2. Statutory Audit Flashcards
What is agency risk?
In a non owner managed company, directors may seek power and monetary reward and not necessarily wish to maximise profit or maximise shareholder value in the long run.
This is called the agency risk.
What are three ways that agency risk can be reduced?
- Using the directors’ remuneration packages as incentives (offering profit-related pay schemes or share options).
- Monitoring the directors’ performance (e.g. ensuring that a certain profit level is met before bonuses are paid.)
- Appointing an external auditor (deterrent)
What are agency costs?
Agency costs are costs borne by the shareholders to monitor the performance of the directors.
aka the gap between owner managed and directors running the company.
What is corporate governance and why is it important?
Corporate governance is the system by which companies are directed and controlled.
Important because it:
1) Allows companies to mitigate the agency risk that arises as a result of the directors running a company on behalf of the shareholders.
2) Ensures that stakeholders with a relevant interest in the organisation are fully taken into account while making decisions.
How can corporate governance reduce agency risk?
By monitoring performance of the business against objectives set by the board of directors.
Thus having a good board limits agency risk by keeping directors on track to ensuring they are prioritising shareholders via actions and behaviour.
What is the role of a good system of internal control in corporate governance?
Internal controls are systems designed and implemented by the management to ensure operations are conducted effectively and efficiently, financial reporting is reliable and applicable laws and regulations are complied with.
What are corporate governance reporting requirements?
CG Reporting requirements are disclosure obligations companies must fulfill to provide transparency about how they are governed, ensuring accountability to shareholders and stakeholders.
Particularly for premium listing entities who have to adopt a ‘comply or explain’ approach to what they are doing due to the agency risk between shareholders and those charged with governance.
e.g.
- The composition and operations of the board and committees.
- Information on the group’s internal control and risk management systems in relation to the financial reporting process.
- Details of significant shareholders.
What is statutory audit and why is it important?
An external, or statutory, audit is an examination of a company’s financial statements by an independent expert that results in the expert providing an opinion on whether the financial
statements give a true and fair view to the shareholders.
Its important because it enables users to trust the financial information put out by management as the auditors give a reasonable assurance that the financial statements give a true and fair
view.
What are the key terms/concepts in audit?
(True/Fair/Material/Profession Scepticism/Professional Judgement/ Independence)
True - Information is factually correct, conforms with relevant standards and laws and has been correctly extracted from accounting books and records.
Fair - the commercial substance of the transaction is reflected. There is no bias in the information. It is generally accepted that the auditor needs to check whether the directors have followed applicable accounting standards, have complied with the CA2006, and have exercised appropriate judgement.
Material - A matter is material if its omission or misstatement could affect the decisions that users have taken based on the financial statements.
Professional scepticism - An attitude of questioning mind, being alert to conditions which may indicate fraud or error in the financial information and critical assessment of evidence.
Professional judgement - Make informed decisions about courses of actions by applying knowledge and experience.
Independence in the context of external audit - The audit firm must be unbiased and objective.
Which companies can obtain an exemption from statutory audit?
1) Small companies,
2) Small charities,
3) Dormant companies.
What are the criteria to meet “small company” exemption from auditing across 2 years?
- Assets 5.1m
- Revenue 10.2m
- Employees 50 or less
What companies can NEVER be exempt from Audit?
A public company (unless dormant)
A banking company
An e-money issuer*
An insurance company
A corporate body whose shares have been admitted to trading on a regulated market
A public sector entity (the vast majority of public sector entities must be audited)
What are the criteria for “Small charities” to be audited in England & Wales and Scotland?
(they are usually exempt)
England and Wales (Audit required where):
Gross income is over £1m; or
Gross assets are over £3.26m and gross income is over £250,000; or
An audit is required by the charity’s constitution or due to trustee or donor preference.
Scotland (Audit required where):
Gross income is £500,000 or more; or
Gross assets are over £3.26m; or
An audit is required by the charity’s constitution or due to trustee or donor preference.
Whats the criteria for a company to be dormant?
A company is dormant if it has had no “significant accounting transactions” during the period.
What legal requirements are auditors subject to as per the Companies Act 2006 (CA 2006)?
(1) Form an independent opinion on the truth and fairness of the financial statement in accordance with the relevant financial reporting framework.
(2) Confirm that the financial statements have been properly prepared in accordance with the Companies Act 2006.
(3) Confirm that the information contained within the directors’ report (the strategic report) is consistent with the financial statements.
(4) Confirm that the directors’ use of the going concern basis of accounting in the preparation of the financial statements is appropriate.
What are the key rights of auditors?
(Two categories of rights)
Rights to receive information:
The right of access at all times to the company’s books, documents and supporting records.
The right to require any directors or employees of the company to provide them with any necessary information and explanations.
The right to require any subsidiaries, incorporated in the UK, of the company (and their auditors if different) to provide them with any information they might need.
Rights in relation to resolutions and meetings:
The right to receive copies of all communications relating to any written resolution proposed to be agreed by a private company.
The right to receive all notices of any general meeting of the company and to attend such meetings.
The right to be heard at any general meeting on any part of the business which concerns them as auditor.
What are the requirements that govern the appointment of auditors?
The CA 2006 requires an auditor to be appointed each financial year that an audit is required.
The auditor is usually appointed by the shareholders via the passing of an ordinary resolution (over 50% of the shareholders agree via a vote).
What are the 3 situations when directors can appoint auditors?
1) Any time before the company’s first period for appointing auditors (i.e., the first time a company
requires an auditor);
2) To fill a casual vacancy (e.g., if an auditor has resigned during the term of office); and
3) If the company had previously taken an audit exemption they would not have an auditor. If they
lost this exemption, and therefore required an auditor, the directors would be able to appoint the
first auditors.
Where the auditor has been appointed by the directors, the shareholders must then decide whether
that auditor should be re-appointed at the end of the next financial year.
What are the differences between public and private companies when it comes to appointing auditors?
Public - An auditor will be appointed/reappointed at each annual general meeting (AGM) by the shareholders.
Private - The auditor of a private company is deemed to have been automatically reappointed unless 5% or more of the shareholders object (or the auditors were first appointed by the directors). It is also possible that a company’s articles of association may prohibit automatic reappointment.
What are the requirements that govern the removal of auditors?
Under the 3 circumstances:
1) Auditor removal during the term of office
2) Failure to reappoint auditor
3) Auditor resignation
1) Auditor removal during the term of office:
- The auditor can be removed at any time by the shareholders.
- The shareholders do this by passing an ordinary resolution. (Copy of motion must be sent, right to attend AGM and make written statements regarding removal and send to shareholders)
2) Failure to reappoint auditor:
- Shareholders could also choose not to reappoint the auditor at the end of the term of office.
- In a similar way to the removal of an auditor, the auditor must be notified that they are to be replaced and the auditor has the right to make written representations regarding the failure to reappoint them and have these distributed to the shareholders.
3) Auditor resignation:
- In order for the auditor to resign from the appointment, the auditor is required to send a letter of resignation and, where the company is a public interest entity (PIE), a statement of circumstances to the registered office of the company and appropriate audit authority e.g. FRC.
What rights do auditors have to protect against unwarranted dismissal?
1) If any shareholders propose a motion to remove the auditors, a copy of this motion must be sent
to the auditors;
2) An auditor has a right to make written statements regarding their removal and have these
passed to the shareholders; and
3) The auditor retains the right to attend the normal AGM of the company in the year in which they
were removed.
What entities are included in Public interest entities in the UK?
All UK entities that are listed on the London Stock Exchange or other regulated market (this does not include the AIM listed entities)
All credit institutions regardless of whether they are listed or not
All insurance undertakings regardless of whether they are listed or not
What is the expectations gap regarding the scope of auditors’ work?
The difference between the understanding that the public has about the auditor’s responsibilities and the actual defined responsibilities of the auditor.
What does the CA 2006 make it an offence for an employee or director to do?
(& what’s the punishment?)
To knowingly or recklessly give a misleading, false or deceptive statement (written or verbal) to an auditor.
Any employee or director who does so is liable to a fine and/or imprisonment.
