The ultimate aim of the audit process is for the auditors to be in a position to express their opinion to the shareholders as to whether the financial statements have been prepared, in all material respects, in accordance with the applicable financial reporting framework.
An item might be deemed material due to its:
• Impact (for example, the $1.00 journal that turns a profit into a loss.)
• Nature (such as transactions with directors)
• Value (such as a significant asset acquired)
Between ½% and 1% revenue
Between 1% and 2% of total assets; or
Between 5% and 10% of profit before tax.
|Nature of circumstances||Material but not pervasive||Material and pervasive|
|Financial statements are materially misstated||QUALIFIED OPINION||ADVERSE OPINION|
|Auditor unable to obtain sufficient appropriate audit evidence||QUALIFIED OPINION||DISCLAIMER OF OPINION|
AR = IR * CR * DR
Audit Inherent Control Detection
Audit risk is the ‘risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated’.
Control risk is the susceptibility of an assertion to a misstatement that could be material, either individually or when aggregated with other misstatements, assuming that there were no related internal controls.
ROMM(Risk of material misstatements) is the risk that a misstatement could occur in an assertion that could be material, either individually or when aggregated with other misstatements, that will not be prevented, or detected and corrected, on a timely basis by the entity’s internal control.
Detection risk is the risk that the auditor’s procedures will not detect a misstatement that exists in an assertion that could be material either individually or when aggregated with other misstatements.
Accounting issue (Audit risk)
When describing RoMMs, an effective approach is to use the following steps to construct your answer
1. 计算重要性 Calculate and conclude on the materiality of the issue where sufficient information is available.
2. 简述规定 Briefly describe the relevant financial reporting requirement.
3. 对应的风险 Relate the risk in the scenario to the accounting treatment.
4. 对报表影响(overstate/understate) Illustrate the impact of the risk on the financial statements
Several customers have returned equipment due to faults.
2. Inventory should be valued at the lower of cost and NRV.
3. For items which have been returned, there is a risk that the NRV falls below the costs.
4. This would result in an overstatement of inventory(or assets) in the statement of financial position and an understatement of cost of sales, therefore an overstatement of profit.
IAS12 Income Taxes
2. IAS 12 Income Taxes requires deferred tax to be recognised in respect of temporary differences which arise between the carrying amount and tax base of assets and liabilities, including the differences from the revaluation of non-current assets.
3./4. The finance director’s suggestion that deferred tax should not be provided for is therefore incorrect, and at present liabilities are understated.
2. According to IAS 12 Income Taxes, a deferred tax asset is recognized for an unused tax loss carry-forward or unused tax credit if, and only if, it is considered probable that there will be sufficient future taxable profit against which the loss or credit carry-forward can be utilised.
3. While it appears that some of the deferred tax asset has been utilised this year, there remains a risk that if it is no longer recoverable, then the amount would need to be written off.
4. This would result in an overstatement of the deferred tax asset.
IAS16 Property, Plant and Equipment
1. The decision to revalue the company’s manufacturing sites and the revaluation gain recognised in equity represents 3·9% of total assets and is therefore material to the financial statements.
2. IAS 16 Property, Plant and Equipment requires all assets in the same class to be revalued.
3. There is a risk that any properties which are manufacturing sites have not been included in the revaluation exercise.
4. This would result in the amounts recognised will not be correct.
There is also a risk that depreciation has not been recalculated on the new, higher value of the properties, leading to overstatement of non-current assets and understatement of operating expenses.
2. According to IAS 16 Property, Plant and Equipment, modernisation costs which give rise to enhanced future economic benefit should be capitalised, whereas costs which do not create future economic benefit should be expensed.
3. There is a risk that the amounts capitalised into non-current assets are not correct in that capital and revenue expenditure may not have been correctly identified and accounted for separately.
4. This would result in a misstatement of the assets’ carrying values and depreciation expense.
2. IAS 16 requires that each part of an item of property, plant and equipment with a cost which is significant in relation to the total cost of the item must be depreciated separately.
3./4. There is a risk that the various components of each warehouse have not been treated as separate components and depreciated over a specific useful life.
1. The change to the estimated useful lives of property, plant and equipment has increased profit by $5 million, which represents 17·9% of profit before tax and is therefore material to the financial statements.
2. This change in accounting estimate is permitted, but the audit team should be sceptical and carefully consider whether the change is justified.
3. There is a risk that the change might be inappropriate.
4. This would result in an overstatement of profit ($5 million)and an overstatement of asset($5 million).
IAS20 Government Grants
2. A grant is recognised as income over the period necessary to match the grant received with the related costs for which they are intended to compensate.
3. Therefore, the $2 million relating to costs incurred this year should be recognised as income, but the remainder should be deferred and released to profit on a systematic basis.
4. The risk is that the grant has been recognised on an inappropriate basis leading to over or understated profit for the year.
IAS21 Exchange Rates
2. According to IAS 21 The Effects of Changes in Foreign Exchange Rates, transactions should be initially recorded using the spot rate, and monetary items such as trade payables should be retranslated at the year end using the closing rate.
3./4. The risk is that the incorrect exchange rate is used for the translation and retranslation, or that the retranslation does not happen at the year end, in which case trade payables and profit could be over or understated.
IAS 23 Borrowing Costs
A qualifying asset is an asset which takes a substantial period of time to get ready for its intended use or sale. If modernisation meets the definition of a qualifying asset, then borrowing costs should be capitalized during the period.
There is a risk that borrowing costs have not been capitalized if the qualifying asset definition has been met, and equally a risk that borrowing costs may have been capitalized incorrectly if the definition has not been met.
This could result in an misstatement of the assets’ carrying values and finance cost.
IAS33 Earnings per Share
IAS 33 requires EPS to be calculated based on the profit or loss for the year attributable to ordinary shareholders as presented in the statement of profit or loss.
The earnings figure used as the basis of the calculation should also not be based on profit before tax but on the post-tax profit.
The denominator should be based on the weighted average number of shares which were in issue during the financial year.
(There is a risk relating to inadequate disclosure, for example, a diluted EPS needs to be presented, as does a comparative for the previous year.)
Being listed –> Attention of investors on EPS
The management should consider whether there are indicators of impairment and if necessary perform an impairment review on the licence. (There is a risk that the recoverable amount is less than the carrying value.)
When there is an indicator of potential impairment of the assets, management should have conducted an impairment review to determine the recoverable amount.
The recoverable amount is the greater of the fair value less cost to sell and the value in use of the assets.
As a cash generating unit the impairment should firstly be allocated against any goodwill relating to the cash generating unit and then be allocated against the remaining assets on a pro-rata basis.
Goodwill should be tested annually for impairment regardless of whether indicators of potential impairment exist.
IAS37 Provisions, Contingent Liabilities and Contingent Assets
2. A provision should be recognised where a reliable estimate can be made in relation to a probable outflow of economic resources and an obligating event has taken place. A contingent liability should be disclosed if there is a possible, rather than probable, outflow of economic benefit.
3./4. The risk is that either a necessary provision is not recognised, understating liabilities and expenses, or that a contingent liability is not appropriately disclosed in the notes to the financial statements.
(The risk is that no provision or an insufficient provision in relation to the warranty has been recognised, leading to understated liabilities and operating expenses.)
Assuming that these criteria have been met, it would be reasonable to expect the full amount to be provided.
For a restructuring provision to be recognized, there must be a present obligation as a result of a past event, and that is only when a detailed formal plan is in place and the entity has started to implement the plan, or announced its main features to those affected.
IAS 38 Intangible Asset
Research costs must be expensed and Development costs are capitalised only after technical and commercial feasibility of the asset for sale or use have been established, and an intention and ability to complete the development and that it will generate future economic benefits.
The cost of acquiring patents for products should be capitalised and recognised as an intangible asset.
If patent costs have been expensed rather than capitalised, this would understate assets and overstate expenses.
Once recognised, patents should be amortised over the period of their duration, and non-amortisation will overstate assets and understate expenses.
2. IAS 38 Intangible Assets states that an intangible asset with a finite useful life is amortised, and an intangible asset with an indefinite useful life is not.
3./4. There is a risk that the assumption that the brand has an indefinite life is not correct, and that the asset is overstated and operating expenses understated through the lack of an annual amortisation charge.
2. The amortisation method should reflect the pattern of benefits and Amortisation should begin when the asset is available for use.
There is a risk that the licence may not be amortized from 1 July 2016 or over the remaining licence period of eight and a half years.
This would result in over or understatement of the amortization charge to profit as well as the carrying value of the intangible asset.
IAS 38 requires that goodwill is tested annually for impairment regardless of whether indicators of potential impairment exist.
IAS 40 Investment Property
According to IAS 40 Investment Property, an entity can use either the fair value model or the cost model to measure investment property. When the fair value model is used the gain is recognised in profit or loss.
The draft consolidated statement of profit or loss and other comprehensive income includes the investment property revaluation gain as other comprehensive income rather than as profit of loss, and therefore the gain is not presented in accordance with IAS 40.
IFRS 2 Share-based Payment
IFRS 2 Share-based Payment states that the liability in respect of the plan should be measured at fair value at the year end.
IFRS 2 Share-based Payment requires an expense and a corresponding entry to equity to be recognised over the vesting period of a share-based payment scheme, with the amount recognised based on the fair value of equity instruments granted.
IFRS 5 NCA Held for Sale and Discontinued Operations
A disposal group is a group of assets to be disposed of together as a group in a single transaction and liabilities directly associated with those assets that will be transferred in the transaction.
An entity shall classify a non-current asset (or disposal group) as held for sale if its carrying amount will be recovered principally through a sales transaction rather than through continuing use.
The asset (or disposal group) must be available for immediate sale in its present condition, subject only to usual and customary sales terms, and the sale must be highly probable(Price reasonable / Management committed / Active programme / within one year).
On classification of the non-current asset (or disposal group) as held for sale, it is written down to fair value less costs to sell (if less than carrying amount).
normally disclosed as current assets and liabilities (not offset).
A discontinued operation is a component of an entity that either has been disposed of or is classified as held for sale and:
a) represents a separate major line of business or geographical area of operations, or
b) is part of a single coordinated plan to dispose of a separate major line of business or geographical area of operations, or
c) is a subsidiary acquired exclusively with a view to resale.
IFRS 8 Operating Segments
IFRS 8 Operating Segments requires listed companies to disclose in a note to the financial statements the performance of the company disaggregated over its operating or geographical segments.
Being a listed entity, ZCG should provide segmental information in the notes to the financial statements in accordance with IFRS 8 Operating Segments.
There is a risk that the segmental information provided is not sufficiently detailed.
There are some unusual trends in the segmental revenue figures from the management accounts. For example, revenue from south east Asia appears to have increased significantly. The projected revenue from that segment is $49·5 million, an increase of 65% compared to 2015.
There is a risk that revenues have been misallocated between segments and that the disclosure is inaccurate.
IFRS9 Financial Instruments
speculative 投机性的 FV through P/L
IFRS 9 requires Speculative investments in equity shares should be measured at fair value through profit or loss.
The treasury management function is involved with forward exchange contracts, meaning that derivatives exist and should be accounted for in accordance with IFRS 9 Financial Instruments.
This is a complex accounting issue, and there are numerous audit risks arising.
There is also a risk in determining the fair value of the derivative at the year end, as this can be judgemental and requires specialist knowledge.
The loan should be initially measured at fair value, and classified according to whether it is subsequently measured at amortised cost or at fair value. As the loan is not held for trading, it should be measured at amortised cost unless Group management decides to use the fair value option.
IFRS15 Revenue from Contracts with Customers
(Revenue should be recognised over time or at a point in time when control is passed. Such points will be determined by the contractual terms. Payments received in advance of control passing should be recognised as deferred income.There is a risk that revenue might be recognised early when payment is received rather than being deferred.
This would result in an overstatement of revenue and an understatement of liabilities for deferred revenue.)
Revenue should be recognised over time or at a point in time when control is passed. Such points will be determined by the contractual terms.
(There is a risk that the revenue from the sale of a licence should not be deferred at all.)
(Or there is a risk that the period over which the revenue is recognized could be inappropriate, resulting in over or understatement of revenue.)
ZCG is supplying customers with a multiple-element contract and is providing access to a mobile phone network and a fixed landline and broadband service.
The elements of the contract should be accounted for separately and the revenue from the contract should be allocated to each component.
Contracts vary in length, lasting two or three years.
The timing of revenue recognition should be in line with the period for meeting its performance obligations.
Costs incurred to fulfill a contract are recognized as an asset if the costs enhance resources which will be used to satisfy performance obligations in the future, and the costs are expected to be recovered.
IFRS 15 which states that when the outcome of a construction contract can be estimated reliably, contract revenue and contract costs associated with the construction contract shall be recognised as revenue and expenses respectively by reference to the proportion of work completed at the end of the reporting period.
For proportion of work completed IFRS15 allows for a variety of methods to be used, for example, based on the proportion that contract costs incurred for work performed to date bear to the estimated total contract costs, or on surveys of work performed.
Why analytical procedures are performed as a fundamental part of our risk assessment at the planning stage of the audit. 3不用背
Analytical procedures are the evaluation of financial information through analysis of plausible relationships between both financial and non-financial data.
Analytical procedures include comparisons of the financial information with:
Comparable information for prior periods
Comparable information from competitors.
Analytical procedures performed at the planning stage help the auditor to identify and respond appropriately to risk, and to assist the auditor in obtaining an understanding of clients. (A risk assessment procedures at the planning stage)
To alert the auditor previously unknown transactions or events
To plan appropriate audit procedures to obtain sufficient appropriate audit evidence
identify the existence of unusual transactions or events
先分析 AP ，再找可能理由，列出可能风险。
- 影响 -> Audit (Revenue/Cost/☆CF☆ /GoingConcern) / Business / Why
Regulation –> Fine / Suspending production/ CF / Reputation –> Revenue decreases
现金流状况 分析(正/负)现金流、可持续经营假设(现有现金)。–> Going Concern
诉讼 -> reputation damage, 影响市场占有率, 增加监管。
Overtrading 特征：收入增加，盈利能力下降，流动性恶化。注意 Going Concern。
Competitor –> Price –> Adapt to changes –> Financial resources
Profitability: Trend in Revenue, Expense, Profit and Margin –>Going Concern
audit procedures, additional information, audit evidence
2. Authorized? – Board minutes
3. Cash book and bank statement (收支)
事件推动 — Case
To confirm the existence of a revenue stream
IAS 36 Impairment
Impairment –> Cash flow forecast –> Assumptions (reasonableness) –> Recalculation (Recoverable amount & Allocation)
It would seem appropriate that the licence is recognised as an intangible asset as it has been purchased as a separable asset without physical substance and has a reliable cost. Management should be able to demonstrate the economic benefit that has been, or is expected to be, derived from the licence. (外购)
Review management accounts and cash flow forecasts to confirm that Farland is generating an income stream and is predicted to continue to generate cash.
Obtain a written representation from management confirming that there are no indications of impairment of the licence of which management is aware.
Consider whether there are any indicators of potential impairment at the year end by obtaining pre year-end sales information and reviewing terms of contracts to supply the products to pharmacies.
IAS 1 Presentation of Financial Statements requires that an individual item of income or expense which is material should be disclosed separately.
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations
written representation to confirm the assets will be sold in one year.
It is not sufficient to simply put management’s justification for the accounting treatment on the audit file and conclude that it is correct.
Using management accounts, determine whether the factory is a separate major line of business in which case its results should be disclosed as a discontinued operation.
Completing the audit
ISA 560: Subsequent events
Events which provide evidence of conditions which existed at the end of the reporting period.
Events that relate to conditions which arose after the end of the
ISA 570: Going concern
Auditors should consider the appropriateness of the managements’ use of the going concern assumptions.
- Net liability or net current liability position (CA < CL)
- Operating losses or fall in value of CGUs
- Negative operating cash flows
- Withdrawal of financial support
- Inability to obtain financing for essential new product development or other essential investments
- Inability to comply with terms of loan agreements (covenant)
- Change from credit to cash-on delivery transactions with suppliers
- Increases in trade payable (days) –> Struggling w/ operating cycle
- Shortage of supplies
- Emergence of successful competitors
- Loss of key management without replacement
- Loss of licence
- Labor difficulties
- Changes in legislation or government policy
Few companies can sustain many consecutive loss-making periods.
The xxx event represents a material uncertainty which may need to be fully disclosed in the financial statements.
Analyse and discuss the cash flow and profit forecasts with management and review assumptions to ensure they are in line with management’s strategy and auditor’s knowledge of the business.
Obtain a copy of the latest management accounts and compare the actual post year-end sales performance with the forecast sales.
Read the minutes of the meeting of shareholders, those charged with governance for reference to trading and financing difficulties.
Audit procedures for Cash Flow Forecast
Review the outcome of previous forecasts prepared by management to assess how effective management has been in the past at preparing accurate forecasts.
Obtain a copy of the latest interim financial statements and compare the actual post year-end sales performance with the forecast sales upon which the cash flow forecast is based.
Agreement of the opening cash position to the audited financial statements and general ledger or bank reconciliation, to ensure accuracy of extracted figures.
Confirmation that casting of the cash flow forecast has been reperformed to check arithmetical accuracy.
Comparison of the cash flow forecast for the period August–November 2013 with management accounts for the same period, to ensure accuracy of the forecast.
Impact on audit report
The note should include a description of conditions giving rise to the significant doubt, and the directors’ plans to deal with the conditions.
If the note contains adequate information on going concern issues, the audit opinion should not be modified. The auditors should modify the auditor’s report by adding a material uncertainty related to going concern paragraph. The material uncertainty paragraph should contain a brief description of the uncertainties, and also refer explicitly to the note to the financial statements where the situation has been fully described.
If note does not contain adequate information on going concern, the auditors should express a modified opinion. The auditor would need to use judgement to decide whether a qualified or an adverse opinion should be given.
The audit report should include a paragraph titled ‘Basis for Qualified Opinion’ or ‘Basis for Adverse Opinion’, and the situation must be discussed w/ those charged with governance.
ISA450 EVALUATION OF MISSTATEMENTS
ISA 450 requires that ‘the auditor shall accumulate misstatements identified during the audit, other than those that are clearly trivial’.
ISA 450 also requires that ‘The auditor shall communicate on a timely basis all misstatements accumulated during the audit with the appropriate level of management, unless prohibited by law or regulation. The auditor shall request management to correct those misstatements.’
ISA 450 requires the auditor to obtain an understanding of management’s reasons for not making the corrections, and to take that understanding into account when evaluating whether the financial statements as a whole are free from material misstatement. Discuss WHY
ISA 450 requires the auditor to communicate uncorrected misstatements to those charged with governance.
In addition the auditor is required to request a written representation from management and, where appropriate, those charged with governance with regard to whether they believe the effects of uncorrected misstatements are immaterial, individually and in aggregate, to the financial statements as a whole.
Three categories of misstatements
Factual misstatements are misstatements about which there is no doubt. 事实错报
Judgmental misstatements are differences arising from the judgments of management concerning accounting estimates that the auditor considers unreasonable, or the selection or application of accounting policies that the auditor considers inappropriate. 判断错报
Projected misstatements are the auditor’s best estimate of misstatements in populations, involving the projection of misstatements identified in audit samples to the entire populations from which the samples were drawn. 推断错报
ISA 520 Overall review of the financial statements
- To perform analytical procedures to form an overall conclusion as to whether the financial statements are consistent w/ the auditor’s understanding of the entity and to reveal further previously unrecognized risk of material misstatement.
- To carefully review the notes to the financial statements for completeness and compliance w/ the applicable financial reporting framework.
- To consider the misstatements identified during the audit. Material misstatements should have been adjusted, otherwise the auditor should consider the impact on the audit report.
ISA 720 Other information
Other matter paragraph
At this stage, the auditor should also read the other information to be issued with the financial statements for consistency with the financial statements.
ISA 580 Written Representations
- fraud 关联方
- Management intention
If a representation is contradicted by other audit evidence, the auditor should reconsider the reliability of other representations made by management.
b) Addressee (Intended user)
c) Opinion paragraph
d) Basis for opinion paragraph (当意见修改)
e) Material uncertainty related to going concern paragraph (if relevant)
f) Emphasis of matter paragraph (if relevant)
g) Key audit matters (KAM) paragraph (for audits of listed entities only)
h) Other matter paragraph (if relevant)
i) Responsibilities of management and those charged with governance for the financial statements
j) Auditor’s responsibilities for the audit of the financial statements
k) Report on other legal and regulatory requirements (if relevant)
l) Name of audit engagement partner
m) Signature of audit engagement partner and/or audit firm
n) Auditor’s address
o) Date of the auditor’s report
Unmodified opinion (Positively )
In our opinion the financial statements present fairly, in all material respects.
Emphasis of matter paragraph
An emphasis of matter paragraph is a paragraph included in the auditor’s report which aims to draw users’ attention to a matter:
1) Which is appropriately presented or disclosed in the financial statements; but
2) Which is of such importance, in the auditor’s judgement, that it is fundamental to users’ understanding of the financial statements.
- The matter has been correctly disclosed/presented in the financial statements.
- This is an important matter which needs to be brought to the attention of the users.
- The audit report should also be with an unqualified opinion but be added an emphasis paragraph to draw attention of the user to this matter.
Since this is fundamental to the users’ understanding of the financial statements, the audit report should be added an emphasis paragraph to draw attention of the user to this matter.
The Emphasis of Matter paragraph should include a clear reference to the matter being emphasised and to the note to the financial statements where the matter is disclosed. The paragraph should also make it clear that the audit opinion is not modified in respect of this matter.
Other matter paragraph
An other matter paragraph is a paragraph referring to a matter which is not presented or disclosed in the financial statements and which is relevant to users’ understanding of the audit.
The auditor must read the other information to ensure it is consistent with the financial statements.
The auditor must use professional judgement to determine if this is a material inconsistency.
If management refuses to amend this, the auditor should include an Other matter paragraph in the audit report to describe the material inconsistency.
Material uncertainty related to going concern paragraph
As the matter disclosed sufficiently, the audit report should be with an unqualified opinion but be added a material uncertainty related to going concern paragraph to draw attention of the user to this matter.
From ISA 705, the term ‘pervasive’ has the following definitions:
1) Are not confined to specific elements, accounts or items of the financial statements;
2) If so confined, represent or could represent a substantial proportion of the financial statements; or
3) In relation to disclosures, are fundamental to users’ understanding of the financial statements. (Going concern)
Implications of the matters
2. Accounting issue
3. Further audit evidence
4. Opinion and impacts (Paragraphs with quantification)
A qualified ‘except for’ opinion should be given, and the Basis for Qualified Opinion paragraph should explain the reason for the qualification, including a quantification of the misstatement.
The Emphasis of Matter paragraph should include a clear reference to the matter being emphasised and to the note to the financial statements where the matter is disclosed. The paragraph should also make it clear that the audit opinion is not modified in respect of this matter.
If management refuses to amend “Other information”, the auditor should include an Other Matter paragraph in the audit report to describe the material inconsistency.
The auditor may also seek legal advice if management refuses to amend the KPI to remove the material inconsistency.
All of the matters affecting the auditor’s report should be discussed with those charged with governance.
审计师责任 (ISA 450)
During the completion stage of the audit, the effect of uncorrected misstatements must be evaluated by the auditor.
The auditor shall obtain an understanding of management’s reasons for not making the corrections
The auditor shall communicate with those charged with governance about uncorrected misstatements and the effect that they, individually or in aggregate, may have on the opinion in the auditor’s report.
Despite the amount being immaterial, it should not be disregarded, as the auditor should consider the aggregate effect of misstatements on the financial statements. ISA 450 does state that the auditor need not accumulate balances which are ‘clearly trivial’
- Request to adjust the financial statements
- Communicate to those charged with governance
- Request a written representation
The basis for qualified opinion paragraph should contain a description of the matters giving rise to the qualification. This should include a description and quantification of the financial effects of the misstatement.
Appraise the report
Audit procedures provide a reasonable, but not absolute, level of assurance on the financial statements.
Key Audit Matter
Those matters that, in the auditor’s professional judgment, were of most significance in the audit of the financial statements of the current period. Key audit matters are selected from matters communicated with those charged with governance.
Three types of matter
1 Areas of higher assessed risk of material misstatement, or significant risks identified. 高风险
2 Significant auditor judgments relating to areas in the financial statements that involved significant management judgment, including accounting estimates that have been identified as having high estimation uncertainty. 判断
3 The effect on the audit of significant events or transactions that occurred during the period. 重大交易
2. How the matter was addressed in the audit.
Auditors’ reports to those charged with governance
Matters to be communicated
- Going concern
- Disagreements with management over accounting treatments or disclosures
- Any expected modifications to the audit report
- Material weaknesses discovered in the internal systems and controls
- Details of any threats to independence and objectivity.
Subsidiary, Joint venture, Associate
- Subsidiary – Control (50%↑) line-by-line (全部进)
- Joint venture – Joint control (一致同意权) Equity (按%进)
- Associate – Significant influence Equity (按%进)
An associate arises where there is significant influence over an investee.
An entity with joint control of, or significant influence over, an investee shall account for its investment in an associate or a joint venture using the equity method.
The company’s loss for the year should be consolidated from the date of acquisition.
Equity accounting requires the investment in the associate to be recognised on one line in the statement of financial position, and the income from the associate to be disclosed on one line of the statement of profit or loss.
- Legal documents w/ number of shares acquired & voting rights attached & NCI interest
- Cash paid
- Recalculation of amounts recognized in equity (pre/post acquisition)
- Minutes of meetings between xxx and yyy to confirm that control is shared and to understand the nature of the relationship. (Joint venture)
- Review organizational structure to confirm appointed members to the board
IFRS 3 Business combination
The purchase consideration should reflect the fair value of total consideration paid and payable. Any deferred or contingent consideration should be included in the consideration.
The net assets acquired should be all identifiable assets and liabilities at the date of acquisition, even those not recognised in financial statements.
Additional depreciation should be charged in respect of the fair value uplift.
IAS 38 requires that goodwill is tested annually for impairment regardless of whether indicators of potential impairment exist.
IFRS 10 Consolidated Financial Statements
On consolidation, the intercompany receivables and payables balances should be eliminated, leaving only balances between the Group and external parties recognised at Group level. (like a single entity)
If the intercompany transaction included a profit element, then the inventory needs to be reduced in value by an adjustment for unrealised profit.
- Reconciliation of the intercompany balances, cash in transit or goods in transit
- Consolidation working paper to confirm the intercompany balances have been eliminated
- Copies of inventory to confirm the quantity of the goods transferred
- A copy of terms of sale to determine the profit margin.
Disposal of subsidiary
B1 P.48 ~ 52
Changes in a parent’s ownership interest in a subsidiary which does not result in the parent losing control of the subsidiary are treated as equity transactions. The gaining is recognized directly in equity and attributed to the owners of the parent.
ISA 600 Audits of Group financial statements
Group auditor: Parent & consolidated
Component auditor: Components (subsidiaries, associates, JV)
If a component weighs more than 15% of the chosen benchmark, the component is deemed as significant because it is likely to include significant risks of material misstatements of the group financial statements.
ISA 600 allows that for components which are not significant components, the group engagement team can perform analytical procedures at group level. However, for a component which is significant due to its individual financial significance to the group, the group engagement, or a component auditor on its behalf, shall perform an audit of the financial information of the component using component materiality.
Matters to be considered relating to using the work of component auditor
- Compliance with local ethical requirements ( & compare)
- Professional competence (relevant industry specific skills)
- Sufficient involvement in component auditor’s work/resource
- Existence of a regulated environment which actively oversees auditors
Matters to consider before accepting appointment as parent company auditor
- The materiality of the portion of the financial statements which the group auditor audits.
- The degree of knowledge regarding the business of the components.
- The risk of material misstatements in the components audited by the component auditors.
- The ability to perform additional procedures
- The relationship with the component auditor
Issues arising when a component is located abroad
- Different accounting policies (must be in line with the policies used by the parent company)
- Cultural problems
- Language problems
Fraud and Law
ISA 240 The auditor’s responsibility relating to fraud
- It is not the auditor’s primary responsibility to detect fraud.
- Management is primarily responsible for preventing and detecting fraud. The auditor is required to obtain reasonable assurance that the financial statements are free from material misstatements whether caused by fraud or error.
The auditor shall maintain professional skepticism throughout the audit and be alert to indicators of potential error.
- Material misstatements arising due to fraud can be difficult for the auditor to detect because fraud is deliberately hidden using sophisticated accounting techniques.
- False statements may be made to the auditors and documents may have been forged. This means that material frauds could go undetected even if appropriate procedures have been carried out.
- Professional scepticism is defined as an attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement and a critical assessment of audit evidence.
- being ready to challenge management & to consider the reliability of information provided by management.
- Going concern assessments and related party transactions (judgement)
- Under pressure (performance target, job and compensation)
- High volume –> difficult to detect
- Judgemental area (percentage of completion)
- Complex issue (multiple elements)
- Cash-rich transactions –> theft of cash
- commonly used method for earnings management
- To change nature of audit procedures
- To change the timing of audit procedures
- To change the extent of procedures (larger sample size)
- When fraud is identified, the auditor should communicate it to the appropriate level of management.
- Fraud should be communicated to those charged with governance.
The auditor may have a legal duty under national law to report fraud to regulatory and enforcement authorities. In such cases, the auditor’s duty of confidentiality is overridden by the law.
Withdrawal from an engagement
- The entity does not take the appropriate action
- material and pervasive fraud
- significant concern about the competence or integrity of management or those charged with governance
the auditor should consider the possibility of withdrawal form the engagement.
- Provisions can be used to smooth profits. (Increased incentive)
- The creation of provisions and their reversal in consequent years is a commonly used creative accounting technique.
- Bill and hold
ISA 250 Considerations of laws and regulations
While it is management’s responsibility to ensure that the entity’s operations are conducted in accordance with the previsions of laws and regulation, the auditor does have some responsibility in relation to compliance with laws and regulations, especially where a non-compliance has an impact on the financial statements.
- Direct effect: Obtaining sufficient appropriate audit evidence regarding compliance
- Do not have a direct effect: Limited to specified audit procedures
- To gain an understanding of the legal and regulatory framework. Help to identify non-compliance.
- To obtain an understanding of the nature of the act and the circumstances in which it has occurred and further information to evaluate the possible effect on the financial statements.
Withdrawal from the engagement
The matter should be discussed with management and those charged with governance. Given the potential severity, the matter should be communicated as soon as possible.
The auditor should determine whether they have a responsibility to report the identified or suspected non-compliance to parties outside the entity. If it is considered to be in the public interest, the auditor should report externally.
An injured party must prove three things:
- A duty of care exists.
- This duty of care was breached.
- The breach caused the injured party loss.
Managing exposure to liability
- Improve audit quality
- Disclaimers of liability
- Liability limitation agreement
The fraud was material and it could be expected that it should have been discovered.
Processes to conceal the true origin and ownership of the proceeds of their criminal activity.
- Placement: The cash obtained through criminal activity is first placed into the financial system to mix the legitimate cash receipts from business activity with the funds they wish to launder.
- Layering: To make the transactions difficult to trace (move the cash internationally)
- Integration: The illegal gained funds are moved back into the legitimate economy.
- Failure to report
- Tipping off
- Money Laundering Reporting Officer
- Training programme
- Customer due diligence (know your client)
- Maintains records of client
Using the work of others
ISA 610 Using the work of internal auditors
The external auditor may decide to use the work of the audit client’s internal audit function to modify the nature or timing, or reduce the extent, of audit procedures to be performed directly by the external auditor. Note that in some jurisdictions the external auditor may be prohibited, or restricted to some extent, by law or regulation from using the work of the internal audit function.
The auditor must evaluate the internal audit function’s organisational status and relevant policies and procedures supporting the objectivity of the internal auditors, the competence of the internal audit function, and whether the internal audit function applies a systematic and disciplined approach, including quality control.
- Objectivity: Unbiased and able to report their findings without being subject to the influence of others.
- Technically competent (Qualification)
- Systematic and disciplined way (effective quality control)
- Obtain written agreement from an authorised representative of the entity that the internal auditors will be allowed to follow the external auditor’s instructions
- Obtain written agreement from the internal auditors that they will keep confidential specific matters and inform the external auditor of any threat to their objectivity
ISA 620 Using the work of an auditor’s expert
ISA 620 contains requirements relating to the objectivity and capabilities of the auditor’s expert and the scope and objectives of their work.
- Objectivity: Not a related party
- Competence: Membership of appropriate professional bodies.
- Scope of work: Objectives of the work, how the expert’s work will be used and the methodology and key assumptions to be used.
- Relevance of conclusions: The auditor should evaluate the relevance and adequacy of the expert’s findings or conclusions. (The source data used, the appropriateness of assumptions)
Specific accounting issues
ISA 540 Auditing accounting estimates
- Obtain understanding of accounting and disclosure requirements
- Understanding management’s method for valuing financial instruments
- Consider internal controls
- Determine resources (skills needed and need for an auditor’s expert)
- Obtain understanding of client’s financial instruments
- The methodology applied to the impairment review should be checked by the auditor, with inputs to calculations, e.g. discount rates, agreed to auditor-obtained information.
- The assumptions used in the impairment test should be confirmed as agreeing with the auditor’s understanding of the business based on the current year’s risk assessment procedures, e.g. assess the reasonableness of assumptions on cash flow projections.
- Obtain an understanding of the controls over the management’s process of performing the impairment test including tests of the operating effectiveness of any controls in place, for example, over the review and approval of assumptions or inputs by appropriate levels of management
- Develop an independent estimate of the impairment loss and compare it to that prepared by management.
- Perform sensitivity analysis to consider whether management has considered alternative assumptions and the impact of any alternative assumptions.
ISA 550 Related parties
ISA 510 Initial audit engagements – opening balances
Audit-related services and other assurance services
Audit v.s. Review
- Regulatory requirements
Review: Not required
- Determination of scope
Audit: Auditing standards
Review: Agreed by the firm and the client
- Nature of procedures
Audit: Wide range of procedures (TOC,substantive procedures)
Review: Narrower range of procedures (Enquiry, AP)
- Level of assurance
Audit: Reasonable assurance
Review: Moderate assurance
Advantages & disadvantages
- Information gathering
- Process of fact finding
- Verification of management representation
- Identification of assets and liabilities
- To value the target company
- To identify and value the intangible assets
- To value the contingent liabilities
- Operational issues
- Acquisition planning
- Economics of scale
- Add credibility, secure the bank loan
- Operational issues: Whether or not to continue the acquisition
DD v.s. Audit
- Fact finding –> much wider range of sources
- Level of assurance:
- will not express any opinion (agreed upon procedure)
- If requested, limited assurance
- Types of procedure performed
- AP and enquiry
- Forward-looking vs mainly history
- No controls testing
Areas to focus and additional information
- 收购可行性 Equity owners
- VC, exist route — Register of shareholders
- 收购的原因 Motivation of acquisition
- Synergy, key skills and expertise — Organisational structure, members of management and key management
- 收购数值 FV of net assets acquired (FP, P/L, CF)
- Internally generated intangible assets
- Tangible assets — Non-current asset register
- Contingent liability — Legal advice
- Revenue — Breakdown of the revenue, repeat customers, sales forecast
- Cost structure — economics of scale
- Finance costs
A list of employees and details of compensation to be paid in case of redundancy
Prospective financial information
- As an internal management tool
- For distribution to third party (regulatory bodies, lenders)
Matters to consider before accepting
- Advocacy threat, self-review, self-interest (Non-audit service provided to an audited entity)
- Discuss w/ those charged with governance
- Use separate teams
- Competence and time frame
- Intended use
- General or limited distributon
- Specific terms of the engagement
- What exact information will be included in the application
- What exact information will be included in the application
- Period and key assumptions
- Agreement that the accounting policies used in preparing the forecast are consistent with those used in historical financial information and comply with IFRS.
- The forecast should be cast to confirm accuracy.
- Review any other information to accompany the forecast for consistency
- Ensure management’s assumptions are not unrealistic
- Analytical review — trend in revenue
Level of assurance
Due to the nature of PFI, the audit firm will be unable to conclude on whether the results forecast will be achieved. Also there may be insufficient evidence available to conclude that the assumptions are free from material misstatement. Therefore, the audit firm can generally only provide a limited level of assurance.
- The auditor can express a qualified opinion.
- The presentation and disclosure
- Assumptions are unreasonable.
- To investigate fraud
- To quantify the extent of loss
- To quantify financial statement fraud
Social, environment and public sector auditing
- The growth in the importance of the environment
- Ethical consumers, investors and employees
- Key stakeholder groups
- Legislation –> fines
- Promoting transparency
- Be a requirement
- Identify areas of weakness
Impact on the audit of financial statements
- Laws and regulations –> Fines –> Provisions
- Dependence on a major customer segment who in threatened by environmental pressures
- Address social or environmental concerns of stakeholders
- Valuation of assets contaminated
- Review minutes from meetings of directors
- Read publicly available information (Regulation)
- Obtain written representations
Assurance on IR
- Acceptance issues
- Ethical issues and risks
- Quality control
- Agreeing the terms of the engagement (Scope)
- Conclusions and reporting
- No required format, agreed in the engagement letter
Outputs are difficult to measure or intangible in nature.
So the auditor should consider how to validate the measurements and how they can measure the information themselves.
To quantify in monetary terms
Difficult to compare between companies or make year on year comparisons
External audit vs Internal audit
External auditors may rely on works of internal auditors.
- Competence: Professional and technical skills
- Sound judgement
- Ethical behavior
If unacceptable, then external auditors carry out their own testing. It may also form part of the external auditor’s overall assessment of risk.
Benefits of outsourcing internal audit
- Free up the time of staff
- Avoid under-utilising self-built internal auditor function
- Independence and objectivity
- Service can be provided in a flexible way.
Drawbacks of outsourcing
- No guarantee for the service
- The skills will be lost
- Commercially sensitivity data
Ethical implications of providing both internal and external audit
The user auditor has no direct contractual relationship with service organization. –> Access and confidentiality problem
The auditor should obtain an understanding of the nature and significance of the service provided by the service organization.
- Limited to recording and processing the transactions
- Execute the user entity’s transactions and maintain accountability (rely on policies and procedures at the service organization)
- Design procedures
- Extent of interaction and integration of systems
Service auditor’s reports
- Type 1 report: Description and design of controls
- Type 2 report: Opinion (Operating effectively)
- Further procedures:
- Contact the service organization
- Visit service organization to perform appropriate procedures
Using internal auditor’s work
- More efficient
- Strong control environment –> Less substantive procedures
- Review system documentation and information on control activities to build its knowledge and understanding of the new audit client
- To rely on the work performed by internal auditor
Matters to consider
- Objectivity of the function
- Organizational status
- Policies and procedures
- Systematic and disciplined approach
- Integrity: Straightforward and honest
- Objectivity: Should not allow bias, conflicts of interest or undue influence of others
- Professional competence and due care: Knowledge and skill, act diligently
- Confidentiality: should not disclose without proper authority
- Professional behaviour
- Self-interest: The auditor has some financial or other interest in the audit client
- Fees on a contingent basis
- Self-review: A previous judgement needs to be reevaluated by members responsible for the judgement.
- Fair value
- Acquisition planning
- Advocacy: The members promote a position or opinion so that the objectivity may be compromised
- Familiarity: Because of a close relationship, members become too sympathetic to the interests of others
- Intimidation: Members are deterred from acting objectively by threats.
When faced with a potential conflict of interest, an auditor should evaluate the significance of any threats and apply safeguards when necessary to eliminate the threats or reduce them to an acceptable level.
- 套话要eliminate to an acceptable level
Commercial considerations do not override the quality of work performed.
- Integrity of the client
- Competent (Time and resources)
- Ethical requirements
- Briefing on the engagement to obtain an understanding of the objectives
- Engagement supervision, staff training and coaching
- Methods of reviewing the work performed
- Documentation of the work performed
Engagement quality control review
An objective evaluation of the significant judgments made by the engagement team and the conclusions reached in formulating the report.
Prior to signing the opinion.
Role of engagement partner
- Overall quality control of the audit engagement
- Evaluation of compliance with ethical requirements
- Acceptance and continuance of client relationships
- Assignment of an engagement team
- Ensure the engagement quality control review takes place
Assume a management responsibility