6 - The Role of Audit Flashcards
what is an external audit
- type of assurance engagement
- gives an independent opinion to enhance confidence intended users have in financial statements through evaluation
three parties in an audit
- practitioner (auditor)
- intended user (shareholders/investors)
- responsible party
types of assurance
- fraud investigations
- due diligence
- environmental audits
- assessment of internal controls
- reviews of business plans and projections
when are companies exempt from needing to audit
if they have two of the following:
- turnover lower than 10.2m
- total assets lower than 5.1m
- no of employees lower than 50
three objectives of auditing
- assurance statements are free from misstatement
- assurance they have been prepared in accordance with frameworks
- write a reporting and communicate accordingly
reasons why an audit is required to be done externally
- shareholders provide finance but do not run the company
- directors manage the company, should be done on behalf of shareholders
- financial statements prepared by directors
- directors have incentives to misreport performance
all these factors create a need for someone external
benefits of an external audit
- improves quality of financial info
- more confidence in reported info
- bias, fraud, risk errors reduced
- statements hold more credibility
- internal controls strengthened
five elements of external auditing
- three parties = preparers, users, practitioner
- the subject matter
- sufficient/appropriate evidence; quantity and quality
- eval in accordance with financial reporting framework
- audit report presented to shareholders
what is the expectations gap
whereby external audits don’t give complete assurance that statements are free from errors because they check a sample
what are the limitations of external audits
‘FIRED’:
F inancial statements contain numerous subjective statements/figures
I nternal controls have inherent weaknesses
R epresentations from management have to be relied upon, though may not always be honest/accurate
E vidence is often persuasive not conclusive
D o not test all transactions and balances, auditors work on samples
role of auditors
agents = obligations to trusting relationships free of bias
stewards = accountable to shareholders
rights of an auditor
- access to accounting records
- access to info/explanations needed
- notice of the companys AGM and to attend/speak to shareholders
- legal rights connected to appointment, removal, resignation, retirement
what is fair presentation
- factual
- free from bias
- reflect commercial substance of transactions
what is materiality when it comes to auditing
the level of error at which a readers view of a set of financial statements changes
which stages does a well designed audit have
- an audit plan; covering engagement terms, risk assessments, timetables
- an interim audit; internal controls documented, tests of control undertaken, limited substantive testing done
- final audit; testing of statements, third party confirmations, analytical review of statements, agreeing statements to records
benefits of well designed/planned audit
- areas are given importance
- identifies/resolves problems quickly
- organises staff efficiently
- ensures audit team have skills/experience
- helps supervise, direct, review work of audit team
- helps co-ordinate input from third parties
what are the two key areas in audit planning
- preliminary engagement
- planning activities
what are preliminary engagement activities
forming agreement with management and setting out in an engagement letter
what are engagement terms, what might they cover?
- comms between 3 parties
- subject matter
- agreeing sufficient/appropriate evidence
- evaluating statements
- audit report
what is the purpose of engagement letters
minimise risk of misunderstanding between parties
what do engagement letters cover
- objective/scope of audit
- auditors + managers responsibility
- relevant reporting frameworks
- relevant professional standards
- limitations
- basis for fees
- rights of auditors
etc etc
what are the planning activities
audit strategy = scope, timing, direction of audit. used to allocate resources eg labour
audit plan = detailed plan to implement strategy
audit risk definition
risk that an auditor gives an incorrect opinion
what are the types of audit risk
inherent risk = susceptibility of material misstatement. can be at industry, entity or balance level
control risk = risk that misstatement wouldn’t be prevented or detected
audit risk equation
AR = IR x CR x DR
IR = inherent risk
CR = control risk
DR = detection risk
audit evidence characteristics
sufficient = quantity of evidence
appropriate = reliability/relevance of evidence
what are tests of control
evaluates the operating effectiveness of controls in preventing/detecting/correcting material misstatements
examples of tests of control
- enquire and document controls
- re-perform transactions
- inspect control mechanisms
what are substantive tests
designed to detect material misstatements
substantive tests examples
- agreeing/reconciling financial statements to records
- examining material journal entries
- examining other adjustments in preparing statements
what is an analytical review
testing large volumes of predictable data by developing an expected balance, comparing to the actual data and reconciling material differences
what is a written representation and why are they used
written statement provided by management to auditor in support in evidence
used to obtain confirmations from clients management that those charged with governance fulfilled their obligations
examples of written representations
- confirmation of balances subject to estimation
- formal confirmation of directors judgements
- aspects of law/compliance that affect statements
what is an unmodified opinion
when the auditor expresses opinion on whether accounts have been prepared in all material aspects in line with reporting standards
unmodified = when it is true
what is an unmodified report
unmodified opinion exists, so report is drawn as no further issues to report to shareholders
what happens if the report needs to be unmodified
- modify report without modifying opinion; statements are true and fair but auditor has items to draw attention to
- modify report with modified opinion; statements don’t show what is reported so is untrue/fair
what are the contents of the report to ‘those charged with governance’
can be in any format
- responsibilities of auditor
- overview and scope of audit
- findings during audit
what are the contents of a management letter
a by-product of the audit in letter form
- deficiencies found in internal control systems, consequences and then how to resolve
- declare it isn’t an exhaustive list and is for sole use of company
what are the 6 sections of the audit firm governance code
- leadership
- values
- independent non executives
- operations
- reporting
- dialogue
what is an internal audit
- independent appraisal function
- to evaluate/examine activities
- to assist members in discharge of responsibilities
who leads internal audit
chief internal auditor
who reports to audit committee
role of chief internal auditor
- review effectiveness of internal control
- to ensure compliance with legal/corp gov obligations
- identify risks
- review economy/effectiveness/efficiency of operations
factors to consider when considering whether to have an internal audit committee
- scale/diversity of operations
- complexity of operations
- no of employees
- costs/benefits considerations
limitations of internal audit
- auditors may not speak out for fear of dismissal
- long standing auditors face familiarity threat
- may require separate reporting channel
- lack of independence means it is outsourced easily
qualities of effective internal audit function
- sufficiently resourced
- well organised
- independent and objective
- not involved in day to day operations
- scope of work agreed by audit committee
- no limitations to organisation
what are financial controls used for
to ensure they are accurately recording transactions
what controls should be put in place by internal auditors (examples of financial controls)
- revenue and cash collections
- acquisitions and expenditures
- production or conversion
- financial capital and payment
- personnel and payroll
- external financial reporting
what are audit checks doing
testing the financial controls
internal audit report most common structure
- terms of reference (scope)
- executive summary
- main body
- conclusions and recommendations
- appendices
advantages of outsourcing
- greater focus on cost/efficiency
- increased and wider staff expertise
- risk of staff leaving passed to outsource firm
- specialist skills more readily available
- employment costs fall from temp staff
- internal audit more independent
- new tech accessed quicker
- reduced management/admin costs
disadvantages of outsourcing internal audit
- conflict of interests if other services provided by external auditors
- pressure on independence if outsourcer wants to renew contract
- lack of company specific knowledge
- cost reduction = reduced effectiveness
- lower flexibility
- lack of control over service provided
- risks blurring lines between internal/external
external vs internal audit differences when it comes to:
responsible to
responsible for
activities
standards
objective
report
appointment
relationship to the business
RESPONSIBLE TO:
internal = management
external = shareholders
RESPONSIBLE FOR:
internal = management tasks requested
external = opinion on truth/fairness
ACTIVITIES:
internal = anything
external = testing
STANDARDS:
internal = anything
external = laws/regulations eg IAS, GAAP
OBJECTIVES:
internal = review efficiency/effectiveness of internal controls to improve company operations
external = form opinion on truth/fairness
REPORT:
internal = internal use
external = publicly available
APPOINTMENT:
internal = audit committee/directors
external = shareholders
RELATIONSHIP TO BUSINESS:
internal = employees/outsource partner
external = independent firm
types of errors
errors of omission = partial/total disclusion from prime entry books
errors of commission = errors arising from transposition (wrong sub-account)
errors of principle = transaction in violation of accounting standards (wrong account)
what are some error prevention methods
- authorisation = transactions above level should be authorised
- documentation = evidence provided
- staffing = segregation of duties to prevent one dictator
- asset safeguarding = properly valued, recorded, used, maintained
- detecting errors = spot errors, don’t leave to chance
what is fraud
false representation of the fact, made with knowledge of its falsity
for it to occur there needs to be:
- dishonesty
- opportunity
- motive
common methods of fraud
- ghost employees
- collusion with third parties
- inflating expense claims
- stealing assets
- manipulation of financial statements/false accounting
- money laundering
- e-crimes eg spamming
examples of fraud strategies
- foster anti fraud culture by creating high ethical standards
- raise awareness of the risk of fraud
- people are expected to come forward if they suspect someone else
- developing internal controls
aspects included in a fraud prevention plan
- segregation of duties
- documentation to evidence
- prohibition of certain activities
- limitation controls
- internal audit investigations
- investigating warning signs
internal responses to fraud
- internal disciplinary action
- civil litigation procedures
- criminal procedures
the audit opinion implies certain things to be true, what are they?
- adequate accounting records are kept
- accounts agree with records
- all info has been received that is necessary
- directors emoluments (pay) details are correctly disclosed
considerations regarding sufficiency of evidence
- risk of material misstatement
- item’s materiality
- nature of internal control/accounting systems
- knowledge/experience of auditor
- outcomes of control tests
- size of population tested
- sample size used
- reliability of evidence
scope of responsibility in the case of a fraud (who is responsible for what?)
MANAGERS = department
FINANCE DIRECTOR = whole finance function
HR DEPARTMENT = ensuring disciplinary procedures followed
AUDIT COMMITTEE = review fraud discovered
INTERNAL AUDIT = investigate fraud
EXTERNAL AUDIT = expertise in discovering fraud
LEGAL ADVISORS = litigation
PUBLIC RELATIONS DEPARTMENT = manage news coverage of large frauds
POLICE = gather evidence for prosecution
INSURERS = handling reimbursement claims
how much does fraud cost organisations and the economy?
- organisations may lose up to 7% of annual turnover
- corruption costs $1.5 trillion each year
- only recover a small % of fraud losses
who usually commits fraud and what is the most common motive
- senior management/executives commit high % of fraud
- greed is main motivator
- often people in finance functions
which sectors is fraud usually found in
- losses are not limited to specific sectors/countries
- prevalence is increasing in emerging markets
