Audit Report Part 2 Flashcards
Monday
Let’s break down the “Auditor’s Responsibility” section of the auditor’s report and provide practical examples to make the concepts clearer.
This section outlines the auditor’s responsibilities and includes the following key points:
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Objectives of the Auditor:
- Obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error.
- Issue an auditor’s report that includes the auditor’s opinion.
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Reasonable Assurance:
- State that reasonable assurance is a high level of assurance but is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement when it exists.
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Material Misstatements:
- State that misstatements can arise from fraud or error.
- Describe that they are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements.
- Provide a definition or description of materiality in accordance with the applicable financial reporting framework.
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Professional Judgment and Skepticism:
- State that the auditor exercises professional judgment and maintains professional skepticism throughout the audit.
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Description of an Audit:
- Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error.
- Obtain an understanding of internal control relevant to the audit to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control.
- Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management.
- Conclude on the appropriateness of management’s use of the going concern basis of accounting.
- Evaluate the overall presentation, structure, and content of the financial statements.
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Communication with Governance:
- State that the auditor communicates with those charged with governance regarding the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control identified during the audit.
- For audits of listed entities, state that the auditor provides those charged with governance with a statement that the auditor has complied with relevant ethical requirements regarding independence and communicates all relationships and other matters that may reasonably be thought to bear on the auditor’s independence, and where applicable, related safeguards.
- Where “Key Audit Matters” are communicated, state that the auditor determines those matters that were of most significance in the audit of the financial statements of the current period and are therefore the key audit matters.
Auditor’s Responsibilities for the Audit of the Financial Statements Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance but is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements. As part of an audit in accordance with ISAs, we exercise professional judgment and maintain professional skepticism throughout the audit. We also: - Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control. - Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. - Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management. - Conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the entity to cease to continue as a going concern. - Evaluate the overall presentation, structure, and content of the financial statements, including the disclosures, and whether the financial statements represent the underlying transactions and events in a manner that achieves fair presentation. We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. For audits of financial statements of listed entities, we also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards. From the matters communicated with those charged with governance, we determine those matters that were of most significance in the audit of the financial statements of the current period and are therefore the key audit matters. We describe these matters in our auditor’s report unless law or regulation precludes public disclosure about the matter or when, in extremely rare circumstances, we determine that a matter should not be communicated in our report because the adverse consequences of doing so would reasonably be expected to outweigh the public interest benefits of such communication.
Let’s consider a practical example involving the evaluation of accounting estimates, which is a key responsibility of the auditor.
Scenario:
XYZ Corporation has an allowance for doubtful accounts, which is an estimate of the amount of receivables that may not be collected. The allowance is based on historical data and management’s judgment.
Calculation:
- Total receivables: $500,000
- Historical default rate: 2%
- Allowance for doubtful accounts:
$$
\text{Allowance} = \text{Total Receivables} \times \text{Historical Default Rate}
$$
$$
\text{Allowance} = 500,000 \times 0.02 = $10,000
$$
Audit Procedure:
The auditor would evaluate the reasonableness of the allowance for doubtful accounts by:
- Reviewing the historical default rate and comparing it with current economic conditions.
- Assessing the appropriateness of management’s judgment in estimating the allowance.
- Testing a sample of receivables to verify their collectibility.
Responsibilities Section Example:
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Auditor’s Responsibilities for the Audit of the Financial Statements
Our objectives are to obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report that includes our opinion. Reasonable assurance is a high level of assurance but is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these financial statements.
As part of an audit in accordance with ISAs, we exercise professional judgment and maintain professional skepticism throughout the audit. We also:
- Identify and assess the risks of material misstatement of the financial statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control.
- Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control.
- Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management.
- Conclude on the appropriateness of management’s use of the going concern basis of accounting and, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern. If we conclude that a material uncertainty exists, we are required to draw attention in our auditor’s report to the related disclosures in the financial statements or, if such disclosures are inadequate, to modify our opinion. Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report. However, future events or conditions may cause the entity to cease to continue as a going concern.
- Evaluate the overall presentation, structure, and content of the financial statements, including the disclosures, and whether the financial statements represent the underlying transactions and events in a manner that achieves fair presentation.
We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. For audits of financial statements of listed entities, we also provide those charged with governance with a statement that we have complied with relevant ethical requirements regarding independence, and communicate with them all relationships and other matters that may reasonably be thought to bear on our independence, and where applicable, related safeguards.
Let’s break down the additional reporting responsibilities and other elements of the auditor’s report with practical examples to make the concepts clearer.
In some countries, the auditor may have additional reporting responsibilities required by local legislation. These responsibilities may be addressed in a separate section of the report titled “Report on Other Legal and Regulatory Requirements.”
Example:
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Report on Other Legal and Regulatory Requirements
In accordance with the requirements of the Companies Act, 2017, we also report that:
- We have obtained all the information and explanations which, to the best of our knowledge and belief, were necessary for the purposes of our audit.
- Proper books of account have been kept by the Company as required by law.
- The statement of financial position and statement of comprehensive income are in agreement with the books of account.
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For audits of complete sets of general purpose financial statements of listed entities, the name of the engagement partner should be included in the auditor’s report. However, if disclosing the name is reasonably expected to lead to a significant personal security threat, the auditor should not include the name and should discuss the severity with those charged with governance.
Example:
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Engagement Partner
The engagement partner on the audit resulting in this independent auditor’s report is John Doe.
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The report should be signed in the name of the audit firm, the personal name of the auditor, or both. The report is usually signed in the name of the firm because the firm assumes responsibility for the audit.
Example:
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Signature
ABC Audit Firm
John Doe, Partner
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The report should give a specific location for the auditor, usually the city where the office responsible for the audit is located.
Example:
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Address
123 Audit Street, Karachi, Pakistan
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The report should be dated no earlier than the date on which the auditor has obtained sufficient appropriate evidence to base their opinion on the financial statements. This date informs the reader that the auditor has considered the effect of subsequent events up to that date.
Example:
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Date
January 13, 2025
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Let’s consider a practical example involving the auditor’s additional reporting responsibilities related to the adequacy of accounting records.
Scenario:
During the audit of XYZ Corporation, the auditor identifies that the company has not maintained proper books of account for certain transactions.
Audit Procedure:
- Review the accounting records to ensure they are complete and accurate.
- Identify any discrepancies or missing records.
- Communicate the findings to those charged with governance.
Reporting Example:
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Report on Other Legal and Regulatory Requirements
In accordance with the requirements of the Companies Act, 2017, we also report that:
- We have obtained all the information and explanations which, to the best of our knowledge and belief, were necessary for the purposes of our audit.
- Proper books of account have not been kept by the Company as required by law for certain transactions.
- The statement of financial position and statement of comprehensive income are in agreement with the books of account, except for the discrepancies noted above.
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I hope this helps clarify the concepts! If you have any specific questions or need further examples, feel free to ask.
