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

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Answers to practice questions

Whether the non-disclosure also affects the true and fair view is more difficult.

On the one hand, the amount is immaterial by size, but it could be considered

to be material by nature – i.e. however small, the amount the users of the

financial statements would want to know about such a loan and therefore the

report should also be qualified on the grounds of true and fair.

Conclusion

The audit senior’s proposal is unsuitable. Unless the appropriate disclosures

are made, the opinion should be qualified – at the very least on the grounds of

non-compliance with local legislation.

32 Gorgeous Goods and Conrads Contracts

(a) Meaning of and relationship between

Materiality

 ‘Materiality’ is an expression of the relative significance or importance of a

particular matter in the context of financial statements as a whole. A

matter is material if its omission or misstatement could influence the

economic decisions of users taken on the basis of the financial statements.

 Materiality may also be considered in the context of any individual

statement within the financial statements or of individual items included

in them (performance materiality).

 Materiality is not capable of general mathematical definition as it has both

qualitative and quantitative aspects.

True and fair

 The term ‘a true and fair view’ is not defined in statute and it has therefore

fallen to the auditing profession to reach a reasoned and consistent

interpretation of the term. Accounts should be true and fair if prepared in

accordance with recommended accounting policies.

 Truth relates to factual accuracy and correctness of the financial

statements. For example, the statement of financial position should be an

‘accurate’ reflection (within acceptable limits) of the company’s assets and

liabilities at the year end.

 Fairness relates to the presentation of information and the view conveyed

to the reader. It is important that information in the financial statements is

presented in a manner that is free from bias and does not lead the reader to

any view that is not a reasonable reflection of the company’s financial

situation.

Relationship between materiality and true and fair

‘True and fair’ is a matter for professional judgement. ‘Materiality’ is just one

of the factors considered in making such a judgement.

For example, if a company’s actual revenue for a year of $220,000 was

inaccurately stated (e.g. at $220,100) the financial statements could still be

judged ‘true and fair’ as knowledge of the error would not cause a reader of

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the financial statements to change his opinion of them (i.e. the misstatement is

not material).

Conversely, if a misstatement is judged to be material, the true and fair view is

impaired.

Accounting standards are intended to give a true and fair view and need not

be applied to immaterial items. Where material, compliance with accounting

standards will normally be necessary for financial statements to give a true

and fair view.

(b) Effect on audit reports and reasons

(1) Gorgeous Goods

Effect on audit report

 The audit opinion on the current year income statement/statement

of comprehensive income and comparative income

statement/statement of comprehensive income (closing inventories)

and statement of financial position (inventories) will be qualified

(‘except for’).

 The qualification arises because of the auditor’s inability to obtain

sufficient appropriate evidence (limitation on scope). It will not be a

disclaimer of opinion as the item is not likely to be pervasive as well

as material.

 The report will refer to how the scope of work has been limited.

 The opinion paragraph will state that ‘except for’ adjustments that

might be necessary to opening inventories and/or closing inventory

comparatives; the financial statements show a true and fair view and

have been properly prepared.

Reasons

 Comparatives are part of the audited financial statements.

 In addition, last year’s closing inventories become the current year’s

opening inventories and this affects current year profits.

(2) Conrads Contracts

Effect on audit report

 If the auditor assesses that the contract is unlikely to be renewed and

that, as a result, the company will no longer be a going concern, a

modified opinion is likely on the grounds of a material misstatement

(disagreement with the application of the going concern concept). A

qualified or adverse opinion would be given.

 If the auditor assesses that the going concern assumption is

appropriate but a material uncertainty exists and the directors have

adequately disclosed the situation, an unmodified opinion would be

given but an emphasis of matter paragraph should be used to

highlight the uncertainty and the note in the financial statements

disclosing it.

Answers to practice questions

 If the auditor assesses that disclosures are inadequate for a true and

fair view, an ‘except for’ qualification would be required on the

grounds of a material misstatement (disagreement with disclosure).

 If the auditors believe that the directors have not provided sufficient

information and explanations on the matter a qualified opinion

(limitation on scope) may be required.

Reasons

 Inventories may not be stated at the lower of cost or net realisable

value, as required by IAS 2.

 There is some uncertainty as to whether Conrads Contracts is a

going concern, given the potential loss of over half their trade.

33 Polar Publishing

(1) Database maintenance

Weakness

Routine maintenance work is behind schedule resulting in a backlog of input

for new subscriptions, cancellations and changes of addresses.

Consequences

 Accounting errors and loss of revenue could arise through

− not invoicing new subscribers

− invoicing cancellations

− sending invoices to incorrect addresses.

 Customer goodwill may be lost if subscribers no longer receive their

magazine through it being sent to the wrong address.

 New subscribers, failing to receive their magazine promptly, may cancel

their subscription.

Recommendations

 Extra staff should be employed to bring the database up to date as soon as

possible. Thereafter it could be kept up to date by a part-time employee.

The cost of this should be outweighed by the benefit gained through

avoiding lost revenue and customer goodwill.

(2) Advertising deals

Weakness

As a result of staff shortages, some deals with advertisers are not being

recorded and order confirmations are not being sent out.

Consequences

 A loss of revenue and customer goodwill could result, as order

confirmation letters are used as the basis for allocating advertising space.

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 Advertisers may be unable to place adverts because no space has been

allocated.

 Advertising space may be allocated in error and then left without an

advertisement.

 The lack of written confirmation of the terms may lead to incorrect

invoicing, resulting in a loss of revenue or customer goodwill.

 There may be delays in receiving monies from advertisers whist invoicing

disputes are being dealt with.

Recommendations

 A pre-printed, pre-numbered document should be used for recording all

deals. These should be filed and referenced to the order confirmation

letters and reviewed on a regular basis.

 Alternatively, a suitable multi-part document could provide a copy to

replace the confirmation letter.

 Additional staff should be allocated to the department to record and

confirm all deals are still current.

34 Non-audit services

Introduction

The provision of non-audit services by external auditors to their clients has become

increasingly common over the years. For larger firms and their (large) clients such

services include a wide rage of consulting services. For other firms with smaller

clients, non-audit services are more likely to include services such as basic

bookkeeping and accounts preparation.

Do such services compromise the integrity of the auditing profession?

The provision of other services can lead to a stronger relationship with the client

and increased knowledge about its business and its problems. This increased

knowledge will indirectly improve the quality of the audit but there may also be

direct audit efficiencies if the audit department can rely on work performed by

other departments within the firm.

On the other hand, if the auditor pushes too far with his cross-selling, the client may

wonder whether the auditor is raising real issues or is trying to sell additional

services. In addition, the outside world may perceive that the auditor lacks true

independence and whether he has taken on the audit merely in order to benefit

from fees for (often) lucrative non-audit services. It must be remembered that ethical

guidance requires the auditor not only to be but also be seen to be independent.

Providing other services to audit clients can also lead to actual (as opposed to

perceived) conflicts of interest or a loss of independence/objectivity.

For example, the audit firm might advise both the company and individual

directors or shareholders, in areas such as personal tax, financial planning or

incentive schemes. In such circumstances it will be impossible to give the best

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advice to both parties. A different type of conflict arises where the auditor ends up

assessing his own work, for example, where the firm has implemented a major

systems change and now that system needs to be audited. Some accountancy bodies

have now tightened up in this area such that firms may no longer take on such

systems work where that work would subsequently need to be relied upon during

the course of the audit.

An actual or perceived loss of independence could arise for the following reasons:

 The importance of the client, i.e. undue reliance on one client which could affect

(or be seen to affect) objectivity or the willingness to argue a point. This situation

is perhaps most likely to occur where the audit fee is relatively small compared

to the fees for other services. The ACCA’s ethical rules seek to avoid this by

restricting the recurring fees from one client (or group of connected clients) to

15% of practice income (10% for a listed client). However, there is no restriction

in terms of a ratio between the audit and non-audit fees.

 The closeness of the personal relationship with a small client who relies on the

audit partner for general advice. However, if this small client is owner-managed

then this will be less of an issue.

 The participation in outsourcing or other arrangements which mean that the

same firm is responsible for both preparing and auditing financial information.

Although there are rules in respect of independence/conflicts of interest in the

ACCA’s ethical rules which must be adhered to, there are situations which do not

breach the rules but could be seen to affect the auditor’s independence.

Are such services in the interests of management?

For management, the attraction of using the already appointed statutory auditor for

these other services may lie in the ‘one-stop shop’, whereby the company has access

to a range of specialists who are already familiar with the entity through their

ongoing audit work.

In addition, the information gained by one department of the (audit) firm can be

used by others in the firm, thereby eliminating the need for management to give

multiple briefings and thus saving them time.

However, going to a different firm for these other services may provide management

with a new view/perspective on their problems which may, in itself, be valuable.

Should client size/listed company status make a difference?

There seems to be no clear reason for the rules to be different for different sizes of

client. Smaller companies will generally use smaller firms for auditors and larger

ones will use the larger firms. Different types of other work and therefore different

types of conflict may arise but the issue is still there.

However, there may be a reason for differentiating between owner-managed

businesses and those with outside shareholders. In listed companies, shareholders

often have no real influence over day-to-day management and rely on the auditors

for an independent view of performance. In the owner-managed entity, the directors

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are arguably at liberty to use the auditors in any way they see fit (though there may

be other users of accounts such as banks which are interested in auditor

independence from management).

Conclusion

Due to recent events, the reputation of the auditor has been severely damaged in the

eyes of the user. Although arguably many of the advantages that apply to

management for engaging the auditor to perform non-audit services have a knock-

on effect to the user, it seems unlikely at the moment, that users will see it this way.

Most users now view the auditor/client relationship as potentially a very cosy one,

with auditors earning huge fees from other services and directors, in turn, having a

blind eye turned to their creative accounting practices. However untrue this may be for

the majority of auditor/client relationships, further action is necessary to undo this

damage.

It may be possible that in the future, audit firms will be appointed for fixed periods

and/or will be banned from carrying out any sort of non-audit work. The latter could

be achieved either by allowing audit firms to perform non-audit work but only for a

non-audit client, or by not allowing audit firms to do anything but audit work.

35 Auditor’s liability

Introduction

There are several ways in which claims against the auditor for negligent auditing

could be reduced, or, once a claim is made, its size mitigated. Some of these

remedies are available to individual firms, some need the input of the profession

and some require governmental action.

Individual firms

Clearly, it is preferable to avoid claims arising for negligent auditing in the first

place. Firms can minimise the risks of being sued by ensuring that high quality

audit work is performed. Auditors should therefore:

 follow appropriate auditing standards

 employ sound quality control procedures

 train staff effectively

 ensure that the firm is up to date with modern auditing methods.

However, if successful claims are made (or if out of court settlements are reached)

the auditor will have to pay damages. If the damages are beyond the means of the

audit firm, in some countries, the law may also allow claims to be made against the

personal assets of partners. As a result, the ACCA and other professional bodies

require members in practice to carry professional indemnity insurance. Such

insurance will pay out if the firm itself is unable to pay.

On the other hand, some take the view that the very existence of professional indemnity

insurance may itself increase the frequency and size of claims made against firms,

Answers to practice questions

which are seen to have large amounts of funds at their disposal to meet claims. The

sceptical might say that it may encourage more careless auditing. In any event, it

imposes a high cost on practices, which has risen as the general level of claims has risen.

Governments

In the light of the above criticisms of professional indemnity insurance, a number of

suggestions have been made of ways in which claims against auditors could be

limited. All of these could require government action.

Governments could allow auditors to agree a ‘cap’ on their liability with their clients

or they could set a statutory limit on claims, based on the size of the audit fee or on

a simple fixed amount. In the UK, the recent Companies Act 2006 allows auditors to

agree a cap on liability with their clients.

Alternatively, in some countries there is still some way to go in overhauling the way

in which audit firms are constituted. Conventionally, in most countries,

accountancy and auditing practices were established as sole practitioners or, where

permitted by local law, partnerships.

The implications of this structure were that the owner or owners had unlimited liability

for the debts of the practice. This would include claims made against the firm for

negligent audit work. As discussed above, in some countries, the owners’ personal as

well as business assets were at risk if the firm itself could not pay claims against it.

This principle was originally designed to promote public confidence in the auditing

profession and to encourage auditors to carry out their work with due care.

Problems began to emerge as businesses grew and the size of claims against

auditors increased.

Governments could respond to the issue by moving towards removing auditors

‘unlimited liability’ status. Accountancy practices could then be allowed to trade

either as limited liability companies or as limited liability partnerships (which is, for

example, now allowed under UK law). However, in the current climate, the public

may perceive this as just another way in which auditors are attempting to wriggle

out of their responsibilities/liabilities.

The auditing profession

Another route may lie in work the profession could do to improve public confidence in

the auditing process. This could include the tightening up of ethical rules, for example,

to make the rotation of audit firms (as opposed to partners) mandatory and to restrict

the amount of non-audit services which an audit firm could carry out for its clients.

Conclusion

Undoubtedly, there are measures which could be taken to reduce or mitigate the

incidence or size of negligence claims. Unfortunately, some of these measures may

be perceived negatively by the public. The most important measure probably lies in

improving the public perception of auditors and ensuring that their work is carried

out to high standards with no hint of any unethical practices.

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36 The audit of small businesses

Introduction

There are three separate assertions made here.

(1) That small businesses are unauditable.

(2) That preparing the accounts of a small business gives the auditor an insight

into that business which is advantageous to his subsequent audit.

(3) That audits of large entities can be rather mechanical.

What is small?

Companies may be defined as small by local legislation using limits based on monetary

amounts of revenue or assets. However, the most useful approach is to define what

makes a small business not by its absolute size but by its characteristics. Such criteria

might be based on owner management, limited formal controls and situations where

the auditor is engaged to carry out a significant amount of accountancy work in

addition to the statutory audit. These criteria form the basis of the following discussion.

Are small businesses unauditable?

Only small businesses which are incorporated are required by law to have an audit.

Others may have one, either voluntarily or under pressure from lenders.

When auditing a small company, the auditor is still required to obtain sufficient

appropriate audit evidence (ISA 500). Given the above characteristics of a small

company the auditor may be faced with poor or non-existent documentation,

doubts about the completeness of income (especially in a cash-based business) and

the need to place reliance on written representations.

In order to get around these issues the auditor is likely to take a substantive

approach to his work, vouching a high number of transactions and using third party

verification wherever possible. He cannot, however, rely on uncorroborated written

representations but must look for evidence to support those representations. If the

auditor is also preparing the accounts then he is more likely to be able to gain

sufficient comfort that they are true and fair.

Ultimately, although small businesses are auditable, if sufficient audit evidence

cannot be obtained, the auditor will have no option but to modify his opinion (most

commonly on an inability to verify completeness of income).

Does preparing the accounts of a small business gives the auditor an

advantageous insight?

The need to understand the client is a fundamental requirement whenever an audit

is performed (ISA 315) and whatever the size of business.

If the auditor is also engaged to prepare the accounts he should gain an increased

understanding of his client during the process of preparation. In addition, some

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verification work will have been performed during this process as the auditor refers

to source documentation.

However, the auditor must be careful not to lose such advantages by failing to audit

other areas, merely because he has put the accounts together himself. Although not

all parts of a ‘standard’ audit programme will be appropriate, the auditor will need

to use his increased knowledge of the client to tailor such a programme to the

smaller client (indeed many firms have specific small company audit programmes).

Are audits of large entities rather mechanical?

The inference of this part of the question is that auditors of larger clients do not have

to be as concerned with understanding their client as they can more easily use a

standard set of audit programmes and working papers.

This is of course wrong. The approach to any client must be tailored to that client’s

needs, based on the auditor’s experience and judgement. The audit team must be

properly briefed and controlled and all work must be reviewed. Without such an

approach the team might perform a ‘standard’ audit and miss a material error due

to a lack of understanding.

The planning process must therefore include the preparation of a detailed audit

planning memorandum. Staff should be briefed to ensure they understand how

their assigned tasks fit into the audit as a whole and they should be encouraged to

refer problems to more senior staff.

In summary, a properly performed audit of a large entity should not be mechanical

although undoubtedly, it can benefit from some standardisation, for example, via

the thoughtful use of pre-prepared working papers, tailored to that client.

Conclusion

When audits are performed properly, small businesses are not completely

unauditable and the approach to large audits is not mechanical.

37 QP Supermarkets

Risks and expected controls

(1) Internet operation – quality/non-delivery

Risks Expected controls

Rapid growth of the internet service

could cause a strain on QPS’s

resources, with difficulty in

responding to demand and meeting

customer needs. There may be a lack

of technical skills to support the rapid

growth.

 Risk assessment established by

management, with details of how

rapid growth will be managed.

 Forecast levels of growth of QPS

internet sales, accompanied by an

agreed strategy for managing that

growth and responding to demands.

Paper P7 INT: Advanced audit and assurance

(1) Internet operation – quality/non-delivery

Risks Expected controls

 Employment of appropriate skilled

technical resource.

Failure to deliver all requested items

could result in customer

dissatisfaction and a switch away

from using the internet service.

 Checks on deliveries.

 Reconciliation of orders and against

payments.

 Inventories checks and controls.

Poor quality of deliveries could arise

from a lack of commitment to the

internet service by the local

supermarkets responsible for delivery

or delays in delivery. This could result

in:

 customer dissatisfaction, customer

complaints and unwillingness of

customers to continue with the

service

 a need to compensate customers

for poor quality/delayed goods

 Clear, documented procedures for

deliveries.

 Quality standards and control for

goods deliveries.

 Monitoring of complaints received.

 Monitoring of trends in use and

identification and review of potential

problem stores.

(2) Internet operation – systems problems

Risks Expected controls

System breakdown resulting in poor

customer service, loss of sales and

financial loss.

 System logs.

 Regular back-up of data.

 Disaster recovery and business

continuity plans in place and subject

to regular testing and review.

 Service standards for system

maintenance.

 IT expertise.

If the internet ordering continues to

grow at a rapid rate, then continued

interruption of services could

ultimately affect profitability and

viability of the company.

 Forecast of levels of ordering with

plans for maintenance of service to

achieve desired levels of service.

QPS sensitive information may be

obtainable by hackers through the

internet capability.

 Data encryption.

 Access controls.

Unauthorised access to customer

information obtained through the

internet resulting in customer

dissatisfaction, complaint and ‘lack of

trust’. Potential to lose customers.

 Access and security controls –

restriction of access, access logs.

 Access reporting and monitoring.

Data may become corrupted or lost,

 System maintenance controls.

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

Подождите немного. Документ загружается.

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