ACCA F8 (INT) Audit & Assurance - 2010 - Study text - Emile Woolf Publishing
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Chapter 3: The statutory audit
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− requiring that the members carry out their audit work in accordance with
appropriate technical standards (for example, in accordance with
International Standards on Auditing, known as ISAs)
− ensuring that auditors remain technically competent and up to date with
modern auditing practice (for example, by following a programme of
continuing professional development)
− providing procedures for monitoring and enforcing compliance by its
members with the rules of the regulatory body. This includes rules and
procedures for the investigation of complaints against members and the
implementation of disciplinary procedures where appropriate
Maintaining a list of ‘registered auditors’, which is made available to the public.
Such a system is referred to as a system of self-regulation. In such a system, the
regulation of auditors is carried out by their own professional bodies.
Regulation by government
The alternative is regulation by government. The government may appoint a public
body with similar responsibilities to a self-regulating professional body. The public
body may therefore establish rules and procedures:
for approving/authorising individuals to perform audit work
for ensuring that authorised auditors have the necessary minimum skills and
knowledge to carry out their audit work to a proper standard
for handling complaints and taking disciplinary measures against auditors,
where appropriate.
In addition, it is usual for statute law to establish that certain individuals are
ineligible to act as an external auditor in the context of a given company, even if
they are a member of an appropriate regulatory body. These exclusions are
designed to help to establish the independence of the auditor.
The following individuals are usually prohibited by local law from acting as the
auditor of a company:
an officer or employee of the company
a partner or employee of an officer or servant of the company
a partnership in which any of the above individuals is a partner.
1.3 Appointment of auditors
Usually, the external auditors are appointed by the shareholders at the annual
general meeting (AGM) of the company, and hold office until the next AGM. At the
next AGM the auditors are re-appointed by the shareholders, or different auditors
are appointed.
However, directors may be allowed to appoint auditors in the following
circumstances, as a matter of practical convenience:
to fill a ‘casual vacancy’; for example where the current auditor is no longer able
to act
to appoint the first auditor of a newly-formed company.
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An auditor appointed by the directors will normally hold office only until the next
AGM, when they will have to submit themselves for re-appointment by the
shareholders.
If neither the shareholders of the company nor its directors have appointed
auditors, company law may allow for an appropriate government department to
make the appointment.
In principle, the remuneration of the auditor is set by whoever appoints him.
However, in practice, where the shareholders make the appointment, it is usual to
delegate to the board of directors the power to set the auditor’s remuneration. The
directors are likely to be more familiar than the shareholders with the nature and
scope of the work involved in the audit process, and so the appropriate level of fees
for that work. (The board of directors may delegate the task of recommending or
approving the audit fee to the audit committee.)
1.4 Resignation of auditors
The auditor may choose to resign during his period of office. However, company
law will generally provide certain safeguards to ensure that the shareholders are
made aware of any relevant circumstances relating to the auditor’s resignation.
The procedures for the resignation of the current auditors will normally include the
following:
The resignation should be made to the company in writing. The company
should submit this resignation letter to the appropriate regulatory authority.
The auditor should prepare a statement of the circumstances. This sets out the
circumstances leading to the resignation, if the auditor believes that these are
relevant to the shareholders or creditors of the company. If no such
circumstances exist, the auditor should make a statement to this effect. This
statement should be sent:
− by the auditor to the regulatory authority
− by the company to all persons entitled to receive a copy of the company’s
financial statements (principally the shareholders).
The auditors may require the directors to call a meeting of the shareholders in
order to discuss the circumstances of the auditor’s resignation.
In certain circumstances, auditors may also be required to notify the authorities
themselves of their removal. For example, in the UK, auditors of listed
companies must do this whenever they cease to hold office and other auditors
must do so when they cease to hold office before the end of their current term
of office.
1.5 Removal of auditors
In certain circumstances, the directors may be empowered to appoint auditors.
However, it would not be appropriate for the directors to have the power to remove
the auditors from office.
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For example, it would be inappropriate for the directors to have the power to
remove the auditors because there may be a disagreement between the directors
and the auditors about an item in the financial statements or about the conduct of
the audit. The directors could silence the auditors by dismissing them. Clearly, it
would be more appropriate for the directors to recommend the appointment of new
auditors to the shareholders, and for the shareholders to make a decision.
Alternatively, auditors resigning from office will be required to give their reasons to
the shareholders and may be required to notify the authorities of their removal.
Therefore, as a general principle, only the ordinary shareholders should be able to
dismiss the auditor. The detailed procedures involved will be based on local law,
but the following general points are likely to apply:
A simple majority (i.e. over 50%) of votes cast at a meeting of shareholders may
be sufficient to remove the auditor.
The auditor will normally be allowed to attend such a meeting and make
statements to the shareholders.
Alternatively, the auditor may require written statements to be circulated to the
shareholders in advance of the meeting.
Documentation should be filed with the appropriate regulatory authority.
These procedures should ensure that the shareholders are given all the relevant
information to allow them to make a well-informed decision about the removal of
the auditors.
1.6 Rights and duties of auditors
In addition to the rights and duties included above, local company law will usually:
impose certain duties on the external auditor, and
grant him certain rights (or powers) to enable him to carry out his duties.
Duties of the external auditor
The primary duty of the external auditor is to:
examine the financial statements, and
issue an auditor’s report on the financial statements, which is then presented to
the shareholders together with the financial statements.
This auditor’s report will set out the auditor’s opinion as to whether (or not) the
financial statements:
give a true and fair view (or “present fairly”) the financial position and
performance of the company, and
have been prepared in accordance with the applicable financial reporting
framework.
The detailed provisions relating to the audit opinion are explained in a later chapter.
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In addition, local law may require the auditor to consider a number of other matters
as part of the statutory audit process. These may include matters such as:
whether the financial statements have been prepared in accordance with
relevant legislation
whether adequate accounting records have been maintained
whether the financial statements are in agreement with the underlying
accounting records.
The outcome of the statutory audit is an opinion on the truth and fairness of the
financial statements. The word ‘opinion’ implies that the auditor has applied his
professional judgement in reaching his conclusion.
This point is arguably one of the limitations of the statutory audit. The audit report
expresses an opinion, not a statement of fact. It is therefore open to disagreement.
In carrying out his audit work, the auditor is unlikely to check every transaction
undertaken by the company during the period. There is, therefore, a risk that the
judgement he forms may be inappropriate, because in performing the audit he has
missed an item of significance.
Rights of the external auditor
External auditors have certain statutory rights, to enable them to perform their
statutory duties. The main statutory rights of the auditor should include the
following:
The right of access to all accounting books and records at all times.
The right to all information and explanations (from management) necessary for
the proper conduct of the audit.
The right to receive notice of all meetings of the shareholders (such as the annual
general meeting) and to attend those meetings.
The right to speak at shareholders’ meetings on matters affecting the audit or the
auditor. This can be important when the auditors are in disagreement with the
directors of the client entity and are unable to communicate with the
shareholders effectively by any other method.
If the company uses written resolutions, the auditors should have a right to
receive a copy of all such resolutions.
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International Standards on Auditing (ISAs)
The role of auditing standards
The process of issuing auditing standards
Other documents issued by IFAC
Preface to International Standards on Quality Control, Auditing, Review,
Other Assurance and Related Services
ISA 200: Overall objectives of the independent auditor and the conduct of an
audit in accordance with International Standards on Auditing
2 International Standards on Auditing (ISAs)
2.1 The role of auditing standards
The role of the audit is to provide a high level of assurance to the users of the
financial statements. This assurance will be of greater value to users if they know
that the audit has been carried out in accordance with established standards of
practice.
In addition, if users compare the financial statements of a number of companies, it is
important that the user has confidence that consistent auditing standards have been
applied to the audits of all of the companies.
International Standards on Auditing (known as ISAs) apply primarily to the
external audit process. However, their provisions can also often be seen as good
practice for relevant areas of the work of the internal auditor.
2.2 The process of issuing auditing standards
Responsibility for ISAs
Both national and international bodies produce auditing standards. The
examination requires knowledge of International Standards on Auditing (ISAs).
ISAs are designed to be implemented internationally but there may be situations
where a conflict may arise between an ISA and local audit requirements.
National standard-setters are expected to aim for compatibility with ISAs as far as
possible. For example, in the UK, since December 2004, all financial statements have
been audited using the UK version of ISAs, known as ISAs (UK and Ireland). These
are based on ISAs with any additional, UK-specific, provisions shown in shaded
boxes.
ISAs are produced the International Audit and Assurance Standards Board
(IAASB), a committee of the International Federation of Accountants (IFAC). IFAC
is an international organisation of professional accountancy bodies, including the
ACCA.
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Producing a new ISA
The process of producing an ISA is as follows:
A subject is selected for detailed study, with a view to eventually issuing an ISA.
After a period of study and research, if there is agreement to proceed, an
exposure draft is produced. The exposure draft is approved by the IAASB and
then distributed widely amongst the profession and others for comment.
Comments and proposed amendments are considered by the IAASB. The draft
standard is then modified and approved by the IAASB.
The new ISA is then published.
2.3 Other documents issued by IFAC
In addition to ISAs, IFAC also issues International Auditing Practice Statements
(IAPSs). These do not have the same authority as ISAs.
IAPSs aim to:
provide help to auditors in implementing ISAs
promote good auditing practice in general.
A limited number of IAPSs are examinable. They will be described in later chapters
where appropriate.
2.4 Preface to International Standards on Quality Control, Auditing, Review,
Other Assurance and Related Services
The IAASB issues a number of other international standards, in addition to ISAs.
The table below sets out these standards, including ISAs, and when the preface says
they are to be applied.
Type of standard When applied
International Standards on Auditing
(ISAs)
In the audit of historical financial
information
International Standards on Review
Engagements (ISREs)
In the review of historical financial
information
International Standards on Assurance
Engagements (ISAEs)
In assurance engagements other than
audits or reviews of historical financial
information
International Standards on Related
Services (ISRSs)
On compilation engagements,
engagements to apply agreed upon
procedures to information and other
related services engagements
International Standards on Quality
Control (ISQCs)
For all the above services
In addition to this preface, ISAE 3000 and ISRE 2400 are examinable in this paper.
They are covered in later chapters. In Paper P7 you will look at other ISREs, ISAEs
and at ISQC 1.
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The IAASB’s pronouncements do not override local laws or regulations. If local laws
or regulations differ from, or conflict with, the IAASB’s standards then a
professional accountant should not state that he has complied with the IAASB’s
standards unless he has fully complied with all of those relevant to the
engagement.
International Standards on Auditing (ISAs)
ISAs are written in the context of an audit of financial statements by an independent
auditor. They are to be adapted as necessary when applied to audits of other
historical financial statements.
Each ISA contains:
an introduction
objectives
definitions (if necessary)
requirements which are shown by the word “shall” and are to be applied as
relevant to the audit
application and other explanatory material which is for guidance only.
International Standards on Quality Control (ISQCs)
ISQCs apply to all services carried out under the IAASB’s engagement standards
(ISAs, ISREs, ISAEs and ISRSs).
Other International Standards
The other international standards (ISREs, ISAEs and ISRSs) contain:
basic principles and essential procedures (identified in bold type and by the
word “should”), and
related guidance in the form of explanatory and other material, including
appendices.
The basic principles and procedures must be followed. In exceptional
circumstances, a professional accountant may judge it necessary not to follow a
relevant essential procedure in order to achieve their objectives. In these
circumstances, the auditor must be prepared to justify the departure from the
requirements of the standard.
Professional judgment
The nature of the international standards requires the professional accountant to
exercise professional judgment in applying them.
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2.5 ISA 200: Overall objectives of the independent auditor and the conduct
of an audit in accordance with International Standards on Auditing
As discussed in a previous chapter, the objectives of the auditor, per ISA 200 are:
to obtain reasonable assurance about whether the financial statements as a
whole are free from material misstatement, whether due to fraud or error. This
allows the auditor to give an opinion on whether the financial statements have
been prepared in accordance with the applicable financial reporting framework.
to report on the financial statements, and communicate as required by the ISAs,
in accordance with the auditor’s findings.
Where the auditor is unable to obtain reasonable assurance and a qualified opinion
is insufficient, the auditor must disclaim an opinion or resign. The different types of
opinions are covered in a later chapter.
ISA 200 requires the auditor to:
comply with all ISAs relevant to the audit
comply with relevant ethical requirements
plan and perform an audit with professional scepticism
exercise professional judgement in planning and performing an audit
obtain sufficient and appropriate audit evidence to allow him to obtain
reasonable assurance
Each of these requirements is covered in detail in later chapters.
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Advantages and limitations of statutory audits
Advantages of statutory audits
Limitations of statutory audits
3 Advantages and limitations of statutory audits
There are several advantages in having an external audit, but there are also some
limitations.
3.1 Advantages of statutory audits
An external audit provides the following benefits:
It increases the credibility of published financial statements.
It confirms to management that they have performed their statutory duties
correctly.
It provides assurance to management that they have complied with non-
statutory requirements, such as corporate governance requirements (where these
are subject to audit or review).
It provides feedback on the effectiveness of internal controls. Where internal
controls are weak or inadequate, the auditor will give recommendations for
improvement. This will assist management in reducing risk and improving the
performance of the company.
Even where a statutory audit is not required, for example due to small company
statutory exemption limits, an audit will increase the credibility of published
financial statements. This may be important for potential lenders to the company.
Potential lenders, such as banks, may insist on the company having an audit as a
pre-condition for lending money.
3.2 Limitations of statutory audits
The main limitations of an audit are as follows:
Its cost. The cost of an audit can be very high. However, if the audit firm is
already hired to carry out non-audit work such as accounts preparation or
advisory work, the additional cost of an audit may be fairly small.
The disruption caused to a company’s staff during the audit. The company’s
staff may be required to assist the auditors by answering questions, providing
documents and other information, and so on.
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