Chapter 2 Flashcards
During an audit team planning meeting, a member of the audit team passed a comment that based on past experience with the client, he was confident that the management of the client was honest and there was no issue as regards management integrity or risk of fraud in the company. Rhe audit manager responded that the auditor should always maintain an attitude of professional skepticism throughout the audit.
Required:
Briefly describe ‘audit skepticism ‘ and elaborate on the response of the audit manager.
Audit skepticism:
Professional skepticism is an attitude that includes:
1. a questioning mind,
2. Being alert to conditions which indicate possible misstatement (due to error or fraud), and
3. Critical assessment of audit evidence.
Elaborate on the response of audit manager:
Reponse of audit manager is correct. Application of professional skepticism helps that auditor does not:
*Overlook unusual circumstances.
*Over-generalize when drawing conclusions from audit observations.
*Use inappropriate assumptions in determining audit procedures, and evaluating results.
The purpose of an external audit and its role are not well understood. You have been asked to write some material for inclusion in your firm’s training materials dealing with these issues in the audit of large companies.
Required:
Draft an explanation dealing with purpose of an external audit and its role in the audit of large companies, for the inclusion in your’s firm training materials.
Purpose of an external audit:
The overall purposes of the auditor are:
*To obtain reasonable assurance whether financial statements are free from material misstatement (whether due to error or fraud), and
*To report on financial statements which includes auditor’s opinion, and
*To communicate auditor’s findings as required per ISAs.
Role in the audit of large companies:
1. It increases credibility of financial statements, as most of misstatements are identied.
2. Auditor indentifies deficiencies in entity’s internal control system, and gives recommendations to management to improve it.
3. It confirms that management is performing its statutory and non-statutory duties.
4. It assists in sale or purchase of business.
5. It assists in grant of loan by bank.
A friend of yours has invested in the shares of Ascender Limited. On receiving the company’s annual report, he made the
following comments:
“The auditor has expressed an unqualified opinion, Since the auditor must have arrived at his opinion after testing majority of the transactions, therefore the financial statements are correct in all respects. Since no control deficiencies and fraudulent conduct had been reported by the auditor, I can safely invest further amount of money in the company because there is no risk that I will lose my money due to fraudulent conduct of management or misrepresentations in the financial statements”
Required:
Write a letter to your friend to remove his misconceptions related to the audit of financial statements including brief explanation of your point of view.
(08)
(ICAP, CAF 08 Level-Antumn 2018. Q # 11
Following are the misconceptions in the comments:
- Auditor does not test majority of transactions. He tests only sample of transactions.
- Auditor does not provide assurance that financial statements are correct in all respects. He provides reasonable assurance that financial statements are correct in material respect.
- Auditor does no report internal control deficiencies in audit report. Further, there are always some limtiations of internal control even if auditor does not report them.
- Auditor is not responsible to report fraud in audit report.
- Audit report is not a guarantee that investment will be safe. Financial statements may contain errors or fraud even after audit because of inherent limitations of audit.
- Further, auditor report is not a guarantee that entity will continue as going concern in future too.
Following is an extract from audit report:
“We have audited the financial statements of Al-Qasim Limited, which comprise the statement of financial position as at June 30, 20x3, and the statement of profit or loss and other comprehensive income, the statement of changes in equity, for the year then ended, and notes to the financial statements”
Required:
Identify the errors in the above paragraph.
(Note: You are not required to redraft the report.)
(02)
(Adapted from ICAP’s Question Bank - Q. # 155)
The word “cash flow statement” has been omitted.
Tip for student:
There may be two types of errors in given “draft paragraph” in exam i.e. Error (something wrong) and Omissions (something missing).
The directors’ report of XCP Limited states without any further explanation that the 20% increase in profit as compared to the previous year is due to increase in sales. The income statement (verified by auditor) for the year shows that profit has increased because costs have reduced mainly on account of reduction in import duty on certain raw materials.
Required: Decide whether auditor should issue unmodified opinion or modified opinion, in this situation? (03) (Adapted from ICAP’s Question Bank - Q. # 157b)
Auditor should issue unmodified opinion, because directors’ report is misstated which is not included in complete set of financial statements. Therefore, financial statements give true and fair view.
The managing director of Birdie Ltd, an external audit client of your firm, has discovered that an employee has diverted £30,000 of company funds into his own bank account by creating and paying purchase invoices on fictitious supplier accounts over the last twelve months. The managing director has contacted your firm to express his concern that the audit team did not discover this fraud during the external audit and has requested a meeting with the engagement partner to discuss the issue. The financial statements for the current year show revenue of £25 million and profit before tax of £1.5 million.
Explain why the managing director’s expectation that the audit team should have discovered the fraud is unrealistic. (04)
(ICAEW-Professional, June 2011)
- Auditor is responsible to obtain reasonable assurance only whether financial statements are free from material misstatement.
- £30,000 is an immaterial amount (being less than 75,000 1,500,000* 5%), and auditor is not responsible to detect immaterial misstatement.
- Further, there are inherent limitations (e.g. use of sampling, collusion among employees) because of which auditor may not be able to detect all misstatements.
- Last but not least, primary responsibility to prevent and detect fraud rests with management.
The managing director of Westco Ltd discovered that staff in the company’s buying department do not follow the company’s policy of checking for the cheapest supplier when ordering goods. For several years, they have been using one of the most expensive suppliers who periodically treats buying department staff to meals in expensive restaurants. The managing director has expressed surprise that the external auditors did not uncover this irregularity during the external audit and has requested a meeting to discuss this matter.
List the matters the external auditor should discuss with the managing director at the meeting.
(04)
(ICAEW Adapted)
This is a weakness in internal control, not a misstatement. Auditor is not responsible to express opinion on internal control. He is responsible to communicate only if significant weakness is identified by him.
External auditor is not responsible if weakness was not significant, or he did not identify it because primary focus of auditor is on financial statements.
An article has appeared in a non-financial Magazine, the extracts of which are as follows:
“A Company’s annual reports and accounts known as financial statements will include a certificate by the Company’s Auditors who have been appointed by the directors. The certificate has to be signed before the directors approve the accounts and it must be read out by the auditors at the extra-ordinary general meeting.
Before the commencement of work, auditors will normally prepare two other documents which are in the form of letters to the shareholders. One is known as letter of weaknesses and deals with matters where audit evidence is weak and the auditor has had to place reliance on verbal assurances given to him by management or directors. It would also deal with the matters relating to improper appointment of auditors.
The other document is referred to as the engagement letter in which the auditor’s report any matters that came to light during the audit which ought to be notified to the shareholders.”
Enumerate atleast five errors in the above extract.
(05)
(ICAP, CFAP 06 Level Winter 1990)
Auditor never ever relies on verbal statement by management.
Auditor signs report after approval of financial statements by directors.
Usually auditor is appointed by shareholders, not by directors.
Auditor is appointed in AGM (not in EOGM).
Letter of weakness deals with deficiencies in internal control (and not where audit evidence is weak).
Letter of weakness is given to management/directors, and not to shareholders.
Engagement letter contains terms and conditions of engagement, and not matters which came to attention of auditor.
You and a colleague are carrying on a heated discussion. The colleague makes a number of statements about the auditing profession that you believe are wrong. Explain why each of the statement is wrong.
(1) “Auditing neither creates goods nor adds utility to existing goods and therefore does not add value to business. Auditing exists only because it has been legally mandated.”
(ii) “The only reason I would hire an auditor is with the expectation that the auditor search for fraud that might exist within my company. Searching for fraud should be the primary focus of an audit.”
(iii) “Auditing is narrow-just to find mistakes. I would rather pursue a career where I really understand a company’s business and would be in a position to make recommendations that would improve it.”
(iv) “If auditors make recommendations to clients based on weaknesses in the company operations, the auditors ought to make those recommendations public. This would help increase the public trust.”
(08)
(i) There are many advantages of conducting audit, even if it is not required by law. (state some of advantages)
(ii) Primary focus of auditor is verification of financial statements. Searching of fraud is not his responsibility. (however, if he identifies a fraud during audit, he communicates it to TCWG)
(iii) Scope of audit also includes obtaining understanding of entity and its internal control, and to make recommendation if deficiency in internal control is identified.
(iv) Auditor should not disclose confidential information to any third party. Further, external parties are usually interested in financial statements, and not in internal control.
