- Sample CPA · 10.3 Legal framework and regulation ... auditors' liability, appointment, removal,...

CPA

CERTIFIED PUBLIC ACCOUNTANTS

PART II

SECTION 4

AUDITING AND ASSURANCE

STUDY TEXT

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CONTENT

10.1 Assurance engagements

- Definition and objectives

- Elements of an assurance engagement

- Types of assurance engagements

- Levels of assurance and reports

- Non-assurance engagements

10.2 Nature and purpose of an audit

- Nature and objectives

- Audit as an assurance engagement

- Development of audit (early audit and modern audit)

- Types of audit and limitations

10.3 Legal framework and regulation

- Regulatory framework within which external audits take place

- Statutory regulations; auditors' liability, appointment, removal, remuneration,

resignation, rights and duties of auditors

- International standards on auditing and other regulations

- Professional ethics/code of ethics for professional accountants

- Fundamental principles, threats and safeguards, other professional guidelines on

audit fees, conflict of interest, advertising and opinion shopping

10.4 Planning and risk assessment

- Obtaining clients acceptance and retention

- Understanding the entity and its environment

- Audit planning, audit programmes and documentation

- Assessing audit risks

- Errors, fraud and other irregularities

10.5 Overview of forensic accounting

- Nature, purpose and scope of forensic accounting

- Types of forensic investigations: Corruption, asset misappropriation, financial

statement fraud, others

- Fraud prevention and deterrence

10.6 Internal control systems

- Internal controls theory and practice

- Evaluation of internal control system and test of control

- Communication on internal control system (management letter)

- Information technology threats and control

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10.7 Audit evidence

- Financial statement assertions and audit evidence

- Audit evidence procedures/techniques

- Audit sampling and other means of testing

- The audit of specific items (income/expenses/assets/liabilities)

- Using the work of others (internal audit and experts)

- Computer assisted audit techniques

10.8 Overall audit review

- Subsequent events review

- Going concern review

- Contingencies and commitments

- Management representations

- Quality control and review

- Role of auditors in receiverships and liquidation

10.9 Audit reports

- 7th

Schedule provisions on audit reports

- Basic elements

- Types of opinions

- Emphasis of master paragraph

- Features of audit reports

10.10 Auditing in the Public Sector

- Introduction to auditing in the Public Sector; regulatory provisions

- Establishment, mandate and functions of public sector auditors; Kenya National Audit

Office (KENAO) and similar national audit bodies

- Role of internal audit function in public entities

- Relationship between external and internal auditors in the public sector

- International Standards on Supreme Auditing Institutions

10.11 Emerging issues and trends

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CONTENT

TOPIC PAGE

1. Assurance engagements………………………………………………………………..5

2. Nature and purpose of an audit………………………………………………………12

3. Legal framework and regulation………………………………………………….….31

4. Planning and risk assessment…………………………………………………………66

5. Overview of forensic accounting…………………………………………………….113

6. Internal control systems…………………………………………………….…….…..125

7. Audit evidence……………………………………………………………….….……..139

8. Overall audit review……………………………………………………….………….193

9. Audit reports…………………………………………………………….….…………211

10. Auditing in the Public Sector………………………………………………...….…..224

Revised on: July 2018

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TOPIC 1

ASSURANCE ENGAGEMENTS

DEFINITION AND OBJECTIVES

The term assurance refers to the expression of a conclusion that is intended to increase the

confidence that users can place in a given subject matter or information. For example, an

auditor’s report is a conclusion that increases the confidence that users can place in a

company’s financial statements.

Audit engagement refers to audit performed by an auditor. It is the very first stage of an audit

procedure where the client is notified by the auditor that the work pertaining to audit has been

accepted by him/her and also provides clarifications with regard to the scope and purpose of

audit. To be more specific, audit engagement can be referred to the written letter that the

auditor uses to notify the client that he/she would be engaging in auditing services. Thus, the

audit engagement procedure is basically a negotiation based on professional terms that takes

place between prospective customer and a public accounting entity. This procedure is used for

finding new customers and offer accounting related services to different businesses.

The auditor uses the term ‘audit engagement’ when the entity has to undergo the auditing

procedure. This could imply varied things and therefore it is necessary that the auditor clarifies

what she/he exactly means by the term. Irrespective of the definition followed by the auditor,

he/she makes it a point to follow certain specific guidelines and procedure for offering the

services.

Full Engagement

Audit engagement consists of several steps that basically revolve around planning,

substantiation, control testing and finalization. The very first step involves providing a letter to

the client reminding him about the audit. Once the client has been contacts, both the auditor

and client meet with each other to determine how, why and when the auditing would take

place. In addition to this, the client also needs to provide the auditor with relevant resources

for conducting the procedure smoothly. Following this, the auditor carries out surveys to find

out more about the organization and its controls. This is followed by testing of controls and

garnering of as much detail and information as is possible. On the basis of the results and

information, the auditor prepares a temporary draft and shares the same with client. Once the

client has gone through the draft report, he responds to the recommendations and findings

made in it. After this, the auditor prepares a final audit report and may also request the client

to fill a survey form to better understand his/her performance. The audit is completed after a

follow up meeting with client, which usually happens within 6 months.

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Objectives of the Practitioner

A practitioner is an the individual(s) conducting the engagement (usually the engagement

partner or other members of the engagement team, or, as applicable, the firm) by applying

assurance skills and techniques to obtain reasonable assurance or limited assurance, as

appropriate, about whether the subject matter information is free from material misstatement

In conducting an assurance engagement, the objectives of the practitioner are:

a) To obtain either reasonable assurance or limited assurance, as appropriate, about

whether the subject matter information (that is, the reported outcome of the

measurement or evaluation of the underlying subject matter) is free from material

misstatement;

b) To express a conclusion regarding the outcome of the measurement or evaluation of the

underlying subject matter through a written report that clearly conveys either

reasonable or limited assurance and describes the basis for the conclusion; and

c) To communicate further as required by relevant ISAEs.

In all cases when .reasonable assurance or limited assurance, as appropriate, cannot be

obtained and a qualified conclusion in the practitioner's assurance report is insufficient in the

circumstances for purposes of reporting to the intended users, the ISAEs require that the

practitioner disclaim a conclusion or withdraw (or resign) from the engagement, where

withdrawal is possible under applicable laws or regulations.

NON-ASSURANCE ENGAGEMENTS

Non-assurance Engagements

If an engagement lacks the five elements of assurance engagements, it is considered non-

assurance (residual definition). Examples of non-assurance engagement are the following:

1. Agreed-upon procedures

2. Compilations engagements

3. Preparation of Income tax returns where no conclusion conveying assurance is

expressed

4. Management advisory services and Consulting

5. Engagement that includes rendering of professional opinions not intended to be an

assurance report

Elements of Assurance Engagements

There are five elements that must all be present in order to qualify the engagement as an

assurance engagement.

1. A three-party relationship involving a practitioner, a responsible party, and intended

users;

2. An appropriate subject matter;

3. Sufficient appropriate evidence;

4. Suitable Criteria;

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5. A written assurance report in the form appropriate to a reasonable assurance

engagement or a limited assurance engagement.

Appropriate Subject Matter

The subject matter and the subject matter information of an assurance engagement can take

many forms, such as:

Financial performance or conditions

Non-financial performance or conditions

Physical characteristics

Systems and Processes

Behavior

An appropriate subject matter is

Identifiable and capable of consistent evaluation or measurement against the identified

criteria

Capable of being subjected to procedures for gathering sufficient appropriate evidence

to support a reasonable assurance or limited assurance conclusion, as appropriate

Sufficient Appropriate Evidence

Sufficiency is the measure of the quantity of evidence

o The quantity of evidence needed is affected by the risk of the subject matter

being materially misstated.

Appropriateness is the measure of the quality of evidence, that is, its relevance and

reliability

o The reliability of evidence is influenced by its source and by its nature, and is

dependent on the individual circumstances under which it is obtained.

o Generalization about the reliability of evidence – evidence is more reliable if:

Obtain from independent source outside the entity

Generated internally when the related controls are effective

Obtained directly by the practitioner than indirect or by inference

Exist in documentary form

Provided by original documents

Merely obtaining more evidence may not compensate for its poor quality

The auditor should consider the cost of obtaining the usefulness of the evidence.

Suitable Criteria

The following are the characteristics of a criteria to be considered suitable:

Relevance – contribute to conclusions that assist decision-making by the intended

users.

Completeness – the relevant factors that could affect the conclusions are not omitted.

Includes benchmarks for presentation and disclosure

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Reliability – allows reasonably consistent evaluation or measurement of the subject

matter including where relevant, presentation and disclosure, when used in similar

circumstances by similarly qualified practitioners

Neutrality – free from bias

Understandability – contribute to conclusions that are clear, comprehensive, and not

subject to significantly different interpretations

TYPES OF ASSURANCE ENGAGEMENTS

1. As to level of assurance:

i. Reasonable Assurance – the objective is a reduction in assurance engagement

risk to an acceptably low level as the basis for a positive form of expression of a

practitioner’s conclusion. (e.g., audit of historical financial statements)

ii. Limited Assurance – the objective is a reduction in assurance engagement risk

to a level that is acceptable in the circumstances of the engagement, but where

the risk is greater that for a reasonable assurance engagement, as the basis for a

negative form of expression of the practitioner’s conclusion. (e.g., review of

historical financial statements

2. As to structure of engagement:

i. Assertion-based – the evaluation or measurement of the subject matter is

performed by the responsible party, and the subject matter information is in the

form of assertion to the intended users.

ii. Direct Reporting – the practitioner either directly performs the evaluation or

measurement of the subject matter, or obtains a representation from the

responsible party that has performed the evaluation or measurement that is not

available to intended users. The subject matter information is provided to the

intended users in the assurance report.

Importance of Assurance Engagements

1. Potential bias in providing information

2. Remoteness between a user and the organization

3. Complexity of the transactions, information, or processing systems

4. Investors need to manage their risk and thereby minimize financial surprises as

consequences to investors, and others, of relying on inaccurate information can be quite

significant.

Limitations of Assurance Engagements

1. Use of selective testing (sampling)

2. Use of judgment

3. Inherent Limitations of internal control

4. Persuasive evidence rather than conclusive evidence

5. Characteristics of the subject matter

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TOPIC 2

NATURE AND PURPOSE OF AN AUDIT

NATURE AND OBJECTIVES

Definition of an Audit:

An audit is the independent examination of an expression of an opinion on the financial

statements of an economic entity by appointed auditor in pursuance of that appointment and in

compliance with any relevant statutory obligation

The objective of an audit is to enable the auditor express an opinion whether financial

statements show a true and fair view of the company state of affairs in accordance with an

identified financial reporting framework.

The purpose of an audit is not to provide additional information but rather it is intended to

provide the users of the accounts with assurance that the information provided to then by

directors is reliable. However, the users should not assume the auditor’s opinion is one to

efficiency with which management has conducted the affairs of the entity.

Financial statement: According to the Companies Act, the company accounts refers to the

balance sheet and the profit and loss account but due to development in business practice and

shareholders information needs, these are inadequate as to the information regarding financial

position and performance of the company. Since most balance sheets and profit and loss

accounts are summarized statements amplified by notes to the statements, the business

community and the accountancy profession require that a cash flow statement as well as a

statement of changes in equity be prepared. The terms company accounts and financial

statements have the same meaning.

Financial Reporting framework: According to International Auditing Standards (ISA 200, the

framework of international standards of auditing), financial statements are usually prepared

and presented annually and are directed at common informational needs of a wide range of

users.

Many of the users rely on the financial statements as their major source of additional

information to meet their specific information needs. Therefore financial statements need to be

prepared in accordance with one or combination of:

International Financial Reporting Standards (IFRS)or IASs

National accounting standards

Any other authoritative and comprehensive financial reporting framework designed for

use in financial reporting and is identified in the financial statements. In Kenya the

financial reporting framework adopted is as prescribed by IFRS.

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Scope of-the Audit

The auditor's opinion on the financial statements deals with whether the financial

statements are prepared, in all material respects, in accordance with the applicable

financial reporting framework: Such an opinion is common to all audits of financial

statements.

The auditor's opinion therefore does not assure, for example, the future viability of the

entity nor the efficiency or effectiveness with which management has conducted the

affairs of the entity. In some jurisdictions, however, applicable law or regulation may

require auditors to provide opinions on other-specific matters, such as the effectiveness

of internal control, or the consistency of a separate management report with the financial

statements.

While the ISAs include requirements and guidance_ in relation to such matters to the

extent that they are relevant to forming an opinion on the financial statements, the

auditor would be required to undertake further work if the auditor had additional

responsibilities to provide such opinions.

STAGES OF AN AUDIT

The suggested audit approach is designed to gather sufficient and reliable evidence to support

the audit opinion in the most efficient and effective way and to enable the engagement team to

fully understand the client's business. There is no difference between an audit of a large and a

small entity except that the procedures adopted may differ depending on the particular

circumstances of each audit

i. Preliminary Engagement Activities

ii. Planning

iii. Execution

iv. Review and Completion

i) Preliminary Engagement Activities

At the Pre-planning stage, the engagement partner ensures that:

- The client acceptance and continuation procedures have been carried out;

- The terms of engagement have been agreed in writing;

- The quality control aspects for the assignment have been reviewed including review of

the competency of the team to carry out the assignment, review of compliance with the

ethical requirements, including review of the independence requirements.

Planning

Planning is an essential component in focusing the audit efforts. The key components of

Identifying the scope of the assignment

Developing an audit strategy taking into consideration the scope of the engagement; the

business and the regulatory environment in which the entity operates; entity specific issues

including reliance on the work of internal audit; reporting objectives, timing of the audit and

the nature of communication required; matters affecting the direction of the audit including

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preliminary setting of materiality levels, preliminary review of risk including fraud risk,

preliminary review of internal control including the control environment, the process adopted

by the entity to identify, measure, monitor and control risks.

- Developing, based on the above, the overall audit plan detailing the nature, timing and

extent of the audit procedures to be performed in order to reduce the audit risk to an

acceptably low level; the nature of tests to be adopted; procedures to be adopted at the

assertion level; and tailoring the audit programmes.

- Ascertaining the nature and the extent of the resources required to perform the audit.

iii) Execution

- The key components of the execution stage are:

- Carrying out the test of controls and substantive tests on transactions and balances

including substantive analytical procedures to obtain sufficient and appropriate audit

evidence to enable the engagement team to draw reasonable conclusions on which to

base the audit opinion.

- Evaluating significant assumptions used in fair value measurement to determine the

reasonableness of the basis used and the disclosures.

- Identification of related parties and obtaining sufficient and appropriate audit evidence

in respect of measurement and disclosure of related party transactions.

- Documenting the nature, timing and extent of the audit procedures performed and the

results and conclusions drawn from the audit evidence obtained

While pre-printed forms and programmes are available in the Manual, the extent and the

timing of the tests should be tailored to the specific assignment. Different tests and different

levels will be appropriate for each assignment. The control of the audit at this stage must be

maintained by a senior team member with the appropriate experience and expertise.

iv) Review and Completion

The review and completion procedures focus on ensuring that sufficient and appropriate

evidence has been obtained to support the audit opinion. This involves ensuring that:

- All outstanding matters have been cleared.

- Consultations on difficult or contentious matters have been documented and adequately

resolved and conclusions therefrom implemented.

- Analytical procedures have been performed to form a conclusion on whether the

financial statements taken as a whole are consistent with the firm's knowledge of the

business.

- Where other appropriate audit evidence cannot be reasonably obtained, written

management representations have been obtained on areas material to the financial

statements.

- Review has been carried out of any material uncertainty relating to events or conditions

that n g may exist which alone or in aggregate cast a significant doubt on the

entity's ability to continue as a going concern.

- There is evidence that the engagement team has considered and confirmed that the

financial reporting framework adopted by the entity is suitable, and that the financial

statements comply with the framework as to both recognition and measurement and

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presentation and disclosure. In the context of Kenya, this in most cases will be the

IFRS's.

- The engagement partner has reviewed the audit file and is satisfied that sufficient and

appropriate evidence has been obtained to support the conclusions derived and the audit

opinion to be issued. As much of the audit evidence obtained is persuasive rather than

conclusive, absolute certainty is rarely obtainable and .therefore the engagement partner

should ensure that the audit risk is reduced to the lowest level possible.

- Where applicable, sufficient and appropriate procedures have been performed to

identify subsequent events tip to the date of the audit report and ensure that all items

that require adjustment or disclosure in the financial statements have been appropriately

dealt with:

- Where appropriate, an engagement quality .control review has been undertaken and all

the issues arising from the review have been fully dealt with and cleared with the

reviewer.

- At the end of each audit, the engagement team is de-briefed, the audit objectives set out

for the assignment have been achieved and that the engagement team has gained

experience from the assignment which will enhance their personal development.

Though not covered by the terms of audit engagement, the engagement team may, as part of

the audit process carry out a business review of the key issues facing the entity and take a

strategic look at the business and at areas where the firm can add value to the entity. In

providing other value added services, the firm and in particular the engagement partner should

be conscious of the independence requirements of the code of ethics

AUDIT AS AN ASSURANCE ENGAGEMENT

It is often not possible to check things for yourself, whether quality, accuracy, performance or

existence.

You might not have the skills or the time, or you might be in the wrong location. Therefore

you must rely on someone else to give you assurance. This means you have to decide:

- What standards should be applied?

- What represents 'good', 'acceptable' or 'unacceptable?

- How much checking should be done? All checking and assurance has an associated cost

Audit is one form of assurance

An audit is defined as: the independent examination of and expression of opinion on the

financial statements of an entity by a duly appointed auditor in pursuit of that appointment.

The important words here are 'independent' and 'opinion'.

Independence is essential and underlies the value of auditing.

Opinion really means that one auditor could look at a set of financial statements and disagree

with the opinion of another auditor.

Judgment is essential to all auditing, there are no certainties and there are no certifications of

correctness or accuracy.

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TOPIC 3

LEGAL FRAMEWORK AND REGULATIONS

STATUTORY REGULATIONS

Auditor’s liability

Auditors are potentially liable for both criminal and civil offences. The former occur when

individuals or organizations breach a government imposed law; in other words criminal law

governs relationships between entities and the state. Civil law, in contrast, deals with disputes

between individuals and/or organizations.

Civil liability

Companies Act Section 206 of the provides that officers of the company and for these

purposes auditors are considered as officers may be liable for financial damages in respect of

the civil offences of misfeasance and breach of trust. This section which is only relevant to

winding up refers to a situation where officers have misused their position of authority for the

purposes of - personal gain e.g. if the auditor uses information acquired in course of an

engagement for his financial gain or for benefit of another party.

Criminal liability

Companies Act Section 46 of the states that an auditor shall be criminally liable if he 'willfully

makes a materially false statement in any report, certificate, financial statement with an

intention to deceive or mislead etc. Willfully implies fraudulently and can be difficult to

prove. Whereby, it is held that where an officer of a body corporate with intent to deceive

members or creditors, publishes or concurs in publishing a written statement of account which

to his knowledge is or may be misleading, false or deceptive in a material particular he shall

on conviction be liable to imprisonment for a term not exceeding 7 years.

Auditors may uncover criminal offences committed by a client or an employee of the client.

This puts them in a difficult position, but the auditor should act carefully and correctly and if-

necessary„ take legal advice. The auditor must not commit a criminal offence himself. It is felt

that he would have committed a criminal offence if:

a) He advises his client to commit a criminal offence;

b) Aids the client in devising or examining a crime;

c) If he agrees with a client to conceal or destroy evidence or mislead the police with 'false

statements;

d) If he knows that his client has committed an arrest able offence and tries to impede his

arrest and prosecution. Impede does not include refusing to answer questions or

refusing to produce documents without the client's consent;

e) If he knows that his client has committed an offence. and agreed to accept consideration

to withhold information;

f) If he knows that the client has committed treason and fails to report the offence to the

proper authority.

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Case history

The application of the law of tort in the auditing profession, and the way in which auditors

seek to limit their exposure to the ensuing liabilities, has been shaped by a number of recent

landmark cases. The most notable of these are Caparo Industries Plc (Caparo) v Dickman

(1990) and Royal Bank of Scotland (RBS) vs Bannerman Johnstone MacLay (Bannerman)

(2002).

In the first case Caparo pursued the firm Touche Ross (who later merged to form Deloitte &

Touche) following a series of share purchases of a company called Fidelity plc. Caparo alleges

that the purchase decisions were based upon inaccurate accounts that overvalued the company.

They also claimed that, as auditors of Fidelity, Touche Ross owed potential investors a duty of

care. The claim was unsuccessful; the House of Lords concluded that the accounts were

prepared for the existing shareholders as a class for the purposes of exercising their class

rights and that the auditor had no reasonable knowledge of the purpose that the accounts

would be put to by Caparo.

It was this case that provided the current guidance for when duty of care between an auditor

and a third party exists. Under the ruling this occurs when:

the loss suffered is a reasonably foreseeable consequence of the defendant’s conduct

there is sufficient ‘proximity’ of relationship between the defendant and the pursuer,

and

it is 'fair, just and reasonable' to impose a liability on the defendant.

In the second case RBS alleged to have lost over £13m in unpaid overdraft facilities to

insolvent client APC Ltd. They claimed that Bannerman had been negligent in failing to detect

a fraudulent and material misstatement in the accounts of APC. The banking facility was

provided on the basis of receiving audited financial statements each year.

In contrast to Touche Ross, who had no knowledge of Caparo’s intention to rely upon the

audited financial statements, Bannerman, through their audit of the banking facility letter of

APC, would have been aware of RBS’s intention to use the audited accounts as a basis for

lending decisions. For this reason it was upheld that they owed RBS a duty of care. The judge

in the Bannerman case also, and crucially, concluded that the absence of any disclaimer of

liability to third parties was a significant contributing factor to the duty of care owed to them.

Decided legal cases have not been consistent on the issue of auditor's liability. Discussed

below are few, of the decided cases on auditors liability

V Crane Christmas & Co.

Majority (Lord Denning dissenting) decided that there could be no liability in the absence of a

contractual relationship. The decision was reached despite Candler having been induced to

invest money in the company on the strength of the accounts which were negligently prepared

by the company's auditors.

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Hedley Bryne & Co Ltd V Heller 4 Partners Ltd

The judges took differed with the above Judgment. They were of the view that the case had

been wrongfully decided. They held that a certificate issued in the ordinary course of a bank's

business would be relied upon by the party to whom it is issued and the absence of a contract

did not constitute a valid defence in negligence claim against the bank.

The Counsel of the Institute of Chartered accountants in England and Wales (ICAEW) on their

part maintained that no third party liability would attach auditors if the financial statements

they have audited under the Companies Act are used without their knowledge or consent by

outsider's ill the investment context.

However it is importance to note that any loss traceable: to negligence of auditors would not

be easy to defend.

- Jeb Fasteners Ltd V Marks Bloom & Co in this case it was held that;

A duty of care was owed by defendant auditors (Marks Bloom & Co.) to the plaintiff.

The plaintiff in realizing the takeover decision had relied on the financial statements

and unqualified report of the auditors.

The accounts did not show a true and fair view of the company and were negligently

prepared.

Judgment would be given for the defendant auditors, but by reason only of the fact that

on the evidence before the court the plaintiff would have acted no differently and would

still have gone ahead to take over the company.

AUDITOR'S PROFESSIONAL LIABILITY UNDER ETHICAL STANDARDS

A member of ICPA K is guilty of professional misconduct if:

He allows any person to practice in his name as an accountant unless such a person is a

holder of a practicing certificate and lie is in partnership with him or employed by him.

He enters, for the purpose of or in the course of practicing as an accountant into

partnership with a person who does not hold a practicing certificate or secures any

professional business through the services of such a person.

He discloses information acquired in the course of professional engagement to any

person other than the client without the consent of the client or otherwise as required by

law.

He certifies or submits in his name or in the name of his firm, a report f an examination

of financial statements and the examination of such statements and related records have

not been made by him, a partner or any employee of his firm:

He fails to observe and apply professional, technical, ethical or any other standards

prescribed by ICPA K as guidelines for practice by members of the institute.

He permits his name or that of his firm to be used in connection with an estimate of

earnings contingent' upon future transaction in a manner which may lead to the belief

that vouches or guarantees for the accuracy of the forecast.

He expresses his opinion as financial statements of any business in which he, his

immediate family, his firm or any partner in his firm has an interest unless he discloses

that interest when expressing his opinion.

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He fails to disclose in financial statements or otherwise, a material fact known to him

the disclosure of which is necessary to ensure that the financial statements are not

misleading.

He fails to report a material misstatement known to him and therefore causes it to

appear in financial statements with which he is concerned in a professional capacity.

He is found to engage in fraudulent acts or acts which result into loss.

He expresses an opinion on any matter with which he is concerned in professional

capacity without obtaining sufficient information on which to base his opinion.

He includes in any statement, return or form to be submitted to ICPA K knowing it to

be false in any particular matter.

is found to engage in any other fraudulent acts or fails to do any other act which may be

prescribed

QUALIFICATIONS, APPOINTMENT, DUTIES, RIGHTS AND DISMISSAL OF

AUDITORS APPOINTMENT OF AUDI TORS

Every company shall at each annual general meeting appoint an auditor or auditors to hold

office from the conclusion of that, until the conclusion of the next, annual general meeting.

At any annual general meeting a retiring auditor, however appointed, shall be deemed to be

reappointed without any resolution being passed unless —

a) he is not qualified for reappointment; or

b) a resolution has been passed at that meeting appointing somebody instead of him or

providing expressly that he shall not be reappointed; or

c) he has given the company notice in writing of his unwillingness to be reappointed:

Provided that where notice is given of an intended resolution to appoint some person or

persons in place of a retiring auditor, and by reason of the death, incapacity or disqualification

of that person or of all those persons, as the case may be, the resolution cannot be proceeded

with, the retiring auditor shall not be deemed to be automatically reappointed by virtue of this

subsection.

Where at an annual general meeting no auditors are appointed or are deemed to be

reappointed, the registrar may appoint a person to fill the vacancy.

The company shall, within seven days of the registrar's power becoming exercisable, give him

notice of that fact, and, if a company fails to give notice as required by this subsection, the

company and every officer of the company who is in default shall be liable to a default fine.

Subject as hereinafter provided, the first auditors of a company may be appointed by the

directors at any time before the first annual general meeting, and auditors so appointed shall

hold office until the conclusion of that meeting:

Provided that—

i. the company may at a general meeting remove any such auditors and appoint in their

place any other persons who have been nominated for appointment by any member of

the company and of whose nomination notice has been given to the members of the

company not less than fourteen days before the date of the meeting; and

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TOPIC 4

PLANNING AND RISK ASSESMENT

OBTAINING CLIENTS ACCEPTANCE AND RETENTION

In the current business environment, it not only makes good business sense to consider client

due diligence, but certain client acceptance and continuance procedures are required by the

auditing and assurance standards.

ISA 210 Agreeing the terms of the audit engagement establishes the preconditions for

accepting an audit, which are:

An acceptable financial reporting framework has been used in the preparation of the

financial statements

Those charged with governance agree that they acknowledge and understand their

responsibilities.

If the preconditions for an audit are not present, the auditor must discuss the matter with those

charged with governance. Unless required by law or regulation to do so, the auditor must not

accept the engagement.

ISA 220 Quality control for an audit of financial statements deals with those aspects of

engagement acceptance that are within the control of the auditor. The engagement partner

must be satisfied that appropriate procedures regarding the acceptance and continuance of

client relationships and audit engagements have been followed, and must determine that

conclusions reached in this regard are appropriate.

Information such as the following assists the engagement partner in determining whether the

conclusions reached regarding the acceptance and continuance of audit engagements is

appropriate:

the integrity of the principal owners, key management and those charged with

governance of the entity

whether the engagement team is competent to perform the audit engagement and has

the necessary capabilities, including time and resources

whether the firm and the engagement team can comply with relevant ethical

requirements

Significant matters that have arisen during the current or previous audit engagement

and their implications for continuing the relationship.

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Ethical requirements

Audit firms should expect the same commitment to quality and integrity on the part of their

clients as they do of themselves. As a result, many have developed and implemented improved

processes for approving new clients as well as reviewing relationships with existing clients.

An important part of the client acceptance process is for the prospective auditor to

communicate with the existing auditor in writing. A professional clearance letter enquires

whether there are any professional or other reasons why the engagement should not be

accepted. For example, one such reason may be a disagreement with some particular

accounting treatment the client wishes to adopt. However, before the existing auditor can pass

on any information to the prospective auditor, they must have the client’s authority to discuss

its affairs. If the client refuses permission then all the existing auditor can do is advise the

prospective auditor that there are matters they would like to discuss but the client has refused

permission for this, and this should speak volumes.

Adequate resources

Prior to acceptance or continuance of an audit engagement, the engagement partner must

determine that the audit team has the necessary technical expertise and sufficient resources

such as time and access to experts. The increasing complexity and regulation of audit requires

a significant investment of practice resources to maintain audit competence. Internal and

external reviews are an important mechanism to help practitioners decide whether they are

competent and adequately equipped to perform audits.

Key message

Typically the process of handling audit client acceptance and continuance varies with the size

of the firm, and such directives should be included in a firm's quality control manual. The

process should provide the audit firm with information to judge whether the entity meets or

exceeds the necessary standards of integrity and whether the firm has the capacity to perform a

quality audit. if these standards are not clearly met, the engagement should not be accepted. If

a client no longer meets the firm's standards, or when the firm cannot commit sufficient

resources to deliver a quality audit to the client, the auditor should not accept the engagement.

As with any auditing procedure, the process should be documented and all correspondence

retained as audit evidence.

The cost of client due diligence is a small fraction of the value of the engagement, and if the

outcome is acceptance this cost should be passed onto the client as part of the audit fee. If the

prospective client is not accepted, then clearly this is time and money well spent. The key

message is that audit firms can turn work down, a firm does not have to accept an audit

engagement, it can say “no” to clients that do not fit the risk profile of the firm and capital will

go where it is deserved. This will contribute towards developing a healthy and profitable

business.

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At a glance – red flag examples

1. Frequent changes of auditors – can mean an organisation is opinion shopping.

2. Poor financial history – prior failed business or bankruptcy could indicate a person who

takes unjustifiable risks.

3. Work/business history – is there unstable address, employment or professional history

4. Overly litigious as a plaintiff or defendant – signals a party who is not afraid to sue,

presents a risk of non-payment or who may not honour their agreements.

5. High turnover in upper management – can indicate a lack of internal stability.

6. Short operating history – where were the management team before they were at the

current organisation?

7. Foreign operations/plants – complex business structures may be concealing something.

8. Reluctance to provide references – if they are reluctant to disclose information now,

how will they be once they are a client?

9. Pressure to start work quickly – can be a sign that they do not want you looking into

their background.

10. Regulatory actions – can indicate poor internal controls or a management team ignoring

internal controls.

Engagement letters

The engagement letter will be sent before the audit. It specifies the nature of the contract

between the audit firm and the client and minimises the risk of any misunderstanding of the

auditor's role.

It should be reviewed every year to ensure that it is up to date but does not need to be reissued

every year unless there are changes to the terms of the engagement. The auditor must issue a

new engagement letter if the scope or context of the assignment changes after initial

appointment.

ISA 210 requires the auditor to consider whether there is a need to remind the entity of the

existing terms of the audit engagement for recurring audits and many firms choose to send a

new letter every year, to emphasise its importance to clients.

The contents of the engagement letter

The contents of a letter of engagement for audit services are listed in ISA 210 Agreeing the

Terms of Audit Engagements. They should include the following:

The objective and scope of the audit;

The responsibilities of the auditor;

The responsibilities of management;

The identification of an applicable financial reporting framework; and

Reference to the expected form and content of any reports to be issued_

In addition to the above the engagement letter may also make reference to:

The unavoidable risk that some material misstatements may go undetected due to the

inherent limitations in an audit;

Arrangements regarding the planning and performance of the audit;

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The expectation that management will provide written representations;

The agreement of management to make available to the auditor draft financial

statements and other information in time to complete the audit in accordance with the

proposed timetable;

The agreement of management to inform the auditor of facts that may affect the

financial statements;

The basis on which fees are computed and billing arrangements;

A request for management to acknowledge receipt of the engagement letter and to agree

the terms outlined;

Agreements concerning the involvement of auditors experts and internal auditors; and

Restrictions to the auditor's liability.

Recurring Audits

On recurring audits, the auditor should consider whether circumstances require the terms of

the engagement to be revised and whether there is a need to remind the client of the existing

terms of the engagement.

The auditor may decide not to send a new engagement letter each period. However, the

following factors may make it appropriate to send a new letter:

Any indication that the client misunderstands the objective and scope of the audit. Any

revised or special terms of the engagement.

A recent change of senior management or those charged with governance.

A significant change in ownership.

A significant change in nature or size of the client's business.

Legal or regulatory requirements.

Acceptance of a Change in Engagement

An auditor who, before the completion of the engagement, is requested to change the

engagement to one which provides a lower level of assurance, should consider the

A request from the client for the auditor to change the engagement may result from a change

in circumstances affecting the need for the service, a misunderstanding as to the nature of an

audit or related service originally requested or a restriction on the scope of the engagement,

whether imposed by management or caused by circumstances. The auditor would consider

carefully the reason given for the request, particularly the implications of a restriction on the

scope of the engagement.

A change in circumstances that affects the entity's requirements or a misunderstanding

concerning the nature of service originally requested would ordinarily be considered a

reasonable basis for requesting a change in the engagement. In contrast a change would not be

considered reasonable .if it appeared that the change relates to information that is incorrect,

incomplete or otherwise unsatisfactory.

Before agreeing to change an audit engagement to a related service, an auditor. who was

engaged to perform an audit in accordance with ISAs would consider, in addition to the above

matters, any legal or contractual implications of the change.

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TOPIC 5

OVERVIEW OF FORENSIC ACCOUNTING

NATURE PURPOSE AND SCOPE OF FORENSIC ACCOUNTING

Definition

Forensic accounting is the use of accounting skills to investigate fraud or embezzlement and to

analyze financial information for use in legal proceedings

Forensic accounting in its present state can be broadly classified into two categories

encompassing litigation support and investigative accounting.

1. Litigation support - is the provision of assistance of an accounting nature in a matter

involving existing or pending litigation. It is primarily focused on issues relating to the

quantification of economic damages, which means a typical litigation support

assignment would involve calculating the economic loss or damage resulting from a

breach of contract. However, it also extends to other areas involving valuations, tracing

assets, revenue recovery, accounting reconstruction and financial analysis. Litigation

support also works closely with lawyers in matters involving, but not limited to,

contract disputes, insolvency litigation, insurance claims, royalty audits, shareholders

disputes and intellectual property claims

2. Investigative accounting - in contrast, investigative accounting is concerned with

investigations of a criminal nature. A typical investigative accounting assignment could

be one involving employee fraud, securities fraud, insurance fraud, kickbacks and

advance fee frauds. No doubt in many assignments, both litigation support and

investigative accounting services are required.

Nature of forensic accounting

Forensic accounting is the specialty area of the accountancy profession which describes

engagements that result from actual or anticipated disputes or litigation. „Forensic" means

suitable for use in a court of law" and it is to that standard and potential outcome that forensic

accountants generally have to work. It is often said „Accountants look at the numbers but

Forensic accountants look behind the numbers. Forensic accountants are trained to look

beyond the numbers and deal with the business realities of the situation. Analysis,

interpretation, summarization and presentation of complex financial and business related

issues are prominent features of the profession Bhasin 2007.

The services provided by Forensic Accountants are as follows

1. Business valuations

2. Divorce proceedings and matrimonial disputes

3. Personal injury and fatal accident claims

4. Professional negligence

5. Insurance claims evaluations

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6. Arbitration

7. Partnership and corporation disputes

8. Shareholder disputes (minority shareholders claiming

9. Civil and criminal actions concerning fraud and financial irregularities - cross

examination, formulate questions

10. Fraud and white-collar crime investigations

Principal Duties of a Forensic Accountant

A forensic accountant's primary duty is to analyze, interpret, summarize and present complex

financial- and business-related issues in a manner that is both understandable by the layman

and properly supported by the evidence.

Forensic accountants are engaged by both government and private agencies cutting across

industries ranging from insurance companies, banks, police forces, regulatory agencies and

other financial and business organizations.

The services rendered by forensic accountants cover a wide spectrum of which the following

are commonly provided:

1. Investigation and analysis of financial evidence;

2. Development of computerized applications to assist in the analysis and presentation of

financial evidence;

3. Communication of findings in the form of reports, exhibits and collections of

documents;

4. Assistance in legal proceedings, including testifying in court as expert witness and

preparing visual aids to support trial evidence.

To properly carry out these functions, the forensic accountant must also be familiar with legal

concepts and procedures, including the ability to differentiate between substance and form

when struggling with any issue.

Specific Assistance in Investigative Accounting and Litigation Support

The forensic accountant can provide more specific assistance in the following ways.

Investigative accounting

1. Reviewing the factual situation and providing suggestions on alternative course of

action.

2. Assisting in the preservation, protection and recovery of assets.

3. Co-ordinating with other experts, including private investigators, expert document

examiners, consulting engineers and other industry specialists;

4. Assisting in the tracing and recovery of assets through civil, criminal and other

administrative or statutory proceedings.

Litigation support

1. Assisting in securing documentation necessary to support or rebut a claim.

2. Reviewing relevant documentation to provide a preliminary assessment of the case and

identify potential areas of loss and recovery.

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3. Assisting in the examination and discovery process, including the formulation of

relevant questions regarding financial evidence.

4. Attending to the examination and discovery process to review the testimony, assisting

with understanding the financial issues and formulating additional questions for

counsel.

5. Reviewing the opposing expert's reports on damages and the strengths and weaknesses

of the positions taken.

6. Assisting in settlement meetings and negotiations.

7. Attending the trial to hear testimony of opposing experts and assisting in the cross-

examination process.

Why Engage a Forensic Accountant?

A logical question to pose is why bring in a forensic accountant and his team when the

organisation's internal auditor and management team can handle the situation which can range

from a simple employee fraud to a more complex situation involving management itself? The

answer would be ' obvious when management itself is involved and the fallout to the discovery

of the fraud leads to low employee morale, adverse public opinion and perception of the

company's image and organisational disorganization generally. Engaging an external party can

have distinct advantages from conducting an internal investigation.

Key Benefits of Using Forensic Accountants

1. Objectivity and credibility - there is little doubt that an external party would be far more

independent and objective than an internal auditor or company accountant who

ultimately reports to management on his findings. An established firm of forensic

accountants and its team would also have credibility stemming from the firm's

reputation, network and track record.

2. Accounting expertise and industry knowledge - an external forensic accountant would

add to the organisation's investigation team with breadth and depth of experience and

deep industry expertise in handling frauds of the nature encountered by the

organisation.

3. Provision of valuable manpower resources - an organisation in the midst of

reorganisation and restructuring following a major fraud would hardly have the full-

time resources to handle a broad-based exhaustive investigation. The forensic

accountant and his team of assistants would provide the much needed experienced

resources, thereby freeing the organisation's staff for other more immediate

management demands. This is all the more critical when the nature of the fraud calls for

management to move quickly to contain the problem and when resources cannot be

mobilised in time.

4. Enhanced effectiveness and efficiency - this arises from the additional dimension and

depth which experienced individuals in fraud investigation bring with them to focus on

the issues at hand. Such individuals are specialists in rooting out fraud and would

recognise transactions normally passed over by the organisation's accountants or

auditors.

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Different roles of a forensic accountant

(i) Criminal Investigations

Practicing forensic accountants could be called upon by the police to assist them in

criminal investigations which could either relate to individuals or corporate bodies.

The forensic accountant would use his/her investigative accounting skills to examine

the documentary and other available evidence to give his/her expert opinion on the

matter. Their services could also be required by Government departments, the

Revenue Commissioners, the Fire Brigade, etc for investigative purposes.

(ii) Personal Injury Claims

Where losses arise as a result of personal injury, insurance companies sometimes

seek expert opinion from a forensic accountant before deciding whether the claim is

valid and how much to pay.

(iii) Fraud Investigations

Forensic accountants might be called upon to assist in business investigations which

could involve funds tracing, asset identification and recovery, forensic intelligence

gathering and due diligence review. In cases involving fraud perpetrated by an

employee, the forensic accountant will be required to give his/her expert opinion

about the nature and extent of fraud and the likely individual or group of individuals

who have committed the crime. The forensic expert undertakes a detailed review of

the available documentary evidence and forms his/her opinion based on the

information gleaned during the course of that review.

(iv) Professional Negligence

The forensic accountant might be approached in a professional negligence matter to

investigate whether professional negligence has taken place and to quantify the loss

which has resulted from the negligence. A matter such as this could arise between

any professional and their client. The professional might be an accountant, a lawyer,

an engineer etc. The forensic expert uses his/her investigative skills to provide the

services required for this assignment

(v) Expert Witness Cases

Forensic accountants Often attend court to testify in eh/il and criminal court

hearings, as expert witnesses. In such Cases, they attend to present investigative

evidence to the court so as to assist the presiding judge in deciding the outcome of

the case.

(vi) Meditation and Arbitration

Some forensic accountants because of their Specialist training they would have

received in legal mediation and arbitration, have extended their forensic accounting

practices to include providing Alternative Dispute Resolution (ADR) services to

clients. This service involves the forensic accountant resolving both mediation and

arbitration disputes which otherwise would have been expensive and time consuming

for individuals or businesses involved in commercial disputes with a third party.

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TOPIC 6

INTERNAL CONTROL SYSTEMS

Introduction

When carrying out the audit, the auditor first needs to carry out an evaluation of the internal

control systems and evaluate its operating effectiveness and its efficiency. This will help the

auditor to ascertain the degree of reliance he or she is going to place on the controls and hence

the level of the level of tests the needs to be carried on the final balances. To ascertain the

effectiveness of these controls, the auditor carries out tests of control. The tests of control will

also help the auditor have a better understanding of the entity. Internal control is covered by

the International Standard on Auditing (ISA) 315 on Understanding the entity and its

environment and assessing the risk of material misstatement.

Internal audit is normally set up by the management to help in the risk assessment process and

to ensure the company adheres to good corporate governance. This function can either be

carried out in-house whereby the employees of the company employed as the internal auditors

or it can be outsourced. Internal auditing is covered by the International Standard of Auditing

(ISA) 610 on considering the work of internal auditing.

ISA 400 defines an accounting system as the series of tasks and procedures by which

transaction are procedures as a means of maintaining proper financial records. The accounting

system identifies, assembles, analyses, defines, records and summarizes transactions of an

entity the mgt requires complete and accurate accounting and other records to assist in

executing their responsibilities which are:

Safeguarding the company assets and preventing fraud and error

Selecting suitable accounting policies and applying them consistently

Ensuring that the company keeps proper accounting records as per the Companies Act.

Delivering to the government agency, court or stock exchange a copy of the company’s

auditor financial statements within the specified period after year-end.

Stating whether applicable accounting standards have been followed subject to any

material departure disclosed and explained in the financial statements.

Prepare the financial statements on a going concern basis unless it is appropriate to

presume that the company will continue operations.

Setting up an internal control system to enable all the above responsibilities to be

carried out as required.

ISA 400 defines internal control system as all the policies and procedures adopted by

management to in achieving objectives as far as practicable. The objectives of an internal

control system are: -

Orderly and efficient conduct of business.

Adherence to management policies.

Safeguarding of company assets

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Prevention and detection of fraud and error.

Accuracy and completeness of accounting records.

Timely preparation of reliable financial information.

Component of accounting and internal control system

These are:-

1. Risk assessment

2. Control environment

3. Control procedures

1. Risk assessment

Audit risk means the risk that the auditor may give an inappropriate audit opinion i.e. the

auditor may report that the financial statements show a true and fair view while in reality they

are materially misstated.

Audit risk is composed of:

a) Inherent risk

b) Control risk

c) Detection risk

d) Inherent risk

a) Inherent risk

This is the risk that the account balances are transactions could be materially misstated

assuming that there were no internal control system. Inherent risk could increase a result of an

adverse attitude of managers on the internal control system i.e. if they view internal control

system as unimportant.

b) Control risk

This is the risk that a material misstatement could occur in an account balance or clan of

transactions which will not be prevented or detected in a timely manner by the entity‟s

accounting and internal control system.

c) Detection risk

This is the risk that the auditor‟s tests of balances and transactions will not detect a material

misstatement that exists in an accounts balance or class of transactions. This implies that

detection risk is the only component of audit risk under the auditor‟s control.

Risk based audit

This audit uses a model called audit risk model. If inherent risk and control risk are assessed to

be high, then to remain within an overall acceptable audit risk, the level of acceptable

detection risk must be low meaning that the level of tests of balances and transactions must be

relatively high. If inherent and control risks are assessed to be low, then the level of acceptable

detection risk may be higher leading to relatively lower level of tests of balances and

transactions. Therefore the assessment of inherent and control risk is an essential part in

deciding the overall approach to an audit.

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For the audit model, audit risk equals inherent risk multiplied by the control risk and detection

risk.

Advantages of audit risk model

Helps eliminate over or under auditing because the nature, extent and timing of audit

procedures performed is determined by the risk assessment carried out.

The results appear more rational and defensible than if the model was not used. i.e.

incase the auditor is called upon to support his decisions in a court of law, he can justify

the level of reliance on the internal control system and the amount of substantive tests

carried out

Helps allow work to be delegated to junior members of audit staff who will be able to

carry on without having to rely too much on their own judgment.

The increased use of computer in business has made the calculations of audit risk easier

leading to more efficient and effective audit.

Disadvantages

The model gives an impression of accuracy which is unrealistic as in practice its

difficult to put a quantitative value on inherent risk.

For the model to be useful, the number of items being tested need to be sufficiently

large to allow for valid statistical conclusions to be made. This rule out the use of the

model in many small audits.

The model has a danger of adapting an overly mechanistic approach and that the

auditor may lose his „feel‟ for the audit assignment.

It requires proper knowledge of the burden to be able to assess the audit risk.

A wrong assessment of inherent and control risk will lead to over or under auditing.

2. Control Environment

ISA 400 refers control environment as being the overall attitude, awareness and actions of

directors and management regarding the internal control system and its importance to the

entity.

The control environment has an effect on the effectiveness of the specific control procedures.

A strong control environment i.e. one with tight budgetary control and an effective internal

audit function can significantly complement specific control procedures. Thus the control

environment sets the tone of the entity by influencing the control consciousness of people. It

may be viewed as the foundation of other components of internal control.

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Factors influencing the control of environment

The function of the board of directors or the audit committee. The control environment

is significantly influenced by the effectiveness of the board of directors or the audit

committee. This effectiveness is determined by the extent of its independence from

management, experience and status of members and the extent to which it raises and

pursues difficult matters with management and also its relationship with internal and

external auditors.

Management philosophy, style and ease with which managers could override controls.

Management philosophy refers to whether the management likes taking risk in business

or has a conservative approach. This has an impact on the overall reliability of financial

statements. If they are risk takers, losses are likely and may want to hide them. If they

are conservative to risk, there may be no business hence low profits and this may lead

to falsification of financial statements.

The implementation of organizational structure and methods of assigning authority and

responsibility. This determines how well employees understand the limits placed upon

their powers and responsibilities. The objective is to separate responsibility for

authorizing a transaction, keeping records for the transaction and custody of assets

acquired from the transaction.

Personnel policies and procedures. Employees should be recruited on basis of skills and

knowledge essential for the performance of their jobs and if necessary, be trained

3. Control procedures

These are the policies and procedures in addition to the control environment, which the

management has established to achieve the entity‟s specific objectives. The mix of types of

controls implemented by mgt will depend on the control objectives and the size of the entity.

a) Organizational plan chart

Companies should have proper organization plans. An organized plan shows clearly the

various departments within the company, their functions and persons charged with ensuring

that such functions are fulfilled. They seek to ensure that the entity is properly

departmentalized preventing duplication of duties across departments and boosting

accountability within the entity. Delegation and limits of authority should be well and clearly

defined.

b) Segregation of duties.

This refers to separation of various duties and responsibilities such that one person cannot

process and record a complete transaction from beginning to the end without being checked by

another person. E.g. in purchase of fixed assets, an individual should not authorize the

purchase, place the order, receive the assets, record the transaction and keep custody of the

assets. To minimize risk of error and or intention the following should be performed by

different individuals and departments as much as practicable.

Initiation of transaction. This is where if an item is found to be out of stock and a

requisition is made.

Authorization Different levels of management should be given limits as to what they

can authorize or to what extent they can commit company resources.

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TOPIC 7

AUDIT EVIDENCE

FINANCIAL STATEMENT ASSERTIONS AND AUDIT EVIDENCE

Financial Statement Assertions are the implicit or explicit claims and representations made

by the management responsible for the preparation of financial statements regarding the

appropriateness of the various elements of financial statements and disclosures.

Financial Statement Assertions are also known as Management Assertions and Audit

Assertions.

In preparing financial statements, management is making implicit or explicit claims (i.e.

assertions) regarding the recognition, measurement and presentation of assets, liabilities,

equity, income, expenses and disclosures in accordance with the applicable financial reporting

framework (e.g. IFRS).

For example, if a balance sheet of an entity shows buildings with carrying amount of sh.10

million, the auditor shall assume that the management has claimed that:

The buildings recognized in the balance sheet exist at the period end;

The entity owns or controls those buildings;

The buildings are valued accurately in accordance with the measurement basis;

All buildings owned and controlled by the entity are included within the carrying

amount of sh.10 million.

Types & Examples

Assertions may be classified into the following types:

Assertions relating to classes of transactions

Assertions Explanation Examples: Salaries & Wages Cost

Occurrence

Transactions recognized in the

financial statements have

occurred and relate to the entity.

Salaries & wages expense has been incurred during

the period in respect of the personnel employed by the

entity. Salaries and wages expense does not include

the payroll cost of any unauthorized personnel.

Completeness

All transactions that were

supposed to be recorded have

been recognized in the financial

statements.

Salaries and wages cost in respect of all personnel

have been fully accounted for.

Accuracy

Transactions have been recorded

accurately at their appropriate

amounts.

Salaries and wages cost has been calculated

accurately. Any adjustments such as tax deduction at

source have been correctly reconciled and accounted

for.

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Cut-off

Transactions have been

recognized in the correct

accounting periods.

Salaries and wages cost recognized during the period

relates to the current accounting period. Any accrued

and prepaid expenses have been accounted for

correctly in the financial statements.

Classification

Transactions have been

classified and presented fairly in

the financial statements.

Salaries and wages cost has been fairly allocated

between:

-Operating expenses incurred in production activities;

-General and administrative expenses; and

-Cost of personnel relating to any self-constructed

assets other than inventory.

Assertions relating to assets, liabilities and equity balances at the period end

Assertions Explanation Examples: Inventory balance

Existence Assets, liabilities and equity

balances exist at the period end.

Inventory recognized in the balance sheet exists at the

period end.

Completeness

All assets, liabilities and equity

balances that were supposed to

be recorded have been

recognized in the financial

statements.

All inventory units that should have been recorded

have been recognized in the financial statements. Any

inventory held by a third party on behalf of the audit

entity has been included in the inventory balance.

Rights &

Obligations

Entity has the right to

ownership or use of the

recognized assets, and the

liabilities recognized in the

financial statements represent

the obligations of the entity.

Audit entity owns or controls the inventory

recognized in the financial statements. Any inventory

held by the audit entity on account of another entity

has not been recognized as part of inventory of the

audit entity.

Valuation

Assets, liabilities and equity

balances have been valued

appropriately.

Inventory has been recognized at the lower of cost

and net realizable value in accordance with IAS 2

Inventories. Any costs that could not be reasonably

allocated to the cost of production (e.g. general and

administrative costs) and any abnormal wastage has

been excluded from the cost of inventory. An

acceptable valuation basis has been used to value

inventory cost at the period end (e.g. FIFO, AVCO,

etc.)

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Assertions relating to presentation and disclosures

Assertions Explanation Examples: Related Party

Disclosures

Occurrence

Transactions and events disclosed

in the financial statements have

occurred and relate to the entity.

Transactions with related parties

disclosed in the notes of financial

statements have occurred during the

period and relate to the audit entity.

Completeness

All transactions, balances, events

and other matters that should have

been disclosed have been disclosed

in the financial statements.

All related parties, related party

transactions and balances that should

have been disclosed have been

disclosed in the notes of financial

statements.

Classification &

Understandability

Disclosed events, transactions,

balances and other financial

matters have been classified

appropriately and presented clearly

in a manner that promotes the

understandability of information

contained in the financial

statements.

The nature of related party

transactions, balances and events has

been clearly disclosed in the notes of

financial statements. Users of the

financial statements can clearly

determine the financial statement

captions affected by the related party

transactions and balances and can

easily ascertain their financial effect.

Accuracy &

Valuation

Transactions, events, balances and

other financial matters have been

disclosed accurately at their

appropriate amounts.

Related party transactions, balances

and events have been disclosed

accurately at their appropriate

amounts.

AUDIT EVIDENCE

Audit evidence refers to the information obtained by the auditor in arriving at the conclusions

on which audit opinion on the financial statements is based. Audit evidence comprises of

source documents and accounting records underlying the financial statements. The accounting

records generally include:

Records of initial entries and supporting records

Records of electronic fund transfers, invoices, contracts and cheques.

General and subsidiary ledgers, journal entries and other adjustments to the financial

statements not reflected in the journal entries

Records such as work sheets and spread sheets supporting cost allocations,

computations and reconciliations.

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Other information the auditor can use as audit evidence are:

Minutes of meetings

Confirmations form third parties

Analysis reports

Comparable data about competitors.

Control annuals.

Information obtained by auditor from audit procedure such as observation and

enquiries.

The sources and amount of evidence needed to achieve the required level of assurance is

determined by the auditor’s judgment. The auditor’s judgment will be influenced by the

materiality of item being examined, the relevance and reliability of evidence available from

each source and cost involved in obtaining it. Audit evidence is obtained through an

appropriate mix of tests of controls and substantive procedures where internal control system

is considered weak; evidence may be obtained entirely from substantive procedures.

Substantive tests are procedures carried out to test the accuracy and validity of accounting

records. They are of two types i.e. analytical review procedure and test of detail.

Qualities of audit evidence

ISA 500 requires that „the auditor should obtain sufficient audit evidence to be able to draw

reasonable conclusions on which to base the audit opinion.‟

What do we mean by:

a) Sufficiency

b) Appropriate

Sufficient means that there needs to be enough evidence. What is enough is a matter of

professional judgment.

Appropriate break down into:

a) Relevance.

Relevance of audit evidence should be considered in relation to the overall audit objective of

forming an opinion and reporting on financial statements. It therefore refers to the ability of

the evidence to assist the auditor in testing management assertions.

b) Reliability

Reliability of audit evidence refers to the credibility of that evidence the credibility is

influenced by its source and its nature

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TOPIC 8

OVERALL AUDIT REVIEW

SUBSEQUENT EVENTS REVIEWS

Subsequent events are transactions occurring after the balance sheet date, but before the

financial statements are either issued or available to be issued.

Auditors must take steps to ensure that any such events are properly reflected in the financial

statements.

To identify any such events, a subsequent events review is carried out.

There are two types of subsequent events:

1. Adjusting event

Event after the reporting period that provides further evidence of conditions that existed

at the end of the reporting period, including events that indicates that the going concern

assumption in relation to the whole or part of the enterprise is not

2. Non-adjusting event

Events after the reporting period that are indicative of a condition that arose after the

end of the reporting period.

Example 1

You are the trainee accountant of Gabriella Enterprises Co and are preparing the financial

statements for the year-ended 30 September 2012. The financial statements are expected to be

approved in the Annual General Meeting, which is to be held on Monday 29 November 2010.

Today’s date is 22 November 2010. You have been made aware of the following matters:

1. On 14 October 2010, a material fraud was discovered by the bookkeeper. The payables

ledger assistant had been diverting funds into a fictitious supplier bank account, set up

by the employee, which had been occurring for the past six months. The employee was

immediately dismissed, legal proceedings against the employee have been initiated and

the employee’s final wages have been withheld as part-reimbursement back to the

company.

2. On 20 September 2010, a customer initiated legal proceedings against the company in

relation to a breach of contract. On 29 September 2010, the company’s legal advisers

informed the directors that it was unlikely the company would be found liable;

therefore no provision has been made in the financial statements, but disclosure as a

contingent liability has been made. On 29 October 2010, the court found the company

liable on a technicality and is now required to pay damages amounting to a material

sum.

3. On 19 November 2010, a customer ceased trading due to financial difficulties owing

$2,500. As the financial statements are needed for the board meeting on 22 November

2010, you have decided that because the amount is immaterial, no adjustment is

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required. The auditors have also confirmed that this amount is immaterial to the draft

financial statements.

Required:

(a) For each of the three events above, you are required to discuss whether the financial

statements require amendment.

Answer:

When presented with such scenarios, it is important to be alert to the timing of the events in

relation to the reporting date and to consider whether the events existed at the year-end, or not.

If the conditions did exist at the year-end, the event will become an adjusting event. If the

event occurred after the year-end, it will become a non-adjusting event and may simply

require disclosure within the financial statements.

1. Fraud

Clearly the fraud committed by the payables ledger clerk has been ongoing during, and

beyond the financial year. Fraud, error and other irregularities that occur prior to the year-end

date – but which are only discovered after the year-end – are adjusting items, and therefore the

financial statements would require amendment to take account of the fraudulent activity up to

the year-end.

2. Legal proceedings

At the year-end, the company had made disclosure of a contingent liability. However,

subsequent to the year-end (29 October 2010), the court found the company liable for breach

of contract. The legal proceedings were issued on 20 September 2010 (some 10 days before

the year-end). This is, therefore, evidence of conditions that existed at the year-end. IAS 10

requires the result of a court case after the reporting date to be taken into consideration to

determine whether a provision should be recognised in accordance with IAS 37, Provisions,

Contingent Liabilities and Contingent Assets at the year-end. In this case, the financial

statements will require adjusting because:

the conditions existed at the year-end

the recognition criteria for a provision in accordance with IAS 37 have been met.

3. Loss of customer

A customer ceasing to trade so soon after the reporting period indicates non-recoverability of a

receivable at the reporting date and therefore represents an adjusting event under IAS 10,

Events After the Reporting Period. Assets should not be carried in the statement of financial

position at any more than their recoverable amount and, therefore, an allowance for

receivables should be made.

The auditor should obtain sufficient appropriate audit evidence about whether events occurring

between the date of the financial statements and the date of the auditor's report that require

adjustment of, or disclosure in, the financial statements are appropriately reflected in those

financial statements in accordance with the applicable financial reporting framework;

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Subsequent events reviews — what auditors need to do

ISA 560 Subsequent Events details the responsibilities of the auditors with respect to

subsequent events and the procedures they can use. As auditors are responsible for their audit

work right up to the date that the financial statements are issued, they should perform

subsequent event reviews until that date has passed.

However, the nature of their responsibility changes at the point the audit report is signed.

Procedures undertaken in performing a subsequent events review might include any of the

following:

• Enquiring into management procedures/systems for the identification of subsequent

events.

• Reading minutes of members' and directors' meetings and of audit and executive

committee meetings, and enquiring about matters not yet put in the minutes.

• Reviewing accounting records including -budgets, forecasts and interim information.

• Making enquiries of directors to ask if they are aware of any subsequent events,

adjusting or non-adjusting, that have not yet been included or disclosed in the financial

statements.

• `Normal' post balance sheet work performed in order to verify yearend balances:

checking after date receipts from receivables verifying the value of accrued

expenses by checking invoices when received

checking inventory valuations are at lower cost and net realisable value by testing

to eventual selling prices.

• Obtaining, from management, a letter of representation.

Subsequent events review — changes triggered by the signing of the audit report

The stage of completion of the annual financial statements determines the procedures the

auditor must undertake in performing subsequent event reviews.

1. Events Up to signing the audit report

Auditors have an active duty to search for all material events between the balance sheet date

and the date the audit report is signed.

The auditor shall perform audit procedures designed to obtain sufficient appropriate audit

evidence that all events occurring between the date of the financial statements and the date of

the auditor's report that require adjustment of, or disclosure in, the financial statements have

been identified. The auditor is not, however, expected to perform additional audit procedures

on matters to which previously applied audit procedures have provided satisfactory

conclusions.

The auditor shall perform the procedures required so that they cover the period from the date

of the financial statements to the date of the auditor's report, or as near as practicable thereto.

The auditor shall take into account the auditor's risk assessment in determining the nature and

extent of such audit procedures, which shall include the following:

a) Obtaining an understanding of any procedures management has established to ensure

that subsequent events are identified.

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TOPIC 9

AUDIT REPORT

7th SCHEDULE PROVISIONS ON AUDIT REPORT

Companies Act stipulates the statements that should be expressly stated in the auditor’s

report. These are;

1. Whether they have obtained all the information and explanations which to the best of

their knowledge and belief were necessary for the purposes of their audit.

2. Whether in their opinion, proper books of account have been kept by the company, so

far as appears from their examination of those books, and proper returns adequate for

the purposes of their audit have been received from branches not visited by them.

3.

- Whether the company's balance sheet and (unless it is framed as a consolidated profit

and loss account) profit and loss account dealt with by the report are in agreement

with the books of account and returns.

- Whether, in their opinion and to the best of their information and according to the

explanations given to them, the said accounts give the information required by this

Act in the manner so required and give a true and fair view—

(a) in the case of the balance sheet, of the state of the company's affairs as at the

end of its financial year; and

(b) in the case of the profit and loss account, of the profit or loss for its financial

year; or, as the case may be, give a true and fair view thereof subject to the

non-disclosure of any matters (to be indicated in the report) which by virtue of

Part III of the Sixth Schedule are not required to be disclosed.

4. In the case of a company which is a holding company and which submits group

accounts whether, in their opinion, the group accounts have been properly prepared in

accordance with the provisions of this Act so as to give a true and fair view of the state

of affairs and profit or loss of the company and its subsidiaries dealt with thereby, so far

as concerns members of the company, or, as the case may be, so as to give a true and

fair view thereof subject to the non-disclosure of any matters (to be indicated in the

report) which by virtue of Part III of the Sixth Schedule are not required to be

disclosed.

When financial statements are finalised, they usually must contain an evaluation – an auditor's

report - from a licensed accountant or auditor. This report provides an overview of the

evaluation of the validity and reliability of a company or organization’s financial statements.

The goal of an auditor's report is to document reasonable assurance that a company’s financial

statements are free from error.

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An audit of a company’s financial statements should result in a report wherein the accountant

or auditor is free to share their opinion about the validity and reliability of a company’s

financial statements.

In this report, the auditor should provide an accurate picture of the company and their financial

statements. The auditor should also state whether they are externally or internally connected to

the company.

Within the report, the auditor can share any reservations about the condition of the company’s

finances or relevant additional information. Reservations could arise if the auditor disagrees

with something found in the financial statements, e.g. if the auditor disagrees with

management about the valuation of an asset because they believe that this has a more

significant impact on the financial statements.

In the report there are rules concerning what an auditor's report should include and the order in

which various items should be reported.

Auditor's reports must adhere to accepted standards established by governing bodies. The

governing bodies help to assure external users that the auditor's opinion on the fairness of

financial statements is based on a commonly accepted framework.

BASIC ELEMENTS

The Companies Act does not stipulate the form the auditor’s report should take. The auditing

standards seek to ensure that the auditor’s report is clear and unambiguous. To this end, it

seeks to standardize the form of the auditor’s report. It does this by giving the basic elements

of the auditor’s report.

i. Appropriate report title

Auditing standards require that the report be titled and that the title includes the word

“independent‟ e.g. independent auditors report‟. The requirement that the title includes the

word independent is intended to convey to users that the audit was unbiased in all aspects.

ii. Address

The report is usually addressed to the company, its stockholders or the board of directors. For

practical reasons, it limits the users of auditor’s report.

iii. Introductory paragraph

The first paragraph has three purposes, fist, it makes a statement that the practice did an audit.

Secondly, it lists all the financial statements that were audited including the balance sheet

dates and accounting periods for the income statement and cash flow statement. The wording

of the financial statements in the report should be identical to those used by management on

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the financial statements. Thirdly, the introductory paragraph states that the statements are the

responsibility of management and that the auditor’s responsibility is to express an opinion on

the statements based on the audit.

iv. Scope paragraph

This paragraph is a factual statement about what the auditor did in the audit. This paragraph

states how the audit was planned and performed in accordance with ISAs and states that the

audit is designed to obtain reasonable assurance whether the financial statements are free of

material misstatements.

v. Opinion paragraph

This final paragraph states the auditors conclusions based on the results of the audit. This part

of the report is so important that often the audit report is simply called the auditor’s opinion.

The opinion paragraph is stated as an opinion rather than a statement of absolute fact or a

guarantee.

vi. Audit report date

The appropriate date for the report is the one on which the auditor has completed the most

important audit procedures in the field. This date is important to users of financial statements

as it indicates the last day of auditor’s responsibility for review of significant events that have

occurred after date of financial statements.

vii. Name of audit firm

The firm’s name is used because the entire firm has the legal responsibility to ensure that the

quality of audit meets professional standards.

TYPES OF OPINIONS

a) Unqualified opinion.

b) Disclaimer opinion

c) Qualified opinion

d) Adverse opinion

Unqualified opinion

This is issued when the auditor is satisfied in all material aspects that enable him express the

required opinion on financial statements without any reservation. This is sometimes called a

clean opinion. It is expressed when the auditor concludes that the financial statements give a

true and fair view in accordance with the relevant financial reporting standards.

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TOPIC 10

AUDITING IN THE PUBLIC SECTOR

INTRODUCTION TO AUDITING IN THE PUBLIC SECTOR; REGULATORY

PROVISIONS

Objectives of public-sector auditing

1. The public-sector audit environment is that in which governments and other public-

sector entities exercise responsibility for the use of resources derived from taxation and

other sources in the delivery of services to citizens and other recipients. These entities

are accountable for their management and performance, and for the use of resources,

both to those that provide the resources and to those, who depend on the services

delivered using those resources, for example citizens, Public-sector auditing helps to

create suitable conditions and reinforce the expectation that public-sector entities and

public servants will perform their functions effectively, efficiently, ethically and in

accordance with the applicable laws and regulations.

2. In general public-sector auditing can be described as a systematic process of objectively

obtaining and evaluating evidence to determine whether information or actual

conditions conform to established criteria. Public-sector auditing is essential in that it

provides legislative and oversight bodies, those charged with governance and the

general public with information and. independent and objective assessments concerning

the stewardship and performance of government policies, programs or operations.

3. Supreme Audit Institutions serve this aim as important pillars of their national

democratic systems and governance mechanisms and play an important role in

enhancing public-sector administration by emphasizing the principles of transparency,

accountability, governance and performance.

Public-sector auditing contributes to good governance by:

1. Providing the intended users with independent, objective and reliable information,

conclusions or opinions based on sufficient and appropriate evidence relating to public

entities;

2. Enhancing accountability and transparency, encouraging continuous improvement and

sustained confidence in the appropriate use of public funds and assets and the

performance of public administration;

3. Reinforcing the effectiveness of those bodies within the constitutional arrangement that

exercise general monitoring and corrective functions over government, and those

responsible for the management of publicly-funded activities;

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4. Creating incentives for change by providing knowledge,- comprehensive analysis and

well- founded recommendations for improvement.

Types of public-sector audit

In general, public-sector audits can be categorized into three main types: audits of financial

statements, performance audits and audits of compliance with authorities.

1. Financial audit focuses on determining whether an entity's financial information is

presented in accordance with the applicable financial reporting and regulatory

framework. This is accomplished by obtaining sufficient and appropriate audit evidence

to enable the auditor to express an opinion as to whether the financial information is

free from material misstatement ^ due to fraud or error.

2. Performance audit focuses on whether interventions, programmes and institutions are

performing in accordance with the principles of economy, efficiency and effectiveness

and whether there is room for improvement. Performance is examined against suitable

criteria, and the causes of deviations from those criteria or other problems are analyzed.

The aim is to answer key audit questions and to provide recommendations for

improvement.

3. Compliance audit focuses on whether a particular subject matter is in compliance with

authorities identified as criteria. Compliance auditing is performed by assessing

whether activities, financial transactions and information are, in ail material respects, in

compliance with the authorities which govern the audited entity. These authorities may

include rules, laws and regulations, policies, established codes, agreed terms or the

general principles governing sound public-sector financial management and the conduct

of public officials.

ELEMENTS OF PUBLIC-SECTOR AUDITING

All public-sector audits have the same basic elements: the auditor, the responsible party,

intended users (the three parties to the audit), the subject matter and the criteria for assessing

the subject matter.

1. The auditor: In public-sector auditing the role of auditor is fulfilled by the Head of the

SA1 and by persons to whom the task of conducting the audits is delegated. The overall

responsibility for public-sector auditing remains as defined by the SAI's mandate.

2. The responsible party: In public-sector auditing the relevant responsibilities are

determined by constitutional or legislative arrangement. The responsible parties may be

responsible for managing the subject matter or for addressing recommendations, and

may be individuals or organizations.

3. Intended users: The individuals, organizations or classes thereof for whom the auditor

prepares the audit report. The intended users may be legislative or oversight bodies,

those charged with governance or the general public.

4. Subject matter refers to the information, condition or activity that is measured or

evaluated against certain criteria. It can take many forms and have different

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