Chapter 11 Reporting on an audit engagement Flashcards
1.1 Financial statements review – appropriate persons
ISA 260 deals with auditor’s responsibility to communicate with those charged with governance in an audit engagement. Those charged with governance include the directors of a company and the members of an audit committee where one exists. The auditor should ensure they are provided with a copy of the engagement letter which sets out:
- The form of communications to those charged with governance will take
- The appropriate persons to whom such communications will be made
- An explanation that only matters as a result of the performance of the audit will be communicated
1.2 Matters to be communicated
The requirements in ISA 260 include the responsibilities of the auditor in relation to the financial statements audit, an overview of the planned scope and timing of the audit and significant findings from the audit. For listed clients, matters relating to auditor independence must also be communicated. Confirmation of the audit team have complied with ethical requirements, declaration of matters that may have a bearing on independence including disclosure of fees received for non-audit services from the client and details of safeguards applied.
1.3 Form of communications
Generally, the auditor can communicate orally or in writing. Discussions should be documented in working papers. Matters communicated to listed companies on the subject of independence and significant deficiencies in internal control must be communicated in writing. Effective communication has the following attributes such as timely, appropriate extent form and frequency, fulfils the expectations of those charged with governance, includes management comments where relevant, repeat the previous year’s points where still unresolved and relevant and includes a disclaimer so that third parties do not reply on the communications.
2.1 Audit reports
The ISAs for audit reports are in line with the equivalent international standards, with additional guidance specific to UK law. Current guidance on the contents of the audit report comes from:
- ISA 700 contents of standard audit reports
- ISA 701 requirement to communicate key audit matters in the audit report
- ISAs 705 and 706 modifications to the audit report
- ISA 720 responsibilities in relation to other information published with the accounts
- FRC bulletin illustrative auditor’s reports
- Companies act 2006 includes requirements that auditors report on certain matters other than the opinion on the accounts
2.2 Unmodified audit report
ISA 700 sets out the main components of an auditor’s report:
- Title: Independent auditor’s report
- Addressee: shareholders
- Auditor’s opinion: identify the statements covered by the auditor’s report. Provide the opinion on true and fair and properly prepared in accordance with relevant financial reporting framework and Companies Act 2006
- Basis for opinion refers to ISAs, independence, and the ethical framework to provide a context for the opinion
- Going concern: UK audit reports must always include this. The specifics are tailored to the engagement. Provides a summary of the auditor’s conclusions on this area. Report in accordance with ISA 570
- Key audit matters: brief description of matters the auditor considers to be of most significance during the audit in accordance with ISA 701
- Other information: report in accordance with ISA 720 where applicable
- Responsibilities of management: refer to statement of directors’ responsibilities is included either in directors’ report or as a separate statement
- Auditor’s responsibilities: set out objectives of the audit, emphasising the audit reports on truth and fairness of the accounts. Include statement regarding extent auditor considers the audit is capable of detecting irregularities including fraud
- Opinion on other matters prescribed by Companies Act 2006: report whether strategic report and directors report are consistent with accounts
- Matters on which the auditor is required to report by exception: UK auditors required identify matters required by Companies Act 2006 to be reported on by exception
- Sign-off: name and signature of engagement partner, auditor’s address, and date of the report (after management approve the accounts)
2.3 Key audit matters
ISA 701 deals with how the auditor reports key audit matters. The auditors of listed companies follow requirements of ISA 701. Key audit matters are matters the auditor has communicated to the client, they are matters the auditor judges to have had the most significant impact on overall audit strategy and audit work. These include most significant risks of material misstatement. The auditor must provide a description of all key audit matters, explaining why the matter is significant and how it was addressed in the audit, include a summary of response and observations in related to significant assessed risks and explain how their scope of work addressed each key audit matter and was influencing by applying materiality.
2.4 Reporting on the director’s report consistency
Auditors report on whether the information within the directors’ report is consistent with the accounts. If an inconsistency is found, auditors ask directors to amend their report. If they fail to do so, the auditor should modify the opinion given.
2.5 Matters on which the auditor is required to report by exception
Companies Act 2006 requires the auditor to report by exception when adequate accounting records have not been kept, returns adequate for the audit have not been received from branches not visited, the accounts are not in agreement with underlying records, directors’ remuneration disclosures were not made and information and explanation necessary for the audit were not received. In addition, they report by exception if a corporate governance statement has not bene prepared by a listed company and material misstatements have been identified, in the directors’ report or strategic report.
2.6 Bannerman
Bannerman case held that the royal bank of Scotland was entitled to reply on the published accounts of a company for purposes of lending the company money. UK auditors have included an extra paragraph stating they do not accept responsibility to anyone other than the company and the company’s shareholders as a body.
2.7 UK corporate governance code
Companies Act 2006 requires listed companies to include a corporate governance statement in their annual report. The auditor’s responsibilities are report by exception if no corporate governance is included and report on the company’s compliance with the specific provisions of the UK corporate governance code.
3.1 Modified audit reports
A modified report is where there is some change to the standard ISA 700 audit report. Modifications are used when the auditor wishes to communicate something of influence on the users of the accounts. The auditors options are a modified report with an unmodified opinion and a modified report and opinion.
3.2 Modified report with an unmodified opinion
This option is used where the accounts show a true and fair view, so the opinion is unmodified, but the auditor has something important to communicate to the users of the accounts. The auditor will include an additional paragraph in the audit report. ISA 706 deals with matters that lead to a modified audit report but do not affect the audit opinion. The two types of paragraph used are:
- Emphasis of matter paragraph: used to highlight in the accounts which has been appropriately presented or disclosed but which is fundamental to understanding of the users of the accounts. This paragraph is headed up ‘Emphasis of matter’, describes the matter and includes a reference to where disclosures can be found in the accounts and states the audit opinion is not modified in this respect. Examples are for material uncertainty concerning outcome of litigation and a major event having a significant impact on entities financial position
- Other matter paragraph: used to highlight a matter not included in the accounts. This is headed up ‘ other matter’ and describes the matter. An example is the prior period accounts were audited by the predecessor auditor, or were not audited at all, as required by ISA 710
These paragraphs traditionally follow the opinion paragraph. The format set out in ISA 700 means an emphasis of matter paragraph is generally inserted below the basis of opinion, but ISA 706 allows flexibility according to the matter covered. These paragraphs should be communicated with those charged with governance.
3.2 Modified report with a modified opinion
Auditors may identify issues that mean they are unable to say the accounts give a true and fair value. The two types of problem are the accounts are misstated (auditor disagrees with directors over accounting treatment or disclosure) and the auditor is unable to obtain sufficient appropriate audit evidence (known as limitation of scope). When an auditor identifies misstatements or limitations on scope, they should ask the client to make an adjustment to the accounts where necessary, consider materiality and consider the impact on the audit opinion.
ISA 705 identifies two levels of significance, that being material (could be by size or nature) and material and pervasive (defined as a matter which is not confined to particular elements of the accounts or represents a substantial proportion of the accounts or is fundamental to the users’ understanding.
If the client does not make the required adjustment or not alternative audit evidence can be found the report will show a modified opinion and explain the reason for modification.
- Qualified opinion is given when the accounts are materially misstated or there is an inability to obtain sufficient appropriate audit evidence and the balance is not material but not pervasive.
- Adverse opinion is given when the accounts are materially misstated and the balance is material and pervasive
- Disclaimer of opinion is given when there is an inability to obtain sufficient appropriate audit evidence and the balance is material and pervasive
4.1 Special considerations – ISA 800 audits of accounts prepared in accordance with special purpose frameworks
Some companies prepare a complete set of accounts on a different accounting basis. For example, prepared on a tax basis to accompany a tax return, prepared using financial reporting provisions of a regulator and prepared on a cash basis to provide cash flow information to creditors. The general principle is that ISAs should be followed, but ISA 800 provides guidance as to how to apply the ISAs. The auditor’s report should include an emphasis of matter paragraph highlighted the use of the special purpose framework.
4.2 ISA 805 special considerations audit of single accounts and specific elements, accounts, or items of a financial statement
Some companies require an audit of a specific element of the accounts, or a single financial statement. For example, externally managed assets and income of a private pension plan, net tangible assets and a balance sheet. The general principle is that ISAs should be followed but ISA 805 provides guidance on how to apply ISAs. Before accepting an appointment to audit a specific element of the accounts or a single financial statement, the auditor should consider whether it is practical to carry out this work without auditing the complete accounts. In some circumstances the work required may be disproportionate to the part of the financial statements being audited.
