Aa Assignment.docx

AUDIT AND ASSURANCE ASSIGNMENT

CHAPTER 9: INTERNAL AUDIT 1. DISCUSS THE SCOPE OF INTERNAL AUDIT AND LIMITATIONS OF INTERNAL AUDIT FUNCTIONS. Scope of internal audit function: The role of internal audit can vary depending on the requirements of the business. Key activities of the internal audit function are -

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Assessing whether the company is demonstrating best practice in corporate governance. Evaluating the company's risk identification and management processes. Testing the effectiveness of internal controls. Assessing the reliability of financial and operating information. Assessing the economy, efficiency and effectiveness of operating activities (value for money). Assessing compliance with laws and regulations. Providing recommendations on the prevention and detection of fraud.

Most of these activities can be seen as helping management comply with corporate governance requirements. In addition to the above, internal audit will carry out ad hoc assignments, as required by management. For example:-

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Fraud investigations - this may involve detecting fraud, identifying the perpetrator of a fraud and quantifying the loss to the company as a result of a fraud. IT systems reviews - performing a review of the computer environment and controls. Mystery shopper visits - for retail and service companies the internal audit staff can pose as customers to ensure that customer service is at the required level. Contract audits- making sure that where material or long term contracts are entered into by the organization, the contract is written to protect the organization appropriately and contractual terms are being adhered to by the supplier in line with the service level agreement. Asset verification- such as performing cash counts and physical inspection of non-current assets to verify existence. Providing direct assistance to the external auditor -internal audit staff can help the external auditor with their procedures under their supervision, in accordance with ISA 610.

Limitations of internal audit function:  Internal auditors may be employees of the company they are reporting on and therefore may not wish to raise issues in case they lose their job.  In smaller organizations in particular, internal audit may be managed as part of the finance function. They will therefore have to report on the effectiveness of financial systems of which they form a part and may be reluctant to say their department (and manager) has deficiencies.

 If the internal audit staff have worked in the organization for a long time. Possibly in different departments, there may be a familiarity threat as they will be auditing the work of long standing colleagues and friends.

It is therefore difficult for internal audit to remain truly objective. However, acceptable levels of independence can be achieved through one, or more, of the following strategies:  Reporting channels separate from the management of the main financial reporting function.  Reviews of internal audit work by managers independent of the function under scrutiny.  Outsourcing the internal audit function to a professional third party.

2. COMPARE AND CONTRAST THE ROLE OF EXTERNAL AND INTERNAL AUDIT FUNCTIONS. EXTERNAL AUDIT

INTERNAL AUDIT Improve the company's operations by reviewing the efficiency and effectiveness of internal controls.

Reporting

Express an opinion on the truth and fairness of the financial statements in a written report. Reports to shareholders.

Availability of report

Publicly available.

Not publicly available. Usually only seen by management or those charged with governance.

Scope of work

Verifying the truth and fairness of the financial statements.

Wide in scope and dependent on management's requirements.

Appointment and removal

By the shareholders of the company.

Objective

Reports to management or those charged with governance.

By the audit committee or board of directors. Relationship with company Must be independent of the company. May be employees (which limits independence) or an outsourced function (which enhances independence).

3. DESCRIBE THE FORMAT AND CONTENT OF INTERNAL AUDIT REVIEW REPORTS AND MAKE APPROPRIATE RECOMMENDATIONS TO MANAGEMENT AND THOSE CHARGED WITH GOVERNANCE. Unlike an independent external auditor's report, the internal audit report does not have a formal reporting structure. It is likely that the format is agreed with the audit committee or board of directors prior to commencing the assignment. These reports will generally be for internal use only. The external auditors may inspect them if they are intending to place reliance on the work of internal audit. A typical report will include:

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Terms of reference - the requirements of the assignment. Executive summary - the key risks and recommendations that are described more fully in the body of the report. Body of the report - a detailed description of the work performed and the results of that work. Appendix - containing any additional information that doesn't belong in the body of the report but which is relevant to the assignment.

Significant deficiencies are those which merit the attention of those charged with governance. [ISA 265, 6b] Examples of matters the external auditor should consider in determining whether a deficiency in internal controls is significant include:

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The likelihood of the deficiencies leading to material misstatements in the financial statements in the future. The susceptibility to loss or fraud of the related asset or liability. 0 The subjectivity and complexity of determining estimated amounts. 0 The financial statement amounts exposed to the deficiencies. The volume of activity that has occurred or could occur in the account balance or class of transactions exposed to the deficiency or deficiencies. The importance of the controls to the financial reporting process. The cause and frequency of the exceptions detected as a result of the deficiencies in the controls. The interaction of the deficiency with other deficiencies in internal control. [ISA 265, A6]

The auditor communicates the deficiencies in a management letter or report to management. It is usually sent at the end of the audit process.

CHAPTER 10: PROCEEDURES 1. DISCUSS SUBSTANTIVE PROCEEDURES FOR AUDIT EVIDENCE. Substantive procedures consist of:

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Tests of detail: - tests of detail to verify individual transactions and balances. Substantive analytical procedures: - analytical procedures (as seen in the chapter 'Risk') involve analyzing relationships between information to identify unusual fluctuations which may indicate possible misstatement.

In some circumstances the auditor may rely solely on substantive testing:

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The auditor may choose to rely solely on substantive testing where it is considered to be a more efficient or more effective way of obtaining audit evidence. E.g. for smaller organizations. The auditor may have to rely solely on substantive testing where the client's internal control system cannot be relied on.

The auditor must always carry out some substantive procedures on material items, and also carry out specific substantive procedures required by ISA 330 The Auditor’s Response to Assessed Risks. The auditor is required to carry out the following substantive procedures:

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Agreeing the financial statements to the underlying accounting records. Examination of material journals and other adjustments made in preparing the financial statements. [lAS 330, 20]

Tests of detail v analytical procedures A test of detail looks at the supporting evidence for an individual transaction such as inspection of a purchase invoice to verify the amount/date/classification of a specific purchase. If there are $000 purchase invoices recorded during the accounting period, this one test 01 detail has only provided evidence for one of those transactions. An analytical procedure would be used to assess the reasonableness of the purchases figure in total. For example, calculate the percentage change in purchases from last year and then compare this with the percentage change in revenue to see if they move in line with each other as expected. The analytical procedure is not looking at the detail of any of the individual purchases but at the total figure. It is possible that there are a number of misstatements within the purchases population which would only be discovered by testing the detail as they may cancel each other out. An analytical procedure would not detect these misstatements. Because of this, analytical procedures should only be used as the main source of substantive evidence where the internal controls have been found to be reliable as there is less chance of misstatements being present as the control system would have detected and corrected them.

2. DISCUSS THE PROCEEDURES ASSOCIATED WITH THE AUDIT AND REVIEW OF ACCOUNTING ESTIMATES. Accounting estimates: There are many accounting estimates in the financial statements, e.g. allowances for receivables, depreciation of property, plant and equipment, provisions, etc. Accounting estimates are inherently risky because they are about the future, are often not supported by documentary evidence and therefore accuracy may not be able to be verified. ISA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates and Related Disclosures requires the auditor to:  Obtain an understanding of how management identities those transactions, events or conditions that give rise to the need for an estimate. [8b] For each estimate in the financial statements, the auditor must also:      

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Enquire of management how the accounting estimate is made and the data on which it is based. [8b] Review the outcome of accounting estimates included in the prior period financial statements. [9] Determine whether events up to the date of the auditor's report provide additional evidence with regard to the appropriateness of estimates. [13a] Test how management made their estimates and evaluating whether the method is appropriate. [13b] Test the effectiveness of controls over estimations. [13c] Develop a point estimate to use in comparison to managements'. [3d] If there are significant risks associated with estimates the auditor should also enquire whether management considered any alternative assumptions and why they rejected them and whether the assumptions used are reasonable in the circumstances. [15] Obtain written representations from management confirming that they believe the assumptions used in making estimates are reasonable. [22]

CHAPTER 11: COMPLETION AND REVIEW 1. DISCUSS THE PROCEEDURES TO BE UNDERTAKEN IN PERFORMING A SUBSEQUENT EVENTS REVIEW. Subsequent events: ISA 560 Subsequent Events, para 4, requires the auditor to:

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Obtain sufficient appropriate audit evidence about whether events occurring between the date of the financial statements and the date of the auditor’s report, that require adjustment or disclosure are appropriately reflected in accordance with the applicable financial reporting framework. Respond appropriately to facts that become known to the auditor after the date at the auditor’s report. Adjusting. Non- adjusting

Subsequent events procedures:

a) b) c) d) e) f) g) h) i) j) k)

Enquiring of the directors if they are aware of any events, adjusting or non-adjusting, that have not yet been included or disclosed in the financial statements. Enquiring into management procedures/systems for the identification of events after the reporting period. Reading minutes of members’ and directors' meetings. Reviewing accounting records including budgets, forecasts, cash flows, management accounts and interim information. Obtaining a when representation from management confirming that they have informed the auditor of all subsequent events and accounted for them appropriately in the financial statements. [ISA 560, 9] Inspection of correspondence with legal advisors. Reviewing the progress of known risk areas and contingencies. Considering relevant information which has come to the auditor’s attention, from sources outside the entity, including public knowledge, competitors, suppliers and customers. Inspecting after date receipts from receivables. Inspecting the cash book after the year-end for payments/receipts that were not accrued for at the year-end. Inspecting the sales price of inventories after the year-end.

2. IDENTIFY AND DESCRIBE THE BASIC ELEMENTS CONTAINED IN THE INDEPENDENT AUDITOR’S REPORT. The objectives of the auditor are:

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To form an opinion on the financial statements based on an evaluation of the conclusions drawn from the audit evidence obtained, and To express clearly that opinion through a written report. [ISA 700 Forming an Opinion and Reporting on Financial Statements, 6]

The auditor forms an opinion on whether the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework. In order to do that they must conclude whether they have obtained reasonable assurance about whether the financial statements as a whole are free from material misstatement (whether due to fraud or error). In particular the auditor should evaluate whether:

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The financial statements adequately disclose the significant accounting policies. The accounting policies selected are consistently applied and appropriate. Accounting estimates made by management are reasonable. Information is relevant, reliable, comparable and understandable. The financial statements provide adequate disclosures to enable the users to understand the effects of material transactions and events. The terminology used is appropriate. [ISA 700, 13]

When the auditor concludes that the financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework they issue an unmodified opinion in the auditor’s report. [ISA 700, 16] If there are no other matters which the auditor wishes to draw to the attention of the users they will issue an unmodified report.

Explanations of the sections: SECTION 1. Title 2. Addressee 3. Auditors Opinion 4. Basis for Opinion

5. Key Audit Matters

6. Other Information

7. Responsibilities of Management and those Charged with Governance for the Financial Statements

PURPOSE To clearly identify the report as an Independent Auditor's Report. To identify the intended user of the report. Provides the auditor's conclusion as to whether the financial statements give a true and fair view. Provides a description of the professional standards applied during the audit to provide confidence to users that the report can be relied upon. To draw attention to any other significant matters of which the users should be aware, to aid their understanding of the entity. (Note: This section is only compulsory for listed entities.) To clarify that management are responsible for the other information such as the Chairman's statement. The auditor‘s opinion does not cover the other information and the auditor's responsibility is only to read the other information and report in accordance with ISA 720. To clarify that management are responsible for preparing the financial statements and for the internal controls. Included to help minimize the expectations gap.

8.Auditor's Responsibilities for the To clarify that the auditor is responsible for expressing Audit of the Financial Statements reasonable assurance as to whether the financial statements give a true and fair view and express that opinion in the auditor's report. The section also describes the auditor's responsibilities in respect of risk assessment, internal controls, going concern and accounting policies. Included to help minimize the expectations gap. 9. Report on Other Legal and Regulatory Requirements

To highlight any additional reporting responsibilities, if applicable. This may include responsibilities in some jurisdictions to report on the adequacy of accounting records, internal controls over financial reporting, or other information published with the financial statements. 10. Name of the engagement partnerTo identify the person responsible for the audit opinion in case of any queries. 11. Signature Shows the engagement partner or firm accountable for the opinion. 12. Auditor's address To identify the specific office of the engagement partner in case of any queries. 13. Date To identify the date up to which the audit work has been performed. Any information that comes to light after this date will not have been considered by the auditor when forming their opinion. The report must be signed and dated after the date the directors approved the financial statements. Often, the financial statements are approved and the auditor’s report signed on the same day.

CHAPTER 12: REPORTING 1. EXPLAIN MODIFIED OPINION IN THE AUDITOR’S REPORT. Modified report with modified opinion: The auditor may decide they need to modify the opinion when they conclude that:

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Based upon the evidence obtained the financial statements as a whole are not free from material misstatement. This is where the client has not complied with the applicable financial reporting framework. They have been unable to gather sufficient appropriate evidence to be able to conclude that the financial statements as a whole are free from material misstatement. This is evidence the auditor would expect to exist to support the figures in the financial statements. [ISA 705. 6]

The nature of the modification depends upon whether the auditor considers the matter to be material but not pervasive, or material and pervasive, to the financial statements. Material but not pervasive - Qualified opinion:

1.

If the misstatement or lack of sufficient appropriate evidence is material but not pervasive, a qualified opinion will be issued.

2.

This means the matter is material to the area of the financial statements affected but does not affect the remainder of the financial statements.

3. 4.

'Except for' this matter, the financial statements give a true and fair view. Whilst significant to users' decision making, a material matter can be isolated whilst the remainder of the financial statements may be relied upon.

[ISA 705, 7] Material and pervasive: A matter is considered 'pervasive' if, in the auditor's judgment:

5.

The effects are not confined to specific elements, accounts or items of the financial statements

6.

If so confined, represent or could represent a substantial proportion of the financial statements, or

7.

In relation to disclosures, are fundamental to users ‘understanding of the financial statements. [ISA 705, 5a] ‘In brief, a pervasive matter must be fundamental to the financial statements, therefore rendering them unreliable as a whole.

2. DESCRIBE PROCEEDURES AN AUDITOR SHOULD PERFORM IN CONDUCTING THEIR OVERALL REVIEW OF FINANCIAL STATEMENTS. Before forming an opinion on the financial statements and deciding on the wording of the auditor’s report, the auditor should conduct an overall review. The auditor should perform the following procedures:

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Review the financial statements to ensure: -Compliance with accounting standards and local legislation disclosure requirements. This is sometimes performed using a disclosure checklist. -Accounting policies are sufficiently disclosed and to ensure that they are in accordance with the accounting treatment adopted in the financial statements. -They adequately reflect the information and explanations previously obtained and conclusions reached during the course of the audit.

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Perform analytical procedures to corroborate conclusions formed during the audit and assist When forming an overall conclusion as to whether the financial statements are consistent with the auditors understanding of the entity. [ISA 520, 6]  Review the aggregate of the uncorrected misstatements to assess whether a material misstatement arises. If so, discuss the potential adjustment with management.