Role of the Audit - Lecture 6a

Question 1

Definition of auditing - from American Accounting Association

Answer 1

“A systematic process of objectively gathering and evaluating evidence in order to ascertain whether assertions about economic actions and events made by individuals/organisations correspond with established
criteria (GAAP and T&F Override) and communicating the results of the examination to users of the reports in which the assertions are made.”

Question 2

What does assertion mean

Answer 2

representation of the truth

Question 3

Who are the individuals/organisation?

Answer 3

-Chair
-CEO
-CFO
-Companies
-Clubs

Question 4

Internal Audits

Answer 4

The company check the accuracy and reliability of its own records and statements.

Question 5

External Audits

Answer 5

An independent firm of auditors (qualified accountants) checks the accuracy and reliability of the company’s records and statements.

Undertaken by professionally qualified an externally accredited auditors independent to the audited business.

Question 6

Why do External audits need to be independent?

Answer 6

To avoid accounting scandals, such as Enron.

Question 7

In large PLCs, who appoint the external auditors?

Answer 7

The FAC - financial audit committee of the PLC.

Question 8

Financial Audit Committee (FAC)

Answer 8

• a subcommittee of the board of directions

-at least three independent non-executive directors

• supplemented by attendance from senior managers within the company

-guidance on composition and function is provided by the UK financial reporting council

-part of their role is to appoint the external auditors

Question 9

Who are companies in the FTSE 100 audited by?

Answer 9

The big 4.
Their external audits are primarily for the benefit of shareholders, and for confidence in market efficiency

Question 10

Kingston Cotton Mills CO (1896) key points

Answer 10

• an auditor is not bound to be detective
  -he is a watchdog, not a bloodhound

Question 11

How to know if an item is material?

Answer 11

An item is material if it’s omission or misstatement would make any difference to the view, held by users (of the accounts).

Question 12

Materiality depends on context:

Answer 12

• High tolerance threshold, probably immaterial.
  -Low tolerance threshold, probably material.

Question 13

Material uncertainty and the going concern concept

Answer 13

Auditors are required to ask if the assumption of the going concern concept is valid. They need to know if it’s safe to assume the entity is going concern.
If they think the answer is no, then they must point out to the shareholders in the annual report that there is material uncertainty that cost doubt on the entities ability to continue as a going concern.

Question 14

What are aspects of the accounts that may cause doubt?

Answer 14

• significantly negative net current assets
  -continually worsening trade payable payment period
• sustained losses
• sales of non-current assets, followed by the leaseback of the same.

Question 15

“A watchdog not a bloodhound”

Answer 15

Does not imply auditors can simply different demand their fee regardless of the quality of work due to:
- common law having established duties.
- professional auditing standards and guidelines
- statutory duties

Question 16

What are the common law having established duties.

Answer 16

• reasonable skill
• care
• caution in the circumstances

Question 17

What are the professional auditing standards and guidelines ?

Answer 17

• informing/increasing the quality of audit work
  -protecting the reputation of auditors
  -shielding auditing from further government involvement

-mandatory compliance disciplinary action may be taken by the profession

Question 18

What are the statutory duties?

Answer 18

The Auditors are to prepare their report to the company’s shareholders on the company’s financial statements, including:
- identifying the FS that are the subject of the audit and the financial reporting framework used
- a description of the scope of the audit and the auditing standards adopted
- a clear statement as to whether the company’s FS gives a true and fair view of its state of affairs at the end of the year and its profit or loss for the year
- have been properly prepared in accordance with the relevant financial reporting framework (ie. IAS or UK GAAP)
- Comply with the Companies Act 2006.

In order to prepare their report, the auditors must carry out investigations and form an opinion as to whether:
– adequate accounting records have been kept by the company
– adequate returns have been received from branches of the company not visited by them
– F/S are in agreement with the accounting records and returns
– in the case of a quoted company, the auditable part of the directors’
remuneration report is in agreement with the accounting records and
returns

Question 19

Independence

Answer 19

Must possess an objective, unbiased attitude of mind, evaluate evidence, and express an opinion in partially without being influenced by personal bias.

Auditors must be seen to be independent, not give the impression to others that they are not independent:
- the case of Enron
-friendly relations, accepting freebies
-over familiarity
-order to rotation

Question 20

How thorough should they be? They should gather evidence required as to:

Answer 20

• completeness of records

-existence/occurrence, e.g. employees/phantom employees

-accuracy, e.g. building revaluation

-valuation/measurement judgements, e.g. depreciation

• ownership/rights and obligations, e.g. leased vs owned assets
• presentation/disclosure (notes to the accounts)

Question 21

Auditors liability

Answer 21

When the auditor accepts audit engagement, it is understood that they agree to perform the audit in accordance with certain statutory and common law obligations. If these obligations are not fulfilled, the audit is liable to certain parties who suffer losses as a result.