ACCA F8 (INT) Audit & Assurance - 2010 - Study text - Emile Woolf Publishing
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Paper F8 (INT)
Audit and assurance
CHAPTER
15
Audit finalisation
Contents
1 Going concern review: ISA 570
2 Subsequent events: ISA 560
3 Written representations: ISA 580
4 Evaluation of misstatements: ISA 450
5 Overall review of the financial statements
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Going concern review: ISA 570
Going concern basis and IAS 1
Going concern: duties of the directors
Going concern: duties of the auditor
Factors that raise questions about the going concern assumption
Going concern assumption: audit procedures
1 Going concern review: ISA 570
After carrying out substantive testing, the auditor is getting close to the end of the
audit process. However, several steps remain to be performed before the auditor
can reach a conclusion on the financial statements or the other information that is
subject to audit. These steps are the subject matter of most of this chapter.
Most of the procedures described here relate to the work of the external auditor, but
some may also be relevant to the work of internal auditors.
1.1 Going concern basis and IAS 1
As covered in Paper F3, it is normally assumed that financial statements can be
prepared on a going concern basis. Under the going concern basis it is assumed that
the entity will continue in operational existence for the foreseeable future. The
‘foreseeable future’ (according to IAS 1) is at least 12 months.
IAS 1 states that management should make an assessment about whether the entity
is able to continue as a going concern. The financial statements should be prepared
on a going concern basis unless management intend to cease trading in the
foreseeable future or will have no realistic alternative but to cease trading.
When management makes an assessment that there are material uncertainties
about whether the entity will continue as a going concern, the financial
statements may be prepared on a going concern basis. However, the
uncertainties about going concern status must be disclosed in a note to the
financial statements.
If the financial statements are not prepared on a going concern basis, this fact
must be disclosed, together with:
− the basis that has been used instead to prepare the financial statements, and
− the reason why the entity is not considered to be a going concern.
1.2 Going concern: duties of the directors
In preparing the financial statements, the directors must satisfy themselves (in
accordance with IAS 1) that the going concern basis is appropriate. In some
countries, there is a requirement for large companies (listed companies) to disclose
the fact that, in the opinion of the directors, the entity is a going concern.
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It is therefore the responsibility of management to make the going concern
assessment.
1.3 Going concern: duties of the auditor
The work of the external auditor on the going concern status of an entity is covered
by ISA 570 Going concern. Key points from ISA 570 are set out below.
The objectives of the auditor in this area, per ISA 570, are to:
obtain sufficient appropriate evidence about the appropriateness of
management’s use of the going concern assumption in the preparation and
presentation of the financial statements
conclude whether a material uncertainty exists that may cast significant doubt
on the entity’s ability to continue as a going concern, and
determine the implications for the audit report.
The impact on the audit report is considered in a later chapter on reporting.
This is a subjective area where judgement will be required to assess the
uncertainties surrounding the assumptions that were made by management in
reaching their conclusion about the going concern status of the entity.
The requirements of ISA 570
The requirements of ISA 570 are as follows:
As required by ISA 315, the auditor must perform risk assessment procedures to
consider whether there are events or conditions that may cast significant doubt on
the entity’s ability to continue as a going concern.
If management has already performed such an assessment, the auditor must:
discuss this assessment with management
determine whether the assessment identified any relevant events or conditions,
and, if so
determine management’s plans to address them.
If management has not yet performed such an assessment, the auditor must:
discuss with management the basis for the intended use of the going concern
assumption, and
enquire of them whether events or conditions exist that may cast significant
doubt on the entity’s ability to continue as a going concern.
The auditor needs to be satisfied that management are realistic in their use of the
going concern assumption.
In evaluating management’s assessment the auditor must consider the same time
period. If management looked less than 12 months into the future, the auditor
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should ask management to make a re-assessment looking at least 12 months into the
future. The auditor must also enquire if management is aware of any relevant
events or conditions beyond this time period.
The auditor should remain alert throughout the audit process for factors or events
that may indicate that the going concern status could be questionable/doubtful.
If the auditor has doubts about the going concern assumption, but management
have used this assumption to prepare the financial statements, the auditor must
report to the shareholders that the use of the going concern assumption is (in the
auditor’s view) inappropriate. This is considered in more detail later.
1.4 Factors that raise questions about the going concern assumption
Factors that may cast doubt on the going concern status of the entity include the
following:
Recurring operating losses.
A heavy dependence on short-term finance for long-term assets.
Working capital deficiencies (such as a large bank overdraft, or exceptionally
low levels of inventory).
High gearing (a high ratio of debt capital to equity).
Loan interest payments are in arrears.
Excessive or obsolete inventory.
A deterioration in the entity’s relationships with its banks (evidenced, perhaps,
in written correspondence).
Increased use of lease and hire purchase finance, in place of purchasing assets.
Use of out-of-date technology.
A low level of current sales orders.
The entity relies very heavily on the success of one product
There are legal proceedings in progress that may jeopardise the entity’s ability to
continue in business.
A loss of key management or staff.
A loss of a key customer or supplier
A significant increase in the level of competition in the market.
1.5 Going concern assumption: audit procedures
Where events or conditions have been identified that may cast significant doubt on
the entity’s ability to continue as a going concern the auditor must obtain sufficient
appropriate evidence to determine whether in fact a material going concern
uncertainty does exist. He does this by performing additional audit procedures.
Discussion with management. Management should be asked to explain the
reasons why they consider the going concern assumption to be valid. They
should also be asked about their future plans for the business. If the entity is
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expecting to make a loss next year, the possible implications of this for the going
concern assumption should be discussed extensively.
Obtain a cash flow forecast. A cash flow forecast should be obtained from the
entity and this should also be discussed with management. The assumptions in
the forecast should be checked and, if appropriate, challenged. If there is a
forecast of a cash shortage, the auditor should discuss with management their
plans for obtaining the additional financing that will be required.
Review the sales order book. If this indicates a decline in sales orders, the issue
should be discussed with management.
Review ageing receivables. Check a list of ageing receivables and assess the
average time to pay. If customers are taking longer to pay, this may have
adverse implications for operational cash flow.
Consider whether planned capital expenditure by the entity may be insufficient
to support the business as a going concern in the future.
If a key senior employee has left the business entity in the recent past, the
possible implications (for example, the possibility of losing key customers with
the loss of the key employee) should be discussed.
Litigation. If the company is involved in continuing litigation, and faces the
possibility of having to pay a large amount of money to settle the dispute, the
implications should be discussed.
Information from the client entity’s bank. If the client entity is expecting to rely
on continuing financial support from its bank (for example, a continuation of its
bank overdraft facility) the bank should be asked to confirm that the finance will
remain available.
After discussing the issues with management, the auditor should obtain a letter
of representation from management confirming their opinion that the entity is a
going concern.
The financial statements are the responsibility of management, and if the auditor
considers that the going concern assumption is invalid whereas management
consider it to be valid, the options available to the auditor are to:
discuss the matter with management, having carried out audit procedures to
obtain more evidence
try to persuade management to change their mind and prepare the financial
statements on a different basis (a break up basis), and
if management does not agree to change its view, consider making a qualified
audit report.
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Unless all those charged with governance are also involved in managing the entity,
the auditor must communicate to those charged with governance any events or
conditions that may cast significant doubt on the entity’s ability to continue as a
going concern. Such communication must include the following:
Whether the events or conditions constitute a material uncertainty.
Whether the use of the going concern assumption is appropriate.
Whether the related disclosures in the financial statements are adequate.
If there is a significant delay in the approval of the financial statements, which the
auditor believes is due to events or conditions related to the going concern
assessment, he must:
perform the additional audit procedures listed above
consider the effect of this delay on his conclusions.
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Subsequent events: ISA 560
IAS 10 and ISA 560
Events occurring up to the date of the audit report
Facts discovered after the date of the audit report
2 Subsequent events: ISA 560
2.1 IAS 10 and ISA 560
It is not possible to prepare financial statements that present a true and fair view by
considering only those events and transactions that take place before the date at
which the balance sheet is prepared. Material events that occur after the reporting
period should also be considered when preparing the financial statements for the
year. Although IAS 10 was covered in your Paper F3 studies, it is such an important
standard in relation to ISA 560 that its principles are revised below.
Purpose of IAS 10
IAS 10 Events after the reporting period has two main objectives:
to specify when an entity should adjust its financial statements for events that
occur after the reporting period, but before the financial statements are
authorised for issue, and
to specify the disclosures that should be given about events that have occurred
after the reporting period but before the financial statements were authorised for
issue.
Events after the reporting period are defined in IAS 10 as ‘those events, favourable
and unfavourable that occur between the end of the reporting period and the date
when the financial statements are authorised for issue.’
There are two types of events after the reporting period:
Adjusting events. These are events that provide evidence of conditions that
already existed at the end of the reporting period.
Non-adjusting events. These are events that have occurred due to conditions
arising after the reporting period.
Accounting for adjusting events after the reporting period
IAS 10 states that if an entity obtains information about an adjusting event after the
reporting period, it should adjust the financial statements to reflect this new
information.
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IAS 10 gives the following examples of adjusting events:
The settlement after the reporting period of a court case, confirming that the
entity had a present obligation as at the end of the reporting period as a
consequence of the case.
The receipt of information after the reporting period indicating that an asset was
impaired at the end of the reporting period.
The determination after the reporting period of the purchase cost of an asset,
where the asset had already been purchased at the end of the reporting period,
but the purchase price had not been finally agreed or decided.
The discovery of fraud or errors showing that the financial statements are
incorrect.
Disclosures for non-adjusting events after the reporting period
Non-adjusting events after the reporting period are treated differently. A non-
adjusting event relates to conditions that did not exist at the end of the reporting
period; therefore the financial statements should not be updated to include the
effects of the event.
However, IAS 10 states that if a non-adjusting event is material, a failure by the
entity to provide a disclosure about it could influence the economic decisions taken
by users of the financial statements. For material non-adjusting events IAS 10
therefore requires disclosure of:
the nature of the event, and
an estimate of its financial effect, or a statement that such an estimate cannot be
made.
This information should be disclosed in a note to the financial statements.
IAS 10 gives the following examples of non-adjusting events:
A fall in value of an asset after the reporting period, such as a large fall in the
market value of some investments owned by the entity, between the end of the
reporting period and the date the financial statements are authorised for issue.
The acquisition or disposal of a major subsidiary.
The formal announcement of a plan to discontinue a major operation.
Announcing or commencing the implementation of a major restructuring.
The destruction of a major plant by a fire after the reporting period.
The role of the auditor: ISA 560
The work of the external auditor in this area is covered by ISA 560 Subsequent events.
The objectives of the auditor, as stated in ISA 560 are as follows:
The auditor should obtain sufficient, appropriate evidence about whether events
occurring between the date of the financial statements and the date of the audit
report are appropriately reflected in those financial statements.
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The auditor should also respond appropriately to facts that become known to
him after the date of the audit report that, had they been known to him at that
date, may have caused him to amend his report.
This means that audit procedures must be planned and performed so as to consider
all significant transactions occurring after the reporting period. This means that the
audit work does not stop with events only up to the end of the reporting period.
There are two key dates after the end of the reporting period: the date of the audit
report and the date that the financial statements are issued:
Before the issue of the audit report, the auditor should actively look for
significant subsequent events. This is sometimes referred to as an active review.
After the issue of the audit report (and up to the time that the financial
statements are issued), the auditor has to consider the impact of any significant
subsequent events that come to his attention. However, he does not have to look
for these events actively. This is sometimes referred to as a passive review.
2.2 Events occurring up to the date of the audit report
Between the end of the reporting period and the date of the audit report, the auditor
is required to obtain sufficient appropriate evidence that all events that require
adjustment of or disclosure in the financial statements:
have been identified, and
are suitably reported in the financial statements.
Normal audit verification work
The auditor may find sufficient evidence of subsequent events in the course of his
normal audit verification work. Where this is the case he is not required to perform
additional audit procedures. Such normal audit verification work might include the
following:
The audit of receivables will consider whether receivables at the end of the
reporting period are collectable. Cash receipts after the year-end may indicate a
significant non-payment, suggesting the need to write off a debt as ‘bad’.
The audit of inventory includes a review of the net realisable value of inventory.
Sales of inventory after the year-end may indicate that some inventory in the
balance sheet is over-valued (because subsequent events have shown that its
NRV was less than cost).
A search for unrecorded liabilities may discover the existence of some
unrecorded liabilities, from invoices received after the reporting period but
relating to the period covered by the financial statements.
A review of the entity’s cash position at the end of the reporting period may find
that a cheque from a customer, recorded as part of the bank balances, was
dishonoured after the reporting period.
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Procedures aimed specifically at identifying subsequent events
The auditor should also actively look for ‘subsequent events’, up to the time that he
prepares the audit report. Taking into account his risk assessment of this area, he
should:
obtain an understanding of management’s procedures for identifying
subsequent events
enquire of management as to whether any subsequent events have occurred
which might affect the financial statements
read the entity’s latest subsequent financial statements
read minutes of shareholders’ meetings, meetings of the board of directors and
senior management meetings held after the date of the financial statements and
enquire about matters discussed at any such meetings where minutes are not yet
available
obtain written representations in respect of subsequent events (covered in a later
section).
2.3 Facts discovered after the date of the audit report
Even after the date on which the audit report is signed, the auditor retains some
degree of responsibility for events of which he becomes aware, up to the time that
the financial statements are issued. He is not required, during this period, to actively
look for subsequent events. His level of responsibility is therefore much reduced
compared with the period before the signing of the audit report.
Between the date of the audit report and the issue of the financial statements
The auditor has no obligation to perform any audit procedures after the date of his
audit report. However, if he becomes aware of a fact that, had it been known to him
at the date of his report, may have caused him to amend his report then he is
required to:
discuss the matter with management
determine whether the financial statements need amending, and
enquire how management intend to address the matter in the financial
statements.
If the financial statements are amended, the auditor is required to:
carry out the necessary audit procedures on the amendment
extend his review of subsequent events up to the date of the new audit report.
(In some jurisdictions management are not prevented from restricting their
amendments to the effects of the subsequent event. In such cases ISA 560 permits
the auditor to restrict his extended review of subsequent events to that amendment
only. In such a case the auditor must draw attention to this restriction in an
emphasis of matter paragraph or other matter paragraph (covered in a later
chapter)).