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Audit completion: the common pitfalls

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2nd Jul 2012
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This is the first of two articles and relates to the completion of the external audit because this is an area that is prone to oversight, sometimes due to fee pressure or misunderstanding of the clarified International Standards on Auditing (UK and Ireland) ISAs, explains Steve Collings.

This article aims to flag up a few of the common pitfalls that practitioners may encounter with the intention of making audit files stand a better chance of successful review. The next article will focus on audit planning.

Going concern

There has been a lot of press attention regarding going concern and the concept is one of those ‘issues’ that will never go away. ISA (UK and Ireland) 570 Going Concern outlines the auditor’s responsibility in ensuring that the going concern presumption is appropriate. The objectives of the auditor according to ISA (UK and Ireland) 570 are:

  • To obtain sufficient appropriate audit evidence regarding the appropriateness of management’s use of the going concern assumption in the preparation of the financial statements
  • To conclude, based on the audit evidence obtained, whether a material uncertainty exists related to events or conditions that may cast significant doubt on the entity’s ability to continue as a going concern
  • To determine the implications for the auditor’s report

Going concern can be split into three component parts:

  1. Financial issues affecting the entity
  2. Operational issues affecting the entity
  3. External factors (or business risks)

Financial issues affecting the entity

The auditor has to consider various financial issues, some (but not all) of which are shown below:

  • Does the balance sheet have net current liabilities and/or net liabilities?
  • Is the relationship between the client and its bankers/suppliers showing signs of strain?
  • Are borrowing facilities nearing renewal? Is it (un)likely such facilities will be renewed?
  • Does the cash flow forecast (if prepared) indicate cash shortages that may be long term?
  • Is the client suffering from recurring trading losses?

Operational issues affecting the entity

Operational issues relate to how the client runs the business, and some of the issues which the auditor has to consider are:

  • Does the company have adequate managerial resources available?
  • Is the client over-reliant on major customers/suppliers?
  • Where the client is a subsidiary, is the subsidiary dependant on the parent or another subsidiary in the group?
  • Have there been problems sourcing raw materials or labour?

External issues (business risk)

Here the auditor must consider those factors that are outside the control of the company, such as:

  • Factors which may cause the client’s products to suffer from obsolescence
  • Legal or regulatory factors that may influence the company’s operations
  • Foreign currency risk that may cause an adverse effect on the company’s operations
  • Any specific external factors that may adversely affect the company’s operations

Many ‘off the shelf’ audit software programmes contain programmes which cover the issue of going concern, but it is important to understand that they should not be viewed as a ‘tick box’ exercise; indeed many audit firms have been criticised for their dismissive approach to going concern.

Also, it is worth pointing out that the mainstream ISA 570 at paragraph 13 requires the auditor to request management extend their assessment of going concern if their assessment is not at least 12 months from the reporting date. However, in the UK and Ireland, the Application and Other Explanatory Material at paragraph A10-1 requires management to make an assessment of going concern for a period of one year from the date of approval of the financial statements. 

Analytical procedures

ISA (UK and Ireland) 520 Analytical Procedures requires the auditor to perform analytical procedures near the end of the audit which will assist them in forming an overall conclusion on the financial statements. According to paragraph A17 in the UK and Ireland ISA 520, the conclusions drawn from the results of analytical procedures applied near the end of the audit are intended to corroborate conclusions formed during the audit of individual components or elements of the financial statements. ISA (UK and Ireland) 520 at paragraph A17-1 outlines five factors which may be considered by the auditor:

  1. Whether information and explanations gathered during the audit are adequately reflected in the financial statements
  2. Whether the audit procedures implemented have revealed any factors that may affect the presentation of, or disclosures, in the financial statements
  3. Whether the analytical procedures applied during the detailed audit fieldwork produce results that assist the auditor in arriving at an overall conclusion as to whether the financial statements are consistent with the auditor’s knowledge of the client
  4. Whether the presentation adopted in the financial statements has been unduly influenced by those charged with governance so as to present such information in a favourable or unfavourable light
  5. The potential impact of uncorrected misstatements on the current year’s financial statements and of the preceding period, if any

It may be the case that when such analytical procedures are adopted, a previously unrecognised risk of material misstatement may arise. If this occurs, ISA (UK and Ireland) 315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and its Environment requires the auditor to revisit the risk assessment of material misstatement and amend the further planned audit procedures to address the previously unrecognised risk. 

Written representations

ISA (UK and Ireland) 580 Written Representations specifically requires the auditor to obtain representations from management and, where appropriate, those charged with governance, confirming that they believe they have fulfilled their responsibility for the preparation of the financial statements and for the completeness of the information provided to the auditor. In addition, certain other representations will be required as follows:

  • Confirmation that the auditor has been provided with all relevant information and access as per the audit engagement
  • Confirmation that all transactions have been recorded and are reflected in the financial statements (this includes access to individuals that hold information relevant to the audit)

The Application and Other Explanatory Material at paragraph A10 does acknowledge that the auditor may also require other written representations about the financial statements, including:

  • Whether the selection and application of accounting policies are appropriate
  • Whether matters such as the following, where relevant under the applicable financial reporting framework, have been recognised, measured, presented or disclosed in accordance with that framework:

o   Plans or intentions that may affect the carrying value or classification of assets and liabilities

o   Liabilities, both actual contingent

o   Title to, or control over, assets, the liens or encumbrances on assets, and assets pledged as collateral

o   Aspects of laws, regulations and contractual agreements that may affect the financial statements, including non-compliance

Subsequent events

ISA (UK and Ireland) 560 Subsequent Events mandates the auditor to obtain sufficient appropriate audit evidence relating to the intervening period between the client’s year-end and the date on which the financial statements are (expected) to be approved and the auditor’s report signed. The overarching objective here is to ensure that any events that take place during the intervening period are considered as such events may be ‘adjusting’ events or ‘non-adjusting’ events in the financial statements. In addition the objective of ISA (UK and Ireland) 560 is for the auditor to respond appropriately to facts that have become known to the auditor after the auditor’s report has been signed that, had they been known to the auditor at that date, may have caused the auditor to amend the auditor’s report.

Such procedures may include:

  • Reviewing accounting records since the year-end
  • Reviewing board minutes
  • Discussions with the directors or management concerning any unusual transactions or events since the year-end and considering whether such events are post balance sheet events
  • Liaising with the client’s legal advisers in relation to claims that have been brought against the company that are ongoing
  • Considering significant accounting estimates, such as stock provisions and ascertaining whether such estimates are reasonable in light of other audit evidence obtained

Audit documentation and file completion

It is always advisable to cross-reference the audited financial statements to the lead schedules in the audit file to enable the review process to be as efficient as possible. In addition, ISA (UK and Ireland) 230 Audit Documentation requires the auditor to prepare audit documentation which is sufficient to enable 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
  • Any significant matters that have arisen during the audit and the conclusions that have been drawn thereon as well as significant professional judgments made in arriving at those conclusions

For the avoidance of doubt, ISA (UK and Ireland) 230 defines an ‘experienced auditor’ as an individual (whether internal or external to the firm) who has practical audit experience, and a reasonable understanding of:

  • Audit processes
  • ISAs and applicable legal and regulatory requirements
  • The business environment in which the entity operates
  • Auditing and financial reporting issues relevant to the entity’s industry

ISA (UK and Ireland) 230 at paragraph A1 also states that the auditor must prepare sufficient and appropriate audit documentation on a timely basis and recognises that documenting audit work after the work has been performed is less likely to be as accurate as documentation prepared at the time such work is performed.

Finalising an audit file does take time after the detailed on-site fieldwork has been completed and ISQC (UK and Ireland) 1 Quality Control for Firms that Perform Audits and Reviews of Financial Statements, and Other Assurance and Related Services Engagements says that the completion of final assembly of audit files would ordinarily not be more than 60 days after the date of the auditor’s report.

Prior period not audited

Paragraphs 14 and 19 to ISA (UK and Ireland) 710 Comparative Information – Corresponding Figures and Comparative Financial Statements outlines the reporting requirements when a client’s financial statements for the previous accounting period were not audited. The auditor’s report must state that the comparative financial statements were not audited in an ‘Other Matter’ paragraph. While the previous financial statements were not subject to audit, ISA (UK and Ireland) 710 at paragraphs 14 and 19 acknowledge that the auditor’s responsibility in relation in obtaining sufficient appropriate audit evidence that the opening balances are not materially misstated is not relieved just because the previous period was not audited. The auditor’s responsibility for opening balances are covered in ISA (UK and Ireland) 510 Initial Audit Engagements – Opening Balances

Conclusion

This article has flagged up a few areas where file reviewers have expressed concern on the issue of completion of audit files. Many audit programmes will contain generic audit procedures that deal with completion, and many of these procedures will be relevant to every audit client. However, it is important that programmes are tailored to be client-specific, which may involve an element of time being saved.

Steve Collings is the audit and technical partner at Leavitt Walmsley Associates and the author of ‘Interpretation and Application of International Standards on Auditing’. He is also the author of ‘The AccountingWEB Guide to IFRS’ and ‘IFRS For Dummies’ and was named Accounting Technician of the Year at the 2011 British Accountancy Awards.

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