Chapter 1 Flashcards
Principles of Auditing and Professional Ethics
Advantage of being a company?
Limited Legal liability
- The most any investor can lose is their overall investment
- Separate legal entity concept
2 Responsibilities of being a company in relation to statements and records?
- Duty to keep accounting records
- The need to provide financial statements
3 Responsibilities in regards to the ‘duty to keep accounting records’
- Must keep adequate accounting records
- Contain entries in relation to income and expenses and the reasonings for why they incurred.
- Keep a record of the assets and liabilities
Private Limited and Public Limited companies in relation to the duration of accounting records?
- Private Limited Company (Ltd)
Valid for 3 years from the date they are prepared. - Public Limited Company (Plc)
Valid for 6 years from the date they are prepared.
What is The Agency Problem?
A conflict of interest that occurs when an agent is supposed to act in the best interests of the principal but may instead act in their own self-interest.
What does it mean to be ‘True and Fair’ from a financial statement perspective?
FYI: 3 Characteristics
- Factual
- Unbiased
- Free from discrimination
What does ‘Faithful Representation’ from a financial statement perspective mean?
FYI: 4 Characteristics CNFR
- Complete
- Neutral (prudence)
- Free from error
- Represents the economic reality of what it portrays
What is ‘Audit’ and what does it provide for users?
- Audit is a review of the financial statements and disclosures produced by directors to ensure they are in line with criteria.
- Provides assurance to users.
Assurance Engagements (flow chart)
FYI: 6 Elements
- Responsible Party
- Subject Matter
- User
- Practitioner
- Evidence aligned with Criteria
- Written Report
What is ‘Audit Appointment’ and who selects this/ and where?
- The process of hiring or selecting an auditor to examine a company’s financial records.
- Usually appointed by shareholders at an Annual General Meeting (AGM).
Audit Exemptions
FYI: 3 Criteria
- Criteria (at least 2 of them met for 2 consecutive years):
1. Revenue not more than £10.2 million during the year
2. Balance sheets total not more than £5.1mm
3. No more than 50 employees
When can Audit Exemptions not be requested?
FYI: 3 Criteria
- Criteria:
1. A public or listed company (Plc)
2. Bank or insurance company
3. Part of a group of companies that are public, bank, or insurance companies
Dormant Companies and Audit Exemptions
- Definition
- 3 criteria for them to be exempt
- A company that is not currently doing any business/making any money.
- Exempt from audit, provided they aren’t:
1. Bank or insurance companies
2. Not required to produce group accounts
3. Fulfil at least 2/3 of the initial criteria
What is an ISA and who are they produced and adopted by?
- An Auditing standard that provides guidelines for auditors on how to perform an audit of financial statements to obtain reasonable assurance for users.
- Produced by the International Auditing and Assurance Standards Board (IAASB)
- Adopted by the Financial Reporting Council (FRC)
What are the 2 overall objectives of the Auditor?
- Obtain reasonable assurance
- To report on the financial statements
Regulation (in regards to what they are)
- FRC
- IAASB
- Financial Reporting Council (FRC)
- The independent regulator of accounting and auditing
- Adopts ISA’s - International Audit and Assurance Standards Board (IAASB)
- The independent body that sets the international standards for auditing
- Responsible/ set up ISA’s
Responsibilities for producing financial statements
- Auditors
- Management
- The Board of Directors
- Auditors
- Not responsible for producing the financial statements - Management
- Responsible for producing financial statements, with oversight from those charged with governance - The Board of Directors
- Responsible to the shareholders and delegate the task of preparing financial statements to management
- Charged with governance
What is Corporate Governance?
The system by which companies are directed and controlled (e.g. FRC).
What are the 5 purposes/ principles of The Board leadership and company?
- Company is led by an effective and entrepreneurial board
- Establish the company’s purpose, values and strategy and ensure these are aligned with promoting a desired culture
- Ensure that resources in place meet its objectives and the measure performance that is against them
- Ensure effective engagement with relevant users
- Ensure that workforce policies/ practices are consistent with the companies values and supports long term success
What are the purposes and principles of the division of responsibilities for the following stakeholders:
- Chair Leads (2)
- Non Executive Directors (2)
- The Board of Directors (4)
- Chair leads
- Oversee the board of directors
- Responsible for overall effectiveness and directing the company - Non-Executive Directors
- Hold management accountable
- Support Executives - The Board of Directors
- Includes Executive and Non-Executive directors
- Run the company on the chair leads behalf
- Expected to be independent
- Ensures it has the policies, processes and information to function effectively and efficiently
What is the ‘Principles-Based approach’?
Providing general/ broad principles and guidelines that companies should follow and allows companies to adapt them to their specific situations.
Internal and External Auditor roles
- Internal
- Support the management of a company by helping to address issues within preparing financial statements - External
- Review the statements and produce reports based on faithful representation and true and fair principles
What is an Audit Committee?
Audit committees are a collection of Non-Executives responsible with overseeing controls in place over audited financial statements.
What are the 4 responsibilities of the Audit Committee ?
- Monitoring the integrity of financial statements
- Whether statements are reflective of the companies position
- Review risk management and internal controls
- Handle the companies relationship with the external auditor
What is Professional Liability?
Being legally responsible for mistakes or failures in your professional work that cause harm to a client or another party.
What is Negligence?
When an Auditor fails to perform their duties with the care, skill, or professionalism required, and this causes harm to the client or other stakeholders.
What is Duty of Care?
A legal obligation that Auditors owe to their client (single body of shareholders).
What is a potential way/ exception that would require Auditors to provide a duty of care to parties?
If the party has informed the auditor that they are reliant on the audited financial statements for a specific purpose.
What are the 2 criteria’s that Courts utilise to decide whether a duty did exist for the parties?
- Breach of duty of care
- Auditor has failed to follow the professional standards - Loss caused
- Party needs to prove a financial loss, and that loss was as a result of the breach in duty of care
What is Audit Failure and what are the 2 consequences if an Auditor is founded to be negligent?
- Audit Failure
- Performing a poor-quality audit resulting in auditors being found guilty of negligence - If Auditors are found to be negligent:
- May have to pay financial reparation (damages) to the claimant
- Potential suspension of the ability to conduct audit
How can liability be restricted?
FYI: 5 ways
- Liability limitation agreement (liability cap)
- Proportional liability
- Statement declaring (Bannerman paragraph in the audit report)
- Limited liability partnership
- Professional indemnity insurance
What is Reasonable Assurance and what type of limitations does it have and why?
- Providing an opinion (not guarantee) that the financial statements are correct and free from big mistakes or fraud.
- Has inherent limitations as its not realistic to expect that an audit will pick up all issues.
What is the Audit Expectation Gap?
Describes the difference between the expectations of what users think Auditors do vs the actual work performed by the auditor (that they are responsible for).
Fraud
- What Audit is designed for in cases of fraud
- 2 ways to determine Fraud
- Audit
- Not designed to uncover fraud
- Responsible for detecting material misstatements which may have arisen due to fraud - Able to determine fraud in 2 ways:
- Intent to cover up (motivated to commit)
- Rationalising fraud (people knowing it’s wrong, but given circumstances can justify that breach/ risk)
What is Professional scepticism?
Having the attitude of critical assessment and having a questioning mind (not taking everything at face value) to prevent overlooking suspicious circumstances and drawing incorrect conclusions.
Proceeds of Crime Act 2002
-What it does and who the Auditors inform
- What is ‘Tipping off’?
- What it does and who the Auditors inform
- Sets down the responsibilities for auditors to inform the National Crime Agency (NCA) of any suspicions they may have - Tipping off
- Auditors must not alert the suspect, as informing them is also a crime
Fraud Triangle in Auditing
- What it does
- What are the three key conditions that increase likelihood of fraud? (IOA)
- What it does:
- Identifies and assesses the risk of material misstatement due to fraud in financial statements - Three Identifiers:
- Incentives/ pressures
- Opportunities
- Attitudes/ rationalisations
What responses can be taken to action/ mitigate the risks of fraud?
- How to combat fraud through:
- Assertion
- Fraudulent Financial Reporting
- Misappropriation of Assets
- Assertion level (checking specific items)
- Surprise visits
- Alteration in audit approach
- Utilising automated resources to analyse data
- Reviewing with a management expert
- Fraudulent financial reporting
- Corroborating (confirming) revenue with customers
- Attending inventory counts without notice
- Using an auditor’s expert to confirm any accounting estimates created by management
- Misappropriation of assets
- Counting cash/ assets close to year end to avoid manipulation
- Automated tools to verify
What is Professional Judgement?
Using your knowledge, skills, and experience to make the right decisions during an audit.
What 2 concepts are taken into consideration with Professional Judgement? (MP)
- Materiality
- Perception
The AAT Code of Professional Ethics
- What are the 2 Ethical principles considered?
- Independence of mind
- The auditor stays objective and makes decisions without being influenced by others
- Independence in appearance
- The auditor avoids any situation that might make them seem biased to others
What are the 5 Fundamental ethical principles
FYI: (PIPCO)
- Professional competence and due care
- Staying up-to-date with skills and knowledge, and perform work carefully and to high standards - Integrity
- Be honest, straightforward, and trustworthy in all professional work - Professional behaviour
- Follow laws, regulations, and professional standards to maintain trust in the profession - Confidentiality
- Protect client information and don’t disclose it unless legally required - Objectivity
- Avoid bias, conflicts of interest, or undue influence when making decisions
What is the Conceptual Framework and what 5 threats should Auditors and Accountants aim to avoid?
FYI: (ASIFS)
Conceptual Framework
- Potential situations or ethical threats that auditors and accountants should aim to avoid
- Advocacy
- Auditor’s independence is compromised because they are seen as promoting or supporting the client’s interests or position - Self-interest
- Carry out decisions or conclusions because of personal benefit/ gain - Intimidation
- Being deterred from acting objectively by potential threats, whether actual or perceived - Familiarity
- Personal relationships may skew auditors objectivity (sympathetic to the clients interest) - Self-Review
- Auditor is in a position of reviewing or evaluating their own work or the results of services they previously performed for the same client
What are Licensed members and what type of threats may they be up against?
Licensed Members
- People who work in practise for a firm (external e.g. auditors).
Specific ethical threats faced:
1. Professional appointment
- Process of a licensed member being selected or reappointed to work with a client
- Second opinions
- Opinion shopping, searching for opinions that match clients interests - Fees and other remuneration
- Auditor’s fees are heavily influenced by factors unrelated to the scope of the engagement e.g. commissions - Marketing professional services
- Market themselves to clients in a way that doesn’t distort the truth or misrepresent (exaggerated/ misleading) - Gifts and hospitality
- Receiving goods or services in exchanged for maintaining good rapport - Custody of client assets
- Auditor holds or has control over a client’s assets - Objectivity and independence
- Relation to all services and assurance engagements
- Affected by all the above
What is the role of having Ethical safeguards?
Either eliminate or reduce threats to objectivity and independence.
What is Confidentiality Revocation and what 3 circumstances can this only be applied to?
Circumstances:
1. Permitted by law and authorised by the client
- Required by law such as court cases or investigations with HMRC or NCA
- Where there is a professional duty or right to disclose that is in the public interest and is not prohibited by law
What does Non-compliance with laws and regulation (NOCLAR) refer to, and what must members do in any instances of it?
NOCLAR
- Refers to situations where an organisation or its employees fail to follow legal rules or regulations
- Member needs to report any instances to the NOCLAR in a timely manner as these may have material impact on the financial statements and create harm to the general public
What is Security and what threats may arise through using virtual forms?
- What 4 controls can be put in place to mitigate the risks to Data Security?
Security:
- Measures ( either physical or virtual) that keep the duty of confidentiality
- Cybersecurity and cyberthreats may arise when storing audit information online
Controls:
1. Qualified IT staff
2. Investment in IT infrastructure
3. Education and awareness
4. Adopting suitable cybersecurity accreditation
When does Conflict of Interest occur?
- What must auditors do in cases of this?
Conflict of Interest:
- Occurs either when a member provides the same service to 2 competing clients, or the interests of both members being conflicted
Auditors role:
- Both parties must be aware you are providing audit for both of them (in competing cases) and they must give consent
