2. Statutory Audit

Question 1

What is agency risk?

Answer 1

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.

Question 2

What are three ways that agency risk can be reduced?

Answer 2

• 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)

Question 3

What are agency costs?

Answer 3

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.

Question 4

What is corporate governance and why is it important?

Answer 4

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.

Question 5

How can corporate governance reduce agency risk?

Answer 5

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.

Question 6

What is the role of a good system of internal control in corporate governance?

Answer 6

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.

Question 7

What are corporate governance reporting requirements?

Answer 7

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.

Question 8

What is statutory audit and why is it important?

Answer 8

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.

Question 9

What are the key terms/concepts in audit?

(True/Fair/Material/Profession Scepticism/Professional Judgement/ Independence)

Answer 9

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.

Question 10

Which companies can obtain an exemption from statutory audit?

Answer 10

1) Small companies,
2) Small charities,
3) Dormant companies.

Question 11

What are the criteria to meet “small company” exemption from auditing across 2 years?

Answer 11

• Assets 5.1m
• Revenue 10.2m
• Employees 50 or less

Question 12

What companies can NEVER be exempt from Audit?

Answer 12

 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)

Question 13

What are the criteria for “Small charities” to be audited in England & Wales and Scotland?

(they are usually exempt)

Answer 13

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.

Question 14

Whats the criteria for a company to be dormant?

Answer 14

A company is dormant if it has had no “significant accounting transactions” during the period.

Question 15

What legal requirements are auditors subject to as per the Companies Act 2006 (CA 2006)?

Answer 15

(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.

Question 16

What are the key rights of auditors?

(Two categories of rights)

Answer 16

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.

Question 17

What are the requirements that govern the appointment of auditors?

Answer 17

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).

Question 18

What are the 3 situations when directors can appoint auditors?

Answer 18

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.

Question 19

What are the differences between public and private companies when it comes to appointing auditors?

Answer 19

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.

Question 20

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

Answer 20

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.

Question 21

What rights do auditors have to protect against unwarranted dismissal?

Answer 21

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.

Question 22

What entities are included in Public interest entities in the UK?

Answer 22

 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

Question 23

What is the expectations gap regarding the scope of auditors’ work?

Answer 23

The difference between the understanding that the public has about the auditor’s responsibilities and the actual defined responsibilities of the auditor.

Question 24

What does the CA 2006 make it an offence for an employee or director to do?

(& what’s the punishment?)

Answer 24

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.

Question 24

How can auditors manage the expectation gap?

Answer 24

One such example is including an explanation of the auditor’s and directors’ responsibilities within the audit report.

Question 25

What are the different stages of the audit process?

Answer 25

1. Acceptance
2. Planning
3. Systems and controls analysis
4. Substantive testing
5. Completion

Ongoing elements:
6. Risk assessment
7. Engagement and client management

Question 26

What’s the difference between an interim and a final audit?

Answer 26

An interim audit refers to audit work that is conducted during the accounting year.

The final audit will take place after the year end and concludes with the auditor forming and expressing an opinion on the financial statements for the whole year, subject to audit.

Question 27

What are recognised qualifying bodies and recognised supervisory bodies, and what are their roles?

Answer 27

The CA 2006 contains provisions to ensure that only people who are appropriately qualified (RQB’s) and properly supervised (RSBs) are appointed as company auditors.

Recognised Supervisory Bodies (RSBs) are required by CA 2006 to maintain and enforce rules that assess:
- The eligibility of persons for appointment as a statutory auditor; and
- The conduct of statutory audit work.

A prospective statutory auditor must firstly become ‘appropriately qualified’ with one of the five recognised qualifying bodies (RQBs).

Question 28

Explain step 1 of becoming a statutory auditor

What does the CA 2006 require to become appropriately qualified?

Answer 28

1. Get qualified through one of the five Registered Qualifying bodies:
   - ICAS (Institute of Chartered Accountants of Scotland)
   - ACCA (Association of Chartered Certified Accountants)
   - AIA (Association of International Accountants)
   - ICAEW (Institute of Chartered Accountants in England and Wales)
   - CAI (Chartered Accountants Ireland)

The CA 2006 lays down three areas of requirement that must be achieved to gain ‘appropriately qualified’ status:

Entry requirements: The CA 2006 requires each RQB to have a minimum entry requirement of a university entry level (or approved equivalent) or 7 years of practical experience in the fields of finance, law and accountancy.

Practical experience: Upon acceptance by the RQB, a trainee must complete 3 years’ practical training at an authorised training firm. To obtain the audit qualification, the CA 2006 requires a substantial part of this training to be in audit, with at least a part being on statutory audit work.

Examinations: The CA 2006 requires each RQB to have a formalised examination structure that tests theoretical and practical knowledge. Once a trainee has completed the training contract and examination programme of their RQB, they become ‘appropriately qualified’.

Question 29

What are the 3 steps to becoming a statutory auditor?

Answer 29

1. Get qualified
2. Get supervised
3. Registered

Question 30

Explain step 2 of becoming a statutory auditor?

Registered Supervising bodies

Answer 30

An ‘appropriately qualified’ accountant must then become a member of one of the recognised supervisory bodies (RSBs) if they wish to obtain statutory auditor status.
There are four RSBs. An ‘appropriately qualified’ accountant must become a member of one of these RSBs if they wish to obtain statutory auditor status. The four bodies are:
- ICAS
- ACCA
- ICAEW
- CAI

Question 31

Explain step 3 of becoming a statutory auditor

Answer 31

Alongside the audit qualification, the auditor must hold a practising certificate from the relevant RSB.

Membership of an RSB is not sufficient to obtain statutory auditor status, and alongside the audit qualification the auditor must hold a practising certificate.

To be eligible for a practising certificate (which must be renewed each year with an annual fee), members must apply to the relevant RSB and prove that they:
- Have completed at least 2 years’ post-qualifying experience; and
- Are able to confirm compliance with the continuing professional development bylaws to the regulation and compliance overview department of the institute to which they are applying for registration; and
- Have professional indemnity insurance.

Question 32

How many NED’s should an audit committee have?

Answer 32

At least three independent NED’s

Question 33

What is included in the “matters reported by exception” under CA 2006?

Answer 33

1. Returns have been received from branches not visited by the auditor.
2. Accounts agree with the underlying records.
3. Proper accounting records have been kept.
4. Information and explanations necessary for the purposes of the audit have been received.
5. Directors’ emoluments (eg salary, bonuses, and pension contributions) and other benefits disclosures are complete.