Clarified ISAs: emerging issues

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The ‘clarified’ International Standards on Auditing (ISAs) have been with us for nearly two years.  However, issues are emerging which frequently trip audit firms up – sometimes due to audit software omitting a requirement of the ISAs or incorrectly interpreting part of an ISA, explains Steve Collings.

This article aims to flag up the more common issues which practitioners are falling foul of so that quality assurance visits by the various professional bodies can run more smoothly.

The rest of the article includes the following sections:

  • Planning
  • Audit fieldwork
  • Examples
  • Audit completion
  • Conclusion

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Steven Collings
Audit and Technical Partner
Leavitt Walmsley Associates Ltd
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By nigel
19th Jun 2012 12:32

A couple of queries

1. You say that performance materiality "is generally expected to be applied (at a minimum) to related party transactions and directors’ remuneration/transactions. " I was taught that the latter was material by definition rather than value, so the monetary value of such transactions is irrelevant. Do you disagree?

2. I appreciate that this is not a treatise on statistics, but the statement "For a sample to be representative, it is normally advisable to work to, say, 70% of such a population – if not more" is mathematical nonsense! If we need to "sample" at least 70% we might as well test 100% and have done with it. I don't think any statistician worth his salt would consider 70% to be a "sample".

Auditors need a better understanding of statistical sampling and how to carry it out properly, then I would have thought much smaller sample sizes could easily be justified as "representative".

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19th Jun 2012 13:19

To be honest
I worked in a firm that had a visit last year from the inspectors and they criticised all the audit files because of insufficient sampling (I knew this previously but the firm did nothing to respond to my recommendations). The officer then said sample sizes were too small and would be better at around 60-70% but it all depends on the client. I work on the basis that sample sizes are dependent on the number of customers the client has but it's all down to interpretation especially where inspectors are concerned.

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19th Jun 2012 13:30

Materiality query
Your article appears to be mixing up the so-called "item specific" or "section specific" materiality from paragraph 10 of the ISA with performance materiality from paragraph 11?

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19th Jun 2012 13:58

Related parties/materiality

Hi All

@Nigel.  I alwayswork on the basis that directors transactions are regarded as material in nature, so I apply a lower level of performance materiality on those, so I agree with you on that point.  More responsibility has been placed on the part of the auditor with regards to related parties in the clarified ISA 550, so inspectors/file reviewers are really expecting performance materiality to be applied to this area because of its subjective nature.  I fully appreciate that every client's/audit firm's situation is different, and my article was to really emphasise that these are two areas of the audit where one would be expected to apply performance materiality (other audits may have more areas where PM is applied).  Re the sampling methods - I agree a better understanding of statitstical sampling would help audit firms.  However, I am aware that firms are widely criticised for sample sizes NOT being representative of populations and them receiving a swathe of criticism because of inappropriate sample sizes (particularly at stock take attendance). Some of the work on my audit files has sampling at 60%-70% depending on the number of debtors/creditors but again this is not a blanket percentage - the objective is to make sure that samples are representative.

@Jennifer Reed.  I'm not sure I understand your query.  A lower level of materiality (perf materiality) has to be applied to those areas of the financial statements where misstatements of lower amounts than financial statement materiality would influence the decisions of users (para 10), which the article does imply.  Para 11 requires an auditor to determine PM to assess risk of material misstatement and determine the nature, timing and extent of further audit procedures. 

Kind regards


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to Manchester_man
20th Jun 2012 14:47

Specific materiality v performance materiality

Hi Steve,

I agree with Jennifer Reed.  Para 10 and all the related application paragraphs (A2 - A11) are dealing with materiality on the financial statements as a whole and lower materiality for specifc balances, transactions and disclosures (this is not performance materiality).

Performance materiality is dealt with in para 11 and A12.  There should be a lower PM (or working materiality) across all areas; how much lower is dependent on risk.

Kind regards,

David Gallagher

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to stepurhan
20th Jun 2012 14:55

Re materiality
@David Gallagher Thank you for your comments. My understanding is that paragraphs 10 and 11 are not referring to the same thing. This is certainly the approach taken by most off the shelf audit systems.

@Steve Collings I agree that areas such as related party transactions may need a lower level of materiality, but that is different to the concept of performance materiality. Paragraph A12 of the Isa appears to make this very clear?

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By zash
19th Jun 2012 17:56

Redrafted/ Clarified ISAs and Small Firms - Sharing Thoughts

Luckily or unluckily I'm a reviewer of audit firms in Pakistan. My first point is that while discussing ISAs, redrafted and clarified or otherwise, problems of Small and Medium-Sized Practices (SMPs) must be kept in mind who interprete and comply ISAs as per their own circumstances and conditions.

Secondly, while fully agreeing with Nigel at materiality and sampling, I would like to add that if 60-70% is still sample then it's better to cover 100% population as it would be more productive than to waste time in 'Sampling Documentation'.

Regarding Materiality I would like to point out that in fact, planning materiality is the threshold amount which is to be considered by a normal financial statements user for investment decisions. Actually it's not to provide shelter or umbrella for the auditors. Further, while determining Planning or Performance Materiality, most of the SMPs seldom consider 'Qualititative' aspects of materiality. In certain cases, determining materiality at any numerical threshold provides complete recipe for total destruction. Remember the article "Could $51 Million be Immaterial when Enron Reports Income of $105 Million? " Now where was the qualitative aspect of materiality? It was totally insane.

I wonder why IFAC with it's all resources is unable to provide comprehensive guideline to determine Planning and Performance Materiality levels at Financial Statements, Account balance and Transaction levels, instead of creating a mess of confusion amongst poor SMP practitioners? I reiterate that this area needs much more attention of standard setters.

Further, at your point regarding documentation: Again, audit teams' meetings are rarely conducted and documented in SMPs. In fact SMPs have started doing it recently but just for the sake of ISA compliance, nothing else. Period. Further, I would also like to point out that in fact, redrafted & clarified ISAs have created more complexity in certain cases instead of providing any clarity. It was all the melt down in financial sector which has caused flood of compliance requirements for SMPs and SMEs. There must be a distinctive treatment both for large and SME clients. Financial sector, being the custodian of public money should be treated completely under different set of ISAs as most of them are audited by Big 4.

Anybody can check the SMPs surveys  conducted by the IFAC where 'compliance' is considered the heaviest load by SMPs.

For the sake of brevity, I'm skipping my views about compliance of 'ISQC 1' by the SMPs.

End Note: I've pointed out matters with reference to SMPs because they form more than 95% audit firms of the world and they are the auditors of SMEs, who form arounr more than 90% of economies. So, their problems are the real problems of the audit world.

(By the way you skipped 'Pre-Engagement Phase' from your discussion. was it delibrate or considered unnecessary? It's very important phase, specially in case of risky/ new clients)


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to SteLacca
20th Jun 2012 03:12

SMP-ISA compliance and Audit Team meeting


You had suggested that Audit Team meeting was done for the sake of complying with ISA, thus, was of no value. I would like to suggest that it all depend on the objective of the partner in charge - he can make use of the meeting to properly plan for the audit and instill professionalism into the work, or he can just conduct 'paper meeting'

Your observation on difficulties facing SMP firms in complying with Clarified ISA is spot on. However, you were suggesting that may there is a need for 2-tier ISA may be stretching auditors a bit too much. Already we are having problem with the numerous IFRS and ISA, another set of ISA will break the camel's back

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By Bryan
19th Jun 2012 19:42

As a former inspector for one of the professional bodies myself, I can fully agree with the comments about sample sizes. I am "old school" but some of the younger generation of officers are expecting sample sizes around at least 50 to 60% to demonstrate material misstatement risk is reduced to an acceptable level in the remaining unsampled items. It always struck me as surprising that auditors had a lack of awareness of various statistical sampling techniques but a good sample would be over the 60% mark but having said that it would also depend on your own risk assessment as Steve pointed out, it's not a "blanket" benchmark. You can quite easily sample 60-70% of a population as easily as you can doing 100% but it wouldn't be as cost effective especially in today's climate.

The point about performance materiality is interesting. Many audit files I used to see never bothered with tolerable error which I found odd. I think the interpretation in the article of how to apply performance materiality is a good practical interpretation and is definitely one that I would concur with. I know QAD and other regulators are expecting performance materiality to be applied to directors transactions , and not just salaries! Related parties have always been high on our agenda so I would agree to apply a lower level of performance materiality there.

The point raised in Zash's post about team meetings is interesting. Certainly here in the UK if you don't have a planning meeting you're in breach of all kinds of ISA's so dispense with the meeting at your peril! Audit documentation is one of those issues which always raises its head during a file inspection and usually because there's either not enough or too much over auditing. There will never be a happy medium.

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By Bryan
20th Jun 2012 15:11

Some interesting comments about PM. I am of the opinion that PM is to be applied to riskier areas of the accounts. Looking at paragraph A12 myself and a couple of colleagues seem to interpret it as "PM being a materiality level determined for a particular class of transaction, account balance or disclosure which is set to reduce the probability that undetected misstatements exceed the financial statement materiality level". Therefore I would argue that financial statement materiality is reduced by an amount dependant on risk to arrive at a performance materiality which is a similar way to how tolerable error works.
"Back in the day " auditing was so simple. Now it's just got very over complex. The clarity project may have tried to clarify the ISA's but we still seem to interpret the requirements differently.

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20th Jun 2012 15:37

Performance Materiality Clarification

Hi All,

The article's 'original' message was to convey to the auditor that they need to calculate a performance materiality level as well as a financial statement materiality level per ISA (UK&IRL) 320 as I hope that many auditors in practice understand how and why performance materiality is calculated (though it seems some audit firms ignore the concept completely even though it is the level at which items need to be tested).

In practice what I do is to (1) set a performance materiality level for the purpose of risk assessment, which then determines the nature, timing and extent of procedures.  I then (2) consider if there are any factors that indicate the need for a lower level of materiality for certain assertions and finally (3) consider whether specific items require a lower performance materiality - such as directors' transactions and related parties and it was this final point that I was trying to convey in the article, but which I seem to have confused the technically-minded of readers for which I apologise. Ultimately though I was not trying to digress into how/why performance materiality is calculated, but merely to remind the auditor that it needs to be done to comply with the clarified ISA.

Best wishes, and many thanks for your input.



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