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Topics for discussion Topics for discussion today today Preliminary engagement activities Planning process
◦Overview ◦Risk and materiality ◦Audit strategy & audit plan
Going concern & factual insolvencySubsequent Events Fraud, AP Act (if time available)Reporting (if time available)
March 2010 5Advanced Auditing Lecture 1
Preliminary Engagement Preliminary Engagement Activities Activities References:
◦ ISA 220 – Quality Control for Audits ◦ ISQC 1 – Quality Control for Firms◦ ISA 210 – Agreeing the terms of audit
engagements
Objectives of Preliminary Engagement Activities ◦ Related to client
the acceptability of a new client OR Consider the ability to continue as auditors for
existing clients ◦ Provision of a quality audit ◦ Regulatory and ethical considerations
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Preliminary Engagement Preliminary Engagement Activities Activities Why perform Preliminary
Engagement Activities ?◦Limitation of auditor’s risks by not
accepting unsatisfactory clients Firm’s professional reputation could suffer
Negative publicity (lawsuits; client failures)
◦Types of risks faced by auditor Legal liability
Against the firm because of company failures (= audit failures)
Reputational damage Because of being associated with a particular client
19 February 2009 7Advanced Auditing
Preliminary Engagement Preliminary Engagement ActivitiesActivitiesStep 1: Perform a Client
Investigation ◦Consider: Independence of Auditor
Overriding requirement of a statutory audit Threats to independence
IFAC Code of Ethics
◦Consider: Integrity of Client Matters to consider include
Business reputation of owners and management Nature of operations Attitude of management regarding interpretation of
accounting standards
19 February 2009 8Advanced Auditing
Preliminary Engagement Preliminary Engagement ActivitiesActivitiesStep 1: Perform a Client
Investigation ◦Consider: Integrity of Client
Matters to consider include Attitude towards keeping audit fee as low as
possible Indications of limitations of scope of audit work Illegal activities of client Reasons for non-reappointment of previous auditor
◦Consider: Changes to Existing Client Refer above
19 February 2009 9Advanced Auditing
Preliminary Engagement Preliminary Engagement ActivitiesActivitiesStep 1: Perform a Client Investigation
◦ Consider: Communication with previous auditor In terms of IFAC Code of Ethics
Informed of intention to replace? Permission to discuss client? Has client’s permission been obtained to discuss client?
No?
◦ Consider: financial responsibility of client Ability and willingness to pay audit fee?
◦ Consider: legal procedures in respect of the engagement Does a vacancy exist?
19 February 2009 10Advanced Auditing
Preliminary Engagement Preliminary Engagement ActivitiesActivitiesStep 2: Determine the auditor’s skills
and competence requirements ◦Does the firm has the necessary
capabilities, competencies, time, and resources?
◦Considerations Knowledge of industry Experience of relevant regulatory or reporting
requirements (or able to obtain such skills) Sufficient personnel with required skills and
competencies Experts available (if needed) Able to meet the audit deadline
19 February 2009 11Advanced Auditing
Preliminary Engagement Preliminary Engagement Activities Activities Step 3: Establish the terms of
engagement ◦Confirmation of relationship ◦Contractual relationship ◦Removal of any misunderstanding◦Copy of letter to be filed in working
papers ◦Reference: ISA 210 – Engagement
Letters Refer to Appendix 1 for example of an
engagement letter
19 February 2009 12Advanced Auditing
Planning: An Overview Planning: An Overview Obtaining an understanding of the
entity, including internal controls Assessing the risk of material
misstatement in the financial statements
Determining materiality Establishing the overall audit
strategy &Developing the audit plan
March 2010 Advanced Auditing Lecture 1 13
Audit Risk and Materiality Audit Risk and Materiality AUDITING NOTES:
◦ Chapter 7. Important Elements of the Audit Process- Concept of Materiality and Audit Risk.
SAICA HANDBOOK:◦ ISA 240: The Auditor’s responsibilities relating to fraud in
an audit of financial statements. ◦ ISA 315: Identifying and assessing the risks of material
misstatement through understanding the entity and its environment.
◦ ISA 320: Materiality in planning and performing an audit. ◦ ISA 330: The Auditor’s responses to assessed risks. ◦ ISA 450: Evaluation of misstatements identified during the
audit◦ ISA 510: Initial audit engagements – opening balances. ◦ ISA 520: Analytical Procedures.
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Advanced Auditing
Audit Risk : the aAudit Risk : the auditor’s uditor’s objective objective
Identify and assess risks of material misstatement ◦ High, Medium, Low
Risk may be due to ◦ FRAUD (ISA 240) or ERROR
2 Levels of risk ◦ Financial Statement level AND Assertion level
How?◦ By obtaining an understanding of entity and its
environment, including internal control Why?
◦ Provides a basis for designing and implementing responses to assessed risks of material misstatement
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Audit Risk Audit Risk
Definition of Audit Risk ◦ The risk that the auditor expresses an
inappropriate audit opinion when the annual financial statements are materially misstated
◦ Audit Risk is a function of the risks of material misstatement (IR & CR), and Detection Risk (Ref: Glossary of Terms)
Risk-based auditing 11 Feb 2010
16Advanced Auditing
ISA 315 ISA 315 Identification of risks
◦Obtaining an understanding of the entity and its environment, including Internal Control
Assessing identified risks ◦Evaluating whether the risks relate more
pervasively to the AFS as a whole ◦Relating the risks to what can go wrong
at the assertion level ◦Considering the likelihood of
misstatement, and possible magnitude of the misstatement
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ISA 315 ISA 315 Significant Audit Risks
◦Risk of fraud ◦Risk related to significant economic,
accounting, or other developments that require specific attention
◦Complex transactions ◦Significant transactions with related
parties ◦Degree of subjectivity ◦Transactions outside normal course of
business for entity
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ISA 315 ISA 315 Where auditor revises assessment of
Audit Risk◦Where assessment changes during the
audit Revision of assessment Modification of audit procedures
Documentation required ◦Discussions between audit team ◦Key elements of understanding ◦ Identified risks
FS level Assertion level
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ISA 315 ISA 315 The link between ISA 315 and Audit
Risk?A failure to identify factors that may
give rise to the risk of material misstatement (and a failure to respond to such risks) Increase in audit risk
Failure to understand The entity and its environment The accounting system and internal control
systems
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The Client Risks The Client Risks “Inherent Risk”
◦Built-in risk that exists before internal controls are put in place!!!
◦Risks related to specific type of industry and type of client
◦Develop assessment by gaining understanding of entity and its environment (A17 – A41) Industry, regulatory and external factors Nature of entity Objectives and strategies, and related business
risks Financial performance of entity
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Advanced Auditing
The Client Risks The Client Risks “Control Risk”
◦ A66 Evaluation of design of control involves considering
whether control is capable of effectively preventing, or detecting and correcting, material misstatements.
Implementation of a control means that the entity is using it
No point in testing a control if it is not designed properly
◦ A67 Risk assessment procedures
Enquiry of personnel Observing the applicable controls Inspecting reports and documentation Tracing transactions i.e. Walk-through
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The Client Risks The Client Risks Control risk
◦Control activities Control environment – NB!!!
E.g. Management override The entity’s risk assessment process The information system Control activities Monitoring of internal controls
◦Essential to evaluate the effect of the identified weaknesses (in system) on the financial statement assertions
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Advanced Auditing
The Auditor’s RiskThe Auditor’s Risk
Detection risk ◦Risk that the auditor will not detect a
misstatement that exists and could be material Risk that is inherent in the client’s
operations and IS NOT addressed by the client’s control system
◦Detection risk is a function of the effectiveness of the auditor’s audit procedures
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The Auditor’s Risk The Auditor’s Risk
Detection risk ◦Detection risk may arise because
Inappropriate audit procedure Misapplication of a procedure Misinterpretation of the results of a
procedure
◦There is an INVERSE relationship between risk of material misstatement [IR & CR] and Detection Risk
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Assessing risk at two Assessing risk at two levels levels
At financial statement levelWill potentially affect many assertions Factors that may affect audit risk at
the financial statement level Management's integrity
Manipulation of AFS to meet their own needs Management’s experience and knowledge
Errors in AFS Pressure on management
Many business failures in industry Need to raise loans
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Assessing risk at two Assessing risk at two levels levels
At financial statement level Factors that may affect audit risk at the
financial statement level (cont.) Nature of entity’s business Factors affecting the industry (→ going
concern problems) Economic conditions Consumer demand for company’s products
Need to consider how these factors will impact on the AFS
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Assessing risk at two Assessing risk at two levels levels
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At financial statement level – responding to risks ◦Assigning staff with appropriate skills and
experience ◦More supervision of staff ◦Professional scepticism ◦Elements of unpredictability in selecting
items to test, and in the performance of the work
◦Adjustment of nature, timing, and extent of audit procedures → more substantive in nature
◦Use of experts (complex & judgmental areas)
Assessing risk at two Assessing risk at two levels levels
At financial statement level – responding to risks ◦Going concern risks → more
discussions with management, audit committee
◦Focusing procedures on high risk areas ◦Consideration of whether to continue
with the audit
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Assessing risk at two Assessing risk at two levels levels
At assertion level◦Risk at financial statement level “trickles”
down, and becomes risk at the assertion level E.g. Poor management integrity
◦Factors that may affect audit risk at the assertion level Susceptibility of an account to misstatement Complexity of transactions Degree of judgement involved Susceptibility of assets to loss or misappropriation Complex and unusual transactions (at year-end) Transactions not subjected to routine processing
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Advanced Auditing
Audit Risk Audit Risk
Events and conditions that may indicate risks of material misstatement ◦Appendix 2 of ISA 315
Do NOT learn “off by heart” Understand and be able to identify in a
question Know how to respond to the identified risk
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ISA 330 – Auditor’s ISA 330 – Auditor’s responses to risks responses to risks
Design and performance of further audit procedures to obtain sufficient, appropriate audit evidence
Nature, timing and extent of further procedures are based on, and are responsive to the assessed risks of material misstatement at assertion level ◦ Tests of controls ◦ Substantive procedures (AR, Tests of Detail) ◦ Ref: ISA 330 Application and Other
Explanatory Material
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ISA 330 – Auditor’s ISA 330 – Auditor’s responses to risks responses to risks
Evaluating the sufficiency and appropriateness of the audit evidence gathered ◦Based on audit procedures performed,
and evidence gathered ◦Need to conclude on whether
assessments of risk of material misstatement at assertion level remain appropriate
◦Does the evidence corroborate or contradict the assertions in the AFS
11 Feb 2010 Advanced Auditing 33
Risk of Material Risk of Material Misstatement: Fraud Misstatement: Fraud
Misstatement of AFS is INTENTIONAL
Responsibility for prevention and detection of fraud ◦ Lies with management and those charged
with governance ◦ Commitment to culture of honesty ◦ Consider potential for override of controls
Responsibility of auditor◦ To obtain reasonable assurance that AFS are
free of material misstatement – through error or fraud
11 Feb 2010 Advanced Auditing 34
Risk of Material Risk of Material Misstatement: Fraud Misstatement: Fraud
Ability of auditor to detect fraud depends on factors such as ◦Skill of perpetrator ◦Frequency and extent of manipulation ◦Degree of collusion ◦Size of amounts ◦Seniority of those involved
More difficult to detect management fraud
11 Feb 2010 Advanced Auditing 35
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Risk of Material Risk of Material Misstatement: Fraud Misstatement: Fraud
Auditor’s requirements ◦Professional scepticism
Irrespective of past experience with client
◦Discussion with audit team ◦Risk assessment procedures
11 Feb 2010 Advanced Auditing 37
MaterialityMateriality References
◦ ISA 320 – Materiality in Planning and Performing an Audit
◦ ISA 450 - Evaluation of Misstatements Identified During an Audit
Audit report ◦ Auditor’s opinion on whether or not the AFS are
materially misstated
AFS will contain a margin of uncertainty ◦ Where misstatement > acceptable margin of
uncertainty Affects user’s decisions based on AFS Misstatement becomes MATERIAL
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Materiality Materiality The nature of materiality
It is subjective Professional judgement is required
It is relative E.g. Coca Cola vs. the corner cafe The balance sheet vs. the income statement
It is qualitative and quantitative Qualitative
Where an amount > amount set as material Quantitative
Judged against a factor other than an amount E.g. Important disclosure that is omitted
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Advanced Auditing
Setting of materiality Setting of materiality
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Auditor must consider and set materiality during the Planning stage of the audit ◦Planning Stage
Assess the risk of materiality misstatement AND consider planning materiality
Formulate an audit plan Nature, timing, and extent of audit procedures
Planning Materiality Planning Materiality
11 Feb 2010 Advanced Auditing 41
The relationship between planning materiality and audit risk ◦ Inverse relationship
Higher audit risk Set materiality lower in order to compensate for this
Lower audit risk Set materiality higher Chance of material misstatement going undetected is lower
◦ Inverse relationship between audit risk and materiality Impact on nature, timing and extent of audit
procedures The risk of material misstatement will have a direct
impact on setting of planning materiality levels
Planning Materiality Planning Materiality It is a benchmark against which to
measure quantitative misstatements
Considerations ◦Amount of misstatement
Quantitative ◦Nature of misstatement
Qualitative ◦2 Levels at which materiality is
considered Overall level Individual level
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Advanced Auditing
Planning materiality Planning materiality Exam technique – when calculating
materiality ◦Stability of indicators – which figures to
use Budget or actual
Budgeted figures – will these figures be achieved? Un-audited figures of current year – whole year’s
figures? Prior year audited figures
◦ Balance sheet or Income Statement Consider the nature of the business Which would be most appropriate ?
Look at “activity” on B/S and I/S. Who are the users? Would they use the I/S or the B/S
mostly?
11 Feb 2010 Advanced Auditing 43
Planning materialityPlanning materialityExam technique – when
calculating materiality◦ Calculation
E.g. use of DP6 ◦ Conclusion
Do not leave materiality in a range – need a number!!
Where it is a high risk audit – be conservative Examples
Incentive to overstate assets and understate liabilities
Possible Going Concern Risks related to particular assets, liabilities etc Risks related to the accounting system
11 Feb 2010 44Advanced Auditing
Planning materiality Planning materiality Quantitative indicators of materiality
◦E.g. DP6 Turnover ½ - 1% Gross profit 1 – 2% Net income 5 – 10% Total assets 1 – 2% Equity 2 – 5%
◦Will calculate upper and lower limits of materiality Using lower limit more conservative level of
materiality detection of more errors
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Planning materiality Planning materiality Qualitative indicators of materiality
◦Consider when quantifying materiality ◦Examples include
Control environment Effectiveness of internal controls Integrity of management Appropriateness of accounting policies and the
disclosure thereof Statutory requirements and regulations Problems and errors – previous years Results of analytical procedures Possibility of illegal transactions
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Advanced Auditing
Final Materiality Final Materiality
Is established at the end of the audit Is the standard against which
identified misstatements are measured, in order to determine the effect on the AFS
Consider responsibilities in terms of reporting responsibilities (ISA 700) ◦Conclusion required by ISA 700 takes into
account auditor’s evaluation of unadjusted audit differences on the AFS (ISA 450)
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Final Materiality Final Materiality Planning Stage
◦Assess the risk of materiality misstatement AND consider planning materiality
◦Formulate an audit plan Nature, timing, and extent of audit procedures
Evaluation of misstatements ◦Selected audit procedures are carried out –
on samples of the population e.g. debtors, sales, creditors
◦Errors in samples ◦Draw audit conclusions about the
populations
11 Feb 2010 Advanced Auditing 48
Final Materiality Final Materiality Process followed by auditor
◦Analyse & project sample errors over the population
◦ If the projected misstatement is unacceptable Perform further tests OR Client to check population in detail for errors
◦Discuss the misstatements with management correction of errors Refusal o correct errors unadjusted
differences use of FINAL MATERIALITY to determine materiality of differences
Misstatement is material more misstatement that acceptable qualification of audit opinion
11 Feb 2010 Advanced Auditing 49
Final Materiality Final Materiality Why would the client refuse to correct
misstatements ◦Disagreement over whether is a
misstatement E.g. estimate of inventory obsolescence is too low
◦Misstatement not regarded as material I.e. Won’t influence the user
◦Ulterior motives E.g. loan covenant – current ratio required
◦Too much bother to make the changes ◦Not concerned about receiving a qualified
opinion
11 Feb 2010 Advanced Auditing 50
Evaluating Unadjusted Audit Evaluating Unadjusted Audit Differences Differences
Distinguish between ◦Factual misstatement (known error)
Able to substantiate with audit evidence E.g. sales invoices posted in wrong period
◦Judgemental misstatement (likely error) Unable to specifically quantify and substantiate
with evidence Level of subjectivity E.g. provision for doubtful debts
◦Projected misstatement I.e. Auditor’s best estimate of misstatement in
a population Arises because of use of audit sampling
11 Feb 2010 Advanced Auditing 51
Evaluating Unadjusted Audit Evaluating Unadjusted Audit Differences Differences
Considerations ◦Ref: ISA 450 – A16 examples ◦Do not consider differences in isolation
Aggregation of differences Trends identified e.g. understatement of
provisions attempt to manipulate AFS?◦Effect of uncorrected differences related
to prior periods ◦Statutory or other contractual obligations
Less likely to tolerate E.g. maintaining specific ratios in terms of a
loan covenant
11 Feb 2010 Advanced Auditing 52
Evaluating Unadjusted Audit Evaluating Unadjusted Audit Differences Differences
Considerations ◦Nature of misstatement
Error in principle VS misallocation of expense Difference arising out of dishonesty of director Subjective differences
◦Impact of misstatement Assess impact on “popular” figures and ratios E.g. where difference affects EPS
◦Absolute size and relative size of difference Absolute size e.g. R1,000,000 Size in relation to other account headings
11 Feb 2010 Advanced Auditing 53
The Overall Audit Strategy The Overall Audit Strategy
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Scope ◦Client-specific issues and circumstances
Number of locations / areas to visit Staff availability Travel and housing of audit staff
◦Engagement team specifics Composition, experience, number QC requirements Use of CAATS
◦Budgeting for the audit Audit time per section Audit fees, expenses
The Overall Audit Strategy The Overall Audit Strategy
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Scope ◦ Communication with entity
Attending meetings Written reports required (and timing) Communication with third parties Previous audit experience
◦ Going concern Applicability of going concern assumption Issues affecting going concern assumption
◦ Previous audit findings and recommendations
◦ Existence of related parties◦ Use of internal auditors, other auditors,
experts
The Overall Audit Strategy The Overall Audit Strategy
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Timing ◦Client dates e.g. inventory counts,
reporting deadlines ◦Timing of audit visits e.g. interim,
final audit ◦Reporting dates
Direction ◦I.e. areas requiring attention
E.g. Debtors
The Audit Plan The Audit Plan
19 February 2009 Advanced Auditing 57
Nature◦Tests of Control (combined approach)
vs. Substantive procedures ◦ Impact of internal controls on
substantive procedures Reliance is justified
Nature – more analytical Timing – verification spread over year Extent – Less
Reliance is NOT justified Nature – more detailed tests Timing – at year-end Extent – more
The Audit Plan The Audit Plan
19 February 2009 Advanced Auditing 58
Timing ◦I.e. when the procedures will be done
Tests of control Performed to cover whole period of reliance
Substantive procedures Performed to verify transactions and year-end
balances Tight audit deadline
Early verification and roll-forward procedures
Extent ◦Relates to number of items to be tested
Greater reliance – larger sample size ◦Sufficient, appropriate audit evidence
Going ConcernGoing ConcernReferences:
◦ Jackson & Stent Chapter 15
Financial statements are normally presented on the “going concern” basis◦Operational existence ◦For the foreseeable future ◦No need to liquidate or curtail operations
Cash is King
March 2010 Advanced Auditing Lecture 1 59
Going Concern Going Concern Management’s responsibility
◦to assess whether company has ability to continue as a going concern
Auditor’s responsibility ◦Risk of expression of unqualified
opinion where has been inappropriately applied
◦Need to gather sufficient, appropriate evidence to support adoption (by management) of the going concern assumption
March 2010 Advanced Auditing Lecture 1 60
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The Audit Plan for Going The Audit Plan for Going Concern Concern Consideration of going concern starts at
the Planning Stage
Nature, timing and extent of procedures is determined by level of risk perceived by auditor
Nature of testing
◦ Substantive evaluation of directors’ assessment of going concern
◦ Procedures Analytical procedures Confirmation of evidence provided Enquiry of personnel
March 2010 Advanced Auditing Lecture 1 62
The Audit Plan for Going The Audit Plan for Going Concern Concern Timing of testing
◦Need most up-to-date information At year-end In post balance-sheet period
Extent of testing◦Determined by “certainty” of
company to continue as a going concern
March 2010 Advanced Auditing Lecture 1 63
Going Concern Going Concern References:
◦ISA 570 (Explanatory Notes)
Framework – events and conditions that cast doubt on ability to continue as a going concern ◦Financial indicators ◦Operating indicators ◦Other indicators
March 2010 Advanced Auditing Lecture 1 64
Going Concern Going Concern Mitigating factors
◦Consideration of management’s plans to return to going concern Specific and feasible Assumptions made by management Management’s written representations to
commit to plans
March 2010 Advanced Auditing Lecture 1 65
Going Concern Going Concern Audit conclusions
◦Based on audit evidence gathered ◦Does a material uncertainty exist
regarding entity’s ability to continue as a going concern? Yes Disclosure in AFS, else AFS don’t
fairly present the state of affairs of the company qualification of audit opinion
March 2010 Advanced Auditing Lecture 1 66
Going Concern – audit Going Concern – audit opinionopinionMaterial uncertainty exists
◦Disclosure made Emphasis of Matter para
◦ Inadequate disclosure, or failure to disclose Disagreement “Except for” or Adverse opinion
Going concern is NOT appropriate ◦Adverse opinion
Unable to determine appropriate basis◦Disclaimer of opinion
March 2010 Advanced Auditing Lecture 1 67
Factual Insolvency Factual Insolvency i.e. Assets < Liabilities All are fairly valued
Matters for auditor’s attention ◦Indicator of going concern problems ◦Irregularities may take place
March 2010 Advanced Auditing Lecture 1 68
Factual Insolvency Factual Insolvency Irregularities
◦Where company is factually insolvent ◦Greater risk of
Common law fraud Reckless trading (S22 of Co’s Act)
◦If taking place Unlawful Act
◦Rest of requirements for S45 RI?
March 2010 Advanced Auditing Lecture 1 69
Subsequent Events Subsequent Events Reference:
◦ISA 560 – Subsequent Events
Types of subsequent events ◦Adjusting events ◦Non-adjusting events ◦Dividends ◦Going concern
March 2010 Advanced Auditing Lecture 1 70
Subsequent Events Subsequent Events Auditor’s duties
◦Between date of AFS and auditor’s report Identification of subsequent events Audit of subsequent events
◦Between date of auditor’s report but before AFS are issued
◦After AFS have been issued
Refer to page 17/15 March 2010 Advanced Auditing Lecture 1 71
Advanced Auditing 72
S45 – Reportable S45 – Reportable Irregularities Irregularities
Reportable irregularity◦An unlawful act or omission committed by
Statutes, regulations, common law ◦Any person responsible for the mgt of
entity ◦Has, or is likely to, cause financial loss to
the entity, its partner, shareholder, creditor, investor OR
◦Is fraudulent or amounts to theft OR ◦Is a material breach of any fiduciary duty
owed by the person to entity etc
March/April 2009Advanced Auditing
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S45 – Reportable S45 – Reportable IrregularitiesIrregularities
The individual registered accountant ◦ Is satisfied or has reason to believe that ◦A reportable irregularity has / is taking
place MUST ◦Without delay ◦Send a written report to the IRBA, with
particulars ◦MUST notify management within 3 days,
and provide management with a copy of the report
◦ Within 30 days of sending report to IRBA ◦ Discuss report with management » representations
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S45 – Reportable S45 – Reportable IrregularitiesIrregularities
Send another report to the IRBA ◦ No reportable irregularity has / is taking
place OR ◦ Suspected RI is no longer taking place, and
that steps have been taken to recover losses OR
◦ RI is continuing
Where RI is continuing ◦ Notify appropriate regulator ASAP
Details of irregularity In writing Copy of report
◦ Regulator may carry out investigations as needed
Advanced Auditing 75
Fraud – Introduction Fraud – Introduction Primary responsibility for prevention and
detection of fraud (and error) rests with management and those charged with governanceGood control environment Risk assessment procedures Implementation, operation, and monitoring of IC
system
Auditor’s responsibility Consider fraud when assessing risk of material
misstatement Respond to assessed, identified, or suspected risk Able to express audit opinion at acceptable level of
audit risk
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Terminology Terminology Error
◦Unintentional act which leads to misstatement of AFS
Fraud ◦Intentional act, in order to obtain unfair
illegal advantage ◦Fraud may be committed by
Management Those charged with governance Employees 3rd parties
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Terminology Terminology Fraud risk factors
◦Indicate an incentive or pressure to commit fraud, or provide an opportunity to commit fraud
Management fraud ◦Committed by member of management
or person charged with management ◦S45 implications
Employee fraud ◦Committed by employee ◦NO S45 implications
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Terminology Terminology 2 Main categories of fraud
◦Fraudulent financial reporting Intentional misstatements, including omissions –
deceive users Perpetrated by management Includes
Falsification of accounting records Management override
◦Misappropriation of assets Embezzlement Theft of physical assets, intellectual property Company pays for goods and services not
received
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Auditor’s Responsibilities Auditor’s Responsibilities Requirements in terms of ISA 240
◦Attitude of professional scepticism Even where management has previously acted
with integrity ◦Discussion amongst audit team
Client’s susceptibility to material misstatement due to fraud and error
◦Obtain information identify risk of material misstatement due to fraud and error NB: consider whether any of the information
obtained indicates whether any of the FRAUD RISK FACTORS are present
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Auditor’s responsibilities Auditor’s responsibilities
Requirements in terms of ISA 240 ◦Assess the risk of material
misstatement due to fraud and error At FS level At assertion level
◦Determine audit response to address the risk At FS level At assertion level
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Auditor’s response to risk Auditor’s response to risk due to fraud due to fraud
At FS level ◦ Assignment and supervision of staff ◦ Consider accounting polices adopted by
management ◦ Element of unpredictability in nature, timing
and extent of audit procedures
At assertion level ◦ Impacts on nature, timing and extent of audit
procedures ◦ Considerations
Attempts to conceal fraud Relevance and reliability of evidence collected
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Auditor’s response to risk Auditor’s response to risk due to fraud due to fraud
Management override ◦ Auditor must design and perform procedures
to respond to the risk of management override
Evaluation of audit evidence ◦ Is initial assessment of material misstatement
(assertion level) still appropriate after initial procedures have been conducted
◦ Examples Discrepancies in accounting records Conflicting or missing evidence Problematic relationships between auditor and
management
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Auditor’s response to risk Auditor’s response to risk due to fraud due to fraud
Management representations ◦To include
Management is responsible for IC systems – prevent and detect fraud
Management has disclosed results of its assessment of risk of material misstatement due to fraud
Management has disclosed all frauds involving management and employees
Management has disclosed any allegations of fraud
◦Should only ever be corroborating evidence
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Fraud Risk Factors Fraud Risk Factors
Stage of audit◦At the planning stage
Gaining understanding of entity and its environment Gather information to identify the risk of material
misstatement due to fraud
Assessing the risk of material misstatement due to fraud
◦Does the information gathered indicate the presence of the risk factors
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Fraud Risk Factors Fraud Risk Factors Consideration of
◦Incentives / pressures On management to report fraudulently On management and employees to
misappropriate assets ◦Opportunities
For management to report fraudulently For management and employees to
misappropriate assets ◦Attitudes / rationalisations
Do attitudes of management and employees indicate Fraudulent reporting Misappropriation of assets
March/April 2009Advanced Auditing
JOIN KHALID AZIZCOMMERCE COACHCOACHING CLASSES ICMAP STAGE 1,2,3,4..& CAM ICAP MODULE A,B,C,DPIPFAMA-ECONOMICSB.COM, BBA & MBABA-ECONOMICS INTER COMMERCE0322-3385752R1173, ALNOOR SOCIETY BLOCK 19, F.B.AREA, KARACHI.
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