9 Completing the Audit

Question 1

What is the window for completing the audit

Answer 1

• Companies have 3 months post year end to publish accounts to the stock exchange or risk being delisted
  o Therefore, auditors only have 3 months max to review final accounts
   Why doing systems testing prior is so important
  o But subsequent events will come to light post year end and need to be reviewed
• This is very difficult work to be competed by audit seniors & managers and will require input from the partner
• Will greatly annoy the client if the audit report and opinion is not ready when they want to publish their accounts

Question 2

What are subsequent events

Answer 2

• Those events, favourable and unfavourable, that occur between the balance sheet date and the date when the financial statements are issued. There are two types of event:
  A. Those that provide evidence of conditions that existed at the balance sheet date (adjusting events); and
  B. Those that are indicative of conditions that arose after the balance sheet date (non-adjusting events). (But disclose as a note to the accounts, if material).
• However, the auditor will also consider highly material events after the date financial statements are authorised – up to and even beyond date of the AGM

Question 3

What are adjusting events

Answer 3

An event after the reporting period that provides further evidence of conditions that existed at the end of the reporting period

Question 4

What is a non adjusting event

Answer 4

An event after the reporting period that is indicative of a condition that arose after the end of the reporting period

Question 5

How should non adjusting events be disclosed

Answer 5

Non-adjusting events should be disclosed if they are of such importance that non-disclosure would affect the ability of users to make proper evaluations and decisions. The required disclosure is a note to the accounts explaining (a) the nature of the event and (b) an estimate of its financial effect

Question 6

What happens if going concern issues arising after end of the reporting period

Answer 6

• An entity shall not prepare its financial statements on a going concern basis if management determines after the end of the reporting period either that it intends to liquidate the entity or to cease trading, or it has no realistic alternative but to do so
• Though as managers would be admitting failure in doing so and they are incentivise to be optimistic
  o But auditors have to see through this and is a point of contention between auditors and directors if the directors will not accept the auditors opinion that they are not a going concern

Question 7

What information should be reviewed by audit seniors to detect post balance sheet events

Answer 7

• Minutes of the Board of Directors
   Most important as an insight into board meeting
   Every important event will be discussed by the board and if proper corporate governance will be properly miniated
   Normally insist only manager or partner will see them
• Management accounts and accounting records
• Profit and cash flow forecasts for the subsequent period
• Enquiry of the legal department and external lawyers
• Known risk areas and contingencies
• Correspondence and memoranda
• Confirmation from third parties
• Information in the public domain
• Management interviews:
   Known risk areas
   New commitments
   Significant assets movements
   Going-concern status
   Significant losses of assets.

Question 8

What is a provision

Answer 8

• A provision (adjustment) is recognized when an entity has:
  1. A present obligation
  2. As a result of a past event
  3. Probably a transfer of economic benefits will be required
  4. Reliable estimate of amount of the obligation.
• This matches the definition of liabilities in the IASB ‘Conceptual Framework for Financial Reporting’ 2018.
• Most common is law suits

Question 9

How do law suits effect going concern

Answer 9

• Amount you can sue for can put going concern at risk
• Or entire business model at risk if being sued for a patent infringement
• If it was certain then wouldn’t go to court
• Auditors would give legal documents to their own in house lawyers for independent opinion
  o As companies lawyers are likely to egg them on to get more fees

Question 10

What is risk

Answer 10

• Don’t know the future but know the proability
  o Coin flip

Question 11

What is uncertainty

Answer 11

• Don’t know the future and don’t know the proability
  o Horse race
• In the case of IAS 37 we dealing with uncertainty
• For a court case it is always uncertain as otherwise would not take the risk and pay the fees, therefore always contingent liabilities otherwise would just pay out

Question 12

How should you recognise potential outflows and inflows

Answer 12

• Outflows are recognised before inflows due to prudence
• Only recognise asset if it is virtually certain
  o Collapses court case as probably going to settle outside of court if you are very likely to win
• If probably then just a note

Question 13

What are some indicators that there is a going concern risk

Answer 13

• Negative cash flows and/or significant losses
• Substantial debts, difficulty servicing these
• Bank overdraft close to/exceeding limit &/or renegotiation of bank loan repayments/overdraft facilities
• Very low current and /or acid test ratio (net current liabilities)
• Reduced or cancelled dividends
• Taking longer to pay creditors
• Employees being made redundant; reorganizing operations
• Declining market and/or products out of fashion
• Major customers in bankruptcy
• Forced sale of non-current assets
• ‘Creative accounting’ to try to hide the problems!

Question 14

How do you approach a going concern risk

Answer 14

• Having to thing about this seriously is last considerations for an audit
• Only if the audit firm is seriously considering the client is at threat of failure and unable to operate
• And is at risk of collapse in the current period

Question 15

How does creative accounting suggest a going concern risk

Answer 15

• Creative accounting is a good indicator of going concern issues
• If you not need to why put in the work and risk or manipulation
• Only motivated when things aren’t going well
• Lots of non financial transfers that can affect profit
  o Depreciation, amortisation, inventory

Question 16

What would you do if the auditors believed there is a going concern risk

Answer 16

• If the auditor finds going concern issues and the directors are not willing to announce it
  o If the evidence is clear and directors are unwilling
• Then must state in the audit report “these accounts show a true and fair view subject to continuing as a going concern”
  o This statement would cause panic with investors
  o But if they don’t could be sued
   Auditors will tell directors they are going to announce this and directors will probably come clean and add a disclaimer to their own accounts that they are only true and fair if they continue as a going concern

Question 17

What is a solicitor’s representation letter

Answer 17

• With managements permission can write to solicitors who disclose anything auditors want to know
  o In particular about all lawsuits regarding the client
• Very likely to reply as they can charge for it
• However dodgy director could hire dodgy solicitor who is willing to give false information especially if tipped off what not to say
• In principle reliable, as external, but weaker so needs to be cross referenced to board meeting minuets to make sure that nothing is missing

Question 18

What is a management letter of representation and how does it relate to the Audit objectives

Answer 18

• ISA580 ‘Written Representations’
• To obtain written representations from management, confirming that they believe that they have fulfilled their responsibilities for:
  o The preparation of the financial statements to show a ‘true and fair view’ (per Companies Act requirements) and
  o The completeness of the information they have provided to the auditor

Question 19

What should a management representation letter include

Answer 19

• Representations about management’s responsibilities:
  (a) Responsibility for preparation of financial statements
  (b) That they have provided the auditor with all relevant information and access as agreed in the terms of the audit engagement and that all transactions have been recorded and are reflected in the financial statements.
• Other representations: these include more specific matters such as appropriateness of accounting policies and specific assertions.
• The management letter of representation should bear the same date as the audit report.

Question 20

Why is a management representation letter needed and what does it really achieve

Answer 20

• In a ‘strict’ legal sense it can be argued that the letter is not needed, as it makes absolutely no difference to the auditor’s duties and legal responsibilities.
• Auditors cannot rely on it as a substitute for any of their audit work. Therefore, it does not reduce the amount of work they must do, or the professional skill and care they must exercise (i.e. the quantity and quality of audit evidence they must obtain).
• It is really a ‘letter of comfort’ rather than a document the auditors can rely on if their work is legally challenged.
  o Therefore, why do auditors always ask for the letter?
• Firstly, it makes managements responsibilities clear to them, providing a ‘formal notice’ and signed ‘acknowledgement’ of these. This, obviously, does not guarantee that the management will not indulge in ‘window-dressing’ or that they will disclose everything they know to the auditors. However, it is better than nothing.
• Secondly, it may reduce the risks that directors may attempt to mislead the auditor. This view is supported by the fact that any director who knowingly or recklessly misleads an auditor may be guilty of an offence

Question 21

How does the Companies Act 2006, s 418 relate to the ‘Directors’ Report’

Answer 21

• Under the Companies Act 2006, s 418 the ‘Directors’ Report’ must contain a statement that gives:
  1. The names of the persons who, during the financial year, were directors of the company, and
  2. The principal activities of the company in the course of the year
  3. A statement so far as the director is aware, that there is no relevant audit information of which the company’s auditor is unaware, and
  4. That they have taken all the steps that they ought to have taken as a director in order to make themselves aware of any relevant audit information and to establish that the company’s auditor is aware of that information
• Every director who either knew that the statement was false, or was reckless to as to whether it was false and failed to take reasonable steps to prevent the report from being approved commits an offence.

Question 22

How is analytical procedures of a audit completed

Answer 22

• A senior member of the audit team (typically the manager) will perform technical analyses of the draft financial statements using ratio analyses and also analysing changes and trends compared to ‘comparative figures’.
  o (Comparatives are the financial statements issued in previous years, but may also include the financial statements of competitors i.e. companies operating within the same sector).
• These analyses will be performed in the context of the audit manager’s detailed knowledge of the client, including its key activities, profitability, financial position, competitive position within the sector, economic factors, and any other information likely to be relevant to the its performance and financial position.
• The audit manager will attempt to assess whether the financial statements appear to be ‘reasonable’ in the context of the above.
  o Numbers which are ‘unexpected’ or ‘difficult to explain’ would probably be discussed with the directors and may possibly require further investigation.
  o Give what they have learnt about the client over the year do the ratios show the same message to external users

Question 23

How are the final assessments of materiality and risk completed

Answer 23

• The audit manager will undertake a final review of materiality and risk factors associated with the draft financial report.
  o Are they comfortable giving their audit opinion based on the materiality of the data found
• If a ‘clean’ (unqualified) audit opinion is to be issued, the audit manager and partner will need to be reasonably confident that there are no numbers, or omissions, or notes to the financial statements which involve any material mis-statements and which could potentially mislead the users of the annual financial report

Question 24

How is a technical review of the financial statements completed

Answer 24

• The audit manager will perform a technical review of the draft financial report ensuring that:
• All relevant accounting standards (IAS & IFRS) have been complied with in all material respects.
  o Exceptionally, if this is not the case, the directors should provide an explanation which the auditor will consider – as explained in Topic 10
• The notes to the financial statements are complete, sufficient and clear, explaining for all material items all relevant accounting policies, any changes to accounting policies, and any other matters required by way of explanation or clarification.
• All relevant regulatory requirements have been complied with. This includes all UK Companies Act disclosure requirements and all European Union directives which have been codified into UK law.

Question 25

How is a final review of the audit working papers completed

Answer 25

• The audit manager / partner will complete a final review and read of all the working papers to ensure:
  1. All ‘matters arising’ dealt with – no outstanding matters in the audit documentation
  2. All important matters have been covered
• The auditor records:
  o Results of analytical review
  o Conclusions on financial statement headings.
  o Memorandum on major account headings
  o Whether evidence recorded supports conclusions
  o Management letter of representation
• Should not be finding errors at this point but if they do then extra work will need to be carried out

Question 26

What are the 3 types of misstatement

Answer 26

1. Factual misstatements, about which there are no doubts.
   a. When it is clear to the auditor the numbers are wrong
2. Judgmental misstatements – differences arising from the judgements of management.
   a. When legal form is taken over substance to misrepresent assets
3. Projected misstatements being the auditor’s best estimate of the aggregate misstatements in sampled populations.
   a. Best estimate for overall inaccuracy based on errors discovered
   b. How many errors in sample and extrapolate to population

Question 27

What happens if directors refuse to correct a misstatment

Answer 27

• If the directors refuse to make any changes relating to material misstatements, the auditor would consider if they have valid reasons for refusing, and the implications for the audit opinion
• Auditor’s don’t want to give a negative (qualified) opinion, so if they do bring this issue to management and they refuse and threaten to drop them from non-audit services (as hard to drop auditor
  o Starts a game of bluff
  o An auditor who lacks integrity will fold
  o This is what the SOX in the USA has sought to prevent by separating audit and non-audit services

Question 28

How do auditors communicate the audit opinion

Answer 28

• See ISA 260 ‘Communication with those charged with governance’
• There will be a ‘final’ meeting between the audit partner and manager, and the Audit Committee (or representatives of the Board of Directors) to discuss the audit outcomes.
• Those charged with governance should have a great interest in the outcome of audit work, and they should be informed of uncorrected misstatements (other than those that are ‘clearly trivial’) and the effect that they may have on the auditors’ opinion.
• Para 14 of ISA 450 ‘Evaluation of Misstatements Identified During the Audit’ requires a list of uncorrected misstatements to be attached to the written representations made by auditors to management. If management believes some or all uncorrected misstatements are not in their opinion misstatements at all, they should explain the basis for their opinion.

Question 29

How do you prepare a management letter (letter of weakness)

Answer 29

• ISA265 ‘Communicating Deficiencies in Internal Control to Those Charged With Governance and Management’
• This was first discussed in lecture topic 1.
• Auditors are not under any legal obligation to provide any management letter
  o It is not a duty in terms of the companies acts or any other legislation
• However, almost all audit firms voluntarily provide this service to their clients, as it is mutually beneficial to do so.
• The main purpose is to inform the management concerning all significant internal control weaknesses that the auditors have detected, and to recommend ways in which these weaknesses can be mitigated or eliminated.
• If management decide to implement these recommendations, control risks will be reduced.
  o Possibly there may also be some efficiency gains and cost savings.
• Reduced control risk is mutually beneficial to both the client and the auditor, as CR is likely to be somewhat reduced during the financial year for the next annual audit.