agency Accountability Stewardship People in positions of power can be The responsibility to take good care of resources. held to account for their actions Known as a ‘fiduciary relationship’ Directors are accountable to the Directors are the stewards of the company shareholders for the decisions they Directors are required to produce financial make in relation to the company statements giving an account of their stewardship Agency When one party, the principal, employs another party, the agent, to perform a task of their behalf Directors are the agents of the shareholders External auditors are the agents of the shareholders Company management are required to produce financial statements giving an account of their stewardship of the company at regular intervals, but there was a need for some kind of independent validation of the financial statements – the independent audit. 4 KAPLAN PUBLISHING KA  Chapter 1 Benefits of audit Expectations Gap Helps improve quality of information. Auditor tests everything. Independent scrutiny. Auditor detects all fraud and error. Reduces risk of management bias, fraud Auditor confirms the company is a going and error. concern. Enhances credibility of FS. Auditor prepares the FS. Deficiencies in internal controls highlighted. Exam focus Limitations of audit FS include subjective estimates and To practise the basics use the following test judgments. your understandings (TYUs) Study Text: Inherent limitations of internal controls. Chapter 1, TYU 1 Representations from management not Chapter 1, TYU 2 reliable. Chapter 1, TYU 3 Evidence is persuasive not conclusive. Do not test all transactions, only a sample. G KAPLAN PUBLISHING 5 Introduction to assurance 6 KAPLAN PUBLISHING KA chapter 2 Rules and regulation In this chapter International and UK standard setting and regulation. Why have an audit. Who may or may not act as an auditor. How are auditors appointed and removed. Auditor’s rights and duties. 7 Rules and regulation International and UK standard setting and regulation IFAC International Federation of Accountants A grouping of accountancy bodies ISAs are adopted, and modified if (including ACCA) necessary, by individual countries or they No legal standing in member's can set their own standards. countries Any modifications reflect the legislation relating to companies in the country IAASB that the client is based, which may be International Audit and Assurance different from that in other jurisdictions. Standards Board Local law overrides ISAs. A subsidiary of IFAC Sets international standards on auditing (ISAs) In the EU all audits must be carried out in accordance with ISAs for accounting periods beginning on or after 1 January 2005 8 KAPLAN PUBLISHING KA  Chapter 2 Why have an audit Legal framework Businesses needed Distinction between can be operated owners and the business. To protect owners from Regular accounts through unscrupulous managers to be produced. companies Businesses run by Accounts require managers not owners To protect the world independent check – Incorporation at large from owners an audit Limited liability status taking advantage of limited liability Therefore in most countries companies require an audit. In many countries there is an exemption for small businesses. G KAPLAN PUBLISHING 9 Rules and regulation Who may or may not act as an auditor MAY NOT ACT    MAY ACT     EXCLUDED BY LAW In Britain INDIVIDUALS An officer (Director or secretary) of the A member of a Recognised Supervisory company Body (RSB) e.g. ACCA and – an employee of the company Allowed by the rules of that body to be – a business partner or employee of the above. an auditor EXCLUDED BY ETHICS or Due to lack of objectivity or independence, for Someone directly authorised by the state. example, due to: FIRMS – close business relationships Controlled by members of a suitably – personal relationships authorised supervisory body – long association with the client Or – fee dependency A firm directly authorised by the state. – non audit services provided. 10 KAPLAN PUBLISHING KA  Chapter 2 How are auditors appointed and removed REMOVAL  imple majority at a general S meeting of the company. APPOINTMENT In most jurisdictions The law requires special notice to be given. The members (shareholders) of the company. Resignation (auditors may Directors can appoint first auditor have to submit to members a and fill a ‘casual vacancy’, but needs statement of the circumstances members’ approval at next AGM. surrounding their resignation). Appointment runs from end of AGM until the end of the next AGM. Where no AGM – automatic annual reappointment unless a shareholder objects. G KAPLAN PUBLISHING 11 Rules and regulation Auditor’s rights and duties Exam focus Rights To practise the basics use the following Access at all times to all books and test your understandings (TYUs) from the records Study Text:  eceive information and explanations R TYU 1 from the officers of the company TYU 2  eceive notice of and attend company R meetings Speak at such meetings  eceive copies of any written resolutions R of the company Requisition an Extraordinary General Meeting (EGM) on resignation Require notice of circumstances relating to resignation to be circulated. Duties Report to the members on whether the financial statements give a true and fair view and have been properly prepared. 12 KAPLAN PUBLISHING KA  3 chapter Corporate governance In this chapter Corporate governance. Audit committees. Nomination committee. Remuneration committee. Risk management. 13 Corporate governance Corporate governance Aligning key executive and board remuneration Corporate governance is about ensuring that Monitoring and managing potential companies are run well in the interests of conflicts of interest of management, their shareholders and the wider community. board members and shareholders Need arose due to high profile collapses of companies. Ensuring the integrity of the corporation’s accounting and financial reporting Good corporate governance is particularly systems, overseeing the process of important for publicly traded companies. disclosure and communications. Maintaining satisfactory standards of Note the term “Board” primarily to mean corporate governance is the responsibility of the Supervisory board in a 2 tier board those operating a company. arrangement or the non-executive directors The board and relevant sub committees in a unitary board structure. The key responsibilities of the board are: Composition of the board Reviewing and guiding corporate strategy Equal numbers of executive and non- Monitoring the effectiveness of the executive directors. company’s governance practices and making changes as needed Segregation of the roles of CEO and chairman. Selecting, compensating, monitoring and, when necessary, replacing key Directors subject to re-election by executives shareholders at least every 3 years. 14 KAPLAN PUBLISHING KA  Chapter 3 Corporate governance in action Segregation of roles Main aspects of Internal audit (chairman and CEO) corporate governance Audit Committees Risk Nomination Remuneration G KAPLAN PUBLISHING 15 Corporate governance Audit committees Reviewing and monitoring the external auditor’s independence and objectivity Composition and the effectiveness of the audit 3 non executives. process. At least 1 with financial expertise. Developing and implementing policy on the engagement of the external auditor Objectives to supply non-audit services. Public confidence in the credibility Reviewing arrangements for confidential and objectivity of published financial reporting by employees and investigation information. of possible improprieties – whistle Assisting directors in meeting their blowing. responsibilities in respect of financial reporting. The audit committee and internal audit Liaison with external auditors. The audit committee should: Function Ensure internal auditor has direct access to the board chairman and to the audit Monitoring integrity of the financial committee statements. Review and assess the annual internal Reviewing internal financial controls. audit work plan Monitoring and reviewing internal audit Receive reports on the results of internal function. audit work Making recommendations re If no IA function in place, review need for appointment, removal and remuneration one annually. of the external auditor. 16 KAPLAN PUBLISHING KA  Chapter 3 Nomination committee Risk management Responsible for appointing executive All companies face risks of many kinds. directors. Companies must address the risk issues Comprised majority non-executive and: directors. Identify the risks faced (e.g. operational, Appoint the best person for the job i.e. financial, legal) appropriate experiences, qualifications and skills. May maintain a risk register Assess the relative importance of each Remuneration committee risk Responsible for deciding on the Sometimes accept the risk as an remuneration of executive directors. inevitable part of its operations. Comprised non-executive directors. Ensures no director is involved in setting their own pay. Should ensure the pay is linked with long term performance of the company. Should be enough to attract, motivate and retain good directors but should not be excessive. G KAPLAN PUBLISHING 17 Corporate governance Exam focus Exam kit questions in this area: Section A – Objective case questions: Sistar Cameron Section B – Constructed response questions: Saxophone Enterprises 18 KAPLAN PUBLISHING KA 4 chapter Ethics and acceptance In this chapter Ethical principles. Independence and objectivity. Fundamental principles, threats and safeguards. ACCA code of ethics and conduct. Threats and safeguards. Confidentiality. Acceptance of engagements. New work and the engagement letter. 19 Ethics and acceptance Ethical principles SOURCES The user needs to believe that ACCA Code of Ethics and assurance practitioners act in Professional Conduct accordance with a code of ethics, and IFAC Code of Ethics The practitioner needs a code of ethics to make sure that he or she is worthy of that level of trust. Exam focus Similar conceptual frameworks Learn the principles in the various Codes of Ethics, but do not be afraid to use your common sense in deciding whether a proposed action is ethically acceptable for an auditor. CONTENTS Fundamental principles of ethical behaviour Potential threats to ethical behaviour Possible safeguards which can be implemented to counter the threats 20 KAPLAN PUBLISHING KA  Chapter 4 Remember: Independence and The Codes of Ethics provide guidance objectivity that the auditor must follow. Independence is freedom from any In some cases the only viable external control or influence in making safeguard is not to accept an assurance decisions. engagement, or to resign from it. Objectivity is the state of mind which has The ACCA reserves the right to discipline regard to all considerations relevant to members who infringe the rules through the task in hand but no other. a process of disciplinary hearings. G KAPLAN PUBLISHING 21 Ethics and acceptance Fundamental principles, threats and safeguards SAFEGUARDS FUNDAMENTAL General PRINCIPLES THREATS Created by the profession Integrity Self-interest Created in the work Objectivity Self-review environment Professional competence Advocacy Specific and due care Segregation of duties Familiarity Review Confidentiality Intimidation Rotation Professional behaviour Ceasing to act Separate teams Independent partner review 22 KAPLAN PUBLISHING KA  Chapter 4 ACCA Code of ethics and professional standards when providing conduct professional services. Confidentiality: Members should Fundamental principles respect the confidentiality of information The code identifies five fundamental acquired as a result of professional principles in professional conduct. and business relationships and should not disclose any such information to Integrity: Members should be third parties without proper and specific straightforward and honest in all authority or unless there is a legal or professional and business relationships. professional right or duty to disclose. Objectivity: Members should not  rofessional behaviour: Members P allow bias, conflicts of interest or should comply with relevant laws and undue influence of others to override regulations and should avoid any action professional or business judgements. that discredits the profession. Professional competence and due care: Members have a continuing duty to maintain professional knowledge and skill to ensure that clients receive competent professional service based on current developments in practice, legislation and techniques. Members should act diligently and in accordance with applicable technical and G KAPLAN PUBLISHING 23 Ethics and acceptance Threats and safeguards Members are required to apply the conceptual framework to identify threats to compliance with the fundamental principles, to evaluate their significance and, if such threats are other than clearly insignificant, to apply safeguards to eliminate them or reduce them to an acceptable level such that compliance with the fundamental principles is not compromised. Eliminate the threat e.g. decline Either enagement Apply safeguards Identify threats Assess threats if necessary Or Reduce the threat to an acceptable level e.g. second partner reviews 24 KAPLAN PUBLISHING KA  Chapter 4 Example Threat Possible safeguard Auditor owns shares in the client (Self-interest ) Sell the shares as soon as possible. Auditor is unduly dependent on client for fees Fees from listed clients should not exceed 15% of the total (Self-interest ) practice income for 2 consecutive years. Significant outstanding fees due from the client Don’t commence audit work until outstanding fees are paid. (Self-interest ) Client requests contingent fee (Self-interest) Refuse. Contingent fees are not acceptable for assurance engagements. Gifts or hospitality from the client (Self-interest Do not accept unless clearly trivial. Audit partner must and familiarity) authorise acceptance. Audit partner has been in post for many years Partner rotation after 7 years for listed clients. May be (Familiarity) extended for 1 year if audit committee approves. Ex-auditor now works for audit client (Familiarity) If ex-auditor was the audit partner, firm should not audit client for 2 years. If ex-auditor was team member, review composition of audit team. Close relationships between auditor and client Remove that person from the audit team. staff (Familiarity) Auditor provides other services (Self-review) Separate teams for each service provided. Don’t provide other services to audit clients where significant reliance will be placed on the non-audit work. Auditor is ex employee of the client (Self-review) Don’t assign that person to the audit team. Client asks auditor to represent them in court Decline. No sufficient safeguard exists. (Advocacy) G KAPLAN PUBLISHING 25 Ethics and acceptance Confidentiality The firm must notify all affected clients of the conflict and obtain their consent to act. The Information confidential to a client or following additional safeguards should be employer acquired in the course of considered: professional work should not be disclosed to a third party, except where: Advise the clients to seek independent advice Consent has been obtained from the client or employer, or Separate engagement teams (with different engagement partners and team There is a public duty to disclose, or members) There is a legal or professional right or Procedures to prevent access to duty to disclose. information, e.g. physical separation Conflicts of Interest: of the team members and confidential/ secure data filing Where conflicts of interest exist, the firm’s work should be arranged to avoid the Signed confidentiality agreements interests of one being adversely affected by Regular review of the application of those of another and to prevent a breach of safeguards by an independent person of confidentiality. appropriate seniority. If adequate safeguards cannot be implemented, the firm must decline, or resign from one or more conflicting engagements. 26 KAPLAN PUBLISHING KA  Chapter 4 Acceptance of engagements Independence & Professional clearance Management integrity objectivity Preconditions for an Money laundering audit (client due diligence) Issues to consider prior to accepting an engagement Reputation of the client Resources Professional Fees Risks competence G KAPLAN PUBLISHING 27 Ethics and acceptance New work and the engagement letter Obtain work by: Recommendation Tender Has risks. Needs thorough research and The engagement letter preparation. includes Responsibilities Objective and scope of audit Reference to legislation and standards Reference to inherent If offered assignment limitations of the audit What communications will Communicate with outgoing auditors. take place Assess independence. Specific planning issues, e.g.: Assess commercial desirability of –– use of internal audit assignment. –– deadlines Engagement letter. –– use of experts etc Basis for fees 28 KAPLAN PUBLISHING KA  Chapter 4 A new letter may be sent every year to Exam focus emphasise its importance to clients. A new letter must be sent if there have Exam kit questions in this area: been changes, such as changes to: Section A – Objective case questions: –– Statutory duties Bark & Co –– Professional duties Miranda & Co –– Other services. Tigger & Co Preconditions for an audit Section B – Constructed response questions: Acceptable financial reporting framework Cinnamon in place. Orange Financials Management understands its responsibility for the financial LV Fones statements. Management understands its responsibility for internal controls. Management will provide the auditor with access to all information required for the audit. G KAPLAN PUBLISHING 29 Ethics and acceptance 30 KAPLAN PUBLISHING KA 5 chapter Risk In this chapter Audit risk. Materiality. Significance of the risk approach. Understanding the entity and its environment. Risk assessment procedures. Analytical procedures. 31 Risk Audit risk Audit risk (AR) Definition The risk of issuing an inappropriate audit opinion. Inherent risk (IR) Control risk (CR) Detection risk (DR) The susceptibility of a balance The risk that the client’s The risk that the auditor fails to to misstatement before controls fail to prevent and detect material misstatement. consideration of controls. detect misstatement. Example Example Example Higher risk: Higher risk: Higher risk: Old or ineffective accounting A client in a volatile industry. software. Using inappropriate Rapidly changing procedures. Lack of segregation of technology. accounting duties; Misinterpreting results. Complex accounting Lack of authorisation treatment. procedures. 32 KAPLAN PUBLISHING  Chapter 5 Materiality Significance Financial statements which are materially misstated will not give a true and fair view. Auditors must test all material balances Materiality Performance materiality Information is material An amount set at less than if its omission or MATERIALITY materiality for the financial misstatement could, statements as a whole, either individually to reduce the risk that or in aggregate, the aggregate of smaller influence the misstatements in individual economic decisions Determining materiality account balances or classes of users taken on the of transactions could exceed basis of the financial Size materiality for the financial statements. Nature statements as a whole. KAPLAN PUBLISHING 33 Risk Assessing materiality is a matter of Misstatement: A difference between a professional judgement and is not a reported financial statement item and the mechanical exercise. amount, classification, presentation, or Each company must be considered with disclosure that is required for the item to be reference to its unique circumstances in accordance with the applicable financial and the informational needs of the users reporting framework. Misstatements can of the financial statements. arise from error or fraud. Common measures for initial assessment of materiality: –– ½ – 1% of revenue –– 5 – 10% of profit before tax –– 1 – 2% of assets Materiality should be reassessed during the audit in response to further information or risk arising. 34 KAPLAN PUBLISHING  Chapter 5 Definition Significance of the risk approach Sampling risk arises from the possibility that Inherent risk and control risk cannot be the auditor’s conclusion, based on a sample directly influenced by the auditor. may be different from the conclusion reached if the entire population were subjected to the The auditor can, however, manipulate same audit procedure. detection risk. If they assess that inherent and control risk are high (i.e. ISA 530 increased risk of material misstatement) they can lower detection risk through the Non-sampling risk is the risk the auditor following means: reaches an inappropriate opinion despite a representative sample being chosen. –– Increasing substantive testing; –– Increasing sample sizes; –– Using more experienced staff; –– Increasing levels of supervision; –– Increasing review procedures. By performing a more thorough audit there is less risk that the auditor fails to detect material misstatement. KAPLAN PUBLISHING 35 Risk Understanding the entity and The measurement and review of the its environment entity’s financial performance. The internal controls relevant to the Auditors are required to obtain an audit. understanding of their client, including their internal controls. This is often referred to as (ISA 315 Identifying and Assessing the Risks Knowledge of the Business, or “KOB.” This of Material Misstatement.) generally includes. The purpose of acquiring this knowledge Relevant industry, regulatory and other is to identify the risks that the business is external factors; exposed to and, ultimately, how could these The nature of the entity, including: lead to a risk of material misstatement in the –– its operations; financial statements. –– its ownership and governance structures; –– the types of investment it makes; and –– the way it is structured and financed. The entity’s selection and application of accounting policies. The entity’s objectives, strategies and related business risks. 36 KAPLAN PUBLISHING  Chapter 5 Risk assessment procedures Involve calculating ratios, computing trends, proving figures in total, and ISA 315 requires auditors to perform the making comparisons. following procedures to understand the entity May disclose anomalies; these must be and its environment. investigated. Enquiries with management and others Used to corroborate answers to within the entity. enquiries. Analytical procedures. Involves comparisons – an individual Observation (e.g. of control procedures) ratio, for example, is meaningless unless and inspection (e.g. of key strategic compared to (e.g.) previous years, documents and procedural manuals). another similar company, actual v budget etc. Analytical procedures When making comparisons make sure The basics calculations use comparable numbers Compulsory for planning and risk (e.g. numbers with similar components assessment (ISA 315). from one year to the next). Can be an efficient and effective source of substantive evidence. Compulsory in the final review to make sure the numbers make sense (ISA 520). KAPLAN PUBLISHING 37 Risk The main ratios Area Ratio Calculation Profitability Gross profit % (Gross profit x 100) / Sales Net profit % (Profit before tax x 100) / Sales Efficiency Receivables days (Receivables x 365) / Sales Inventory turn (Inventory x 365) / Cost of sales or Cost of Sales / Inventory Payables days (Payables x 365) / Purchases Liquidity Current ratio Current assets / Current liabilities Quick ratio Current assets – Inventory / Current liabilities Gearing Share capital + Reserves : Borrowings Return ROCE (Return On (Profit before interest and tax) / Share capital + Reserves Capital Employed) + Borrowings 38 KAPLAN PUBLISHING  Chapter 5 Sycamore Exam focus Recorder Communications For a question on audit risk you must ensure Kangaroo Construction that your answer is based on the scenario facts and not just provide a standard answer. Sunflower Stores Abrahams You must give audit risks, not business risks. Redsmith Audit risk will either be risk of material misstatement or detection risks. Exam kit questions in this area: Section A – Objective case questions: Flute Epica Section B – Constructed response questions: Prancer Construction Hurling Sitia Sparkle Aquamarine Venus KAPLAN PUBLISHING 39 Risk 40 KAPLAN PUBLISHING chapter 6 Planning In this chapter Planning process. Audit strategy and the plan. Impact of fraud. Fraud risk assessment procedures. Laws and regulations. Quality control. Documentation. Benefits of documentation. Working papers. 41 Planning Meet AUDIT Use their deadlines PLANNING time properly Set Identify timetable problem The right areas people Build in Knowledge review process Assess and of the business address risk Analytical review Assess Efficiency materiality and effectiveness How much Design Potential evidence needs appropriate impact of to be gathered procedures fraud 42 KAPLAN PUBLISHING KA  Chapter 6 Planning process Adequate planning helps to ensure that:  ttention is paid to the important areas A of the audit  otential problems are identified and P resolved on a timely basis  he audit engagement is organised and T managed in order to be performed in an efficient and effective manner  ork is properly assigned to the W individual team members Reduces risk of giving the wrong opinion. G KAPLAN PUBLISHING 43 Planning Audit strategy and the plan Planning involves establishing the overall audit strategy for the engagement and developing an audit plan. Scope: Establish – engagement characteristics; overall audit – reporting objectives; strategy – significant engagement factors; – preliminary activity results; and – the resources needed. Timing of when to deploy resources; Management, direction and supervision of resources (including meetings, debriefs, reviews etc) Develop an audit Nature, timing and extent of risk assessment procedures. plan Nature, timing and extent of further audit procedures, including: – what audit procedures; – who should do them; Start to carry – how much should be done; and out audit – when the work should be done. procedures Other necessary procedures. The audit strategy and audit plan should be updated and revised as necessary during the course of the audit. 44 KAPLAN PUBLISHING KA  Chapter 6 Interim v Final audits The interim audit Auditors should “maintain an attitude of will normally focus on documenting professional scepticism throughout the systems, evaluating controls, some tests audit” – this is especially true re fraud of details. The final audit focuses on where there is intent to deceive (as statement of financial position areas, opposed to cases of honest error). finalisation of the financial statements and the audit report. RISK OF FRAUD HIGH Impact of fraud ISA 240 identifies 2 types of misstatements deriving from fraud relevant Maybe Reduce to the auditor – fraudulent financial reduce reliance reliance on reporting and misappropriation of assets. on management internally It is the responsibility of management representations. generated evidence. to prevent and detect fraud, not the auditors’ job. The auditor is concerned with fraud Increase Reduce the because fraud may lead to a material focus on materiality. misstatement in the financial statements. externally generated If the auditor assesses that the risk evidence. of fraud is high, there is an increased Increase probability of misstatement. level of testing. G KAPLAN PUBLISHING 45 Planning Definition Laws and regulations Obtain an understanding of the legal Professional scepticism – An attitude that and regulatory framework governing the includes a questioning mind and a critical client. assessment of evidence. Perform procedures to identify instances of non-compliance which may affect the Fraud risk assessment FS, e.g. unrecorded fines and provisions. procedures Obtain written representation from Engagement teams should discuss the management that they have informed risk of fraud. the auditor of all instances of non Consider the results of controls tests and compliance. analytical procedures. If non-compliance is identified, report to Enquire of client how they assess, and management and those charged with respond to, fraud risk. governance. Enquire if client is aware of actual or Consider whether non-compliance suspected fraud. was deliberate and casts doubt over management integrity. Consider incentives to commit fraud e.g. performance related bonuses. 46 KAPLAN PUBLISHING KA  Chapter 6 Quality Control (ISA 220) Documentation ISA 220 Quality Control for an Audit of Definition Financial Statements Documentation means the material (working The firm should have a system of quality papers) prepared by, or for, or obtained and control to ensure: retained by, the auditor in connection with Compliance with professional standards, the performance of the audit. Such material and may be in the form of paper or electronic Reports issued are appropriate in the media. circumstances. The working papers must be sufficiently complete and detailed to provide an The engagement partner takes overall overall understanding of the audit. responsibility for the overall quality of the In particular, the working papers should engagement including the direction, supervision record the auditor’s reasoning on all and performance of the engagement. significant matters which require the An engagement quality control reviewer must exercise of judgement, and the auditor’s be assigned for listed entities and high risk conclusions thereon. engagements focusing on significant matters Working papers are usually split into two and areas involving significant judgment. separate files: The firm’s quality control processes must –– p  ermanent file – matters of be monitored to ensure they are relevant, continuing interest eg loan adequate and operating effectively. agreements, title deeds, systems documentation G KAPLAN PUBLISHING 47 Planning –– c urrent file – matters of this year’s Working papers interest eg bank letter, results of Required: audit tests. –– as evidence of work done Benefits of documentation –– a  s part of quality control, there is Provides evidence of the auditors basis work to review. of conclusion. They are the property of the auditor. Provides evidence the audit was planned Must be kept secure (implications for and performed in accordance with ISAs. safe custody of paperwork and also Assists with direction, supervision and for work kept on computers and other review of work. electronic storage media). Enables the engagement team to be Audit documentation should be retained accountable for its work. for 5 years from completion of the audit (ISA 230). Retains a record of matters of continuing significance for future audits. The basics Enable quality control to take place. If it’s not recorded it didn’t take place (no evidence of the audit activity). If it cannot be understood, it might as well not have happened (working papers must be clear). 48 KAPLAN PUBLISHING  Chapter 6 Exam focus Exam kit questions in this area: Section A – Objective case questions: Veryan Autumn Section B – Constructed response questions: Specs4You To practise the basics use the following test your understandings (TYUs) Study Text: Chapter 6: TYU 1 TYU 2 TYU 3 TYU 4 KAPLAN PUBLISHING 49 Planning 50 KAPLAN PUBLISHING KA 7 chapter Evidence In this chapter Type of audit evidence. Audit procedures. Assertions. Computer assisted audit techniques. Sampling. Relying on the work of others. 51 Evidence Type of audit evidence Less reliable More reliable The auditor should obtain sufficient Obtained from Obtained from appropriate audit evidence to be able to draw inside the entity independent sources outside the entity reasonable conclusions on which to base the audit opinion (ISA 500). Obtained Obtained directly by indirectly or by the auditor inference Audit evidence Oral Exists in representation documentary form Photocopy of a Original document document Sufficient Appropriate Substantive procedures: procedures designed to detect material misstatement at Quantity Quality an assertion level. Can be tests of detail or analytical procedures. Tests of controls: procedures to test the Affected by: operating effectiveness of the internal control Reliable system at preventing, detecting or correcting Risk Relevant to the material misstatements at an assertion level. Materiality FS assertions Reliability 52 KAPLAN PUBLISHING KA  Chapter 7 Audit procedures Inspection of records or May give direct evidence of the existence of an asset, ownership, documents that a control is operating, about cut-off. Inspection of tangible Conclusive evidence of existence, may give evidence of valuation. assets Observation Involves looking at a process or procedure: may provide evidence that a control is being operated. Enquiry Enquiry is a major source of audit evidence but the results of enquiries usually need to be corroborated. Confirmation Usually consist of obtaining confirmation regarding balances or representations made by management directly from an external third party. Recalculation Checking the arithmetical accuracy of the client’s calculations. Reperformance Includes re-performing management or accounting procedures, such as year-end reconciliations. Analytical procedures Comparisons of sets of data to identify unusual relationships or variances that could indicate fraud or error. Results of analytical reviews need to be corroborated by other forms of test. G KAPLAN PUBLISHING 53 Evidence Assertions Management is responsible for the preparation of financial statements which give a true and fair view. For each item in the financial statements, management are making assertions. TRANSACTION ACCOUNT & EVENTS BALANCES 1 EXISTENCE 1 OCCURRENCE 2 RIGHTS & OBLIGATIONS 2 COMPLETENESS 3 COMPLETENESS 3 ACCURACY 4 ACCURACY, VALUATION 4 CUT-OFF AND ALLOCATION 5 CLASSIFICATION 5 CLASSIFICATION 6 PRESENTATION 6 PRESENTATION 54 KAPLAN PUBLISHING KA  Chapter 7 Analytical procedures as substantive procedures The suitability of this approach depends on: –– the assertions being tested (maybe good for valuation, bad for existence) –– the reliability of the data (unsuitable if controls are weak as numbers could be wrong) –– the degree of precision possible (more suited to regular transactions than one off items) –– the amount of variation which is acceptable (some numbers in financials require greater accuracy than others). G KAPLAN PUBLISHING 55 Evidence Computer assisted audit Considerations affecting use techniques Computer knowledge of the audit team. Cost/benefit analysis. Test data Audit software Time available (CAATs take a long time to set up). Test data is Software data generated by specially designed the auditor which for audit purposes. is then processed using the client’s computer systems. It is used for: Put dummy Selecting samples. data through the Checking system and make computations and sure the controls calculations by within operate as reperformance. they should. Comparing two or Valid data should be more different files. accepted Performing detailed Invalid data should analytical review. be rejected. 56 KAPLAN PUBLISHING KA  Chapter 7 Sampling all transactions in a particular area are of great monetary significance Audit sampling involves the application population is non-homogeneous. of audit procedures to less than 100% of the items within a class of transactions Designing the sample or account balance such that each has a chance of selection. The auditor must choose between statistical and non-statistical sampling. Statistical Audit sampling is usually preferable to sampling involves random selection of a testing all items, because: sample and then the use of probability it would be prohibitively expensive and theory to evaluate the sample results. Any time-consuming to test every single item other sampling approach is non-statistical sampling. users of the financial statements are looking for reasonable assurance, not Selecting the sample 100% accuracy Statistical sampling requires random full substantive testing of the accounting selection, e.g. using random number records will not verify that all transactions tables or a computer program to are recorded (i.e. it does not prove generate random numbers. completeness). Non-statistical sampling requires the However audit sampling is not appropriate if: auditor to use judgement to select the sample items to be representative of the population is small population. G KAPLAN PUBLISHING 57 Evidence Evaluating the sample results The auditor is still responsible for The auditor carries out audit procedures obtaining sufficient and appropriate audit on each item selected and documents the evidence. results. Errors identified in the sample are Experts must be independent, objective, then projected across the population as a competent and experienced. whole. Unmodified audit reports do not refer to the use of experts. Sampling Methods: Random Before work is performed by expert. Haphazard Agree nature, scope and objectives. Agree roles and responsibilities. Monetary Unit Sampling Agree nature, timing and extent of Systematic communication. Block Agree the need for the expert to Relying on the work of observer confidentiality. others Evaluating the work of an expert Use of auditor’s experts (ISA 620) Relevance and reasonableness of Auditors cannot delegate responsibility findings. to experts. Relevance and reasonableness of Examples include: surveyors, valuers, assumptions. expert inventory counters, actuaries etc. Relevance, completeness and accuracy of source data. 58 KAPLAN PUBLISHING KA  Chapter 7 Using the work of internal audit (ISA 610) Using internal audit to provide direct assistance The external auditor may wish to rely on the work of internal audit in order to reduce Internal audit function can provide direct the amount of detailed testing that they (the assistance to the external auditor under external auditor) must perform. their supervision and review. Cannot be provided where laws and Before any reliance is made, assess the regulations prohibit such assistance. internal audit function in terms of: The competence and objectivity of the Organisational status internal auditor must be considered. Scope of function Must not do work which involves Technical competence significant judgement, a high risk of Due professional care. material misstatement or with which the internal auditor has been involved. When the external auditor intends to use Planned work must be communicated specific work of internal audit, they should with those charged with governance. perform audit procedures on that work to confirm its adequacy for auditing purposes. Cannot make excessive use of internal auditor. Sufficient appropriate evidence obtained Management must not intervene in that Conclusion are valid work. Work has been properly supervised and Internal auditors must keep the external reviewed auditor’s information confidential. G KAPLAN PUBLISHING 59 Evidence External auditor will provide direction, If controls are expected to operate supervision and review of the internal effectively: auditor's work. –– Obtain a Type 2 report External auditor should remain alert to –– P  erform tests of controls at the the risk that the internal auditor is not service organisation objective or competent. –– U  se another auditor to perform tests Service organisations of controls. ISA 402 Audit Considerations Relating to an Reporting Entity Using a Service Organisation –– M  odify the auditor’s report if Obtain an understanding of the service sufficient appropriate evidence has organisation (nature of services not been obtained. provided and relationship with the client, –– T  he use of the service organisation materiality of transactions) to assess the or their auditor is not mentioned in risk of material misstatement. This can the report. be obtained through: –– Inquiries with client –– C  onfirmations from the service organisation and their auditors –– Visits to the service organisation –– T  ype 1 or Type 2 report from service organisation auditors. 60 KAPLAN PUBLISHING KA  Chapter 7 Exam focus Exam kit questions in this area: Section A – Objective case questions: Hemsworth Delphic Section B – Constructed response questions: Lily Window Glass G KAPLAN PUBLISHING 61 Evidence 62 KAPLAN PUBLISHING KA chapter 8 Systems and controls In this chapter Internal control systems. The auditor and controls. Sales cycle. Purchase cycle. Payroll system. Cash system. Inventory. Communications on internal controls. 63 Systems and controls Internal control systems Definition Internal control is the process designed and effected by the directors and others to enable the achievement of the entity’s objectives with regard to reliability of financial reporting, effectiveness and efficiency of operations, and compliance with applicable laws and regulations. More reliable The auditor The more effective systems of must: and reliable the control mean Understand the system the lower the lower risk system. audit risk and the of material Understand the greater the reliance misstatement. controls within the auditor can seek Reliable systems the system. to place upon the contain stronger Test whether the system. controls. controls work. More reliable system = Lower audit risk = Less substantive testing 64 KAPLAN PUBLISHING  Chapter 8 Internal control consists of the following 5 4 Control activities (APIPS) components (ISA 315): Authorisation 1 Control environment Performance reviews This includes the attitude and Information processing philosophy of management with Physical controls regard to control e.g. a commitment Segregation of duties to integrity and ethical values, a 5 Monitoring of controls formal organisation structure and proper training of staff. Management must monitor controls to be sure that they are operating 2 Entity’s risk assessment process and are effective. A more robust risk assessment The 5 components can be remembered with process will reduce the risk of the mnemonic CRIME (control activities, risk misstatement. assessment process, information system Information system relevant to 3