ACCA P7 (INT) Advanced Audit & Assurance - Study Text - 2010 (Emile Woolf Publishing)
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Chapter 14: Reporting
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reach a conclusion about whether Robin’s report is suitable. This may involve
setting out what would have been suitable if Robin’s report is not suitable.
Matters relevant to forming an opinion
The following matters are relevant to forming an appropriate opinion.
(1) The accounting records for the opening three or four months of the year are
missing.
(2) The accounting records are missing because the former CEO absconded with
them. There must be some reason why he took the accounting records: fraud
is a possible reason.
(3) The audit opinion for the previous financial year was unmodified. This would
imply that the opening balances for the current year and comparative figures
for the previous year are correct. However, this might not be the case.
(4) If there is a possibility of fraud, this would raise doubts about the correctness
of the audit report for the previous year. There may have been fraud last year
that was undetected fraud. And this might have caused material misstatement
to that audit report.
(5) There is an inability to obtain sufficient appropriate audit evidence (limitation
on scope) for the year to 31 December Year 8.
Comments on these matters
Matter listed
above
Comment
(1) This constitutes a limitation on the scope of the audit (item 5
above). The auditors will not be able to obtain sufficient
appropriate audit evidence about the relevant period. Therefore
the audit opinion will be modified.
The modification should (a) give details of what records are
missing and why, or (b) cross-refer to where this information is
given in the financial statements.
The extent of the modification will depend on which records are
missing and where the auditors’ scope is limited. It is likely that
the information with regard to the income statement/statement of
comprehensive income is limited, but possibly not the statement of
financial position. A modification might be limited to a
qualification (‘except for’) over the statement of comprehensive
income for the first few months of the year.
(2) However, there is an indication in the manner in which the CEO
has taken the accounting records that there may have been a fraud.
It is therefore probable that the auditors will have to modify the
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opinion even if they are able to reconstruct the financial records as
it will not be possible to gain sufficient appropriate evidence about
the possible fraud.
(3) and (4) The previous audit report cannot be withdrawn but the auditors
are not precluded from modifying their opinion for the current
year on the basis of the comparative figures for the previous year.
It is probable that any fraud in progress at the start of this financial
year could have affected the previous financial year, unknown to
the auditors at the time.
Conclusion about Robin’s draft
Robin is correct to modify the opinion on the grounds of limitation of scope.
However, the draft should:
make reference to the exact nature of the problem/possible fraud
take account of a possible modification in relation to the comparative figures for
the previous financial year
take account of the fact that the problem may be limited to the statement of
comprehensive income.
Example 2
A client company has recently prepared draft financial statements for the year to 31
December Year 2. During the year, the company closed a factory that made a loss-
making product which contributed 14% to total sales revenue in the previous year
and 10% in the current year.
The closure is permanent. It is mentioned in the directors’ report and in the annual
business review, but not in the financial statements themselves.
Required
What should be the auditor’s view of this situation?
Answer
The factory appears to have been a separate component of the company’s business,
making a separate product that contributed materially to total sales income.
The closure represents a discontinued operation, and failure to disclose the details is
a failure to comply with IFRS 5 Non-current Assets Held for Sale and Discontinued
Operations. It is also in breach of the requirements of IAS 7 Statements of Cash Flow
and IFRS 8 Operating Segments which also require disclosures relating to
discontinued operations.
The matter is material, but is not pervasive. If management do not amend the
financial statements to provide the required disclosures, a qualified audit opinion
(for a misstatement) would be appropriate.
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Example 3
A client company has prepared draft financial statements for the year to 31
December Year 3. In February Year 4 a legal claim was made against the company,
claiming substantial damages. The company’s lawyers have advised that the claim
has less than 50% chance of success. If it did succeed, the company would have
sufficient cash resources to meet the claim in full.
The matter is disclosed in the draft financial statements in a note, as a material
contingent liability.
Required
Should the audit opinion be unmodified, and if so, should the report contain an
‘emphasis of matter’ paragraph?
Answer
The claim was made after the end of the reporting period, and is a non-adjusting
event. The probability that the claim will be successful is less than 50% (on the
assumption that the lawyers have given a reasonable opinion).
It is therefore appropriate to disclose the item as a contingent liability (in this case, a
material non-adjusting event after the reporting period). The auditor should
therefore give an unmodified opinion.
An ‘emphasis of matter’ paragraph is normally only used when the matter involves
considerable uncertainty. ‘Considerable uncertainty’ usually exists only when there
is some concern about the going concern status of the entity or about a matter that
could have a major impact on the financial statements. In this case, we are told that
the company has sufficient cash resources to meet the legal claim in full, in the event
that it is successful.
It therefore appears that considerable uncertainty does not exist, and an ‘emphasis
of matter’ paragraph would be inappropriate.
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The impact on the audit report of opening balances and comparatives
ISA 510: Initial engagements – opening balances
ISA 710: Comparatives
4 The impact on the audit report of opening balances
and comparatives
The audit work needed on opening balances and comparatives (ISAs 510 and 710)
was described in an earlier chapter. The auditor must consider the possible impact
of this work on the audit report.
4.1 ISA 510: Initial audit engagements – opening balances
The audit report is required by ISA 510 to be modified where the auditor:
is unable to obtain sufficient appropriate audit evidence re the opening balances
(qualified (“except for”) or a disclaimer of opinion)
concludes that there is a misstatement in the opening balances that materially
affects the current period’s financial statements and the misstatement is not
properly accounted for/disclosed (qualified (“except for”) or adverse opinion)
concludes that accounting policies have not been consistently applied (or a
change of accounting policy has not been properly accounted for/disclosed)
(qualified (“except for”) or adverse opinion)
or where
the prior period’s audit report was modified, and the matter is still relevant and
material to the current period’s financial statements (modify as appropriate).
4.2 ISA 710: Comparative information – corresponding figures and
comparative financial statements
Financial statements include audited figures for the current financial year (just
ended) and for the previous financial year, which are presented as comparative
information.
The audit opinion should not normally refer to the corresponding figures, unless the
following circumstances apply:
Circumstance ISA 710 requirement
The auditor gave a qualified opinion
for the previous financial period and
the problem remains unresolved.
Modify this year’s audit report.
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Circumstance ISA 710 requirement
The auditor finds a material
misstatement in the prior period
financial statements, on which an
unmodified opinion was previously
given, and the corresponding
figures have not been appropriately
restated.
Give a qualified or adverse opinion
on the current period financial
statements, in respect of the
corresponding figures included.
The prior period financial
statements were audited by another
auditor
Use an “other matter” paragraph to
explain this fact and the type of
opinion given.
The prior period financial
statements were not audited.
Use an “other matter” paragraph to
state this fact. (However, the auditor
remains responsible, per ISA 510, for
obtaining sufficient appropriate
evidence on opening balances.)
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The impact of going concern on the audit report: ISA 570
Where the use of the going concern assumption is appropriate but a material
uncertainty exists
Management’s attitude to disclosure of material uncertainty
Where the use of the going concern assumption is inappropriate
5 The impact of going concern on the audit report:
ISA 570
If indications are found which suggest that the going concern basis might not be
appropriate for preparing the financial statements, the auditor is required by ISA
570 to consider the implications for his audit report.
The form of the report will depend on the auditor’s judgement. There are two
possible views he could take:
the use of the going concern assumption is appropriate but a material
uncertainty exists, or
the use of the going concern assumption is inappropriate.
If management is unwilling to make or extend a going concern assessment (see
previous chapter on ISA 570) the auditor is also required to consider the
implications of this for his audit report.
5.1 Where the use of the going concern assumption is appropriate but a
material uncertainty exists
Where the auditor considers that the going concern assumption is appropriate, but
a material uncertainty exists, he must consider whether the financial statements:
adequately describe the principal events or conditions that may cast significant
doubt on the entity’s ability to continue as a going concern and management’s
plans to deal with those events or conditions, and
disclose clearly that there is a material uncertainty related to events or
conditions that may cast significant doubt on the entity’s ability to continue as a
going concern .
If there is adequate disclosure, then the auditor should express an unmodified
opinion. However, he should use an emphasis of matter paragraph to:
highlight the uncertainty, and to
draw attention to the relevant note in the financial statements.
An example of such an emphasis of matter paragraph was given above.
If there is not adequate disclosure, the auditor should express a qualified or
adverse opinion.
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5.2 Management’s attitude to disclosure of material uncertainty
The management of a client company will probably be reluctant to include a
disclosure about material uncertainty in relation to the going concern assumption.
There are several reasons for this.
Admitting that there is material uncertainty about whether the company can
continue as a going concern for the next 12 months can be seen as a sign of
management failure. Management will probably be reluctant to admit their
responsibility for failure to the company’s shareholders.
A statement that there is material uncertainty about the ability of the company
to continue in business will make the situation even worse for the company.
Banks will be reluctant to lend more money and may withdraw existing
lending facilities. Suppliers may be reluctant to supply more goods without a
credit guarantee (which the company would have to buy from an insurance
company). Customers may stop buying the company’s products due to concern
that the company will not be in existence to provide after-sales service.
Employees will become more concerned for job security, and many might look
for jobs with other employers. Staff turnover would therefore increase.
It is also possible that management do not accept that there is material uncertainty
about the ability of the company to continue in business. There could therefore be
genuine disagreement between management and the auditor on this issue.
As indicated above, if management refuse to provide suitable disclosure the audit
opinion should be modified.
5.3 Where the use of the going concern assumption is inappropriate
Where the financial statements have been prepared on the going concern basis, but
the auditor considers the going concern assumption is inappropriate, the auditor
should express an adverse opinion.
The auditor may give an unmodified opinion if the financial statements have been
prepared on an alternative acceptable basis (for example, a break-up basis) and
there is adequate disclosure of this basis. An emphasis of matter paragraph may be
required in the audit report.
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Communicating with those charged with governance: ISA 260
Introduction
Matters to be communicated
The communication process
6 Communicating with those charged with governance:
ISA 260
6.1 Introduction
In most countries, the auditor communicates to the shareholders, as owners of the
company, by means of his audit report. ISA 260 Communication with those charged
with governance requires in addition that the external auditor should communicate
formally to those charged with governance to provide useful feedback about the
audit.
In the case of a company those charged with governance are the board of directors
or the audit committee (which is a sub-committee of the board of directors). In your
exam it will usually mean the directors of the company.
The auditor’s objectives in respect of ISA 260 are to:
communicate his responsibilities and give an overview of the planned scope and
timing of the audit
obtain information relevant to the audit
provide timely observations arising from the audit which are significant to
management’s responsibility to oversee the financial reporting process
promote effective communication between the auditor and those charged with
governance.
As a result of the communication, the auditor should be satisfied that there is
sufficient documentation of all the significant matters in the audit and that these
have been brought to the attention of the individuals in the client entity who are
accountable to its owners.
6.2 Matters to be communicated
The auditor is required by ISA 260 to communicate the following matters.
His responsibilities in relation to the audit, including notification that:
− he is responsible for forming and giving an opinion on the financial
statements prepared by management, and
− the audit does not relieve management or those charged with governance of
their responsibilities.
An overview of the planned scope and timing of the audit.
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Any significant findings from the audit. These are often called the management
letter points and are usually communicated along with any deficiencies in
internal control as required by ISA 265 (see below). They include:
− the auditor’s views on the entity’s accounting policies, estimates and
financial statement disclosures
− any significant difficulties encountered during the audit
− any significant matters arising from the audit already brought to the
attention of management and written representations requested*
− any other matters arising from the audit that are significant to the oversight
of the financial reporting process.
For listed entities a statement (which must be made in writing):
− that the audit team/firm have complied with relevant ethical requirements in
respect of independence
− of all matters relevant to independence (such as relationships and non-audit
fees) and the safeguards applied.
*This requirement does not apply if those charged with governance are involved in
managing the entity as they will already be aware of these issues. The significant
matters do not include material weaknesses in internal controls as such a report is a
requirement of ISA 265, not ISA 260 (see next section).
6.3 The communication process
The communication with those charged with governance may be provided either in
writing or orally. It could take place as a discussion between the auditor and an
appropriate level of management, perhaps with the audit committee in the case of a
larger company.
However, where oral communication would not be adequate, ISA 260 requires that
communication is in writing, in the form of a letter or report. If communication is
oral then the matters communicated, to whom and when must be documented.
Communication must be made on a timely basis. The appropriate timing will vary
depending on the matter to be communicated. Communication in respect of
planning matters will be likely to be made early in the engagement. Any significant
difficulties encountered during the audit should be communicated as soon as
practicable, especially if likely to lead to a modified opinion.
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Communicating deficiencies in internal control: ISA 265
Introduction and requirements of ISA 265
The management letter
7 Communicating deficiencies in internal control: ISA
265
7.1 Introduction and requirements of ISA 265
ISA 315, covered largely in an earlier chapter, requires the auditor to communicate
material weaknesses in internal control identified during the audit to
management. This requirement is embodied in ISA 265 Communicating deficiencies in
internal control to those charged with governance and management.
A deficiency is defined by ISA 265 as where:
a control is designed, implemented or operated in such a way that it is unable to
prevent, or detect and correct, misstatements in the financial statements on a
timely basis, or
a control necessary to prevent, or detect and correct, misstatements in the
financial statements on a timely basis is missing.
A significant deficiency is one which merits the attention of those charged with
governance.
ISA 265 requires the auditor to:
Communicate significant deficiencies identified during the audit to those
charged with governance in writing on a timely basis.
Communicate any other deficiencies to an appropriate level of management
The communication of significant deficiencies must be in writing and is required to
cover:
A description of the deficiencies and an explanation of their potential effects.
Sufficient information to allow those charged with governance and management
to understand the context of the communication, including an explanation that:
- the purpose of the audit was to express an opinion on the financial
statements
- whilst the audit did include consideration of internal controls in order to
design appropriate audit procedures, this was not done for the purpose of
expressing an opinion on the effectiveness of internal control, and
- the matters being reported are limited to those deficiencies identified
during the audit and considered of sufficient importance to be reported.
The above should make it clear that the report covers only those weaknesses that
have been discovered as a result of the audit work that has been undertaken. It is a