External audit

Question 1

The objective of an external audit is to

Answer 1

express an opinion (in terms of truth and fairness) on whether the financial statements are prepared, in all material respects, in accordance with an identified reporting framework (e.g. International Financial Reporting Standards) and the relevant law.

Question 2

Statutory audits (i.e. carried out according to statutory provisions) became mandatory for companies in the UK in

Answer 2

1900

Question 3

Company law requires statutory (external) audits

Answer 3

in the jurisdiction in which a corporation operates.

Question 4

Internal auditing –

Answer 4

an independent, objective assurance and consulting activity designed to add value and improve an organisation’s operations.

Question 5

The purpose of internal auditing is

Answer 5

It helps an organisation accomplish its objectives by bringing a systematic, disciplined approach to evaluating and improving the effectiveness of risk management, control, and governance processes.

Question 6

The expansion of the role of internal audit, whether required by legislation (e.g. in public sectors), listing regulations, corporate governance codes (e.g. the UK Corporate Governance Code) or as a voluntary activity, reflects

Answer 6

organisations’ economic and international growth.

Question 7

Assurance services –

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independent professional services that improve the quality of information, or its context, for decision-makers.

Question 8

An external audit provides confidence in the

Answer 8

integrity of corporate reporting for the benefit of stakeholders and society by providing an external and objective view of the statutory financial statements. Specifically, the audit enhances the degree of confidence of the shareholders in the financial statements.

Question 9

As an assurance service, an external audit must include the five elements of an assurance engagement:

Answer 9

1 - The subject matter is the financial statements prepared under the applicable financial reporting framework (e.g. IFRS Standards).
2 - The three-party relationship includes:
the directors, who are responsible for the financial statements;
the practitioner (i.e. the external auditor); and
the shareholders (and other intended users of the financial statements).
3 - The criteria used to evaluate the financial statements include the financial reporting framework.
4 - The external auditor plans and performs the audit engagement to obtain sufficient appropriate evidence to support the expression of an opinion on the financial statements.
5 - An opinion in an assurance report – the “independent auditor’s report”.

Question 10

Stewardship

Answer 10

Stewardship is the practice of managing another person’s property. Directors and other managers of an entity have the responsibility of stewardship for the property of that entity, which the shareholders own.

Question 11

Agency

Answer 11

An agent is an individual (or another entity) employed or used to provide a particular service. The individual using the agent is the principal.

Question 12

Accountability

Answer 12

Accountability is where one party is held responsible (answerable) to another party; it will be required to justify its actions and decisions to that party.

Question 13

ISAs provide the necessary standards for

Answer 13

audit work to enable the auditor to express an independent opinion on the financial statements.

Question 14

Each standard contains an

Answer 14

introduction, objectives, definitions, requirements and application detail (see Exhibit 1 below). If any objective cannot be achieved, the auditor must use his judgment to re-evaluate his ability to achieve the overall audit objective and, therefore, the effect on the auditor’s report.

Question 15

Statutory regulations cover, for example:

Answer 15

Requirement for audited accounts and audit exemption.
Eligibility and requirements to become and remain statutory auditors.
Appointment, removal or resignation of auditors.
Auditors’ reports, duties and rights.
Monitoring of auditors.
Rights of shareholders to raise audit concerns at the company’s annual general meeting of shareholders (AGM).
Liability of auditors.
Requirement of specific reports (e.g. for annual audits, interim financial statements for listed companies and accounts of small companies).

Question 16

Duties

Answer 16

4.5 Rights and Duties of Auditors
4.5.1 Duties
In most instances, the primary duty of a statutory auditor is to report to the company’s shareholders on the financial statements (statement of financial position, statement of profit or loss and other comprehensive income, statement of cash flows, accompanying notes, etc.) prepared to an accounting reference period (usually for a year).

Other duties relating to the statutory audit will vary between jurisdictions but may, for example, include the requirement to report that:

proper accounting records have been kept;
the auditor has received all necessary information and explanations; and
the directors’ report is consistent with the information contained in financial statements.

Question 17

Rights

Answer 17

An auditor cannot fulfil statutory duties without commensurate rights (which must also be legislated). For example:

To have access to the books, accounts, and vouchers at all times.
To require from company officers any information and explanations considered necessary for the audit.
To have unrestricted access to persons within the entity from whom the auditor determines it necessary to obtain audit evidence.
To receive notice of, attend and be heard at the general meeting of the company on business which concerns them as an auditor (e.g. a resolution to remove them from office).
Also, the auditor may have rights associated with his vacation of office (e.g. by resignation or removal) to bring matters to the attention of shareholders and creditors (e.g. if the auditor is removed because he gives a qualified audit opinion or if he resigns because he is not given access to necessary information).

Question 18

The X are ultimately responsible for the appointment of the external auditor.

Answer 18

shareholders

Question 19

As the shareholders are responsible for the appointment of the auditor, only the

Answer 19

shareholders have the power to remove the auditor from office (e.g. by ordinary resolution in a general meeting of shareholders).

Question 20

Resignation During Engagement

Answer 20

Although it is relatively rare, there are reasons why an auditor would resign from an engagement. These include:

significant limitations placed on the work of the auditor by management;
loss of trust/working relationship with management (e.g. significant doubt over management’s integrity); and
regulatory requirements (e.g. discovery of significant fraud).
Typically, the auditor must give written notice of his resignation to the client, which is sent to the appropriate regulatory and audit authorities.

The auditor must consider his professional duty to complete the engagement (e.g. he should not resign to avoid giving a qualified audit opinion) and the legal consequences of resignation.

Where resignation may have implications for legal proceedings (see Chapter 11), the auditor should seek ethical and legal advice before taking any action (e.g. from the ACCA and solicitors).

Question 21

Role of the Audit Committee

Answer 21

Where an entity has an audit committee, there is often a requirement under various corporate governance codes for such committees to have specific responsibilities with the external auditors (e.g. recommending appointment, remuneration, reviewing circumstances of resignation).

Question 22

The auditor cannot provide absolute assurance in an audit because of the inherent limitations of external audits. These inherent limitations arise from:

Answer 22

the nature of financial reporting;

the nature of audit procedures; and
the need for the audit to be conducted within a reasonable period and at a reasonable cost.

Question 23

The Nature of Financial Reporting

Answer 23

Some financial statement items are subject to an inherent level of variability because they involve judgment by management or subjective decisions or assessments, or a degree of uncertainty (e.g. accounting estimates).There are practical and legal limitations on the auditor’s ability to obtain audit evidence, including the following:

Question 24

There are practical and legal limitations on the auditor’s ability to obtain audit evidence, including the following:

Answer 24

There is a possibility that management or others may not intentionally or unintentionally provide all information that the auditor requires.

An audit is not an investigation into alleged wrongdoing, so the auditor does not have any specific legal powers necessary for such an investigation.

Any system of internal control has inherent limitations (see Chapter 9).
Fraud may be concealed so that it is difficult to detect with audit procedures (see Chapter 11).

Most audit evidence is persuasive, rather than conclusive (see Chapter 15). For example, physical possession of an asset does not necessarily prove legal ownership.
Testing is on a sample basis (see Chapter 19).

Question 25

Timeliness and Cost v Benefit

Answer 25

There is an expectation by users of financial statements that the auditor will form an opinion on the financial statements within a reasonable period and will achieve a balance between benefit and cost.

As it is impracticable for the auditor to address all information that may exist, it is necessary for the auditor to:

Plan the audit so that it is performed effectively.
Direct audit efforts to the areas where the risk of material misstatement is most expected.
Use testing and other means of examining populations for misstatement.