AOF Audit and Assurance

Lecture note

AUDIT AND ASSURANCE

STUDY NOTE

Updated to March 24

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SECTION 1: AUDIT FRAMEWORK AND REGULATION 5

1. THE CONCEPT OF AUDIT AND OTHER ASSURANCE ENGAGEMENTS 5

2. DEVELOPMENT AND STATUS OF IAS 12

SECTION 2: CODE OF ETHICS AND CONDUCT 19

1. FUNDAMENTAL PRINCIPLES OF PROFESSIONAL ETHICS 19

2. THREATS TO INDEPENDENCE AND OBJECTIVITY 21

SECTION 3: RISK ASSESSMENT 30

1. INTRODUCTION TO RISK 30

2. MATERIALITY 33

3. UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT 36

4. RESPONDING TO THE RISK ASSESSMENT 37

5. FRAUDS 42

SECTION 4: AUDIT PLANNING AND DOCUMENTATION 44

1. AUDIT PLANNING 44

2. AUDIT DOCUMENTATION 47

3. INTRODUCTION TO AUDIT EVIDENCE 51

4. ASSERTION 53

5. AUDIT PROCEDURES 54

SECTION 5: INTERNAL CONTROLS 56

1. INTERNAL CONTROL SYSTEMS 56

2. THE USE OF INTERNAL CONTROL SYSTEMS BY AUDITORS 61

3. EVALUATION OF INTERNAL CONTROL COMPONENTS 64

4. CONTROL OBJECTIVES, CONTROL PROCEDURES AND TEST OF CONTROL FOR MAIN CYCLE 65

SECTION 6: AUDIT SUBSTANTIVE PROCEDURES 85

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1. AUDIT PROCEDURES 85

2. SALES AND RECEIVABLES 87

3. INVENTORY 95

4. LIABILITIES AND CAPTIAL 104

5. CASH AND BANK 112

6. NON-CURRENT ASSETS (FIXED ASSETS) 115

SECTION 7: REPORTING 118

1. INDEPENDENT AUDITOR’S REPORT 118

2. BASIC ELEMENTS OF AN AUDIT REPORT 121

3. MATERIALITY 124

4. PERVASIVENESS 124

5. TYPES OF AUDIT REPORT 125

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SECTION 1: AUDIT FRAMEWORK AND REGULATION

1. THE CONCEPT OF AUDIT AND OTHER ASSURANCE ENGAGEMENTS
WHAT IS OBJECTIVE OF AN EXTERNAL AUDIT?
The objective of an audit of financial statements is to enable the auditor to express an
opinion on whether the financial statements are prepared, in all material respects, in
accordance with an applicable financial reporting framework.
The phrases used to express the auditor’s opinion are “give a true and fair view” or
“present fairly, in all material respects”, which are equivalent terms.
Truth and fairness

True Information is factual and conforms to reality. In addition, the information

conforms to required standards and law. The financial statements have been
correctly extracted from the books and records.

Fair Information is free from discrimination and bias and in compliance with
expected standards and rules. The accounts should reflect the commercial
substance of the company's underlying transactions.

An audit gives the reader reasonable assurance on the truth and fairness of the financial
statements. The audit report does not guarantee that the financial statements are correct,
but that they are true and fair within a reasonable margin of error.
Audits give reasonable assurance that the accounts are free from material misstatement.
WHAT ARE BENEFITS OF EXTERNAL AUDITS?
Under Company Act, most companies are required to have an audit.
The advantages (benefits) of statutory audit include:

Shareholders The impartial view provided by the auditors

Companies Recommendations being made in relation to accounting and control

systems and the possibility that auditors might detect fraud and error

Other - More credibility for financial statements prepared by management

advantages - Reduce the risk of fraud and errors
- Other users like banks, government, creditors, employees can use
the audited accounts to help them in decision making.

ACCOUNTABILITY, STEWARDSHIP AND AGENCY

An audit of a company's accounts is needed because in companies, the owners of the
business are often not the same persons as the individuals who manage and control that
business.
■ The shareholders own the company.

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■ The company is managed and controlled by its directors.

The directors have a stewardship role. They look after the assets of the company and
manage them on behalf of the shareholders. In small companies the shareholders may be
the same people as the directors. However, in most large companies, the two groups are
different.
The relationship between the shareholders of a company and the Board of Directors is also
an application of the general legal principle of agency. The concept of agency applies
whenever one person or group of individuals acts as an agent on behalf of someone else
(the principal). The agent has a legal duty to act in the best interests of the principal, and
should be accountable to the principal for everything that he does as agent. As agents of
the shareholders, the board of directors should be accountable to the shareholders, in order
for the directors to show their accountability to the shareholders, it is a general principle of
company law that the directors are required to prepare annual financial statements, which
are presented to the shareholders for their approval.
Over time, the annual audit was developed as a way of adding credibility to the financial
statements produced by management. The statutory audit is now a key feature of Company
Law throughout the world. An auditor reports to the shareholders on the financial
statements produced by a company's management.
Accountability is where one party is held responsible (answerable) to another party for its
actions; it will be required to justify its actions and decisions to that party.
Eg:
 Directors are accountable to the shareholders. Many jurisdictions place legal
requirements on directors with regard to how they are accountable and the way
they communicate with stakeholders, for example through directors' reports and
financial statements prepared under an appropriate framework (e.g. IFRS).
 Directors of listed companies will also be subject to listing rules and corporate
governance codes (e.g. publication of interim financial statements, regular
meetings with financial institutions, profit and going concern warnings, analysis
and management of risk, audit committees and annual general meetings).
 The auditors of a company's financial statements are accountable to shareholders.
They act in the interest of the shareholders (the primary stakeholders) while also
having regard to the wider public interest in that other stakeholders will read their
report (but note that they are not the agents of any other stakeholder and their
report is not addressed to such stakeholders, only to the shareholders)..]
Stewardship means taking care of another person’s property or investment.
[Stewardship is when a person is responsible for taking care of something on behalf of
another. Directors are responsible for the management of the shareholders property.]
Responsibilities (e.g. duties embodied in statute and corporate governance requirements)
may include:

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 Keeping books of accounts and proper accounting records.

 Safeguarding the entity's assets.
 Implementing appropriate business, financial and risk management controls.
 Producing financial statements (statement of financial position, statement of
comprehensive income, statement of cash flows, statement of changes in equity,
disclosure notes) that give a true and fair view and the results of their stewardship.
 Producing a directors' report and other information (e.g. as required by listing
rules) which is consistent with the financial statements and contains certain
specified information.
Agents are people employed or used to provide a particular service. In the case of a
company, the people being used to provide the service of managing the business also have
the second role of trying to maximize their personal wealth in their own right
[Agency is where an agent acts on behalf of a principle to perform tasks for them. In the
context of a company, the directors are the agents of the shareholders (principles) who
entrust them to manage the running of the business. Auditors, as they are appointed by the
shareholders in most jurisdictions, are also agents of the shareholders.]
This separation of ownership and management is often referred to as the ‘Agency
Problem’ or “Agency Relationship Problem”
Applying these three terms together, we can say:
Directors are accountable to shareholders. Directors act as stewards of the shareholders’
investments. They are agents of the shareholders.

Directors of all companies are required to produce financial statements annually which
give a true and fair view of the affairs of the company and its profit and loss for the period.
They are also encouraged to communicate with shareholders on matters relating to
directors’ pay and benefits, going concern and management of risks. An assurance
engagement may help to confirm that the information presents a fair picture.
An audit provides assurance to the shareholders and other stakeholders of a company on
the financial statements because it is independent and impartial.
ASSURANCE ENGAGEMNTS

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An assurance engagement is one in which a practitioner expresses a conclusion designed to

enhance the degree of confidence of the intended users other than the responsible party
about the subject matter information (that is, the outcome of the evaluation or
measurement of a subject matter against criteria).
Assurance means the auditors’ satisfaction as to the reliability of the assertion made by one
party for use by another party.
An assurance engagement performed by a practitioner will consist of the following FIVE
elements:

(a) A three party relationship

 Intended users are the person, persons or class of persons for whom the practitioner
prepares the assurance report.
 The responsible party is the person (or persons) responsible for the subject matter
(in a direct reporting engagement) or subject matter information of the assurance
engagement.
 The practitioner is the individual providing professional services that will review
the subject matter and provide the assurance.
(b) A subject matter: for which the auditor is giving assurance on. For audit assurance,
the subject matter is the financial statements.
(c ) Suitable criteria: use by the auditor to measure the subject matter
(d) Evidence collection: collected by auditor to support the assurance to be given
(e) A conclusion or an opinion report

Reasonable vs. Limited Assurance

The level of assurance is determined by the nature of procedures performed and their
results.

Reasonable assurance Limited Assurance

ISAE 3000 (Revised) Assurance engagements Limited assurance is a lower level of

other than audits or reviews of historical assurance. ISAE 3000 states that the

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financial information states that the objective

objective of a limited assurance
of a reasonable assurance engagement is a engagement is a reduction in assurance
reduction in assurance engagement risk to an
engagement risk to a level that is
acceptably low level in the circumstances of
acceptable in the circumstances of the
the engagement as the basis for the assurance
engagement, but where that risk is greater
practitioner's conclusion. The conclusion than for a reasonable assurance
would usually be expressed in a positive engagement, as the basis for a negative
form. form of expression of the practitioner’s
E.g., Statutory audit (audit of financial conclusion.
statements) E.g. Engagement to examine a forecast.
“In our opinion, the financial statements “Nothing has come to our attention which
present a true and fair view.” causes us to believe that these
assumptions do not provide a reasonable
basis for the forecast.”

REVIEW ENGAGEMENTS
(= a type of assurance engagement but not the same as audit)
The objective of a review engagement is to enable a practitioner to state whether, on the
basis of procedures which do not provide all the evidence that would be required in an
audit, anything has come to the practitioner’s attention that causes the auditor to believe
that the financial statements are not prepared, in all material respects, in accordance with
an applicable financial reporting framework.
EXTERNAL AUDIT
1. It is a review and assessment of the financial records to form an overall
conclusion as to whether:
 The financial statements have been prepared using acceptable accounting policies,
which have been consistently applied.
 The financial statements comply with all the relevant regulations and statutory
requirements.
 Adequate disclosure of all material matters relevant to the proper presentation of
financial information has been made.
2. Objective of external audit engagements: “Opinion”: The auditor’s report
contains a clear written expression of opinion on the financial statements.
3. Important points to remember
 Auditors do not bear any responsibility for the preparation and presentation of
the financial statements
 This is the responsibility of the directors
quan niem sai lam
 There are many misconceptions about the role of the auditors, which are
khoang cach ki vong
referred to as ‘the expectations gap’.

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The expectations gap is the gap between what auditors do and what people think they
(should) do
• Statutory audits
 Required by law for most companies
cty nho va vua dc mienx
 Small and dormant companies may be exempt
 Various other bodies require an audit under law, including Building societies,
Some charities
- Non‐statutory audits: Performed on various clubs, sole traders and partnerships because
the owners want them, not because it is legally needed

GENERAL PRINCIPLES OF EXTERNAL AUDIT ENGAGEMENTS

According to the International Standards on Auditing, the general principles of an audit
are:
1. Compliance with Code of Ethics (IFAC’s)
2. Performance of an audit in accordance with ISAs
3. Audit with professional skepticism
4. Professional judgment
5. Sufficient appropriate audit evidence
INHERENT LIMITATIONS OF AUDIT/ REASONS WHY ABSOLUTE
ASSURANCE CANNOT BE GIVEN
1. Sampling – it is not practical for an auditor to test 100% of transactions and so they
have to apply sampling methodologies in selecting balances/transactions to test.
Therefore, there could be an error in an item not selected for testing by the auditor.
2. Subjectivity – financial statements include judgmental and subjective areas and
therefore the auditor is required to use their judgment in assessing whether the
financial statements are true and fair. xet doan ca nhan
3. Inherent limitations of internal control systems – an internal control system is
operated by people and hence is liable to human error. In addition, there is the
possibility of controls override by management and of collusion and fraud. It is
impossible to remove all of these inherent limitations and as the auditor relies on
the internal control systems, this can reduce the usefulness of the audit.
4. Evidence is persuasive not conclusive – the opinion is based on audit evidence
gathered; however, while this evidence can indicate possible issues affecting the
audit opinion, evidence involves estimates and judgments and hence does not give
a definite conclusion. Chng c có sc thuyt phc ch không phi kt lun
5. Even if everything reported on was examined and found to be satisfactory, there
may be other items which should have been included– the completeness problem.
6. Auditors plan their work to detect material errors and frauds only – so small frauds
(or large frauds split into many small amounts) may go unnoticed.

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OTHER ISSUES WHICH REDUCE EXTERNAL AUDIT’S USEFULNESS

1. Audit report format – the format of the opinion is determined by International
Standards on Auditing. However, the terminology used is not usually understood
by non‐accountants. This means that users may not actually understand the audit
opinion given.
2. Historic information – the audit report is often issued sometime after the year end,
and so the financial information can be quite different to the current position. In the
current marketplace where companies’ financial positions can change quite
quickly, the audit opinion may no longer be relevant as it is out of date.
3. Auditors need to understand their clients in great depth if they are to understand
how fraud could be carried out and hidden. However, auditors cannot become too
close to their clients or their independence will be called into question.
4. Where auditors spot errors or fraud, their primary legal responsibility is to report
this to management. Any external reporting is hampered by rules on
confidentiality

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2. REGULATIONS OF AUDITORS
ELIGIBILITY TO ACT AS AUDITOR
To be allowed to perform external audits, an individual must go through an
approval process. The individual must:
 Pass an approved set of examinations set by a Recognized Qualifying Body
(RQB). Examples of an RQB include the ACCA and the ICAEW;
 Become a member (and stay a member) of a Recognized Supervisory Body
(RSB). The ACCA and the ICAEW are also examples of RSBs.
In addition, the individual must not be either of:
• A director or employee of the client or any of its associated companies;
• A business partner or employee of a director or employee of the client, or
any of its associated companies
DUTIES OF EXTERNAL AUDITOR

Maintenance of adequate accounting The auditor while performing his duties

records must check whether proper and adequate
accounting records have been maintained
and prepared.

Compliance with legislation It is the duty of an auditor to ensure that

all the applicable regulations have been
complied with while preparing the
financial statements.

Verification of records The auditor’s duty is to examine, compare

and verify the accounting records and
returns with the financial statements.
If the accounting records do not agree
with the financial statements or are
incomplete, then it is the duty of the
auditor to report this fact to the
shareholders.

Truth and fairness It is the primary duty of the auditor to

prepare a report on the financial
statements examined by him and state
whether, in his opinion and to the best of
his knowledge, the financial statements
provide:
- A true and fair state of affairs at
the end of accounting period, in
the case of statement of financial
position (SOFP) and
- A true and fair view of the amount

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of profit or loss during the

accounting period, in the case of
statement of comprehensive
income (SOCI).

Adequate disclosure Another duty of an auditor is to ensure

that the financial statements and all the
other material disclosures are made in
accordance with the applicable statute.
The auditor also needs to verify whether
all the payments and benefits accruing
to directors from the company are
properly disclosed in the accounts.

RIGHTS OF EXTERNAL AUDITOR

An auditor cannot fulfil statutory duties without commensurate rights (which must also be
legislated). For example:
 To have access at all times to the books, accounts and vouchers.
 To require from officers of the company any information and explanations
considered necessary for the purposes of the audit.
 To have unrestricted access to persons within the entity from whom the auditor
determines it necessary to obtain audit evidence.
 To receive notice of, attend and be heard at the general meeting of the company on
business which concerns them as auditor (e.g. a resolution to remove them from
office).
Also, the auditor may have rights associated with his vacation of office (e.g. by resignation
or removal) to bring matters to the attention of shareholders and creditors (e.g. if the
auditor is removed because he gives a qualified audit opinion or if he resigns because he is
not given access to necessary information).
APPOINTMENT OF AUDITOR

The shareholders are ultimately responsible for the appointment of the external
auditor.

Usually, the external auditors are appointed by the shareholders at the annual general
meeting (AGM) of the company, and hold office until the next AGM. At the next AGM
the auditors are re‐appointed by the shareholders, or different auditors are appointed.
However, directors may be allowed to appoint auditors in the following circumstances,
as a matter of practical convenience:
 To fill a 'casual vacancy'; for example where the current auditor is no longer
able to act
 To appoint the first auditor of a newly‐formed company.

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REMOVAL OF AUDITORS
Key points
 Directors cannot remove the auditors themselves.
 Auditors can be removed by a simple majority at a general meeting.
 The auditors should be given notice of such a meeting
 They are allowed to speak at the general meeting
 Deposit at the company’s registered office a statement of the circumstances
connected with the removal/resignation or a statement that there are no such
circumstances. They can request an Extraordinary General Meeting (EGM) of
the company to explain the circumstances of the resignation
RESIGNATION: Sometimes it is necessary for the auditors to resign. If an auditor
resigns, they should do so in writing and they may wish to speak to the shareholders to
explain their reasons
The procedures for the resignation of the current auditors will normally include the
following:
– The resignation should be made to the company in writing. The company should submit
this resignation letter to the appropriate regulatory authority.
– The auditor should prepare a Statement of the Circumstances. This sets out the
circumstances leading to the resignation, if the auditor believes that these are relevant to
the shareholders or creditors of the company. If no such circumstances exist, the auditor
should make a statement to this effect. This statement should be sent:
 By the auditor to the regulatory authority
 By the company to all persons entitled to receive a copy of the company's
financial statements (principally the shareholders).
3. DEVELOPMENT AND STATUS OF IAS
RULES GOVERNING AUDITS

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The International Standards on Auditing (ISAs) are produced by the International Auditing
and Assurance Standards Board (IAASB), a technical standing committee of IFAC.
An explanation of the workings of the IAASB and the authority of ISAs are laid out in the
Preface to the International Standards on Quality Control, Auditing, Review, Other
Assurance and Related Services.
- ISAs are to be paid in the audit of historical financial information
- In exceptional circumstances, an auditor may judge it necessary to depart from an ISA
in order to more effectively achieve the objective of an audit. When such a situation
arises, the auditor should be prepared to justify the departure.
- ISAs do not override the local regulations governing the audit of financial or other
information in a particular country, but:

When the ISAs conform with local The audit of financial or other information in that
regulations on a particular subject country in accordance with local regulations will
automatically comply with the ISA regarding that
subject.

When local regulations differ Member bodies should comply with the obligations
from, or conflict with, ISAs on a of members set forth in the IFAC Constitution as
particular subject regards these ISAs (ie encourage changes in local
regulations to comply with ISAs).

THE WORKING PROCEDURES OF THE IAASB

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Research and consultation

A project task force is established to develop a draft standard or practice statement.

Transparent debate
A proposed standard is discussed at a meeting, open to the public

Exposure for public comment

Exposure drafts are put on the IAASB's website and widely distributed for comment
for a minimum of 120 days.

Consideration of comments
Any comments as a result of the exposure draft are considered at an open meeting
of the IAASB, and it is revised as necessary for a minimum of 120 days.

Affirmative approval
Approval is made by the affirmative vote of at least 2/3 of IAASB members. of the
IAASB, and it is revised as necessary for a minimum of 120 days.

STATUS OF ISA
International Standards on Auditing (ISAs) are issued by the International Auditing and
Assurance Standards Board (IAASB) and provide guidance on the performance of an
audit.
ISAs only apply to the audit of historical financial information. They are written in the
context of an audit of financial statements by an independent auditor.
The ISAs contain basis principles and essential procedures together with related guidance
in the form of explanatory material and appendices. It is necessary to consider and
understand the entire text of an ISA to understand and apply the basic principles and
essential procedures.
The basic principles and essential procedures of an ISA are to be applied in all cases. If in
exceptional cases the auditor deems it necessary to depart from an ISA to achieve the
overall aim of the audit, then this departure must be justified.

CURRENT ISAs
(no need to remember, just be aware)

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Preface to International Standards on Quality Control, Auditing Review, Other

Assurance and Related Services
Glossary of terms
International Standards on Quality Control
1 Quality control for firms that perform audits and reviews of historical
financial information, and other assurance and related services engagements
Framework for Assurance Engagements
International Standards on Auditing
200 Overall objectives of the independent auditor and the conduct of an audit in
accordance with International Standards on Auditing
210 Agreeing the terms of audit engagements
220 Quality Control for an Audit of Historical Financial Statements
230 Audit documentation
240 The auditor's responsibilities relating to fraud in an audit of financial
statements
250 Consideration of laws and regulations in an audit of financial statements
260 Communication with those charged with governance
265 Communicating deficiencies in internal control to those charged with
governance and management
300 Planning an audit of financial statements
315 Identifying and assessing the risks of material misstatement through
understanding the entity and its environment
320 Materiality in planning and performing an audit
330 The auditor's responses to assessed risks
402 Audit considerations relating to an entity using a service organisation
450 Evaluation of misstatements identified during the audit
500 Audit evidence
501 Audit evidence – specific considerations for selected items
505 External confirmations
510 Initial audit engagements – opening balances
520 Analytical procedures
530 Audit sampling
540 Auditing accounting estimates, including fair value accounting estimates,
and related disclosures
550 Related parties
560 Subsequent events
570 Going concern
580 Written representations
600 Special Considerations – Audits of Group Financial Statements
(Including the Work of Component Auditors)
610 Using the work of internal auditors
620 Using the work of an auditor's expert
700 Forming an opinion and reporting on financial statements
701 Communicating Key Audit Matters in the Auditor’s report
705 Modifications to the opinion in the independent auditor's report
706 Emphasis of matter paragraphs and other matter paragraphs in the
independent auditor's report
710 Comparative Information – Corresponding Figures and Comparative
Financial Statements
720 The Auditor’s Responsibility Relating to Other Information in Documents
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Containing Audited Financial Statements

International Standards on Review Engagements
2400 Engagements to Review Financial Statements
2410 Review of Interim Financial Information Performed by the Independent
Auditor of the Entity
International Standards on Assurance Engagements
3000 Assurance Engagements Other than Audits or Reviews of Historical
Financial Information
International Standards on Related Services
4400 Engagements to Perform Agreed – Upon Procedures Regarding Financial
Information
4410 Engagements to Compile Financial Statements

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SECTION 2: CODE OF ETHICS AND CONDUCT

1. FUNDAMENTAL PRINCIPLES OF PROFESSIONAL ETHICS

The ACCA’s Code of ethics and conduct aligns with the IFAC’s Code of ethics for
professional accountants and sets out the 5 fundamental principles of principles of
professional ethics and provides a conceptual framework for applying them.

THE ACCA’s FUDAMENTAL PRINCIPLES OF PROFESSIONAL ETHICS

Integrity Members should be straightforward and honest in all professional

business, personal and financial relationships.
không nên cho phép s thiên v, xung t li ích hoc nh hng quá mc ca ngi khác
Objectivity Members should not allow bias, conflicts of interest or undue
influence of others to override professional or business judgements.

Professional Members have a continuing duty to maintain professional

competence and knowledge and skill at the level required to ensure that a client or
due care employer receives competent professional services based on current
nang luc developments in practice, legislation and techniques.
chuyen mon va
Members should act diligently and in accordance with applicable
tinh than trong
technical and professional standards.

Confidentiality Members shall respect the confidentiality of information acquired as

a result of professional and business relationships and, should not
tinh bao mat disclose any such information to third parties without proper and
specific authority, or unless there is a legal or professional right
or duty to disclose.
Confidential information acquired as a result of professional and
business relationships should not be used for the personal advantage
of members or third parties.

Professional Members should comply with relevant laws and regulations and
behaviour avoid any action that discredits the profession.
tuân th lut pháp và quy nh có liên quan và tránh mi hành ng làm mt uy tín ngh nghip.

CONFIDENTIALITY tinh bao mat

General rules

Information obtained during an audit is normally held to be confidential; that is it will not
be disclosed to a third party.
However, client information may be disclosed where:
- Consent has been obtained from the client
- There is a public duty to disclose or
- There is a legal or professional right or duty to disclose

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However, these rules are general principles only; more detailed guidance is also available
to accountants, as explained below.

SITUATIONS WHERE AN AUDITOR MAY DISCLOSE CONFIDENTIAL

INFORMATION ABOUT A CLIENT?

ACCA’s Code of ethics - obligatory disclosure

As noted above, ACCA’s Code of ethics confirms that when a member agrees to work for
a client in a professional capacity, it is an implied term of that agreement that the member
will not disclose a client’s affairs to any other person.
The recognised exceptions to this rule are where
- a member knows or suspects that his client has committed treason, or
- is involved in drug trafficking or terrorist offences.
In this situation, information must be disclosed to a competent authority. The actual
disclosure will depend on the laws of the jurisdiction where the auditor is located.
The auditor may also be obliged to provide information where a court demands disclosure.
Refusal to provide information is likely to be considered contempt of court with the
auditor being liable for this offence.

ACCA Code of ethics - voluntary disclosure

A member may also disclose client confidential information voluntarily, that is without
client permission, in a limited number of situations.
- To protect a member’s interest e.g. to allow a member to sue a client for unpaid
fees or defend an action for negligence.
- Where there is a public duty to disclose e.g. the client has committed an action
against the public interest such as unauthorised release of toxic chemicals.

CODE OF ETHICS DOES NOT INCLUDE “INDEPENDENCE”?

OBJECTIVITY AND INDEPENDENCE

Objectivity is a state of mind but in certain roles, the preservation of objectivity has to be
shown by the maintenance of independence from those influences which could impair
objectivity.
The auditor is impartial and independent of management, so that he can give an objective
view on the financial statements of an entity. The onus is always on the auditor not only to
be ethical but also to be seen to be ethical.

WHAT IS INDEPENDENCE?

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Independence of The state of mind that permits the provision of an opinion

mind without being affected by influences that compromise
professional judgement, allowing an individual to act with
integrity, and exercise objectivity and professional scepticism.

Independence in The avoidance of facts and circumstances that are so significant

appearance that a reasonable and informed third party, having knowledge of
all relevant information, including safeguards applied, would
reasonably conclude a firm's, or a member of the assurance
team's, integrity, objectivity or professional scepticism had been
compromised

2. THREATS TO INDEPENDENCE AND OBJECTIVITY

Self-interest The auditors’ own personal interest, e.g. the auditors may fear
the loss of fees.

Self-review When carrying out the audit, the auditors, review work that their
own firm has undertaken previously, e.g. preparing accounts or
making a valuation.

Advocacy If the auditors get involved in disputes concerning the client, they
may end up acting for or against the client, which undermines the
appearance of objectivity.

Familiarity If the auditors are involved with the client for a long time, they
may become unduly sympathetic towards directors and
management and thus too inclined to trust their unsupported
word.

Intimidation The auditors may be intimidated by a dominant or aggressive

atmosphere at the client.

IMPORTANT TERMS
QCR: Quality control Review (independent partner review) – having a professional
accountant who was not involved with the assurance service review the assurance work
performed.
Chinese walls: use of separate engagement teams, with different engagement partners and
team members.
Public interest entities are:
(a) All listed entities; and
(b) Any entity:
 Defined by regulation or legislation as a public interest entity; or

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 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 circulated by any relevant regulator,
including an audit regulator

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TYPES OF THREATS AND APPROPRIATE SAFEGUARDS

1. SELF-INTEREST THREAT SAFEGUARDS

a. FINANCIAL INTERESTS
[Key term]: A financial interest exists Appropriate safeguards:
where an audit firm has a financial interest - Disposing of the interest
in a client's affairs, for example, the audit - Removing the individual from the
firm owns shares in the client, or is a trustee team if required
of a trust that holds shares in the client. - Keeping the client's audit committee
informed of the situation
- Using an independent partner to
The following parties are not allowed to
review work carried out if necessary
own a direct financial interest or an indirect
material financial interest in a client: Audit firms should have quality control
procedures requiring staff to disclose
- The assurance firm
relevant financial interests for themselves
- A member of the assurance team
and close family members. They should
- An immediate family member of a
also foster a culture of voluntary disclosure
member of the assurance team
on an ongoing basis so that any potential
problems are identified in a timely manner.

b. CLOSE BUSINESS RELATIONSHIPS

Examples of inappropriate close business Unless the interest is clearly insignificant,
relationships: an audit provider should not participate
- Having a financial interest in a joint in such a venture with an audit client.
venture with either the client or a
controlling owner, director, officer Appropriate safeguards are therefore to end
or other individual who performs the assurance provision or to terminate the
senior managerial activities for that (other) business relationship.
client
- Arrangements to combine one or
more services or products of the If an individual member of an audit team
firm with one or more services or has such an interest, they should be
products of the audit client and to removed from the audit team.
market the package with reference
to both parties
- Distribution or marketing Purchasing goods and services from an
arrangements under which the firm audit client on an arm's length basis does
acts as distributor or marketer of the not constitute a threat to independence
audit client's products or services or
vice versa

c. EMPLOYMENT WITH ASSURANCE

CLIENT
Staff might transfer between an audit firm Appropriate safeguards:
and a client, or that negotiations or
interviews to facilitate such movement - Considering modifying the

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might take place. assurance plan

- Ensuring the audit is assigned to
someone of sufficient experience as
Both situations are a threat to independence: compared with the individual who
(i) An audit staff member might be has left
motivated by a desire to impress a future - Involving an additional professional
possible employer (objectivity is therefore accountant not involved with the
affected – self-interest threat). engagement to review the work
done
(ii) A former audit partner turned Finance - Carrying out a quality control
Director has too much knowledge of the review of the engagement
audit firm's systems and procedures. - In respect of audit clients, a partner
should not accept a key management
position at an audit client until at
The extent of the threat depends on: least 2 years have elapsed since the
- The role of the individual has taken conclusion of the audit he was
up at the client involved with.
- The extent of his influence on the - An individual who has moved from
audit previously the firm to a client should not be
- The length of time that has passed entitled to any benefits or payments
between the individual’s connection form the firm unless these are made
with the audit and the new role at in accordance with pre-determined
the client. arrangements.
- A firm should have quality control
procedures setting out that an
individual involved in serious
employment negotiations with an
audit client should notify the firm
and that this person would then be
removed from the engagement.

d. FAMILY AND PERSONAL

RELATIONSHIPS Appropriate safeguards:
Factors to consider are: - When an immediate family member
- The individual's responsibilities on of a member of the audit team is a
the audit engagement director, an officer or an employee
- The closeness of the relationship of the audit client in a position to
- The role of the other party at the exert direct and significant influence
audit client over the subject matter information
of the audit engagement, the
individual should be removed from
the audit team.
- A firm should have quality control
policies and procedures under which
staff should disclose if a close
family member employed by the
client is promoted within the client
- Undertaking a quality control
review of the audit

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AOF Audit and Assurance
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- Discussing the matter with the audit

committee of the client

e. GIFTS AND HOSPITALITY

Unless the value of the gift/hospitality is trivial and inconsequential, a firm or a member of
an audit team should not accept

f. OVERDUE FEES
Where there are overdue fees, the auditor Audit firm should discuss with those
runs the risk of making a loan to client. charged with governance or the possibility
of resining if overdue fees is not paid.

g. PERCENTAGE OR CONTINGENT
FEES A firm should not enter into any fee
[Key term]: Contingent fees are fees arrangement for an audit or assurance
calculated on a predetermined basis relating engagement under which the amount of the
to the outcome or result of a transaction or fee is contingent on the result of the
the result of the work performed assurance work or on items that are the
subject matter of the assurance engagement.

h. HIGH PERCENTAGE OF FEES

A firm should be alert to the situation Appropriate safeguards:
arising where the total fees generated by an - Discussing the issues with the audit
assurance client represent a large proportion committee
of a firm’s total fees. - Taking steps to reduce the
dependency on the lcient
- Obtaining external/ internal quality
control reivews
- Consulting a third party such as the
ACCA
The public may perceive that a member’s
objectivity is likely to be in jeopardy where
the fees for audit and recurring work paid
by one client or group of connected clients
exceed 15% of the firm’s total fees. Where
the entity is listed or a public interest
company, this figure should be 10%.

i. LOWBALLING Appropriate safeguards:

When a firm quotes a significantly lower - Maintaining records such that the
fee level for an audit service than would firm is able to demonstrate that
have been charged by the predecessor firm, appropriate staff and time are
there is a significant self-interest threat allocated to the engagement
- Complying with all applicable
auditing standards, guidelines and
quality control procedures

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k. RECRUITMENT
Recruiting senior management for an audit Audit providers must not make management
client, particularly those able to affect the decisions for the client.
subject matter of an audit engagement, Their involvement could be limited to
creates a self-interest threat for the audit reviewing a shortlist of candidates,
firm providing that the client has drawn up the
criteria by which they are to be selected.

l. LOAN AND GUARANTEES

The advice on loans and guarantees falls Client is a bank or other similar:
into two categories: - If the loan is material it will be
- The client is a bank or other similar necessary to apply appropriate
institution safeguards to bring the risk to an
- Other situations acceptable level.
- A suitable safeguard is likely to be
If a lending institution client (eg a bank)
an independent review (by a partner
lends an immaterial amount to an audit firm
from another office in the firm).
or member of assurance team on normal
commercial terms, there is no threat to
independence.

Other situations:
An audit firm or individual on the audit
- The self-interest threat created by
engagement should not enter into any loan entering into such an arrangement
or guarantee arrangement with a client that would be so significant that no
is not a bank or similar institution (unless safeguard would be able to reduce
immaterial to both parties which is the threat to an acceptable level.
unlikely). - In addition, loans should not be
made by an audit firm or an audit
team member to an audit client.

2. SELF-REVIEW THREAT SAFEGUARDS

a. RECENT SERVICE WITH AN

ASSURANCE CLIENT
Individuals who have been a director or Appropriate safeguards:
officer of the audit client, or an employee
in a position to exert direct and - Obtaining a quality control review
significant influence over the preparation of the individual's work on the
of the accounting records or financial assignment
statements in the period covered by the - Discussing the issue with the audit
audit report, should not be assigned to the committee
audit team

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b. PREPARING ACCOUNTING
RECORDS AND FINANCIAL Appropriate safeguards:
STATEMENTS
- Using staff members other than
Auditors may routinely assist management assurance team members to carry
with the preparation of financial statements out work
and give advice about accounting treatments - Obtaining client approval for work
and journal entries undertaken
Firms should not prepare accounts or
financial statements for listed or public
interest clients.
For any client, assurance firm are not
allowed to:
- Determine or change journal entries
without client approval
- Authorize or approve transactions
- Prepare source documents

c. VALUATION SERVICES Factors to consider when applying

safeguards for immaterial valuation:
[key term]: A valuation comprises the
making of assumptions with regard to future - The extent of the audit client’s
developments, the application of certain knowledge of the relevant matters in
methodologies and techniques, and the making the valuation
combination of both in order to compute a - The degree of judgment involved
certain value, or range of values, for an - How much use is made of
asset, a liability or for a business as a whole. established methodologies
- The degree of uncertainty in the
valuation
Audit firm should not carry out
Appropriate safeguards:
valuations on matters which are
subjective and material to the financial - Second partner review
statements. - Confirming that the client
understands the valuation and the
assumptions used
- Ensuring that the client
acknowledges responsibility for the
valuation
- Using separate personnel for the
valuation and the audit

d. CORPORATE FINANCE
Assurance firms are not allowed to Appropriate safeguards:
promote, deal in or underwrite an assurance - using different teams of staff and
client's shares. They are also not allowed to - ensuring that no management
commit an assurance client to the terms of a decisions are taken on behalf of the
transaction or consummate a transaction on
client.
the client's behalf.

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Other corporate finance services, such as

assisting a client in defining corporate
strategies, assisting in identifying possible
sources of capital and providing structuring
advice, may be acceptable providing that
safeguards are used.

3. ADVOCACY THREAT SAFEGUARDS

Advocacy threats arise in those situations

where the audit firm promotes a position or Appropriate safeguards:
opinion to the point that subsequent
objectivity is compromised. - using different departments to carry
out the work and
- making disclosures to the audit
Examples include committee
- Acting in an advocacy role for an
audit client in resolving a dispute or
litigation
- Promoting shares for a listed audit
client

4. FAMILIARITY THREAT SAFEGUARDS

Familiarity threat occurs when, because of

close relationship, members become too All firms should monitor the relationship
sympathetic to the interests of others. between staff and established clients and
use safeguards such as:
Examples include: - Rotating senior staff off the
assurance team
- Family and personal relationships
- Obtaining second partner reviews;
between the client and firm
and
- Long association with an assurance
- Independent quality control review
client
- Employment with an assurance
client
- Recent service with an assurance
client

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5. INTIMIDATION THREAT SAFEGUARDS

An intimidation threat arises when members

of the assurance team may be deterred from Appropriate safeguards:
acting objectivity by threats, actual or
perceived. - Disclosing to the audit committee
the nature and extent of the
litigation
An intimidation threat arises when the client - Removing specific affected
threatens to sue, or does sue, the audit firm individuals from the engagement
for work that has been done previously. The team
firm is then faced with the risk of losing the - Involving an additional professional
client, bad publicity and the possibility that accountant on the team to review
it will be found to have been negligent, work
which will lead to further problems. - If the litigation is at all serious, the
auditor may resign from the
engagement
Factors to consider:
- The materiality of the litigation
- The nature of the assurance
engagement
- Whether the litigation relates to a
prior assurance engagement

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SECTION 3: RISK ASSESSMENT

1. INTRODUCTION TO RISK
Audit risk

Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the
financial statements are materially misstated.

Audit risk has 3 components:

Inherent risk Inherent risk is the susceptibility of an assertion to a misstatement that

could be material individually or when aggregated with other
misstatements, assuming there were no related internal controls.

Inherent risk describes something about the nature of a business or its

transactions that make it particularly susceptible to material
misstatements.
Inherent risk is affected by the nature of an entity and factors which can
result in an increase include:
– Changes in the industry it operates in.
– Operations that are subject to a high degree of regulation.
– Going concern and liquidity issues including loss of significant
customers.
– Developing or offering new products or services, or moving into new
lines of business.
– Expanding into new locations.
– Application of new accounting standards.
– Accounting measurements that involve complex processes.
– Events or transactions that involve significant accounting estimates.
– Pending litigation and contingent liabilities.

Control risk Control risk is the risk that a material misstatement that could occur in
an assertion and that could be material, individually or when aggregated
with other misstatements, will not be prevented or detected and corrected
on a timely basis by the entity's internal control.
It is the risk that an organisation’s internal control systems do not
adequately protect the organization either because they have not been
adequately designed and / or implemented.
The following factors can result in an increase in control risk:
– Lack of personnel with appropriate accounting and financial reporting
skills.
– Changes in key personnel including departure of key management.

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– Deficiencies in internal control, especially those not addressed by

management.
– Changes in the information technology (IT) environment.
– Installation of significant new IT systems related to financial reporting

Detection Detection risk is the risk that the procedures performed by the auditor to
risk reduce audit risk to an acceptably low level will not detect a
misstatement that exists and that could be material, either individually or
when aggregated with other misstatements.
Detection risk is affected by sampling and non-sampling risk and factors
which can result in an increase include:
– Inadequate planning.
– Inappropriate assignment of personnel to the engagement team.
– Failing to apply professional scepticism.
– Inadequate supervision and review of the audit work performed.
– Incorrect sampling techniques performed.
– Incorrect sample sizes

The auditors have a degree of control over detection risk, because, if

audit risk is too high to be tolerated, the auditors can carry out more
work to reduce this aspect of audit risk, and therefore audit risk as a
whole.

What is risk of material misstatement (ROMM)?

Risk of material misstatement is risk that the financial statements are materially misstated
prior to audit. This consists of two components: inherent risk and control risk.
WHAT ARE THE KEY DIFFERENT DIFFERENCES BETWEEN AUDIT RISK,
INHERENT RISK, CONTROL RISK
AUDIT RISK MODEL

Audit Risk = Inherent risk × Control Risk × Detection risk

Needs to be at High High Must be low

acceptably low
level

REMEMBER: An Auditor has control over DR but not IR and CR!

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The audit risk model used by auditors, dictates that for a given level of audit risk, the
acceptable level of detection risk bears an inverse relationship to the assessment of the risk
of material misstatement.
For example, on an audit assignment where the risk of material misstatement has been
assessed as high, in order to achieve a low level of audit risk, detection risk must be set as
low.
In such circumstances the auditor would need to direct an appropriate level of resources to
the testing of the assertion in question. This will comprise adequate planning, proper
assignment of personnel, the application of professional scepticism and supervision and
review of the audit work performed.

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2. MATERIALITY
ISA 320 Materiality in planning and performing an audit

The concept of materiality is applied by the auditor both in planning and performing the
audit, and in evaluating the effect of identified misstatements on the audit and of
uncorrected misstatements, if any, on the financial statements and in forming the opinion
in the auditor’s report.
ISA 320.5

EXPLAIN THE CONCEPTS OF MATERIALITY AND PERFORMANCE

MATERIALITY IN ACCORDANCE WITH ISA 320 MATERIALITY
Definition

Materiality: Misstatements, including omissions, are considered to be material if they,

individually or in the aggregate, could reasonably be expected to influence the economic
decisions of users taken on the basis of the financial statements.

Auditors often calculate the following values (benchmark) and take an average or weighted
average of all the figures as the materiality level:

Value Percentage

Profit before tax 5%

Revenue 0.5%

Total asset 1%

How to assess materiality?

In assessing the level of materiality, there are a number of areas that should be considered:

Amount and First the auditor must consider both the amount (quantity) and the nature
nature of (quality) of any misstatements, or a combination of both.
misstatements Material by size (importance depends on value)-Quantitative factors
 1% of revenue;
 2% of total assets;
 10% of PBT.
Material by nature: an amount that might be low in value but due to its
prominence could influence the user’s decision

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Examples
 Bank balances
 Related party transactions ( including remuneration and personal
expenses of directors)
 Fraud/ Unlawful transactions (e.g. illegal payments)
 Violation of regulatory requirements
 Incorrect selection or application of an accounting policy that has
an immaterial effect on the current period but is likely to have a
material effect on future periods
 Failure to meet requirements of debt-covenants
 Key Performance Indicators of the company (e.g. converting loss
into profit)

Calculating As per ISA 320, materiality is often calculated using benchmarks such as
materiality 5% of profit before tax or 1% of total revenue or total expenses. These
value are useful as starting point for assessing materiality.

Assessment of The assessment of what is material is ultimately a matter of auditor’s

what is material professional judgement, and it is affected by the auditor’s perception of
the financial information needs of users of the financial statements and
the perceived level of risk; the higher risk, the lower level of overall
materiality

Not material In assessing materiality, the auditor must consider that a number of errors
individually but each with a low value may, when aggregated, amount to a material
material misstatement.
aggregated

Performance materiality

Performance materiality is the amount or amounts set by the auditor at less than
materiality for the financial statements as a whole to reduce to an appropriately low level
the probability that the aggregate of uncorrected and undetected misstatements exceeds
materiality for the financial statements as a whole.
Performance materiality also refers to the amount or amounts set by the auditor at less
than the materiality level or levels for particular classes of transactions, account balances
or disclosures.

Why does the auditor need to calculate performance materiality?

Performance materiality is normally set at a level lower than overall materiality. It is used
for testing individual transactions, account balances and disclosures.
The aim of performance materiality is to reduce the risk that the total of errors in balances,
transactions, and disclosures does not in total exceed overall materiality.

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Why materiality is important for the auditor?

The materiality level will impact on the auditor's decisions relating to:
- How many items to examine
- Which items to examine
- Whether to use sampling techniques
- What level of misstatement is likely to result in a modified audit opinion?

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3. UNDERSTANDING THE ENTITY AND ITS ENVIRONMENT

WHY? - REASON FOR OBTAINING AN UNDERSTANDING

The auditor obtains an understanding of the entity, its control environment and its detailed
internal controls:
- To identify and assess the risks of material misstatements in the financial
statements and to provide a basis for designing and implementing responses to
these risks
- To determine the extent to which the auditor would rely on the internal control
system.
- To assess whether the team is competent to perform the audit
- To understand relevant law and regulations impacting the entity
- To consider the reliability of various evidence sources.

WHAT? - MATTERS TO CONSIDER WHEN OBTAINING AN UNDERSTANDING

What matters to be obtained? How to obtain understanding?

- Industry, regulatory and other external Prior year financial statements: Provides
factors( for example financial reporting information in relation to the size of the
framework, laws and regulations, client as well as the key accounting policies,
stakeholders, economic conditions like disclosure notes and whether the audit
volatility of exchange rates, competition, opinion was modified or not.
level of technology
Discussions with the previous
- Nature of entity and accounting policies auditors/access to their files: Provides
( legal structure, ownership and governance, information on key issues identified during
main sources of finance) the prior year audit as well as the audit
- Objectives, strategies and related approach adopted.
business risks! (e.g. new products/services, Prior year report to management: If this
explansion, use of IT) can be obtained from the previous auditors
- Measurement and review of Financial or from management, it can provide
performance (measures important to the information on the internal control
deficiencies noted last year. If these have
client, KPIs i.e. Key Performance
not been rectified by management, then they
Indicators, budgets, targets)
could arise in the current year audit as well
- Internal control (gain an understanding and may impact the audit approach
about the design and implementation of
internal controls) The client‘s accounting systems
notes/procedural manuals: Provides
information on how each of the key
accounting systems operates and this will be
used to identify areas of potential control
risk and help determine the audit approach.
Discussions with management: Provides
information in relation to the business, any
important issues which have arisen or

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changes to accounting policies from the

prior year.
Review of board minutes: Provides an
overview of key issues which have arisen
during the year and how those charged with
governance have addressed them.
Current year budgets and management
accounts: Provides relevant financial
information for the year to date. It will help
the auditor during the planning stage for
preliminary analytical review and risk
identification.
The client’s website: Recent press releases
from the company may provide background
on the business during the year as this will
help in identifying the key audit risks.
Financial statements of competitors: This
will provide information about the client’s
competitors, in relation to their financial
results and their accounting policies. This
will be important in assessing the client’s
performance in the year and also when
undertaking the going concern review.
Analytical procedures: provide
information about the fluctuations and
relationships that are inconsistent with other
relevant information

4. RESPONDING TO THE RISK ASSESSMENT

ISA330
The auditor's responses to assessed risks

Overall responses Responses to the risks of material

(FS level) misstatement at the assertion level

Substantive
Test of controls
- professional scepticism procedures
- additional or more
experienced staff
- Supervision
- general changes to the Substantive
analytical Test of
nature, timing or extent of
procedure detailed
audit procedures

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AUDITOR’S RESPONSES TO RISK

Having identified the audit risk students are often required to identify the relevant response
to these risks.

Common mistakes: A common mistake made by students is to provide a response

that management would adopt rather than the auditor.
For example:
In relation to the risk of valuation of receivables if a company has a number of
receivables who were struggling to pay, many students suggested that management needed
to chase these outstanding customers.
 This is not a response that the auditor would adopt, as they would be focused on
testing valuation through after date cash receipts or reviewing the aged receivables
ledger.
 Overall responses
ISA 330 lists the following overall responses that may be used by auditors in order to
address the assessed risks of material misstatement at the financial statement level:
 Emphasizing to the audit team the need to maintain professional scepticism.
 Assigning more experienced staff, those with special skills, or using experts.
 Providing more supervision.
 Incorporating additional elements of unpredictability in the selection of further
audit procedures to be performed.
 Making general changes to the nature, timing or extent of audit procedures
 Specific responses
Examples from past exams

Audit Risks Auditor’s responses

The finance director Abrahams is A breakdown of the development

planning to capitalize the full $2.2 expenditure should be reviewed and tested
million of development expenditure in detail to ensure that only projects which
incurred. However in order to be meet the capitalization criteria are
capitalized it must meet all of the criteria included as an intangible asset, with the
under IAS 38 intangible Assets. The risk balance being expensed.
is that the criteria has not been and assets
might be overstated.

In September Abrahams Co introduced a The new system will need to be

new accounting system. This is a critical documented in full and testing should be
system for the accounts preparation and if performed over the transfer of data from

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AOF Audit and Assurance
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there were any errors that occurred the old to the new system.
during the changeover process, these
could impact on the final amounts in the
trial balance.

TEST OF CONTROL
Definition

Tests of controls are an audit procedure designed to evaluate the operating effectiveness
of controls in preventing, or detecting and correcting, material misstatements at the
assertion level.

WHEN to carry out test of control?

- When the auditor’s assessment of risks of material misstatement at the assertion level
includes an expectation that the controls are operating effectively (that is, the auditor
intends to rely on the operating effectiveness of controls in determining the nature, timing
and extent of substantive procedures); or
- When the substantive procedures alone cannot provide sufficient appropriate audit
evidence at the assertion level

HOW to carry out test of control? (refer to Section 4 – 5. Audit procedures)

In carrying tests of control, the following audit technique should be used:

- Inquiries: must use
- Re-performance: often be a helpful procedure
- Inspection: often be a helpful procedure
- Analytical procedures: CANNOT (You cannot use analytical procedures (AP) to test
controls, we use AP as a substantive test)

SUBSTANTIVE PROCEDURES
Definition

Substantive procedures are audit procedures designed to detect material misstatements at

the assertion level.
Substantive procedures fall into two categories:
(a) Substantive analytical procedures
(b) Tests of details (of classes of transactions, account balances, and disclosures)

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WHEN to carry out substantive procedures?

The auditor must always carry out substantive procedures on material items

HOW to carry out substantive procedures? (refer to Section 4 – 5. Audit procedures)

A
E
I
O
U

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AOF Audit and Assurance
Lecture note

INTERIM AND FINAL AUDIT

Interim audit procedures are performed before the year end. An interim audit is not
required, but may be performed:
- to reduce the workload and time pressure of the final audit;
- to help plan the year-end audit with a better understanding of the reliance that can
be placed on internal controls.

The final audit is the main period of audit testing, when work is focused on the final
financial statements.

Interim Audit Final Audit

Timing Before year end At or after year end

Required No Yes

Procedures Primarily tests of controls Primarily substantive

with some substantive procedures or, when
procedures when risk is low appropriate or necessary, a
and evidence is available. combination of substantive
procedures and tests of
controls.

Basis for audit opinion Only when combined with Evidence gathered during
evidence gathered during the the final audit can be used as
final audit. the basis for the audit
opinion, even when no
interim procedures have
been performed.

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5. FRAUDS
What is fraud?

Fraud is an intentional act by one or more individuals among management, those

charged with governance, employees, or third parties, involving the use of deception to
obtain an unjust or illegal advantage. Fraud may be perpetrated by an individual, or
colluded in, with people internal or external to the business.

What is error?
Error is a material misstatement cause by mistake.

What are types of frauds?

There are two types of fraud causing material misstatement in financial statements:

Fraudulent financial reporting

Fraudulent financial reporting involves intentional misstatements, including omissions of
amounts or disclosures in financial statements, to deceive financial statement users.
Examples include:
- Manipulation, falsification or alteration of accounting records / supporting
documents
- Misrepresentation (or omission) of events or transactions in the financial
statements
- Intentional misapplication of accounting principles
Misappropriation of assets
Misappropriation of assets involves the theft of an entity's assets and is often perpetrated
by employees in relatively small and immaterial amounts. However, it can also involve
management who are usually more capable of disguising or concealing misappropriations
in ways that are difficult to detect.
This is the theft of the entity's assets (for example, cash, and inventory). Employees may
be involved in such fraud in small and immaterial amounts, but it can also be carried out
on a larger scale by management who may then conceal the misappropriation, for
example, by:
- Embezzling receipts (for example, diverting them to private bank accounts)
- Stealing physical assets or intellectual property (inventory, selling data)
- Causing an entity to pay for goods not received (payments to fictitious vendors)
- Using assets for personal use

What is MANAGEMENT’s responsibility to fraud?

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The primary responsibility for the prevention and detection of fraud is with those charged
with governance and the management of an entity. This is effected by having a
commitment to creating a culture of honesty and ethical behaviour and active oversight
by those charged with governance

What is AUDITOR’s responsibility to fraud?

In summary, according to ISA240, auditor’s responsibilities for fraud are:

- An auditor conducting an audit in accordance with ISA 240 The auditor's
responsibilities relating to fraud in an audit of financial statements is
responsibilities for obtaining reasonable assurance that the financial statements
taken as a whole are free from material misstatement, whether caused by fraud or
error.
- In order to fulfill this responsibility, auditors are required to identify and assess the
risks of material misstatement of the financial statements due to fraud
- The auditor will need to obtain sufficient appropriate audit evidence regarding the
assessed risks of material misstatement due to fraud, through designing and
implementing appropriate responses
- In addition, auditor must respond appropriately to fraud or suspected fraud
identified during the audit
- When obtaining reasonable assurance, the auditor is responsible for maintaining
professional skepticism throughout the audit, considering the potential for
management override of controls and recognizing the fact that audit procedures
that are effective in detecting error may not be effective in detecting fraud.
- To ensure that the whole engagement team is aware of the risks and
responsibilities for fraud and error, ISAs, require that a discussion is held within
the team For members not present at the meeting the engagement partner should
determine which matters are to be communicated to them

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SECTION 4: AUDIT PLANNING AND DOCUMENTATION

1. AUDIT PLANNING
THE IMPORTANCE OF PLANNING (WHY plan?)

ISA 300 Planning an audit of financial statements which states that the auditor shall plan
the audit so that the engagement is performed in an effective manner.
Audits are planned to:
- Help the auditor devote appropriate attention to important areas of the audit
- Help the auditor identify and resolve potential problems on a timely basis
- Help the auditor properly organize and manage the audit so it is performed in an
effective manner
- Assist in the selection of appropriate team members and assignment of work to them
- Facilitate the direction, supervision and review of work

formulate translate
Auditors Audit strategy Audit plan

AUDIT STRATEGY
The audit strategy sets the scope, timing and direction of the audit, and guides the
development of the more detailed audit plan.
Matter to consider in establishing an overall audit strategy

 Financial reporting framework

 Industry-specific reporting requirements
 Expected audit coverage

Characteristics of the  Nature of business segments

engagement  Availability of internal audit work
 Use of service organizations
 Effect of information technology on audit procedures
 Availability of client personnel and data

Reporting objectives,  Entity's timetable for reporting

timing of the audit and
nature of  Organization of meetings with management and those
communications charged with governance

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 Discussions with management and those charged with

governance
 Expected communications with third

 Determination of materiality
 Areas identified with higher risk of material misstatement
 Results of previous audits
 Need to maintain professional skepticism
Significant factors,
preliminary engagement  Evidence of management's commitment to design,
activities, and knowledge implementation and maintenance of sound internal control
gained on other  Volume of transactions
engagements
 Significant business developments
 Significant industry developments
 Significant changes in financial reporting framework
 Other significant recent developments

 Selection of engagement team

Nature, timing and extent
 Assignment of work to team members
of resources
 Engagement budgeting

What are the items which should be included in overall audit strategy?

- Industry-specific financial reporting requirements

- Number of locations to be visited
- Audit client's timetable for reporting to its members
- Communication between the audit team and the client

AUDIT PLAN
The audit plan converts the audit strategy into a more detailed plan and includes the
nature, timing and extent of audit procedures to be performed by engagement team
members in order to obtain sufficient appropriate audit evidence to reduce audit risk to an
acceptably low level.

What are the items which should be included in the audit plan?

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(a) A description of the nature, timing and extent of planned risk assessment procedures
sufficient to assesses the risk of material misstatement.
This would include assessment of IR and CR at both the entity and assertion level. An
important element of the plan would be the understanding and assessment of the
control environment of the organisation
(b) A description of the nature, timing and extent of planned further audit procedures at
the assertion level for each material class of transactions, account balance and
disclosure
This would include an explanation of the decision whether to test the operating
effectiveness of controls (an important decision is whether reliance is to be placed on
controls) and on the nature, timing and extent of planned substantive procedures (this
would depend on the decision as to the level of control risk)
(c) Audit procedures required to be carried out for the engagement to comply with the
ISAs, for example, the use of external confirmations to obtain sufficient appropriate
evidence at the assertion level

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2. AUDIT DOCUMENTATION
ISA 230 Audit documentation

Audit documentation/'working papers'/'work papers' is the record of audit procedures

performed, relevant audit evidence obtained, and conclusions the auditor reached.

Why do auditors need to record their work? (Importance of working paper)

(a) It provides evidence of the auditor's basis for a conclusion about the achievement of
the overall objective.
(b) It provides evidence that the audit was planned and performed in accordance with
ISAs and other legal and regulatory requirements.
(c) It assists the engagement team to plan and perform the audit.
(d) It assists team members responsible for supervision to direct, supervise and review
audit work.
(e) It enables the team to be accountable for its work.
(f) It allows a record of matters of continuing significance to be retained.
(g) It enables the conduct of quality control reviews and inspections (both internal and
external)

What are the form and content of working papers?

The general rule of the content of working papers:

“ The auditor shall prepare audit documentation that is sufficient to enable an experienced
auditor, having no previous connection with the audit, to understand:
(a) The nature, timing, and extent of the audit procedures performed to comply with the
ISAs and applicable legal and regulatory requirements;
(b) The results of the audit procedures performed, and the audit evidence obtained; and
(c) Significant matters arising during the audit, the conclusions reached thereon, and
significant professional judgments made in reaching those conclusions”

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EXAMPLE OF WORKING PAPER

Name of Working paper
client reference
Client: XYZ Co. Ref: A.1.1
Balance Year-end: 31 December 20X7 Prepared by: Price Young Preparer
sheet date
Subject: NRV of inventory Date: 10 Feb 20X7
Subject Date prepared

Objective Aim:
of work
- Sample selection
- Work done
- Source of information
Work done: - Key to any audit risks
- Appropriate cross-referencing

- Results
- Analysis of errors or other significant
Results: observations

- Conclusions
- Key points Conclusions:

Reviewer
Reviewed by: T Cooper
Date: 15 Feb 20X7
Date reviewed

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HOW TO ORGANIZE WORKING PAPER?

For recurring audits, working papers may be split between Permanent audit files (PAF)
and Current audit files (CAF)
What is the different between PAF and CAF?

PAF contain information of continuing important to the audit

CAF contain information of relevance to the current year’s audit

PERMANENT AUDIT FILES

- Engagement letters
- New client questionnaires
- The memorandum and articles
- Other legal documents such as prospectuses, leases, leases and sales agreement
- Details of the history of the client’s business
- Board minutes of continuing relevance
- Previous years’ signed accounts, analytical review and management letters
- Accounting system notes, previous year’s control questionnaires

CURRENT AUDIT FILES

- Financial statements
- Accounts checklists
- Management accounts details
- Reconciliations of management and financial accounts
- A summary of unadjusted errors
- Report to partner including details of significant events and errors
- Review notes
- Audit planning memorandum
- Time budgets and summaries
- Letter of representation
- Management letter
- Notes of board minutes
- Communications with third parties such as experts or other auditors

HOW LONG WORKING PAPERS RETAINED?

ACCA RECOMMENDATION: Auditors should retain their working papers for at least 7

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years before destroying them.

Working papers are the property of the auditors
Auditors must follow ethical guidance on the confidentiality of audit working papers. They
may release the working papers to the entity, as long as disclosure does not undermine “the
independence or validity of the audit processes”.

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3. INTRODUCTION TO AUDIT EVIDENCE

The need of audit evidence

Audit evidence is all the information used by the auditor in arriving at the conclusions on
which the auditor's opinion is based.

WHAT ARE THE REQUIREMENTS OF THE AUDIT EVIDENCE?

“The objective of the auditor is to design and perform audit procedures in such a way as to
enable the auditor to obtain sufficient appropriate audit evidence to be able to draw
reasonable conclusion on which to base the auditor’s opinion.”

Sufficiency Appropriateness
• The measure of the quantity of • The measure of the quality of
audit evidence audit evidence;
• The quantity of audit evidence • That is, its relevance and its
required is affected by the auditor reliability in providing support for
assessment of the risks of material the conclusions on which the
and also by the quality of such auditor's opinion is based
audit evidence

WHAT FACTORS AFFECT SUFFICIENCY OF EVIDENCE?

- Assessment of risk at the financial statement level and/or the individual transaction
level. As risk increases then more evidence is required.
- The materiality of the item. More evidence will normally be collected on material
items whereas immaterial items may simply be reviewed to ensure they appear
correct.
- The nature of the accounting and internal control systems. The auditor will place more
reliance on good accounting and internal control systems limiting the amount of audit
evidence required.
- The auditor’s knowledge and experience of the business. Where the auditor has good
past knowledge of the business and trusts the integrity of staff then less evidence will
be required.
- The findings of audit procedures. Where findings from related audit procedures are
satisfactory (e.g. tests of controls over receivables) then substantive evidence will be
collected.
- The source and reliability of the information. Where evidence is obtained from
reliable sources (e.g. written evidence) then less evidence is required than if the
source was unreliable (e.g. verbal evidence).

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WHAT FACTORS AFFECT RELIABILITY OF EVIDENCE?

APPROPRIATENESS = relevance + reliability
Relevance: deals with the logical connection with the purpose of the audit procedure and
the assertion under consideration (we look at assertions in the next section).
The relevance of information may be affected by the direction of testing
Factor affecting the reliability of audit evidence:

External Audit evidence from external sources is more reliable than that obtained
from the entity's records because it is from an independent source.

Auditor Evidence obtained directly by auditors is more reliable than that obtained
indirectly or by inference.

Entity (ICS Evidence obtained from the entity's records is more reliable when the
strength) related control system operates effectively.

Written Evidence in the form of documents (paper or electronic) or written

representations are more reliable than oral representations, since oral
representations can be retracted.

Originals Original documents are more reliable than photocopies or facsimiles,

which can easily be altered by the client.

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4. ASSERTION
Financial statement assertions
Assertions are representations by management, explicit or otherwise, that are embodied in
the financial statements, as used by the auditor to consider the different types of potential
misstatements that may occur.
The use of assertions by auditor
Assertions used by the auditor when auditing the class of transactions or balance

WHAT ARE ASSERTIONS AND THEIR MEANINGS?

Table 1: Assertion for class of transactions or events for the year

Occurrence Transactions and events that have been recorded or disclosed have
occurred, and such transactions and events pertain to the entity

Completeness All transactions and events that should have been recorded have been
recorded

Accuracy Amounts and other data relating to recorded transactions and events
have been recorded appropriately

Cut-off Transactions and events have been recorded in the correct reporting
period

Classification Transactions and events have been recorded in the proper accounts

Table 2: Assertion for account balances as at year end

Existence Assets, liabilities and equity interests exist

Rights and The entity holds or controls the rights to assets, and liabilities are the
obligations obligations of the entity.

Completeness All assets, liabilities and equity interests that should have been recorded
have been recorded.

Valuation and Assets, liabilities and equity interests are included in the financial
allocation statements at appropriate amounts and any resulting valuation or
allocation adjustments are appropriately recorded.

Why need to split into table 1 and table 2?

You must use the correct assertion to do the audit.

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5. AUDIT PROCEDURES
What is purpose of audit procedures?

The auditor obtains audit evidence by undertaking audit procedures to do the following:
- Obtain an understanding of the entity and its environment to assess the risks of
material misstatement at the financial statement and assertion levels (risk assessment
procedures)
- Test the operating effectiveness of controls in preventing, or detecting and correcting,
material misstatements at the assertion level (tests of controls)
- - Detect material misstatements at the assertion level (substantive procedures).

What procedures auditors should use to obtain evidence?

Inspection of - Inspection of tangible assets that are recorded in the accounting

assets records confirms existence, but does not necessarily confirm rights
and obligations or valuation.
- Confirmation that assets seen are recorded in accounting records
gives evidence of completeness.

Inspection of - This is the examination of documents and records, both internal and
documentatio external, in paper, electronic or other forms.
n or records - This procedure provides evidence of varying reliability, depending
on the nature, source and effectiveness of controls over production
(if internal).
- Inspection can provide evidence of existence (e.g. a document
constituting a financial instrument), but not necessarily about
ownership or value.

Observation - This involves watching a procedure or process being performed (for

example, post opening).
- It is of limited use, as it only confirms the procedure took place
when the auditor was watching, and because the act of being
observed could affect how the procedure or process was performed.

Enquiry - This involves seeking information from client staff or external

(Inquiry) sources.
- Strength of evidence depends on the knowledge and integrity of
source of information.

Confirmation - This is the process of obtaining a representation of information or of

an existing condition directly from a third party e.g. confirmation

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from bank of bank balances.

Recalculation - Checking the mathematical accuracy of client’s record

Re- - This involves the auditor's independent execution of procedures or

performance controls that were originally performed as part of the entity's internal
control.

Analytical - This consists of evaluations of financial information through

procedures analysis of plausible relationships amount both financial and non-
financial data.
- It also encompasses such investigation as is necessary of identified
fluctuations and relationships that are inconsistent with other
relevant information or that differ from expected values by a
significant amount.

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SECTION 5: INTERNAL CONTROLS

The auditors must understand the accounting system and control environment in order
to determine their audit approach.
1. INTERNAL CONTROL SYSTEMS
WHAT IS INTERNAL CONTROL
Internal control is the process designed, implemented and maintained by those charged
with governance, management, and other personnel to provide reasonable assurance about
the achievement of the entity's objectives with regard to:
(1) Reliability of financial reporting
(2) Effectiveness and efficiency of operations, and
(3) Compliance with applicable laws and regulations.

ELEMENT OF INTERNAL CONTROL

ISA 315 – Understanding the entity and its environment and assessing the risks of material
misstatement identified 5 elements of internal control

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CONTROL ENVIRONMENT
What is control environment?
Control environment includes the governance and management functions and the
attitudes, awareness and actions of those charged with governance and management
concerning the entity's internal control and its importance in the entity.

What should the auditor consider when obtaining understanding of the control
environment?

Communication
and enforcement  Essential elements which influence the effectiveness of the
of integrity and design, administration and monitoring of controls
ethical values

 Management's consideration of the competence levels for

Commitment to
particular jobs and how those levels translate into requisite skills and
competence
knowledge

 Independence from management

Participation by  Experience and stature

those charged  Extent of involvement and scrutiny of activities
with governance
 Appropriateness of actions and interaction with internal and
external auditors

 Approach to taking and managing business risks

Management's
 Attitudes and actions towards financial reporting
philosophy and
operating style  Attitudes towards information processing and accounting
functions and personnel

Organizational  The framework within which an entity's activities for achieving

structure its objectives are planned, executed, controlled and reviewed

Assignment of  How authority and responsibility for operating activities are

authority and assigned and how reporting relationships and authorization
responsibility hierarchies are established

Human resource
 Recruitment, orientation, training, evaluating, counselling,
policies and
promoting, compensation and remedial actions
practices

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ENTITY’S RISK ASSESSMENT PROCESS

The auditor shall obtain an understanding of whether the entity has a process for:
- Identifying business risks relevant to financial reporting objectives
- Estimating the significance of the risk
- Assessing the likelihood of their occurrence
- Deciding on actions to address those risk
If the entity has established such a process, the auditor shall obtain an understanding of it.
If there is not a process, the auditor shall discuss with management whether relevant
business risks have been identified and how they have been addressed.
ISA 315.15

INFORMATION SYSTEMS (IS)

The information system relevant to financial reporting is a component of internal control

that includes the financial reporting system, and consists of the procedures and records
established to initiate, record, process and report entity transactions (as well as events and
conditions) and to maintain accountability for the related assets, liabilities and equity.

CONTROL ACTIVITIES
Control activities are those policies and procedures in addition to the control environment
which are established to achieve the entity’s specific objectives.
Control activities include those activities designed to prevent or to detect and correct
errors.
Specific control activities can be summarized into the following 5 types:
- Authorization
- Performance review
- Information processing
- Physical controls
- Segregation of duties
Examples of specific control activities

Example Explanation Category

Approval and Transactions should be approved by an appropriate

control of person. For example, overtime should be approved by Authorization
documents departmental managers.

Controls over We shall look at computer controls later in this Information

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computerized chapter. processing

applications

Checking the
arithmetical For example, checking to see if individual invoices Information
accuracy of have been added up correctly. processing
records

Maintaining and Control accounts bring together transactions in

reviewing individual ledgers. Trial balances bring together
Performance
control accounts transactions for the organization as a whole.
review
and trial Preparing these can highlight unusual transactions or
balances accounts.

Reconciliations involve comparison of a specific

balance in the accounting records with what another
source says the balance should be; for example, a Information
Reconciliations
bank reconciliation. Differences between the two processing
figures should only be reconciling items (resulting
from e.g. timing differences).

Comparing the
results of cash,
For example, in a physical count of petty cash, the
security and Performance
balance shown in the cash book should be the same
inventory counts review
as the amount held.
with accounting
records

Comparing
internal data For example, comparing records of goods dispatched
Performance
with external to customers with customers' acknowledgement of
review
sources of goods that have been received.
information

Limiting Only authorized personnel should have access to

physical access certain assets (particularly valuable or portable ones), Physical
to assets and e.g. ensuring that the inventory stores locked are control
records unless store personnel are there.

Assigning different people the responsibility of Segregation

Segregation of
authorizing transactions, recording transactions and of
duties
maintaining custody of assets duties

MONITORING OF CONTROLS
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Monitoring of controls is a process to assess the effectiveness of internal control

performance over time. It includes assessing the design and operation of controls on a
timely basis and taking necessary corrective actions modified for changes in conditions.
If the entity has an internal audit function, the auditor shall obtain an understanding of
the nature of its responsibilities and how it fits in the organizational structure and the
activities performed / to be performed.

LIMITATIONS OF ACCOUNTING AND CONTROL SYSTEMS

Any internal control system can only provide the directors with reasonable assurance that
their objectives are reached, because of inherent limitations. These include:
(1) The costs of control not outweighing their benefits
(2) The potential for human error
(3) Collusion between employees
(4) The possibility of controls being bypassed or overridden by management
(5) Controls being designed to cope with routine and not non-routine transactions

These factors demonstrate why auditors cannot obtain all their evidence from tests of the
systems of internal control. The key factors in the limitations of control systems are
human error and potential for fraud. The safeguard of segregation of duties can help
deter fraud. However, if employees decide to perpetrate frauds by collusion, or
management commits fraud by overriding systems, the accounting system will not be able
to prevent such frauds.

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2. THE USE OF INTERNAL CONTROL SYSTEMS BY AUDITORS

WHY DO THE AUDITOR NEED TO UNDERSTAND INTERNAL CONTROL?

In obtaining an understanding of internal control, the auditor must understand the design
of the internal control and the implementation of that control.
There may be occasions where substantive procedures alone are not sufficient to address
the risks arising. Where such risks exist, auditors shall evaluate the design and determine
the implementation of the controls; that is, by controls testing. This is most likely to be
the case in a system which is highly computerized and which does not require much
manual intervention.

HOW DO WE DOCUMENT THE INTERNAL CONTROL?

NARRATVIE NOTES
The purpose of narrative notes is to describe and explain the system, at the same time as
making any comments or criticisms which will help to demonstrate an intelligent
understanding of the system.
What are advantages and disadvantages of narrative note?

Advantages Disadvantages

They are relatively simple to Describing something in narrative notes can be a lot
record and can facilitate more time consuming than, say, representing it as a
understanding by all audit team simple flowchart, particularly where the system
members. follows a logical flow.

They can be used for any system They are awkward to update if written manually.
due to the method's flexibility.

Editing in future years can be It can be difficult to identify missing internal controls
relatively easy if they are because notes record the detail of systems but may
computerized. not identify control exceptions clearly.

FLOW CHARTS
Flowcharts can take many forms, but in general are graphic illustrations of the physical
flow of information through the accounting system. Flowlines represent the sequences of
processes, and other symbols represent the inputs and outputs to a process.

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What are advantages and disadvantages of flowchart?

Advantages Disadvantages

After a little experience they can be They are most suitable for describing
prepared quickly. standard systems. Procedures for dealing
with unusual transactions will normally
have to be recorded using narrative notes.

As the information is presented in a Major amendment is difficult without

standard form, they are fairly easy to follow redrawing.
and review.

They generally ensure that the system is Time can sometimes be wasted by charting
recorded in its entirety, as all document areas that are of no audit significance.
flows have to be traced from beginning to
end. Any 'loose ends' will be apparent from
a cursory examination.

They eliminate the need for extensive

narrative and can be of considerable help in
highlighting the salient points of control and
any deficiencies in the system.

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QUESIONAIRE

What are advantages and disadvantages of questionnaires?

Advantages Disadvantages

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3. EVALUATION OF INTERNAL CONTROL COMPONENTS

WALK-THROUGH TEST
Definition
In order to confirm their understanding of the control systems, auditors will often carry out
walk-through tests.
How to carry out walk-through test
This is where they pick up a transaction and follow it through the system to see whether all
the controls they anticipate should be in existence were in operation with regard to that
transaction.

TEST OF CONTROL
Definition

Tests of control are tests performed to obtain audit evidence about the effectiveness of the:
- Design of the accounting and internal control systems, ie whether they are suitably
designed to prevent, or detect and correct, material misstatement at the assertion level;
and
- Operation of the internal controls throughout the period.

How to carry out test of control?

(a) Inspection of documents supporting controls or events to gain audit evidence that
internal controls have operated properly, e.g. verifying that a transaction has been
authorized
(b) Enquiries about internal controls which leave no audit trail, e.g. determining who
actually performs each function, not merely who is supposed to perform it
(c) Re-performance of control procedures, e.g. reconciliation of bank accounts, to
ensure they were correctly performed by the entity
(d) Examination of evidence of management views, e.g. minutes of management
meetings
(e) Observation of controls to consider the manner in which the control is being operated

Auditors should consider:

- How controls were applied
- The consistency with which they were applied during the period
- By whom they were applied

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4. CONTROL OBJECTIVES, CONTROL PROCEDURES AND TEST OF CONTROL

FOR MAIN CYCLE
1. The sale system
2. The purchase system
3. The payroll system
4. The cash system
5. The inventory system
6. Non-current assets systems

Risks
identified/ Controls Controls Test of
Assertion objective procedures control
related

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THE SALE SYSTEM

gui hang, nhan hoa don ghi nhan nhan tien

gui
ghi chep
hang toi
vao so ke
khach
toan
hang
tang ghi nhan vao so ke
sxuat gui hoa don, toan

hoa nhan tien ma chua

hang gui
don ghi ghi vao so or tien
chua co
nhan dang chuyen
hoa don
sai tai
or hoa
khoan
don bi gui
or
loi
khong
ghi

quy trinh kiem soat thu tuc kiem soat

Control objectives Controls procedures Tests of controls

 To ensure that  The tasks of taking  Observe the processing of
recorded sales orders, recording sales orders through the sales cycle
transactions and receiving payment and inspect sign-offs to
represent goods or are allocated to three evaluate whether proper
services provided. different staff members. segregation of duties is
dam bao giao dich operating.
ban hang duoc ghi
the hien da cung  Sales are only recorded  For a sample of sales
cap hh dv if there is an approved invoices, ensure there is a
sales order form and related sales order form that
shipping/despatch has been authorised and
documentation. shipping documentation.
 Accounting for  Examine application controls
numerical sequences of for authorisation.
invoices.  Inspect invoices to confirm
 Monthly customer whether they are sequentially
statements sent out and numbered.
customer queries and  Review entity's procedures
complaints handled for sending out monthly
independently. statements and dealing with

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customer queries and

complaints.

 To ensure that  Authorisation of credit  Review entity's procedures

goods and terms to customers for granting credit to
services are only (senior staff customers.
supplied to authorisation,  Examine a sample of sales
customers with references/credit checks orders for evidence of proper
good credit for new customers, credit approval by the
ratings. regular review of credit appropriate senior staff
limits). member.
 Authorisation by senior  Examine application controls
staff required for for credit limits.
changes in other  Review all new customer
customer data such as files to ensure satisfactory
address etc. credit references have been
 Orders not accepted obtained.
unless credit limits
reviewed first.
 To ensure that  Authorised price lists  Verify that price lists and
goods and and specified terms of terms of trade are properly
services are trade in place. documented, authorised and
provided at communicated.
authorised prices  Examine application controls
and on authorised for authorised prices and
terms. terms.
 To ensure that
customers are
encouraged to pay
promptly.
 To ensure that all  Accounting for  Review and test entity's
revenue relating to numerical sequences of procedures for accounting for
goods despatched invoices. numerical sequences of
is recorded. invoices, and inspect invoices
to confirm whether they are
sequentially numbered.
 To ensure that all  Shipping/despatch  For a sample of
goods and documentation is shipping/despatch
services sold are matched to sales documents, ensure each has
correctly invoiced. invoices. been matched to a related

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sales invoice that was

subsequently recorded.

  Sales invoices are  Review a sample of

reconciled to the daily reconciliations performed.
sales report. Reperform a sample of
 An open-order file is reconciliations.
maintained and reviewed  Inspect the open-order file for
regularly. unfilled orders.
 To ensure that all  Sales invoices and  Review supporting
sales and matching documents documents for a sample of
adjustments are required for all entries sales entries to ensure they
correctly and the date and contain the written details
journalised, reference of the entry are that indicate they were
summarised and written on each referred to when entered.
posted to the document.
correct accounts.
 To ensure that  All shipping  Compare dates on sales
transactions have documentation is invoices with dates of
been recorded in forwarded to the corresponding shipping
the correct period. invoicing section on a documentation.
daily basis.  Compare dates on sales
 Daily invoicing of goods invoices with dates recorded
shipped. in the sales ledger.
 To ensure that all  Chart of accounts  Inspect any documentary
transactions are (COA) in place and is evidence of review (such as
properly classified regularly reviewed for emails requesting update to
in accounts. appropriateness and COA as a result of review).
updated where  Test application controls for
necessary. proper codes.
 Codes in place for
different types of
products or services.

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PURCHASE SYSTEM

Control objectives Controls procedures Tests of controls

 To ensure that  Authorisation  Inspect policies and procedures
recorded procedures and policies and enquire about them.
purchases in place for ordering  Observe the processing of
represent goods and services. purchase orders throughout the
goods and purchasing cycle and evaluate
services whether proper segregation of
received. duties is operating.
 The responsibility for  Examine a sample of purchase
placing the orders, orders to ensure they have been
recording the purchase appropriately authorised.
order and making the  Review the delegated list of
payment is carried out authority for purchases.
by three different staff  For a sample of goods received
members. notes (GRNs), ensure there is a
 Purchase orders raised related purchase order that has
for each purchase and been properly approved.
authorised by
appropriate senior
personnel.
 Approved purchase

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order for each receipt of

goods.

  Staff receiving goods  Observe receipt of goods by

check them to the staff to confirm whether the
purchase order. check is done.
 Stores clerks sign for  Inspect a sample to confirm
goods received. whether stores staff undertake
 Purchase orders and this check.
GRNs are matched with  Examine supporting
the suppliers' invoices. documentation to ensure it has
 Supplier statements been matched for a sample of
independently reviewed invoices.
and reconciled to trade  Review procedures for
payable records. reconciling supplier statements
and re-perform a sample of
reconciliations.
 To ensure that  Purchase orders and  For a sample of purchase orders
all purchase GRNs are matched with in the year ensure each has been
transactions the suppliers' invoices. matched to a related invoice that
that occurred was subsequently recorded.
have been
recorded.  Periodic accounting for  Review entity's procedures for
pre-numbered GRNs accounting for pre- numbered
and purchase orders. documents and inspect a sample
 Independent check of of GRNs for sequential
amount recorded in the numbering.
purchase journal.  Examine application controls.
 Supplier statements  Examine documentation for
independently reviewed evidence of this check.
and reconciled to trade  Review procedures for
payable records. reconciling supplier statements
and reperform a sample of
reconciliations.
 To ensure that  Purchase orders and  Examine supporting
recorded GRNs are matched with documentation to ensure it has
purchases the suppliers' invoices. been matched for a sample of
represent the invoices.
liabilities of
the entity.
 To ensure that  Purchase orders and  Examine supporting
purchase GRNs are matched with documentation for a sample of

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transactions the suppliers' invoices. invoices.

are correctly  Mathematical accuracy  Review a sample of invoices for
recorded in the of the supplier's invoice evidence the accuracy has been
accounting is verified. verified (eg signature or initials)
system.  Amount posted to and re-perform the check.
general ledger is  Review reconciliations for
reconciled to the evidence of this check.
purchases ledger.  Review purchases journal and
 Chart of accounts in general ledger for
place. reasonableness.
 To ensure that  All goods received  Compare dates on reports to
purchase reports forwarded to dates on relevant vouchers.
transactions accounts payable  Compare dates on vouchers with
are recorded in department daily. dates they were recorded in the
the correct  Procedures in place that purchases journal.
accounting require recording of
period. purchases as soon as
possible after
goods/services received.

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INVENTORY SYSTEM

Inventory controls are designed to ensure safe custody. Such controls include restriction
of access, documentation and authorisation of movements, regular independent inventory
counting and review of inventory.

Assertion Control objectives Controls procedures Tests of controls

Occurrence  To ensure that all  Pre-numbered  Review documentation
and existence inventory documentation in use.
movements are such as GDNs and  Review a sample of
authorised and GRNs in use. reconciliations to
recorded.  Reconciliations of confirm they are
inventory records performed and then
with general reviewed by an
ledger. independent person.
 Separate  Observe the recording
responsibilities for of inventory and
maintenance of discuss inventory
records and procedures with
custodianship. relevant staff to ensure
that proper segregation
of duties is operating.
 To ensure that  Physical  Review security
inventory safeguards in place systems in place (eg
included on the to ensure inventory locked warehouses,
statement of is not stolen. CCTV).
financial position  Separate  Review policies and
physically exists. responsibilities for procedures in place;
maintenance of discuss procedures with
records and relevant staff.
custodianship.  Review procedures for
 Inventory counted counting inventory.
regularly.  Attend inventory count.

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Completeness  To ensure that all  Procedures in place  Review entity's

purchases and to include procedures relating to
sales of inventory held at consignment inventory.
inventory have third parties and  Review reconciliations
been recorded in exclude inventory performed and inspect
the accounting held on them for evidence of
system. consignment for review. Re-perform a
third parties. sample of
 Reconciliations of reconciliations.
accounting records
with physical
inventory.
Rights and  To ensure that  Procedures in place  Review entity's
obligations inventory to include procedures relating to
records only inventory held at consignment inventory.
include items third parties and
that belong to the exclude inventory
entity. held on
consignment for
third parties.
Accuracy,  To ensure that  Periodic or annual  Review and test entity's
valuation and inventory comparison of procedures for taking
allocation and quantities have inventory with physical inventory.
classification been accurately amounts shown in
determined. continuous
(perpetual)
inventory records.
 To ensure that  Standard costs  Review and test entity's
inventory is reviewed by procedures for
properly stated at management. developing standard
the lower of cost  Review of cost costs.
and net accumulation and  Inspect variance reports
realizable value. variance reports. produced.
 Inventory  Discuss with inventory
managers review managers how this is
inventory regularly done.
to identify slow-  Observe the procedure
moving, obsolete being performed.
and excess
inventory.

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Cut-off  To ensure that all  All despatch  Inspect documentation

purchases and documents to confirm daily
sales of processed daily to processing.
inventory are record the despatch  Inspect documentation
recorded in the of finished goods. to confirm daily
correct  All goods inward processing.
accounting reports processed  Review reconciliations
period. daily to record the performed.
receipt of
inventory.
 Reconciliations of
inventory records
with general
ledger.
Presentation  To ensure that  Orders for  Review entity's
inventory materials and procedures and
transactions and production data documentation used to
balances are forms used to classify inventory.
properly process goods
identified and through
classified in the manufacturing.
financial
statements.
 To ensure that  Approval by  Review entity's
disclosures Finance Director. working papers for
relating to evidence of review.
classification and
valuation are
sufficient.

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CASH SYSTEM
Cash payments

Assertion Control objectives Controls procedures Tests of controls

Occurrence  To ensure that  Separate  Observe the processing of

only valid cash responsibilities for cash and review the
payments are the recording, entity's policies to
made. payment and evaluate whether proper
reconciliation of segregation of duties is
cash. operating.
 Supplier statements  Review procedures for
independently reconciling supplier
reviewed and statements.
reconciled to trade  Review reconciliations to
payable records. confirm whether
 Monthly bank undertaken and reviewed.
reconciliations  Review delegated list of
prepared and authority for cash
reviewed. payments.
 Only authorised  Inspect relevant
staff can make documentation for
electronic cash evidence of approval by
payments and issue senior personnel.
cheques.
 Electronic cash
payments and
cheques prepared
only after all source
documents
 Have been
independently
approved.

Completeness  To ensure that all  Separate  Observe the processing of

cash payments responsibilities for cash and review the
that occurred are the recording, entity's policies to
recorded. handling and evaluate whether proper
reconciliation of segregation of duties is
cash. operating.

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Completeness   Supplier statements  Review procedures for

independently reconciling supplier
reviewed and statements.
reconciled to trade  Review reconciliations to
payable records. confirm whether
 Monthly bank undertaken and
reconciliations independently reviewed.
prepared and  Inspect sample of listings
reviewed. for evidence of senior
 Review of cash review.
payments by  Review a sample of
manager before reconciliations for
release. evidence that they have
 Daily cash been done.
payments reconciled  Examine evidence of use
to posting to of pre- numbered cheques.
payable accounts.
 Use of pre-
numbered cheques.

Accuracy,  To ensure that  Reconciliation of  Review reconciliation, to

valuation and cash payments daily payments ensure performed,
allocation are recorded report to electronic reviewed and any
and correctly in the cash payment discrepancies followed up
classification ledger. transfers and on a timely basis.
cheques issued.  Review reconciliations for
 Supplier statements a sample of accounts.
reconciled to  Review bank
payable accounts reconciliation for evidence
regularly. it was done and
 Monthly bank independently reviewed.
reconciliations of Reperform a sample of
bank statements to bank reconciliations.
ledger account.
 To ensure that  Supplier statements  Review reconciliations for
cash payments reconciled to a sample of accounts.
are posted to the payable accounts  Review postings from
correct payable regularly. journal to general ledger.
accounts and to  Agreement of
the general monthly cash
ledger. payments journal to
general ledger
posting.

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 Payable accounts  Review reconciliation, to

reconciled to ensure performed,
general ledger reviewed and any
control account. discrepancies followed up
on a timely basis.

Cut-off  To ensure that  Reconciliation of  Review reconciliation and

cash payments electronic funds check it is carried out
are recorded in transfers and regularly.
the correct cheques issued with
accounting postings to cash
period. payments journal
and payable
accounts.

Presentation  To ensure that  Chart of accounts.  Review cash payments

cash payments  Independent journal to assess
are charged to the approval and review reasonableness of
correct accounts. of general ledger charging of accounts.
account assignment.  Review assignment of
general ledger account.

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Cash receipts

Assertion Control objectives Controls procedures Tests of controls

Occurrence  To ensure that all  Separate  Observe the processing of

valid cash responsibilities for cash and review the
receipts are the recording, receipt entity's policies to
received and and reconciliation of evaluate whether proper
deposited. cash. segregation of duties is
 Use of electronic operating.
cash receipts transfer  Examine application
not received or controls for electronic
deposited. cash receipts transfer.
 Monthly bank  Review monthly bank
reconciliations reconciliations to confirm
performed and performed and reviewed.
independently  Observe cash sales
reviewed. procedures.
 Use of cash registers
or point-of-sale
devices.

Occurrence   Periodic inspections  Enquire of managers

of cash sales about results of
procedures. inspections.
 Restrictive  Observe mail opening,
endorsement of including endorsement of
cheques immediately cheques.
on receipt.  Observe mail opening
 Mail opened by two procedures.
staff members.  Observe preparation of
 Immediate cash receipts' records.
preparation of cash  Review documentation
book or list of mail for evidence of
receipts. independent check.
 Independent check of  Review documentation
agreement of for evidence of
cash/cheques to be independent check.
deposited at bank
with register totals
and receipts listing.
 Independent check of
agreement of bank
deposit slip with

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daily cash summary.

Completeness  To ensure that all  Separate  Observe the processing of

cash receipts are responsibilities for cash and review the
recorded. the recording, receipt entity's policies to
and reconciliation of evaluate whether proper
cash. segregation of duties is
 Use of electronic operating.
cash receipts transfer  Examine application
not received or controls for electronic
deposited. cash receipts transfer.
 Monthly bank  Review monthly bank
reconciliations reconciliations to confirm
performed and performed and reviewed.
independently  Re- perform a sample of
reviewed. the reconciliations.
 Daily cash receipts  Review reconciliation.
listing reconciled
with posting to
customer accounts.

Completeness   Customer statements  Enquire of management

prepared and sent out about handling of
on a regular basis. customer statements.
 Examine a sample of
customers and note
frequency of statements.

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Accuracy,  To ensure that  Daily remittance  Review reconciliations.

valuation and cash receipts are report reconciled to  Review reconciliations
allocation recorded at control listing of for evidence they were
and correct amounts. remittance advices. performed and
classification  Monthly bank independently reviewed.
statement performed
and reviewed
independently.
 To ensure that  Daily remittance  Review reconciliations.
cash receipts are report reconciled  Review entity's
posted to correct daily with postings procedures for sending
receivables to cash receipts out statements.
accounts and to journal and customer  Review journal and
the general accounts. posting to general ledger.
ledger.  Monthly customer  Review reconciliations.
statements sent out.
 Monthly cash
receipts journal
agreed to general
ledger posting.
 Receivables' ledger
reconciled to control
account.

Cut-off  To ensure that  Bank reconciliation  Review and test

cash receipts are at period end. reconciliation.
recorded in the
correct
accounting
period.

Presentation  To ensure that  Chart of accounts  Inspect any documentary

cash receipts are (COA) in place and evidence of review (such
charged to the is regularly reviewed as emails requesting
correct accounts. for appropriateness update to COA as a result
and updated where of review).
necessary.  Test application controls
 Codes in place for for proper codes.
different types of
receipt.

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PAYROLL SYSTEM

Assertion Control objectives Controls procedures Tests of controls

Occurrence  To ensure that  Segregation of duties  Review payroll and HR

and existence payment is between HR and job descriptions and
made only to payroll functions. company policies on
bona fide  Personnel files held payroll process, to
employees of for all employees. evaluate whether proper
the entity.  Authorisation segregation of duties is in
procedures for place.
hiring, terminating,  Review a sample of
time worked, wage starters and leavers in the
rates, overtime, year to ensure correct
benefits etc. documentation is in place.
 Any changes in  Review and test
employment status of authorisation procedures
employees (eg in place.
maternity, special  Review policies and
leave) informed to procedures in place for
HR department. changing status and
 Use of time clocks to consider whether
record time worked. adequate.
 Clock cards  Review personnel files for

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Lecture note

approved by a sample of employees

supervisor. whose status changed in
the year.
 Observe employees' use
of time clocks.
 Inspect a sample of clock
cards for evidence of
approval by appropriate
level of management.
Occurrence   Employee numbers  Review and test
and existence assigned to each procedures for entering
employee in the and removing employee
payroll master file. numbers from the payroll
Only employees with master file.
valid employee  Review budgeting
numbers are paid. procedures.
 Payroll budgets in
place and reviewed
by management.
Completeness  To ensure that  Pre-numbered clock  Review numerical
all payroll costs cards in use. sequence of clock cards.
are recorded for  Regular  Review a sample of
work done by reconciliations reconciliations to ensure
employees. carried out of payroll they are properly carried
records and out. Reperform a sample
employee costs of reconciliations.
recorded in the  Enquire whether
general ledger. comparisons are being
 Comparison of made between payment
cheques and bank records and payroll and
transfer list with inspect any documentary
payroll to ensure all evidence of the review.
employees paid have  Examine paid cheques or
been recorded via a certified copy of the
payroll. bank list for employees
 Preparation and paid by cheque or bank
authorization of transfer to ensure proper
cheques and bank authorization.
transfer lists.

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Accuracy,  To ensure that  Re-performance of a  Review documentary

valuation and all benefits and sample of payroll evidence that
allocation and deductions (tax, benefit and deduction recalculation occurred
classification pension etc.) calculations. (e.g. spreadsheet
are computed  Payroll budgets in printout).
correctly. place and reviewed  Review budgeting
by management. procedures.
 Agreement of gross  Inspect documentation for
earnings and total tax evidence of management's
deducted with review.
taxation returns.
 To ensure that  Changes to master  Review reconciliation
payroll payroll file verified 'before and after' reports
transactions are through 'before and to payroll master file.
correctly after' reports.  Review reconciliation
recorded in the  Payroll master file payroll master file to
accounting reconciled to general general ledger. Confirm
system. ledger. whether discrepancies are
followed up promptly and
resolved.
Cut-off  To ensure that  All starters, leavers,  Review entity's
payroll changes to salaries procedures for reporting
transactions are and deductions are changes to the payroll
recorded in the reported promptly to department.
correct payroll department  Verify sample of starters
accounting and changes are and leavers.
period. updated in the
payroll master file
promptly.
Presentation  To ensure that  Chart of accounts.  Review chart of accounts.
payroll  Independent  Review procedures for
transactions are approval and review classifying payroll costs.
properly of accounts charged  Review budgeting
classified in the to payroll. procedures.
financial  Payroll budgets in
statements. place and reviewed
by management.

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Lecture note

CAPITAL EXPENDITURE (FIXED ASSETS)

Assertion Control objectives Controls procedures Tests of control

Authorization  To ensure that  Orders for capital items  Review policies and
expenditure is should be authorized by procedures in place.
properly appropriate levels of
authorized. management.
 Orders should be  Examine a sample of
requisitioned on orders for appropriate
appropriate (different to authorisation.
revenue) documentation.
 Invoices should be  Inspect invoices to
approved by the person verify the invoice has
who authorised the been appropriately
order. approved.
 Invoices should be  Inspect invoices to
marked with the verify the invoice has
appropriate general the correct general
ledger code. ledger code marked
on it.

Classification  To ensure that  All the standard controls 

expenditure is over purchases are
classified relevant here
correctly in the
financial
statements as
capital or
revenue
expenditure.

Completeness  To ensure that  Capital items should be  Review reconciliation

all non-current written up in the non- to ensure it is
assets are current asset register. regularly carried out,
correctly  The non-current asset reviewed by a more
recorded in the register should be senior person, and
accounting reconciled regularly to that all discrepancies
system. the general ledger and are followed up and
any differences resolved on a timely
investigated and basis.
resolved promptly.

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SECTION 6: AUDIT SUBSTANTIVE PROCEDURES

1. AUDIT PROCEDURES

Recall
Audit procedures comprise of:
- Test of control
- Substantive procedures, in which:
+ Substantive analytical procedures
+ Tests of detail (of transaction, account balance and disclosures)

SUBSTANTIVE ANALYTICAL PROCEDURES

What are AP?

‘Analytical procedures’ actually means the evaluation of financial and other information,
and the review of plausible relationships in that information. The review also includes
identifying fluctuations and relationships that do not appear consistent with other relevant
information or results.

Different types of AP?

Analytical procedures can be used as:

- Comparison of comparable information to prior periods to identify unusual changes or
fluctuations in amounts.
- Comparison of actual or anticipated results of the entity with budgets and/or forecasts,
or the expectations of the auditor in order to determine the potential accuracy of those
results.
- Comparison to industry information either for the industry as a whole or by
comparison to entities of similar size to the client to determine whether receivable
days, for example, are reasonable.

Where do we use AP in the audit?

AP can be used in 3 different stages/ways

Risk assessment procedures

Analytical procedures are used at the beginning of the audit to help the auditor obtain an
understanding of the entity and assess the risk of material misstatement. Audit procedures
can then be directed to these ‘risky’ areas.
Analytical procedures as substantive procedures

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Analytical procedures can be used as substantive procedures in determining the risk of

material misstatement at the assertion level during work on the income statement and
statement of financial position (balance sheet).
Analytical procedures in the overall review at the end of the audit
Analytical procedures help the auditor at the end of the audit in forming an overall
conclusion as to whether the financial statements as a whole are consistent with the
auditor’s understanding of the entity.

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TYPICAL SUBSTANTIVE PROCEDURES FOR ASSERTIONS

Audit assertion Substantive procedures

Completeness (a) Review of post year end items

(b) Cut-off testing
(c) Analytical review
(d) Confirmations
(e) Reconciliations to control accounts

Rights and obligations (a) Reviewing invoices for proof that item belongs to the company
(b) Confirmations with third parties

Valuation and (a) Matching amounts to invoices

allocation (b) Recalculation
(c) Confirming accounting policy is consistent and reasonable
(d) Review of post year end payments and invoices
(e) Expert valuation

Existence (a) Physical verification

(b) Third-party confirmations
(c) Cut-off testing

Occurrence (a) Inspection of supporting documentation

(b) Confirmation from directors that transactions relate to business
(c) Inspection of items purchased

Accuracy (a) Recalculation of correct amounts

(b) Third-party confirmation
(c) Analytical review

Classification and (a) Confirming compliance with law and accounting standards
understandability (b) Reviewing notes for understandability

Cut-off (a) Cut-off testing

(b) Analytical review

2. SALES AND RECEIVABLES

What are main documents used in auditing receivable and sale?

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RECEIVABLES
What are key ASSERTIONS relating to the audit of RECEIVABLES?

Existence: Recorded receivables exist

Completeness: All receivables that should have been recorded have been recorded
Valuation: Receivables are included in the accounts at the correct amounts
Rights and obligations: the entity controls the rights to receivables and related accounts

What are substantive procedures to confirm EXISTENCE OF RECEIVABLES?

1. Perform a receivables circularisation on a sample of year-end trade receivables

(Confirmation: Send and follow up )
2. Perform alternative procedures:
- Review after-date cash receipts by inspecting bank statements and cash receipts
documentation.
- Examine the customer's account and customer correspondence to assess whether
the balance outstanding represents specific invoices and confirm their validity.
- Examine the underlying documentation (purchase order, dispatch documentation,
duplicate sales invoice etc).
- Enquire from management explanations for invoices remaining unpaid after
subsequent ones have been paid.
- Observe whether the balance on the account is growing and, if so, find out why by
discussing with management.

Confirmation of receivables
 Objectives of confirmation

ISA 505 External confirmations

External confirmations are audit evidence obtained as a direct written response to the
auditor from a third party in paper form or by electronic or other medium.
The verification of trade receivables by direct confirmation is the normal means of
providing audit evidence to satisfy the objective of testing whether customers exist and
owe bona fide amounts to the company (existence and rights and obligations)

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 Positive vs. negative confirmation

When confirmation is undertaken, the method of requesting information from the customer
may be either positive or negative

Positive The customer is requested to confirm the accuracy of the balance shown or
state in what respect they are in disagreement.
It is preferable as it is designed to encourage definite replies from those
customer.

Negative The customer is requested to reply only if the amount stated is disputed.

 When the auditor use negative confirmation letter?

The negative method provides less persuasive audit evidence and shall not be used as the
sole substantive procedure to audit receivables unless all of the following are present:
(a) The risk of material misstatement has been assessed as low.
(b) The auditor has obtained sufficient appropriate audit evidence on the operating
effectiveness of relevant controls.
(c) The population consists of a large number of small, homogeneous account balances.
(d) A very low exception rate is expected.
(e) The auditor is not aware of circumstances or conditions that would cause customers to
disregard the requests.

 Steps for confirmation:

 Statements prepared by the client

 Confirmation letter on the client’s paper and signed by the client
 Sent out physically by auditor
 Replied directly to auditors’ own office in a pre-paid envelope

Auditors remained in control through these steps in sending out confirmation.

 Sample of confirmation letter

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 Sample selection – which debtor to select for sending confirmation?

When constructing the sample, the following classes of account should receive special
attention:
- Large debtors amount
- Old, unpaid accounts
- Accounts with credit balances
- Accounts settled by round sum payments.

 Follow-up procedures
What should auditor do after sending confirmation?

 An exception is a response that shows a difference between the information

requested to be confirmed, or contained in the entity’s records, and information
provided by the confirming party.
A non-responses is a failure of the confirming party to respond, or fully respond, to

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a positive confirmation request, or a confirmation request returned undelivered.

 Exception
For disagreement with the balance stated (both positive and negative confirmation)
where specific amounts should have identified
(a) There is a dispute between the client and the customer. The reasons for the dispute
would have to be identified, and provision made if appropriate against the debt.
(b) Cut-off problems exist, because the client records the following year’s sales in the
current year or because goods returned by the customer in the current year are not
recorded in the current year. Cut-off testing may have to be extended.
(c) The customer may have sent the monies before the year-end, but the monies were
not recorded by the client as receipts until after the year-end. Detailed cut-off work
may be required on receipts.
(d) Monies received may have been posted to the wrong account or a cash-in-transit
account. Auditors should check if there is evidence of other mis-posting. If the
monies have been posted to a cash-in-transit account, auditors should ensure this
account has been cleared promptly.
 Non-response
The auditor shall perform alternative audit procedures to obtain relevant and
reliable audit evidence. These could include reviewing subsequent cash receipts,
shipping documentation and sales near the period-end.

What are audit procedures to confirm VALUATION OF RECEIVABLE?

 Substantive analytical procedures:

1. Compare receivables turnover and receivables days with the previous year and/or with
industry data.
2. Compare the aged analysis of receivables from the aged trial balance with the
previous year.
3. Review the adequacy of the allowance for uncollectable accounts through discussion
with management.
4. Compare the irrecoverable debt expense as a % of sales with the previous year and/or
with industry data.
5. Compare the allowance for irrecoverable debts as a % of receivables or credit sales
with the previous year and/or with industry data.

 Test of detailed

1. Confirm adequacy of allowance by reviewing correspondence with customers and

solicitors.
2. Examine credit notes issued after year-end for allowances that should be made against
current period balances.

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3. Examine large customer accounts individually and compare with the previous year's
balances.
4. For a sample of old debts on the aged trial balance, obtain further information
regarding their recoverability by discussions with management and review of
customer correspondence.

What are audit procedures to confirm COMPLETENESS OF RECEIVABLE?

 Test of detailed

1. Agree the balance from the individual sales ledger accounts to the aged
receivables' listing and vice versa.
2. Match the total of the aged receivables' listing to the sales ledger control
account.
3. Cast and cross-cast the aged trial balance before selecting any samples to test.
4. Trace a sample of shipping documentation to sales invoices and into the sales
and receivables ledger.

What are audit procedures to confirm RIGHT AND OBLIGATION OF

RECEIVABLE?
 Test of detailed

1. Review bank confirmation for any liens on receivables.

2. Make enquiries of management, review loan agreements and review board minutes
for any evidence of receivables being sold (eg to factors).

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SALES
What are key ASSERTIONS relating to the audit of SALES?

Occurrence: All sales transactions recorded have occurred and relate to the entity
Completeness: All sales transactions that should have been recorded have been recorded
Accuracy: Amounts relating to transactions have been recorded appropriately
Cut-off: All transactions have been recorded in the correct period
Classification: All transactions are recorded properly

What are audit procedures to audit SALE?

 Occurrence

- For a sample of sales transactions recorded in the ledger, vouch the sales invoice back
to customer orders and despatch documentation.

 Completeness

- Compare the gross profit percentage by product line with the previous year and
industry data.
- Trace a sample of shipping documentation to sales invoices and into the sales ledger.

 Accuracy

- For a sample of sales invoices, compare the prices and terms to the authorised price list
and terms of trade documentation.
- Test whether discounts have been properly applied by recalculating them for a sample
of invoices.
- Test the correct calculation of tax on a sample of invoices.

 Cut-off

- Perform analytical procedures on sales returns, comparing the ratio of sales returns to
sales.
- For a sample of sales invoices around the year end, inspect the dates and compare with
the dates of despatch and the dates recorded in the ledger for application of correct cut-
off.
- For sales returns, select a sample of returns documentation around the year end and
trace to the related credit entries.

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- Review material after-date invoices, credit notes and adjustments and ensure that they
are recorded correctly in the relevant financial period.

 Classification

- Take a sample of sales invoices and examine for proper classification into revenue
accounts.

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3. INVENTORY
What are the key ASSERTIONS relating to INVENTORY?

Existence: Inventory on the statement of financial position physically exists.

Completeness: All inventory at year end is included on the statement of financial
position.
Rights and obligations: The entity has rights to inventory recorded in the period and at
the year-end.
Valuation: Costs are accurately determined in accordance with accounting standards;
inventory is recorded at year end at the lower of cost and net realizable value (NRV).
Cut-off: All purchases and sales of inventories are recorded in the correct period.
Presentation and disclosure: Inventory is properly classified in the accounts. ;
Disclosures relating to classification and valuation are adequate and in accordance with
accounting standards.

What is the main accounting requirements related to inventory?

Cost is defined by IAS 2 as comprising all costs of purchase and other costs incurred in
bringing inventory to its present location and condition.
Net realisable value is the estimated selling price in the ordinary course of business, less
the estimated costs of completion and the estimated costs necessary to make the sale.

We need to value inventory at the lower of cost or NRV. So if the NRV is less than cost,
we will have to adjust the inventory from cost to write it down to NRV (lower figure), and
the difference we charge to P&L as a loss.

What are audit procedures for inventory?

 Completeness

- Complete the disclosure checklist to ensure that all the disclosures relevant to
inventory have been made.
- Trace test counts to the detailed inventory listing.
- Where inventory is held in third-party locations, physically inspect this inventory
or review confirmations received from the third party and match to the general
ledger.
- Compare the gross profit percentage to the previous year or industry data.


 Existence

- Observe the physical inventory count (see more in section “attendance at the
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inventory count”)

 Rights and obligations

- Verify that any inventory held for third parties is not included in the year-end
inventory figure by being appropriately segregated during the inventory count.
- For any 'bill and hold' inventory (ie where the inventory has been sold but is being
held by the entity until the customer requires it), identify such inventory and ensure
that it is segregated during the inventory count so that it is not included in the year-
end inventory figure.
- Confirm that any inventory held at third-party locations is included in the yearend
inventory figure by reviewing the inventory listing.

 Valuation and Allocation

- Obtain a copy of the inventory listing and agree the totals to the general ledger.
- Cast the inventory listing to ensure it is mathematically correct.
- Vouch a sample of inventory items to suppliers' invoices to ensure it is correctly
valued.
- Manufactured goods (RM + DL + OH)
- For materials, agree the valuation of raw materials to invoices and price lists.
- For labour costs, agree costs to wage records.
- Compare the actual manufacturing overhead costs with budgeted or standard
manufacturing overhead costs
- Testing for NRV
- Make enquiries of management to ascertain any slow-moving or obsolete inventory
that should be written down.
- Examine prices at which finished goods have been sold after the year end to
ascertain whether any finished goods need to be written down.
- If significant levels of finished goods remain unsold for an unusual period of time,
discuss with management and consider the need to make allowance.
- Compare the gross profit % to the previous year or industry data.
- Compare inventory days to the previous year and industry average

 Cut-off

- Note the numbers of the last GDNs and GRNs before the year end and the first
GDNs and GRNs after the year end and check that these have been included in the
correct financial year.

What are the most important audit procedures related to inventory?

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THE PHYSICAL INVENTORY COUNT (STOCKTAKE)

Why do the auditor need to attend stocktake?
The objective of the auditor is to obtain sufficient appropriate audit evidence regarding the
existence and condition of inventory.

ISA 501.4:
“If inventory is material to the financial statement, the auditor shall obtain sufficient
appropriate audit evidence regarding the existence and condition of inventory by:
(a) Attendance at physical inventory counting, unless impracticable, to:
i. Evaluate management's instructions and procedures for recording and controlling the
result of the entity’s physical inventory counting;
ii. Observe the performance of management’s count procedures
iii. Inspect the inventory; and
iv. Perform test counts; and
(b) perform audit procedures over the entity's final inventory records to determine whether
they accurately reflect actual inventory count results”

The inventory count (2 difference system)

A business may count inventory by one or a combination of the following methods:

Physical inventory From the viewpoint of the auditor, this is often the best method.
counts at the year end

Continuous (or The management has a program of inventory counting

perpetual) inventory throughout the year

AUDIT PROCEDURES FOR CONTINUOUS INVENTORY COUNT:

 Attend one of the inventory counts (to observe and confirm that instructions are being
adhered to).
 Follow up the inventory counts attended to compare quantities counted by the
auditors with the inventory records, obtaining and verifying explanations for any
differences, and checking that the client has reconciled count records with book
inventory records.

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 Review the year's inventory counts to confirm the extent of counting, the treatment
of discrepancies and the overall accuracy of records (if matters are not satisfactory,
auditors will only be able to gain sufficient assurance by a full count at the year-end).
 Assuming a full count is not necessary at the year end, compare the listing of
inventory with the detailed inventory records, and carry out other procedures (cut-
off, analytical review) to gain further comfort.
 The audit work when continuous inventory counting is used focuses on tests of
controls rather than substantive audit work. Nevertheless, the auditor will also need to
do some further substantive audit work on completeness and existence at the year end.

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AUDIT PROCEDURES FOR YEAR END INVENTORY COUNT:

For year-end physical stock take, we will divide the exercise into 3 difference stages:
 Step 1: Planning attendance at inventory count (BEFORE THE COUNT)

Before the physical inventory count, the auditors should ensure audit coverage of the
count is appropriate, and that the client’s count instructions have been reviewed

Procedures

- Planning inventory count

- Get the client to send over their stock take instruction and review the instruction

Planning inventory count

Gain - Review previous year's arrangements

knowledge - Discuss with management the inventory count arrangements and
significant changes

Assess key - The nature and volume of the inventory

factors - Risks relating to inventory
- Identification of high value items
- Method of accounting for inventory
- Location of inventory and how it affects inventory control and
recording
- Internal control and accounting systems to identify potential areas of
difficulty

Plan - Ensure a representative selection of locations, inventory and

procedures procedures are covered
- Ensure sufficient attention is given to high value items
- Arrange to obtain from any third parties confirmation of inventory
they hold
- Consider the need for expert help

Get the client to send over their stock take instruction (or inventory count
instructions) and we need to review the instruction to ensure:

Organisation - Supervision by senior staff including senior staff not normally

of count involved with inventory
- Tidying and marking inventory to help counting
- Restriction and control of the production process and inventory
movements during the count
- Identification of damaged, obsolete, slow-moving, third-party and

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returnable inventory

Counting - Systematic counting to ensure all inventory is counted

- Teams of two counters, with one counting and the other checking or
two independent counts

Recording - Serial numbering, control and return of all inventory sheets

- Inventory sheets being completed in ink and signed
- Information to be recorded on the count records (location and
identity, count units, quantity counted, conditions of items, stage
reached in production process)
- Recording of quantity, conditions and stage of production of work-
in-progress
- Recording of last numbers of goods inwards and outwards records
and of internal transfer records
- Reconciliation with inventory records and investigation and
correction of any differences

 Step 2: Attendance at inventory count (DURING THE COUNT)

Attendance at an inventory count gives evidence of the existence and apparent

ownership of inventory. It also gives evidence of the completeness of inventory, as do
the follow-up tests to ensure all inventory sheets were included in the final count.

Procedures:

- Observe whether the client's staffs are following instructions, as this will help to
ensure the count is complete and accurate.
- Perform test counts to ensure procedures and internal controls are working
properly, and to gain evidence over existence and completeness of inventory.
- Ensure that the procedures for identifying damaged, obsolete and slow-moving
inventory operate properly; the auditors should obtain information about the
inventory's condition, age, usage and, in the case of work-in-progress, its stage of
completion to ensure that it is later valued appropriately.
- Confirm that inventory held on behalf of third parties is separately identified and
accounted for so that inventory is not overstated.
- Conclude whether the count has been properly carried out and is sufficiently
reliable as a basis for determining the existence of inventories.
- Consider whether any amendment is necessary to subsequent audit procedures.
- Gain an overall impression of the levels and values of inventories held so that the
auditors may, in due course, judge whether the figure for inventory appearing in the
financial statements is reasonable.

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 When carrying out test counts the auditors should select items from the count records
and from the physical inventory and check one to the other, to confirm the accuracy of
the count records.
 The auditors should concentrate on high value inventory. If the results of the test
counts are not satisfactory, the auditors may request that inventory be recounted.
 After the inventory count (AFTER)

After the count, the auditor should check that final inventory sheets have been properly
compiled from count records and that book inventory has been appropriately adjusted.
After the count, the matters recorded in the auditors' working papers at the time of the
count or measurement should be followed up.

Procedures:

- Trace items that were test counted to final inventory sheets.

- Observe whether all count records have been included in final inventory sheets.
- Inspect final inventory sheets to ensure they are supported by count records.
- Ensure that continuous inventory records have been adjusted to the amounts
physically counted or measured, and that differences have been investigated.
- Confirm cut-off by using details of the last serial number of goods inward and
outward notes and details of movements during the count.
- Review replies from third parties about inventory held by or for them.
- Confirm the client's final valuation of inventory has been calculated correctly.

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What are audit procedures to audit INVENTORY HELD BY THIRD PARTIES or

in public warehouse (SPECIAL CASE)

ISA 501.8
“If inventory under the custody and control of a third party is material to the financial
statements, the auditor shall obtain sufficient appropriate audit evidence regarding the
existence and condition of that inventory by performing one or both of the following:
(a) Request confirmation from the third party as to the quantities and condition of
inventory held on behalf of the entity.
(b) Perform inspection or other audit procedures appropriate in the circumstances.”

Other procedures:

- Attending, or arranging for another auditor to attend, the third party's inventory count
- Obtaining another auditor's report on the adequacy of the third party's internal control
for ensuring that inventory is properly counted and adequately safeguarded
- Inspecting documentation in respect of third-party inventory (eg warehouse receipts)
- Requesting confirmation from other parties when inventory has been pledged as
collateral

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VALUATION (Importance assertion to audit)

Auditors must ensure that the company is applying the method consistently and that
each year the method used gives a fair approximation to cost.
Additional audit procedures:
- Reviewing price changes near the year end
- Ageing the inventory held
- Checking gross profit margins to reliable management accounts
Checking NRV
Auditor should compare cost and net realisable value for each item of inventory. Where
this is impracticable, the comparison may be done by group or category.
NRV is likely to be less than cost when there has been:
- An increase in costs or a fall in selling price
- Physical deterioration
- Obsolescence of products
- A marketing decision to manufacture and sell products at a loss
- Errors in production or purchasing

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4. LIABILITIES AND CAPTIAL

4.1. Trade payables, other payables and Accruals
What are key ASSERTIONS relating to the audit of Trade payables, other payables
and Accruals?

Existence: Trade payables and accrued expenses are valid liabilities.

Rights and obligations: Trade payables and accrued expenses are the obligations of the
entity
Completeness: All liabilities have been recorded
Valuation and allocation: All liabilities are included in the accounts at appropriate
amounts

What are audit procedures to audit Trade payables, other payables and Accruals?

Auditor should be aware of the possibility of understatement of liabilities to improve

liquidity and profits.
The objective will be to ascertain whether liabilities existing at the year-end balance have
been completely and accurately recorded

 Completeness

Payables (Creditors)
- Obtain a listing of trade accounts payables and agree the total to the general ledger by
casting and cross-casting.
- Test for unrecorded liabilities by enquiries of management on how unrecorded
liabilities and accruals are identified and examining post year end transactions
- Obtain selected suppliers' statements and reconcile these to the relevant suppliers'
accounts.
- Perform a confirmation of accounts payables choosing the low or zero balance
suppliers
- Compare the current year balances for trade accounts payables and accruals with the
previous year
- Compare the payables turnover and payables days to the previous year and industry
data.
- complete the disclosure checklist to ensure that all the disclosures relevant to liabilities
have been made

 Accuracy

- Recalculate the mathematical accuracy of a sample of suppliers' invoices to confirm

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the amounts are correct.

- Recast calculation of remuneration.
- Re-perform calculation of statutory deductions to confirm whether correct.
- Confirm validity of other deductions by agreeing to supporting documentation.
- Recast calculation of other deductions.

 Other assertions related to Trade payables, other payables and Accruals

Existence:

- Vouch selected amounts from the trade accounts payables listing and accruals listing to
supporting documentation, such as purchase orders and suppliers' invoices.
- Obtain selected suppliers' statements and reconcile these to the relevant suppliers'
accounts.
- Perform a confirmation of accounts payables for a sample.
- Perform analytical procedures comparing current year balances with the previous year
to confirm reasonableness, and also calculating payables' turnover and comparing with
the previous year

Rights and obligations:

- Vouch a sample of balances to supporting documentation, such as purchase orders and

suppliers' invoices, to obtain audit evidence regarding rights and obligations

Valuation and allocation:

- Trace selected samples from the trade accounts payables listing and accruals listing to
the supporting documentation (purchase orders, minutes authorising expenditure,
suppliers' invoices etc).
- Obtain selected suppliers' statements and reconcile these to the relevant suppliers'
accounts.
- Compare the current year balances for trade accounts payables and accruals with the
previous year.
- Compare the amounts owed to a sample of individual suppliers in the trade accounts
payables listing with amounts owed to these suppliers in the previous year.

Cut-off:

- For a sample of vouchers, compare the dates with the dates they were recorded in the
ledger for application of correct cut-off.
- Test transactions around the year end to determine whether amounts have been
recognised in the correct financial period.

 Reconciliations of accounts payables with suppliers’ statements

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Because suppliers’ statements are a source of documentary evidence originating outside of

the entity, they are reliable source of evidence to support suppliers’ balances and provide
evidence as to the existence, completeness and valuation of balances.

 Selection of only large balances or those with many transactions will not yield an
appropriate sample as understatement of liabilities is being tested for. The auditor
should consider the volume of business (look for active suppliers to audit) during the
year. Low or zero balances will be included in the sample.
 If the balance agrees exactly, no further work needs to be carried out.
 Where the differences arise, these need to be categorised as either in transit items or
other items. In-transit items will be either goods or cash
- If the difference relates to goods-in-transit, ascertain whether the goods were received
before the year end by reference to the GRN and that they are included in year-end
inventory and purchase accruals. If not, a cut-off error has occurred and should be
investigated. If the goods were received after the year end, the difference with the
suppliers' accounts is correct.
- Similarly, cash-in-transit would arise where the payment to the supplier was made by
cheque before the year end but was not received by them until after the year end. The
date the cheque was raised and its subsequent clearing through the bank account after
the year end should be verified by inspecting the cash book and the post year end bank
statements
However, if the cheque clears after the year-end date, it may indicate that the cheque,
though raised before the year end, was not sent to the supplier until after the year end.
The relevant amount should be added back to year-end accounts payable and to the end
of year bank balance.
Differences which do not arise from in-transit items need to be investigated and
appropriate adjustments made where necessary. These differences may have arisen due
to disputed invoices or invoices have been held back in order to reduce the level of
year-end account payables.

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4.2. Provisions and contingencies

 Under IAS 37 Provisions, contingent liabilities and contingent assets, an entity
should not recognize a contingent asset or a contingent liability unless:
 When provisions and contingent liabilities are recognised:

Where, as a result of past events, there may be an outflow of resources embodying future
economic benefits in settlement of (a) a present obligation or (b) a possible obligation
whose existence will be confirmed by the occurrence or non-occurrence of one or more
uncertain future events not wholly within the entity’s control, and

there is a present obligation there is a possible there is a possible

that probably requires an obligation or a present obligation where the
outflow of resources, obligation that may, but likelihood of an outflow of
probably will not, require resources is remote.
an outflow of resources,

A provision is recognised No provision is recognised No provision is recognised

and disclosures are required but disclosures are and no disclosure is
for the provision required for the contingent required.
liability

 When contingent assets are recognised:

Where, as a result of past events, there is a possible asset whose existence will be
confirmed by the occurrence or non-occurrence of one or more uncertain future events
not wholly within the entity’s control, and

the inflow of economic the inflow of economic the inflow is not probable,
benefits is virtually certain, benefits is probable but
not virtually certain,

The asset is not contingent. It No asset is recognised but No asset is recognised and
is a normal asset that we can disclosures are required. no disclosure is required.
recognised.

 Audit procedures for provisions/contingencies:

 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:
– Review of correspondence relating to the item

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– Discussion 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 in the post year end period in respect
of the item by reviewing after-date cash
– Review of correspondence 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?
– 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 a
contingent liability is disclosed in the accounts.
 Consider the nature of the client's business. Would you expect to see any other
provisions eg warranties?
 Consider the adequacy of disclosure of provisions, contingent assets and contingent
liabilities in accordance with IAS 37.

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4.3. PURCHASE, OTHER EXPENSES

 What are the key ASSERTIONS relating to PURCHASES?

Occurrence: All purchase transactions recorded have occurred and relate to the entity.
Completeness: All purchase transactions that should have been recorded have been
recorded
Accuracy: Amounts relating to transactions have been recorded appropriately
Cut-off: Purchase transactions have been recorded in the correct period
Classification: Purchase transactions are recorded properly

 Audit procedures

- Inspect a sample of purchase invoices to ensure they agree to the amount posted to
the general ledger.
- Compare expenses making up administrative expenses to the prior year charge and
to expectations on a line by line basis. Where differences from expectations are
discovered they should be investigated.
- Enquire of management whether there are any unsettled claims or obligations
arising before the year end and ensure these are provided for (to give evidence over
the completeness of the charge in the related expense category in the statement of
profit or loss)
- Recalculate accruals and prepayments to gain evidence that other expenses are not
over- or understated.
- Compare gross profit margin with the previous year, the gross margin per the
budget and expectations. Investigate any unexpected fluctuations.

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4.4. Auditing payroll expenses

 What are the key ASSERTIONS relating to payroll expenses?
- Completeness
- Accuracy
Procedures:

 Reperform casts of payroll records to confirm completeness and accuracy

 Confirm payment of net pay per payroll records to cheque or bank transfer summary
 Agree net pay per cash book to payroll
 Inspect payroll for unusual items and investigate them further by discussion with
management
 Perform proof-in-total (analytical procedures) on payroll by multiplying estimated
average wage (using last year's figures plus expected increases) by average number of
employees (therefore incorporating starters and leavers) and compare to figure in draft
financial statements to assess reasonableness
 Reperform calculations of statutory deductions to confirm whether correct
 Confirm validity of other deductions by agreeing to supporting documentation
 Recast calculation of other deductions
 Agree individual remuneration per payroll to personnel records, records of hours
worked, salary agreement
 Confirm existence of employees on payroll by meeting them, attending wages payout,
inspecting personnel and tax records, and confirmation from managers.
 Agree benefits on payroll to supporting correspondence

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4.5. Auditing Directors’ emoluments

The area of directors’ emoluments is said to be material by nature.
The requirement to disclose directors' emoluments can also be linked to International
Financial Reporting Standards because they require compensation payments to key
management personnel to be disclosed.
 Audit procedures (for directors emoluments)

 For each director, obtain a schedule of emoluments for the year, split between wages,
bonuses, benefits, pension contributions and other emoluments.
 Check the addition of the schedule and ensure the totals are in agreement with the
disclosure in the financial statements.
 Ask each individual director to confirm the emoluments listed are complete and in
line with their expectations.
 Compare the emoluments with both the previous year's emoluments and with
expectations, taking into account the knowledge obtained during the audit (for
example, if you know a director has left during the year, is there any compensation for
loss of office expected?).
 Agree salaries, fees, bonuses and pension contributions to payroll records for the
individual directors and check the amounts paid on the bank statements agree with the
payroll records.
 Review the directors' contracts and ensure emoluments are consistent with the terms
of these contracts.
 Review board meeting minutes and meetings of any remuneration committee for
evidence of any bonuses, fees or other emoluments not disclosed.
 Review the cash book for any unusual transactions which suggest undisclosed
directors' emoluments.
 Obtain and review returns to tax authorities made by the company on behalf of the
directors which detail non-cash benefits. Ensure these are consistent with the benefits
disclosed in the financial statements.
 Consider the adequacy of disclosure of directors' emoluments in accordance with
applicable accounting standards and local legislation, including the separate disclosure
of amounts due to or from directors in respect of directors' emoluments.

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5. CASH AND BANK

What are key ASSERTIONS relating to audit of cash and bank?

Existence: Recorded cash balances exist at the period end

Completeness: Recorded cash balances include the effects of all transactions that have
occurred
Rights and obligations: The entity has legal title to all cash balances shown at the period
end
Valuation: Recorded cash balances are realizable at the amounts stated
presentation and disclosure: Disclosures relating to cash are adequate and in accordance
with accounting standards and legislation

Audit procedures: Audit of Bank

 Bank confirmation procedures

 The audit of bank balances will need to cover completeness, existence, rights and
obligations and valuation. All of these assertions can be audited directly by obtaining
third-party confirmations from the client's banks and reconciling these with the
accounting records, having regard to cut-off.
 The audit objectives linking these assertions are as follows
- Recorded cash balances exist at the year-end (existence).
- Recorded cash balances include the effects of all transactions that occurred
(completeness).
- Year-end transfers are recorded in the correct period (cut-off).
- Recorded balances are realizable at the amounts stated (valuation and allocation).
- The entity has legal title to all cash balances shown at the year-end (rights and
obligations)
 This audit evidence is valuable because it comes directly from an independent source.
ISA 505 External confirmations:
 Prepare and dispatch of requests and receipt of replies
- Control over the content and dispatch of confirmation requests is the responsibility of
the auditors.
- However, it will be necessary for the request to be authorized by the client entity
- Replies should be returned directly to the auditors and to facilitate such a reply, a pre-
addressed envelope should be enclosed with the request
 Content of a bank confirmation request:
The information to be requested:
- Balances due to or from the client entity on current, deposit, loan and other accounts

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- Nil balances on accounts, and accounts which were closed in the 12 months prior to the
chosen confirmation date
- other information, such as the maturity and interest terms on loans and overdrafts,
unused facilities, lines of credit/standby facilities, any offset or other rights or
encumbrances, and details of any collateral given or received.
- contingent liabilities, such as those arising on guarantees, comfort letters and bills
- any securities and other items in safe custody on behalf of the client

 Substantive procedures for bank (=cash at bank) balance

 Obtain company’s current bank account reconciliation and check the additions to
ensure arithmetical accuracy.
 Obtain a bank confirmation letter from company’s bankers for all of its accounts.
 For the current account, agree the balance per bank statement to an original year-end
bank statement and also to the bank confirmation letter.
 Agree the reconciliation’s balance per the cash book to the year-end cash book.
 Trace all of the outstanding deposits (uncredited deposits) to the pre year-end cash
book, post year-end bank statement and also to paying-in-book pre year end.
 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.
 Examine any old unpresented cheques to assess if they need to be written bank into the
purchase ledger as they are no longer valid to be presented.
 Agree all balances listed on the bank confirmation letter to company’s bank
reconciliations or the trial balance to ensure completeness of bank balances.
 Review the cash book and bankstatements 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 Fox or
any legal right of set-off as this may require disclosure.
 Review the financial statements to ensure that the disclosure of cash and bank balances
are complete and accurate.

Audit of cash

 Auditors will be concerned that the cash exists, is complete, and belongs to the
company (rights and obligations) and is stated at the correct value.
 Where the auditors determine that cash balances are potentially material they
may conduct a cash count, ideally at the period end.

Things to look out for when counting cash:

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 insist that the cash custodian be present thoughout the count;

 control all cash held by the client until all funds have been counted;
 ascertain that all undeposited checks are payable to the order of the client; &
 obtain a signed receipt from the custodian on return of the cash to the client.
 Ensure that at no time should the auditors be left alone with the cash

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6. NON-CURRENT ASSETS (FIXED ASSETS)

What are key ASSERTIONS relating to audit of NON-CURRENT ASSETS?

Existence Recorded assets represent those physically exist and in use at the year
end

Completeness All additions and disposals that occurred in the year have been recorded
Balances represent assets in use at the year end

Rights and The entity has rights to the assets purchased and those recorded at the
obligations year end

Valuation Non-current assets are correctly stated at cost less accumulated

depreciation
Additions and disposals are correctly recorded
Any assets that have impairment will have to be written down

Presentation Disclosures relating to cost, additions and disposals, depreciation

and policies, useful lives and assets held under finance leases are adequate
disclosure and in accordance with accounting standards

 Key internal controls over fixed assets include:

 The non-current asset register enables assets to be identified, and comparisons

between the general ledger, non-current assets register and the assets themselves
provide evidence that the assets are completely recorded.
 The procedures over acquisitions and disposals are another significant control. It
should ensure acquisitions are properly authorized, disposals are authorized and
proceeds accounted for.
 Security arrangements over non-current assets are sufficient.
 Non-current assets are maintained properly.
 Depreciation is reviewed every year.

 Audit procedures

Completeness - Obtain or prepare a summary of tangible non-current assets showing

how the following reconcile with the opening position.
+ Gross book value
+ Accumulated depreciation
+ Net book value
- Compare non-current assets in the general ledger with the non-

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current assets register and obtain explanations for differences.

- For a sample of assets which physically exist, agree that they are
recorded in the non-current asset register.

Existence - Confirm that the company physically inspects all items in the non-
current asset register each year.
- Inspect assets, concentrating on high value items and additions in-
year. Confirm that items inspected:
+ Exist
+ Are in use
+ Are in good condition
+ Have correct serial numbers

Valuation - Verify valuation to valuation certificate.

- Consider reasonableness of valuation, reviewing:
+ Experience of valuer
+ Scope of work
+ Methods and assumptions used
+ Valuation bases are in line with accounting standards

Valuation - Review depreciation rates applied in relation to:

(Depreciation) + Asset lives
+ Residual values
+ Replacement policy
+ Past experience of gains and losses on disposal
+ Consistency with prior years and accounting policy
+ Possible obsolescence
- Review non-current assets register to ensure that depreciation has
been charged on all assets with a limited useful life.
- Reperform calculation of depreciation rates to ensure it is correct.
- Compare ratios of depreciation to non-current assets (by category)
with:
+ Previous years
+ Depreciation policy rates

Rights and - Verify title to land and buildings by inspection of:

obligations + Title deeds
(Charges and + Land registry certificates
commitments)
+ Leases

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- Inspect registration documents for vehicles held, confirming that

they are in client's name.
- Examine documents of title for other assets

Addition - Verify additions by inspection of architects' certificates, solicitors'

completion statements, suppliers' invoices etc.
- Review capitalization of expenditure by examining for non-current
assets additions and items in relevant expense categories (repairs,
motor expenses, sundry expenses) to ensure that:
+ Capital/revenue distinction is correctly drawn
+ Capitalization is in line with consistently applied company policy
- Inspect non-current asset accounts for a sample of purchases to
ensure they have been properly allocated.
- Check purchases have been authorized by directors/senior
management by reviewing board minutes
- Ensure that appropriate claims have been made for grants, and
grants received and receivable have been received, by inspecting
claims documentations and bank statements
- Check that additions have been recorded by scrutinizing the non-
current asset register and general ledger

Disposals - These tests are to confirm rights and obligations, completeness,

occurrence and accuracy.
- Verify disposals with supporting documentation, checking transfer
of title, sales price and dates of completion and payment.
- Recalculate profit or loss on disposal.
- Check that disposals have been authorized by reviewing boards
minutes
- Consider whether proceeds are reasonable

Classification - Review non-current asset disclosures in the financial statements to

and ensure they meet IAS 16 criteria.
understandabil
ity

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SECTION 7: REPORTING
1. INDEPENDENT AUDITOR’S REPORT

INDEPENDENT AUDITOR’S REPORT

To the shareholders of ABC Company [or Other Appropriate Address]

Report on the Audit of the Financial Statements

Opinion
We have audited the financial statements of ABC Company (the Company) set out on
pages 10 to 40, which comprise the statement of financial position as at December 31,
20X1, and the statement of profit or loss and other comprehensive income, statement of
changes in equity and statement of cash flows for the year then ended, and notes to the
financial statements, including a summary of significant accounting policies.
In our opinion, the financial statements give a true and fair view of the financial position
of the Company as at 31 December, 20X1, and of its financial performance and its cash
flows for the year then ended in accordance with International Financial Reporting
Standards (IFRSs) issued by the International Accounting Standards Board and have been
properly prepared in compliance with the Companies Act.
Basis for Opinion
We conducted out audit in accordance with International Standards on Auditing (ISAs)
issued by the IFAC. Our responsibilities under those standards are further described in the
Auditor’s Responsibilities for the Audit of the Financial Statements section of our report.
We are independent of the Company in accordance with the IFAC’s Code of Ethics for
Professional Accountants (the Code), and we have fulfilled our other ethical
responsibilities in accordance with the Code. We believe that the audit evidence we have
obtained is sufficient and appropriate to provide a basis for our opinion.
Key Audit Matters
Key audit matters are those matters that, in our professional judgment, were of most
significant 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.
[Description of each key audit matter in accordance with ISA 701, which applies to audits
of the financial statements of listed entities.]
Other information
The directors are 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 responsibilities is to read the
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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.
Responsibilities of Management and Those Charged with Governance for the
Financial Statements
The directors are responsible for the preparation of the financial statements that give a
true and fair view in accordance with IFRSs issued by the IASB and the (Country’s)
Companies Act, and for such internal control as the directors determine is necessary to
enable the preparation of financial statements that are free from material misstatement,
whether due to fraud or error.
In preparing the financial statements, the directors are responsible for assessing the
Company’s ability to continue as a going concern, disclosing, as applicable, matters
related to going concern and using the going concern basis of accounting unless
management either intends to liquidate the Company or to cease operations, or has no
realistic alternative but to do so.
Those charged with governance are responsible for overseeing the Company’s financial
reporting process.
Auditor’s Responsibilities for the Audit of the Financial Statements
Our objectives are to obtain reasonable assurance about whether the financial statements
as a whole are free from material misstatement, whether due to fraud or error, and to issue
an auditor’s report that includes our opinion. Reasonable assurance is a high level of
assurance, but is not a guarantee that an audit conducted in accordance with ISAs will
always detect a material misstatement when it exists. Misstatements can arise from fraud
or error and are considered material if, individually or in the aggregate, they could
reasonably be expected to influence the economic decisions of users taken on the basis of
these financial statements.
As part of an audit in accordance with ISAs, we exercise professional judgment and
maintain professional skepticism throughout the audit. We also:
 Identify and assess the risks of material misstatement of the financial statements,
whether due to fraud or error, design and perform audit procedures responsive to those
risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for
our opinion. The risk of not detecting a material misstatement resulting from fraud is
higher than for one resulting from error, as fraud may involve collusion, forgery,
international omissions, misrepresentations, or the override of internal control.
 Obtain an understanding of internal control relevant to the audit 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 Company’s internal control.
 Evaluate the appropriateness of accounting policies used and the reasonableness of
accounting estimates and related disclosures made by management.
 Conclude on the appropriateness of management’s use of the going concern basis of
accounting and, based on the audit evidence obtained, whether a material uncertainty
exists related to events or conditions that may cast significant doubt on the
Company’s ability to continue as a going concern. If we conclude that a material
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uncertainty exists, we are required to draw attention in our auditor’s report to the
related disclosures in the financial statements or, if such disclosures are inadequate, to
modify our opinion. Our conclusions are based on the audit evidence obtained up to
the date of our auditor’s report. However, future events or conditions may cause the
Company to cease to continue as a going concern.
 Evaluate the overall presentation, structure and content of the financial statements,
including the disclosures, and whether the financial statements represent the
underlying transactions and events in a manner that achieves fair presentation.
We communicate with those charged with governance regarding, among other matters,
the planned scope and timing of the audit and significant audit findings, including any
significant deficiencies in internal control that we identify during our audit.
We also provide those charged with governance with a statement that we have complied
with relevant ethical requirement regarding independence, and to communicate with
them all relationships and other matters that may reasonably be thought to bear on our
independence, and where applicable, related safeguards.
From the matters communicated with those charged with governance, we determine those
matters that were of most significance in the audit of the financial statements of the
current period and are therefore the key audit matters. We describe these matters in our
auditor’s report unless law or regulation precludes public disclosure about the matter or
when, in extremely rare circumstances, we determine that a matter should not be
communicated in our report because the adverse consequences of doing so would
reasonably be expected to outweigh the public interest benefits of such communication.
Report on Other Legal and Regulatory Requirements
[The form and content of this section of the auditor’s report would vary depending on the
nature of the auditor’s other reporting responsibilities prescribed by local law or
regulation. The matters addressed by other law or regulation (referred to as “other
reporting responsibilities”) shall be addressed within this section.

The engagement partner on the audit resulting in this independent auditor’s report is
[name].

XYZ & Co
Certified Public Accountants (Practicing) or Certified Public Accountants
[Auditor Address]
[Date]

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2. BASIC ELEMENTS OF AN AUDIT REPORT

Title The title should indicate that the report is by an independent auditor
to confirm all the relevant ethical standards regarding independence
have been met. These help readers to identify the auditor’s report
and to easily distinguish it from reports that might be issued by
others.

Addressee The auditor’s report shall be addressed as required by the

circumstances of the engagement, but is likely to be the
shareholders or board of directors.

Auditor’s opinion The auditor’s report shall include a section with the heading
“Opinion”
If the auditor concludes that the financial statement give a true and
fair view, the auditor shall express an unmodified opinion which
states that the financial statements give true and fair view or present
fairly, in all material aspects, in accordance with the applicable
financial reporting framework.

Basis for opinion The basis for opinion section will (i) state that the audit was
conducted in accordance with the ISAs, (ii) includes a statement that
the auditor has fulfilled their ethical responsibilities and (iii) states
whether the auditor believes that the audit evidence obtained is
sufficient and appropriate to provide a basis for the audit opinion.

Going concern Where the auditor considers a material uncertainty related to going
concern exists, this should be described in a separate paragraph
headed ‘Material uncertainty related to going concern’. (ISA 570)

Key audit matters For the audit of listed entities, or where required by law and
regulation, the auditor should include a ‘Key audit matter’ section.
This section describes the matters that, in the auditor’s professional
judgment, are the most significant to the audit. (ISA 701)

Other For the audit of listed entities or any other entity where the auditor
information has obtained other information, an ‘Other information’ section (ISA
720) section should include:
 A statement that management is responsible for the other
information
 An identification of the other information obtained before the
date of the auditor’s report
 A statement that the auditor’s opinion does not cover the other
information
 A description of the auditor’s responsibilities for reading,
considering and reporting on other information, and
 Where other information has been obtained, either a statement

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that the auditor has nothing to report, or a description of any

uncorrected material misstatement.

Responsibilities There must be a heading ‘Responsibilities of management for the

for the financial financial statements’.
statements This section describes management’s responsibility including the
following:
 The preparation of the financial statements in accordance with the
applicable financial reporting framework
 The implementation of such internal control as a necessary to
enable the preparation of financial statements that are free from
material misstatement, whether due to fraud or error
 The assessment of the entity’s ability to continue as a going
concern, the appropriateness of the going concern basis of
accounting and adequacy of related disclosures.

Auditor’s The auditor’s report shall include a section with the heading
responsibilities ‘Auditor’s responsibilities for the audit of financial statements’.
for the audit of The report shall state that the objectives of the auditor are to obtain
the financial reasonable assurance whether the financial statements as a whole
statements are free from material misstatement, whether due to fraud or error,
and to issue an auditor’s report that includes the auditor’s opinion.
The report should state that the auditor’s responsibilities are:
 To exercise professional judgment and maintains professional
skepticism throughout the audit.
 To identify and assess the risks of material misstatement of the
financial statements and design and perform procedures in
response to those risks
 To obtain an understanding of internal control relevant to the
audit in order to design audit procedures but not to enable the
auditor to express an opinion on the effectiveness of the entity’s
internal control
 To evaluate the appropriateness of the accounting policies used,
the reasonableness of estimates and the related disclosures in the
financial statements
 To conclude on the appropriateness of management’s use of the
going concern basis of accounting and whether any material
uncertainties exist
 To evaluate if the overall presentation, structure and content of
the financial statements, including disclosures, are prepared in
accordance with the fair presentation framework (where
applicable)
 To describe responsibilities in a group audit engagement (where
applicable e.g. obtaining sufficient appropriate audit evidence
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within the group and express an opinion on the group financial

statements)
In circumstances when the auditor also has a responsibility to
express an opinion on the effectiveness of internal control in
conjunction with the audit of the financial statements, the auditor
shall omit the phrase that the auditor’s consideration of internal
control is not for the purpose of expressing an opinion on the
effectiveness of the entity’s internal control
To communicate applicable matters (e.g. planned scope and timing
of the audit and significant audit findings, a statement that the
auditor has complied with relevant ethical requirements regarding
independence and where relevant, related safeguards and key audit
matters) with those charged with governance

Other reporting If the auditor is required by law to report on any other matters, this
responsibilities must be done in an additional paragraph below the opinion
paragraph which is titled 'Report on other legal and regulatory
requirements' or otherwise as appropriate.

Name of the The name of the audit engagement partner is included in the
engagement auditor’s report for audits of complete sets of general purpose
partner financial statements of listed entities.

Auditor’s The report shall contain the auditor’s signature, whether this is the
signature auditor’s own name or the audit firm’s name.
An auditor’s report shall state the auditor’s name.

Auditor’s address The location where the auditor practices must be included. This is
usually the city where the auditor has his office.

Date of the report The report shall be dated. This informs the reader that the auditor
has considered the effect on the financial statements and on his
report of events or transactions about which he became aware that
occurred up to that date. The date should not be earlier than the date
on which the auditor has obtained sufficient appropriate audit
evidence on which to base the opinion on the financial statements.

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3. MATERIALITY

Materiality is an expression of the relative significance or importance of a particular

matter in the context of the financial statements as a whole.
A matter is material if its omission or misstatement would reasonably influence the
economic decisions of users taken on the basis of the financial statements.

How to determine materiality?

Materiality must always be a matter of judgment for the auditor. The following figures are
appropriate starting points for the consideration of materiality.

Value %

Profit before tax

Revenue

Total assets

4. PERVASIVENESS

Pervasiveness is a term used to describe the effects or possible effects on the financial
statements of misstatements or undetected misstatements.
There are three types of pervasive effects:
 Those that are not confined to specific elements, accounts or items in the financial
statements
 Those that are confined to specific elements, accounts or items in the financial
statements and represent or could represent at substantial portion of the financial
statements
 Those that relate to disclosure which are fundamental to users’ understanding of the
financial statements

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5. TYPES OF AUDIT REPORT

HOW MANY TYPES OF AUDIT REPORT AND AUDIT OPINION?
There are two (02) types of audit report and four (04) types of audit opinion:
1. Unmodified report:
 Unmodified opinion
 Key audit matters (with Unmodified opinion)
2. Modified report:
(a) Matters that do not affect the auditor’s opinion:
 Emphasis of matter (with Unmodified opinion)
 Other matter (with Unmodified opinion)
(b) Matters that do affect the auditor’s opinion
 Qualified (Except for) opinion
 Disclaimer of opinion
 Adverse opinion

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UNMODIFIED OPINION
Sample (extracted)

Opinion
We have audited the financial statements of ABC Company (the Company) set out on
pages 10 to 40, which comprise the statement of financial position as at December 31,
20X1, and the statement of profit or loss and other comprehensive income, statement of
changes in equity and statement of cash flows for the year then ended, and notes to the
financial statements, including a summary of significant accounting policies.
In our opinion, the financial statements give a true and fair view of the financial position
of the Company as at 31 December, 20X1, and of its financial performance and its cash
flows for the year then ended in accordance with International Financial Reporting
Standards (IFRSs) issued by the International Accounting Standards Board and have been
properly prepared in compliance with the Companies Act.

KEY AUDIT MATTERS

ISA 701 Communicating Key Audit Matters in the Independent Auditor’s Report
What are Key Audit Matters (KAM)?

Those matters that in the auditor’s professional judgment, were of most significant in the
audit of the FS of the current period. KAM are selected from matters communicated with
those charged with governance.

THREE matters to take into account when determining those matters which required
significant auditor attention during the course of the audit, and therefore would
qualify as KAM:

a) Areas which are susceptible to higher risks of MM or which were deemed to be

“significant risks” as defined under ISA315.
b) Significant auditor judgments in relation to areas of the FS that involved
significant management judgment. This might include accounting estimates which have
high degree of estimation uncertainty.
c) The effect on the audit of significant events and transactions that have taken place
during the period.

Communicating KAM

Once the auditor has determined which matters to be included in KAM, the auditor must
ensure that each matter is appropriately described in the auditors’ report including a
description of:
a) Why the matter was determined to be one of the most significance and therefore a
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KAM, and
b) How the matter was addressed in the audit (which my include a description of the
auditor’s approach, a brief overview of procedures performed with an indication of their
outcome and any key observations in respect of the mater).

Example of KAM
 Impairment of testing on goodwill – IFRS 3 requires goodwill to be tested for
impairment at each reporting date and this annual impairment test may be regarded
as a KAM where the carrying amount of goodwill is material. Impairment test are
inherently complex and judgmental.
 Effect of new IAS/IFRS – eg IFRS 15 Revenue from contracts with customers.
Application of the new IFRS 15 may give rise to the new accounting requirements
becoming a KAM as they will impact on the company’s financial position and
performance.
 Valuation of Financial Instruments and other assets/liabilities at fair value is a
KAM because of its significant measurement uncertainties esp in assets where
there are no quoted price, FV measurements can be complex and subjective.

Sample draft paragraph of KAM

Key Audit Matters

Key audit matters are those matters 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.
Goodwill
Under HKFRSs, the Group is required to annually test the amount of goodwill for
impairment. This annual impairment test was significant to our audit because the balance
of XX as of December 31, 20X1 is material to the financial statements. In addition,
management’s assessment process is complex and highly judgmental and is based on
assumptions, specially [described certain assumptions], which are affected by expected
future market or economic conditions, particularly those in [name of country or
geographical area].
Our audit procedures included, among others, using a valuation expert to assist us in
evaluating the assumptions and methodologies used by the Group, in particular those
relating to the forecasted revenue growth and profit margins for [name of business line].
We also focused on the adequacy of the Group’s disclosures about those assumptions to
which the outcome of the impairment test is most sensitive, that is, those that have the
most significant effect on the determination of the recoverable amount of goodwill.
The Company’s disclosures about goodwill are included in Note 3, which specially
explains that small changes in the key assumptions used could give rise to an impairment

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of the goodwill balance in the future.

EMPHASIS OF MATTER
ISA 706 Emphasis of matter paragraphs and other matter paragraphs in the
independent auditor’s report
Emphasis of Matter paragraph – A paragraph included in the auditor's report that refers to
a matter appropriately presented or disclosed in the financial statements that, in the
auditor's judgement, is of such importance that it is fundamental to users' understanding of
the financial statements.
Emphasis of matter paragraphs are used to draw readers' attention to a matter already
presented or disclosed in the financial statements that the auditor feels is fundamental to
their understanding, provided that the auditor has obtained sufficient appropriate audit
evidence that the matter is not materially misstated.
When an emphasis of matter paragraph is included in the auditor's report, it comes
immediately after the opinion paragraph and is entitled 'Emphasis of matter' (or
appropriate). The paragraph must contain a clear reference to the matter being
emphasised and to where relevant disclosures that fully describe it can be found in the
financial statements.
The paragraph must state that the auditor's opinion is not modified in respect of the matter
emphasised.
Examples of circumstances where the auditor may consider it necessary to include an
Emphasis of Matter paragraph are:
 An uncertainty relating to the future outcome of exceptional litigation or regulatory
action
 A major catastrophe that has had, or continues to have, a significant effect on the
entity's financial position
An example of an emphasis of matter paragraph:

Emphasis of Matter
We draw attention to Note X to the financial statements which describes the uncertainty
related to the outcome of the lawsuit filed against the company by XYZ Company. Our
opinion is not qualified in respect of this matter.

OTHER MATTER
ISA 706 Emphasis of matter paragraphs and other matter paragraphs in the
independent auditor’s report

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Other matter paragraph - a paragraph included in the auditor's report that refers to a matter
other than those presented or disclosed in the financial statements that, in the auditor's
judgment, is relevant to users' understanding of the audit, the auditor's responsibilities or
the auditor's report.
Example:
- the prior period financial statements of an audit client were not audited: In “other
matter paragraph” of audit report, the auditor will state that the corresponding
figures are unaudited. This is a requirement of ISA 710 -Comparative information –
corresponding figures and comparative financial statements

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MODIFIED OPINIONS
ISA 705 Modifications to the opinion in the independent auditor’s report

ISA 705.6
‘The auditor shall modify the opinion in the auditor’s report when:
1) The auditor concludes that, based on the audit evidence obtained, the financial
statements as a whole are not free from material misstatements; or
2) The auditor is unable to obtain sufficient appropriate audit evidence to conclude
that the financial statements as a whole are free from material misstatement.’

Different types of modified opinion:

Nature of circumstances Material but not pervasive Material and pervasive

1) Financial statements Qualified opinion Adverse opinion

are materially misstated (auditor state that the
(Except for)
(auditors express a qualified accounts do not give a true
opinion on a particular aspect and fair view)
of the accounts which is not
considered pervasive but it is
material only)

2) Auditor unable to Qualified opinion Disclaimer of opinion

obtain sufficient (No opinion, unable to
Except for
appropriate audit
evidence (auditor express a qualified form an opinion)
opinion on a particular aspect (auditors state they are
of the accounts which is not unable to form an opinion
considered pervasive but it is on truth and fairness)
material only)

3 different types of modified opinion (not including Emphasis of Matter)- ISA705

1) ‘The auditor shall express a qualified opinion (EXCEPT FOR) when:

a) The auditor, having obtained sufficient appropriate audit evidence, concludes that
misstatements, individually or in the aggregate, are material, but not pervasive, to
the financial statements; or
b) The auditor is unable to obtain sufficient appropriate audit evidence on which to base
the opinion, but the auditor concludes that the possible effects on the financial
statements of undetected misstatements, if any, could be material but not pervasive.’

ISA 705.8

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2) ‘The auditor shall express an adverse opinion when the auditor, having obtained
sufficient appropriate audit evidence, concludes that misstatements, individually or in
the aggregate, are both material and pervasive to the financial statements.’

ISA 705.9
3) ‘The auditor shall disclaim an opinion when the auditor is unable to obtain sufficient
appropriate audit evidence on which to base the opinion, and the auditor concludes
that the possible effects on the financial statements of undetected misstatements, if
any, could be both material and pervasive.’

QUALIFIED OPINION (sample)

Note: No need to memorize the detailed content, just remember the basis of opinion and
how the opinion is being written.
 Material misstatement of the financial statements (MM in the FS)
 A qualified opinion (=Except for) due to a material misstatement of inventories –
material but not pervasive (only inventory is affected)

Qualified Opinion
In our opinion, except for the effects of the matter described in the Basis for Qualified
Opinion paragraph, the financial statements give a true and fair view of the state of the
Company’s affairs as at 31 December 31 20X1, and of its [profit][loss] and its cash flows
for the year then ended in accordance with International Financial Reporting Standards
and have been properly prepared in accordance with the Company Act.
Basis for Qualified Opinion
The Company’s inventories are carried in the statement of financial position at xxx.
Management has not stated inventories at the lower of cost and net realisable value but
has stated them solely at cost, which constitutes a departure from International Financial
Reporting Standards. The company's records indicate that, had management stated the
inventories at the lower of cost and net realisable value, an amount of xxx would have
been required to write the inventories down to their net realisable value. Accordingly,
cost of sales would have been increased by xxx, and income tax, net income and
shareholders' equity would have been reduced by xxx, xxx and xxx, respectively.

ADVERSE OPINON (sample)

Adverse opinion due to a material misstatement because of non-consolidation of a
subsidiary (material and pervasive)

Adverse Opinion
In our opinion, because of the significance of the matter discussed in the Basis for
Adverse Opinion paragraph, the consolidated financial statements do not give a true and
fair view of the state of affairs of the Company and of the Group as at 31 December
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Lecture note

20X1, and of the Group’s [profit][loss] and cash flows for the year then ended in
accordance with International Financial Reporting Standards. In all other respects, in our
opinion the consolidated financial statements have been properly prepared in accordance
with the Companies Act.
Basis for Adverse Opinion
As explained in Note X, the Company has not consolidated the financial statements of
subsidiary DEF Limited it acquired during 20X1 because it has not yet been able to
ascertain the fair values of certain of the subsidiary’s material assets and liabilities at the
acquisition date. This investment is therefore accounted for on cost basis. Under the
International Financial Reporting Standards, the subsidiary should have been
consolidated because it is controlled by the Company. Had DEF been consolidated, many
elements in the financial statements would have been materially affected. The effects on
the consolidated financial statements of the failure to consolidate have not been
determined.

QUALIFIED OPINION (sample)

A qualified opinion (Except for) due to the auditor’s inability to obtain sufficient
appropriate audit evidence about an investment in the foreign affiliate which is material
but not pervasive.

Qualified Opinion
In our opinion, except for the possible effects of the matter described in the Basis for
Qualified Opinion paragraph, the financial statements give a true and fair view of the
state of the Company’s affairs as at 31 December 20X1, and of its [profit][loss] and cash
flows for the year then ended in accordance with International Financial Reporting
Standards and have been properly prepared in accordance with the Companies Act.
Basis for Qualified Opinion
ABC Limited’s investment in DEF Limited, a foreign associate acquired during the year
and accounted for by the equity method, is carried at xxx on the [balance sheet]
[statement of financial position] as at 31 December 20X1, and ABC’s share of DEF’s net
income of xxx is included in ABC’s income for the year then ended. We were unable to
obtain sufficient appropriate audit evidence about the carrying amount of ABC’s
investment in DEF as at 31 December 20X1 and ABC’s share of DEF’s net income for
the year because we were denied access to the financial information, management, and
the auditors of DEF. Consequently, we were unable to determine whether any
adjustments to these amounts were necessary.

DISCLAIMER OPINION (sample)

A disclaimer of opinion due to the auditor’s inability to obtain sufficient appropriate audit
evidence about a single element of the financial statements (financial information of a joint
venture investment representing over 90% of company’s net assets = material and
pervasive)

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Lecture note

Disclaimer of Opinion
Because of the significance of the matter described in the Basis for Disclaimer of Opinion
paragraph, we have not been able to obtain sufficient appropriate audit evidence to
provide a basis for an audit opinion. Accordingly, we do not express an opinion on the
financial statements. In all other respects, in our opinion the financial statements have
been properly prepared in accordance with the Company Act.
Basis for Disclaimer of Opinion
The Company’s investment in its joint venture DEF (Country X) Limited is carried at xxx
on the Company’s [balance sheet][statement of financial position], which represents over
90% of the Company’s net assets as at 31 December 20X1. We were not allowed access
to the management and the auditors of DEF, including DEF’s auditors’ audit
documentation. As a result, we were unable to determine whether any adjustments were
necessary in respect of the Company’s proportional share of DEF’s assets that it controls
jointly, its proportional share of DEF’s liabilities for which it is jointly responsible, its
proportional share of DEF’s income and expenses for the year, and the elements making
up the statement of changes in equity and [cash flow statement][statement of cash flow].

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