ACCA P7 (INT) Advanced Audit & Assurance - Study Text

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Chapter 2: The regulatory environment

1.4 Professional regulation

Auditors are required to carry out audits according to professional standards

(international standards on auditing). Some assurance work is also covered by

professional standards, although this is a developing area and less guidance is

available. In many cases, guidance given in auditing standards can be adapted for

use in assurance services where there is not specific guidance for that service.

As assurance provision goes increasingly ‘global’ the harmonisation of such

professional guidance has become necessary.

Harmonisation of the accountancy and auditing profession

The International Federation of Accountants (IFAC) is an international regulatory

body for the profession but each country has its own regulatory regime for auditing,

which may not necessarily apply the same principles of audit behaviour as those

used by IFAC.

The same arguments that have been made in favour of the universal adoption of

international accounting standards can also be made in respect of other regulatory

aspects of the auditing and accounting profession.

 These include advantages such as the adoption of global auditing standards,

which should improve the efficiency of the audit process for multinational

companies and should improve transparency in audit reporting.

 Disadvantages include the problems of getting international agreement on

auditing practices, and the need for many countries to change their local law to

bring it into line with the agreed international practice.

A number of initiatives are taking place to harmonise the regulation of the auditing

profession internationally. These include the following:

 All listed companies in the European Union should now be carried out in

accordance with International Standards on Auditing.

 There have been moves to establish a more formal, statute-based corporate

governance regime (such as Sarbanes-Oxley in the USA).

 The development of national regulatory models for the profession, headed by a

single unified body.

The SEC in the USA is a long-established example of a unified body. In the UK, the

Financial Reporting Council also has a unified role, and

 sets accounting standards

 sets auditing standards

 enforces and monitors those standards

 oversees the self-regulatory professional bodies, such as ACCA.

It has been suggested that stricter regulation from an external authority (such as the

SEC in the US and the FRC in the UK) is needed to balance the increasing global

power of the ‘Big Four’ professional accountancy firms.

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Professional standards

 The international standard-setting process

 The authority of national and international standards

 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 accordanec with International Standards on Auditing

2 Professional standards

2.1 The international standard-setting process

International Standards on Auditing (ISAs) are set by the International Audit and

Assurance Standards Board (IAASB), which is a part of IFAC.

A subcommittee of IAASB is asked to write an exposure draft of the new standard

when IAASB considers that one is required. This draft is then ‘exposed’ to interested

parties, who comment on the exposure draft. Interested parties include national

standard setters (such as the Auditing Practices Board in the UK) and professional

bodies, such as ACCA.

The comments are reviewed within the IAASB and the draft is amended as

required. Finally a new ISA will be issued.

2.2 The authority of national and international standards

International standards are drafted to be used internationally, but situations may

arise where the requirements of the international standard clash with national

standards.

In this situation, there are a number of matters that should be considered:

 ISAs are not designed to overrule national requirements, so auditors should

follow national requirements.

 However, as ISAs represent international best practice, countries are encouraged

by IFAC to change their national practice so that ISAs can be followed. 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.

 If there is no comparable guidance to the ISA in the country, then individual ISA

practice can be adopted immediately.

Chapter 2: The regulatory environment

2.3 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, certain ISREs, ISAEs, ISRSs and ISQC 1 are examinable in

this paper. They are covered in later chapters.

As discussed above, 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.

This structure arose out of the work carried out as part of the IAASB’s “Clarity

Project”.

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IAASB Clarity Project Update

In October 2008 the IAASB issued a final Clarity Project Update – slightly ahead of

the December 2008 date by which the last of the clarified ISAs were to be approved

by the Public Interest Oversight Board. The clarified ISAs come into effect for audits

of financial statements beginning on or after 15 December 2009.

Key points from this update, which give some background to the project, are as

follows:

 The Clarity Project was the IAASB’s 18 month program to comprehensively

review all of its ISAs and ISQCs to improve their clarity and therefore the

consistency of their application.

 36 clarified ISAs were issued, along with a clarified ISQC1.

 16 of the ISAs were substantially revised as well as redrafted and one new ISA

(ISA 265) was issued. The other 19 ISAs were redrafted, but not revised.

 All the clarified ISAs contain improvements, including:

- identifying the overall objectives of the auditor when conducting an audit

in accordance with ISAs

- setting an objective in each ISA

- establishing an obligation on the auditor in relation to those objectives

- clarifying the obligations imposed on auditor by the requirements of the ISAs

and the language used (using “shall” instead of the previous “should”)

- eliminating ambiguity about the requirements which an auditor needs to

fulfil.

 As set out above, the ISAs have a new structure with Introductory Material,

Objectives, Definitions, Requirements and Application and Other Explanatory

Material presented in separate sections in the ISA.

 In order to allow stakeholders a period of stability in which to implement the

clarified ISAs and ISQC1, the IAASB has agreed, subject to any unforeseen

circumstances, not to issue any additional standards that would become

effective in the next two years.

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) follow the format of the

original ISAs. They 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.

Chapter 2: The regulatory environment

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 judgement

The nature of the international standards requires the professional accountant to

exercise professional judgment in applying them.

2.4 ISA 200: Overall objectives of the independent auditor and the conduct

of an audit in accordance with International Standards on Auditing

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 revised in a later chapter.

In line with what you should remember from your previous studies, 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.

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Corporate governance

 The meaning and nature of corporate governance

 Directors’ and auditors’ responsibilities

 The requirement for an audit committee

3 Corporate governance

3.1 The meaning and nature of corporate governance

Corporate governance is the way in which companies are managed and controlled.

In particular, it focuses on the role of directors and their responsibilities to

shareholders and other stakeholders.

As a form of business entity, an important feature of companies is the divorce of

ownership from control.

 One group (the directors) manage the business and make the important strategic

decisions.

 A different group (the shareholders) finance the company and own it.

Directors are seen as ‘agents’ of the shareholders. As agents of the shareholders:

 they should take decisions that are in the best interests of their shareholders, and

 they should be accountable to the shareholders for the way in which they have

used the company’s resources.

The need for regulation for good corporate governance

There is some regulation of corporate governance in company law. However, basic

legal requirements have proved inadequate for protecting shareholders from losses,

in a number of corporate scandals caused by directors of the company.

As a result, more specific regulations or guidelines have been introduced to improve

corporate governance.

Regulations and guidelines vary from country to country. In some countries there

are detailed ‘rules’, in others there are none. You are not expected to have a detailed

knowledge of the corporate governance rules in any particular country.

Examination questions will deal with general principles of good corporate

governance. However, it may be helpful if you are able to illustrate the general

principles by reference to the rules that apply in a particular country. For example,

you could develop your knowledge of the corporate governance rules that apply in

your own country.

Chapter 2: The regulatory environment

3.2 Directors’ and auditors’ responsibilities

In all aspects of corporate reporting there is a basic distinction between the role of

the directors and the role of the auditors:

 The directors are responsible for the preparation of information that complies

with the relevant regulations.

 The auditors are responsible for reviewing that information and, in some cases,

reporting on the extent to which the directors have complied with their

responsibilities.

It is good practice in accordance with ISA 210 Agreeing the terms of audit engagements

to clarify the relative responsibilities of the directors and auditors in corporate

governance matters.

Taking the UK as an example, the respective responsibilities of directors and

auditors are set out in the table below.

Note that where the auditor’s role is to read a document, the objective is to identify

and then try to resolve any possible misstatements in the document, or any

inconsistencies with the information contained in the audited financial statements.

This is simply an application of the general principles of ISA 720 Other information in

documents containing audited financial statements.

Area

Directors’ responsibility in

relation to the annual report

Auditors’ responsibility

General

compliance with

the Combined

Code (UK Listing

Rules requirement)

Disclose in a narrative

statement as to how they have

complied with the principles

of the Code.

Read the narrative

statement.

Detailed provisions

of the Code

Present a statement as to

whether they have complied

with the provisions of the

Code throughout the year.

Comply or explain.

Review seven defined

items and report if there is

non-compliance (see

below).

Read other material.

Directors’

remuneration

Include a detailed statement of

directors’ remuneration.

Audit the statement as if it

were part of the financial

statements and include in

the scope of the normal

audit opinion.

Going concern

status

Include a statement that the

business is a going concern

with any necessary supporting

assumptions or qualifications.

Review and report if there

is non-compliance.

Paper P7: Advanced audit and assurance (International)

The nine defined items in the Combined Code which should be reviewed by the

auditors are as follows:

(1) C1 Does the annual report contain a statement of the directors’ and

auditors’ responsibilities?

(2) C2 Have the directors carried out a review of the effectiveness of internal

controls and reported to the shareholders that they have done so?

(3) C3 Has the board established an audit committee (see next section)?

(4) C3 Is the role of the audit committee appropriate?

(5) C3 Does the annual report describe the work of the audit committee?

(6) C3 Has the audit committee ensured adequate arrangements whereby staff

of the company may raise concerns to them in confidence?

(7) C3 Has the audit committee reviewed the effectiveness of internal audit?

(8) C3 Does the audit committee have primary responsibility for

recommending the appointment of external auditors?

(9) C3 Does the annual report explain how the objectivity of auditors is

safeguarded, if non-audit services are provided?

3.3 The requirement for an audit committee

In many countries, listed companies are required or expected to have an audit

committee. In the UK for example, an audit committee is a requirement of the

Combined Code for listed companies.

The audit committee is a ‘sub-committee’ of the board of directors, and it reports to

the main board. In the UK, it should be made up entirely of independent non-

executive directors. (‘Independence’ is defined in the Combined Code.)

One purpose of an audit committee is to establish a ‘buffer’ between the auditors

and the executive directors, in order to minimise the risk that the auditors might

come under undue pressure from the executive members of the board. (For

example, the auditors may be influenced by the threat that the company will take

away their audit work or non-audit work, and so may be more inclined to agree

with the opinions and arguments of the management.)

The audit committee should therefore help to ensure the independence of the

external auditors.

Chapter 2: The regulatory environment

Money laundering

 Definition of money laundering

 Regulation

 Obligations placed on professional firms

 Duty of confidentiality and money laundering

 Global dimension

4 Money laundering

4.1 Definition of money laundering

Money laundering can be defined as the process by which criminals attempt to

conceal the true origin and ownership of the proceeds of their criminal activities.

Criminal activities include drug trafficking, terrorism, theft, fraud and tax evasion.

Money laundering is a process by which money earned from criminal activities

(‘dirty money’) is transferred and transformed so that it appears to have come from

a legitimate source (‘clean money’).

If it is undertaken successfully, money laundering allows criminals to maintain

control over the proceeds of their criminal activity and to provide a legitimate cover

for their sources of income.

There are various criminal offences connected with money laundering. The UK

examples are:

 possessing, in any way dealing with, or concealing, the proceeds of any crime

 attempting, conspiracy or incitement to commit the above offence

 aiding, abetting, counselling or procuring the commission of such an offence

 an act which would constitute any of these offences if done in the UK

 failure by a person in the regulated sector to inform the appropriate party of a

knowledge or suspicion that another person is engaged in money laundering

 making a disclosure which is likely to prejudice an investigation into money

laundering (tipping off)

The last two offences are the ones that accountants may find themselves affected by

even inadvertently, as accountants operate in the regulated sector and are therefore

required to report suspicions of money laundering.

It is made more complicated by the fact that ‘suspicion’ is not defined in the law.

However, it appears to be somewhere between mere speculation and actual proof.

Paper P7: Advanced audit and assurance (International)

There are various defences to charges of money laundering:

 a report had been made to the appropriate party

 there was an intention to make a report and a reasonable excuse (likely to

include fear of physical violence or other menaces) for not having done so

 acquiring or using property for adequate consideration in good faith

4.2 Regulation

Due to the work of inter-governmental bodies such as the Financial Action Task

Force on Money Laundering (FATF), many countries now have legal provisions in

place designed to detect, report and ultimately prevent money-laundering activities.

These provisions vary from country to country. The following notes are based

mainly on regulations in the UK, but similar regulations are applied by many other

countries.

An important feature of the UK regulations is that the proceeds of any crime come

within the scope of UK regulation if they are laundered and detected in the UK. This

is irrespective of where in the world the criminal activity took place.

The UK Money Laundering Regulations 2003 implement the recommendations of

FATF in relation to customer due diligence, record-keeping, reporting of suspicious

transactions and compliance.

4.3 Obligations placed on professional firms

Money laundering may be of particular relevance to accountants, and in particular

auditors, in cases where criminals establish companies and use transactions between

their companies to ‘launder’ their dirty money.

Specific obligations for detecting and reporting suspicions of money laundering are

placed on professional firms (for example, lawyers and accountants) and financial

institutions. These requirements include the following.

 Putting into place systems, controls and procedures to ensure that the firm is not

used for money laundering purposes.

 Appointing a Money Laundering Reporting Officer, whose responsibility is to

receive reports on suspected money laundering activities from other employees

and report them to the appropriate authorities, that is, the Serious Organised

Crime Agency (SOCA). (Note that the responsibility for having appropriate

systems in place to prevent and detect money laundering rests collectively with

senior management. The responsibility for compliance with the money

laundering regulations does not rest solely with the Money Laundering

Reporting Officer.)

 Establishing and enhancing the record-keeping systems (1) for all transactions

(which must be kept for at least five years, with controls to ensure that they are

not inadvertently destroyed) and (2) for verifying the identity of clients (by

obtaining official documents, such as – for an individual – passport or driving

license, supported by recent utilities bills, and – for a company – certificate or

ACCA P7 (INT) Advanced Audit &amp; Assurance - Study Text - 2010 (Emile Woolf Publishing)

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ACCA P7 (INT) Advanced Audit & Assurance - Study Text - 2010 (Emile Woolf Publishing)