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AccountingWEB guide to clarified ISAs

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4th Sep 2013
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During the early part of this century UK and Ireland auditing standards were replaced by International Standards on Auditing (ISAs).

But after accountants complained that the ISAs were hard to understand standard setters tweaked them for UK and Irish users. In 2009, the International Auditing and Assurance Standards Board published about 36 “clarified” international audit standards and issued ISA 265 Communicating Deficiencies in Internal Control to Those Charged with Governance and Management.

This guide presents an overview of these clarified standards, which now apply to audit engagements in the UK and Ireland. They are arranged in a set of numerical series, with each 100 bracket governing a separate topic.

200 series - Responsibilities and objectives of an audit

ISA 200 - Overall objectives of the independent auditor and the conduct of an audit in accordance with International Standards on Auditing (UK and Ireland)

This standard explains that the purpose of an audit is to increase confidence in an organisation’s financial statements. An auditor should get “reasonable assurance” that the accounts don’t include material misstatement, whether due to fraud or error; and produce a report of their findings as required by the ISAs.

ISA 210 - Agreeing the terms of audit engagements

Auditors should have sent revised engagement letters to clients to comply with ISA 210, and should also assess whether clients are using an appropriate framework such as UK GAAP or EU-adopted IFRS. 

The engagement letter should also include the ‘preconditions’ of an audit, i.e.:

  • Get confirmation from the client’s managers that they acknowledge their responsibilities for preparing financial statements
  • Get the client’s managers to acknowledge their responsibilities for internal controls to reduce the risk of fraud and error in financial statements
     

ISA 220 - Quality control for an audit of financial statements

Auditors should ensure they have adequate procedures to ensure a good quality audit and comply with professional, legal and regulatory requirements. The auditor’s report should be “appropriate in the circumstances”. Some audit firms will undergo an “engagement quality control review” for an objective evaluation of how the auditors made important decisions.

ISA 230 - Audit documentation

Requires the auditor to prepare documentation that an experienced auditor, with no previous connection to the audit, to understand:

  • The nature, timing and extent of the audit procedures performed
  • The results of those audit procedures, and the evidence obtained
  • Significant matters that arose during the audit and the conclusions drawn from them, including the professional judgments made in arriving at those conclusions

ISA 240 - The auditor's responsibilities relating to fraud in an audit of financial statements

Among other requirements of this UK and Ireland ISA, this clarified ISA requires the audit team to discuss the susceptibility of the financial statements to material misstatement due to fraud. Auditors are also required to justify their reasons if they consider revenue recognition fraud is not applicable to the client. Under ISA (UK & Ireland) 550 Related Parties, the audit team is also required to discuss the susceptibility of the financial statements to misstatement due to fraud and error with related parties.

ISA 250A Consideration of laws and regulations in an audit of financial statements

Auditors should consider how laws and regulations affect their clients and the figures and information disclosed in their financial statements (it is to be noted that non-compliance with laws and regulations can directly, and indirectly, affect the financial statements).

Auditors should:

  • Obtain sufficient appropriate audit evidence regarding compliance with laws and regulations that affect financial statements
  • Carry out procedures to find examples where the client is not complying with laws and regulations and which may have a material effect on the financial statements
  • Respond appropriately to non-compliance or suspected non-compliance with laws and regulations identified during the audit

ISA 250B The auditor's right and duty to report to regulators in the financial sector

The auditor has two main responsibilities under this standard: to report on matters specified in legislation and a statutory duty to report information relevant to the regulators' functions that auditors uncover during their audit work.

An auditor should report information to a regulator if there is “reasonable cause” to believe it is or may be of “material significance” to the regulator.

ISA 260 (Revised October 2012) Communication with those charged with governance

The auditor is responsible for communicating with those charged with governance. Management also has a responsibility to communicate about governance.

The auditor should:

  • Explain the auditor’s responsibilities clearly to those charged with governance and set out an overview of the scope and timing of the audit
  • Obtain information relevant to the audit from those charged with governance
  • Provide the governance team with timely observations arising from the audit that are that are relevant to their responsibility to oversee the financial reporting process
  • Promote effective two-way communication between the auditor and those charged with governance

ISA 265 - Communicating deficiencies in internal control to those charged with governance and management

Deals with the auditor’s responsibility to communicate any internal control deficiencies to those charged with governance and management. A deficient internal control is defined as being “unable to prevent, or detect and correct, misstatements in the financial statements on a timely basis”.

300 series - Planning

ISA 300 - Planning an audit of financial statements

Planning an audit involves setting the overall strategy for the engagement and developing an audit plan. This standard aims to help auditors do an effective audit. Good planning will help auditors identify problem areas promptly and pick the right people for the audit engagement team.

ISA 315 - Identifying and assessing risks of material misstatement through understanding the entity and its environment

Aims to help the auditor identify and assess the risks of material misstatement, whether due to fraud or error in financial statements and assertions by the client’s management in financial statements. The standard doesn’t define a material misstatement, although this can be roughly defined as the difference between a reported figure in a company’s accounts, and the figure that should be reported in order for the accounts to give a true and fair view of the company’s financial performance (although ISA (UK & Ireland) 320 Materiality in planning and performing an audit says that ‘Misstatements, including omissions, are considered to be material if they, individually or in the aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of the financial statements’). The discrepancy will be significant and will usually have a major effect on a company’s performance.

Doing a risk assessment can help an auditor understand the client’s business and the likelihood of a material misstatement appearing in the accounts.

ISA 320 - Materiality in planning and performing an audit

Tries to explain how the concept of materiality applies to audits. The FRC doesn’t say how auditors should calculate materiality during an audit (although the Application and other explanatory material to ISA (UK & Ireland) 320 gives examples of benchmarks that may be appropriate, such as profit before tax, total revenue, gross profit and total expenses, total equity or net asset value. It says an auditor’s determination of materiality is about “professional judgment” and should consider the

needs of people using the company’s financial statements. This vagueness seems to have confused auditors although standard setters and software suppliers may be able to come up with some methods for calculating it over time, according to AccountingWEB technical editor Steve Collings.

ISA 330 - The auditor's responses to assessed risks

Auditors should plan how they will respond to possible material misstatements in an audit. ISA 330 requires the auditor to perform tests of controls if the auditor’s assessment of risk of material misstatement at the assertion level includes an expectation that the controls are operating effectively or where substantive procedures alone will not be able to provide sufficient appropriate audit evidence at the assertion level. However, care must be taken when placing reliance on internal controls; where the auditor places greater reliance on the effectiveness of a control, they must obtain more persuasive audit evidence.

400 series – Using service companies and dealing with misstatements

ISA 402 Audit considerations relating to an entity using a service organization

Services provided by a service organisation are relevant to the audit of a user entity’s financial statements when those services, and the controls over them, are part of the client’s information system, including business processes that are relevant to financial reporting. Auditors should understand the services provided by an outsourcer and any risks for the audit client. What safeguards does the audit client have against the business risks of an outsourcing contract?

If the auditor is unable to obtain a sufficient understanding of these internal controls from their client the audit it may be necessary to get information from the supplier, visiting the business if necessary.

ISA 450 - Evaluation of misstatements identified during the audit

Requires the auditor to accumulate misstatements identified during the audit, with the exception of those deemed “clearly trivial”. But Steve Collings has warned “clearly trivial” does not mean “not material”.

The auditor is also required to determine whether the audit strategy and audit plan should be revised in light of the misstatements, such as considering the nature of the identified misstatements and the circumstances surrounding their occurrence. 

500 series – Evidence

ISA 500 - Audit evidence

An audit file is not just an accounts preparation file with a couple of extra lead schedules. The audit file has to tell a story about how the audit was planned, how it was conducted, how the file was reviewed and how the conclusions that form the basis of the audit opinion were reached.

ISA 500 requires auditors to “design and perform audit procedures that are appropriate in the circumstances for the purposes of obtaining sufficient appropriate audit evidence”. The amount of evidence an auditor will need will depend on how risky the audit is: the more risk will require more evidence.  ‘Sufficiency’ is the measure of the quantity of audit evidence; ‘appropriateness’ is the measure of the quality of audit evidence. 

ISA 501 Audit evidence - specific considerations for selected items

Relates to ISA 500. Aims to help auditors get sufficient audit evidence in three areas:

  • Existence and condition of inventory
  • Completeness of litigation and claims involving the entity
  • Presentation and disclosure of segment information in accordance with the applicable financial reporting framework

ISA 505 External confirmations

Deals with the auditor’s use of external confirmation procedures to obtain audit evidence in accordance with the requirements of ISAs 330 and 500. It does not address inquiries regarding litigation and claims, which are dealt with in ISA 501.

The key principles it sets out are:

  • Audit evidence is more reliable when it is obtained from independent sources outside the entity
  • Audit evidence obtained directly by the auditor is more reliable than audit evidence obtained indirectly or by inference
  • Audit evidence is more reliable when it exists in documentary form, whether paper, electronic or other medium

ISA 510 Initial audit engagements - opening balances

Requires the auditor to obtain sufficient appropriate audit evidence about whether opening balances are materially misstated which affects the current period’s financial statements and whether appropriate accounting policies reflected in the opening balances have been consistently applied and where changes are made to such accounting policies that they have been appropriate accounted for, adequately presented and appropriately disclosed. 

If the client is new to the audit firm and the previous auditor modified their audit report for the previous financial year, the auditor must consider whether the matter(s) giving rise to the modification has a material impact on the current period’s financial statements.

ISA 520 Analytical procedures

Requires analytical procedures to be applied near the end of the audit help the auditor form an overall conclusion whether the financial statements are consistent with the auditor’s understanding of the entity. Some firms correctly apply analytical procedures during the planning stage of the audit, but then do not apply paragraph 6 to ISA (UK and Ireland) 520, which requires the auditor to design and perform analytical procedures near the end of the audit in order to form an overall conclusion. 

ISA 530 Audit sampling

Audit samples should allow provide a reasonable basis for the auditor to draw conclusions about all of a client’s data. When designing an audit sample, the auditor shall consider the purpose of the audit procedure and the characteristics of the entire data set from which the sample will be drawn.

The auditor shall determine a sample size sufficient to reduce sampling risk to an acceptably low level.

ISA 540 Auditing, accounting estimates, including fair value accounting estimates, and related disclosures

Combines the old ISA 540 on accounting estimates (financial statement items that cannot be measured precisely) and the previous ISA 545 on fair values. This is important for clients whose financial statements include material accounting estimates and covers (among other things) significant risks relating to estimation uncertainty.

The objective for the auditor is to obtain sufficient appropriate audit evidence to show accounting estimates, (including fair value accounting estimates) are reasonable and related disclosures in the financial statements are adequate

ISA 550 Related parties

Requires the audit team to discuss the susceptibility of the financial statements to material misstatement due to fraud in relation to transactions with related parties in the planning meeting. This is in addition to the requirement in ISA 240 for the audit team to discuss the susceptibility of the financial statements to material misstatement in relation to fraud. 

Auditors should be able to recognise fraud “risk factors” from related party relationships and transactions.

ISA 560 Subsequent events

Auditors should obtain sufficient audit evidence about whether events occurring between the date of the financial statements and the date of the auditor’s report require adjustments to the financial statements or a disclosure to be made. Auditors should respond appropriately to facts that become known after the date of the auditor’s report, that, had they been known may have caused the auditor to amend their report.

ISA 570 Going concern

Business managers are responsible for assessing going concern – namely, that the organisation has the resources to carry on operating. The auditor’s responsibility is to consider the appropriateness of management’s assessment that the going concern basis is applicable in the circumstances. In particular, the auditor must consider whether there are material uncertainties that may cast doubt on an entity’s ability to continue trading for the foreseeable future. In many cases the auditor will consider the going concern presumption to be appropriate to an entity’s particular circumstances and no reference to going concern uncertainty will be made in the financial statements. This does not, however, guarantee that the entity is a going concern.

ISA 570 requires management to make an assessment of going concern by looking forward at least 12 months from the date of approval of the financial statements.

The auditor must consider whether there are any events or conditions, together with related business risks, which may cast significant doubt on an entity’s ability to continue to trade for the foreseeable future. Where the auditor identifies such uncertainties, the auditor must consider the effect such uncertainties have on the risk of material misstatement and hence the impact on their audit opinion.

ISA 580 Written representations

The auditor’s responsibility to obtain written representations from management and, where appropriate, those charged with governance in an audit of financial statements.

Key points for auditors:

  • To obtain written representations from management and, where appropriate, those charged with governance that they believe that they have fulfilled their responsibility for the preparation of the financial statements and for the completeness of the information provided to the auditor
  • To support other audit evidence relevant to the financial statements or specific assertions in the financial statements by means of written representations if determined necessary by the auditor or required by other ISAs (UK and Ireland)
  • To respond appropriately to written representations provided by management and, where appropriate, those charged with governance, or if management or, where appropriate, those charged with governance do not provide the written representations requested by the auditor.

It is to be emphasised that written representations, on their own, are not sufficient and appropriate audit evidence as they are internally-generated. Written representations complement additional audit evidence obtained in relevant audit areas.

600 series – reliance on external parties (internal auditor, outside experts)

ISA 600 - Special considerations: audits of group financial statements (including the work of component auditors)

This standard aims to help the auditor decide whether to act as the auditor of the group financial statements. If acting as the auditor of the group financial statements, they will need to communicate clearly with other  “component” auditors about the scope and timing of their work on financial information related to components and their findings; and to obtain sufficient audit evidence about the financial information of the components and the consolidation process to be able to express an opinion on whether the group financial statements are prepared, in all material respects, in accordance with the applicable financial reporting framework.

ISA 610 - Using the work of internal auditors

External auditors should decide whether they can use the work of internal audit at a client. If using the work of the internal audit function, auditors should consider whether the work is adequate for purposes of the audit. If internal auditors are providing direct assistance to external auditors, external auditors should supervise and review their work. ISA (UK & Ireland) 610 was amended in June 2013 and paragraph 5-1 prohibits the use of internal auditors to provide ‘direct assistance’.

ISA 620 - Using the work of an auditor's expert

This standard includes five things auditors should consider when working with an expert:

  1. The nature of the matter to which that expert’s work relates;
  2. The risks of material misstatement in the matter to which that expert’s work relates;
  3. The significance of that expert’s work in the context of the audit;
  4. The auditor’s knowledge of and experience with previous work performed by that expert
  5. Whether that expert is subject the auditor’s firm’s quality control policies and

procedures.

700 series - audit reports

ISA 700 (Revised June 2013) The independent auditor's report on financial statements

Auditors should form an opinion on the financial statements based on conclusions drawn from the audit evidence obtained; and express that opinion clearly through a written report that also describes the basis for the opinion.

The auditor’s report on the financial statements should contain a clear written expression of opinion on the financial statements, based on the auditor evaluating the conclusions drawn from the audit evidence obtained.

Key points for auditors: 

  • Sufficient appropriate audit evidence as to whether the financial statements as a whole are free from material misstatement, whether due to fraud or error has been obtained
  • Uncorrected misstatements are material, individually or in aggregate. This evaluation shall include consideration of the qualitative aspects of the entity’s accounting practices, including indicators of possible bias in management’s judgments
  • Under a true and fair framework, the financial statements, including the related notes, must give a true and fair view

705 (Revised October 2012) Modifications to opinions in the independent auditor's report

The auditor’s responsibility to issue a report when the auditor concludes that a modification to the auditor’s opinion on the financial statements is necessary. There are three types of modified opinions: a qualified opinion, an adverse opinion, and a disclaimer of opinion. It is worth pointing out that an ‘emphasis of matter’ paragraph (discussed in ISA (UK & Ireland) 706) is NOT a modification of the auditor’s opinion, but a modification of the auditor’s report. 

ISA 706 (Revised October 2012) Emphasis of matter paragraphs and other matter paragraphs in the independent auditor's report

Provides rules for when the auditor considers it necessary to highlight information disclosed in the financial statements or things aren’t in the financial statements that, in the auditor’s opinion, should be. The emphasis of matter paragraph in the auditor’s report refers to something in the financial statements that, in the auditor’s judgment, is of such importance that it is “fundamental to users’ understanding of the financial statements”.

An Other Matter paragraph in the auditor’s report refers to a matter other than those presented or disclosed in the financial statements that, in the auditor’s judgment, is relevant to users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report.

710 Comparative information - corresponding figures and comparative financial statements

For corresponding figures (comparative year/ periods), the auditor’s opinion on the financial statements refers to the current period only. For comparative financial statements, the auditor’s opinion refers to each period that financial statements are presented.

Auditors need to obtain sufficient and appropriate audit evidence about whether the comparative information included in the financial statements has been presented in accordance with the requirements for comparative information in the applicable financial reporting framework.

If the auditor becomes aware of a possible material misstatement in the comparative information while performing the current period audit, the auditor should perform additional procedures to determine whether a material misstatement exists.

ISA 720A (Revised October 2012) The auditor's responsibilities relating to other information in documents containing audited financial statements

Auditors should respond appropriately when documents containing audited financial statements and the auditor’s report include other information that could undermine the credibility of those financial statements and the auditor’s report.

If the auditor finds a “material inconsistency”, the auditor should consider whether the audited financial statements or the other information should be revised. If revision of the other information is necessary and management refuses to make the revision, the auditor has options including withholding the auditor’s report; including an other matters paragraph in the audit report describing the material inconsistency in accordance with ISA 706; or withdrawing from the engagements, where withdrawal is possible under applicable law or regulation

720B The auditor's statutory reporting responsibility in relation to directors' reports

The objective of the auditor is to form an opinion on whether the information given in the directors’ report is consistent with the financial statements and to respond appropriately if it is not consistent.

If the auditor identifies any inconsistencies between the information in the directors’ report and the financial statements the auditor shall seek to resolve them. If the auditor is of the opinion that the information in the directors’ report is materially  inconsistent with the financial statements, and has been unable to resolve the  inconsistency, the auditor shall state that opinion and describe the inconsistency in the auditor’s report.

If an amendment is necessary to the financial statements and management and those charged with governance refuse to make the amendment, the auditor shall express a qualified or adverse opinion on the financial statements.

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By Tickers
05th Sep 2013 12:58

Very useful guide. Thanks

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