Audit and Assurance Chapter 1

Question 1

What is a company?

Answer 1

A company is an organization set up for a specific purpose.

It is a separate legal entity and is registered under a piece of UK legislation called the Companies Act 2006.

Question 2

Benefits of being a company?

Answer 2

The concept of Limited Liability.

Question 3

What are the 2 main responsibilities of a company?

Answer 3

• The duty to keep accounting records
• They need to provide financial statements

Question 4

How long should accounting records be kept for? (Section 388)

Answer 4

For a private company- 3 years from the date on which they are prepared

For a public company- 6 years from the date on which they are prepared.

A company’s accounting records must be kept at its registered office or such other place as the directors see fit and must at all times be open to inspection by the company’s officers and auditors.

Question 5

How does an Audit address the agency problem?

Answer 5

An external audit provides assurance to those who need it, which in this case is those stakeholders who rely on the FS of a company

Question 6

What is an audit?

Answer 6

It is an independent review of the financial statements and disclosures produced by directors to ensure that they are both honest and unbiased.

Question 7

What is assurance?

Answer 7

Is a degree of confidence that is provided by a practitioner when reviewing subject matter produced by a responsible party for the benefit of the users of that subject matter.

Assurance can be expressed in different ways and to different extents.

Question 8

When are the auditors appointed?

Answer 8

At the AGM. But can be appointed by directors in certain circumstances such as:
- the date of incorporation
- or if the existing auditors resign and the replacements need to be appointed before the next AGM

Question 9

How does a company qualify for the audit exemption?

Answer 9

A company has to satisfy at least two of the following requirements for two consecutive years:
- Revenue of not more than £10.2 million during the year
- Balance sheet total of not more than £5.1 million
- Not more than 50 employees

Question 10

Under what circumstances cant the audit exemption be claimed?

Answer 10

• A public or listed company
• A bank or insurance company
• A company that is part of a group of companies that are public companies, banks, or insurance companies

Dormant companies are also exempt from audit, provided: they are not a bank or insurance company; they are not required to produce group accounts; and they fulfill two of the three criteria above. However, they can be a plc.

Question 11

What are the benefits gained from assurance?

Answer 11

• Satisfies external stakeholders such as banks and shareholders that the business is operating satisfactorily
• It can act as a deterrent against the threat of fraud occurring in the business
• the business may grow to levels beyond the exemption threshold one day so getting used to an audit now makes it less difficult to have one in the future

Question 12

What does ISA stand for?

Answer 12

International Standards on Auditing

Question 13

What is ISA 200, Overall objectives of the auditor?

Answer 13

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 o. 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 ISAs, in accordance with the auditors findings.

Question 14

What is corporate governance?

Answer 14

the system by which companies are directed and controlled

Question 15

What is meant by negligence?

Answer 15

Is the way in which a service is carried out and the legal wrong which arises when a person breaks a legal duty of care that is owed to another and causes loss to that other.

Question 16

What three things must be established to prove negligence?

Answer 16

1) the fact that a duty of care existed
2) the fact that this duty of care was breached
3) the fact that this caused loss to the claimant

Question 17

What is the duty of care?

Answer 17

The duty of care is a legal obligation to meet a required standard of care towards another party.

This duty of care is implied in the contract between an auditor and a client and cannot be disputed.

Question 18

Who is the client in negligence cases within an audit?

Answer 18

It is the body of shareholders, known as the company

Question 19

Why cant other parties sue for negligence? (e.g. bank)

Answer 19

The auditor does not automatically owe them a duty of care, and they would have to prove that one existed.

The way that a duty of might exist is if these parties have constructed a relationship with the auditors
e.g. by:
- warning them that a duty of care exists, or
- telling them they are relying on the audited financial statements for a special purpose.

However, even then it is not automatic and the courts will have to decide whether such a duty did exist, examing the facts.

Question 20

How can a breach of duty of care be proven?

Answer 20

For example, if an audit firm does not adhere to professional standards throughout the course of an audit.

Question 21

How to show a loss caused in terms of negligence?

Answer 21

The claimant will have to show not only that he has suffered a loss but also that the loss was a result of the breach of duty of care on the part of the auditors.

If auditors are found to have been negligent, they may have to pay financial reparation to the claimant.

Question 22

What are the consequences of audit failure?

Answer 22

• Financial loss
• Bad publicity
• FRC could take disciplinary action, which could result in its ability to conduct audits being suspended

Question 23

How can an audit firm restrict their liability?

Answer 23

• liability cap
• proportional liability
• Bannerman paragraph, many firms include a statement in their auditors report specifically excluding their liability to parties other than shareholders.
• set up an LLP, where the partners have limited liability but this increases publicity (filing accounts with companies house)
• a firm may insure against professional liability by taking out professional indemnity insurance; if a firm is found liabile the injured parties can be compensated

Question 24

What is the audit expectation gap?

Answer 24

the ‘expectation gap’ is used to describe the difference between the expectations of those who rely upon an auditor’s report concerning the audit work they think should be performed, and the actual work performed by the auditor.

Such misunderstandings might include the following:
- it is the auditor’s duty to prevent and detect fraud at an audit client
- the auditor is liable for any errors found in the financial statements

Question 25

What is professional skepticism?

Answer 25

is the attitude of critical assessment and the use of a questioning mind necessary to prevent overlooking suspicious circumstances of from drawing incorrect conclusions.

The auditor should neither assume that management is dishonest nor fail to question whether they are honest.

Question 26

How does ‘money laundering’ cover aspects of fraud?

Answer 26

Covers some of the following
- offences that indicate dishonest behaviour- such as tax evasion or not returning overpayments by customers

-offences that involve saved costs (such as where a company is saving money by not complying with the law, e.g. dumping waste illegally rather than paying a company to remove it)

• conduct overseas that would be illegal in the UK, e.g. bribing government officials

Question 27

What are the fundamental principles?

Answer 27

‘PIPCO’

• Professional competence and due care
• Integrity
• Professional Behaviour
• Confidentiality
• Objectivity

Question 28

What is meant by professional competence and due care?

Answer 28

to maintain professional knowledge and skill at the level required to ensure that a client or employer receives competent professional service based on current developments in practice, legislation, and techniques.

Question 29

what is meant by integrity?

Answer 29

to be straightforward and honest in all professional and business relationships

Question 30

What is meant by Professional behaviour?

Answer 30

to comply with relevant laws and regulations and avoid any action that brings our profession into disrepute.

Question 31

What is meant by confidentiality?

Answer 31

in accordance with the law to respect the confidentiality of information as a result of professional and business relationships and not disclose any such information to third parties without proper and specific authority unless there is a legal or professional right or duty to disclose. This confidential information as a result of personal and business relationships should not be used for the personal advantager of the memeber or third parties.

Question 32

What is meant by objectivity?

Answer 32

To not allow bias, conflict of interest, or undue influence of others to override professional or business judgments.

Question 33

What is the conceptual framework and what does it involve?

Answer 33

These are potential situations or ethical threats that auditors and accountants should aim to avoid.

‘AS IFS’

• Advocacy
• Self-interest
• Intimidation
• Familiarity
• Self-review

Question 34

What is meant by advocacy?

Answer 34

When a member promotes a position or opinion to the point that subsequent objectivity may be compromised.

e.g. promoting shares in a listed entity when that entity is a financial statement audit client.

Question 35

What is meant by self-interest?

Answer 35

where a financial or other interest will inappropriately influence the members judgment or behaviour.

e.g. having a close business relationship with a client

Question 36

What is meant by intimidation?

Answer 36

when a member may be deterred from acting objectively by threats, whether actual or perceived.

e.g. being pressured to reduce inappropriately the quality or extent of work performed in order to reduce fees.

Question 37

What is meant by familiarity?

Answer 37

When, because of a close or personal relationship, a member becomes too sympathetic to the interests of others.

e.g. a member of the engagement team having a close or personal relationship with a director or officer of the client.

Question 38

What is meant by self-review?

Answer 38

When a previous judgement needs to be re-evaluated by the member responsible for that judgement.

e.g. the discovery of a significant error during a re-evaluation of the work of the member in practice.

Question 39

What is meant by faithful representation?

Answer 39

The financial information that is being reported represents the substance as well as the legal form, possessing the characteristics of completeness, neutrality and being free from error.

Question 40

What is meant by true and fair?

Answer 40

‘true’ means honest and factual, while ‘fair’ means free from bias. ‘Presents fairly in all material aspects’ is used the same way as ‘true and fair view’.

Question 41

What are the main two types of misstatement and give an example?

Answer 41

• Misappropriation or theft of assets, for example, an employee arranges for goods to be despatched to their home address but then subsequently cancels all traces of the transaction and sells the asset for cash.
• fraudulent financial reporting, for example, a decision by a manufacturer to manipulate the amounts to be charged to a provision used for warranty claims so it hits a profit target, triggering a management bonus.