Professional Documents
Culture Documents
AUE2601 Exam Pack GR
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Assignment 1 is compulsory and due 21 August 09 (study guide topics 1 – 4)
- counts towards final module mark
Aue2601
AUE2601 th
Assignment 2 is compulsory and due 25 September 09 (study guide topic 5)
- counts towards final module mark
Detailed Summarised
Detailed summarisedNotes & past
notes &
Assignment 3 is NOT compulsory and doesn't count towards final mark – self assessment
Internal auditors – perform independent assignments on behalf of senior management of the company – normally to
evaluate the efficiency, economy and effectiveness of the company’s internal control systems and business activities.
Enhances management’s degree of confidence that the company’s systems are functioning as intended. Employee of
the company, but should be independent of the department, division or subsidiary which they are auditing.
Government auditors – evaluate and investigate the financial affairs of government departments and report their
findings to senior government therefore increasing the degree of confidence which they have in their departments.
Employee of the government, but must be independent of the government department they are auditing.
Forensic auditors – concentrate on investigating and gathering evidence where there has been alleged financial
mismanagement, theft or fraud. Work independent of the entity under investigation and increases the degree of
confidence the investigating body has in the evidence which is presented.
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Special purpose auditors – specialise in a particular field such as environmental auditors and VAT auditors. Enhance
the confidence people have in the “correctness” of the information that is being presented.
MUST BE INDEPENDENT OF THE ENTITY BEING AUDITED.
Engagement of auditing can either be because of statutory requirements (e.g. companies) or on a voluntary basis :
Statutory audits – audits required in terms of an Act – e.g. Companies Act which state that all companies must be
audited on an annual basis. These acts normally spell out the statutory duties and responsibilities of the auditor.
Non-statutory audits – audits that are requested by clients but are not obligatory in terms of legislation – e.g. if
member wants audit of a CC.
Objective of :
Audit engagement – to enable the auditor to express an opinion as to whether the financials statement are prepared
(in all material respects) in accordance with an applicable financial reporting framework
Review engagement – to enable the auditor to state whether or not anything has come to the auditor's attention that
causes the auditor to believe that the financial statements are not prepared (in all material respects) in accordance with
an identified financial reporting framework. A review engagement is conducted on the basis of procedures that do not
provide all the evidence that would be required in an audit.
Agreed-upon-procedures engagement – for the auditor to carry out procedures of an audit nature to which the auditor
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and the entity and any appropriate 3 parties have agreed and to report on the factual findings
Compilation engagement – to use accounting expertise as opposed to auditing expertise to collect, classify and
summarise financial information.
OBJECTIVE OF A FINANCIAL AUDIT (AUDIT OF FINANCIAL STATEMENTS) – to provide users of the financial
statements of companies with a high degree of assurance about the creditability of the assertions made by the
management of the company in its financial statements. The assurance is in the form of an expression of an
opinion in the auditor’s report as to whether or not the financial statements are a fair presentation of the
company’s operating activities.
The determination of fair presentation relates to the financial statements taken as a whole. Fair presentation is
determined based on the auditor reporting on the information on the financial position (balance sheet), performance
(income statement) and any changes in the financial position of the company (cash flow statement).
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ISA 200 – OBJECTIVE AND GENERAL PRINCIPLES GOVERNING AN AUDIT OF FINANCIAL
STATEMENTS
Auditor must comply with relevant ethical requirements relating to audit engagements.
Audit must be conducted in accordance with International Standards on Auditing, but will also have to comply with other
professional, legal or regulatory requirements - ISA’s do not override local laws and regulations.
Auditor should also plan and perform an audit with an attitude of professional skepticism realising that there may be
circumstances resulting in the financial statements being materially misstated.
Auditor conducting an audit in accordance with ISA’s has reasonable assurance that the financial statements taken as a
whole are free from material misstatement (due to fraud or error). Reasonable assurance allows the auditor to conclude
that there are no material misstatements in the financial statements taken as a whole.
Management is responsible for identifying risks to the business however the auditor is only concerned with risks that
may effect the financial statements.
Audit risk = the risk that an auditor may express an inappropriate audit opinion when the financial statements are
materially misstated (risk of material misstatement).
Detection risk = the risk that the auditor will not detect misstatement of the financial statements. The auditor performs
audit procedures to assess the risk of material misstatement and sees to limit detection risk by performing further audit
procedures based on that assessment. Risk is a function of the effectiveness of an audit procedure and its application
by the auditor and can never be reduced to zero because the auditor never examines the full class of transactions,
account balances or disclosure or other factors (e.g. auditor may select an inappropriate audit procedure, misapply an
appropriate audit procedure or misinterpret the audit results.) Can normally be addressed through adequate planning,
proper assignment of personnel of the engagement team, application of professional skepticism and supervision and
review of the audit work performed. Relates to the nature, timing and extent of the auditor’s procedures that are
determined by the auditor to reduce audit risk to an acceptably low level. FOR GIVEN LEVEL OF AUDIT RISK - THE
ACCEPTABLE LEVEL OF DETECTION RISK BEARS AN INVERSE RELATIONSHIP WITH THE RISK OF MATERIAL
MISSTATEMENT AT THE ASSERTION LEVEL, so the greater the risk of material misstatement that the auditor
believes exists, the less the detection risk that can be accepted AND the less risk of material misstatement the auditor
believes exists, the greater the detection risk that can be accepted.
The audit should be planned and preformed to reduce audit risk to an acceptably low level, by designing and performing
audit procedures to obtain sufficient appropriate audit evidence to draw reasonable conclusions on which to base an
audit opinion. Reasonable assurance is obtained when the auditor has reduced audit risk to an acceptably low level.
The auditor is concerned with material misstatements and isn’t responsible for detecting misstatements that are not
material to the financials as a whole. Auditor must consider risk of material misstatements on two levels :
· overall financial statement level – refers to risks of material misstatement relating pervasively to the financial
statements as a whole and that potentially affect many assertions. These risks often relate to the entity’s control
environment (e.g. management’s override of internal controls) but could also be declining economic conditions, but
are mainly relevant due to the risk of material misstatement arising from fraud. Auditor must use knowledge, skill
and ability of personnel assigned significant engagement responsibilities, appropriate levels of supervision and if
there is any event or condition that may cast significant doubt on the entity’s ability to continue as a going concern.
· in relation to classes of transactions, account balances and disclosures and related assertions – assists in
determining the nature, timing and extent of further audit procedures at the assertion level. Auditor must have
sufficient appropriate audit evidence at class of transactions, account balance and disclosure level so that the
auditor at completion of the audit can express an opinion on the financial statements taken as a whole at an
acceptably low level of audit risk (can use a model that expresses the general relationship of the components of
audit risk in mathematical terms to arrive at an appropriate level of detection risk).
Risk of material misstatement at the assertion level consists of :
· inherent risk = susceptibility of an assertion to a misstatement that could be material (either alone or in total with
other misstatements) assuming that there are no related controls. Greater in some assertions and related classes
of transactions, account balances and disclosure (e.g. complex calculations are more likely to be misstated then
simple calculations, and accounts estimates subject to significant measurement uncertainly pose greater risks then
accounts that have relatively routine factual data.) External circumstances giving rise to business risks can also
influence inherent risk (e.g. technological developments can made a product obsolete therefore causing inventory to
be susceptible to overstatement). Factors in the entity and its environment can also influence the inherent risk
related to a specific assertion (e.g. lack of sufficient working capital to continue operations or declining industry
characterised by a large number of business failures.)
· control risk = risk that misstatement could occur in an assertion that could be material, either individually or in total
with other misstatements, and will not be prevented or detected an corrected by the entity’s internal control system.
Some risk will always exist because of the inherent limitations of internal control – and control risk is a function of
the effectiveness of the design and operation of internal control in achieving the entity’s objectives relevant to the
preparation of the financials.
Inherent and control risks are risks of the entity – they exist independently from the audit of financials. The auditor is
required to assess the risk of material misstatement at the assertion level as a basis for further audit procedures, but
that assessment is a judgment rather then a precise measurement of risk. The assessment of the risk of material
misstatement can be expressed in quantitive terms (e.g. percentages) or in non-quantitive terms.
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Auditor’s responsibility = forming and expressing an opinion on the financial statements
Management responsibility = preparing and presenting the financial statements in accordance with the applicable
financial reporting framework. Must identify that framework and must :
· design, implement and maintain internal controls that are free from material misstatement (from either fraud or error)
· select and apply appropriate accounting policies
· make accounting estimates that are reasonable in the circumstances
Financial statements = structured representation of the financial information which are derived from accounting
records and are intended to communicate the entity’s economic resources or obligations at a point in time (or changes
therein) for a period of time in accordance with a financial reporting framework, normally including notes.
FOLLOWING MIGHT NOT YET BE APPLICABLE (ISA notes say to be implemented at future date) : auditor should
determine if the financial reporting framework that management has used in preparing the financial statements is
acceptable.
Acceptable financial reporting frameworks for general purpose financial statements normally show :
· relevance
· completeness
· reliability
· neutrality
· understandability
If auditor makes comparison of the entity’s financials against the requirements of an existing framework and differences
are identified, then must consider the reasons for the difference and if the application of the accounting convention
could result in misleading financials. If auditor decides that the framework used by management is not acceptable –
then must consider the implications in relation to engagement acceptance and the auditor’s report.
Expressing an opinion on the financials – refer to ISA 700 (revised), 701 and 800 when expressing an opinion, but
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ISA is only effective for audits of financials on or after 15 December 2005!
Amendment to ISA 200 states that auditor can (in exceptional circumstances) depart from a basic principle or an
essential procedure in order to achieve the objective of the audit. In that case the auditor may still represent compliance
with ISA’s provided the departure is appropriately documented.
Advantages of audit of financial statements – assures the creditability of the financial statements to various users
such as:
· banks and loan giving companies
· SARS for tax collection
· investors who base investment decisions on auditing info
· employers relying on audited info when taking decisions affecting employee benefits
· creditors for decisions regarding the extending of trade credit
· settlement of claims e.g. insurance claims
Audit helps auditor to advise the company on :
· improvements to the accounting system if necessary
· ways of increasing efficiency and profits
Reasonable assurance – auditor doesn’t certify or confirm the absolute correctness of financial information, instead
expresses an opinion on its fair presentation (cos audit is to provide reasonable assurance that the financial statements
taken as a whole are free of material misstatement NOT that they are 100% correct.
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ISA – Objective and General Principals provides list of factors :
· use of testing – auditor cannot examine every single transaction in the business so does “test check” (check a
sample of transactions and balances). Obviously If has only test checked then can’t say that everything is 100%
correct cos hasn’t tested everything.
· inherent limitations of account and internal control systems – auditor has to rely on the client’s systems to
provide financial information and these systems will have limitations which may result in failure to detect errors or
frauds (so information that auditor is using to supply an opinion may be flawed.)
· audit evidence is usually persuasive rather then conclusive – auditor can only be “persuaded” that an event or
transaction took place by looking at the documents or information that management provides. Didn’t actually
witness the event
· subjectivity in the financial statements and in the auditor’s approach to the audit – many account balances in
the financials contain balances which are subjective (fixed) and many current assets are affected by estimates
(subjective) of depreciation impairment, stock obsolescence and bad debts. Cos impossible for auditor to know
which debtors will not pay or which stock will become obsolete so the auditor’s decisions as to which type of tests
and the timing and extend of those tests will all be subjective – i.e. one auditor will not necessarily conduct the audit
in the same way as another auditor.
Assurance engagements broken up into :
· reasonable assurance – objective is reduction in assurance engagement risk to an acceptably low level in the
circumstances of the engagement as the basis for a positive form of expression of the practitioner’s conclusion
· limited assurance engagements – objective is reduction in assurance engagement risk to a level that is
acceptable in the circumstances of the engagement, but where the risk is great then for a reasonable assurance
engagement as the basis for a negative form of expression of the practitioner’s conclusion.
SA Institute of Chartered Accountants (SAICA) says professional has certain characteristics including :
· mastery of a particular intellectual skill acquired by training and education
· acceptance of duties to society as a whole in additional to duties to the client or employer
· outlook which is essentially objective and
· rendering personal services to a high standard of conduct and performance.
Companies Act states that all companies (public and limited interest companies – i.e. private companies) must be
audited. Shareholders must appoint directors and also an auditor. Act regulates who may be appointed as directors
and auditors and also how they can be dismissed or may resign and also provides legal backing for the financial
reporting standards.
Also requires the appointment of an audit committee to enhance the audit function and provides the auditor with the
right to access the company’s records. Also gives requirements which must be fulfilled by the auditor before he can
report an opinion to the shareholders (e.g. if the financial statements are in agreement with the accounting records) and
places a duty on the auditor to report to the shareholders. Act also stipulates that the auditor’s report must contain the
auditor’s opinion on whether the report of the directors to the shareholders fairly presents the financial position of the
company at the specified date and the results of its operation for the period ending on that date.
Assertions of management in the AFS’s (i.e. their representations about the company’s assets, equity, liabilities,
transactions and events). As laid down in ISA 500 – Audit Evidence
· completeness – all assets, liabilities, transactions or events which should have been recorded have been recorded
· occurrence – a transaction or event which has been recorded took place and pertains to the entity
· existence – asset, liabilities and equity interest exist at a given date
· cut off – transaction and events have been recorded in the correct accounting period
· accuracy – amount and other date relating to recording transactions and events have been recorded appropriately
· classification – transactions and events have been recorded in proper accounts
· rights and obligations – entity holds or controls the rights to assets, and liabilities are the obligations of the entity
· valuation and allocation – assets, liabilities and equity interest are included in the financial statements at
appropriate amounts and any resulting valuation or allocation adjustments (e.g. depreciation or obsolescence) are
appropriately recorded
· presentation and disclosure
Ø occurrence and rights and obligations, disclosed events, transactions and other matters have occurred and
pertain to the entity
Ø completeness – all disclosures that should have been included in the financial statements have been included
Ø classification and understandability – financial information is appropriately presented and described and the
disclosures are clearly expressed
Ø accuracy and valuation – financial and other information is disclosed fairly and at appropriate amounts
see example pg 1/16 of text book in 5.2
Auditor’s responsibility to obtain sufficient appropriate evidence that the assertions in the financial statements are fairly
presented.
Operational audit – appraises the effectiveness with which managements objectives are being carried out, identifies
shortcomings and makes recommendations to management. Achieved by weighing up the effectiveness and operation
of sections within the entity against corporate and industry standards
Management audit – evaluates the entity’s management systems and determines if the management systems are
operating effectively and if not, what are the risks for the entity.
Comprehensive auditing – combined operational and management audit is performed instead of an external audit.
Therefore evaluates the effectives and functions of management objectives and management systems, identifies
shortcomings and makes recommendations to management.
Forensic audit – combination of accounting, auditing and investigative expertise is used to gather evidence of criminal
conduct and the financial implications of this conduct. Can be asked to assist with the determination or rebuttal of
possible claims for damages
Governmental audit – Auditor General performs audits on all government and State revenue and expenses and
reports to parliament. Normally uses independent auditors to do so.
SAICA Code of Professional Conduce (Preface) states : that professional are characterised by :
· mastery of a particular intellectual skill – acquired by training and education
· acceptance of duties to society as a whole in addition to duties to the client or employer
· an essentially objective outlook
· personal services rendered of a high standard of conduct and performance.
The code is established on the basis that unless a limitation is stated, then these objectives and fundamental principles
are valid for all professional accountants if they are in public practice, business, public sector or education.
Recognition principles
General principles applying to the recognition of academic, core assessment, training and education programmes by the
IRBA :
· recognition – status granted by the Board to academic, core assessment, training and education programmes of
certain professional bodies that meet the recognition standards defined by the IRBA (minimum requirements
necessary to achieve the objectives of the programme and if person achieved the standard is assessed by the
Public Practice Examination
· applications for accreditation – in terms f the accreditation model prescribed by the IRBA
· relationships with regard to recognition and monitoring – no direct relationship between the IRBA and the
various institutions that provide recognised programmes.
· monitoring recognised programmes – must continue to meet the recognition standards as defined by the IRBA.
If professional body uses various institutions to deliver the recognised programme then IRBA will monitor the
professional body NOT the providers of the programme.
Membership of professional bodies - simply passing the PPE doesn’t automatically mean that membership is granted
to any professional body – admission requirements for membership is are determined by each specific professional
body.
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Recognition guidelines
IRBA monitors programmes that lead to registration as a registered auditor through co-operation with professional
bodes and uses the following guidelines as basis for application of the accreditation model :
· accreditation is partnership between IRBA and professional bodies where their programmes lead to registered
auditor registration
· recognition process not based on prescription of specific and consistent quantitative measures but rather
encourages diverse and coherent learning programmes that lead to registration of registered auditor
· recognition process aim is to proved access to and progression within the auditing profession for those who want to
and have ability to register as registered auditors
· recognition seeks to achieve and maintain constant high standards in learning programmes
· Registered auditors should be professionally competent people who can adapt to change and are committed to
lifelong learning process in order to enable them to make a meaningful contribution to the profession
· standards of programmes that lead to registration must be on par with international standards
Study guide pg 38
Professional person generally have superior skills or expertise in their field and their work is based on the knowledge
and skills that they have – not just working for a source of income.
Skills offered to the general public by professional based on intellectual skills and expertise that is members possess –
they attain a high level of formal education qualifications and technical competence that gives them superior skills
Characteristics of a professional :
· collective organisation – professionals are self-regulated rather then being regulated by the State, which assumes
that the are capable of organizing, controlling and regulating themselves by co-operative and collective means.
Professionals work together to form voluntary institutions or boards that interact on their behalf with the general
public and the State
· credentialling – superior expertise of professionals is accredited by professional body that has a system of
credentialling, which sets them apart from unqualified people who may offered the services on a more casual basis
· professional standards and disciplinary control – need for autonomy in performing professional work as area of
work is complete and requires judgment (so cannot be completely standardised). Board has responsibility for
setting out the standards of performance for the work carried out by its members and needs to have appropriate
mechanisms in place to monitor compliance with standards and to exercise disciplinary control over it’s members
· ethical element – professionals have public respect and trust and in return have to undertake to organise, educate
and train their members to proved a competent and ethical service – professional standards and disciplinary control
can only succeed if Board has integrity in the marketplace
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Principals or criteria of professionals are applicable to auditing profession in SA :
· specialist knowledge and skills – people wanting to be admitted by the Board have to have formal educational
qualifications and must pass the Public Practice Examination in Accounting and Auditing and serve the applicable
period under a training contract
· collective organisation only persons registered with the IRBA (statutory board governing accounting and auditing
profession) can function and represent themselves as auditors. Also have professional instructions that promote
the interests of the profession by maintaining programmes that establish appropriate standards for professional
work as well as monitoring adherence to those standards and laying down the codes of professional conduct for
their members.
SOUTH AFRICAN INSTITUTE OF CHARTERED ACCOUNTANTS (SAICA) currently has largest proportion of
registered members of the accounting and auditing profession, but there are 14 other professional institutes and
only members of these institutes who are registered auditors can carry out the external or public auditing function in
terms of statutory requirements
· credentialling – only people registered as accountants and auditors in terms of the Auditing Professional Act of
2005 can use the designation Registered Accountant and Auditor (RAA).
Members of SAICA can use the designation “Chartered Accountant (SA) or CA(SA)
· professional standards and disciplinary control – in SA, the Auditing Standards Committee of SAICA and
International Auditing and Assurance Standards Board (IAASB) establish appropriate standards for the performance
of the audit function – called International Standards of Auditing (ISA’s). Only registered auditors are permitted to
audit companies in SA and an annual audit is mandatory for every company that conducts business in SA
· ethical element – Code of Professional Conduct and Disciplinary Rules of the IRBA governs the professional
conduct of registered accountant and auditors. SAICA has its own Code of Conduct which is parallel to the IRB
ones. The ethical principals contained in these Codes govern member’s professional conduct to ensure the
integrity of the profession and ensure the esteem and trust of the general public.
IRBA has set the following admission requirements for the Public Practice Examination (PPE) :
· recognised academic programme – CTA or equivalent offered by universities accredited by SAICA for purposes
of admission to Part 1 of the qualifying exam
· recognised core assessment programme – Part 1 of the qualifying exam of SAICA
· minimum of 18 months of a recognised training programme registered with the IRBA (currently training
contracts administered by SAICA and registered with the IRBA)
· recognised education programme – currently the Auditing Specialisation Course administered by the IRBA valid
for 5 calendar years after the calendar year in which the education programme was successfully completed.
SAICA is registered with International Federation of Accountants (IFAC) and looks after the interest of professional
accountants either as professional accountant in public practice or professional accountant in business.
To qualify as a member of SAICA must :
· pass recognised qualification from accredited university
· pass Part I and II of the SAICA qualifying exam and
· serve a training contract either :
Ø TOPP – training outside of public practice in Approved training Organisation (ATO)
Ø TIPP – training in public practice in auditing firm such as Deloittes
Can then join SAICA and use the designation CA (SA)
Professional accountant in public practice is an accountant in a firm (can be sole practitioner) who provides,
accounting, auditing, taxation, management consulting or financial management services e.g. partner at Price
Waterhouse
Professional accountant in business is employed or engaged in areas like commerce, industry, service, public sector
or education e.g. financial director at listed company
NO INDIVIDUAL OR FIRM CAN OFFER ACCOUNTING SERVICES UNLESS IT IS REGISTERED WITH IRBA in terms
of the Auditing Professional Act.
So if not registered with IRBA CANNOT :
· perform any audit
· pretend to be registered in terms of Act
· use the designation “registered auditor, public accountant, certified public accountant, registered accountant and
auditor, accountant and auditors in public practice” or any other description that will create an impression of being a
registered auditor in public practice.
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IRBA looks after the professional interests of the auditors and deals with things like registration, education and training,
accrediting professional bodies (e.g. SAICA) for membership and prescribing the standards of competence and ethics.
Also protects the public and disciplines IRBA members who don’t follow the rules.
To register as member of IRBA must :
· satisfy all the educational requirements of SAICA (obtain recognised university qualification and pass Parts I and II
of the SAICA qualifying exam)
· complete a training contract in public practice
· obtain an audit specialism qualification
If registered with IRBA then can use the title “registered auditor”
Note : IRBA is not responsible for educating prospective registered auditors – only sets the Professional Practice Exam
(Part II of the SAICA qualifying exam). IRBA only accredits other professional bodies (currently only SAICA) who satisfy
the registration requirements of the accredited body.
Study guide pg 41
Structure of the auditing profession in SA :
IRBA – Independent Regulatory Board is the main statutory body and regulates and controls the auditing profession in
SA. Cannot practice as a public accountant and auditor unless registered with the Board and IRBA also determines the
qualifications and training that is needed to be registered with them and thus be public accountant and auditor
SAICA – SA Institute of Charted Accountants. Voluntary institute in SA that promotes the rights of auditing profession.
Can only use the designation Chartered Accountant (SA) if you have passed the SAICA professional qualifying exams.
Other professional institutes / bodies :
· ICFASA – Institute of Commercial and Financial Accountants of Southern Africa
· ICB – Institute of Certified Bookkeepers
· ICSA – SA Institute of Chartered Secretaries and Administrators
· IAC – Institute of Administration and Commerce of Southern Africa
· IIA – Institute of Internal Auditors
· IMTA – Institute of Municipal Treasurers and Accountants
Cannot do any auditing unless registered as an auditor and accountant – if offer services for this then must be
registered for “public practice’.
Study guide pg 46
Accountability of the auditing progression
Fundamental principle of auditing is that auditor is held accountable for the quality of his work and his opinion on the
quality of the financial statements published by the audited entity (report is addressed to the owners of the entity -
stakeholders).
Secondary stakeholders – other people who have interests in the entity (e.g. lenders, employees or creditors) but
audit doesn’t address their needs and auditor doesn’t report to them and is generally not accountable to them in law.
Auditor held accountable for the quality of work and opinions expressed by :
· internal quality control mechanisms within auditing firms – audit firms required to set up internal controls to
control the standards of audit work performed for individual audits (such as internal peer review) and to monitor the
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professional conduct of individual auditors of the firm. AUDITORS WITHIN A FIRM ARE JOINTLY AND
SEVERALLY LIABLE FOR ANY NEGLIGENT WORK ON THE PART OF THEIR COLLEAGUES. Auditors are
required to maintain adequate quality control processes according to auditing standards
· disciplinary processes of professional bodies – professional bodies hold their members accountable for the
quality of their work and their conduct by means of a disciplinary process (ensures that the profession is
accountable to the society {general public} that it serves).
Disciplinary measures include :
Ø reprimands or warnings
Ø imposition of fines
Ø suspension from practice for a specified period of time
Ø cancellation of membership or registration
Ø qualified, temporary or permanent disqualification of membership / registration
· courts of law – auditors can be called to account for the quality of their work and their opinions in legal actions in
court :
Ø civil action – plaintiff institutes lawsuit seeking damages for alleged negligent work done by auditor. Action
normally tries to prove that the auditor’s work wasn't according to professional auditing standards. Action can
be brought by :
§ company itself (the body of shareholders) in terms of the contract that exists between the client and the
auditor to provide audit services
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§ 3 parties such as individual shareholders of the company, creditors etc who also have the right to institute
legal action for damages on the basis of some form of illegal act or wrongful conduct by the auditor
Ø criminal proceedings – if auditor is accused of performing engagement dishonestly or fraudulently
Regulated by :
· professional bodies
Ø SA Auditing Standards (SAAS)
Ø Code of Professional Conduct
Ø Disciplinary Rules
· statutory laws
Ø Public Accountants and Auditors Act
Ø Companies Act 1973
Statutory regulations
Audit work is monitored by and controlled through different legislation and is changed by according to regulatory or
legislated requirements.
Auditing Professional Act of 2005 contains important legislation governing auditing activities in SA and :
· restricts auditing to only people who are registered in terms of the Act
· determines the education and training requirements for persons wishing to enter auditing profession
· lays down powers and duties of auditors in relation to the audit function
· describes offences in connection with auditing practice and specifies penalties for these offences
· provides for creation of regulations concerning the rules of professional conduct and disciplinary processes
Provides for inspections by the Independent Regulatory Board for Auditors (where practitioners performing audits
undergo practical evaluation on their compliance to ISA’s.)
Companies Act 61 of 1973 provides for compulsory annual audit of AFS for all companies in SA.
· establish mechanisms for registered auditors to gain recognition of qualifications in other countries and enter into
agreement with professional bodies outside SA for this purpose
· establish and administer an education fund for the purpose of training, professional development and continued
education for auditors and hopeful auditors
· advise, assist or consult with any statutory or professional body regarding the training, educating or professional
development of registered auditors and hopeful auditors
Functions with regard to fees and charges :
· Regulatory Board must prescribe :
Ø accreditation, registration, renewal of registration and re-registration fees
Ø annual fees
Ø date on which fee is payable
Ø fees payable in respect of any examination conducted by any accredited professional body or the IRBA (Section
37)
Ø any fees payable for the purposes of the education fund (Section 7)
Ø fees payable for an inspection or review undertaken by the Regulatory Board (in terms of Section 47)
Ø fees payable for any other service rendered by the IRBA
· can also grant exemption from the payment of any fees.
Conclude :
· evaluate audit evidence
· report accordingly
Study guide pg 50
Nature and objectives of ISA’s
In auditor’s interest to establish and maintain the appropriate professional standards for audit work on a continual basis
– auditing standards must be kept up to date so that they change in accordance with the way different areas of an audit
practice change.
But must note :
· auditing standards that are applied are only a framework and each individual audit will have different standards.
The auditor must exercise professional judgment on a continual basis to apply the standards as much as is practical
· standards are not the force of law – they have some authority as persuasive indicators of the quality of audit work
(i.e. the standard of the audit work), but are not conclusive evidence that the audit is competent. Basically ISA’s are
the minimum standards of performance and quality for audit work
· professional auditing standards are formulated in response to public expectations concerning the quality of the
auditing function – basically a mix of research on, studying of auditing and past experience of actual audit practice
conditions.
Business ethics
In 1930’s Rotary International developed ethical code which uses the following questions to address any ethical issue
that a business might have to face :
· is it the truth?
· is it fair to everyone involved?
· will it prompt goodwill and friendships?
· would it be beneficial to all involved?
Ethical conduct = the general nature of moral values and choices made by an individual in his relation with others.
Individual should ensure that his daily decisions have high ethical standards by using :
· ethical commitment – taking decisions to behave in an ethical manner
· ethical awareness – the ability to foresee the ethical consequences of a matter
· ethical competence – capacity for sound moral reasoning and to develop a practical problem-solving strategy.
Should use this general model when making ethical decisions :
· obtain or identify all the necessary facts on the matter that gave rise to the ethical question
· consider who is affected
· consider an alternative course of action
· consider the possible consequences of each alternative course of action
· compare the courses of action with the norms for the respective ethical questions
· choose a course of action.
Members of the auditing profession are expected to exercise self discipline and also comply with the
requirements of codes and rules. Codes of Professional Conduct recognise the auditing profession’s
responsibility towards the public, clients and colleagues.
Code of Professional Conduct – ethic principles governing the conduct of auditors in the profession are summarised
in :
· SAICA’s Code of Professional Conduct – in the SAICA Member’s Handbook
· IRBA’s Code of Professional Conduct – in the IRBA Manual of Information.
SAICA / IFAC Code applies to anyone registered with SAICA, irrespective if he is in public practice (i.e. in a firm that
provides professional accounting services) or in business (professional accountant employed or engaged in commerce,
industry or public sector.)
Partner in auditing firm required to register with IRBA in order to get licence to practice and will normally also register
with SAICA, and although a financial accountant working in business normally won’t register with IRBA, he will probably
still register with SAICA.
Also applies to trainee accountants as if have a formal training contract which is registered with SAICA then is bound by
the code – so if you breach the code you are disciplined.
Threats
Self interest threats – occur as a result of financial or other interests of either the auditor or immediate or close family
e.g. auditor has shares in a company which is about to become an audit client
Self-review threats – occur when previous work needs to be re-evaluated by the professional account responsible for
that work e.g. auditor has written up the accounting records of a client for which he has also been appointed to audit
Advocacy threats – occur when auditor promotes a position or opinion to the point that he subsequent objectivity may
be compromised e.g. professional accountant values a client’s shares and then leads the negotiations of the sale of the
client’s company
Familiarity threats – occur when auditor becomes sympathetic to the interest of others due to a close relationship e.g.
when auditor doesn’t disclose fraud cos the client is a close friend
Intimidation threats – occur when professional accountant doesn’t act objectively cos of actual or perceived threats
e.g. auditor fails to report fraud by employer cos scared will be dismissed if does so.
Safeguards
Unless the threat is CLEARLY insignificant the professional accountant must apply safeguards to eliminate or reduce
the threat to an acceptable level.
Can only decide if the threat is clearly insignificant by :
· professional judgment
· taking into account the public interest (if public interest is affected the threat is significant)
rd
· decision should be one that a reasonable and informed 3 party having knowledge of all the relevant information
would make.
2 categories of safeguards - either :
· created by professional, legislation or regulation e.g. Companies Act prevents professional accountant from
being a director in his own client’s company
· or safeguarded in the work environment – company has sound procedures which protect an employed
professional accountant from intimidatory threats from his manager.
If no suitable safeguard can be put in place then professional accountant will have to withdraw from the engagement or
employment contract.
Financial statement audit engagement = reasonable assurance engagement where professional accountant in public
practice expresses an opinion as to whether the financial statements are prepared (in all material respects) in
accordance with an identified reporting framework. (e.g. statutory audit ordered by the Companies Act)
Assurance team =
· all members of the engagement team for the assurance engagements (management, staff and any experts
contracted by the firm for the audit)
· all others within the firm who can directly influence the outcome of the assurance engagement (e.g. IT providers)
Independence :
· independence of mind – state of mind that permits the provision of an opinion without being affected by influences
that compromise professional judgment and allow auditor to act with integrity, objectivity and professional
skepticism
· independence in appearance – avoidance of facts and circumstances that are so significant that a reasonably
rd
informed 3 party with all the relevant information would reasonably conclude that the auditor’s integrity, objectivity
or professional skepticism had been compromised
· state of mind & in appearance – both are very important as even if auditor with financial interest in client might
have actually performed his duties with the highest level of independence (state of mind) he may NOT be perceived
by another party who know of his financial interest in the client of being independent (appearance). So auditor must
not only be independent but must also be seen to be independent.
Financial interest = interest in an equity or other security, debenture, loan or other debt instrument of an entity
(including rights and obligations to acquire such an interest)
Direct financial interest = financial interest owned directly by or under control of auditor or audit entity or financial
interest beneficially owned through an investment vehicle (unit trust, mutual fund) that is controlled by auditor or audit
entity.
Indirect financial interest = financial interest beneficially owned through a collective investment vehicle (e.g. unit trust,
mutual fund) estate or trust over which the auditor or audit entity has NO control
Immediate family = spouse or dependent
Close family = parent, child or sibling who is not an immediate family member
Listed entity = company whose shares or debt (debentures) are listed on a recognised stock exchange e.g. JSE
Network firm = entity under common control, ownership or management with the firm or any entity that a reasonable
rd
informed 3 party would reasonably conclude was part of the firm nationally or internationally. So basically threats of
independence must be considered by the firm as a whole and not just a single geographical office or branch.
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see the illustrative examples on pages 2/21 to 2/35 of Jackson & Stent where specific situations, circumstances
or relationships where independence may be threatened.
Primary threat is objectivity.
Study guide pg 52
Objectives of accountancy profession :
· strive for the highest standards of professionalism
· attain the highest level of performance
· meet the public interest requirement
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Status of the Code of Professional Conduct
Code contains the objectives and fundamental principles for the auditing and accountancy professions and also gives
detailed guidelines on the proactive application of these in a number of typical situations that occur in the profession.
see notes and Do 1-3 questions on pgs 53 to 62.
MAKE SURE KNOW ANSWERS TO DO QUESTIONS AND READ ALL THE SECTIONS IN CODE.
Practitioner can prepare tax returns using estimates if that is a generally accepted practice or if impractical in
circumstances to obtain exact data. Estimated amounts must also be reasonable in the circumstances.
If preparing a tax return then practitioner can rely on information furnished by the client provided the information
appears reasonable – if possible the practitioner should make provision on supporting data. Should also use the client’s
prior year returns if feasible and make reasonable inquires if the information appears incorrect or incomplete and should
make reference to the records of the business.
If practitioner finds material error or omission in a tax return of a prior year then has an obligation to advise the client
and recommend that SARS be told. Practitioner NOT obligated to inform SARS and CANNOT inform then without
permission and if client doesn’t correct the error within reasonable time, then practitioner should :
· inform the client that he cannot act for them in connect with that return or any other related information submitted to
the authorities and
· consider if he continue to be associated with that client in any professional capacity.
If practitioner concludes that he can continue the professional relationship with the client then must take all reasonable
step to ensure that the error is not repeated in future tax returns.
Client’s monies
Practitioner entrusted with client’s monies should have a designated bank account and should :
· keep that money separate form personal or firm monies
· use the money only for the purpose for which it is intended
· be ready at all times to account for those monies – a detailed book of accounts should be available as a record of
practitioner’s dealings with the client’s monies and a statement of account should be provided to the client at least
once a year
· deposit the money without delay to the credit of a client’s account or safeguard any documents or titles to money
against unauthorised use
Practitioner should not hold client’s monies if there is reason to believe they were obtained from or used for illegal
activities.
Money can only be drawn from the client’s account on the instructions of the client and fees owning to the practitioner
can only be withdrawn with the client’s permission.
Payments from the clients account cannot be more then the balance of the money being held for the client.
If client’s monies held for a significant period of time then the practitioner should place the monies in an interest-bearing
account within a reasonable time and all interest on client’s monies should be credited to the client’s account.
Foreign assignments
Practitioners working in another country should adhere to local professional or legal requirements even if they are not in
accordance to this Code.
If the profession is not controlled in the foreign country then the guidance of the Code should be followed unless there is
a recognised, well established and reputable local standard.
Firm names
Practitioners can practice under any name that has been approved by the PAAB in order to prohibit any names that
could be offensive to the average person or could attempt to secure an unfair competitive advantage.
Normally practice under the names of past or present members of the firm but if general non-purpose name used then
must not be misleading or not in profession good taste (must be consistent with the dignity of the profession and should
not impair or compromise the good name of the profession)
Name cannot be :
· misleading – cannot be described as international just cos one partner was overseas. Cannot allow any confusion
with the name of an existing firm
· use of “And Associates” “And Co” “And Partners” acceptable provided names of all members are on all firm
stationery
· name cannot contain “Chartered Accountant, Registered Accountant and Auditor, Business Advisor, Consultant” as
part of the name however practitioners qualifications should be on all firm stationery and all practitioners should
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have “Registered Accountant and Auditor” under their name on the signature line of any professional
correspondence and on audit reports
Multiple firms
Practitioner can be a member of more then one audit firm or of an audit firm and some other type of professional firm.
Can also practice under different names from different offices as long as it is not misleading and there must be a clear
distinction if there are different accounting firms.
Stationery
Practitioner’s stationery should be of a professional standard.
Should contain all the company details and information and can also include the names of the partners and assistants
who are qualified as well as the names of other employees, associates or consultants who are not partners or qualifies
provided it is clear that they are not so.
Accountants signing reports or certificates
Practitioner cannot delegate to anyone who is NOT a partner the power to sign audit or other reports or certificates,
unless there are extraordinary circumstances and the need for the delegation has been reported to the client and to the
Board.
Client’s monies
· practitioner cannot hold client’s monies if has reason to believe that they are obtained from illegal activities
· practitioner entrusted with client’s monies in course of professional work must :
Ø keep the monies separate from personal or firm monies
Ø use the monies only for the purpose for which they are intended
Ø at all times be ready to account for these monies
· practitioner should have a designated bank account for client’s monies
· client’s monies must be deposited without delay to the credit of the client’s account
· money may only be drawn from a client account on instruction of the client
· fee due from a client may only be drawn from client’s monies provided the client has agreed to the withdrawal
· payments from a client account shall not exceed the balance of the credit of the client
· when it seems likely that client’s monies will remain in the client account for a significant period of time then
practitioner should place monies in an interest bearing account with the agreement of the client
· all interest earned on the client’s monies must be credited to the client’s account
· practitioner must keep books of account to establish clearly all dealings with client’s monies in general and the
monies of the individual clients in particular. Must give client statement of account at least once a year.
Remember – IRBA code applies to all registered auditors but if auditor is also a SAICA member then must also comply
with the IFAC (SAICA) Code.
Liability to clients – based upon breach of contract or delict (i.e. client can sue auditor for financial loss on grounds
that auditor didn’t meet the terms of the engagement contract or in delict on the grounds that the auditor didn’t meet his
duty of care.)
rd rd
Liability to 3 parties – NOT breach of contract as not engagement contract between auditor and 3 party so can only
be delictual action against the auditor to prove that :
· auditor was negligent in expressing the opinion or report
rd
· 3 party relied on the opinion or report
rd
· 3 party suffered a loss as result of the reliance and
· auditor knew or could reasonably have been expected to know
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rd
· that 3 party would reply on the opinion or report.
Study guide pg 64
Negligence proved when auditor’s work is compared to auditing standards and if there is a deviation then auditor must
prove that the deviation did not result in failure to achieve the generally accepted auditing standards.
Decided in court of law by evaluating the auditor’s performance against professional auditing standards against the
public interest.
Basis for legal decisions is a combination of the relevant common law and statutory law provisions and also precedents
from prior case law on auditors’ liability for fraud or negligence.
Common law – legal principles that are handed down from decided cases (in SA based on Roman-Dutch law) and is
not derived from legislation.
Statute law – law from legislation.
Auditor’s legal liability from either common or statute law – duties imposed by these laws may result in auditor being
held liable if he either fails to perform them or fails to perform them with due care and skill.
Wrongful conduct :
· fraud – if auditor’s opinion on the financial statements is intentionally false or misleading. So auditor has knowingly
failed to express the appropriate opinion indicating that the financial statements are misstated when it was his duty
to do so, and the auditor knew of it at the time the audit report was issued. Basically amounts to issueing a report
on the financial statements with the intent to deceive users of that report
· gross negligence – if the auditor’s opinion on the financial statements is intentionally false or misleading then the
evidence necessary to prove fraud may be lacking but the auditor’s actions may be so grossly negligent that the
users of the audit report were mislead. Conduct like that is considered to be fraudulent (auditor has issued an audit
opinion without any genuine belief in the truth of the opinion which is an act of dishonesty)
· ordinary negligence – plaintiff must prove that the auditor failed to carry out the audit work with the degree of care
and skill that can reasonably be expected from a professional auditor.
Auditing Professional Act contains provisions regulating the auditor’s legal liability with the following effects :
rd
· auditor shall incur no liability to his client or any 3 party unless it is proved that the auditor’s opinion was expressed
maliciously or pursuant to a negligent performance of his dies (no-fault liability)
rd
· extent of auditor’s liability to 3 parties for negligent conduce must be determined within specific boundaries of the
rd
foreseeability of the 3 parties reliance on the auditor’s report.
Registered auditor cannot through an agreement or in any other way limit or reduce the liability that an auditor may incur
in terms of this section.
Auditor’s civil liability towards clients – legal action can be instituted against an auditor by a client cos of the
contractual relationship they have. Terms of the relationship depends on the terms of the contract they have (audit
engagement letter) and so any breach in terms of the contract can be addressed by the client suing the auditor for
breach of contract under the law of contract.
Duty to report irregularities – auditor who knows or has reason to believe that a reportable irregularity has taken or is
taking place must immediately send a written report of the irregularity to the IRBA and must notify the management
board of the entity in writing within 3 days of sending the report and must give management a copy of the report.
Registered auditor must as soon as possible, but within 30 days from the date that the report was sent to the IRBA take
all reasonable measures to discuss the report with the management board of the entity and afford the management
board the opportunity to make representations in respect of the report.
Auditor must also send another report to IRBA including statement from auditor to say that :
· no reportable irregularity has or is taking place (including detailed information supporting this) or
· that the suspected irregularity is no longer taking place and that adequate steps have been taken to prevent or
recover any loss or
· the reportable irregularity is continuing.
Once IRBA has been informed that the reported irregularity is continuing then must notify a regulator in writing with the
details and give regulator a copy of the report. Regulator can be any authority or agency but if it is a criminal act then
IRBA will report to Director or Public Prosecutions and will then be investigated by SAPS – auditor obliged to hand over
documents to SAPS as there is no legal privilege between practitioner and client and there is no confidentiality clause.
Should seek legal advice.
If employee commits an unlawful act under direction or with knowledge of any person responsible for management then
the auditor will regard this as an unlawful act committed by management.
If lawful act or omission is committed by management which has caused or is likely to cause loss to any of the
shareholders or stakeholders then it is reportable.
If won’t cause financial loss then it doesn’t have to be reported in terms of this, but might still be reportable in terms of
fraud / theft or breach of fiduciary duty. (e.g. company submits and is paid out on false insurance claim).
If loss is material is matter of professional judgement – doesn’t relate to materiality levels set for the audit, but the
absolute and relative size of the loss must be considered. But even if immaterial, must still be reported if as a result of
an unlawful act. Not the same as audit materiality.
Only inconsequential or trivial breaches are regarded as non-material.
If benefit has been received cos of unlawful act then it cannot be offset against the loss that has been incurred (e.g.
company pays a R 1 million bribe which means that the company gets R 20 million contract so cannot say that the bribe
resulted in a R 19 million increase for the good of the company).
Fiduciary duties directors owe to the entity include ;
· preventing conflict of interest between themselves and the company
· not exceeding the limitations of their powers (ultra vires)
· considering the affairs of the company in an objective manner and in best interests of the company (unfettered
discretion)
· exercising their powers for the purpose for which they were granted.
In order to report an irregularity, registered auditor doesn’t need absolute or irrefutable proof that a reportable act has
taken place – only has to be satisfied or have reason to believe. If challenged will have to show that there were
sufficient grounds to report the irregularity BUT THERE IS NO LEGAL PROTECTION FOR THE AUDITOR IF HE
REPORTS THE IRREGULARITY WITHOUT SUFFICIENT GROUNDS.
rd
Not a breach of confidentiality if use information from other sources (i.e. another company or from a 3 party) as it is a
legal requirement that the registered auditor considers all information.
In terms of engagement of “agreed upon procedures” (no opinion given for this sort of engagement) then not required to
report suspected fraud as is not a reportable irregularity, BUT if also an audit client then would have to report it.
Section 47 – Inspections
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Regulatory Board or any authorised person can inspect or review the practice of a registered auditor and any training
contracts and may make copies of any documentation – must be done at least every 3 years if it is a public interest
company. Costs of the inspection can be recovered from the registered auditor.
Registered auditor must submit annually any information or returns that the Regulatory Board may request.
Auditor may not refuse Regulatory Board access to any information even if he is of the opinion that it contains
confidential information about a client – if acts in good faith by producing information then auditor may not be held liable
criminally or under civil law.
Subject to the Constitution and any other law, a person who is involved in this inspection CANNOT disclose any
information obtained except ;
· for the purpose of an investigation or hearing under this chapter
· if it is being supplied for the performance of functions under this Act
· when ordered to by a court of law
· at the written request of any appropriate regulator who requires it for an investigation, disciplinary action or criminal
prosecution or
· at the written request of any appropriate international regulator of audits or auditors
Study Guide pg 73
Auditor’s professional duties are mainly set out in :
· Code of Professional Conduct
· Disciplinary Rules
· International Standards on Auditing (ISA’s)
Error = unintentional act which results in misstatement in the financial statements including :
· mistake in gathering or processing date from which financial statements are prepared (e.g. mathematical or
clerical misstates or omission of a transaction)
· oversight or misinterpretation of facts (e.g. charging incorrect rates of interest cos didn’t understand terms of the
loan agreement)
· misapplication of accounting policies (e.g. capitalising an operating least cos doesn’t understand GAAP).
rd
Fraud = intentional act by either management, someone charged with governance, employees or 3 parties
involving the use of deception to obtain an unjust or illegal advantage.
Fraud risk factors = events or conditions that indicate an incentive or pressure to commit fraud or provide an
opportunity to commit fraud
Employee fraud = fraud by only employees NOT management or those charged with governance
Fraudulent financial reporting = involves intentional misstatements (including omissions) in the financial
statements meant to deceive financial statement users. Normally by management or those charged with
governance and could be done by :
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· manipulation, falsification or alternation of the account records or supporting documentation underlying the financial
records
· misrepresentation in or intentional omission from the financial statements of events, transactions or other significant
information
· intentional misapplication of accounting principles to amounts, classification manner of presentation or disclosure
· management override (especially where controls are operating effectively)
see text book pg 7/31 for examples.
Essential difference between fraud and error is INTENTION – not always easy to determine intention, but auditor would
use his assessment of the integrity of management as a consideration.
Management representations – auditor must obtain written representations from management relating to fraud.
Representations should :
· contain management’s acknowledgment that management is responsible for the design and implementation of
internal control to prevent and detect fraud
· state that management has disclosed to the auditor the results of the assessment of the risk that the financial
statements may be materially misstated as a result of fraud
· state the management has disclosed to the auditor it’s knowledge of fraud involving management and employees
· state that management has disclosed to the auditor any allegations of fraud or any suspected fraud affecting the
entities financial statements communicated by employees, former employees, analysts, regulators etc.
Communication regarding fraud with management, those charged with governance and others
If auditors identifies misstatement due to fraud then must take action, but should first consider :
· confidentiality – auditor cannot simply inform everyone cos of confidentiality issue (cannot go directly to SAPS etc)
· management could be involved in the fraud – auditor must take care in deciding whom to report the fraud to (if
unsure if anyone on top of the ladder can be trusted – i.e. Chairperson of the Board – then could consider reporting
it to IRBA as a “reportable irregularity”
· absolute evidence of fraud – auditor doesn’t have to have absolute proof of fraud, but should have sufficient
appropriate evidence and should not make direct accusations, MUST document the whole matter
Study Guide pg 77 to 81
Auditor’s responsibility regarding detection of non-compliance with laws and regulations :
Reasonable assurance that the financials being audited are free of material misstatement
Detection of non-compliance :
Ø design and carry out audit procedures in order to identify instances of non-compliance with laws and regulations
that should be taken into account when preparing the entity’s financial statements
Ø obtain audit evidence about compliance with the relevant laws and regulations which affect the determination of
material amounts and disclosure in the entity’s financial statements.
Reasons why the auditor doesn’t have a duty to prevent non-compliance with laws and regulations and why he
only has a limited responsibility to detect non-compliance
Any audit is subject to the unavoidable risk that some material misstatements of the financial statements will not be
detected – even if the audit is properly planned and is performed in accordance with SA Auditing Standards.
Risk of material misstatements cos of non-compliance is higher when :
· auditor cannot be expected to evaluate compliance with laws and regulations in every area of the entity’s operations
- there are laws and regulations relating mainly to the operating aspects of the entity that do not normally have a
material effect on the financials and are not identified by the accounting and internal control systems
· effectiveness of audit procedures is affected by the inherent limitations of the accounting and internal control
systems and by the use of testing
· most of the evidence obtained by the auditor is persuasive rather then conclusive in nature
· non-compliance may involve conduct designed to conceal it (collusion, forgery, failure to record transactions,
overrides and lying by management)
· auditor is not a law specialist.
AUDITOR ONLY TAKES INTO CONSIDERATION THE LAWS AND REGULATIONS THAT AFFECT THE FORM AND
CONTENT OF THE FINANCIAL STATEMENTS AND ALSO LAWS AND REGULATIONS THAT CAN HAVE A
FUNDAMENTAL INFLUENCE ON THE OPERATIONS OF AN ENTITY.
Steps to be followed if auditor becomes aware of a possible non-compliance with laws and regulation :
· obtain understanding of the nature of the act and the circumstances in which it occurred
· obtain an understanding of sufficient other information to evaluate the possible effects on the financial statements
· document the findings
· discuss the findings with managements (or with entity or entity’s lawyers if necessary)
· consider the effect on the auditor’s report (especially if couldn’t obtain sufficient information)
· consider the implications for other aspects of the auditor – especially reliability of management representations.
do questions in section 3.3 of tutorial 102 and check answers in the key of section 3.3 of tutorial 103
Jackson & Stent pgs 1/4 to 1/6 – Assurance and non-assurance engagements
Assurance engagements – “expresses a conclusion designed to enhance the degree of confidence of the intended
users, other then the responsible party about the outcome of the evaluation or measurement of a subject matter against
the criteria” (International Framework of Assurance Engagements)
· sufficient appropriate evidence · the evidence the practitioner needs to be in a position to conclude
that the financial statements are free of material misstatement
Audit of financial statements – assurance engagements – registered auditor gathers sufficient appropriate evidence
to be in a position to pass an opinion on whether the directors (who are responsible for the financial statements) have
applied the International Financial Reporting Framework appropriately in presenting fairly the financial position, financial
performance and cash flow information of the company for the financial year.
Other assurance engagements – if all evidence is as above then there can be other types of engagements that are
classified as an assurance engagement e.g. :
· engagement to report on the effectiveness of a client’s internal control system (provided there are criteria against
which this can be measured)
· engagement to report on whether the client is complying with the requirements of the Sarbannes-Oxley Act 2002 )
relating to corporate governance
Non-assurance engagement – professional accountant DOESN’T express an opinion or comment on the subject
rd
matter of the engagement, no 3 party involved or there are no benchmarks to measure the subject matter against, e.g.
:
· auditor has to compile (collect, classify and summarise) info for client, but not to express opinion
· auditor prepares company’s tax return without expressing an opinion on it
Reasonable Assurance – auditor only provides reasonable assurance that the financial statements (as a whole) are
free of material misstatement NOT that they are 100% correct cos of :
· use of testing
· inherent limitations of accounting and internal control systems
· audit evidence usually persuasive rather then conclusive
· subjectivity in the financial statements and also in the auditor’s approach to the audit
Statutory assurance engagements – engagements conducted cos of statute (Act of Parliament) e.g. Companies Act
Non-statutory assurance engagements – NOT cos of legal requirements but rather specifically for that entity (e.g.
bank wants assurance that the business’s financials are compliant with corporate governance requirements before
granting loan)
Review Engagements
Standards - ISRE 2400 Engagements to review financial statements
ENGAGEMENT
reasonable moderate no no
assurance assurance assurance assurance
Review engagements are assurance engagements - limited assurance engagements in terms of International
Framework for Assurance Engagements (IFAE).
Review engagement provides moderate assurance that the information subject to review is free of material
misstatement (expressed as negative assurance)
Objective of the review is to provide a limited (moderate) assurance but general principles of a review engagement are
virtually identical to those of an audit.
Terms of engagement :
ISRE 2400 requires that an engagement letter needs to be obtained for review engagements – must include :
· objective of the service being performed
· managements responsibility for the financial statements
· scope of the review, including reference to the ISRE statement
· unrestricted access to whatever records, documentation and other information is requested for the review
· sample of the report expected to be rendered
· must state that the engagement cannot be relied on to disclose errors, illegal acts or other irregularities (e.g. fraud
or defalcations)
· statement that an audit is not being performed and that an audit opinion will not be expressed (to clarify, should
rd
perhaps mention that review engagement will not satisfy any statutory or 3 party requirements for an audit)
· basis of fees
· deadlines
Objective
To enable auditor to state whether or not (on basis of procedures – less evidence then for full audit) anything
has come to auditor’s attention that causes the auditor to believe that the financial statements are not prepared
in accordance with the identified financial reporting framework and statutory requirements, in all material
requirements.
This is a negative assurance.
Review procedures are limited and not as comprehensive as full audit procedures so only a moderate assurance is
given.
Planning and documentation – engagement must be properly planned and work must be documented. Reporting
considerations are :
· standards and structure – report given for the review engagement must be to standards of reporting and structure
will be the same as the audit report. All the modification opinions which are available for audit reports are also
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applicable to review reports (i.e. report can be qualified “except for” and an adverse opinion, disclaimer of opinion or
emphasis of matter can be given). Rules for reporting are the same as for audit reports
· title of report – “Review Report to the directors of … entity…” Can include independent auditor and report can be
addressed to other parties
· introduction paragraph – must :
Ø state clearly that a review has been carried out NOT an audit
Ø identify the information on which the review has been conducted and
Ø lay out the responsibility of the preparers and reviewers
· scope paragraph – must convey :
Ø nature of the procedures conducted
Ø fact that the intention was for moderate assurance only
Ø that audit was NOT carried out
Ø that no opinion was expressed
· review opinion paragraph (termed conclusion paragraph) – will vary depending on what is being reviewed but
auditor must convey negative assurance and NOT positive assurance
· modified review reports – auditor may need to qualify the assurance he is giving or provide an emphasis of
matter. Exactly the same considerations are applied when qualifying a review report as when qualifying an audit
report (is there a matter which warrants consideration for qualification? does the matter affect the auditor’s opinion
or not? is it based upon disagreement or scope limitation? is it material or material and pervasive? if auditor
decides that a qualification is required then :
Ø explanation paragraph will be added before the conclusion paragraph – termed ‘basis for qualified conclusion or
adverse conclusion”
Ø working of the review opinion will be amended
· emphasis of matter may be appropriate – then same principles apply to emphasis that particular matter and there
will be a paragraph under the review opinion paragraph which will describe the matter to be emphasised
· signing off – name, Registered Auditor, Charted Accountant (SA), date, place
see text book pgs 19/5 & 19/6 for examples of paragraphs and reports
Objective
Auditor is engaged to carry out procedures (usually of audit nature) which have been agreed upon by the
parties involved and he reports only on the facts as found – NO OPINION or ASSURANCE is given and the
users of the reports have to draw their own conclusions from the presented facts.
Terms of engagements – must be clear to all parties and client must understand that no opinion will be given. Terms
should be set out in an engagement letter and must :
· include clear indication that the engagement doesn’t constitute an audit or review and that no assurance will be
given
· give nature, timing and extent of the specific procedures
· include the purpose of the engagement
· identify the financial information to which the agreed upon procedures will be applied
· the anticipated form of the report of factual findings
· limitations on the distribution of the report.
Reporting considerations :
· title – Independent Auditor’s report to the directors of …entity … on factual findings
· scope (including procedures used)
· opinion paragraph – NO assurance given – basically just an inclusion of the results of the procedures that were
carried out
Qualified reports – NO opinion and NO assurances is given so NO qualification report – results are presented
WITHOUT opinion or comment
Closing off – must add paragraph which states the report is solely for the purpose of the scope of the report and for
information and NOT to be used for any other purposes or to be distributed to any other parties. Report relates only to
the accounts and items specified above and doesn’t extend to the financial statements taken as a whole.
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Signed, Registered Auditor, Charted Accountant (SA), date, place.
see text book pgs 19/7 & 19/8 for examples of paragraphs and reports
Compilation engagements
ISRS 4410 – Engagements to compile financial statements.
Objective – in compilation accounting or audit firm is engaged to use accounting expertise and not auditing expertise to
collect, classify and summarise financial information. No testing is conducted and no assurance is given. Compilation
engagements often including compiling financials, the principles that are applicable involve compiling financial
information on behalf of the client.
Compliance with standards - same general principles of integrity and objectivity, professional competence and due care
(technical standards), confidentiality and professional behaviour, as well as complying with ISRS 4410 and the
engagement must be properly planned and documented.
Terms of engagement
Must be clear to client and practitioner and must be set out in engagement letter including :
· clear indication of the nature of the engagement (including fact that neither audit or review will be carried out and
that no assurance will be given
· statement that engagement cannot be relied on to disclose errors, unlawful acts etc
· nature of the information to be supplied by the client
· fact that management is responsible for the accuracy and completeness of the information supplied
· basis of accounting on which the information is to be compiled
· intended use of the compiled information
· form of the report
· acknowledgment from management of their responsibilities
Procedures – overall objective to collect, classify and summarise the date provided by the client, but accountant must :
· obtain a general knowledge of the business and operations of the client
· become familiar with the accounting principles and practices of them in use with which the client operates
· be familiar with the form and content of the financial information required
· consider if the compiled information is free from obvious errors / misstatements
NOT necessary to :
· assess the reliability of the information provided by the client
· assess internal controls
· verify anything (any matters)
· verify explanations
but MUST maintain a degree of professional skepticism and must query unusual or unexpected information. If
management is uncooperative then practitioner can withdraw from the engagement.
Reporting considerations
· title – Compilation Report to the members of … CC
· introductory paragraph
· no scope paragraph, but should indicate the limited nature of the engagement by saying “ we have not audited or
reviewed these financial statements and accordingly express no assurances thereon”
· must emphasise the limited reliance that the report has by using words “unaudited” or “compiled without audit or
review” on each page of the financial information.
NO assurance so NO qualification report is given, but can add an additional paragraph to the report if :
· accountant that performed the compilation is not independent of the entity
· there was material departure from the reporting framework in terms of the information that was compiled (e.g.
financial leases not capitalised in terms of the International Accounting Standards.
see :
ISRS 4410 – Engagements to compile financial statements
ISRS 4400 – Engagements to perform agreed upon procedures
International Framework for Assurance Engagements
ISRS 2400 – Engagements to review financial statements
Study guide pg 86
In financial statements management states explicitly to that the financial information reflected in the statements
complies with certain assertions :
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· completeness
· occurrence
· existence
· accuracy
· cut-off
· classification
· valuation and allocation rights and obligations
· presentation and disclosure
Auditor then carries out series of procedures and activities to collect audit evidence to enable him to express an
opinion on the financial statements – audit evidence is normally collected for every assertion in the financials and
enables him to reach the conclusions on which the audit opinion is based.
At end of audit the auditor expected to give the client a degree of assurance that the information is free of material
misstatements (no absolute level cos the inherent limitations)
Auditor’s desired level of assurance = degree of satisfaction obtained and level of assurance provided is determined
by the audibility of the financial information, nature and extent of the procedures carried out and results obtained.
Positive assurance – high (but NOT absolute level of assurance) that the audited information is free of material
misstatement and expressed in the audit report as reasonable assurance.
Negative assurance – moderate level of assurance that the review information is free of material misstatement and is
expressed in the auditor report as a form of negative assurance
No assurance – no assurance expressed in the report.
Differences between various types of audits and the objectives and levels of assurance for each :
Type of engagement Objectives Level of assurance given
Audit To enable auditor to express an opinion as to whether Positive assurance in the audit report –
engagement the financial statements, in all material respects, fairly high but NOT absolute that the
represent the financial position of the entity at a information subject to the audit is free of
specific date and the results of its operations and cash material misstatement.
flow information for the period ended on that date
Review To enable the auditor to state whether anything has Auditor’s satisfaction is expressed in form
engagement come to his attention which has caused him to believe of a negative assurance – auditor
that the financial statements have not been compiled provides only moderate level of
in accordance with an identified financial reporting assurance that information subject to the
framework in all material respects. Review audit is free of any material misstatement.
engagement is based on procedures that don’t proved
all the evidence required for an audit
Agreed-upon To enable the auditor to report on factual finding on Auditor reports only on factual findings
rd
procedures certain procedures that the auditor, client and any 3 and expresses NO assurance that
engagement party have agreed on information is free of material
misstatement
Compilation Auditor uses accounting expertise and NOT auditing Auditor is acting as an accountant –
engagement expertise in order to collect, classify and summarise auditors involvement in drafting the
financial information financial statements enhances the
creditability of the statements, BUT
auditor provides NO assurances in the
report
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Preparation and presentation of financial statements is the responsibly of management of entity – audit of financial
statements is the responsibility of the management of the entity and audit doesn’t relieve any of management’s
responsibly.
Expression by the auditor of an audit opinion on the financial information enhances the credibility of the financial
statements, but doesn’t provide assurance regarding the future viability of the entity or the competence or efficiency with
which the entity is managed.
ISA 200 – Objective and General Principles governing an Audit of Financial Statements 33 to 36
33. Auditor’s responsibility = forming and expressing an opinion on the preparation and fair presentation of the
financial statements
34. Financial statements = structured representation of the financial information (including notes) derived from
accounting records and communicates entity’s economic resources or obligations at a point in time or the changes
therein for a period of time, in accordance with a financial reporting network.
35. Requirements of the financial reporting framework determine the form and content of the financial statements
and what constitutes a complete set of financials. (e.g. IPSAS – International Public Sector Accounting Standard –
says that primary financial statements is a statement of cash receipts and payments. IFRS – Financial Reporting
Standards – says needs information about financial position, performance and cash flows and so need balance
sheet, income statement, statement of changes in equity, cash flow statement and notes.
36. Management responsibility = preparing and presenting of the financial statements in accordance with the
applicable financial reporting framework. Must identify that framework and also :
· design, implement and maintain internal controls that are free from material misstatement (from either fraud or
error)
· select and apply appropriate accounting policies
· make accounting estimates that are reasonable in the circumstances
ISA 200 – Objective and General Principles governing an Audit of Financial Statements 37 to 48
Determining the acceptability of the financial reporting framework
37. Auditor should determine whether the financial reporting framework adopted by management in preparing the
financials is acceptable (normally taken into account when considering whether to accept the audit engagement)
38. Auditor determines if financial reporting framework adopted by management is acceptable in view of the nature of
the entity and the objective of the financial statements.
39. financial statements designed to meet the financial information needs of specific users – so needs of users
determines the applicable financial reporting framework.
40. financial statements designed to meet the common financial information needs of a wide range of users – called
general purpose financial statements
41. currently no objective and authoritative basis recognised globally to judge the acceptability of financial reporting
frameworks for general purpose financial statements, so use IFRS’s, IPSAS’s and GAAP
42. some jurisdictions may have legislative and regulatory requirements supplementing a financial reporting framework
with additional requirements for the preparation and presentation of financial statements. If the additional
requirements conflict with the applicable financial reporting framework then the auditor discusses the nature of the
requirements with management and decides if the additional requirements can be met through additional
disclosures – if not possible then auditor must decide if must modify the auditor’s report
43. if entity is registered or operating in jurisdiction that doesn’t have authorised or recognised standards then entity
must identify an applicable financial reporting framework.
44. acceptable financial reporting frameworks for general purpose financial statements normally have the following :
· relevance (info in the financials if relevant to the nature of the entity and objective of the financial statements )
· completeness – ensure transactions and disclosures etc that could affect the fair presentation of the financial
statements aren’t omitted
· reliability – info in financials :
Ø reflects economic substance of events and transactions and not merely their legal form
Ø results in reasonably consistent evaluation, measurement, presentation and disclosure when used in similar
circumstances
· neutrality – free from bias
· understandability – info is clear and comprehensive and not subject to significantly different interpretation
45. CANNOT use mixture of accounting conventions devised to suit individual preferences – NOT acceptable financial
reporting framework for financials intended to address common information needs of wide range of users
46. description of the financial reporting framework in the financials must include information about the basis of
preparation and the accounting policies selected and applied for significant transactions and other significant events
47. auditor may decide to compare accounting conventions to the requirements of an existing framework. If done and
differences are identified then must decide if accounting contraventions adopted by management constitute an
acceptable financial reporting framework or if could result in financial statements that are misleading
48. if auditor concludes that the financial reporting framework adopted by management is not acceptable then auditor
must consider the implications in relation to the engaging acceptance and the auditor’s report.
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Study guide pg 90
If financial statements are a fair presentation in all material respects then means that statements regarding the entity’s
financial position, result of its operations and its cash flow are a reasonable indication of the true state of affairs and
have been drafted in accordance with an identified financial reporting framework and / or statutory requirements.
Companies Act 61 of 1973 section 286 states that company has a “duty to make out annual financial statements and lay
them before the annual general meeting” and that they should conform with GAAP and fairly present the state of affairs
of the company and its business.
Section 4 specifies the disclosure requirements in respect of balance sheet and income statement items in the financials
of company – if financial statements drafted in terms of GAAP and other statutory requirements then they should fairly
represent the company’s operations.
Professional judgement = auditor’s professional opinion and involves his choices and decisions during the
performance of various aspects of audit work. Used to determine how they will proceed in order to achieve auditing
objectives, what kind and how much evidence they will need and the extend of their procedures and what conclusion
they reach on the basis of the audit evidence they have collected.
Auditors must have knowledge of information systems, Companies Act, accounting statements, auditing standards and
GAAP as well as knowledge of human nature.
Legislation and auditing standards give the auditor guidelines and boundaries within which he can exercise his
professional judgement, but ability to judge and reason relies on auditor’s education, training, knowledge and
experience.
Professional judgement essential at every stage of auditing process – but especially during planning (auditor
establishes priorities) and evaluation (auditor forms an opinion)
do questions in section 4.1 of tutorial 102 and check answers in the key of section 4.1 of tutorial 103
So as to be able to express an audit opinion on the fair presentation of the financial statements the auditor collects audit
evidence in support of the assertions in the financial statements and in support of his audit opinion. Collects audit
evidence by carrying out a series of procedures and activities – obtained from various sources and every document
used as audit evidence must be assessed for appropriateness, reliability and sufficiency.
Accounting system
Is the foundation that enables management to achieve the objectives of internal financial control – series of tasks and
records by which transactions are processed to create financial records. Accounting system identifies, assembles,
analyses, calculates, classifies, records, summaries and reports transactions and other events.
Main elements of account system are :
· people – who carry out the procedures and or can use computer system
· paper – which facilitates the recording of the transactions. to replace people and paper
Accounting system alone CANNOT achieve internal financial control – need control procedures to ensure that financial
information is valid, accurate, complete and timeously produced.
Executing
(can be combined with authorising)
Should all
Custody of the asset be separate
(should be separated from recording) duties
(i.e. different
people)
Recording
(should be separated from custody)
Companies cycles (e.g. acquisitions and payments) should be divided into functions and then duties within the functions
should be separated further.
Isolation of responsibility – for internal control to work effectively people involved in the system must be fully aware of
their responsibilities and must be accountable for their performances. Staff should acknowledge writing that they have
performed the task or control procedure (sign it off) or should transfer responsibility from one person to another (e.g.
signing to receive goods to signify acknowledgment of physical transfer and also to isolate responsible person).
Access / custody controls – designed to :
· prevent damage to or deterioration of physical assets (e.g. proper storage and treatment of assets)
· prevent deterioration of non-physical book assets (e.g. controls to ensure debtors don’t get behind in their
payments)
· prevent unauthorised use / theft / loss of physical assets (e.g. security measures)
· prevent unauthorised use / theft or loss of non-physical book assets (e.g. limiting number of personnel who have
signing powers to transfer cash or sell investments or preventing debtors ledger form being altered or destroyed.)
Source document design – paper controls should promote accuracy and completeness of recorded transactions by
being :
· pre-printed in a format that leaves minimum amount of information to be manually filled in
· pre-numbered – identifies missing documents
· multi-copied, carbonised and designed for multiple use
· designed in manner that is logical and simple to complete
· contain blank blocks or girds which can be used for authorizing or approving the document – facilitates isolation of
responsibility.
Comparison and reconciliation – good control system should be frequently and timeously compared and reconciled
by different staff then the one who completed functions and recorded the transactions. Must compare and reconcile :
· stock and fixed assets (physical) to the records (theoretical)
· bank and investment records to external bank statements
· records of creditors to supplier statements
· subsidiary ledgers to the general ledger (e.g. debtors ledger to general ledger)
Reconciliations should be reviewed by senior personnel and reconciling items followed up
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Audit evidence
Fundamental to audit function and auditor has duty to gather SUFFICIENT appropriate audit evidence to be able to
draw reasonable conclusions on which to base the audit opinion.
Sufficient appropriate evidence
Sufficient evidence – quantity of audit evidence that is gathered. Auditor must evaluate if there is enough evidence to
support an opinion – important as auditors do not examine every transaction only samples.
Evidence is cumulative in nature and evidence about an assertion is not gathered by performing a single procedure but
by performing a number of procedures each of which contribute some evidence. Auditor has to balance the extent of
each procedure performed.
Statistical models assist in determining sample sizes but auditor still has to make subjective decisions. Quality of audit
evidence relates to the extent of testing which is a component of audit plan (other components = nature and timing of
tests) but audit plan is only decided upon once the full exercise of devising the overall audit strategy has taken place.
Planning process also includes subjective decisions – e.g. evaluating inherent risk and auditor is left using professional
expertise to determine if (in light of prevailing circumstances surrounding the audit) there has been enough evidence
gathered.
Appropriate evidence – quality of audit evidence. Made up of relevance of evidence to the assertion which is being
audited and the reliability of the evidence (source and nature).
Relevance – to the assertion which is being audited. Important that the auditor understands exactly to which assertion
the evidence relates as if not understood then incorrect conclusions may be drawn.
see stock example pg 5/11 of text book.
When performing tests of control the auditor attempts to determine whether the major objective of the accounting
system and related internal controls is producing valid, accurate and complete information. While doing this the auditor
obtains evidence relating to the :
· occurrence
· accuracy
· cut-off
· classification and
· completeness of assertions relating to the transactions processed through that accounting system.
Single procedure will not necessarily be relevant to only one assertion – procedure may provide evidence relevant to a
number of assertions.
Influencing factors to determine whether sufficient appropriate evidence has been obtained :
· assessment of inherent risk and control risk at the client – if higher level of risk relating to a particular assertion
then more evidence from the most reliable source will be needed
· materiality of the item being examined – so what is most material will be more important to gather sufficient
appropriate evidence then for items that are less material (cos more material items will probably have more material
misstatements)
· experience gained during previous audits – as auditor develops relationship with his client so knowledge of
potential problem areas will help to guide the auditor in where to focus the audit
· results of audit procedures already conducted – if initial tests on some sections prove highly successful then
auditor may deceived to perform less additional tests then originally planned and visa versa
· source and reliability of the information available – auditor will want to use the best evidence available, but if it
is not reliable then auditor will be forced to gather more evidence from a number of less reliable sources to be in a
position to form an opinion of a particular assertion
· persuasiveness of the audit evidence – evidence gathered on one section of the audit which is supported or
corroborated by evidence from another section will be more persuasive then if it is contradictory.
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Financial statement assertions
Financial statements are just assertions of the directors to the shareholders concerning the financial positions and
results of operations of the company (in a prescribed format).
ISA 500R states that auditor should use assertions for classes of transactions, account balances and presentation and
disclosure in sufficient detail to form a basis for the assessment of risks of material misstatement and the design and
performance of further audit procedures.
Assertions are categorised as follows :
· assertions about classes of transactions and events – e.g., sales, purchases, interest received
· assertions about account balances – e.g. accounts receivable, property plant and equipment, accounts payable
· assertions about presentation and disclosure – e.g. notes which support balance sheet account headings,
contingent liabilities
Assertions about classes of transactions and events for the period under audit :
· occurrence – transactions and events that have been recorded have occurred and pertain to the entity
· completeness – all transactions and events that should have been recorded have been recorded
· accuracy – amounts and other data relating to recorded transactions and events have been recorded properly
· cut-off – transactions and events have been recorded in the correct accounting periods
· classification – transactions and events have been recorded in the proper accounts
Auditor’s duty is to gather sufficient appropriate evidence to support the assertion that is being audited – especially
those that present a risk of material misstatement (that might lead the auditor to express an inappropriate opinion on the
financials if it is not detected).
Auditor must identify the assertions for which evidence should be gathered and then design an audit approach which
will provide enough relevant and reliable evidence on which to base an opinion.
see examples on pgs 5/13 and 5/14 of text book – NB!
Auditor’s Toolbox
Auditor has two sets of tests or procedures that can be used to gather sufficient appropriate evidence for financial
statement assertions :
· tests of control – used to test whether the control procedures relating to the accounting system have been
complied with and
· substantive procedures – used to verify (substantiate) transactions and balances.
If the accounting systems and related control procedures are ok, then the balances and totals produced will be ok and
so auditor who is interested in the fair presentation of balances and totals can test the accounting system and control
procedures to find out if they will produce reliable balances and totals. These are tests of controls.
If these tests reveal that the accounting system and related controls are sound then auditor will be confident that
balances and totals are fair and will spend less time substantiating / verifying the balances and totals.
Tests of controls are performed to obtain evidence of :
· if controls are suitable designed to prevent or detect and correct material misstatements
· if these controls operated effectively throughout the period that is being audited.
Satisfactory results from tests of controls reduce control risk and hence audit risk.
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CANNOT ONLY PERFORM TESTS OF CONTROLS! Even if accounting system and related control procedures are
excellent :
· internal control systems have inherent limitations which mean they are not totally efficient
· internal control system may have been excellent at the time that auditor performed the tests, but not at other times
during the year
· there is still the inherent risk to consider.
Successful tests of controls will reduce the extent and maybe change the nature of substantive tests, BUT CANNOT
eliminate the need to perform substantive tests.
Substantive procedures
Financial statements consisting of collection of balances (Balance Sheet) and summary of totals (Income Statement)
and accompanying notes – tests of control cannot provide auditor with sufficient appropriate evidence pertaining to
balances, totals and disclosures, so auditor must perform procedures of a substantive nature.
Substantive procedures can be performed on balances and totals themselves or on the individual transactions which
make up the balance or total. Either tests of detail or analytical procedures.
Substantive procedures seek to provide evidence to support the financial statement assertions :
· balances – completeness, existence, valuation, rights and obligations, presentation and disclosure
· transactions – completeness (totals), occurrence, measurement, presentation and disclosure
Basic principals to adhere to when obtaining certain types of audit evidence or when performing certain types of audit
procedures :
· when using information produced by the entity then must obtain audit evidence about the accuracy and
completeness of information. Use :
Ø test of controls over the production and maintenance of the information
Ø obtained as an integral part of the relevant audit procedure itself
Ø specific additional audit procedures
· if audit evidence from one source is inconsistent with audit evidence from another source, then auditor must
consider what additional audit procedures are needed to resolve the inconsistency
· CANNOT omit a necessary procedure during audit just to save costs
· auditor must always perform risk assessment procedures BUT not enough to provide sufficient appropriate audit
evidence and must be supplemented by tests of control and substantive procedures
· tests of control needed when :
Ø auditor’s risk assessment includes an expectation that internal controls are functioning effectively (operating
effectiveness) – control risk at a level less then high
Ø substantive procedure alone do not provide sufficient appropriate audit evidence
· substantive procedures are always required to obtain sufficient appropriate audit evidence for material classes of
transactions, account balances and disclosures – cos the assessed risks of material misstatement (assessed levels
of inherent risk and control risk) can never be zero cos of the judgmental nature of the auditor’s risk assessment
and limitations of internal control.
· conclusions of the auditor in forming his opinion with regard to each individual audit item as well as financial
statements as a whole are based on the audit evidence obtained
· in forming audit opinion the auditor evaluates the sufficiency and appropriateness of the audit evidence obtained – if
unable to obtain sufficient appropriation audit evidence in respect of a material financial statements assertion then
must express a qualified opinion or disclaimer of opinion.
Auditor’s response to assessed risks at assertions level including considerations regarding nature, timing and
extent of audit procedures
Risk assessment procedure performed by the auditor identifies risks of material misstatement at the assertions level –
auditor should design and perform further audit procedures to respond to these risks.
Auditor must design and perform audit procedures whose nature, timing and extend are responsive to assessed risks at
the assertions level :
· nature of audit procedures – refers to purpose and type of procedures that include inspection, observation,
inquiry, confirmation, recalculation, reperformance and analytical procedures
· timing of audit procedures – refers to when an audit procedure is performed or the period or date to which the
audit evidence applies
· extent of audit procedures – refers to quality of specific procedure to be performed
Valid audit conclusions are possible by using sample basis.
see pgs 49 to 54 of ISA 330 & ISA 500 – obtaining Audit Evidence of Financial Statements (Summary
and Interpretations, incorporating aspects of general audit theory)
Study guide pg 94
Assertions are made by management when presenting the financial statements. Categories of the financials statement
are the balance sheet, income statement, cash flow statement and notes.
Simply by presenting financials management is saying that all the assets, liabilities, income and expenditure are
complete, did occur, did actually exist, have been correctly recorded, at the correct value and the rights and obligations
have been correctly presented and disclosed.
When performing audit, auditor obtains audit evidence for every assertion in the financial statements.
Summary of the assertions or statements that management makes with regard to balances and transactions
contained in the balance sheet or income statement of an entity :
Income Statement & Balance Sheet
Balance Sheet (asset & liabilities
Assertion (transactions) balances)
Completeness X X
Occurrence X
Accuracy X
Cut-off X
Classification X
Existence X
Valuation & Allocation X
Rights & Obligations X
Presentation & Disclosure X
see Do 1 examples on pg 96 of study guide (examples of describing assertions)
Tests of control are carried out in order to collect audit evidence regarding the design of accounting and
internal control systems and the operation of the systems during the audit.
Tests of control can be following :
· description of the accounting and internal control systems
· control questionnaire aimed at identifying poor and good control measures
· tests of control
· conclusions
· recommendations
Substantive procedures are carried out to support assertions in the financial statements
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ISA 500 emphasises that MUST obtain auditor evidence in respect of each assertion for balance sheet and income
statement transactions and balances. – CANNOT obtain audit evidence for one assertion and not obtain audit evidence
for another assertion.
e.g. if obtaining audit evidence on debtors : existence would be proven by comparing the monthly statements with the
balances in the debtor’s ledger – but won’t prove that all the debtors have been completely accounted for. To
check the completeness of the debtors, the auditor should check the reconciliations between the debtor’s ledger,
list of debtors and the debtor’s control account.
Some kinds of audit evidence can also support more then one assertion – e.g. obtaining a management certificate in
respect of debtor’s balances provides supplementary audit evidence in respect of the existence, completeness, value,
rights and presentation and disclosure of debtors – BUT just cos have management certificate regarding all the
assertions doesn’t mean that auditor doesn’t have to carry out further audit procedures in support of the specific
assertions.
Sufficiency of audit evidence determines how MUCH audit evidence is required and should be obtained by the auditor.
Is influenced by :
· nature and level of inherent risk
· assessment of the control risk
· materiality of items
· experience gained by auditors during previous audits
· results of audit procedures
· source and reliability of audit evidence.
Appropriateness of audit evidence measures the quality of audit evidence and its relevance to a particular assertion.
Appropriateness also depends on the extent to which it will help the auditor achieve the set audit objectives which are
based on the assertions with regard to certain income statement and balance sheet transactions and balances which
the auditor intends to investigate.
Auditor should weigh up the cost of obtaining audit evidence against the usefulness of such evidence – degree of
difficulty and cost do not in themselves constitute a valid reason for failing to carry out the necessary audit procedures.
Reason’s why an auditor may decide not to rely on a client’s internal controls :
· preliminary investigation of the internal control system for a specific type of transaction indicated that the system
cannot be relied on
· volume of transactions of that type is insufficient to justify tests of controls
· risks of material misstatement at the assertion level can be reduced to an acceptable low level with audit evidence
obtained from substantive procedures.
Influence of auditor’s decision not to rely on the internal controls on the audit process means that he will NOT perform
tests of controls, but should rather carry out more extensive substantive procedures – BUT must still keep audit risk at
an acceptable level.
Auditor uses his professional judgement in evaluating the audit evidence what has been collected regarding the
assertions in the financial statements. Influenced by :
· significance of the potential misstatement in the assertion and the likelihood of its material effect on the financials
(either individually or aggregated with other potential misstatements)
· effectiveness of management’s responses and controls to address the risks
· experience gained during previous audits with respect to similar potential misstatements
· results of audit procedure performed (including whether these audit procedures identified specific instances of fraud
or error)
· source and reliability of the available information
· persuasiveness of audit evidence
· understanding of the entity and its environment – including its internal control
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If auditor has not obtained sufficient appropriate audit evidence for a material financial statement assertion and is
unable to obtain sufficient appropriate audit evidence then he should express a qualified opinion or disclaimer of
opinion.
Auditor should document the overall responses to address the assessed risks of material misstatement at the financial
statement level and the nature, timing and extent of further audit procedures and the linkage of these procedures with
the assessed risks at the assertion level and the results of the audit procedures.
If auditor plans to use audit evidence about the operating effectiveness of control obtained in prior audits then should
document the conclusions reached with regard to replying the control that were tested in a prior audit.
see full ISA 330 – Auditor’s Procedures in Response to Assessed Risks
do questions in section 4.2 of tutorial 102 and check answers in the key of section 4.2 of tutorial 103
So as to be able to express an audit opinion on the fair presentation of the financial statements in all material aspects,
the auditor must determine what is material using professional judgement. Materiality depends on the size of the item
or error in relation to the particular circumstances in which it was omitted or misstated.
Audit risk is the risk that the auditor may express an inappropriate audit opinion when the financial statements
have been materially misstated.
In order to estimate audit risk and design audit procedures to keep the risk at an acceptable low level – auditor must first
have a suitable knowledge of the accounting and internal control system so as to plan the audit and develop an effective
audit approach.
When audit carried out, auditor should consider the question of materiality and its relationship to audit risk.
Nature of materiality
· materiality is very subjective – largely decided by professional judgement and so different auditors will have
different decisions when setting up a materiality level (level of acceptable misstatement) at planning stage or
deciding if a particular matter is material to fair presentation at the evaluating stage.
· materiality is relative, not absolute – what is material will vary from user to user and from client to client and what
might be material to small company won’t be material to large company. Need to establish bases against which
materially can be measured so some auditing firms set a planning materiality level which can use percentages of
account headings as a starting point or rule of thumb.
Most important point is that most misstatements affect the income statement and the balance sheet BUT CAN BE
MATERIAL TO ONE AND NOT THE OTHER. So better to use the net income before tax as a basis to measure the
materiality of the misstatement as it is “truer” figure and so materiality will be more relevant to the company.
Note : ISA 320 doesn’t set any percentages to be used for setting materiality levels so auditor needs to use his
professional judgement.
· materiality is both quantitative and qualitative :
Ø quantitatively material amount is one that exceeds the amount which the auditor has determined is material
(so that is the amount of misstatement what would influence the decisions of a user)
Ø qualitatively material amount is one which is regarded as material when judged against a factor other then an
amount – so if an important disclosure is omitted from the financials and the omission would influence a user.
Both the quantitative and qualitative aspect of materiality should be considered by the auditor as something might
be material in respect of one and not the other.
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Planning materiality
Dealt with differently be different audit firms – can either use a Rand amount based on guideline percentages or can
work with set formulas, or can just use concept to focus audit in a general way to get an idea of what is important.
Using planning materiality in a general way
Basically auditor will identify account headings or classes of transactions that appear important in relation to the other
accounts. Once have largest amounts will use majority of audit resources (time and expertise) to assess the risk of
misstatement and then carrying out the audit procedures on these account headings. This is basic audit strategy and
audit plan in general way
Setting planning materiality levels
Actually quantifying the amount of misstatement which can be in the financial statements without it affecting fair
presentation. (What amount of misstatement is acceptable?)
Once done then will be to consider the amount of misstatement that is acceptable within an account heading or class of
transaction – decision as to what amount will influence the fair presentation of the financials will have a direct effect on
the extent of the testing and the nature and timing of audit testing. Also remember that what might not be material
against a large account like stock or property, plant and equipment may be high against net profit before tax.
Inverse relationship between materiality and audit risk. So lower the materiality level the higher the audit risk, and
more amount of testing. Higher materiality level the less audit risk but less amount of testing that has to be done.
Materiality level Extent of testing Audit risk
Lower materiality level Greater Greater
Final materiality
Planning materiality is done before audit and the risk of misstatement is assessed and then the auditor forms the audit
plan (nature, timing and extent of testing that will be done). Auditor then carries out the selected audit procedures which
are normally samples of different accounts (populations). Errors will be found in the samples and as audit conclusions
are drawn from the populations where the sample came from the auditor, must analyze and project the error in the
sample over the population that has been sampled either by :
· using statistical basis – if has used statistical basis for selecting the sample then must use the appropriate
statistical method for projecting the error in the sample over the population
· proportional method – to obtain an idea of the extent that the population is misstated :
error value in sample x total value of population
total value of sample
Whichever method of projection is used – if the projected misstatement for the population is unacceptable then the
auditor must decide if further tests should be carried out by the audit team or if the client should be asked to
check the population in detail for further errors.
Auditor will then discuss all misstatements with management in an attempt to have them rectified. If
management won’t correct the misstatement then auditor left with unresolved audit differences and this is when use
final materiality.
Management might refuse to correct misstatements because they may :
· disagree that there is a misstatement – client thinks that their estimation of stock obsolescence is fair but auditor
thinks that it is too low
· not regard the misstatement as material – i.e. it would not influence a user
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· have ulterior motives – e.g. directors want to achieve particular ratios which are based on figures in the financial
statements and if the auditor’s adjustments are made then the ratios will not be achieved
· regard it as “too much hassle” to make the changes – e.g. adjustment would mean changing the income
statement, balance sheet, consolidation etc
· be unconcerned about receiving a qualified audit opinion
Auditor must decide if the unresolved audit differences are immaterial (so will not influence the decision of the user) or if
they are material (so failure to correct them will result in financial statements which contain more misstatement then is
acceptable i.e. some of the financials will not be fairly presented and the auditor will have to give a qualified opinion.)
Decision is not just deciding that final materiality should be equal to planning materiality and anything over that would be
material – still have to consider various factors at the evaluation stage.
Reasons why planning materiality can differ from the auditor’s assessment of final materiality
Auditor usually considers materiality for planning purposes even before the financial information to be audited has been
compiled – so materiality is merely being estimated on the basis of provisional, forecasts / budgets etc from previous
periods
During evaluation and conclusion stage of auditor, materiality is established on the actuals on which he is reporting, so
final materiality (actuals) may differ from planning materiality (estimated).
Auditor may also set planning materiality at a lower level then the expected final materiality in order to ensure that they
have based the audit procedures on a conservative estimate of materiality.
Calculating materiality
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Normally matter for professional judgment but can use following as guidelines :
· pre-tax income – between 5% and 10%
· total assets or gross profit – between 1% and 2%
· average of total assets and income – percentage used or statistical procedures (such as regression analysis)
Auditor can use any basis for calculating materiality as long as he can give reasons for his decisions in respect of that
specific client.
In evaluating the fair presentation of the financials auditor also has to decide if the total of uncorrected misstatements
(both qualitatively and quantitatively) that were detected in the course of the audit are material or not.
If material then auditor should consider :
· reducing the audit risk by carrying out further audit procedures or
· requesting management to correct the financials.
see example of how to calculate the materiality figure on pg 108/109 of study guide
Auditor identifies the financial statement assertions which may be at risk of misstatement and tries to counteract the risk
by designing an audit strategy and audit plan that reduces the risk that there are material misstatements that won’t be
detected to an acceptable level.
If auditor fails to identify the factors that give rise to the risk of material misstatement and fails to respond to them then
audit risk increases.
If auditor doesn’t understand the entity and the entity’s environment then more likely to fail in identify potential risk and
therefore audit risk is increased.
Control risk
Risk that a misstatement that could occur in an assertion and that could be material (individually or in total) will
not be prevented or detected and corrected on a timely basis by the entity’s internal controls. (So if internal
control system doesn’t detect the error then high chance that there will be misstatement that the auditor is not aware
off).
Basically control risk dependent on the design and operation of the internal controls achieving its objectives but because
of the inherent limitations of the internal controls the control system will not be perfect and there will be some control
risk.
Inherent limitations of the internal control system :
· management’s requirement that the cost of the internal control doesn’t exceed the expected benefits to be
derived (cost / benefit)
· most internal controls are directed at routine transactions rather then non-routine transactions
· potential for human error due to carelessness, distraction, mistakes of judgement and misunderstanding
instructions
· possibility of circumvention of internal controls through collusion of a member of management or employees
with parties either inside or outside the company
· possibility that person responsible for the internal control will abuse that responsibility (e.g. management
overriding a control)
· possibility that procedures may become inadequate due to changes in conditions and compliance with control
procedures may deteriorate
Control activities can be put in place by a client to achieve internal control objectives such as :
· strong control environment
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· efficient risk monitoring system must be evaluated
· segregation of duties by auditor
· physical and logical access controls
Not just sufficient for the auditor simply to identify the weaknesses in the internal control system – auditor also has to
evaluate the effect on the financials assertions.
Detection risk
Risk that auditor will not detect a misstatement that exists in an assertion that could be material, either
individually or in total with misstatements in other assertions.
Detection risk relates to the effectiveness of an audit procedure and how the audit procedure is applied. Can arise cos
auditor :
· selects an inappropriate audit procedure
· misapplies an appropriate procedure
· misinterprets the results of a test
All these should be kept to absolute minimum.
Detection risk has inverse relationship to the combined level of inherent risk and control risk. (So when inherent and
control risks are assessed as being high then the acceptable level of detection risk must be low so that audit
risk is kept to an acceptably low level)
Acceptable level
Inherent Risk Control risks of detection risk
Low
High High (audit risk must
also be kept low)
If inherent risk and control risk at a client evaluated as being high there is a strong possibility of material misstatement in
the financial statements. Auditor must minimize the chance of expressing an inappropriate opinion on financials so
must therefore reduce the audit risk to an acceptable level.
Done by adopting an appropriate audit strategy and plan and assigning the right staff (competent and experienced) and
by getting the nature, timing and extent of the audit procedures right. By doing this you reduce the risk of failing to
detect the misstatements which you expect (cos of high inherent and control risks) to an acceptable level which is
therefore a low detection risk.
Auditor has no control over inherent built-in risks and management is responsible for internal control, but auditor can
respond to those risks by reducing the detection risk.
Detection risk is controlled by the auditor.
Levels of risk
Difference ways of describing risk – can either be :
· high, medium or low
· pervasive or
· increased or decreased
Only level of audit risk in the auditing standards is significant risk, but impossible to say what constitutes significant risk
or how significance risk changes to non-significant risk cos of differences in every audit, so have to rely on experience
and professional judgement that are used to assess risk and potential severity of material misstatement.
Nature of the risk is part of classifying if risk is significant and following all suggestions that significant risk is
present and that special consideration should be given if risk :
· is risk of fraud (e.g. manipulation of financial data)
· is related to recent significant accounting or other developments and therefore requires special attention (e.g.
introduction of IFRS’s
· arises from the complexity of certain transactions (e.g. complex merger or acquisition)
· involves related parties (e.g. inter-company transactions within group)
· non-routine, unusual, infrequently occurring transactions (e.g. BEE transactions)
Main issue is what procedures auditor puts into place to reduce the risks to an acceptable level.
Assessment of inherent risk is a question of professional judgment and auditor can use standard questionnaires or
reviews of what factors should be taken into account when assessing the inherent risk.
Auditor assesses the control risk by carrying out tests of control in order to obtain audit evidence in respect of :
· effective design of the accounting and internal control system and
· effective operation of the internal controls throughout the entire period under review.
Tests of control are :
· inspection
· observation
· confirmation
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· recalculation
· reperformance
· analytical procedures
Influence of high estimate of control risk on detection risk, audit risk and the nature and extent of the audit procedures to
be performed – high control risk implies that the internal controls may be limited or completely absent, or that the set up
internal controls are not working the way they should be.
If high estimate of control risk then auditor must take the following actions and decisions :
· after preliminary evaluation of internal controls the auditor may decide not to rely on them
· auditor would not plan to carry out tests of control
· would only carry out substantive procedures to achieve acceptable level of audit risk (detection risk will be low cos
of inverse relationship with control and inherent risk)
· extent of substantive procedures will be expanded
· cos of increase in extent of substantive procedures the audit risk will be reduced to an acceptable level.
If low control risk then good internal controls have been implemented and they are functioning in the way that they
were designed to. Auditor will then decide to take the following actions and decisions in response to the low
assessment of control risk :
· after preliminary evaluation auditor would decide to rely provisionally on internal controls
· tests of controls will be carried out and depending on the results and conclusion the auditor will determine to what
extent it is possible to rely on the internal controls
· if the results of the tests of controls indicate that the internal controls have not functioned the way they were
designed to then auditor would assess the level of control risk as high and would then carry out more
comprehensive substantive procedures
· if the results of the tests of controls indicate that the internal controls have function in the way they were designed to
then the auditor can reduce the extent of the substantive procedures
· cos of reduction in the substantive procedures audit risk will be high (cos of inverse relationship with control and
inherent risk)
· because of the reduction in the extent of the substantive procedures the audit risk will be reduced to an acceptable
level
Auditor can limit his detection risk by performing substantive procedures to reduce the risk of material management.
Components of audit risk are inherent risk, control risk and detection risk.
Inherent and control risks are independent of the audit, but detection risk relates to the efficiency of the auditor’s
substantive procedures.
Auditor must first assess inherent and control risk and this will then directly influence the nature, timing and extent of the
substantive procedures he will carry out. Higher the inherent and control risk the more audit evidence the auditor
will obtain by means of substantive procedures in order to reduce his audit risk.
Interaction between components of audit risk can be expressed as :
audit risk = inherent risk x control risk x detection risk
Inverse relationship between detection risk and the combined level of inherent and control risk – when inherent and
control risk are high the acceptable level of detection risk must be low in order to reduce the audit risk to an acceptably
low level (so more substantive procedures must be carried out).
But if inherent and control risk are low then the auditor can accept a higher detection risk and still reduce the audit risk
to acceptably low levels cos the client’s internal controls, accounting and internal systems are so good that they prevent,
identify and timeously correct any material errors or omissions and so the auditor can accept a higher detection risk and
carry out less extensive substantive procedures.
see pgs 112/113 of study guide for practical example of system evaluation.
Materiality directly influences the nature, extent and timing of the audit procedures
if audit risk is high = low materiality figure should be established
if audit risk is low = higher materiality figure can be accepted
do questions in section 4.3 of tutorial 102 and check answers in the key of section 4.3 of tutorial 103
TOPIC 5 – THE PRACTICAL APPROACH TO AN AUDIT
Study Topic 5.1 – Risk Management and Internal Control
ISA 315 – Understanding the entity and its environment and assessing the risks (including appendix
1 to 3)
Jackson & Stent pgs 5/1 to 5/9
Jackson & Stent pgs 7/4 to 7/14
Control environment
· sets tone of organisation – influencing control consciousness of its people
· factors including integrity, ethical values, competence, authority, responsibility
· foundation of all other components of control
Risk assessment
· identification and analysis of relevant risks to achieving the entity’s objectives
– forming the basis for determining control activities
Control activities
· policies / procedures that ensure management directives are carried out
· range of activities, including approvals, authroisations, verificiations,
recomendaitons, performace reviews, asset security and segregation of duties
Monitoring
· assessment of a control system’s performance over time
· combinations of ongoing and separate evaluation
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Information system
Auditor needs to obtain an understanding of the information system relevant to financial reporting and communication,
must have thorough understanding of :
· classes of transactions in the client’s operations that are significant to the financial statements (e.g. sales, wages)
· procedures of how both IT and manual systems record, process, correct and transfer transactions to the GL and
financials
· related accounting records, supporting information and special accounts in the financials
· how info system captures events and conditions
· financial reporting process used to prepare entity’s financials including significant accounting estimates and
disclosures
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· control over the passing of non-standard journal entries used to record non-recurring unusual transactions or
adjustments
· manner in which financial information is conveyed to management, board, audit committee and external bodies
see text book pg 7/11 & 7/12 for specific examples of IT information and risks
Details of information system gathered by :
· inspection of flowcharts of the system
· observation of the system in action
· inquiry of staff and the completion of internal control questionnaires
· discussions with prior year audit staff, management and outsiders (e.g. software suppliers)
· discussions with internal audit staff and review of internal audit workpapers
· tracing information through the information system.
Control activities
Policies and procedures that are implemented to ensure management’s objectives are carried out – e.g. :
· authorisation of transactions
· segregation of duties
· physical control over assets
· comparison and reconciliation
· access controls
· custody controls over blank / unused documents
· good document design
· sound general and application controls in IT systems
Monitoring of controls
Auditor must find out how client monitors the control activities and how problems are identified and resolved. Normally
regulated by internal audit departments but can include employee performance reviews.
Important control activity.
Information about monitoring can be gathered by inquiry of management and staff, working with internal audit and
inspecting documentation related to monitoring process or performance reviews.
Significant risks
Risks that require special audit consideration. Could be :
· risk of fraud
· risk related recent significant economic, accounting or other developments that requires special attention
· risk arising out of complex transactions
· risk involving significant transactions with related parties
· degree of subjectivity in the measurement of financial information related to the risk.
· risk involves significant transactions that are outside the normal course of business for the entity or otherwise
appear to be unusual.
Communicating with those charged with governance and management – as soon as possible auditor must make the
people charged with governance and management aware of material weaknesses in the design or implementation of
internal controls that have come to the auditor’s attention (including weaknesses in the client’s risk assessment
process).
Documentation
General requirement is that auditor must document his work – procedures conducted, information gathered and
conclusions reached must be clearly and concisely recorded.
ISA 315 – Understanding the entity and its environment and assessing the risks
(including appendix 1 to 3)
Auditor should perform the following risk assessment procedures to obtain an understanding of the entity and its
environment including its internal control :
· inquiries of management and others within the entity
· analytical procedures (e.g. risk assessment procedures) and
· observation and inspection
Minimum requirements for risk management at an entity ??
Study guide pg
5 essential components that must be present to implement an effective and efficient internal control system :
· control environment
· risk assessment
· information and communication
· control activities
· monitoring
see study guide pg 122 for list of what should be noted from studied information
Inherent limitations of internal controls and the reasons why they exist :
Limitations Reason for existence
Control is inefficient if the cost of the internal control exceeds the advantages that
Cost of internal control can be obtained from it
Problems with Internal controls are usually designed with a view to routine transactions
non-routine transactions
2 or more person could conspire with parties inside or outside the entity to
Collusion circumvent certain internal controls
Occurs because conditions change continually and the internal controls are not
Procedures may be come always adapted accordingly. Compliance with procedures may be relaxed after a
inadequate time
Once auditor has an understanding of the accounting system and tests of controls then he must make a preliminary
assessment of control risk – involves evaluating the effectiveness of the entity’s accounting and internal controls in the
prevention or detection and rectifications of material misstatements.
Control risk is always present cos of inherent limitations of any accounting and internal control system.
Control risk = risk that material misstatement could occur in an account balance or class of transaction (either
individually or totaled with other misstatements) and will not be prevented or detected and timeously corrected by the
accounting and internal control systems
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Tests of controls = carried out in order to obtain audit evidence about the suitability of design and effective operation
of the account and internal control systems and their operations throughout the period which is subject to audit.
Made up of :
· inspection
· observation
· confirmation
· recalculation
· re-performance
· analytical procedures
Ethical requirements
Engagement partner responsibility to encourage and develop ethical behaviour on the audit and must also watch for
non-compliance of this by the engagement team. If occurs then must be followed up on, dealt with and then
documented.
Independence
Engagement partner needs to “form a conclusion” on how the audit engagement complied with independence
requirements. Engagement partner must :
· obtain information from the firm to identify and evaluate circumstances and relationships that would create a threat
to independence
· evaluate any threats that may be significant
· take appropriate actions to eliminate or reduce the threat to an acceptable level
· document conclusions on the independence of the audit team.
Engagement performance
Engagement partner is responsible for the direction and supervision of audit and review of audit performance –
objective is to ensure audit has been carried out with compliance to professional standards, regulatory and legal
requirements and that enough audit evidence has been obtained to support the audit opinion that was given.
Key areas :
· direction – engagement partner informs engagement team of :
Ø their responsibilities (e.g. maintaining objective, professional skepticism, ethics etc)
Ø nature of entity’s business
Ø risk-related issues and potential problems
Ø detailed audit strategy and audit plan
· supervision :
Ø monitoring progress on the audit
Ø considering capabilities and competence of each member of the team (do they have time? do they understand
instructions? are they carrying them out in accordance with the audit strategy and plan?)
Ø addressing significant issues that arise on the audit and modifying the strategy and plan accordingly
Ø identifying matters for consultation or consideration by more experienced members of audit team
· review – more experienced team members review work performed by less experienced team members e.g. :
Ø is work performed in accordance with professional standards, regulatory and legal requirements?
Ø have significant matters been raised for further consideration?
Ø have appropriate consultations taken place? (were recommendations put in place and documented?)
Ø is there a need to revise the nature, timing and extent of audit work?
Ø does work performed support the conclusions reached and is it adequately documented?
Ø is the evidence obtained sufficient and appropriate to support the auditor’s report?
Ø have the objectives of the audit procedure been achieved?
Consultation and differences of opinion
If differences occur then engagement partner has to ensure that they are resolved by consulting with appropriate
persons and that the nature, scope and conclusions of the consultation are documented, confirmed and implemented.
Firm’s policies and procedures for settling the difference must be followed.
Monitoring
Auditing firms required to monitor their quality control procedures to ensure they are :
· relevant
· adequate
· operating effectively
· complied with during audit engagements.
High quality audit is the best defense against accusations of negligence. Partners in an audit firm jointly and individually
responsible for negligent performance of work by staff.
read though ISA 220 and the 1996 appendix (showing illustrative examples of quality control procedures in
audit firm).
ISQC 1 requires that the firm must establish policies and procedures :
· for engagement teams to put together finalised engagement files on a timely basis – i.e. set deadlines, review and
sign off files
· designed to maintain confidentiality, safe custody, integrity (no tampering or contamination), accessibility and
retrievably of engagement documentation e.g.
Ø use of password on computerised workpapers
Ø back up routines
Ø controls over the distribution of workpapers (e.g. signing a register)
Ø physical controls over hardcopy and electronic work papers (e.g. archive room with library routines)
· for retention of engagement documentation for as long as needed (not less then 5 yrs from date of auditor’s report).
Audit documentation is the property of the firm and firm doesn’t have to make it available to the client or any other party
unless required by law.
Audit documents can be in various medias – either written, digital or recorded. Heading of workpapers example
Client :
Workpapers should : Financial year end :
· be correctly headed regardless of their form Date :
· contain conclusions of the preparer of the working paper Section of Audit :
Prepared by :
· include adequate legends / keys to symbols on the workpaper Reviewed by : Date :
· display adequate cross referencing to other workpapers
· contain written and commentary on any usual or exceptional maters and how they were dealt with
· contain sufficient information concerning the matter to which the workpaper relates to enable the person reviewing
the work paper to judge if the tests were performed satisfactorily and to agree or disagree with the conclusion
reached as a result of the tests.
Auditor may prepare a completion memorandum (summary) describing significant matters that were identified during the
audit and how they were addressed. Can facilitate effective and efficient reviews and also cross reference to other
supporting audit documentation.
Auditor should document discussions of significant matters with management and others on a timely basis.
If information identified that contradicts or is inconsistent with final conclusion regarding a significant matter - then
auditor must document how he addressed the contradiction or inconsistency when forming the final conclusion.
If auditor judges necessary to depart from a basic principle or essential procedure in exceptional circumstances then
must document how the alternative audit procedure were performed and how they achieved the objective of the audit as
well as the reasons fro the departure.
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Under exceptional circumstances can change documentation after the date of the auditor’s report, but must then
document :
· circumstances encountered
· new or additional audit procedures that were performed, audit evidence obtained and the conclusions that were
reached
· when and by whom the resulting changes were made and who reviewed them
(Exceptional circumstances may have been something that existed at the date of the auditor’s report that would have
affected the auditor’s report if the auditor had been aware of it).
Puttick and van Esch say principals of preparation for working papers are :
· heading
· signature and date
· referencing
· cross referencing
· audit tickmarks
· audit conclusions
Auditor responsible for maintaining procedures for safeguarding audit files and they are solely for the use of the auditor.
Also required to ensure that the information remains confidential.
Sections of working papers can be made available to the client for use – but cannot replace the client’s accounting
records.
do questions in section 5.4 of tutorial 102 and check answers in the key of section 5.4 of tutorial 103
Conclude :
· evaluate audit evidence
· report accordingly
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Documentation
Audit strategy and audit plan as well as any changes to either must be carefully documents – documents will record key
decisions made, be a source of reference for the audit team and proof of the proper planning and performance of the
audit.
Statutory audits – objective and scope of audit and auditor’s obligations are laid down by law. Extent of the
engagement can be extended but not limited.
Non-statutory audits – extent of audit is agreed with the client and is subject to the condition that the auditor would not
accept an engagement if it cannot be carried out in accordance with IAS’s.
Audit engagement letter purpose is to document and confirm the auditor’s acceptance of the appointment as well as
objective and extent of the audit, the extent of the auditor’s responsibilities towards the client and the format of the
reports.
When auditor accepts audit engagement from client then a contractual relationship arises between auditor and client (so
special obligations and responsibilities should be put in writing).
Audit materiality is information that is material if its omission or misstatement could influence the economic decisions
of users taken on the basis of the financial statements
Inverse relationship between materiality and level of audit risk – so higher the materiality level the lower the audit risk
and visa versa.
Auditor may initially assess the acceptable audit materiality at a lower level during the planning stage then at the
finalisation stage of the audit to reduce the probability of undetected misstatements and so give auditor a safety margin
when considering the effect of any misstatements detected during the audit. (So basically the auditor therefore bases
all his audit procedures on more conservative materiality figure)
Overall audit plan = strategy where the auditor achieves the overall audit objective (i.e. acquisition of sufficient
appropriate audit evidence to make it possible to draw reasonable conclusions on which to base the audit opinion)
Developed by evaluating sources of information and assessing risks related to material account balances and classes of
transactions in the financials. Once all information gathered then that, plus the overall audit decisions taken during the
early planning stage of the audit, are combined into the overall audit plan.
When drawing up audit plan then must pay attention to :
· deciding on stages at which audit will be carried out
· allocating personnel to the audit so that various audit tasks can be assigned to competent people.
Advantages for the development and documentation of overall audit plan for engagement are :
· preparation of the overall audit plan helps auditor to analyze factors that influence audit decisions comprehensively
and systematically
· audit plan provides framework to help auditor to evaluate efficiency and effectiveness and completeness of the
planned audit procedures for achieving overall audit objective
· effective way of introducing audit approach to members of the audit team.
Some of the overall audit plan may have to be revised when auditor becomes aware of matters that mean that the audit
procedures may have to change – e.g. new information could be found that would mean more testing.
Any changes should be documented along with the reason why.
Auditor then develops an approach to how he is going to audit every material account / group of transactions and
balances in the financials – called planned audit approach and reflects the general nature, timing and extent of the
necessary audit procedures for every accounting balance or class of transactions.
Approach to each section of the audit must be outlined in the overall audit plan in sufficient detail to serve as the basis
for the development and preparation of the audit programme.
Exact form and content of overall audit plan different for each audit engagement cos of :
· size of the business
· complexity of the audit
· specific audit methodology and technology that auditor is using.
see example of overall audit plan pgs 152 / 153 of study guide
Relationship between preliminary reliance on internal controls, control risk & audit procedures
Reliance on
internal controls Control risk Tests of controls Substantive procedures
High Low Will be carried out Reduced extent of testing
Audit programme
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To implement the overall audit plan the auditor must draw up and document an audit programme that details the nature,
timing and extent of the planned audit procedures that will be carried out.
Audit programme for tests of control and substantive procedures must be drawn up for every material account / groups
of transactions and are supported by working papers that document the audit procedures that have to be carried out
and other information that has to be compiled or collected in course of the audit.
Auditor must also apply the assessment of inherent risk and preliminary assessment of control risk and materiality (got
from compiling audit plan at level of financials) at the level of the accounting balances and transaction classes.
Advantages from the development and documentation of audit programme is :
· changes the audit approach or audit plan into a comprehensive description of work that has to be carried out
· results in a document that has to be checked and approved before audit work can begin
· provides direction to personnel on how audit should be conducted and so reduces the risk that important
procedures will be left out or that incorrect procedures will be applied by inexperienced staff
· enables the auditor to check the adequacy of subsequent audit work.
Proper planning ensures cost-effective audit as well as audit work of a high standard.
do questions in section 6.1 of tutorial 102 and check answers in the key of section 6.1 of tutorial 103
Study Topic 6.2 – Obtaining and Evaluating Audit Evidence and Concluding the Audit
Jackson & Stent pgs 5/15 to 5/17
Jackson & Stent pgs 7/20 to 7/41 covered in other
ISA 240 – Auditor’s Responsibility to Consider Fraud in an Audit sections of notes
ISA 320 (paragraph 12 – 16) – Audit Materiality
Main classes of audit procedures consist of
Substantive procedures :
Tests of controls
· analytical procedures
· tests of details of transactions
· tests of details of balances and disclosures
Study guide pg 159
Tests of control = tests that are carried out in order to obtain audit evidence on the suitability of the design and
effective operation of the accounting and internal control systems and on their operation throughout the period
Substantive procedures = tests that are carried out in order to obtain audit evidence to support the financial
statements – auditor is interested in balances and transactions
Audit risk = risk that auditor may express an inappropriate audit opinion when the financial statements have been
materially misstated
Sequence in which test of controls and substantive procedures are carried out :
AFTER THE PRELIMINARY ASSESSMENT AUDITOR DECIDES :
YES NO
If decides YES can rely on internal controls : If auditor decides NOT to rely on internal
controls :
· auditor carries out tests of controls to evaluate the internal
controls · if preliminary investigation indicates that
internal controls didn’t function as should
· if tests of controls indicate that the internal controls have
then auditor will carry out no tests of
done as they should then auditor decides on low level of
controls
control risk
· control risk is then estimated as high
· cos control risk is reduced, inherent risk or detection risk
must be increased in order to bring the audit risk to · cos control risk has increased the inherent
acceptable level risk or detection risk must be reduced to
bring audit risk to acceptable level
· inherent risk is independent of the internal controls, but
(inherent risk is independent so auditor
directly related to transactions and balances – auditor
can’t do anything to change it)
assesses inherent risk and bears it in mind during the audit
but cannot do anything about it · detection risk must therefore be reduced to
bring the audit risk to an acceptable level.
· detection risk must therefore be increased in order to bring
To reduce detecting risk the extent of
audit risk to an acceptable level. To increase detection risk
substantive procedures must be increased
the extent of the substantive procedures is reduced (and
(so more substantive procedures will be
fewer substantive procedures are required).
required)
Interaction between the components :
Inverse relationship between detection risk and the combined level of inherent and control risk. e.g. when inherent and
control risk are high then the acceptable level of detection risk must be low so as to reduce audit risk to an acceptably
low level (so should carry out more substantive procedures).
Difference between tests of controls and substantive procedures is the purpose for which they are carried out and NOT
their nature. Some procedures serve a duel purpose in that they comply with the objectives of both tests of controls and
substantive procedures.
Substantive procedures are carried out to detect material misstatements in the financials – consist of :
· audit of transactions (transaction audit)
· audit of balances and disclosures in the financials
· analytical procedures.
Method used to identify substantive procedures related to activities in an accounting system for different
transactions or items in the financials statements :
· identify the authorisation for the transaction in question
· identify the source documents used to record the transaction
· identify the information in the source documents that can be used for checking the transaction
· identify the accounting records used in bringing the transaction to book (subsidiary journals / ledgers)
· identify the accounting entries used in bringing the transactions to book
· identify the way in which ledger balance are dealt within the accounting system until they are disclosed in the
financial statements.
Transaction audit - procedures and activities to be investigated with regard to the flow of a transaction :
Authorisation of transaction :
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· completion of source documents – such as invoices / receipts
· information from source documents recorded in :
Ø subsidiary journals (cash book, general journal etc)
Ø inventory records
Ø fixed asset register
· transactions are updated from subsidiary journals to the ledgers :
Ø general ledger
Ø sub-ledgers (e.g. debtor’s and creditors)
Audit of balances in the financial statements – would investigate procedures / activities of the flow of the transaction :
· calculate ledger balances
· draw up trail balance
· make a list of the balances in the sub-ledger
· reconcile total of the list of balances with the control account in the general ledger
· apply the correct cut-off to related transactions (unless done during audit of transactions)
· account for information according to the applicable accounting policy
· compare tangible assets with accounting records
· draw up financials
Audit procedure sequence is very important to prevent over-auditing or wasting time. When auditor determines the
timing of the audit procedures must take into account that certain related items have to be audited simultaneously.
Timing of the audit procedures depends on the kind of audit that is being performed, either :
· continuous audit or
· final audit.
Final audit is carried out at year end after all the entries have been made in the accounting records and the draft
annual financials have been drawn up by the client. Normally smaller client where accounting records only have to be
audited once a year.
Continuous audit – one or more interim audits and then a final audit. For big clients where there is large amount of
testing so necessary to start the audit on an interim basis. Interim audits are arranged with the client for interim periods
during financial year (i.e. quarterly, monthly). Normally do most of the transaction tests during the interim audit and
remainder of transaction tests and financial statement tests are performed at year-end during final audit.
Auditor tries to determining the cause of any errors detected during the audit procedures and considers the possible
influence on the financials.
If auditor is convinced errors are unintentional then will try to establish the underlying cause – could be :
· failure to understand the prescribed procedures
· inadequacy of the prescribed procedures
· human factors e.g. fatigue or carelessness.
If failure to understand then error could be compounded during the year – auditor needs to consider probability that
similar errors have taken place and that the result could be a material error in the financials. Must also consider if the
risk assessment of the accounts in question should be revised (adjustment of the nature, timing and extent of the audit
procedures) and if the audit programme needs to be modified. If error is large enough then it should be reported to
management.
If thinks error is intentional then must establish how the error took place (what level of personnel is involved and what
weakness in the accounting and internal control system was responsible).
Auditor must consider the total amount of audit evidence obtained and then use judgment to determine if reason to
suspect could be fraud – if fraud suspected then auditor’s risk assessment must be reconsidered.
Total of the differences (net differences after the client has made corrections) will then include the following :
· specific errors in amounts included in the financials and detected (e.g. tests of key items and other detailed tests of
balances / transactions)
· total projected errors for all representative samples for accounting balances / transaction classes
· any amount where the amount in an accounting estimate in the financials differs from the amount the auditor
considers is a reasonable estimate.
Net effect of the unrectified audit differences of the previous year must also appear on the summary of audit differences
as can still influence the evaluation of the current year’s financials.
When finalising the audit the auditor examines conclusions drawn from the collected audit evidence and evaluates them
as the basis for expressing an opinion on the financials.
Must also consider the general presentation of the financials including :
· general influence of any qualitative material misstatement on the financials
· whether the financial statements have been prepared in accordance to GAAP
· whether they comply with the relevant statutory provisions
do questions in section 6.1 of tutorial 102 and check answers in the key of section 6.1 of tutorial 103
see example of emphasise of matter of auditor’s report on bottom pg 18/5 of text book
Must be positioned under the opinion paragraph and must open with the words “without qualifying our opinion above ..”
Material matters – if knowledge of the matter would be likely to influence the economic decisions of the user of the
financials.
Material and pervasive – when the auditor has decided that an unresolved matter is sufficiently material to warrant a
qualification to the auditor report then audit also has to decide if the matter is material and pervasive in the context of
fair presentation. If it is then an adverse opinion or disclaimer of opinion on the financials as a whole will be required.
Examples :
· a scope limitation is material and pervasive if the limitation has resulted in the auditor being unable to obtain
sufficient appropriate evidence and so he is unable to express any opinion
· disagreement becomes material and pervasive when its impact on the financials is so great that fair presentation
as a whole is undermined and that an “except for” qualification doesn’t adequately convey the misleading or
incomplete nature of the financials
Nature of the materiality of the matter giving rise to the qualification, adverse or disclaimer of opinion are both important.
ALL material matters (either based on disagreement or limitation of scope) will give rise to “except for” qualifications.
Material and pervasive limitations of scope can only result in disclaimers of opinion and
Material and pervasive disagreements can only result in adverse opinions
Adverse opinion states that the financials statements do not fairly present the state of the company
Disclaimer states that the auditor cannot say if financials fairly present the state of company or not (can’t form an
opinion)
MODIFICATION OF THE STANDARD AUDIT REPORT
DISCLAIMER ADVERSE
OF OPINION OPINION
Types of audit opinions
Once auditor has decided that an unqualified opinion cannot be given then must decide which type of qualified opinion
he must give :
· qualified opinion - except for limitation of scope – given when an unqualified opinion cannot be given due to a
limitation of scope, but that the limitation is not so material and pervasive that a disclaimer of opinion must be given
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· disclaimer of opinion - limitation of scope – when possible effect of a limitation of scope is so material and
pervasive that the auditor has not been able to obtain sufficient appropriate evidence and accordingly is not able to
express an opinion
· qualified opinion - “except for disagreement – when an unqualified opinion cannot be given due to a
disagreement (with directors about accounting policies selected, method of their application or the adequacy of
disclosures) which is not so material and pervasive as to require an adverse opinion
· disagreement - adverse opinion – when the effect of a disagreement is so material and pervasive to the financial
that the auditor concludes that a qualification of the report is not adequate to disclose the misleading or incomplete
nature of the financials.
If auditor concludes that he cannot issue an unqualified auditor’s report then need to decide which form of modified
report to use. Would first ask himself if his opinion is affected by the matter in question? :
· if no – auditor can issue an unqualified auditor’s report with emphasis of matter paragraph
· if yes – auditor must then decide if the opinion was included cos of limitation on the scope or auditor’s work or
because of a difference of opinion with management.
Then must decide if the matter is pervasive or not (i.e. is it pervading – spread throughout the financials)
TYPES OF
AUDITOR’S
REPORTS :
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Before an auditor expresses an audit opinion in the auditor’s report he should review and assess all the conclusions that
he has drawn from the audit evidence as a basis for the formations of his audit opinion.
Once has formed his audit opinion on the financials as a whole he expresses his opinion in the auditor’s report.
If matter that has occurred because of limitation on the scope of the Auditor’s work :
Influence of the matter Influence on the audit opinion
Not material Unqualified opinion
do questions in section 6.3 of tutorial 102 and check answers in the key of section 6.3 of tutorial 103
go through all the assessment criteria at the start of each study unit – make sure can do all points.
go through all the self assessments at the end of each study unit – make sure can answer all the questions.
Inherent risk = susceptibility of an assertion to a misstatement that could be material (either separately or when
aggregated with other misstatements) assuming that there are no related controls.
System of quality control in a firm is designed to provide reasonable assurance that the firm and its staff comply with
professional standards as well as regulatory and statutory requirements and that the auditor’s reports issued by the firm
or engagement partners are appropriate in the circumstances.
5 essential aspects of control that MUST be present in order to implement an effective and efficient internal control
system :
· control environment
· control activities
· monitoring of controls
· entity’s risk assessment process
· information system (information and communication)
Reportable irregularity = any unlawful act or omission committed by any person responsible for the management of
the entity which :
· has caused or may cause material financial loss to the entity or any user of the entity
· is fraudulent or amounts to theft
· represents a material breach of any fiduciary duty to the entity
Audit risk = risk auditor may express an inappropriate audit opinion when the financials are materially misstated (risk of
material misstatement)
Objective of audit = enable auditor to express opinion as to whether or not the financials fairly present (in all material
respects) the financial position of the entity at that specific date and the results of its operations and cash flow in
accordance with IFRS and the Companies Act.
Audit function = provides users with a high degree of assurance regarding the creditability of the assertions made by
management in the financials.
Audit documentation :
· assists audit team to plan and perform the audit
· facilitates supervision and review on the audit
· enables audit team to be accountable for their work
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· retains record of matters for future audits
· facilitates audit quality control reviews
· means experienced auditor will be able to conduct external inspections in accordance with applicable legal,
regulatory or other requirements.
Advantages of an audit :
· enhances creditability of the financials
· allows auditor to advise the company on how to :
Ø improve the accounting system
Ø increase efficiency and profits.
Auditor must obtain understanding of client’s accounting and internal control system to :
· assess the suitability of the system as a basis for compiling accurate financial information
· formulate a suitable audit approach
· design appropriate audit procedures
· express an opinion on the financials with an acceptable audit risk.
Detection risk = risk that auditor won’t detect a misstatement in the account balances or classes of transaction that
could be material (either individually or when aggregated).
Fundamental principals :
· integrity
· professional competence and due care
· professional behaviour
· objectivity
· confidentiality
Internal control = process designed, implemented and maintained by management and other staff to provide
reasonable assurance about the achievement of the entity’s objectives regarding the reliability of financial reporting.
Threats :
· self interest
· self review
· advocacy (auditor promotes a position or opinion and is therefore no longer objective)
· familiarity
· intimidation
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Tests of control categories :
· reperformance
· observation
· enquiry
· inspection
Audit materiality = omission or statement where influence of this omission or statement will effect the economic
decisions of users based on information in the financials
Emphasis of matter :
· highlights matter that is already in financials but that would be important to users
· significant uncertainty about something in the future
· material if inconsistency in some part of the financials that management refuses to change.
Qualified opinion if :
· limitation on scope of auditors work
· disagreement with management.
Material and pervasive limitation of scope = disclaimer of opinion
Material and pervasive disagreement with management = adverse opinion
Disclaimer of opinion = auditor cannot say if financials fairly present the state of company or not (no opinion)
Adverse opinion = auditor states that financials do not fairly present the state of the company
rd
Fraud = intentional act by one or more people among management, employees or 3 parties with the intent to obtain an
unjust or illegal advantage
Risk management = identification and evaluation of actual and potential risk areas pertaining to the company where
risks are either terminated, transferred, accepted or mitigated.
Overall audit plan = strategy where the auditor achieves the overall audit objective (i.e. acquisition of sufficient
appropriate audit evidence to make it possible to draw reasonable conclusions on which to base the audit opinion)
Glossary
Professional accountant = auditor
Postulate = something that is claimed as a basis for reasoning (e.g. a starting point)
It is an obligation for certain other companies to have their annual financial statements audited, regardless
of their public interest score. These are:
· Public companies (LTD) and state owned companies
· A company which holds assets (exceeding R5m) in the ordinary course of its primary activities in a
fiduciary capacity for persons not related to the company
The reason for these specific requirements is obvious, there is a strong element of public interest.
Safeguards are actions or other measures that may eliminate threats or reduce them to an acceptable level (SAICA
Code of Professional Conduct, sec 100.13). For example, if you are an auditor and have shares in a public company,
you will have to sell the shares if you become the engagement partner on the audit.(Threat to independence)
List and briefly explain the five fundamental principles of professional conduct which should be adhered to by auditors
(chartered accountants and registered auditors).
· Integrity – straight forward, honest, fair and truthful in their professional and business relationship
· Objectivity – CA’s should not be associated with information they believe to be false, misleading (by
conclusion or omission) or recklessly provided
· Professional competence and due care (J&S p 2/6) – the chartered accountant must act carefully, thoroughly
and in accordance with the requirements of the assignment. Maintain professional knowledge and skills
· Confidentiality (J&S p 2/6) – CA should not disclose confidential information to any third party
· professional behaviour (J&S p 2/6) – the CA must comply with relevant laws and regulations, avoid any action
that my bring discredit to the profession. Professional behaviour i.r.o. publicity, advertising, solicitation,
recruitment and responsibilities to colleagues.
Threats – circumstances which can threaten compliance with the fundamental priciples:
1. Self-interest threats
2. Self-review threats
3. Advocacy threats
4. Familiarity threats
5. Intimidation threats
Safeguards
Unless the threat is CLEARLY insignificant the professional accountant must apply safeguards to eliminate
or reduce the threat to an acceptable level.
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· professional judgment , taking into account the public interest (if public interest is affected the threat is
significant), decision should be one that a reasonable and informed 3rd party having knowledge of all the
relevant information would make.
·
Control risk is the risk that misstatements could occur without the internal control system of an organisation
preventing them, detecting them or fixing them
Inherent risk refers to the susceptibility of an assertion to a misstatement that could be material, either individually or
when aggregated with other misstatements, assuming that there are no related controls. Some accounts, assertions,
transactions, disclosures and industries pose greater risks for misstatement than others.
ISQC 1 requires that the firm must establish policies and procedures :
· for engagement teams to put together finalised engagement files on a timely basis – i.e. set deadlines, review
and sign off files
· designed to maintain confidentiality, safe custody, integrity (no tampering or contamination), accessibility and
retrievably of engagement documentation e.g.
! use of password on computerised workpapers
! back up routines
! controls over the distribution of workpapers (e.g. signing a register)
! physical controls over hardcopy and electronic work papers (e.g. archive room with library routines)
! for retention of engagement documentation for as long as needed (not less then 5 yrs from date of
auditor’s report).
Explain in relation to the element “monitoring”, as one of the elements of quality control in accordance with ISQC
1, what it should include in the monitoring process
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1. The firm shall establish a monitoring process designed to provide it with reasonable assurance that the
policies and procedures relating to the system of quality control are relevant, adequate, and operating
effectively. This process shall:
2. Include an ongoing consideration and evaluation of the firm’s system of quality control√^ including, on a
cyclical basis, inspection of at least one completed engagement for each engagement partner√^.
Outline, in terms of section 45 of the Auditing Profession Act, 2005, the procedures that the auditor should follow due
to the existence of a reportable irregularity
Duty to report on irregularities Section 45 - J&S p3/84
This section stipulates that the individual registered auditor who:
· Is satisfied or has reason to believe that
· A reportable irregularity has taken or is taking place must
· Without delay
· Send a written report, giving particulars of the irregularity to the Regulatory board and must
· Within 3 days, notify the management board of the entities writing of the sending of the report, and must
provide management with a copy of the report
State the procedure to be followed by the board of directors of following the resignation of the company’s
registered auditors.
The following procedure should be followed when a vacancy arises:
· The board of directors must propose to the audit committee, within 15business days, the name of at least one
registered auditor to be consideredfor appointment.
· The audit committee has five business days after the proposal has beendelivered to it, to reject the proposed
replacement auditor in writing, ifthey so wish, otherwise the board of directors may make the appointment.
· Whatever the situation, a new auditor must be appointed within 40 businessdays of the vacancy arising.
List the requirements of the audit committee regarding the independence of the new auditor to be appointed.
The person appointed as the auditor must be acceptable to the company’s audit committee as being independent of
the company. To this end, the audit committee must
· ascertain that the auditor does not receive any direct or indirect remuneration except
! as an auditor or
! for rendering other nonaudit services which have been determined by the audit committee
· consider whether the auditor’s independence may have been prejudiced
! as a result of any previous appointment as auditor or
! having regard to the extent of any consultancy, advisory or other work undertaken by the auditor for
the company
· consider whether the auditor complies with the “rules and regulations” of the IRBA, for example, the Code of
Professional Conduct, in relation to independence and conflict of interest
· The audit committee must evaluate the independence of the auditor in the context of the company itself, and
within the group of companies, if the company is a member of a group
1.5.2 List three (3) duties of the audit committee in connection with the appointment of external auditors
1. To nominate, for appointment as auditor of the company under section 90, a registered auditor who, in the opinion of the
audit committee, is independent of the company;
2. to determine the fees to be paid to the auditor and the auditor’s terms of engagement;
3. to ensure that the appointment of the auditor complies with the provisions of this Act and any other legislation relating to
the appointment of auditors;
4. to determine, the nature and extent of any non-audit services that the auditor may provide to the company, or that the
auditor must not provide to the company, or a related company;
5. to pre-approve any proposed agreement with the auditor for the provision of non-audit services to the company;
The auditor issues an engagement letter to the client at the BEGINNING of the audit, this engagement letter will
explain certain aspects to the client regarding the audit. When an auditor accepts an audit engagement from a client, a
contractual relationship arises between the auditor and the client. As stated in ISA 210 (para A22), it is in the interests
of both the entity and the auditor that the latter should send an audit engagement letter prior to commencing the audit
to help avoid any misunderstandings in the audit.
2.1 List four (4) aspects that should be included in an audit engagement letter in terms of International Standards on
Auditing.
1. objective of the engagement, clearly stated i.e. to express an opinion on the financial statements
2. The scope of the engagement – an outline of what is to be done and, where appropriate, reference to
applicable legislation, regulation or other pronouncements to which the auditor adheres eg ISAs
3. The form of any reports or other communication of results of the engagement
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2.2 Explain the differences between a reasonable assurance engagement and a limited assurance engagement
Review engagement provides moderate assurance that the information subject to review is free of material
misstatements, which is expressed in the form of negative assurance. Positive and negative forms of opinion are
discussed when a review is conducted, procedures are limited and not as comprehensive as audit procedures;
consequently only moderate assurance is given i.r.o. the fairness of the financial information.
Reasonable assurance engagement: audit engagements where a positive form of expression of opinion is given;
extensive procedures carried out. Reasonable assurance engagement arises out of an audit engagement.
Limited assurance engagement: review engagements, where a negative form of expression of opinion is given; less
extensive procedures carried out. Limited assurance arises out of a review engagement.
Reasonable Assurance Engagement Limited Assurance Engagement
A reduction in assurance engagement risk to an A reduction in assurance engagement risk to a level that
acceptably low level is acceptable in the circumstances of the engagement,
but where that risk is greater than for a reasonable
assurance engagement
A positive form of expression of the practitioner’s A negative form of expression of the practitioner’s
conclusion conclusion
An audit engagement A review engagement
Sufficient appropriate evidence is gathered as part of a Procedures for gathering sufficient appropriate evidence
systematic engagement process are deliberately limited relative to a reasonable assurance
engagement.
The examples of audit procedures given cannot be categorised simply asa risk assessment procedure, test of control
or substantive procedure. Theprocedure will be categorised in terms of what the auditor is in fact trying toachieve.
Inspection - Inspection involves examining records, documents (physical files or electronic
storage media) or tangible assets. Example: inspecting a lease agreement to determine whether it has been signed by
an authorised signatory (test of control and/or substantive procedure)
Observation - Observation entails looking at a process or procedure being performed by the client’s staff. Example:
attending the annual inventory count to observe the performance of
the counters (substantive procedure)
Inquiry - Inquiry involves seeking information from knowledgeable persons in or outside the entity. Inquiries may
range from formal written inquiries addressed to third parties to informal oral inquiries addressed to persons inside the
entity. Example: inquiring from the warehouse controller about the methods of identifying obsolete or damaged
inventory (test of control)
Recalculation - Recalculation entails checking the arithmetic accuracy of source documents and accounting records.
Example: recalculating depreciation on plant and equipment (substantive procedure)
Analytical procedures - Analytical procedures relate to the analysis of significant ratios and trends and the resulting
investigation of fluctuations and relationships that are inconsistent with other relevant information or deviate from
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predicted amounts. Example: Ratio analysis is conducted on the turnover and compared to the ratios for prior years
(risk assessment procedure and/or substantive procedure).
Reperformance - Reperformance entails the auditor repeating, either wholly or in part, the same procedures
performed by the client. Example: reperforming the bank reconciliation at the financial year-end (substantive
procedure).
External confirmation - External confirmation involves obtaining a direct written response from a third party to a
request/query from the auditor to that third party. Example: confirming an accounts receivable balance (debtor’s
balance) directly with a debtor (substantive procedure).
The procedure will be categorised in terms of what the auditor is trying to achieve E.G.:
Ask (inquire) the credit manager for details of procedures followed for the granting of credit and authorisation of sales
– test of control.
Perform analytical review procedures of sales per month and obtain explanations for extraordinary fluctuations –
substantive procedure.
Inspect duplicate sales invoices for the authorising signature of the sales manager – test of control.
Observe procedures followed regarding gate control at the inventory store – test of control.
Reperform the leave pay accrual at year-end – substantive procedure.
Perform a debtor’s confirmation at year-end on selected large debtors, requiring the debtors to confirm the balance at
year-end – substantive procedure.
Test of Control - correct test of control to be performed by the auditor in order to test the operating effectiveness
thereof .
Understand the relationship of the components of audit risk and how they have an impact on each other.
As stated in ISA 200: A42, there is an inverse relationship between detection risk and the combined level of inherent and control
risk. When inherent and control risk are high, for example, the acceptable level of detection risk must be low in order to reduce the
audit risk to an acceptably low level (additional audit procedures must be conducted).
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Types of Auditor
· Registered external auditors – who express an independent opinion
· Internal auditors – who perform independent assignments on behalf of the board of the company
· Government auditors – perform a role similar to that of the internal auditor, but within the government
departments, reporting their findings to senior government
· Forensic auditors – concentrate on investigating and gathering evidence where there has been alleged
financial mismanagement, theft or fraud
· Special purpose auditor – specialise in a particular field such as environmental auditors, or VAT auditors
1.2.2. Describe the overall objective of the auditor in terms of ISA 200
· To obtain reasonable assurance about whether the financial statements as a whole are free from material
misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether
the financial statements are prepared, in all material respects, in accordance with an applicable financial
reporting framework; and
· To report on the financial statements, and communicate as required by the ISAs, in accordance with the
auditor’s findings
· In all cases when reasonable assurance cannot be obtained and a qualified opinion in the auditors report is
insufficient in the circumstances for purposes of reporting to the intended users of the financial statements,
the ISAs require that the auditor disclaim an opinion or withdraw/resign from the engagement, where
withdrawal is possible under applicable law or legislation.
Control activities = policies and procedures that ensure controls are in place to achieve internal control
objectives e.g.
Types of control activities
· Approval, authorisation
· Segregation (division) of duties
· Isolation of responsibility
· Assess/custody (security)
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Substantive procedures
Financial statements consisting of collection of balances (Balance Sheet) and summary of totals (Income
Statement) and accompanying notes – tests of control cannot provide auditor with sufficient appropriate
evidence pertaining to balances, totals and disclosures, so auditor must perform procedures of a
substantive nature.
Substantive procedures can be performed on balances and totals themselves or on the individual
transactions which make up the balance or total. Either tests of detail or analytical procedures.
Substantive procedures seek to provide evidence to support the financial statement assertions :
· balances – completeness, existence, valuation, rights and obligations, presentation and disclosure
· transactions – completeness (totals), occurrence, measurement, presentation and disclosure
The sources and procedures the auditor could use to obtain preliminary information on the business are as follows:
· the previous auditor: communication with the previous auditor (in compliance with the Code of Professional
Conduct)
· those charged with governance: discussion with the client’s directors, senior financial personnel, audit
committee and so on
· external sources: inquiries from the firm’s bankers, legal counsel and so on (permission would have to be
sought)
· external information: background searches of relevant databases (eg the internet)
· internal documentation: review of any documentation, either public or made available by the prospective client
(eg group or management reports)
· the auditor’s firm: regarding independence, inquiry and analysis of the status of the firm and its employees in
relation to the potential client
· the financial press: searches in financial magazines for relevant information
Independence :
· independence of mind – state of mind that permits the provision of an opinion without being affected
by influences that compromise professional judgment and allow auditor to act with integrity, objectivity
and professional skepticism
· independence in appearance – avoidance of facts and circumstances that are so significant that a
reasonably informed 3rd party with all the relevant information would reasonably conclude that the
auditor’s integrity, objectivity or professional skepticism had been compromised
· state of mind & in appearance – both are very important as even if auditor with financial interest in
client might have actually performed his duties with the highest level of independence (state of mind) he
may NOT be perceived by another party who know of his financial interest in the client of being
independent (appearance). So auditor must not only be independent but must also be seen to be
independent.
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A positive form of expression of the practitioner’s A negative form of expression of the practitioner’s
conclusion conclusion
Procedures for gathering sufficient appropriate Procedures for gathering sufficient appropriate
evidence are deliberately more compared to a evidence are deliberately limited relative to a
limited assurance engagement. reasonable assurance engagement.
3.2.1 Identify four (4) control weaknesses regarding control activities in (e) to (k) in the scenario;
3.2.2 For each identified control weakness, describe what control could be put in place to overcome the
weakness in the control activity.
3.2.1Control weakness 3.2.2 Control
e) The person who performs the There should be proper segregation
bank reconciliation also of duties implemented
authorises the payments that
are made.
f) The creditors reconciliations inadequate review by senior
are not signed off by the management
financial manager after review
g) It was detected that the Inadequate comparison and
individual creditors accounts are reconciliation
not compared to the creditor’s
statements when the creditors
reconciliation is prepared
h) Management of Anytime acts Management supervision should be
with integrity and enforces this put in place to review the
throughout the whole performance of each of the
organisation employees
i) There are no background Procedures must be put in place to
checks performed on pilots that screen pilots employed by Anytime
are employed by Anytime
k) Entry to the aircraft Strict access controls should be put
warehouse is not strictly in place
controlled and anybody can
enter
Reportable irregularity = any unlawful act or omission committed by any person responsible for the
management of the entity which :
· has caused or may cause material financial loss to the entity or any user of the entity
· is fraudulent or amounts to theft
· represents a material breach of any fiduciary duty to the entity
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List and describe the assertions applicable to turnover (turnover) in the working paper
· Occurrence: ^ All the turnover included relates to genuine sales/ turnover of the entity (i.e: not
In this question, 2 November 2013 is the most appropriate date to issue an audit report.
The auditor’s report should be dated no earlier than the date on which the auditor has obtained sufficient appropriate
audit evidence on which to base his or her opinion.
Before an auditor can sign the auditor’s report, all the statements comprising the financial statements, including the
relevant notes, must have been prepared, and those with the recognised authority must have accepted responsibility
for the financial statements.
Subsequent events should be performed for the dates 30 October to 2 November
ASSIGNMENT 1
A sample of printers was selected from the administration offices and was traced to the fixed asset listing. = satisfies
the completeness assertion as it provides evidence that all printers that are on the premises have been recorded
completely in the fixed asset listing.
A sample of items on the inventory count sheet was selected and these were compared to the physical inventory on
hand. = the auditor has satisfied himself/herself that inventory that was recorded on the inventory count sheet actually
exists
A sample of goods delivery notes were matched to the corresponding sales invoice and to the entry in sales journal =
satisfies the completeness assertion as it provides evidence that all sales made have actually been recorded in the
accounting records
Inspected the title deeds of the property to determine whether there were any encumbrances on the property =
satisfies the assertion of rights and obligations relating to the property registered in Jody’s name
An unregistered person may be appointed by the Auditor General to carry out on his behalf any audit which he is, in
terms of the Public Audit Act, required to undertake. = The Auditor General may appoint a person who is not a
registered auditor to carry out anaudit in terms of the Public Audit Act, 2004 on his behalf.
A person who is not a registered auditor may not accept an appointment as an auditor, actas an auditor or engage in
public practice as an auditor in terms of sec 41 of the AuditingProfession Act, 2005. Options 1, 2 and 4 are, therefore,
prohibited.
The Independent Regulatory Board for Auditors (IRBA) has specific goals as described in the IRBA Manual of
Information
1 To register an auditor who meets the registration requirements.
2 To monitor the compliance of registered auditors against professional standards.
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3 To develop and maintain shareholder relationships and enhanceperformance, accountability and public confidence
is one of the IRBA’s goals.
4 To investigate and take appropriate action against registered auditors in respect of improper conduct.
It is the responsibility of the auditor to gather sufficient and appropriate audit evidence to be in a position to give
an independent opinion on whether the annual financial statements issued by the directors to the shareholders
present fairly, the financial position and results of operations of the company in terms of the applicable financial
reporting framework.
Directors are responsible for running the business and reporting the results of their management to the
shareholders in the annual financial statements
Directors are responsible for preparing the financial statements in terms of an appropriate financial reporting
framework.
Finance costs are reflected on the statement of profit and loss and other comprehensive income. Which of
the financial statement assertions are relevant to the disclosure of finance costs?
There are three categories of management assertions, namely:
• Assertions about classes of transactions and events for the period under audit (Statement of profit and loss and
other comprehensive income line items)
• Assertions about account balances at the period end (Statement of financial positions line items)
• Assertions about presentation and disclosure
First ask yourself under which category the disclosure of finance costs falls. We are addressing the disclosure of
finance costs and the assertions relating to presentation and disclosure will, therefore, apply, as stated in option 4. To
answer a question of this nature it is imperative that you understand which assertions fall under the three categories.
You also need to bear in mind that finance cost is a class of transaction and assertions pertaining to class of
transaction will apply.
Internal auditing is a management function which functions independently within an organisation, but remains part of
the entity. the internal auditors still remain part of the organisation even though they function independently. The
internal auditors report to the management of an entity, receive a mandate from management and they perform a
management function and not an external attest function.
A postulate is a foundation on which a discipline is built and there are certain underlying principles or postulates,
which serve as the basis of auditing theory
Postulate = something that is claimed as a basis for reasoning (e.g. a starting point)
1. no conflict of interest between the auditor and management / employees of the entity being audited
2. auditor must act exclusively as an auditor in order to offer an independent and objective opinion on
the fair presentation of financial information
3. professional status of the independent auditor imposes commensurate professional obligations
4. financial data if verifiable
5. internal controls reduce the probability of errors and irregularities
6. application of IRFS results in fair presentation
7. that which held true in the past will hold true in the future (in the absence of contrary evidence)
8. financial statements submitted to the auditor for verification are free of collusive and other unusual
irregularities
The fact that that the auditor’s work is governed by regulatory bodies is not an inherent limitation of an audit; it merely
means that the conduct of registered auditors is regulated. Consult the reference for a comprehensive guideline on the
inherent limitations of an audit.
The financial reporting framework is the framework adopted by management in the preparation of the financial
statements that is acceptable in view of the nature of the entity and the objective of the financial statements.
internal control: The financial reporting framework provides direct support to the entity’s management
and provides a strong internal control environment within the entity for monitoring
compliance with established policies and procedures and reporting to management.
An auditor will not be guilty of improper conduct if prescribed fees are received.
improper conduct on the part of a registered auditor in public practice in terms of the rules regarding
improper conduct of the Independent Regulatory Board for Auditors (IRBA)
· failure to perform work with a degree of professional competence, due care and skill is not
permitted as it contravenes rule 2.7. (Failure to perform work with reasonable care and skill.)
· permitting a registered auditors name to be used in connection with any estimate in a manner
which may lead to the belief that the registered auditor vouches for the accuracy of the estimate
contravenes rule 2.9. (A registered auditor vouching for the accuracy of forecast results which
were estimated by management of the company being audited)
· a registered auditor may not receive a payment from a trainee auditor, who has been serving a
training contract for agreeing, to cancel the contract. The only compensation which may be
claimed is in respect of a reimbursement actually made to IRBA if satisfactory proof can be
produced to the satisfaction of IRBA. (Requiring compensation from a trainee auditor for
cancellation of a training contract except for actual expenses paid to the Independent
Regulatory Board for Auditors (IRBA) in respect of the training contract)
when can the shareholder hold the auditor responsible for negligence in terms of the Auditing
Profession Act:
The auditor will be liable to the shareholder if at the time when the negligence occurred the registered
auditor knew or could reasonably have been expected to know that the shareholder would rely on the
opinion in order to enter into a transaction
The shareholder will have to bring a delictual action against the auditor and, amongst other things,
prove that the auditor knew or reasonably could have been expected know that the third party would
rely on the opinion
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Take note that there is a distinction between the liability to clients and to third parties. An auditor’s
liability to a client may be based on breach of contract. An auditor generally has no contract with third
parties and breach of contract cannot, therefore, be used as a basis for liability to third parties.
Inventory to the value of R67 256 was purchased by Hamiltoon Ltd and is disclosed in the Purchases
account in the statement of profit and loss and other comprehensive income. By including this amount
in the statement of profit and loss and other comprehensive income, management declares amongst
other things that: all inventory purchases are recorded, and that all inventory purchases are recorded
in the proper accounts. Which two management assertions are being addressed with these
statements? Classification and completeness
Purchases of inventory are classified as transactions and events for the period under audit. The assertions relating to
classes of transactions and events will, therefore, apply. In this question we specifically asked you which assertions
relate to “all purchases are recorded” (Completeness), and “all purchases are recorded in the proper accounts”
(Classification). It is thus very important that you understand what is meant by the assertions in each of the three
categories.
Threats
A close family member of the assurance team has a direct or material interest in an assurance client.
This may create a self interest threat
The audit partner has been involved with a client over a long period of time. This may create a
familiarity, self-interest and/or self-review threat
Not a threat
The audit partner advises the audit client on accounting principles and disclosure = These activities are
considered to be part of the audit and are considered appropriate means to promote the fair
presentation of the financial statements.
An audit client gives each member of the engagement team an inexpensive pen bearing the
company’s logo, at the completion of the annual audit.The gift is insignificant
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· Human resources.
· Leadership responsibilities for quality in the firm
· Relevant ethical requirements (including independence)
· Acceptance and continuance of client relationships and specific requirements
The objective of the firm in establishing a system of quality control is to provide the firm with
reasonable assurance that the firm and its personnel comply with professional standards and
applicable legal and regulatory requirements and that reports issued by the firm or engagement
partners are appropriate in the circumstances.
Management assertions are representations by management, explicit or otherwise, that are embodied
in the financial statements, as used by the auditor, to consider the different types of potential
misstatements that may occur.
Graded questions
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State 3 matters which will be affected by the company’s public interest score.
●Whether the company is audited or reviewed and who must carry out the independent review. √
●Which financial reporting standard the company must use to prepare its annual financial statements.
√
●The level of financial rescue practitioner who would be engaged, if the company needed financial
rescue. √
All companies and close corporations must, calculate their public interest score. √
What are the various threshold categories set by the Regulations for public interest scores?
· Equal to or above 350 points √
· Equal to 100 or above, but less than 350 points √
· Below 100 points. √
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Note: There are other regulations that can change the above mentioned decision table.
Statement 2 ^: Essentially this postulate says that if the auditor is going to give an opinion√^that is
worthwhile to users, he must be free of any bias (independent) √^. Furthermore theauditor must not
compromise his audit independence by offering the client other services whichmay impinge in any way
on his independence. √^ (Max 3)
Statement 5 ^: This postulate proposes that it is to verify the client’s financial data√^ i.e. thatthere will
be evidence (documentary or otherwise) which will enable the external auditor to“verify” the
transactions recorded in the client’s books√^. If financial information is not verifiablethere can be no
audit. √^ (Max 3)
Statement 6 ^: This postulate suggests that a company without internal controls provides theauditor
with little chance of conducting an efficient or economical audit. √^ If a company is not“controlling” its
activities e.g. no division of duties, no proper documentation etc, a positive auditoutcome is not
feasible. √^ (Max 3)
Statement 8 ^: This postulate suggests that in business “things generally stay the same”. √^Obviously
businesses develop, expand, contract etc, but generally from year to year the coreactivities and
philosophy of the business remain the same. √^ Hence, historical informationabout a client is important
to the auditor. √^ The postulate in a sense also alerts the auditor tothe fact that if there has been
change, the effect of the change must be considered for thepurposes of the audit. √^ (Max 3)
Statement 10 ^: This postulate simply means that the auditor must understand that theprofessional
status which the audit profession and its members have, brings with it aresponsibility to meet their
professional obligations, √^ e.g. auditors must ensure they keep upto date, act with objectivity and
integrity etc. √^ (Max 3)
(Max 15)
c) Statements which are not postulates
Statement 1: True. ^ The assertions are the representations which the directors are makingabout the
assets, liabilities, transactions and disclosures in the financial statements. Thus theyform the basis of
the financial statements. √^ (Max 2)
Statement 3: False. ^ An unqualified opinion is a statement that the financial statements“present fairly”
the financial position etc of the company. √^ It is not a statement that the annualfinancial statements
are 100% correct. √^ The auditor can never be in a position to “certify” due to inter alia, the limitations
of the audit function and the extensive use of judgment and
estimates in financial statements. √^ (Max 2)
Statement 4: True. ^ One of the fundamental principles of professional conduct is that an auditor is
required to “maintain professional knowledge and skill” √^and “act in accordance with applicable
technical and professional standards”. √^ Furthermore, an opinion arising from an audit conducted by
an incompetent audit team will be worthless.√^ (Max 2)
Statement 7: True. ^ In South Africa the individual must be registered with the Independent
Regulatory Board for Auditors (IRBA). √^ (Max 2)
Statement 9: True. ^ Although the auditor expresses an independent opinion it is very important that
there is communication and co-operation with the client’s directors/management. √^ The auditor audits
the assertions of the directors, and evidence is frequently required from individual directors or
members of the management team. √^ For example, a detailed explanation about a major transaction
may be required from the financial director; if he will not co-operate, the auditor may not be able to
“audit” the transaction to determine whether it has been fairly presented in the financial statements. √^
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כ
כ any,
shareholders, etc. √
(Max 5)
(b) outline the procedure which you would have followed on satisfying yourself that a
reportable irregularity was taking place
I would have …
· “without delay” have sent a written report to the IRBA, giving particulars of the reportable
irregularity √
· within 3 days of this report, notified the Board of Franschoek (Pty) Ltd in writing of the sending
of the report to the IRBA √
· as soon as reasonably possible but within 30 days of sending the first report √ …
! have taken all reasonable measures to discuss the report with the Board of Franschoek
(Pty) Ltd and √
! have sent another report to the IRBA which included a statement that I am of the opinion
that √
- no reportable irregularity is taking or has taken place √
- the reportable irregularity is no longer taking place and that adequate steps have
taken place for the prevention or recovery of any loss or √
- the reportable irregularity is continuing. √(Max 7)
c. Changed circumstances
(i) It would make no difference √, the Section applies to unlawful acts conducted by persons
responsible for the management of the company √. The fact that they are also shareholders is not a
factor. √ (Max 2)
(ii) I would still submit my first report √. If within 30 days thereof I am satisfied that the directors have in
fact taken adequate steps to “make good”; √ I would notify the IRBA accordingly i.e. the process must
still be followed. √ (Max 2)
(iii) If Franschoek (Pty) Ltd is an audit client √ it does not matter that the unlawful act was identified
whilst conducting other work. √ (Max 2)
(iv) It would probably not be a reportable irregularity but this would depend on the interpretation of a
“person responsible” for the management of the entity √. The financial director is partially responsible
but does not make up the “management board”. √
The matter could possibly be dealt with as an employee type fraud which could be reportedto the
Board. √ If the Board does not take appropriate action then it would definitelybecome a reportable
irregularity. √ (Max 2)
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1. VishBhogal has been the lead engagement partner on the audit of Kybher Ltd, a listed company
for the past five consecutive year-end audits
Familiarity threat. √
Safeguard:Auditor rotation as required by the Companies Act. √^
2. The audit firm of Ajax and Real are asked to provide internal audit services to Clarkson Ltd, one
of its audit clients
Self review threat √ where the services relate to internal accounting control/financialsystems.
However, this situation would not be acceptable to the audit committee interms of King III.
Safeguard:Only safeguard is not to accept this appointment. √^
Probably no threat √ where the services relate to operational (non-financial) systems
Safeguard:The safeguard would be for the audit committee to approve the appointment.
Thecommittee would only approve if the auditor’s independence was not threatened. √^
3. Ngcobo and Zwane, an audit firm, has been requested by one of its audit clients to lend it (the
audit client) two trainee accountants to work in its accounting department for a period of six
weeks
Self review threat √ and potential familiarity threat √ as trainees become friendly with client
accounting staff.
Safeguards:
! Trainees should not make any “management” decisions. √^
! Trainees should not exercise discretionary authority to commit the client, e.g. sign a
purchase order or write off a bad debt. √^
! Trainees should not be assigned to the audit. This will be particularly effective in
addressing any familiarity threat. √^
4. Jessie James and Com, a firm of auditors, has been approached by Odeon (Pty) Ltd a large
audit client, to recruit a financial director on its behalf
Self interest threat, √ familiarity threat. √
Safeguards:
! Limiting the service to reviewing the suitability of the client against a list of criteria drawn
up by the client. √^
! Proposing not just one individual but rather two or three potential appointees and leaving
the final decision to the client (the board will appoint the individual as a director). √^
! Ensuring the service is rendered by a professional at the firm who is not part of the audit
team. √^
5. The fee for the assignment (in 4) will be equal to 15% of the remuneration package of the
financial director for 1 year. The remuneration package will be negotiated between your firm
and the successful candidate
Self interest threat. √
Safeguards:
! Odeon (Pty) Ltd sets the fee prior to the assignment. √^
! Fairness of the fee should be reviewed by independent 3rd party or “industry norms”. √^
6. Flyfast(Pty) Ltd, a travel agency, offers Thyse Burger and Lewey Koen, the partner in charge
and manager of its external audit team, free airline tickets to Europe to watch the tour de
France. The tickets are part of a Flyfast (Pt) Ltd sales promotion
Self interest threat√ and familiarity threat√ (possibly future intimidation).
Safeguard:
! Offer should not be accepted. (The fact that it is part of a sales promotion has no
bearing.) √^
7. Carter Brown, the senior-in-charge of the audit of Finsbank, obtains a loan from the bank to
finance the purchase of his new BMW
No threat (provided loan is given under normal terms and conditions.) √
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1. Kingston Jones, a chartered accountant in public practice, was found guilty of bribing a government
official in the provincial traffic department in connection with a speeding fined he had received. Does
this amount to a breach of the SAICA Code of Professional Conduct? Discuss.
1. ● The question here is whether the Code Of Professional Conduct relates to Kingston Jones’
behaviour outside of his practice.
● The fundamental principle of integrity requires that a chartered accountant behonest in all
professional and business relationships. Is it implied that thisextends to honesty in all aspects of
his life? √
● The fundamental principle of professional behaviour requires a charteredaccountant to comply
with relevant laws. Does this mean relevant only to hisbusiness dealings? √
● This fundamental principle also states that the chartered accountant must avoid anyaction which he
knows may discredit the profession. √
● Furthermore being a member of the accounting profession creates a responsibility toact in the public
interest. √
● Bribing a traffic official is a form of corruption and is neither an act “in the public”interest or an act
which would reflect positively on the profession, as honesty is anessential feature of the profession
and (theoretically at least) a government officialworks within the public interest. √
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2. Harvey Goosen a charted accountant in public practice, was approached by one of his clients to
sign a statement reflecting expenses incurred by the client. The statement was used by the client to
obtain a reduction in taxes payable to the local authority under which his business fell. As he was not
giving an opinion on the statement Harvey Goosen glanced briefly at it, checked the additions and
signed it in his capacity as a chartered accountant. The statement was false. Could Harvey Goosen be
found guilty of breaching the SAICA Code of Professional Conduct? Justify your answer.
● Whilst it does not appear that Harvey Goosen has been intentionally dishonest in signing a false
statement (which would be a breach of the fundamental principles of integrity√ and professional
behaviour) √, he has failed to recognise a threat to his compliance with the fundamental principle of
professional competence and due care. √
● Even though he is not giving an opinion on the statement, he should have realised that:
1. The statement could be false (the client stands to benefit from it). √
2. His signature will convey a level of “certification”/assurance to the local authority (signed by a
CA(SA)). √
● Harvey Goosen has not acted diligently or exercised sound judgement in applying professional
knowledge and skill and thus is in breach of the fundamental principle of professional competence
and due care. √
3. Raj Reddy a chartered accountant, was surprised one morning to see that an electronic funds
transfer of R500 000 had been made into his firm’s bank account. His secretary informed him two days
earlier when Raj Reddy had been out, one of the firm’s clients Benny Marks had phoned and
requested the firm’s banking details so that he could make the transfer. The secretary had provided
the banking details as requested and Benny Marks had indicated that he would phone Raj Reddy “in a
day or so”. Later that morning Benny Marks phoned Raj Reddy and requested that Raj Reddy take
custody of the money until further notice. Discuss the action which Raj Reddy should take with regard
to the R500 000 so as to comply with the Code of Professional Conduct.
● This situation requires that Raj Reddy comply with Section 270 – Custody of client assets. √ Failing
to do so may constitute a threat to his compliance with the fundamental principles of integrity, √
professional behaviour √ and objectivity. √
● Raj Reddy must therefore put the following safeguards in place:
* Satisfy himself, by discussion with Bennie Marks and or other means, that the money (R500 000) is
not from an illegal source. √^
* Determine why Bennie Marks wishes to place the money in the custody of Raj Reddy’s firm and to
what purposes the money must be put. √^
* If satisfied, Raj Reddy must promptly transfer the money out of the firm’s bank account and into an
account
● In an entity registered in terms of the Bank Act 1990 √^Designated as a client account under the
control of Raj Reddy’s firm, e.g. Reddyclient Trust account. √^
* If Raj Reddy, for any reason, does not wish to hold these funds, the money shouldbe transferred
back to Bennie Marks immediately. √^
* Proper up to date detailed records of the money held in trust and any movementson the balance (e.g.
Interest, withdrawals) must be recorded and the records mustbe available for inspection. √^
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4. Zuma and Patterson is a firm of chartered accountants in public practice operating in a small country
town. They offer many kinds of financial services, conduct tow audits and sell property. During the
current year they received, inter alia:
4.1. fee income calculated as a percentage of the selling price of a farm which they sold for a client
4.2. 15% if the value of an insurance claim paid to a client. Zuma and Patterson had prepared the
claim to the insurers on behalf of the client
4.3. audit fees from the two audits. These fees are calculated at 1% of the audited net profit after tax
for the year. This basis applied ot both clients
Discuss whether the basis on which each of these fees was charged, satisfies the requirements
of the SAICA Code of Professional Conduct?
4.1 All of the fees mentioned are contingent fees, i.e. they are based on the outcome of a
transaction or service. √ Zuma and Patterson should, in terms of Sec 290 – Contingent Fees,
recognise that with all contingent fees there is a self-interest threat √ to their independence and that
safeguards must be put in place. √ With regard to the sale of the property, the normal method of
remuneration for the selling agent is a percentage of the selling price. Zuma and Patterson should
have agreed the percentage they would charge with the client before the sale was made. They appear
not to be in breach of the COPC. √
4.2 With regard to the insurance claim, this is not a “regulated method of charging” and does not
appear to be commensurate with the value of the service offered, and is not a defendable basis of
charging. √ However, the client may have agreed to this basis, in which case Zuma and Patterson
must be quite sure that …
* the fee equates fairly to the skill and time involved in providing the service √
* they do not compromise their objectivity and integrity by falsifying the amount claimed to increase
their fee √
* the client understands exactly the basis of charging and is satisfied with it. √
4.3 With regard to the basis of charging audit fees, the firm is in breach of the COPC. √ The COPC
states categorically that a contingent fee cannot be charged for assurance engagements, as the self-
interest threat to the chartered accountant cannot be adequately addressed by other appropriate
safeguards. √ Assurance engagement fees should be charged on a defendable basis relating to the
time and expertise employed on the audit. There is no justification for linking the audit fee to the net
profit! √
5. Skip Skoombie, a chartered accountant in public practice, operates a small practice which offers
assurance services and general business advice to small enterprises, as he does not bother to keep
up to date with the tax legislation, he refers all of his clients tax matters to a friend who runs a tax
practice. Sometimes he tells his client that he is doing so but sometimes he doesn’t. for every client he
refers to his friend, Skip Skoombie receives a fee which his friend determines. Discuss Skip
Skoombie’s actions in terms of the SAICA Code of Professional Conduct.
There are a number of COPC considerations:
● In terms of Section 130 – Professional competence and due care √, all chartered accountants are
obliged to maintain professional knowledge at a level required to ensure that clients receive competent
professional service, so firstly Skip Skoombie should be considering whether he is in breach of this
requirement by not bothering to keep up to date. √ For example, if he does not keep up to date he may
well fail to pick up tax issues which should be referred to his "tax expert".√
● In terms of Sec 130, he is entitled to obtain advice and assistance externally to carry out
engagements satisfactorily, √ but is this a realistic long-term solution, as his clients may be losing out
over tax issues which Skip Skoombie has not even recognised as a potential benefit for his clients?
● In terms of Section 140 – Confidentiality, √ Skip Skoombie should not be disclosing client information
to 3rd parties without the client’s permission. √ So in the cases where he does not tell the client that he
is referring tax work to a friend, he would be in breach of the COPC. √
● In terms of Sec 240 – Fees and other types of remuneration, √ Skip Skoombie may receive a referral
fee from his friend for the tax work he refers, but this presents a self-interest threat √to his compliance
with the fundamental principles of objectivity √ and professional competence. √
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● To reduce this threat to an acceptable level, Skip Skoombie should disclose in advance, in writing,
the arrangement to obtain a referral fee. He does not do this. √
b. Self-interest threats
A self-interest threat arises where the chartered accountant has a relationship or
financial involvement with a client which √ may give rise to the professional accountant
looking after his/her own interests rather than taking an independent stance. √ The
relationship or financial involvement will inappropriately influence the chartered
accountants judgment or behaviour. √
c. Intimidation threats
A self-interest threat arises where the chartered accountant has a relationship or
financial involvement with a client which √ may give rise to the professional accountant
looking after his/her own interests rather than taking an independent stance. √ The
relationship or financial involvement will inappropriately influence the chartered
accountants judgment or behaviour. √
3. Identify the types of threat to Marcus Login’s compliance with the fundamental principles of
professional conduct, to which the situation in 1 above give rise. Justify your answer
1. There is a familiarity √ threat brought about by the relationship between Marcus Login and
Fred Spiral. Justification:
● The two of them are close friends, and as Fred Spiral is the financial director and Marcus
Login the audit manager, they will be working closely together on the audit. √^
● Due to this close relationship Marcus Login’s independence will be (and will be seen to be)
compromised, for example, problems on the audit may be ignored. √^
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2. There is a self-interest √ threat brought about by the fact that Marcus Login has a lucrative
sponsorship which runs for three years.
Justification:
2.1 This amounts to financial involvement with an audit client which threatens Marcus Login’s
independence. √^
2.2 He is far less likely to follow up questionable practices/transactions etc on the audit or
“make waves” in case he falls out with Skyhi (Pty) Ltd and loses his sponsorship. √^
3. There is an intimidation √ threat arising out of the sponsorship Marcus Login enjoys.
Justification:
● In a sense, Fred Spiral now has a hold over Marcus Login. He can threaten (directly or
indirectly) to have Marcus Login’s sponsorship taken away unless Marcus Login does what
Fred Spiral requires with regard to the audit, e.g. overlook discrepancies etc. √^
● This presents a direct threat to Marcus Login’s independence. √^ This is not a fundamental
principle.
4. Discuss the scheme proposed by the financial director to settle the audit fee of Bills and Co as
laid out in situation 2, in terms of the SAICA Code of Professional Conduct
1. In terms of the Code of Professional Conduct, this arrangement would amount to improper
conduct. √
2. In terms of Section 240 – Fees, Bills and Co are entitled to negotiate a fee but must charge
appropriate fees. √
● To simply add on R22 000 “fictitious” audit fees would be a breach of this section as well as a
breach of the fundamental principle of professional behaviour (even though the client has
proposed it). √^
3. In terms of Section 290 – Independence, the long - term loan would amount to Bills and Co
having a direct financial interest in an assurance client. √
● This would pose a self-interest threat to the firm. √^
● As there is no safeguard to reduce this threat to an acceptable level, the arrangement
proposed by the financial director should be rejected. √^
5. Discuss the conduct of Davey Jones in terms of the SAICA Code of Professional Conduct –
situation 3
1. Davey Jones has failed to recognise, or chosen to ignore, a self-interest threat to his
compliance with the fundamental principle of confidentiality √ and professional behavior. √
● By disclosing to his, estate agent wife, confidential information (purchase of properties and
prices the client is prepared to pay), acquired as a result of his professional relationship with
Chickentogo (Pty) Ltd, Davey Jones has breached Section 140 – Confidentiality, of the
COPC.√^
● Whether or not he was aware that she would use it to the owners of the properties advantage
is not relevant (she will earn commission on the inflated price which Chickentogo (Pty) Ltd is
prepared to pay). √^
● Davey Jones’ actions have harmed the client and placed them at a disadvantage when
negotiating the purchase of the properties. In doing what he did, he has compromised his
professional behaviour and discredited himself and his firm. √^
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Communication and enforcement of ethical values are part of the control environment, which is a
component of internal control
Hysbak (Pty) Ltd is a large company which manufactures all kinds of lifting equipment e.g. elevators,
hydraulic jacks. Each of the following procedures or conditions takes place or exists at the company:
1. Any employee who is found guilty of unauthorised use of company assets or theft, is dismissed
immediately =Control environment. √
2. Expensive spares and components are kept in a secure area in the warehouse = Control
activity √ – (iii) Custody control (physical control). √
3. All employees working on accounting applications on the company’s local area network are
subject to user identification, password and user profile controls = Control activity √ (iii)
Access controls and segregation of duties (user profile) √
4. The buying clerks are required to sign all purchase orders (in designated block) and before
sending the order to the supplier, must have the order authorised by the chief buyer (who must
also sign in the designated block) = Control activity√ - (i& ii & iv) Isolation of responsibility,
segregation of duties andauthorisation. √
5. Management adopt a management philosophy which places emphasis on leadership sound
judgement and ethical behaviour= Control environment. √
6. The production manager approves all overtime hours to be worked before they are worked=
Control activity √ - (iv) Authorisation √
7. The company conducts regular inventory cycle counts, all differences between physical
inventory and recorded inventory quantities are carefully followed up= Control activity √ - (v)
Comparison and reconciliation (in this case between actual and theoretical inventory). √
8. All company cheques must be signed by two authorised signatories= Control activity √ - (iii)
Custody control (protecting the cash in bank). √
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9. The senior creditors clerk reconciles each creditors statement with the creditors account in the
creditors ledger on a monthly basis. Selected reconciliations are reperformed by the financial
accountant, before payment is made. All reconciliations reperformed are signed by the financial
accountant.= Control activity √ (v) Comparison and reconciliation, division of duties and
isolation of responsibility. √
10. Receiving clerks are required to count goods received and must sign all GRN’s they make out =
Control activity √ (v & ii) Comparison/reconciliation (goods against order/supplier
delivery note) and isolation of responsibility. √
In terms of ISA 500 the Audit Evidence, the auditor is required to obtain sufficient, appropriate
evidence
Factors that will influence the auditor in determining whether he has gathered the necessary evidence
to support his audit opinion
· The source of the evidence gathered
· The persuasiveness of the evidence gathered
· The quantity of evidence gathered
The following factors will influence the auditors decision on how much evidence he must gather
pertaining to a particular assertion
· The inherent risk applicable to the assertion
· The materiality of the account heading to which the assertion relates
· The auditors experience gained on previous audits of the clients company’s financial
statements
When deciding on the appropriateness of audit evidence gathered the auditor will consider the
relevance and reliability of the evidence
When deciding on the reliability of audit evidence gathered, the auditor will consider the nature and
source of the evidence gathered
Most reliable evidence pertaining to existence of a clients inventory is a physical inspection of the
clients inventory by the audit team
A piece of evidence obtained on one section of the audit which supports another piece of evidence on
another section of the audit is described as corroborative evidence
The term “further audit procedures” includes: substantive tests and tests of control
Test of control
· Inquiry
· Observation
· Inspection
Explain the term “assertions” in the context of the annual financial statement of a company
· The annual financial statements are in effect the report (in a prescribed format) of the directors
of a company to the shareholders of the company. √
· In the financial statements the directors convey information to the shareholders with regard to
the assets, liabilities, transactions and events pertaining to the company at the financial year-
end and for the year then ended. √
· The assertions are a convenient categorisation of what the directors are representing to the
shareholders about the assets, liabilities, transactions, etc, and the disclosures included in the
financial statements. √ For example, when the directors include anamount of say, R10m for
plant and equipment, they are asserting (representing)that …
! the plant and equipment included in the R10m exists and is owned (rights) by
thecompany
! R10m is an appropriate value for the plant and equipment and
! all plant and equipment owned by the company is included (completeness).
· Different assertions apply in respect of account balances, transactions and events,and
presentation and disclosure. √
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Contingent liability: the company is currently engaged in a court case with Trident Ltd pertaining to the
malfunction of a machine manufactured by JomoC (Pty) Ltd and purchased by Trident Ltd Trident Ltd
alleges that the malfunction cuased extensive damage to its production line. JomoC (Pty) Ltd is being
sued for R5 000 000
Explain what a user of the financial statements may infer from the note pertaining to the contingent
liability at JomoC (Pty) Ltd
4. Contingent liabilities √
A user may infer the following:
Assertions pertaining to account balances:
Completeness^ - the contingent liability arising from the Trident Ltd case is the only contingent liability
(and all necessary information pertaining to the contingent liability, has been disclosed) √^
Existence^ - the contingent liability, existed at year end date.√ ^
Valuation and allocation^ - the contingent liability has been reflected in the statement of financial
position at appropriate amounts√^
Rights^ - the company has (holds or controls) the right of ownership to the contingent liability reflected
in the statement of financial position√^
Assertions pertaining to presentation and disclosure:
Occurrence ^ – the underlying event (court case) giving rise to the contingent liability, has been set in
motion (it is not fictitious). √^
Right and Obligation ^ – the contingent liability is a potential liability of JomoC (Pty) Ltd and no other
party. √^
Completeness ^ – the contingent liability arising from the Trident Ltd case is the only contingent
liability (and all necessary information pertaining to the contingent liability, has been disclosed) √^
Accuracy ^ – the information has been fairly disclosed and the amount of R5m is accurate. √^
Classification and understandability^ – the contingent liability has been correctly classified (i.e. it
should not have been classified as a provision) and the details pertaining to the contingent liability
have been clearly expressed to reflect the true situation. √^
When conducting risk assessment procedures, the auditor does not consider the assertions. True or
False? Justify your answer
False. ^
● Risk assessment procedures are conducted so that the auditor is in a position toevaluate the risk of
material misstatements in the financial statements at financialstatement level, at account balance,
class of transaction level. √^
● To do this effectively, the auditor will consider each of the assertions, and based onthe results of his
risk assessment procedures, assess the risk of materialmisstatement applicable to each assertion
within an account heading/transaction.For example, the auditor may decide, on the basis of the
information gathered by therisk assessment procedures, that there is a high risk that the company’s
inventorymay be materially overstated by the inclusion of non-existent inventory, and theinclusion of
inventory-in-transit for which the risks and rewards of ownership have notyet passed to the company.
√^
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1. physical inspection of the company’s vehicles confirms that the company owns the vehicles and
can contribute evidence as to the valuation of the vehicle
● False: ^ Physical inspection simply proves that the vehicles exist, not that the company owns
them. (Physical inspection does provide evidence relating to the valuation of the vehicle,
specifically whether there is any impairment of the vehicles for which a write down is required.)
√^
2. inspection of the title deeds to the company’s property provides evidence as to the company’s
rights (ownership) of the property
● True: ^ Title deeds provide evidence of ownership, and will also provide evidence of any
encumbrances on the property which the company must disclose in the AFS. √^
3. from an audit perspective, the completeness assertion relating to trade creditors is generally far
more important than the existence assertion relating to trade creditors
● True: ^ In general terms a company is far more likely to understate its trade creditors balance
than to overstate it, as an understated creditors balance “improves” the statement of financial
position in the AFS. √^ (The auditor will not accept this as a fact; he will assess the risks of
understatement or overstatement based on his risk assessment procedures.)
1. Discuss materiality in the context of the preparation and presentation of financial statements
● Misstatements, including omissions, are considered to be material √ if they, individually or in
aggregate, √ could reasonably be expected to influence the economic decisions of users taken
on the basis of the financial misstatements. √ Expressed slightly differently, if the misstatement
is something which the user “should know about” then it will be material.
● Judgements about materiality are made in the light of surrounding circumstances, and are
affected by the size √ or nature √ of a misstatement, or a combination of both. √ In effect this
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means that there is no “one size fits all” for materiality and that there are both qualitative and
quantitative aspects to materiality.
3. Explain the difference between using the concept of materiality at the planning stage of the
audit and at the evaluating stage of the audit
! Using the concept of materiality at the planning stage amounts to the auditor setting
materiality limits or levels which provide a basis for planning and conducting risk
assessment procedures as well as further audit procedures. √ Unless the audit team has
an idea of what amount is considered material, they will be unable to identify and
address “material” misstatement. √
! Using the concept of materiality at the evaluation stage amounts to the auditor setting
amounts by which the auditor believes an account heading in the financial statements
can be misstated by uncorrected misstatements before it will affect the user. √ The
auditor measures uncorrected misstatements against the final materiality limit to
determine whether the financial statements will require qualification if the misstatement
is not corrected. (There will also be a qualitative evaluation at this stage.) √
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6. What effect is a significant risk, identified during the “identifying and assessing the risk of
material misstatement” stage of planning. Likely to have on the performance materiality limit?
Significant risks increase the auditor’s assessment of the risk of misstatement. √ Thus the
auditor will set a stricter (lower) planning materiality limit to ensure that an unacceptable amount
of misstatement does not go undetected. √ The extent of audit work will be increased. √
8. When the auditor identifies misstatements, he or she should discuss all the misstatements with
the client in an attempt to have them rectified. However management may decide not to correct
the misstatement. Provide four reasons why the client may choose not to correct the
misstatements.
! The client may disagree with the auditor that there is a misstatement i.e. the client thinks
the figures presented are “correct”. √^
! The client may regard the misstatement as immaterial. √^
! The client may have ulterior motives, e.g. the client may be trying to present a particular
set of ratios which would not be achieved if the misstatement was recognized as a
misstatement and an adjustment made. √^
! The client may regard it as “too much hassle” to amend the financial statements, e.g.
changing income statement, notes, supporting schedules, etc. √^
! The client may be unconcerned about receiving a qualified opinion. √^
Comments:
It is imperative to refer back to ISA 320 to obtain an in depth understanding of the concept of
materiality. Remember in the determination of materiality different aspects must be considered, as
entity’s risk assessment, control environment and the objective assessment of the auditor. The method
to determine materiality must be properly documented.
In terms of ISAs an audit engagement can only be accepted if; the auditor has established with the
client that the preconditions for an audit are present
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If management attempts to impose a material limitation on the scope of the auditor’s work prior to the
acceptance of an audit engagement, the auditor: should decline the engagement
The engagement letter must contain reference to the financial reporting framework to be adopted for
the preparation of the annual financial statements
The audit plan is best described as the nature, timing and extent of planned risk assessment
procedures, “further” and “other” procedures
Planning materiality for an audit is a judgement made by the auditor about the size of misstatements in
the financial statements that will be considered material
Auditors responsibility when carrying out the concluding stage of the audit process
· Evaluating whether the financial statements adequately disclose the significant accounting
policies selected and applied
· Evaluating whether the terminology used in the financial statements is appropriate
· Evaluating whether sufficient, appropriate evidence has been obtained to reduce audit risk to an
acceptable level
Continue graded questions p 104 (5.5 nr 1) and AUE 2601 TL 103 page 26
Once the audit strategy and plan are formulated, they should not be changed.
False. ^ Neither the audit strategy nor the audit plan is static (fixed). √ They can and should be
changed as the audit develops. √ A strategy and plan are based on what is expected to occur on the
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audit, based on knowledge about the client that the auditor has at the start of the audit and the risk
assessment results. √ If this expectation changes, so must the strategy and plan. √ Information which
was used in formulating the strategy and plan may be superseded by new information e.g. substantive
tests may reveal that the risk of material misstatement in a particular account heading is greater than
originally thought, necessitating a change in the strategy and/or plan. √
does the process of setting the audit strategy assist the auditor in determining the resources necessary
for the audit?
Yes. ^ The process of setting the audit strategy assists with
1. Deciding on the nature of resources required e.g. Levels of staff, use of experts. √
2. Deciding on when and where audit resources will be deployed, e.g. Numbers of staff required to
conduct branch inventory counts. √
3. The timing of the visits to the client, e.g. The strategy may require two interim visits and the
year-end visit, and the determining resources necessary to undertake the interim and year end
visits. √
4. Establishing appropriate standards of managing, directing and supervising the audit resources
e.g. If the strategy calls for the use of experts, how and when will the expert be appointed,
supervised and evaluated. √
The availability of audit resources should be a major factor in determining the audit
False. ^ This is theoretically unsound and “back to front”! The audit firm does not say “we have the
following resources available so we will adopt the following audit strategy and plan”. The firm
formulates a strategy and plan to perform an effective audit based on the auditor’s knowledge of the
client, √ the risk assessment etc, and then asks the question, what resources do we need to implement
the strategy and plan? √strategy and plan.
The audit firm does not say “we have the following resources available so we will adopt the following
audit strategy and plan”. The firm formulates a strategy and plans to perform an effective audit by
gathering sufficient√^, appropriate, evidence √^and then asks the question, what resources do we
need to implement the strategy and plan? √^
In what way does adequate planning benefit the audit of financial statements?
· Proper audit planning benefits the audit by helping the auditor:
· To identify important areas of the audit to ensure appropriate time is devoted to them. √
· To ensure that potential problems are promptly identified, and resolved on a timely basis. √
· To ensure that the audit is properly organised and managed so that it is performed inan
effective and efficient manner. √
! The work is completed expeditiously (deadlines are met). √
! To ensure proper assignment of work (cost effective, efficient). √
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· In the selection of engagement team members with appropriate levels of capabilities and
competence. √
· To facilitate the direction and supervision of engagement team members and the review of their
work. √
· In co-ordination of work done by other auditors and experts. √
Should the audit strategy and plan be discussed with the audit client?
Yes. ^ Aspects of the strategy and plan may well be discussed with the audit committee as well as
relevant directors and senior financial personnel, as an audit cannot be carried out in isolation. √
However, care must be taken not to compromise the effectiveness of the audit by forewarning the
client of any procedures which require an element of unpredictability. √
Comment:
The strategy and audit plan is fundamental to any audit. These documents should be detailed.
Although aspects of the strategy and plan can be discussed with the audit committee as well as senior
management, care must be taken not to compromise the effectiveness of the audit by forewarning the
client of any procedures which require an element of unpredictability.
Explain why it is necessary to set a (preliminary) planning materiality level before conducting risk
assessment procedures.
· When the auditor conducts risk assessment procedures, his objective is to identify and evaluate
the risk of material misstatements in the financial statements. √
· If he has no guideline as to what misstatement would be material, the above procedures cannot
be effectively carried out. √
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* combined with the fact that he was recruited by the chairman √^suggests that he will be significantly
influenced by the chairman in financial mattersincluding the selection of accounting policies and the
“manipulation” √^ of the financialstatements.
● The apparent decline in the application of sound corporate governance increases √the risk of
material misstatement at financial statement level
* in terms of sound corporate governance principles, the chairman should be anindependent non-
executive director and should not be involving himself in suchmatters as (unilaterally) “requesting” the
resignation of the financial director,making their working relationship untenable, recruiting a new
financial director,and setting up joint ventures and other business √^
* furthermore, Floyd Nelson should not be a member of the audit committee andcertainly not the
chairman. This appointment (by Edgar Hoover) further suggeststhat Edgar Hoover intends to control
what goes into the financial statements and22take any measures which could prevent this, e.g. by
neutralising (controlling) theaudit committee. √^
3. ● The introduction of joint ventures and other business alliances increases √ the risk ofmaterial
misstatement at financial statement level. The risk of non-armslengthtransactions having occurred, is
increased as these are now more related parties andrelated party transactions. √^ The increase in
related parties provides an opportunityto manipulate the financial statements. √^
● The fact that the documentation relating to the entities which have been set up andthe transactions
with them appears to be minimal, √^ also increases the risk ofmaterial misstatement potentially in any
account heading affected by the transaction.It is also an indicator that manipulation of the financial
statements may have takenplace. √^
4. ● The attitude displayed by Floyd Nelson with regard to the auditors and valuation ofinventory (“the
auditors don’t make the rules…..”) suggests that he doesn’t placemuch importance on the audit
function and will do whatever suits himself and thechairman with regard to accounting matters and the
AFS. √^ The risk of materialmisstatement at the financial statement level is increased. √
● This is emphasised by the fact that Floyd Nelson is also chairman of the auditcommittee; we as
auditors have no “independent” client committee with which we canresolve audit issues. √^
5. ● Chemtrade (Pty) Ltd manufactures and trades in a product which has high inherentrisk, i.e.
chemicals. From the audit perspective there is a high √ risk of materialmisstatement in the account
heading for the following reasons.
* The auditor will often not know one chemical from another. This increases the riskrelating to
existence (does the chemical listed in the inventory records actuallyexist, or is the auditor being
shown some other chemical?). √^ Alternatively, therisk may relate to valuation (if the auditor cannot
identify the chemical, he can’tvalue it).
* Chemicals in their various forms (e.g. raw materials, finished goods) frequentlyhave a shelf life which
can render the chemical obsolete. √^ It is very difficult forthe auditor to “identify obsolescence” which
directly affects the valuation assertion√^ as there is the risk of material misstatement in the form of the
understatementof the write-off/allowance for obsolescence.
* The process of manufacture of chemicals can be reasonably complex, which couldresult in material
misstatement of work-in-progress. √^
● In prior years the response to these risks was that Chemtrade (Pty) Ltd insisted thatthe auditors work
with an independent chemical specialist. The fact that Floyd Nelsonhas rejected this policy increases √
the risk of material misstatement of inventory in itsvarious forms.
● The risk is further increased by the fact that the company has a large stockpile of arange of
chemicals which is manufactured only for export to Europe, but for whichorders have virtually dried up.
√^ The problem is so severe that no manufacture of theproduct has taken place for seven months and
there are no plans to commenceproduction. There is a risk that the stockpile of this range of products
is notsaleable/obsolete and should be written down (valuation inventory). √^
● There is also an increase √ in the risk of material misstatement of plant andequipment. As
mentioned in 5.3 above, the company has certain plant andAUE2601/10323equipment which has been
lying idle for seven months and for which there is no planto re-commence use. √^ Furthermore this
plant and equipment cannot be adapted forthe manufacture of other chemicals.
● The risk is that no impairment loss (or an inadequate impairment loss) will berecognised. This relates
to the valuation assertion for plant and equipment. √^
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1.1. Describe the different functions of external auditors, internal auditors and
forensic auditors.
External auditor
• The function of the external auditor is to give an independent opinion on whether thefinancial
statements of a company fairly present the financial position and results of thecompany’s
operations. À
• The external auditor gathers evidence in support of the assertions made by managementin the
financial statements. ÀMax 2
Internal auditor
• The internal auditor performs independent assignments on behalf of the board of directorsÀ
• The internal auditor is concerned with the efficiency, effectiveness and economy of
thecompany’s internal control (and related) procedures. À Max 2
Forensic auditor
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• Forensic auditors concentrate on investigating and gathering evidence in the event ofalleged
financial mismanagement, theft or fraud. À
• Forensic auditors need to be independent of the entity under investigation. À
Max 2
1.2.2 Describe the overall objectives of the auditor in terms of ISA 200.
1.2.2 Overall objectives of the auditor
• To obtain reasonable assurance about whether the financial statements as a whole arefree from
material misstatement, whether due to fraud or error, À thereby enabling theauditor to express an
opinion on whether the financial statements are prepared, in allmaterial respects, À in
accordance with an applicable financial reporting framework.À
• To report on the financial statements and communicate as required by the ISAs, inaccordance
with the auditor’s findings.À
(1 x 4 = 4)
1.4 Assertions
1.4.1 For each assertion mentioned in the working paper for salaries,explain whether you agree
with the applicability of the mentionedassertion to salaries.
1.4.1 Applicability of the assertions
Existence: This assertion does not apply À to salaries, as it is an assertion relevant to account
balances at period end or year end. À
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Obligation: This assertion does not apply À to salaries, as it is an assertion relevant to account
balances at period end or year end. À Max 6
1.4.2 List and describe the other management assertions applicable tosalaries that are not
mentioned in the working paper.(6)(8)
1.4.2 Additional assertions applicable to salaries
The other assertions applicable to salaries for the period under audit are as follows:
Occurrence: ^ All salaries included are genuine salaries of the entity (they are not fictitious). À^
Completeness: ^ All salaries that should have been recorded have been recorded. À^
Accuracy: ^ All salaries have been recorded at the correct amount. À^
Cut-off: ^ All salaries have been recorded in the correct accounting period. À^
(.5 x 4 = 2)
(1.5 x 4 = 6)
Max 8
1.5.2 List and describe three (3) examples of activities that may beclassified as control activities
in terms of ISA 315.(2) (6)
1.5.2 Examples of control activities
Approval/Authorisation ^
Management authorise employees to perform certain tasks within certain parameters. À^
Isolation of responsibility ^
For any internal control system to work effectively, the people involved in the system must be fully
aware of their responsibilities and must be held accountable for their performance. À^
Performance reviews ^
These include reviews and analyses of actual performance versus budgets, forecasts and prior period
performance; relating different sets of data to one another; comparing internal data with external
sources of information; and reviewing of performance. Reviewing of performance provides a basis for
identifying problems. À^
Information processing^
These are controls in a computerised environment, which include general and application controls. À^
Access/Custody/Physical controls ^
Control activities include actions, policies and procedures that protect the company’s assets. À^
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Segregation of duties ^
Different people are assigned the responsibilities of authorising transactions, recording transactions
and maintaining custody of assets. À^
Comparison and reconciliation ^
Reconciliation is a comparison of two different sets of recorded information. The objective is to identify,
investigate and resolve differences. À^
1.6.3 Identify, from the information given in (a) to (g) of the scenario,which audit procedures are
classified as substantive procedures.
a) Analytical review procedures of salaries per month have been performed and explanations have
been obtained for extraordinary fluctuations. À
b) The calculation of the leave pay accrual at year end was reperformed. À f) The bonus payments to
management at year end were recalculated. À
g) The amount per the electronic funds transfer for December was confirmed by agreeing it to the
amount on the payroll for December. À (1 x 4 = 4)
1.1 List and describe the assertions applicable to the inventory balance in the statement of financial
position. (7)
Assertions related to inventory balance
· Completeness^ - all inventory owned by the company, is included in the balance reflected in the
financial statements.√ ^
· Existence^ - all inventory included in the balance, existed at year end date.√ ^
· Valuation and allocation^ - the inventory has been reflected in the statement of financial
position at appropriate amounts√^; this means that reasonable adjustments have been made
for damages and/or obsolescence.
· Rights^ - the company has (holds or controls) the right of ownership to the inventory reflected in
the statement of financial position (any encumbrances on that ownership must be disclosed) √^
1.2 Explain in relation to the element “monitoring”, as one of the elements of quality control in
accordance with ISQC 1, what Alpha and Co. should include in the monitoring process. (3)
Monitoring the Firm’s Quality Control Policies and Procedures
Include an ongoing consideration and evaluation of the firm’s system of quality control√^ including, on
a cyclical basis, inspection of at least one completed engagement for each engagement partner√^.
The firm shall establish a monitoring process designed to provide it with reasonable assurance that the
policies and procedures relating to the system of quality control are relevant, adequate, and operating
effectively.
PS: ISQC1 establishes a firm’s responsibility for its system of quality control while
ISA 220 provides guidance on the quality control for audit engagements.
1.3.1 Based on scenario 1, identify and explain in terms of the SAICA Code of Professional Conduct
(COPC) the fundamental principles that were violated by David Mabola.
1.3.1 Scenario 1
• Section 130 – Professional competence and due care√, all chartered accountants are obliged to
maintain professional knowledge√^ at the level required to ensure that the client receives competent
professional service. David Mabola did not maintain his professional knowledge by not keeping up to
date with the tax legislation.√^Since David is a tax consultant and recently qualified, Hlakudihis
knowledge of the tax legislation should be up to date. √^
• Section 140 – Confidentiality√, chartered accountants should not disclose client information to 3rd
parties without the client’s permission. √^ David Mabola disclosed Utopia’s tax information to his friend
who runs a tax practice and thus disclosed confidential information without obtaining permission from
Utopia. √^
1.3.2 Based on scenario 2, describe in terms of the SAICA Code of Professional Conduct (COPC), the
threats to the fundamental principles and recommend safeguards to eliminate or reduce thethreats
to an acceptable level. (7)
1.3.2 Scenario 2
• Self interest threat√ to Objectivity, Integrity, Professional behaviour^ (max .5)
This threat is created by accepting a free membership at the golf estate which is not available to the
general public√^. The partner may overlook issues√^ that arise during the audit so as not to
jeopardise the offer or future gifts.
• Familiarity threat√ to Objectivity, Professional competence and due care^(max .5)
This type of situation changes the professional relationship between the audit partner and the client
from professional to “familiar”. √^ In return the directors may expect “favours” from the audit partner or
this may affect the independence of the auditor in relations to the client.√^
Safeguards:
!Victor Adams should not accept the membership.√^
!Remove Victor Adams from this specific engagement if he accepts the membership.√^
!Implement a firm policy which forbids the acceptance of gifts and hospitality which are anything other
than clearly insignificant. √^
!Notify the audit committee of the situation and put safeguards in place. √^
!The membership must not be accepted if not available on the same terms as offered to the general
public. √^
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1.4.2 Outline, in terms of section 45 of the Auditing Profession Act, 2005, the procedures that the
auditor should follow due to the existence of a reportable irregularity.
Duty to report a reportable irregularity
• The auditor must send, without delay, a written report to the Independent Regulatory Board for
Auditors (IRBA). √
• The report must give particulars of the reportable irregularity and must include such other information
and particulars as the auditor considers appropriate. √
• Within 3 days√ of sending the report to the IRBA the auditor must notify the members of the
management board of the entity in writing of the sending of the report to the IRBA and supply them
with a copy of the report sent to the IRBA.√
• As soon as possible, but within 30 days√ after the date on which the report was sent to the
Regulatory Board;
(a) The auditor must take all reasonable measures to discuss the report with the members of the
management board of the entity, and √
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(b) Give the members of the management board of the entity the opportunity to make representations
in respect of the report. √
(c) Send another report to the Regulatory Board√, which must include a statement that the registered
auditor is of the opinion that:
- no reportable irregularity has taken place or is taking place; √ or
- the suspected reportable irregularity is no longer taking place and
- that adequate steps have been taken for the prevention or recovery of any loss as a result thereof√;
or
- the reportable irregularity is continuing.√
1.5.2 List five (5) duties of the audit committee in connection with the appointment of external
auditors.
Duties of the Audit committee in connection with the auditor
An audit committee of a company has the following duties:
(a) To nominate, for appointment as auditor of the company under section 90, a registered auditor
who, in the opinion of the audit committee, is independent of the company; √
(b) To determine the fees to be paid to the auditor √
(c) To determine the auditor’s terms of engagement; √
(d) To ensure that the appointment of the auditor complies with the provisions of this Act and any other
legislation relating to the appointment of auditors;√
(e) To determine, subject to the provisions of this Chapter, the nature and extent of any nonaudit
services that the auditor may provide to the company, or that the auditor must not provide to the
company, or a related company; √
(f) To pre-approve any proposed agreement with the auditor for the provision of non-audit services to
the company; √
2.1 List two (2) aspects that should be included in an audit engagement letter in terms of International
Standards on Auditing. (Note: You are not required to draft the engagement letter.) (2)
Matters to be included in an audit engagement letter
• The objective and scope of the audit of the financial statements.À
• The responsibilities of the auditor.À
• The responsibilities of management.À
• Identification of the applicable financial reporting framework for the preparation of the financial
statements.À
• Reference to the expected form and content of any reports to be issued by the auditor and a
statement that there may be circumstances in which a report may differ from its expected form and
content.À
• Arrangements concerning the involvement of other auditors and experts in some aspects of the
audit.
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• Arrangements concerning the involvement of internal auditors and other staff of the entity.
• Arrangements to be made with the predecessor auditor, if any, in the case of an initial audit.
• Any restriction of the auditor’s liability when such possibility exists.
• A reference to any further agreements between the auditor and the entity
• Any obligations to provide audit working papers to other parties.
2.2 Explain the differences between a reasonable assurance engagement and a limited assurance
engagement. (6)
2.3 Based on the information given regarding the entity’s internal control:
2.3.1 List the five (5) components of internal control.
Internal control components
Control environmentÀ
The entity’s risk assessment processÀ
The information systemÀ, including the related business processes, relevant to financial reporting, and
communication
Control activitiesÀ
Monitoring of controlsÀ
2.3.2 For each of the policies described in (a) to (f) in the scenario, identify the relevant component of
internal control. Complete your answer in the following format:
Policies relating to internal control components
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2.4 State whether each of the identified factors in (g) to (j) in the scenario willincrease or decrease the
risk of material misstatement at the overall financialstatement level. Give reasons for your answer.
(10)
Assessment of risk at the financial statement level
g) The risk of material misstatement will be increased À– This may indicate a going concern
problemÀ^.
h) The risk of material misstatement will be decreased À – This may indicate that the business is
sustainable and impact the ability of the entity to continue as a going concern in the foreseeable
futureÀ^.
i) The risk of material misstatement will be decreased À - Most of the directors have been with the
company for many years which suggests that they will be experienced in the industry and hence able
to cope with the difficult trading conditionsÀ^.
j) The risk of material misstatement will be increased À – This may indicate an incentive for the
directors to manipulate the accounting records/financial statements to reflect improved performanceÀ^.
2.6 For each of the procedures in (l) to (o) above formulate a test of control tobe performed by the
auditor in order to test the operating effectivenessthereof.
k) Reperformanceof the monthly bank reconciliation to confirm that thebalance per the statement of
receipts and payments reconciles to the balance per the bank statement.
l) Inspection of a sample of purchase orders over R50 000 for an authorised signature. À^
m) Observation or inquiry of the procedures actually conducted by warehouse personnel when
receiving goods ordered for comparison with the written procedures. À^
n) Recalculation of the depreciation on computer equipment. À^
o) Inquiry from the warehouse controller as to the methods of identifying obsolete or damaged
inventory. À^
2.7 State whether you agree or disagree with the following statement andmotivate your answer:
“Performance materiality is set by the auditor at a higher level than planningmateriality for the financial
statements as a whole." (4)
Performance materiality and materiality for the financial statements as a whole.
DisagreeÀ
Performance materiality is set by the auditor at lower than planning materiality for the financial
statements as a wholeÀ^ to reduce to an appropriate low level the probability that the aggregate of
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undetected and uncorrected misstatements exceeds materiality for the financial statements as a
wholeÀ^.
2.10 Assuming that the “risks of material misstatement” has been assessed as high and that the
auditor requires an acceptable level of audit risk. Explain the relationship between the components of
audit risk and how the auditor can achieve an acceptable level of audit risk. (3)
The relationship between the components of audit risk
For a given level of audit risk, the acceptable level of detection risk bears an inverse relationshipÀ^ to
the assessed level of the risk of material misstatement at the assertion level.
As a result of the high assessment of the risk of material misstatement, the auditor can accept less
detection riskÀ^ and, accordingly, the audit evidence required by the auditor will have to be more
persuasiveÀ^.The lower detection risk will result in an acceptable level of audit risk À^.
ASSIGNMENT 2 – 2013 SEMESTER 2
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Control risk
Control risk is the risk that a misstatement that could occur in an assertion about a class of transaction,
account balance or disclosure and that could be material, either individually or when aggregated with
other misstatements Àwill not be prevented, or detected and corrected, on a timely basis by that
entity’s internal control. À
Detection risk
Detection risk is the risk that the procedures performed by the auditor to reduce audit risk to an
acceptably low level will not detect a misstatement that existsÀ and that could be material, either
individually or when aggregated with other misstatements. À
1.2.2 Classify each of the four (4) above-mentioned risks in (a) to (d) as inherent risk, control risk or
detection risk.
Classification of audit risk
a) The company trades in nuclear energy – Inherent risk. À
b) The company has decided to retrench its internal auditors in an attempt to save costs – Control risk.
c) There was a problem with the assignment of personnel to the audit and as a result no members of
the audit team have had previous experience with the company – Detection risk. À
d) The financial accountant resigned two months before year end and as a result the bank
reconciliations were not up to date – Control risk. À
1.3 Independence
1.3.1 Describe the two (2) requirements for independence in terms of the SAICA Code of Professional
Conduct.
Independence requires the following:
· Independence of mind ^
This is the state of mind that permits the expression of a conclusion without being affected by
influences that compromise professional judgment, À thereby allowing an individual to act with
integrity, and to exercise objectivity and professional skepticism. À
· Independence in appearance ^
This is the avoidance of facts and circumstances that are so significant À that a reasonable and
informed third party would be likely to conclude, weighing all the specific facts and circumstances,
that a firm’s or a member of the audit team’s, integrity, objectivity or professional skepticism has
been compromised. À
1.3.2 Describe, with reasons, the threats to independence that Heuer and Lex may face by
continuing to perform the audit of Zigzag Ltd. Indicate what safeguards should be implemented to
ensure that such threats are reduced to an acceptable level.
Threats to independence
• The audit manager’s wife is the financial director of Zigzag. This may create a selfinterest threat,
À familiarity threat À or intimidation threat. À
Safeguard to be implemented
!The audit manager must be removed from the audit engagement team. À^
• The fee income that is being earned from Zigzag represents 80% of the total fee incomeof Jackie
Jovaras, the engagement partner. This may create a self-interest threat À oran intimidation threat.
À
Safeguards to be implemented
!Reduce the dependency on the audit client. À^
!Have a chartered accountant review the work or otherwise advise as necessary. À^
!Ensure regular independent internal or external quality reviews of the engagement. À^
• Heuer and Lex have lent a trainee auditor to Zigzag to assist in the accounting department. This may
create a self-review threat. À
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Safeguards to be implemented
!The trainee may not take any management decisions or exercise discretionary authority that will
commit the client. À^
!The trainee on “loan” should not be given audit responsibility for any function he or she has
performed whilst on loan. À^
!The audit client must acknowledge its responsibility for directing and supervising the “onloan trainee”.
À^
• Jackie Jovaras is currently providing tax planning and advisory services that can affect matters to be
reflected in the financial statements. This may create a self-review threat.
Safeguards to be implemented
!Use professionals who are not members of the audit team to perform the service. À^
!Have a tax professional, who was not involved in providing the tax service, advise the audit team on
the treatment and review of the financial statements. À^
!Obtain advice on the service from an external tax professional À^
!Obtain pre-clearance or advice from the tax authorities. À^
1.4.2 Determine whether the purchase of the BMW would constitute a reportable irregularity. Give
reasons for your answer. (13)
Reportable irregularity
To qualify as a reportable irregularity, the following criteria must be satisfied:
1. The act must be committed by a person(s) responsible for management of the
entity. À
The financial director, who is responsible for the financial management of Phantom Ltd, claimed
personal expenses through the entity. À^
2. The act must be an unlawful act. À
This act amounts to defrauding SARS, by reducing normal taxation of the entity by claiming non-
business-related expenditures À^ and not paying PAYE on director’s remuneration. À^
3. The act must result in material financial loss. À
This criterion is satisfied, as the financial director is claiming a personal expense. SARS is likely to
have suffered financial loss for unpaid tax. À^ The profits available for distribution have been reduced
because a non-deductible expense was claimed. À^
4. The act is fraudulent or amounts to theft. À
Money has been misappropriated from the company to fund the purchase of a BMW for the financial
director. À^
5. The act represents a breach of fiduciary duty. À
This act amounts to a breach of fiduciary duty by the financial director to the entity. À^
This will therefore constitute a reportable irregularity. À
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1. Indicate the correct assertions that, amongst others relate to the audit of the following transaction:
- Credit sale transaction: Invoice 222 to the value of R42 030
1 The credit sale transaction took place during the period under review; was recorded at the proper
amount; and the transaction was recorded in the correct period (occurrence, accuracy and cut-off).
2. Section 41 of the Auditing Profession Act, 2005, prohibits an unregistered person from practising as
a registered auditor. Which one of the following appointments is not prohibited by this Act?
3 An unregistered person may be appointed by the Auditor General to carry out on his behalf any audit
which he is, in terms of the Public Audit Act, required to undertake.
Comment: A person who is not a registered auditor may not accept an appointment as an auditor, act
as an auditor or engage in public practice as an auditor in terms of sec 41 of the Auditing Profession
Act, 2005.
3. The Independent Regulatory Board for Auditors (IRBA) has specific goals as described in the IRBA
Manual of Information.Goals of the IRBA
· To register an auditor who meets the registration requirements.
· To monitor the compliance of registered auditors against professional standards.
· To investigate and take appropriate action against registered auditors in respect of improper
conduct.
4. Auditors, directors and the shareholders are the various parties involved in an audit engagement.
Consider the following statements in respect of the role of the directors of a company. The role of the
directors?
Reporting the results of their stewardship (management) to the shareholders of thebusiness.
Comments
1. The shareholders receive the annual financial statements from the directors and provide finance for
the business.
2. It is the responsibility of the auditor to gather sufficient and appropriate audit evidence to be in a
position to give an independent opinion on whether the annual financial statements issued by the
directors to the shareholders present fairly, the financial position and results of operations of the
company, in terms of the applicable financial reporting framework.
3. Directors are responsible for running the business but don’t appoint auditors, the latter is the
responsibility of the shareholders.
5. The management of a company includes an amount of R1 426 589 under the line item “Trade and
other receivables” in the company’s financial statements. Which financial statement assertions underlie
this line item?
Completeness; existence; valuation and allocation; rights and obligations.
Trade and other receivables is an account balance at year end and all the assertions relating to an
account balance will therefore apply. The other assertions of cut-off, accuracy, occurrence and
classification only apply to classes of transactions and events for the period under audit. Separate
assertions are given for presentation and disclosure.
6. Internal auditing
Internal auditing is a management function which functions independently within an organisation, but
remains part of the entity.
Comment:
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The internal auditors still remain part of the organisation even though they function independently. The
internal auditors report to the management of an entity, receive a mandate from management and they
perform a management function and not an external attest function.
7. A postulate is a foundation on which a discipline is built and there are certain underlying principles
or postulates, which serve as the basis of auditing theory. Examples of an auditing postulate
· An auditor must act exclusively as an auditor in order to be able to offer an independent and
objective opinion on the fair presentation of financial information.
· Effective internal controls reduce the probability of errors and irregularities.
· The financial statements submitted to the auditor for verification are free of collusive and other
unusual irregularities.
8. The following are possible descriptions of the different types of auditors that are found and the
different audit procedures that they can perform:
Auditors who express an independent opinion on whether the annual financialstatements fairly present
the financial position and results of the company’s operationare called external auditors.
Auditors who specialise in a particular field are called special purpose auditors.
Auditors concentrating on investigation and gathering evidence where there has beentheft or fraud are
called forensic auditors.
9. Correct Statement:In the case of an audit engagement the auditor expresses a high, but not
absolute level of assurance.
Comment:
The auditor expresses a high, but not absolute level of assurance in an audit engagement; this is as a
result of the inherent limitations of an audit.
Comment:
The fact that that the auditor’s work is governed by regulatory bodies is not an inherent limitation of an
audit it only means that the conduct of registered auditors is regulated. Refer to the reference for a
comprehensive guideline on the inherent limitations of an audit.
11. Description for the applicable financial reporting framework, in terms of ISA 200
The financial reporting framework is the framework adopted by management in the preparation of the
financial statements that is acceptable in view of the nature of the entity and the objective of the
financial statements.
Comment:
The management of an entity is required to prepare the financial statements based on the applicable
financial reporting framework.
12. Which one of the following acts/omissions of an auditor will constitute improper conduct in terms
of the Rules regarding Improper Conduct of the Independent Regulatory Board for Auditors (IRBA)
and/or South African Institute of Chartered Accountants (SAICA’s) Code of Professional Conduct?
If an auditor seeks before the commencement of the period of training of a trainee auditor to impose a
restraint on the trainee concerned which will apply after the date of termination of the training period.
Comment:
An auditor is guilty of improper conduct if any restraints are placed upon trainee auditors after the date
of termination of their training contract (Rules regarding Improper Conduct 2.10). Options 1 (SAICA
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Handbook Sec 240.7), 2 (SAICA Handbook Sec 140.7), and 3 (Rules regarding Improper Conduct Sec
2.11) are all permitted in terms of the Code of Professional Conduct and/or the Rules Regarding
Improper Conduct.
13. The following are possible fundamental ethical principles contained in the SAICA’s Code of
Professional Conduct governing the auditor’s professional responsibilities: Ethical principles governing
the auditor’s professional responsibilities according to International Standards on Auditing?
· Professional competence and due care.
· Professional behaviour.
· Confidentiality.
14. Statements in terms of the South African Institute of Chartered Accountants (SAICA’s) Code of
Professional Conduct
· A practitioner entrusted with monies belonging to others, in the course of professional work,
should keep such monies separate from firm monies.
· Clients’ monies received by a practitioner should be deposited without delay to the credit of a
client account.
· Monies may only be drawn from the client account on the instructions of the client.
Comment:
An auditor may only use the assets of a client for the purposes for which they were intended.By
drawing money to pay audit fees without the client’s consent the SAICA Code ofProfessional
Conduct has been contravened.
15. Indicate the correct instance when the shareholder can hold the auditor responsible for negligence
in terms of the Auditing Profession Act:
The auditor will be liable to the shareholder if at the time when the negligence occurred the registered
auditor knew or could reasonably have been expected to know that the shareholder would rely on the
opinion in order to enter into a transaction.
Comment:The shareholder will have to bring a delictual action against the auditor and amongst other
things prove that the auditor knew or reasonably could have been expected know that the third party
would rely on the opinion. Take note that there is a distinction between the liability to clients and to the
3rd parties. An auditor’s liability to a client is based on breach of contract.
16. Inventory to the value of R45 762 was purchased by BullSharks Ltd and is included in purchases in
the statement of comprehensive income. By including this amount in the statement of comprehensive
income, management declares amongst other things that: all inventory purchases are recorded, and
that all inventory purchases are recorded in the proper accounts. Which two management assertions
are being addressed with these statements?
Classification and completeness.
Comment:
Purchases of inventory are classified as transactions and events for the period under audit and the
assertions relating to classes of transactions and events will therefore apply. In this question we
specifically asked you which assertions relate to “all purchases are recorded” – Completeness and “all
purchases are recorded in the proper accounts” – Classification.
17. Indicate which one of the following individuals’ applications for registration as a registered auditor,
accompanied by the prescribed fee, will be approved by the Independent Regulatory Board for
Auditors (IRBA).
Margot Simpson, a resident of Cape Town, is twenty-eight years old. She completed her training
contract and passed the Board’s public practice examination at the age of twenty-four. Directly
thereafter, she changed her occupation to that of a housewife. She now lodges a written application for
registration as a registered auditor with the Board.
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18. A registered auditor and auditor’s practice may be conducted as a company provided that certain
requirements are complied with. The following are possible requirements:
· Every shareholder must be a registered auditor.
· Only natural persons who are registered auditors may be members or shareholders of the
company.
· The company’s articles of association must provide that a member of the company shall not
appoint a person who is not a member of the company to attend, or speak or vote, in his/her
stead at any meeting of the company.
19. In one of the types of engagements referred to in The International Framework for Assurance
Engagements, a moderate level of assurance is expressed for this type of engagement and the auditor
expresses a negative form of assurance in the report. Indicate which one of the following types of
engagements is associated with the objective of providing the level of assurance described above.
A review engagement.
Comment:
· In a review engagement a limited level of assurance is expressed negatively.
· No assurance is expressed in an agreed upon procedures engagement.
· A reasonable level of assurance is expressed in an audit engagement.
· No assurance is expressed in a compilation engagement.
1.1 Components of internal control - Match relevant aspects from the above planning scenario to
the applicable components of internal controls in a tabular format
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Note the following: Management is responsible for internal control. Managers establish
policies and processes to help the organisation achieve specific objectives. Auditors are
responsible for identifying risks and to provide management with the assurance that the
controls in place are in fact effective and efficient.
1.2 Mention six (6) INHERENT LIMITATIONS OF AN INTERNAL CONTROL SYSTEM. (9)
· Management’s usual requirement is that the cost of internal control does not exceed the
expected benefit to be derived (cost vs benefit). √^
· The tendency is for internal controls to be directed at routine transactions rather than non-
routine transactions. √^
· The potential exists for human error due to carelessness, distraction, mistakes of judgement
and misunderstanding of instructions. √^
· The possibility exists of circumvention of internal controls through the collusion of a member of
management, or an employee, with parties outside the company. √^
· The possibility exists that a person responsible for exercising an internal control could abuse
that responsibility, for example, a member of management overriding an internal control. √^
· The possibility exists that procedures may become inadequate due to changes in conditions
and, therefore, compliance with procedures may deteriorate. √^
· There may be an error in the design of, or in the change to, a control. √^
· Operation of a control may not be effective, such as where information produced for the
purposes of internal control is not effectively used because the individual responsible for
reviewing the information does not understand its purpose or fails to take appropriate action.
(Exception reports) √^
Note the following: Internal control, no matter how effective, can provide an entity with onlylimited
assurance about achieving the entity’s financial reporting objectives. The likelihood oftheir
achievement is affected by inherent limitations of internal control. These include therealities that
human judgement in decision-making can be faulty and that breakdowns ininternal control can occur
because of human error.
1.3 Give two (2) reasons why the auditor may change the materiality level as the audit progresses. (3)
· The auditor shall revise materiality for the financial statements as a whole (and, if applicable,
the materiality level or levels for particular classes of transactions, account balances or
disclosures):
· In the event of becoming aware of new information during the audit, that would have caused the
auditor to have determined a different amount (or amounts) initially. √^
· Change in circumstances that occurred during the audit. (For example, decision to dispose of a
major part of the entity’s business) √^
· Change in the auditor's understanding of the entity and its operations as a result of performing
further audit procedures. (For example, if during the audit it appears as though actual financial
results are likely to be substantially different from the anticipated period end financial results
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that were used initially to determine materiality for the financial statements as a whole, the
auditor revised that materiality. √^
Note the following: In determining materiality, various aspects need to be taken into
account, such as the entity's risk assessment, control environment as well as the objective
judgement of the auditor. The method of determining materiality should be properly
documented.
1.4 From the above scenario (audit evidence) indicate for each type of evidence the level of reliability:
Most reliable/ more reliable/ least reliable
1.5
Draw up a working paper in which you document the following:
1.5.1 List and describe MANAGEMENTASSERTIONS that relate to the inventory balance in the
Statement of Financial Position.(10)
Note the following: Assertions refer to management representations embodied in the financial
statement “declaration”, for example, that revenue presented on the face of the statement of
comprehensive income (income statement) is complete and that all assets presented on the face of
the statement of financial position exist.
1.5.2 List the 7 (seven) types of AUDIT PROCEDURES that can be performed to obtain audit
evidence.(7)
• Inspection √
• Observation √
• External confirmation √
• Recalculation √
• Reperformance √
• Analytical procedures √
• Inquiry √
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10. The professional status of the independent auditor imposes commensurate professional
obligations on the auditor
(b. Indicate which of the above statements (1 to 10) are regarded as postulates of auditing.
Explain briefly each of the postulates you have idenditfied
The following of the mentioned statements are generally regarded as the postulates of auditing.
Statement 2: Essentially this postulate says that if the auditor is going to give an opinion√^ that is
worthwhile to users, he must be free of any bias (independent) √^. Furthermore the auditor must not
compromise his audit independence by offering the client other services which may impinge in any
way on his independence. (Max 3)
Statement 5: This postulate proposes that it is to verify the client’s financial data√^ i.e. that there will
be evidence (documentary or otherwise) which will enable the external auditor to “verify” the
transactions recorded in the client’s books√^. If financial information is not verifiable there can be no
audit. (Max 3)
Statement 6: This postulate suggests that a company without internal controls provides the auditor
with little chance of conducting an efficient or economical audit. √^ If a company is not “controlling” its
activities √^e.g. no division of duties, no proper documentation etc, a positive audit outcome is not
feasible. √^ (Max 3)
Statement 8: This postulate suggests that in business “things generally stay the same”. √^ Obviously
businesses develop, expand, contract etc, but generally from year to year the core activities and
philosophy of the business remain the same. √^ Hence historical information about a client is important
to the auditor. √^ The postulate in a sense also alerts the auditor to the fact that if there has been
change, the effect of the change must be considered for the purposes of the audit. √^ (Max 3)
Statement 10: This postulate simply means that the auditor must understand that the professional
status which the audit profession and its members have, brings with it a responsibility to meet their
professional obligations, √^ e.g. auditors must ensure they keep up to date, act with objectivity and
integrity etc. √^ (Max 3)
(c) For each of the above statements which you have not identified as a postulate, state
whether the statement is true or false. Justify your choice
Statement 1: True. ^ The assertions are the representations which the directors are making about the
assets, liabilities, transactions and disclosures in the financial statements. Thus they form the basis of
the financial statements. √^ (Max 2)
Statement 3: False. ^ An unqualified opinion is a statement that the financial statements “present
fairly” the financial position etc of the company. √^ It is not a statement that the Annual Financial
Statements are 100% correct. √^ The auditor can never be in a position to “certify” due to inter alia, the
limitations of the audit function and the extensive use of judgment and estimate in financial statements.
Statement 4: True. ^ One of the fundamental principles of professional conduct is that an auditor is
required to “maintain professional knowledge and skill” √^and “act in accordance with applicable
technical and professional standards”. √^ Furthermore, an opinion arising from an audit conducted by
an incompetent audit team will be worthless.√^ (Max 2)
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Statement 7: True. ^ In South Africa the individual must be registered with the Independent
Regulatory Board for Auditors (IRBA). √^ (Max 2)
Statement 9: True. ^ Although the auditor expresses an independent opinion it is very important that
there is communication and co-operation with the client’s directors/management. √^ The auditor audits
the assertions of the directors, and evidence is frequently required from individual directors or
members of the management team. √^ For example, a detailed explanation about a major transaction
may be required from the financial director; if he will not co-operate, the auditor may not be able to
“audit” the transaction to determine whether it has been fairly presented in the financial statements.
√^(Max 2)
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Written assurance report√ – this is the conclusion which Hendricks and Co will draw as a result of
gathering evidence. The conclusion (whether or not the information provided by the shop owners is
fair) will be reported to Propcorp (Pty) Ltd. √^ (Max 2)
1. The Auditing Profession Act 2005 applies only to those registered auditors who performs audits of public
companies not private companies. True or False? Justify
False^ The Act applies to any individual who is registered with the IRBA √^(i.e. registered auditor). To
conduct an audit of any company the individual must be aregistered auditor in terms of the Auditing
Profession Act 2005. √^
2. The MOI of a company may include a clause which requires that if a reportable irregularity is discovered
by the external auditor, it should be reported to the shareholders and not the IRBA provided the external
auditor agrees to this at the time of discovering the reportable irregularity. true or false? Justify
False^
2.1 Such a clause in the Memorandum of Incorporation (MOI) would have no affect whatsoever.√^ The
auditor’s duty to report a reportable irregularity to the IRBA is laid down in theAuditing Profession Act
2005, and a Memorandum of Incorporation (MOI) cannot simplydisregard this duty created by the law. √
2.2 Obviously the auditor cannot agree to such a clause as he/she is duty bound to follow theprocedure
for reportable irregularities stipulated in the Act. √^
3. The designation, chartered accountant (SA) is restricted to auditors registered with the IRBA. Comment
3.1 This is not correct. ^The designation CA (SA) is the designation of those individualsregistered with
SAICA. √^ The designation “registered auditor” is restricted to thoseregistered with the IRBA.√^
3.2 To be registered with the IRBA it is not a requirement that the individual be registered withSAICA (i.e.
CA (SA)). √^
4. Mohammed Mubarak offers internal audit services to various companies. He is not registered with the
IRBA. He wishes to advertise his consultancy in one of the following ways. Indicate whether or not each
of these are permissible. Justify
a. “Mohammed Mubarak Consultants – registered internal auditors”
b. “Mohammed Mubarak Consultants – financial advisors and auditors”
c. “Mohammed Mubarak Consultants – internal auditors and accountants
The essence of Section 41 of the Auditing Profession Act 2005 is that a person may notpretend to be a
registered auditor (mislead the public) or use any description which createsthe impression that they are
registered with the IRBA or not. √ ^
· The description in 4.1 of the question would be unlikely to be a contravention as Sec 41 allows
the use of the description “internal auditor”. Presumably Mohammed Mubarak is registered with
the Institute of Internal Auditors and he doesn’t appear to be “pretending” to be registered with
IRBA. √ ^
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· The description in 4.2 is likely to be unacceptable, whilst the financial advisor part is no problem,
the description creates the impression that his consultancy carries out audits i.e. that they are
registered auditors√ ^ (Note: only a registered auditor in public practice may perform audits).
· The description in 4.3 is perfectly acceptable. In terms of Sec 41 both internal auditor and
accountant are acceptable descriptions.√ ^
5. Mildred Tiles is the designated auditor of BuildwithBricks (Pty) Ltd a large brick and paver wholesaler.
The company has elected in its MOI to have its AFS audited externally every year. Whilst conducting the
current year’s audit, she discovered a reportable irregularity. However, she intentionally decided not to
report it to the IRBA. Indicate whether each of the following would be a justifiable reason for not reporting
to the IRBA as required by the AP Act:
a. As BuildwithBricks (Pty) Ltd is audited because its MOI requires it to be, and not because its
public interest score requires it, there is no duty on Mildred Tiles to report it to the IRBA
of the question is not an acceptable reason. ^ The Auditing Profession Act states clearly
thatwhere a registered auditor conducts an audit, he or she will have an obligation to report
areportable irregularity.√^ The fact that BuildwithBricks (Pty) Ltd is a private company is
notrelevant; once the company has engaged a registered auditor to perform an audit,
theregistered auditor must adhere to the Auditing Profession Act. √^
b. The financial director requested Mildred Tiles no to report to the IRBA as the consequences of
doing so could result in dismissals and other job losses at the company
is not an acceptable reason.^ Whilst it is possible that there will be negative consequencesfor the
company as a result of the reportable irregularity, the auditor (Mildred Tiles) mustcarry out her
duties in terms of the Auditing Profession Act. √^ It is as a result of the directors’actions that
employees may lose their jobs; it is not the fault of Mildred Tiles. √^
c. Mildred Tiles did not want to spend the hours following up on the reportable irregularity, writing
reports, attending hearings etc, as she was under audit deadline pressure at a number of her
other audits
is not an acceptable reason. ^ It is true that the reportable irregularity may result in MildredTiles’
having to put in more hours than she wishes. √^ However,
· she has a duty to comply with the Auditing Profession Act√^
· she is facing a serious threat to compliance with the fundamental principles of
integrity,objectivity, professional competence and due care, and the only realistic
safeguardwould be to comply with her duty. √^
6. Freeloites and Co, a large audit firm wishes to employ the following individuals to work on the audit of
Anglotec Ltd, a listed company. Each of the individuals has a particular audit expertise required on the
audit:Discuss Freeloites and Co’s intentions to employ Hendrik Hertz and JabuMotaung with reference to
the Auditing Profession Act 2005. Indicate whether the two individuals could become partners at the firm
a. Hendrik Hertz, who does not have an auditing background but is a computer fraud expert.
Hendrik Hertz was convicted five years ago for his involvement in a computer based fraud and
has served a three year sentence. Since completing his sentence he has offered his services as
a fraud investigator
In terms of the Auditing Profession Act, Hendrik Hertz cannot be registered with IRBA
(notqualified) and could therefore not become a partner of Freeloites and Co but the fact that
heis not specifically qualified as an auditor, does not mean he cannot be employed byFreeloites
and Co. √^
· The requirement is that the audit be conducted by or under the direction of a
registeredauditor. √^
· Thus it would appear that in terms of the Auditing Profession Act, there is nothing
toprevent Freeloites from employing Hendrik Hertz to work on the audit. √^ Whether
itwould be a wise employment/business decision would be for the partners to decide.
b. JabuMotaung, who was registered with the IRBA before spending ten year in New York as a
stock trader, during which time he allowed his registration with the IRBA to lapse.
Again the fact that JabuMotaung is not registered with the IRBA means that he could not be
made a partner at this point but he could be employed by Freeloites.√^
· as he has previously been registered with the IRBA he must have the basic educationand
training requirements but he would have to show that he has the necessarycompetency
requirements as he has not practiced for some time (10 years). √^
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7. Maggs and Mabhida, a medium sized firm of registered accountants and auditors, wishes to incorporate
(form itself into a company) the propose shareholders will be: (Comment on the proposed appointment of
each of the above as shareholders of the new company, Maggs and Mabhida Incorporated)
a. Archie Angel: the current senior partner of the firm- Archie Angel: currently a partner in an audit
firm therefore must be registered with the IRBA, can become a shareholder, and must be a director
(Sec 38). √^
b. SydSithole CA (SA): currently a senior member of an international bank who will leave the
bank and join Maggs and Mabhida -SydSithole: does not appear to be registered with the IRBA, is
registered with SAICA so must have basic education and training requirements with IRBA but may
have to prove his competency for public practice; must also be appointed a director. √^
c. Monty Maggs: Registered Auditor and CA (SA): he is the son of the founding partner of
Maggs and Mabhida. He currently has his own audit practice but will join Maggs and Mabhida
to become the executive director of the new company- MontyMaggs: may become a
shareholder and executive director, has all qualifications and requirements as he is currently
practicing. √^
d. AravindaSilv: currently the other partner in Monty Maggs’ audit firm who will also join the new
company, but will not be a director – Aravinda Silva: as he is currently in public practice he
satisfies all the requirements to become a shareholder but he must be appointed a director as well.
√^
e. Stix martin: an attorney who has expertise in company law - Stix Martin: may not become a
shareholder or a director. Section 38 limits these appointments to registered auditors. As Stix Martin
is a lawyer he cannot register with the IRBA as his qualifications do not meet the requirements. √^
f. The three other existing partners of Maggs and Mabhida - The three other existing partners may
all be appointed shareholders and must be appointed directors as well. √^
g. Finance (Pty) Ltd, the company which will provide the initial finance for the new company to
get started e.g. office lease, overdraft, purchase of computers etc (5% holding only) - Finance
(Pty) Ltd may not be shareholders; the company is not an individual, cannot be registered with the
IRBA and cannot be a director. √^
3. from Graded questions 3.7 Intimidation threats can affect the auditor’s objectivity and
integrity.
False.An auditor must be both independent in mind and appearance. √^
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Users of audit services must perceive that the auditor is independent. Even if the auditoracts with the
highest level of independence of mind, if he is in some way linked with the cliente.g. a minor
shareholder, he will not appear to be independent. The auditor must be, and beseen to be,
independent. √^(Max 3)
4. from Graded questions 3.7 The Spouse of a chartered accountant in public practice is
regarded as a close family member for purposes of applying the Code of Professional Conduct.
True. ^ for both spouse and dependents. √^(Max 2)
5. (can’t find question referred to in Graded questions) True. ^provided Carter Repson obtains the
loan under the same procedures, conditions andinterest rates that are applicable to members of the
public, √^ i.e. he receives no preferentialtreatment.(Max 2)
6. (can’t find question referred to in Graded questions) False. ^as the advertising manager, Lolly
Patrick is not “in a position to exert direct andsignificant influence over the subject of the audit, √^i.e.
the financial statements”, PeterPatrick is not automatically in breach of the Code as his independence
is not likely to beimpaired. √^(Max 2)
7. (can’t find question referred to in Graded questions)True. ^ Desai & Co may advertise their
services during this time slot provided the contentand presentation of the advertisements does not
threaten their compliance with thefundamental principle of professional behavior. √^ This has been
interpreted as meaning theadvertisement should be in good taste and conform with the accepted
norms of legality,decency, honesty and truthfulness, and reflect a due sense of responsibility to the
professionand the public. √^ The advertisement must not bring the profession into disrepute, √^
andmust not contain exaggerated claims about services, qualifications or experience. √^ It mustnot
make disparaging references or unsubstantiated comparisons to the work of another. √^(Max 3)
9. (can’t find question referred to in Graded questions)True. ^ Chivanga and Skeate should
provide de Villiers and Grant with information about theclient (assuring permission has been granted)
but are under no obligation to discuss theiraudit strategy or plan. √^ They may do so if they wish.
10. (can’t find question referred to in Graded questions)True. ^ This amounts to financial
involvement with the audit client which may lead to selfinterest(or intimidation) threats to the firm’s
independence. √^(Max 2)
11. (can’t find question referred to in Graded questions)False. ^Gomez and Pillay are not in full
compliance. √^
11.1 The money must be placed in a separate bank account suitably designated, with aninstitution
registered in terms of the Banks Act 1990. √^
11.2 The money must be deposited without delay. √^
11.3 Gomez and Pillay must check the source of the money they are given to ensure that themoney is
legal and not being laundered. √^
11.4 Gomez and Pillay must be able to account for the money, any interest it has earned and
anyexpenditures made at all times. √^(Max 3)
12. (can’t find question referred to in Graded questions)False. ^If a client wishes to get other
opinions on its financial information it can do so – theclient owns the information! √^ However, in this
situation the chartered accountant who is toprovide the second opinion should obtain the client’s
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permission to discuss the matter fullywith the chartered accountant who provided the first opinion as
there is a threat tocompliance with the fundamental principles. √^(Max 2)
13. False. ^If John Jarvis is faced with a threat to his compliance with the fundamental principles,he is
still required to evaluate the threat and only if it is not significant, may he ignore it. √^ Ifthe threat is not
acceptable, he must put suitable safeguards in place√^, if possible whetheror not it is in his employer’s
best interest. √^
General
Situation 1
!independence would be threatened and on two counts.^
!Overdue fees could give rise to a self-interest threat. √^
Explanation: If there are already substantial fees outstanding, the firm may not put the necessary
resources and time into any future audit work because the partner/manager does not expect the fee to
be paid promptly, if at all. √^ This external factor may create bias which will affect audit performance.
(Professional competence is threatened). √^
!The issue of shares to the partners would amount to a self-interest threat. √^
Explanation: Being shareholders in an audit client amounts to the partners having a direct financial
interest in the audit client. √^
!The firm would not be independent in mind or appearance e.g. because he has a personal
investment in the client, the partner in charge of the audit may “turn a blind eye” to matters which he
may otherwise have followed up more diligently. √^ The auditor may not hold shares in an audit client.
√^ (Max 5)
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Situation 2
!independence would be threatened in a number of ways. ^
!This arrangement could give rise to a self-interest^ and/or intimidation threat^ in respect of the
trainee.
Explanation: A financially needy trainee accountant who is receiving money from a client becomes
dependent on that client. √^
Acting out of self-interest, the trainee, not wanting to jeopardize the financial support, may overlook
certain matters on the audit which he or she may otherwise take further action on. √^
On the other hand the client may “threaten” the trainee with withdrawal of the financialsupport (if the
trainee does not act as the client wishes) giving rise to an intimidationthreat. √^
!Where a trainee accountant fails a year, he or she becomes a debtor of the client (thefees paid must
be repaid) which amounts to direct financial involvement. ^
Explanation: Although this situation may not give rise to an obvious threat toindependence, it is
unlikely that the trainee (or the firm) will be seen to be independent(appearance). √^ In addition, will a
trainee who owes an audit client money, be totallyimpartial (in mind)? √^
!From the perspective of the firm, this amounts to indirect financial involvement with aclient which
could give rise to a self-interest^ or intimidation threat^.
Explanation: In effect the audit client is funding the audit firms’ employees. Thissituation is highly
beneficial to the audit firm, and may result in a favor from the auditclient, and likewise providing the
audit client with some power over the firm, i.e. theclient threatens to stop the arrangement.√^
Note: It could be argued that if the trainee is not actually a member of the audit team forthis specific
client, the threat to independence (for that trainee) is reduced. However, thearrangement would still
severely compromise the firm’s independence and should not beagreed to.
Situation 3
!independence would be threatened. ^
!This situation would give rise to (potential) self-interest,^ intimidation ^and familiarity threats.^
!"Explanation: The threat is that Rudolf Nel will, whilst conducting Quickies (Pty) Ltd’s audit, view
himself as an employee of Quickies (Pty) Ltd and may not wish to act in a manner which may
jeopardize his appointment √^as financial accountant (selfinterest)^ e.g. he may overlook contentious
audit issues. √^
!"As it is likely that the client’s accounting staff, as well as other senior staff will be aware of the
pending appointment of Rudolf Nel, it is probable that they will not treat Rudolf Nel as an “independent
auditor” √^during the current year’s audit, seeing him rather as one of them (familiarity)^.
!There is also the possibility that Quickies (Pty) Ltd could place pressure on Rudolf Nel to overlook
contentious issues√^ on the audit by “threatening” not to appoint him as financial accountant. √^
Note: After Rudolf Nel takes up the position of financial accountant, some threat to independence will
remain, most likely a familiarity or intimidation threat. Having been the senior on the audit, Rudolf Nel
may be friendly with the audit team or may be able to intimidate junior members of the team.
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b) List the other four components of Internal control, other than that the entity’s risk
assessment process
· Control environment ^
· The information system^, including the related business processes relevant to financial reporting
and communication.
· Control activities^
· Monitoring of controls. ^
d). Discuss whether the external auditor is directly interested in all the business risks which are
identified by the company’s risk process.
The external auditor’s objective is to form an opinion on the fair presentation of the financial
statements of the company. √^ The financial statements are a product of the financial reporting system
which in turn is part of the company’s information system. √^
!The auditor must obtain an understanding of the information system and therefore will be directly
interested in any business risk which might affect the financial reporting information system and the
control activities which are implemented by management to address the risks. √^
!It is probably fair to say that the auditor is at least indirectly interested in all business risks
(sometimes to a very minor degree) as this knowledge will help the auditor in obtaining a better overall
understanding of the client’s business. √^ (Max 3)
e). Describe briefly the elements which make up that part of a company’s information system
which is relevant to a company’s financial reporting system
The classes of transactions in the entity’s operations that are significant to the company’s financial
statements, e.g. sales, purchases, salaries, etc. √^
!"The procedures (both computerized and manual), by which these transactions are initiated,
processed, recorded, corrected and transferred to the general ledger and reported in the financial
statements, e.g. place and order, receive the goods, transfer the goods to the warehouse, etc. √^
!The related accounting records and supporting information and documentation relating to the
transaction, e.g. purchase order, goods received note, creditors ledger, etc. √^
!How the information system captures events and conditions other than transactions, e.g. subsequent
events, litigation. √^
!The financial reporting process used to prepare the entities financial statements including significant
accounting estimates and disclosures√^ e.g. who draws financial statements up, who checks
compliance with accounting statements, etc. √^
!The control around the passing of journal entries, including non-standard journal entries, e.g. an
impairment loss. √^ (Max 6)
f). State, using four key words in your answer, the objective which management aims to
achieve in an accounting (financial reporting ) system by implementing application control
procedures
The production of valid^, accurate^ and complete ^data timeously.^
staff the importance of internal control √^e.g. they should not ignore controls themselves, should act
with integrity, provide leadership etc. √^ Where there is a strong control environment, internal controls
are effective. √^ max2
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Comments:
Internal control, despite how effective it is, in an entity may provide only reasonable assurance
regarding the achievement of the entity’s financial reporting objectives. The likelihood of achieving
them is affected by the inherent limitations of internal control. These include the realities that human
prejudice in decision-making can be faulty and error-operation in internal control can occur because of
human error.
1. Extracted a sample of items from the inventory sheets and performed test counts at the
annual inventory count
(a) Source - evidence obtained from the client. √
(b) Less reliable√
· The evidence is not obtained from a source independent of Bathlight Ltd, it isinternally
generated. √^
· The opinions of the credit manager and sales director only constitute an informedestimate as to
what amounts will ultimately be recovered. √^
· Neither party is “independent” of the information they are giving – they will notwant to admit that
debts can’t be collected as they originally extended the credit bymaking the sale.
· Their evidence will need to be corroborated, it will not be sufficient on its own. √^(Max 4)
2.Reviewed the report of an electronics expert who was engaged (by the audit firm) to value
work-in-progress at year-end
(a) Source - evidence developed by the auditor. √
(b) Highly reliable (primarily as a test of control) √
· Observation of the client’s cycle count procedures constitutes direct personalknowledge
acquired by the auditor. √^
· Although the counters were not independent of the company they wereindependent of inventory
custody and were competent; there should therefore beno question as to the independence (or
quality) of the source of the evidence. √^(Max 4)
3. Reviewed the minutes of the monthly directors meetings and recorded all important
decisions in the audit workpapers
(a) Source - evidence obtained from third parties. √
(b) Moderately reliable √
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4. Discussed the allowance for bad debts with the credit controller
(a) Source - evidence obtained from sources outside the entity√
(b) Highly reliable √
· The certificate does not pass through the hands of the client but is sent directly tothe auditor. √^
· Hence it is not subject to manipulation by the client. √^
· It is reasonable to assume that banks constitute an independent source ofevidence. √^
· There is also a basic assumption that the bank official providing the confirmation isauthorised
and competent to do so. √^(Max 4)
5. Observed the control procedures taking place in the receiving bay whilst goods are being
delivered by a supplier
(a) Source - evidence developed by the auditor√
(b) Moderately reliable√
· Although the auditor will have verified the major components of the computationand despite the
fact that such evidence falls within the direct knowledge of theauditor, √^ analytical procedures
provide general substantive evidence rather thanspecific evidence. √^
· The analysis of the difference will also be influenced by information andexplanations
provided/produced by the company itself√^ and although the auditorcomputed the ratio and
performed the analysis, only the outcome can be regardedin an overall light and cannot be
relied upon as irrefutable evidence of anything. √^(Max 4)
Comments:
Remember that all information obtained through the audit is evidence.The relevance (reliability and
relevance) and the sufficiency of evidence must be substantiated –obtain written/ documentary
evidence.
11. Solution to question 4.8 (a & b) in Graded Questions (not the correct question as per Unisa)
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Comments:
The purpose of this question is to revise your understanding of the assertions as set out in ISA315 par
A111. It is imperative to know and understand the assertions to enable you the apply
yourunderstanding and knowledge in any type of question.
a. Describe the procedures you will conduct to assist you in your assessment of “Procedures to
Assess the Risk of Material Misstatement in the Financial Statements. Give examples of the
information you would be seeking for each procedure
a) Assessment of the risk of material misstament
3. Ben Burger has the incentive and opportunity to manipulate the financial statements to reflect a
better financial position.√^
3.1 As both Ben Burger and Louis Green (operations director) have shares in the company, it is in their
interests to keep the company going√^, and as they are the only directors remaining, the governance
oversight which the board should provide is meaningless in this situation. √^
3.2 The financial accountant Miles Julius who is not experienced in financial statement presentation,
will probably follow Ben Burger’s instructions without query as he will not be keen to lose his job and
may not know any better. √^
3.3 Ben Burger who is in any event aggressive, can override anything Miles Julius believes should be
included/excluded in the presentation of the financial statements. √^
3.4 As Ben Burger has some knowledge of accounting from his many years in business, he is probably
able to manipulate the financial statements to suit his needs. √^ (Max 4)
4. There is a high risk associated with the presentation of the financial statements on the going
concern basis. √^
4.1 Prices on the world market are falling; Metalman (Pty) Ltd sells mainly into this market. √^
4.2 The local scrap market is unstable and in decline. Even though only 30% of sales are local, there
seems little chance of increasing this. √^
4.3 The company is facing a severe liquidity crisis to the extent that the bank appears to be
considering withdrawing its financial support. √^
4.4 Important employees, who are best suited to addressing the financial crisis, have left the company,
e.g. the financial director. √^
4.5 Recoverability of overseas accounts receivable appear to be in question which will have a further
negative effect on cash flow. √^
4.6 The company has a very narrow customer base (Taiwanese industrialists) so any decline in that
country’s economy will be felt by Metalman (Pty) Ltd. √^ (Max 3)
5. Tight deadline√
5.1 All of the above are compounded by the fact that there is an important deadline for theaudited
financial statements. √^
5.2 Those responsible for the preparation of the AFS are going to be placed under extremepressure
brought about by a lack of staff, and insufficient knowledge and experience. √^
Errors are likely to be made and the manipulation is made easier to facilitate. √^
5.3 We will be under pressure to carry out the audit properly for the same reason and due to thefact
that the short “post balance sheet period” limits our opportunity to perform good qualitytests on
confirming year end balances. √^(Max 2)
6. Ben Burger has indicated that the financial statements will “show what the bank needs tosee”. √^
This suggests strongly that he will see to it that the financial statements will reflect afinancial position
more positive than it is, and that fraudulent reporting is likely to take place.√^ (Max 2)
(Total 15 marks)
b. Evaluate the risk of Risk of Material Misstatement in the Financial Statement Level
Overall response to the high risk of misstatement at financial statement level will be to:
1. Assign staff to the audit who are experienced in the ways and means of fraudulent
financialreporting, √^ and who have the personal attributes to deal with an aggressive director who
isunder pressure. √^
2. Emphasise to the audit team the high risk of manipulation, √^ and the need to maintainprofessional
skepticism. √^
3. Provide more supervision on the audit as this is not going to be a clean, neat,straightforward audit.
√^
4. Incorporate some elements of unpredictability into the audit. √^
5. Concentrate on verifying balances at year end particularly those which could bemanipulated to
improve the financial statements. √^(Max 5)
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c. Comment on your overall response to the Risk of Material Misstatement in the Financial
Statement Level
Risk relating to assertions at transaction level/account heading – medium to high√^
1. There is a reasonably high risk of misstatement occurring in the recording of transactions(accuracy,
cut off, occurrence, classification) √^
1.1 Control activities have been placed under strain. √^
1.2 The company is involved in foreign transactions which require the application of
accountingstandards with which the remaining accounting staff may not be familiar. √^(Max 3)
2. The risk relating to transactions is mitigated by the fact that there are not a great number of
suppliers or customers. √^ This makes it more difficult to manipulate (overstate) sales/debtors and
(understate) purchases/creditors. √^ (Max 2)
4. There is at least a medium risk of misstatement of accounts receivable (valuation and existence). √^
4.1 As discussed above, there is a risk with the existence of debtors, as the “other half” of any fictitious
sales entry. √^
4.2 There is also the risk that the allowance for bad debts will be understated. There are already
delays in payment from overseas debtors and this coupled with falling prices on world markets, must
bring the recoverability of these debts into question. √^ (Max 3)
6. Overstatement of liabilities. √^
6.1 As mentioned earlier, the financial statements could be manipulated to an extent by failing to raise
a creditor, √^e.g. record the purchase from a mine as inventory but do not raise the mine as a creditor.
√^
6.2 This risk does exist but is mitigated by the fact that there are not many suppliers, so “hiding” this
manipulation may be difficult. √^ (Max 3)
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(Total 18 marks)
Comments:
Question c is of a high standard, and was given to you to provide some insight on answering a
question relating to risk assessment at the assertion level. In this question the following was dealt with:
(1)&(2) Risks relating to recording of transactions (transaction & event)
(3) Risks relating to sales (transaction & event)
(4) Risks relating to accounts receivable (account balance)
(5) Risks relating to inventory balance (account balance)\
(6) Risks relating to liabilities (account balance) In an exam this type of question would specifically
identify the category to be dealt with.
Always remember that one of the main objectives of an auditor is to identify and assess the risks of
material misstatement, whether due to fraud or error, at the financial statement and assertion levels,
through understanding the entity and its environment, including the entity’s internal control, thereby
providing a basis for designing and implementing responses to the assessed risks of material
misstatement.
1.3 The Wool Company Ltd is a reasonably complex business√^. It imports, exports, hasprocessing
facilities and operates across a wide geographical location and operates in avolatile world market. √^
2. Risk at financial statement level which increased by the above factors would be reduced asa result
of the following:
2.1 Most of the directors have been with the company for many years which suggests that theywill be
experienced √^in the industry and hence able to cope with the difficult tradingconditions√^.
2.2 Our relationship with them suggests that the directors have integrity√^ which means thatthey would
be less inclined to "manipulate" (misstate) the financial statements. √^(Max 6)
Tests should be conducted to determine that the rights of ownership for all inventory included in the
financials has actually transferred to the company√^, e.g. (Max 5)
2. Assertion: Existence^
2.1 The risk associated with this assertion should be regarded as high^ for the following reasons:
2.1.1 At year end the company may have "raw material" inventory at multiple locations √^ which will
make physical inspection difficult for the auditor and provides opportunity for the company to overstate
its inventory. √^
2.2 This problem is compounded by the fact that due to the nature of the company’s product, both raw
and processed, the auditor will not really know what he or she is looking for. √^
2.3 Initial analysis of inventory levels reflects an increase in inventory (over previous year) which could
indicate the presence of overstatement by the inclusion of fictitious inventory. √^ (Max 8)
3. Assertion: Completeness^
3.1 For the same reasons as above (2.2) there is a risk that some inventory which should be included
in the year-end figure will be omitted. √^
3.2 However, this risk will be significantly reduced (and can probably be regarded as low) ^ by the fact
that the directors, under pressure to reflect the best possible financial performance√^, would endeavor
to ensure that all inventory is included, i.e. the tendency will be to overstate (existence) rather than
understate (completeness). √^ (Max 5)
4. Assertion: Valuation^
4.1 The risk associated with this assertion will be high.^ Inventories should be valued at the lower of
cost or net realiasable value √^and both of these figures may be difficult to verify. √^ (Max 3)
General
The following points increase the risk on the account heading as a whole:
1. Inventory is material to the financial statements (R110m) and an important account balance in a
trading company. √^The balance is large enough to possibly contain material misstatement which in
turn could have a significant effect on the fair presentation of the financial statements. √^ (Max 4)
(Total 25 marks)
Comments:
In a question of this nature, please note that you must read the required part of the question carefully.
The question focused on a specific group of assertions and not all as well as the risk on financial
statement level. Note that there is a difference.
When conducting an audit, the entire audit process can be broken down into distinct but interlinked
stages which are described as follows:
1. Preliminary engagements
2. Planning
3. Responding to assessed risks
4. Concluding
1. Preliminary activities
1.1 This stage provides the opportunity for the audit firm to assess whether a professional relationship
with the prospective client should be accepted or whether the relationship with an existing client should
be continued.√^
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1.2 It is during this stage that the audit firm must consider:
• The integrity of the client’s principal owners, key management and those charged with governance.
√^
• Whether the firm is competent to perform the engagement i.e. does the firm have the necessary
skills, resources and time; √^
• Whether the ethical requirements can be completed with e.g. no conflicts of interest with the client,
no independence threats. √^
1.3 The final step in this stage is to formalise the relationship by both parties signing an engagement
letter. √^ (Max 4)
2. Planning
2.1 Planning is a vital stage in the process as it leads to the manner in which the audit is to be
conducted. √^
2.2 It is during this stage that the overall audit strategy and audit plan are developed/established. √^
2.3 Establishing the audit strategy sets the scope, timing and direction of the audit. √^
2.4 Establishing the audit plan amounts to determining the nature, timing and extent of procedures to:
√^
• identify and assess the risks of material misstatement;√^
• respond to the risks identified (further audit procedures); √^
• to comply with any other procedures required by the ISAs; √^
2.5 At the planning stage, planning materiality is also considered. √^ (Max 4)
4. Concluding
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4.1 This stage of the audit process is concerned with evaluating the audit evidence √^to determine
whether sufficient (enough), appropriate (relevant and reliable) √^, evidence has been gathered on the
audit for an opinion to be expressed. √^
4.2 It is also the stage at which the auditor evaluates whether misstatements (which have not been
corrected) result either individually or in aggregate, in a material misstatement of the financial
statements, and if there is material misstatement, what the appropriate modification of the audit report
would be. √^
4.3 Finally, the auditor evaluates whether the financial position, financial performance, cash flows, etc
are fairly presented (see 4.2) and draft the report. √^ (Max 4)
You are required to indicate whether your firm should accept the invitation to make a presentation for
the audit of Foil (Pty) Ltd based on the contents of the letter from Gregory Grace, the financial director.
Your answer must explain fully, all the reasons for your decision
Weaknesses indentified:
1. The letter is undated.√^
2. It does not indicate to which year’s audit the terms of engagement apply.√^
3. It should be addressed to the directors of the board. √^
4. It is addressed to the shareholders and to the chairman in different places. √^
5. The letter suggests it should be signed by the audit manager. In fact it should be signed bythe
“Designated Auditor”, i.e. the partner who takes responsibility for the audit (See AuditingProfession Act
2005). √^
6. There is no identification of the designated auditor. √^
7. Auditors do not “certify”, they give an opinion on fair presentation. √^
8. The letter should not be imposing a deadline on this, our first audit. √^
9. The point relating to the limitations of the audit is poorly expressed – it looks as though thefirm is
“making excuses” before the audit has even started.√^
10. Basing the fees on prior years, particularly in the case of a first audit, is not an appropriatemethod
of fee charging; √^ fees will be negotiated with the audit committee based on time,skill, experience,
etc. This is particularly true as we were not the auditors in the prior year.
11. No explanation as to why the client must sign the letter (acknowledge the terms of
theengagement). √^
12. An unqualified report can never be guaranteed, for many reasons, not simply the limitationsof the
audit. √^
13. It is in appropriate to open the letter with “we have carried out an investigation” – this has
anegative connotation, and there is no need to refer to preliminary procedures which do not
constitute an investigation into Vortex (Pty) Ltd. √^
14.
14.1 The letter contains no indication that the objective of the audit will be for us to express
anopinion√^ on the financial statements which comprise the balance sheet, the incomestatement,
statement of changes in equity and cash flow statement, and a summary ofsignificant accounting
policies and other explanatory information. √^
14.2 There is also no indication as to why this audit is required√^. As a private company, Vortex(Pty)
Ltd is not required to be audited in terms of the Companies Act 2008; √^so the lettershould indicate
whether it is an audit at the request of the Board, the Memorandum ofIncorporation, √^ or at the
request of a third party. √^
15. Our responsibilities as auditor are also inadequately explained. √^ No reference to
15.1 the fact that the audit will be conducted in accordance with ISAs. √^
15.2 compliance by us with ethical requirements. √^
15.3 planning and performing to obtain reasonable assurance the financial statements are free of
material misstatement. √^
15.4 the fact that procedures selected depend on the auditor’s judgement. √^
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Comments:
ISA 210 par 10 states that the letter of engagement should include:
(a) The objective and scope of the audit of the financial statements
(b) The responsibility of the auditor
(c) The responsibilities of management
(d) Identification of the applicable financial reporting framework for the preparation of the financial
statements; and
(e) Reference to expected form and content of any reports to be issued by the auditor and a statement
that there may be circumstances in which a report may differ from its expected form and content.
It is imperative to agree on the terms of the engagement before commencing with the audit.
Identify and explain the fundamental principles on which the Code of Professional Conduct is based
and with which chartered accountants must comply
Discuss each of the situations in terms of the Code of Professional Conduct. Where you believe a
threat or potential threat to compliance with the fundamental principles exists, you should identify the
nature (category) of the threat
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Comment:
The fundamental principles of professional conduct is a cornerstone of the auditing profession, acrucial
element in the statutory corporate reporting process and a key prerequisite for the addingof value to an
audited financial statement. You should obtain in depth understanding andknowledge of these threats
and safeguards to enable you to apply the knowledge in any scenario.
Indicate whether your first year trainee’s is understanding of financial statement assertions is good,
reasonable or weak. Justify your answer.
It is clear that the trainee accountant does not understand the assertions! √^
1. Repairs and Maintenance
This account reflects the amount spent on repairs and maintenance transactions; the applicable
assertions are therefore completeness^, occurrence^, accuracy^, cut-off^ and classification^.
He is probably confused with the “occurrence” assertion which represents that the repairs and
maintenance transactions making up the amount of R173 291 were valid (not fictitious) repairs and
maintenance transactions pertaining to Rizone (Pty) Ltd. √^
!Obligation - this assertion relates to liabilities (balances) √^and represents that the liabilities included
in the balance sheet pertain (are obligations of) Rizone (Pty) Ltd and not someone else. √^
!Valuation - this assertion relates to balances not transactions. √^
He is confusing it with accuracy, cut-off and classification which represents that repairs and
maintenance have been appropriately recorded at the proper amount in the correct period, and in the
proper accounts. √^
In addition the trainee does not appear to know of the other assertion for transactions
!Completeness - this represents that all repairs and maintenance transactions which should have
been recorded have been recorded. √^
Note: As there are no disclosures relating to repairs and maintenance the assertions relating to
presentation and disclosure are not applicable.
2. Trade Creditors
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This account reflects the amount (balance) owed by Rizone (Pty) Ltd to its trade creditors; the
applicable assertions are therefore completeness, existence, obligation and valuation.
Assertion relating to creditors is the obligation assertion which represents that the trade creditors
included are valid obligations of Rizone (Pty) Ltd and nobody else. √^
!"Completeness - this assertion represents that all amounts owed by Rizone (Pty) Ltd to its trade
creditors are included in the balance not only those creditors who have supplied invoices, i.e. all
creditors which should have been recorded have been recorded. √^
In addition the trainee does not appear to know of the other assertion applicable to the account
heading. √^
!Existence - this assertion represents that all the creditors included in the balance actually exist i.e.
they are not fictitious. √^
Note: It is not necessary to mention the assertions relating to presentation and disclosure unless
specifically stated in the question. (Max 15)
Comments:
As stated in ISA315 the auditor use assertions to consider different types of potential misstatements
that may occur in balances, transactions or in the presentation and disclosure of financial information.
As mentioned previously it is important to obtain sufficient knowledge about assertions.
Question 3 - Question 6.4 in Graded Questions 18 marks(not question 6.4 unsure which one)
(a) I would assess the risk at financial statement level, as high^ (8)
!The financial accountant and financial director are not at all co-operative. √^ As they arethe two
people most responsible for the financial information we audit, a very difficultsituation will arise in our
gathering of sufficient appropriate evidence√^
!There could also be a more sinister reason for their lack of co-operation, e.g. are theymanipulating
the figures in some way? √^
!The company does a lot of work outside of the country, in other jurisdictions and isinvolved in major
foreign transactions. √^
!These factors will filter down to assertion level, but overall they create an inherentlymore risky
environment. √^We will need to be familiar with the business risks ofoperating in foreign countries and
will have to understand the relevant legislation ofthese countries. √^ Furthermore many neighboring
states are rife with corruption andgraft, e.g. insisting on bribes to get contracts etc. This may be the
reason behind thefinancial director and financial accountant being unco-operative, not wishing to
divulgeinformation about certain contracts etc. √^ The complex journal entries may be a meansof
hiding irregular transactions. √^
!"The fact that there are numerous complex journal entries being put through at year endincreases
the risk of fraudulent financial reporting by manipulation of various accountheadings. √^
!"The fact that supporting documentation is minimal increases this risk as it makes it verydifficult for
us as auditors to evaluate the validity (and accuracy) of the journal entries.√^
!Authorisation of the entries by the financial director does not reduce the risk at financialstatement
level √^as manipulation/fraudulent financial reporting would involve thefinancial director himself, so he
is in effect “authorizing” his own actions. √^(Max 8)
(b) I would assess the risk of material misstatement at assertion level, as high ^
!Existence^, completeness^ and valuation^ of operating equipment^ (accountbalance).
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!60% of the company’s plant and equipment is in remote areas and other countries,making physical
verification very difficult. √^
!For the same reason, checking its condition for wear and tear and any impairmentlosses will also be
difficult. √^
!As some of the equipment is leased on long-term contracts, there is the added risk thatequipment
which should have been capitalized (finance lease), has been omitted. √^
!Completeness^ and valuation^ of long-term liabilities^ (account balance).
!If leases which are not finance leases and have not been capitalized, long-termliabilities will be
understated. √^
!As the lease is likely to be in foreign currency, there is a risk that the incorrecttransaction rates could
have been used in the capitalization calculations. √^
!Completeness^/occurrence^ of contract revenue (revenue recognition) ^(transactionand event)
!As contracts can last up to five years, material misstatement may occur in the timing ofrevenue
recognition. √^
!Due to the complexity of such contracts and the location of the contracts, we willprobably have to rely
on an “expert” in the employ of the company to provide thenecessary evidence. √^
Comments:
Based on the information given in this question only certain of the assertions were included in part (b)
of the solution.
Please note that we will be very clear about the class of account balance/ transaction and event or
presentation and disclosure. For example, we would indicate operating equipment, long-term liabilities
or revenue.
It is important to ensure that you obtain sufficient knowledge and understanding regarding risks of
material misstatement at financial statement and assertion level. Theoretical knowledge is not enough
and you should be in a position to apply your knowledge.
To gather the evidence which is required pertaining to the assertions, the auditor conducts procedures
which have been developed and refined to meet the audit objective. The various procedures which will
be conducted by the auditor will be mixed but balanced – no single procedure will supply all the
evidence needed.
The procedures can be categorised as follows:
1. Inspection
2. Observation
3. Inquiry
4. Recalculation
5. Analytical Procedures
6. Reperformance
7. External confirmation
Required:
a. Explain each of the above procedures
b. Indicate whether each procedure can be applied as a substantive test, or a test of controls or
both
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c. Give one example for each category of test (1 to 7 above). Your example can be a substantive
test or a test of controls
1. Inspection
a) Inspection consists of examining records, documents (physical files or electronic storage media), or
tangible assets. √^
b) It can be a Substantive procedure ^ or a test of controls.^
c) Examples:
Inspect a lease agreement to determine whether it has been signed by an authorised signatory. √^
Inspect the date on a supplier’s delivery note to confirm that goods received close to the year-end
have been accounted for in the correct financial period. √^ (Max 1!)
2. Observation
a) Observation consists of looking at a process or procedure being performed by the client's staff. √^
b) Normally a test of control ^but could be a substantive procedure.^
c) Examples:
Attendance at the annual inventory count to observe the performance of the counters (may be
substantiating quantities). √^
Observing a receiving clerk accepting goods being delivered by a supplier. √^ (Max 1!)
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3. Inquiry
a) Inquiry consists of seeking information of knowledgeable persons inside or outside the entity.
Enquiries may range from formal written enquiries addressed to third parties to informal oral inquiries
addressed to persons inside the entity. √^
b) Substantive procedures^ or a test of controls.^
c) Examples:
Inquiring of the warehouse controller as to the methods of identifying obsolete or damaged inventory.
√^
Inquiring of the orders clerk as to what procedures are followed when an order is received from a
customer. √^ (Max 1!)
4. Recalculation
a) Recalculation consists of checking the arithmetical accuracy of source documents and accounting
records. √^
b) Substantive procedures^ or a test of controls.^
c) Examples:
Casting the payroll for a particular week. √^
Recalculating depreciation on plant and equipment. √^ (Max 1!)
5. Analytical procedures
a) Analytical procedures consist of the analysis of significant ratios and trends and the resulting
investigation of fluctuations and relationships that are inconsistent with other relevant information or
which deviate from predicted amounts. √^
b) Substantive procedure ^as well as a risk assessment procedure. ^
c) Examples:
Ratio analysis is conducted on the gross profit and compared to prior year ratios. √^
The current years bad debts are analysed and compared to prior years. √^ (Max 1!)
6. Reperformance
a) Reperformance involves the auditor repeating, either wholly or in part, the same procedures
performed by the client. √^
b) Substantive procedures^ or a test of controls.^
c) Examples:
Reperforming the bank reconciliation at the financial year-end. √^
Reperforming the procedures/calculations pertaining to interest owed on loans at year-end. √^ (Max
1!)
Note: computation and reperformance are very similar, computation may however, result in new
totals/computations i.e. nothing is being reperformed.
7. External confirmation
a) External confirmation involves obtaining a direct written response from a third party to a
request/query from the auditor to that third party. √^
b) Usually substantive procedure ^ but where a third party forms part of an internal control the
application could be tested by confirmation with that 3rd party. √^
c) Examples:
Obtaining a bank confirmation (balance etc) √^
Confirming a debtor’s balance. √^ (Max 1!)
d. State whether the above procedures can be used by the auditor when identifying and assessing
the risk of material misstatement. Explain.
Yes^, these procedures are used when identifying and assessing risk. √^ For example, the
auditormight observe the manufacturing process to assess the risk of misstatement of year-end work-
in progress. √^The auditor may perform analytical procedures on the gross profit percentages to obtain
insight into problems which may have resulted in the decline of the percentage since the prior year. √^
(Max 2)
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Comments:
It is important to always start a procedure with the proper verb; it will give structure to your procedure.
This will also give the opportunity to earn the maximum marks for a question relating to setting
procedures.
Question 5 - Question 1.4 in Graded Questions (1&3)(NOT QUESTION 1.4 UNSURE WHICH
QUESTION IT IS)
Comments:
Always remember that every audit will have specific limitations which should be taken in consideration
throughout the whole audit and not only at the planning stage of the audit. Refer to ISA 200 para A45-
A52 for more detail on the inherent limitations of an audit.
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