ACCA P7 (INT) Advanced Audit & Assurance - Study Text - 2010 (Emile Woolf Publishing)
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procedures were omitted during the engagement
the firm should determine what further action is needed. This might include
obtaining legal advice.
The firm should produce an annual report for partners setting out:
the monitoring procedures performed
the conclusions drawn
any systematic deficiencies found and remedial action taken.
The monitoring system should include procedures for dealing with complaints and
allegations against the firm. These should include establishing channels through
which employees can come forward without fear of reprisals.
Documentation of quality control procedures
The following matters are required to be documented.
Evidence of the operation of each element of the system of quality control.
Complaints and allegations made against the firm and how these were resolved.
Documentation must be retained for a sufficient period of time, as a minimum to
comply with relevant laws and regulations.
1.5 Quality control procedures specific to individual engagements
The quality control procedures applied to the conduct of each individual audit
engagement will be based around the effective management of the audit team
working on that engagement. This will involve:
the direction and supervision of staff, and
review of their work.
Direction of audit staff
The direction of audit staff is the responsibility of the engagement partner for the
audit. Direction is achieved by the following methods:
The audit team members should be informed of the work they are expected to
carry out and the objectives that the work is intended to achieve.
There should be a well-prepared audit work programme and staff should be
familiar with the overall audit plan.
In addition, the members of the audit team should understand:
their responsibilities
the nature of the business of the client company
risk-related issues
problems that may arise with the audit and how these problems should be dealt
with if they do occur
the detailed approach to the performance of the audit work.
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The members of the audit team should:
maintain an objective state of mind and retain their independence
perform their work with due care, and
raise any questions they might have with more experienced members of the
audit team.
Supervision of audit staff
Supervision should continue throughout the audit. It includes the following:
Tracking the progress of the audit.
Monitoring the competence of team members, including:
− whether they have sufficient time to carry out their work
− whether they understand their instructions
− whether they are carrying out their work in accordance with the audit plan.
Addressing significant issues that arise during the audit, assessing how
significant they are and modifying the audit approach accordingly.
Identifying where there is a need for an audit team member to consult more
experienced members of the team.
Monitoring the behaviour of team members (particularly inexperienced junior
members of the team), to ensure that they maintain ethical standards.
Review of audit work
Review of audit work is a key aspect of quality control. All audit work should be
reviewed, ideally by an auditor with a higher level of competence and experience
than the audit team member who performed the audit work. The review process
may take any of the following forms:
Hot review: This is a review that takes place during the course of the audit.
Post audit review: This is a review that takes place between the end of the audit
work and the issue of the audit report. This review will usually be performed by
the audit manager first and then by the audit partner (see below).
Second partner review: A review by another partner may be appropriate,
especially where a modified audit opinion is under consideration.
Peer review: This is a review by another firm of auditors, or a partner from
another office of the audit firm.
Review by a specialist ‘Audit review department’. This may only be
appropriate in larger audit practices that can afford to operate a specialist
department.
The purpose of audit review is to check whether:
the audit work was carried out to proper professional standards
the objectives of the audit have been achieved
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the work carried out during the audit and the audit evidence are suitably
documented, and that the audit evidence supports the conclusions that have
been reached.
The review of the audit work should cover:
the audit planning process
audit procedures, including:
− documentation (the audit working papers)
− the audit tests performed and the audit evidence gathered
− compliance with the audit work programme
− the resolution of problems encountered on the audit
whether the conclusion reached is consistent with the audit evidence obtained
and documented.
The review process itself should also be documented.
Review by the engagement partner (and audit manager)
As discussed above, before the audit report is issued, the engagement partner
needs to be satisfied that sufficient appropriate audit evidence has been obtained
to support the conclusions reached and for the audit report to be issued. He should
therefore:
review the audit documentation, and
hold discussions with the audit team.
This process is usually referred to as the partner’s review. It should be scheduled
into the audit plan, towards the completion of the audit.
Before the partner’s review, the audit senior should try to ensure that every file is
complete and cross-referenced, in order to cut down the number of points that
might be raised by the partner’s review.
The partner’s review will usually be preceded by a manager review, in the hope
that the audit manager will identify some matters that can be resolved before they
come to the attention of the engagement partner.
Assessing the adequacy of quality control
An exam question that asks you to discuss the adequacy of quality control in an
audit will probably expect you to identify weaknesses in the conduct of the audit,
such as:
poor or inadequate planning of the audit, such as a failure to identify the key
audit risks
giving complex audit work to relatively inexperienced members of the audit
team
inadequate supervision
inadequate review of the audit working papers by the audit manager.
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Example: quality control issues
An audit firm has just carried out the annual audit for a client company. The audit
manager has just learned that during the audit planning process, a junior member of
the audit team, who is an IT graduate from a major university, gave advice to the
client about improvements that could be made in the client’s finance and accounting
IT systems.
What professional and ethical issues exist in this situation?
Answer
The situation raises some questions about quality control in the audit.
Junior members of an audit team must be given suitable directions about their
responsibilities, and their activities should also be properly supervised. In this
situation, a junior member considered that he was allowed to offer advice to the
client, which clearly should not be the case. This suggests poor direction and
supervision in the audit.
The junior member obviously believed that he could offer advice directly to the
client. In practice, if any member of the audit team identifies weaknesses in the
client’s internal controls their findings should be reported to a senior member of
the audit team, who should then decide the appropriate action to take. Failure
by the junior team member to report his findings to a senior auditor also raises a
concern about quality control. The firm may require much better training of staff
about audit responsibilities and procedures.
It is important to establish the details of the advice that the junior team member
has given to the client, and to find out whether the client has acted on that
advice yet. The audit partner should discuss the situation with the client’s
management in order to find out whether the advice has been acted upon. If the
client has acted on the advice and this advice was poor, the audit firm may be
liable.
1.6 Quality control in large firms and small firms
Quality control in large firms
Large international practices operate in several countries, with local partnerships
and offices further down the chain of control. Local partnerships and offices within
a large practice will have access to:
regional and national training programmes
the firm’s comprehensive audit manual
a central technical department, available to answer technical questions from any
office or local partnership
in-house technical publications
the firm’s standardised audit documentation
a formal system of inter-office reviews..
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Quality control in small firms
The need for quality control in a small firm is just as important as for large firms.
However, many of the facilities listed above are not available to small firms, because
they cannot afford them. Alternative arrangements for quality control might
include:
reciprocal arrangements for review and consultation with other audit firms
the use of audit manuals and standardised documentation from third parties or
professional bodies
external training, and sending staff on courses provided by third parties or
professional bodies.
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Changes in a professional appointment
Why a change might arise
Procedures before accepting a new audit appointment
Deciding whether to accept a new audit appointment
Books, documents and records
2 Changes in a professional appointment
2.1 Why a change might arise
An ACCA member may be asked to accept a new audit appointment in a situation
where the previous auditor (‘old’ auditor) will not be reappointed.
This may be for any of the following reasons:
The current firm is too small to cope with the demands of an expanding client
(who now operates from multiple locations, in different towns or countries).
There may be a change in the composition of the company’s board of directors,
and the new directors wish to appoint an auditor of their own choice.
There may be a perceived lack of independence, possibly one that has just arisen.
There may have been a disagreement between the directors and the ‘old’ audit
firm (for example, over the accounting treatment of an item in the financial
statements).
There may have been a loss of confidence in the ‘old’ audit firm.
In theory, the auditor is appointed by the shareholders. However, in practice
recommendations are made by the directors to the shareholders when they consider
that there should be a change of auditors.
If the outgoing auditor feels that the change is for a reason that should be brought to
the attention of the shareholders (for example, in the case of a dispute) then national
legislation will allow him to make representations to the shareholders.
2.2 Procedures before accepting a new audit appointment
Before accepting an appointment, the audit firm should take the following steps:
It should assess whether there are any professional problems attached to
accepting the engagement. These might include, for example, problems of lack of
independence, or a lack of technical expertise, or a conflict of interest.
It should ensure that resources are available to complete the audit assignment; in
particular it must ensure that there will be sufficient staff (of the right level of
expertise) available at the right time.
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It should take up references on the proposed client company and its directors, if
they are not already known to the auditors. This is usually referred to as client
screening.
It should communicate with the ‘old’ auditors, if there are any, to discuss the
appointment, the client and the audit work. The method of communication
should be a professional etiquette letter.
Client identification
In order to comply with anti-money laundering regulations, the audit firm should
carry out client identification procedures. The purpose of these procedures is to
confirm that the client ‘is who he says he is’, and that there are no grounds for
suspicion that the client may be involved in money laundering activities.
If the client is a company or other business entity, documentary evidence of the
identity of the entity should be obtained – for example a certificate of
incorporation in the case of a company.
Evidence should also be obtained to confirm the address of the entity, such as
headed letter paper.
If the client is an individual, evidence of identity can be obtained from a
passport or driving licence, and evidence of address (possibly) from a recent
utility bill.
The audit firm should consider whether the business of the potential new client
‘makes commercial sense’. For example, it would not make sense for a very large
company to be engaged in operating a number of dry cleaning shops, because
the size of the company would be too large for the nature of its business
operations. When this happens, the client’s declared business may simply be a
front or cover for hidden illegal activities.
In most cases, the client identification procedures should be a formality, and the
client may be surprised that they are necessary. The audit firm should explain the
regulatory purpose of client identification, to remove any doubts or concerns that
the new client may have.
Communication with the current auditors
The reason for communication with the current auditors is:
partly a matter of courtesy between professionals, and
partly to establish whether there are circumstances relating to the change which
the incoming auditors should be aware of before accepting the appointment.
The following points should be noted in connection with communicating with the
current auditors:
Client permission is required for any such communication. If the client refuses to
give its permission, the appointment as auditor should not be accepted.
If the client does not give the current auditor permission to reply to any relevant
questions, the appointment as auditor should not be accepted.
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If the current auditor does not provide any information relevant to the
appointment, the new auditor should accept or reject the engagement based on
other available knowledge.
If the current auditor does provide such information, the new auditor should
assess all the available information and take a decision about whether or not to
accept the audit work.
Note that if the ‘old’ auditor provides information that is relevant to the decision to
accept the audit engagement, the new auditor may still accept the engagement.
However, he should exercise appropriate professional and commercial judgement
in doing so.
2.3 Deciding whether to accept a new audit appointment
An audit firm may occasionally decide that to accept a new audit appointment
would threaten the firm’s reputation and might also raise serious ethical issues. The
following example is based on a previous P7 examination question.
Example: accepting a new audit appointment
Backle Company is an owner-managed company. It has asked your firm to become
its auditors. The following information has been obtained about the company,
mainly from the company’s current auditors.
(1) The current auditors have just resigned from the audit because they no longer
have sufficient resources to carry out the audit work for Backle. They had
taken on the audit two years earlier, after the previous auditors had resigned
due to a dispute about fees. The current auditors commented that the
company’s management liked to keep a close control over costs, and they had
agreed to do the audit for a lower fee.
(2) The current auditors had discovered a number of internal control weaknesses
in Backle and had reported them to management, but nothing appeared to
have been done by management to improve the control system.
(3) There were ongoing disputes with the tax authorities about the amount of tax
payable by Backle on profits for the previous three years.
(4) Backle Company has a poor public relations image. It is currently under
investigation by both the police authorities and the regulatory authorities for
alleged breaches of regulations, and some of these had been widely reported.
(5) The company is ambitious and plans to expand its business in the next year or
so. It expected to obtain bank loans to finance most of the expansion.
What issues should the audit firm consider when deciding whether or not to accept
the new audit appointment?
Answer
The following matters may be considered.
Reputation. The audit firm may decide that it does not wish to be associated
with a client company whose public relations image is poor. The bad reputation
of the company may transfer to its auditors.
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Advocacy threat. The criminal or regulatory investigation may lead to legal
action, and the audit form may be faced with an advocacy threat, and be
expected to defend the company against the allegations that have been made
against it.
Aggressive management. Backle Company has aggressive managers who are
willing to argue with auditors and who want to keep costs as low as possible.
There is a high risk of continuing disputes over audit fees.
Audit risk. If the company applies for new bank loans, it will probably be
required to submit audited financial statements to the bank as part of the loan
application. The management of Backle have a strong interest in presenting
financial statements that show strong profits and a healthy statement of financial
position. The risk that the financial statements may be misstated could therefore
be high. (The audit firm would probably wish to consider including a disclaimer
in their audit report, to reduce the risk of liability to a bank for ‘negligent’
auditing in the event that the financial statements turn out to be misstated and
the errors are not identified by the auditors.)
High audit risk is also suggested by the weak internal controls and failure by
management to improve controls.
The high audit risk means that a new auditor would want to conduct a very
careful audit of the opening balances: this would add to the cost and time
required for the audit, which Backle management may refuse to accept.
However there is no evidence of fraud (or suggestion of fraud) by anyone in the
company, and the audit firm may decide to accept the audit appointment, subject to
agreement about fees. Acceptance of a new audit client is a matter of judgement.
2.4 Books, documents and records
Client books and records: right of lien
Once a new auditor has been appointed, the outgoing auditor should arrange for
the transfer of any books and records belonging to the client that are in his
possession.
However, where fees remain unpaid, the outgoing auditor may wish to exercise a
legal right of lien over those client books and records.
A lien is a right to retain possession of property belonging to another until
amounts due are paid.
Auditors have a ‘particular’ (as opposed to a ‘general’) lien. This means that the
right of lien is only in respect of those books and records on which the auditor
has performed audit work.
In order for the lien to be applied:
the documents must have come into the auditor’s possession lawfully, and
an invoice must have been sent to the client company for the fees owing, and
there must be no dispute over fees.
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Unfortunately, in some countries, legal decisions have been taken that mean a lien
cannot be exercised over books and records which the client is required to keep by
law. In many cases, this legal requirement applies to most of the client’s books and
records. Consequently, these legal decisions may significantly reduce the
effectiveness of the right of lien.
Auditor working papers
Audit working papers are documents prepared by the auditors for the purpose of
carrying out their audit work. In general, these belong to the auditors, unless there
is a provision to the contrary in the engagement letter or in national law.
However, the outgoing auditor will be expected to provide the proposed new
auditor with information that is sufficient for a reasonable handover of audit
responsibilities. The precise nature of this information will depend on the stage that
the audit has reached when the responsibility for the audit passes from the ‘old’
audit firm to the new one.