AA Flashcards
Name the components of the 3-Party relationship
NPractitioner
Intended user
Responsible party
Give examples for the 3-party relationship components?
Practitioner= Surveyor, Assurance firm
Intended user= buyer
Responsible party= Seller, Directors
What is an assurance engagement?
It is one in which the practitioner expresses 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 a subject matter against criteria.
What are the 2 types of assurance?
Limited and Reasonable
Describe the characteristics of limited assurance (3)
- Moderate/lower level of assurance
- Conclusion expressed negatively - ‘Nothing has come to our attention that causes us to believe these assumptions on forecast are wrong”
- Eg. Engagement to examine a forecast
Describe the characteristics of reasonable assurance (3)
- High but not absolute level of assurance
- Opinion expressed positively -e.g. “In our opinion, the financial statements give a true and fair view”
- Audit of financial statements
Why does a reasonable assurance report provide more confidence than a limited one?
- There are more regulations/standards governing a reasonable assurance assignment.
2.The procedures carried out in a reasonable assignment will be more thorough
3.The evidence gathered will need to be of a higher quality
4 examples of an assurance engagement?
- Audit of financial statement
- Review of financial statement
- Examination of a forecast
- Review of internal controls
What’s the need for an external audit?
- Directors manage the company on behalf of the shareholders in order to achieve the objectives of that company.
- The directors must prepare financial statements to the shareholders to provide info on the financial position
- Provides an independent verification of the financial statements to ensure they give a true and fair view.
- Shareholders provide the finance for a company
- The directors have various incentives to manipulate the financial statments
Pros and Cons of an audit
+
Higher qual of info
Independent scrutiny and verification valuable to management
Reduces risk of management bias, fraud and error
Enhances credibility of financial statements
Deficiencies in the internal control system highlighted to auditor
-
Financial statements include subjective estimates and other limitations
Internal controls may be relied on which have their own inherent limitations
Representations from management and other client generated evidence are less reliable than independent evidence or evidence obtained directly by the auditor
Evidence is often persuasive not conclusive
Do not test all transactions
What’s an expectation gap?
Misconceptions of an auditor.
Beliefs include:
1. Auditors test all transactions
2. Will detect all fraud
3. Responsible for preparing the financial statement.
4. Unmodified auditor’s opinion guarantees the company is a going concern.
What’s a review engagement?
It’s an example of limited assurance engagement. A company that isnt legally required to have an audit may choose to have a review of its financial statements instead. Focuses on analytical procedures and enquiries of management.
Less costly and disruptive.
4 things that national law effects are?
- Which company requires an audit
2.Who can and cannot carry out an audit
- Auditor appointment, resignation, removal
- The rights and duty of an auditor
What are the 2 reasons for audit exclusion?
Excluded by law:
Have personal connection or business to the company being audited
Excluded by the code of ethics: Need to consider factors that would prevent them from acting as auditor such as competence/independence or issues regarding confidentiality.
What does the removal of auditors require?
The removal has to be structured in such a way that
What are the rights of an auditor during appointment?
- Access to the company’s books and records at any reasonable time
- To receive info and explanations necessary for the audit
- To receive and attend notice of any general meeting of the company and for their concerns to be heard
4.To receive copies of any written company resolutions
Advantages of corporate governance?
-Greater transparency
-Greater accountability
-Efficiency of operation
-Better able to respond to risk
-Less likely to be mismanaged
What are the two main approaches to ethical guidance?
Principles and Rules based- conceptual framework relies on principles
What are the principles based approach?
Requires compliance with the spirit of the guidance
Requires the accountant to use professional judgement
Flexible so can be applied to new unusual or rapidly changing situation
Principles may be applied across national boundaries where laws may not
Can still incorporate specific rules for ethical situations to affect many firms
What does the rules based approach mean?
May b easier to follow as rules are clearly defined
Needs frequent updating to ensure the guidance applies to new situations
May encourage accountants to interpret requirements narrowly in order to get around the spirit of requirements
Impossible to deal with every situation that might come up especially across various national boundaries in a dynamic industry.
What are the 5 Fundamental ethical principles?
Integrity
Objectively
Professional competence and due care
Confidentiality
Professional behaviour
What are the 5 threats to independence?
Self-interest
Familiarity
Self-review
Advocacy
Intimidation
What is a safeguard?
An action that eliminated a threat or reduces it to an acceptable level. If the threat cannot be eliminated/ reduced to an acceptable level, the assurance provider must decline or resign from the employment.
Examples of safeguards with owning shares/having a financial interest in a client?
Sell the shares
Examples of safeguards with fee dependency?
Non-listed clients: Fees from 1 client shouldn’t exceed 30% of the firms fee income for 5 years consecutive years.
Listed: Fees from one client shouldn’t exceed 15% of firm’s fee income for 2 consecutive years
Independent engagement quality review (EQR) performed by a person not a member of the audit firm
Reduce dependency by:
- Increasing the client base to reduce dependency
-Having an independent review of the work
Examples of safeguards with gifts and hospitality?
-Only accept if trivial and inconsequential
(Unless offered as inducement to influence auditors behaviours- reject offer)
Examples of safeguards with employment with the client?
-Auditor should notify the firm of possible employment
- Remove person form the team
- Perform independent review of significant judgements made by that individual
Examples of safeguards with Business relationships?
-Firm shouldn’t have any close business relationship unless any financial interest is immaterial and the business relationship is insignificant.
- Purchase of goods and services isnt a threat if the transaction is normal
Examples of safeguards with Overdue fees?
-Cease audit work until full/partial payments been made
-Dont issue the current year auditors report until payment received
-Perform an independent review of the work
-Consider resigning if fees there for a long time
Examples of safeguards with Loans?
-Audit firms cant make loans to audit clients unless immaterial to both parties
- Loans from an audit client which is a bank/financial institution are allowed made under normal procedures/rates
-If loan from bank is material then someone NOT from audit team from a network firm should review audit work
Examples of safeguards with Long association:
Non-listed clients:
-Rotate individuals off the audit
-Change the role/nature of tasks the individual performs
-Perform an EQR
Listed clients:
-Rotate the audit partner after 7 years and they must serve a cooling off period for 5 years before returning to client
-Where an EQR is rotated a cooling-off period of 3 years must be served
Examples of safeguards with personal relationships:
-Remove the person from the team
- Structure the team so the individual does nt deal with matters that are the responsibilty of the family member
Examples of safeguards with Accounts preparation:
Non-listed clients:
- Only services which are routine and mechanical in nature provided
Listed clients: Accounts preparation, bookkeeping and payroll services are prohibited.
When should an auditor breach confidentiality?
3 situations
1- Disclosure permitted by law and is authorised by the client/employer
2.Required by law e.g production of documents/other provision of evidence in the course of legal proceedings. Disclosure to the appropriate public authorities of infringements of law that come to light
- Professional duty/right to disclose when not prohibited by law :
To comply with ACCA quality review
To respond to an inquiry/investigation by ACCA
To protect the professional interests of a professional accountants in legal proceedings
To comply with technical standards and ethic requirements.
What are the 10 Acceptance considerations?
- Professioanl clearance
- Preconditions for an audit
- Reputation of client
4.Professional competence
- Independence and objectivity
- Fees
- Risks
- Resources
- Money laundering
- Management integrity
When do conflicts of interest occur?
When an audit firm is appointed to 2 firms which interact with each other.
Before an auditor can accept a job, ISA 210 (preconditions) should be present. What does this mean?
Requires the auditor to determine whether the financial reporting framework to be applied in the preparation of the financial statements is acceptable.
And to obtain the agreement of management that it acknowledges and understands its responsibility for preparing the financial statements in accordance, internal control needed for the preparation of statements to be free from material misstatement and providing the auditor with access to info relevant for the audit and access to staff
What is an engagement letter and what is its purpose?
It specifies the nature of the contract between the audit firm and client. It minimises the risk of misundertandings, confirms acceptance of engagement and sets out the conditions.
What are the risks associated with IAS 1 presentation of Financial statements and IAS 2 Inventories?
Risk of inadequate disclosure of going concern uncertainties if the directors do not make such disclosures. Risk of inventory being overstated as its not valued at lower of cost or NRV. This may be indicated by an increase in inventory holding period
What are the risks associated with IAS 10- Events after reporting period and
IAS 16- PPE?
Risk if recieveables being overstated if a company doesnt adjust the financial statements in respect of bankruptcy of a customer after year end where the customer is included asa receiveable at the year end.
Risk if expenditure on repairs treated as capital expenditure
What are the risks associated with IAS 37- provisions, contingent liabilities and contingent assets and IAS 38 Intangible assets?
Risk that provisions have been overstated if the IAS 37 criteria hasnt been met.
Risk that they are overstated if the criteria hasnt been met for development costs
What are the risks associated with IAS 15 - Revenue from Contracts with customers?
Risk that revenue overstated if company has recognised revenue before the performance obligations within the contract have been fufilled.
What is control risk?
Risk that misstatement is not prevented, detected or corrected by the entity’s controls.
What is detection risk?
Risk that procedures performed by auditor don’t detect misstatement that exits and could be material. It’s made up of sampling risk and non-sampling risk.
What is non-sampling risk?
Drawing up the wrong conclusion eg
it’s an auditors first year auditing this client and there isnt much prior knowledge.
Client is putting the auditor under undue time pressure resulting in audit being rushed and misstatements undetected.
The client operates from multiple sites and the auditor cant visit them all
What’s sampling risk?
Risk that the conclusion is drawn from the results of sample is different to the conclusion that would have been drawn had the whole population been tested
Definition of materiality?
Misstatements including omissions or in the aggregate are said to be material if they influence an individuals economic decisions taken on the basis of financial statements
What are the materiality by size thresholds?
0.5-1 % Revenue
5-10% Total profit
1-2% Total assets
What are the materiality by nature points?
- Compliance with laws and regulations
- Compliance with debt covenants
- Turn a profit to a loss
- Transactions with directors
What are 4 risk assesment procedures?
Enquiries
Analytical procedures
Observation
Inspection
What are the 4 areas an auditor should understand in terms of an entity?
The entity- eg organisational structure, objectives and strategies
The environment- E.g competition, economic conditions
The applicable financial reporting framework- e.g industry specific practices and financial instruments
The entity’s system of internal control - e.g. control environment and information system
What is inherent risk?
The susceptibiltiy of an assertion about transactions, balances or disclosure to a misstatement that could be material before any consideration of any related internal controls. May be qualitive or quantitive.
What are the main contents of an engagement letter?
Objective and scope
Responsibilities
Financial reporting framework
Form and content of reports
What are the 3 reasons for issuing a new engagement letter?
Change in statutory duties due to new laws
Changes in professional duties due to changed auditing standards
Changes to other services requested by the client
What are the benefits of an audit committee?
Improved credibility of the financial statements through review and discussion of financial statements through external auditors
Increased public confidence in the audit opinion as audit committee will monitor independence of external auditors
Stronger control environment
Internal audit committee will report to the audit committee which increases their independence
Skills that the audit committee provides is an invaluable resource
May be cheaper to arrange finance as the presence of good corporate governance
Less burden of meeting listing requirements if committee already in place
What are the cons of an audit committee?
Difficult recruiting the right non-exec directors who have relevant skills and time to become effective members of the committee
Expensive as the member will be paid for their time
Whats the composition, objective and function of an audit committee?
Composition-
Minimum of 3 NED’s
At least 1 with financial expertise
Independent of operational management
Objectives-
Increased public confidence
Provide financial awareness
Strengthen independence
Function-
Monitor financial statements
Review controls
Monitor and review annual audit
Monitor independence of external audit
What does directional testing reduce?
Directional testing reduces duplication and therefore over-auditing, so allows for a more efficient audit.
What Key assertions are tested for bank and cash?
existence and accuracy, valuation & allocation.
What are the main sources of evidence for bank and cash audit?
bank confirmation letter, the bank reconciliation, the cash book / bank ledger account and the bank statements.
Auditor will ensure that the bank balance agrees to information supplied by the bank and, if not same figure as financial statements (cash book / bank ledger account figure), then bank reconciliation should show what the reconciling items are and the auditor will need to test these to ensure they are valid.
How does a auditor get a bank confirmation letter?
Get permission from company then ask bank
Which assertions are tested by obtaining the bank letter?
Existence, accuracy & valuation, rights & obligations
What does a bank reconciliation statement look like?
Differences X / (x)
Balance per the bank statement X
Less unpresented cheques Subtract (X)
Add outstanding lodgements X
Balance per the cash book / bank ledger account Subtract X(X)
What assertions are tested for non-current liabilites?
completeness, accuracy, valuation & allocation, classification and presentation.
What is the main evidence used to test non-current liabilites assertions?
bank confirmation letter, the bank reconciliation, loan agreement, loan statement, the cash book / bank ledger account and the bank statements.
auditor need to ensure that the loan balance agrees to information supplied by the bank and that the loan is disclosed appropriately in the financial statements.
What does the completeness assertion mean for non-current liabilities?
Completeness is the most difficult assertion to test as the auditor is looking for something that has not been recorded or disclosed to them
Internal Audit departments are expensive to set up- what reasons does it depend on?
Scale and diversity of activities
Complexity of operations
Cost benefit
Number of employees
History of fraud in that company
Management needs advice on assurance and risk
Who do internal auditors report to?
Audit committee or board of directors
What are the 9 tasks taken on by Internal audit?
-Financial audit
-Audit of IT systems
-Corporate governance
-Operational audits
-Risk identifcation
-Fraud investigation
- Compliance with law and regs
-Value for money (The 3 E’s)
-Effectivness of controls
Advantages of Internal Audit team Outsourcing and Disadvantages?
+ overcome skill shortage
+Cost of employing permenant staff avoided
+Access to new market place tech
+ Reduced in house management time
- Firms lack intimate knowledge and understanding of organisation
- Lack of control over service
-Professional fees are high
-Constrained by contractual time
-possible conflict of interest if both external and internal auditor (not a UK problem)
What format does the internal audit report follow?
TEBA
Terms of reference- requirements of assignment
Executive summary- key risks and reccos which are described fully in body of report
Body of the report
Appendix- additional info
What are the 5 components of internal control?
-Control environment
- Monitoring
-Entity’s risk assesment process
-Information System
-Control Activities
What are the 5 inherent limitations of a control system?
- Human error
- Collusion of staff
- Ineffective controls
- Managment override
- No routine controls- If a company has a lot of transactions outside of the system, such as journal entries, there is a risk that no internal controls have been applied to them and any errors will go unnoticed.
PARVS stand for what?
Specific control activities-
1.Authorisation
2.Verification
3.Physical/logical controls to prevent the theft of assets/data
4.Segreggation of duties to reduce fraud risk
5. Reconciliations
Definition of Information Processing Control?
Relate to the processing of information in IT applications or manual processes that directly address risks to the integrity of information
Definition of General IT controls?
Support the continued proper operation of IT environment including effective functioning of the information processing controls and the integrity of information in the information system
Ascertaining control systems includes:
- Enquiries of relevant personnel
- Observing application of controls
- Walkthrough test
- Inspecting documents such as internal procedure manuals
3 Ways an auditor can test the system?
Tests of controls happen to ensure the controls are in place and working effectively.
Observation
Test data
Inspection of documents
What are direct controls?
control procedures which are properly designed, in place, and working effectively to address the risk of material misstatement at the assertion level.
What is a test of control?
A test of control is an audit procedure which will provide evidence as to whether the control procedure is in place and working effectively.
Tests of controls are not substantive procedures. Therefore, when testing the control, the auditor does not need to test the balance which will go into the financial statements.
What disclaimers are listed in a management letter?
- The report is not a comprehensive list of deficiencies, but only those that came to light during the audit procedure
- The report is sole use of the company
- No responsibility is assumed to any other parties
4.No disclosure should be made to 3rd party without written agreement from the auditor
When are deficincies significant?
- When theyre likely to lead to material mistatements in the financial statements
- Increase susceptibility to loss/fraud
- Relate to complex/subjective amounts
- Relate to balances or transactions with a high volume of activity
If you’re testing for an overstatement, which way does the directional testing occur?
We will test for occurrence or existence. We work backwards so we start with the financial statements and work back to the documents.
Understatement- completeness- start with documents and go to financial statements
What assertions are tested for in non-current assets?
rocvaae
rights and obligations
completeness accuracy
existence
valuation allocation
What assertions are tested for Intangible non-current assets?
Vaee
Valuation- allocation
Existence
Accuracy
What does the following statement test for assertion wise- Review the repairs and maintenance account in the statement of profit and loss to ensure assets have not been expensed.
This tests completeness of non-current assets.
Who audits intangible non-current assets?
Senior auditors as this is more complex.
The main area for the auditor to consider is whether the costs meet the criteria of the relevant accounting standard.
Key assertions tested for in Inventories?
existence, accuracy, valuation & allocation, completeness, and rights & obligations.
What does ISA 250 state?
to obtain sufficient appropriate audit evidence regarding compliance with the provisions of those laws and regulations generally recognised to have a direct effect on the determination of material amounts and disclosures in the financial statements
to perform specified audit procedures to help identify instances of non-compliance with other laws and regulations that may have a material effect on the financial statements
to respond appropriately to identified or suspected non-compliance with laws and regulations identified during the audit.
