20 Assurance Flashcards
Definition of assurance
An assurance engagement is one in which a practitioner aims to obtain sufficient appropriate evidence to express a conclusion designed to enhance the degree of confidence of the intended users other than the responsible party about the outcome of the evaluation or measurement of an underlying subject matter against criteria
Elements of an assurance engagement
All assurance engagements must involve the following five elements:
Three party relationship (practitioner, responsible party, user)
Subject matter
Criteria
Evidence
Written report
Levels of assurance
Reasonable assurance engagements result in a positive expression of opinion and the level of assurance given is deemed to be high.
Limited assurance engagements result in negative assurance and the level of assurance given is
deemed to be moderate.
Types of audit procedure
ISA 500 suggests that the following procedures can be used as risk assessment procedures, tests of
controls or substantive procedures in an assurance engagement:
Inspection
Observation
External confirmation
Recalculation
Re-performance
Analytical procedures
Enquiry
Internal controls
Internal controls
ISA 315 identifies the following control activities which may help an organisation to prevent and detect
fraud and error:
Authorisation
Performance reviews
Information processing
Physical controls
Segregation of duties
Prospective financial information
What is it?
Prospective financial information (PFI) means financial information based on assumptions about
events that may occur in the future, and possible actions by an entity.
Prospective financial information - what is a forecast PFI?
A forecast is PFI based on future events which management expects to occur.
Prospective financial information - what is a projection PFI?
A projection is PFI based on hypothetical assumptions about future events which are not necessarily expected to occur.
Providing assurance on PFI
The need for assurance
Management may seek an assurance report over their forecasts and projections for many reasons, the most significant being
To aid in negotiations around a potential takeover or merger (see due diligence below)
To present as part of a business plan in order to raise finance
Providing assurance on PFI
The Level of assurance
ISAE 3400 The Examination of Prospective Financial Information dictates that an assurance report in relation to PFI can only ever give limited assurance, since PFI is by definition highly subjective in
nature.
PFI reports - how will the opinion be worded?
The opinion contained within a PFI assurance report will always be negatively worded, since the level of assurance is limited
The main features of a PFI assurance report will be
A statement of negative assurance as to whether the assumptions provide a reasonable basis
for the PFI
An opinion as to whether the prospective financial information is properly prepared on the basis of the assumptions and the relevant reporting framework
Appropriate caveats as to the achievability of the forecasts
PFI assurance procedures
Typically, a PFI assurance engagement will focus mainly on enquiries and analytical procedures, since
traditional audit procedures on historical financial information will not be an option.
Suggested procedures when reviewing PFI include:
Reviewing the experience of the preparer of the PFI
Casting all financial information provided
Performing sensitivity analysis
Verifying historic comparative information to financial statements
Obtaining quotes for any planned purchases
Comparing forecast figures to similar figures in historic periods to identify unexpected trends
Reviewing minutes of Board meetings to verify planned transactions e.g. dividend payments
Due diligence
When is it used?
When a company is seeking to make an acquisition, there may be a need to engage an independent
firm to provide due diligence. This is essentially a fact-finding exercise to make the purchaser aware of any relevant information about the target company before a final decision is made and a purchase price is agreed.
Types of due diligence
Financial due diligence
Commercial due diligence
Operational due diligence
Technical due diligence
IT and cyber due diligence
Legal due diligence
Tell me about financial due diligence
Financial due diligence is a review of the target company’s financial position, financial risk and
projections (for example, in relation to earnings and cash flows). However, it is not the same as a
statutory audit, its purposes are more specific to an individual transaction and to particular user
groups, and there is normally a specific focus on risk and valuation.
This will involve evidence gathering procedures over historic financial statements using traditional audit testing techniques, as well as over forecast financial statements (see PFI above).
Tell me about commercial due diligence
Commercial due diligence complements financial due diligence by considering the target company’s
markets and external economic environment. It examines where the target company’s competitive
advantage comes from and whether or not it is sustainable.
Some of the areas which commercial due diligence may focus on include
Competitors
Marketing strategy
Resources and competencies
KPIs used in appraising performance
Review of industry and macroeconomic factors
Tell me about operational due diligence
Operational due diligence considers the operational risks and possible improvements which can be made in a target company. This will involve consideration of the detailed practical issues which may
arise within the target business or during the acquisition process
Tell me about technical due diligence
Technical due diligence involves reviewing the feasibility of any technical benefits expected as a result
of the potential acquisition
Tell me about IT and Cyber due diligence
IT due diligence assesses the suitability and risks arising from IT factors in the target company (for example, any issues surrounding IT security, or integrating IT systems post-acquisition).
Tell me about Legal due diligence
Legal due diligence aids in structuring the terms of a takeover, in addition to searching out hidden
liabilities or contingent liabilities which may be acquired with the target company.
This will include a review of the target company’s tax affairs to ensure that their payments are up to
date. In addition, tax due diligence will consider how the new group should be structured after
acquisition
What are agreed upon procedures?
In an engagement to perform agreed upon procedures (AUP), a practitioner is required to carry out
and report on specific procedures, as agreed. No opinion is given by the practitioner, instead the recipients of the report will form their own conclusions.
(technically not an assurance engagement as no opinion)
Service level agreements
Need for assurance
When a company enters into a new relationship with a customer or supplier, a service level agreement
may be written to clarify expectations of both parties
This may involve setting key performance indicators around such areas as
Delivery times
Quality of products and services provided
Environmental and sustainability issues
Recourse in the event of failure to meet contract terms
Assurance may be sought as to whether the conditions of a service level agreement have been met
Assurance procedures for a joint venture partner - initial assurance
- Review JA agreement (in combination with legal advisers) for onerous, ambiguous or omitted clauses
- Ensure the purposes & scope of the JA is clear and the respective rights of both parties are established in the contractual arrangements
- Review tax status of JA entity, governance procedures, key decision making processes to ensure partner has appropriate level of control over key decisions
- Establish that initial capital has been contributed and legal rights to use assets
- Establish creditworthiness, going concern and reputation of partner
- Ensure terms of disengagement are clear
- Health and safety responsibility established
Assurance procedures for a joint venture partner - ongoing assurance
- Audit rights and access of information need to be established
- Ensure the operations of the JA are within terms of the agreement
- Ensure internal controls and accounting systems are being applied and are effective
- accounting systems of JA need to be capable of recording accurately and completely the costs incurred. RIsk areas may include overhead allocations
- If permitted within terms of the contract, audit access to the accounting records of the partner would provide additional assurance (though may have to be reciprocated)
- Level of assurance needs to be determined
