Revision Notes

ACCA
Advanced Audit and Assurance (AAA)
Exams from December 2020
ii Introduction ACCA AAA

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ACCA AAA Introduction iii

Contents
Page

Introduction i

1 The exam v
2 UK versus International Stream v

1: Regulatory environment 1

1 Audit committees 1
2 Money laundering 2
3 Laws and Regulations 3

2: Professional and ethical considerations 5

1 Code of Ethics for Professional Accountants 5

2 Fraud and error 8
3 Professional liability 9
4 Professional and ethical developments 10
5 Additional notes for UK Stream Students 10

3: Practice management 13

1 Quality control 13
2 Advertising, publicity and obtaining professional work and fees 14
3 Tendering 15

4: Planning and risk assessment 17

1 Materiality guidelines 17
2 Risk 18

5: Audit evidence 21

1 Evidence 21
2 Audit procedures and evidence evaluation 22
3 The impact of social and environmental matters on audit 24

6:Group audits 25

1 Group Audits 25
2 Transnational audits 29

7: Completion and reporting 31

1 Subsequent events 31
2 Going concern 32
3 Evaluation of misstatements 33
4 Auditor’s reports 34

8: Other assignments 39

1 Audit-related and assurance services 39

2 Specific assignments 40
iv Introduction ACCA AAA

3 The audit of social, environment and integrated reporting 42

9: Insolvency (UK Stream students only) 43

1 Introduction 43
2 Liquidation 44
3 Administration 46
ACCA AAA Introduction v

1 The exam
The syllabus is assessed by a 3 hour 15 minutes exam which consists of two sections:

Section A Case study

This section will comprise a Case Study, worth 50 marks, set at the planning stage of the audit, for
a single company, a group of companies or potentially several audit clients.
You will be provided with a number of exhibits such as extracts of financial, strategic or
operational information for a client business, as well as extracts from audit working papers,
including results of analytical procedures.
The case study will contain a range of requirements covering topics such as planning, risk
assessment, evidence gathering and ethical and professional considerations.
Four professional marks will be available in section A.

Section B
This section will contain two compulsory 25 mark questions, each based around a short scenario.
One question will always predominantly focus on completion, review and reporting.
The other question can be drawn from any other area of the syllabus.

The AAA syllabus

Full details of the Advanced Audit and Assurance syllabus can be found on the ACCA website at:
https://www.accaglobal.com/uk/en/student/exam-support-resources/professional-exams-study-
resources/p7/syllabus-study-guide.html

2 UK versus International Stream

The only significant difference between the UK and International streams is the inclusion of
“insolvency” in the UK stream, which is not examinable under the International Stream, and “the audit
of performance information in the public sector” in the International stream which is not examinable
under the UK stream. Insolvency is covered in Chapter 9 of these revision notes.
Important note:
Please note that for students who ultimately want to obtain a practising certificate from the ACCA,
they must take the UK stream of the paper.
 1

Regulatory environment

1 Audit committees
The presence of an audit committee, comprised of non-executive directors (NEDs) should increase
investor confidence. Their responsibilities will include the following.

Audit Committee responsibilities

‘Internal’ aspects ’External’ aspects
 Reviewing systems of internal controls  Reviewing accounting policies and FS as a
 Agreeing agenda of work for the internal audit whole to ensure that they are appropriate
department  Reviewing the independence and competence
 Reviewing the results of internal audit work of the external audit firm
 Liaising with the external auditor if there are
any queries/concerns

1.1 Advantages of an audit committee

 Increased public confidence in the credibility and objectivity of published financial information.
 Shareholders may view the committee as a form of “internal control”.
 Can check the financial statements to ensure that they comply with IFRSs.
 The audit committee could have a variety of business backgrounds, bringing valuable skills,
knowledge and expertise to the company.
 May be easier and cheaper to raise finance if there is a perception of good corporate
governance created by the presence of an audit committee.
 2 1: Regulatory environment ACCA AAA

2 Money laundering
Money laundering is the process by which criminals attempt to conceal the true origin and ownership
of the proceeds of criminal activities.
It is widely defined, to include possession of, or concealment of, the proceeds of any crime.

Examples of money laundering include:

 Acquiring, using or possessing the proceeds of criminal activities such as drug trafficking or
terrorist activities
 Retaining the proceeds of tax evasion
 Benefits obtained through bribery and corruption
 Saving money by avoiding health and safety laws
The three stages of the money laundering process are:

Placement – placing “dirty” money into financial products e.g. bank deposits of small amounts.

Layering – creating a series of transactions so that the original source of funds is obscured and difficult
to trace. This is the concealment stage and sometimes uses off-shore bank accounts.

Integration – converting the proceeds of money laundering into a legitimate form, e.g. the purchase of
a legal asset such as a car or house.

FATF has outlined a number of criminal offences relating to money laundering:

(a) Assisting another to retain the benefit of crime
(b) Acquiring, possession and use of criminal proceeds
(c) Concealing or transferring proceeds to avoid prosecution
(d) Failure to disclose knowledge or suspicion of money laundering
(e) Tipping off.
Also, professional accountants are generally bound by a duty of confidentiality to their clients.
Therefore, guidance is needed to explain when they can override this duty and to whom to report any
suspicions.

2.1 How accountants meet their obligations to help prevent and detect
money laundering
Money Laundering Regulations 2017 place certain obligations on accounting firms including:
(a) Putting into place systems, controls and procedures to ensure that the firm is not used for
money laundering purposes.
(b) Appointing a Money Laundering Compliance Principal (MLCP) to oversee procedures in the
firm – must be a senior partner, and a Money Laundering Reporting Officer (“MLRO”) to whom
staff report suspicions and who decides whether to report to NCA. These MAY be the same
person, but do not have to be.
(c) Establishing/enhancing the record keeping systems for all transactions and for verifying the
identity of clients. This is most commonly done by obtaining the passports of key client staff.
ACCA AAA 1: Regulatory environment 3

(d) Customer due diligence (“know your client”) procedures.

(e) Written risk assessments relating to money laundering at clients.
(f) Training and educating staff – offered to all staff members.
The penalties for not complying with these obligations can render the firm liable to unlimited fines
and its principals to possible imprisonment.

3 Laws and Regulations

Management It is the responsibility of management to prevent and detect non-
compliance with laws and regulations.

Auditors Responsible for detecting material misstatements in the FS.

Not, and cannot be held to be, responsible for preventing non-compliance.

3.1 To whom should non-compliance be reported?

To management/those charged with governance

Non-compliance is
believed to be Communicate the finding AS SOON AS PRACTICABLE
INTENTIONAL and
MATERIAL

Non-compliance is
believed to involve Report to next higher level at entity IE AUDIT COMMITTEE
SENIOR
MANAGEMENT

Where no higher authority exists the auditor should seek legal advice.
If management/TWCG do not take appropriate and timely action, the auditors must consider what to
do next. Under NOCLAR this will include considering whether it is necessary to report externally (see
below).

To the users of the auditor’s report on the financial statements (i.e. shareholders)

Non-compliance has a
Express a MODIFIED opinion (i.e. ‘except for’ material
MATERIAL effect on
misstatement or adverse opinion)
the FS

Auditor prevented Express a MODIFIED opinion (i.e. ‘except for’ or disclaimer)

from obtaining
sufficient appropriate
evidence Possible material non-compliance
4 1: Regulatory environment ACCA AAA

To regulatory and enforcement authorities

The auditor’s duty of confidentiality prevents reporting non-compliance to a third party unless that
duty of confidentiality is overridden by statute, law or by courts of law.

Possible statutory duty to report to regulator (NB only possible)

POSSIBLE EXCEPTIONS
Possible requirement to report in PUBLIC INTEREST (obtain legal
advice first)

To protect their reputation, an auditor who questions the integrity of the client directors should
consider resignation. However, resignation is not an appropriate alternative to reporting in the public
interest. If a public interest report is made, the auditors may also resign.
 5

Professional and ethical

considerations

1 Code of Ethics for Professional Accountants

The ACCA is a member of IFAC (the International Federation of Accountants) and is required to enforce
strict ethical standards, (“ethical principles”). UK students: The UK’s FRC has also issued its own Ethical
Standard to complement the IFAC Code – see end of chapter.

1.1 The five fundamental principles

OBJECTIVITY. Fair and PROFESSIONAL

INTEGRITY. A professional COMPETENCE AND DUE
not allowing personal
accountant should be CARE. Keep up-to-date
bias or influence of
honest and with recent
others to override
straightforward. developments and
objectivity.
techniques.

PROFESSIONAL
CONFIDENTIALITY
BEHAVIOUR. Refrain
Respect for the
from any conduct which
confidentiality of
might bring discredit to
information acquired.
the profession.
6 2: Professional and ethical considerations ACCA AAA

1.1.1 Confidentiality
There are circumstances where the auditor has a responsibility to disclose client information without
needing the client’s permission:
 Obligatory responsibility – suspicion of money-laundering, drug-trafficking or terrorist offences,
auditor compelled by a court order or summons.
 Voluntary disclosure – public interest e.g. if management are involved in fraud, defence against
a claim of negligence or suing for unpaid fees.

1.2 Threats to independence

Self-interest threat
A financial or other interest that causes bias so objectivity is threatened

Response: Auditors must monitor fee levels and ensure

Example: Undue dependence on
that any outstanding fees are settled before starting any
fees, unpaid fees, owning shares
new work. Any shares held by key audit staff should either
in a client.
be sold or the member of staff removed from the audit.

Self-review threat
Conscious or unconscious bias in reviewing the original work threatens objectivity

This occurs when, for example, an

auditor reviews work that he has Response: Separate teams.
already prepared.

Advocacy threat
Bias may arise from being so involved in justifying a client’s actions.

Example: Professional accountant Response: The auditor should decline any offer to
promotes shares in an audit advocate the work of their clients.
client.

Familiarity threat
Again, this causes bias, so objectivity is threatened

Example: A member of the Responses: Any member of the audit team who has a
engagement team has a close “family” relationship with a senior member of the audit
family relationship with a director client should not have any involvement with that audit.
of the client or having an audit
Audit partners should be rotated every seven years (listed
client for a long period of time
companies). This should be considered for any company too
(e.g. > 7 years).
ACCA AAA 2: Professional and ethical considerations 7

Intimidation threat
Link with self-interest, the auditor may act without objectivity

Example: Being threatened with Response: Any threats should be discussed with those
dismissal or replacement in charged with governance. The auditor may also consider
relation to a client engagement or resignation.
being threatened with litigation.

Management threat
Often present at the same time as self-review threat. Partners and employees of the audit firm are
prohibited from taking decisions on behalf of the management of the audited entity. This is because
their views may become aligned with management, affecting objectivity and professional scepticism.

Example: when an auditor is Response: Auditors may give business advice but should
requested to suggest IT be careful not to in effect make business decisions for
systems to the client clients. This is a matter of professional judgement. Also
can ensure there is ‘informed management’ by obtaining
written representation of management’s understanding of
their responsibililties

Conflict of interest
For example, an audit firm with a key client in the soft drinks market might be requested to do the
audit of a rival firm in the same industry (e.g. Pepsi and Coca-Cola). This causes a threat to objectivity
(the firm might be biased towards one of the clients, eg the one that pays most or the one they’ve
been involved with the longest) and a threat to confidentiality (the firm might pass confidentiality
information from one client to the other).

Provision of non-audit services to audit clients by auditors

In the UK, many non-audit services (including internal audit services) may not be provided to listed
clients by the same firm (see UK rules later). The IESBA Code permits the provision of most non-audit
services to listed clients but with significant provisos:
 Valuation services: may not be provided to listed entities if valued item is material to the
financial statements being audited.
 Internal audit services: may not be provided to listed entities if it relates to the internal controls
over financial reporting or information that is significant to the generation of financial
statements or material to them.
 IT services: may not be provided to listed entities if it relates to the design or implementation of
systems that will generate information for the financial statements or provide controls relating
to the financial reporting system.

EXAM SMART
Ethics is examined in part d) of question 1 of the Specimen paper for 8 marks. Candidates are
asked to “identify and evaluate any ethical threats and other professional issues” based
around a scenario where the audit firm is asked to:
 Provide advice on a new accounting and management information system
 Attend a meeting with the client’s bank where they will be renegotiating their lending
facilities
 8 2: Professional and ethical considerations ACCA AAA

2 Fraud and error

KEY TERMS
 Error. An unintentional mistake or oversight made by an employee of a company.
 Irregularity. An action that is contrary to a rule or principle e.g. not depreciating a non-
current asset.
 Misstatement. The incorrect statement of a value or word e.g. a non-current asset
stated at a cost of $1m when the actual cost is $1.5m. Note that a misstatement can
occur due to an error, irregularity or fraud.
 Fraud. The intentional act by one or more individuals, involving the use of deception to
obtain an unjust or illegal advantage.

Two types of intentional misstatements:

 Those resulting from misappropriation of assets and
 Those resulting from fraudulent financial reporting.

2.1 The responsibilities for fraud and error

Management The primary responsibility for the prevention and detection of

fraud rests with both those charged with governance of the
entity and management.

External auditors The auditors’ responsibility is to consider the risk of material

misstatement in the financial statements due to fraud.

It is NOT the auditors’ responsibility to prevent fraud and error.

2.2 When and to whom fraud and error should be reported

To management/those charged with governance

Fraud suspected or Communicate with management AS SOON AS PRACTICABLE

discovered

Fraud is believed to
involve SENIOR Report to next higher level at entity i.e. AUDIT COMMITTEE
MANAGEMENT

Where no higher authority exists, or if the auditor believes that the report may not be acted upon, the
auditor should consider seeking legal advice.
ACCA AAA 2: Professional and ethical considerations 9

To the users of the auditor’s report on the financial statements (i.e. shareholders)

Express a MODIFIED opinion (i.e. ‘except for’ disagreement or

Fraud has a MATERIAL adverse)
effect on the FS

Possible material effect on FS

Auditor cannot obtain

sufficient appropriate Express a MODIFIED opinion (i.e. ‘except for’ or disclaimer)
evidence

To regulatory and enforcement authorities

POSSIBLE EXCEPTIONS Possible requirement to report in PUBLIC INTEREST (obtain legal

advice first)

3 Professional liability
An auditor or accountant can be:
 Sued by the client under the law of contract. For example, if an accountant performs a tax
return negligently, the company could bring an action against the auditor for breach of
contract, if they suffered financial loss, the remedy for which would be damages.
 Sued by a third party under the law of tort (negligence). A shareholder in a company is not
deemed to have a contract with that company’s auditor and is therefore seen in law as a third
party. To succeed in a claim of negligence, the injured party must prove:
– That a duty of care existed
– That this duty was breached
– That the breached caused actual financial loss.

3.1 Restricting auditor’s liability

There are a number of ways in which accountants can attempt to limit their liability:
 Ensuring they have good procedures over client acceptance so they do not accept risky clients.
 Performing a thorough audit with good quality control procedures.
 Incorporation –this would protect the partners (or “directors”) from personal bankruptcy.
 Limited Liability Partnership (LLPs) – permits the partners not to be personally liable for the
liabilities of the firm.
 Capping liability – would allow auditors to limit the amount of their liability for an individual audit.
 Professional Indemnity Insurance (PII) – insurance taken out by an accountant against claims
made by clients and third parties arising from work that the accountant has carried out.
 Fidelity Guarantee Insurance (FGI) – insurance taken out by an accountant against any liability
arising through acts of fraud or dishonesty by any partner or employee in respect of money or
goods held in trust by the accountancy firm.
 Disclaimers (below).
10 2: Professional and ethical considerations ACCA AAA

3.2 Disclaimer paragraphs / liability limitation agreements

A disclaimer paragraph states that the auditor’s report is intended solely for the use of the company’s
members as a body and that no responsibility is accepted to anyone other than the company and the
company’s members as a body.
Advantages Disadvantages
Helps to reduce the exposure of the audit firm to Reduces the value of an audit report.
liability claims from anyone outside of the company.
Highlights to users the fact that the audit report is Such clauses could lead to poor quality audits.
NOT a stamp of approval and is merely an opinion
which is only intended to give reasonable, but not
absolute, assurance.

When faced with questions on this topic, it is worth referring to the case of Royal Bank of Scotland v
Bannerman (“the Bannerman case’). In this case, Bannerman were the auditors of APC Ltd. The court
found that Bannerman were liable for losses incurred by a bank (RBS) that claimed to have based its
lending decision on the audited accounts of APC, who subsequently failed.

4 Professional and ethical developments

Any question on professional and ethical developments is likely to be covered by an article in Student
Accountant prior to the exam. The week before your exam, visit the ACCA website, see if there are any
relevant articles about recent issues, and familiarise yourself with it if so.
www.accaglobal.com/uk/en/student/exam-support-resources/professional-exams-study-
resources/p7/technical-articles.html.

EXAM SMART
In the Specimen paper current issues are tested in question 3 part a) for 8 marks. This
question focusses on the provision of non-assurance services to audit clients.

5 Additional notes for UK Stream Students

As well as the ACCA Code of Ethics, UK auditors are also bound by the Ethical Standards Code, issued
by the FRC.

Part A Overarching Principles and Supporting Ethical Provisions

Part A covers the fundamental concepts of integrity, objectivity and independence.
Integrity Being trustworthy, straightforward honest and fair and behaving in a way that would uphold
public trust in the profession.
Objectivity This is a state of mind; being uncontaminated, acting impartially without discrimination or bias.
Independence: This is how we appear to others: freedom from situations and relationships which
make it probable that a reasonable and informed third party would conclude that objectivity either is
impaired or could be impaired. Independence is related to and underpins objectivity.
ACCA AAA 2: Professional and ethical considerations 11

Part B

Section 1
Section 1 deals with policies, procedures and roles to be put in place by the firm to help facilitate
compliance with the other sections.

Section 2: Financial, business, employment and personal relationships

The audit firm, any partner in the firm or anyone in a position to influence the audit should not hold
any direct or indirect financial interest in the client.
The auditor should not enter into business relationships with a client or its management except in the
ordinary course of business or where the transaction is clearly immaterial.
An audit firm should not employ a person to undertake audit work if that person is also employed by
the client. Similarly, an audit firm should not enter into an agreement with the client to provide a
partner or employee to work for a temporary period.
Where a partner leaves the audit firm and is appointed as a key manager with a client, the audit firm
should resign as auditor and shall not accept reappointment for another two years.

Section 3: Long association with the audit engagement

Where audit partner and key staff have a long association with a client, safeguards should be applied,
such as rotating the audit partner and having a second partner review. After ten years apply
‘reasonable third party test’ to ensure independent.
For listed clients, no partner shall act as partner for more than five years. Engagement quality control
reviewers, key partners involved in the audit and senior staff for listed clients can’t be a quality control
reviewer after seven years for a further five years. An audit tender should be carried out every 10
years and there should be a mandatory rotation of audit firm every 20 years.

Section 4: Fees, remuneration, litigation, gifts and hospitality

Percentage or An audit cannot be undertaken on a contingent fee basis.
contingent fees
High percentage Where total fees for both audit and non-audit services will regularly exceed 10% for a
of fees listed entity and 15% for an unlisted entity the firm must not act as auditor.
Where total fees from an audited entity exceed 5% for a listed entity (10% for an
unlisted entity) the audit engagement partners should disclose that fact to the ethics
partner and those charged with governance of the audited entity.
Where non-audit services are permitted they are limited to no more than 70% of the
audit fee, calculated on a rolling three-year basis.
Lowballing Where the fee quoted is significantly lower than would have been charged by the
predecessor firm the engagement partner must be satisfied that:
The appropriate staff and time are spent on the engagement irrespective of the fee
All assurance standards and quality control procedures have been complied with.
Fee has not been influenced by the provision of non-audit services.
Gifts and Unless the value of a gift or hospitality is clearly insignificant, a firm or a member of an
hospitality engagement team should not accept them.
12 2: Professional and ethical considerations ACCA AAA

Evaluation  There should be a firm’s policy on the extent to which gifts, hospitality etc may be
policies accepted from audited entities.
 Audit staff should not be assessed, or have their performance appraisal or their
pay related to their ability to cross sell the firm’s products.
 For listed clients, an external independent quality control review (hot review)
MUST be undertaken.
 The firm should resign as auditor where there is actual or potential litigation
between the firm and the audited entity.

Section 5: Non-audit services provided to audit clients

Service Implications
Internal audit Listed companies: Prohibited.
Unlisted companies: The firm should not undertake internal audit work, where its external
audit opinion is based on significant reliance on its internal audit role or where it would
take the role of management
Valuation and Listed companies: The firm should never undertake valuation services for listed audit
actuarial entities
valuation Unlisted audited entity: Not where the valuation would:
Involve a significant degree of subjective judgement, and
Have a material effect on the financial statements.
IT Listed companies: The firm should not undertake work on IT systems which would be
important to any significant part of the accounting system on which the auditors would
place significant reliance.
Unlisted companies: Only if they are not significant to the accounting system or
production of financial statements.
Tax Listed companies: the firm must not prepare, calculate or provide tax advice including
deferred tax services.
Unlisted companies: the firm should not undertake tax services which:
 Could involve undertaking a management role
 Material to the financial statements (calculation of current and deferred tax)
 Dependent on a future or contemporary audit judgement.
Transaction Transaction related services are ‘one-off’ engagements such as due diligence work. Such
related work often involves undertaking a management role.
Listed companies: Prohibited
Unlisted companies: The firm needs the client to have ‘informed management’
Accounting Listed entities: Prohibited
Unlisted companies: Such judgements on accounting policies and presentation would
involve the auditor undertaking a management role which must be safeguarded against.

Section 6 Provisions Available for Small Entities

In the context of work with smaller entities there is some relaxation of the above rules.
 13

Practice management

1 Quality control
1.1 At a firm level
The firm must implement policies and procedures to ensure overall quality control systems exist:

Ethical The firm should gain reasonable assurance that the firm and its personnel
requirements comply with relevant ethical requirements.

Human resources The firm should have assurance that it has sufficient personnel with the
competence, and commitment to ethical principles necessary to perform
its engagements in accordance with professional standards. Such policies
and procedures address issues including recruitment, performance
evaluation and promotion.

Client acceptance Before accepting a new client, an audit firm should carry out the following
procedures procedures:
(a) Ascertain the level of risk attached to the client e.g. possible money
laundering. The auditor will need to assess the integrity/reputation
of the client.
(b) Ascertain whether the firm has adequate resources to perform the
work.
(c) Ascertain whether the firm has the necessary technical competence
to perform the work.
(d) Ensure that he is independent of the client.
(e) Obtain professional clearance from the outgoing auditors.
(f) Discuss and agree the terms of engagement (in the engagement letter).
14 3: Practice management ACCA AAA

1.2 Quality control for audits

Firms must ensure quality on individual audit engagements, including the adequate planning,
direction and supervision and review of all audit engagements.
For example, supervision should be continuous during the engagement. Any problems that arise
during the audit should be rectified as soon as possible.
All audit work should be reviewed by a more senior audit staff member. The engagement partner
should carry out an overall review of the working papers. He should examine all key areas of
judgement and all audit evidence relating to high risk areas.
The firm should require an engagement quality control review for all audits of financial statements of
listed entities.

EXAM SMART
Questions often ask students to “identify the ethical and other professional issues” in a
scenario.
As well as the ethical threats to independence outlined in Chapter 2, the “professional
issues” often include quality control issues such as a lack of planning, direction, supervision
or review of an audit junior.
Quality control can also be examined together with completion, as quality control reviews
often take place when the audit field work has finished. In the Specimen paper question 2
part a) for 10 marks, candidates are asked to “explain the quality control and other
professional issues raised, discussing any implications for the completion of the audit.” This
question is located in the appendix to these revision notes.
In an exam question, be conscious of timings. If you are doing a hot review (ie before the
audit report is signed) it is appropriate to suggest changes to the audit opinion. If you are
doing a cold review, it is not. In either case, if the audit field work is finished, it will not be
appropriate to suggest removing an individual from the audit team!

1.3 Quality control developments

Current guidance being developed on both areas above (to keep quality guidance up to date and to
account for issues such as technological developments). Also, guidance being developed specific to the
quality control engagement review required for listed companies.

2 Advertising, publicity and obtaining professional work and fees

Audit firms are allowed to advertise, but advertisements should not:
 Bring ACCA into disrepute or bring discredit to the member, firm or the profession generally
 Mislead the reader
 Contravene the requirements of the relevant advertising codes

2.1 Fees
Where reference is made to fees, the basis on which those fees are calculated, (e.g. hourly rates)
should be clearly stated.
Fees should not be charged on a percentage, contingency or similar basis, save where that course of
action is generally accepted practice for certain specialised work.
ACCA AAA 3: Practice management 15

2.2 ‘Lowballing’
This is where the audit fee for the first year of the audit is set particularly low in order to win the client
in the hope of keeping the client for a number of years in order to recoup these initial losses or in the
hope of winning lucrative non-audit work, such as the tax work.

There is a risk relating to professional competence if the non-audit work does not materialise and the
lowballing firm comes under pressure to cut corners or resort to irregular practices (e.g. the
falsification of audit working papers) in order to ‘keep within budget’.

3 Tendering
There are various reasons why an entity might change its auditor:
 The client may perceive the audit fee to be too high or poor value for money.
 The client may have become too large for its auditors.
 The audit firm may have new independence issues with the client
 The auditor may have doubts about the integrity of the client staff.
 A breakdown in the working relationship between the auditor and the client.

3.1 Matters to be considered when a firm is invited to submit a proposal or

fee quote for an audit

Independence checks (fee

Audit firm resource levels, shareholdings)

Preparing a Additional services that

Any client-specific risks,
proposal could be offered
deadlines

Any specialist skills required Previous audit fee

16 3: Practice management ACCA AAA
 17

Planning and risk assessment

1 Materiality guidelines
An item may be considered material if it is:
 Above ½% of revenue
 Above 1% of total assets
 Above 5% of profit before tax
Note that you should apply these percentages appropriately. For example, when determining whether
an asset is material or not, you should compare the asset value to the total assets. If you are looking at
an expense, you should compare that to revenue and profits.

1.1 Performance materiality

“Performance materiality”, which should be used to record all misstatements which could accumulate
into a material misstatement. These are often recorded on a Schedule of Unadjusted Misstatements.
At the end of the audit, misstatements that have a similar effect are added up, to assess whether
overall a material misstatement exists.
18 4: Planning and risk assessment ACCA AAA

2 Risk
2.1 Business risk
Business risk is defined as a threat which could mean that a business fails to meet one of its key
business objectives.

EXAM SMART
In questions on business risk, you should focus on any factors which would have an impact on the
client’s revenue, costs, profits or reputation. Essentially, you have to ignore any accounting issues.
Use wording like “there is a risk that...”.

2.2 Risk of material misstatement

Risk of material misstatement is the risk that a set of financial statements are materially misstated,
through inaccurate or incomplete recording of transactions or disclosures.

EXAM SMART
The Examiner could use the term “financial statement risk” instead of “risk of material
misstatement”.

Material misstatement is defined as the risk that the financial statements are materially misstated
prior to audit, and consists of two components – inherent risk and control risk.

These are two components of the audit risk model, the third being detection risk. When answering a
requirement based on the risk of material misstatement you should focus your answer on inherent
risk and control risk factors only.

DETECTION RISK IS NOT PART OF THE RISK OF MATERIAL MISSTATEMENT.

There is usually a direct relationship between business risk and financial statement risk. For example,
if a company identifies slow-moving inventory as a business risk, then there is a financial statement
risk that inventories are overstated in the FS.
In order for you to adequately identify any financial statement risk, you must be familiar with the
appropriate accounting treatment for the item in the question.

EXAM SMART
A good approach to questions on financial statement risk would be:
 State whether the item is material or not in relation to relevant comparator (eg X% of
total assets)
 State the relevant accounting rules relating to the topic in the question and how they
are or are not met (show off your accounting knowledge).
 Use wording such as “there is a risk that ”X” is overstated/understated/omitted/ not
disclosed properly in the financial statements due to…”.
ACCA AAA 4: Planning and risk assessment 19

2.3 Audit risk

Audit risk is the risk of giving an inappropriate opinion on the financial statements. Another way of
looking at this is that it is the risk of the financial statements containing a material misstatement and
the auditors not detecting that misstatement.

For exam purposes, you can treat questions asking you to discuss audit risks in a similar way to
questions on “financial statement risk” outlined above. There may be additional considerations
relevant to detection risk, such as “new audit client” but most of the “audit risks” will be risks that the
financial statements are inaccurate.

EXAM SMART
Audit risk is examined in the first part of question 1 of the Specimen paper for 20 marks.
Candidates are asked to “evaluate the audit risks to be considered in planning the audit of
the Group, using analytical procedures to identify relevant audit risks”
This question is located in the appendix to these revision notes.

2.4 Analytical procedures / analytical review

The auditor should apply analytical procedures at three distinct stages of the audit:
 At the planning stage to assess risk and to obtain an understanding of the entity.
 During the final audit, as a substantive test.
 In the overall review at the end of the audit.

2.5 Obtaining an understanding of a given entity and its environment

There are five main aspects of the client’s business which the auditor should understand:

Industry and The industry in which the company operates, including the level of
regulatory framework competition and the level of technology used in the industry.

Nature of the entity Having an understanding of the legal structure of the company, the
and its accounting ownership and governance structure, and the main sources of
policies finance used by the company.

Objectives and Having an understanding of what the directors are trying to

strategies and related achieve and what difficulties that exposes the company to.
business risks

Measurement and Understanding the performance measures which management and

review of the entity’s others consider to be of importance e.g. profit-related pay.
financial performance

Internal control includes the control environment, the entity’s risk

Internal control assessment procedures, information systems, control activities,
and the monitoring of controls.
20 4: Planning and risk assessment ACCA AAA

Remember that there is an exposure draft on guidance relating to understanding the entity and
planning – watch out for technical articles in this area which might suggest an exam question on the
related issues.

2.6 Big data and data analytics

Big Data is a significant feature of modern business. It is large data sets drawn from a number of
sources, including social media. Businesses increasingly use such data in their business.
Auditors are also making increased use of data analytics which are computer programmes capable of
interrogating huge quantities of data and presenting it differently, in a way that can be useful for risk
identification.

Examples of the use of data analytics on an audit

 Comparing cost price of items of inventory with most recent sale price (large scale NRV testing)
 Analysis of revenue trends (by region/product/season/month)
 Analysis of which ‘users’ did what in the system, ie segregation of duty testing
 Matching of purchase orders to purchase invoices/goods received notes/payments
 21

Audit evidence

1 Evidence
1.1 Related parties
A party is related to an entity when the party “controls, is controlled by or is under the common
control of the entity”.

Management Is responsible for the identification and disclosure of related parties and
transactions with such parties.

Auditors Is responsible for ensuring the disclosure of related parties and

transactions with such parties in the FS is true and fair.

Problems with the audit of related parties

 Easy to conceal from the auditors, particularly if they are at nil value.
 It may not be easy to determine exactly who is and who isn’t a related party (the rules
surrounding related parties are a bit of a grey area).
Possible audit procedures include reviewing prior year working papers for names of known related
parties and reviewing shareholder records to determine the names of principal shareholders.
22 5: Audit evidence ACCA AAA

1.2 Written representations

The letter usually confirms items such as whether all matters occurring since the reporting date have
been brought to the auditors’ attention and whether all of the accounting records have been made
available to the auditors.
If management refuses to provide a representation that the auditor considers necessary, this
constitutes a scope limitation and the auditor should express a qualified opinion or a disclaimer of
opinion.

1.3 Use of experts

 Evaluate the competence of the expert (qualifications/experience)
 Evaluate the independence of the expert
 Evaluate the adequacy of the work of the expert

1.4 Use of internal audit

 Obtain an understanding of the function (status/scope/competence/approach)
 Perform work on whether the specific work to be relied on is adequate
 In some jurisdictions IA can be used to give direct assistance on audit (with restrictions)

2 Audit procedures and evidence evaluation

EXAM SMART
Typical questions on this area include the wording:
“Comment on the matters to consider and state the audit evidence you should expect to
find in respect of...”
“Recommend the principal audit procedures to be performed in relation to X”

2.1 Matters to consider

When faced with questions asking you for “matters to consider”, it is worth using wording such as:
 “The item is material/not material because”  use the figures in the question to help you
determine whether the matter is material or not. Nine times out of ten, it will be material.
 “The item is/is not correctly accounted for using the accounting standard on ...”.  this gives
you an opportunity to show off your financial reporting knowledge on a particular topic to
determine whether the item is correctly valued or disclosed in accordance with accounting
standards.
ACCA AAA 5: Audit evidence 23

2.2 Evidence
Be careful with the “evidence” part of these questions.

“Audit evidence you Essentially the documents that you would expect to see on an
would expect to find” audit file relating to the matter.

 This will almost always include invoices and written representations but not “discuss with
management” although if evidence would be restricted to management, it would be
appropriate to write ‘notes of a discussion held with management about….’

2.3 Procedures

“Audit procedures” May include “discussions” and other procedures, eg

inspections/confirmations/recalculations that will prove an
assertion.

EXAM SMART
Audit evidence is examined in question 1 part c) of the Specimen paper for 10 marks.
Candidates are asked to recommend the principal audit procedures to be performed in
respect of an investment in associate and a brand name within non-current assets.

2.4 Corresponding figures and comparative financial statements

KEY TERMS
 Corresponding figures ─ where amounts and other disclosures for the preceding period
are included as part of the current period financial statements. Most commonly seen
in financial statements. Since the auditor is forming an opinion on the current year’s
accounts as a whole, they will also need to review these corresponding figures.
 Comparative financial statements ─ where amounts and other disclosures for the
preceding period are included for comparison with the financial statements of the
current period, but do not form part of the current period financial statements.

The auditor should determine whether the accounting policies used are consistent with those of the
current period and whether the amounts agree to those presented in the prior period.
When the auditor’s report on the prior period included a qualified opinion and the matter which gave
rise to the modification is:
(a) Unresolved and results in a modification of the auditor’s report regarding the current period
figures ─ the auditor’s report should also be modified regarding the corresponding figures; or
(b) Resolved and properly dealt with in the financial statements, the current report does not
ordinarily refer to the previous modification. However, if the matter is material to the current
period, the auditor may include an emphasis of matter paragraph dealing with the situation.
When the comparatives are presented as comparative financial statements, the auditor should issue a
report in which the comparatives are specifically identified because the audit opinion is expressed
individually on the financial statements of each period presented.
24 5: Audit evidence ACCA AAA

If the opinion on that period had changed since it was originally issued, an emphasis of matter
paragraph should be used to explain why.

3 The impact of social and environmental matters on audit

Auditors must be aware of social or environmental matters which have an impact on the financial
statements.
In particular, such issues might impact on financial statements in terms of:
 Assets being impaired by environmental events
 Provisions being needed for breaches of environmental policies (if constructive obligation) or
regulations (legal obligations)
 Contingent liabilities where such potential liabilities are possible rather than probable.
 25

Group Audits

1 Group Audits
Ginny plc
31.12
Audit & Co

Willmott Ltd Harford Ltd Gleeson Sarl Watson Ltd Fleetwood Ltd
31.12 31.12 31.12 31.12 31.10
40% 100% 100% 75% 65%
UK UK France UK UK
Audit & Co Audit & Co Audit & Co Tickit & Bash Audit & Co

The group auditor is responsible for providing the audit opinion on the group financial statements.

“Components” of the group financial statements can include subsidiaries, associates, joint ventures,
and branches. The components are audited by ‘component auditors’.

Component auditors may be the same firm, and even engagement team, as the group auditor, but it
may be a different firm altogether.

1.1 Acceptance/continuance of a group audit

The auditor should only accept or continue appointment as the group auditor if the group engagement
partner concludes that it will be possible to obtain sufficient appropriate audit evidence on which to
base the group audit opinion.
26 6: Group audits ACCA AAA

1.2 Planning a group audit

Group auditor must understand:
 The group
 The components
 The consolidation process
Group auditor must evaluate whether components are significant or not.
 Individually financially significant (different from material, and a matter of audit judgement but
15% benchmark can be used)
 Potential for significant risk of material misstatement in group accounts (again, judgement)
Group auditor determines audit approach to components (for the purpose of the group audit)
 Individually financially significant component: Full audit
 Significant component through significant risk of material misstatement in group accounts:
Procedures to address the risks (could range from full audit to specific procedures)
 Individually insignificant component: Analytical procedures at group level
Overall auditor must ensure that sufficient appropriate audit evidence is obtained for group financial
statements as a whole (which may involve performing more work on some individually insignificant
components).
Group auditor determines whether the work done to support the group audit opinion is done by
component auditors or group auditors.
In relation to significant components, group auditor must be involved in risk assessment.

1.3 Component auditors

Component auditors are auditors who, at the request of the group engagement team, perform work
on the financial information related to a component for the group audit.

Component auditors may be from the same firm as the auditor but may also be a different firm.
The group auditor should ensure that the component auditor is independent and competent and able
(in terms of resources) to obtain sufficient appropriate audit evidence.
Specific procedures relating to the work of the component auditor:
 Review the local ethical code (if any) followed by the component auditor.
 Establish whether the component auditor is a member of an auditing regulatory body, and the
professional qualifications issued by that body.
 Obtain confirmations of membership of any professional body.
 Discuss the audit methodology used by the component auditor, and compare it to those used
under ISAs (e.g. how materiality is calculated).
 A questionnaire or checklist could be used to provide a summary of audit procedures used.
 Ascertain the quality control policies and procedures used by the component auditor
In addition to the matters above, the risk of material misstatement in the subsidiary being audited by
the component auditor must be fully assessed, as areas of high risk may require input from the group
audit team.
ACCA AAA 6: Group audits 27

For areas of high risk, the group audit team may consider providing instructions to the component
auditor on the audit procedures to be performed.

1.3.1 Communication with the component auditor

The group auditor and the component auditor should communicate with each other on a timely basis.
Such communications would include:
 A request that the component auditor will cooperate with the group auditor
 The component’s materiality
 Information on instances of non-compliance with laws or regulations that could give rise to a
material misstatement of the group financial statements;
 A list of uncorrected misstatements of the financial information of the component
 Indicators of possible management bias;
 Description of any identified material weaknesses in internal control;
 Other significant matters that the component auditor communicated to those charged with
governance of the component, including fraud;
 The component auditor’s overall findings, conclusions or opinion.
It may be the case that, having performed the actions outlined above, the group auditor concludes
that further audit work is required on the financial statements of a company.
The group auditor takes sole responsibility for the group audit opinion. This means that the auditor’s
report on the group financial statements should not refer to a component auditor.

1.3.2 The auditor’s report on the financial statements of an entity where the opinion on
a component is modified
The group auditor issues an opinion on the consolidated financial statements as a whole. He should
therefore consider the materiality of any modifications to a component’s audit report to the group as
a whole.
Since the materiality level of the group accounts will almost certainly be higher than the materiality
level for any subsidiary, the auditor will need to assess whether the “material” modification in the
subsidiary’s books is “material” in the context of the group.
Similarly, a pervasive modification in a subsidiary may only be considered material in a group context.
A modified audit report may also be appropriate if the group auditor is unable to satisfy himself as to
the adequacy of evidence available for the subsidiary’s accounts.

EXAM SMART
Group audits are examined in the first question of the Specimen paper. In part b) candidates
are asked to “explain the matters to be considered, and the procedures to be performed” in
respect of planning to use the work of a component auditor.
28 6: Group audits ACCA AAA

1.4 Matters to consider when auditing groups

1.4.1 Classification of investments
An auditor will need to ascertain whether investments have been correctly treated in the group accounts:

KEY TERMS
 Subsidiary – any company which the parent company controls.
 Associate – any company over which the parent has significant influence.

The degree of influence could probably be simply vouched to the percentage of shares owned, which
can be vouched back to share certificates or the degree of influence (such as representation on the
board of directors).

1.4.2 Differing accounting policies

A group must prepare its accounts using a single set of accounting policies. If a subsidiary or associate
has a different accounting policy, it must convert these policies into the group’s policies.

1.4.3 Non-coterminous financial year-ends

A subsidiary should prepare financial information to the same year end as the group, unless their year-
ends are less than 3 months apart and significant transactions are adjusted for.

1.4.4 Overseas components

Further problems may arise if the component is based overseas:
 Its geographical location may mean that overseas auditors may have to be used.
 The local audit may be different in scope from that required in the parent company’s own country.
 Different accounting policies may be used.
 Language problems may arise with foreign subsidiaries and liaising with the local auditor.
 Translation of the amounts in the foreign currency financial statements will be required.

1.4.5 Auditing the consolidation

Audit procedures include:
 Checking that figures have been accurately extracted from the accounts of the components
 Gathering evidence appropriate to the specific consolidation adjustments:
– Goodwill calculation and impairment review
– Fair value adjustments
– Calculation of the non-controlling interest
– Cancellation of inter-company balances and transactions
– Provision for unrealised profits as a result of inter-company transactions
– Re-translation of financial statements of components denominated in a foreign currency.
 Recalculating the consolidation schedule to confirm mathematical accuracy
 Recalculating the time apportionment of the results for components acquired or disposed of
during the year.
 Re-translation of financial statements of components denominated in a foreign currency
 Reviewing the disclosures, such as related party transactions and non-controlling interests
ACCA AAA 6: Group audits 29

1.5 Joint audits

A joint audit is when two audit firms each sign the audit report on a set of financial statements.

1.5.1 Advantages and disadvantages of joint audits

Advantages Disadvantages
When a new subsidiary is acquired by the group, the The group auditor will also need to build up
parent company may want to keep the subsidiary’s knowledge of the new subsidiary’s business and
existing audit firm, which will have built up also become familiar with the audit methods and
considerable knowledge and experience of the procedures used by the other auditor.
business of the component.
Better availability of resources, as there will be It may be difficult for the two firms to work together
access to staff from both firms. if they use different audit methods.
The inclusion of members of staff from the group Cost implications for the client.
audit firm within the audit team of the subsidiary
should also improve the efficiency of the audit of
the consolidation process.

2 Transnational audits
IFAC defines a “transnational audit” as an audit of financial statements which may be relied upon
outside the audited entity's home jurisdiction for purposes of significant lending, investment or
regulatory decisions.

This will include audits of all financial statements of companies with listed equity or debt and other
public interest entities which attract particular public attention because of their size, products or
services provided.
Audit risk is higher on a transnational audit due to the following factors:
 Some components may be audited using standards other than ISAs, which may impact audit
quality
 Some components may prepare their financial statements under different frameworks to IFRS,
resulting in the need for adjustments, restatements and reconciliations
 Component auditors will be subject to different levels of regulation and oversight, which may
impact audit quality
 Components will be subject to varying Corporate governance requirements, which may result in
weaker control environments or the need for additional compliance work
In order to promote consistent and high quality standards of financial reporting and auditing practices
worldwide, a “Forum of Firms” has been established. The Forum brings together firms that perform
transnational audits, including the “big 4” firms of accountants.
30 6: Group audits ACCA AAA
 31

Completion and reporting

EXAM SMART
Completion and reporting will be tested in one of the 25 mark questions in your exam. In the
Specimen paper it appears in question 2, which focusses on:
 Quality control and completion
 The evaluation of uncorrected misstatements
 The impact of unadjusted misstatements on the auditor’s opinion and report

1 Subsequent events
Subsequent events are events occurring between the period end and the date of the auditor’s report
and those discovered after the date of the auditor’s report.

Time

Reporting Adjusting Non-adjusting Auditor’s FS issued

date event event report
issued

1 2 3

Events occurring up to the date of the Auditor’s Report – period 1

The auditor has an active duty to search for any material subsequent events – ie carry out relevant
procedures (inquiry, inspection of board minutes or cash books are key procedures)
32 7: Completion and reporting ACCA AAA

Facts discovered after the date of the Auditor’s Report but before the date the financial statements
are issued – period 2
The auditor only has a duty to act if they are made aware of something – a “passive duty”
Facts discovered after the financial statements have been issued – period 3
The auditor only has a duty to act if they are made aware of something – a “passive duty”

2 Going concern
Under the going concern assumption, an entity is ordinarily viewed as continuing in business for the
“foreseeable future” with neither the intention nor the necessity of liquidation. This “foreseeable
future” should be at least 12 months after the period end.

Management should assess the entity’s ability to continue as a going concern and ensure
that the correct basis of preparation is made. Where the directors intend to
cease trading, the financial statements should be prepared on a ‘break up’
basis.

Auditor
must consider the appropriateness of the management’s use of the going
concern assumption in the preparation of the financial statements.

2.1 Procedures
In order to establish whether a company is a going concern or not, the key evidence the auditor will
review is management’s assessment of going concern. They should evaluate whether:
 It is reasonable (which may involve testing of any cash forecasts included and any assumptions
made, for example, in relation to sales trends in the coming year)
 It takes into account all the issues that the auditor is aware of relating to going concern.
Where the client has prepared forecasts suggesting that there is no problem with going concern, the
auditor should
 Compare previous years’ forecasts with actual results to determine the historical accuracy of
the client’s forecasts as this will give a degree of assurance about whether the current forecast
is likely to be accurate.
If the auditor has identified events or conditions that raise doubt concerning going concern, the
auditor should perform additional audit procedures:
 Obtain a copy of the cash flow forecast and discuss the results of this with the directors.
 Make enquiries of the directors and examine appropriate documentation supporting the
company’s going concern status such as budgets and cash flow forecasts.
 Consider the appropriateness of assumptions which directors have made, the sensitivity of
assumptions to external and internal changes, the existence and adequacy of borrowing
facilities and the directors’ plans to deal with any going concern problems.
ACCA AAA 7: Completion and reporting 33

 Document the extent of any concerns, taking account of matters that have come to their
attention during the course of the audit and in particular, financial, operational, or other
indicators of going concern problems that are present.
 Obtain the entity’s latest available interim financial statements to ascertain whether there is
sufficient audit evidence to confirm or dispel whether or not a material uncertainty regarding
going concern exists.
 Make enquiries of the entity’s lawyer regarding the existence of litigation and claims and the
reasonableness of management’s assessments of their outcome and the estimate of their
financial implications.
 Seek written representations from management regarding its plans for future action.
 Review correspondence from company bankers regarding continuance of loan facilities.
 Review receivables ageing analysis to determine whether there is an increase in days – which
may also indicate cash flow problems.

3 Evaluation of misstatements
Auditors must:
 Accumulate misstatements unless clearly trivial
 Consider whether it is necessary to revise audit plan as a result of identified misstatements
 Communicate identified misstatements to management on a timely basis
 Evaluate the impact of uncorrected misstatements on the audit opinion
 Perform procedures to ensure misstatements do not remain when management have corrected
 Obtain written representations concerning uncorrected misstatements
When evaluating misstatements, consider their nature:
 Factual misstatements are misstatements about which there is no doubt. Should be corrected.
 Judgemental misstatements are differences arising through judgements (ie where management
and auditor judgements differ in relation to a particular item or policy). Should probably be
corrected, particularly if auditor believes management judgement leads to material
misstatement (or will result in qualified opinion)
 Projected misstatements are the auditor’s best estimate of misstatements in populations based
on audit testing. Should not be adjusted for – testing should be extended and actual
misstatements adjusted.
34 7: Completion and reporting ACCA AAA

4 Auditor’s reports
An unmodified audit report states that the financial statements present fairly in all material respects
(UK: give a “true and fair” view of) the financial statements.

4.1 Modified report with an unmodified opinion

4.1.1 Material uncertainty relating to going concern
This paragraph is used where:
 A material uncertainty related to going concern exists
 This has been adequately disclosed in the financial statements, so they give a true and fair view.
 The auditor gives an unmodified opinion.
However, as the uncertainty is material, the auditor will emphasise the material uncertainty by
highlighting it in a paragraph after the basis of opinion paragraph under the heading “Material
uncertainty relating to going concern”. This will draw attention to the disclosures made by the
directors in the FS concerning the uncertainty, and will confirm that the audit opinion is not modified
in relation to this matter.

4.1.2 Emphasis of matter

The emphasis of matter paragraph is used to draw users’ attention to matters presented within the
financial statements that are of such importance they are fundamental to the users’ understanding.
There is no material misstatement and sufficient, appropriate evidence has been obtained so the
auditor will give an unmodified opinion.
Examples of when an emphasis of matter paragraph may be appropriate include:
 An uncertainty relating to the future outcome of litigation
 A major catastrophe that has had a significant effect on the company’s financial position

4.1.3 Other Matter Paragraphs

The Other Matter paragraph is included in an auditor’s report to refer to a matter other than those
presented in the financial statements that, in the auditor’s judgement, is relevant to users’
understanding of the audit, the auditor’s responsibility or the auditor’s report.
Examples of such matters include:
 An elaboration on matters that provide further explanation of the auditor’s responsibility or
audit report
 Any restrictions on the distribution of the auditor’s report
 The auditor may be reporting on more than one set of financial statements using different
frameworks (e.g. one according to UK GAAP and one according to international standards)

4.2 Modified report with a modified opinion

 Qualified opinion – inability to obtain sufficient appropriate audit evidence, potentially material
 Qualified opinion – material misstatement
 Pervasive inability to obtain sufficient appropriate audit evidence (“disclaimer” of opinion)
 Pervasive misstatement (“adverse” opinion)
ACCA AAA 7: Completion and reporting 35

Has the auditor received

all of the information and
explanations required to
form an opinion?
Yes No

Modified audit opinion due to

Does the auditor agree
an inability to obtain
with all of the numbers,
sufficient appropriate audit
disclosures?
evidence

Yes No

Unmodified audit Modified audit Material Material and Pervasive

report opinion due to a Qualified opinion Disclaimer
material of opinion
“FS give a true and
misstatement
fair view”

Material: Material and Pervasive

Qualified opinion Adverse opinion

4.3 How the audit report is modified

For modified opinions, the following wording is appropriate in the opinion paragraph:
 For a qualified opinion (material but not pervasive) : “except for the matter leading to the
modification, the financial statements give a true and fair view and have been prepared in all
material respects in line with the applicable reporting framework.”
 For adverse opinions: “the financial statements do not give a true and fair view”
 For disclaimers of opinion: “We do not express an opinion”
Where a modification occurs, the auditor must also amend the headings. “Opinion” to “Qualified
opinion” and “basis for opinion” to “basis for qualified opinion” (for material matters) or “Opinion” to
“Adverse opinion” and “basis of opinion” to “basis for adverse opinion” or “Opinion” to “Disclaimer of
opinion” and “basis of opinion” to “basis for disclaimer of opinion”, for pervasive matters, as
appropriate.
This section should explain the reason why the opinion is modified and, if possible, provide a
quantification of the financial effect of the modification.
36 7: Completion and reporting ACCA AAA

4.4 Going concern and the audit report

Is the company a
going concern?
Yes Yes, but a material No
uncertainty exists

Unmodified audit Is this fact adequately Is this fact adequately reflected in

report disclosed? the accounting basis and disclosed?

No No
Yes
Yes

Qualified audit Adverse audit

Unmodified audit opinion
opinion – material opinion – pervasive
with a material uncertainty
misstatement misstatement
relating to going concern
paragraph

Unmodified audit opinion

with an emphasis of matter
paragraph

4.5 Key audit matters

 Required for listed clients
 Permissible for non-listed clients on a voluntary basis
 Matters that in the auditors’ opinion were of most significance in audit because:
– High risk of material misstatement
– Significant auditor judgements

4.6 Auditor’s responsibilities for ‘other information’

“Other information” is included in the annual report, but is not part of the “financial statements”
e.g. the directors’ report or integrated report.

Inconsistency

An “inconsistency” is information which contradicts information contained in the audited financial

statements. For example, the environmental report in an annual report might state that profits are
£1m whereas the profit or loss account might state that profits are £1.5m.

If an amendment to the audited financial statements is required but not made, there will be
disagreement, resulting in the expression of a qualified or adverse opinion (rare).
Where an amendment to “other information” is necessary, but refused, the auditor’s report describe
the inconsistency in the ‘Other Information’ paragraph in the auditor’s report.
ACCA AAA 7: Completion and reporting 37

Misstatement of fact

A “misstatement of fact” relates to information that is unrelated to matters in the

audited financial statements but inconsistent with auditor’s knowledge of the business.

For example, the environmental report in an annual report might state that the board had met three
times to discuss a particular issue when the auditors know from reading board minutes that this is not
the case. This matter wouldn’t affect the financial statements, so the auditor will not refer to it in the
audit report, but needs to take action to not be associated with such incorrect information.
38 7: Completion and reporting ACCA AAA
 39

Other assignments

1 Audit-related and assurance services

Audit firms often have to perform work that is related to audit but does not require the firm to
produce a true and fair opinion.

Summary of audit-related and assurance services

Nature of service Audit of historic FS Review of historical FS Agreed-upon procedures
Comparative level of High, but not absolute, Limited assurance No assurance
assurance provided by assurance
the auditor
Report provided Positive assurance on Negative assurance on Factual findings of
assertion(s) assertion(s) procedures

1.1 Engagements to Review Historical Financial Statements

Objective: to enable the auditor to obtain limited assurance as to whether the financial statements
have been prepared in accordance with an identified financial reporting framework.
When: a company who used to need a statutory audit may now be exempt but still choose to have a
review or a company may choose to have its interim financial statements reviewed.
Wording: the auditor would state that ‘we are not aware of any material modifications that should be
made to the financial statements….’. - ‘assurance worded in a negative way (negative assurance)’.
A review report is addressed to the directors of the company and not to the shareholders.
If matters have come to the auditor's attention, the auditor should express a qualification of negative
assurance.
Typical audit procedures for a review engagement are similar to those for an audit but with a greater
emphasis on analytical procedures and enquiry.
40 8: Other assignments ACCA AAA

1.2 Engagements to Perform Agreed-upon Procedures regarding Financial

Information
The objective of an agreed-upon procedures engagement is for the auditor to carry out procedures of
an audit nature to which the auditor and the entity and any appropriate third parties have agreed
and to report on factual findings e.g. reporting on compliance with the UK Corporate Governance
Code.
These findings are factual in nature and so the reader will have to draw their own conclusions from
those findings. No assurance is expressed because the audit firm is simply reporting on the facts.

2 Specific assignments
2.1 Due diligence reviews
This is a form of “fact-finding” audit which most commonly takes place when one entity is purchasing
another. The purpose of due diligence includes:
 Information gathering – to ensure the acquirer has full knowledge of the operations,
performance, legal and tax situation of the target company.
 Verification of specific management representations e.g “we have never been the subject
of a tax investigation”
 Identification of assets and liabilities, including items such as brands which aren’t
recognised in the financial statements
 Operational issues such as high staff turnover
 Acquisition planning, including the commercial benefits and drawbacks of the acquisition.
 Management involvement can be reduced, allowing them to spend time on the “core”
areas of their business
 Credibility of the investment decision is enhanced
The scope of a due diligence assignment will draw upon a wide range of sources of information, including:
 Employment contracts – to see if there are any payments that may need to be made in
the event of redundancies
 Organisational structure – identifying who does what
 Audited financial statements
 Latest management accounts and forecasts
 Correspondence with solicitors – to see if there is any pending litigation
 Correspondence with banks, confirming overdraft limits and loan arrangements

2.2 Review of interim financial information

Such reviews largely follow the process of a review as set out earlier. There is specific guidance relating
to reviews of interim financial information.
ACCA AAA 8: Other assignments 41

2.3 Prospective financial information (PFI)

PFI means financial information based on assumptions about events that may occur in the future and
possible actions by an entity. It can be in the form of a forecast, a projection or a combination of both.

A “forecast”. PFI which management expects to take place and the actions management expects to
take as of the date the information is prepared (best-estimate assumptions). A forecast is often used
to estimate the figures for a short time period (i.e. less than a year).

A “projection”. PFI prepared on the basis of assumptions about future events and management
actions. A projection is generally for periods of more than one year (typically two to five years).

EXAM SMART
The review of prospective financial information features in question 3 part b) of the
Specimen paper for 15 marks. Candidates are asked to:
 Explain the matters to be considered before accepting the engagement
 Describe the procedures to be performed in respect of the forecast statement of profit
or loss
 Discuss the content of the report and the level of assurance that will be provided

2.4 Forensic audits

Forensic accounting utilises accounting, auditing, and investigative skills to conduct an examination
into a company’s financial statements. The aim of forensic accounting is to provide an accounting
analysis that is potentially suitable for use in court.

Forensic accounting is an umbrella term encompassing both forensic investigations and forensic
audits. It includes the audit of financial information to prove or disprove a fraud, the interview process
used during an investigation, and the act of serving as an expert witness.
A forensic investigation is a process whereby a forensic accountant carries out practical procedures to
gather evidence, which could ultimately be used in legal proceedings or to settle disputes. This could
include, for example, an investigation into money laundering or an investigation into theft from
company premises.
42 8: Other assignments ACCA AAA

3 The audit of social, environment and integrated reporting

EXAM SMART
In the exam you may be asked to suggest performance indicators that reflect the client’s
social and environmental responsibilities and evidence that should be available to provide
assurance on their accuracy.

Performance indicators include:

KPI Evidence
Environmental
Level of gas emissions Output records
% of waste recycled (from total waste) Waste bills/log book of recycled amounts per week
Staff
Job satisfaction levels (% of staff satisfied or better) Questionnaire of staff or appraisal records
Percentage of female employees Human resource permanent file
Average wage per staff member Human resource permanent file
Customers
Number of customer complaints Complaints book
Number of customer injuries/accidents Accident log book, with a description of incident

4 The audit of performance information in the public sector

This section of the chapter is relevant to INTERNATIONAL Stream candidates only as this issue is not
examinable in the UK Stream.

4.1 The audit of performance information

This is a developing topic as public sector bodies (for example, governments or government
departments or services, such as the NHS in the UK) become increasingly accountable to users and are
increasingly encouraged to include performance information in their annual reporting. Such reporting
may require auditing, in addition to the financial information issued by such bodies.
Auditing performance information enables the auditor to conclude on whether performance reported
against predetermined objectives is useful and reliable, in all material respects, based on
predetermined criteria.
 43

Insolvency (UK Stream

students only)

1 Introduction
There is one significant difference between the UK and International Streams of Paper AAA, the topic
of insolvency. This topic is only relevant for students taking the UK Stream.

The following is a summary of how this topic has been examined in AAA over the last few years. Note
that this topic is not guaranteed to appear in every exam session

 Alternatives to a creditors voluntary liquidation

 Director’s personal liability on liquidation and impact of compulsory liquidation on employees
and creditors
 Determining whether a company is insolvent or not and the options open to directors
(administration or liquidation)
 Procedures needed to place a company into compulsory liquidation and the consequences of a
compulsory liquidation for a company’s creditors.
“Insolvency” refers to the inability of a company to pay for its debts as they fall due.
When a company faces insolvency, it can either go into liquidation (= stop the operations of a
company) or administration (= make an attempt to save the company with the help of the courts).
44 9: Insolvency (UK Stream students only) ACCA AAA

2 Liquidation
Liquidation (also called winding up) means the termination of a company’s operations. The assets of
the business are sold, debts are paid out of the proceeds and any surplus amounts are repaid to the
members.

Liquidation may be voluntary, (simpler, cheaper and quicker) or compulsory, i.e. ordered by court.
UK legislation on this area is contained in the Insolvency Act 1986.

Liquidation

Voluntary Compulsory
(company is insolvent)

Member’s voluntary Creditors voluntary

(company is solvent) (company is insolvent)

2.1 Compulsory liquidation

Compulsory liquidation was examined in June 2011 and June 2014.

A company is usually placed under compulsory liquidation by a payable, who uses compulsory
liquidation as a means to recover monies owed by the company. The payable would petition the court.
The most common ground for this petition is when a company is unable to pay its debts.

2.1.1 Unable to pay its debts

Where a creditor is owed more than £750 and makes a written demand to the company for payment.
If the company fails to pay the debt within 21 days and does not dispute the debt, then the payable
may present a winding-up petition at court.
The application for a winding up order will be granted at a court hearing where it can be proven that:
 The debt is undisputed,
 Attempts to recover the debt have been made, and
 The company has neglected to pay the debt.
(Note: it is also possible for a company to face compulsory liquidation under “just and equitable
grounds” if, for example, its directors fall out. This is less common.)
On a compulsory liquidation, the court will appoint an Official Receiver. This Receiver takes over
control of the company and usually begins to close it down. The company’s directors are asked to
prepare a statement of affairs. The Receiver will investigate the cause of the company’s failure.
The liquidation is deemed to have started at the date of the presentation of the winding up petition.
At the end of the winding up of the company, a final meeting with payables is held and a final return is
filed with the court and the Registrar. At this point, the company is dissolved.
ACCA AAA 9: Insolvency (UK Stream students only) 45

2.2 Consequences of a compulsory liquidation

A compulsory liquidation has an impact on three key stakeholders:

Payables – The Official Receiver will sell the company’s assets and distribute the proceeds to various
parties in a prescribed order.

Employees – are automatically dismissed and a prescribed amount of their unpaid wages paid to them
before the payables of the company.

Shareholders – get paid after all other parties have received the amounts owed to them. In most
liquidations, the shareholders receive nothing.

2.3 Voluntary liquidation

There are two parties that can “volunteer” the company to be wound up:

2.3.1 Members’ voluntary liquidation (company solvent)

The liquidation is instigated by the members via a special resolution.
The directors form a statutory declaration of solvency setting out that company will be able to meet
its debts in full. There is a fine and/or prison for directors making this statement who have no
reasonable grounds for the statement.
The members then appoint a liquidator, who sells the company assets, pays the company’s debts and
distributes surplus to members.

2.3.2 Creditors’ voluntary liquidation (company is insolvent)

The winding up is instigated by a special resolution of the company in a general meeting, by which the
company states that it cannot continue to trade because of its liabilities.

2.3.3 Creditors' meeting

The company must call a meeting of creditors for a day not later than the 14th day after the day on
which the special resolution was passed.
The notice must state either:
 The name and address of an insolvency practitioner or
 A local place where, on the two business days before the meeting of creditors is held, a list of
the names and addresses of the company's creditors will be available for inspection.
Notice of the creditors' meeting must be advertised in the legal newspaper “The Gazette” and in at
least two local newspapers.
46 9: Insolvency (UK Stream students only) ACCA AAA

2.4 Liquidator
During the period before the creditors' meeting but after the resolution for winding-up, the members
will nominate a provisional liquidator.
At the creditors' meeting the creditors may appoint their own nominee to act as liquidator. The
creditors' choice will prevail over the members' choice if there is a conflict; usually there is not.

2.5 Statement of affairs

The directors of the company must prepare and lay before the creditors' meeting a “statement of
affairs” of the company but, importantly, they do not have to make a statutory declaration of
solvency.

3 Administration
Administration puts an insolvency practitioner in control of a company with a programme to rescue
the company from insolvency as a going concern.
The aim is to try and save the company or at the very least to try and get a better deal for all creditors.
A court order is issued that forbids any form of legal or insolvency action without the court’s
permission.

An insolvency practitioner is appointed to take control of the company and to attempt to rescue it as a
going concern.
Administration protects the company from the actions of creditors while a restructuring plan is
prepared.
Administration can commence without a court order. The directors themselves may be able to appoint
an administrator where a company is unable to pay its debts, though this depends on the company’s
articles of association.
Alternatively, a majority of shareholders, the directors or one or more creditors can apply for
administration through the court. It is likely to be more expensive and time consuming to apply to the
court.
The administrator takes on the role of the directors, and within eight weeks of appointment must send
a document to the company’s shareholders and creditors in which they state their proposals for
rescuing the company, or states that the company cannot be saved.

3.1 How administration ends

 When the administration has been successful
 12 months after appointment, unless court extends
 Court order