Chapter 18: Using the Work of Others Flashcards
What are the key differences between internal auditors and external (statutory) auditors in terms of relationship, appointment, qualifications, scope, reporting, and report format?
- Relationship/Independence: Internal auditors are employees of the entity; external auditors are independent. - Appointment: Internal auditors are appointed by the Board of Directors/Audit Committee; external auditors are appointed by the shareholders. - Qualifications: Internal auditors’ qualifications are determined by the Board/Audit Committee; external auditors’ qualifications are determined by law. - Scope/Objectives: Internal auditors evaluate and improve governance, management, and internal control (scope set by the Board/Audit Committee); external auditors express an opinion on the financial statements (scope set by ISAs, laws, and regulations). - Reporting: Internal auditors report to the Board/Audit Committee with restricted reports; external auditors report to members with publicly available reports. - Report Format: Internal auditors can use any format depending on circumstances; external auditors use formats determined by law.
Under what circumstances is an internal audit function established in an entity?
An internal audit function is established when its benefits exceed its cost. It is not required for every company and may be carried out by the entity’s own full-time staff or by an external firm.
Who appoints the internal audit function/department, and what is its primary objective?
The internal audit function is appointed by Those Charged With Governance (TCWG) to assist in ensuring good governance of the entity.
What are the primary functions (scope) of an internal audit department?
The scope may include: 1) Monitoring internal controls (testing and recommending improvements); 2) Examining financial and operating information (inquiries and tests on transactions and balances); 3) Reviewing compliance with laws and regulations; 4) Reviewing operating activities (operational audits or ‘Value for Money’ audits); 5) Conducting special investigations (e.g., fraud investigations).
In what two ways can external auditors make use of the work performed by internal auditors?
External auditors can use internal audit work by: 1) Relying on the work as audit evidence, and 2) Obtaining direct assistance (having internal auditors perform procedures under the external auditor’s direction, supervision, and review).
When an external auditor plans to use the work of an internal auditor, what key evaluation procedures are required by ISAs?
The external auditor must: 1) Evaluate the internal audit function (its objectivity, competence, systematic approach, etc.); 2) Determine in which areas the internal auditor’s work can be used (avoiding high-risk or high-judgment areas); 3) Evaluate the adequacy of the work performed (ensuring proper planning, supervision, and documentation); 4) Document the evaluation and basis for using the work.
What criteria should be used to evaluate the internal audit function’s competence and objectivity?
Criteria include: - Organizational Status: The chief internal auditor should report to TCWG (not management). - Scope Determination: Work scope should be set by the audit committee. - Freedom from Conflicts: Internal auditors should not perform managerial tasks. - Rotation: Periodic rotation (e.g., every 3–5 years) to avoid familiarity threats. - Employment Decisions: Decisions made by TCWG, not management. - Adequate Resources and Training: Ensuring sufficient education, qualifications, and professional experience. - Systematic and Disciplined Approach: Proper planning, supervision, documentation, and quality control.
In which audit areas is it generally acceptable for an external auditor to use the work of an internal auditor?
It is generally acceptable to use internal audit work for: 1) Documenting the accounting and internal control system; 2) Conducting risk assessments; 3) Testing the operating effectiveness of controls; 4) Performing substantive procedures that involve limited judgment; 5) Observing inventory counts; 6) Testing compliance with regulatory requirements; 7) Tracing transactions within the information system.
What audit procedures should an external auditor perform to evaluate the adequacy of internal audit work used?
Procedures include: 1) Reperformance of the work on a sample basis; 2) Inquiries with internal auditors; 3) Observation of the procedures performed; 4) Inspection of working papers to confirm proper planning, supervision, documentation, and resolution of exceptions. The extent of these procedures depends on risk, materiality, and the internal audit function’s competence and objectivity.
What communications and documentation are required when an external auditor uses internal audit work?
The external auditor must: 1) Communicate the planned use of internal audit work to TCWG; 2) Document the evaluation of the internal audit function (competence, objectivity, systematic approach); 3) Record the basis for the decision regarding the nature and extent of work used; 4) Document the audit procedures performed to evaluate the adequacy of the work.
What factors affect the independence of internal auditors?
Factors include: - Reporting Structure: Internal auditors should report to TCWG rather than management. - Scope Determination: Their work should be set by the audit committee. - Avoidance of Managerial Functions: They should not be involved in designing or operating controls. - Rotation: Regular rotation (e.g., every 3–5 years) to prevent familiarity. - Employment Decisions: Should be made by TCWG rather than management.
What is meant by ‘direct assistance’ from internal auditors in the context of an external audit?
Direct assistance refers to using internal auditors to perform audit procedures under the external auditor’s direction, supervision, and review.
Under what conditions can an external auditor obtain direct assistance from internal auditors, and in which areas should it NOT be used?
Before obtaining direct assistance, the external auditor must consider: 1) Whether law prohibits it; 2) The objectivity and competence of the internal audit function; 3) The risk and judgment involved in the area. Direct assistance should NOT be used in areas with high risk or significant judgment, evaluating fraud risks, determining unannounced audit procedures, handling external confirmations, deciding on internal audit functions, or areas where internal auditors are already involved.
What written agreements must be obtained before using direct assistance from internal auditors?
Written agreements must be obtained from: 1) An authorized representative of the entity confirming that internal auditors will follow the external auditor’s instructions without interference, and 2) The internal auditors themselves, agreeing to maintain confidentiality and notify the external auditor of any threats to their objectivity.
What are the external auditor’s responsibilities regarding direction, supervision, and review when using internal auditors for direct assistance?
The external auditor must: 1) Direct the internal auditors’ work to ensure proper audit procedures are followed; 2) Provide more extensive supervision (given the internal auditors’ lack of independence); 3) Review the work, including checking underlying evidence, to ensure sufficient appropriate audit evidence is obtained.
What must be communicated to TCWG when direct assistance from internal auditors is used?
The external auditor must communicate the nature and extent of the planned use of internal auditors for direct assistance to TCWG.
List the documentation requirements if direct assistance from internal auditors is obtained.
Documentation must include: 1) The evaluation of the internal auditors’ competence and any threats to their objectivity; 2) The basis for deciding on the nature and extent of work performed by the internal auditors; 3) Details of who reviewed the work, including dates and the extent of the review; 4) Written agreements from both the entity’s authorized representative and the internal auditors; 5) The working papers prepared by the internal auditors.
What is an auditor’s expert?
An auditor’s expert is an individual or organization possessing specialized expertise and experience in a field other than accounting or auditing.
List examples of areas or situations in which an auditor’s expert may be engaged.
Examples include: 1) Valuation of assets (e.g., property); 2) Legal opinions; 3) Actuarial calculations (e.g., pension liabilities); 4) Engineering data (e.g., estimating the life of machinery or oil/gas reserves); 5) Analysis of complex or unusual tax issues; 6) Interpretation of contracts, laws, and regulations; 7) IT expertise.
What factors should be considered when assessing the need to engage an auditor’s expert?
The decision depends on: 1) The nature, significance, and complexity of the matter; 2) The risk of material misstatement; 3) The availability of alternative sources of evidence.
What steps should an external auditor take to evaluate an expert’s competence, capabilities, and objectivity?
The auditor should evaluate the expert’s professional qualifications (e.g., licenses, membership in professional bodies), experience, reputation, and independence (ensuring no conflicts of interest or relationships that could impair objectivity).
Why must an external auditor obtain an understanding of the expert’s field of work?
Understanding the expert’s field is necessary to determine the nature, scope, and objectives of the expert’s work and to evaluate whether the expert’s work is adequate as audit evidence.
What key terms should be agreed upon with an auditor’s expert before engagement?
Key terms include: 1) The nature, scope, and objectives of the expert’s work; 2) The respective responsibilities of the auditor and the expert; 3) The form and content of the expert’s report; 4) Confidentiality requirements.
How should an external auditor evaluate the adequacy of the work performed by an expert?
The auditor should evaluate: 1) The accuracy, completeness, and relevance of significant source data; 2) The reasonableness and relevance of the assumptions and methods used; 3) The consistency and reasonableness of the expert’s findings and conclusions with other audit evidence.
What actions must an external auditor take if the expert’s work is found to be inadequate for audit purposes?
If the expert’s work is inadequate, the auditor should: 1) Agree with the expert on additional work, or perform additional audit procedures (e.g., engage another expert); 2) If still inadequate, consider it a scope limitation that may lead to a qualified or disclaimer of opinion if the effect is material or pervasive.
What are three factors an external auditor should consider when assessing the competence and objectivity of an expert?
The auditor should consider: 1) The expert’s professional qualifications; 2) The expert’s experience and reputation; 3) The expert’s independence (ensuring no conflicts of interest or relationships with the client).
Does the use of an expert’s work affect the external auditor’s responsibility for the audit opinion?
No. Even if the auditor uses an expert’s work to obtain audit evidence, the auditor remains solely responsible for forming and expressing the audit opinion.
Under what circumstances may an external auditor refer to the use of an expert in the audit report?
The auditor may refer to the use of an expert if: 1) It is required by law or regulation; 2) The reference is necessary to explain a modification to the auditor’s opinion; or 3) It is a Key Audit Matter. The report must state that the auditor remains fully responsible for the audit opinion.
Can an auditor mention the use of an expert in his audit report, and if so, when?
Yes, an auditor can mention the use of an expert, but only if it is required by law/regulation or necessary to explain modifications to the audit opinion, or as part of a Key Audit Matter. Any such reference must clarify that the auditor retains sole responsibility for the audit opinion.
(Case Study) Would you rely on the work of an internal auditor who reports to the Finance Manager and is involved in pre-audit functions such as preparing invoices?
Generally, no. Reporting to the Finance Manager and involvement in pre-audit functions can compromise the internal auditor’s independence and objectivity, making their work less reliable for external audit purposes.
(Case Study) How might ignoring the internal audit activity due to perceived lack of independence affect overall audit performance?
Ignoring the internal audit function may result in lost opportunities for audit efficiency and lead to insufficient audit evidence. Even if concerns about independence exist, a proper evaluation might reveal that valuable, reliable evidence is available.
