CFAP-6 Advanced Auditing & Assurance

Study Manual

Table of Contents
ABOUT THE INSTRUCTOR....................................................................................... 5
CHAPTER 1: INTRODUCTION ................................................................................. 6
1.1 ICAP Course outline ................................................................................................................................................. 6
1.2 ICAP PAPERS ANALYSIS (of last 16 attempts till Winter 2019): ............................................................................... 9
1.3 IMPORTANT PARAGRAPH REFERENCE (VERSION 2017-18)................................................................................... 17

CHAPTER 2: AUDIT PLANNING & RISK ASSESSMENT ........................................... 20

2.1 AUDIT RISK & BUSINESS RISK CONSIDERATIONS ................................................................................................... 20
2.2 BUSINESS RISK FACTORS ........................................................................................................................................ 27
2.3 BEING ANALYTICAL ................................................................................................................................................ 28
2.4 ADDRESSING AUDIT RISK ....................................................................................................................................... 30

CHAPTER 3: AUDIT EXECUTION & CONCLUSION .................................................. 75

3.1 CONTROL ACTIVITIES AT BUSINESS PROCESS LEVEL .............................................................................................. 75
3.2 CONTROL AT VARIOUS ACCOUNT HEADS .............................................................................................................. 79
3.3 CONTROLS AND TEST OF CONTROLS ..................................................................................................................... 83

CHAPTER 4: AUDIT REPORTING........................................................................... 91

4.1 DRAFTING MODIFICATIONS: .................................................................................................................................. 91
4.2 PRACTICAL REPORTS - EXAMPLES .......................................................................................................................... 95
4.3 PROSPECTIVE FINANCIAL INFORMATION ............................................................................................................ 109

CHAPTER 5: SUMMARY OF AUDIT, REVIEW & OTHER STANDARDS ................... 112

5.1 ISA 200 – OVERALL OBJECTIVE OF THE INDEPENDENT AUDITOR ........................................................................ 112
5.2 ISA 300 - PLANNING AN AUDIT OF FINANCIAL STATEMENTS .............................................................................. 113
5.3 ISA 240 AUDITORS RESPONSIBILITY RELATING TO FRAUD IN AUDIT OF FS ......................................................... 115
5.4 ISA 705 - MODIFICATIONS TO THE OPINION IN THE INDEPENDENT AUDITOR’S REPORT ................................... 119
5.5 ISA 706 – EOMP AND OMP .................................................................................................................................. 120
5.6 ISA 570 - GOING CONCERN .................................................................................................................................. 122
5.7 ISA 701 – KEY AUDIT MATTERS (KAM) ................................................................................................................. 123
5.8 DIFFERENT TYPES OF AUDIT REPORTS IN STANDARDS ........................................................................................ 128
5.9 ISA 560 SUBSEQUENT EVENTS ............................................................................................................................. 129
5.10 ISA 510 - INITIAL AUDIT ENGAGEMENTS—OPENING BALANCES....................................................................... 131
5.11 ISA 710 COMPARATIVES FINANCIAL INORMATION ........................................................................................... 132
5.12 ISA 720 - OTHER INFORMATION CONTAINED IN THE DOCUMENT CONTAINING AUDITED FS ......................... 134
5.13 ISA 800 - SPECIAL CONSIDERATIONS – AUDIT OF FS PREPARED IN ACCORDANCE WITH SPF ........................... 140
5.14 ISA 805 - AUDIT OF SINGLE FINANCIAL STATEMENT, SPECIFIC ELEMENTS, ACCOUNTS OR ITEMS OF FS ......... 140
5.15 ISA 810 - AUDIT OF SUMMARISED FINANCIAL STATEMENTS ............................................................................ 141

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5.16 ISRE 2400 - ENGAGEMENTS TO REVIEW FINANCIAL STATEMENTS ................................................................... 142

5.17 ISRE – 2410 REVIEW OF INTERIM FINANCIAL INFORMATION ........................................................................... 146
5.18 ISRS – 4400 ENGAGEMENTS TO PERFORM AGREED-UPON PROCEDURES REGARDING ................................... 149
5.19 ISRS – 4410 ENGAGEMENTS TO COMPILE FINANCIAL INFORMATION .............................................................. 149
5.20 ISAE – 3000 ASSURANCE ENGAGEMENTS ......................................................................................................... 152
5.21 ISAE – 3400 THE EXAMINATION OF PROSPECTIVE FINANCIAL INFORMATION ................................................. 153
5.22 ISAE – 3402 ASSURANCE REPORTS ON CONTROLS AT A SERVICE ORGANIZATION ........................................... 156
5.23 ISAE – 3420 COMPILATION OF PRO FORMA FINANCIAL INFORMATION INCLUDED IN PROSPECTUS............... 159
5.24 SUMMARY CHART OF ENGAGEMENTS .............................................................................................................. 161
5.25 ISA 210 – AGREEING ON TERMS OF ENGAGEMENT .......................................................................................... 162
5.26 ISA 220 QUALITY CONTROL FOR AN AUDIT OF FS ............................................................................................. 164
5.27 ISA 230 AUDIT DOCUMENTATION ..................................................................................................................... 165
5.28 ISA 250 CONSIDERATION OF LAWS AND REGULATIONS IN AUDIT OF FS .......................................................... 166
5.29 ISA 260 - COMMUNICATION WITH THOSE CHARGED WITH GOVERNANCE ...................................................... 169
5.30 ISA 265 - COMMUNICATING DEFICIENCIES IN INTERNAL CONTROL TO TCWG ................................................. 170
5.31 ISA 402 - AUDIT CONSIDERATIONS RELATING TO AN ENTITY USING A SERVICE ............................................... 171
5.32 ISA 500 – AUDIT EVIDENCE ................................................................................................................................ 172
5.33 ISA 505 - EXTERNAL CONFIRMATIONS............................................................................................................... 173
5.34 ISA 520 - Analytical Procedures ......................................................................................................................... 175
5.35 ISA 530 - AUDIT SAMPLING................................................................................................................................ 178
5.36 ISA 540 - AUDITING ACCOUNTING ESTIMATES ................................................................................................. 179
5.37 ISA 550 - RELATED PARTIES ............................................................................................................................... 180
5.38 ISA 580 - WRITTEN REPRESENTATIONS ............................................................................................................. 182
5.39 ISA 600 - AUDITS OF GROUP FINANCIAL STATEMENTS ..................................................................................... 183
5.40 ISA 610 - USING THE WORK OF INTERNAL AUDITORS ....................................................................................... 186
5.41 ISA 620 - USING THE WORK OF AN AUDITOR’S EXPERT .................................................................................... 187
5.42 CODE OF ETHICS FOR CHARTERED ACCOUNTANTS (2019) ............................................................................... 188
5.43 IMPACT OF PERFORMANCE OF NON-ASSURANCE SERVICES ON INDEPENDENCE: ........................................... 234
5.44 ISQC & Quality control on an Individual Audit - ISA 220.................................................................................... 246
5.45 MONEY LAUNDERING ........................................................................................................................................ 249

CHAPTER 6: SUMMARIES OF IMPORTANT FINANCIAL REPORTING STANDARDS

(IAS & IFRS) ....................................................................................................... 253
6.1 IAS 10 — Events After the Reporting Period ....................................................................................................... 253
6.2 IAS 16 — Property, Plant and Equipment ............................................................................................................ 255
6.3 IAS 20 — Government Grants.............................................................................................................................. 258
6.4 IAS 23 – Borrowing Costs ..................................................................................................................................... 259
6.5 IAS 24 – Related Party ......................................................................................................................................... 260
6.6 IAS 33 – Earning Per Share ................................................................................................................................... 262

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6.7 IAS 36 – Impairment of Assets ............................................................................................................................. 266

6.8 IAS 37 - Provisions, Contingent Liabilities and Contingent Assets ....................................................................... 271
6.9 IAS 38 - Intangibles .............................................................................................................................................. 273
6.10 IAS 40 Investment Property ............................................................................................................................... 276
6.11 IFRS 2 — Share-based Payment ......................................................................................................................... 279
6.12 IFRS 5 Non-current Assets Held for Sale and Discontinued Operations ............................................................ 282
6.13 IFRS 9 – Financial Instruments ........................................................................................................................... 286
6.14 IFRS 13 - Fair Value Measurement .................................................................................................................... 287

AUDIT PROCEDURES (REPORTING) .................................................................... 292

IFRS 5 – Non-current Assets Held for Sale and Discontinued Operations ................................................................. 292
IAS 24 – Related Parties Disclosures .......................................................................................................................... 293
IFRS 15 – Revenue from Contracts with Customers .................................................................................................. 297
IAS 40 – Investment Properties ................................................................................................................................. 299
IAS 10 and 37 – Contingencies and Commitments with Events after reporting period ............................................ 301
IFRS 16 – Leases ......................................................................................................................................................... 303
IFRS 09, IFRS 07, IAS 32: Financial Instruments ......................................................................................................... 304
IAS 19 – Employee benefits ....................................................................................................................................... 315
IFRS 2 – Share-based payment .................................................................................................................................. 317
IAS 21 and 29 – Foreign currency translation and hyperinflation ............................................................................. 318
IAS 12 – Income Taxes ............................................................................................................................................... 319
Groups: types of investment and business combination .......................................................................................... 321

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ABOUT THE INSTRUCTOR

Hasnain R. Badami is a qualified Chartered Accountant with
cumulative experience of 13+ years in the profession. He also holds
a master’s degree in Philosophy - with critical thinking as his area of
research interest. His particularly versatile academic background
from humanities and business is what makes his classrooms a
thoroughly intriguing experience.

Hasnain believes in learning through experience and stories. His real

life stories come from his equally diverse experience working in
large local and multinational organisations, as well as from training
professionals, teachers, and students. More specifically, he has
worked with Ernst & Young (Karachi, Dubai and Jeddah offices) and
also with Internal Audit function at Engro Polymer before he finally
quit Engro to pursue his passion for learning and development work.
Presently, he is the co-founder and Director of Ingenium Business
solutions that is working in leadership, finance, and digital learning
space.

Hasnain is a senior faculty member at KnS Institute of Business

Studies with 9+ years teaching experience of Advanced Auditing to CA final students. He has taught more
than 2650 students with proud 1200+ CA qualified alumni. He uses Socratic style of teaching and inquiry by
not only focusing on the ‘whats’ and ‘hows’ of the subject matter but, more importantly, on the ‘whys’ of it.
He also served as an MBA visiting faculty member at a business school in Karachi.

At corporate level, his core areas of training expertise are Thinking Skills (critical, creative, and collaborative
thinking), Corporate Ethics, Leadership skills, Business Acumen, and Internal Auditing. Notably, he has
trained professionals from Engro Corporation, Engro Fertilizer, Engro Foods, Bayer Crop Science, Bank Al
Falah, NIB Bank, Bank Al Habib Limited, Khaadi, Bayer Pakistan, Soneri Bank, Byco, Jubilee Insurance, Linde
Pakistan, EFU General Insurance, HUBCO, PPL, Aisha Steel, IBA, Aisha Steel LImited, KPMG, FINCA
Microfinance Bank, NIFT, Telenor Bank, K-Electric, SSGC, Ernst & Young, United Bank Limited, Habib Bank
Limited, Getz Pharma, Fauji Fertilizer, Atlas Honda, Lucky Cement, TCS Pvt. Limited etc.

Besides working with corporates and students, Hasnain devotes a substantial portion of his time volunteering
for empowerment of teachers. He is also on board of EDLAB Pakistan, a non-profit that works on equipping
teachers with 21st century pedagogical skills. Hasnain is also an elected member of the prestigious Southern
Regional Committee of Institute of Chartered Accountants of Pakistan (ICAP) that is responsible to oversee
CA members’ Continued Professional Development (CPD) and Student’s affairs.

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CHAPTER 1:
INTRODUCTION
1.1 ICAP Course outline
CFAP – 6 CERTIFIED FINANCE AND ACCOUNTING PROFESSIONAL
AUDIT, ASSURANCE AND RELATED SERVICES
Objective
To Develop Competence Which Is Necessary For Performing Audit, Assurance And Other Related
Services In Accordance With The International And Local Pronouncements.

Learning Outcome
On The Successful Completion Of This Paper Candidates Will Be Able To:
1. Comprehend Professional Environment
2. Perform Assurance Services In Accordance With The International And Local
Pronouncements
3. Make Professional Judgment At All Level Of Assurance And Non - Assurance Services
4. Conclude And Formulate Opinion On Complex Matters Of Assurance Services
5. Consider And Demonstrate Professional Attitude While Performing Assurance And Non-
Assurance Services.

Grid Weightage
Performance of audit 45-55
Audit conclusion and reporting 20-30
Other assurance engagements and related services 10-15
Professional Ethics, Quality Control and current development 10-15
Total 100

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Syllabus
Content Level
Ref
A. Performance of audit
a. Performance of audit — General
1. Overall Objectives of the Independent Auditor and the Conduct of an 3
Audit in accordance with International Standards on Auditing
2. Initial engagements and opening balances 3
3. Agreeing the terms of Audit engagement 3
4. The planning and mobilization phase 3
5. Risk assessment procedures and response to risks 3
6. Internal Controls (including Test of controls) 3
7. Audit materiality 3
8. Sampling and other means of testing 3
9. Audit evidence(including Specific considerations for Selected Items 3
10. Substantive tests (including Analytical Procedures) 3
11. Responsibility to consider fraud 3
12. Evaluation of misstatements identified during the audit 3
Syllabus Content Level
Ref
13. Consideration of laws and regulation 3
14. External confirmations 3
15. Related parties 3
16. Audit documentation 3
17. Communication with the management and those charge with 3
governance (including communication of deficiencies in internal
controls)
18. Subsequent event 3
19. Management representation 3

b. Performance of audit - specific

1. Going concern 3
2. Fair value measurement and accounting estimates 3
3. Entities using service organizations 3
4. Work of expert and internal auditor 3
5. Special consideration – Auditor of group financial statement 3
(including work of component auditor)

B. Audit conclusion and reporting

a. Audit Report
1. Unmodified audit report 3
2. Modification in audit report 3
3. Emphasis of matter and other matter in audit report 3
4. Communicating key audit matters in the independent report 3
5. Reporting consideration on other information 3
6. Reporting consideration on other information in document 3
contaminating financial statements

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7. Assurance report on control at a service organization 3

8. Audit repot under the companies Act, 2017 3

b. Audit And Report On Specialized Area

1. Audit of special purpose financial statements prepared in accordance 3
with special purpose framework
2. Audit of single financial statement and specific elements accounts or 3
items
3. Engagement to report on summary financial statements 3
4. Auditing financial instrument 3
5. Understanding of prevision related to audit and accounts under the 3
banking companies ordinance 1962
6. Understanding of prevision related to audit and accounts under the 3
insurance companies ordinance 1962
Syllabus Content Level
Ref
C. Other Assurance Engagement And Related Service (Including
Reporting On Relevant Service)
a. Other Assurance Engagement
1. Review engagements 3
2. Assurance Engagement other than audits or review historical financial 3
information
3. Examination of prospective financial statement 3

b. Related Service
1. Agreed-upon 3
2. Compilation engagements 3
3. Assurance engagements to report on the compilation of pro forma 3
financial information include in prospectus
4. Service under the provision of corporate laws 3
5. Service under the provision of tax laws 3

D. Professional ethics, Quality control and current development

1. Code of ethics issued by the institute of chartered Accountants of 3
Pakistan
2. Quality control – ISQC 1, ISA 220, Quality control framework of ICAP, 3
Quality Assurance board of ICAP
3. Acceptance and continuance of client including legal, professional 3
and ethical consideration relating to appointment and removal of
auditor
4. Current development in auditing profession exposure draft issued by 3
IAASB, Draft Conceptual framework and other development projects
of IAASB
5. Key element that creates an environment for audit quality 3

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1.2 ICAP PAPERS ANALYSIS (of last 16 attempts till Winter 2019):
TIMES MARKS PERCENTAGE IMPACT
DESCRIPTION / AREA COMMENTS
TESTED TESTED TESTED (AVERAGE)
A B C = B / B-Total D=B/A
Acceptance and
continuance 4 26 2% 7 Often tested.

Agreed Upon Procedures 3 33 2% 11 Often tested.

Audit Execution 14 111 7% 8 100%

Audit Reporting 59 477 30% 8 100%

Audit Risk 18 286 18% 16 100%

Rarely tested
Client relationships 1 9 1% 9 but is impactful
Due diligence and Rarely tested
business plan 3 32 2% 11 but is impactful

Engagement Proposals 1 8 1% 8

Ethics 38 248 16% 7 100%

Now frequently
Group audit 8 65 4% 8 tested
Tested in every
alternative
Internal Controls 8 57 4% 7 attempt

ISA 810 Summarised FS 1 7 0% 7

ISAE 3402 1 5 0% 5

ISRS 2400 & 2410 2 16 1% 8

Other assurance 1 10 1% 10
Prospective FI 9 66 4% 7 Often tested.
Risk assessment 6 56 4% 9
Strategy: Materiality
computation 1 10 1% 10
Grand Total 190 1600 100%

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DETAILED ATTEMPT-BY-ATTEMPT ANALYSIS OF ICAP PAPERS:

Q# ATTEMPT STAGE IFRS / LAW ISA MARKS
SUMMER 2012
1(a) Summer 2012 Audit Risk - Mixed form IAS 37, 38 ISA 520, 570 19
2(a) Summer 2012 Audit Reporting - Execution phase IAS 37 7
2(b) Summer 2012 Audit Reporting - Conclusion phase ISA 720 4
2(c) Summer 2012 Audit Reporting - Conclusion phase IAS 37 6
3(a) Summer 2012 Ethics - Conflict of interest 8
3(b) Summer 2012 Ethics - Independence - Non assurance 8
services
4(a) Summer 2012 Prospective FI - Client acceptance 10
4(b) Summer 2012 Prospective FI - Assumptions challenged 6
5(a) Summer 2012 Other assurance - Possible engagement ISA 700 7
5(b) Summer 2012 Audit Reporting - Drafting modification ISA 705 6
6(a) Summer 2012 Audit Reporting - Execution phase ISA 500 7
7(a) Summer 2012 Ethics - Independence - Financial Interest Code of ethics 7
7(b) Summer 2012 Ethics - ISQC ISQC 5
SUMMER 2013
1(a) Summer 2013 Audit Reporting - Execution phase ISA 570 10
1(b) Summer 2013 Audit Reporting - Execution phase ISA 570 10
2(a) Summer 2013 Audit Reporting - Conclusion phase IAS 16 8
2(b) Summer 2013 Audit Reporting - Execution phase IAS 2 8
3(a) Summer 2013 Audit Reporting - Execution phase ISA 250 7
3(b) Summer 2013 Ethics - ISQC ISQC 6
4(a) Summer 2013 Ethics - ISQC Code of ethics 9
4(b) Summer 2013 Ethics - Independence - Business Code of ethics 5
Relationships
4(c) Summer 2013 Ethics - Independence - Non assurance Code of ethics 5
services
5(a) Summer 2013 Internal Controls - sales ISA 240 6
6(a) Summer 2013 Audit Risk - Narrative form IAS 16, 37 ISA 570 16
7(a) Summer 2013 Audit Reporting - Conclusion phase IAS 16 6
7(b) Summer 2013 Audit Reporting - Execution phase IAS 28 4

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Q# ATTEMPT STAGE IFRS / LAW ISA MARKS

SUMMER 2014
1(a) Summer 2014 Audit Reporting - Execution phase IFRS 15 14
2(a) Summer 2014 Ethics - Independence - Non assurance Code of ethics 4
services
2(b) Summer 2014 Ethics - Independence - Non assurance Code of ethics 8
services
2(c) Summer 2014 Ethics - Independence - Non assurance Code of ethics 5
services
3(a) Summer 2014 Audit Execution - Audit Procedure IAS 24 8
3(b) Summer 2014 Risk assessment - Corporate governance CCG 4
4(a) Summer 2014 Audit Execution - Audit Procedure IAS 16 8
4(b) Summer 2014 Audit Execution - Audit Procedure IAS 12 5
5(a) Summer 2014 Other assurance - Possible engagement ISRS 4400, 8
ISA 3000
5(b) Summer 2014 Other assurance - Possible engagement ISAE 3000 3
6(a) Summer 2014 Internal Controls - cash / bank ISA 315 7
7(a) Summer 2014 Audit Risk - others 10
8(a) Summer 2014 Audit Reporting - Execution phase 10
8(b) Summer 2014 Audit Reporting - Execution phase 6
SUMMER 2015
1(a) Summer 2015 Audit Risk - Narrative form 15
2(a) Summer 2015 Audit Execution - Evidence Investments 12
3(a) Summer 2015 Ethics - Independence - Family & Code of ethics 4
Personal relationships
3(b) Summer 2015 Ethics - Independence - Non assurance Code of ethics 4
services
3(c) Summer 2015 Ethics - Independence - Non assurance Code of ethics 4
services
4 (e.) Summer 2015 Risk assessment - Corporate governance 3
4 (f) Summer 2015 Risk assessment - Control environment 4
4(a) Summer 2015 Audit Execution - Audit Procedure 4
4(b) Summer 2015 Audit Reporting - Execution phase 5
4(c) Summer 2015 Audit Reporting - Execution phase 5
4(d) Summer 2015 Risk assessment - Corporate governance 8
5(a) Summer 2015 Strategy: Materiality computation ISA 320 10
5(b) Summer 2015 Audit Execution - Audit Procedure IAS 38 ISA 510 7
6(a) Summer 2015 Audit Reporting - Execution phase IAS 37 7
7(a) Summer 2015 Engagement Proposals 8

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Q# ATTEMPT STAGE IFRS / LAW ISA MARKS

SUMMER 2016
1(a) Summer 2016 Audit Reporting - Execution phase 8
1(b) Summer 2016 Audit Reporting - Execution phase 5
1(c) Summer 2016 Audit Reporting - Execution phase 6
2(a) Summer 2016 Client relationships 9
3(a) Summer 2016 Ethics - Independence - Family & Personal 5
relationships
3(b) Summer 2016 Ethics - Conflict of interest 5
4(a) Summer 2016 Audit Risk - Analytical form 18
5(a) Summer 2016 Audit Execution - Audit Procedure IAS 38 10
5(b) Summer 2016 Audit Reporting - Execution phase IAS 38 7
6(a) Summer 2016 Ethics - ISQC ISQC 5
6(b) Summer 2016 Acceptance and continuance 4
7(a) Summer 2016 Group audit ISA 600 3
7(b) Summer 2016 Audit Reporting - Conclusion phase 3
7(c) Summer 2016 Internal Controls - sales 5
8(a) Summer 2016 Other assurance - Possible engagement ISA 810 7
SUMMER 2017
1(a) Summer 2017 Audit Risk - further explanation 10
1(b) Summer 2017 Risk assessment - Corporate governance 10
2(a) Summer 2017 Audit Execution - Audit Procedure Currency 6
swaps
2(b) Summer 2017 Audit Execution - Audit Procedure Currency 9
swaps
3(a) Summer 2017 Ethics - ISQC Code of ethics 7
3(b) Summer 2017 Ethics - Independence - Family & Personal Code of ethics 3
relationships
4(a) Summer 2017 Agreed Upon Procedures - drafting report ISRE 4400 12
5(a) Summer 2017 ISAE 3402 - Type 1, Type 2 report ISAE 3402 10
6(a) Summer 2017 Audit Reporting - Drafting modification ISA 705 6
6(b) Summer 2017 Internal Controls - sales ISA 315 5
7(a) Summer 2017 Group audit ISA 600 10
8(a) Summer 2017 Prospective FI - Cash flow forecast ISAE 3400 12
procedure

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Q# ATTEMPT STAGE IFRS / LAW ISA MARKS

SUMMER 2018
1(a) Summer 2018 Audit Risk - Mixed form 20
2(a) Summer 2018 Due diligence and business plan 15
3(a) Summer 2018 Audit Reporting - Appraisal 11
4(a) Summer 2018 Audit Execution - Audit Procedure IFRS 2 6
5(a) Summer 2018 Ethics - Independence - Financial Interest Code of ethics 15
6(a) Summer 2018 Audit Reporting - Execution phase ISA 570 14
6(b) Summer 2018 Audit Reporting - Drafting modification ISA 705 5
7(a) Summer 2018 Internal Controls - FSCP 7
7(b) Summer 2018 Risk assessment - Control environment 7
SUMMER 2019
Summer 2019
1(a) Audit Risk - Narrative form IFRS 5 24
Summer 2019
2(a) Audit Reporting - Execution phase 5
Summer 2019
2(b) ISRS 2400 & 2410 - Review engagements 10
Summer 2019
3(a) Acceptance and continuance 11
Summer 2019
4(a) Ethics - Independence - Long association Code of ethics 8
Summer 2019
5(a) ISA 810 Summarised FS Code of ethics 5
Summer 2019
5(b) Audit Reporting - Execution phase 15
Summer 2019
6(a) Internal Controls - General 12
Summer 2019
7(a) Audit Reporting - Drafting KAM 10
WINTER 2012
1(a) Winter 2012 Audit Risk - Analytical form Various 12
2(a) Winter 2012 Ethics - Independence - Non assurance Code of ethics 10
services
2(b) Winter 2012 Ethics - Fee related Code of ethics 3
3(a) Winter 2012 Audit Reporting - Conclusion phase IAS 37 ISA 560 17
3(b) Winter 2012 Audit Reporting - Appraisal ISA 705 4
4(a) Winter 2012 Other assurance - Possible engagement ISA 805 6
5(a) Winter 2012 Audit Reporting - Conclusion phase ISA 720 4
5(b) Winter 2012 Audit Reporting - Execution phase IAS 38 ISA 720 11
6(a) Winter 2012 Agreed Upon Procedures - drafting report ISRS 4400 16
7(a) Winter 2012 Audit Reporting - Execution phase ISA 500 8.5
7(b) Winter 2012 Audit Reporting - Execution phase ISA 500 8.5

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Q# ATTEMPT STAGE IFRS / LAW ISA MARKS

WINTER 2013
1(a) Winter 2013 Audit Execution - Audit Procedure IAS 38 10
1(b) Winter 2013 Audit Execution - Audit Procedure IAS 20 6
2(a) Winter 2013 Prospective FI - Cash flow forecast ISAE 3400 12
procedure
2(b) Winter 2013 Prospective FI - Drafting modification ISAE 3400 6
3(a) Winter 2013 Audit Risk - Mixed form 18
4(a) Winter 2013 Internal Controls - inventory ISA 315 6
5(a) Winter 2013 Ethics - Independence - Actual and Code of ethics 7
threatened litigation
5(b) Winter 2013 Ethics - Conflict of interest 6
6(a) Winter 2013 Audit Reporting - Execution phase 10
7(a) Winter 2013 Acceptance and continuance 5
7(b) Winter 2013 Ethics - Professional Appointment Code of ethics 5
7(c) Winter 2013 Audit Reporting - Conclusion phase ISA 720 9
WINTER 2014
1(a) Winter 2014 Audit Reporting - Execution phase ISA 510 8
1(b) Winter 2014 Audit Reporting - Execution phase IAS 24 ISA 550 9
2(a) Winter 2014 Audit Reporting - Conclusion phase IAS 720 12
2(b) Winter 2014 Audit Reporting - Drafting modification ISA 705 5
3(a) Winter 2014 Ethics - Custody of assets Code of ethics 10
4(a) Winter 2014 Audit Risk - Mixed form 15
5(a) Winter 2014 Ethics - ISQC Code of ethics 6
5(b) Winter 2014 Ethics - Conflict of interest Code of ethics 4
6(a) Winter 2014 Audit Risk - further explanation 10
7(a) Winter 2014 Audit Reporting - Execution phase 7
7(b) Winter 2014 Audit Reporting - Execution phase 7
7(c) Winter 2014 Audit Reporting - Execution phase 7

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WINTER 2015
1(a) Winter 2015 Audit Risk - Narrative form 12
2(a) Winter 2015 Audit Risk - further explanation 7
2(b) Winter 2015 Risk assessment - Corporate governance 4
2(c) Winter 2015 Risk assessment - Corporate governance 5
3(a) Winter 2015 Ethics - Independence - Financial Interest 8
3(b) Winter 2015 Ethics - Independence - Compensation 6
and evaluation
3(c) Winter 2015 Ethics - Conflict of interest 7
4(a) Winter 2015 Internal Controls - assets IAS 40 ISA 315 9
4(b) Winter 2015 Audit Reporting - Drafting modification IAS 40 ISA 705 6
5(a) Winter 2015 Audit Reporting - Execution phase ISA 502, 15
Confirmations
5(b) Winter 2015 Risk assessment - Fraud 13
6(a) Winter 2015 Group audit ISA 600 8
WINTER 2016
1(a) Winter 2016 Audit Reporting - Conclusion phase ISA 701 11
2(a) Winter 2016 Due diligence and business plan ISA 570 12
2(b) Winter 2016 Due diligence and business plan ISA 570 5
3(a) Winter 2016 Risk assessment - Control environment 5
3(b) Winter 2016 Audit Risk - Mixed form 15
4(a) Winter 2016 Audit Reporting - Conclusion phase ISA 700 4
5(a) Winter 2016 Other assurance - Possible engagement ISAE 3000 6
6(a) Winter 2016 Other assurance - Possible engagement ISAE 3000 14
7(a) Winter 2016 Audit Reporting - Execution phase 7
7(b) Winter 2016 Audit Reporting - Execution phase 6
8(a) Winter 2016 Ethics - Independence - Long association 9
8(b) Winter 2016 Ethics - Independence - Non assurance 6
services

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Q# ATTEMPT STAGE IFRS / LAW ISA MARKS

WINTER 2017
1(a) Winter 2017 Audit Risk - Mixed form 20
2(a) Winter 2017 Audit Reporting - Execution phase IAS 16 10
2(b) Winter 2017 Audit Reporting - Conclusion phase IAS 16 5
3(a) Winter 2017 Audit Execution - Audit Procedure 15
4(a) Winter 2017 Other assurance - Possible engagement 12
4(b) Winter 2017 Other assurance - Possible engagement 3
5(a) Winter 2017 Audit Reporting - Drafting modification ISA 701 5
5(b) Winter 2017 Audit Reporting - Drafting modification ISA 701 5
5(c) Winter 2017 Audit Reporting - Drafting modification ISA 701 5
6(a) Winter 2017 Ethics - Fee related Code of ethics 10
6(b) Winter 2017 Ethics - Independence - Business Code of ethics 5
Relationships
7(a) Winter 2017 Agreed Upon Procedures - drafting report ISRE 4400 5
WINTER 2018
1(a) Winter 2018 Audit Risk - Mixed form IAS 40 23
2(a) Winter 2018 Audit Reporting - Execution phase IAS 37 14
3(a) Winter 2018 Audit Reporting - Conclusion phase IAS 36, 37 12
Winter 2018 Prospective FI - Cashflow forecast
4(a) procedure ISAE 3400 10
Winter 2018 ISQC, Code of
5(a) Ethics - Professional Appointment ethics 6
5(b) Winter 2018 Ethics - Conflict of interest Code of ethics 6
6(a) Winter 2018 ISAE 3402 - Type 1, Type 2 report ISAE 3402 6
6(b) Winter 2018 Audit Execution - Audit Procedure IAS 24 ISA 550 5
7(a) Winter 2018 Group audit ISA 300, 600 13
7(b) Winter 2018 Group audit ISA 600 5
WINTER 2019
1(a) Winter 2018 Group audit-Execution phase ISA 600 15
1(b) Winter 2018 Group audit-Audit Procedure type ISA 600 5
Winter 2018 IFRS 2
2 Internal Controls - General options 7
3 Winter 2018 Audit Risk - Mixed form IAS 40 22
4 Winter 2018 Group audit-Execution phase ISA 600 6
Winter 2018 ISA 720,
5 Audit Reporting -Conclusion phase Disclosure. 20
Winter 2018 Ethics -Non assurance services-
6 Bookkeeping services Code of ethics 10
7 Winter 2018 Risk assessment – Fraud ISA 240 5
Winter 2018 Prospective FI - Cashflow forecast
8 procedure ISAE 3400 10
TOTAL 1600

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1.3 IMPORTANT PARAGRAPH REFERENCE (VERSION 2017-18)

DESCRIPTION READING PLAN
Code of Ethics Will be given separately
ISQC One read at least, remember the Elements of System of QC
(Para 16,26)
200–299 GENERAL PRINCIPLES AND RESPONSIBILITIES
ISA 200 Overall Objectives of the 11, 13, 21, A16, A18, A19, A20, A21, A23, A25, A34 – A52.
Independent Auditor and the Covered adequately in my lectures.
Conduct
ISA 210 Agreeing the Terms of Audit Complete with Appendix 1, Appendix 2 (para-3), Can omit Para
Engagements A3,A8-A13,A15,A16,A18,A19-A23,A28,A29,A37,A39.
ISA 220 Quality Control for an Audit Not required
of Financial Statements
ISA 230 Audit Documentation Para 3,6,9,14,15,16,A2, A7, A10, A12, A20 – A24,
Appendix (Check out the relevant paragraph to learn
application of specific requirement)
ISA 240 The Auditor's Responsibilities 2,3,4,10,29,32,38,40 – 43,17, A1 – A5,A10 – A11,A16,A23,A29
Relating to Fraud in an Audit A37, A43, A48, A51 - A54
All appendixes
ISA 250 Consideration of Laws and 4,5, 12 - 21,23-24,25,26 A2, A3, A11, A13, A14,
Regulations in an Audit of
ISA 260 Communication with Those 13-17,22,Appendix 1 (Check out the relevant paragraph to
Charged with Governance learn application of specific requirement)

ISA 265 Communicating Deficiencies 6-11, A6, A7, A15, A20, A22-A24
in Internal Control to Those

300–499 RISK ASSESSMENT AND RESPONSE TO ASSESSED RISKS

ISA 300 Planning an Audit of Financial 2,6,8, Appendix
Statements
ISA 315 Identifying and Assessing the 6,11, 14, 15, 18, 27, 28,A7,A25, A32, A38,A40, A44, A46, A51,
Risks of Material A54 – A58, A61, A70,A78, A88, A111, A119 – A125,
Misstatement A128,A129,A141,A142 Appendix1 and 2
ISA 320 Materiality in Planning and 2,9, 10-13, A4- A7, A10, A12, A13
Performing an Audit
ISA 330 The Auditor’s Responses to 10 – 23,A1,A4,A13,A14,A51 (Also, covered in my lectures)
Assessed Risks
ISA 402 Audit Considerations Relating Complete, (Paras that should be given more importance
to an Entity Using a Service include 9,10,12,15,17,A8,A15,A22,A23,A33).
ISA 450 Evaluation of Misstatements A13 - A16, A21.
Identified during the Audit

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DESCRIPTION READING PLAN

500–599 AUDIT EVIDENCE
ISA 500 Audit Evidence 8,9,11, A4- A5, A10, A18, A27, A28, A31, A36, A38, A40, A43,
A48
ISA 501 Audit Evidence—Specific 4-11, A2 – A7, A18, A22 – A25,A27
Considerations for Selected
Items
ISA 505 External Confirmations 6-9, 15,A4,A18, A24
ISA 510 Initial Audit Engagements— 4, 6, 8,10,11,13 A6- A9, All appendices
Opening Balances
ISA 520 Analytical Procedures 5,A15.
ISA 530 Audit Sampling Only appendices
ISA 540 Auditing Accounting A27,A31,A45,A46
Estimates
ISA 550 Related Parties Complete.(**A17,A22,A38)
ISA 560 Subsequent Events Complete. Read with my flowcharts and lectures notes.
ISA 570 Going Concern Complete. Read with my flowcharts and lectures notes.
ISA 580 Written Representations Appendix 1 (Check out the relevant paragraph to learn
application of specific requirement) , Appendix 2
600–699 USING THEWORK OF OTHERS
ISA 600 Special Considerations— 9, 19,21, 26, 27, 28, 29,32-37, 40, 41,A11, A47,A56, Flow
Audits of Group Financial diagram, All appendices
Statements
ISA 610 Using the Work of Internal Very short standard, do it completely
Auditors
ISA 620 Using the Work of an 6, 8, 11, 12, A1, A7 – A9, A13, A15, A17, A24, A33, Appendix
Auditor’s Expert
700–799 AUDIT CONCLUSIONS AND REPORTING
ISA 700 Forming an Opinion and Read completely as they will enable you to understand better
Reporting on Financial or Use my lectures and flowcharts, they adequately cover all
Statements requirements and will save great amount of time.
ISA 701 Key Audit Matters Read completely as they will enable you to understand better
or Use my lectures and flowcharts, they adequately cover all
requirements and will save great amount of time.
ISA 705 Modifications to the Opinion Read completely as they will enable you to understand better
in the Independent Auditor’s or Use my lectures and flowcharts, they adequately cover all
Report requirements and will save great amount of time.
ISA 706 Emphasis of Matter Read completely as they will enable you to understand better
Paragraphs and Other or Use my lectures and flowcharts, they adequately cover all
Matter Paragraphs requirements and will save great amount of time.

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DESCRIPTION READING PLAN

700–799 AUDIT CONCLUSIONS AND REPORTING
ISA 710 Comparative Information— Read completely as they will enable you to understand better
Corresponding Figures and or Use my lectures and flowcharts, they adequately cover all
requirements and will save great amount of time.
ISA 720 The Auditor’s Read completely as they will enable you to understand better
Responsibilities Relating to or Use my lectures and flowcharts, they adequately cover all
Other Information in requirements and will save great amount of time.
800–899 SPECIALIZED AREAS
ISA 800 Special Considerations— Read completely as they will enable you to understand better
Audits of Financial or Use my lectures and flowcharts, they adequately cover all
Statements requirements and will save great amount of time.
ISA 805 Special Considerations— Read completely as they will enable you to understand better
Audits of Single Financial or Use my lectures and flowcharts, they adequately cover all
Statements requirements and will save great amount of time.
ISA 810 Engagements to Report on Read completely as they will enable you to understand better
Summary Financial or Use my lectures and flowcharts, they adequately cover all
Statements requirements and will save great amount of time.
Part – 2
1013 Electronic Commerce— 19, 20, 22, 23, 28, 31, 33
Effect on the Audit of
2400 Engagements to Review There are a lot of repetitions. You can skim through this
Financial Statements standard. Will hardly take you 15 mins.
2410 Review of Interim Financial There are a lot of repetitions. You can skim through this
Information standard. Will hardly take you 15 mins.
3000 Assurance Engagements Complete (** 22-24)
Other than Audits or
Reviews of
3400 The Examination of Complete
Prospective Financial
Information
3402 Assurance Reports on Complete
Controls at a Service
Organization
4400 Engagements to Perform Very short standard. Complete
Agreed-Upon Procedures
Regarding
4410 Engagements to Compile Very short standard. Complete
Financial Information

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CHAPTER 2:
AUDIT PLANNING & RISK ASSESSMENT
2.1 AUDIT RISK & BUSINESS RISK CONSIDERATIONS
1. RISK

The auditor must be aware of two types of risk.

• Audit risk (sometimes known as ‘assignment’ or ‘engagement risk’)

• Business risk
You must be able to distinguish between audit risk and business risk. Whilst many business risks will
have consequences for the audit by increasing audit by increasing audit risk they are two separate
issues. For example the fact that a company has foreign exchange transactions is not an audit risk in
itself. The audit risk is the potential for misstatement in the financial statements.

1.1 AUDIT RISK

Auditors must assess the risk of material misstatement arising in financial statements and carry out
procedures in response to assessed risks.

ISA 200 objective and general principles governing an audit of financial statements states ‘that the auditor
should plan and perform the audit to reduce audit risk to an acceptably low level that is consistent with the
objective of an audit’.

Audit risk is the risk that auditors may give an inappropriate opinion on the financial statements. Audit
risk has two key components – the risk of material misstatement in financial statements (financial
statement risk) and the risk of the auditor not detecting the material misstatement in financial
statements (detection risk). Financial statement risk breaks down into inherent risk and control risk.

Inherent risk is the susceptibility of an account balance or class of transactions to material

misstatement, either individually or when aggregated with misstatements in other balances or
classes, irrespective of related internal controls.

Control risk is the risk that a misstatement:

• Could occur in an account balance or class of transactions

• Could be material, either individually or when aggregated with misstatements in other balances of
classes, and
• Would not be prevented, or detected and corrected on a timely basis, by the accounting and
internal control systems

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Detection risk is the risk that auditor’s substantive procedures do not detect a misstatement that
exists in an account balance or class of transactions that could be material, either individually or when
aggregated with misstatements in other balances or classes.

For instance, an oil company has abandoned one of its oil rigs. This abandonment is a financial statement
risk because the abandonment gave rise to impairment in the value of the rig, which might not have been
reflected in the financial statement. In other words, there is a risk that the financial statements were
misstated in respect of this oil rig.

1.1.1 INHERENT RISK#

Inherent risk is the risk that items will be misstated due to characteristics of those items, such as the fact
that they are estimates or that they are important items in the accounts. The auditors must use their
professional judgement and the understanding of the entity they have gained to assess inherent risk. If no
such information or knowledge is available then the inherent risk is assessed as high.

FACTORS AFFECTING CLIENT AS A WHOLE (RISK AT OVERALL FINANCIAL STATEMENT LEVEL)

Integrity and attitude to risk of directors and Domination by a single individual can cause problems
management
Management experience and knowledge Changes in management and quality of financial
management
Unusual pressures on management Examples include tight reporting deadlines, or market or
financing expectations
Nature of business Potential problems include technological obsolescence or
over-dependence on single product
Industry factors Competitive conditions, regulatory requirement,
technology developments, changes in customer demand
Information technology Problems include lack of supporting documentation,
concentration of expertise in a few people, potential for
unauthorized access

FACTOR AFFECTING INDIVIDUAL ACCOUNT BALANCES OR TRANSACTIONS

Financial statement accounts prone to Accounts which require adjustment in previous period or
misstatement require high degree of estimation
Complex accounts Accounts which require expert valuations or are subjects
of current professional discussion
Assets at risk of being lost or stolen Cash, inventory, portable non-current assets (computers)
Quality of accounting systems Strength of individual departments (sales, purchases cash
etc.)
High volume transactions Accounting system may have problems coping
Unusual transactions Transactions for large amounts, with unusual names, not
settled promptly (particularly important if they occur at
period-end)
Staff Staff changes or areas of low morale

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1.1.2 CONTROL RISK

Control risk is the risk that client controls fail to detect material misstatement. A preliminary assessment of
control risk at the planning stage of the audit is required to determine that level of controls and substantive
testing to be carried out.

1.1.3 DETECTION RISK

Detection risk is the risk that audit procedures will fail to detect material errors. Detection risk relates to the
inability of the auditors to examine all evidence. Audit evidence is usually persuasive rather than conclusive
so some detection risk is usually present, allowing the auditors to seek ‘reasonable assurance’.

The auditors’ inherent and control risk assessments influence the nature, timing and extent of substantive
procedures required to reduce detection risk and thereby audit risk.

1.2 BUSINESS RISK

Business risk is the risk arising to companies through being in operation.

Business risk is the risk inherent to the company in its operations. It is risk at all levels of the business.
It is split into three categories:

Financial risks are the risks arising from the financial activities or financial consequences of an
operation, for example, cash flow issues or overtrading.

Operational risks are the risk arising with regard to operations, for example, the risk that a major
supplier will be lost and the company will be unable to operate.

Compliance risk is the risk that arises from non-compliance with the laws and regulation that
surround the business.

The above components of business risk are the risks that the company should seek to mitigate and manage.
The process of risk management for the business is as follow:

• Identify significant risks which could prevent the business achieving its objectives
• Provide a framework to ensure that the business can met its objectives
• Review the objectives and framework regularly to ensure that objectives are met

RELATIONSHIP BETWEEN BUSINESS RISK AND AUDIT RISK

On the one hand, business risk and audit risk are completely unrelated:

• Business risk arises in the operations of a business

• Audit risk is focused on the financial statements of the business
• Audit risk exists only in relation to an opinion given by auditors

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In other ways, the two are strongly connected. The strong links between them can be seen in the inherent
and control aspects of audit risk. In audit risk these are limited to risks pertaining to the financial
statements.

Business risk includes all risks facing the business. In other words, inherent audit risk may include business
risks.
In response to business risk, the directors institute a system of controls. These will include controls to
mitigate against the financial aspect of the business risk. These are the controls that audit control risk
incorporates.
Therefore, although audit risk is very financial statements focused, business risk does from part of the
inherent risk associated with the financial statements, not least, because if the risks materialise, the going
concern basis of the financial statements could be affected.

2.1 BUSINESS RISKS FROM CURRENT TRENDS IN IT

2.1.1 Audit considerations

Auditors must assess their clients’ procedures for identifying and addressing these risks (ISA 315). Some
main considerations are:

• Has management established an information and internet security policy?

• How does the entity identify critical information assets and the risk to these assets?
• Does the entity have cyber insurance (many general policies now exclude cyber events)?
• Is there a process for assuming security when linked to third party systems (eg partners/contractors)?
• What controls are in place to ensure that employees only have access to files and applications that are
required for their job?
• Are regular scans carried out to identify malicious activity?
• Are procedures in place to ensure that security is not compromised when the company’s systems are
accessed from home or on the road?
• What plans are in place for disaster recovery in case of an incident?
These issues will be built into the auditor’s assessment of the control environment of the entity and in some
cases may influence the auditor’s view as to whether here are any uncertainties relating to the going
concern status of the entity.

2.1.2 E-commerce

IAPS 1013 Electronic commerce – effect on the audit of financial statement of emphasizes the importance
of risk identification where an entity undertakes e-commerce.

Specific business risks include:

• Loss of transaction integrity

• Pervasive e-commerce security risks
• Improper accounting policies for example capitalization of website development costs
• Non-compliance with tax, legal and regulatory requirements
• Over-reliance on e-commerce
• Systems and infrastructure failures

Audit procedures regarding the integrity of the information in the accounting system relating to e-
commerce transactions will be concerned with evaluating the reliability of the system for capturing and
processing transactions.

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Therefore, in contrast to audit procedures for traditional business activities which focuses separately on
control process relating to each stage of transaction processing, audit procedures for sophisticated e-
commerce often focuses on automated controls.

Case study: Risk in an e-commerce environment

In this case study, e-commerce has been used to illustrate the issue of risks. E-commerce is a topical area,
and you should be familiar with the issue arising for audit and assurance from e-commerce. However, you
need to be able to recognize issues for any business scenario you are given.

Try to learn to let key phrases trigger your thoughts about particular issues such as systems and going
concern, above all, think about the nature of the business in the scenario and the strengths and
weaknesses likely to exist within it.

Tipper Co. is a travel agency operating in three adjacent towns. The directors have recently taken the
decision that they should cease their operations and convert into a dot.com. The new operations,
Tippers.com, will benefits from enlarge markets and reduced overheads, as they will be able to operate from
single, cheaper premises.

Such a business decision has opened Tripper Co up to significant new business risks.

Customers

Converting to a dot.com company in this way enforces a loss of ‘personal touch’ with customers. Trippers
stall will no longer meet the customers face to face. In a business such as a travel agency, this could be a
significant factor. Customers may have appreciated the service given in branches and may feel that this level
of service has been lost if it is now redirected through computers and telephones. Trippers should be aware
of the possibility of, and mitigate against, loss of customers due to perceived reduction in service.

Competition

Be leaving the local area and entering a wider market, Trippers is opening itself up to much more substantial
competition. Whereas previously, Trippers competed with other local travel agents, it will now be competing
theoretically with travel agents everywhere that have Internet facilities.

Technology issues

As Trippers has moved into a market that necessitates high technological capabilities, a number of business
risks are raised in relation to technological issues:

Viruses

There is a threat of business being severely interrupted by computer viruses, particularly if the staff of
Trippers are not very computer literate or the system the company invests in is not up to the standard
required.

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Viruses could cause interrupted sales and loss of customer goodwill, which could have a significant impact on
the going concern status of the company.

Loss of existing custom

Technology could be another reason for loss of existing customers. Their existing customers might not have
Internet access or ability to use computers. We do not know that Trippers’ demographic was prior to
conversion.

However, if conversion means that Trippers lose their existing client base completely and have to rebuild
sales, the potential cost in advertising could be excessive.

Cost of system upgrades

Technology is a fact moving area and it will be ital that Trippers’ website is kept up to current standards. The
cost of upgrade, both in terms of money and business interruption, could be substantial.

New supply chain factors

Trippers may keep existing links with holiday companies and operators. However, the will have new suppliers,
such as Internet Service Providers to contend with.

Personnel

Due to the conversion, Trippers.com will require technical staff and experts. They may not currently have
these staff. If this is the case, they could be at risk of serve business interruption and customer
dissatisfaction.

If the directors are not computer literate, they may find that they are relying on staff who are far more
expert than they are to ensure that their business runs efficiently.

Legislation

There are a number of issues to consider here. The first is data protection and the necessity to comply with
the law when personal details are given over the computer. It is important that the website is secure.

E-commerce is also likely to an area where there is fact moving legislation as the law seeks to keep up with
developments. Trippers must also keep up with developments in the law.

Lastly, trading over the Internet may create complications as to what domain. Trippers are trading in for the
Purposes of law and tax.

Fraud exposure

The company may find that it is increasingly exposed to fraud in the following ways.

• Credit card fraud relating from transactions not being face to face
• Hacking and fraud relating from the website not being source
• Over-reliance on computer expert personnel could lead to those people committing fraud

Trippers’ auditors will be regarding the conversion with interest. The conversion will also severely affect audit
risk.

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Impact on audit risk

Inherent risk
Many of the business risks identified above could have significant impacts on going concern.

Control risk
The new operations will require new systems, many of which may be specialized computer systems.

Detection risk
The conversion may have the following effects:

• Create a ‘paperless office’ as all transactions are carried out outline – this may make use of CAATs
essential
• The auditors may have no experience in e-commerce which may increase detection risk
• There are likely to be significant impacts on analytical review as results under the new operations are
unlikely to be very comparable to the old
• There may be a significant need to use the work of experts to obtain sufficient, appropriate audit
evidence

1.3 FINANCIAL STATEMENT RISK (‘loosely referred’ as AUDIT RISK)

1.3.1 Definition

This is the risk that the financial statements are materially misstated. The material misstatement could
involve:

• Errors in the amounts recorded in the statement of comprehensive income or statement of financial
position
• Errors in or omission from the disclosure notes

1.3.2 Link with business risk

Many, if not all, business risk will produce a financial statement risk.

In scenario questions you could be asked to explain either business or financial statement risks. It is
important to use the scenario in the correct way and answer the exact question that is being asked.

Using the information in the previous case study to illustrate the link:

BUSINESS RISK FINANCIAL STATEMENT RISK

The business may lose sales as a result of Uncertainties over going concern may not be fully
computer viruses, which could threaten the disclosed.
Company’s going concerns status
Breaches of data protection law and other Provisions relating to breaches of regulations
regulations could result in the company suffering
financial
The business may suffer losses from credit card Losses arising from frauds may not be recognized
fraud. in the financial statements.

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2.2 BUSINESS RISK FACTORS

EXTERNAL FACTORS

• State of the economy and government regulation;

• High degree of complex regulation;
• Changes in the industry in which the entity operates;
• Changes in the supply chain;
• Declining demand for the entity’s products or services;
• Inability to obtain required materials or the personnel with skills required for production;
• Deliberate sabotage of an entity’s products or services; and
• Constraints on the availability of capital and credit.

BUSINESS STRATEGIES

• Operations in regions that are economically unstable;

• Operations exposed to volatile markets;
• Developing or offering new products or services, or moving into new lines of business;
• Entering into business areas/transactions with which the entity has little experience;
• Setting of inappropriate or unrealistic objectives and strategies;
• Aggressive expansion into new locations;
• Acquisitions and divestitures;
• Complex alliances and joint ventures;
• Use of complex financing arrangements;
• Corporate restructurings; and
• Significant transactions with related parties.

ENTITY’S ORGANIZATION

• Poor corporate culture and governance;

• Incompetent personnel in key positions;
• Changes in key personnel including departure of key executives;
• Complexity in operations, organization structure and products;
• Failure to recognize the need for change such as in skills required or the use of technology;
• Response to rapid growth or decline in sales that can strain internal control systems & people’s
skills;
• Lack of personnel with appropriate accounting and financial reporting skills;
• Weaknesses in internal control, especially those not addressed by management; and
• Inconsistencies between the entity’s IT strategy and its business strategies.

OTHER

• Product or service flaws that may result in liabilities and reputation risk;
• Relationships with external funders, such as banks;
• Going-concern and liquidity issues including loss of significant customers; and
• Installation of significant new IT systems related to financial reporting.

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2.3 BEING ANALYTICAL

1. ACCOUNTS RECEIVABLE
▪ When increase in Receivables % is greater than increase in Revenue %. This is indicative of
the overstatement of revenue/ receivables.

What Could Go Wrong

▪ Deliberate overstatement of receivables primarily (and revenue too as a result thereof)
probably due to early invoicing;
▪ Doubtful debts may not be provided.

2. GROSS MARGIN
▪ When gross margin % rises significantly as compared to the previous year. This is indicative
of overstatement of revenue or understatement of purchases.

What Could Go Wrong

▪ Deliberate overstatement of revenue probably due to early invoicing or cutoff errors
▪ Understatement of costs probably due to unrecorded liabilities.

3. WORK-IN-PROGRESS
▪ When increase in WIP % is greater than the increase in Revenue %. This is indicative of
overstatement of WIP.

What Could Go Wrong

▪ Percentage of overhead applied is judgmental therefore it may have management bias
which could be overstated.
▪ Losses on contracts not provided.

4. PURCHASES/ PAYABLES
▪ When increase in Purchase/ Direct cost % is less than the increase in accounts payables %.
This is indicative of the understatement of purchases.

What Could Go Wrong (Audit risk factor)

▪ Understatement probably due to unrecorded liabilities or accruals at year end;
▪ There could be translation errors in case of foreign currency balances.

5. DAYS RECEIVABLE
▪ Increase in days receivable compared with the normal trading terms or the preceding period.
This is indicative of the overstatement of debtors.

What Could Go Wrong

▪ Possibly due to early recording of invoices or unrecoverable debts. (calculate % change in
provision for doubtful debts to substantiate the fact)
▪ There could be translation errors if there are foreign debtors.

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6. DAYS PAYABLE
▪ Reduction in days payable as compared with the previous year. This is indicative of
understatement of purchases/payables.

What Could Go Wrong

▪ Probably due to failure to record all supplier invoices at yearend.
▪ There could be translation errors if there are foreign creditors.

7. INTEREST VS LOANS
▪ Increase in interest expense compared to increase in loans

8. DEBT TO EQUITY RATIO

▪ Debt to equity = Total Liabilities
Total equity
9. CURRENT RATIO
▪ Current Ratio = Current asset .
Current Liabilities
10. QUICK RATIO
▪ Quick Ratio = Current assets – Inventories – Prepayments
Current liabilities

Liquidity ratios are used as a basis for liquidity problems and to establish going concern issues

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2.4 ADDRESSING AUDIT RISK

2.4.1 AUDIT PROCEDURES

Statement of Comprehensive Income / Profit or Loss Account

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Sales (Analytical procedures) • Discuss with appropriate client’s personnel the accounting policies
stated and followed with respect to revenue recognition and
evaluate the appropriateness of said policies.
• Discuss with appropriate client’s personnel the existence of
significant uncertainties at the time of sales, if any, like
recoverability, warranty and other obligations, price protection
agreement or revenue limitation. Also corroborate with historical
pattern.
• Compare income and expense account balances with those of the
prior year, and with current year budget (if available), and obtain
explanation for any unusual or significant variations.
• Review the comparative monthly analysis of sales by product line,
division or other business segment, including gross sales, returns
and allowances and discounts.
• Perform comparative analyses for following and investigate
significant fluctuations:
o Sales per day.
o % of commissions to sales.
o % of returns and allowances to sales.
o % of discounts to sales.
o % of freight to sales.
o % warranty to sales.
o Gross profit ratio.
• Compare the revenue generated from operations with a level of
activity carried out in the company during the period, such as
comparing the amount of revenue with the unit shipped.
Sales (General verification • Have the client reconcile totals for gross sales and sales
deductions to the general ledger control accounts.
procedures)
• Trace selected monthly totals for sales and sales deductions to the
sales journal or similar record. Investigate significant differences.
• Verify the sales invoices and check that the customer name,
product description and quantities and price are mentioned on
the invoice and compare it with the description of sales order.
• Review applicable sales invoices and shipping documents to
determine the accuracy and validity of each selected sales
transaction and sales tax charged thereof, if applicable.
• Scan the sales journal to check whether there is any duplication of
sales invoice numbers or gap in the sequence of invoice numbers
to identify invoices cancelled, if any.
• Review significant sales returns and credit memos issued during
the period as well as subsequent to the balance sheet date to
determine whether they were properly authorized and recorded
in the proper period.

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Statement of Comprehensive Income / Profit or Loss Account

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Sales (Cut-off verification • Have the client reconcile totals for gross sales and sales
deductions to the general ledger control accounts.
procedures)
• Trace selected monthly totals for sales and sales deductions to the
sales journal or similar record. Investigate significant differences.
• Verify the sales invoices and check that the customer name,
product description and quantities and price are mentioned on
the invoice and compare it with the description of sales order.
• Review applicable sales invoices and shipping documents to
determine the accuracy and validity of each selected sales
transaction and sales tax charged thereof, if applicable.
• Scan the sales journal to check whether there is any duplication of
sales invoice numbers or gap in the sequence of invoice numbers
to identify invoices cancelled, if any.
• Review significant sales returns and credit memos issued during
the period as well as subsequent to the balance sheet date to
determine whether they were properly authorized and recorded
in the proper period.
• Judgmentally select shipping transactions before and after the
physical inventory date to test the client's inventory cutoff
procedures and controls. The Items selected should be selected
from the transactions 15 days before and after the physical
inventory date.
• Trace cutoff data recorded before and after the physical inventory
date into the accounting records to determine if proper cutoff was
obtained.
• Scan the sales register and the purchases / receipts journal for
periods before and after the physical inventory date for unusual
items.
• Consider responses to accounts receivable confirmations that
might indicate potential inventory cutoff problems.
• Review sales returns subsequent to the year-end to ensure that it
does not exceed the industry norms and client’s past practice.

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Statement of Comprehensive Income / Profit or Loss Account

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Cost of sales (Analytical • Compare the balances of cost of sales accounts with the
comparable balances for the preceding period and with the
procedures)
budgeted amounts for the current period. Investigate significant
or unusual fluctuations.
• Compare gross profit margins with comparable margins for the
preceding period with comparable margins for industry and with
budgeted margins for the current period and investigate unusual
fluctuations.
• Prepare and analyse gross profit analysis by taking into account
sales and cost components.
• Compare gross profit ratios by product line, division or period to
those of the prior year and obtain explanation for unusual
variations.
Cost of sales (General procedures) • Test controls over conversion cycle in respect of material
requisition, production reporting, inventory management and
inventory perpetual records.
• Perform a predictive test of cost of sales by product line, division
or other business segment by reference to details of units shipped
and average unit costs. Investigate significant variances between
the predicted and recorded amounts.
• For a selected sample, test the related cost of sales transactions
by tracing the unit costs used to cost records.
• Trace the overhead and variance accounts to the analytical
reviews performed in conjunction with the audit of standard
inventory costs.
• Trace provisions for depreciation, depletion and amortization
included in cost of sales to the tests performed in the audit of
accumulated depreciation.
Basis of overhead allocation • For fixed overheads:
o In case of underutilization of normal capacity, the unabsorbed
overheads should be charged as an expense for the period
o In case of abnormally high production, the allocated overheads
should not exceed the actual amount as this may result in over
valuation of inventory.
• For variable overheads allocation should be made on actual
production, the basis of which should be consistent.
• Review that the manufacturing and operating expenses of shut
down period are not deferred. As shut down due to strike, lock-
out or mechanical problems etc. are part of operating cycle of an
enterprise, these should not be deferred as this will not only
distort the current picture of the profit or loss, it will also burden
the subsequent periods for no reason.

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Statement of Comprehensive Income / Profit or Loss Account

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Purchases and other expenses • Inspect a sample of purchase invoices and agree the amount is
included correctly within the purchase ledger.
• Inspect purchase orders for evidence of authorization by a
responsible official.
• Observe the process for logging purchase invoices into the system
to ensure that all invoices are entered completely and accurately.
• Observe the goods received department to assess whether goods
received are checked against purchase orders and reviewed for
adequate quality.
• Discuss with management whether there have been any changes
in the key suppliers used and compare this to the purchase ledger
to assess completeness and accuracy of purchases.
• Recalculate the accuracy of a sample of purchase invoices.
• Recalculate the prepayments and accruals charged at the year end
to ensure the accuracy of the other expenses.
• Select a sample of purchase orders and match them to the goods
received notes and purchase invoices to ensure completeness of
the purchase cycle.
Legal and professional expenses • Have the client prepare a schedule of all legal and professional
expenses incurred during the period showing:
o The name of lawyer /tax advisor or other consultant;
o A description of professional services rendered to the entity;
and
o The amount of professional fee / charges.
o Tie up the total of such schedule with the General Ledger.
• Compare current period total of such expenses with the
corresponding prior period amount and investigate reasons for
significant fluctuations.
• Understand, document and evaluate the entity’s internal control
policies and procedures for authorizing, executing and recording
such expenses.
• Based on the schedule of legal and professional expenses, ensure
that all expenses were:
o Authorized by the appropriate level of authority;
o Properly supported by bills / invoices and other relevant
documents;
o For business purposes; and
o Verified by the entity’s internal audit department, where
applicable.
• Cross-reference the names of legal advisors and tax consultants as
appearing in the schedule of legal and professional expenses with
the respective confirmation control sheets.
• Ensure that proper accrual for such expenses have been made at
period end.
• Link the cases reported by the solicitors in their respective
responses to the contingencies and commitments and quantify
the impact, if any, if possible.

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Statement of Comprehensive Income / Profit or Loss Account

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Auditor’s remuneration • Review minutes of the meetings of Board of Directors and
Shareholders fixing and approving auditors’ remuneration.
• Cross refer audit fee appearing in the engagement letter
submitted to the client.
• Ensure disclosure requirement as per relevant Schedule of the
Companies Act are fulfilled.
• Ensure accrual of audit fee and other service fee, if any.
Payroll expense • Trace selected amounts to the payroll register and to prior year
working papers otherwise those tested in payroll cycle.
• Scan the payroll register for unusual balances or amounts.
• If the department-wise figure of an expense account is not equal
to the balance of the account, obtain an explanation of the nature
and approximate amounts of the other categories of entries that
have affected the account balance.
• Compute the ratios of material amounts of fringe benefits to the
total compensation earned by covered employees or other data.
Compare with the comparable ratios for the preceding period and
investigate significant or unusual fluctuations.
• Perform following procedures for a sample of employees from the
payroll register:
o Inspect time cards or other records to support hours
worked/attendance record.
o Inspect wage/salary authorization or agreements to support
the rates paid.
o Inspect authorization forms to support amounts withheld.
o Inspect personal files for appropriate documentation and
evidence for the existence of employees.
o Test the calculations of net pay and the clerical accuracy of
payroll register cumulative amounts.
o Inspect board minutes for approval of slab increments, and
bonus awarded.
• Ensure payment through cross cheques/bank transfers as per the
provision of the Income Tax Ordinance.

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Statement of Comprehensive Income / Profit or Loss Account

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Depreciation or amortization • Examine the Company’s procedures for reviewing the useful life
expense and carrying value of property, plant and equipment and note
down any action taken by the management for change in the
estimate of the useful life of the asset and carrying value. Also
check any impairment in the value of assets.
• Perform a predictive test of depreciation expense. Compare to
actual and investigate significant differences. Compare expense to
prior year.
• Compare the provision for depreciation, depletion and
amortization, by class of property, with comparable amounts for
prior periods and with budgeted amounts for the current period.
Investigate significant or unusual fluctuations after considering
the effects of additions, retirements and fully depreciated assets.
• Compare the ratio of the provision for depreciation, depletion and
amortization to total cost of property, plant and equipment with
comparable ratios for prior periods and with industry averages.
Investigate significant or unusual fluctuations.
• Discuss with appropriate client personnel the accounting policies
that affect accumulated depreciation, depletion and amortization.
Consider the acceptability of the stated policies. Evaluate any
changes in policies as to whether they constitute a change in
accounting principles or otherwise require disclosure in the
financial statements.
• Consider the reasons for any changes and determine whether the
revised estimates are reasonable.
• Select sample of property items from the supporting subsidiary
records and test the computation of the depreciation, depletion
or amortization recorded during the period.
Tax expense • Review client reconciliation of the prior period's book estimate of
income taxes payable to income taxes actually paid per the tax
return. Verify the clerical accuracy of the reconciliation and
examine support for significant reconciling items.
• Summarize the variations between the actual and estimated
permanent and temporary differences. Consider the effect on the
income tax provision and deferred tax. Consider the above
difference during testing of current year permanent and
temporary differences.
• Determine that the adjustments to record the effect of
differences between actual and estimated amounts have been
properly recorded.
• Review the working schedule of provision for taxation prepared by
the Company and ensure that the reconciling items are computed
in accordance with the provisions of the Income Tax Ordinance,
2001 and cross refer such items to the work performed in the
other areas of audit.
• Test significant permanent differences identified in the
reconciliation. Cross-reference the significant permanent

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differences to support contained in other areas of the working

papers.
• Compare the amounts of significant permanent differences for the
current period with comparable amounts for the preceding
period. Investigate significant or unusual fluctuations.
• Test the current provision for income taxes by multiplying taxable
income by the appropriate statutory tax rates for the current
period and cross refer the tax credit and expenses to the related
income statement account.
Earnings per share • Discuss with management the requirements of IAS 33 and request
that management recalculates the EPS in accordance with those
requirements.
• Review board minutes to confirm the authorization of the issue of
share capital, the number of shares and the price at which they
were issued.
• Inspect any other supporting documentation for the share issue,
such as a share issue prospectus or documentation submitted to
the relevant regulatory body.
• Confirm that the share issue complies with the company’s legal
documentation (e.g. the memorandum and articles of
association).
• Recalculate the weighted average number of shares for the year
to year end.
• Recalculate EPS using the profit as disclosed in the statement of
profit or loss and the weighted average number of shares.
• Discuss with management the existence of any factors which may
impact on the calculation and disclosure of a diluted EPS figure,
for example, convertible bonds.
• Read the notes to the financial statements in respect of EPS to
confirm that disclosure is complete and accurate and complies
with IAS 33.

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Statement of Financial Position / Balance Sheet

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Property, plant & equipment Valuation of property, plant and equipment (PPE):
(Assertion wise procedures) • Review depreciation policies for reasonableness by comparison to
prior year, industry practices, the entity’s replacement policy and
the profits/losses arising on disposal of assets.
• For a sample of assets recalculate the depreciation charge for the
year and agree to the entity asset register.
• Perform a proof in total calculation of depreciation, considering
the timing of additions and disposals and compare this
expectation to the actual charge, and investigate any significant
differences.
• If any assets have been revalued during the year then assess the
reasonableness of the valuer. In particular consider their
experience, independence, scope of work and assumptions used.
• Agree the revalued amounts to a valuation report, for a sample
recalculate the revaluation surplus and agree to the revaluation
reserve.
• For a sample of the additions, vouch the cost to a recent purchase
invoice.
Completeness of PPE:
• Reconcile the schedule of PPE with the general ledger.
• Select a sample of assets physically present at the entity’s
premises and inspect the asset register to ensure that these are
included.
• Reperform the reconciliation of the non-current asset register to
the general ledger, investigate any differences.
• Review the repairs and maintenance expense account in the
statement of comprehensive income for items of a capital nature.
Rights and obligations of PPE:
• Verify ownership of property via inspection of title deeds and land
registration documents.
• For a sample of additions agree to purchase invoices to verify
invoice relates to the entity.
• Review any new lease agreements to ensure assets are correctly
treated as finance or operating leases.
• Inspect vehicle registration documents to confirm ownership of
motor vehicles.
Property, plant & equipment • Trace all significant additions made during the year from fixed
(Additions) assets register.
• For major property additions, obtain a listing of additions, review
invoice support and to approval in minutes.
• Scan the supporting subsidiary ledgers and other similar records
to ensure that all the additions over a listing scope are properly
included in property, plant and equipment.
• Examine critical forms and documents supporting the additions
like in case of real estate additions, examine the deed, title
abstract etc., or in case of vehicles examine registration
documents.

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• In case of imported plant and machinery, examine the bill of

lading, LCs, landed cost sheet for the components of cost and
other documentation as an evidential matter.
• In case of an imported asset, ensure that purchase price includes
only the C&F value, import duties, non-refundable purchase taxes
and any directly attributable cost to bringing the assets to its
working conditions. Also ensure that any trade discounts and
rebates are deducted therefrom.
• Review and ensure that all the additions over specified limit are
properly approved by the Board of Directors.
• Review and ensure that start-up and pre-production costs have
not been added to the cost of an asset unless it is necessary to
bring the assets to its working condition.
• Trace the cost of the individual addition to the suppliers invoice
and to a counterfoil of a cheque. Also note whether the
description on the invoice is of an item that should be capitalized
under the company’s accounting policies and relate to the
company’s business.
• Discuss with appropriate client personnel the assets addition
approval process and prepare system notes.
Property, plant & equipment • Obtain a listing of all sales or other asset dispositions over a
(Disposals) certain amount, indicating the accounting treatment for each, and
review propriety of accounting. Inquire if there are any
unrecorded retirements.
• Tie gain/loss on disposition to lead schedule.
• Examine cash receipts for all retirements over a certain amount
and determine that proper cost and accumulated depreciation
were removed from the books.
• For material disposals, determine that proper authorization to
dispose was obtained.
• Obtain a copy of Board’s approval for disposals.
• Examine and scan relevant supporting subsidiary ledger or other
similar records to ensure that all dispositions over a listing scope
are properly included in the disposition schedule.
• Obtain listings of any abandoned assets or any assets destroyed
during the year.
• For significant disposition, review the supporting subsidiary
records and determine whether the cost basis, accumulated
depreciation are properly removed from the records.
• Inquire about any related party sales and cross refer the
disposition with transaction with related parties.
Property, plant & equipment • Tour the plant facilities before physical verification preferably
(Physical verification procedures) atleast 15 days earlier to the year-end/inventory observation date.

• Observe the taking of physical inventories of selected property

categories, noting the adequacy of the client's procedures and the
condition of the property items. Consider using Form Inventory
Observation Checklist.
• Prepare a summary memorandum describing the basis for
selecting locations observed, the procedures followed during the
observations and the principal observations.

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• Conclude as to the effectiveness of the methods of inventory-

taking and the measure of reliance that may be placed on the
client's representations about the quantities and physical
condition of the property items.
• Review the reconciliation of the physical inventory to the general
ledger balances for property, plant and equipment. Determine
whether reconciling items have been properly accounted for.
• Through discussions with appropriate client personnel, determine
whether idle, under-utilized, poorly performing or obsolete
property exists. Determine whether, and on what basis, the client
has made appropriate write downs for any such items and
whether any additional write downs should be recorded to state
them at their net realizable value.
Property, plant & equipment • Obtain a schedule of Revaluation of fixed assets showing assets
(Revaluation surplus) wise detail, cost of the assets, revalued amount, name of valuer.
• Test the summarization of the schedule.
• Trace totals to the general ledger.
• Examine the valuer’s report to ensure the correctness of revalued
amount of the fixed assets and ensure independence of the valuer
and checked appropriateness of assumptions used by valuer.
• Check that the surplus on revaluation of the fixed assets has been
applied:
o Only to the extent actually realized on disposal of revalued
assets.
o On setting –off any deficit arising from the revaluation of any
other fixed assets of the company.
• Check incremental depreciation transferred from surplus to
unappropriated profit / accumulated loss.
• Check compliance with the requirement of IFRS 12 “Income Taxes
(Revised)” in respect of deferred Tax on surplus on revaluation of
fixed assets.

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Statement of Financial Position / Balance Sheet

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Property, plant & equipment - • Obtain a copy of the valuation report and consider the reliability
Evaluating Expert’s Work of valuation after taking account of:
o the basis of valuation; and
(Property valuer)
o in respect of the valuer:
➢ independence/ objectivity,
➢ qualifications,
➢ experience/ competence/ expertise,
➢ reputation.
• Compare the value attributed to the company’s property to the
value of other similar assets.
• Reperform calculation of revaluation adjustments and ensure that
they have accounted for correctly.
• Ensure the depreciation is based on the revalued amount.
• Inspect notes to the financial statements to ensure appropriate
disclosures.
• Ensure all the assets in class are revalued.
• Subsequent events should be monitored for any additional
evidence provided on the valuation of the properties.
• For example, the sale of an investment property shortly after the
year end may provide additional evidence relating to the fair value
measurement.
• Obtain a management representation regarding the
reasonableness of any significant assumptions, where relevant, to
fair value measurements or disclosures.
• Inspection of the written instructions provided by Company to the
valuer, which should include matters such as the objective and
scope of the valuer’s work, the extent of the valuer’s access to
relevant records and files, and clarification of the intended use by
the auditor of their work.
• Evaluation, using the valuation report, that any assumptions used
by the valuer are in line with the auditor’s knowledge and
understanding of the Company. Any documentation supporting
assumptions used by the valuer should be reviewed for
consistency with the auditor’s business understanding, and also
for consistency with any other audit evidence.
• Assessment of the methodology used to arrive at the fair value
and confirmation that the method is consistent with that required
by IAS 40.
• The auditor should confirm, using the valuation report, that a
consistent method has been used to value each property.
• It should also be confirmed that the date of the valuation report is
reasonably close to the year end of the Company.
• Physical inspection of the investment properties to determine the
physical condition of the properties supports the valuation.

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Statement of Financial Position / Balance Sheet

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Investment property • Obtain movement schedule of investment properties both for cost
and accumulated depreciation. Check casting and cross casting of
the schedule.
• Trace opening balances from investment properties' subsidiary
records, general ledger and last year’s working papers.
• Ensure that:
o Properties are owned and held by client.
o Remaining useful life appears to be correct.
• If a client holds property partly held to earn rentals or for capital
appreciation and partly held for own use then the property should
be classified as investment property only if these portions could
be sold separately (or leased out separately under a finance lease)
or if an insignificant portion is held for own use. Ensure the
compliance with requirement of IAS 40.
• Ensure that a property is classified as investment property only if
its cost may be determined. Under construction properties should
not be classified as investment properties.
• For selected capitalsations during the current period:
o Appropriate approvals and bills/ invoices and certificates.
o Ensure that expenditure relating to an investment property
should be debited to the investment property when it is
probable that future economic benefits, in excess of the
originally assessed standard of performance of the existing
investment property, will flow to the enterprise. All other
expenditure should be recognized as an expense in the period
in which it is incurred.
• For any property disposed of during the current period:
o Examine documents authorizing disposal.
o Examine documents supporting amounts for which sale was
affected e.g. cash receipts
o Calculate gain or loss on disposal of fixed assets
• To check depreciation expense:
o Determine the reasonableness of accounting policy and
depreciation method, rates and their consistency with prior
years.
o Check calculation of depreciation.
• Ensure that none of the property is impaired or the recoverable
amount of any property is not less than its carrying amount. If the
carrying amount of an asset is more than its recoverable amount,
that same should be reduced to recoverable amount recognizing
the reduction as impairment loss.
• Inspect property documents to ensure ownership.
• Ensure that where fair value model has been adopted the fair
value of investment property should reflect the actual market
state and circumstances as of the balance sheet date, not as of
either a past or future date.
• Ensure that valuer's assumptions are reasonable.

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• Ensure that there is no restrictions on the realisability of

investment property or the remittance of income and proceeds of
disposal.
• Ensure that closing balances as per our working paper file are in
match with general ledger.
Acquisition of brand • Review board minutes for evidence of discussion of the purchase
of the acquired brand, and for its approval.
• Agree the consideration paid for the brand to the company’s cash
book and bank statement.
• Obtain the purchase agreement and confirm the rights of acquirer
in respect of the brand.
• Discuss with management the estimated useful life of the brand
and obtain an understanding of how useful life has been
determined as appropriate.
• If the useful life is a period stipulated in the purchase document,
confirm to the terms of the agreement.
• If the useful life is based on the life expectancy of the product,
obtain an understanding of the basis for this, for example, by
reviewing a cash flow forecast of sales of the product.
• Obtain any market research or customer satisfaction surveys to
confirm the existence of a revenue stream.
• Consider whether there are any indicators of potential
impairment at the year-end by obtaining pre-year-end sales
information and reviewing terms of contracts to supply the
products to pharmacies.
• Recalculate the amortization expense for the year and agree the
charge to the financial statements, and confirm adequacy of
disclosure in the notes to the financial statements
Measurement of intangible asset • Obtain the license agreement and confirm the length of the
recognized in respect of the license license period from the date it was granted.
• Confirm whether the license can be renewed at the end of the
period, as this may impact on the estimated useful life and
amortization.
• Re-perform management’s calculation of the amortization
charged as an expense.
• Discuss with management the process for identifying an
appropriate amortization method and where relevant, how the
pattern of future economic benefits associated with the license
have been determined.
• Confirm with management when the intangible was available to
use (operational date).
• Review a sample of contracts with customers to verify that
contracts commenced from the operational date.
• Enquire with management on the existence of any factors
indicating that a shorter useful life is appropriate, for example, the
stability of market demand or possible restrictions on the use of
license.
• Review management accounts and cash flow forecasts to confirm
that license is generating an income stream and is predicted to
continue to generate cash.

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• Obtain a written representation from management confirming

that there are no indications of impairment of the license of which
management is aware.
Measurement and recognition of • Obtain a schedule of development costs and check that costs
development cost meet the relevant capitalization criteria and:
o Agree employee costs to payroll records
o Agree material costs to invoices
o Identify any items capitalized and ascertain from management
the reasons these costs were capitalized.
• Inspect the audit work performed on tangible assets to ascertain
whether depreciation charges are reliable:
o Trace the depreciation capitalized to the accounting records
for equipment
o Confirm the related asset is used in product development.
• Ascertain the basis for attributing overheads and:
o Consider the reasonableness of this basis
o Agree the overhead costs to the management accounts
o Reperform the calculations.
• Inspect evidence of management’s impairment review.
• Ascertain the basis for the estimate of useful life and consider its
reasonableness by:
o Comparing it to other similar companies
o Comparing it to the length of contracts negotiated with retail
customers.
o Obtaining expert advice on how long this type of technology is
likely to last before being superseded.
• Reperform the amortization calculation
Unamortized intangible asset • Agree the cost of the brand to the supporting documentation.
(brand) • Agree the cost of brand to the PY financial statements.
• Review the monthly income streams generated by the brand for
indication of decline in sales.
• Review the results of impairment reviews performed by
management.
• Perform an independent impairment review and compare it with
the management impairment review.
• Review the assumption used and establish its validity e.g. discount
rate used, growth rate used, etc.
• Inquire as to the result of customer satisfaction surveys to gain an
understanding of the public perception (impairment indicator).
• Consider whether non-amortization is a generally accepted
practice in industry.
• Discuss with management the reasons for non-amortization.
Impairment of assets (General • Interview management to evaluate whether or not the
procedures) assumptions on which the value measurements are based, are
reasonable and consistent with:
o the general economic environment, the economic
environment of the specific industry, existing market
information and the entity’s economic circumstances;
o assumptions made in prior periods; and

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o the risk associated with cash flows, including the potential

variability in the amount and timing of the cash flows and the
related effect on the discount rate.
• Check whether the forecast have been approved at the
appropriate level of management.
• Compare prior year forecasts with current year actual result and
identify and assess the variances.
• Check the cash flow projections with the most recent financial
budgets/forecasts approved by management.
• Check the projections covered the maximum period of five years
as prescribed by IAS 36. If the period is greater than five years,
understand how the entity has justified it.
• Ensure that projections do not include any cash flows arising from
future restructuring.
• Evaluating the competence, capabilities and objectivity of
personnel preparing the projections.
• Check the appropriateness of discount rate used by the
management
• Test the underlying data to confirm that it is accurate, complete,
and relevant and provides objective support for the assumptions
used in the valuation analysis.
• Consider involving internal expert to review the working.
• Check subsequent period performance as far as possible.
Impairment of goodwill • The assumptions used in the impairment test should be confirmed
as agreeing with the auditor’s understanding of the business
based on the current year’s risk assessment procedures, e.g.
assess the reasonableness of assumptions on cash flow
projections.
• Confirm that the impairment review includes the goodwill relating
to all business combinations.
• Consider the impact of the auditor’s assessment of going concern
on the impairment review, e.g. the impact on the assumption
relating to growth rates which have been used as part of the
impairment calculations.
• Obtain an understanding of the controls over the management’s
process of performing the impairment test including tests of the
operating effectiveness of any controls in place, for example, over
the review and approval of assumptions or inputs by appropriate
levels of management and, where appropriate, those charged
with governance.
• Confirm whether management has performed the impairment
test or has used an expert.
• The methodology applied to the impairment review should be
checked by the auditor, with inputs to calculations, e.g. discount
rates, agreed to auditor-obtained information.
• Develop an independent estimate of the impairment loss and
compare it to that prepared by management.
• Confirm that the impairment calculations exclude cash flows
relating to tax and finance items.
• Perform sensitivity analysis to consider whether, and if so how,
management has considered alternative assumptions and the

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impact of any alternative assumptions on the impairment

calculations.
• Check the arithmetic accuracy of the calculations used in the
impairment calculations.
Impairment of brand • Obtain management’s calculations relevant to the impairment and
review to understand methodology, for example, whether the
brand has been entirely or partly written off.
• Evaluate the assumptions used by management in their
impairment review and consider their reasonableness.
• Confirm the carrying value of the brand pre-impairment to prior
year financial statements or management accounts.
• From management accounts, obtain a breakdown of total revenue
by brand, to evaluate the significance of the brand to financial
performance and whether it constitutes a separate line of
business for disclosure as a discontinued operation.
• If the brand is not fully written off, discuss with management the
reasons for this treatment given that the brand is now
discontinued.
• Obtain a breakdown of operating expenses to confirm that the
impairment is included.
• Review the presentation of the income statement, considering
whether separate disclosure of the impairment is necessary given
its materiality.
Deferred tax asset • Whether the recognition criteria for deferred tax asset as
specified in IFRS has been met.
• Whether the methods estimating the amount of deferred tax are
appropriate and have been applied consistently, and whether
changes, if any, in accounting estimates are appropriate in the
circumstances.
• Determining whether events occurring up to the date of the
auditor’s report provide evidence regarding the deferred tax
asset.
• Review the future projections provided by the client and their
viability.
• Checking appropriateness of disclosures related to the
requirements of IAS 12.
• Written representations from the management.
Accounts receivable (General • Review receivables ageing to identify any old outstanding
procedures) amounts which may need a provision;
• Perform a positive trade receivables circularization of a
representative sample of the Company’s year-end balances, for
any non-replies, with the Company’s permission, send a reminder
letter to follow up.
• Review the after-date cash receipts and follow through to pre-
year-end receivable balances.
• Calculate average receivable days and compare this to prior year,
investigate any significant differences.
• Review the reconciliation of sales ledger control account to the
sales ledger list of balances.

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• Select a sample of goods dispatched notes (GDN) before and just

after the year end and follow through to the sales invoice to
ensure they are recorded in the correct accounting period.
• Inspect the aged receivables report to identify any slow-moving
balances, discuss these with the credit control manager.
• For any slow moving/aged balances review customer
correspondence to assess whether there are any invoices in
dispute.
• Review board minutes of the Company to assess whether there
are any material disputed receivables.
• Review a sample of post year-end credit notes to identify any that
relate to pre-year-end transactions to verify that they have not
been included in receivables.
• Select a sample of year-end receivable balances and agree back to
valid supporting documentation of GDN and sales order to ensure
existence.
• Perform cutoff tests on a sample of invoices just before and after
the YE to ensure that only the invoices for services/ goods
dispatched prior to YE are recorded,
• Re-perform calculation of allowances & ascertain from
management the reasonableness of its basis.

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Statement of Financial Position / Balance Sheet

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Bank balances • Obtain the company’s bank reconciliation and check the additions
to ensure arithmetical accuracy.
• Obtain a bank confirmation letter from the company’s bankers.
• Verify the balance per the bank statement to an original year end
bank statement and also to the bank confirmation letter.
• Verify the reconciliation’s balance per the cash book to the year-
end cash book.
• Trace all of the outstanding lodgments to the post year end bank
statement.
• Examine any old unpresented cheques to assess if they need to be
written back into the purchase ledger as they are no longer valid
to be presented.
• Trace all unpresented cheques through to a pre year end cash
book and post year end statement. For any unusual amounts or
significant delays obtain explanations from management.
• Agree all balances listed on the bank confirmation letter to the
company’s bank reconciliations or the trial balance to ensure
completeness of bank balances.
• Review the cash book and bank statements for any unusual items
or large transfers around the year end, as this could be evidence
of window dressing.
• Examine the bank confirmation letter for details of any security
provided by the company or any legal right of set-off as this may
require disclosure.
Inventory • Evaluate and test controls over:
o inventory count procedures
o updates to the perpetual inventory records o updates to
component costs
o the interface between inventory and cost accounting systems
• Review reports of previous inventory counts, evaluate the level of
discrepancies and consider the implications for the reliability of
the inventory system
• Perform test counts of inventory at a periodic count
• Match dispatch records with entries on the parts inventory system
• Identify slow-moving or obsolete items by reviewing the age
analysis of inventory
• Compare fixed selling prices to costs of parts to determine
whether NRV is less than carrying value
• Compare the inventory of parts with the number of engines still in
use and assess whether the parts will be used
• Discuss the basis of provision with management
• Obtain standard cost specifications for each part and for a sample
of parts:
o test cost of components to suppliers’ invoices
o vouch labor costs to payroll
o ascertain the basis of overhead allocation
o ensure overhead allocation is based on normal level of activity

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o reperform calculations o reperform a sample of foreign

currency translations and check rates to a reliable source.
Valuation of Work in Progress • For the contract costing system:
✓ discuss functionality issues with management
✓ ascertain controls over the transfer of data to new system
✓ test the transfer of a sample of balances from the old system
to the new system
✓ evaluate and test the controls over
o the interface between the purchases and payroll systems
and the contract costing system
o the initial recording of purchase and payroll costs.
• For a sample of contracts underway at the year-end:
✓ vouch entries for labor to payroll records
✓ vouch entries for components to suppliers’ invoices
✓ physically inspect WIP.
• To identify potential losses:
✓ compare actual costs to budget to identify cost overruns
✓ compare contract price to estimated total costs
✓ inspect ageing of WIP to identify any irrecoverable WIP
✓ inspect post year-end sales invoices to ascertain if WIP is
invoiced soon after year end
✓ inspect post year-end receipts
✓ obtain a written representation from management confirming
the adequacy of the provisions for losses
• For attributable overhead calculations:
✓ ascertain the basis of the assumptions
✓ reperform the calculation
✓ check that only attributable overheads are included
✓ agree the figures to the management accounts
✓ test the reliability of the management accounts
✓ assess the consistency of the valuation with previous years
✓ assess reasonableness of basis.
• For a sample of items purchased from overseas suppliers:
✓ recalculate the foreign exchange translation
✓ check the rate used to a reliable independent source.
• Agree the figure on the WIP schedule to the amount included in
the financial statements.

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Statement of Financial Position / Balance Sheet

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Valuation of inventory • Select a representative sample of goods in inventory at the year
end, agree the cost per the records to a recent purchase invoice
and ensure that the cost is correctly stated.
• Select a sample of year end goods and review post yearend sales
invoices to ascertain if NRV is above cost or if an adjustment is
required.
• For a sample of manufactured items obtain cost sheets and
confirm:
o raw material costs to recent purchase invoices
o labor costs to time sheets or wage records
o overheads allocated are of a production nature.
• Review aged inventory reports and identify any slow-moving
goods, discuss with management why these items have not been
written down.
• Compare the level/value of aged product lines to the total
inventory value to assess whether the provision for slow moving
goods of 1% should be reinstated.
• Review the inventory records to identify the level of adjustments
made throughout the year for damaged/obsolete items.
• If significant consider whether the year-end records require
further adjustments and discuss with management whether any
further write downs/provision may be required.
• Follow up any damaged/obsolete items noted by the auditor at the
inventory counts attended, to ensure that the inventory records
have been updated correctly.
• Perform a review of the average inventory days for the current
year and compare to prior year inventory days. Discuss any
significant variations with management.
• Compare the gross margin for current year with prior year. Discuss
significant variations in the margin with management.
Procedures to determine if NRV is • Obtain actual sales prices by reference to invoices issued after the
above cost year-end and determine that the sales were genuine by vouching
sales invoices to orders, dispatch notes and subsequent receipt of
cash.
• If actual sales prices are not available, the auditor should obtain
estimated sales prices from management. The auditor might be
aided in this respect by reviewing the reports from sales staff
backed up by discussions with management.
• Attention should be paid to sales prices of goods identified as
slow-moving.
• For damaged goods disposal price may be nil or very low and the
E.A should examine records of disposal of such goods in the past.

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Statement of Financial Position / Balance Sheet

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Inventory held at third party • Send a letter requesting direct confirmation of inventory balances
locations held at year end from the third-party warehouse providers used
by the Company regarding quantities and condition.
• Attend the inventory count (if one is to be performed) at the
third-party warehouses to review the controls in operation to
ensure the completeness and existence of inventory.
• Inspect any reports produced by the auditors of the warehouses
in relation to the adequacy of controls over inventory.
Short-term investments • Agree the fair value of the shares held as investments to stock
market share price listings at the year end.
• Confirm the original cost of the investment to cash book and bank
statements.
• Discuss the accounting treatment with management and confirm
that an adjustment will be made to recognise the shares at fair
value.
• Review the notes to the financial statements to ensure that
disclosure is sufficient to comply with the requirements of IFRS 9.
• Enquire with the treasury management function as to whether
there have been any disposals of the original shares held and
reinvestment of proceeds into the portfolio.
• Review board minutes to confirm the authorization and approval
of the amount invested.
• Review documentation relating to the scope and procedures of
the new treasury management function, for example, to
understand how the performance of investments is monitored.
• For any investments from which dividends have been received,
confirm the number of shares held to supporting documentation
such as dividend received certificates or vouchers.
Valuation of currency swap • Obtain the details of the foreign currency swap contracts.
contract • Assess the reasonableness of assumptions used in the foreign
currency swap contracts.
• Verify the valuation rates used, if available from authentic
websites (e.g. Bloomberg).
• Check subsequent settlement of contracts, if any, for verification
of the valuation rates.
• In case valuation methodologies have been used in valuation of
derivative contracts then apart from assessing the reasonableness
of the assumptions, get the valuation re-performed for the
contract by the auditor.
• Evaluate whether the auditor’s expert has the necessary
competence, capabilities and objectivity for the auditor’s
purposes.

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Statement of Financial Position / Balance Sheet

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Disposal of wholly-owned • Obtain the statement of financial position of the subsidiary as at
subsidiary the disposal date to confirm the value of assets and liabilities
which have been derecognised from the Group.
• Review prior year group financial statements and audit working
papers to confirm the amount of goodwill that exists in respect of
the subsidiary and trace to confirm it is derecognised from the
group on disposal.
• Confirm that the group is no longer listed as a shareholder of the
subsidiary company.
• Obtain legal documentation in relation to the disposal to confirm
the date of the disposal and confirm that subsidiary’s profit has
been consolidated up to disposal date only.
• Agree or reconcile the profit recognized in the group financial
statements to subsidiary’s individual accounts as at disposal date.
• Perform substantive analytical procedures to gain assurance that
the amount of profit consolidated from the beginning of the year
to disposal date appears reasonable and in line with expectations
based on prior year profit.
• Reperform management’s calculation of profit on disposal in the
group financial statements.
• Agree the proceeds received to legal documentation, and to cash
book/bank statements.
• Confirm that proceeds received reflect the fair value and that no
deferred or contingent consideration is receivable in the future.
• Review the group statement of profit or loss and other
comprehensive income to confirm that the profit on disposal is
correctly disclosed as part of profit for the year (not in other
comprehensive income) on a separate line.
• Using a disclosure checklist, confirm that all necessary information
has been provided in the notes to the group financial statements.
• Obtain the parent company’s statement of financial position to
confirm that the cost of investment is derecognised.
• Using prior year financial statements and audit working papers,
agree the cost of investment derecognised to prior year’s figure.
• Reperform the calculation of profit on disposal in the parent
company’s financial statements.
• Reconcile the profit on disposal recognized in the parent
company’s financial statements to the profit recognized in the
Group financial statements.
• Obtain management’s estimate of the tax due on disposal,
reperform the calculation and confirm the amount is properly
accrued at parent company and at group level.
• Review any correspondence with tax authorities regarding the tax
due.
• Possibly the tax will be paid in the subsequent events period, in
which case the payment can be agreed to cash book and bank
statement.

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Statement of Financial Position / Balance Sheet

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Planned acquisition of a company • Read board minutes to understand the rationale for the
acquisition, and to see that the acquisition is approved.
• Discuss with group management the way that control will be
exercised over the target company, enquiring as to whether the
group can determine the board members of target company.
• Review the minutes of relevant meetings held between
management of the group and target company to confirm matters
such as:
o That the deal is likely to go ahead
o The likely timescale
o The amount and nature of consideration to be paid
o The shareholding to be acquired and whether equity or non-
equity shares
o The planned operational integration (if any) of target company
into the group
• Obtain any due diligence reports which have been obtained by the
group and review for matters which may need to be disclosed in
accordance with IAS 10 or IFRS 3.
• Obtain copies of the finance agreement for the funds used to
purchase target company.
• After the reporting date, agree the cash consideration paid to
bank records.
Classification of the 50% equity • Obtain the legal documentation supporting the investment and
shareholding as a joint venture agree the details of the investment including:
o The date of the investment
o Amount paid
o Number of shares purchased
o The voting rights attached to the shares
o The nature of the profit-sharing arrangement between equity
partners
o The nature of access assets under the terms of the agreement
o Confirmation that there is no restriction on shared control
• Read board minutes to confirm the approval of the investment
and to understand the business rationale for the investment.
• Read minutes of relevant meetings between equity partners to
confirm that control is shared between the two companies and to
understand the nature of the relationship and the decision-
making process.
• Obtain documentation such as organisational structure to confirm
that both partners have successfully appointed members to the
board and that those members have equal power to the members
appointed by other partner(s).

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Statement of Financial Position / Balance Sheet

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Measurement of goodwill on • Agree the purchase consideration to the legal documentation
acquisition pertaining to the acquisition and review the documents to ensure
that the figures included in the goodwill calculation are complete.
• Review due diligence report relevant to the acquisition, for
confirmation of acquired assets and liabilities and their fair values.
• Verify and assess the reasonableness of the discount rate used for
discounting the purchase consideration received on xyz date.
• Evaluate the methods / assumptions used to determine the fair
value of acquired assets, including the property and liabilities, to
confirm compliance with IFRS 3 and IFRS 13.
• Review of board minutes for discussions relating to the acquisition
and for the relevant minutes of board approval.
• Verify and assess the reasonableness of the fair value of NCI.
Classification of non-controlling • Determine the percentage shareholding acquired, using purchase
interest (NCI) documentation, legal agreements, etc.
• Confirm that the percentage shareholding is within the normal
range for an associate i.e. between 20 and 50% of equity shares.
• Obtain a list of directors (using published financial statements or
an internet search) for the companies to confirm whether the
Company has appointed director(s) to the boards.
• Discuss with the directors of the Company their level of
involvement in policy decisions made at the companies.
• Obtain a written representation detailing the nature of
involvement and influence exerted over the companies (for
example, a letter from the investee’s board of directors
confirming the voting power of the Company).
• Consider the identity of the other shareholders and the
relationship between them and the Company. This may reveal
that the situation is in substance a joint venture and would need
to be accounted for as such.
Procedures on consolidation • Agree correct extraction of the individual company figures by
schedule reference to individual company audited financial statements;
• Cast and cross cast all consolidation schedules;
• Recalculate all consolidation adjustments, incl Goodwill,
elimination of pre-acquisition reserves, cancellation of inter-
company balances, fair value adjustments and accounting policy
adjustments;
• By reference to the prior year audited consolidated financial
statements, agree accounting policy have been consistently
applied;
• Agree prior year figures to the prior year audited consolidated
financial statements;
• Agree that any post acquisition profits consolidated arose since
the date of acquisition of control passing per purchase agreement;
• Reconcile opening and closing group reserves and agree
reconciling items to group financial statements.

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Statement of Financial Position / Balance Sheet

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Procedures to decide the extent of • Review the local ethical code (if any) followed by the local firm
reliance on the work of component (the firm) and compare with the IESBA Code of Ethics for
Professional Accountants for any significant difference in
auditor (if different firm) – group
requirements and principles.
audit situation • Obtain confirmation from the firm of adherence to any local
ethical code and the IESBA Code.
• Establish through discussion or questionnaire whether the firm is
a member of an auditing regulatory body, and the professional
qualifications issued by that body.
• Obtain confirmations of membership from the professional body
to which the firm belongs, or the authorities by which it is
licensed.
• Discuss the audit methodology used by the firm in the audit of
subsidiary and compare it to those used under ISAs (e.g. how the
risk of material misstatement is assessed, how materiality is
calculated, the type of sampling procedures used).
• 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
firm, both firm-wide and those applied to individual audit
engagements.
• Request any results of monitoring or inspection visits conducted
by the regulatory authority under which the firm operates.
Assets held for sale • Review board minutes to confirm that the sale has been approved
and to agree the date of the approval to the board minutes and
relevant staff announcements.
• Obtain correspondence with market participants for example,
estate agents to confirm that the asset or disposal group is being
actively marketed.
• Obtain confirmation, for example, by a review of production
schedules, inventory movement records and payroll records, that
asset or disposal group is not being used and thus it is available for
immediate sale.
• Use an auditor’s expert to confirm the fair value of the asset or
disposal group and agree that this figure has been used in the
impairment calculation.
• Using management accounts, determine whether the asset or
disposal group represents a separate major line of business in
which case its results should be disclosed as a discontinued
operation.

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Statement of Financial Position / Balance Sheet

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Trade payables • Obtain a listing of trade payables from the purchase ledger and
agree to the general ledger and the financial statements.
• Reconcile the total of purchase ledger accounts with the purchase
ledger control account, and cast the list of balances and the
purchase ledger control account.
• Review the list of trade payables against prior years to identify any
significant omissions.
• Calculate the trade payable days for the Company and compare to
prior years, investigate any significant differences.
• Review after date payments, if they relate to the current year then
follow through to the purchase ledger or accrual listing to ensure
completeness.
• Review after date invoices and credit notes to ensure no further
items need to be accrued.
• Obtain supplier statements and reconcile these to the purchase
ledger balances, and investigate any reconciling items.
• Select a sample of payable balances and perform a trade payables’
circularisation, follow up any non-replies and any reconciling items
between balance confirmed and trade payables’ balance.
• Enquire of management their process for identifying goods
received but not invoiced or logged in the purchase ledger and
ensure that it is reasonable to ensure completeness of payables.
• Select a sample of goods received notes before the year-end and
follow through to inclusion in the year-end payables balance, to
ensure correct cut-off.
• Review the purchase ledger for any debit balances, for any
significant amounts discuss with management and consider
reclassification as current assets.
• Ensure payables included in financial statements as current
liabilities.
Provision or claim • Obtain the letter received from the authorities and review to
understand the basis of the claim, for example, to confirm if it
refers to a specific incident when damage was caused to the coral
reefs.
• Discuss the issue with the legal adviser, to understand whether in
their opinion, the company could be liable for the damages, for
example, to ascertain if there is any evidence that the damage to
the coral reef was caused by activities of the company or its
customers.
• Discuss with the legal adviser the remit and scope of the
legislation.
• Discuss with management and those charged with governance the
procedures which the company utilises to ensure that it is
identifying and ensuring compliance with relevant legislation.
• Obtain and read all correspondence between the company and
authorities, to track the progress of the legal claim up to the date
that the auditor’s report is issued, and to form an opinion on its
treatment in the financial statements.

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• Obtain a written representation from management, as required by

ISA 250, that all known instances of non-compliance, whether
suspected or otherwise, have been made known to the auditor.
• Review the disclosures, if any, provided in the notes to the
financial statements, to conclude as to whether the disclosure is
sufficient for compliance with IAS 37.
• Read the other information published with the financial
statements, including chairman’s statement and directors’ report,
to assess whether any disclosure relating to the issue has been
made, and if so, whether it is consistent with the financial
statements.
Provision for warranty claims • Inspect the terms of the warranty agreements.
• Ascertain the basis of the assumptions used in the provision
calculation:
o reperform any calculations
o assess the reasonableness of the basis
• Compare the previous year's provision to actual claims made to
establish the reliability of director’s estimates.
• Perform an analytical procedure based on the historical claim rate
and the level of current year contracts.
• Inspect post year-end claims and compare to the provision
• Inspect customer correspondence:
o identify complaints relating to any of the installations.
o trace claims back to their inclusion in the provision calculation.
• Inspect board minutes for an indication of problems with any of
the company’s installations.
• Inspect records of rectification costs to assess the amounts
involved.
• Obtain a written representation from management regarding the
assumptions underlying the provisions.
• Agree the figures on the warranty schedule to the amounts
included in the financial statements.

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Statement of Financial Position / Balance Sheet

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Provision for redundancy costs • Obtain the schedule detailing the redundancy provision.
• Re-perform any calculations and confirm the provision reflects
redundancy terms.
• Discuss with the directors the basis for their estimate of the
provision and consider its reasonableness.
• Multiply the expected number of employees to be made
redundant by the average pay-out and compare to the provision.
Obtain an explanation for any difference.
• For a sample of items on the schedule detailing the redundancy
provision:
o inspect employees’ contracts for redundancy terms
o check HR records to confirm length of service
• Inspect board minutes and ensure that the basis of the provision is
consistent with what directors have authorised.
• Obtain copies of the public announcement and notices to
employees and ensure that they were published before year end.
• Confirm that notices to employees offer enhanced terms.
• Review any post year-end payments.
• Obtain a written representation from management on whether
the assumptions underlying the provision are reasonable.
Procedures on actuarial liability • Assess that the management expert should have relevant
(IAS-19) competence and capable enough of doing the tasks assigned.
• Evaluate whether the auditor’s expert has the necessary
competence, capabilities and objectivity for the auditor’s
purposes.
• Obtain and ensure the completeness and accuracy of the data in
respect of staff retirement benefits provided by the management
to the management and auditor’s expert.
• Independently assess the accuracy of the assumptions pertaining
to salary increase rate, discount rate, retirement age, pension
indexation, if any on the basis of historical trend and current
status of the things.
• Discuss and resolve the differences, if significant, between the
report of the expert and report of auditor’s expert.
• Ensure that proper disclosure is given in the financial statements
in respect of defined benefit plan liability.

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Statement of Financial Position / Balance Sheet

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Share based payment plan • Obtain the details of the share-based payment plan to ascertain
the major terms of the plan including:
o The grant date and vesting date
o The number of executives and senior managers awarded
options
o The number of share options awarded to each individual
o The required conditions attached to the options
o The fair value of the share options at the grant date.
• Scrutinize the conditions attached to the options to confirm the
according to IFRS 2.
• Review the assumptions used, and inputs into the option pricing
model used by management to estimate the fair value of the
share options at the grant date.
• Consider the appropriateness of the model used to generate a fair
value for the share options.
• Consider the use of an expert possessing specialist skills in share
option pricing, such as a chartered financial analyst, to provide
evidence as to the validity of the fair value of share options used
in the calculations.
• Obtain and review a forecast of staffing levels or employee
turnover rates relevant to executives and senior managers over
the vesting period and consider whether assumptions used
appear reasonable.
Recognition and measurement of • Obtain the documentation relating to the grant to confirm the
the government grant amount, the date the cash was received, and the terms on which
the grant was awarded.
• Review the documentation for any conditions attached to the
grant.
• Discuss with management the method of recognition of the
amount received, in particular how much of the grant has been
recognized in profit and the treatment of the amount deferred in
the statement of financial position.
• For the part of the grant relating to criteria, confirm that the grant
criteria have been complied with by examining supporting
documentation.
• Using the draft financial statements, confirm the accounting
treatment outlined by discussion with management has been
applied and recalculate the amounts recognized.
• Confirm the cash received to bank statement and cash book.

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Statement of Financial Position / Balance Sheet

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Trasactions with associated • The terms of the transactions with the associated company need
company / related party to be obtained and compared with market terms.
• If the price charged to the related party is not the market price
transactions
seek justification from the management and document it
appropriately.
• If credit terms are not comparable with those prevailing in the
market, the transaction with the related party may be construed
as a financing transaction.
• If the entity is unable to produce relevant approval of the
shareholders in respect of loan, it will constitute a non-compliance
with laws and regulations.
• The auditor shall consider the need to obtain legal advice.
• The auditor shall also evaluate the implications of non-compliance
in relation to other aspects of the audit, including the auditor’s
risk assessment and the nature, timing and extent of audit
procedures.
• Ensure that transactions with associated company are approved
and authorized by the board of directors.
• If the transaction with associated company lacks logical business
rationale then reassess the management integrity.
• Check whether the transaction has been disclosed as required
under IAS 24.
Going concern • Obtain profit and cash flow forecasts for the 12-month period
after the year end / date of approval of financial statements:
o Ascertain if company can meet its debts as they fall due
o Assess company’s ability to meet the loan covenant
o Consider the reasonableness of the assumptions
o Ascertain the headroom available in the overdraft facility
o Perform sensitivity analysis on key variables, such as new
contracts / exchange rates / interest rates.
• Obtain a written representation from management regarding the
feasibility of company’s plans.
• Inspect post year-end management accounts.
• Ascertain the length of contracts negotiated with retailers to date
and review post year-end events to identify whether any further
contracts have been signed.
• Inspect correspondence with suppliers to ascertain whether any
accounts have been put on stop, if so enquire of management
how it will continue to manufacture.
• Inspect inventory balances to see if production schedules can be
maintained.
• Review industry commentary and company’s product reviews to
ascertain if company’s products are rated favourably.
• Review the loan agreement to ascertain the loan terms and the
consequences of a breach of the interest cover requirement.
• Inspect correspondence with the bank to ascertain the quality of
company’s relationship with its bank.

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• Obtain comfort letters from shareholders and assess their ability

to continue to support the company.
Auditing accounting estimates • Enquire of management as to how the accounting estimate is
made and the data on which it is based.
• Determine whether events occurring up to the date of the
auditor’s report (after the reporting period) provide audit
evidence regarding the accounting estimate.
• Review the method of measurement used and assess the
reasonableness of assumptions made.
• Test the operating effectiveness of the controls over how
management made the accounting estimate.
• Develop an expectation of the possible estimate (point estimate)
or a range of amounts to evaluate management’s estimate.
• Review the judgments and decisions made by management in the
making of accounting estimates to identify whether there are
indicators of possible management bias.
• Evaluate overall whether the accounting estimates in the financial
statements are either reasonable or misstated.
• Obtain sufficient appropriate audit evidence about whether the
disclosures in the financial statements related to accounting
estimates and estimation uncertainty are reasonable.
• Obtain written representations from management and, where
appropriate, those charged with governance whether they believe
significant assumptions used in making accounting estimates are
reasonable.
• Review subsequent events which confirm the estimate made.
• Review any work carried out post year end on specific faults that
have been provided for. Agree that all costs are included in the
year end provision.
• Agree cash expended on rectification work in the post balance
sheet period to the cash book.
• Agree cash expended on rectification work post year end to
suppliers’ invoices, or to internal cost ledgers of work carried out.
• Read customer correspondence received post year end for any
claims received since the year end.

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Statement of Financial Position / Balance Sheet

FSLI / Audit Area Plan to Address / Audit Procedures / Program
Recently appointed auditor • Check opening balances are properly brought forward and
(Opening balances) corresponding amounts are correctly classified and disclosed.
• Perform test of controls over Financial Statement Closing Process.
• Consider reliability of opening balances by reviewing accounting
records and controls procedures and discuss with management.
• Ensure sufficient staff in place to complete the audit work
effectively.
• Independent QCR of subjective and judgmental areas.
• Request to review PY working papers of previous auditors to gain
understanding of the business and assurance over the PY figures.
• Perform substantive procedures on opening balances if they can’t
be verified from other means.

Possible management bias • Particular attention to be directed towards accounting policies

and other judgmental areas;
• Independent Partner Review of the judgmental areas e.g.
[highlighted in question] should be undertaken;
• Compare actual results to forecasted results [Name the specific
area] to identify the areas of possible misstatement or bias;
• Re-compute and ascertain that bonus calculations (assumed being
linked with profit) takes into account the audit adjustments
identified;
Possible risk of non-compliance • Ascertain and evaluate the procedure in place to ensure the
with laws and regulations compliance with laws / regulations;
• Inspect correspondence with regulators and board minutes to
identify compliance issues.

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2.4.2 AUDIT ASSERTIONS

Account balance Transaction Classes Disclosures
Existence – Assets, liabilities, Occurrence-Transactions events Occurrence- Disclosed events
and equity interests exist. that have been recorded have and transactions have occurred.
occurred and pertain to the
entity.
Rights and obligations- The Rights and obligations-Disclosed
entity holds or controls the events pertain to the entity.
rights to assets, and liabilities
are the obligations of the entity.
Completeness- All assets, Completeness-All transactions Completeness-All disclosed that
liabilities, and equity interests and events have been recorded. should have been included have
have been recorded. been included.
Valuation and allocation-Assets, Accuracy-Amounts and other Accuracy and valuation-
liabilities, and equity interests data relating to recorded Information is disclosed fairly
are included at appropriate transactions have been and at appropriate amounts.
amounts. recorded appropriately.
Cutoff-transactions and events
have been recorded in the
correct accounting period.
Classification-Transactions and Classification and
events have been recorded in understandability-Information is
the proper accounts. presented and described
clearly.

BUT WHAT ARE ASSERTIONS? DO WE REALLY ADDRESS THEM?

___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________
___________________________________________________________________

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2.4.3 SUBSTANTIVE PROCEDURES (TOD + SAP)

Numerous other terms have been used in both the professional standards and in auditing texts. Some of the
more frequent terms that you will find in written audit programs include the following:

• Agree (schedule balances to general ledger)

• Analyze (account transactions)
• Compare (beginning balances with last year’s audited figures)
• Count (cash, inventory, etc.)
• Examine (authoritative documents)
• Foot (totals)
• Prove (totals)
• Read (minutes of directors’ meetings)
• Reconcile (cash balance)
• Review (disclosure, legal documents)
• Scan (for unusual items)
• Trace (from support to recorded entry)
• Vouch (from recorded entry to support)
• Inspect (documents)

The auditor may obtain the assistance of client personnel to perform certain tasks (e.g., prepare schedules)
providing the auditor adequately tests the work performed by these individuals.

TYPES OF PROCEDURES:
Audit procedures (acts to be performed) are used as risk assessment procedures, tests of controls, and
substantive procedures. The following is a list of types of procedures:

• Inspection of records or documents (e.g., invoice for an equipment purchase transaction) Inspection
of tangible assets (e.g., inventory items)
• Observation (e.g. observation of inventory count, observation of control activities)
• Inquiry (e.g., written inquiries and oral inquiries)
• Confirmation (e.g., accounts receivable)
• Recalculation (e.g., checking the mathematical accuracy of documents or records.)
• Reperformance (e.g., reperforming the aging of accounts receivable)
• Analytical procedures (e.g., scanning numbers for reasonableness, calculating ratios)

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FS ACCOUNT: ____________________________________
Description Existence or Accuracy / Completeness Cut-off/ Rights Classification / Pres. &
occurrence valuation / Cut-off & obligation allocation Disclosure

Inquiry

Observation /
Physical
count

Inspection or
review

Confirmation

Recalculati-
on or
Reperforma-
nce

Vouching or
Tracing

Analytical
procedures

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FS ACCOUNT: ____________________________________
Description Existence or Accuracy / Completeness Cut-off/ Rights Classification / Pres. &
occurrence valuation / Cut-off & obligation allocation Disclosure

Inquiry

Observation /
Physical
count

Inspection or
review

Confirmation

Recalculati-
on or
Reperforma-
nce

Vouching or
Tracing

Analytical
procedures

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FS ACCOUNT: ____________________________________
Description Existence or Accuracy / Completeness Cut-off/ Rights Classification / Pres. &
occurrence valuation / Cut-off & obligation allocation Disclosure

Inquiry

Observation /
Physical
count

Inspection or
review

Confirmation

Recalculati-
on or
Reperforma-
nce

Vouching or
Tracing

Analytical
procedures

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FS ACCOUNT: ____________________________________
Description Existence or Accuracy / Completeness Cut-off/ Rights Classification / Pres. &
occurrence valuation / Cut-off & obligation allocation Disclosure

Inquiry

Observation /
Physical
count

Inspection or
review

Confirmation

Recalculati-
on or
Reperforma-
nce

Vouching or
Tracing

Analytical
procedures

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FS ACCOUNT: ____________________________________
Description Existence or Accuracy / Completeness Cut-off/ Rights Classification / Pres. &
occurrence valuation / Cut-off & obligation allocation Disclosure

Inquiry

Observation /
Physical
count

Inspection or
review

Confirmation

Recalculati-
on or
Reperforma-
nce

Vouching or
Tracing

Analytical
procedures

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FS ACCOUNT: ____________________________________
Description Existence or Accuracy / Completeness Cut-off/ Rights Classification / Pres. &
occurrence valuation / Cut-off & obligation allocation Disclosure

Inquiry

Observation /
Physical
count

Inspection or
review

Confirmation

Recalculati-
on or
Reperforma-
nce

Vouching or
Tracing

Analytical
procedures

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FS ACCOUNT: ____________________________________
Description Existence or Accuracy / Completeness Cut-off/ Rights Classification / Pres. &
occurrence valuation / Cut-off & obligation allocation Disclosure

Inquiry

Observation /
Physical
count

Inspection or
review

Confirmation

Recalculati-
on or
Reperforma-
nce

Vouching or
Tracing

Analytical
procedures

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FS ACCOUNT: ____________________________________
Description Existence or Accuracy / Completeness Cut-off/ Rights Classification / Pres. &
occurrence valuation / Cut-off & obligation allocation Disclosure

Inquiry

Observation /
Physical
count

Inspection or
review

Confirmation

Recalculati-
on or
Reperforma-
nce

Vouching or
Tracing

Analytical
procedures

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SUBSTANTIVE ANALYTICAL PROCEDURES

Receivable:

• Current year vs Last year

• Receivable turnover in days
• Receivable turnover in times
• Allowance as a % of receivable

Payables

• Current year vs Last year (completeness and valuation)

• Creditors turnover in days (Completeness and valuation)
• Document the nature of recording of each major category of expense and ascertain if all
accruals have been recorded or not
• Creditors turnover in times

Inventory

• Inventory turnover rates; (completeness and valuation)

• Days' sales in inventory;
• Gross profit rates; (completeness)
• Book-to-physical inventory adjustments; and (valuation)
• Compare the balances of the inventory accounts by major category of inventory (e.g., raw
materials, work-in-process, finished goods, supplies, etc.)
• Compare the balances of the inventory accounts by location with prior year balances.
• Scan inventory listing to highlight items having very high quantities, negative or zero
quantities, large fluctuation in cost per unit from prior period and items with significant
aging, etc. (valuation)

Long-term loan

• Current year vs Last year (completeness and valuation)

• Reasonableness of total interest expense for the period and amount accrued at year-end.
• Compare interest expense with the loans standing during the period.

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Sales

• Analyze Price and volume variances

• Compare with sales tax returns submitted
• Comparative analysis of:
o Sales per day.
o % of commissions to sales.
o % of returns and allowances to sales.
o % of discounts to sales.
o % of freight to sales.
o % warranty to sales.
o Gross profit ratio.
• Comparative monthly analysis of sales by product line, division or other business segment,
including gross sales, returns and allowances and discounts.
• Current year vs budget
• Revenue vs activity (Qty shipped)
• Monthly totals for sales and sales deductions with prior period totals

Cost of goods sold

• Current year vs last year

• Compare gross profit margins with comparable margins for the preceding period with
comparable margins for industry and with budgeted margins for the current period
• Prepare and analyse gross profit analysis by taking into account sales and cost components
• Compare gross profit ratios by product line, division or period to those of the prior year and
obtain explanation for unusual variations
• Perform a predictive test of cost of sales by product line, division or other business segment
by reference to details of units shipped and average unit costs.
• Predictive tests based on the agreed/average prices and received quantity.

Fixed assets

• Current year vs last year (category wise) and consider the reasonableness of differences in
the light of budgeted capital expenditure, recent acquisitions, disposals of assets, new
product lines, discontinuance of products, etc.
• Actual expense vs budget (category wise)
• Compare balance of each significant category of repairs and maintenance with budgeted
amount

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Expenses

• Compare individual account balances with those of the prior year, and with current year
budget (if available)
• Current year vs last year at account head level
• Compare expense with related account (interest exp as a %, allowance as a %, depreciation
as a %)

Payroll expense

• Predictive analysis of via new hires, firing, bonus, increment (completeness and valuation)
• Monthly analysis and investigate variance
• Region wise payroll analysis

Cash and bank

• Account head and category wise vs last year

• Compare ratio of available cash to cash invested with the comparable ratio for the
preceding period
• Relate changes in working capital and in debt balances to changes in cash balances and
compare cash balances to seasonal fluctuations in the entity’s business.
• Cash flow statement

Investment

• Compare current year vs last year

o held for trading;
o held to maturity;
o available for sale; and
o investment property.
• Compare changes in investment balances with dividends or earnings
• Review the reasonableness of current year income from securities and any realized gains or
losses from sales of securities.

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CHAPTER 3:
AUDIT EXECUTION & CONCLUSION
3.1 CONTROL ACTIVITIES AT BUSINESS PROCESS LEVEL

3.1.1 SALES SYSTEM

Sales Order processing
1 Quotation should have specifications, price, delivery date, etc.
2 Customers should be added in database and to be checked on creditworthiness.
3 Sales Orders (SO) should be documented, pre-numbered, authorized.
4 SO system should be integrated with Inventory module.
5 Order to move ahead only when goods are available.
6 Order to approve only when under automated (recommended),
pre-authorized (BOD) credit limit.
7 Credit limit to be independent of Sales function or Limit of Authority (LOA) should be
defined.
8 Sales Discounts should be documented and approved by authorised personnel.
9 Online / Manual order processing to avoid any conflict of inventory existence.
10 Sales discounts should have a LOA defined, if under sales staff's discretion.

Dispatch and invoicing

11 Warehouse should review the Pick list with sales order.
12 Warehouse should generate a GDN
13 GDN to be integrated with Inventory module that should update.
14 GDN should be pre-numbered sequentially.
15 GDN copies to immediately move to F&A for evidence of dispatch.
16 Invoice should be generated immediately.
17 Data for invoice should be picked directly from sales order. E.g. discount, etc.
18 Invoice should update Sales ledger, debtor’s ledger.

Receivables
19 Periodic customer balance reconciliations
20 Approval by credit controller on write-offs, should be independent of sales function

3.1.2 BANK RECEIPTS

1 Bank reconciliations to be prepared and reviewed monthly basis.
2 Bank recons. to be independent of treasury function
3 Receipts to be applied by accounts staff against respective customer balances.
4 Periodic customer reconciliations to be made by sales accountant, independent.
5 Cheques shall not be applied by Sales staff, it should be accounting to avoid fraud.
6 Crossed cheques to be received by customers.

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7 Bank receipt voucher to directly affect bank ledger and customer balance.
8 Daily bank statements to be received that allows sales accountant to apply receipts
9 BRV should be pre-numbered sequentially.
10 Receipt and posting function should be segregated.
11 Cheques in hand to kept in safe.
12 Key to be with authorized personnel
13 Cheques to be deposited within the same day.

3.1.3 CASH SALES

1 Cash to be received and recorded by the teller.
2 Cash to be recorded in accounting system independent of teller.
3 Cash counts to be performed on a monthly, random basis.
4 Cash to be kept in safe.
5 Customer sign to be taken by the customer
6 Reconciliation to be made with CRM data or sales staff data by accounts dept. on a regular
basis.
7 CRV should be pre-numbered, sequential.
8 Receipts should be kept separately from Petty cash.
9 Cash sales shall not be used for petty cash expenses.
10 Amount to be deposited on same day.
11 Daily cash count sheets to be reconciled with cash in hand.

3.1.4 PURCHASE CYCLE

1 Purchase Requisition (PR) raised by User dept. or Warehouse dept.
2 LOA to be defined at PR level.
2 PR to be signed by dept. head of the User
3 PR documented, pre-numbered, sequential.
4 Procurement Dep. (PD) will send RFQ and ask for bids.
5 Below a certain level there will be direct purchase and after a certain level, bids.
6 Approved vendor list and blacklisted vendor list is kept at Procurement dept.
7 Bids analyzed at financial level by PD and awarded to lowest. In case of exception,
proper authorization need to be made. Criteria are quality, delivery time, cost, etc.
8 Pre-numbered, sequential PO to be raised.
9 LOA at PO level.
10 For large purchases, keep treasury in loop, obtain email or written approval so that
funds could be arranged.
11 Warehouse dept. signs DC and generates GRN.
12 GRN pre-numbered, sequential.
13 GRN should update inventory balance.
14 Inspection to be performed by User dept and should update the status of inventory as
an Available inv.
15 Match with PO as per requirement at WH.
15a. As a month-end process, accrual to be recorded on all goods Received But Not
Invoiced (RBNI) by vendor.
16 Invoice received by F&A.

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17 Invoice to be matched by Accounts with Inspected GRN (system of manual) and PO (3-
way matching concept)
18 Invoice processed should raise a liability.
19 All month-end accruals to be reversed.

For service requisition:

20 Accounts sends invoice to User dept.
21 Acknowledgment on invoice by User.
3.1.5 FIXED ASSETS
1. Budget approved by Board.
2. PR cannot go above budget. System or manual control.
3. Fixed Asset Register to be updated.
4. In case of capital project, costs should be capitalized on partial completion.
5. Delays in cap. Means depreciation and asset understatement.

3.1.6 BANK PAYMENTS

1 Designated bank account of the company to be used.
2 Bank account in company name and not personal.
3 Cheque to printed by system.
4 Cheque to be prepared after all review process.
5 Cheque to be signed by two signatories.
6 LOA at cheque signing level.
7 Delays / early payments will increase our cost.
8 System reports should be tracking the payments due date.
9 KPIs to be set.

3.1.7 CASH PAYMENTS

1 Not more than the prescribed limit by ITO to avoid tax reversal.
2 From petty cash, limits defined for each individual payment.
3 Petty cash expense sheets to be provided on reimbursement.
4 No unsupported payments are reimbursed, exceptions to be escalated.
5 Petty cash limit to be defined.
6 Petty cash types of expenses to be defined.
7 Should be with an authorized person and no one else.
8 2 copies of Key of safe for petty cash to be kept.
9 CPV should be pre-numbered, sequential.
10 Expense sheets to be reviewed by superior in accounts dept.

3.1.8 PAYROLL
1 Absence of checks on payroll
2 Increments must be added by a senior person
3 Overtime or absences must be authorized
4 Record of leave availed to be maintained
5 Hiring staffs / leaving details must be adjusted by an independent person
6 Tax computations, labor compliance to be reviewed
7 Time clock
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8 Payroll account to be designated for effectiveness purposes

9 Employee files to be maintained with increment letters, bonus, cv, NIC, etc.
10 Comparison of time cards to job sheets
11 Payroll reconciliation to be prepared between payment made and payroll prepared
12 Cash payment not exceeding the prescribed limit as per ITO.

3.1.9 CONSTRUCTION CONTRACTS REVENUE

1 Completion certificates to be prepared by Project Incharge
2 Completion certificates pre-numbered, sequential, controlled by an independent person
3 Approval procedure for adding / removing sub-contractors
4 Master database to be maintained for approved sub-contractors
5 Independent senior person should review the status of work,
6 Signed copy of Completion cert. to go to Finance for payment
7 Finance should not be authorized to make payment unless signed by Independent person
8 Budgetary review to be made on monthly review meeting
9 Revenue to be recorded based on % of completion and unearned adjustment to be made.

3.1.10 INVENTORY
1 No movement during stock take.
2 Organized, racks arranged and tagged inventory
3 Neat environment for HSE
4 Proper physical access controls (camera, guards)
5 Supervised independently
6 To be performed in pairs (one independent) and role to be identified before the count
starts.
7 Sequentially pre-numbered sheets to be used
8 Must be signed by the respecting person counting
9 Obsolete/ slow moving stock to be identified during the count
10 Sheets not to be discarded after stock take.
11 Must be done in systematic and sequential order
12 Differences noted during the stock count must be reconciled after it
13 Expert services for valuation of quantity
14 Internal / external audit must supervise and test count and not perform the entire count.

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3.2 CONTROL AT VARIOUS ACCOUNT HEADS

Understanding Internal Control and Assessing Control Risk

Asset retirements are recorded by removing the asset and accumulated depreciation from the general
ledger—a gain (loss) may occur on the transaction. In the case of an exchange of assets, the firm has policies
to determine that IFRS is properly followed in recording the transaction.

The following bullet points outline the controls that are typically necessary in various transaction cycles and
accounts. While the lists are clearly too lengthy to memorize, review them and obtain a general familiarity.
Candidates with little actual business experience will probably find them especially helpful for questions that
require analysis of internal control deficiencies.

The checklists are organized into subtopics—generally by category of balance sheet account (e.g., cash,
receivables, fixed assets, liabilities, shareholders’ equity, etc.). The related nominal accounts should be
considered with the real accounts (e.g., depreciation and fixed assets, sales and accounts receivable).

1. General Cash funds - continued

▪ Chart of accounts Accounting procedures ▪ Reimbursement checks to order of
manual custodian
▪ Organizational chart to define ▪ Surprise audits No employee check
responsibilities cashing Physically secure Custodian
▪ Absence of entries direct to ledgers has no access to cash receipts
▪ Posting references in ledgers Custodian has no access to accounting
▪ Review of journal entries records.
▪ Use of standard journal entries
▪ Use of pre-numbered forms 3. Cash receipts
▪ Support for all journal entries ▪ Detail listing of mail receipts
▪ Access to records limited to authorized ▪ Restrictive endorsement of checks
persons ▪ Special handling of postdated checks
▪ Rotation of accounting personnel ▪ Daily deposit
▪ Required vacations ▪ Cash custodians bonded
▪ Review of system at every level ▪ Cash custodians apart from negotiable
▪ Appropriate revision of chart of accounts instruments
▪ Appropriate revision of procedures ▪ Bank accounts properly authorized
▪ Separation of recordkeeping from ▪ Handling of returned NSF items
operations Comparison of duplicate deposit slips
▪ Separation of recordkeeping from with cash book
custodianship ▪ Comparison of duplicate deposit slips
▪ Record retention policy with detail AR
▪ Bonding of employees ▪ Banks instructed not to cash checks to
▪ A conflict of interest policy company
▪ Control over cash from other sources
2. Cash funds Separation of cashier personnel from
▪ Imprest system accounting duties
▪ Reasonable amount ▪ Separation of cashier personnel from
▪ Completeness of vouchers credit duties
▪ Custodian responsible for fund ▪ Use of cash registers
▪ Numbered cash receipt tickets ▪ Cash register tapes
▪ Outside salesmen cash control
▪ Daily reconciliation of cash collections
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4. Cash disbursements Investments - continued

▪ Numbered checks ▪ Credit and sales departments
▪ Sufficient support for check independent Control of back orders
▪ Limited authorization to sign checks ▪ Sales order and sales invoice
▪ No signing of blank checks comparison Shipping invoices pre-
▪ All checks accounted for numbered
▪ Detail listing of checks ▪ Names and addresses on shipping
▪ Mutilation of voided checks invoice Review of sales invoices
▪ Specific approval for unusually large checks ▪ Control over returned merchandise
Proper authorization of persons signing ▪ Credit memoranda pre-numbered
▪ checks Matching of credit memoranda and
▪ Control over signature machines receiving
▪ Check listing compared with cash book ▪ reports
Control over interbank transfers Prompt ▪ Control over credit memoranda
accounting for interbank transfers ▪ Control over scrap sales
▪ Checks not payable to cash ▪ Control over sales to employees
▪ Physical control of unused checks ▪ Control over COD sales
▪ Cancellation of supporting documents ▪ Sales reconciled with cash receipts and
▪ Control over long outstanding checks AR
▪ Reconciliation of bank account ▪ Sales reconciled with inventory change
▪ Independence of person reconciling bank AR statement to all customers
statement ▪ Periodic preparation of aging schedule
▪ Bank statement direct to person ▪ Control over collections of written-off
reconciling No access to cash records or receivables
receipts by check signers ▪ Control over AR write-offs (e.g., proper
authorization)
▪ Control over AR written off (i.e., review
for possible collection)
▪ Independence of sales, AR, receipts,
billing, and shipping personnel

5. Investments 6. Notes receivable

▪ Proper authorization of transactions ▪ Proper authorization of notes
▪ Under control of a custodian ▪ Detailed records of notes
▪ Custodian bonded ▪ Periodic detail to control comparison
▪ Custodian separate from cash receipts ▪ Periodic confirmation with makers
Custodian separate from investment ▪ Control over notes discounted
records Safety-deposit box ▪ Control over delinquent notes
▪ Record of all safety-deposit visits ▪ Physical safety of notes
▪ Access limited Presence of two required for ▪ Periodic count of notes
access ▪ Control over collateral
▪ Periodic reconciliation of detail with ▪ Control over revenue from notes
control ▪ Custodian of notes independent from
▪ Record of all aspects of all securities cash and recordkeeping
▪ Availability of brokerage advices, etc.
▪ Periodic internal audit 7. Inventory and cost of sales
▪ Securities in name of company Proper ▪ Periodic inventory counts
segregation of collateral ▪ Written inventory instructions
▪ Physical control of collateral ▪ Counts by non-custodians
▪ Periodic appraisal of collateral ▪ Control over count tags

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Inventory and cost of sales - continued Prepaid expenses and deferred charges -
▪ Periodic appraisal of investments continued
▪ Adequate records of investments for ▪ Control over inventory adjustments Use
application of equity method. of perpetual records
▪ Periodic comparison of G/L and
perpetual records
▪ Investigation of discrepancies
▪ Control over consignment inventory
Control over inventory stored at
warehouses
▪ Control over returnable containers left
with customers

8. Accounts receivable and sales 10. Accounts payable

▪ Sales orders pre-numbered ▪ Designation of responsibility
▪ Credit approval ▪ Independence of AP personnel from
▪ Preparation of receiving reports Pre- purchasing, cashier, receiving functions
numbered receiving reports ▪ Periodic comparison of detail and
▪ Receiving reports in numerical order control
Independence of custodian from ▪ Control over purchase returns
recordkeeping ▪ Clerical accuracy of vendors’ invoices
▪ Adequacy of insurance ▪ Matching of purchase order, receiving
▪ Physical safeguards against theft report, and vendor invoice
▪ Physical safeguards against fire ▪ Reconciliation of vendor statements
▪ Adequacy of cost system with AP detail
▪ Cost system tied into general ledger ▪ Control over debit memos
▪ Periodic review of overhead rates ▪ Control over advance payments Review
▪ Use of standard costs of unmatched receiving reports
▪ Use of inventory requisitions ▪ Mutilation of supporting documents at
▪ Periodic summaries of inventory usage payment Review of debit balances
▪ Control over intra-company inventory Investigation of discounts not taken
transfers
▪ Purchase orders pre-numbered
▪ Proper authorization for purchases
▪ Review of open purchase orders

9. Prepaid expenses and deferred charges 11. Accrued liabilities and other expenses
▪ Proper authorization to incur ▪ Proper authorization for expenditure
▪ Authorization and support of amortization and incurrence
▪ Detailed records ▪ Control over partial deliveries
▪ Periodic review of amortization policies ▪ Postage meter
▪ Control over insurance policies ▪ Purchasing department
▪ Periodic review of insurance needs ▪ Bids from vendors
▪ Control over premium refunds ▪ Verification of invoices
▪ Beneficiaries of company policies Physical ▪ Imprest cash account
control of policies ▪ Detailed records
▪ Responsibility charged
▪ Independence from G/L and cashier
functions
▪ Periodic comparison with budget

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12. Intangibles 15. Payroll

▪ Authorization to incur ▪ Authorization to employ Personnel data
▪ Detailed records records
▪ Authorization to amortize Periodic review ▪ Tax records
of amortization ▪ Time clock Supervisor review of time
cards
▪ Review of payroll calculations
▪ Comparison of time cards to job sheets
▪ Imprest payroll account
▪ Responsibility for payroll records
▪ Compliance with labor statutes
▪ Distribution of payroll checks
▪ Control over unclaimed wages Profit-
sharing authorization Responsibility for
profit-sharing computations

13. Fixed assets 16. Long-term liabilities

▪ Detailed property records ▪ Authorization to incur
▪ Periodic comparison with control ▪ Executed in company name
accounts ▪ Adequacy of detailed records
▪ Proper authorization for acquisition ▪ Comparison of transfer agent’s report
▪ Written policies for acquisition Control with records
over expenditures for self-construction ▪ Physical control over blank certificates
▪ Use of work orders ▪ Physical control over treasury
▪ Individual asset identification plates certificates
▪ Written authorization for sale ▪ Authorization for transactions
▪ Written authorization for retirement ▪ Tax stamp compliance for canceled
▪ Physical safeguard from theft certificates
▪ Control over fully depreciated assets ▪ Independent dividend agent Imprest
▪ Written capitalization—expense policies dividend account
▪ Responsibilities charged for asset and ▪ Periodic reconciliation of dividend
depreciation records account Adequacy of stockholders’
▪ Written, detailed depreciation records ledger
▪ Depreciation adjustments for sales and ▪ Review of stock restrictions and
retirements provisions
▪ Valuation procedures for stock
issuances
▪ Other paid-in capital entries
▪ Other retained earnings entries

14. Shareholders’ equity

▪ Use of registrar
▪ Use of transfer agent

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ISA 265 Communication of internal control–related matters.

ISA 265 requires auditors to communicate significant deficiencies and material weaknesses to management
and to those charged with governance. At this point study the outline of ISA 265 in Appendix A. This and the
communication in the following section are referred to as “by-product” reports since they result from an
audit, but are not the primary report of an audit (i.e., they are not the audit report). Make certain that you
know the following points related to the ISA 265 communication:

Summary of likelihood and potential amount involved

Deficiency Severity Required Communication to Management
and Those Charged with Governance?
Control Deficiency Design or operation of control does not
allow management or employees, in the Communicate to management if
normal course of performing their assigned deficiency merits management’s
functions, to prevent or detect and correct attention.*
misstatements on a timely basis.

Significant Deficiency Less severe than a material weakness, yet Yes

important enough to merit attention by
those charged with governance.
Material Weakness A reasonable possibility that a material Yes
misstatement will not be prevented, or
detected and corrected on a timely basis

3.3 CONTROLS AND TEST OF CONTROLS

Transaction cycles
1. Introduction
For your examination, you may be expected to apply your auditing knowledge to the main transaction
cycles of an entity. These are:
▪ The revenue (sales) and receivables cycle
▪ The purchases and payables cycle
▪ The payroll cycle. You may also be required to show an understanding of controls and audit tests in
relation to:
▪ Bank and cash transactions
▪ Inventory non-current assets.

This section of the chapter provides you with checklists, for each of these audit areas. The checklists set
out:
▪ The control objectives
▪ The key internal controls
▪ Tests of control that might be applied
▪ Substantive tests that might be carried out (usually on a sampling basis).

If you are not familiar with the items in the checklists, you should revise tests of control and substantive
testing in your study material for basic audit and assurance.

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However, auditing of the transaction cycles is examined in detail at the CAF stage and it is more likely
that exam questions at the CFAP stage will focus on the audit of items relating to specific IFRSs or IASs.

2. Revenue and receivables

Control objectives Key controls Tests of control Substantive tests
▪ There must be ▪ Segregation of ▪ Sequence checks ▪ Check the accuracy
proper duties (order on all documents of the arithmetic in
authorization and acceptance/ ▪ Check on evidence books of prime
recording of dispatch of authorization at entry.
customer orders, ▪ Check that a each stage in the ▪ Check entries in
goods returned and customer’s order is cycle. books of prime
allowances within the ▪ Check for evidence entry back to the
(discounts) given customer’s credit that the arithmetic/ source documents.
▪ Revenue must be limit. calculations in all ▪ Check the accuracy
recorded for all ▪ Authorization of documents and of postings to
goods or services orders. records have been ledgers.
delivered. ▪ Use of pre- checked. ▪ Check invoices and
▪ All documents and numbered sales ▪ Check that credit notes for
records must be order forms. documents have accuracy in the
recorded accurately ▪ Dispatch notes been matched, arithmetic and
▪ All documents and should be pre- where appropriate. pricing.
records must be numbered and ▪ Check that control ▪ Check that
recorded accurately matched with sales account inventory records
▪ A policy should be orders and reconciliations have been correctly
established for the invoices/ invoicing.) have been updated for
collection of ▪ Authorization of performed and dispatches of goods
receivables dispatches after reviewed, with to customers.
checking appropriate ▪ Review control
▪ Invoices should be adjustments being account
authorized for made to the reconciliations.
sending to records. ▪ Test the sales cut-
customers, after off.
checking them for ▪ Apply analytical
accuracy and procedures, such as
against sales orders trend analysis for
and dispatch notes sales, and gross
▪ Invoices should be profit margin.
recorded promptly
in the sales ledger.
Batching of invoices
for input and batch
totals may be used
as a control.
▪ Sales returns and
allowances
(discounts) should
be checked and
authorized.
▪ Credit notes must
be recorded
accurately.
▪ The control
account for

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receivables in the
main ledger should
be reconciled
regularly with
account balances in
the receivables
ledger.
▪ Statements should
be sent regularly
(monthly) to credit
customers
▪ Debt collection
procedures should
be followed
systematically, in
accordance with
debt collection
policy
▪ Writing off any bad
debts must be
authorized

3. Purchases and payables

Control objectives Key controls Tests of control Substantive tests
Goods and services are ▪ Segregation of ▪ Sequence checks ▪ Check the accuracy
purchased: duties (ordering, on all documents of the arithmetic in
▪ with proper receipt of goods, (purchase orders, books of prime
authority recording invoices, goods received entry.
▪ under proper payment). notes). ▪ Check entries in
procedures ▪ Use of official pre- ▪ Check on evidence books of prime
▪ for the business numbered of authorization at entry back to the
▪ from authorized documentation each stage in the source documents.
suppliers (purchase orders). purchasing cycle. ▪ Check the accuracy
▪ and are inspected ▪ Appropriate ▪ Check for evidence of postings to
for description, authorization that the arithmetic/ ledgers
quantity and quality procedures should calculations in all
be used for orders documents and
and payments records have been
checked
Before being recorded ▪ There is a policy for ▪ Check that ▪ Check invoices and
purchase invoices are: re-ordering regular documents have credit notes for
▪ Authorized items of inventory. been matched accuracy in
▪ Checked for ▪ Goods received where appropriate. arithmetic and
arithmetic accuracy notes (GRNs) are ▪ Check that control pricing.
and pricing used, and signed, account ▪ Check that
▪ Checked against as evidence that reconciliations inventory records
supporting the quantity, have been have been correctly
documentation (for quality and performed and updated for
example, purchase description of all reviewed, with receipts of goods
orders). goods received appropriate from suppliers.
Completeness and have been checked. adjustments being

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accuracy of ▪ Matching of made to the ▪ Review control

recording. documents records. account
(purchase reconciliations.
requisitions, ▪ Test purchases cut-
purchase orders, off.
GRNs and purchase ▪ Apply analytical
invoices). procedures Review
▪ Procedures should other audit areas
exist for analyzing and prior year
purchase invoices working papers for
and recording them evidence of
in the correct possible
expense or asset unrecorded
accounts. liabilities.
▪ Use of control
accounts and batch
totals to ensure
completeness and
accuracy of
processing.
▪ Accurate records
should be kept of
purchases returns,
and these should
be matched with
credit notes from
the supplier.

4. Payroll
Control objectives Key controls Tests of control Substantive tests
▪ Gross pay is ▪ Segregation of Check: Check:
calculated at the duties (establishing ▪ that payroll ▪ the accuracy of the
correct rates. „ pay rates, information is arithmetic in
Employees are paid calculating pay, reconciled payroll calculations
only for work done. recording pay). between periods and payroll records
▪ Maintenance of up- and any changes ▪ postings to ledger
to-date personnel between periods accounts
records. are explained ▪ that correct pay
▪ Authorization of ▪ entries in the rates are used
joiners and leavers, wages control
pay rates, account, if used
overtime, voluntary
deductions from
pay.
▪ Gross pay, net pay ▪ Regular ▪ The accuracy and ▪ that correct,
and deductions are management completeness of authorized rates
recorded review of overall ledger account are used for
completely and cost of payroll. entries statutory
accurately in the ▪ Establishment of ▪ The accuracy of the deductions (such as
payroll, cash standard arithmetic in tax) and voluntary
records and ledger procedures, payroll records deductions
accounts. timetables and ▪ that overtime,
bonuses and similar

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▪ The correct systems for ▪ That the payroll payments have

employees are paid processing payroll. records agree with been properly
the correct ▪ Approval of payroll, cash/bank records authorized
amounts. once prepared. ▪ Agree payroll ▪ that joiners are
▪ The correct amount ▪ Use of a control amounts to bank properly authorized
of deductions are account for payroll records. ▪ that employees
paid to the tax expenses/ ▪ Review payroll for have not been paid
authorities and liabilities. unusual amounts. for periods before
other authorities. ▪ Safe custody of When employees are they join or after
cash, where paid in cash: they leave
employees are paid ▪ Check that ▪ the pay for hours
in cash. unclaimed wages worked or output
▪ Verification of the are kept safe and produced should be
identity of reasons for not checked against the
employees, when claiming wages are authorized
payment is in cash. explained. documentation
▪ Signature received ▪ Attend and observe ▪ that payments of
for pay, when a distribution of deductions have
payment is in cash. pay. been made to the
▪ Custody and ▪ Compare names on appropriate
investigation of payroll to names authorities
unclaimed pay on pay packets. ▪ the signed receipts
packets, when ▪ examine signed for wages paid in
payment is in cash. receipts for pay cash
▪ Use of a separate ▪ Check that no ▪ That the correct
bank account for employee receives entries have been
payroll more than one pay made in the wages
▪ Authorization of packet. control account
cheques/bank Also:
transfers, when ▪ Verify the existence
employees are paid of a sample of
by these methods employees on the
payroll.
▪ When wages are
paid in cash,
observe the
distribution of pay
packets.
Carry out analytical
procedures, such as
trend analysis, average
pay per employee.

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5. Bank and cash

Control objectives Key controls Tests of control Substantive tests
Bank
▪ All money ▪ Segregation of ▪ Review bank ▪ Send bank
belonging to the duties. reconciliations for confirmation
company is ▪ Listing and prompt unusual items and letter(s).
received and is recording and evidence of ▪ Check or prepare
promptly and banking of all management bank reconciliation
accurately receipts. review of statement.
recorded. ▪ Authorization for all statements. ▪ Assess audit
▪ All payments are payments. ▪ Review cash book significance of
properly authorized ▪ Regular for unusual entries. other information
and are promptly reconciliations are ▪ Check additions in in the reply from
and accurately performed and cash book and the bank
recorded. reviewed entries in ledgers.
Bank
▪ There are sufficient ▪ Review payments ▪ Review large or
physical custody for evidence of round-sum
controls over authorization amounts just
cheques and cash. before and just
after the reporting
period
▪ Carry out analytical
procedures
Cash
▪ As for bank above ▪ As for bank above ▪ Observe that ▪ Attend/carry out
procedures for cash counts.
opening mail and ▪ Check that postings
handling cash are are made correctly
being followed. to ledger accounts.
▪ Check amounts ▪ Analytical
recorded as procedures
receipts against
remittance advices
from customers.
▪ Check the amounts
in receipt books or
on till rolls against
paying in slips
(paying in cash to
the bank), the cash
book and bank
statements.
▪ Check whether
cash is banked
daily.
▪ Check payments
out of cash takings,
if any.
▪ Check petty cash
payments for
authorization

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▪ Check the
documents that
support any cash
payments (for
example, receipts)

6. Inventories
Many of the points listed above in relation to the purchases cycle (for example, in relation to the
receipt of goods) and the sales cycle (for example, in relation to the dispatch of goods) should also
apply to the inventory system. For example, the requirement for authorization procedures and
segregation of duties are the same. The table below focuses on additional points.
Control objectives Key controls Tests of control Substantive tests
▪ Inventory in the ▪ There should be ▪ Review and ▪ Attend inventory
inventory records regular inventory observe inventory count:
should represent counts, with counting - observe
inventory that reconciliations of procedures. procedures
physically exists. physical counts to ▪ Check that any - Record test
▪ Inventory is valued inventory records. necessary changes counts
at the lower of cost Differences should to inventory - Record cut-off
and net realizable be explained. records are made. information.
value (NRV). ▪ Reviews of ▪ Check that NRV ▪ Check inventory
▪ Inventory inventory for items reviews are valuation, at lower
quantities are where NRV may be performed. of cost and NRV.
maintained at a below cost. ▪ Confirm that cut- ▪ Check inventory
level suitable to the ▪ Accurate, upto- off procedures are cutoff.
business date inventory operating. ▪ Perform
records are ▪ Review inventory appropriate
maintained. levels for adequacy analytical review
▪ Inventory cutoff procedures.
procedures are in ▪ Confirm the
place. existence of
inventory held at
outside locations
▪ Appropriate ▪ Check that physical ▪ Check the
physical custody custody procedures treatment of
procedures should are operational (= inventory held on
be in place applied in practice). the client’s
premises but
owned by a third
party.

7. Non-current assets

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Again, some of the controls and tests that are listed above (for example, the requirement that
purchases/expenditure should be properly authorized) are also relevant here. The table below lists
additional points.
Control objectives Key controls Tests of control Substantive tests
▪ Records of ▪ Use of authorized ▪ Check for the ▪ Review the
noncurrent assets capital expenditure proper movement in non-
should be complete budgets and authorization of current assets for
and correct. project evaluation additions and the period.
▪ There should be techniques, if disposals. ▪ Check additions,
adequate controls appropriate. ▪ Check and the calculations
for the safe custody ▪ Use of a reconciliations of of depreciation and
of non-current noncurrent asset ledger balances gain or loss on
assets. register that is with the non- disposals.
▪ Depreciation, regularly checked current asset ▪ Physically verify a
revaluations and and reconciled to register sample of
disposals must be the non-current additions.
dealt with correctly. asset accounts in ▪ Trace proceeds for
the main ledger. disposals to cash
▪ Impairment records.
reviews are ▪ Review for
performed as unrecorded
necessary disposals.
▪ Review evidence
relating to any
asset revaluations
during the period

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CHAPTER 4:
AUDIT REPORTING

4.1 DRAFTING MODIFICATIONS:

Modification # 1:
• Although there is a significant level of concern about the company’s ability to continue as a going
concern the financial statements and notes do not disclose this fact and the directors have
prepared the financial statements on the going concern basis.
• The auditor considers that the financial statements should disclose that there is a material
uncertainty representing inability to obtain replacement financing and the Company is also
considering entering insolvency proceedings. This may cast significant doubt on the company’s
ability to continue as a going concern.

Modification # 2:
• The balance sheet date being audited is 31 December 20X1.
• In assessing whether the going concern assumption is appropriate the directors have taken into
account the period up to 30 November 20X2 which is only 11 months from the balance sheet date
i.e. less than the 12 months from the balance sheet date.
• The directors have refused to either extend their assessment period to a period of more than
twelve months from the balance sheet date.

Modification # 3:
• The balance sheet date being audited is 31 December 2008.
• The Company has not provided impairment review of an equipment despite a major damage
caused to one its parts costing Rs. 20 million (WDV 15 million). The matter is material but not
pervasive.

Modification # 4:
• The balance sheet date being audited is 31 December 20X1.
• Investments (Held for trading securities) in money market made by the Company have not been
marked to market by the Directors of the Company. The cost exceeds market value of investments
by Rs. 32 million. PBT is 302 million. Short-term investments cost Rs. 122 million.

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Modification # 5:
• The balance sheet date being audited is 31 December 20X1.
• Law suit by ABC Industries has been filed against the Company in 1998 for claiming the sum
disclosed in FS, the knowledge of which is fundamental to users’ understanding. The matter has
been adequately disclosed by the management in note 32.4 of the financial statements. No
decision has been yet given by the court.

Modification # 6:
• The balance sheet date being audited is 31 December 20X1.
• The Company has revalued its brand “Papa Johns” during the year without having any reference
to an ‘active market’. Cost of “Papa Johns” is Rs. 5 million while the revalued amount as per
management is Rs. 25 million. The matter is material but not pervasive.

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SUGGESTED ANSWERS
Modification # 1
Adverse opinion on financial statements

As explained in note x to the financial statements the company’s financing arrangements expired
and the amount outstanding was payable on 31 December 20X1. The company has been unable to
re-negotiate or obtain replacement financing and is considering entering insolvency proceedings.
These events indicate a material uncertainty which may cast significant doubt on the company’s
ability to continue as a going concern and therefore it may be unable to realise its assets and
discharge its liabilities in the normal course of business. The financial statements (and notes
thereto) do not disclose this fact and have been prepared on the going concern basis.

In our opinion, because of the omission of the information referred to above, the financial
statements do not give a true and fair view, in accordance with International Financial Reporting
Standards, of the state of the company’s affairs as at 31 December 20X1 and of its profit [loss] for
the year then ended.

[In case of a material uncertainty due to net negative equity, current assets < current liabilities,
then use them]

Modification # 2
Qualified opinion arising from departure from IAS 1 ‘Presentation of Financial Statements’
Option 1: In assessing whether it is appropriate to prepare the financial statements on a going
concern basis, the Directors/ Company has provided us an assessment of its going concern
assumption for 11 months period ending on 30 November 20X2 which is less than twelve months
from the balance sheet date. This is contrary to the requirements of International Accounting
Standard 1 ‘Presentation of Financial Statements’.

Owing to the absence of above, the effects thereof on the accompanying financial statements
cannot presently be determined.

Option 2: Contrary to the requirements of IAS 1 ‘Presentation of Financial Statements’, the

Directors/ Company has provided us an assessment of the appropriateness of the use of its going
concern for 11 months period ending on 30 November 20X2 which is less than twelve months from
the balance sheet date.

Owing to the absence of above, the effects thereof on the accompanying financial statements
cannot presently be determined.

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Modification # 3
Inability to obtain SAAE
As explained in note x to the accompanying financial statements, we have not been provided an
impairment review of equipment X1C of the Company despite major damage has been caused to
its part costing Rs. 20 million (Written Down Value amounting to Rs. 15 million) during the year
ended 31 December 20X1 indicating impairment in the value of said asset, which under such
circumstances, requires an impairment review as stipulated under IAS 36 “Impairment of Assets”.
Owing to the absence of above, the effects thereof on the accompanying financial statements
cannot presently be determined.

Modification # 4
Misstatement arising from departure from IFRS 9 ‘Financial Instruments’
as explained/ disclosed in note x to the financial statements, the Directors/ Company has not
marked its held-for-trading investments costing Rs. 122 million to their fair market values to Rs. 90
million, which is contrary/ in contravention to the requirements of International Financial
Reporting Standard 9 - ‘Financial Instruments’.

Had the Company incorporated/ made the above referred impairment in the accompanying
financial statements, the profit before tax and short-term investments would have been reduced
by Rs. 32 million.

Modification # 5:

We draw attention to note 32.4 of the accompanying financial statements, with regard to a law suit
filed by ABC Industries against the Company during the year ended 31 December 1998. Pending a
decision of the court in this respect, the Company has not made any provision for the amount
claimed by ABC Industries in the accompanying financial statements. Our opinion is not qualified in
respect of the said matter.

Modification # 6:

As disclosed in note x to the accompanying financial statements, the Company has revalued one of
its brand name “Papa John’s” during the year ended 31 December 20X1. However, the said value
has not been determined with reference to an ‘active market’, as defined under IAS 38 “Intangible
Assets” which, in case of an absence of an active market, requires such assets to be carried at cost
less accumulated depreciation and impairment losses, if any.

Had the Company not revalued the above referred intangible asset in the accompanying financial
statements, the total assets and the related revaluation surplus would have been reduced by Rs. 20
million.

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4.2 PRACTICAL REPORTS - EXAMPLES

These are extracts of EOMP, OMP, basis of modification paragraph and opinion paras taken from
practical signed reports. These will help you understand how audit report modifications are
drafted (using the format I have described) and respective opinions are amended accordingly.
Some of the reports might be old but are produced here only to understand how these are
drafted. The placement of these paragraphs will be guided by the report as provided in annexures
of ISA 700.
4.1.1 AUDITORS' REPORT TO THE DIRECTORS
We have examined the accompanying amalgamated summarised financial statements of ABC
(Private) Limited (the Company) as of 30 June 2009, comprising balance sheet and related
summarised notes thereon, in accordance with the International Standards on Auditing. These
amalgamated summarised financial statements have been derived from the amalgamation of the
separate audited financial statements of ABC (the Firm) and the Company as at 30 June 2009 and
have been prepared for the specific purpose of the management of the Company.

We have separately expressed unqualified opinions on the financial statements of the Firm and the
Company for the year ended 30 June 2009. These financial statements have been prepared and
presented in accordance with the accounting policies which are consistent with the audited
financial statements of the Firm and the Company for the year ended 30 June 2009.

The preparation of these amalgamated summarised financial statements is the responsibility of the
Company’s management. Our responsibility is to express an opinion on these amalgamated
summarised financial statements based on our examination.

In our opinion, the accompanying amalgamated summarised financial statements are consistent, in
all material respects, with the audited financial statements from which they have been derived.
For a better understanding of the Company’s financial position and of the scope of our
examination, the amalgamated summarised financial statements should be read in conjunction
with separate audited financial statements from which these amalgamated summarised financial
statements have been derived.

Chartered Accountants
Audit Engagement Partner’s Name: DEF
Date:
Place: Karachi
RAFT

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4.1.2 AUDITORS' REPORT TO THE MEMBERS

We have audited the annexed … we report that:
(a) the Company has not followed the requirement of IAS – 40 “Investment Property” with
regard to the disclosure of the fair value of its investment property for the reasons
discussed by the management in note 5 to the accompanying financial statements.
Accordingly, the effects thereof on the accompanying financial statements cannot presently
be determined;
(b) in our opinion, except for the effects of such adjustments, if any, as might have been
determined to be necessary had the Company followed the IAS, referred to in (a) above,
and to the best of our information and according to the explanations given to us, the
balance sheet, profit and loss and cash flow statement, together with the notes forming
part thereof conform with approved accounting standards as applicable in Pakistan, and,
give the information required by the Companies Ordinance, 1984, in the manner so
required and respectively give a true and fair view of the state of the company's affairs as at
30 June 2009 and of the profit, its cash flows and changes in equity for the year then
ended; and

4.1.3 AUDITORS' REPORT TO THE MEMBERS

We have audited the annexed balance sheet of .. we report that:

(a) the Company has not followed the requirements of International Accounting Standard - 36
“Impairment of Assets” with respect to the impairment testing of Goodwill, as disclosed in
note 6 to the accompanying financial statements. Accordingly, the effects thereof on the
accompanying financial statements of the Company cannot presently be determined;

(d) in our opinion, except for the effects on the accompanying financial statements of such
adjustments, if any, as might have been determined to be necessary had the Company
followed the requirements of International Accounting Standard 36, as stated in paragraph
(a) above, and to the best of our information and according to the explanations given to us,
the balance sheet, profit and loss account, statement of comprehensive income, cash flow
statement and statement of changes in equity together with the notes forming part thereof
conform with approved accounting standards as applicable in Pakistan, and, give the
information required by the Companies Ordinance, 1984, in the manner so required and
respectively give a true and fair view of the state of the Company's affairs as at 30 June
2010 and of the profit, total comprehensive income, its cash flows and changes in equity
for the year then ended; and
DRAFT

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4.1.4 AUDITORS' REPORT TO THE MEMBERS

We have audited the annexed balance sheet of PQR … we report that:

(a) Without qualifying our opinion, we draw attention to the contents of note 2 to the financial
statements which indicates that the company incurred a net loss of Rs.0.033 (2008: Rs.
2.354) million during the year ended 30 June 2009 as a result of which its accumulated loss
at the end of the year amounted to the Rs.2.387 million. This condition, along with other
matters as set forth in the above referred note, indicate the existence of a material
uncertainty which may cast significant doubt about the company’s ability to continue as a
going concern.

4.1.5 AUDITORS’ REPORT TO THE MEMBERS

We have audited the annexed balance sheet of ABC Limited as at 30 June 2010 and the related
profit and loss account, cash flow statement and statement of changes in equity together with the
notes forming part thereof for the year then ended and we state that, we have obtained all the
information and explanations which, to the best of our knowledge and belief, were necessary for
the purposes of our audit.

It is the responsibility of the Company’s management to establish and maintain a system of internal
control, and prepare and present the above said statements in conformity with the approved
accounting standards and the requirements of the Companies Ordinance, 1984. Our responsibility
is to express an opinion on these statements based on our audit.

Except as discussed in paragraph(i) below, we conducted our audit in accordance with the auditing
standards as applicable in Pakistan. These standards require that we plan and perform the audit to
obtain reasonable assurance about whether the above said statements are free of any material
misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts
and disclosures in the above said statements. An audit also includes assessing the accounting
policies and significant estimates made by management, as well as, evaluating the overall
presentation of the above said statements. We believe that our audit provides a reasonable basis
for our opinion and, after due verification, we report that:
(i) we could not physically verify cash-in-hand, aggregating to Rs.1.346 million, as shown in
note 16, as the same was not made available to us for our verification at the close of the
year. Accordingly, the effects thereof on the accompanying financial statements cannot
presently be determined.

We further report that the Company has not followed the requirements of the following
International Accounting Standards (IASs):
(a) IAS -36 “Impairment of Assets” in respect of impairment in the value of investment in
the Associated Company, amounting to Rs.______ (2009: Rs.26.343)million, as shown in
note 7, which has not been recorded in the accompanying financial statements during the
current year;
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Had the Company recorded the above referred impairment, profit before taxation would
have turned into loss before taxation of Rs.21.511 whereas long term investment would
have been reduced by the same sum;

(b) IAS – 28 ‘Investment in Associates’ with regard to the use of “equity method” of accounting
for its investment in its associated undertaking, as shown in note 7 to the accompanying
financial statements nor has the Company determined the effects of the said departure
from the IAS on the accompanying financial statements;

(c) IAS – 19 “ Employee Benefits” with regard to the measurement and disclosures relating to
the defined benefit plans (staff gratuity scheme) in the accompanying financial statements
for the reasons disclosed by the management in note 20.2.1. The effects thereof on the
accompanying financial statements of the Company cannot presently be determined;

(d) in our opinion, proper books of accounts have been kept by the Company as required by
the Companies Ordinance, 1984.

(e) in our opinion:

(i) the balance sheet and profit and loss account together with the notes thereon have
been drawn up in conformity with the Companies Ordinance, 1984, and are in
agreement with the books of account and are further in accordance with accounting
policies consistently applied except for the changes, as stated in note 4.2, with
which we concur;
(ii) the expenditure incurred during the year was for the purpose of the Company’s
business; and
(iii) the business conducted, investments made and the expenditure incurred during the
year were in accordance with the objects of the Company;
(f) in our opinion, except for the effects on the accompanying financial statements of the
matter referred to in paragraph (a) above and the effects of such adjustments, if any, as
might have been determined to be necessary had we been able to perform the procedure
discussed in paragraph (i) above and the Company followed the requirements of
International Accounting Standards 28 and 19, as stated in paragraphs (b) and (c) above,
and to the best of our information and according to the explanations given to us, the
balance sheet, profit and loss account, cash flow statement and statement of changes in
equity together with the notes forming part thereof confirm with approved accounting
standards as applicable in Pakistan, and, give the information required by the Companies
Ordinance, 1984, in the manner so required and respectively give a true and fair view of the
state of the Company’s affairs as at 30 June 2010 and of the profit, its cash flows and
changes in equity for the year then ended; and
(g) in our opinion, no zakat was deductible at source under the Zakat and Ushr Ordinance,
1980 (XV111 of 1980).

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4.1.6 AUDITORS' REPORT TO THE MEMBERS

We were engaged to audit the annexed balance sheet of ABC Limited (the Company) as at 30 June
2010 and the related profit and loss account, statement of comprehensive income, cash flow
statement and statement of changes in equity together with the notes forming part thereof, for
the year then ended and we state that except as stated in paragraphs (a) to (d) below, we have
obtained all the information and explanations which to the best of our knowledge and belief, were
necessary for the purposes of our audit.

It is the responsibility of the Company’s management to establish and maintain a system of internal
control, and prepare and present the above said statements in conformity with the approved
accounting standards and the requirements of the Companies Ordinance, 1984. Our responsibility
is to express an opinion on these statements based on our audit.

Except as stated in paragraphs (a) to (d) below, we conducted our audit in accordance with the
auditing standards as applicable in Pakistan. These standards require that we plan and perform the
audit to obtain reasonable assurance about whether the above said statements are free of any
material misstatement. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the above said statements. An audit also includes assessing the
accounting policies and significant estimates made by management, as well as, evaluating the
overall presentation of the above said statements. We believe that our audit provides a reasonable
basis for our opinion and, after due verification, we report that:
(a) as referred to in notes 7 and 31.2 to the accompanying financial statements, the
investment in WTC (Private) Limited (WTC), an associated company, amounted to Rs.50.00
(2009: 50.00) million whereas long-term loans and advances, trade debts, accrued mark-up
and current account balances due from WTC, M Limited (ML) and SG (Private) Limited
(SGPL), associated companies, amounted to Rs.344.82 (2009: Rs.411.96) million, Rs.5.74
(2009: Rs.5.52) million and Rs.84.95 (2009: Rs.84.94) million, respectively, aggregating to
Rs. 435.51 (2009: Rs.502.42) million, as of the date of the balance sheet. The auditors of
WTC and SGPL have expressed adverse opinions on the financial statements of these
entities on account of impairment of investments in an associated company not recorded
by these entities, amounting to Rs.579.12 (2009: Rs.638.26) million and Rs.237.79 ( 2009:
Rs.290.50) million, respectively, at the end of the current year.

Further, an emphasis of matter paragraph has been added by the auditors in their report
on the financial statements of these entities for the year ended 30 June 2010 in respect of
the going concern issue. Furthermore, the auditors of ML had modified their report for the
year ended 30 June 2008, stating that the financial statements of ML for the said year were
prepared on a going concern basis which would be valid only if the entity was able to start
its business and generate revenue.

In view of the above, in our opinion, the above referred investment and financial assets
should be tested for impairment by the management in accordance with the requirements
of International Accounting Standard (IAS) -36 “Impairment of Assets” and IAS-39 “Financial
Instruments: Recognition and Measurement”. As we have not been provided with any
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evidence regarding such impairment test in respect of the above investment and financial
assets, we are unable to satisfy ourselves as to whether the same have been stated at their
respective recoverable amount;

(b) as referred to in note 6.1 to the accompanying financial statements, during the year ended
30 June 2003, the management bifurcated the cost of land and building in respect of WTC
building acquired during the year ended 30 June 1988 and reversed the depreciation of
Rs.7.39 million, charged in years prior to the year ended 30 June 2003, on the basis of said
bifurcation. In the absence of any independent professional valuation in support of the
above bifurcation of cost of WTC land and building, we were unable to satisfy ourselves in
respect of the accuracy of the carrying amounts of land and building amounting to Rs.24.50
(2009: Rs.24.50) million and Rs.74.46 (2009: Rs.76.31) million, respectively (note 6), and
the depreciation charged on such building during the current year, amounting to Rs.4.31
million;

(c) as referred to in note 31.2.1 to the accompanying financial statements, we have not been
provided with the audited financial statements of A I (Private) Limited, ML and AY Services
(Private) Limited, associated companies, for the year ended 30 June 2010.
Similarly, we have not been provided with the audited financial statements of AH City
(Private) Limited, for the year ended 30 June 2010.
Owing to the absence of the aforementioned audited financial statements, we could not
(a) confirm the balances outstanding in the corresponding financial statements and (b)
ascertain the break-up value of the investee company. Accordingly, the effects thereof on
the accompanying financial statements cannot presently be determined;
(d) due to significant time lag, i.e. over a year between the close of the financial year and the
issuance of these financial statements, and the non-availability of required information
such as interim financial statements, we have not been able to review the events
subsequent to the balance sheet date. However, we have been provided management’s
representation that no events and transactions have occurred after the balance sheet date
to the present time which would materially affect the financial statements and the related
disclosures for the year ended 30 June 2010;

We further report that:

(e) the Company has not followed the requirements of IAS – 40 ‘Investment Property’ with
regard to the non-disclosure of the fair value of investment property for the reasons
discussed by the management in note 6.3 to the accompanying financial statements nor
has the Company determined the effects of the said departure from the IAS on the
accompanying financial statements;
Accordingly, the effects of the departure from the above IAS, as stated in paragraph (e) above, on
the accompanying financial statements cannot presently be determined;

(f) in our opinion, proper books of account have been kept by the Company as required by the
Companies Ordinance, 1984;

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(g) in our opinion:

i) except for the effects on the financial statements, if any, of the matters stated in
paragraphs (a) to (e) above, the balance sheet and profit and loss account together
with the notes thereon have been drawn up in conformity with the Companies
Ordinance, 1984, and are in agreement with the books of account and are further
in accordance with accounting policies consistently applied except for the changes,
as stated in note 4.2, with which we concur;
ii) the expenditure incurred during the year was for the purpose of the Company's
business; and

iii) the business conducted, investments made and the expenditure incurred during
the year were in accordance with the objects of the Company;
(h) because of the significance of the matters stated in paragraph (a) above, we have not been
able to obtain sufficient appropriate audit evidence to provide a basis for an audit opinion
that whether the balance sheet, profit and loss account, statement of comprehensive
income, cash flow statement and statement of changes in equity together with the notes
forming part thereof conform with approved accounting standards as applicable in
Pakistan, and, give the information required by the Companies Ordinance, 1984, in the
manner so required and whether respectively give a true and fair view of the state of the
Company’s affairs as at 30 June 2010 and of the profit, total comprehensive income, its
cash flows and changes in equity for the year then ended. Accordingly, we do not express
an opinion on the accompanying financial statements; and
(i) in our opinion, no zakat was deductible at source under the Zakat and Ushr Ordinance,
1980 (XVIII of 1980).

We draw attention to the contents of:

(i) note 1.2 to the accompanying financial statements, which states that the accompanying
financial statements are separate financial statements of the Company and the Company is
in the process of preparing consolidated financial statements of the Group;
(ii) note 31.2.2 to the accompanying financial statements, which states that the auditors of A I
(Private) Limited – an associated company, have qualified their initialed report for the year
ended 30 June 2008 in respect of the matter stated therein; and

(iii) note 24.1.1 to the financial statements which provides details relating to contingencies with
respect to tax matters, the ultimate outcome of which cannot presently be determined
and, hence pending the resolution thereof, no provision has been made thereagainst in the
accompanying financial statements.

Chartered Accountants
Audit Engagement Partner’s Name: ABC
Date: 19 August 2011
Place: Karachi

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4.1.7 AUDITORS' REPORT TO THE MEMBERS

We have audited the annexed balance sheet of LBDN … we report that:
(a) in our opinion, proper books of account have been kept by the Company as required by the
Companies Ordinance, 1984;

(b) in our opinion:

(i) the balance sheet and profit and loss account together with the notes thereon have
been drawn up in conformity with the Companies Ordinance, 1984, and are in
agreement with the books of account and are further in accordance with accounting
policies consistently applied except for the changes, as discussed in the note 4.2, to
the financial statements with which we concur; (this is how/ where change in
accounting policy is reflected in audit report)

(ii) the expenditure incurred during the year was for the purpose of the Company's
business; and

(iii) the business conducted, investments made and the expenditure incurred during the
year were in accordance with the objects of the Company;

(c) in our opinion and to the best of our information and according to the explanations given to
us the balance sheet, profit and loss account, statement of comprehensive income, cash
flow statement and statement of changes in equity together with the notes forming part
thereof conform with approved accounting standards as applicable in Pakistan, and, give
the information required by the Companies Ordinance, 1984, in the manner so required
and respectively give a true and fair view of the state of the Company's affairs as at 30 June
2010 and of the profit, total comprehensive income, its cash flows and changes in equity for
the year then ended;
(d) in our opinion, Zakat deductible at source under the Zakat and Ushr Ordinance, 1980 (XVIII
of 1980), was deducted by the Company and deposited in the Central Zakat Fund
established under Section 7 of that Ordinance; and

Without qualifying our opinion, we draw attention to the contents of:

i) notes 14.2(a) and 14.3 to the accompanying financial statements in respect of the
lawsuit filed by the Company during the year ended 30 June 2000 in the High Court
of Sindh (the Court) with regard to the recovery of Karachi Relief Rebate,
Interconnect discount and other related amounts from Pakistan Telecommunication
Company Limited (PTCL). On an application filed by the Company, the Court passed
an interim order in favour of the Company and appointed a firm of Chartered
Accountants to determine the actual amount due from the PTCL in this regard. The
said firm submitted its report to the Court during the year ended 30 June 2002,
containing various amounts determined under various alternatives, for the period
commencing January 1997 to August 2001. Accordingly, pending a final decision by
the Court in this matter, no provision for any amount that may not be recoverable
has been made in the accompanying financial statements;

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ii) note 14.2(b) to the accompanying financial statements with regard to a lawsuit filed
by the PTCL against the Company during the year ended 30 June 2002. Pending a
decision of the Court in this respect, the Company has not made any provision for
the amount claimed by the PTCL in the accompanying financial statements;

iii) note 14.6 to the accompanying financial statements in respect of the Pakistan
Telecommunication Authority’s (PTA) claim for Access Promotion Contribution for
Universal Service Fund of Rs.2,269.148 million, out of which the Company paid a
sum of Rs.2,111.115 million to the PTA up to the end of the current year under
protest. The Islamabad High Court, however, decided the case in favour of the PTA
during the current year. As a result, the Company has filed an appeal in the
Supreme Court of Pakistan, and, hence, pending a final decision in this matter, no
adjustment has been made to the above referred sum of Rs.2,111.115 million
shown by the Company under other receivables (note 14.6) nor any provision has
been made for the remaining sum of Rs.158.033 in the accompany financial
statements;
iv) notes 32.1 to 32.12 to the accompanying financial statements in respect of
contingencies the ultimate outcome of which cannot presently be determined and,
hence, pending the resolution thereof, no provision has been made for any liability
that may arise therefrom in the accompanying financial statements;

v) note 13.1 to the accompanying financial statements in respect of additional mark-

up claimed by the Company from a commercial bank which has been accrued by the
Company in the accompanying financial statements. Pending a final decision in this
matter, no provision has been made thereagainst in the accompanying financial
statements;

vi) note 45 to the accompanying financial statements in respect of prior period

adjustments, accounted for by the Company during the current year in accordance
with the requirements of IAS-8 “Accounting Policies, Changes in Accounting
Estimates and Errors”, as a result of the matters discussed in note 6.3.1; and

vii) note 26 in respect of amount due to PTA shown under non-current liabilities, as a
result of a Writ Petition instituted by the WLL Industry, including the Company,
subsequent to the end of the current year.

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4.1.8 AUDITORS' REPORT TO THE MEMBERS

We have audited the annexed balance sheet of SMX (PRIVATE) LIMITED … we report that:
(a) in our opinion, proper books of accounts have been kept by the Company as required by
the Companies Ordinance, 1984;
(b) in our opinion:
(i) the balance sheet and profit and loss account together with the notes thereon
have been drawn up in conformity with the Companies Ordinance, 1984, and are in
agreement with the books of account and are further in accordance with
accounting policies consistently applied;
(ii) the expenditure incurred during the year was for the purpose of the Company's
business; and
(iii) the business conducted and the expenditure incurred during the year were in
accordance with the objects of the Company;
(c) in our opinion and to the best of our information and according to the explanations given to
us, the balance sheet, profit and loss account, cash flow statement and statement of
changes in equity together with the notes forming part thereof conform with approved
accounting standards as applicable in Pakistan, and, give the information required by the
Companies Ordinance, 1984, in the manner so required and respectively give a true and fair
view of the state of the Company's affairs as at 30 June 2009 and of the loss, its cash flows
and changes in equity, for the year then ended;
(d) in our opinion, no Zakat was deductible at source under the Zakat and Ushr Ordinance,
1980 (XVIII of 1980); and
(e) without qualifying our opinion, we draw attention to the contents of:
(i) note 2 to the accompanying financial statements wherein the matter set forth in the
said note indicate the existence of a material uncertainty which may cast significant
doubt about the Company’s ability to continue as a going concern;

(ii) note 36.1 to the accompanying financial statements relating to contingencies. The
ultimate outcome thereof cannot presently be determined and, hence, pending the
resolution of the same, no provision has been made for any liability that may arise
as a result of the said resolution in the accompanying financial statements.

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4.1.9 AUDITORS' REPORT TO THE MEMBERS

We have audited the annexed balance sheet of JOHNSON … we report that:

(e) without qualifying our opinion, we draw attention to note 1.2 in the accompanying financial
statements which indicates that the Company incurred a net loss of Rs.45.695 (2009:
Rs.36.215) million during the year ended 30 June 2010, resulting in a negative equity of
Rs.195.119 (2009: Rs.149.424) million and as of that date, the Company’s current liabilities
exceeded its total assets by Rs.194.291 (2009: Rs.147.429) million. These conditions, along
with other matters as set forth in the above referred note, indicate the existence of a
material uncertainty which may cast significant doubt about the Company’s ability to
continue as a going concern

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4.1.10 AUDITORS' REPORT TO THE MEMBERS

We have audited the annexed balance sheet of ABC Microfinance Bank Limited (the ‘Bank’) as at
December 31, 2008 and the related profit and loss account, cash flow statement and statement of
changes in equity together with the notes forming part thereof (here-in-after referred to as the
'financial statements') for the year then ended and we state that we have obtained all the
information and explanations which, to the best of our knowledge and belief, were necessary for
the purposes of our audit.
It is the responsibility of the Bank’s management to establish and maintain a system of internal
control, and prepare and present the above said statements in conformity with the approved
accounting standards and the requirements of the Companies Ordinance, 1984 and the Microfinance
Institutions Ordinance, 2001. Our responsibility is to express an opinion on these statements based
on our audit.

We conducted our audit in accordance with the auditing standards as applicable in Pakistan. These
standards require that we plan and perform the audit to obtain reasonable assurance about
whether the above said statements are free of any material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting policies and significant estimates made
by management, as well as, evaluating the overall presentation of the financial statements. We
believe that our audit provides a reasonable basis for our opinion and, after due verification, we
report that:

1. As more fully explained in note 32.3.1 to the accompanying financial statements, BSD Circular
No. 7 of 2008 dated March 20, 2008 issued by the State Bank of Pakistan requires that
Microfinance Banks (MFBs) licensed to operate nationally shall maintain a minimum paid up
capital, free of losses, of not less than five hundred million rupees. The circular further requires
all MFBs to maintain at all times the minimum paid up capital (free of losses).

Section 10 of Microfinance Institutions Ordinance, 2001 states that no microfinance bank shall
operate unless it has a minimum paid-up capital as the State Bank may, from time to time,
prescribe.

The Bank was incorporated on March 9, 2006 as a public limited company under the Companies
Ordinance, 1984 with a paid-up capital of Rs 500 million. During the year ended December 31,
2008 the Bank incurred a loss of Rs 22,859,437 and its total accumulated losses as at that date
amounted to Rs 68,912,788. Consequently, the net equity of the Bank as at December 31, 2008
has depleted to Rs 431,087,212.

The above non-compliance may result in cancellation of the Bank’s license to operate. Further,
penalties may be imposed under section 23 (3) of the Microfinance Institutions Ordinance, 2001.
This matter casts significant doubt about the Bank’s ability to continue as a going concern.
2. (a) In our opinion, proper books of accounts have been kept by the Bank as required by the
Companies Ordinance, 1984;
(b) In our opinion:

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(i) the balance sheet and profit and loss account together with the notes thereon have
been drawn up in conformity with the Companies Ordinance, 1984 and the
Microfinance Institutions Ordinance, 2001 and are in agreement with the books of
account and are further in accordance with accounting policies consistently applied;

(ii) the expenditure incurred during the year was for the purpose of the Bank's business;
and

(iii) the business conducted, investments made and the expenditure incurred during the
year were in accordance with the objects of the Bank;
(c) In our opinion and to the best of our information and according to the explanations given
to us, except for the possible effects of the matter referred to in paragraph 1 above, the
balance sheet, profit and loss account, cash flow statement and statement of changes in
equity together with the notes forming part thereof conform with approved accounting
standards as applicable in Pakistan, and give the information required by the Companies
Ordinance, 1984 and the Microfinance Institutions Ordinance, 2001, in the manner so
required and respectively give a true and fair view of the state of the Bank's affairs as at
December 31, 2008 and of the loss, its cash flows and changes in equity for the year then
ended; and

(d) In our opinion, Zakat deductible at source under the Zakat and Ushr Ordinance, 1980, was
deducted by the Bank and deposited in the Central Zakat Fund established under Section
7 of that Ordinance.

Chartered Accountants
Karachi
Dated:

4.1.11 INDEPENDENT AUDITORS’ REPORT TO THE CERTIFICATE HOLDERS

REPORT ON THE FINANCIAL STATEMENTS

We have audited the accompanying financial statements of ABC Energy Fund (here in after referred to as “the
Fund”), which comprise the statement of assets and liabilities as at June 30, 2012, and the related income
statement, distribution statement, statement of movement in certificate holders’ fund - per certificate,
statement of changes in equity and cash flow statement for the year then ended, and a summary of significant
accounting policies and other explanatory information.

Management Company’s responsibility for the financial statements

The Management Company of the Fund is responsible for the preparation and fair presentation of these
financial statements in accordance with approved accounting standards as applicable in Pakistan, and for such
internal control as management determines is necessary to enable the preparation of financial statements
that are free from material misstatement, whether due to fraud or error.

Auditor’s responsibility
Our responsibility is to express an opinion on these financial statements based on our audit. We conducted
our audit in accordance with the International Standards on Auditing as applicable in Pakistan. Those
standards require that we comply with ethical requirements and plan and perform the audit to obtain
reasonable assurance whether the financial statements are free from material misstatements.

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An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the
financial statements. The procedures selected depend on the auditor’s judgment, including the assessment
of the risks of material misstatement of the financial statements, whether due to fraud or error. In making
those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair
presentation of the financial statements in order to design audit procedures that are appropriate in the
circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal
control. An audit also includes evaluating the appropriateness of accounting policies used and the
reasonableness of accounting estimates made by management, as well as evaluating the overall presentation
of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate
to provide a basis for our audit opinion.

Opinion
In our opinion, the financial statements give a true and fair view of the financial position of the Fund as at June
30, 2012, and of its financial performance, cash flows and transactions for the year then ended in accordance
with approved accounting standards as applicable in Pakistan.

Emphasis of matter paragraph

We draw attention to note 1.3 to the accompanying financial statements which, inter-alia, states that the
management company has to hold a meeting of the certificate holders of the Fund within one month of
November 21, 2012 to seek their approval to convert the fund into an open-end scheme or revoke the closed-
end scheme in accordance with clause 65 of the Non-Banking Finance Companies and Notified Entities
Regulations, 2008. Our conclusion is not qualified in respect of this matter.

REPORT ON OTHER LEGAL AND REGULATORY REQUIREMENTS

In our opinion, the financial statements have been prepared in all material respects in accordance with the
relevant provisions of the Non-Banking Finance Companies and Notified Entities Regulations, 2008.

Chartered Accountants
Engagement Partner: XYZ
Dated: October 9, 2012
Karachi

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4.3 PROSPECTIVE FINANCIAL INFORMATION

4.3.1 AUDIT PROCEDURES FOR PROVIDING ASSURANCE SERVICES ON PROSPECTIVE FINANCIAL
INFORMATION

▪ Obtain the company’s cash flow forecast and review the cash in and out flows. Assess the
assumptions for reasonableness and discuss the findings with management to understand if
the company will have sufficient cash flows.
▪ Perform a sensitivity analysis on the cash flows to understand the margin of safety the
company has in terms of its net cash.

RECEIPTS
▪ Inflows reflect the gradual increase in receipts and take into account the seasonal fluctuation;
▪ Growth expectations are feasible, considering market research and economic climate;
▪ Inflows are subject to sensitivity analysis;
▪ Loan from bank is shown in forecast prior to any major outflow of cash and is sufficient to fund
expansion and respect payments.
▪ Verify that discounts have been accounted for in cash sales-receipts;

PAYMENTS
▪ Agree the opening cash position to cash book / signed financial statements and bank recon/
statement;
▪ Check the arithmetical accuracy of the forecast;
▪ Payment for furniture and fixtures are complete, supported by quotations and included prior
to opening of outlets;
▪ Payment for advertising, recruitment and training are reflected prior to the opening of outlets;
▪ Payment to suppliers reflect the company’s payment policy and exchange rates used to
translate payments are subject to sensitivity analysis;
▪ Rent is included quarterly in advance from the date of acquisition of lease & with regular rent
reviews;
▪ Interest payments reflect the level of borrowing & are in line with the market expectations &
subject to sensitivity analysis, paid on due dates;
▪ Taxes are consistent with the profit forecast & are paid on due dates;
▪ Payments reflect additional cost of operations, shipping cost, etc
▪ Recalculate the pattern of receipts from credit customers by applying stated credit terms to
credit sales;
▪ Recalculate the pattern of payment to credit suppliers by applying credit terms to credit
purchases;
▪ Review the latest available ageing analysis to confirm the pattern of payment to suppliers and
receipts from customers;
▪ Using the latest information, recalculate creditors / debtors turnover in days to compare the
stated terms and conditions;
▪ Operating cost should reflect higher amounts while running old;

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▪ Receipts and payments should take into account the expected level of inflation;
▪ Proceed from sale of scrapping should be included after installation of new system/ machinery,
etc.
▪ Obtain written management representations for intended use, significant assumptions and for
management’s responsibility.
▪ Review board minutes for approval of plan, financing, issue of shares, purchase / disposal of
fixed assets, or change in any policy, e.g. supplier/ debtors credit terms, etc

ADDITIONAL PROCEDURES
▪ Review any current agreements with the bank to determine whether any key ratios have been
breached.
▪ Review any bank correspondence to assess the likelihood of the bank renewing the overdraft
facility.
▪ Discuss with the directors whether they have contacted any alternative banks for finance to
assess whether they have any other means of repaying the bank overdraft.
▪ Review the company’s post yearend sales and order book to assess if the levels of trade are
likely to increase and if the revenue figures in the cash flow forecast are reasonable.
▪ Review post year end correspondence with suppliers to identify if any further restrictions in
credit have arisen, and if so ensure that the cash flow forecast reflects an immediate payment
for trade payables.
▪ Inquire of the lawyers of the Company as to the existence of litigation and claims, if any exist
then consider their materiality and impact on the going concern basis.
▪ Perform audit tests in relation to subsequent events to identify any items that might indicate
or mitigate the risk of going concern not being appropriate.
▪ Review the post year end board minutes to identify any other issues that might indicate
financial difficulties for the Company.
▪ Review post year end management accounts to assess if in line with cash flow forecast.
▪ Consider whether any additional disclosures as required by IAS 1 Presentation of Financial
Statements in relation to material uncertainties over going concern should be made in the
financial statements.
▪ Obtain a written representation confirming the director’s view that the Company is a going
concern.
▪ Enquire as to the competence and experience of the preparer,
▪ Discuss the reason for capital expenditure,
▪ Enquire about any other source of finance,
▪ Additional cost to be incurred, e.g. recruitment costs, installation of fixtures, plant, etc.

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[PRACTICAL REPORT – EXAMPLE]

ASSURANCE REPORT TO THE BOARD OF DIRECTORS OF
_________________
ON EXAMANIATION OF PROSPECTIVE FINANCIAL INFORMATION

We have examined the projection made in annexed Projected Balance Sheet, Projected Profit and Loss
Account, Projected Cash Flow Statement of _________________for the period from April 30, 2007 to
June 30, 2011 in accordance with International Standard on Assurance Engagements 3400 applicable to
the examination of prospective financial information. Management is responsible for the Projection
including the assumptions set out in note 2 to on which these are based.

This projection has been prepared for reflecting company’s ability to settle its liabilities due to financial
institutions over the period of projection based on its liquidity and solvency. The projection has been
prepared using a set of assumptions that include hypothetical assumptions about future events and
management’s actions that are not necessarily expected to occur. Consequently, readers are cautioned
that this projection may not be appropriate for the purpose other than that described above.

Based on our examination of the evidence supporting the assumptions, nothing has come to our attention,
which causes us to believe that these assumptions do not provide a reasonable basis for the projection
assuming that the company would get its short term and long term loan liabilities rescheduled /
restructured with grace period, revised markup rates and other details as disclosed in note 2.3, the
management will be able to generate cash inflows of aggregate amount of 530 million as disclosed in note
2.1 and 2.5 and Research and Development Support will continue to be provided over the period of
projection by the Government as projected in note 2.14.

Further, in our opinion the Projection is properly prepared on the basis of the assumptions and is
presented in accordance with approved accounting standards as applicable in Pakistan.

Even if the events anticipated under the hypothetical assumptions described above occur, actual results
are still likely to be different from the projections since other anticipated events frequently do not occur
as expected and the variations may be material.

This report is for the use of management as required by it solely to meet the requirement of its lenders.
Chartered Accountants
Karachi:
Dated:

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CHAPTER 5:
SUMMARY OF AUDIT, REVIEW & OTHER
STANDARDS
PLANNING & RISK ASSESSMENT
5.1 ISA 200 – OVERALL OBJECTIVE OF THE INDEPENDENT AUDITOR

Introduction:
This ISA deals with auditor’s responsibility or audit of FS and objectives of auditor to obtain
reasonable assurance and report on FS.

Overall objectives of the Auditor’s:

i. Obtain reasonable assurance whether FS as a whole are free from material misstatements; and
ii. Report on FS.

Definitions:
• Audit evidence – Information used by the auditor in arriving at the conclusions on which the
auditor’s opinion is based.
• Audit risk – The risk that the auditor expresses an inappropriate audit opinion when the financial
statements are materially misstated. Audit risk is a function of the risks of material misstatement
and detection risk.
• Audit risk does not include the risk that the auditor might express an opinion that the
financial statements are materially misstated when they are not. This risk is ordinarily
insignificant.
• Detection risk – The risk that the procedures performed by the auditor to reduce audit risk to
an acceptably low level will not detect a misstatement. For a given level of audit risk, the
acceptable level of detection risk bears an inverse relationship to the assessed risks of material
misstatement at the assertion level.
• Risk of material misstatement – The risk that the financial statements are materially misstated
prior to audit. It may exist at two levels:
• The Overall financial statement level; and
• The Assertion level for classes of transactions, account balances, and disclosures.
• Two components at the assertion level:
• Inherent risk – The susceptibility of an assertion to a possible material misstatement
before consideration of any related controls.
• Control risk – The risk that a possible material misstatement in an assertion, will not
be prevented, or detected and corrected, on a timely basis by the entity’s internal
control.
Responsibility for preparation of FS:
The primary responsibility for the preparation of FS is that of the must and includes:
• identification and preparation of FS in a accordance with AFRF;
• incorporating such internal controls to enable preparation of FS, that are free from M/M.
Scope of Audit:
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Purpose of audit is to enhance the degree of confidence of intended users. Auditor is required to
exercise professional judgment and maintain professional skepticism throughout.
• Planning and performance of audit;
• Identifying and assessing ROMM;
• Obtaining sufficient and appropriate AE; and
• Forming an opinion on FS.

Inherent Limitations of Audit:

• Absolute certainty in auditing is rarely attainable because:
a. The audit work involves judgment; and
b. The nature of evidence is persuasive.
• There is always an unavoidable risk that some M/M may remain undiscovered in an audit
because of the test nature and inherent limitations of internal controls.
• An audit, therefore, cannot be relied upon to ensure discovery of all frauds and errors.
• Need that an audit is to be conducted at a reasonable cost and within a reasonable time.

5.2 ISA 300 - PLANNING AN AUDIT OF FINANCIAL STATEMENTS

Introduction:
The auditor should plan his work to enable him to conduct an effective audit in an efficient and
timely manner. Plan should be based on knowledge of client’s business.

Objectives of Planning:
To ensure:
1. Prompt identification of potential problems;
2. Appropriate attention is devoted to important areas of the audit;
3. Expeditious completion of work;
4. Proper utilization of team; and
5. Coordination of work done by other auditors and expects.

Factors to be considered while planning:

1. Complexity of the Audit;
2. Environment in which the entity operates;
3. Previous experience of the auditor with his client;
4. Knowledge of the client’s business.

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Elements of Planning:
Audit planning involves:
1. Development of an overall plan. Following maters should be considered:
i. Terms of engagement and statutory requirements;
ii. Nature and timings of reports and other communications;
iii. Relevant legal / statutory requirements;
iv. Accounting policies and changes therein;
v. Effect of new accounting / auditing pronouncements;
vi. Identification of significant areas;
vii. Determination of materiality;
viii. Areas requiring special attention;
ix. Degree of reliance to be placed on controls;
x. Possible rotation of emphasis on specific audit areas;
xi. Nature and extent of audit evidence;
xii. Involvement of expects, internal auditor in audit;
xiii. Establishing and coordinating staff requirements.

2. Developing Audit Programme:

Auditor should prepare a written Audit programmes. Its main contents are:
• Audit procedures;
• Audit objectives of each area;
• Instruction to audit team;
• Evidence to be obtained.

Review / Revision of the Plan:

• Planning should be continuous throughout the engagement;
• It commences ideally at the conclusion of the previous year’s audit;
Audit plan alongwith audit programmes should be modified throughout the course of Audit, as a
resultant of modification an understanding of entity and its environment including internal
controls.

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5.3 ISA 240 AUDITORS RESPONSIBILITY RELATING TO FRAUD IN

AUDIT OF FS

Introduction:
Misstatement in FS may arise either from Fraud / Error. Distinguishing factor between both these
actions is underlying intention:
Fraud – Intentional
Error – Unintentional
Two types of intentional M/S are relevant to Audit.
i. M/S resulting from fraudulent financial reporting;
ii. M/S resulting from misappropriation of assets.

Primary Responsibility:
The primary responsibility for the detection and prevention of fraud and error is of those charged
with Governance and the management of the entity.
- Management designs and operates A/c and internal control system to discharge this
responsibility;
- Responsibility to those charged with Governance will be to ensure the integrity of an entity’s
A/C and financial reporting system and appropriateness of established controls.

Responsibility of Auditor:
Auditor is responsible to obtain Reasonable Assurance that FS are free from M/M due to fraud /
error.
- Due to inherent limitation even an audit which is properly planned and performed, may fail to
detect a cleverly concealed fraud.
- Risk of not detecting a M/S resulting from management fraud is greater than an employee
fraud.

Characteristics of Fraud:
Fraud frequently involves: Pressure
Fraud a. Pressure to commit; Rationale
Risk b. Perceived opportunity to do so; to commit
Factors c. Intention; fraud.
d. Rationalization.
Intention Opportunity
Audit Approach:
- Auditor shall work with a certain degree of Professional Skepticism (PS) in order to be alert to
any signals of M/S. This does not imply that he should perform his work with suspicion, unless
there is a reasonable ground of doubt. E.G.: when presented with a photocopies document, the
auditor should exercise PS and consider the need to obtain original documents.

- Discussion among team members regarding the susceptibility of entity’s FS to M/M from fraud
and planned audit procedures.
- Assessing the ROMM resulting from fraud, the Auditor should:
i. Consider whether fraud risk factors are present that indicate the possibility of fraud;
ii. Make inquiries of Management and TCWG to obtain into about its understanding and
assessment of the likelihood of fraud occurring within entity.

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FRAUD RISK FACTORS (Examples)

1. Risk of Fraudulent Financial Reporting:

i. Management’s characteristics and influence over the control environment:

• Management is unduly aggressive about maintaining stock prices / earning trend;
• Management’s compensation plan is contingent on stock prices;
• Disregard for Ethics;
• Tax evasion:
• Domination of management by a single person / small group;
• Inadequate monitoring of controls;
• Disregard for Regulatory Authorities;
• Management turnover is high, without planned replacement;
• Owner – manager makes no distinction between personal and business transactions;
• Strained relations between management and the _______ or predecessor Auditor
(unreasonable time constraints, restricted access to evidence, frequent disputes).
• Non-financial management participates excessively in the selection of A/C policies and
significant A/C estimates.
• Continued employment of incompetent A/C and technology staff.

ii. Industry Conditions:

• New A/C, statutory or regulatory requirements;
• Highly competitive industry, market saturation / inadequate earnings relative to others in
the industry;
• Declining industry with increasing business failures;
• Significant decline in customer demands;
• Rapid changes in the industry like rapid product obsolescence.

iii. Financial Stability:

• Inability to generate cash flow from operations;
• Significant related party transactions;
• Pressure to obtain additional capital;
• Unusual / highly complex transaction near year end;
• Unusual profitability relative to competing companies;
• High dependence an debt;
• Threat of bankruptcy / foreclosure / hostile takeover;
• Deteriorating financial conditions guaranteed personally by management.

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2. Risk of Misappropriation of Assets:

i. Susceptibility of Assets to misappropriation:

• Large amount of cash processed / in hand;
• Small size, high value, high – demand inventory;
• Easily convertible assets such as diamonds, bonds;
• Small, untraceable, marketable fixed assets.

ii. Controls:
• Inadequate segregation of duties;
• Lack of management foresight;
• Inadequate screening of job applicants;
• Inadequate system of transaction authorization and approval;
• Untimely and inadequate documentation of transactions;
• Poor safeguards over cash, investments, fixed assets / inventory.
• No mandatory vacation policy for employees.

RESPONSES TO ASSESSED FRAUD RISK FACTORS

1. Overall Modifications:
- Professional skepticism: increased sensitivity in selecting audit evidence substantiating
material transactions.
- Assignment of Engagement Team: Staffing the audit team with individuals having
knowledge, skill and ability which commensurate with audit risk.
- Evaluating the selection and application of A/C policies particularly those related to complex
transactions / subjective measurements.
- Incorporating an element of unpredictability in audit procedures.

2. Nature, Timing and Extent of Procedures to be Modified:

• Nature – more reliable / additional corroborative information;
• Timing – closer to / at year end;
• Extent – increase sample size.

3. Considerations at A/C balance, class of transaction and Assertion Level:

• Visit locations on surprise basis;
• Detailed review of quarter – end / year end adjusting entries;
• Investigate unusual transaction;
• Conduct interview of personnel in areas of high risk.

4. Specific Responses – M/S from Fraudulent Financial Reporting:

- Revenue recognition – additional into in confirmation request – terms of contract and
absence of side agreements;
- Inventory quantities – surprise checks;
- Testing the appropriateness of Journal entries:
• making inquiries of individuals involved;
• selecting JE’s made at the end of a reporting period; and
• considering need to test JE’s throughout the period.

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5. Specific Responses – M/S from misappropriation of Assets:

- Modify control risk assessment;
- Detailed testing directed towards certain A/C balance.
- Presumed fact that there are risks of fraud in Revenue Recognition. If auditor concludes
that the presumption is N/A in the circumstances of the engagement, the Auditor should
include its reasons in Audit documentation.

SKETCH OF ISA - 240

Assess / consider the ROMM in FS resulting from Fraud / Error. To do this:
• be alert (PS);
• have discussion with Audit team;
• make discussion with Audit team;
• identify fraud risk factors.

• Assess the significance and relevance of fraud risk factors (FRF);

• Design procedures to address FRF and modify nature, timing and extent of substantive
procedures;
• Document FRF along with the ways they have been addressed.

Suspicion of Fraud is indicated by FRF and Audit evidence

Believe it to have material No Able to continue No

effect on FS engagement
Yes Yes

Perform Modified / Additional Consider legal reporting

Audit Procedures requirements and withdraw
from engagement

Yes
SUSPICION IS
CONFIRMED
NEITHER CONFIRMED
No NOR DISPELLED
Issue Appropriate Consider its impact 1. Communicate the findings to
Audit Report on FS and Audit appropriate level of management /
Report TCWG;
2. Consider the implications for other
aspects of Audit particularly
reliability of management
representations.
3. Satisfy himself that FS are adjusted
and issue appropriate Audit Report
or withdraw from engagement.

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REPORTING STANDARDS
5.4 ISA 705 - MODIFICATIONS TO THE OPINION IN THE
INDEPENDENT AUDITOR’S REPORT
MODIFICATIONS TO THE OPINION

Inability to obtain SAAE Material misstatement

(Possible effects could be material) (Effects are material)

Not pervasive Pervasive Not pervasive Pervasive

Qualify Disclaimer Qualify Adverse

- Reasons for inability
What is a pervasive effect??
- Not confined to a single element; Specific amounts Narrative disclosure
- If so, then must represent a substantial portion - Description
of the FS; - Quantification, if practicable
- In relation to disclosures, are fundamental to - Mention, if not practicable
the users’ understanding.
What could be an ‘inability’ to obtain SAAE? Non- disclosure inadequate discl.
- Circumstances beyond entity’s control – - Describe the nature of the
destroyed records, significant component Omitted info. Explanation as to how
seized by govt. etc. the disclosures are
misstated
- Circumstances relating to the nature and timing
of the audit work– unable to observe inventory
- Include the omitted disclosure,
count, ineffective controls where substantive If possible (incase where they’re
alone do not provide SAAE; Voluminous or not provided by the
- Limitations imposed by management – Management)
management prevents to send confirmations,
stock take, etc.

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▪ In case of multiple uncertainties (Illustration #5, ISA 705), in rare circumstances, disclaim
the opinion.
▪ In case of Adverse or Disclaimer of opinion, also, disclose any other matter that may require
a modification to the opinion.
▪ In case of Disclaimer of opinion, do not disclose KAM as per ISA 701.
▪ Any limitation imposed after the engagement has been accepted, the auditor shall qualify, if
not pervasive, and
- Withdraw, if pervasive, and before doing the same, communicate any matters that
may have given rise to modifications to the report.
- Disclaim (if not allowed to withdraw) and consider the need to include this in OMP.

5.5 ISA 706 – EOMP AND OMP

• EOMP - Already disclosed adequately and fundamental to users of FS.
o Doesn’t apply where it’s a Modification as per ISA 705
o Doesn’t apply where is a Going concern issue as per ISA 570
o Doesn’t apply where it’s a KAM
o Contents:
▪ Reference to matter in FS
▪ Mentions information already disclosed
▪ Indication that opinion is not modified
• OMP – not required to be disclosed but still relevant to users
o Not prohibited by law or other ethical standards (e.g. confidentiality)
o Not required to be provided by the management
o Doesn’t apply where it’s a KAM
o Not a Other reporting responsibilities para

Circumstance where EOMP is required by Standard

1. When Financial reporting framework prescribe by law would be unacceptable but for the fact
that it is prescribed by law. (ISA 210 Paragraph 19b)
2. To alert users that FS are prepared in accordance with a Special Purpose Framework (ISA 800
Paragraph 14)
3. When facts become known after the date of Auditors’ report and a new or amended report is
provided (ISA 560 Paragraph 12b and 16)

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Circumstance where EOMP may be necessary

1. Uncertainty related to future outcome of a litigation or regulatory action
2. Significant subsequent event that occurs between the date of FS and auditors report
3. Early application of a new accounting standard with a material effect
4. A major catastrophe that had or continues to have a significant effect on entity

Circumstance where OMP is required by Standard

1. When facts become known after the date of Auditors’ report and a new or amended report is
provided (ISA 560 Paragraph 12b and 16)
2. When in corresponding figures, last year is audited by a predecessor auditor, also mention.
a. Type of opinion and reasons of modification, if any
b. Date of that report
3. When in corresponding figures, last year figures are unaudited (ISA 710 Para 14)
4. When in comparative figures, opinion on prior period FS is different from previously expressed
opinion last year (ISA 710 Para 16)
5. When in Comparative figures, last year is audited by a predecessor auditor, also mention.
a. Type of opinion and reasons of modification, if any
b. Date of that report
Unless predecessor’s auditor reissues audit report on prior period FS. (ISA 710 Para 18)
6. If predecessor auditor unwilling to reissue the report, OMP to indicate that previous auditor
reported on figure prior amendment. (ISA 710 A11, Para 18)
7. When in Comparative figures, last year FS are unaudited (ISA 710 Para 19)

Circumstance where OMP may be necessary

1. Planning, scoping and application of materiality in the context of audit (A9)
2. Explanation of why withdrawal was not possible despite a pervasive inability / limitation
3. Reference to the fact that another set of FS are prepared in accordance with GPF
4. Where FS prepared with a SPF, reference to the fact that its intended solely for a intended
users and restriction on distribution

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5.6 ISA 570 - GOING CONCERN

MATERIAL UNCERTAINTY
(Because of the magnitude of the potential impact requires disclosure for fair presentation or not a
misleading presentation)

GC ASSUMPTION APPROPRIATE GC ASSUMPTION INAPPROPRIATE

DISCLOSED ADEQUATELY NOT DISCLOSED ADJUSTED NOT ADJUSTED

ADEQUATELY

GC PARA QUALIFIED/ ADVERSE EOMP ADVERSE

Adequate disclosure means:

-adequately describe principal events and conditions,
-management’s plan to deal with them.
-disclose that there material uncertainty on entity’s ability to continue GC and may not be able to
discharge its assets/liabilities. (All GC disclosureshave this sentence in disclosure notes)

In situations where there are multiple material uncertainties (MU), that are significant to the FS as a whole,
then auditor may consider it app. to express a DISCLAIMER instead of a GC Para. (Illustration# 5 – ISA 705)
This is the case when auditor is not able to form an opinion. Based on a number of events / factors, govt.
attempting to seize record, new claim being filed by customers, brand in disrepute, etc.

If managements is unwilling to make an assessment, then the auditor may Qualify Or Disclaim the
opinion based on inability. For period exceeding one year, or 12 months, only inquiry is required to
be made, in case some are identified, we need to perform all the procedures as required.

Responsibilities for GC assumption assessment:

IAS 1 (AFRF) says management needs to make assessment.
ISA 570 says, no matter what AFRF says (e.g. Indian AS or USGAAP) auditor needs to obtain
assessment of GC assumption.
What is a Material Uncertainty?
Impact and likelihood is so significant to the business that it might affect the fair presentation, if
not disclosed in FS or compliance presentation as per compliance framework.

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5.7 ISA 701 – KEY AUDIT MATTERS (KAM)

What is KAM
KAM are defined as those matters that, in the auditor’s professional judgment, were of most
significance in the audit of the financial statements of the current period. ISA 701 only applied to
listed entities and other circumstances where auditor otherwise decides to communicate KAM in
audit report.

What is NOT a KAM

A KAM is not:
• A substitute for disclosures in the financial statements (AFRF)
• A substitute for a modified opinion (ISA 705)
• A substitute for reporting a material uncertainty related to GC (ISA 570)
• A separate opinion on individual matters (ISA 700 – Other reporting resp.)
• An implication that a matter has not been resolved by the auditor.

Determination of KAM:
KAM Judgment Based Decision-Making Framework:

Matters that were communicated with

Board Audit Committee

Matters that required significant attention

Matters of
most significance
in audit

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Types of matters reported by different auditors as KAM

• Property valuation and impairment
• Goodwill impairment
• Acquisition and disposals of operating activities
• Inventory valuation
• Revenue recognition
• Pension accounting
• Claims & litigation
• Taxation (deferred and current)
• IT environment and control deficiencies
• Management override of controls

How to write KAM:

The description of KAM must always include:
1. Why the matter is considered a KAM
2. How the matter was addressed in the audit
3. Reference to the related disclosure(s), if any.

1. Why the matter is considered a KAM

• High ROMM
• Significantly subjective or Judgmental
• Uncertainty of matter
• Complexity
• challenges w.r.t. information access of subsidiary (group audit) or covering all aspects
of related parties
• areas of audit expert
• areas where consultation was required
• Assessed Significant Risks that required Sig. audit attention
• Change in audit approach during the audit as a result of an unexpected audit evidence
• the severity of control deficiency identified

Materiality and context of entity shall be taken into account.

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The description may make reference to principle considerations such as:

• Economic conditions that affected the auditors ability to obtain audit evidence
• New or emerging accounting policies
• Changes in the entity’s strategy and business model that had a material effect

EXAMPLE: COCHLEAR LIMITED Y/E 30 JUNE 2015

Patent dispute provision $21.3 million
The patent dispute provision relates to a specific claim that has been made against the
Consolidated Entity. We focused on this area as a key audit matter due to the amounts
involved being material as well as the inherent uncertainty in the application of the
measurement aspects of accounting standards to determine the amount, if any, to be
provided for and the disclosures to be made in respect of this matter.

Cochlear’s Note 5.4 Provisions

PATENT DISPUTE
In a trial of the patent infringement lawsuit by the Alfred E. Mann Foundation for Scientific
Research and Advanced Bionics LLC in January 2014, a Jury found that Cochlear Limited and its
US subsidiary Cochlear Americas infringed four claims across two patents, the infringement
was wilful and awarded United States dollars (USD) 131,216,325 in damages. On 1 April 2015,
a Judge in the United States District Court in Los Angeles, California held that three of the four
patent claims were invalid and Cochlear’s infringement of the remaining claim was not wilful.
The Judge overturned the damages awarded because three of the four claims were held to be
invalid. On 21 April 2015, the Court entered Judgment on liability only and stayed a new trial
on damages pending the outcome of the appeal by all parties from the Judgment to the
United States Court of Appeals for the Federal Circuit. As the patents have expired, the
Judgment will not disrupt Cochlear’s business or customers in the United States.
The directors have obtained external advice and are of the opinion that the facts and the law
do not support the Court’s decision on infringement of the one remaining claim. The nature of
the above legal process is such that final future outcomes are uncertain. The directors have
made judgments and assumptions relating to their best estimate of the outcome of this
litigation and actual outcomes may differ from the estimated liability. A provision was
expensed in the half year ended 31 December 2013 in relation to this dispute. No additional
amount has been provided since that initial provision. For the purpose of determining this
provision, Cochlear considered its independent damages expert’s assessment prepared for the
trial to estimate the liability that could result from the dispute.

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2. How the matter was addressed in the audit

It may include:
• Aspects of the auditor’s response or approach
• A brief overview of procedures performed
• An indication of the outcome of the audit procedures
• Key observations with respect to the matter

EXAMPLE: DOWNER EDI LIMITED Y/E 30 JUNE 2015

Our procedures included, amongst others
• We assessed management’s determination of the Group’s CGUs based on our
understanding of the nature of the Group’s business and the economic environment
in which the segments operate. We also analysed the internal reporting of the Group
to assess how earnings streams are monitored and reported;
• We evaluated management’s process regarding valuation of the Group’s goodwill
assets to determine any asset impairments. We tested controls were being
performed, such as the preparation and review of forecasts. These forecasts take into
consideration the impacts of the sector specific challenges that the Group faces;
• We challenged the Group’s assumptions and estimates used to determine the
recoverable value of its assets, including those relating to forecast revenue, cost,
capital expenditure, discount rates and foreign exchange rates by adjusting for future
events and corroborating the key market related assumptions to external data;
• We checked the mathematical accuracy of the cash flow models and agreed relevant
data to the latest forecasts;
• We assessed the historical accuracy of forecasting of the Group;
• We performed sensitivity analysis in two main areas. These included the discount rate
and terminal growth assumptions on the CGUs with a higher risk of impairment; and
• We also assessed whether assumptions, such as working capital and capital spend,
had been determined and applied consistently across the Group.

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3. Reference to the related disclosure(s), if any.

EXAMPLE: ASX LIMITED Y/E 30 JUNE 2015

Refer to page 40 (Consolidated balance sheet) and page 54 note C1 for details of
management’s impairment test and assumptions.

KAM should be entity-specific, audit-specific and avoid standardised, overly technical words and
jargon.
Each KAM must have a separate sub-heading with the following introductory para:

KEY AUDIT MATTERS

Key audit matters are those that, in our professional judgement, were of most significance
in our audit of the financial statements of the current period. These matters were
addressed in the context of our audit of the financial statements as a whole, and in forming
our opinion thereon, and we do not provide a separate opinion on these matters.

What Order:

• No requirement for a specific ordering.

• May be organised in order of relative importance
• May correspond to the order in which matters are disclosed in FS.

No related disclosure necessary

• Matter to which a KAM relates may not be disclosed in the financial statements
• Description of a KAM only needs to include a reference to a related disclosure, if there is
one.
• As a general rule, KAM would not provide original information, which is any information
about the entity that has not otherwise been made publicly available by the entity.

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5.8 DIFFERENT TYPES OF AUDIT REPORTS IN STANDARDS

S. NO DESCRIPTION Opinion Type Standard
Ref.
Illustration 1 Qualification as to opening inventory count - Limitation Qualification 510

Illustration 2 Qualification as to opening inventory count (Balance Qualification 510

sheet not qualified) – Limitation
Illustration 1 EOMP for going concern (accumulated losses + CA> CL) EOMP 570

Illustration 2 Qualification as to the expiry of financing arrangements – Qualification 570

inadequate disclosure of a material uncertainty

Illustration 3 Adverse opinion for expiry of financing arrangements – Adverse 570

nondisclosure of a material uncertainty
Illustration 1 Clean Report – General purpose FS of a listed company – Clean Report 700
Fair presentation framework
Illustration 2 Clean Report – General purpose consolidated FS of a Clean Report 700
listed company – Fair presentation framework
Illustration 3 Clean Report – General purpose FS of a non-listed Clean Report 700
company – Fair presentation framework (website ref.)

Illustration 4 Clean Report – General purpose FS of a non-listed Clean Report 700

company – Compliance framework
Illustration 1 Qualification as to valuation of inventory (cost/NRV) – Qualification 705
material misstatement
Illustration 2 Adverse opinion as to non-consolidation of subsidiary – Adverse 705
material misstatement
Illustration 3 Qualification as to non-valuation of foreign investment - Qualification 705
Limitation
Illustration 4 Disclaimer as to non-valuation of Joint venture - Disclaimer 705
Limitation
Illustration 5 Disclaimer as to multiple elements misstated Disclaimer 705
Illustration 1 EOMP due to fire EOMP 706
Illustration 2 Qualified as to short-term securities, not marked to Qualification 706
market – material misstatement + EOMP due to fire +EOMP
Illustration 1 Qualified as to ‘no depreciation charged’ (PY/CY) – Qualification 710
corresponding figures, material misstatement
Illustration 2 Qualified as to opening inventory (PY / CY) – comparative Qualification 710
FS, limitation
Illustration 3 Clean report – corresponding figures Clean Report 710
Illustration 4 Qualified as to ‘no depreciation charged’ (PY/CY) – Qualification 710
comparative FS , Limitation

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5.9 ISA 560 SUBSEQUENT EVENTS

DATE OF FS DATE OF AUDITORS REPORT DATE OF ISSUANCE OF REPORT

Between the date of FS and the date of auditor’s report it is the auditors responsibility to perform
procedures and obtain reasonable assurance that all those items have been disclosed and
accounted for as per IAS 10 and IAS 37.

The procedures are:

- Inquiry of management;
- Reading minutes of the meeting;
- Reading entity’s latest financial statements;
- Confirmation and inquiry with the legal counsel;
- Requesting written representation from management.

After Auditor’s report date, there is no obligation to perform procedures, however, if any event /
fact comes across which may require amendment of auditor’s report, then the auditor should:
- Discuss with the management/ TCWG;
- Determine whether it needs amendment;
- Inquire how the management intends to address the matter

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FACT BECOMES KNOWN

MANAGEMENT AGREES TO AMENDMENT MANAGEMENT DOESNOT AMEND

NECESSARY PROCEDURES WHERE LAW DOES NOT PROHIBIT,

NECESSARY PROCEDURES TO THE
EXTENT OF EVENT
REPORT LIES REPORT LIES
WITH MANAGEMENT WITH
AUDITOR
AMENDED REPORT
DUAL DATING (A12) &
AN AMENDED REPORT MODIFIED
REPORT (705/706)

OR

INCLUDE A DESCRIPTIVE STATEMENT

IN EOMP / OMP in the amended/ new
report
NOTIFY TCWG/
MANAGEMENT NOT TO ISSUE

IF ISSUED, SEEK LEGAL ADVICE FOR

AUDITOR’S RESPONSIBILITIES IN THIS
CASE

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5.10 ISA 510 - INITIAL AUDIT ENGAGEMENTS—OPENING BALANCES

Initial Audit Engagement, where:
• FS for prior period were not audited; or
• FS for prior period were audited by predecessor auditor.

Opening Balances: i. A/C balances which existed at the beginning of the period;
ii. closing balances of the preceding period brought forward to current
period;
iii. effect of transactions, e vents and A/C policies applied in preceding
period (including contingencies and commitments).

Audit shall obtain sufficient appropriate Audit Evidence by:

• determining closing balances have been correctly b/f.;
• determining appropriate A/C policies are being consistently applied;
• performing one of the following:
i. Reviewing the predecessor auditor’s working papers;
ii. Evaluating whether audit procedures performed in current period provide evidence
relevant to opening balance; or
iii. Performing specific audit procedures to obtain evidence regarding opening balance.

REPORTING

Opening Consistency Modified Prior

Balances of A/C Policies Period Audit Report

- Auditor unable to obtain • Policies not consistently Modification Still Relevant

sufficient and appropriate applied
audit evidence on opening Or
balances • Change in accounting Yes No
policy is not appropriately
disclosed
Qualified / Disclaimer
Material OMP
Qualified / adverse opinion
to Current in current
- Auditor concludes opening
balances contain a M/S that period FS year FS
could materially affect
current period FS and the
effect is not appropriately Modify opinion
accounted for / disclosed on current
Qualified / Adverse
period FS
In case of difficulties are faced with respect to obtaining audit evidence w.r.t. opening balance,
include the matter in KAM.

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5.11 ISA 710 COMPARATIVES FINANCIAL INORMATION

Corresponding figures – prior year figures on provided with relevance to current year figures.
Comparative Financial statements – prior year figures are audited

Corresponding figures – only CY figures audited

Prior Year Audit Report

A. Modified Opinion B. Unmodified Opinion

Resolved Unresolved Still clean Found a MM

No need to refer
to modification

Relevant to CY Fig. Not relevant

Not adjusted / reissued
PY FS

Modify CY AR of Modification may be

the possible effects on CY Required w.r.t. comparability of
and corresponding figures Corresponding figures

CY corresponding fig.
Adjusted CY corresponding
fig. not adjusted

EOMP Modify wrt

comparability

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Comparative figures
Prior Year Audit Report

By Other auditor By Us

Similar opinion Different opinion/

Found a MM
Similar opinion Different opinion
-Communicate
mgmt./tcwg
No effect
-Request to inform No effect Disclose in OMP
previous auditor of the substantive reasons
when adjusted, if not, then
apply ISA 705

PY amended and predecessor PY not amended or

agrees to reissue amended not reissued by pred. auditor

Report only on CY FS
With no ref. to PY adjustment in
Audit report
Adjusted our FS CY / Comparative
of CY & comparative(A11) not adjusted

Modify CY as per 705

If issue only pertains to PY, then Modify
OMP to be included that says that w.r.t. comparability
Predecessor auditor reported on
figures before amendment.

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5.12 ISA 720 - OTHER INFORMATION CONTAINED IN THE

DOCUMENT CONTAINING AUDITED FS

“Other information” is financial or non-financial information (other than financial statements and
the auditor’s report thereon) included in an entity’s annual report.

Annual report – usually includes information about entity’s developments, future outlook, risks,
uncertainties, Boards statements, governance and matters, etc.

Examples included: Examples not included:

• Management report, commentary, or • Industry specific separate reports

operating financial review or similar (Capital Adequacy Reports)
reports by TCWG (e.g. Directors Report)
• Chairman statements • CSR reports, sustainability reports
• Corporate governance statement • Diversity reports,
• Internal Controls and risk assessment • Product responsibility reports
• Labor practices reports
• Human rights reports

Inconsistency – when the Other information contradicts with the information:

• contained in audited FS; or Auditor’s Response
o “Revenue for 2015 comprised xxx million from product Y and ▪ m/m of Other
xx million Product Y” Information
• with auditors’ knowledge ▪ m/m of FS
o Major operation is in country x” ▪ knowledge needs
o Matters like business prospects, future cash flows updation.
available to entity
o Planned cessation of product line
(auditors shall read to find it)
Misstatement –when Other information is incorrectly stated or misleading.
o Other than obtained via audit
o Internal inconsistency between OI
(auditors shall remain alert while reading)

Responding when inconsistency / misstatement appears to exist

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Material Misstatement Of Other Information Exists:

▪ Agrees to make correction
▪ Refuses to make correction
o Communicate TCWG
▪ OI obtained prior to audit report
• Consider implications (discussed below)
• Consider withdrawal or disclaimer, if withdrawal not possible
(integrity issue due to management’s intent to mislead)
▪ OI obtained after the audit report issued
• Consider legal advice
o Appropriate action include
▪ Providing a modified report to management
• Review steps taken by management to provide
the modified report to users
▪ Address the matter in AGM
▪ Communicating to regulator
▪ Engagement continuance implications

Reporting
▪ The auditor’s report will always include a separate Other Information section when the auditor
has obtained some or all of the other information as of the date of the auditor’s report.
▪ For audits of financial statements of listed entities, an Other Information section will also be
included if the auditor expects to obtain other information after the date of the auditor’s
report.

Please open ISA 720 Appendix-1 and read examples of OI included in annual report

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ISA 720 (Revised) includes illustrative examples to show how reporting on other information may
be done in various circumstances.
ILLUSTRATION/ SCENARIO: 1
• Any entity,
• Unmodified opinion,
• Obtained ALL of the other information prior
• Not identified a material misstatement

Other Information [or another title if appropriate, such as “Information Other

than the Financial Statements and Auditor’s Report Thereon”]
Management is responsible for the other information. The other information comprises the
[information included in the X report, but does not include the financial statements and our auditor’s
report thereon.]
Our opinion on the financial statements does not cover the other information and we do not express
any form of assurance conclusion thereon.

In connection with our audit of the financial statements, our responsibility is to read the other
information and, in doing so, consider whether the other information is materially inconsistent with
the financial statements or our knowledge obtained in the audit or otherwise appears to be materially
misstated. If, based on the work we have performed, we conclude that there is a material
misstatement of this other information, we are required to report that fact. We have nothing to
report in this regard.

ILLUSTRATION/ SCENARIO: 5
▪ Any entity,
▪ Unmodified opinion,
▪ Obtained ALL of the other information prior
▪ Identified a material misstatement

In connection with our audit of the financial statements, our responsibility is to read the other
information and, in doing so, consider whether the other information is materially inconsistent with
the financial statements or our knowledge obtained in the audit or otherwise appears to be
materially misstated. If, based on the work we have performed, we conclude that there is a material
misstatement of this other information, we are required to report that fact. As described below, we
have concluded that such a material misstatement of the other information exists.
[Description of material misstatement of the other information]

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ILLUSTRATION/ SCENARIO: 2
▪ Listed entity,
▪ Unmodified opinion,
▪ Obtained part of the other information prior
▪ Not identified a material misstatement
▪ Expects to obtain part after the audit report date

Management12 is responsible for the other information. The other information comprises the X
report13 (but does not include the financial statements and our auditor’s report thereon), which we
obtained prior to the date of this auditor’s report, and the Y report, which is expected to be made
available to us after that date.

….We have nothing to report in this regard.

[When we read the Y report, if we conclude that there is a material misstatement therein, we are
required to communicate the matter to those charged with governance and [describe actions
applicable in the jurisdiction]]

ILLUSTRATION / SCENERIO: 3
▪ Non-listed entity,
▪ Unmodified opinion,
▪ Obtained part of the other information prior
▪ Not identified a material misstatement
▪ Expects to obtain part after the audit report date

Management17 is responsible for the other information. The other information obtained at the date
of this auditor’s report is [information included in the X report, 18 but does not include the financial
statements and our auditor’s report thereon]
Our opinion on the financial statements does not cover the other information and we do not express
any form of assurance conclusion thereon.
In connection with our audit of the financial statements, our responsibility is to read the other
information and, in doing so, consider whether the other information is materially inconsistent with
the financial statements or our knowledge obtained in the audit, or otherwise appears to be
materially misstated.

If, based on the work we have performed on the other information obtained prior to the date of this
auditor’s report, we conclude that there is a material misstatement of this other information, we are
required to report that fact. We have nothing to report in this regard.

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ILLUSTRATION / SCENERIO: 4
▪ Listed entity,
▪ Unmodified opinion,
▪ Obtained No other information prior
▪ Expects to obtain part after the audit report date

Management21 is responsible for the other information. The other information comprises the
[information included in the X report,22 but does not include the financial statements and our
auditor’s report thereon]. The X report is expected to be made available to us after the date of this
auditor's report.
Our opinion on the financial statements does not cover the other information and we will not express
any form of assurance conclusion thereon.
In connection with our audit of the financial statements, our responsibility is to read the other
information identified above when it becomes available and, in doing so, consider whether the other
information is materially inconsistent with the financial statements or our knowledge obtained in
the audit, or otherwise appears to be materially misstated.
[When we read the X report, if we conclude that there is a material misstatement therein, we are
required to communicate the matter to those charged with governance and [describe actions
applicable in the jurisdiction].]23

ILLUSTRATION / SCENERIO: 6
▪ Any entity,
▪ Qualified opinion, wrt to a limitation of scope of a material item in FS which also affects
Other information
▪ Obtained ALL of the other information prior

If, based on the work we have performed, we conclude that there is a material misstatement of
this other information, we are required to report that fact. As described in the Basis for Qualified
Opinion section above, we were unable to obtain sufficient appropriate evidence about the carrying
amount of ABC’s investment in XYZ as at December 31, 20X1 and ABC’s share of XYZ’s net income for
the year. Accordingly, we are unable to conclude whether or not the other information is materially
misstated with respect to this matter.
ILLUSTRATION / SCENERIO: 7
▪ Any entity,
▪ Adverse opinion, wrt to a matter in FS which also affects Other information
▪ Obtained ALL of the other information prior

If, based on the work we have performed, we conclude that there is a material misstatement of this
other information, we are required to report that fact. As described in the Basis for Adverse Opinion
section above, the Group should have consolidated XYZ Company and accounted for the acquisition
based on provisional amounts. We have concluded that the other information is materially

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misstated for the same reason with respect to the amounts or other items in the X report affected
by the failure to consolidate XYZ Company.

SCENERIO: 8
In case of Disclaimer of Opinion – No Other Information para as per revised ISA 720
ICAP Question Summer 2012: (4 Marks)
Q2 (b) The directors’ report of XCP Limited states without any further explanation that the 20%
increase in profit as compared to the previous year is due to increase in sales and austerity
measures introduced by the management. The income statement for the year shows an increase in
profits and sales amounting to Rs. 20 million and Rs. 8 million respectively whereas the costs have
reduced by Rs. 12 million. A review of your working papers however indicates that costs have
reduced mainly on account of reduction in import duty on certain raw materials.
ICAP Answer
• If there are material inconsistencies in the other information presented with the financial
statements the auditor should discuss the reasons thereof with the management and ask
them to revise the other information.
• In case of disagreement, the auditor shall communicate the matter to those charged with
governance.
• Include in the auditor’s report an ‘other matter paragraph’ describing the material
inconsistencies
Revised Answer
• This represents an inconsistency between the auditor’s knowledge and Other information
[as Annual Report includes information presented in Director’s Report (DR)]
• Information presented in DR is misleading and therefore, the auditor should request
management to amend DR to reflect true facts
• If management refuses, communicate the entire matter to TCWG
• In case of no action, the auditor should report the matter in Other Information para clearly
describing the misleading nature of disclosure
• The auditor may consider withdrawal or disclaimer (if prohibited) in case of the intention to
mislead creates integrity issues.

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5.13 ISA 800 - SPECIAL CONSIDERATIONS – AUDIT OF FS PREPARED

IN ACCORDANCE WITH SPF
General Purpose framework: designed to meet the needs of wide range of users – ISA 700 deals
with it.
Special purpose framework: designed to meet the needs of specific users e.g. tax basis accounting,
receipt and disbursements basis accounting, etc. If in a contract you are required to comply with all
provisions of IFRS except for few then, you cannot refer to the fact that your framework is Fair
presentation framework.
In accepting the engagement, the auditor should consider:
- The purpose of preparation
- Intended users
- Reasonableness/ acceptability of reporting framework

Add: An EOMP that the FS are not intended to be used for any other purpose and they are
prepared for this purpose + restriction on distribution.
When SPF is based on Fair PF, but not in full compliance, cannot show so.

5.14 ISA 805 - AUDIT OF SINGLE FINANCIAL STATEMENT, SPECIFIC

ELEMENTS, ACCOUNTS OR ITEMS OF FS
▪ Ensure practicability/ competence, if you are not the auditor of complete set of FS.
▪ A separate opinion
▪ If it is included with complete set, the auditor should ensure that there are differentiated
with single element and shall not issue the report until satisfied with the differentiation.
▪ May require auditing interrelated items if you are not the auditor, for example lease
disbursements with deposits of lease, etc.
▪ The auditor determines the effect of EOMP / OMP in complete FS on single element /
financial statement.
▪ The auditor may include OMP to refer to the modification in complete set of FS when the
auditor judges it to be relevant even if it doesn’t relate to audited FS or element.
▪ If the auditor has expressed an adverse or disclaimer of opinion, the auditor shall also not
include an unmodified opinion in same report/ document with respect to the same
reporting framework on a single FS or one or more specific elements or items of FS because
that would contradict the auditors previous opinion on the FS as a whole.
o Except for the,
• Expression of an unmodified opinion on one financial reporting framework
on the same FS while an adverse opinion on the other financial reporting
framework.
• Expression of disclaimer of opinion regarding the results of operations while
an unmodified opinion on financial position, so in this case disclaimer is not
expressed on the FS as a whole.

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• An adverse or disclaimer of opinion expressed in complete FS but in the

context of a separate audit of specific element, the auditor may express an
unmodified opinion, where 1) the auditor is not prohibited by law, 2) opinion
is published in another document, and 3) the element does not constitute a
major portion.
▪ Materiality may be lower than the complete set of FS.

5.15 ISA 810 - AUDIT OF SUMMARISED FINANCIAL STATEMENTS

▪ Scope: summarized FS derived by the audited FS by the same audotr- rationale: that
another auditor would not be able to have that understanding.
▪ Does not cover events after the date of audited FS, since these not an update, if the auditor
comes to know of any then apply ISA 560 subsequent events
▪ Opinion is expressed as an Adverse (no qualification), if the summary FS materially
inconsistent with the audited FS.
▪ If audited FS contain a qualified opinion, EOMP or OMP, 1) state the same, and 2) describe
the basis of qualification and 3) effect on the summary FS. ‘would have been effect’
▪ If audited FS contain an adverse or disclaimer of opinion, 1) state the same, and 2) describe
the basis thereof and 3) state that as a result thereof, it is inappropriate to express an
opinion on summary FS.
▪ If audited FS carries a restriction on distribution, etc or because of Special purpose
framework, include the same in Summary FS.
▪ In case of supplementary information, ask management to differentiate the same with the
audited, just in case, and on refusal, explain in auditors’ report that it is not covered in our
opinion or form part thereof.
▪ Read Para 8 of ISA 810 for nature of procedures performed.

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REVIEW STANDARDS

5.16 ISRE 2400 - ENGAGEMENTS TO REVIEW FINANCIAL

STATEMENTS

A&C – Acceptance and Continuance

• Practitioner is not auditor of the entity’s FS.

• Practitioner obtaining limited assurance.
• Practitioner performs primarily inquiries and analytical procedures.
• Practitioner becomes aware of material misstatements in FS, then he performs additional
procedures.

Analytical Procedures (AP)

Evaluation of financial information them analysis of plausible relationship among both financial and
non-financial data.

Engagement risk

Practitioner expresses an inappropriate conclusion when FS are materially misstated.

Inquiry

Seeking information of knowledgeable persons from within / outside the entity.

Limited Assurance

Engagement risk is reduced to an acceptable level, atleast sufficient for the practitioner to obtain a
meaningful level of assurance.

Factors affecting A&C

Unless required by law / regulation shall not accept a review engagement if:

i. Practitioner is not satisfied with:

• Rational purpose of engagement;

• Review engagement would be appropriate in the circumstances;

ii. Practitioner believes ethical requirement will not be satisfied;

iii. Preliminary understanding indicates information required to perform review would be

unavailable / unreliable;

iv. Practitioner doubts management’s integrity;

v. Management / TCWG would impose a limitation on scope of work.

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Pre-conditions for A&C

• Determining FRF applied for preparation of FS is acceptable;

• Management agrees and acknowledges its responsibilities:

i. For preparation of FS;

ii. For establishing system of IC;

• Practitioner will be provided with:

i. Access to all information;

ii. Additional information practitioner may request; and
iii. Unrestricted access to persons within the entity.

Terms of Engagement letter (EL):

i. Intended use and distribution of FS;

ii. AFRF;
iii. Scope of review Engagement;
iv. Responsibilities of practitioner;
v. Responsibilities of Management;
vi. Statement that Engagement is not an Audit;
vii. Expected from and content of report.

Understanding of the entity and its environment:

a. Relevant industry, regulatory and other external factors;

b. Nature of the entity:

• Its operations;
• Ownership and governance stenature;
• Entity’s objectives and strategies;

c. Entity’s A/C system and A/C records; and

d. Entity’s selection and application of A/C policies.

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Procedures:

1. Inquiries
• How management makes significant A/C estimates;
• Identification f RP and RP transactions;
• Significant, unusual / complex transactions, events / matters that have affected / may affect
entity’s FS;
• Significant transaction near the end of reporting period;
• Status of any uncorrected M/S;
• Existence of any actual, suspected / alleged fraud;
• Non-compliances with laws and regulations;
• Basis for management’s assessment of entity’s ability to continue as going concern;
• Events / conditions that may cast doubt on entity’s ability to continue as going concern;
• Whether management has identified / addressed events occurring between date of FS and
date of practitioner’s report;
• Material commitments, contractual obligations / contingencies.

2. Analytical Procedures: Examples of AP include

• Comparing interim financial information with financial formation of immediately preceding
interim period / corresponding interim period of the preceding FY;
• Comparing current FI with Budgets;
• Comparing with same industry;
• Comparing relationships among elements e.g.; expenses by type as a % of sales, assets by
type as a % of total assets, % of change in sales to % of change in R/A;
• Comparing disaggregated data:
• by period;
• by product line / source of revenue;
• by location;

• By attributes of the transaction, e.g. sales through retail outlets and factory outlets.

3. Related Parties
Practitioner shall remain alert during review for information that may indicate existence of RP
relationships; if practitioner identifies any significant transactions outside the entity’s normal
course of business, inquire management about:

• Nature of transactions;
• Whether RP could be involved; and
• The business rationale of those transactions.

4. Fraud and non-compliance with laws / regulations

Indication that fraud / non-compliance may have occurred, the practitioner shall:
• Communicate to appropriate level of senior management / TCWG;
• Request management’s assessment of its effect on FS;
• Consider its effects on practitioner’s report; and
• Responsibility to report to a party outside the entity.

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5. Going Concern

If during the review, practitioner become aware of events / conditions that may cast significant
doubts about entity’s ability to continue as GC the practitioner shall:
• Inquire of management about plans for future actions;
• Evaluate the results of those inquiries.

Subsequent events:
Practitioner has no obligation after the date of practitioner’s report. If after the date of PR, but
before the date FS are issued, facts because known to practitioner that, had it been known to the
practitioner at the date of the practitioner’s report, may have caused the practitioner to amend the
report, practitioner shall:

Discuss the matter with management / CWG

FS need amendment

Management agrees to amendment Management does not

agree to amendment
and FS issued
Inquire management how it intends
to address the matter in FS
Seek legal advice
to prevent reliance
Management Representations:

i. Management has fulfilled its responsibility for preparation of FS;

ii. All transactions have been recorded and reflected in FS;
iii. Management has disclosed to practitioner:

• All RP relationships and transactions;

• Any fraud / suspected fraud;
• Known actual / possible non-compliance of L&R;
• All information relevant to going concern assumptions;
• All event subsequent to the date of FS;
• Material commitments, contractual obligations / contingencies;
• Material non-monetary transactions / transactions for no consideration.

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Management does not provide on / more requested representation.

Discuss with the TCG

Re-evaluate integrity of management

Withdraw from engagement Disclaim

(if possible) conclusion

Reporting:

1. If FS are materially misstated – qualified / adverse conclusion.

2. Inability to obtain SAAE – Qualified / disclaim a conclusion.
3. Limitation on the scope imposed by management.
Withdraw from engagement
4. EOMP: necessary to draw user’s attention and matter already disclosed in FS.
5. OMP: necessary to communicate a matter other than those disclosed in FS.

5.17 ISRE – 2410 REVIEW OF INTERIM FINANCIAL INFORMATION

• Review of interim FI by the independent auditor of FS of the entity;

• Review is not designed to obtain reasonable assurance.

Undertaking the entity and its environment:

• Reading the documentation, of preceding year’s audit and review of prior interim period;
• Considering any significant period;
• Reading most recent annual / comparable prior period FI;
• Considering materiality;
• Considering result of corrected MM and identified uncorrected immaterial M/S in prior year’s
FS;
• Considering result of internal audit;
• Inquiring management of any significant charges in IC;
• Reading minutes of meeting of shareholders.

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Procedures:

1. Inquiries: (Same as ISRE – 2400)

2. Analytical Procedures: (Same as ISRE – 2400)

3. Going Concern: (Same as ISRE – 2400)

4. Subsequent Events: (Same as ISRE – 2400)

For Convenience and efficiency, the auditor may decide to performance certain audit procedures
concurrently with the review. E.g: performing audit procedures on significant revenue transactions,
business combinations, destructing’s.

Management Representations (Same as ISRE – 2400 EXCEPT THE Consequences if management does
not provide any representation)

Auditor’s Responsibility for Other Information

• The auditor should read the other information to consider whether any such information is
materially with FI.

• Material inconsistency

Management refuses to amend

Include an additional para in Withhold the issuance of With draw from

review report describing review report. engagement.
material inconsistency.

• Material Misstatement
Management refuses to amend – Notify TCWG and Seek legal advice.

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Communication:

Any matter comes to auditor’s attention that causer auditor to believe that it is necessary to make
a material adjustment – communicate the matter as soon as practicable to management.

Management does not

respond appropriately
within reasonable time.

Inform TCWG

TCWG does not respond

within reasonable time.

Consider:
• Modifying Report;
• Possibility of
withdrawal; and
• Possibility of resigning
from the appointment
to audit Annual FS.

Reporting:

1. Material adjustment should be made to interim financial information – Qualified / Adverse.

2. Limitation on scope by management:

- before acceptance – don’t accept engagement;
- after acceptance – communicate to TCWG;
- Consider legal and regulatory responsibilities;
- Disclaim a conclusion and provide the reason why the review can’t be completed.

3. Other limitation on scope due to circumstances:

- Qualified / Disclaim a conclusion.

4. EOMP (Same as ISRE – 2400)

5. OMP (Same as ISRE – 2400)

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RELATED SERVICES
5.18 ISRS – 4400 ENGAGEMENTS TO PERFORM AGREED-UPON
PROCEDURES REGARDING

Agreed upon Procedures: is an engagement where the auditor and the specified users (i.e. client /
other third party users) agree to carry out procedures of an audit nature and factual finding
reported thereon.

- e.g: examination for proposed acquisition.

- No assurance is expressed; users of the report assess for themselves the procedures and
findings reported by the auditor and draw their own conclusions from the auditor’s work.
- Report is restricted to those parties who have agreed to the procedures.

Procedure and Evidence:

• Inquiry and analysis;
• Re-computation, comparison;
• Observation;
• Inspection;
• Obtaining confirmations.

Reporting:

Factual findings report is issued for agreed upon procedures. Please refer appendix 2 of ISRS 4400
for report format.

5.19 ISRS – 4410 ENGAGEMENTS TO COMPILE FINANCIAL

INFORMATION

Compilation Engagement: engagement in which a practitioner applies A/C and financial reporting
expertise to assist management in the preparation and presentation of FI.

• Compilation engagement is not an assurance engagement.

• Management retains responsibility for FI and basis on which it is prepared and presented.

Terms of Engagement: Practitioner shall agree with management, on:

• Intended use and distribution of FI;
• AFRF;
• Scope of compilation Engagement;
• Statement that Engagement is not an Audit;
• Form and content of Report.

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Compiling the Financial information:

• Compile FI using the records, documents, explanation and other information provided by
management;
• Discuss significant judgements with management and TCWG;
• Prior to completion of Engagement, practitioner shall read compiled FI in the light of
practitioner’s understanding of entity and AFRF.

Practitioner becomes aware records, docs, explanations are incomplete, in accurate /

unsatisfactory.

Request management for complete and accurate information.

Management fails to provide satisfactory information.

Withdraw from Engagement and inform TCWG.

Practitioner becomes aware FI does not adequately refer to AFRF / FI maternally misstated /
information is misleading;

Propose appropriate amendments to management;

If Management declines / does not permit practitioner to amend FI

Withdrawal possible

Yes No

Withdraw from engagement Seek Legal Advice

inform TCWG

• Practitioner shall obtain acknowledgment from management that they have taken
responsibility for the final version

Documentation include

• Significant matters arising during engagement;

• Reconciliation of FI with undertaking records;
• Final version of compiled financial information.

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Reporting

• Practitioner’s report is not a vehicle to express an opinion / conclusion on FI in any form.

• Practitioner should clearly communicate the nature of engagement and practitioner’s role and
responsibilities in Engagement.
• Explanation that compilation Engagement is not an assurance Engagement.

Please refer appendix 2 of ISRS 4410 for report format.

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ASSURANCE ENGAGEMENTS OTHER THAN AUDITS OR

REVIEWS OF HISTORICAL FINANCIAL INFORMATION

5.20 ISAE – 3000 ASSURANCE ENGAGEMENTS

Attestation Engagement:

Party other than the practitioner measures / evaluates the underlying subject matter against the
criteria. Practitioner’s conclusion addresses whether SMI is from MM.

Direct Engagement:
Practitioner measures / evaluates the underlying subject matter against the applicable criteria and
the practitioner presents assurance report on resulting SMI.
Criteria - benchmarks used for evaluation.

Pre-conditions for Assurance Engagement:

• Underlying subject matter is appropriate;

• Criteria that the practitioner expects to be applied are suitable, with following characteristics.
- Relevance;
- Completeness;
- Reliability;
- Neutrality;
- Understandability.

Understanding the Subject Matter:

Practitioner shall make inquiries regarding

• Any actual, suspected / alleged intentional M/S or non – compliance with laws and Regulations;
• Party responsible for internal audit;
• Any expect used in preparing SMI;

Obtaining Evidence:
Practitioner chooses a combination of procedures, depending on the context
• Inspection;
• Recalculation;
• Inquiry;
• Observation;
• Re-performance;
• Confirmation; and
• Analytical procedures.

Reporting:
1. Qualified conclusion / Adverse.
SMI does not present fairly in all maternal respect;

• Qualified / Disclaimer of conclusion:

Limitation on scope unable to obtain SAAE on SMI.

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Form of conclusions:

• Limited Assurance: “in our opinion, the entity has complies, in all material respects, with x 42
Law”.
• Reasonable Assurance: “Based on the procedures performed and evidence obtained, nothing
has come to our attention that causes us to believe …………..”.
• Compliance Engagement: “in compliance with”.

Examples of Assurance Engagement other than Audit or Review of FI

1. Sustainability;
2. Compliance with Law / regulation;
3. Value for Money.

5.21 ISAE – 3400 THE EXAMINATION OF PROSPECTIVE FINANCIAL

INFORMATION
Prospective financial information (PFI): information based on assumptions about events that may
occur in the future and possible action by an entity.
- Highly subjective and
- Requires considerable judgment.

Forecast Projections
• prepared on realistic assumptions about • Prepared on hypothetical assumptions
future events. about future events.
• Management actions expected to take • Management not necessarily expected
place. to take place.
• Best estimate assumptions. • A mixture of – estimate and
hypothetical assumptions.

- PFI can include FS / any elements of FS and may be prepared:

• As an internal management tool, to assist in evaluating decision;
• For distribution to 3rd parties:
- Prospectus, with information about future expectations;
- Docs for information of lender, e.g. cash flow forecasts.

Primary Responsibility of PFI

• Management is responsible for preparation and presentation of PFI.

Responsibility of Auditor

• Auditor may be asked to examine and report on the PFI to enhance it credibility whether it is
intended for use by 3rd parties / for internal purpose.

• Since its generally future oriented and speculative in nature, auditor is not in a position to
express an opinion as to the achievement of its results.

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Acceptance of engagement:

Before acceptance, auditor would consider:

i. Intended use of information;

ii. Information will be for general / limited distribution;
iii. Nature of assumption, whether best estimate hypothetical;
iv. Elements to be included in information;
v. Period covered by information.

Auditor should not Accept or Withdraw from engagement when the assumptions are unrealistic /
when auditor believes PFI would be inappropriate for its intended use.

Knowledge of business: auditor should sufficient knowledge of business to evaluate significant

assumptions:

• Internal controls over the system used to prepare PFO;

• Nature of documentation supporting management’s assumptions;
• Extent to which statistical, mathematical and computer assisted techniques are used;
• Methods used to develop and apply assumptions;
• Accuracy of PFI prepared in prior periods and reasons for significant variances.

Procedures:
* determining nature, timing and extent of examination procedures, auditor should consider:
• Likelihood of MM;
• Knowledge obtained during previous engagement;
• Management’s competence for preparation of PFI;
• Adequacy and reliability of underlying data.

* when hypothetical assumptions are used, all significant implications of such assumptions have
been considered. (sales assumed to grow beyond current production capacity them necessary
to include investment in additional plant).

* Evidence supporting hypothetical assumptions need not be obtained. Auditor only need to
satisfy that there are no reasons to believe they ae unrealistic.

* Make clerical checks like recompilation;

* Focus on areas sensitive to variation that will have material effects on results of PFI;

* when any period has elapsed that is included in PFI, auditor would consider extent to which
procedures need to be applied.

* obtain written Rep.

* For projections obtain (if available)

• Correspondences with Lender and PFI;
• Quotations;
• Board minutes;
• Possible agreements.

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Reporting

1. Presentation and disclosure is not adequate – Qualified / Adverse opinion / withdraw;

2. Significant assumptions do not provide reasonable basis for best – estimate hypothetical
assumption: Adverse opinion / with draw;

3. One / more necessary procedure precluded due to circumstances – Disclaim the opinion and
describe scope limitation / withdraw.

Since format is not given in standard, please refer Report 1.4 CSR Assurance Report in
Section 1 in ICAP’s document ‘Compilation of different audit reports’

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5.22 ISAE – 3402 ASSURANCE REPORTS ON CONTROLS AT A SERVICE

ORGANIZATION

Type1 report: (same as ISA-402)

Type1 report: (same as ISA-40)

Carve-Out Method Inclusive Method

• Description of service org system includes • Description of service org system includes
the nature of services provided by sub- the nature of services provided by sub-
service org. service org.
• Sub-service organization’s control • Sub-service organization’s control
objectives and controls are excluded from objectives and controls are included in the
scope of the service Auditor’s Engagement. scope of the service Auditor’s Engagement.

Control objectives relate to risks that controls seek to mitigate.

Acceptance and contrivance

• Determine whether:
* service auditor has competence and capabilities to perform the engagement;
* criteria applied by service organization to prepare the description of its system are suitable;
* scope of the engagement will not be limited;

• Responsibilities of service organization;

• Provide service auditor with:

* access to all information;
* additional info that the service auditor may request;
* unrestricted access to persons within service organization.

So (Service Organization)

Service organization

Suitability of the criteria: Service auditor shall determine, at a minimum: (Description of system)

• Whether description presents how the service organization’s system was designed and
implemented;

• Type of services provide;

• Procedures, within both information technology and manual system, by which services are
provided;

• Related records and supporting information;

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Service auditor shall determine, at a minimum (Design of system):

• Service organization has identified the risks that threaten achievement of the control objectives
stated in description of its system;

• Control identified, if operated as desired provide reasonable assurance that those risks do not
prevent stated control objectives.

- Service auditor shall determine (operating effectiveness of controls)

• Whether the controls were consistently applied as designed throughout the specified period.

Obtaining Evidence

1. Description of System:

• SA should obtain and read the SO’s description of its system;

• Evaluate:

- Control objectives stated SO’s description are reasonable in the circumstances;

- Control identifies in the SO’s description were implemented;
- Services Performed by subservice organization are adequately described.

2. Design of Controls: Assess control were suitably designed by:

• Identify the risks that threaten the achievement of control objectives;

• Evaluating the linkage of control with identified risks.

3. Operating Effectiveness of Controls (Type 2 Report) designing and performing TOCs, the SA
shall:

• Perform procedures alongwith inquiry to obtain evidence about:

i. How control were applied;

ii. Consistency with which controls were applied; and
iii. By whom and by what means controls were applied.

• Determine whether control testing depend upon other controls (indirect controls) and
necessity to obtain evidence on operating effectiveness of indirect controls.

• Determine means of selecting items for testing are effective.

Sampling:
When SA uses sampling, the SA shall:
a. Consider purpose of procedure and characteristics of population;
b. Determine sample size sufficient to reduce sampling risk to an acceptably low level;
c. Select items for sample in such a way that each sampling unit has a chance of selection;
d. If designed procedure is N/A to a selected item, perform the procedure on replacement item;
e. If unable to apply procedure / suitable alternative, treat that item as deviation.
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Nature and Cause of Deviations:

• Identified deviations are within the expected rate of deviation;

• Additional TOCS to reach at conclusion whether controls operating effectively throughout
specified period;
• SA considers deviation discovered in a sample to be an anomaly and no other controls have
been affected, the SA should obtain a high degree of certainty that such deviation is not
representative of the population.

Reporting:

1. Qualified / Adverse opinion:

- SO’s descript does not fairly present, in all material respects, the system as designed and
implemented;

- Control related to control objectives stated in the description tested did not operate
effectively.

2. Qualified / Disclaimer of opinion:

- SA in unable to obtain SAAE.

• Because of scope limitation, it is in appropriate to identify the procedures that were

performed to do so might overshadow the disclaimer of opinion.

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5.23 ISAE – 3420 COMPILATION OF PRO FORMA FINANCIAL

INFORMATION INCLUDED IN PROSPECTUS

Pro-forma Adjustments – in relation to unadjusted FI, these include:

• Adjustments to unadjusted FI that shows the impact of a significant event / transaction AS IF

the event had occurred / transaction had been undertaken at an earlier date.

Pro-forma FI:

FI that shows pro forma adjustments presented in columnar format consisting of:

• Unadjusted FI;
• Pro-forma adjustments; and
• Resulting pro-forma column.

Determining the Suitability of Applicable Criteria:

Practitioner shall determine at a minimum:

• Unadjusted FI to be extracted from appropriate source;

• Proforma adjustments be:

* directly attributable to the event / transaction;

* factually supportable; and
* consistent with the entity’s AFRF.

• Appropriate disclosures ae provided to enable the intended users understand the information
correctly.

Understanding How Proforma FI has been compiled:

• Events / transactions in respect of which proforma FI is being compiled;

• How responsible party has compiled proforma FI (PFI);
• Nature of the entity; including:

- Its operations;
- Its assets and liabilities;
- Its structure and how its financed.

• Relevant industry, legal and regulatory framework;

• AFRF.

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Appropriateness of source from which unadjusted FI has been extracted.

Audit / Review carried out Audit / Review not carried Audit / Review lever carried
out out

Be satisfied that the source • Whether practitioner Unlikely that law and regulation
from which information has previously Audited / will permit entity to issue
has been extracted is reviewed the FI; prospectus.
appropriate, is not • How recently entity’s FI
diminished was audited;
• Whether entity is
subject to periodic
review.

Evidence regarding appropriateness of proforma Adjustment:

Practitioner shall determines.

• Directly attributable to event / transaction;

• Factually supportable; and
• Consistent with entity’s AFRF.

Reporting:

1. Unmodified opinion: Proforma FI has been complied, in all material respect, by responsible
party.

2. Modified opinion: Relevant law and regulation precludes publication of prospectus that contain
a modified opinion. The practitioner shall discuss the matter with responsible party. If
responsible party does not agree, practitioner shall:

• Withhold the report;

• With from Engagement;
• Seek legal advice.

3. EOMP: (Same as ISRE-2400)

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5.24 SUMMARY CHART OF ENGAGEMENTS

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OTHER STANDARDS CONTAINING SPECIFIC REQUIREMENTS

5.25 ISA 210 – AGREEING ON TERMS OF ENGAGEMENT

Introduction:
This ISA deals with the agreement of terms of engagement before accepting / continuing an Audit,
through:
- establishing that pre-conditions for Audit are present;
- confirming that there is a common understanding between auditor and management on terms
of engagement.

Preconditions of audit:
- Whether AFRF is acceptable.
- Agreement of management and TCWG on premise for Audit (acknowledging responsibilities)

Content of Engagement Letter (EL):

EL shall include:

i. Objective and scope of audit of FS;

ii. Responsibilities of the auditor;
iii. Responsibilities of management;
iv. Identification of AFRF for preparation of FS; and
v. Expected form and content of report to be issued.

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Engagement Letter

First year audit Recurring Audit

Send - Assess that circumstances

require revision.
- Determine if there is need to remind
management of the existing terms.

Yes No
Send Revise EL
Don’t Send

Change Request by Management to an engagement with lower assurance level

Reasonable Justification?
No

Permitted by management to carryout Original Audit

Yes No

Continue - Withdraw from engagement

with audit - Report to TCWG and Regulators

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5.26 ISA 220 QUALITY CONTROL FOR AN AUDIT OF FS

Introduction:
The firm has an obligation to establish and maintain a system of quality control to provide it with
reasonable assurance.
Objective:
To implement QC procedures to provide auditor with reasonable assurance that:
i. audit complies with professional standards and applicable legal and regulatory requirements;
and
ii. auditors’ report issued is appropriate in the circumstances.

Leadership:
Engagement partner takes the responsibility for overall quality an each audit engagement.
- Throughout the engagement, engagement partner shall remain alert for evidences of non-
compliance by engagement team.

Assignment of Engagement Team:

Collectively have appropriate competence and capabilities to:
• perform audit engagement:
• enable auditors report to be appropriate.

Engagement Quality Control Reviewer:

For listed entities and other engagement, if any, the engagement partner shall.
i. determine quality control reviewer, (QCR);
ii. discuss significant matter during audit with QCR; and
iii. wait till completion of Quality Control Review before dating AR.

Responsibilities of Quality Control Reviewer:

i. discussion of significant matters;
ii. review of FS and proposed Audit report;
iii. review of selected audit documentation relating significant judgements and evaluation of
conclusions reached.
iv. evaluating engagement team’s independence;
v. ensuring appropriate consultation has taken place on matters involving differences of opinion
/ contentions matters and the conclusions arising from those consultations; and
vi. ensuring Audit documentation reflects the work performed in relation to significant
judgments and supports the conclusion.

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5.27 ISA 230 AUDIT DOCUMENTATION

Audit Documentation (AD):

- Record of Audit procedures performed;
- Relevant Audit Evidence obtained; and
- Conclusions the Auditor reached.

Audit Documentation Provides:

• Evidence of the auditor’s basis for a conclusion;
• Evidence that the audit was planned and performed in accordance with the regulatory
requirement.

AD should be sufficient to enable an experienced auditor, having to previous connection with Audit
to understand:
i. Nature, timing and extent of audit procedures performed along with
• the characteristics of specific items / matters tested;
• who performed the audit work and date of its completion;
• who reviewed the audit work and date of review;
ii. Results of AP performed and audit evidence obtained.
iii. Significant matters and conclusion reached and significant judgments made.
iv. If auditor identified information that is inconsistent with auditor’s final conclusion, the auditor
shall document how the inconsistency was addressed.

Matters arising after the date of Auditor’s Report:

- In exceptional circumstance, the auditor performs new / additional procedures / draws new
conclusions after the date of auditor’s report, the auditor shall document;
- Circumstances encountered;
- New / additional procedures performed / audit evidence obtained and conclusions reached;
- When and by when changes were made and reviewed.
- Appropriate time limit to complete the final audit file is not more than 60 days after the date of
auditor’s report;
- Only administrative changes to final audit file allowed after date of auditor’s report:
• Deleting / discarding superseded documentation;
• Sorting, collating and cross-referencing working papers;
• Signing off on completion checklist;
• Documenting audit evidence obtained prior to the date of audit report.
- Retention period for audit engagements is no shorter than 5 years from the date of audit report.

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5.28 ISA 250 CONSIDERATION OF LAWS AND REGULATIONS IN

AUDIT OF FS

Non-Compliance:
Refers to the acts of omission / commission by the entity, either intentional / unintentional and are
contrary to prevailing Laws / Regulation.
- It does not include personal misconduct of entity’s management / employees.

Responsibility for compliance:

It is the responsibility of the management to ensure compliance with laws and regulations
applicable to it and prevent and detect non-compliances.
Responsibility of Auditor:
Although audit may act as a deterrent the auditor is not responsible for preventing non-compliance
with laws and regulations.

ISA distinguishes auditor’s responsibilities in relation to compliance with two different categories of
L&R:
1. Laws and Regulation having direct effect on material amounts and disclosures in FS;
2. L&R having no direct effect on FS, but compliance with which is fundamental to the operating
aspects.

Audit Procedures to ensure compliance:

i. Obtain general understanding of legal and regulatory framework applicable to the entity;
ii. Inquire of material effect on FS;
iii. Inspect correspondence with relevant licensing / Regulatory authorities;
iv. Obtain evidence about compliance with L&R which affect the determination of material
amounts and disclosures in FS.

Audit Procedures to identify non-compliance:

i. Read minutes of board meetings;
ii. Inquire with management and legal advisor about litigations, claims and assessments;
iii. Obtain written representation from management;
iv. Perform test of details of transactions / balances.

Procedures when non-compliance is discovered:

i. Evaluate possible effect on FS (fines, penalties etc. and its impact on truth and fairness of FS;
ii. Discuss the findings with DCWG where they may be able to provide additional Audit Evidence;
iii. Consult in house legal counsel / external legal counsel to determine contravention of L&R.
iv. Consider implications for the Audit, in particular reconsider risk assessment and reliability of
Management Representations.

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Reporting non-compliances:
i. To Management:

Non-compliance covers to the notice of the auditor, he should communicate it to BOD, AC /

Management. If senior management is also involved in non-compliance then to the next higher
level of Authority, such authority doesn’t exist seek legal Advice.

ii. To Users:

• Non-compliance has a material effect on FS, but FS don’t reflect it adequately – Qualified /
Adverse.
• Unable to obtain SAAE to assess materiality of non-compliance – Qualified / Disclaimer of
Opinion.
• Instances where non-compliance have occurred because of limitations imposed by
circumstances rather than by Management / TCWG – evaluate effect on Audit Report (ISA –
705).

iii. To Regulatory and Enforcement Authorities:

• Auditor has a professional duty to maintain confidentiality, which may be overridden by Law /
Statute.
• Obtain legal advice and determine Duty to Report.

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SKETCH OF ISA 250

Obtain general understanding of L& R framework applicable to the entity

Perform audit procedures to ensure entity’s compliance with L&R having

material effect on FS
• inquire with management;
• inspect correspondence with licensing / Regulatory authorities;
• obtain SAAE about compliance.

Identify non-compliance through performing audit procedures.

• Reading minutes of board meetings;
• Inquiring with Management and Legal counsel;
• Performing substantive testing;
• Obtaining Management Representations.

Non-compliance discovered No

Yes

Communicate to users. • Communicate non-

compliance to
- Non-compliance has material • Communicate to
Management / TCWG /
effect on FS and not reflected Regulatory and
AC or higher level of
adequately and Qualified / Enforcement Agency
Authority.
Adverse. and
and
- Unable to obtain SAAE to
• Seek Legal Advice. • Seek Legal Advice on
assess materiality of non-
confidentiality and
compliance – Qualified /
duty to report.
Disclaimer of Opinion.
- Non-compliance because of
limitations caused by
circumstances – consider ISA-
705.

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5.29 ISA 260 - COMMUNICATION WITH THOSE CHARGED WITH

GOVERNANCE

Those charged with Governance (TCWG):

Person(s) with responsibility for overseeing the strategic direction of the entity and obligations
related to the accountability of the entity.

Management:
Person(s) with executive responsibility for the conduct of entity’s operations.

Identification of TCWG:
Factors to be considered for such identification:
a. Governance structure of the entity;
b. Circumstances of the engagement;
c. Legal requirements;
d. Importance and relevance of the significant matter of governance interest.

Matters to be communicated:
• Planned scope and timing of Audit;
• Adoption / changes in significant A/C policies;
• Significant finding from Audit;
• Significant qualitative aspects of Accounting practices;
• Significant difficulties encountered during Audit;
• Significant matters discussed with management;
• Form and content of Audit Report
• Auditor’s independence.

Communication Process:
• Form of communication: Shall be in writing, oral communication would not be adequate.
• Timings: Timely communication throughout the audit contributes to the achievement of robust
two-way dialogue between TCWG and Auditor.
• Adequacy: Auditor should evaluate whether two-way communication between the Auditor and
TCWG is adequate. If not, then Auditor shall take appropriate action.
• Process for taking action and reporting back on matters communicated by the auditor and vice
versa.

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5.30 ISA 265 - COMMUNICATING DEFICIENCIES IN INTERNAL

CONTROL TO TCWG

Deficiency in Internal Control; exists when:

• Control is designed and implemented in such a way that it is unable to prevent, detect / correct
M/S in FS on timely basis; or
• Control necessary to prevent, detect / correct, on M/S in FS on timely basis is missing.

Significant Deficiency in Internal Control:

Deficiency in internal control that in auditor’s professional judgment, is of sufficient importance to
merit the attention of TCWG.
Significant of deficiency Depend not only on whether a M/S has actually occurred, but also on the
likelihood that a misstatement could occur and the potential magnitude of the M/S Examples:
• Transaction with related party are not approved;
• No bank reconciliations prepared;
• Management does not oversee the preparation of FS.

Certain identified significant deficiencies in intend control may call into question the integrity /
competence of management. Accordingly, it may not be appropriate to communicate such
deficiency directly to management.

For Significant Deficiency:

Communicate it to TCWG and Management, unless inappropriate.

For Other Deficiencies in Internal Controls:

May be of sufficient importance to management’s attentions. Need not be in writing, may be
communicated orally.

Contents of Management Letter:

1. Description of the deficiency and explanation of possible effect;
2. Suggestions for remedial actions / recommendation;
3. Management’s Response; and
4. Statement as to whether any steps have been taken to verify the implementation of
Management Response.

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5.31 ISA 402 - AUDIT CONSIDERATIONS RELATING TO AN ENTITY

USING A SERVICE

Introduction:

To prescribe standards for an auditor whose client uses a service organization:

Type 1 Report:
Report on the description sand design of controls at a service organization.
• Service auditor provides reasonable assurance on the description of service organization’s
system and suitability of the design of controls.

Type 2 Report:
Report on the description, design and operating effectiveness of controls at a service organization.
• Service auditor provides reasonable assurance on description, control objectives and suitability
of design of control and its operating effectiveness.
• A description of TOC’s performed and its results.

Understanding the effects of IC at Service Organization on Auditor’s Risk Assessment:

• Understanding how a service organization affects the client’s A/C and IC.
• Assessing the relevance of service organization’s activities to the audit and significance of
activities.
• The material FS assertions that are affected by the use of service organization and inherent risk
associated with those assertions.
• Extent to which client’s A/C and IC system interact with the system at the service organization
and client’s IC that are applied to the transactions processed by the service organization.
• Effect of failure of service organization on client.
• Information contained in 3rd party reports about the A/C and IC system of the service
organization.

Procedures when Auditor is unable to obtain SAAE on controls at Service Organization:

• Obtaining type 1 / type 2 report;
• Contacting service organization, to obtain specific information;
• Visiting the service organization and performing procedures;
• Using another auditor to perform procedures to provide the necessary info about controls.

Determining sufficiency and appropriateness of Report: Auditor shall be satisfied as to:

• Service auditor’s professional competence and independence;
• Adequacy of standards under which report was issued (type 1 and type 2).

Reporting:
• Auditor shall modify opinion of he is unable to obtain SAAE regarding service provided by
service organization relevant to audit.
• Unmodified report issued – auditor shall not include reference of service auditor.
• Modified report – reference only to the extent of understanding modification and such
reference shall not diminish the uses auditor’s responsibility for that opinion.

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5.32 ISA 500 – AUDIT EVIDENCE

Obtain sufficient appropriate Audit Evidence

Test of Controls Substantive procedures

Evaluate evidence for sufficiency and appropriateness by keeping in mind

factors such as:

• Degree of risk of misstatements;

• Materiality of item;
• Experience gained through previous audit;
• Results of audit procedures;
• Type of information available;
• Trend indicated by A/C rations and analysis.

Reasonable basis for forming opinion i.e. in case of TOC assures completeness,
accuracy, validity, restricted access and incase of substantive procedures
assures existence, rights and obligations, occurrence, completeness, valuation,
accuracy, presentation and disclosure.

No Yes

Issue Qualified, Adverse / Issue Unqualified

Disclaimer of Opinion Opinion

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Reliability of Audit Evidence

More reliable Examples

• External evidence obtained by Auditor Confirmations

• External evidence held by the client Supplier’s invoices,
bank statements
• Internally generated written evidence,
if any controls are operating effectively Sales invoices, GDN
• Oral Evidence Management Explanations

Least Reliable

5.33 ISA 505 - EXTERNAL CONFIRMATIONS

Necessity:
i. Determine whether the use of external confirmations is necessary to obtain sufficient
appropriate audit evidence.
ii. Auditor should employ external confirmation procedures in consultation with Management.

Considerations before sending Confirmations:

a. Materiality;
b. Assessed level of misstatement and control risk;
c. Impact of evidence from other planned audit procedures in reducing audit risk to acceptably
low level.

Relationship of Confirmations to auditor’s assessment of inherent risk and control risk:

a. If confirmation reduces the inherent risk and control risk to low level then reduce the extent of
substantive testing and vice versa.
b. For unusual / complex transactions confirm the terms of transactions with other parties as
inherent and control risk are high for them.

Design:
• Positive confirmation request: request that confirming party respond directly to the auditor
indicating whether the confirming party agrees / disagree with the info in the request /
providing the info.
• Negative confirmation: request that confirming party respond directly to the auditor only if he
disagrees with the info.

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Characteristics of Respondent:
Confirmation request should be directed to an appropriate individual which implies the respondent
should have requisite:
i. Competence;
ii. Independence;
iii. Objectivity;
iv. Authority to
v. Knowledge of matter being confirmed;
vi. Ability and willingness to respond;
vii. Motivation and economic independence from entity.

Reliability of Responses:
Factors that may indicate doubts about the reliability of a responses include:
• it was received by auditor indirectly;
• appeared not to come from the originally intended confirming party;
• responses received electronically
• respondent may not be authorized to respond;
• integrity of the transmission may have been compromised.

Non-Response:
For each non-response, perform alternate audit procedures, example:
• For A/C R/A Balances: examining subsequent cash receipts, shipping documents and sales near
the period end.
• For A/C P/A Balances: examining subsequent cash disbursements, correspondences from third
parties and goods received notes.

Management Request for not confirming:

• Consider whether there are valid grounds for accepting such request.
• Management should specify the reason, and auditor should document it.
• If grounds are reasonably justified – apply alternative procedures.
• Management refusal request is unreasonable / auditor is unable to obtain relevant and reliable
audit evidence from alternate audit procedures, auditor shall communicate it to TCWG and
shall determine implications on Audit report.

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5.34 ISA 520 - Analytical Procedures

Introduction
Analytical procedures can be used at three stages of the audit.
• Planning
• Substantive procedures
• Overall review
Analytical procedures consist of comparing items, for example current year financial information with prior year
financial information, and analysing predictable relationships, for example the relationship between receivables
and credit sales.

Use of Analytical Procedures Generally

There are a number of occasions and assignments when an auditor will look to take an analytical procedures
approach. One has already been mentioned in this chapter. When auditors use the business risk approach they
seek to use a high level of analytical procedures. Other examples include:
• Reviews
• Assurance engagements
• Prospective financial information
There are a number of factors which the auditors should consider when deciding whether to use analytical
procedures as substantive procedures.
Factors to consider Example
The plausibility and predictability of the The strong relationship between certain selling expenses and
relationships identified for comparison and revenue in businesses where the sales force is paid by commission
evaluation
The objectives of the analytical procedures
and the extent to which their results are
reliable
The detail to which information can be Analytical procedures may be more effective when applied to
analysed financial information or individual sections of an operation, such as
individual factories or shops.
The availability of information Financial: budgets or forecasts
Non-financial: e.g. the number of units produced or sold
The relevance of the information available Whether the budgets are established as results to be expected rather
than as tough targets (which may well not be achieved)
The comparability of the information Comparisons with average performance in an industry may be of
available little value if a large number of companies differ significantly from
the average.
The knowledge gained during previous The effectiveness of the accounting and internal controls
audits The types of problems giving rise to accounting adjustments in prior
periods

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Factors which should also be considered when determining the reliance that the auditors should place on the
results of substantive analytical procedures are:
Factors to consider Example
Other audit procedures directed towards Other procedures auditors undertake in reviewing the collectability
the same financial statements assertions of receivables, such as the review of subsequent cash receipts, may
confirm or dispel questions arising from the application of analytical
procedures to a profile of customers' accounts which lists for how
long monies have been owed.
The accuracy with which the expected Auditors normally expect greater consistency in comparing the
results of analytical procedures can be relationship of gross profit to sales from one period to another than
predicted in comparing expenditure which may or may not be made within a
period, such as research or advertising.
The frequency with which a relationship is A pattern repeated monthly as opposed to annually.
observed

The peculiarity of analytical procedures is that they aim to find out whether or not there is a relationship
between variables (eg between sales and expenses) that is plausible and reasonable. This is the opposite of
other substantive procedures, where the aim is to discover misstatements, rather than reasonability.

Practical Techniques
When carrying out analytical procedures, auditors should remember that every industry is different and each
company within an industry differs in certain aspects.
Important accounting ratios ▪ Gross profit margins, in total and by product, area and months/quarter (if
possible)
▪ Receivables ratio (average collection period)
▪ Inventory turnover ratio (inventory divided into cost of sales)
▪ Current ratio (current assets to current liabilities)
▪ Quick or acid test ratio (liquid assets to current liabilities)
▪ Gearing ratio (debt capital to equity capital)
▪ Return on capital employed (profit before tax to total assets less current
liabilities)
Related items ▪ Payables and purchases
▪ Inventory and cost of sales
▪ Non-current assets and depreciation, repairs and maintenance expense
▪ Intangible assets and amortization
▪ Loans and interest expense
▪ Investments and investment income
▪ Receivables and bad debt expense
▪ Receivables and sales

Ratios mean very little when used in isolation. They should be calculated for previous periods and for
comparable companies. The permanent file should contain a section with summarised accounts and the chosen
ratios for prior years.
In addition to looking at the more usual ratios, the auditors should consider examining other ratios that may be
relevant to the particular client's business, such as revenue per passenger mile for an airline operator client, or
fees per partner for a professional office.
Other analytical techniques include:

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(a) Examining related accounts in conjunction with each other. Often revenue and expense accounts are
related to statement of financial position accounts and comparisons should be made to ensure
relationships are reasonable.
(b) Trend analysis. Sophisticated statistical techniques can be used to compare this period with previous
periods.
(c) Reasonableness tests. These involve calculating expected value of an item and comparing it with its
actual value, for example, for straight-line depreciation.
(Cost + Additions – Disposals) x Depreciation % = Charge in statement of profit or loss and other
comprehensive income

Investigating Results
If analytical procedures produce results that are inconsistent with other relevant information or expected
values, the auditors should investigate this by making enquiries of management and performing other audit
procedures as necessary.

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5.35 ISA 530 - AUDIT SAMPLING

Introduction:
Determination of design and selection of an audit sample and evaluation of sample results.

Audit Sample is a process of applying audit procedures to less than 100% of a population to
estimate some characteristics about population.

Sampling unit are individual auditable elements, as defined by auditor, that constitute that
population.

Sampling Risk is the risk that auditor’s conclusion based on a sample may be different from the
conclusion he would reach if the same audit procedures were applied to the entire population.

Tolerable Error is maximum error (substantive procedures) to accept in the population and still
conclude that the audit objective has been achieved.

Expected Error is the deviation rate expected by the auditor on the basis of his prior experience.

Stratification involves dividing a population into homogeneous sub-populations, each of which may
be subject to a separate testing.

Sampling Plan: important elements:

1. Design of the sample:
a. Audit objective to select procedures;
b. Population relevant to the assertion;
c. Sample size.
Lower the sampling risk, the auditor is willing to accept, greater the sample size and vice
versa.

2. Selection of the sample:

a. It is drawn from the whole population;
b. All sampling units have an equal chance of being selected.

3. Evaluation of sample results:

a. Analysis of errors in the sample;
b. Projection of errors;
c. Reassessing sampling risk.

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5.36 ISA 540 - AUDITING ACCOUNTING ESTIMATES

Introduction:
Obtain SAAE about:
i. Accounting estimates are reasonable;
ii. Related disclosures are adequate.

Accounting Estimate:
An approximation of a monetary amount in the absence of a precise means of measurement.

Auditor’s point estimate:

Amount / range derived from audit evidence for use in evaluating management’s point estimate.

Estimation uncertainty:
Susceptibility of an A/C estimate to an inherent lack of precision in measurement.

Management Bias:
Lack of neutrality by management.

Management’s point estimate: The amount selected by management for recognition / disclosure in
FS as an A/C estimate.

Responsibility of Management:
Management is responsible for establishing the process for A/C estimates.

Responsibility of Auditor:
Auditor should obtain SAAE to be able to conclude:
a. Whether necessary procedures and methods have been established by management to
develop estimates.
b. Whether estimates are:
• reasonable in the circumstances; and
• are appropriately disclosed.

Responses to Assessed ROMM:

1. Auditor may review and test the process used by management to make estimate by evaluating:
• method of measurement used is appropriate;
• Assumptions used by management are reasonable.
2. Develop a point estimate / a range to evaluate management’s point estimate.
3. Test the operating effectiveness of controls over how management made A/C estimate
4. Review of subsequent events may provide the auditor with AE regarding A/C estimates.

Responses to Significant Risk: Auditor shall evaluate:

• How management has considered alternative assumptions / outcomes, and why it has rejected
them;
• Whether the significant assumptions used by management are reasonable;

Indicators of Possible Management Bias: Examples:

• Changes in A/C estimate, where management has made a subjective assessment that there has
been a change in circumstances;
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• Estimates favorable for management objectives;

• Estimate that may indicate a pattern of optimism / pessimism.

5.37 ISA 550 - RELATED PARTIES

Related Part: A party:

• defined as RP by AFRF;
• person / entity having control / influence over reporting entity;
• another entity over which reporting entity has control / influencing
• another entity that is under common control with reporting entity through:
- Common controlling ownership
- Owners who are close family members; or
- Common key management personnel.
* Entities under common control by Government are not considered as RP unless they are
engage in significant transactions / sharing significant resources.

Auditor’s Responsibility:
Auditor should obtain SAAE regarding:
• identification and adequacy of disclosures of RP; and
• identification and adequacy of disclosures of material transactions with RP.

Determining existence of RP:

• Refer to prior year’s working papers to identify RP;
• Understanding of controls over:
- identification of RP relationships and transactions;
- authorization and approval of significant transactions with RP
- authorization and approval of transactions outside normal course of business.
• Inquiries from management;
• Inquiries about affiliation of directors and key management to personnel and officers with
other entities;
• Review of register of shareholders to identify significant statement;
• Review of income tax returns and information supplied to regulatory authorities;
• Review of material investment transactions;
• Review minutes of meeting of BOD, TCWG and SH;
• Examining loan confirmations for information on guarantees given / received.
• Reports of internal audit function;
• Significant contract re-negotiated by entity;
• Correspondence from entity’s professional advisors;
• Statement of conflicts of interest from Management and TCWG;
• Significant contracts not in the ordinary course of business;

Identifying previously unidentified RP:

Auditor should review A/C records for large, unusual / non-recurring transactions / balances such
as:
• transaction not having normal terms of trade (e.g. borrowing at rates of interest above / below
market price);
• transactions lacking apparent logics (sale of fixed asset);
• transactions where substance differs from form;
• transactions processed in unusual manner (loan granted in absence of repayment terms);

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• transactions which have occurred but have no A/C recognition (e.g. providing free of cost
service);
• Business relationships through special purpose vehicles.
• Guarantees / guarantor relationship.

Identifying Significant transactions outside normal course of business:

• Complex equity transactions;
• Transactions with offshore entities in jurisdiction with weak corporate laws;
• Sales transactions with unusually large discounts / returns;
• Transactions with circular arrangements, e.g. sales with a commitment to repurchase;
• Transactions under contracts whose terms are changed before expiry.

Written Representation: from TCWG on:

• Specific RP transactions that:
* materially affect the FS; or
* involve management.
• Specific oral representations made by CWGG on certain RP transactions;
• RP when they have financial / other interest in transactions;
• RP transactions don’t involve undisclosed side agreements.

Communication with CWG: Auditor should communicate:

• Significant RP transactions that have not been appropriately authorized and approved, which
may give rise to suspected fraud;
• RP transactions not disclosed to auditor by management (whether intentional / not), which may
alert TCWG to significant RP relationships / transactions of which they may not have been
previously aware;
• Disagreement with management regarding A/C or disclosure of significant RP transactions in
accordance with AFRF;
• Non-compliance with applicable law / regulations prohibiting / restricting specific type of RP
transactions. Difficulties in identifying the party that ultimately controls the entity.

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5.38 ISA 580 - WRITTEN REPRESENTATIONS

The management, through representation, should accept its responsibility for the preparation of FS
and knowledge of the matters concerned.

Basic Elements of Representation Letter: It should be:

i. Professional judgments should be used by the auditor for determining the matters on which,
he wishes to obtain representation.
ii. In case, where the representation is obtained on matters which are material to FS, the auditor
should:
* seek corroborative evidence;
* evaluate the reasonableness and consistency of such a representation with other
evidence;
* consider whether person making representation is well – informed.

Doubt as to Reliability of Written Representation:

• If representation are inconsistent with other audit evidence, auditor shall perform procedures
to resolve the matter;

• If matter remains unresolved and raise concerns about competence, integrity, ethical value of
management
• Withdraw from engagement
• If TCWG, put in place corrective measures – continue audit and issue appropriate AR.

Requested Representation Not Provided:

1. Discuss the matter with management;

2. Re-evaluate integrity of management and evaluate the effect on reliability of representation
and audit evidence;
3. Auditor conclude that the audit cannot be conducted, he may disclaim the opinion.

Note for students:

• Representation letter shall not be dated later than the audit report;
• In case where the MR is inconsistent with other audit evidence, the auditor should consider
the reliability of the audit evidence obtained in general.

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5.39 ISA 600 - AUDITS OF GROUP FINANCIAL STATEMENTS

GET – Group Engagement Team

Introduction: Applicable on:

i. Group audits;
ii. In circumstances when the auditor involves other auditors in the audit of FS, that are not Group
FS e.g.: Inventory count / Physical fixed assets at a remote location.

- Group engagement partner is responsible for direction, supervision and performance of group
audit engagement.
- Significant component: Component identified by Group engagement team:
• that is of individual financial significance to the group; or
• that due to its specific nature / circumstances is likely to include significant ROMM of the
group FS.

Acceptance and continuance:

• GET won’t be able to obtain SAAE due to restriction imposed by Group Management; and
• Possible inability would result in Disclaimer:

Continuing engagement New engagement

Withdraw from L&R prohibits L&R prohibits Not

engagement from withdrawal from declining accept
engagement
Disclaim on
opinion
Disclaim on opinion

Understanding the component auditor: GET shall obtain understanding:

• Whether component auditor understands and comply with ethical requirements:

• Component auditor’s professional competence;
• Component auditor operates in a regulatory environment that actively overseas auditor;
• GET will be able to obtain SAAE from component auditor’s.

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Materiality:
GET should determine:
i. Materiality of GFS;
ii. Materiality level to be applied to any particular classes of transactions, A/C balances /
disclosures,
iii. Component materiality;
iv. Amounts / threshold for SAD.

Responding to assessed Risks:

Significant Component

Yes No

• Audit of FS using component • Analytical procedures at Group

materiality; level;
• Audit of 1 / more A/C balances, COT or • Not able to obtain SAAE through
disclosures relating significant ROMM; AP them;
• Specified Audit procedures relating i. Audit of FS of component
significant ROMM. ii. Audit of 1 / more items
iii. Specified audit procedures
iv. Review of FS

Subsequent Events:
• Component auditor shall perform procedures designed to identify events that occur between
the dates of financial information of component and date of AR on GFS and notify it to GET if
they become aware of subsequent event.

Component Auditor’s Communication to GET:

• Instances of non-compliances to law and regulations;

• List of incorrected M/S;
• Indicators of possible management bias;
• Significant deficiencies in internal control;
• List of RP;
• Component auditor’s overall findings and conclusion and opinion.

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Communication with TCWG:

• Deficiencies in Group-wide internal controls;

• Deficiencies in internal controls;
• Deficiencies in IC that component auditors have bought to the attention of GET; and
• Fraud identified by GET.

Group Audit Process

Can the auditor Can the auditor Yes, then serve as Auditor
serve as group auditor? No serve as component component
Auditor

Yes No

Can SAAE be No Withdrawal / disclaim if

obtained? required by laws and
Yes Regulation to Report.

• Determine engagement teams.

• Develop audit strategy.
• Understand the Group.
• Understand component auditor.

Will reference be made to No Determine type of work for

Component auditor in Group AR? Component.

Determine involvement in
component auditor
Yes engagement.

Issue standard AR.

• Provide % audited by component auditor.

• Wish to name component auditor in Group AR.

Yes

• Obtain component auditor’s permission.

• Name the auditor and present its report.

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5.40 ISA 610 - USING THE WORK OF INTERNAL AUDITORS

External auditor uses the work of internal audit function to modify nature, timing / reduce extent of
AP.
Factors considered before using Internal Audit Work:
• Level of competence;
• Systematic and disciplined approach by IA;
• Extent to which IA policies and procedures support objectivity of IA.
• If IA evaluation does not support the above factors, then auditor shall not use work of IA.

Extent and nature of work of IA to be used:

External auditor shall prevent undue reliance on work of IA, and shall plan to use less of the work of
IA and perform more of the work directly, when:

i. More judgement is involved;

ii. Higher assessed ROMM and significant risks;
iii. Lower level of competence of IA.

Direct assistance shall not be obtained, when:

• Significant threat to objectivity;
• Internal auditor lacks sufficient competence.

Using Internal Auditor to Provide Direct Assistance:

• Obtain written agreement from an authorized representative of the entity that the internal
auditor will be allowed to follow external auditor.
• Obtain written agreement from IA that they will keep matters confidential.
• External auditor shall check back the AE on some of the work performed by IA.

Examples of Work of IA that can be used by the Auditor:

• Testing of the operating effectiveness of controls;
• Substantive procedures involving limited judgement;
• Observations of inventory controls;
• Tracing transactions through the IS relevant to FR;
• Testing of compliance with regulatory requirements;
• Audit / Review of financial information of subsidiaries that are not significant component to the
Group.

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5.41 ISA 620 - USING THE WORK OF AN AUDITOR’S EXPERT

Evaluate the need to use the work of an expert after considering factors such as:
• Materiality and complexity of info;
• Availability of alternative source of AE.

Consider whether expert appointed by client / auditor has desired skill, competence and
objectivity.

Gain knowledge about specific aspects such as:

• Terms of engagement;
• Objective and scope and subject matter of his work;
• Degree of confidentiality;

Evaluate the work of expert after examining:

• Appropriateness of source data;
• Appropriateness of reasonableness of assumptions and methods used by the expert.

Work of Expert Adequate

No
• Agree on nature, timing and Yes
extent of further work.
• Perform additional AP. Audit report
modified

Yes and modification

Relates to area of No
Expert’s work
Don’t refer to
work of expert
in AR
• Give reference to expert’s report;
• include that this does not
reduce auditor’s responsibility.

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5.42 CODE OF ETHICS FOR CHARTERED ACCOUNTANTS (2019)

SUMMARY OF SIGNIFICANT CHANGES FROM CODE 2016

Significant changes in the revised ICAP Code of Ethics

The revised ICAP Code of Ethics is based on the latest version of IESBA Code of Ethics issued in July 2018.
Consequently, it brings in following key enhancements in comparison to the extant ICAP Code of Ethics for
Chartered Accountants:

▪ Completely re-written and structured in four parts for ease of use and navigation. The requirements
are identified with the letter ‘R’, while the application guidance paragraphs are denoted with the letter
‘A’.

▪ Contains an enhanced and more prominently featured conceptual framework.

▪ Provides the framework to guide the chartered accountants as to what actions to take in the public
interest when they become aware of a potential illegal act (known as Non compliance with laws and
regulations (NOCLAR)).

▪ Strengthens independence provisions relating to the long association of personnel with an audit or
assurance client. Now the required cooling off period is:
- 5 years for Engagement Partner
- 3 years for Engagement Quality Control Reviewer
- 2 years for Other Key Audit Partner

▪ Strengthens the provisions pertaining to the offering or accepting of inducements, including gifts and
hospitality.

▪ Brings in new application material to emphasize the importance of understanding facts and
circumstances when exercising professional judgment.

▪ Outlines new and revised sections dedicated too chartered accountants in business relating to (a)
preparing and presenting information; and (b) pressure to breach the fundamental principles.

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PART 1 CONCEPTUAL FRAMEWORK OF CODE OF ETHICS

▪ A chartered accountant shall comply with the Code.
▪ There might be circumstances where laws or regulations preclude an accountant from
complying with certain parts of the Code. In such circumstances, those laws and regulations
prevail, and the accountant shall comply with all other parts of the Code. (R100.3)
▪ The conceptual framework specifies an approach for a chartered accountant to:
(a) Identify threats to compliance with the fundamental principles;
(b) Evaluate the threats identified; and
(c) Address the threats by eliminating or reducing them to an acceptable level. (R120.2)
▪ When applying the conceptual framework, the chartered accountant shall:
(a) Exercise professional judgment;
(b) Remain alert for new information and to changes in facts and circumstances; and
(c) Use the reasonable and informed third party test (R120.5)

Fundamental Principles
1. Integrity – to be straightforward and honest in all professional and business relationships.
2. Objectivity – not to compromise professional or business judgments because of bias, conflict
of interest or undue influence of others.
3. Professional Competence and Due Care – to:
a. Attain and maintain professional knowledge and skill at the level required to ensure that a
client or employing organization receives competent professional service, based on
current technical and professional standards and relevant legislation; and
b. Act diligently and in accordance with applicable technical and professional standards.
4. Confidentiality – to respect the confidentiality of information acquired as a result of
professional and business relationships.
5. Professional Behavior – to comply with relevant laws and regulations and avoid any conduct
that the chartered accountant knows or should know might discredit the profession.

Threats to Fundamental Principles

Threats as defined by the code of ethics have been categorized into five types.
1. Self-interest threat occurs when a financial interest, or other interest inappropriately
influences a CA’s judgment or behavior.
2. Self-review threat the threat that a chartered accountant will not appropriately evaluate the
results of a previous judgment made; or an activity performed by the accountant (or by
another individual within the accountant’s firm or employing organization) on which the
accountant will rely when forming a judgment;
3. Advocacy threat is that a chartered accountant will promote a client’s or employing
organization’s position to the point that the accountant’s objectivity is compromised.
4. Familiarity threat is due to a long or close relationship with a client, or employing organization,
a chartered accountant will be too sympathetic to their interests or too accepting of their work

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5. Intimidation threat is that a chartered accountant will be deterred from acting objectively
because of actual or perceived pressures, including attempts to exercise undue influence over
the accountant.

Example situations creating threats under Code of Ethics

SELF INTEREST THREAT SELF REVIEW THREAT ADVOCACY THREAT
1- Financial interest 1- Recent services with 1- Contingent fees
2- Close business assurance client 2- Legal services
relationships 2- Preparing accounting 3- Corporate finance services
3- Employment with records
assurance clients 3- Valuation services
4- Partner on client board 4- Tax services
5- Family and personal 5- Internal audit services
relations 6- Corporate finance
6- Gifts and hospitality services

7- Loans and guarantees 7- Other services

8- Overdue fees
9- Contingent fees
10- High percentage of fees
11- Undercutting

FAMILIARITY THREAT INTIMIDATION THREAT

1- Long association with 1- Litigation
assurance client 2- Close business relations
2- Family and personal 3- Family and personal
relations relations

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Addressing Threats / Safeguards

▪ If the CA determines that the identified threats to compliance with the fundamental principles
are not at an acceptable level, the CA shall address the threats by eliminating them or reducing
them to an acceptable level. The accountant shall do so by:
o Eliminating the circumstances, including interests or relationships, that are creating the
threats;
o Applying safeguards, where available and capable of being applied, to reduce the threats to
an acceptable level; or
o Declining or ending the specific professional activity. (R120.10)
▪ To conclude whether the threats are at an acceptable level, the CA shall:
o Review any significant judgments made or conclusions reached; and
o Use the reasonable and informed third party test. (R120.11)

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PART 2 – CHARTERED ACCOUNTANT IN BUSINESS

In this Part, the term “chartered accountant” refers to:
(a) A chartered accountant in business; and
(b) An individual who is a chartered accountant in practice when performing professional activities
pursuant to the accountant’s relationship with the accountant’s firm, whether as a contractor,
employee or owner.

SEC 210 CONFLICTS OF INTEREST

▪ A chartered accountant shall not allow a conflict of interest to compromise professional or
business judgment.
▪ COI creates threat to objectivity. Such threats might be created when:
o A chartered accountant undertakes a professional activity related to a particular
matter for two or more parties whose interests with respect to that matter are in
conflict; or
o The interest of a chartered accountant with respect to a particular matter and the
interests of a party for whom the accountant undertakes a professional activity
related to that matter are in conflict.
▪ A party might include an employing organization, a vendor, a customer, a lender, a
shareholder, or another party.
▪ A chartered accountant shall take reasonable steps to identify circumstances that might
create a conflict of interest.
▪ It is generally necessary to:
(a) Disclose the nature of the conflict of interest and how any threats created were
addressed to the relevant parties, including to the appropriate levels within the employing
organization affected by a conflict; and
(b) Obtain consent from the relevant parties
▪ Consent might be implied
▪ If such disclosure or consent is not in writing, the chartered accountant is encouraged to
document
o nature of the circumstances giving rise to COI
o safeguards applied; and
o consent obtained

SEC 220 PREPARATION AND PRESENTATION OF INFORMATION

▪ When preparing or presenting information, a chartered accountant shall:
(a) Prepare or present the information in accordance with a relevant reporting framework,
where applicable;
(b) Prepare with an intention neither to mislead nor to influence contractual or regulatory
outcomes inappropriately;
(c) Exercise professional judgment to:
(i) Represent the facts accurately and completely in all material respects;

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(ii) Describe clearly the true nature of business transactions or activities; and
(iii) Classify and record information in a timely and proper manner; and
(d) Not omit anything with the intention of rendering the information misleading
▪ When the CA knows or has reason to believe that the information with which the accountant is
associated is misleading, the accountant shall take appropriate actions to seek to resolve the
matter.

SEC 230 - ACTING WITH SUFFICIENT EXPERTISE

A CA shall not intentionally mislead an employing organization as to the level of expertise or
experience possessed.
A self-interest threat to compliance with the principle of professional competence and due care
might be created if a chartered accountant has:
▪ Insufficient time for performing or completing the relevant duties.
▪ Incomplete, restricted or otherwise inadequate information for performing the duties.
▪ Insufficient experience, training and/or education.
▪ Inadequate resources for the performance of the duties.

If a threat to compliance with the principle of PC & DC cannot be addressed, a CA shall determine
whether to decline. If the accountant determines that declining is appropriate, the accountant shall
communicate the reasons.

SEC 240 FINANCIAL INTERESTS, COMPENSATION AND INCENTIVES LINKED TO FINANCIAL

REPORTING AND DECISION MAKING
▪ Having a financial interest, or knowing of a financial interest held by an immediate or close
family member might create a self-interest threat to compliance with the principles of
objectivity or confidentiality.
▪ Examples of circumstances that might create a self-interest threat include situations in
which the chartered accountant or an immediate or close family member:
o Has a motive and opportunity to manipulate price-sensitive information in order to
gain financially.
o Holds a direct or indirect financial interest in the employing organization and the
value of that financial interest might be directly affected by decisions made by the
accountant.
o Is eligible for a profit-related bonus and the value of that bonus might be directly
affected by decisions made by the accountant.
o Holds, directly or indirectly, deferred bonus share rights or share options in the
employing organization,
o Participates in compensation arrangements which provide incentives to achieve
targets or to support efforts to maximize the value of the employing organization’s
shares.

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SEC 250 INDUCEMENTS, INCLUDING GIFTS AND HOSPITALITY (TO BE COVERED WITH PART 3)
SEC 260 RESPONDING TO NON-COMPLIANCE WITH LAWS AND REGULATIONS (TO BE COVERED
WITH PART 3)

SEC 270 PRESSURE TO BREACH THE FUNDAMENTAL PRINCIPLES

▪ A CA shall not:
o Allow pressure from others to result in a breach of compliance with the
fundamental principles; or
o Place pressure on others that the accountant knows, or has reason to believe, would
result in the other individuals breaching the fundamental principles.
▪ Examples of pressure:
o Pressure related to conflicts of interest
o Pressure to influence preparation or presentation of information
o Pressure to act without sufficient expertise or due care
o Pressure related to financial interests
▪ Discussing the circumstances creating the pressure and consulting with others about those
circumstances might assist the chartered accountant to evaluate the level of the threat.
▪ An example of an action that might eliminate threats created by pressure is the CA’s
request for a restructure of, or segregation of, certain responsibilities and duties so that the
accountant is no longer involved with the individual or entity exerting the pressure.
▪ The CA is encouraged to document:
o The facts.
o The communications and parties with whom these matters were discussed.
o The courses of action considered.
o How the matter was addressed.

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PART 3 – CHARTERED ACCOUNTANT IN PRACTICE

Definitions
RELATED ENTITIES:
An entity that has any of the following relationships with the client:
(a) An entity that has direct or indirect control over the client if the client is material to such entity;
(b) An entity with a DFI in the client if that entity shas significant influence over the client and the
interest in the client is material to such entity;
(c) An entity over which the client has direct or indirect control;
(d) An entity in which the client, or an entity related to the client under (c) above, has a DFI that
gives its significant influence over such entity and the interest is material to the client and its
related entity in (c); and
(e) An entity which is under common control with the client (a "sister entity") if the sister entity and
the client are both material to the entity that controls both the client and sister entity.
Independence requirement apply to all related entities in case of listed audit client. For all other
audit clients, it applied to only entities over which the client has direct or indirect control i.e. part (c)
above.

Companies Act 2017 clarifies control and significant influence:

Subsidiary – Parent company directly or indirectly controls composition of board, beneficially owns
or holds more than 50% of its voting securities or otherwise has power to elect and appoint more
than fifty per cent of its directors;
Associated undertaking –
1. Undertakings under common management/ control
2. Holding not less than 20% of voting rights, 10% in case of Modaraba Managed company
Ownership includes voting rights held by Person, Spouse or Minor child cumulatively.
IAS 27: Control also exists when the parent owns half or less of the voting power of an entity when
there is:
(a) power over more than half of the voting rights by virtue of an agreement with other
investors;
(b) power to govern the financial and operating policies of the entity under a statute or an
agreement;
(c) power to appoint or remove the majority of the members of the board of directors or
equivalent governing body and control of the entity is by that board or body; or
(d) power to cast the majority of votes at meetings of the board of directors or equivalent
governing body and control of the entity is by that board or body.

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IAS 28:
If an investor holds, directly or indirectly (e.g. through subsidiaries), 20 per cent or more of the
voting power of the investee, it is presumed that the investor has significant influence (SI), unless it
can be clearly demonstrated that this is not the case. Conversely, if the investor holds, directly or
indirectly (e.g. through subsidiaries), less than 20 per cent of the voting power of the investee, it is
presumed that the investor does not have significant influence, unless such influence can be clearly
demonstrated.
SI over representation on board, participation in policy-making processes including dividends or
other distributions; material transactions between the investor and the investee; interchange of
managerial personnel; or provision of essential technical information.

SEC – 310 CONFLICT OF INTEREST:

A Conflict of Interest (COI) creates threats to compliance with the principle of objectivity and other
FPs.
A CA shall not allow a conflict of interest to compromise professional or business judgment. Threat
may arise when:
a. The CA provides a professional service related to a particular matter for two or more clients
whose interests (with respect to that matter) are in conflict; or
b. The interests of the CA w.r.t. a particular matter and the interests of the client for whom
the CA provides a professional service related to that matter are in conflict.

Time of evaluation: Before accepting the new engagement or during the engagement
The firm shall also consider COI that might arise w.r.t relationship of a network firm. (R310.7)
Factors:
- The nature of the relevant interests and relationships between the parties involved;
- The nature of the service and its implication for relevant parties.
Litmus test: RITP would conclude that objectivity / confidentiality not compromised.
Examples: (310.4 A1)
- Performing transaction advisory services to acquirer for a previous audit client, where the
firm has obtained confidential information during the course of the audit that maybe
relevant to the transaction;
- Advising competing clients;
- Services to vendor and purchaser;
- Valuation services for assets of clients in adversarial positions w.r.t. assets;
- Representing two clients in court in opposite positions;
- In relation to a license agreement, providing an assurance report for a licensor on the
royalties due while advising the licensee on the amounts payable.
- Advising a client to invest in business in which a relative has interest;
- Providing an advice to client and also having a venture with the competitor;
- Advising client for product purchase and receiving commission for the purchase;
- Advising client on acquisition with also firm’s interest in acquisition

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Safeguards:
- Using separate engagement teams
- Creating separate areas of practice
- Establishing policies and procedures to limit access to client files, the use of confidentiality
agreements signed by employees and partners and/or the physical/ electronic separation of
confidential information.
- Specific and dedicated training and communication
- Another CA to review judgmental areas
- Consulting with third parties, such as a professional body, legal counsel or another
chartered accountant. When obtaining advice, remain alert to principle of confidentiality.
- QC Partner or independent member to review application of safeguards
Disclosure & Consent
- Disclosure to clients in conflict, obtain consent
o Specific consent
o General consent
o implied consent – document the nature, safeguards and consent obtained
- In case explicit consent is refused, eliminate the threat by discontinuance.

Confidentiality & COI

- When making specific disclosure for the purpose of obtaining explicit consent would result
in a breach of confidentiality, and such consent cannot therefore be obtained, the firm shall
only accept or continue an engagement if:
o The firm does not act in an advocacy role for one client in an adversarial position
against another client in the same matter;
o Specific measures are in place to prevent disclosure of confidential information
between the engagement teams serving the two clients; and
o The firm is satisfied that a RITP would be likely to conclude that it is appropriate for
the firm to accept or continue the engagement because a restriction on the firm’s
ability to provide the professional service would produce a disproportionate adverse
outcome for the clients or other relevant third parties. (R310.12)
- Example: Hostile takeover, fraud investigations
- CA shall document the nature of circumstances, measure taken to prevent disclosure,
reason to accept engagement.

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SEC 320 PROFESSIONAL APPOINTMENT

▪ Threats to compliance with the principles of integrity or professional behavior might be
created, for example, from questionable issues associated with the client (its owners,
management or activities).
▪ A CA shall determine whether there are any reasons for not accepting an engagement when
the accountant:
(a) Is asked by a potential client to replace another accountant;
(b) Considers tendering for an engagement held by another accountant; or
(c) Considers undertaking work that is complementary or additional to that of another
accountant.
▪ A proposed accountant will usually need the client’s permission, preferably in writing, to
initiate discussions with the existing or predecessor accountant.
▪ If unable to communicate with the existing or predecessor accountant, the proposed
accountant shall take other reasonable steps to obtain information about any possible
threats.
▪ When an existing or predecessor accountant is asked to respond to a communication from
a proposed accountant, the existing or predecessor accountant shall:
(a) Comply with relevant laws and regulations governing the request; and
(b) Provide any information honestly and unambiguously.
▪ In the case of an audit/ review of FS, a CA shall request the existing / predecessor
accountant to provide known information of which the proposed accountant needs to be
aware before acceptance. Except for the circumstances involving NOCLAR:
(a) If the client consents, the existing / predecessor accountant shall provide the
information honestly and unambiguously; and
(b) If the client fails/ refuses to grant permission, the existing or predecessor accountant
shall disclose this fact, who shall carefully consider whether to accept the appointment.
▪ For a recurring client engagement, a chartered accountant shall periodically review whether
to continue with the engagement.
▪ When a chartered accountant intends to use the work of an expert, the accountant shall
determine whether the use is warranted.

SEC – 321 SECOND OPINION

Situations where a CA in practice is asked to provide a second opinion on matters of accounting,
auditing, reporting or other standards by (or on behalf of) an entity that is not an existing client
may create self-interest or other threats to compliance with PC and DC.
Safeguards:
▪ Seek client permission and obtain information from previous accountant;
▪ Describing the limitations surrounding any opinion in communications with the client.
▪ Providing the existing or predecessor accountant with a copy of the opinion.
If the company refuses to permit communication with existing / previous accountant, determine
whether to provide such services or not.

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SEC- 330 ENGAGEMENT FEE, PRICING AND RELATED MATTERS

Level of fee
A chartered accountant in practice may quote whatever fee deemed to be appropriate
commensurate with the nature and service to be rendered. However, CA should not quote fee
lower than that charged by the previous auditors. (undercutting/ low balling)
Exception:
However, if the scope and quantum of work of the current engagement materially differs from the
scope and quantum of work carried out by the previous auditors, the current auditor may charge a
lower fee.
Factors:
▪ Making client aware of service covered and fee;
▪ Fee set by a regulatory body of not.

Safeguards:
▪ Adjusting the level of fees or the scope of the engagement.
▪ Having an appropriate reviewer review the work performed.

Referral Fee / Commission

A self-interest threat to Objectivity and PC&DC is created when CA pays/ receives a referral fees/
commission relating to a client.
SAFEGUARDS:
- Obtaining advance agreement from the client for commission
- Disclosing referral arrangement to client.
Purchase of Firm
CA in practice may purchase all or part of another firm on the basis that payments will be made to
individuals formerly owning the firm or to their heirs or estates. Such payments are not regarded as
commissions.

SEC 340 INDUCEMENTS, INCLUDING GIFTS AND HOSPITALITY

An inducement is an object, situation, or action that is used as a means to influence another
individual’s behavior, but not necessarily with the intent to improperly influence that individual’s
behavior.
Examples: Gifts, Hospitality, Entertainment, Political or charitable donations, Appeals to friendship
and loyalty, Employment or other commercial opportunities, Preferential treatment, rights or
privileges.

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Offering or accepting inducements might create a self-interest, familiarity or intimidation threat to

compliance with the fundamental principles, particularly the principles of integrity, objectivity and
professional behavior.
To ensure compliance, the CA shall understand laws/ regulations that prohibit offering/ accepting
inducements in certain circumstances.
With an intent to influence behavior
A CA shall not offer/ accept/ encourage any inducement that is made, or a RITP would likely to
conclude is made, with the intent to improperly influence the others’ behavior.
Safeguards:
▪ Informing senior management of the firm or those charged with governance of the client
regarding the offer.
▪ Amending or terminating the business relationship with the client.

With no intent to influence behavior

If such an inducement is trivial and inconsequential, any threats created will be at an acceptable
level.
Actions to eliminate:
▪ Declining or not offering the inducement. (this will eliminate the threat)
▪ Transferring responsibility for the provision of any professional services to the client to
another individual

Safeguards:
▪ Being transparent with senior management of the firm/ client about it
▪ Registering the inducement in a log monitored by senior management of the firm
▪ Having an appropriate reviewer, who is not otherwise involved in providing the professional
service
▪ Donating the inducement to charity after receipt and appropriately disclosing the donation
▪ Reimbursing the cost of the inducement, such as hospitality, received.
▪ As soon as possible, returning the inducement

A CA shall remain alert to potential threats to the accountant’s compliance with the fundamental
principles created by the offering of an inducement:
▪ By an IMF or CFM of the accountant to an existing or prospective client.
▪ To an IMF or CFM of the accountant by an existing or prospective client.

Where the CA becomes aware of an inducement being offered to or made by an IMF or CFM with
an intent to improperly influence the behavior of the accountant (or RITP test), the accountant
shall advise the IMF or CFM not to offer/ accept the inducement.

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SEC 350 - CUSTODY OF CLIENT ASSETS

▪ Holding client assets creates a self-interest or other threat to compliance with the principles
of PB and Obj.
▪ A chartered accountant shall not assume custody of client money or other assets unless
permitted to do so by law and in accordance with any conditions

Before Taking Custody

▪ Make inquiries about the source of the assets; and
▪ Consider related legal and regulatory obligations

After Taking Custody

A chartered accountant entrusted with money or other assets belonging to others shall:
▪ Comply with the laws and regulations relevant to holding and accounting for the assets;
▪ Keep the assets separately from personal or firm assets;
▪ Use the assets only for the purpose for which they are intended; and
▪ Be ready at all times to account for the assets and any income, dividends, or gains generated,
to any individuals entitled to that accounting.

SEC 360 RESPONDING TO NON-COMPLIANCE WITH LAWS AND REGULATIONS (NOCLAR)

▪ A self-interest or intimidation threat to compliance with the principles of integrity and
professional behavior is created when a chartered accountant becomes aware of non-
compliance or suspected non-compliance with laws and regulations (L&R).
▪ Two categories of L&R:
(a) With a direct effect on the determination of material amounts/ disclosures in client’s FS;
and
(b) Others that do not have a direct effect on the determination of the amounts/ disclosures,
but compliance might be fundamental to the operating aspects of the client’s business, to its
ability to continue its business, or to avoid material penalties.

Examples:

• Fraud, corruption, bribery

• Money laundering, terrorist financing
• Securities market and trading
• Banking
• Data protection
• Tax, and other laws
• Environment protection
• Public health and safety

▪ The accountant shall obtain an understanding of legal or regulatory provisions and comply
with them, including:
(a) Any requirement to report the matter to an appropriate authority; and
(b) Any prohibition on alerting the client.

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Responsibilities of all CA
The CA shall take timely steps to comply with this section and shall have regard to the nature of the
matter & the potential harm to the interests of the entity, investors, creditors, employees or the
general public.

Audits of Financial Statements

If a CA engaged to perform an audit of FS becomes aware of information concerning non-
compliance, the accountant shall obtain an understanding of the matter.
This understanding shall include the nature of the non-compliance or suspected non-compliance
and the circumstances in which it has occurred / might occur.
If the CA identifies that a non-compliance has occurred / might occur, the accountant shall discuss
the matter with appropriate level of management and TCWG, where appropriate. If management
is involved, then TCWG.
In discussing the non-compliance, the CA shall advise them to take appropriate and timely actions,
if not already done so, to:
▪ Rectify, remediate or mitigate the consequences of the noncompliance;
▪ Deter the commission of the non-compliance where it has not yet occurred; or
▪ Disclose the matter to an appropriate authority where required

The CA shall consider whether management and those charged with governance understand their
legal or regulatory responsibilities. If they don’t, CA might suggest appropriate sources of
information or recommend that they obtain legal advice.
The CA shall comply with applicable L&R and requirements under auditing standards.
Group FS
Where a CA becomes aware of non-compliance in relation to a component of a group in either of
the following two situations, the accountant shall communicate the matter to the group
engagement partner unless prohibited by L&R:
▪ The accountant is, for purposes of an audit of the group FS, requested by the GET to perform
work on financial information related to the component; or
▪ The accountant is engaged to perform an audit of the component’s financial statements for
purposes other than the group audit, for example, a statutory audit.

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Where the group engagement partner becomes aware of non-compliance in the course of an audit
of group financial statements, the group engagement partner shall consider whether the matter
might be relevant to one or more components:
▪ Whose financial information is subject to work for purposes of the audit of the group FS; or
▪ Whose FS are subject to audit for purposes other than the group audit, for example, a
statutory audit.

When relevant, group engagement partner shall:

▪ take steps to have the matter communicated to those performing work at the components,
unless prohibited.
▪ If necessary, the group engagement partner shall arrange for appropriate inquiries to be
made

Where the CA has withdrawn from the professional relationship, the accountant shall, on request
by the proposed accountant, provide all relevant facts and other information concerning the non-
compliance to the proposed accountant. The predecessor accountant shall do so, even where the
client fails/ refuses to grant the permission.
If the CA determines that disclosure of the non-compliance to an appropriate authority is an
appropriate course of action in the circumstances, and that disclosure is permitted under Code, the
accountant shall consider whether it is appropriate to inform the client of the accountant’s
intentions before disclosing the matter.
In exceptional circumstances, the chartered accountant might become aware of actual or intended
conduct that the accountant has reason to believe would constitute an imminent breach of a L&R
that would cause substantial harm to investors, creditors, employees or the general public. Having
first considered whether:
▪ it would be appropriate to discuss the matter with management or TCWG of the entity,
▪ the accountant shall exercise professional judgment and determine whether to disclose the
matter immediately to an appropriate authority in order to prevent or mitigate the
consequences of such imminent breach.
▪ If disclosure is made, that disclosure is permitted under Code.

In relation to non-compliance or suspected non-compliance that falls within the scope of this
section, the chartered accountant shall document:
▪ how management / TCWG have responded to the matter.
▪ courses of action the accountant considered, the judgments made and the decisions that
were taken, having regard to the RITP test.
▪ how the accountant is satisfied that the accountant has fulfilled the responsibility.

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Professional Services Other than Audits of Financial Statements

If the CA identifies that a non-compliance has occurred / might occur, the accountant shall discuss
the matter with appropriate level of management and TCWG, if access available.
If the chartered accountant is performing a non-audit service for:
(a) An audit client of the firm; or
(b) A component of an audit client of the firm,
the accountant shall communicate the non-compliance within the firm, unless prohibited, as per
protocols of firm. In the absence of such protocols and procedures, it shall be made directly to
the audit engagement partner.
If the chartered accountant is performing a non-audit service for:
(a) An audit client of a network firm; or
(b) A component of an audit client of a network firm, the accountant shall consider whether to
communicate the non-compliance or suspected non-compliance to the network firm as per
protocols of firm. In the absence of such protocols and procedures, it shall be made directly to
the audit engagement partner.

If the chartered accountant is performing a non-audit service for a client that is not:
(a) An audit client of the firm or a network firm; or
(b) A component of an audit client of the firm or a network firm, the accountant shall consider
whether to communicate the non-compliance to the firm that is the client’s external auditor, if
any.
The chartered accountant shall also consider whether further action is needed in the public
interest.
If the CA determines that disclosure of the non-compliance to an appropriate authority is an
appropriate course of action in the circumstances, and that disclosure is permitted under Code, the
accountant shall consider whether it is appropriate to inform the client of the accountant’s
intentions before disclosing the matter.
In exceptional circumstances, the chartered accountant might become aware of actual or intended
conduct that the accountant has reason to believe would constitute an imminent breach of a L&R
that would cause substantial harm to investors, creditors, employees or the general public. Having
first considered whether
▪ it would be appropriate to discuss the matter with management or TCWG of the entity,
▪ the accountant shall exercise professional judgment and determine whether to disclose the
matter immediately to an appropriate authority in order to prevent or mitigate the
consequences of such imminent breach.
▪ If disclosure is made, that disclosure is permitted under Code.

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SEC 370 - PUBLIC NOTICES, ANNOUNCEMENTS AND COMMUNICATIONS UNDUE PUBLICITY

BE AVOIDED
In any communications, announcements and public notices, CA should not:
(a) use means, which bring the profession into disrepute;
(b) make exaggerated claims for the services they are able to offer, the qualifications they possess,
or experience they have gained; and
(c) denigrate the work of other accountants.
A CA preparing or authorizing the issue of matter falling within this Section should do so with a due
sense of responsibility to the profession and to the public as a whole.
In particular, such material should be in good taste both as to content and presentation and should
not belittle services offered by others, whether members or not, either by claiming superiority for
the services of a particular member or otherwise.
Advertising for solicitation be avoided
(a) All announcements, communications and public notices should:
(i) be aimed at informing the recipients or the public in an objective manner;
(ii) conform to the basic principles of legality, decency, clarity, honesty and truthfulness; and
(iii) not project an image, which is inconsistent with that of a professional person bound to high
ethical and technical standards.
(b) Activities which may expressly be considered not to meet the above criteria and are therefore
prohibited include those that:
(i) create false, deceptive or unjustified expectations of favorable results;
(ii) imply the ability to influence any court, tribunal, regulatory agency or similar body or official;
(iii) consist of self-laudatory statements that are not based on verifiable facts;
(iv) make comparisons with other chartered accountants in practice;
(v) contain testimonials or endorsements;
(vi) contain any other representations that would be likely to cause a reasonable person to
misunderstand or be deceived; and
(vii) make unjustified claims to be an expert or specialist in a particular field of accountancy.
Examples:
▪ Appointments and Awards
▪ Chartered Accountants Seeking Employment or Professional Business
▪ Directories & Internet
▪ Books, Articles, Interviews, Lectures, and Electronic Media
▪ Training Courses, Seminars, etc.

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▪ Professional Literature and Publications

▪ Staff Recruitment
▪ Recruitment on behalf of Clients
▪ Brochures and Firm Directories
▪ Stationery and Nameplates
▪ Newspaper announcements
▪ Inclusion of the name of a CA in practice in a document issued by a Client
▪ Advertising Material used to promote a course, which he has been asked to conduct
▪ The Use of the CA title on an Employer's Stationery
▪ Greeting and Invitation Cards

PART 4A and 4B – INDEPENDENCE CONSIDERATIONS

Independence
Independence impacts are significant; therefore, ISQC also discusses such requirements separately.
Policies and procedures should be established by firm to ensure all those who are subject
independence must follow it.
Such Policies and procedures must require:
1. Firm to communicate independence requirements to all those who are subject to
independence.
2. Identify and evaluate circumstances and relationship that create threats to independence,
and to take appropriate action.
3. Engagement partners to provide the firm with relevant information about engagements and
scope of services.
4. Personnel to promptly notify the firm of circumstances and relationship that create threats.
5. The accumulation and communication of relevant information to appropriate personnel so
that personnel can determine whether they satisfy requirements, firm can maintain and
update its records of independence and firm can take appropriate action regarding identified
threats to independence.
6. Firm to be notified of breaches of independence requirements, and to enable it to take
appropriate actions to resolve such situations.

At least annually, the firm should obtain written confirmation of compliance with its policies and
procedures on independence from all firm personnel required to be independent by the Code and
national ethical requirements.
Firm should establish policies and procedures:
(a) To reduce the familiarity threat to an acceptable level when using the same senior personnel
on an assurance engagement over a long period of time; and
(b) For audits of listed entities, requiring the rotation of the engagement partner after a specified
period in compliance with the Code and national ethical requirements that are more
restrictive.

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DEFINITIONS:
KEY AUDIT PARTNERS
Lead partner, EQC reviewer and other partner taking significant judgments. Depending upon the
circumstances and the role of the individuals on the audit, “other audit partners” might include, for
example, audit partners responsible for significant subsidiaries or divisions.
ENGAGEMENT PERIOD
1. Covers period of engagement
2. Start when assurance teams commence work and ends with final report unless of a
recurring nature

PERSONS SUBJECT TO INDEPENDENCE

1. Assurance team
2. Firm
3. Network firm
4. Immediate family of AST
5. Close family of AST
6. Quality control reviewer / Independent Partner
7. Those from which consultation sought
8. Other partners and their immediate and family members where lead engagement partner
practices.
9. Other partners and their immediate and family members who provides non-assurance
services.
10. Any experts used.

PUBLIC INTEREST ENTITIES:

(a) All Listed entities; and
(b) Any entity:
(i) Defined by regulation or legislation as a Public Interest Entity; or
(ii) For which the audit is required by regulation or legislation to be conducted in compliance with
the same independence requirements that apply to the audit of listed entities. Such regulation may
be promulgated by any relevant regulator, including an audit regulator i.e. ICAP
Factors for PIE: Large number of stakeholders, size, no. of employees.

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NETWORK FIRMS:
A larger structure:
(a) That is aimed at co-operation; and
(b) That is clearly aimed at:
▪ profit or cost sharing or shares common ownership,
▪ control or management,
▪ common quality control policies and procedures,
▪ common business strategy involving an agreement,
▪ the use of a common brand-name (the firm shall take care of the perception as well even if
it does not become part of affiliate brand name), or
o If the practice is sold and as part of agreement the component may continue to use
the name for a limited time, even though not connected.
o They are not Network firms, by definition and hence, they should determine how to
disclose the fact that they are no more part of the network.
▪ a significant part of professional resources
o Common systems that enable firms to exchange information such asclient data,
billing and time records;
o Partners and staff; Technical departments; issues, transactions or events for
assurance engagements;
o Audit methodology or audit manuals and Training courses and facilities (they do not
form a significant part in isolation)

What is NOT a Network:

▪ If merely a referral arrangement.
▪ Sharing of immaterial cost
▪ Limited to only cost related to development of manuals, audit methodologies, training
courses.
▪ Merely providing joint services or products otherwise by an unrelated entity
▪ Joint reply to a proposal

Member in practice as per Chartered Accountants Ordinance

CAO –(2) A member of the Institute shall be deemed "to be in practice" when individually or in
partnership with chartered accountants in practice, he, in consideration received or to be received-
(i) engages himself in the practice of accountancy; or
(ii) offers to perform services involving the auditing, or verification of financial transactions, books,
accounts, or records or the preparation, verification or certification of financial accounting and
related statements or holds himself out to the public as an accountant; or
(iii) renders professional services or assistance in or about matters of principle or detail relating to
accounting procedure or the recording, presentation or certification of financial facts or data.
Explanation - salaried employee of CA in practice shall be deemed to be in practice for the limited
purpose of the training of [students]

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ENGAGEMENTS SUBJECT TO INDEPENDENCE

Types of engagements:
1. Assurance engagements.
Independence is required for all assurance engagements.
Two types:
a) Assertion-based assurance engagements.
b) Direct reporting assurance engagements.

a) Assertion based assurance engagements

Financial Statement Audit Engagements
1. Members of the assurance team
2. Firm
3. Network firms

Other Assertion-Based Assurance Engagements

1. Members of the assurance team
2. Firm
b) Direct Reporting Assurance Engagements
1. Members of the assurance team
2. Firm

2. Non-assurance engagements
For non-assurance engagements, independence is not mandatory. However, in case independence
is not followed, a statement to that effect would be made in the report of factual findings (AUP) or
compilation report.
REQUIREMENTS OF ISQC-1
The firm should establish policies and procedures designed to provide it with reasonable assurance
that the firm and its personnel comply with relevant ethical requirements.
The firm’s policies and procedures reinforce the ethical requirements by:
(a) Leadership of the firm,
(b) Education and training,
(c) Monitoring, and
(d) Process for dealing with non-compliance

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MERGERS AND ACQUISITIONS

▪ On merger or acquisition (M&A), the firm shall identify and evaluate previous and current
interests and relationships with the related entity.
▪ The firm shall take steps to end any interests or relationships that are not permitted by the
Code by the effective date of the merger or acquisition.
▪ As an exception to above is, if the interest or relationship cannot reasonably be ended by
the effective date of M&A, the firm shall:
(a) Evaluate the threat that is created by the interest or relationship; and
(b) Discuss with TCWG the reasons why it cannot reasonably be ended by the effective date
and the evaluation of the level of the threat.
▪ The firm shall do so only if:
(a) The interest or relationship will be ended as soon as reasonably possible but no later
than 6 months after the effective date of the M&A;
(b) Any individual who has such an interest or relationship, including one that has arisen
through performing a non-assurance service that would not be permitted by code, will not
be a member of the engagement team for the audit or the individual responsible for the
engagement quality control review; and
(c) Transitional measures will be applied, as necessary, and discussed with those charged
with governance.
▪ Examples of such transitional measures include:
o Having a CA review the audit or non-assurance work as appropriate.
o Having a CA, who is not a member of the firm expressing the opinion on the FS,
perform a review that is equivalent to an engagement QCR.
o Engaging another firm to evaluate the results of the non-assurance service or having
another firm re-perform the non-assurance service

▪ The firm might have completed a significant amount of work on the audit prior to the
effective date of the merger or acquisition and might be able to complete the remaining
audit procedures within a short period of time. In such circumstances, if those charged with
governance request the firm to complete the audit while continuing with an interest or
relationship, the firm shall only do so if it:
(a) Has evaluated the level of the threat and discussed the results with TCWG;
(b) Complies with above requirements; and
(c) Ceases to be the auditor no later than the date that the audit report is issued.
▪ If still create a threat that cannot be addressed such that objectivity would be
compromised. If so, the firm shall cease to be the auditor.

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BREACH OF AN INDEPENDENCE PROVISION FOR AUDIT AND REVIEW ENGAGEMENTS

If a firm concludes that a breach of a requirement in this Part has occurred, the firm shall:
(a) End, suspend or eliminate the interest or relationship that created the breach and address the
consequences of the breach;
(b) Consider whether any legal or regulatory requirements apply to the breach and, if so:
(i) Comply with those requirements; and
(ii) Consider reporting the breach to a professional or regulatory body or oversight authority if
such reporting is common practice or expected in the relevant jurisdiction;

(c) Promptly communicate the breach in accordance with its policies and procedures to:
(i) The engagement partner;
(ii) Those with responsibility for the policies and procedures relating to independence;
(iii) Other relevant personnel in the firm and, where appropriate, the network; and
(iv) Those subject to the independence requirements in Part 4A who need to take appropriate
action;
(d) Evaluate the significance of the breach and its impact on the firm’s objectivity and ability to
issue an audit report; and
(e) Depending on the significance of the breach, determine:
(i) Whether to end the audit engagement; or
(ii) Whether it is possible to take action that satisfactorily addresses the consequences of the
breach and whether such action can be taken and is appropriate in the circumstances.

In making this determination, the firm shall exercise professional judgment and take into account
whether a RITP would be likely to conclude that the firm’s objectivity would be compromised, and
therefore, the firm would be unable to issue an audit report.

SEC 410 RELATIVE SIZE, OVERDUE, CONTINGENT FEE

Fee - Relative Size
If the total fee generated by an assurance client represents a large proportion of the firm’s total fee
or a partner’s total fee or individual office, it gives rise to the self-interest threat, the significant of
which depends upon,
- the structure of the firm, and
- whether the firm is well established or not,
- Significance of client to the firm
Significance to be evaluated and if the threat is other than clearly insignificant safeguards should be
applied. (290.202)
Public Interest Entities: If total fee from audit client and related entities for 2 consec. years
constitute 15% of firm’s total fee, intimate to TCWG and either, prior to 2nd years report issuance,
an engagement QC review to be performed by someone not a member of firm, or post issuance of
2nd years report (and before 3rd year) engagement QC to be performed. In case of significantly
higher than 15%, pre-issue review to be performed.
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Fee - Overdue
A self-interest threat may be created if fee from an assurance client in this case, especially if a
significant part is outstanding before the issuance of the following year assurance reports.
Generally, the payment is required before the report issue. May be constituted as loan to client
Contingent Fees
Contingent fee is not allowed for audit and other assurance engagements. Contingent means =
amount of the fee is contingent on the result of the assurance or non-assurance work or items that
are the subject information of the engagement.
Contingent fee in respect of a non-assurance engagement to an assurance client is not allowed if:
- The outcome of non-assurance service and the fee becomes material part of SMI of
assurance engagement, or
- The fee charged by the firm or network firm is material to them (Only in case of audit
engagements).
Exception
However, if fees is fixed in % by the court, it is not regarded as contingent. Contingent fee is
allowed if approved by the ICAP.

SEC 411 COMPENSATION AND EVALUATION POLICIES

▪ When an audit team member for a particular audit client is evaluated on or compensated
for selling non-assurance services to that audit client, the level of the self-interest threat will
depend on:
(a) What proportion of the compensation / evaluation is based on the sale of such services;
(b) The role of the individual on the audit team; and
(c) Whether the sale of such non-assurance services influences promotion decisions.
▪ Examples of actions to eliminate threat include
o Revising the compensation plan or evaluation process for that individual.
o Removing that individual from the audit team.
▪ An example of an action that might be a safeguard to address such a self-interest threat is
having an appropriate reviewer review the work of the audit team member.
▪ A firm shall not evaluate or compensate a key audit partner based on that partner’s success
in selling non-assurance services to the partner’s audit client.
▪ This requirement does not preclude normal profit-sharing arrangements between partners
of a firm.

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SEC 420 & 906 - GIFTS & HOSPITALITY

Applies to: CA in practice (all assurance engagements) and CA in business, IMF or CFM

1. This may create self-interest, intimidation and familiarity threat, which cannot be reduced
to an acceptable level, unless the value is clearly trivial and inconsequential. Consequently,
such gifts should not be accepted.
2. CA shall not make inducements to influence judgment or obtain confidential information
under pressure or otherwise.

RELEVANT SELECTED OPINIONS OF ICAP

SO – VOLUME VI
2.1- The Management of ABC Suguar Mills Limited is pressing for the reduction of the audit fees in
view that the operations are slightly reduced i.e. sugar crushed per ton is reduced. Further
comparison is made within the industry regarding the audit fees.
In this regard code of ethics states that auditor should not accept fees lower than what previous
auditors have charged. However, But there is nothing in the Code of Ethics regarding change in
audit fee by the existing auditors
SO – VOLUME VII
2.4 The minimum fee prescribed by the ATR-14 should remain same even in case of joint audits. In
this case it depends on the work each auditor undertakes and fees should be shared accordingly.
2.13 If the auditor resigns from being the auditor of the company, not because of the pressure
from management of any sort, and a new auditor is appointed in its place, will the professional fees
of the new auditor if less than the preceding auditor, come in the sphere of undercutting? It is
pertinent to mention here that all these proceedings have occurred before the annual general
meeting of the company. (This is regarded as undercutting unless scope and quantum differs
materially).
SO – Volume VIII
2.8 ATR 14 does not apply to cost audits.
RELEVANT ICAP ATRs
ATR 16
A member of the Institute in practice shall be deemed to be guilty of professional misconduct, if he
accepts the appointment as auditor of an entity in case the undisputed audit fee of another
Chartered Accountant for carrying out the statutory audit under Companies Ordinance, 1984 or
under other statutes has not been paid. Undisputed audit fee means the amount which has been
agreed to and provided for in the financial statements.

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ATR 14
Firms are required to follow the rates for the assurance team as mentioned in ATR 14 for purpose
of quoting fees to the clients, mostly in case of tenders / submission of proposals. Further,
minimum threshold of audit fee based on turnover is stipulated for SME, MSE, ESE and Listed
entities.
ATR 13
An auditor cannot held books of accounts of the client for the recovery of fees / other expenses in
case auditors do not have lien on such books of accounts. Accordingly, legal advice should be
sought for the recovery of outstanding amounts.

SEC 430 & 907 ACTUAL OR THREATENED LITIGATION

▪ When litigation with an audit client occurs, or appears likely, self-interest and intimidation
threats are created.
▪ Such adversarial positions might affect management’s willingness to make complete
disclosures.
▪ Factors that are relevant in evaluating the level of such threats include:
o The materiality of the litigation.
o Whether the litigation relates to a prior audit engagement.
Action:
▪ If the litigation involves an audit team member, example action is removing that individual
from the audit team.
▪ An example of an action that might be a safeguard to address such threats is to have an
appropriate reviewer review the work performed.

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SEC 511, SEC 911 LOANS AND GUARANTEES

(For audit/ review and other assurance engagements)

BANKS, BROKERAGE HOUSE & OTHER THAN BANKS i.e. COMPANIES

SIMILAR INSTITUTIONS

TO FIRM & AST, Immediate FM NOT under

normal lending conditions. Threat is so
significant that no safeguards available.

1. TO FIRM 1. TO / FROM FIRM & AST, IMD FM

Self-interest exists if the transaction is No safeguards available unless amount is

made under normal lending procedures, immaterial to both.
T&C and the amount material to either
party.
Apply safeguards.

2. TO AST OR IMMEDIATE FAMILY

No threats if the transaction is made under

normal lending procedures.

NOTE:

In case of an audit/ review engagements, requirements also apply to network firms.

In determining materiality to an individual, the combined net worth of the individual and
the individual’s IMF may be taken into account.

PROVISIONS OF COMPANIES ACT 2017

Section 247 (3) (d) do not allow a firm to be auditors of the Company if it is indebted to the
company. However, it also states that firm shall not be deemed to be indebted to the
company if: (a) sum of money exceeding PKR 1,000,000 to a credit card issuer; or (b) a sum
to a utility company in form of unpaid dues for a period not exceeding 90 days.
Section 254 (3) (C) do not allow person to be auditors of the Company where the person
has given a guarantee or security in connection with indebtedness of third person to the
companyother thanin ordinary course of business

Safeguard: Having the work reviewed by an appropriate reviewer, who is not an audit team
member, from a network firm that is not a beneficiary of the loan.

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2.10 SELECTED OPINION – VOLUME VII

It sometimes happens that a partner of audit firm or the firm itself is engaged in some
business dealing with a company for whom the firm is also auditor. Examples are: (a)
obtaining vehicles on leases, (b) operating a bank account and (c) obtaining share brokerage
services by one of the partners of the firm. These transactions may be in normal course of
business and are arms length transaction. Whether the above can be called “indebtedness”
to the Company and hit from the provision of sub-section 3(d) of section 254 of the
Companies Ordinance, 1984?
Opinion:
The instances mentioned above do not fall within the purview of section 254 of the
Companies Ordinance, 1984, as these are from banks and in the normal course of business as
per code of ethics requirements.

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SEC 520 & 920 - CLOSE BUSINESS RELATIONS WITH ASSURANCE CLIENT
Example of close business relations described by the code:
1) Material financial interest in a joint venture with: (a) Assurance client or (b) Controlling
owner, director, officer or senior managerial employees.
2) Arrangements to combine services or products of the firm with that of the assurance client
and to market the package with reference to both parties.
3) Distribution or marketing arrangements under which the firm acts as a distributor or
marketer of the assurance client’s products or services, or vice versa.

(A) No close business relationship between:

- Firm, assurance team member (network firm incase of audit/ review client), and
- assurance client or its management
Unless
- the financial interest is immaterial and
- the relationship is clearly insignificant to the firm, assurance team member, the
assurance client, its management,
no safeguards could reduce the threat to an acceptable level.

(B) Common Interest in closely held entities (C) Buying Good/ services
Business relationships involving an interest Purchase of goods and services from
held by - an assurance client
- the Firm, Network firm or AST or their - by the firm, member of AST,
immediate family in a closely held immediate FM
entity when would not generally create a threat to
- the audit client or a director or officer, independence, if
or any group thereof, also has an - the transaction is in the normal
interest in that entity, course of business and
creates threats, - on an arm’s length basis.
unless: Magnitude of transaction may create Self
- business relationship is insignificant, interest threat.
- interest is immaterial to investors, and Actions: Eliminate/ reduce or remove
- the interests does not give either one
the control over the entity.

Section 247 (4) (f) do not allow a person to be auditors of the Company where, a person or a firm,
has business relationship other than in the ordinary course.

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SEC 521 & 921 FAMILY AND PERSONAL RELATIONS

Relationships between Director, Officer or Employee in a position to exert director and significant
influence over SMI or SM, may create self-interest, familiarity and intimidation threats.
(1) Immediate family (2) Close family (3) One having (4) Family &
close relation Personal relations
of other partners
/ employees

SMI SM SMI SM
Threats may be Threats may be
created depends created depends
upon the relation. upon the relation.
AST is responsible Other partners &
to identify such employees are
Eliminate Safeguards Safeguards Safeguards
persons and if responsible to
threat there there there
threats there, identify such
(presumably) (presumably)
apply relevant persons and if
safeguards. threats there,
apply relevant
safeguards.

Consider the following general rules in all of the above:

1- Position of the person in the assurance client and assigned responsibilities on the assurance
client
2- Position of the member of AST and assigned responsibilities on the assurance engagement
3- Closeness of the relationship between above two.

Actions:
1. Remove individual from team
2. Structure the responsibilities in a way that the team member does not deal with matters in
family/friend’s responsibilities.
3. Having an appropriate reviewer perform review

Inadvertent violation
In case of inadvertent violation, follow the general rules in accordance with the firm’s established
policies.
CCG: No listed company shall appoint a person as an external auditor or a person involved in the
audit of a listed company who is a close relative, i.e., spouse, parents, dependents and non-
dependent children, of the CEO, the CFO, an internal auditor or a director of the listed company.

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Section 247 (3) (C) do not allow person to be auditors of the Company where the person is the
spouse of a Director of the company;

SEC 522 & 922 RECENT SERVICES WITH AN ASSURANCE CLIENT

Recent services with an assurance client may create self-interest, self-review and familiarity
threats. Assurance team shall not include:
- Former officer, director of assurance client
- Former employee in a position to exert significant influence on subject matter information

During the period Prior to the period E.g. Threats created if a decision
covered by the covered by the made or work performed by
assurance report assurance report individual in the prior period, while
employed, is to be evaluated in the
current period as part of the
current assurance engagement.

Eliminate threat.
Remove the person. Safeguards available. E.g. Having an appropriate reviewer.
Significance depends on:
- Position held with the assurance client;
- Length of time passed since individual left assurance client
- Role the individual plays on the assurance team.

Section 247 (3) (a) do not allow firm to be auditors of the Company where, a person who is, or at
any time during the preceding 3 years was, a Director, Other officer or Employee of the company.

SEC 523 & 923 SERVING AS DIRECTOR OR OFFICER OF AN ASSURANCE CLIENT

1) If partner or employee of firm serves on the board of client, no safeguards are available.
2) If partner or employee of firm serves as company secretary to audit client, no safeguards are
available.
3) If partner or employee of firm serves as company secretary (only for admin work) to client
would not pose any threat if management decisions taken by client.
In case of audit/ review engagement, requirements also apply to network firm.
Section 254 (4) (b) do not allow a person to be auditors of the Company where, a person who is, in
employment of, a Director, Other officer or Employee of the company.

SEC 524 & 924 – EMPLOYMENT WITH AN ASSURANCE CLIENT

If any of the following individuals have been an assurance team member, it might create familiarity
or intimidation threats:
- Former officer, director of assurance client
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- Former employee in a position to exert significant influence on subject matter information

Factors: Depending upon position taken, involvement with audit team, length of time since part of
audit team, former role, etc.
FOR AUDIT / REVIEW (524):
No significant connection to remain between the firm, network firm, and
- Former partner
- Former assurance team member who joined the client as,
o Director or officer
o An employee in a position to exert significant influence on accounting record or FS

Significant connection remains when:

- The individual is not entitled to any benefits or payments from the firm or network firm not
made in accordance with fixed pre-determined arrangements,
- Any amount owed to the individual is not material to the firm, network firm; and
- The individual does not continue to participate (or appear) in the firm's, or network firm’s
business or professional activities.
Actions:
- Modify the plan,
- Assign individuals with sufficient experience,
- having an appropriate reviewer

For Public Interest Entity (R 524.6 - 7)

When KAP or Senior or Managing Partner joins the audit client
- as director of officer, or
- in a position to influence SMI,
independence would be compromised unless:
- In case of KAP, subsequent to the partner ceasing as such,
o the entity had issued audited financial statements covering a period of not less than
12 months and
o the partner was not a member of the audit team with respect to the audit of those
financial statements.
- In case of SP or MP, unless
o twelve months have passed since the individual was the Senior or Managing Partner
(CEO or equivalent) of the firm.

R524.8 As exception, independence is not compromised in above position if as a result of Business

Combination, and:

• the position is taken in contemplation of a business combination.

• all benefits settled in full by firm or network firm (unless as per predetermined
arrangement & amount owed by firm is not material),
• no participation in firms or network firm’s business,

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• firms discusses the position held with TCWG.

Section 247 (3) (b) do not allow a person to be auditors of the Company where, a person who is, in
employment of, a Director, Other officer or Employee of the company.
OTHER ASSURANCE (924):
- A Former partner, or
- A Former assurance team member who joined the client as,
o Director or officer
o An employee in a position to exert significant influence on subject matter
information
shall not continue to participate in firms business of professional activities.
Actions:
- Modify the plan,
- Assign individuals with sufficient experience,
- having an appropriate reviewer,
- amount owed is not material,
- the individual is not entitled to any benefits or payments from the firm or network firm not
made in accordance with fixed pre-determined arrangements

Firm (or network firm, in case of audit/ review) shall have policies requiring member of AST to
notify when entering employment negotiations with client.
Actions: Remove, having a reviewer

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SEC 540 & 940 LONG ASSOCIATION OF SENIOR AST MEMBER WITH CLIENT
ALL ASSURANCE ENGAGEMENTS REQUIREMENTS OF LAWS AND REGULATIONS

Threats: Rotation of auditors

Familiarity threat might be created when It is mandatory that all listed companies in
same individual is long associated with: the financial sector shall change their external
- client auditors every five years:
- its senior management Provided that all inter related companies/
- SM & SMI institutions, engaged in business of providing
Self-interest threat might be created on financial services shall appoint the same firm
concern of losing client. of auditors to conduct the audit of their
Factors/ The significance depends on: accounts.
• Length of time the individual has been a Explanation:- Financial sector, for this
member of AST purpose, means banks, non-banking financial
• Length of relationship companies (NBFCs), modarabas and
• Nature of roles insurance or takaful insurance companies.
• Extent of review and supervision by more
senior people It is mandatory that all listed companies other
• Ability to influence outcome than those in the financial sector shall, at
• Closeness of relationship the minimum, rotate the engagement partner
• Nature, frequency, extent of interaction after every five years:

Actions: Provided that in case the audit firm is a sole

• Rotate the individual proprietorship then after completion of five
• Change the role/ tasks performed years such audit firm shall be changed.
• Having an appropriate reviewer perform
review Requirements of ISQC-1
• Regular internal / external quality reviews Firm should establish policies and procedures:
(a) To reduce the familiarity threat to an
If address to threats only possible via rotation, acceptable level when using the same
then individual cannot be member of AST, senior personnel on an assurance
provide QC or exert direct influence on engagement over a long period of time;
outcome over an appropriate period. and
(b) For audits of listed entities, requiring the
rotation of the engagement partner after
a specified period in compliance with the
Code and national ethical requirements
that are more restrictive.

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Public Interest Entities as per Code OF Ethics

- An individual shall not be a KAP for more than 7 years unless
o law prescribes a shorter period or
o an exemption is provided by independent regulatory authority with specified
requirements
- May extend to 1 more years in rare unforeseen circumstances provided
- Shall serve cooling off period consecutively.
- independence is not compromised.
- When audit client becomes PIE then, if KAP has served for:
o Less than 5 years, then remaining period.
o 6 years or more, then 2 additional years can be served.
- When a firm has only a few people with the necessary expertise on audit of a public interest
entity, rotation of key audit partners may not be an available safeguard. Provided that an
independent regulator allows exemption and specified alternative safeguards which are
applied, such as a regular independent external review.
- The length of time also includes time the individual was KAP at a prior firm.
Cooling off period:
- If served as engagement partner for 7 cumulative years, then cooling off period shall be 5
years
- If served as engagement QC reviewer for 7 cumulative years, then cooling off period shall
be 3 years
- If served in other partner capacity for 7 cumulative years, then cooling off period shall be 2
years
Serving in combination
- Combination of KAP roles and engagement partner as 4 more years cumulatively, then 5
years
- Combination of KAP roles and engagement QC reviewer as 4 more years cumulatively, then
3 years (subject to below condition)
- Combination of engagement partner & engagement QC reviewer role for 4 more years
cumulatively, then
o 5 years cooling off period, incase engagement partner for 3 or more years
o 3 years cooling off period, incase of any other combination
- In all other combinations, 2 years cooling off period.
- If law has established cooling off period shorter than 5 years, then higher of that period or 3
years may be substituted for cooling off period of 5 consecutive years (wherever 5 years is
suggested)

Restrictions during cooling off period

The individual shall not be:
- Engagement team member,
- Consult with team or client
- Be responsible for leading or coordinating
- Undertake any role that may have frequent/ significant interactions,exerti direct influence
on outcome of audit.

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Selected Opinion – Volume IX

In accordance with the Code of Corporate Governance, every listed company is required to
change their auditor (or at least the audit partner) who have been auditing for last five years.
In this regard we request clarification regarding the following years. our firm was a sole
proprietorship upto January 2003 and was converted into partnership. Previously Mr. A was
signing the accounts, but since the partnership I am the partner of all listed companies.
Q. 1 Will our firm fall within the requirement of rotation of auditor by December 2003.
Q. 2 What is the status of two firms, which are merged?
Q. 3 Is it the name of the audit firm that mattes or the structure of firm i.e. sole
proprietorship / partnership. At the time of entering into partnership we were
considering the change of name of the firm, but the same was deferred and we are now
considering the change in the near future.
Q. 4 If we plan to change the name of our firm, what will be the status of our firm in respect
of the following:-
a) Will be QCR (satisfactory status) already issued to our firm remain valid.
b) Will this change of name cause casual vacancy in the office of the auditor of listed and
unlisted companies or will we be required to carry the old name upto the AGM of the
Companies and in the AGM the new name will be proposed.
c) Will the requirement of rotation of auditor (as per the listing rules) apply retrospectively
to the new named firm.
Opinion:
The appropriate Committee of the Institute would like state that the purpose of introduction
of rotation clause in the Code of Corporate Governance was to bring more transparency and
independence in audit and this objective would not be achieved if firms change their names
or merge with any other firm or do few cosmetic changes just to avoid rotation.
Therefore the Committee is of the opinion that mere change of firm’s name or conversion of
sole proprietorship into partnership or merger may not be treated as a new firm with regards
to the applicability of rotation of auditors.
Following are the responses to the queries you have raised:-
1. Yes, for the reason we have mentioned above;
2. Though the merger of two firms will constitute a new firm, for rotation purposes it would
not change the status as it was before merger. If two firms A & B merge into AB & Co. and
if A or B were due for rotation then AB will also be due for rotation.
3. Neither the name nor the conversion from sole proprietorship to partnership will make
any difference for rotation purpose;
4. a. Your firm will not be subject to a fresh Quality Control Review (QCR);
b. You will carry your old name upto the AGM of companies when the new name may be
proposed. Please refer section 47 of the Partnership Act, 1932 as quoted below:

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47. Continuing authority of partners for purpose of winding-up. – After the dissolution of
a firm the authority of each partner to bin the firm, and the other mutual rights and
obligations of the partners, continue notwithstanding the dissolution, so far as may be
necessary to windup the affairs of the firm and to complete transactions begun but
unfinished at the time of the dissolution, but not otherwise.

SEC 524 TEMPORARY PERONNEL ASSIGNMENTS

The loan of personnel to an audit client might create a self-review, advocacy or familiarity threat.
When familiarity and advocacy threats are created by the loan of personnel by a firm or a network
firm to an audit client, such that the firm or the network firm becomes too closely aligned with the
views and interests of management, safeguards are often not available.
A firm or network firm shall not loan personnel to an audit client unless:
(a) provided for a short period of time;
(b) The personnel are not involved in providing prohibited non-assurance services; and
(c) The personnel do not assume management responsibilities and the audit client is responsible
for directing and supervising the activities of the personnel.
Actions:
- Conducting an additional review
- Not including the loaned personnel as an audit team member
- Not giving the loaned personnel audit responsibility for any function already performed

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SEC 510 & 910 FINANCIAL INTEREST SUMMARY

Holding FI in client might create self-interest threat
Factors:
(a) The role of the person holding the financial interest,
(b) Whether the financial interest is Direct or Indirect, and
(c) The materiality of the financial interest.
FOR AUDIT/ REVIEW (510)
FI held by persons
If following persons owns DFI or MIDFI as purchased
a) Firm, network firm, members of audit team & Immediate Family
b) Other partners & immediate family, where lead engagement partner practices
c) Partners & Managerial employee provides non-audit services and immediate family

then no safeguards available. Eliminate the threat.

However, as an exception, an IMF of (b) and (c) may hold DFI of MIDFI, if as a result of employment
rights and should be disposed-off ASAP.
FI held as trustees
If above persons owns as a trustee then only allowed in case following conditions meet:
- Persons not beneficiary of trust,
- Not material to trust,
- No SI over client by trust,
- Persons investing cannot exercise SI over investment decision involving interest.
FI in entity controlling client
Firm, network firm, members of audit team & Immediate family owns DFI OR MIDFI in an entity
- which controls audit client and
- client is material to entity.
No safeguards available. Eliminate the threat.
FI common with client
Firm, network firm, members of audit team or IMF shall not hold interest in entity where audit
client also owns interest unless
- interest is immaterial to both, and
- client cannot exercise SI.
Before joining the audit team, the interest shall be disposed off of enough of it to render the
remaining as not material.

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FI received unintentionally
Firm, network firm, a partner or employee of firm, or its IMF receives a DFI or MIDFI as a result of
inheritance / gift or merger and that interest would not have been permitted then:
- If received by firm, network firm, audit team member, or IMF, the FI shall be disposed of
immediately or enough of it to render it as not material.
- If received by an individual who is not an audit team member, or IMF, FI shall, as soon as
possible, be disposed of or enough of it to render it as not material. Pending the disposal
shall also address the threat.

FI – Other circumstances
Immediate family member (IMF)
Self-interest, familiarity, intimidation threat created if audit team member or IMF, firm, network
firm, owns interest in entity where directors or officers or controlling owner of client also owns
interest.
Threat depends upon:
- Role on the audit team;
- ownership is closely or widely held;
- Interest gives the investor the ability to control or SI the entity; and
- Materiality of interest.

Close family member (CFM)

If an audit team member knows that a close family member has DFI of MIDFI in audit client. Threat
depends upon:
- Nature of relationship;
- DFI of IDFI;
- Materiality to CFM

Other individuals
If an audit team member knows that
- a partner, professional employees of firm, network firm or their IMF (not already covered)
or
- individuals with close relationship with audit team members holds a financial interest in
audit client.

Action:
- remove individual,
- having an appropriate reviewer
- Exclude individual from decision making concerning audit

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Retirement benefit plan

Self-interest threat may be created if firm’s retirement benefit plan owns DFI or MIDFI in an audit
client. Safeguards are there. Threat to evaluate.
FOR OTHER ASSURANCE (910)
FI held by persons
If following persons owns DFI or MIDFI as purchased by Firm, members of AST & IMF then no
safeguards available. Eliminate the threat.

FI held as trustees
If above persons owns FI as a trustee, then only allowed in case following conditions meet:
- Persons not beneficiary of trust,
- Not material to trust,
- No SI over client by trust,
- Persons investing cannot exercise SI over investment decision involving interest.

FI received unintentionally
Firm, AST, or its IMF receives a DFI or MIDFI as a result of inheritance / gift or merger and that
interest would not have been permitted then:
- If received by firm, the FI shall be disposed of immediately or enough of it to render it as
not material.
- If received by AST or IMF, FI shall, as soon as possible, be disposed of or enough of it to
render it as not material.

FI – Other circumstances
Close family member (CFM)
Self-interest threat might be created, if an audit team member knows that a close family member
has DFI of MIDFI in audit client. Threat depends upon:
- Nature of relationship;
- DFI of IDFI;
- Materiality to CFM

Other individuals
Self-interest threat might be created, if an audit team member knows that
- a partner, professional employees of firm, network firm or their IMF (not already covered)
or
- individuals with close relationship with audit team members holds a financial interest in
audit client.

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Example actions:
- remove individual,
- having an appropriate reviewer
- Exclude individual from decision making concerning audit
Retirement benefit plan
Self-interest threat may be created if firm’s retirement benefit plan owns DFI or MIDFI in an audit
client.
Safeguards are there. Threat to evaluate.
RELEVANT PROVISIONS OF COMPANIES ACT 2017
Section 247 (3) (j) do not allow person to be auditors of the Company where, persons or his spouse
or minor children, or in case of a firm, all partners of such firm holds any share of an audit client or
any of its associated companies.
If shares held prior to appointment, disclose on appointment and disinvest within 90 days of such
appointment.

OTHER DISQUALIFICATIONS UNDER Sec 247 of COMPANIES ACT 2017

- A body corporate
- Convicted by a court for fraud within previous 10 years
- Ineligible to act under ICAP Code of Ethics
- A person disqualified if he is ineligible for appointment for the entity’s holding company,
subsidiary or holding’s subsidiary.

CHARTERED ACCOUNTANTS’ ORDINANCE1961

DISABILITIES UNDER CAO 1961:
(i) has not attained the age of 21 years; or
(ii) is of unsound mind so adjudged by a competent Court; or
(iii)is an undischarged insolvent; or
(iv) having been discharged of insolvency, has not obtained from the Court a certificate stating
that his insolvency was caused by misfortune without any misconduct on his part; or
(v) has been convicted by a competent Court, whether within or without Pakistan, of an
offence involving moral turpitude and punishable with transportation or imprisonment or
of an offence, not of a technical nature, committed by him in his professional capacity
unless in respect of the offence committed he has either been granted a pardon or, on an
application made by him in this behalf, the FG has, by an order in writing, removed the
disability; or
(vi) has been removed from the membership of the Institute on being found on inquiry to have
been guilty of such professional or other misconduct.
Member can have his name in register after the expiry of such period.

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PROFESSIONAL MISCONDUCT
In relation to chartered accountants in practice
A Chartered Accountant in practice shall be deemed to be guilty of professional misconduct, if he-
(1) allows any person to practice in his name as a chartered accountant, unless such person is also
a chartered accountant in practice and is in partnership with, or employed by, him;

(2) pays or allows or agrees to pay or allow, directly or indirectly, any share, commission or
brokerage or the fees or profits of his professional business to any person other than a member of
the Institute or a partner or a retired partner or the legal representative of a deceased partner.

Explanation:- In this clause, "partner" includes a person residing outside Pakistan with whom a
Chartered Accountant in practice has entered into partnership which is not in contravention of
clause (4) of this part;

(3) accepts or agrees to accept any part of the profits of the professional work of a lawyer,
auctioneer, broker, or other agent who is not a member of the Institute.

(4) Places his professional service at the disposal of, or enters into partnership with, an unqualified
person in a position to obtain business of the nature in which chartered accountants engage by
means which are not open to a member of the Institute:
Provided that this paragraph shall not be construed as prohibiting a member from practicing in a
country outside Pakistan in association with a person who is entitled under the laws in force in that
country to perform functions similar to those of a member of the. Institute is entitled to perform in
Pakistan:

(5) Solicits clients for professional work either directly or indirectly by circular, advertisement,
personal communication or interview or by any other means;

(6) Advertises his professional attainments or services, or uses any designation or expression other
than chartered accountant on professional documents. Visiting cards, letter head or sign boards,
unless it be a degree of a University established by law in Pakistan or recognized by the Federal
Government or the Council;

(7) Accepts a position as auditor previously held by another member of the Institute without first
communicating with him in writing;

(8) accepts appointments as auditor of a company without first ascertaining from it whether the
requirements of sub-section (6) of section 144 of the Companies Act, 1913 (VII of 1913), in respect
of such appointment have been duly complied with;

(9) charges or offers to charge, accepts or offers to accept in respect of any professional
employment fees which are based on a percentage of profits or which are contingent upon the
findings or results of such employment except in cases which are permitted under any law for the
time being in force or by an order of the Government;

(10) Engages in any business or occupation other than the profession of Chartered Accountants
unless permitted by the Council so to engage;

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Provided that nothing contained herein shall disentitle a Chartered Accountant from being a
director of a company unless he or any of his partners is interested in such company as an auditor;
(11) accepts a position as auditor previously held by some other Chartered Accountant in such
conditions as to constitute undercutting;

(12) allows a person not being a member of the Institute or a member not being his partner to sign
on his behalf or on behalf of his firm; any balance sheet, profit and loss account, report or financial
statement; or

(13) gives estimates of future profits for publication in a prospectus or otherwise or certifies for
publication the statements of average profits over a period of two years or more without, at the
same time, stating the profits or losses for each year separately.
In relation to members engaged in management consultancy
A member of Institute engaged in management consultancy shall be deemed to be guilty of
professional misconduct, if he-
(1) advertises or solicits for work or issues any circular, calendar or publicity material;

(2) issues brochures, except to existing clients or in response to an unsolicited request;

(3) uses designatory letters indicating qualifications of the directors and members of the company
on letter head, note-papers, or professional cards excepts as provided in clause (6) of Part 1 of this
Schedule;

(4) refers to associate firms of Chartered Accountants on his letter head or professional cards or
announcements;
(5) adopts a name or associates himself as a partner or director of a firm or a company whose
name is indicative of its activities;
(6) uses the term chartered accountants for his management consultancy firm or company;
(7) shares profits of remuneration in a manner contrary to clauses (2) and (3) of Part 1 of this
Schedule, except when he associates with non- members as
stated in clause (10) of this part;
(8) or his partner in any firm accepts auditing, taxation, or other conventional accounting work
from any client introduced to him for management consultancy services by the client's own
professional accountant;

(9) uses the term "Management Consultant(s)" except in respect of a company engaged in
management consultancy field;

(10) associates with non-members for the rendering of various management services except as
long as such non-member observes the bye-laws and code of professional ethics of the Institute;

(11) does not communicate with the existing professional accountant or consultant, if a member of
the Institute, informing him of the special work he has been asked to undertake in the event of an
introduction for management consultancy work other than through the existing professional
accountant; or

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(12) Under the guise or through the medium of a company or firm does anything which he is not
allowed to do as an individual.

In relation to members of the Institute in service

A member of the Institute (other than a member in practice) shall be deemed to be guilty of
professional misconduct, if he, being an employee of any company, firm or person:
(1) pays or allows or agrees to pay directly or indirectly to any person any share in the emoluments
of the employment undertaken by the member;
(2) accepts or agrees to accept any part of fees, profits or gains from a lawyer, chartered
accountant or broker engaged by such company, firm or person or agent or customer of such
company, firm or person by way of commission or gratification; or
(3) discloses confidential information acquired in the course of his employment except as and when
required by law or except as permitted by the employer

In relation to chartered accountants in practice requiring action by a High Court

(1) discloses information without the consent of his client or otherwise than as required by any law
for the time being in force;
(2) certifies or submits in his name or in the name of his firm a report of examination of FS unless
the examination of such statements and the related records has been made by him or by a partner
or an employee in his firm or by another chartered accountant in practice;
(3) permits his name or the name of his firm to be used in connection with any estimates of
earnings contingent upon future transactions in a manner which may lead to the belief that he
vouches for the accuracy of the forecast;
(4) expresses his opinion on financial statements of any business or any enterprise in which he, his
firm or a partner in his firm has a substantial interest, unless he discloses his interest in his report;
(5) fails to disclose a material fact known to him which is not disclosed in a financial statement, but
disclosure of which is necessary to ensure that the financial statement is not misleading;
(6) fails to report a material mis-statement known to him to appear in a financial statement with
which he is concerned in a professional capacity;
(7) is grossly negligent in the conduct of his professional duties;
(8) fails to obtain sufficient information to warrant the expression of an opinion or his exceptions
are sufficiently material to negate the expression of an opinion; or
(9) fails to keep moneys of his client in a separate banking account or fails to use such moneys for
purposes for which they are intended.

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In relation to members engaged in management consultancy requiring action by a High Court

(1) discloses information acquired in the course of his professional engagements to any person
other than his client, without the consent of his client or otherwise than as required by any law for
the time being in force;
(2) is grossly negligent in the conduct of his professional duties; or
(3) fails to keep moneys of his client in a separate banking account or fails to use such moneys for
purposes to which they are intended.
In relation to the students of the Institute
A student of the Institute shall be deemed to be guilty of professional misconduct if he-
(1) contravenes any of the provisions of the Ordinance or the bye-laws made there under;
(2) does not supply the information called for by the Institute;
(3) does not comply with any requirements which he is asked by the Institute to comply with;
(4) does not comply with any of the directives issued by the Council or any of its committees;
(5) discloses confidential information acquired in the course of his training

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5.43 IMPACT OF PERFORMANCE OF NON-ASSURANCE SERVICES ON

INDEPENDENCE:
Code of Corporate Governance:
No listed company shall appoint its auditors to provide services in addition to audit except in
accordance with the regulations and shall require the auditors to observe applicable IFAC
guidelines in this regard and shall ensure that the auditors do not perform management functions
or make management decisions, responsibility for which remains with the Board of Directors and
management of the listed company.
Interpretational Guidance & Code of Ethics:

Type of non- Independence Would NOT Be Impaired Independence Would Be Impaired

assurance
services

Bookkeeping Routine or Mechanical nature Tasks Management Tasks

• Record transactions for which • Determine or change journal
management has determined or approved entries, account codings or
the appropriate account classification, or classification for transactions, or
post coded transactions to a client's general other accounting records without
ledger. obtaining client approval.
• Prepare financial statements based on • Authorize or approve
information in the trial balance. transactions.
• Post client-approved entries to a client's • Prepare source documents.
trial balance.
• Make changes to source
• Propose standard, adjusting, or correcting documents without client approval.
journal entries or other changes affecting
the financial statements to the client
provided the client reviews the entries and
the member is satisfied that management
understands the nature of the proposed
entries and the impact the entries have on
the financial statements.

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Type of non- Independence Would NOT Be Impaired Independence Would Be Impaired

assurance
services

Non tax • Using payroll time records provided and • Accept responsibility to authorize
approved by the client, generate unsigned payment of client funds,
Disbursement
checks, or process client's payroll. electronically or otherwise, except
as specifically provided for with
• Transmit client-approved payroll or other
respect to electronic payroll tax
disbursement information to a financial
payments.
institution provided the client has authorized
the member to make the transmission and • Accept responsibility to sign or
has made arrangements for the financial cosign client checks, even if only in
institution to limit the corresponding emergency situations.
• Maintain a client's bank account

individual payments as to amount and or otherwise have custody of a

payee. In addition, once transmitted, the client's funds or make credit or
client must authorize the financial institution banking decisions for the client.
to process the information.
• Approve vendor invoices

Investment— • Recommend the allocation of funds that a • Make investment decisions on

client should invest in various asset classes, behalf of client management or
advisory or
depending upon the client's desired rate of otherwise have discretionary
management return, risk tolerance, etc. authority over a client's
investments.
• Perform recordkeeping and reporting of
client's portfolio balances including • Execute a transaction to buy or
providing a comparative analysis of the sell a client's investment.
client's investments to third-party
• Have custody of client assets,
benchmarks.
such as taking temporary
• Review the manner in which a client's possession of securities purchased
portfolio is being managed by investment by a client.
account managers, including determining
whether the managers are (1) following the
guidelines of the client's investment policy
statement; (2) meeting the client's
investment objectives; and (3)conforming to
the client's stated investment styles.

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Type of non- Independence Would NOT Be Impaired Independence Would Be Impaired

assurance
services

• Transmit a client's investment selection to

a broker-dealer or equivalent provided the
client has authorized the broker-dealer or
equivalent to execute the transaction.

Corporate • Assist in developing corporate strategies. • Commit the client to the terms of
finance— a transaction or consummate a
• Assist in identifying or introducing the
transaction on behalf of the client.
consulting or client to possible sources of capital that
meet the client's specifications or criteria. • Act as a promoter, underwriter,
advisory
broker-dealer, or guarantor of
• Assist in analyzing the effects of proposed
client securities, or distributor of
transactions including providing advice to a
private placement memoranda or
client during negotiations with potential
offering documents.
buyers, sellers, or capital sources.
• Maintain custody of client
• Assist in drafting an offering document or
securities.
memorandum.
• Participate in transaction negotiations in
an advisory capacity.
• Be named as a financial adviser in a client's
private placement memoranda or offering
documents

Executive or • Recommend a position description or • Commit the client to employee

candidate specifications. compensation or benefit
employee
arrangements.
search • Solicit and perform screening of candidates
and recommend qualified candidates to a • Hire or terminate client
client based on the client-approved criteria employees.
(e.g., required skills/ experience).
•Acting as a negotiator on the
• Participate in employee hiring or client's behalf
compensation discussions in an advisory
capacity.

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Type of non- Independence Would NOT Be Impaired Independence Would Be Impaired

assurance
services

Business risk • Provide assistance in assessing the client's • Make or approve business risk
business risks and control processes. decisions.
consulting
• Recommend a plan for making • Present business risk
improvements to a client's control processes considerations to the board or
and assist in implementing these others on behalf of management.
improvements.

Information • Install or integrate a client's financial • Design or develop a client's

information system that was not designed or financial information system.
systems—
developed by the member (e.g., an off-the-
design, • Make other than insignificant
shelf accounting package).
modifications to source code
installation or
• Assist in setting up the client's chart of underlying a client's existing
integration accounts and financial statement format financial information system.
with respect to the client's financial
• Supervise client personnel in the
information system.
daily operation of a client's
• Design, develop, install, or integrate a information system.
client's information system that is unrelated
• Operate a client's local area
to the client's financial statements or
network (LAN) system.
accounting records or does not form
significant part of FS.
• Provide training and instruction to client
employees on information and control
system.

Internal audit • Client designates an appropriate and • Setting internal audit policies or
assistance competent resource to be responsible strategic direction;
• Client's management or those charged with • Directing and taking
governance reviews, responsibility;
• assesses and approves the scope, risk and • Deciding on recommendations;
frequency of the internal audit services; • Reporting the results to TCWG on
• Client's management evaluates adequacy of behalf of management;
audit services and the findings; • Performing procedures that form
• Client's management evaluates and part of the internal control, such
determines which recommendations as reviewing and approving
changes to employee data access;

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Type of non- Independence Would NOT Be Impaired Independence Would Be Impaired

assurance
services

Internal audit • resulting from internal audit services to • Taking responsibility for
assistance – implement; and designing, implementing and
cont’d • Client's management reports to TCWG. maintaining controls;
• Performing outsourced services,
comprising substantial portion of
internal audit
Benefit plan • Communicate summary plan data to plan • Make policy decisions on behalf
trustee. of client management.
Administrati-
on • Advise client management regarding the • When dealing with plan
application or impact of provisions of the participants, interpret the plan
plan document. document on behalf of
management without first
• Process transactions (e.g., investment/
obtaining management's
benefit elections or increase/decrease
concurrence.
contributions to the plan; data entry;
participant confirmations; and processing of • Make disbursements on behalf of
distributions and loans) initiated by plan the plan.
participants through the member's
• Have custody of assets of a plan.
electronic medium, such as an interactive
voice response system or Internet
connection or other media.
• Prepare account valuations for plan
participants using data collected through the
member's electronic or other media.
• Prepare and transmit participant
statements to plan participants based on
data collected through the member's
electronic or other medium.

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SUMMARY OF NON ASSURANCE SERVICES TO AN AUDIT CLIENT:

Please read below with my lectures and make appropriate notes.
Non-assurance Services Public Interest Entities Not Public Interest Entities
Accounting / bookkeeping Creates Self Review threat.
Firm/ Network firm shall not Shall not provide services,
provide accounting and unless:
bookkeeping services (a) of a routine or mechanical
including preparing financial nature; and
statements. (b) the firm addresses threats
It may provide services of a created that are not at an
routine or mechanical nature acceptable level.
for divisions or related entities
(RE) if the personnel providing
the services are not audit
team members and
- relevant divisions or RE are
collectively immaterial to FS;
or
- the service relates to matters
that are collectively
immaterial to the
FS of the division or RE.
Administrative Services Clerical nature. Does not usually create threat.
Valuation services Creates advocacy, self-review threat.

Material effect on FS 1. Material effect on FS, and

2. Significant degree of
subjectivity
No safeguards No safeguards
Taxation services Creates self-interest and advocacy threats, depending upon,
judgment, complexity, role of firm, level of expertise of clients
personnel, external review by tax auth.
- Tax Return Preparation Does not usually create a threat.
- Tax Calculations for No safeguards for material tax Threat to be evaluated.
Accounting Entries calculations. Safeguards are there.
- Tax Planning and Other Self-review or advocacy threat created especially when advice
advisory affects FS.
Where 1) effectiveness of advice depends upon a particular
treatment in FS, and 2) audit team has reasonable doubt, and
3) outcome having a material effect on FS then No safeguards
but to refuse.

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Non-assurance Services Public Interest Entities Not Public Interest Entities

- Tax services with Above requirements of valuation services apply.
valuations
- Assistance in the Might create self-review or advocacy threat. Firm/ network
Resolution of Tax firm shall not provide services to an audit client if:
Disputes (a) involve acting as an advocate for the audit client before a
public tribunal/ court in the resolution of a tax matter; and
(b) the amounts involved are material to FS

Internal audit services When providing IA services, the firm shall be satisfied that:
- the client designates competent resource
- Management or TCWG approves scope, risk, frequency
of IA services
- Management evaluates adequacy of IA service and
findings
- Management evaluates recommendations and
manages implementation process
- Management reports findings and recommendations to
TCWG
No IA services in relations to: Self-review threat created due
1. Significant part of the to possibility on relying on
internal controls own work without appropriate
2. Financial accounting evaluation. Threat to evaluate.
systems are significant to FS Factors: Materiality of related
3. Amounts/ disclosure amount, ROMM of related
material to FS assertion, degree of reliance.
When providing IS services, the firm shall be satisfied that:
- the client acknowledges responsibility
- the client designates competent resource
- client makes all design/ implementation decisions
- Management evaluates adequacy of results of design/
implementation
- Management is resp for operating system and for data
it uses/ generates
IS Systems If IT systems form significant If IT systems form significant
part of ICFR or generate info part of ICFR or generate info
significant to accounting significant to accounting
records. records.
No safeguards available. Safeguards are there.
Litigation support services May create advocacy or self-review threat. Evaluate.
For services involving valuation, relevant requirements apply.

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Non-assurance Services Public Interest Entities Not Public Interest Entities

Legal services May create advocacy or self-review threat.
a) Appointment of any member of the firm as General
Counsel for legal affairs of an audit client. No safeguards
available.
b) Acting in advocacy role involving material amounts. No
safeguards available.
Recruitment Services Creates self-interest, familiarity or intimidation threats.
Evaluate the situation with no management role.
When providing RS, the firm shall be satisfied that:
- the client assigns responsibility to a competent
resource
- client makes all management decisions wrt hiring
process, including determining suitability, employment
terms, selecting suitable candidates.

Shall not act as a negotiator on client’s behalf

Shall not provide following services w.r.t.
• Seeking out candidates; and
• Undertaking reference checks
- a director or officer
- a senior position having SI over FS
Corporate Advisory Services Self-review or advocacy threat created especially when advice
affects FS.
Shall not provide to an audit client that involve promoting,
dealing in, or underwriting the client’s shares.

Where effectiveness of advice depends upon a particular

treatment in FS, and
1) audit team has reasonable doubt, and
2) outcome having a material effect on FS then No safeguards
but to refuse.

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PROHIBITIONS APPLICABLE TO AUDITS OF PUBLIC INTEREST ENTITIES (PIE)

A. Prohibited Non-Assurance Services
i) Prohibited Without Regard to Materiality
ii) Prohibited if material to the financial statements
B. Prohibited Interests and Relationships

A) Prohibited Non-Assurance Services

i) Without Regard to Materiality
▪ Assuming a management responsibility
▪ Serving as General Counsel
▪ Accounting services*
▪ Bookkeeping services*
▪ Payroll services*
▪ Preparing the financial statements and related financial information*
▪ Promoting, dealing in, or underwriting client shares
▪ Negotiating for the client
▪ Recruiting directors/officers, or senior management who will have significant influence over
accounting records or financial statements
▪ Evaluating or compensating a key audit partner based on that partner’s success in selling
non-assurance services to the partner’s audit client

* Can be provided to divisions/related entities if routine/mechanical, or in an emergency, if

specified conditions are met.

ii) Prohibited Non-Assurance Services - if material to the financial statements:

▪ Valuation services
▪ Calculations of current/deferred taxes
▪ Tax or corporate finance advice that depends on a particular accounting treatment/financial
statement presentation with respect to which there is reasonable doubt as to its
appropriateness.
▪ Acting as an advocate before a public tribunal or court to resolve a tax matter
▪ Internal audit services relating to internal controls over financial reporting, financial
accounting systems, or financial statement amounts/disclosures
▪ Designing/implementing financial reporting IT systems
▪ Estimating damages or other amounts as part of litigation support services.
▪ Acting as an advocate to resolve a dispute

B) Prohibited Interests and Relationships

▪ Financial interests in the client.
▪ Financial interests in an entity in which the client has a material interest, and can
significantly influence.
▪ Loans from a client lending institution that have not been made under normal lending
procedures, terms, and conditions, or from a client that is not a lending institution and that
are material.
▪ Material loans to a client.
▪ Deposits with a client not held under normal terms.

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▪ Close business relationships with a client that are significant or entail a material financial
interest
▪ Audit team members whose immediate family member is a client director/officer, or an
employee able to significantly influence the accounting records or financial statements
▪ Former audit team members or a partner joining the client if significant connections with
the firm remain.
▪ A key audit partner or senior/managing partner joining a client before a defined period of
time
▪ A key audit partner serving for more than 7 years (5 years for listed).
▪ An individual being on the audit team if, during the period covered by the audit, the person
was a client director/officer, or an employee able to significantly influence the accounting
records or financial statements
▪ Partners/employees serving as a client director or officer
▪ Accepting gifts or hospitality from the client that are other than trivial and inconsequential

LISTING REGULATIONS OF KSE:

However, local laws in Pakistan prevail over the code of ethics, which also prohibits the auditors to
perform other services which are as follows:

31-C SERVICES PROHIBITED UNDER LISTING REGULATION OF KARACHI STOCK EXCHANGE

The Regulations shall apply to all companies, and securities applying for listing and those listed on
the Exchange.
(i) Non Listed company shall, appoint or continue to retain any person as an auditor who is
engaged by the company to provide services that are prohibited.
(ii) A listed company shall also not appoint or continue to retain any person as an auditor, if a
person “associated with the auditor” is, or has been, at any time during the preceding three
months engaged as a consultant or advisor or to provide any services that are prohibited.

Explanation:
For the purposes of this regulation, the expression “associated with” shall mean any person
associated with the auditor, if the person:-
(a) is a partner in a firm, or is a director in a company, or holds or controls shares carrying more
than twenty percent of the voting power in accompany, and the auditor is also partner of that
firm, or is a director in that company or so holds or controls shares in such company; or
(b) is a company or body corporate in which the auditor is a director or holds or controls shares
carrying more than twenty percent of the voting power in that company or has other interest
to that extent.

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Explanation:
For the purposes of this regulation the services that are prohibited shall mean the following:-
1. Preparing financial statements, accounting records and accounting services;
2. Financial information technology system design and implement, significant to overall financial
statements;
3. Appraisal or valuation services for material items of financial statements;
4. Acting as an Appointed Actuary within the meaning of the term defined by the Insurance
Ordinance, 2000;
5. Actuarial advice and reviews in respect of provisioning and loss assessments for an insurance
entity;
6. Internal audit services related to internal accounting controls, financial systems or financial
statements;
7. Human resource services relating to:-
i. Executive recruitment
ii. Work performed (including secondments) where management decision will be made on
behalf of a listed audit client;
8. Legal Services;
9. Management functions or decision;
10. Corporate finance services, advice or assistance which may involve independence threats
such as promoting, dealing in or underwriting of shares of audit clients.
11. Any exercise or assignment for estimation of financial effect of a transaction or event where
an auditor provides litigation support services as identified in Code of Ethics for Chartered
Accountants.
12. Share Registration Services (Transfer Agents) and;
13. Any other service(s) which the Council with the prior approval of the Securities & Exchange
Commission of Pakistan, may determine to be a “prohibited service”.

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CLIENT ACCEPTANCE AND CONTINUANCE

FROM CODE OF ETHICS
Before acceptance, determination by CA in practice of any threat to fundamental principles, and if
they cannot be reduced, decline to accept. Also, recommended to review acceptance decision for
recurring engagements. Self-interest threat to PC&DC arises when CA does not have adequate
expertise.

FROM COMPANIES ACT 2017 - Sec246

1. Every company shall at each AGM appoint an auditor from the conclusion of meeting until the
next AGM.
2. May be removed before conclusion of the next AGM through a special resolution.
3. Appointment of firm means appointment of all partners.
4. First auditor to be appointed by Directors within 90 days of incorp. till next AGM.
5. The Directors may fill in casual vacancy within 30 days who shall hold office till next AGM and
during the period of vacancy, surviving auditor may act.
6. Where first auditor is not appointed within 90 days or casual vacancy not filled within
30 days or no auditors appointed in AGM, or auditors removed by company, SECP may
appoint a person to fill in.
7. A notice by a member with 10% shares, not less than 7 days before AGM, shall be required
for a resolution to appoint an auditor other than the retiring auditor. The company shall send
a copy of notice to retiring auditor and post on website.
8. If retiring auditor makes representation in writing 2 days before general meeting to
made to members and request communication to members, the company shall in notice
to members send a copy of thereof. If not sent, then it is to be read out in GM. Exception
allowed if registrar satisfied of abuse.
9. Every company within 14days from appointment of auditor or ceasing to hold
office to send intimation to registrar to get her consent in writing of the new
auditor.
Sec247
1. For public company or a company subsidiary of public company having paid-up capital of PKR 3
million or more, only ICAP CA.
2. For others, CMA or other firm of CAs.

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FROM CODE OF CORPORATE GOVERNANCE

The Board of Directors of a listed company shall recommend appointment of external auditors
for a year, as suggested by the Audit Committee. The recommendations of the Audit Committee
for appointment of an auditor or otherwise shall be included in the Directors' Report. In case of
a recommendation for appointment of an auditor other than the retiring auditor the reasons
for the same shall be included in the Directors' Report.

FROM BANKING COMPANIES ORDINANCE (BCO) -SEC35 (2)

An auditor shall hold office for a period of three years and shall not be removed from office before
the expiry of that period except with the prior approval of the CB.

5.44 ISQC & Quality control on an Individual Audit - ISA 220

ISA 220 requires firms to implement quality control procedures over individual audit engagements.
The objective of the auditor is to implement quality control procedures at the engagement level that provide
the auditor with reasonable assurance that:
(a) The audit complies with professional standards and applicable legal and regulatory requirements; and
(b) The auditor’s report issued is appropriate in the circumstances.

The burden of this falls on the audit engagement partner, who is responsible for the audit and the ultimate
conclusion.
1. Leadership Responsibilities
The engagement partner shall take responsibility for the overall quality on each audit engagement to which
that partner is assigned.

2. Ethical Requirements
Throughout the audit engagement, the engagement partner shall remain alert, through observation and
making inquiries as necessary, for evidence of non-compliance with relevant ethical requirements by
members of the engagement team.
The engagement partner shall form a conclusion on compliance with independence requirements that apply
to the audit engagement. In doing so, the engagement partner shall:
(a) Obtain relevant information form a conclusion on compliance with independent;
(b) requirements that apply to the audit engagement. In doing so, the engagement partner shall:
• Evaluate information on identified breaches if any, of the firm’s independence policies and
procedures to determine whether they create a threat to independence for the audit engagement;
and
• Take appropriate action to eliminate such threats or reduce them to an acceptable level by applying
safeguards, or, if considered appropriate, to withdraw from the audit engagement, where
withdrawal is possible under applicable regulatory environment.

3. Acceptance / Continuance of Client Relationships and Specific Audit Engagements

If the engagement partner obtains information that would have caused them to decline the audit in the first
place they should communicate that information to the firm so that swift action may be taken. They must
document conclusions reached about accepting and continuing the audit.

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4. Assignment of Engagement Teams

This is also the responsibility of the audit engagement partner. They must ensure that the team is
appropriately qualified and experienced as a unit.

5. Engagement Performance
Several factors are involved in engagement performance.

5.1. Direction
The partner directs the audit. They are required by other auditing standards to hold a meeting with the audit
team to discuss the audit, in particular the risks associated with the audit. This ISA suggests that direction
includes ‘informing members of the engagement team of:
• Their responsibilities (including objectivity of mind and professional skepticism).
• Responsibilities of respective partners where more than one partner is involved in the conduct of the
audit engagement.
• The objectives of the work to be performed.
• The nature of the entity’s business.
• Risk related issues.
• Problems that may arise.
• Detailed approach to the performance of the engagement.

5.2. Supervision
The audit is supervised overall by the engagement partner, but more practical supervision is given within the
audit team by senior staff to more junior staff, as is also the case with review. It includes:
• Tracking the progress of the audit engagement;
• Considering the capabilities and competence of individual members of the team, and whether they have
sufficient time and understanding to carry out their work;
• Addressing significant issues arising during the audit engagement and modifying the planned approach
appropriately; and
• Identifying matters for consultation or consideration by more experienced engagement team members
during the audit engagement.

5.3. Review
Review includes consideration of whether:
• The work has been performed in accordance with professional standards and regulatory and legal
requirements.
• Significant matters have been raised for further consideration.
• Appropriate consultations have taken place and the resulting conclusions have been documented and
implemented.
• There is a need to revise the nature, timing and extent of work performed.
• The work performed supports the conclusions reached and is appropriately documented.
• The evidence obtained is sufficient and appropriate to support the auditor's report.
• The objectives of the engagement procedures have been achieved.
Before the audit report is issued, the engagement partner must be sure that sufficient and appropriate audit
evidence has been obtained to support the audit opinion. The audit engagement partner need not review all
audit documentation but may do so.

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5.4. Consultation
The partner is also responsible for ensuring that if difficult or contentious matters arise, the teams appropriate
consultation on the matter and that such matters and conclusions are properly recorded. If differences of
opinion arise between the engagement partner and the team, or between the engagement partner and the
quality control reviewer, these differences should be resolved according to the firm's policy for such
differences of opinion.

5.5. Quality Control Review

The audit engagement partner is responsible for appointing a reviewer, if one is required. They are then
responsible for discussing significant matters that arise with the reviewer and for not issuing the audit report
until the quality control review has been completed.
A quality control review should include:
• An evaluation of the significant judgments made by the engagement team.
• An evaluation of the conclusions reached in formulating-the auditor's report.
The engagement quality control reviewer shall document, for the audit engagement reviewed, that:
(a) The procedures required by the firm's policies on engagement quality control review have been
performed.
(b) The engagement quality control review has been completed on or before the date of the auditor’s
report; and
(c) The reviewer is not aware of any unresolved matters that would cause the reviewer to believe that the
significant judgments the engagement team made and the conclusions it reached were not appropriate.
A quality control review for a listed entity will include a review of:
• Discussion of significant matters with the engagement partner.
• Review of financial statements and the proposed report.
• Review of selected audit documentation relating to significant audit judgements made by the audit team
and the conclusions reached.
• Evaluation of the conclusions reached in formulating the auditor’s report and consideration of whether
the auditor’s report is appropriate.
5.6. Monitoring
The audit engagement partner is required to consider the results of monitoring of the firm’s (or network
firm's) quality control systems and consider whether they have any impact on the specific audit they are
conducting.

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5.45 MONEY LAUNDERING

Anti-Money Laundering Ordinance 2009
Section 3 Offence of money laundering.-(1) A personal shall be guilty of offence of money
laundering, if the person:-
(a) acquires, converts, possesses, uses or transfers property, knowing or having reason to believe
that such property is proceeds of crime; or
(b) conceals or disguises the true nature, origin, location, disposition, movement or ownership of
property, knowing or having reason to believe that such property is proceeds of crime; or
(c) holds or possesses on behalf of any other person any property knowing or having reason to
believe that such property is proceeds of crime; or
(d) participates in, associates, conspires to commit, attempts to commit, aids, abets, facilities, or
counsels the commission of the acts specified in clauses (a), (3) and (c).

MONEY LAUNDERING - DEFINITION

Money laundering is the process by which criminals attempt to conceal the true origin and
ownership of the proceeds of their criminal activity, allowing them to maintain control over the
proceeds and, ultimately, providing a legitimate cover for their sources of income. The term is
widely defined to include: possessing, in any way dealing with, or concealing, the proceeds of any
crime (‘criminal property’). It also includes:

• an attempt or conspiracy or incitement to commit such an offence

• aiding, abetting, counselling or procuring the commission of such an offence
• an act which would constitute any of these offences if done in the UK.

INTERNATIONAL AUDIT PRACTICE STATEMENT 1006

Reputational risk:
The risk of losing business because of negative public opinion and consequential damage to the
bank’s reputation arising from failure to properly manage risks under this IAPS, or from
involvement in improper or illegal activities by the bank or its senior management, such as money
laundering or attempts to cover up losses.
Para 27
By the nature of their business, banks are ready targets for those engaged in money laundering
activities by which the proceeds of crime are converted into funds that appear to have a legitimate
source. In recent years during traffickers in particular have greatly added to the scale of money
laundering that takes place within the banking industry. In many jurisdictions, legislation requires
banks to establish policies, procedures and controls to deter and to recognise and report money
laundering activities. These policies, procedures and controls commonly extend to the following:

• A requirement to obtain customer identification (know your client).

• Staff screening.
• A requirement to know the purpose for which an account is to be used.

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• The maintenance of transaction records.

• The reporting to the authorities of suspicious transactions or of all transactions of a particular
type, for example, cash transactions over a certain amount.
• The education of staff to assist them in identifying suspicious transactions.
In some jurisdictions, auditors may have an express obligation to report to the authorities certain
types of transactions that come to their attention. Even where no such obligation exists, an auditor
who discovers a possible instance of noncompliance with laws or regulations considers the
implications for the financial statements and the audit opinion thereon. ISA 250, “Consideration of
Laws and Regulations in an Audi of Financial Statements” gives further guidance on this matter.
Fraud Risk Factors in Respect of the Deposit Taking Cycle
Depositors’ Camouflage
(Hiding the identity of a depositor, possibly in connection with funds transformation or money
laundering.)
What are the regulations in Pakistan???
1. Anti Money Laundering Ordinance 2009
2. Anti Money Laundering Rules 2009
3. SBP Prudential Regulations for corporate / commercial banking

SBP PRUDENTIAL REGULATIONS FOR CORPORATE / COMMERCIAL BANKING

Regulation M-1 Know your customer (KYC).
Regulation M-2 Anti-money laundering measures.
Regulation M-3 Record retention.
Regulation M-4 Correspondent banking.
Regulation M-5 Suspicious transactions.
ANTI-MONEY LAUNDERING PROGRAMME
Basic elements
The basic elements to be considered when designing an anti-money laundering programme
include:
a) Dedicated resources
b) Written policies and procedures
c) Comprehensive coverage
d) Timey escalation and resolution of matters
e) Explicit management support
f) Sufficient training and education
g) Regular review/audit of the programme.

a) Dedicated resources
A person should be identified and charged with the responsibility for overseeing the entire anti-
money laundering programme. The MLRO must be:
• competent and knowledgeable about money laundering
• empowered with full responsibility and authority to make and enforce policies and
procedures.

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b) Written policies and procedures, and risk factors

Written, reviewed and approved policies and procedures are the foundation of any programme.
Procedures should use technology where available and identify risk factors, the presence of which
may suggest money laundering activity. Risk factors include:

• when an account holder wishes to:

- associate secrecy with a transaction
- route transactions via a jurisdiction or financial institution with inadequate CDD practices
(eg ‘shell bank’ 1)
- route transactions through several jurisdictions or financial institutions to disguise the
nature, source, ownership or control of the funds
- use accounts at a central bank or other government-owned bank or use government
accounts as the source of funds of a transaction
• a rapid increase/decrease in the balance in an account that is not attributable to fluctuations
in the underlying market value of investments held
• frequent or excessive use of funds/wire transfers, and wire transfers that do not provide
information about the beneficial owner of an account or the originator of the information
when such information is expected or required
• large currency or bearer instrument transactions
• repeated deposits or withdrawals just below the monitoring and reporting threshold on or
around the same day
• high value deposits or withdrawals not commensurate with the type of amount
• a pattern that after a deposit or wire transfer the same (or nearly the same amount is wired
to another financial institution (especially one that is offshore).

c) Comprehensive coverage
All aspects of a company’s business, particularly those that have contact with customers should be
covered. KYC guidelines are crucial and, at a minimum, should include an examination of:

• the account holder’s identity when compared to government lists of known or suspected
terrorists or terrorist organisations
• all affiliated and other relationships that may result in franchise risk.

d) Timely escalation and resolution of matters

Timely escalation, reporting, and resolution of these matters are crucial. Reports identifying
suspicious activity should:

• be produced in a timely manner

• be subject to appropriate levels of review
• clearly identify the resolution of identified issues.

e) Explicit management support

Management, at the most senior level, should set the ‘tone at the top’ by demonstrating explicit
support for the firm’s anti-money laundering efforts. This support needs to be clearly articulated to
all employees.

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f) Sufficient training and education

This should be an integral part of any anti-money laundering programme. Relevant employees
should be trained to:

• recognise possible signs of money laundering that could arise during the course of their
duties
• know what to do once the risk is identified.

g) Regular review/audit of the programme

A regular review of the programme should be undertaken to ensure that it is functioning as
designed. Such a review could be performed by external or internal resources, and should be
accompanies by a formal assessment or written report.

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CHAPTER 6:
SUMMARIES OF IMPORTANT
FINANCIAL REPORTING STANDARDS
(IAS & IFRS)

6.1 IAS 10 — Events After the Reporting Period

Overview
IAS 10 contains requirements for when events after the end of the reporting period should be adjusted in the
financial statements. Adjusting events are those providing evidence of conditions existing at the end of the
reporting period, whereas non-adjusting events are indicative of conditions arising after the reporting period (the
latter being disclosed where material).

Key definitions
Event after the reporting period: An event, which could be favourable or unfavourable, that occurs between the
end of the reporting period and the date that the financial statements are authorised for issue. (Refer examples
discussed in class)
Adjusting event: An event after the reporting period that provides further evidence of conditions that existed at
the end of the reporting period, including an event that indicates that the going concern assumption in relation to
the whole or part of the enterprise is not appropriate. (Refer examples discussed in class)
Non-adjusting event: An event after the reporting period that is indicative of a condition that arose after the end
of the reporting period.
Accounting
• Adjust financial statements for adjusting events - events after the balance sheet date that provide further
evidence of conditions that existed at the end of the reporting period, including events that indicate that the
going concern assumption in relation to the whole or part of the enterprise is not appropriate.
• Do not adjust for non-adjusting events - events or conditions that arose after the end of the reporting period.
• If an entity declares dividends after the reporting period, the entity shall not recognise those dividends as a
liability at the end of the reporting period. That is a non-adjusting event.

Going concern issues arising after end of the reporting period

An entity shall not prepare its financial statements on a going concern basis if management determines after the
end of the reporting period either that it intends to liquidate the entity or to cease trading, or that it has no realistic
alternative but to do so.

Disclosure
• Non-adjusting events should be disclosed if they are of such importance that non-disclosure would affect the
ability of users to make proper evaluations and decisions.
• The required disclosure is (a) the nature of the event and (b) an estimate of its financial effect or a statement
that a reasonable estimate of the effect cannot be made.

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• A company should update disclosures that relate to conditions that existed at the end of the reporting period
to reflect any new information that it receives after the reporting period about those conditions.
• Companies must disclose the date when the financial statements were authorised for issue and who gave that
authorization. If the enterprise's owners or others have the power to amend the financial statements after
issuance, the enterprise must disclose that fact.

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6.2 IAS 16 — Property, Plant and Equipment

Recognition of Property, Plant and Equipment
Property, plant and equipment are tangible items that are held for use in the production or supply of goods or
services, for rental to others, or for administrative purposes; and are expected to be used during more than
one period.
IAS 16 states that the cost of an item of property, plant and equipment shall be recognized as an asset if, and only
if:
• it is probable that future economic benefits associated with the item will flow to the entity; and
• the cost of the item can be measured reliably.
This recognition principle shall be applied to all costs at the time they are incurred, both incurred initially to acquire
or construct an item of property, plant and equipment and incurred subsequently after recognition to add to,
replace part of or service it.

Initial costs
Some items of property, plant and equipment might be necessa to acquire for safety or environmental reasons.
Although they do not directly increase the future economic benefits, they might be inevitable to obtain future
economic benefits from other assets and therefore, should be recognized as an asset.
For example, water cleaning station might be necessary in order to proceed with some chemical processes within
chemical manufacturer.

Subsequent costs
Day-to-day servicing of the item shall be recognized in profit or loss as incurred because they just maintain (not
enhance) item’s capacity to bring future economic benefits.
However, some parts of the item of property, plant and equipment may require replacement at regular intervals,
for example, aircraft interiors.
In such a case, an entity derecognizes carrying amount of older part and recognizes the cost of new part into the
carrying amount of the item. The same applies to major inspections for faults, overhauling and similar items.

Measurement
• Initial Measurement:
An item of property, plant and equipment that qualifies for recognition as an asset shall be measured at its cost.
The cost of an item of property, plant and equipment comprises:
1. its purchase price including import duties, non-refundable purchase taxes, after deducting trade discounts
and rebates
2. any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable
of operating in the manner intended by management. Examples of these costs are: costs of site preparation,
professional fees, initial delivery and handling, installation and assembly, etc.,
3. the initial estimate of the costs of dismantling and removing the item and restoring the site on which it
is located.
The cost of an item of property, plant and equipment is the cash price equivalent at the recognition date.
If payment is deferred beyond normal credit terms, the difference between the cash price equivalent and the total
payment is recognized as interest over the period of credit (unless such interest is capitalized in accordance
with IAS 23).

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• Subsequent Measurement
An entity may choose 2 accounting models for its property plant and equipment:
1. Cost model: An entity shall carry an asset at its cost less any accumulated depreciation and any accumulated
impairment losses.
2. Revaluation model: An entity shall carry an asset at a revalued amount. Revalued amount is its fair value at the
date of the revaluation less any subsequent accumulated depreciation and subsequent accumulated
impairment losses.
An entity shall revalue its assets with sufficient regularity so that the carrying amount does not differ materially
from its fair value at the end of the reporting period. If an item of property, plant and equipment is revalued, the
entire class of property, plant and equipment to which that asset belongs shall be revalued.
The change of asset’s carrying amount as a result of revaluation shall be treated in the following way:

Change in
Where
Carrying Amount
Other comprehensive income Profit or loss if reverses previous revaluation decrease of
Increase
(heading “Revolution surplus”) the same value.
Other comprehensive income if reduces previously
Decrease Profit or loss recognized revaluation surplus (heading “Revaluation
surplus”).

Depreciation (both models)

Depreciation is defined as the systematic allocation of the depreciable amount of an asset over its useful life.
When dealing with the depreciation please do have 3 basic things in mind:
• Depreciable amount: Depreciable amount is simply HOW MUCH you are going to depreciate. It is the cost of an
asset, or other amount substituted for cost, less its residual value.
• Depreciation period: Depreciation period is simply HOW LONG you are going to depreciate, and it is basically
asset’s useful life.
Useful life is the period over which an asset is expected to be available for use by an entity; or the number of
production or similar units expected to be obtained from the asset by an entity.
Factors that shall be considered when establishing item’s useful life:
✓ expected usage of the item,
✓ expected physical wear and tear,
✓ technical or commercial obsolescence of the item, and
✓ legal or other limits on the use of the asset.
Useful life and asset’s residual value (input to depreciable amount) shall be reviewed at least at the end of each
financial year.
Change in useful life shall be accounted for as a change in an accounting estimate as per IAS 8 (no restatement
of previous periods).

• Depreciation method: Depreciation method is simply HOW, IN WHAT MANNER you are going to depreciate.
The depreciation method used shall reflect the pattern in which the asset’s future economic benefits are
expected to be consumed by the entity.
An entity may select from variety of depreciation methods, such as straight-line method, diminishing balance
method and the units of production methods.
Selected method shall be reviewed at least at the end of each financial year.

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If there is a change in the expected pattern of asset’s usage, then the depreciation method shall be changed
and be accounted for as a change in an accounting estimate as per IAS 8 (no restatement of previous periods).
Depreciation shall be recognized in profit or loss unless it is capitalized into the carrying amount of another asset
(for example, inventories, or another item of property, plant and equipment).
Each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost
of the item shall be depreciated separately. For example, aircraft interior cost might be depreciated separately
from the remaining airplane cost.

Impairment
Here, IAS 16 refers to another standard, IAS 36 Impairment of Assets that prescribes rules for reviewing the
carrying amount of assets, determining their recoverable amount and impairment loss, recognizing and reversing
impairment loss and more.
IAS 16 states that compensation from third parties for items of property, plant and equipment that were impaired,
lost or given up shall be included in profit or loss when the compensation becomes receivable.
For example, claim for compensation of damage on insured property from insurance company is recognized to
profit or loss when insurance company accepts claim, closes the case and agrees to compensate (or after whatever
procedure is agreed in the insurance contract).

Derecognition
IAS 16 prescribes that the carrying amount of an item of property, plant and equipment shall be derecognized on
disposal; or when no future economic benefits are expected from its use or disposal.
The gain (not classified as revenue) or loss arising from the derecognition of an item of property, plant and
equipment shall be included in profit or loss when the item is derecognized. The gain or loss from the derecognition
is calculated as the net disposal proceeds (usually income from sale of item) less the carrying amount of the item.

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6.3 IAS 20 — Government Grants

Overview
The main objective of IAS 20 is to prescribe the accounting for and the disclosure of
• The government grants – simply speaking, these are the actual resources, whether monetary or non-monetary,
transferred to an entity by a government, in most cases upon completion of some conditions;
• The government assistance – these are other actions of the government designed to provide some economic
benefit to an entity, for example free marketing or business advices.
How to Account for Government Grants
Recognize grants as income over the relevant periods to match them with the related expenditures or costs they
should compensate.
Specific accounting treatment depends on the purpose of the grant received. An entity can receive a grant either
for:
• Acquisition of an asset, or
• Reimbursement of costs.

Grant related to assets

If an entity receives the grant for acquisition of some assets, there are 2 options to present such grant in the
financial statements:
1. To present it as deferred income; or
2. To deduct the grant from the carrying amount of an asset acquired.

Grant related to income (reimbursement of expenditures)

Here, you need to differentiate between the grants for past costs (already incurred) or the grants for current or
future costs.
If the grant is provided to reimburse costs incurred in the past, then it is recognized immediately in profit or loss.
If the grant is provided to reimburse costs incurred or to be incurred at the present time or in the future, then the
grant is recognized in profit or loss in the periods when the costs are incurred.
From the presentation point of view, there are 2 options:

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1. To present the grant income as a separate line item as “other income”, or

2. To deduct the grant income from the related expense.

(Refer 3 Illustrations discussed in class).

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6.4 IAS 23 – Borrowing Costs

Objective
The core principle of IAS 23 Borrowing Costs is that you should capitalize borrowing costs if they are directly
attributable to the acquisition, construction or production of a qualifying asset.
Other borrowing costs are expensed in profit or loss.

What are qualifying assets?

Qualifying assets are assets that take a substantial period of time to get ready for their intended use or sale.
Note here that IAS 23 does not say it must necessarily be an item of a property, plant and equipment under IAS 16.
It can also include some inventories or intangibles, too!
But what is a substantial period of time? Normally, if an asset takes more than 1 year to be ready, then it would be
qualifying.

What can we capitalize?

IAS 23 specifically mentions 3 types of borrowing costs that can be capitalized:
1. Interest expenses (refer to the effective interest method under IFRS 9 or IAS 39);
2. Finance charges on finance leases under IAS 17; and
3. Exchange differences on borrowings in foreign currencies, but only those representing the adjustment to
interest costs.

How do you capitalize?

IAS 23 differentiates between capitalizing borrowing costs on general borrowings and specific borrowings.

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Specific borrowings
If you borrowed some funds specifically for the acquisition of a qualifying asset, then the capitalization is easy:
You simply capitalize the actual costs incurred less any income earned on the temporary investment of such
borrowings. (Refer example discussed in class)

General borrowings
General borrowings are those funds that are obtained for various purposes and they are used (apart from these
other purposes) also for the acquisition of a qualifying asset.
In this case, you need to apply so-called capitalization rate to the borrowing funds on that asset, calculated as
the weighted average of the borrowing costs applicable to general pool. (Refer example discussed in class)

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6.5 IAS 24 – Related Party

Objective
to ensure that an entity's financial statements contain the disclosures necessary to draw attention to the possibility
that its financial position and profit or loss may have been affected by the existence of related parties and by
transactions and outstanding balances with such parties.

Who are related parties?

A related party is a person or entity that is related to the entity that is preparing its financial statements (referred
to as the 'reporting entity').

(a) A person or a close member of that person's family is related to a reporting entity if that person:
(i) has control or joint control over the reporting entity;
(ii) has significant influence over the reporting entity; or
(iii) is a member of the key management personnel of the reporting entity or of a parent of the reporting
entity.

(b) An entity is related to a reporting entity if any of the following conditions applies:
(i) The entity and the reporting entity are members of the same group (which means that each parent,
subsidiary and fellow subsidiary is related to the others).
(ii) One entity is an associate or joint venture of the other entity (or an associate or joint venture of a
member of a group of which the other entity is a member).
(iii) Both entities are joint ventures of the same third party.
(iv) One entity is a joint venture of a third entity and the other entity is an associate of the third entity.
(v) The entity is a post-employment defined benefit plan for the benefit of employees of either the reporting
entity or an entity related to the reporting entity. If the reporting entity is itself such a plan, the
sponsoring employers are also related to the reporting entity.
(vi) The entity is controlled or jointly controlled by a person identified in (a).
(vii) A person identified in (a)(i) has significant influence over the entity or is a member of the key
management personnel of the entity (or of a parent of the entity).
(viii) The entity, or any member of a group of which it is a part, provides key management personnel services
to the reporting entity or to the parent of the reporting entity.

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The following are deemed not to be related:

• Two entities simply because they have a director or key manager in common
• Two venturers who share joint control over a joint venture
• Providers of finance, trade unions, public utilities, and departments and agencies of a government.
• A single customer, supplier, franchiser, distributor, or general agent with whom an entity transacts a significant
volume of business merely by virtue of the resulting economic dependence.

What are related party transactions?

A related party transaction is a transfer of resources, services, or obligations between related parties, regardless of
whether a price is charged.

Disclosure
• Relationships between parents and subsidiaries.
• Management compensation. Disclose key management personnel compensation in total and for each of the
specified categories.
• Related party transactions.

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6.6 IAS 33 – Earning Per Share

Objective of IAS 33
The objective of IAS 33 is to set out principles for:
• The calculation of EPS; and
• The presentation of EPS in the financial statements.

Scope of IAS 33
IAS 33 applies only to publicly-traded entities or those which are about to be publicly traded. A publicly-traded
entity is an entity whose shares are traded by the investing public, for example on a stock exchange.
Most publicly-traded entities prepare consolidated financial statements as well as individual financial statements.
When this is the case, IAS 33 requires disclosure only of EPS based on the figures in the consolidated financial
statements.

Basic EPS
Basic earnings per share is calculated by dividing the profit or loss on continuing operations by the weighted average
number of ordinary shares in issue during the period.
The calculation of the basic EPS is as follows:
Formula: Basic EPS = Net profit (or loss) attributable to ordinary shareholders during a period
Weighted average number of shares in issue during the period

IAS 33 gives guidance on:

• the earnings figure that must be used being the net profit (or loss) attributable to ordinary shareholders during
a period (commonly referred to as total earnings); and
• The number of shares to be used in the calculation being the weighted average number of shares in issue
during the period. Changes in share capital during a period must be taken into account in arriving at this
number. IAS 33 provides guidance on how to do this.

Total earnings
The total earnings figure is the profit or loss from continuing operations after deducting tax and preference
dividends (and in the case of consolidated financial statements, after excluding the earnings attributable to non-
controlling interests). Total earnings include any income from associates (i.e. any share of profits or losses of
associates).
Earnings from discontinued operations are dealt with separately. An EPS from any discontinued operations must
also be disclosed, but this does not have to be disclosed on the face of the statement of profit or loss. Instead, it
may be shown in a note to the financial statements.
The total earnings figure must be adjusted for the interests of preference shareholders before in can be used in
EPS calculations.

Preference shares
Preference shares must be classified as equity or liability in accordance with the rules in IAS 32: Financial
Instruments: Presentation. If a class of preference shares is classified as equity, any dividend relating to that share
is recognized in equity. Any such dividend must be deducted from the profit or loss from continuing operations as
stated above.
If a class of preference shares is classified as liability (redeemable preference shares), any dividend relating to that
share is recognized as a finance cost in the statement of profit or loss. It is already deducted from the profit or loss
from continuing operations and no further adjustment need be made.

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Changes in the number of shares during a period

IAS 33 gives guidance on how to incorporate changes in share capital during a period into the calculation of the
weighted average of shares that must be used in the EPS calculation.
There are different ways in which the number of shares may change:
• Issues for full consideration (issue or redemption) of shares at a full market price).
• Issues for no consideration (issue or redemption) of shares with no change in net assets), for example:
✓ Bonus issues
✓ Share splits (where one share is split into several others)
✓ Reverse share splits (share consolidation)
✓ Bonus elements in other issues (see later discussion on rights issues)
✓ Rights issues (issue of shares for consideration but at less than the full market price of the share).

1. Issue of shares at full market price

The consideration received is available to boost earnings. Therefore, the shares are included from the date of
issue to ensure consistency between the numerator (top) and denominator (bottom) of the EPS calculation.
The starting point for the weighted average number of shares is the number of shares in issue at the beginning
of the period. This is then adjusted for any shares issued during the period and a time weighting factor must
then be applied to each figure.
There is no adjustment to comparatives resulting from an issue at full price.

2. Partly paid shares

The number of ordinary shares is calculated based on the number of fully paid shares. In order to do this partly
paid shares are included as an equivalent number of fully paid shares to the extent they are entitled to
participate in dividends.
3. Bonus issues of shares
A bonus issue of shares (also called a scrip issue or a capitalisation issue) is an issue of new shares to existing
shareholders, in proportion to their existing shareholding, for no consideration. In other words, the new shares
are issued ‘free of charge’ to existing shareholders.
Bonus shares are treated as if they have always been in issue.
The new number of shares (i.e. the number of shares after the bonus issue) can be found by multiplying the
number of shares before the bonus issue by the bonus issue fraction.

Comparatives in case of bonus issue:

There is no time apportionment for a bonus issue. This means that all comparative figures must be restated
into the same terms to take account of the bonus.
In order to ensure that the EPS in the year of the bonus issue is comparable with the previous year’s EPS, IAS
33 requires that the weighted average number of shares should be calculated as if the bonus shares had always
been in issue.
This means that:

• The current period’s shares are adjusted as if the bonus shares were issued on the first day of the year;
and

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• The comparative EPS for the previous year is restated on the same basis.

4. Rights issues of shares

A rights issue of shares is an issue of new shares for cash, where the new shares are offered initially to current
shareholders in proportion to their existing shareholdings.
The issue price of the new shares in a rights issue is always below the current market price for the shares
already in issue. This means that they include a bonus element which must be taken into account in the
calculation of the weighted average number of shares.
Also note that any comparatives must be restated by multiplying them by the inverse of the rights issue bonus
fraction.

Steps to calculate EPS in case of right issue:

• Step 1 – Calculate “Theoretical Ex-Rights Price”
• Step 2 – Calculate “Rights Issue Bonus Fraction”
• Step 3 – Calculate “Weighted average number of shares” and “EPS”.
• Step 4 – Revise comparative by multiplying prior year EPS with inverse of the rights issue bonus fraction.
(Refer example discussed in class)
Diluted EPS
IAS 33 requires publicly-traded companies to calculate a diluted EPS in addition to their basic EPS for the current
year (with a comparative diluted EPS for the previous year), allowing for the effects of all dilutive potential ordinary
shares.
Potential ordinary shares might not dilute the EPS. The diluted EPS calculation only includes potential ordinary
shares that would be dilutive. Note: potential ordinary shares are ‘dilutive’ when there might have been a reduction
or ‘dilution’ in EPS if they had been actual ordinary shares during the financial period.
1. In case of convertible preference shares and convertible bonds
When there are convertible bonds or convertible preference shares, diluted EPS is calculated as follows, by
making adjustments to total earnings and the number of shares in issue used in the basic EPS calculation.

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Total earnings
Total earnings are adjusted because the entity would not have to pay the dividend or interest on the convertible
securities.
• For convertible preference shares, add back the preference dividend paid in the year. Total earnings will
be increased by the preference dividend saved.
• For convertible bonds, add back the interest charge on the bonds in the year less the tax relief relating to
that interest. Total earnings will increase by the interest saved less tax.

Number of shares
The weighted average number of shares is increased, by adding the maximum number of new shares that
would be created if all the potential ordinary shares were converted into actual ordinary shares.
The additional number of shares is calculated on the assumption that they were in issue from the beginning of
the year or from the date of issue whichever is later.

2. In case of options and warrants

A different situation applies with share options and share warrants.
Options (warrants) are contracts issued by a company which allow the holder of the option to buy shares of
the company at some time in the future at a pre-agreed price.
The following steps must be taken:
• Step 1: Calculate the cash that would be received if the options are exercised.
• Step 2: Calculate the number of shares that could be sold at (average) full market price to raise the same
amount of cash. (Divide the figure from step 1 by the average share price in the period).
• Step 3: Identify the number of shares that will be issued if all the options are exercised.
• Step 4: Subtract the number of shares in step 2 from the number at step 3. These shares are treated as
having been given away for free and is added to the existing number of shares in issue, to obtain the total
shares for calculating the diluted EPS.

Options are only included in the diluted EPS calculation if the average share price in the year is greater than
the exercise price of the option. If this were not the case the option would not be exercised. (Nobody would
pay an exercise price of Rs. 100 for something worth only Rs. 80). (Refer example discussed in class)

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6.7 IAS 36 – Impairment of Assets

What is the objective of IAS 36?
The objective of IAS 36 Impairment of assets is to make sure that entity’s assets are carried at no more than their
recoverable amount.
The Standard also defines when an asset is impaired, how to recognize an impairment loss, when an entity
should reverse this loss and what information related to impairment should be disclosed in the financial
statements.
The following scheme shows to what assets IAS 36 does and does not apply:

What
is an

impairment of assets?
An asset is impaired when its carrying amount exceeds its recoverable amount.

Identify an asset that might be impaired

Perform the following procedures:
• You need to assess whether there is any indication that an asset might be impaired at the end of each
reporting period.
(REMEMBER!!! You don’t need to perform impairment testing if there’s no indication. However, you need
to assess the existence of such an indication.)
• If you hold some intangible asset with an indefinite useful life (such as trademarks) or intangible asset not
yet available for use, then you need to test these assets for impairment annually.

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• If your accounting records show some goodwill acquired in a business combination, you also need to test
this goodwill for impairment annually.

What are the indications of impairment?

1. External sources of information
• Observable indications that the asset’s value has declined during the period significantly more than would
be expected as a result of the passage of time or normal use.
• Significant changes with an adverse effect on the entity in the technological, market, economic or legal
environment in which the entity operates or in the market to which an asset is dedicated.
• Market interest rates or other market rates of return on investments have increased during the period,
and those increases are likely to affect the discount rate used in calculating an asset’s value in use and
decrease the asset’s recoverable amount materially.
• The carrying amount of the net assets of the entity is higher than its market capitalization.
2. Internal sources of information
• Obsolescence or physical damage of an asset.
• Significant changes with an adverse effect on the entity related to the use of an asset, for example: an
asset becoming idle, plans to discontinue or restructure the operation to which an asset belongs, plans to
dispose of an asset before the previously expected date, and reassessing the useful life of an asset as finite
rather than indefinite.
• Evidence is available from internal reporting that indicates that the economic performance of an asset is,
or will be, worse than expected.

Measure recoverable amount

Recoverable amount is the higher of an asset’s (or cash-generating unit’s) fair value less costs of disposal and its
value in use.

You don’t necessarily need to determine both of these amounts, because if just one of them is higher than
asset’s carrying amount, then there’s no impairment.

When an individual asset does not generate cash inflows that are largely independent of those from other assets
(or groups of assets), then you need to determine recoverable amount for the cash-generating unit (CGU) to which
this asset belongs.

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1. Fair value less costs of disposal

Rules and guidelines for measuring the fair value of any assets are set by the standard IFRS 13 Fair Value
Measurement. This standard applies for all periods beginning on 1 January 2013 or later, so you need to make
sure to take it into account.
Costs of disposal are for example legal costs, stamp duties and similar transaction taxes, costs of removing the
asset and direct incremental costs to bring an asset into condition for its sale.

2. Value in use
Value in use is the present value of the future cash flows expected to be derived from an asset or cash-
generating unit.
In order to determine value in use, you need take the following elements into account:
• An estimate of the future cash flows the entity expects to derive from the asset.
• Expectations about possible variations in the amount or timing of those future cash flows.
• The time value of money, represented by the current market risk-free rate of interest.
• The price for bearing the uncertainty inherent in the asset.
• Other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the
entity expects to derive from the asset.

Recognize and measure an impairment loss

If the asset’s recoverable amount is lower than its carrying amount, then an entity must recognize an impairment
loss as a difference between these 2 amounts.
An impairment loss shall be recognized to profit or loss or as a revaluation decrease if the asset is carried at
revalued amount in line with other IFRS.
Do not forget to adjust the depreciation in the future periods in order to reflect the asset’s new carrying
amount.

Cash-generating units
A cash-generating unit is the smallest identifiable group of assets that generates cash inflows that are largely
independent of the cash inflows from other assets or groups of assets.
If you are not able to determine recoverable amount for an individual asset, then you might need to establish cash-
generating unit to which this asset belongs.
In determining your cash-generating unit you need to be consistent from period to period to include the same asset
or type of assets.

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You need to be consistent in determining the carrying amount of cash-generating unit with determining
recoverable amount of that unit. It means that you need to include the same assets in calculation of carrying
amount and recoverable amount, too.

Goodwill
If there is a goodwill acquired in a business combination, then it must be allocated to each of the acquirer’s cash-
generating units (or group of them) that are expected to benefit from the synergies of the combination.
Goodwill should be tested for impairment on an annual basis.
A cash-generating unit (CGU) with allocated goodwill shall be tested for impairment at least annually. In this case
testing means to compare:
• The carrying amount of CGU including the goodwill, and
• The recoverable amount of that CGU.

Impairment loss of cash-generating unit

If the recoverable amount of CGU is lower than its carrying amount, then an entity shall recognize the impairment
loss.
The impairment loss shall be allocated to reduce the carrying amount of the assets of the unit in the following
order:
• Reduce the carrying amount of any goodwill allocated to the CGU.
• Allocate remaining impairment loss to the other assets of the unit pro rata on the basis of the carrying
amount of each asset in the unit. These reductions are recognized as impairment losses on individual
assets.

In allocating an impairment loss you must make sure that you don’t reduce the carrying amount of an asset below
the highest of:
• Its fair value less cost of disposal;
• Its value in use;
• Zero.

Reversal of impairment loss

Here, you need to take the same approach as in identifying the impairment loss. You need to assess at the end of
each reporting period whether there is any indication that an impairment loss recognized in prior periods for an
asset (other than goodwill) may no longer exist or may have decreased.
You need to assess the same set of indications from external and internal sources than when assessing the existence
of impairment, just from the other side.

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You can reverse an impairment loss only when there is a change in the estimates used to determine the asset’s
recoverable amount. It means that you cannot reverse an impairment loss due to passage of time or unwinding the
discount.

Reversal of an impairment loss for an individual asset

You can reverse an impairment loss only when there is a change in the estimates used to determine the asset’s
recoverable amount. It means that you cannot reverse an impairment loss due to passage of time or unwinding the
discount.
Reversal of an impairment loss is recognized in the profit or loss unless it relates to a revalued asset. The increased
carrying amount due to reversal should not be more than what the depreciated historical cost would have been if
the impairment had not been recognized.
Also, you must not forget to adjust the depreciation for future periods to reflect revised carrying amount.

Reversal of an impairment loss for a cash-generating unit

When you reverse an impairment loss for a cash-generating unit, you need to allocate reversal to the assets of the
unit (except for goodwill) pro rata with the carrying amounts of these assets.
The carrying amount of an assets shall not be increased above the lower of:
• Its recoverable amount and
• The carrying amount that would have been determined (net of amortization or depreciation) without any
prior impairment loss.

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6.8 IAS 37 - Provisions, Contingent Liabilities and Contingent Assets

What is a provision?
Provision is a liability of uncertain timing or amount.
If timing and amount are certain or almost certain, then you don’t deal with the provision but with a payable or an
accrual.
To understand provisions better, let’s break down the definition of a liability in IAS 37:
A liability is a present obligation arising from past event that is expected to be settled by an outflow of economic
benefits from an entity.
In other words, if there is no past event, then there is no liability and no provision should be recognized.
Past event can create 2 types of obligation:
• Legal obligation that arises from legislation, a contract or other legal act; or
• Constructive obligation that arises from some business practice or customs and created an expectation in
other parties to fulfill the obligation (in other words, people simply expect some company to fulfill the
obligation even if it’s not in the law or any contract).

When to recognize a provision?

The standard sets 3 criteria for recognizing a provision:
• There must be a present obligation as a result of a past event;
• The outflow of economic benefits to satisfy the obligation must be probable (i.e. more than 50% probable)
• The amount of economic benefits required to satisfy the obligation must be reliably estimated.

If all 3 criteria are met, then you should recognize a provision.

If just one of them is not met, then you should either:
• Disclose a contingent liability (read more about it below), or
• Do nothing if the outflow of economic benefits is remote.
If you are unsure whether to recognize a provision in a particular situation or not, just ask yourself a simple
question:
Can the obligation be avoided by some future actions?
If yes, then you should NOT book a provision.
If you cannot avoid the obligation by some future action, then you have to recognize a provision. For example,
when you promised a free warranty service for defective products at the point of sale, then you have a present
obligation. If your past statistics show that you needed to spend some cash for warranty repairs, then you need to
make a provision.

How to measure a provision?

The amount of the provision should be measured at the best estimate of the expenditures required to satisfy the
obligation at the end of the reporting period.

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Provisions in specific circumstances

Standard IAS 37 specifies the treatment of provisions in a few specific situations:

❖ Future operating losses

You should not make a provision for future operating loss.
Why?
Because there is no past event. The future operating losses can be avoided by some future actions, for example
– by selling a business.
However, you should test your assets for impairment under IAS 36 Impairment of Assets.

❖ Onerous contracts
Onerous contract is a contract in which unavoidable costs of fulfilling exceed the benefits from the contract.
In other words, it is a loss contract that cannot be avoided.
You should make a provision in the amount lower of:
• Unavoidable costs of fulfilling the contract and
• Penalty for not meeting your obligations from the contract
❖ Restructuring
Restructuring is a plan of management to change the scope of business or a manner of conducting a business.
You should recognize a provision for restructuring only when the general criteria for recognizing provisions are
met.
In the case of restructuring, an obligation to restructure arises only if:
• There is a detailed formal plan for restructuring with relevant information in it (about business, location,
employees, time schedule and expenditures)
• A valid expectation related to restructuring has been raised in the affected parties.
IAS 37 also clarifies which type of expenses can / cannot be included in the provision. (Discussed in class)

What are contingencies?

Except for provisions, we can deal both with contingent liabilities and contingent assets.

❖ Contingent liabilities
A contingent liability is either:
• A possible obligation (not present) from past event that will be confirmed by some future event; or
• A present obligation from past event, but either:
✓ The ouflow of economic benefits to satisfy this obligation is not probable (less than 50%), or
✓ The amount of obligation cannot be reliably measured (this is very rare, in fact).
For example, you might face a lawsuit, but your lawyers estimate the probability of losing the case at 30% – in
this case, it’s not probable that you will have to incur any expenditures to settle the claim and you should not
book a provision. It’s typical contingent liability.
If you identify you have a contingent liability, you DO NOT recognize it – no journal entry. You should only make
appropriate disclosures in the notes to the financial statements.

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❖ Contingent assets
A contingent asset is a possible asset arising from past events that will be confirmed by some future events not
fully under the entity’s control.
Similarly as with contingent liabilities, you should not book anything in relation to contingent assets, but
you make appropriate disclosures.

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6.9 IAS 38 - Intangibles

Overview
IAS 38 Intangible Assets outlines the accounting requirements for intangible assets, which are non-monetary assets
which are without physical substance and identifiable (either being separable or arising from contractual or other
legal rights).
• Intangible assets meeting the relevant recognition criteria are initially measured at cost.
• Subsequently measured at cost or using the revaluation model, and amortized on a systematic basis over their
useful lives (unless the asset has an indefinite useful life, in which case it is not amortized).

Scope
IAS 38 applies to all intangible assets other than:
• financial assets
• exploration and evaluation assets (IFRS 6)
• expenditure on the development and extraction of minerals, oil, natural gas, and similar resources
• intangible assets arising from insurance contracts issued by insurance companies
• intangible assets covered by another IFRS, such as intangibles held for sale (IFRS 5), deferred tax assets
(IAS 12), lease assets (IAS 17), assets arising from employee benefits (IAS 19), and goodwill (IFRS 3).

Examples of intangible assets:

• patented technology, computer software, databases and trade secrets
• trademarks, trade dress, newspaper mastheads, internet domains
• video and audiovisual material (e.g. motion pictures, television programmes)
• customer lists
• mortgage servicing rights
• licensing, royalty and standstill agreements
• import quotas
• franchise agreements
• customer and supplier relationships (including customer lists)
• marketing rights

Intangibles can be acquired:

• by separate transaction (purchased, as part of a business combination, by a government grant, by
exchange of assets)
• by self-creation (internal generation)

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Recognition criteria
IAS 38 requires an entity to recognise an intangible asset, whether purchased or self-created (at cost) if, and only
if:

• it is probable that the future economic benefits that are attributable to the asset will flow to the entity;
and
• the cost of the asset can be measured reliably.

IAS 38 includes additional recognition criteria for internally generated intangible assets (see below).
If recognition criteria not met. If an intangible item does not meet both the definition of and the criteria for
recognition as an intangible asset, IAS 38 requires the expenditure on this item to be recognized as an expense
when it is incurred.
Reinstatement. The Standard also prohibits an entity from subsequently reinstating as an intangible asset, at a later
date, an expenditure that was originally charged to expense.

Initial recognition: research and development costs

• Charge all research cost to expense. [IAS 38.54]
• Development costs are capitalized only after technical and commercial feasibility of the asset for sale or
use have been established. This means that the entity must intend and be able to complete the intangible
asset and either use it or sell it and be able to demonstrate how the asset will generate future economic
benefits.

If an entity cannot distinguish the research phase of an internal project to create an intangible asset from the
development phase, the entity treats the expenditure for that project as if it were incurred in the research phase
only.

Initial recognition: in-process research and development acquired in a business

combination
A research and development project acquired in a business combination is recognized as an asset at cost, even if a
component is research.
Subsequent expenditure on that project is accounted for as any other research and development cost (expensed
except to the extent that the expenditure satisfies the criteria in IAS 38 for recognizing such expenditure as an
intangible asset). [IAS 38.34]

Initial recognition: internally generated brands, mastheads, titles, lists

Brands, mastheads, publishing titles, customer lists and items similar in substance that are internally generated
should not be recognized as assets.

Initial recognition: certain other defined types of costs

The following items must be charged to expense when incurred:
• internally generated goodwill
• start-up, pre-opening, and pre-operating costs
• training cost
• advertising and promotional cost, including mail order catalogues
• relocation costs

Initial measurement
Intangible assets are initially measured at cost.

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Measurement subsequent to acquisition: cost model and revaluation models allowed

An entity must choose either the cost model or the revaluation model for each class of intangible asset.
Cost model. After initial recognition intangible assets should be carried at cost less accumulated amortization and
impairment losses.

Revaluation model. Intangible assets may be carried at a revalued amount (based on fair value) less any subsequent
amortization and impairment losses only if fair value can be determined by reference to an active market. [Such
active markets are expected to be uncommon for intangible assets. Examples where they might exist:

• production quotas
• fishing licences
• taxi licences

Classification of intangible assets based on useful life

Intangible assets are classified as:
• Indefinite life: no foreseeable limit to the period over which the asset is expected to generate net cash
inflows for the entity.
• Finite life: a limited period of benefit to the entity.

Measurement subsequent to acquisition: intangible assets with finite lives

The cost less residual value of an intangible asset with a finite useful life should be amortised on a systematic basis
over that life:
• The amortization method should reflect the pattern of benefits.
• If the pattern cannot be determined reliably, amortise by the straight-line method.
• The amortization charge is recognized in profit or loss unless another IFRS requires that it be included in
the cost of another asset.
• The amortization period should be reviewed at least annually.

The asset should also be assessed for impairment in accordance with IAS 36.

Measurement subsequent to acquisition: intangible assets with indefinite useful lives

An intangible asset with an indefinite useful life should not be amortized.
Its useful life should be reviewed each reporting period to determine whether events and circumstances continue
to support an indefinite useful life assessment for that asset. If they do not, the change in the useful life assessment
from indefinite to finite should be accounted for as a change in an accounting estimate.
The asset should also be assessed for impairment in accordance with IAS 36.

Subsequent expenditure
Due to the nature of intangible assets, subsequent expenditure will only rarely meet the criteria for being
recognized in the carrying amount of an asset. Subsequent expenditure on brands, mastheads, publishing titles,
customer lists and similar items must always be recognized in profit or loss as incurred.

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6.10 IAS 40 Investment Property

Objective of IAS 40
IAS 40 Investment Property prescribes the accounting treatment and disclosure with respect to investment
property.

What is investment property?

The investment property is a land, a building (or a part of it), or both, held for the following specific purposes:
• To earn rentals;
• For capital appreciation; or
• Both.
If you hold a building or a land for any of the following purposes, then it cannot be classified as investment property:
• For production or supply of goods or services,
• For administrative purposes, or
• For sale in ordinary course of business.

Examples of investment property

What specifically can be classified as investment property?
Here is a couple of examples:
• Land held as an investment for long-term capital appreciation, or for future undetermined use.
• A building owned by the entity and leased out under one or more operating leases. Includes a building that is
still vacant, but you plan to lease it out.
• Any property that you actually construct or develop for future use as investment property.
Be careful here!! When you construct a building for some third party, then you should apply IAS IFRS 15.

When to Recognize investment property

The rules for recognition of investment property are essentially the same as stated in IAS 16 for property, plant and
equipment, i.e. you recognize an investment property as an asset only if 2 conditions are met:
• It is probable that future economic benefits associated with the item will flow to the entity; and
• The cost of the item can be measured reliably.

How to measure investment property initially

Investment property shall be initially measured at cost, including the transaction cost.

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The cost of investment property includes:

• Its purchase price and
• Any directly attributable expenditure, such as legal fees or professional fees, property taxes, etc.

You should NOT include:

• Start-up expenses. (If start-up expenses are directly attributable to the item of investment property, then you
can include them).
• Operating losses that you incur before planned occupancy level is achieved, and
• Abnormal waste of material, labor or other resources incurred at construction.

When payment for investment property is deferred, then discount it to its present value to set the cash price
equivalent.
Subsequent measurement of investment property
After initial recognition, you have 2 choices for measuring your investment property:
Once choice has been made, stick to it and measure all of your investment property using the same model (there
are actually exceptions from that rule).

Option 1: Fair value model

Under fair value model, an investment property is carried at fair value at the reporting date.
The fair value is determined in line with the standard IFRS 13 Fair Value Measurement.
A gain or loss from re-measurement to fair value shall be recognized in profit or loss.
Sometimes, the fair value cannot be reliably measurable after initial recognition. This can happen in absolutely rare
circumstances (e.g. active marked ceased existing) and in this case, IAS 40 prescribes:
• To measure your investment property at cost, if it’s not yet completed and is under construction; or
• To measure your investment property using cost model, if it’s completed.
Option 2: Cost model
The second choice for subsequent measurement of investment property is a cost model.
Here, IAS 40 does not describe it in details, but refers to the standard IAS 16 Property, Plant and Equipment. It
means you need to take the same methodology as in IAS 16.

Switching the models

Can we switch from cost model to fair value model or vice versa from fair value model to cost model?

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The answer is YES, but only if the change results in the financial statements providing better, more reliable
information about company’s financial position, results and other events.

What does it mean in practice?

Switching from cost model to fair value model would probably meet the condition and therefore, you can do it
whenever you’re sure that you’ll be able to determine the fair value regularly and the fair value model fits better.
However, the opposite change – switch from fair value model to cost model – is highly unlikely to result in more
reliable presentation. Therefore, you should not really do it, and if – rarely and for good reasons.

Transfers from and to investment property

When we speak about transfers related to investment property, we mean the change of classification, for example,
you classify a building previously held as property, plant and equipment under IAS 16 to investment property under
IAS 40.
The transfers are possible, but only when there’s a change in use or asset’s purpose, for example:
• You start renting out the property that you previously used as your headquarters (transfer to investment
property from owner-occupied property under IAS 16)
• You stop renting out the building and start using it for yourself
• You held a land for undefined purpose and recently, you decided to construct an apartment house to sell
apartments when they are built (transfer from investment property to inventories).
What’s the accounting treatment in this case?
It depends on the type of a transfer and the accounting choice for your investment property.
If you opted to account for your investment property at cost model, then there’s no problem with the transfers,
you simply continue with what you did.
However, if you picked up a fair value model, then it’s a bit more complicated:
• When you transfer to investment property, then the deemed cost is a fair value at the date of transfer.
Difference between asset’s carrying amount and its fair value is treated in the same way as revaluations under
IAS 16.
• When you transfer from investment property, then the deemed cost is also fair value at the date of transfer.

Derecognition of investment property

The derecognition rules (when you can remove your investment property from your books) in IAS 40 are similar to
the rules in IAS 16.
You can derecognize your investment property in two circumstances:
• On disposal, or
• When the investment property is permanently withdrawn from use and no future economic benefits are
expected.

You need to calculate gain or loss on disposal as a difference between:

• Net disposal proceeds, and
• Asset’s carrying amount.

Gain or loss on disposal is recognized in profit or loss.

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Disclosures
IAS 40 Investment property prescribes a lot of disclosures to be presented in the financial statements, including the
description of selected model, how the fair value was derived, what the classification criteria for investment
property are, movements in investment property during the reporting period (please refer to IAS 40.74 and
following for more information).

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6.11 IFRS 2 — Share-based Payment

Objective
The objective of IFRS 2 Share-based payment is to specify the financial reporting by an entity when it undertakes a
share-based payment transaction.
IFRS 2 requires an entity to reflect the effect of share-based payment transactions (including share options to
employees) in its profit or loss and statement of financial position.

What is a share-based payment transaction?

Share-based payment transaction is a transaction in which the entity:
• receives goods or services from the supplier (including employee) in a share-based payment arrangement; or
• incurs an obligation to settle the transaction with the supplier in a share-based payment arrangement when
another group entity receives those goods or services.

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Share-based payment arrangement is an agreement between the entity and another party (including an employee)
whereby the other party receives:
• Cash or other assets of the entity for amounts that are based on the price (or value) of equity instruments
(including shares or share options) of the entity or another group entity.
This type of arrangement is cash-settled share-based payment transaction.
• Equity instruments (including shares or share options) of the entity or another group entity.
This type is called equity-settled share-based payment.

If there are some specified vesting conditions, these must be met before receiving any share-based payment.

Vesting conditions
Some share-based payment transactions include vesting conditions that must be met before any payment is made.
IFRS 2 recognizes 2 types of vesting conditions:
1. Service conditions: they require the counterparty to complete a specified period or service;
2. Performance conditions: they require the counterparty to complete a specified period of services AND
specified performance targets to be met.

A performance condition might include a market condition that is linked to the market price of shares in some way,
for example, vesting might depend on achieving a minimum increase in the share price of the entity.
How to recognize share-based payments
The basic recognition principle is to recognize goods or services received in a share-based payment
transaction when the goods are obtained or as the services are received.
Goods or services acquired should be recognized as expenses in profit or loss unless they qualify for recognition as
assets. That’s the debit side of an accounting entry.
The credit side depends on the type of share-based payment arrangement:
• If the goods or services were acquired in an equity-settled share-based payment transaction, then the
corresponding increase is recognized in equity.
• If the goods or services were acquired in a cash-settled share-based payment transaction, then the
corresponding increase is recognized as a liability.

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Recognition of equity-settled share-based payment transactions

• How to measure equity-settled share-based payment?
The key principle in IFRS 2 is to measure the amount of transaction at fair value of the goods or services
received. This is relatively easy when the transaction is with parties other than employees.
However, sometimes (for example, when transaction is with employees), the fair value of goods or services
received cannot be measured reliably. In such a case, the entity should measure their value by reference to fair
value of the equity instruments granted.
And specifically, for employees, the entity should measure the services received from employees at the grant
date (not at the date of their receipt).
• How to determine the fair value of equity instruments granted?
When possible, the fair value should be based on the market prices if available. If not, then it is acceptable to
use some valuation technique (for example, share option pricing model).
• How to deal with vesting conditions?
Here, the principal question is whether vesting condition exists or not.
• NO: If the share-based payment IS vested immediately, or there are no vesting conditions, then IFRS 2
regards this transaction as granted in return for the supplier’s (employee’s) service in the past. Therefore,
an entity needs to recognize the services received immediately in full at the grant date, with the
corresponding increase in equity.

• YES: If the share-based payment DOES NOT vest until the counterparty meets some vesting conditions,
then IFRS 2 regards this transaction as granted in return for the supplier’s (employee’s) service rendered
during the vesting period. In this case, an entity should recognize an amount for the goods or services
received during the vesting period based on the best available estimate of the number of equity
instruments expected to vest.

• How to deal with changes?

Sometimes, an entity might change the terms of the share-based payment transaction.
Modification of the terms on which equity instruments were granted depends on the fair value of the new
equity instruments:
• If the fair value of the new instruments is greater than the fair value of the old instruments, then the
incremental amount is recognized over the remaining vesting period (or immediately if modification
happens after the vesting period).
• If the fair value of the new instruments is lower than the fair value of the old instruments, the original fair
value of the equity instruments granted should be expensed as if the modification never occurred.

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If an entity cancels or settles the equity instruments, then it is recognized as an acceleration of the vesting
period and any remaining unrecognized amount is recognized immediately.
Recognition of cash-settled share-based payment transactions

Typical examples of cash-settled share-based payment transactions are:

• Share appreciation rights: employee is entitled to the cash payment in the future based on the increase of
entity’s share price over specified period of time from a specified level;
• Rights to redeemable shares: employee will receive the shares in the future that are redeemable in cash.
Similarly as in the equity-settled share-based payment transaction, the goods or services received are measured at
the fair value of the liability.
The fair value of the liability has to be remeasured at each reporting date until this liability is settled and any
changes of fair value are recognized in profit or loss.
Vesting conditions are treated in the similar manner as in the equity-settled share-based payment transactions.

* * * * * * * * *

6.12 IFRS 5 Non-current Assets Held for Sale and Discontinued

Operations
Objective of IFRS 5
IFRS 5 focuses on 2 main areas:
1. It specifies the accounting treatment for assets (or disposal groups) held for sale, and
2. It sets the presentation and disclosure requirements for discontinued operations.

When to classify an asset as held for sale

You should classify a non-current asset as held for sale if its carrying amount will be recovered principally through
a sale rather than continuing use.
The same applies for a disposal group.
Disposal group: represents a group of assets and liabilities to be disposed of together as a group in a single
transaction.
For example, when a company runs a few divisions and decides to sell one division, then all assets (including PPE,
inventories, deferred tax, etc.) and all liabilities of that division would represent a disposal group.

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What if we abandon an asset?

The question is whether you should classify a non-current asset as held for sale in the case when you plan to stop
using it, or abandon it.
The answer is NO. Why?
Because, you will recover its carrying amount through asset’s continuing use and not sale. What does it practically
mean?
It means that you will NOT apply “held-for-sale accounting”, i.e. you will NOT keep an asset at lower of fair value
less costs to sell and its carrying amount (as specified below).
But, it also means, that you WILL need to assess the criteria for presenting the abandoned asset or operation as
discontinued operation.

When will an asset be recovered through a sale?

First of all, the asset or disposal group must be available for immediate sale in its present conditions and the sale
must be highly probable.
IFRS 5 sets a few criteria for the sale to be highly probable:
• Management must be committed to a plan to sell the asset;
• An active program to find a buyer must have been initiated;
• The asset must be actively marketed for sale at a price reasonable to its current fair value;
• The sale is expected to be completed within 1 year from the date of classification;
• Significant changes to the plan are unlikely.

How to account for assets held for sale

Once you classify an asset or a disposal group as held for sale, then you should measure it under IFRS 5.
However, IFRS 5 lists a few measurement exceptions:
• Deferred tax assets (IAS 12).
• Assets arising from employee benefits (IAS 19).
• Financial assets within the scope of IFRS 9.
• Non-current assets that are accounted for in accordance with the fair value model in IAS 40.
• Non-current assets that are measured at fair value less costs to sell in accordance with IAS 41 Agriculture.
• Contractual rights under insurance contracts as defined in IFRS 4 Insurance Contracts.

When you classify any of the above types of assets as assets held for sale, you continue measuring them under the
same accounting policies as before classification (e.g. financial instrument held for sale will still be measured under
IFRS 9, not IFRS 5).
Why have we classified these assets as held for sale though?
The reason is that although you don’t change their accounting treatment, you change their presentation and
disclosures. You will still need to present these assets separately from others and disclose some additional
information.

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All other assets not excluded in the above list must be measured at lower of their carrying amount and fair value
less costs to sell. That’s the main measurement principle of IFRS 5.

Measurement immediately before classification

Immediately before you classify an asset as held for sale, you should measure it under applicable IFRS. For example,
you would measure an item of property, plant and equipment under IAS 16.
Measurement after classification
Subsequently, after you classified an asset as held for sale, you should measure it at lower of its carrying amount
and fair value less costs to sell (except for measurement exceptions listed above).
Impairment
With regard to any impairment, immediately before classification as held for sale, the impairment is recognized in
line with the applicable IFRSs, for example, under IAS 36 for property, plant and equipment.
In this case, you would recognize any impairment loss in profit or loss, but sometimes also in other comprehensive
income – that’s when you apply revaluation model for your property, plant and equipment and you have a
revaluation surplus to decrease.
After you classify an asset as held for sale, you would recognize any impairment loss in profit or loss only.

What are discontinued operations

IFRS 5 specifies that you need to pay special attention to presenting any discontinued operation. But, what is it?
It is a component of an entity (understand: a cash-generating unit or a group of cash-generating units) that
either has been disposed of or is classified as held for sale, and at the same time:
• Represents a separate major line of business or geographical area of operations,
• Is part of a plan to dispose it of, or
• Is a subsidiary acquired exclusively with a view to resale.

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How to present discontinued operations

Once you identify a discontinued operation, you should present it separately from other continuing operations in
your financial statements.
1. In the statement of comprehensive income: a single amount comprising the total of:
✓ The post-tax profit or loss of discontinued operations, and
✓ The post tax gain or loss recognized on the measurement to fair value less costs to sell a or on the disposal
of assets or disposal groups.
The analysis of a single amount shall be reported in the notes or in the statement of comprehensive income.
2. In the statement of cash flows: the net cash flows attributable to the operating, investing and financing
activities of discontinued operations. You can present these disclosures in the notes or in the financial
statements themselves.

3. In the statement of financial position: you shall present a non-current asset or assets of a disposal group
classified as held for sale separately from other assets. The same applies for liabilities of a disposal group
classified as held for sale.

* * * * * * * * *

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6.13 IFRS 9 – Financial Instruments

Financial Instruments
Financial Assets (Equity* and Debt**) Financial Liabilities
Description
Amortised Cost Fair value Fair value Amortised Cost Fair value
through Profit through OCI through Profit
and Loss and Loss
Business Held to realise Held for trading Held to realise All financial Derivates that
model cash flows (for in short term and sell in long liabilities are liabilities
example, term. (except unless held in
dividend or Debt: Revocable derivates hedging
interest) option. Can be classified as relationships
reclassified FVTPL) and the qualify
through P/L. for hedge
Equity: Irrevocable accounting.
option. Cannot be
reclassified
through P/L.

Initial Fair value of Fair value of Fair value of Fair value of Fair value of
measurement consideration consideration consideration consideration consideration
given. (Present given. given. received. received.
value of future (Present value
cash flows of future cash
discounted at flows
effective discounted at
interest rate or effective
market rate, interest rate or
whichever is market rate,
applicable) whichever is
applicable)
Subsequent Ammortised Marked to Marked to Ammortised Marked to
measurement cost market market cost market
Transaction Capitalised as a Expensed out Capitalised as a Capitalised as a Expensed out
cost part of carrying immediately part of carrying part of carrying immediately
amount on from statement amount on initial amount on from statement
initial of profit or loss. recognition. initial of profit or loss.
recognition. recognition.
Fair value Not applicable Statement of Other Not applicable Statement of
changes on Profit or Loss comprehensive Profit or Loss
reporting date income
Gain or loss on Statement of Statement of Statement of Normally no gain or loss.
derecognition Profit or Loss Profit or Loss Profit or Loss
* Example: Share in listed company.
** Examples: PIBs, DSCs, Sukuks, Loan and receivables.

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6.14 IFRS 13 - Fair Value Measurement

Why IFRS 13?
The objectives of IFRS 13 are:
• to define fair value;
• to set out in a single IFRS a framework for measuring fair value; and
• to require disclosures about fair value measurements.

Fair
value is a market-based measurement, not an entity-specific measurement. It means that an entity:
• shall look at how the market participants would look at the asset or liability under measurement
• shall not take own approach (e.g. use) into account.

What is fair value?

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.
This is the notion of an exit price.
When an entity performs the fair value measurement, it must determine all of the following:
• the particular asset or liability that is the subject of the measurement (consistently with its unit of account)
• for a non-financial asset, the valuation premise that is appropriate for the measurement (consistently with its
highest and best use)
• the principal (or most advantageous) market for the asset or liability
• the valuation techniques appropriate for the measurement, considering:
✓ the availability of data with which to develop inputs that represent the assumptions that market
participants would use when pricing the asset or liability; and
✓ the level of the fair value hierarchy within which the inputs are categorized.

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Asset or liability
The asset or liability measured at fair value might be either:
• a stand-alone (individual) asset or liability (for example, a share or a pizza oven)
• a group of assets, a group of liabilities, or a group of assets and liabilities (for example, controlling interest
represented by more than 50% of shares in some company, or cash-generating unit being pizzeria).
Whether the asset or liability is stand-alone or a group depends on its unit of account. Unit of account is determined
in accordance with the other IFRS standard that requires or permits fair value measurement (for example, IAS 36
Impairment of Assets).
When measuring fair value, an entity takes into account the characteristics of the asset or liability that a market
participant would take into account when pricing the asset or liability at measurement date.
These characteristics include for example:
• the condition and location of the asset
• the restrictions on the sale or use of the asset.

Transaction
A fair value measurement assumes that the asset or liability is exchanged in an orderly transaction between market
participants at the measurement date under current market conditions.
❖ Orderly transaction
The transaction is orderly when 2 key components are present:
• there is adequate market exposure in order to provide market participants the ability to obtain knowledge
and awareness of the asset or liability necessary for a market-based exchange
• market participants are motivated to transact for the asset or liability (not forced).

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❖ Market participants
Market participants are buyers and sellers in the principal or the most advantageous market for the asset or
liability, with the following characteristics:
• independent
• knowledgeable
• able to enter into transaction
• willing to enter into transaction.

Principal vs. the most advantageous market

A fair value measurement assumes that the transaction to sell the asset or transfer the liability takes place either:
• in the principal market for the asset or liability; or
• in the absence of a principal market, in the most advantageous market for the asset or liability.

Principal market is the market with the greatest volume and level of activity for the asset or liability. Different
entities can have different principal markets, as the access of an entity to some market can be restricted.
The most advantageous market is the market that maximizes the amount that would be received to sell the asset
or minimizes the amount that would be paid to transfer the liability, after taking into account transaction costs and
transport costs.

Highest and Best use

Fair value of a non-financial asset shall be measured based on its highest and best use from a market participant’s
perspective.
The highest and best use takes into account the use of the asset that is:
• physically possible − it takes into account the physical characteristics that market participants would consider
(for example, property location or size);
• legally permissible – it takes into account the legal restrictions on use of the asset that market participants
would consider (for example, zoning regulations); or
• financially feasible – it takes into account whether a use of the asset generates adequate income or cash flows
to produce an investment return that market participants would require. This should incorporate the costs of
converting the asset to that use.

The highest and best use of a non-financial asset may be on a stand-alone basis or may be achieved in combination
with other assets and/or liabilities (as a group).
When the highest and best use is in an asset/liability group, the synergies associated with the asset/liability group
may be reflected in the fair value of the individual asset in a number of ways, for example, by some adjustments
via valuation techniques.

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Valuation techniques
When determining fair value, an entity shall use valuation techniques:
• Appropriate in the circumstances
• For which sufficient data are available to measure fair value
• Maximizing the use of relevant observable inputs
• Minimizing the use of unobservable inputs.
Valuation techniques used to measure fair value shall be applied consistently.
However, an entity can change the valuation technique or its application, if the change results in equally or more
representative of fair value in the circumstances.
An entity accounts for the change in valuation technique in line with IAS 8 as for a change in accounting estimate.
IFRS 13 allows 3 valuation approaches:
• Market approach: uses prices and other relevant information generated by market transactions involving
identical or comparable (i.e. similar) assets, liabilities, or a group of assets and liabilities, such as a business
• Cost approach: reflects the amount that would be required currently to replace the service capacity of an asset
(often referred to as current replacement cost).
• Income approach: converts future amounts (e.g. cash flows or income and expenses) to a single current (i.e.
discounted) amount. The fair value measurement is determined on the basis of the value indicated by current
market expectations about those future amounts.

❖ Fair value hierarchy

IFRS 13 introduces a fair value hierarchy that categorizes inputs to valuation techniques into 3 levels. The
highest priority is given to Level 1 inputs and the lowest priority to Level 3 inputs.
An entity must maximize the use of Level 1 inputs and minimize the use of Level 3 inputs.
Level 1 inputs - are quoted prices in active markets for identical assets or liabilities that the entity can access
at the measurement date.
Level 2 inputs - other than quoted prices included within Level 1 that are observable for the asset or liability,
either directly or indirectly.
Level 3 inputs - are unobservable inputs for the asset or liability. An entity shall use Level 3 inputs to measure
fair value only when relevant observable inputs are not available.

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The following scheme outlines the fair value hierarchy together with examples of inputs to valuation
techniques:

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 Audit Focus
IFRS 5 – NON-CURRENT ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

AUDIT PROCEDURES (REPORTING)

IFRS 5 – Non-current Assets Held for Sale and Discontinued
Operations
1. PRESENTATION AND DISCLOSURE OF SEGMENT INFORMATION
ISA 501, Audit evidence – Specific Considerations for Selected Items governs the auditor's approach to
auditing segment information.
Auditors are required to obtain sufficient, appropriate audit evidence regarding the presentation and
disclosure of segment information by:
(a) obtaining an understanding of the methods used by management in determining segment
information:
(i) evaluating whether such methods are likely to result in disclosure in accordance with the
applicable financial reporting framework,
(ii) where appropriate, testing the application of such methods; and
(b) performing analytical procedures or other audit procedures appropriate in the circumstances. (ISA
501.13)

When the ISA talks about obtaining an understanding of management's methods, the following may
be relevant:

• Sales, transfers and charges between segments, elimination of inter-segment amounts

• Comparisons with budgets and other expected results; for example, operating profits as a
percentage of sales
• Allocations of assets and costs
• Consistency with prior periods, and the adequacy of the disclosures with respect to inconsistencies

It is important to stress that auditors only have a responsibility in relation to the financial statements
taken as a whole. Auditors are not required to express an opinion on the segment information
presented on a standalone basis.

2. HELD FOR SALE ASSETS

IFRS 5 requires that assets which meet the criteria 'held for sale' are shown at the lower of carrying
amount and fair value less costs to sell, that held for sale assets are classified separately on the
statement of financial position and the results of discontinued operations are presented separately on
the statement of profit or loss and other comprehensive income.

3. AUDIT PROCEDURES
To ensure assets meet the criteria include the following:
• Inquiries/written representations from management concerning intentions
• Reviewing minutes of management for evidence of firm plan to sell
• Ascertaining whether appropriate estate agent appointed (by reviewing contract between the
parties)
• Reviewing sale particulars
• Comparison of sale price per sale particulars to fair value
• Asking estate agent of likelihood of completion within a year

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 Audit Focus
IAS 24 – RELATED PARTIES DISCLOSURES

IAS 24 – Related Parties Disclosures

ISA 550 provides guidance on the auditor's responsibilities, and audit procedures regarding related parties
and transactions with such parties.

ISA 550 is applicable whether or not IAS 24, Related Party Disclosures is a requirement of the reporting
framework for the entity concerned.

1. AUDITOR RESPONSIBILITIES
The auditor has a responsibility to perform audit procedures to identify, assess and respond to the
risks of material misstatement arising from the entity's failure to appropriately account for or disclose
related party relationships, transactions or balances.

2. RISKS
The following audit risks may arise from a failure to identify a related party.
• Failure of the financial statements to comply with IAS 24.
• There may be a misstatement in the financial statements – transactions may be on a non-arm’s
length basis and thus may result in assets, liabilities, profit or loss being overstated or understated.
For example, special tax rates may apply to profits reported on sales to related parties.
• The reliance on a source of audit evidence may be misjudged. An auditor may rely on what is
perceived to be third-party evidence when in fact it is from a related party. More generally, reliance
on management assurances may be affected if the auditor were made aware of non-disclosure of
a related party.
• The motivations of related parties may be outside normal business motivations and thus may be
misunderstood by the auditor if there is non-disclosure. In the extreme, this may amount to fraud.

The inherent risk linked to related party transactions (RPT) can be high, especially where management
is unaware of the existence of all the related party relationships or transactions, or where there is an
opportunity for collusion, concealment or manipulation by management. There is an increased risk
that the auditor may fail to detect a RPT, where:

• there has been no charge made for a RPT (ie, a zero cost transaction);
• disclosure would be sensitive for directors or have adverse consequences for the company;
• the company has no formal system for detecting RPTs;
• RPTs are with a party that the auditor could not reasonably expect to know is a related party;
• RPTs from an earlier period have remained as an unsettled balance;
• management have concealed, or failed to disclose fully, related parties or transactions with such
parties; and
• the corporate structure is complex.

Point to note: The term 'arm's length' continues to be used in the context of IAS 24 even though it has
been removed from the definition of fair value in IFRS 13.

2.1 Risk assessment procedures

In planning the audit, the auditor needs to consider the risk of undisclosed related party transactions.
This is a difficult area because IAS 24 does not have consideration for materiality. Thus, even small
RPTs should be disclosed by a company. Indeed, related party relationships where there is control
(e.g, a subsidiary) need to be disclosed even where there are no transactions with this party.

The auditor needs to perform the following procedures:

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 Audit Focus
IAS 24 – RELATED PARTIES DISCLOSURES
(a) The engagement team shall discuss the risks of fraud-related misstatements. Matters to be
addressed would include the importance of maintaining professional scepticism and circumstances
which may indicate the existence of related party relationships or transactions that management
has not identified.
(b) Make inquiries of management about the identities of related parties and any RPTs. This includes:
(1) the identity of related parties, including changes from prior period;
(2) the nature of the relationships between the entity and its related parties;
(3) whether any transactions occurred between the parties and, if so;
(4) what controls the entity has to identify, account for and disclose related party relationships
and transactions;
(5) what controls the entity has to authorize and approve significant transactions and
arrangements with related parties; and
(6) what controls the entity has to authorize and approve significant transactions and
arrangements outside the normal course of business.
(c) Obtain an understanding of controls established to identify, account for and disclose RPTs and to
authorize and approve significant transactions with related parties / outside the normal course of
business.

Where controls are ineffective or non-existent, the auditor may be unable to obtain sufficient,
appropriate audit evidence and will need to consider the impact of this on the audit opinion.

The auditor is also required to be alert for related party information when reviewing records or
documents. In particular, the auditor must inspect bank and legal confirmations and minutes of
meetings of the shareholders and those charged with governance. Where these procedures reveal
significant transactions outside the entity's normal course of business, the auditor must inquire of
management about the nature of these transactions and whether a related party could be involved.

2.2 Responses to the risks of material misstatement

In accordance with ISA 330, the auditor must design and perform further audit procedures to obtain
sufficient, appropriate evidence about the assessed risks of material misstatement. These may
include:
• confirming or discussing the transactions with intermediaries eg, banks, lawyers or agents;
• confirming the purposes, specific terms or amounts of the transaction with the related party; and
• reading the financial statements of the related party for evidence of the transaction in the related
party's accounting records.

Where the risk of misstatement may be due to fraud additional procedures may apply:

• Inquiries of and discussion with management and those charged with governance
• Inquiries of the related party
• Inspection of significant contracts with the related party
• Background research eg, internet
• Review of employee whistleblowing reports

Identification of previously unidentified or undisclosed related parties or significant related party

transactions

If the auditor identifies related parties or significant related party transactions that management has
not previously identified or disclosed to the auditor, the auditor must do the following:

• Promptly communicate the relevant information to the other members of the engagement team

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IAS 24 – RELATED PARTIES DISCLOSURES
• Where the applicable reporting framework establishes related party requirements request
management to identify all transactions with the newly identified related parties and inquire as to
why the entity's controls have failed to identify and disclose the transaction
• Perform appropriate substantive audit procedures These might include making inquiries regarding
the nature of the entity's relationships with the newly identified related party, conducting an
analysis of accounting records for transactions with the newly identified related party and verifying
the terms and conditions of the newly identified related party transaction
• Reconsider the risk that other unidentified related parties or significant related party transactions
may exist
• If the non-disclosure by management appears intentional and therefore indicates possible fraud
evaluate the implications for the rest of the audit

Identified significant related party transactions outside the entity's normal course of business

Where significant related party transactions outside the entity's normal course of business are
identified, the auditor must do the following:

• Inspect the underlying contracts and agreements and evaluate whether:

– the business rationale or lack of suggests fraud;
– the terms are consistent with the management's explanations; and
– the transaction has been appropriately accounted for and disclosed.
• Obtain audit evidence that transactions have been appropriately authorized and approved

Management assertions

If management has made assertions in the financial statements to the effect that a related party
transaction was conducted on terms equivalent to those prevailing in an arm's length transaction, the
auditor must obtain evidence to support this. The nature of the evidence obtained will depend on the
support management has obtained to substantiate their claim but may involve:

• considering the appropriateness of management's process for supporting the assertion;

• verifying the source of internal and external data supporting the assertion and testing it for
accuracy, completeness and relevance; and
• evaluating the reasonableness of any significant assumptions on which the assertion is based

2.3 Evaluation of accounting and disclosure

The auditor is required to evaluate whether related parties and related party transactions have been
properly accounted for and disclosed and do not prevent the financial statements from achieving fair
presentation

2.4 Written representations

The auditor is required to obtain written representations from management and, where appropriate,
those charged with governance that all related parties and related party transactions have been
disclosed to the auditor and that these have been appropriately accounted for and disclosed.

An entity may require its management and those charged with governance to sign individual
declarations in relation to related party matters. It may be helpful if any such declarations are
addressed jointly to a designated official of the entity and also to the auditor

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IAS 24 – RELATED PARTIES DISCLOSURES
2.5 Documentation
The auditor is required to include in the audit documentation to identity of related parties and the
nature of related party relationships.

2.6 Identifying undisclosed related parties

It is often difficult to identify related party relationships and transactions which should have been
disclosed, but are not.
ISA 550 points out that the existence of the following relationships may indicate the presence of
control or significant influence:
(a) Direct or indirect equity holdings or other financial interests in the entity
(b) The entity's holdings of direct or indirect equity or other financial interests in other entities
(c) Being part of those charged with governance or key management (that is, those members of
management who have the authority and responsibility for planning, directing and controlling the
activities of the entity)
(d) Being a close family member of any person referred to in subparagraph (c)
(e) Having a significant business relationship with any person referred to in subparagraph (c)

The related parties described in subparagraph (c) above, and by extension those described in (d) and
(e), are often the hardest to identify. While entities related through equity interest should be fairly
clearly documented, auditors frequently struggle to identify related party transactions established
through connected persons.

The following risk assessment procedures are relevant when testing for the existence of undisclosed
related parties:

• Enquire of management and the directors as to whether transactions have taken place with related
parties that are required to be disclosed by the disclosure requirements that are applicable to the
entity
• Review prior year working papers for names of known related parties
• Review minutes of meetings of shareholders and directors and other relevant statutory records,
such as the register of directors' interests
• Review accounting records for large or unusual transactions or balances, in particular transactions
recognised at or near the end of the financial period
• Review confirmations of loans receivable and payable and confirmations from banks. Such a review
may indicate the relationship, if any, of guarantors to the entity
• Review investment transactions, for example purchase or sale of an interest in a joint venture or
other entity
• Enquire as to the names of all pension and other trusts established for the benefit of employees
and the names of their management and trustees
• Enquire as to the affiliation of directors and officers with other entities
• Review the register of interests in shares to determine the names of principal shareholders
• Enquire of other auditors currently involved in the audit, or predecessor auditors, as to their
knowledge of additional related parties
• Review the entity's tax returns, returns made under statute and other information supplied to
regulatory agencies for evidence of the existence of related parties
• Review invoices and correspondence from lawyers for indications of the existence of related
parties or related party transactions.

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 Audit Focus
IFRS 15 – REVENUE FORM CONTRACTS WITH CUSTOMERS

IFRS 15 – Revenue from Contracts with Customers

1. AUDIT PROCEDURES FOR TESTING IFRS 15
Stage of IFRS 15 Suggested audit procedures
Step 1: Identify the • Obtain copies of contracts between entities and customers
contract(s) with a
customer.
• Inspect contracts to confirm they are legally binding and effective for the year
of audit.
• For implied contracts (such as retail contracts) clarify the likely contractual
terms to establish rights and responsibilities in each case.

Step 2: Identify • Confirm the goods or services to be transferred, either individually or as part
separate performance of a series, by reference to the contracts in place.
obligations.
• Confirm whether any of the goods or service are not distinct by reference to
the contracts in place and if separate bundles.

Step 3: Determine the • Identify the amount of consideration by reference to the contract
transaction price.
• Where appropriate, confirm the split between variable and fixed elements and
re-calculate any variable amounts by reference to the contract terms.
• Test the hypothesis that variable consideration is highly probable by reviewing
the reasonableness of the underlying assumptions used in the entity's
calculations.

Step 4: Identify • Confirm stand-alone prices to individual elements of the contract as

separate performance performance obligations are settled
obligations.
• In the case of estimated stand-alone prices, test the assumptions
underpinning the calculations used by the entity for reasonableness.

Step 5: Recognize • For performance obligations satisfied at a point in time (such as retail sales)
revenue as or when confirm the occurrence of the event required (such as the sale itself) by
each performance reference to supporting documentation.
obligation is satisfied.

Other tests • For deferred consideration, confirm the proportion split between the value of
the goods on the date of sale and the financing income by reference to the
contract and testing the reasonableness of the entity's calculations for
recognizing revenue (such as interest rates for estimating fair value)

Consignment • Consider the existence of any indicators of consignment arrangements, such

arrangements as:
 Confirming who controls the product and what (if any) conditions need to
have occurred for control to be passed on.
 Clarifying who can require the return of a product or transfer it to a third
party.

Bill and hold • Consider the existence of such arrangements and if present, review the
arrangements conditions required by IFRS 15 have been met:

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 Audit Focus
IFRS 15 – REVENUE FORM CONTRACTS WITH CUSTOMERS
• Confirm that the customer owns the products stored by the seller by
reference to the contract terms, and obtain confirmation from the customer
that they are happy for the seller to hold them.
• Inspect the agreement between the seller and customer to confirm the
products can be accessed at any time and not transferred to another
customer.

2. AUDIT PROCEDURES FOR CONTRACTS IN WHICH PERFORMANCE OBLIGATIONS ARE SATISFIED OVER TIME
('CONSTRUCTION CONTRACTS')
Remember, under IFRS 15, the entity recognizes revenue in such cases by measuring progress
towards complete satisfaction of the performance obligation. Progress can be measured using output
methods (measuring the value to the customer of goods or services transferred to date) or input
methods (measuring the cost to the entity of goods or services transferred to date).
(IFRS 15.B14)

The following audit procedures will be relevant:

• Confirm contract price to contract agreed between client and customer
• Determine any amounts of conditional revenue/costs including the associated conditions
• Confirm the progress to date of the work completed, including any potential delays or problems
• Confirm costs incurred to date (inputs) by reference to management accounts, invoices, budgets
and other relevant documentation
• Identify any expenditure not supporting fulfilment of the contract by inspecting board minutes,
management accounts or other documentation (such as legal correspondence)
• Confirm total costs estimated for contract to ensure no planned overspends have been identified
(again, budgets, board minutes or management accounts can be inspected)
• Confirm the amounts of contract work certified as complete (outputs) at the year end by reference
to relevant documentation (such as surveyors' reports or client estimates).

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 Audit Focus
IAS 40 – INVESTMENT PROPERTIES

IAS 40 – Investment Properties

1. AUDIT EVIDENCE
Issue Evidence
Classification as an Confirm that all investment properties are classified in accordance with the
investment property IAS 40 definition. This will include:
• a building owned by the entity and leased out under one or more operating
leases; and.
• a building that is vacant but is held to be leased under one or more
operating leases.

Verify rental agreements, ensuring that the occupier is not a connected

company and that the rent has been negotiated at arm's length
If the building has recently been built, check the architect's certificates to
ensure that cost/fair value is reasonable.

Valuation If cost model adopted, check compliance with IAS 16.

If fair value model adopted:
• Check that fair value has been measured in accordance with IFRS 13
• Where current prices in an active market are not available confirm that
alternative valuation basis is reasonable and in accordance with IFRS 13,
and document the relevant audit evidence
• Agree valuation to valuer's certificate
• Recalculate gain or loss on change in fair value and agree to amount in
statement of profit or loss and other comprehensive income
• If fair value cannot be measured reliably confirm use of cost model
• Consider the use of an auditor's expert to review the appropriateness of
the underlying market assumptions and valuation methodology used

Disclosure Confirm compliance with IAS 40/IFRS 13, for example:

• Disclosure of policy adopted
• If fair value model adopted disclosure of a reconciliation of carrying
amounts of investment property at the beginning and end of the period
• Disclosure of the inputs used to measure fair value based on the fair value
hierarchy (Level 1, Level 2 or Level 3)
• Where Level 2 or Level 3 inputs are used, a description of the valuation
techniques and inputs used (interest rates, net reversionary yield,
stabilised net rental value, costs to complete and developer's profit)
• For fair value measurements using significant unobservable inputs (Level
3), the effect of the measurements on profit or loss and other
comprehensive income for the period

Note: IAS 40 states that fair value should be measured in accordance with IFRS 13.

2. RISK
The valuation process is inherently judgmental, which is why we consider this to be a risk of material
misstatement. In particular, changes in assumptions such as the capitalization rates, forecast rent per
square foot, forecast occupancy levels and, in the case of investment property under construction,
cost to complete can lead to significant movements in the value of the property, as can changes in the
underlying market conditions.

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 Audit Focus
IAS 40 – INVESTMENT PROPERTIES
How the scope of our audit responded to the risk

(a) We assessed the design and implementation of controls around the property valuations by
considering the level of management oversight and review of the valuations prepared by the
external valuation specialists engaged by management, who have been named in note 14;
(b) We tested the integrity of the information provided by management to the valuer by agreeing key
inputs such as actual occupancy and net rent per square foot to underlying records and source
evidence;
(c) We modelled eight years of valuations and key valuation inputs to the investment property
portfolio, to understand the historical trends of key inputs and compared these against the key
forecast assumptions included in the property valuation;
(d) We met with the valuer. We assessed their independence, the scope of the work they were
requested to perform by management, and the valuation methodology applied. For each property
we identified as having significant or unusual valuation movements (compared to market data or
previous periods), we challenged the valuer on the key assumptions applied. Our challenge was
informed by input from our internal valuation specialists, utilizing their knowledge and expertise
in the market at a macro level and the relevant geographies to challenge the key judgmental inputs
noted adjacent. We also researched comparable transactions and understood trends in analogous
industries. We understood the rationale for outlying valuations or movements and obtained
corroborative evidence. We also assessed the valuations for a sample of other properties; and
(e) We visited a sample of properties to assess the condition of the buildings.

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 Audit Focus
IAS 10 AND 37 – CONTINGENCIES AND COMMITMENTS WITH EVETS AFTER REPORTING PERIOD

IAS 10 and 37 – Contingencies and Commitments with Events after

reporting period
1. AUDITING PROVISIONS AND CONTINGENCIES
Much of the audit work here is focused on ensuring that the recognition and treatment of these items
is in accordance with IAS 37, which we looked at in section 2 of this chapter.

The audit procedures that should be carried out on provisions and contingent assets and liabilities are
as follows:
• Obtain details of all provisions which have been included in the accounts and all contingencies that
have been disclosed.
• Obtain a detailed analysis of all provisions showing opening balances, movements and closing
balances.
• Determine for each material provision whether the company has a present obligation as a result of
past events by:
 reviewing of correspondence relating to the item; and
 discussing with the directors. Have they created a valid expectation in other parties that they will
discharge the obligation?
• Determine for each material provision whether it is probable that a transfer of economic benefits
will be required to settle the obligation by:
 checking whether any payments have been made after the end of the reporting period in respect
of the item;
 reviewing correspondences with solicitors, banks, customers, insurance company and suppliers
both pre and post year end;
 sending a letter to the solicitor to obtain their views (where relevant);
 discussing the position of similar past provisions with the directors. Were these provisions
eventually settled; and
 considering the likelihood of reimbursement.
• Recalculate all provisions made.
• Compare the amount provided with any post year end payments and with any amount paid in the
past for similar items.
• In the event that it is not possible to estimate the amount of the provision, check that this contingent
liability is disclosed in the accounts.
• Consider the nature of the client's business. Would you expect to see any other provisions, for
example warranties?
• Consider whether disclosures of provisions, contingent liabilities and contingent assets are correct
and sufficient.

2. PROCEDURES REGARDING LITIGATION AND CLAIMS

2.1 Litigation and claims
Litigation and claims involving the entity may have a material effect on the financial statements, and
so will require adjustment to or disclosure in those financial statements.

The auditor shall design and perform procedures in order to identify any litigation and claims involving
the entity which may give rise to a risk of material misstatement. (ISA 501.9)

Such procedures would include the following:

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IAS 10 AND 37 – CONTINGENCIES AND COMMITMENTS WITH EVETS AFTER REPORTING PERIOD
• Make appropriate inquiries of management and those charged with governance including obtaining
representations.
• Review board minutes and correspondence with the entity's lawyers.
• Examine legal expense account.
• Use any information obtained regarding the entity's business including information obtained from
discussions with any in-house legal department.

When litigation or claims have been identified or when the auditor believes they may exist, the
auditor must seek direct communication with the entity's lawyers.

(ISA 501.10)

This will help to obtain sufficient, appropriate audit evidence as to whether potential material
litigation and claims are known and management's estimates of the financial implications, including
costs, are reliable.

Form of the letter of inquiry

The letter, which should be prepared by management and sent by the auditor, should request the
lawyer to communicate directly with the auditor.

If it is thought unlikely that the lawyer will respond to a general inquiry, the letter should specify the
following.

• A list of litigation and claims

• Management's assessment of the outcome of the litigation or claim and its estimate of the financial
implications, including costs involved
• A request that the lawyer confirm the reasonableness of management's assessments and provide
the auditor with further information if the list is considered by the lawyer to be incomplete or
incorrect.

The auditors must consider these matters up to the date of their report and so a further, updating
letter may be necessary.

A meeting between the auditors and the lawyer may be required, for example where a complex
matter arises, or where there is a disagreement between management and the lawyer. Such meetings
should take place only with the permission of management, and preferably with a management
representative present.

If management refuses to give the auditor permission to communicate with the entity's lawyers or if
the lawyer refuses to respond as required and the auditor can find no alternative sufficient evidence,
this would mean that the auditor is unable to obtain sufficient, appropriate evidence and should
ordinarily lead to a qualified opinion or a disclaimer of opinion.

(ISA 501.11)

3. PROCEDURES REGARDING EVENTS AFTER THE REPORTING PERIOD

ISA 560, Subsequent Events sets out the audit requirements in relation to events occurring after the
reporting period.

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 Audit Focus
IFRS 16 – LEASES

IFRS 16 – Leases
1. AUDITING LEASES
In auditing leases recognized at fair value, the auditor must evaluate whether the fair value is
appropriate.

The table below summarises the areas of audit focus when auditing leases in accordance with IAS 17,
and provides some examples of audit evidence required.
Issue Evidence
Ascertaining that the leases Obtain schedules of finance leases and operating leases, including any
recorded in the financial leases that existed at the end of the prior period, and any new leases.
statements are complete.
Determine that any leased property is still in use.
Obtain assurance about the completeness of the schedule by making
inquiries of informed management, and consider any evidence of
additional leases by examining other documents such as board meeting
minutes, significant contracts and property additions.
The classification of the Review lease agreements for indicators that the risks and rewards of
leases reflects the substance ownership have been transferred to the entity, such as:
of the transaction. • responsibility for repairs and maintenance;
• transfer of legal title at the end of the lease term;
• the lease is for most of the assets' useful life; and
• the present value of the minimum lease payments is substantially all of
the assets' fair value.
Ascertaining that the Select a sample of entries in the lease expense account, and verify that
operating lease expenses they relate to operating leases.
have been correctly recorded
in profit or loss Recalculate operating lease expenses, on a straight-line basis over the
lease term.
Ascertaining that the finance Recalculate the finance charges charged against profit and loss.
leases have been correctly Agree interest rates used in calculations to lease agreements.
recorded in the statements Agree the calculation of the leased assets' fair value to external evidence,
of financial position and such as market prices or surveyors' reports.
profit or loss Recalculate the depreciation charges applied to non-current assets
Review the assumptions made in respect of the useful life of each finance
lease asset, and agree the useful life/lease term to the depreciation
workings to ensure that the assets are depreciated over an appropriate
period.
Review rentals paid during the year to verify that rental payments are split
between the finance charge element and the repayment of capital in
accordance with IAS 17.
Ascertaining that the lease Review the disclosures in the financial statements to determine whether
liability has been disclosed in the disclosures are consistent and complete.
the financial statements in
accordance with IFRSs

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 Audit Focus
IFRS 09, IFRS 07, IAS 32: FINANCIAL INSTRUMENTS
IFRS 09, IFRS 07, IAS 32: Financial Instruments
1. AUDIT ISSUES AROUND FAIR VALUE
For the auditor the use of fair values will raise a number of issues. The determination of fair value will
generally be more difficult than determining historical cost. It will be more difficult to establish
whether fair value is reasonable for complex assets and liabilities than for more straightforward assets
or liabilities which have an actively traded market and therefore a market value.

Generally speaking, the trend towards fair value accounting will increase audit work required, not only
because determining fair values is more difficult, but also because fair values fluctuate in a way that
historical costs do not, and will need vouching each audit period. Fair value will, for the same reasons,
increase audit risk.

The ISA treats fair values as a type of accounting estimate and therefore the requirements of the ISA
apply to fair values as they would to any other type of accounting estimate.

2. RISK ASSESSMENT
Management is responsible for establishing the process for determining fair values. This process will
vary considerably from organization to organization. Some companies will habitually value items at
historical cost where possible, and may have poor processes for determining fair values if required.
Others may have complex systems for determining fair value if they have a large number of assets and
liabilities which they account for at fair value, particularly where a high degree of estimation is
involved.

Not all financial statement items requiring measurement at fair value involve estimation uncertainty.
In accordance with IFRS 13, entities should maximize the use of relevant observable inputs. For
example, if using a Level 1 input (eg, the unadjusted quoted price in an active market of equity shares
in a listed company), there is no estimation uncertainty.

For others, however, there may be moderate (eg, Level 2 inputs) or relatively high estimation
uncertainty (eg, Level 3 inputs), particularly where they are based on significant assumptions, for
example:

• Fair value estimates for derivative financial instruments not publicly traded
• Fair value estimates for which a highly specialized entity-developed model is used or for which there
are assumptions or inputs that cannot be observed in the marketplace.

ISA 540 requires the auditor to assess the entity's process for determining fair value measurements
and disclosures and the related control activities and to assess the risks of material misstatement.

In practical terms, this would include considering the following:

• The valuation techniques adopted (ie, Level 1, 2 or 3)

• The valuation approach used in making the accounting estimate (ie, income approach, market
approach, cost approach)
• The market in which the transaction is assumed to have taken place (ie, principal market or most
advantageous market)
• The relevant control activities over the process (eg, controls over data and the segregation of duties
between those committing the entity to the underlying transaction and those responsible for
undertaking the valuations)
• The expertise and experience of those persons determining the fair value measurements

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• The role that information technology has in the process
• The types of accounts or transactions requiring fair value measurements or disclosures (eg, whether
the accounts arise from routine/recurring transactions or non-routine/unusual transactions)
• The significant management assumptions used (particularly where Level 3 unobservable inputs are
used)
• Whether there has been or ought to have been a change from the prior period in the methods for
making the accounting estimates, and, if so, why (a change in valuation technique is considered to
be a change in accounting estimate in accordance with IAS 8.)
• Whether, and if so how, management has assessed the effect of estimation uncertainty
• The extent to which the process relies on a service organization.
• The extent to which the entity uses the work of experts in determining fair value measurements and
disclosures
• Documentation supporting management's assumptions
• The methods used to develop and apply management assumptions and to monitor changes in those
assumptions
• The integrity of change controls and security procedures for valuation models and relevant
information systems, including approval processes
• Controls over the consistency, timeliness and reliability of the data used in valuation models.

Evaluating the appropriateness of fair value

ISA 540 requires the auditor to evaluate whether the fair value measurements and disclosures in the
financial statements are in accordance with the entity's applicable financial reporting framework.

In some cases, the financial reporting framework may prescribe the method of measurement – for
example, a particular model that is to be used in measuring a fair value estimate. In many cases,
however, the method is not specified, or there may be a number of alternative methods available.
The auditor may consider the following:

• How management considered the nature of the asset or liability when selecting a particular method
• Whether the entity operates in a particular business, industry or environment in which there are
methods commonly used to make the particular type of estimate.

Audit procedures in response to risk assessment

ISA 540 states that the auditor must perform further audit procedures designed to address the risk of
misstatement.

The nature, timing and extent of further audit procedures will depend heavily on the complexity of
the fair value measurement. For example, the fair value measurement of assets that are sold in open,
active markets which provide readily available and reliable information on the prices at which
exchanges actually occur should be relatively straightforward eg, published price quotations for
marketable securities.

Alternatively, a specific asset may not have an active market or may possess characteristics that make
it necessary for management to estimate its fair value (eg, an investment property or a complex
derivative financial instrument). The estimation of fair value may be achieved through the use of a
valuation model (for example, a model premised on projections and discounting of future cash flows,
or an option pricing model) or through the help of an expert such as an independent expert (e.g., to
value property, brands or other specialist assets).

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IFRS 09, IFRS 07, IAS 32: FINANCIAL INSTRUMENTS
Complex fair value measurements, particularly Level 3 unobservable inputs, are normally
characterized by greater uncertainty regarding the reliability of the measurement process. This
greater uncertainty may be the result of the following:

• The length of the forecast period.

• The number of significant and complex assumptions associated with the process
• A higher degree of subjectivity associated with the assumptions and factors used in the process
• A higher degree of uncertainty associated with the future occurrence or outcome of events
underlying the assumptions used When obtaining audit evidence, the auditor evaluates whether the
following are true:
• The assumptions used by management are reasonable.
• The fair value was measured using an appropriate model (eg, the model prescribed in IFRS 13, if
applicable).
• Management used relevant information that was reasonably available at the time.

Other actions by the auditor would include the following:

• The auditor should consider the effect of subsequent events on the fair value measurements and
disclosures in the financial statements.
• The auditor should evaluate whether the disclosures about fair values made by the entity are in
accordance with its financial reporting framework (eg, IFRS 13 disclosure requirements).
• The auditor should obtain written representations from management.

Where an accounting estimate has high estimation uncertainty the auditor may conclude that this
must be communicated as a KAM in accordance with ISA 701.

(ISA 540.A114).

3. AUDITING FINANCIAL INSTRUMENTS

IAPN 1000
The introduction of the IAPN sets out the scope. It explains that the IAPN does not address the
simplest financial instruments such as cash, simple loans, trade accounts receivable and trade
accounts payable, nor the most complex ones. It also does not address specific accounting
requirements, such as those relating to hedge accounting, offsetting or impairment.

Section I – Background information about financial instruments

Purpose and risks of using financial instruments
Financial instruments are used for the following purposes:
• Hedging purposes (ie, to change an existing risk profile to which an entity is exposed)
• Trading purposes (ie, to enable an entity to take a risk position to benefit from long-term investment
returns or from short-term market movements)
• Investment purposes (eg, to enable an entity to benefit from long-term investment returns)

Management and those charged with governance might not:

• fully understand the risks of using financial instruments

• have the expertise to value them appropriately
• have sufficient controls in place over financial instrument activities

Business risk and the risk of material misstatement also increase when management inappropriately
hedge risk or speculate.

In particular the entity may be exposed to the following types of risk:

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(a) Credit risk (the risk that one party will cause a financial loss to another party by failing to discharge
an obligation)
(b) Market risk (the risk that the fair value or future cash flow of a financial instrument will fluctuate
because of changes in market prices eg, currency risk, interest rate risk, commodity and equity
price risk)
(c) Liquidity risk (includes the risk of not being able to buy or sell a financial instrument at an
appropriate price in a timely manner due to a lack of marketability for that financial instrument)
(d) Operational risk (related to the specific processing required for financial instruments)

The risk of fraud may also be increased where an employee in a position to perpetrate a financial
fraud understands both the financial instruments and the process for accounting for them, but
management and those charged with governance have a lesser degree of understanding.

Controls relating to financial instruments

The level of sophistication of an entity's internal control will be affected by the size of the entity and
the extent and complexity of the financial instruments used. An entity's internal control over financial
instruments is more likely to be effective when management and those charged with governance
have:

(a) established an appropriate control environment;

(b) established a risk management process;
(c) established information systems that provide an understanding of the nature of the financial
instrument activities and the associated risks; and
(d) designed, implemented and documented a system of internal control to:
• provide reasonable assurance that the use of financial instruments is within the entity's risk
management policies;
• properly present financial instruments in the financial statements;
• ensure that the entity is in compliance with applicable laws and regulations; and
• monitor risk.

The Appendix to IAPN 1000 provides examples of controls that may exist in an entity that deals with a
high volume of financial instrument transactions. These include authorization, segregation of duties
(particularly of those executing the transaction (dealing) and those initiating cash payments and
receipts (settlements)) and reconciliations of the entity's records to external banks' and custodians'
records.

Completeness, accuracy and existence

The IAPN discusses a number of practical issues. For example, it explains that where transactions are
cleared through a clearing house the entity should have processes to manage the information
delivered to the clearing house. Adequate IT controls must also be maintained.

It also explains that in financial institutions where there is a high volume of trading, a senior employee
typically reviews daily profits and losses on individual traders' books to evaluate whether they are
reasonable based on the employee's knowledge of the market. Doing so may enable management to
determine that particular trades were not completely or accurately recorded, or may identify fraud by
a particular trader.

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IFRS 09, IFRS 07, IAS 32: FINANCIAL INSTRUMENTS
Valuation of financial instruments

Section I also provides material on financial reporting requirements. It explains that many financial
reporting frameworks require financial instruments, including embedded derivatives, to be measured
at fair value. In general, the objective of fair value is to arrive at the price at which an orderly
transaction would take place between market participants at the measurement date under current
market conditions; that is, it is not the transaction price for a forced liquidation or distressed sale. In
meeting this objective all relevant market information is taken into account. It also explains that fair
value measurement may arise at both the initial recording of transactions and later when there are
changes in value. Changes in fair value measurement may be treated differently depending on the
reporting framework. The IAPN then explores features of different financial reporting frameworks,
including the following:

• The fair value hierarchy (as adopted by IFRS 13)

• The effects of inactive markets
• Management's valuation processes
• The use of models, third-party pricing sources and experts (entities often make use of a third party
to obtain fair value information, particularly when expertise or data are required that management
does not possess).

Section II – Audit considerations relating to financial instruments

IAPN 1000 identifies certain factors that make auditing complex financial instruments particularly
challenging:
• Management and the auditors may find it difficult to understand the nature of the instruments and
the risks to which the entity is exposed.
• Markets can change quickly, placing pressure on management to manage their exposures
effectively.
• Evidence supporting valuation may be difficult to obtain.
• Individual payments may be significant, which may increase the risk of misappropriation of assets.
• The amount recorded may not be significant, but there may be significant risks and exposures
associated with these complex financial instruments.
• A few employees may exert significant influence on the entity's financial instruments transactions,
in particular where compensation arrangements are tied to revenue from these.

Professional scepticism

The need for professional scepticism increases with the complexity of the financial instruments, for
example with regard to the following:

• Evaluating whether sufficient appropriate audit evidence has been obtained (which can be
particularly challenging when models are used or in determining if markets are inactive)
• Evaluating management's judgements and potential for management bias in applying the applicable
financial reporting framework (eg, choice of valuation techniques, use of assumptions in valuation
techniques)
• Drawing conclusions based on the audit evidence obtained (for example assessing the
reasonableness of valuations prepared by management's experts)

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Planning considerations

The auditor's focus in planning is particularly on the following:

• Understanding the accounting and disclosure requirements ISA 540 requires the auditor to obtain
an understanding of the requirements of the applicable financial reporting framework relevant to
accounting estimates.
• Understanding the complex financial instruments This helps the auditor to identify whether:
– important aspects of a transaction are missing or inaccurately recorded;
– a valuation appears appropriate;
– the risks inherent in them are fully understood and managed by the entity; or
– the financial instruments are appropriately classified into current and non-current assets and
liabilities.
Understanding management's process for identifying and accounting for embedded derivatives
will help the auditor to understand the risks to which the entity is exposed.

• Determining whether specialized skills and knowledge are needed in the audit

The engagement partner must be satisfied that the engagement team and any auditor's experts
collectively have the appropriate competence and capabilities.

• Understanding and evaluating the system of internal control in the light of the entity's financial
instrument transactions and the information systems that fall within the scope of the audit.

This understanding must be obtained in accordance with ISA 315. This understanding enables the
auditor to identify and assess the risks of material misstatement at the financial statement and
assertions levels, providing a basis for designing and implementing responses to the assessed risks
of material misstatement.

• Understanding the nature, role and activities of the internal audit function Areas where the work of
the internal audit function may be particularly relevant are as follows:
– Developing a general overview of the extent of use of financial instruments.
– Evaluating the appropriateness of policies and procedures and management's compliance with
them
– Evaluating the operating effectiveness of financial instrument control activities
– Evaluating systems relevant to financial instrument activities
– Assessing whether new risks relating to financial instruments are identified, assessed and
managed
• Understanding management's process for valuing financial instruments, including whether
management has used an expert or a service organization Again this understanding is required in
accordance with ISA 540.
• Assessing and responding to the risk of material misstatement (see below)

Assessing and responding to the risk of material misstatement

Factors affecting the risk of material misstatement include the following:

• The volume of financial instruments to which the entity is exposed

• The terms of the financial instruments
• The nature of the financial instruments
• Fraud risk factors (eg, where there are employee compensation schemes, difficult financial market
conditions, ability to override controls)

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The assessment of risk will determine the appropriate audit approach in accordance with ISA 330, The
Auditor's Responses to Assessed Risks, including substantive procedures and tests of controls. Where
the entity is involved in a high level of trading and use of financial instruments, it is unlikely that
sufficient evidence will be obtained through substantive testing alone. Where there are relatively few
transactions of this nature a substantive approach may be more efficient. In reaching a decision on
the nature, timing and extent of testing of controls the auditor may consider factors such as:

• the nature, frequency and volume of financial instrument transactions;

• the strength of controls including design;
• the importance of controls to the overall control objectives;
• the monitoring of controls and identified deficiencies in control procedures;
• the issues controls are intended to address;
• frequency of performance of control activities;
• level of precision the controls are intended to achieve;
• evidence of performance of control activities; and
• timing of key financial instrument transactions (eg, whether they are close to the period end).

Designing substantive procedures will include consideration of the following:

• Use of analytical procedures – they may be less effective as substantive procedures when performed
alone, as the complex drivers of valuation often mask unusual trends
• Non-routine transactions – this applies to many financial instrument transactions and a substantive
approach will normally be the most effective means of achieving the planned audit objectives
• Availability of evidence – eg, when the entity uses a third-party pricing source, evidence may not be
available from the entity
• Procedures performed in other audit areas – these may provide evidence about completeness of
financial instrument transactions eg, tests of subsequent cash receipts and payments, and the
search for unrecorded liabilities
• Selection of items for testing – where the financial instrument portfolio comprises instruments with
varying complexity and risk judgmental sampling may be useful.

In some cases 'dual-purpose' tests may be used ie, it may be efficient to perform a test of controls and
a test of details on the same transaction eg, testing whether a signed contract has been maintained
(test of controls) and whether the details of the financial instrument have been appropriately
captured in a summary sheet (test of details). Areas of significant judgement would normally be
tested close to, or at, the period end.

Procedures relating to completeness, accuracy, existence, occurrence and rights and obligations may
include the following:

• Remaining alert during the audit when inspecting records or documents (eg, minutes of meetings of
those charged with governance, specific invoices and correspondence with the entity's professional
advisers)
• External confirmation of bank accounts, trades and custodian statements
• Reconciliation of external data with the entity's own records Reading individual contracts and
reviewing support documentation
• Reviewing journal entries or the internal control over the recording of such entries to determine if
entries have been made by employees other than those authorized to do so
• Testing controls eg, by reperforming controls.

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IFRS 09, IFRS 07, IAS 32: FINANCIAL INSTRUMENTS
Valuation of financial instruments

Management is responsible for the valuation of complex financial instruments and must develop a
valuation methodology. In testing how management values the financial instrument, the auditor
should undertake one or more of the following procedures:

(a) Test how management made the accounting estimate and the data on which it is based (including
any models)
(b) Test the operating effectiveness of controls over how management made the accounting estimate,
together with appropriate substantive procedures
(c) Develop a point estimate or a range to evaluate management's point estimate
(d) Determine whether events occurring up to the date of the auditor's report provide audit evidence
regarding the accounting estimate.

Audit procedures may include the following:

• Reviewing and assessing the judgements made by management

• Considering whether there are any other relevant price indicators or factors to take into account
• Obtaining third-party evidence of price indicators eg, by obtaining a broker quote
• Assessing the mathematical accuracy of the methodology employed
• Testing data to source materials

Significant risk

The auditor's risk assessment may lead to the identification of one or more significant risks relating to
valuation. The following circumstances would be indicators that a significant risk may exist:

• High measurement uncertainty

• Lack of sufficient evidence to support management's valuation
• Lack of management understanding of its financial instruments or expertise to value these correctly
• Lack of management understanding of the complex requirements of the applicable financial
reporting framework
• The significance of valuation adjustments made to model outputs when the applicable reporting
framework requires or permits such adjustments.

Where significant risks have been identified the auditor is required to evaluate how management has
considered alternative assumptions or outcomes and why it has rejected them, or how management
has addressed estimation uncertainty in making the accounting estimate. The auditor must also
evaluate whether the significant assumptions used by management are reasonable. To do this the
auditor must exercise professional judgement.

The IAPN also considers audit considerations for valuation in three specific circumstances: when
management uses a third-party pricing source, when management estimates fair value using a model
and when a management's expert is used.

Possible approaches to gathering evidence regarding information from third-party pricing sources
may include the following:

• For Level 1 inputs, comparing the information from third-party pricing sources with observable
market prices
• Reviewing disclosures provided by third-party pricing sources about their controls and processes,
valuation techniques, inputs and assumptions

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• Testing the controls management has in place to assess the reliability of information from third-
party pricing sources
• Performing procedures at the third-party pricing source to understand and test the controls and
processes, valuation techniques, inputs and assumptions used for asset classes or specific financial
instruments of interest
• Evaluating whether the prices obtained from third-party pricing sources are reasonable in relation
to prices from other third-party pricing sources, the entity's estimate or the auditor's own estimate
• Evaluating the reasonableness of valuation techniques, assumptions and inputs
• Developing a point estimate or a range for some financial instruments priced by the thirdparty
pricing source and evaluating whether the results are within a reasonable range of each other
• Obtaining a service auditor's report that covers the controls over validation of the prices.

When management estimates fair value using a model IAPN 1000 states that testing the model can be
accomplished by two main approaches:

(1) The auditor can test management's model, by considering the appropriateness of the model used
by management, the reasonableness of the assumptions and data used, and the mathematical
accuracy.
(2) The auditor can develop their own estimate and then compare the auditor's valuation with that of
the entity.

When a management expert is used the requirements which must be applied are the basic
requirements of ISA 500 as discussed in Chapter 6. Procedures would include evaluating the
competence, capabilities and objectivity of the management's expert, obtaining an understanding of
their work and evaluating the appropriateness of that expert's work as audit evidence.

Presentation and disclosure

Audit procedures around presentation and disclosure are designed in consideration of the assertions
of occurrence and rights and obligations, completeness, classification and understandability, and
accuracy and valuation.

Other relevant audit considerations

Written representations should be sought from management in accordance with ISA 540 and ISA 580,
Written Representahkations.

2.1.1 Practice Note 23

Practice Note 23 Special Considerations in Auditing Financial Instruments was revised in July 2013.
The revised Practice note is based on IAPN 1000 discussed above. Some additional points are however
included as follows:

Section 1
• Operational risk includes model risk (the risk that imperfections and subjectivity of valuation models
are not properly understood, accounted for or adjusted for) (PN23.18)
• Complete and accurate recording of financial instruments is an essential core objective (PN23.24-1)
• When quoted prices are used as evidence of fair value, the source should be independent and where
possible more than one quote (PN23.44-1)
• Where a price has been obtained from a pricing service and that price has been challenged, when
considering whether the corrected price is a suitable basis for valuation, consideration should be

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given to how long the challenge process has taken and whether the underlying data remains valid
(PN23.56-1)
• A key control over management's valuation process may be an independent price verification
function which forms part of internal control (PN23.62-1)

Section 2

• Although it is not part of the auditor's role to determine the amount of risk an entity should take on,
obtaining an understanding of the risk management process may identify risks of material
misstatement (PN23.70-1)
• Assertions about valuation may be based on highly subjective assumptions, therefore evaluating
audit evidence in respect of these requires considerable judgment (PN23.71-2)
• Determining materiality for financial instruments may be particularly difficult (PN23.73-1)
• When deciding which audits other than those of listed entities require an engagement quality
control review, the existence of financial instruments may be a relevant factor (PN23.73-2)
• When obtaining an understanding of the entity's financial instruments, the auditor will consider the
view of any correspondence with regulators in accordance with the FCA Code (PN23.76-2)
• The involvement of experts or specialists may be needed (PN23.79)
• The auditor may need to consider the control environment applicable to those responsible for
functions dealing with financial instruments (PN23.89-2)
• Substantive procedures will include reviewing operational data such as reconciling differences
(PN23.104)
• The auditor may use information included in a Prudent Valuation Return (prepared by UK banks and
other regulated entities in the financial sector) to understand the uncertainties associated with the
financial instruments used and disclosed by these entities (PN23.108-1)
• Tests of valuation include: verifying the external prices used to value financial instruments,
confirming the validity of valuation models, and evaluating the overall results and reserving for
residual uncertainties (PN23.113-1)
• The auditor must consider whether management has given proper consideration to the models used
(PN23.134-1)
• When evaluating the amount of an adjustment that might be required, the auditor considers all
factors taken into account in the valuation process and uses experience and judgment (PN23.137-
1).

4. AUDITING DERIVATIVES
Auditing derivatives in the modern world
The key to using derivatives as part of an overall investment strategy is to have adequate internal
controls in place and trained personnel handling the investments. Derivatives, which have been
around for a very long time in one form or another, have been put to good use by transferring risk
from one party, the hedger, to another, the speculator. There are many factors in today's world which
can cause derivative investment strategies to go wrong. As we have seen, such factors can include the
following:
• A lack of internal controls
• A laissez-faire management
• Greed
• Ineffective systems to identify and monitor risk
• Inexperience

An understanding of the business process involved in derivatives trading is necessary in order to audit
derivatives successfully. The steps in a typical process are as follows:

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(1) Entering the deal in the trader's deal sheet
(2) Trader types the deal into the system and sends an email
(3) The back office include the deal in reports
(4) Back office process the deal using market quote information from agencies
(5) Enter details into a 'pre-programmed' Excel sheet and/or other processing package
(6) Confirm deal with brokers/counterparties
(7) Carry out monthly settlement/processing
(8) Net off between Accounts Payable and Accounts Receivable and wire the payment as necessary.

Each type of derivative will be different and non-standard derivatives will be unique. This poses
challenges for the auditor.

Generally, however, the auditor should seek to:

(a) understand the client's business in order to establish the real role played by, and the risks that are
inherent in, the derivatives activity;
(b) document the system. This would involve documenting various processes;
(c) identify the controls in each process in order to establish the risk passed to the client by inadequate
or missing controls; and, therefore, to establish the audit risk and thus the audit work that needs
to be performed;
(d) carry out the appropriate control and substantive audit procedures; and
(e) make conclusions and report on the outcome of the audit of derivatives.

Obviously, the exact nature of what is to be done is dependent on the circumstances of the client.
Ensuring that the information has been captured completely and accurately in each case is important.

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IAS 19 – EMPLOYEE BENEFITS

IAS 19 – Employee benefits

1. AUDITING EVIDENCE
Issue Evidence
Scheme assets (including • Ask directors to reconcile the scheme assets valuation at the
quoted and unquoted securities, scheme year-end date with the assets valuation at the reporting
debt instruments, properties) entity's date being used for IAS 19 purposes.
• Obtain direct confirmation of the scheme assets from the
investment custodian.
• Consider requiring scheme auditors to perform procedures.
Scheme liabilities • Auditors must follow the principles relating to work done by a
management's expert as defined in ISA (UK) 500, Audit Evidence
(and covered in Chapter 6) to assess whether it is appropriate to
rely on the actuary's work.
• Specific matters would include:
– the source data used;
– the assumptions and methods used; and
– the results of actuaries' work in the light of auditors' knowledge
of the business and results of other audit procedures. Actuarial
source data is likely to include:
• scheme member data (for example, classes of member and
contribution details); and
• scheme asset information (for example, values and income and
expenditure items)
Actuarial assumptions (for Auditors will not have the same expertise as actuaries and are unlikely
example, mortality rates, to be able to challenge the appropriateness and reasonableness of the
termination rates, retirement assumptions. They should nevertheless ascertain the qualifications and
age and changes in salary and experience of the actuaries. Auditors can, also, through discussion with
benefit levels) directors and actuaries:
• obtain a general understanding of the assumptions and review the
process used to develop them;
• consider whether assumptions comply with IAS 19 requirements ie,
are unbiased and based on market expectations at the year end,
over the period during which obligations will be settled;
• compare the assumptions with those which directors have used in
prior years;
• consider whether, based on their knowledge of the reporting entity
and the scheme, and on the results of other audit procedures, the
assumptions appear to be reasonable and compatible with those
used elsewhere in the preparation of the entity's financial
statements; and
• obtain written representations from directors confirming that the
assumptions are consistent with their knowledge of the business.
Items charged to profit or loss • Discuss with directors and actuaries the factors affecting current
(current service cost, past service cost (for example, a scheme closed to new entrants may see
service cost, gains and losses on an increase year on year as a percentage of pay with the average
settlements and curtailments) age of the workforce increasing).
• Confirm that net interest cost has been based on the discount rate
determined by reference to market yields on high-quality fixed-rate
corporate bonds
Items recognized in other • Check basis of updated assumptions used to calculate actuarial
comprehensive income gains/losses.
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• Check basis of calculation of return on plan assets ie, using current
fair values. Fair values must be measured in accordance with IFRS
13
Contributions paid into plan • Agree cash payments to cash book/bank statements.
(Retirement benefits paid out
are paid by the pension plan
itself so there is no cash entry in
the entity's books)

Where the results of auditors' work are inconsistent with the directors' and actuaries', additional
procedures, such as requesting directors to obtain evidence from another actuary, may help in
resolving the inconsistency.

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IFRS 2 – SHARE-BASED PAYMENT

IFRS 2 – Share-based payment

1. AUDIT EVIDENCE
Issue Evidence
Number of employees in scheme/number of • Scheme details set out in contractual
instruments per employee/length of vesting documentation
period
Number of employees estimated to benefit • Inquire of directors
• Compare to staffing numbers per forecasts and
prediction
Fair value of instruments • For equity-settled schemes check that fair value is
estimated at the grant date.
• For cash-settled schemes check that the fair value
is recalculated at the end of the reporting period
and at the date of settlement.
• Check that model used to estimate fair value is in
line with IFRS 2 and is appropriate to the
conditions. Consider obtaining expert advice on
the valuation if appropriate.
General • Obtain representations from management
confirming their view that:
– the assumptions used in measuring the expense
are reasonable, and
– there are no share-based payment schemes in
existence that have not been disclosed to the
auditors.

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IAS 21 AND 29 – FOREIGN CURRENCY TRANSLATION AND HYPERINFLATION

IAS 21 and 29 – Foreign currency translation and hyperinflation

1. AUDIT PROCEDURES
These would include the following:

• Check that the balances of the subsidiary have been appropriately translated to the group reporting
currency:
– Assets and liabilities at the closing rate at the end of the reporting period.
– Income and expenditure at the rate ruling at the transaction date. An average would be a suitable
alternative provided there have been no significant fluctuations.
• Confirm consistency of treatment of the translation of equity (closing rate or historical rate).
• Check that the consolidation process has been performed correctly eg, elimination of intragroup
balances.
• Check the basis of the calculation of the non-controlling interest.
• Confirm that goodwill has been translated at the closing rate.
• Check the disclosure of exchange differences as a separate component of equity.
• Assess whether disclosure requirements of IAS 21 have been satisfied.
• If the foreign operation is operating in a hyperinflationary economy confirm that the financial
statements have been adjusted under IAS 29, Financial Reporting in Hyperinflationary Economies
before they are translated and consolidated.
• Involve a specialist tax audit team to review the calculation of tax balances against submitted and
draft tax returns.

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IAS 12 – INCOME TAXES

IAS 12 – Income Taxes

1. AUDIT RISKS
Until recently, tax accounting has been of secondary concern in the corporate group reporting
process. The tax figures in the financial statements are, however, often material by their nature, and
the increased public interest around tax avoidance now places greater pressure on companies and
groups to get tax reporting right.
The following factors increase the audit risk in respect of current and deferred tax, particularly in a
group reporting context:
• Lack of tax accounting knowledge: even in larger groups with in-house tax specialist resource, the
board is often more interested in the cash cost of tax than in tax accounting, although getting the
tax rate in line with analysts' expectations does still promote investor confidence.
• Lack of foreign tax knowledge: the tax figures of foreign operations are particularly at risk of
misstatement, and auditing them may require specialist knowledge.
• Complex or unusual transactions: the tax implications of such transactions may be overlooked by
management, but they can be complex and material.
• Lack of appropriate tax reporting processes: the basic processes (such as Excel spreadsheets) used
by many entities are unable to respond to complex tax reporting requirements. The use of manual
input increases the risk of errors, and may render workings difficult to audit.

Use of tax specialists

On the audit of larger or more complex entities, tax audit specialists are likely to be actively involved
from the start of the audit as members of the audit team, using their tax accounting expertise to carry
out the review of tax figures in the statement of financial position and statement of profit or loss. In
such cases, the tax audit team will report their findings, including any identified misstatements and
any areas of significant uncertainty, to the audit team. The tax team's workings papers must be
included within the audit working papers file.

2. CURRENT TAX: AUDIT PROCEDURES

Auditors (or the tax specialists involved in the audit) should carry out audit procedures including the
following:
• Obtain copies of the prior period tax computation.
• Inquire whether any tax enquiries have been raised by the tax authorities in the period.
• Inquire into the status of any unresolved tax enquiries, and obtain supporting correspondence with
the tax authorities. Obtain copies of the current period tax computation, and evaluate whether:
– the opening balances agree to the closing balances in the prior period tax computation;
– the figures in the tax computation agree to figures in the financial statements;
– estimates contained within the tax computation are based on reasonable assumptions; and
– all tax rates and allowances are based on applicable tax legislation.
• Review details of tax payments made/refunds received in the period, and agree payments to the
cash and bank account.

3. DEFERRED TAX: AUDIT PROCEDURES

The following procedures will be relevant:
• Consider whether it is appropriate for the company to recognize deferred tax (eg, is the company
expected to make future taxable profits against which the deferred tax would unwind?).
• Obtain a copy of the deferred tax workings.
• Check the arithmetical accuracy of the deferred tax working.

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• Agree the figures used to calculate temporary differences to those on the tax computation and the
financial statements.
• Consider the assumptions made in the light of the auditor's knowledge of the business and any other
evidence gathered during the course of the audit to ensure reasonableness.
• Agree the opening position on the deferred tax account to the prior year financial statements.
• Review the basis of the provision to ensure:
– it is in line with accounting practice under IAS 12, Income Taxes; and
– any changes in accounting policy have been disclosed.
• Verify that the rate of corporation tax at which the deferred tax asset/liability unwinds is appropriate
and in line with current tax legislation.
• To test for completeness (understatement) the auditor should review the draft financial statements
to identify items that would normally be expected to give a temporary difference and ensure they
have been included.

Transfer pricing
Besides auditing current and deferred tax, transfer pricing is an important area over which sufficient
appropriate audit evidence must be sought. When the entity's transfer pricing policies are challenged
by the tax authorities, the effect on the company's current tax position over several years is likely to
be material.

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Groups: types of investment and business combination

1. PLANNING AND RISK ASSESSMENT AS GROUP AUDITOR
The planning and risk assessment process will need to take into account the fact that all elements
of the group financial statements are not audited by the group auditor directly. The group auditor
will not be able to simply rely on the conclusions of the component auditor. ISA 600 requires the
group auditor to evaluate the reliability of the component auditor and the work performed. This
will then determine the extent of further procedures.

2. RISK ASSESSMENT PROCEDURES

General accounting issues
Consolidated financial statements give rise to additional audit risks:
• Are consolidated group accounts correctly prepared?
• Where there have been any disposals of material business segments, have the requirements
of IFRS 5, Non-current Assets Held for Sale and Discontinued Operations been satisfied?
• Have adequate disclosures of significant investments and financing been made?
• Where there have been acquisitions during the year, have new assets and liabilities been
correctly brought into the financial statements?
• Where there have been acquisitions during the year, has purchase consideration been
correctly accounted for and disclosed?
• Have foreign taxes (including corporate tax, income taxes for employees and capital gains tax)
been accounted for correctly?
• Have transfer pricing issues around intercompany transactions, and their VAT impact, been
considered?

Acquisition
Acquisitions can take many forms. The type of acquisition (eg, hostile, friendly) and future
management of the subsidiary (fully integrated, autonomous) will also impact on risk.
Risk areas Key issues
Valuation of assets and liabilities These should be valued at fair value at the date of
acquisition in accordance with IFRS 13.
Valuation of consideration This should be at fair value and will include any
contingent consideration. Any deferred
consideration should be discounted.
Goodwill This must be calculated and accounted for in
accordance with IFRS 3.
Date of control The results of any subsidiary should only be
accounted for from the date of acquisition.
Level of control or influence This will determine the nature of the investment and
its subsequent treatment in the group financial
statements eg, subsidiary, associate and should be
determined in accordance with IFRS 10/IAS 28 (IFRS
10 retains control as the key concept underlying the
parent/subsidiary relationship but has broadened
the definition and clarified the application).
Accounting policies/reporting periods Accounting policies and reporting periods must be
consistent across the group.
Consolidation adjustments The group must have systems which enable the
identification of intra-group balances and accounts

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Adequacy of provisions in the target While the acquirer is likely to know its plans, other
company provisions may be necessary within the acquired
entity.
If such provisions are currently unrecognized and
have never been recorded (eg, in board minutes),
there is a clear risk that the acquiring entity will
overpay
Use of provisions to manipulate post Provisions may be recognised at the point of
acquisition profits acquisition and then released at some point in the
future in order to make post-change results appear
impressive. This may imply that change was a correct
business decision. The use of such provisions has
been reduced by IAS 37

3. AUDIT PROCEDURES
`The diagram below summarises the key points in the context of the group audit.

Figure: Audit procedures

Potential misstatement in group accounts Factors affecting risk of material misstatement in

due to subsidiary financial statements
• Misclassification of investments (subsidiary • Scope of component auditors' work (may not
vs associate vs financial asset) provide sufficient appropriate evidence that
• Inappropriate inclusion, or exclusion from, financial statements are free from material
consolidation or incorrect treatment of misstatement)
excluded subsidiaries • Past audit problems
• Inappropriate consolidation method • Anticipated changes
• Inappropriate translation method for • Materiality
overseas subsidiaries • Sufficiency of evidence to confirm amounts
• Incorrect consolidation adjustments eg, • Overseas subsidiaries (see section 12.8)
failure to eliminate intra-group items • Non-coterminous year ends
properly eg, leading to potential • Existence of letter of comfort (see section 12.9)
overstatements of assets and profits
• Inconsistent accounting policies for
amounts included in consolidation
• Incorrect calculation (fair values) or
treatment of goodwill
• Incorrect calculation of profit/loss on
disposal or classification of results of
subsidiaries disposed of (continuing vs
discontinued)
• Incorrect determination of date of
acquisition

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• Deferred or contingent consideration; step
acquisition

Acquisition
If the group audit includes a newly acquired subsidiary or a subsidiary which is disposed of,
compliance with IFRS 3 and IFRS 10 will be relevant. The auditor will need to consider the
following issues in particular
Issue Audit consequence
Level of control The auditor will need to consider whether the
appropriate accounting treatment has been adopted
depending on the level of control (per IFRS 10 an
investor controls an investee if it has power over the
investee, exposure or rights to variable returns and the
ability to use power to affect returns). Procedures will
be as follows:
• Identify total number of shares held to calculate %
holding.
• Review contract or agreements between companies
to identify key terms which may indicate control and
any restriction on control eg, right of veto of third
parties.
Date of control/change in stake The auditor should:
• Review purchase agreement to identify date of
control.
• Ensure consolidation has occurred from date control
achieved.
• Review consolidation schedules to ensure amounts
have been time apportioned if appropriate.
Valuation of assets and liabilities at fair A review will need to be carried out of the fair value of
value assets and liabilities at the date of acquisition, adjusted
to the year end (in accordance with IFRS 13). Review of
trade journals or specialist valuations may be required.
Where specialist valuers have been used (eg, to value
brands) an assessment will need to be made on the
reliability of these valuations. Where intangibles have
been recognized on consolidation which were not
previously recognised in the individual financial
statements of the company acquired the auditor will
need to give careful consideration as to the justification
of this and whether the treatment is in accordance with
IFRS 3/IFRS 13.
Estimates for provisions existing at the date of
acquisition will need to be assessed for reliability.
Valuation of consideration Contingent consideration should be included as part of
the consideration transferred. It must be measured at
fair value at the acquisition date.
The discount rate used to discount deferred
consideration should be validated
Goodwill The auditor will need to consider whether the initial
calculation is correct in accordance with IFRS 3.

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Performance of the subsidiary company will need to be
reviewed to identify whether any impairment is
necessary
Tax liabilities and assets The amount of corporation tax liabilities provided for
will need to be reviewed
Deferred tax assets and liabilities must also be
reviewed. The impairment of assets or goodwill should
be taken into account
Prior year audit of subsidiary As first year of inclusion of subsidiary, review last
year's audit report for any modification and consider
implications for this year's audit if necessary.
Planning issues Adjust audit plan to ensure visit to subsidiary is
included. If audited by another auditor contact
secondary auditor to discuss the following:
• Audit deadline
• Type and quality of audit papers
• Review of audit
• Identification of consolidation adjustments.

Disposal
Where the group includes a subsidiary which has been disposed of during the year, the
following issues will be relevant:
• Identification of the date of the change in stake
• Assessment of the remaining stake to determine the appropriate accounting treatment post
disposal
• Assessment of the fair value of the remaining stake
• Whether the profit or loss on disposal has been calculated in accordance with IFRSs
• Whether amounts have been appropriately time apportioned eg, income and expense items.

Auditing an ongoing group of companies

Certain issues will be relevant to the auditor each year irrespective of whether there is any
change in the structure of the group. In particular, the auditor will need to ensure that IFRS 10
has been complied with. The following will be relevant.
Issue Audit consequence
Accounting policies/reporting period Identify subsidiary's accounting policies from review
of financial statements, compare to parent
company's and adjust for consistency where
necessary.

Further adjustments may be required if some group

companies prepare financial statements in
accordance with IFRSs and others in accordance with
UK GAAP.

Ensure that subsidiary's reporting period is consistent

with the parent company's or that interim accounts
have been prepared where necessary. (If not possible
subsidiary's accounts may still be used for
consolidation provided that the gap between the
reporting dates is three months or less.)

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Consolidation adjustments Review consolidation schedules, purchase, sales
ledger and intra-group accounts to identify any intra-
group transactions or outstanding balances, ensure
these have been cancelled out in the group accounts.
Transactions involving group companies Transactions
involving group companies should be audited in the
same way as other transactions with third parties.
However, systems should exist to ensure all intra-
group transactions are separately identified to
ensure they are all appropriately eliminated on
consolidation.
Intra-group balances
These should be audited in the same way as balances
with third parties. In particular:
• share certificates should be examined;
• dividends should be verified;
• intra-group balances should be verified including
any security attaching thereto;
• carrying amounts should be assessed in the same
way as third-party investments; and
• the need for transfer pricing adjustments
assessed.
Intercompany guarantees
Any intercompany guarantees (eg, as surety for
external loans) should be ascertained and
consideration given to whether disclosure as a
contingent liability is required.

4. THE CONSOLIDATION: AUDIT PROCEDURES

After receiving and reviewing all the subsidiaries' (and associates') financial statements, the
group auditors will be in a position to audit the consolidated financial statements. The ICAEW
Audit and Assurance faculty booklet Auditing in a Group Context: Practical Considerations for
Auditors warns against treating the consolidation as simply an arithmetical exercise. It indicates
that there are risks inherent in the consolidation process itself, for example:
• Consolidation adjustments are a major source of journal entries therefore procedures relating
to the detection of fraud may be relevant.
• Risks may arise from incomplete information to support adjustments between accounting
frameworks.

An important part of the work on the consolidation will be checking the consolidation
adjustments. Consolidation adjustments generally fall into two categories:

• Permanent consolidation adjustments

• Consolidation adjustments for the current year

The audit steps involved in the consolidation process may be summarised as follows.

Step 1
Compare the audited accounts of each subsidiary/associate to the consolidation schedules to
ensure figures have been transposed correctly.

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Step 2
Review the adjustments made on consolidation to ensure they are appropriate and comparable
with the previous year. This will involve the following:

• Recording the dates and costs of acquisitions of subsidiaries and the assets acquired
• Calculating goodwill and pre-acquisition reserves arising on consolidation
• Preparing an overall reconciliation of movements on reserves and NCIs
• Adjusting the individual subsidiary financial statements for differences in accounting policies
compared to the parent. This may include compliance with the accounting regulations of a
different jurisdiction (eg, where the individual subsidiary is UK GAAP compliant and the group
reports under IFRSs)

Step 3
For business combinations, determine the following:

• Whether combination has been appropriately treated as an acquisition

• The appropriateness of the date used as the date of combination
• The treatment of the results of investments acquired during the year
• If acquisition accounting has been used, that the fair value of acquired assets and liabilities is
in accordance with IFRS 13
• Goodwill has been calculated correctly and impairment adjustment made if necessary

Step 4
For disposals:

• agree the date used as the date for disposal to sales documentation; and
• review management accounts to ascertain whether the results of the investment have been
included up to the date of disposal, and whether figures used are reasonable.

Step 5
Consider whether previous treatment of existing subsidiaries or associates is still correct
(consider level of influence, degree of support)

Step 6
Verify the arithmetical accuracy of the consolidation workings by recalculating them

Step 7
Review the consolidated accounts for compliance with the legislation, accounting standards
and other relevant regulations. Care will need to be taken in the following circumstances:

• Where group companies do not have coterminous accounting periods

• Where subsidiaries are not consolidated
• Where accounting policies of group members differ because foreign subsidiaries operate
under different rules, especially those located in developing countries
• Where elimination of intra-group balances, transactions and profits is required.

Other important areas include the following:

• Treatment of associates
• Treatment of goodwill and intangible assets

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• Foreign currency translation
• Taxation and deferred tax
• Treatment of loss-making subsidiaries
• Treatment of restrictions on distribution of profits of a subsidiary
• Share options

Step 8
Review the consolidated accounts to confirm that they give a true and fair view in the
circumstances (including subsequent event reviews from all subsidiaries updated to date of
audit report on consolidated accounts).

The Audit and Assurance faculty document Auditing Groups: A Practical Guide also highlights
the importance of considering the process used to perform the consolidation process. Where
spreadsheets are used it is not enough to check the data that has been entered. Auditors also
need to check that the consolidation spreadsheets are actually working properly.

Overseas subsidiaries
The inclusion of one or more foreign subsidiaries within a group introduces additional risks,
including the following:
• Non-compliance with the accounting requirements of IAS 21
• Potential misstatement due to the effects of high inflation
• Possible difficulty in the parent being able to exercise control, for example due to political
instability
• Currency restrictions limiting payment of profits to the parent
• There may be threats to going concern due to economic and/or political instability
• Non-compliance with local taxes or misstatement of local tax liabilities. Audit procedures
should include the following:
• Check that the balances of the subsidiary have been appropriately translated to the group
reporting currency:
– Assets and liabilities at the closing rate at the end of the reporting period
– Income and expenditure at the rate ruling at the transaction date. An average would be a
suitable alternative provided there have been no significant fluctuations
• Confirm consistency of treatment of the translation of equity (closing rate or historical rate)
• Check that the consolidation process has been performed correctly eg, elimination of
intragroup balances
• Check the basis of the calculation of the non-controlling interest
• Confirm that goodwill has been translated at the closing rate
• Check the disclosure of exchange differences as a separate component of equity
• Assess whether disclosure requirements of IAS 21 have been satisfied
• If the foreign operation is operating in a hyperinflationary economy confirm that the financial
statements have been adjusted under IAS 29, Financial Reporting in Hyperinflationary
Economies before they are translated and consolidated
• Involve a specialist tax audit team to review the calculation of tax balances against submitted
and draft tax returns.

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5. PROMOTING BEST PRACTICE IN GROUP AUDITS
Understand group Understand the group structure and the nature of the components of the
management's process group.
and timetable to Consider whether to accept an engagement where the group auditor is only
produce consolidated directly responsible for a minority of the total group
accounts Understand the accounting framework applicable to each component and
any local statutory reporting requirements

Understand the component auditors – consider their qualifications,

independence and competence For unrelated auditors or related auditors
where the group auditor is unable to rely on common policies and
procedures, consider the following:
• Visiting the component auditor
• Requesting that the component auditor completes a questionnaire or
representation
• Obtaining confirmation from a relevant regulatory body
• Discussing the component auditor with colleagues from their own firm
For component auditors based overseas consider whether they have
enough knowledge and experience of ISAs
Design group audit Get involved early. Talk to group management while they are planning the
process to match consolidation
management's process Draft instructions to component auditors allocating work and be clear as to
and timetable deadlines required
Focus the group audit on high risk areas
Consider risks arising from the consolidation process itself:
• Consolidation adjustments
• Incomplete information to support adjustments between accounting
frameworks eg, where a subsidiary prepares its local accounts under US
GAAP and the parent is preparing IFRS financial statements Discuss fraud
with component auditors and consider the following:
• Business risks
• How and where the group financial statements may be susceptible to
material misstatement due to fraud or error
• How group management and component management could perpetrate
and conceal fraudulent financial reporting and how assets of the
components could be misappropriated
• Known factors affecting the group that may provide the incentive or
pressure for group or component management or others to commit fraud
or indicate a culture or environment that enables those people to
rationalize committing fraud
• The risk that group or component management may override controls
Understand internal control across the group:
• Request details of material weaknesses in internal controls identified by
component auditors
• Communicate material weaknesses in group-wide controls and significant
weaknesses in internal controls of components to group management

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Clearly communicate Explain the extent of the group auditors' involvement in the work of the
expectations and component auditors:
information required • Make it clear what the component auditors are being asked to perform eg,
including timetable a full audit, a review or work on specific balances or transactions.
• Clarify the timetable and format of reporting back
Review completed questionnaires and other deliverables from component
auditors carefully
Decide whether and when to visit component auditors and when to request
access to their working papers
Get group management to obtain the consent of subsidiary management to
communicate with the group auditor to deal with concerns about client
confidentiality and sensitivity
Consider whether holding discussions with or visiting component auditors
could deal with secrecy and data-protection issues
Obtain information There is often only a short time for group auditors to resolve any issues
early where arising from the report they receive from component auditors.
practicable
Request some information early, such as copies of management letter
points from component auditors carrying out planning and control testing
before the year end
Keep track of whether Where component auditors indicate up front that they will not be able to
reports have been provide the information requested, consider alternatives rather than
received and respond waiting until the sign-off deadline
to any issues in a Put in place a system to monitor responses to instructions and follow up on
timely fashion non-submission
Conclude on the audit The group auditors should be in a position to form their opinion on the
and consider possible group financial statements
improvements for the The group auditors will consider the need for a group management letter
next year's process and reporting to those charged with governance of the group
including management Debrief the team and consider whether the process worked as well as it
letter issues could have done, along with any changes to future accounting and auditing
requirements, and whether there are any issues that should be
communicated to management and those charged with governance, or any
changes to next year's audit strategy.

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