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4. BA4 CIMA > 6 - The Role of Audit > Flashcards

6 - The Role of Audit Flashcards

1
Q

what is an external audit

A
  • type of assurance engagement
  • gives an independent opinion to enhance confidence intended users have in financial statements through evaluation
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2
Q

three parties in an audit

A
  1. practitioner (auditor)
  2. intended user (shareholders/investors)
  3. responsible party
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3
Q

types of assurance

A
  • fraud investigations
  • due diligence
  • environmental audits
  • assessment of internal controls
  • reviews of business plans and projections
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4
Q

when are companies exempt from needing to audit

A

if they have two of the following:
- turnover lower than 10.2m
- total assets lower than 5.1m
- no of employees lower than 50

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5
Q

three objectives of auditing

A
  1. assurance statements are free from misstatement
  2. assurance they have been prepared in accordance with frameworks
  3. write a reporting and communicate accordingly
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6
Q

reasons why an audit is required to be done externally

A
  • 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

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7
Q

benefits of an external audit

A
  • improves quality of financial info
  • more confidence in reported info
  • bias, fraud, risk errors reduced
  • statements hold more credibility
  • internal controls strengthened
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8
Q

five elements of external auditing

A
  1. three parties = preparers, users, practitioner
  2. the subject matter
  3. sufficient/appropriate evidence; quantity and quality
  4. eval in accordance with financial reporting framework
  5. audit report presented to shareholders
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9
Q

what is the expectations gap

A

whereby external audits don’t give complete assurance that statements are free from errors because they check a sample

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10
Q

what are the limitations of external audits

A

‘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

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11
Q

role of auditors

A

agents = obligations to trusting relationships free of bias
stewards = accountable to shareholders

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12
Q

rights of an auditor

A
  • 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
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13
Q

what is fair presentation

A
  • factual
  • free from bias
  • reflect commercial substance of transactions
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14
Q

what is materiality when it comes to auditing

A

the level of error at which a readers view of a set of financial statements changes

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15
Q

which stages does a well designed audit have

A
  1. an audit plan; covering engagement terms, risk assessments, timetables
  2. an interim audit; internal controls documented, tests of control undertaken, limited substantive testing done
  3. final audit; testing of statements, third party confirmations, analytical review of statements, agreeing statements to records
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16
Q

benefits of well designed/planned audit

A
  • 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
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17
Q

what are the two key areas in audit planning

A
  • preliminary engagement
  • planning activities
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18
Q

what are preliminary engagement activities

A

forming agreement with management and setting out in an engagement letter

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19
Q

what are engagement terms, what might they cover?

A
  • comms between 3 parties
  • subject matter
  • agreeing sufficient/appropriate evidence
  • evaluating statements
  • audit report
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20
Q

what is the purpose of engagement letters

A

minimise risk of misunderstanding between parties

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21
Q

what do engagement letters cover

A
  • objective/scope of audit
  • auditors + managers responsibility
  • relevant reporting frameworks
  • relevant professional standards
  • limitations
  • basis for fees
  • rights of auditors

etc etc

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22
Q

what are the planning activities

A

audit strategy = scope, timing, direction of audit. used to allocate resources eg labour
audit plan = detailed plan to implement strategy

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23
Q

audit risk definition

A

risk that an auditor gives an incorrect opinion

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24
Q

what are the types of audit risk

A

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

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25
Q

audit risk equation

A

AR = IR x CR x DR

IR = inherent risk
CR = control risk
DR = detection risk

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26
Q

audit evidence characteristics

A

sufficient = quantity of evidence
appropriate = reliability/relevance of evidence

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27
Q

what are tests of control

A

evaluates the operating effectiveness of controls in preventing/detecting/correcting material misstatements

28
Q

examples of tests of control

A
  • enquire and document controls
  • re-perform transactions
  • inspect control mechanisms
29
Q

what are substantive tests

A

designed to detect material misstatements

30
Q

substantive tests examples

A
  • agreeing/reconciling financial statements to records
  • examining material journal entries
  • examining other adjustments in preparing statements
31
Q

what is an analytical review

A

testing large volumes of predictable data by developing an expected balance, comparing to the actual data and reconciling material differences

32
Q

what is a written representation and why are they used

A

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

33
Q

examples of written representations

A
  • confirmation of balances subject to estimation
  • formal confirmation of directors judgements
  • aspects of law/compliance that affect statements
34
Q

what is an unmodified opinion

A

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

35
Q

what is an unmodified report

A

unmodified opinion exists, so report is drawn as no further issues to report to shareholders

36
Q

what happens if the report needs to be unmodified

A
  1. modify report without modifying opinion; statements are true and fair but auditor has items to draw attention to
  2. modify report with modified opinion; statements don’t show what is reported so is untrue/fair
37
Q

what are the contents of the report to ‘those charged with governance’

A

can be in any format

  • responsibilities of auditor
  • overview and scope of audit
  • findings during audit
38
Q

what are the contents of a management letter

A

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
39
Q

what are the 6 sections of the audit firm governance code

A
  1. leadership
  2. values
  3. independent non executives
  4. operations
  5. reporting
  6. dialogue
40
Q

what is an internal audit

A
  • independent appraisal function
  • to evaluate/examine activities
  • to assist members in discharge of responsibilities
41
Q

who leads internal audit

A

chief internal auditor
who reports to audit committee

42
Q

role of chief internal auditor

A
  • review effectiveness of internal control
  • to ensure compliance with legal/corp gov obligations
  • identify risks
  • review economy/effectiveness/efficiency of operations
43
Q

factors to consider when considering whether to have an internal audit committee

A
  • scale/diversity of operations
  • complexity of operations
  • no of employees
  • costs/benefits considerations
44
Q

limitations of internal audit

A
  • 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
45
Q

qualities of effective internal audit function

A
  • 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
46
Q

what are financial controls used for

A

to ensure they are accurately recording transactions

47
Q

what controls should be put in place by internal auditors (examples of financial controls)

A
  • revenue and cash collections
  • acquisitions and expenditures
  • production or conversion
  • financial capital and payment
  • personnel and payroll
  • external financial reporting
48
Q

what are audit checks doing

A

testing the financial controls

49
Q

internal audit report most common structure

A
  1. terms of reference (scope)
  2. executive summary
  3. main body
  4. conclusions and recommendations
  5. appendices
50
Q

advantages of outsourcing

A
  • 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
51
Q

disadvantages of outsourcing internal audit

A
  • 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
52
Q

external vs internal audit differences when it comes to:

responsible to
responsible for
activities
standards
objective
report
appointment
relationship to the business

A

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

53
Q

types of errors

A

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)

54
Q

what are some error prevention methods

A
  1. authorisation = transactions above level should be authorised
  2. documentation = evidence provided
  3. staffing = segregation of duties to prevent one dictator
  4. asset safeguarding = properly valued, recorded, used, maintained
  5. detecting errors = spot errors, don’t leave to chance
55
Q

what is fraud

A

false representation of the fact, made with knowledge of its falsity

for it to occur there needs to be:
- dishonesty
- opportunity
- motive

56
Q

common methods of fraud

A
  • ghost employees
  • collusion with third parties
  • inflating expense claims
  • stealing assets
  • manipulation of financial statements/false accounting
  • money laundering
  • e-crimes eg spamming
57
Q

examples of fraud strategies

A
  • 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
58
Q

aspects included in a fraud prevention plan

A
  • segregation of duties
  • documentation to evidence
  • prohibition of certain activities
  • limitation controls
  • internal audit investigations
  • investigating warning signs
59
Q

internal responses to fraud

A
  • internal disciplinary action
  • civil litigation procedures
  • criminal procedures
60
Q

the audit opinion implies certain things to be true, what are they?

A
  • adequate accounting records are kept
  • accounts agree with records
  • all info has been received that is necessary
  • directors emoluments (pay) details are correctly disclosed
61
Q

considerations regarding sufficiency of evidence

A
  • 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
62
Q

scope of responsibility in the case of a fraud (who is responsible for what?)

A

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

63
Q

how much does fraud cost organisations and the economy?

A
  • organisations may lose up to 7% of annual turnover
  • corruption costs $1.5 trillion each year
  • only recover a small % of fraud losses
64
Q

who usually commits fraud and what is the most common motive

A
  • senior management/executives commit high % of fraud
  • greed is main motivator
  • often people in finance functions
65
Q

which sectors is fraud usually found in

A
  • losses are not limited to specific sectors/countries
  • prevalence is increasing in emerging markets

4. BA4 CIMA (16 decks)

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