Assurance

Question 1

Audit approach

Answer 1

Audit approach (Assurance)
• If Control Risk assessed at Maximum, then no reliance may be placed on controls, resulting in no Tests of Controls, and a Substantive approach must be followed

• If Control Risk assessed at less than Maximum, then some reliance may be placed on controls, based on results of Tests of Controls, which could lower the amount of substantive work to be done at year-end. Such an approach is generally referred to as a Combined approach

Question 2

General assurance standards

CASE 3000/CSAE 3001

Answer 2

Standards for assurance engagements OTHER THAN audits of financial statements and other historical financial information.

• Attestation engagements (CSAE 3000): a party other than the practitioner measures or evaluates the underlying subject matter against the criteria
• Direct engagements (CSAE 3001): the practitioner measures or evaluates the underlying subject matter against the criteria

General standards:
• Before undertaking an assurance engagement, the practitioner should have a reasonable basis for believing the engagement can be completed in accordance with the relevant standards.
• The practitioner should seek management’s acknowledgment of responsibility for the subject matter as it relates to the objective of the engagement.
• The assurance engagement should be performed with due care and with an objective state of mind.
• The practitioner and any other persons performing the assurance engagement should have adequate proficiency in such engagements and collectively possess adequate knowledge of the subject matter.

Question 3

Reporting alternatives – Specific items

CAS 805

Answer 3

CAS 805 Report – Audit of a Single Financial Statement and Specific Elements, Accounts or Items of a Financial Statement

• A report providing audit level assurance on individual financial statements or accounts, rather than financial statements on the whole

The auditor must
• comply with all CAS’s relevant to the audit (CAS 200)
• determine the acceptable financial reporting framework to be applied and document the agreed terms of the audit engagement, including the expected form of any reports to be issued (CAS 210)

CAS’s written in the context of an audit of financial statements are to be adapted as necessary when applied to audits of other historic financial information.
When forming an opinion and reporting on a single financial statement or on a specific element of a financial statement, the auditor shall apply the requirements in CAS 700, adapted as necessary in the circumstances of the engagement.

Question 4

Control Deficiencies

Answer 4

• The most effective format to address controls weaknesses consists of a short statement of the problem (deficiency), its potential effect(s) on the financial statements or operations (implication) and suggestions to address the matter (recommendation)

o Deficiency (D) – this is generally a case fact outlining something that might be deficient with the current controls

o Implication (I) – here, we go beyond case facts to explain the effects of the noted deficiency either on the financial statements or on operations. To the extent possible, effects on the financial statements must be tied to assertions or at least the affected accounts must be outlined along with a discussion of how they might be affected by the deficiency

o Recommendation (R) – this involves suggesting a solution to rectify the noted deficiency that is specific and practical given the case facts and circumstances.

Question 5

Financial statement assertions

Answer 5

• Assertions about classes of transactions and events for the period under audit:

o Occurrence – transactions and events that have been recorded have occurred and pertain to the entity

o Completeness – all transactions and events that should have been recorded have been recorded

o Accuracy – amounts and other data relating to recorded transactions and events have been recorded appropriately

o Cut-off – transactions and events have been recorded in the correct accounting period

o Classification – transactions and events have been recorded in the proper accounts

o Presentation – transactions and events are appropriately aggregated or disaggregated and clearly described, and related disclosures are relevant and understandable

• Assertions about account balances at the period end:

o Existence – assets, liabilities, and equity interests exist

o Rights and obligations – the entity holds or controls the rights to assets, and liabilities are the obligations of the entity

o Completeness – all assets, liabilities and equity interests that should have been recorded have been recorded

o Accuracy, valuation, and allocation – assets, liabilities, and equity interests are included in the financial statements at appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded

o Classification – assets, liabilities, and equity interests have been recorded in the proper accounts

o Presentation – assets, liabilities, and equity are appropriately aggregated or disaggregated and clearly described, and related disclosures are relevant and understandable

Question 6

Common audit risk factors

Answer 6

• New or additional users
• Management bias
• Going concern
• Debt covenants
• Cash flow issues
• Control issues
• New problems or issues
• Significant growth in revenues or assets
• Legal claims
• High risk industry
• Complex systems
• Changes in operating environment
• New personnel
• Changes to information systems
• New technologies
• Changes in products or activities
• Corporate restructuring
• Expanded foreign operations
• New accounting pronouncements

Question 7

Review engagements

Answer 7

• The objective of a review engagement is to obtain limited assurance about whether the financial statements as a whole are free from material misstatement

• A conclusion is formed on whether anything has come to the practitioner’s attention to cause them to believe the financial statements are not prepared, in all material respects, in accordance with an applicable financial reporting framework, i.e. ASPE, IFRS
• Limited assurance about the results of the examination is provided, with an explicit statement that an audit opinion is not expressed
• Report expresses negative assurance – “nothing has come to our attention…”
• Similar to an audit, independence is required as it is an assurance engagement
• Materiality must be determined
• Typical procedures include:
o Obtaining knowledge of the client’s business
o Making inquiries of management and client personnel
o Performing analytical procedures

Question 8

Reporting alternatives – Compliance reporting

Answer 8

• CSAE 3530 Report: Attestation engagement — A reasonable assurance or limited assurance engagement to report on management’s statement of an entity’s compliance with agreements, specified authorities, or a provision thereof
o A report concluding on whether management’s stated compliance with the
terms of the agreement is fairly stated

• CSAE 3531 Report: Direct engagement — A reasonable assurance or limited assurance engagement to report on an entity’s compliance with agreements, specified authorities, or a provision thereof
o A report stating compliance with the terms of the agreement

• Section 9100 Report – Results of Applying Specified Auditing Procedures
o A report providing the factual results of the specific procedures that can be
chosen to be performed
o No assurance provided but is the most flexible of all alternatives

Question 9

What is the overall objective of the auditor in an audit of financial statements?

Answer 9

Canadian Auditing Standards; CAS 200.11:

In conducting an audit of financial statements, the overall objectives of the auditor are:

(a) To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework; and
(b) To report on the financial statements, and communicate as required by the CASs, in accordance with the auditor’s findings.

Question 10

When reporting on the results of applying specified auditing procedures to financial information, what six things should the public accountant report?

Answer 10

Other Canadian Standards; Related Services; Section 9100 Reports on the Results of Applying Specified Auditing Procedures to Financial Information Other than Financial Statements; 9100.11:

When reporting on the results of applying specified auditing procedures to financial information, the public accountant should:

(a) specifically identify the financial information to which the auditing procedures were applied;
(b) specify the procedures performed;
(c) state only the factual results of those procedures and not express any form of negative assurance;
(d) state that an audit has not been performed on the financial information and disclaim an opinion thereon;
(e) indicate restrictions, if any, on distribution of the report; and
(f) disclose the addressee, the name of the public accountant (or firm), the date of the report, and the place of issue.

Question 11

In an audit of financial statements, what are the requirements related to evaluating management’s assessment of the going concern assumption?

Answer 11

Canadian Auditing Standards; CAS 570.12-.14

12. The auditor shall evaluate management’s assessment of the entity’s ability to continue as a going concern. (Ref: Para. A7-A9, A11-A12)
13. In evaluating management’s assessment of the entity’s ability to continue as a going concern, the auditor shall cover the same period as that used by management to make its assessment as required by the applicable financial reporting framework, or by law or regulation if it specifies a longer period. If management’s assessment of the entity’s ability to continue as a going concern covers less than twelve months from the date of the financial statements as defined in CAS 560, the auditor shall request management to extend its assessment period to at least twelve months from that date. (Ref: Para. A10-A12)
14. In evaluating management’s assessment, the auditor shall consider whether management’s assessment includes all relevant information of which the auditor is aware as a result of the audit.

Question 12

In relation to subsequent events in an audit of financial statements, what is the definition of the “date the financial statements are issued”?

Answer 12

Canadian Auditing Standards; CAS 560.5 (d)

Date the financial statements are issued — The date that the auditor’s report and audited financial statements are made available to third parties.

Question 13

What is the objective of the firm in establishing and maintaining a system of quality control?

Answer 13

Canadian Standards on Quality Control; CSQC 1.11:

The objective of the firm is to establish and maintain a system of quality control to provide it with reasonable assurance that:

(a) The firm and its personnel comply with professional standards and applicable legal and regulatory requirements; and
(b) Reports issued by the firm or engagement partners are appropriate in the circumstances.

Question 14

Where would you find additional guidance related to the compilation of a financial forecast or projection?

Answer 14

Assurance and Related Services Guidelines; AuG-16 Compilation of a Financial Forecast or Projection

Question 15

What is an engagement letter?

Answer 15

The engagement letter: The auditor clarifies their responsibilities with management of the audited company at the start of the engagement by issuing an engagement letter, which specifies the terms of the engagement. Such a letter will include details of the auditor’s responsibilities and the scope of the engagement. The engagement letter also indicates that there is a risk that some material misstatements may not be detected, even though the audit is properly planned and performed in accordance with the applicable framework.

Question 16

What is an Auditor’s report?

Answer 16

The auditor’s report: This report contains an explanation of the auditor’s responsibilities. In addition, it contains a description of the scope of the audit to assist in clarifying to the shareholders the role of the auditor.

Question 17

CAS 220 Quality Control for an Audit of Financial Statements

Answer 17

consideration of the the following information should assist the engagement partner in determining whether the acceptance or continuance of a prospective client is appropriate:

• The integrity of the principal owners, key management and those charged with governance of the entity;
• Whether the engagement team is competent to perform the audit engagement and has the necessary capabilities, including time and resources;
• Whether the firm and the engagement team can comply with relevant ethical requirements; and
• Significant matters that have arisen during the current or previous audit engagement, and their implications for continuing the relationship.

Question 18

What factors should a practitioner consider in assessing a client’s integrity?

Answer 18

• What is the reputation of the client in the business community? What is the reputation of the client’s management, directors, and key stakeholders?
• What is the client’s attitude toward risk? How does the client manage risk?
• Will the client be co-operative in providing the practitioner with access to information?
• What is the client’s attitude toward the audit fee?
• In the case of a client acceptance decision, why does the potential client want to switch audit firms?

Question 19

CAS 210 specifically identifies the following situations where a new client or an existing client should not be accepted, unless required by law to do so:

Answer 19

• where management does not acknowledge its responsibilities in writing
• where the chosen financial reporting framework is not acceptable

Question 20

What is the purpose of the engagement letter

Answer 20

The purpose of the engagement letter is to lay out the terms of the engagement, including the following:

• the objective and scope of the audit of the financial statements
• the responsibilities of the practitioner
• the responsibilities of management
• identification of the applicable financial reporting framework for the preparation of the financial statements
• reference to the expected form and content of any reports to be issued by the practitioner and a statement that there may be circumstances in which a report may differ from its expected form and content
• the basis on which fees are computed and any billing arrangements

Question 21

Before accepting a new client, what questions must we ask ourselves?

Answer 21

• Does the practitioner (or their firm) have the necessary resources available to perform the engagement, such as expertise, experience, and availability of staff?
• Are there any independence prohibitions, threats, or conflicts of interest between the practitioner and the client?
• Is the practitioner able to mitigate or accept engagement risk factors? Does the practitioner have a clear understanding of the user’s requirements for this engagement?
• Is there industry legislation or regulations impacting the financial reporting requirements of the client?
• Has the client’s management agreed to its responsibilities in writing?
• Are there any known scope limitations that may restrict the practitioner’s ability to provide an opinion?

Question 22

The rules of professional conduct provide ethical standards based on five key principles:

Answer 22

• Objectivity: CPA Canada members must maintain an independent and objective state of mind when providing assurance services.
• Integrity and due care: CPA Canada members must act with integrity and due care in the performance of their professional activities.
• Professional competence: CPA Canada members must maintain their knowledge and skill at a level required by the professional bodies and must not undertake work for which they lack the necessary competence.
• Confidentiality: CPA Canada members must maintain confidentiality with respect to the affairs and the business of the client.
• Professional behaviour: CPA Canada members must behave in a professional way that maintains the good reputation of the profession and serves the public interest. Members are expected to avoid actions that would discredit the profession.

Question 23

What is independence?

Answer 23

Independence is defined as the practitioner’s ability to act with objectivity, integrity, and professional skepticism, and falls under the rule of objectivity.

Practitioners must maintain an independent attitude in fulfilling their responsibilities. It is very important that the users of the financial information have confidence in the independence of the practitioner both in fact and in appearance.

Question 24

What are the different threats to indepence?

Answer 24

• Self-interest threats occur where the practitioner (or his or her firm) has a financial interest in the client, as in the following examples:

o Assurance team members involved in the assurance engagement and/or their immediate family members own shares of, or have made a loan to, the client.

o The client’s fees are significant in relation to the total fee base of the practitioner (or his or her firm).

o A loan is made by a client to an assurance team member that is outside of normal lending terms.

• Self-review threats occur where the practitioner is in the position of having to form an opinion on his or her own work, as in the following examples:

o The practitioner, or an assurance team member, has recently been an employee or a director of the client and has had an opportunity to prepare original data or records for the client.

o The practitioner, or an assurance team member, has provided internal audit services, human resource services, valuations, information technology services, or corporate finance services to the client. The practitioner then provides assurance over these services.

• Advocacy threats occur where the practitioner (or his or her firm) is perceived to promote, or actually promotes, the position of the client, as in the following examples:

o The practitioner (or his or her firm) promotes the sale of shares or other securities for the client. In this situation, the practitioner may or may not receive a commission for such sales.

o The practitioner (or his or her firm) represents the client in a legal dispute.

o The practitioner (or his or her firm) represents the client in negotiations with a third party, such as a major creditor of the client.

• Familiarity threats occur where a close relationship exists between the practitioner and the client, creating an environment where it is difficult for the practitioner to behave with professional skepticism, as in the following examples:

o The practitioner (or his or her firm), or an assurance team member, has a long-standing association with the client.

o A former partner of the public accounting firm now holds a senior position (such as chief financial officer or chief operating officer) at the client.

o The practitioner, or an assurance team member, has accepted other than very minor gifts from the client.

o The practitioner, or an assurance team member, has accepted other than very minor gestures of hospitality from the client, such as tickets to a sporting event or meals.

• Intimidation threats occur where the client intimidates the practitioner (or his or her firm), as in the following examples:

o The client threatens to replace the practitioner next year.

o There is pressure from the client to reduce the number of audit hours in an effort to reduce assurance engagement fees.

Question 25

How do you determine materiality?

Answer 25

Step 1: Identify the users of the financial statements

Step 2: Identify the users’ objectives

Step 3: Determine the base for materiality

The most common bases, otherwise known as benchmarks of materiality, are:

• normalized income before tax (this is the most common case for for-profit entities)
• total assets
• total revenues
• total expenses
• total equity

Step 4: Identify the percentage threshold for materiality

The Professional Engagement Guide (PEG) suggests the following guidelines for the calculation of materiality:

For-profit entities:

• 3% to 7% of normalized income before tax
• 1% to 3% of revenues or expenses
• 1% to 3% of total assets
• 3% to 5% of equity

Not-for-profit entities:

• 1% to 3% of revenues or expenses
• 1% to 3% of total assets

Step 5: Determine overall materiality

Step 6: Determine performance materiality

A possible suggested base for PM per PEG is 60% to 80% of overall materiality, but actual percentages used vary throughout audit firms and should be based on professional judgment.

Step 7: Determine specific materiality

Step 8: Determine specific performance materiality

Question 26

What is audit risk?

Answer 26

The risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated.

Question 27

What is the audit risk model?

Answer 27

audit risk is equal to risk of material misstatement (RMM) multiplied by detection risk:

AR = RMM × DR

AR = audit risk

RMM = IR × CR

IR = inherent risk: general and fraud risks at the overall financial statement level (OFSL) and the assertion level

CR = control risk: control risks at the OFSL and the assertion level

DR = detection risk (set based on the reliance on substantive procedures)

The purpose of the audit risk model is to help the practitioner understand how inherent and control risk drive the level of detection risk and the reliance on substantive procedures (DR).

Question 28

Examples of inherent risk factors that increase the RMM at the OFSL include:

Answer 28

• A company in poor financial health: The company may not be a going concern, thus impacting the presentation of the financial statements as a whole.
• Significant market competition that is driving down prices and pressuring cost structures: Significant market competition may create aggressive revenue recognition. Management may be biased to overstate earnings in order to maintain the ability to raise financing.
• The company has never been audited before: The opening and comparative balances may not be reliable.
• An upcoming purchase or sale of the company: The sellers of the company will have an inherent bias to make the financial statements appear more favourable. The purchasers of the company will be relying on the audit report to make a decision.
• Imposition of more stringent regulation on the industry and the company: Given that regulatory agencies may be reviewing and scrutinizing the client’s financial statements, there will be new users of the financial statements.
• An initial public offering, issuance of new debt, or bank covenants: Additional users relying on the audit report increases risk, as the preparers of the statements have an inherent bias to make the financial statements appear more favourable to their new users.
• Employees with reliance on net income for compensation (bonuses): The employees will have an inherent bias to make the financial statements appear more favourable

Question 29

What are the possible Audit Opinions?

Answer 29

Unqualified - “clean” opinion - FS are presented fairly
Qualified - FS are presented fairly EXCEPT FOR…
there is a single issue:
- departure from GAAP
- scope limitation (ie: auditor could not count inventory)
Adverse - “you suck” - FS are NOT presented fairly
Disclaimer - we do not express an opinion
- auditor lacks independence
- EXTENSIVE scope limitation
- substantial uncertainty or doubt about the company’s ability to continue as a
going concern