Save content
Have you found this content useful? Use the button above to save it to your profile.
AIA

Is this a ‘good’ audit file?

by
14th Feb 2011
Save content
Have you found this content useful? Use the button above to save it to your profile.

In an age where auditing and financial reporting are heavily regulated by both the professional bodies and external regulators, such as the Audit Inspection Unit, practitioners often ask me during lectures whether their files would "pass" an inspection.

Clearly I cannot determine whether a file would pass without seeing it, but I can highlight some key areas where practitioners often trip up during external reviews which may offer some solution as to how firms should improve their files to enable them to stand up to scrutiny by an external inspector.

Engagement letter

One of the most frequently cited deficiencies in a review of a file is the fact that an up to date engagement letter is not on file. Where an engagement letter is on file the audit engagement partner should review the terms of the engagement and consider whether the client needs to be reminded of the terms.

Under the “clarified” ISAs, audit firms will need to update their engagement terms to ensure they reflect the “preconditions” of the engagement under ISA 210 Terms of Audit Engagements.

Remember, you should not undertake an audit without a signed letter of engagement in place.

Planning

If a file is going to fail an inspection, the chances are that it will fail on either planning or completion.  Firms who undertake audit work without doing any sufficient planning are essentially “doomed”.

Sound planning will include:

  • detailed notes on what the client does and how it conducts its operations
  • business and audit risks
  • how management identify and manage business risks
  • the internal control systems and the effectiveness of the control environment
  • matters arising from prior year files
  • significant financial reporting issues and a review of the critical accounting policies
  • debt and financing structure
  • investments and group activities (where applicable)
  • objectives and strategies of the business

The planning meeting held between the audit team members will also be included within the planning section, together with any preliminary discussions held with the client pre-audit.  Regulators frequently cite inadequate planning as one of the key “hotspots” when they undertake inspections.

Also, remember that under the clarified ISAs, the audit team discussion must cover the susceptibility of material misstatement of the financial statements due to related party issues as well as fraud.

N/A

In a lot of cases audit files will contain the abbreviation “N/A” in quite a number of areas. It is worth mentioning that some regulators are considering the abbreviation to stand for “not attempted” as opposed to “not applicable”. In cases where an audit test is deemed to be not applicable it is often beneficial to include a reason as to why the auditor considers such a test to be “not applicable”, for example if a standard audit procedure would not generate sufficient appropriate audit evidence, for whatever reason, it should be documented as to why the test would be inadequate and what alternative procedures have been used.

Lack of evidence

Along with poor planning, a lack of audit evidence is up there with the regular “hotspots”. Under the ISAs, audit evidence needs to be both “sufficient” and “appropriate”. ISA 500 Audit Evidence recognises “sufficiency” as the measure of the quantity of audit evidence, whereas “appropriateness” is the measure of the quality of the audit evidence.

It is a sad fact that audit firms frequently appear in the disciplinary pages of their professional institute’s magazine for issuing unqualified audit opinions when the audit evidence they have gathered is both insufficient and inappropriate (i.e. the evidence does not support the opinion expressed).

On the flip side of lack of evidence, be careful not to “over-audit” certain areas. Spending hours and hours auditing a £200 petty cash balance is inappropriate or over-auditing certain areas of the accounts because they are “easy” is a waste of resources. Also remember that photocopying reams of invoices is also unnecessary, though copies of invoices might be obtained for tax purposes but could well be put on a separate accounts file.

Materiality considerations

During file reviews it is clearly obvious that materiality has been calculated at the planning stage, but then completely forgotten about during the course of the audit. Materiality must be reassessed when facts come to light which might have caused a different materiality level to be considered. Also, do not forget the new concept of “performance materiality” which I covered in a recent article. This is to be applied on high risk areas, such as related parties and directors’ remuneration.

In addition, materiality should also be recalculated at the completion stage of the audit to determine whether unadjusted errors approach, or are over, initial materiality levels as well as determining whether additional audit procedures are necessary. 

Redundant papers

A good audit file should only have relevant working papers on file. If working papers are superseded then they should be destroyed, not retained on file. Where firms complain that the size of their files are enormous, it is usually because there are reams of redundant working papers on it.

Related parties

It was only a matter of time before this problem child hit the article. Over the years related party issues have become more and more complex and the clarified ISAs place more responsibility on the part of the auditor. Auditors must ensure that they undertake adequate procedures which will enable sufficient and appropriate audit evidence to be gathered to support management’s assertions insofar as related parties are concerned. In addition, auditors should also be alert to the fact that there may well be undisclosed related parties during the course of their audit and perform procedures which are designed to detect any undisclosed related parties.

Such an area is another key “hotspot” for regulators!

Management representations

Management representations are required for the material areas of the financial statements. In addition, management representations must be obtained from the client relating to issues of fraud. 

Regulators frequently cite:

  • no management representation on file; or
  • the management representation letter has been signed after the date of the auditor’s report

In relation to the second point, the management representation letter must either be signed on the same day the auditor’s report is signed and the financial statements approved, or extremely close to the date of the auditor’s report. It must never be signed after the date of the auditor’s report.

Disclosure checklist

Using a disclosure checklist will help immensely in ensuring that the correct disclosures have been made in the financial statements. Incorrect or lack of disclosures are, again, one of the most frequently cited gripes which regulators have. Disclosure issues have also been covered in previous articles. If you are technically up to speed with disclosure requirements and you are happy that there are no major changes from the previous year and do not consider that completion of the disclosure checklist is necessary in the current year’s audit, it is important to document the reasons why a disclosure checklist is deemed “not applicable” this year as regulators will expect to see a checklist on file.

Going concern

A final “hotspot” is the area of going concern. Some audit firms are guilty of just simply ticking the boxes on the going concern questionnaire and determining the going concern basis to be appropriate without any consideration given to issues which might have occurred post balance sheet date. It is always a good idea to incorporate further going concern procedures (sometimes over and above the standard audit programme tests) in with the subsequent events testing.

Reviews of up to date management information, order books, budgets and forecasts and such like is always a good idea. It is also worth obtaining the accounts of key customers from Companies House to see if there are any going concern problems from major customers which may well affect the going concern of the client.

Conclusion

A reliable source of mine tells me that auditing used to be considered as “accountancy plus common sense”. Unfortunately legislation and regulation, as well as the odd corporate disaster thrown into the mix, has meant auditing has slowly but surely become more specialised and if you are not up to speed on the ISAs or other technical issues then you are going to be exposed to some publicity in the disciplinary section of your professional magazine, an introduction to the disciplinary panel, a nice sizeable fine and in some extreme cases, the chance to have a clear out of your audit client portfolio when your audit registration is withdrawn. 


Steve Collings is the audit and technical partner at
Leavitt Walmsley Associates and the author of ‘The Interpretation and Application of International Standards on Auditing’ (Wiley 4 March 2011). He also lectures on financial reporting and auditing issues.

Tags:

Replies (3)

Please login or register to join the discussion.

avatar
By Towards excellence
15th Feb 2011 07:59

Very helpful

Thanks Steve, very useful.

Can I point out a 'typo' where you have mentioned 'letter of engagement' under management representations?

Kind regards

SA

Thanks (0)
collings
By Steven Collings
15th Feb 2011 08:11

Typo

Well spotted!! Thanks for that.  I'll arrange for it to be amended.

Best regards

Steve

Thanks (0)
avatar
By Mukkarram Ali
14th Nov 2018 13:20

Great article. Thanks

Thanks (0)