ACCA F8 (INT) Audit & Assurance - 2010 - Study text - Emile Woolf Publishing
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Chapter 15: Audit finalisation
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If management do not amend the financial statements for the subsequent event,
but the auditor feels that an amendment should be made, the auditor is required to
take the following action:
If the audit report has not yet been provided to the entity, modify his opinion as
appropriate. (Modified audit reports are covered in a later chapter.)
If the audit report has been provided to the entity:
− instruct management not to issue the financial statements before the
necessary amendments have been made
− if they do so, take appropriate action to prevent reliance on the audit
report, after taking legal advice.
Facts discovered after the financial statements have been issued
As above, the auditor has no obligation to perform any audit procedures after the
financial statements have been issued. 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
review the steps taken by management to inform anyone who received the
original financial statements and audit report of the situation
extend his review of subsequent events up to the date of the new audit report
issue a new audit report, containing an emphasis of matter paragraph or other
matter paragraph (covered in a later chapter). This should refer to a note in the
revised financial statements that explains in more detail the reason for the re-
issue of the financial statements.
As usual, in the real exam, you are likely to be asked to apply your knowledge to a
given scenario.
Example
You are the auditor in charge of the audit of Hindsight, which has a 30 June year
end. The subsequent events review for the year ended 30 June Year 5 revealed that,
on 1 August Year 5, a receiver was appointed at a major customer. At 30 June Year 5
that customer owed $200,000 and goods costing $300,000 made to that customer’s
specification were held in inventory. Both these amounts are material.
Required
List the matters to which you would direct your attention in respect of the above in
relation to the audit for the year ended 30 June Year 5, if the audit report on the
financial statements has not yet been written
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Answer
Check that the directors are willing to adjust the financial statements for this
adjusting event after the reporting period.
Establish whether any cash has been received from this customer since the year
end.
Review any correspondence from the receiver to establish to what extent the
outstanding debt will be recovered.
Consider whether the goods held in inventory are now valued at the lower of
cost and NRV, given that these goods were made to the customer’s
specification. This may depend on whether or not those goods can be sold to a
different customer.
In the light of the above, consider whether any write downs proposed by the
directors to receivables and/or inventory are reasonable.
If they are not, or if the directors refuse to adjust the financial statements,
consider the impact on the audit report.
Note
If the event occurs after the date of the audit report but before the financial
statements are issued, the auditor should discuss the matter with the directors of the
client entity and ask what they propose to do.
If the directors intend to amend the financial statements to include or report the
event, the auditor should re-write the audit report accordingly and give it a new
date.
If the directors say that they do not intend to amend the financial statements, the
auditor must consider the most appropriate course of action. If it is too late to re-
write the audit report the auditor should consider communicating with the
shareholders in another way; for example by asking to speak at the annual
general meeting of the entity (which is the auditor’s right).
In the longer term, the auditor should also consider resigning from the audit, but
this would not be appropriate as an immediate response to the problem. The
immediate requirement is to convey the auditor’s opinion to the shareholders.
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Written representations: ISA 580
Definition and objectives
Written representations as audit evidence
Written representations about management’s responsibilities
Form and contents of the letter of representation
Refusal to provide requested written representations
3 Written representations: ISA 580
3.1 Definition and objectives
ISA 580 defines a written representation as a written statement by management
provided to confirm certain matters or to support other audit evidence.
The objectives of the auditor in this area, per ISA 580, are to:
obtain written representations from management that it has fulfilled its
responsibilities in respect of the financial statements and the audit
obtain written representations as appropriate to support other audit evidence
respond appropriately to written representations provided by management or if
management refuse to provide the written representations requested.
ISA 580 requires appropriate written representations from management (often
referred to as “management representations”) to be in the form of a letter of
representation, addressed to the auditor.
These management representations may be an important source of audit evidence.
3.2 Written representations as audit evidence
If the auditor considers that written representations are needed to support other
audit evidence he is required to request such other written representations.
During the course of the audit, management will make many representations to the
auditor. Some of these will be unsolicited but some will be given in response to
specific enquiries from the auditor. The auditor will have recorded such verbal
discussions with management in the audit working papers. However, verbal
evidence is not strong audit evidence. In order to improve the quality of this
evidence, the auditor will ask for any significant discussions to be confirmed in
writing.
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Such representations are likely to be needed:
to support the auditor’s understanding of management’s intention or judgment
(for example, in respect of future plans for the business or a specific matter such
as the net realisable value of inventory), or
in respect of the completeness of a specific item (for example, that all liabilities
have been provided for).
However, although such written representations provide necessary audit evidence,
they do not provide sufficient appropriate evidence on their own.
If a representation by management is contradicted by other audit evidence, the
auditor should:
consider whether his risk assessment of that area is still appropriate
consider whether additional audit procedures are needed
if he has concerns about the integrity of management, document those concerns
and consider withdrawing from the audit.
The auditor is also required by specific other ISAs to request certain other written
representations. These requirements are illustrated in the example letter set out
below.
3.3 Written representations about management’s responsibilities
The auditor is also required by ISA 580 to obtain certain other specific written
representations from management. In these representations management
acknowledges that:
it has fulfilled its responsibility for the preparation and fair presentation of the
financial statements in accordance with the applicable financial reporting
framework
it has provided the auditor with all relevant information
all transactions have been recorded and are reflected in the financial statements.
Again, these points are illustrated in the example letter set out below.
3.4 Form and contents of the letter of representation
The letter of representation is:
usually drafted by the auditor (since he knows the areas on which he requires
written representations)
addressed to the auditor
dated as near as practicable (but not after) the date of the audit report.
A management representation letter may include the following statements.
The management representation letter relates to the audit of the client company.
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The management of the entity have fulfilled their responsibilities for the
preparation of the financial statements, and the financial statements give a true
and fair view and are free from material misstatement.
The assumptions made by management to make accounting estimates and reach
fair values are reasonable.
Related party relationships and transactions have been disclosed.
All events after the reporting period have been either adjusted or disclosed.
The effect of any uncorrected misstatements (a list of which should be attached
to the letter) is immaterial.
The auditors have been provided with all relevant material, including the books
of account, and unrestricted access to individuals within the entity.
All transactions have been recorded and are included in the financial statements.
Management have disclosed to the auditors all information that is relevant to
fraud or suspected fraud.
Management have disclosed all known instances of non-compliance with laws
or regulations that are relevant to the preparation of the financial statements.
Representations may also be included that refer to specific assertions in the
financial statements, if the auditors require that such assertions should be made.
Examples
The following example of a letter of representation shows the minimum contents of
such a letter. However, remember that the auditor may also need to request
management to provide written representations about specific assertions in the
financial statements.
Example of a letter of representation
(Entity Letterhead)
(To Auditor) (Date)
This representation letter is provided in connection with your audit of the financial
statements of ABC Ltd for the year ended 31 December 31 20X1 for the purpose of
expressing an opinion as to whether the financial statements are presented fairly,
in all material respects, (or give a true and fair view) in accordance with International
Financial Reporting Standards.
We confirm that (to the best of our knowledge and belief, having made such inquiries as
we considered necessary for the purpose of appropriately informing ourselves):
Financial statements
We have fulfilled our responsibilities for the preparation and presentation of the
financial statements as set out in the terms of the audit engagement dated….. and,
in particular, the financial statements are fairly presented (or give a true and fair
view) in accordance with International Financial Reporting Standards.
Significant assumptions used by us in making accounting estimates, including
those measured at fair value, are reasonable. (ISA 540)
Related party relationships and transactions have been appropriately accounted for
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and disclosed in accordance with the requirements of International Financial
Reporting Standards. (ISA 550)
All events subsequent to the date of the financial statements and for which
International Financial Reporting Standards require adjustment or disclosure have
been adjusted or disclosed. (ISA 560)
The effects of uncorrected misstatements are immaterial, both individually and in
the aggregate, to the financial statements as a whole. A list of the uncorrected
misstatements is attached to the representation letter. (ISA 450)
Information provided
We have provided you with:
all information, such as records and documentation, and other matters that are
relevant to the preparation and presentation of the financial statements
additional information that you have requested from us; and
unrestricted access to those within the entity.
All transactions have been recorded in the accounting records and are reflected in
the financial statements.
We have disclosed to you the results of our assessment of the risk that the financial
statements may be materially misstated as a result of fraud. (ISA 240)
We have disclosed to you all information in relation to fraud or suspected fraud
that we are aware of and that affects the entity and involves:
management
employees who have significant roles in internal control; or
others where the fraud could have a material effect on the financial statements.
(ISA 240)
We have disclosed to you all information in relation to allegations of fraud, or
suspected fraud, affecting the entity’s financial statements communicated by
employees, former employees, analysts, regulators or others. (ISA 240)
We have disclosed to you all known instances of non-compliance or suspected
non-compliance with laws and regulations whose effects should be considered
when preparing financial statements. (ISA 250)
We have disclosed to you the identity of the entity’s related parties and all the
related party relationships and transactions of which we are aware. (ISA 550)
3.5 Refusal to provide requested written representations
If management refuse to provide requested written representations the auditor is
required to:
discuss the matter with management
re-evaluate the integrity of management and reconsider the impact on other
representations and audit evidence
take appropriate action, including considering the effect on the audit report.
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Example
The following points have arisen during the audit for the year ended 30 June 20X6 of
Compo, a nationwide dealer in used cars.
1. During the year, five of Compo’s properties were revalued by an independent
surveyor.
2. One property was sold during the year to the marketing director.
3. It was discovered that some cars were scrapped for cash. Not all of these
transactions have supporting documentation.
4. The directors have refused to make provision against a bad debt.
Required
Explain whether or not each of the above would be referred to in the letter of
representation for the year ended 30 June 20X6.
Answer
1. No – other evidence should be available (the independent surveyor’s report).
2. Yes – to support the completeness of disclosure of loans and other transactions
with directors.
3. Yes – evidence is needed of the completeness of such cash sales (although other
evidence will also be required, such as analytical procedures and review of
cash received).
4. No – the impact on the audit report will need to be considered. (And if the
directors have refused, and the auditor is sure the debt is bad, the directors are
not going to provide evidence to support this view in the letter of
representation.)
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Evaluation of misstatements: ISA 450
Objective of ISA 450
Requirements of ISA 450
4 Evaluation of misstatements: ISA 450
4.1 Objective of ISA 450
As illustrated above, ISA 450 Evaluation of misstatements identified during the audit
requires a list of the uncorrected misstatements to be attached to the letter of
representation. Such a list is often referred to as a summary of unadjusted audit
differences.
The objective of the auditor in this area, per ISA 450, is to evaluate the effect of:
identified misstatements on the audit, and
any uncorrected misstatements on the financial statements.
A misstatement could be in relation to the amount, classification, presentation or
disclosure of an item.
4.2 Requirements of ISA 450
ISA 450 requires the auditor to do the following:
Accumulate all misstatements found during the audit, unless they are clearly
trivial.
If the total of misstatements identified during the audit approach (or could
approach) materiality decide if the overall audit strategy and audit plan need to
be revised.
Communicate all misstatements found during the audit to an appropriate level
of management and request that the misstatements be corrected.
If management refuse to correct the misstatements obtain the reasons for this
and take those reasons into account when evaluating whether the financial
statements as a whole are free from material misstatement.
Prior to evaluating the effect of uncorrected misstatements reassess materiality
per ISA 320.
Decide whether uncorrected misstatements are material, individually, or when
added together. In making this assessment the auditor should take into account
the size, nature and circumstances of the misstatements and the effect of any
uncorrected misstatements from prior periods.
Communicate to those charged with governance the effect that uncorrected
misstatements may have on the audit report.
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Request a written representation from management as to whether they believe
the effect of uncorrected misstatements are immaterial, individually, or in total
(see example letter of representation above).
Document:
− the amount below which misstatements would be regarded as clearly trivial
− all misstatements accumulated during the audit and whether they have been
corrected
− his conclusion as to whether uncorrected misstatements are material,
individually, or in total.
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Overall review of the financial statements
General review
Specific review
5 Overall review of the financial statements
After the detailed audit work has been completed, the auditor will carry out an
overall review of the financial statements. By this stage of the audit, the financial
statements should be in their final draft form.
This review will normally be carried out by a senior member of the audit team,
often the manager or partner.
5.1 General review
At a general level, the review will check that a clear conclusion has been reached
and documented on each of the financial statement areas. Analytical procedures
may be used as a final check that the information contained in the draft financial
statements ‘makes sense’.
5.2 Specific review
More specifically, the overall review will cover the following matters:
Compliance by the client with the relevant accounting framework (national
legislation and relevant accounting standards).
A review of the accounting policies adopted by the entity, to assess whether they
are acceptable (and comply with accounting standards and industry practice).
A review of the financial statements for adequate disclosure of relevant
information.
An assessment of whether the information contained in the financial statements
is consistent with known business facts.