Chapter 8 Assurance Flashcards
1.1 Due diligence
This is a form of assurance engagement and usually takes place in an acquisition or refinancing. Objectives may include:
- Confirming the accuracy of information
- Providing the bidder with an independent assessment of the target business
- Identifying and quantifying areas of commercial and financial risk
- Giving assurance to finance providers
- Place the bidder in a better position to determine the value of the target company
There are several types of due diligence work:
- Financial: to check the accuracy of financial information
- Commercial: understand the market, customers, satisfaction
- Technical: see what research and development is taking place
- IT: highlight any issues in merging the systems
- Legal: check for legal impediments
- HR: highlight any HR issues, or redundancies required
- Tax: search for any historical tax liabilities
1.2 Due diligence: exam technique
Step 1 Due diligence risks: identify the risks from the information provided. Typical risk areas include overstatement of earnings and assets, draft financial statements used to increase risk of error, analytical review identifies unusual relationships, accounting estimates manipulated to overstate earnings or assets, highly complex or subjective areas more likely to be misstated, post-acquisition markets may not support the level of growth forecasted, bid values may be over optimistic and costs of integration greater than expected.
Step 2 Due diligence procedures: need to describe specific procedures that link to risk identified. Aim to perform a specific action on a specific source. Generic procedures include:
- Inspect borrowing agreements to ensure there are no restrictive covenants of which the bidder was not aware
- Validate underlying assumptions to estimate the redundancy costs
- Review valuation reports to attest to the FV of assets
- Compare the discount rate to market interest rates to review appropriateness
- Review regional growth, changes in local competition and other market data to gain assurance over the predicted growth levels
- Validate any potential cost savings
- Legal due diligence will establish rights over a brand
- Review future orders for assurance over the future sales
- Assess compatibility of IT systems between combining companies, to see if it can be integrated or if additional costs will be required
3.1 Other assurance engagements
ISAE 3402 gives guidance on assurance reports on controls at a service organisation. These reports can be used by the user organisations and their auditors. Key procedures include:
- Assess the description of the service organisation’s system provided to user organisations
- Evaluate whether the controls related to control objectives stated in the description were suitably designed
- Test controls to assess whether they were operating effectively throughout the period
Types of report include a type 1 report which reports on description and design of controls only. Type 2 report, reports on description, design and operating effectiveness of controls. Both types of report provide reasonable assurance and thus the conclusions are positively worded.
3.2 Agreed upon procedures
In an agreed-upon procedures engagement a factual findings report is provided of the specific procedures carried out. No assurance is expressed and the recipients must form their own conclusion.
As a minimum, practitioners are required to comply with international standards on related services (ISRS 4400), engagements to perform agreed-upon procedures regarding financial information.
The value of an AUP comes from the practitioners objectively carrying out procedures and tests with relevant expertise. The exam approach is:
- Identify the purpose and nature of the engagement, so that priority can be applied to the procedures
- Suggest specific procedures, as per due diligence, with specific actions and reasons why the procedure addresses the purpose of the engagement
3.3 Environmental auditing
An environmental audit is an evaluation of how well an entity is performing, with the aim of helping to safeguard the environment. It is also used for auditing the truth and fairness of an environmental report. The audit could be a general review of the organisation’s environmental policy or specific aspects of environmental performance. This could be linked to ESG reporting. There are three main stages in most environmental audits:
- Establishing the metrics to assess the environment, such as % of waste recycled
- Measuring planned performance with actual performance
- Reporting the results
Potential audit concerns:
- Board and management’s understanding of the environmental impact and related legislation
- Adoption and communication of policies to ensure compliance
- Adoptions of appropriate environmental information systems
- Quantifiable targets are used for review
- Assessment of whether the progress is made economically and efficiently
- Implementation of previous recommendations
- True, fair and complete reporting of environmental activities
3.4 Assurance for ESG content
Quoted companies and large unquoted companies are required to disclose information about ESG issues as part of the Director’s report.
This does not require an auditor’s opinion, however, the external auditor is responsible for reviewing all of the information disclosed in the document containing the audited financial statements.
This will limit the risk of misleading disclosures being made, as the auditor should confirm that there are no material inconsistencies between the disclosures and the financial statements.
