Audit misconceptions addressed

Audit inspectors frequently complain about firms that undertake audit work which falls short of acceptable benchmarks.  Certainly during the course of lectures I have come across questions/assumptions that are not necessarily true in the course of audit work and I have put together a few of the more common audit areas which seem to crop up during the course of regulatory visits or cited by other experienced external file reviewers as those matters with which they are concerned.

The ‘hotspots’ are as follows:

• Analytical review
• Opening balances
• Written representations
• Emphasis of matter paragraphs
• Related parties
• Subsequent events
• Professional scepticism
• Going concern

Analytical review

ISA (UK and Ireland) 520 Analytical Procedures requires analytical procedures to be applied near the end of the audit in order to aid the auditor in forming an overall conclusion as to whether the financial statements are consistent with the auditor’s understanding of the entity.  Seemingly some firms have correctly applied analytical procedures during the planning stage of the audit but then do not apply paragraph six 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.

Opening balances

ISA (UK and Ireland) 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.  If the matter(s) is relevant and material to the current year’s financial statements, the new auditor must modify their opinion accordingly (ISA 510.13).  A case became apparent whereby an audit firm had expressed an unqualified audit opinion in the year they were appointed despite not attending the stock count at the previous year-end and not being able to apply alternative procedures in order to gather sufficient appropriate audit evidence concerning the opening stock value.  In this case, the audit firm should have expressed a qualified audit opinion on the grounds of being unable to obtain sufficient appropriate audit evidence concerning the opening stock figure.

Written representations

ISA (UK and Ireland) 580 Written Representations requires the auditor to obtain written representations about various matters.  Some firms have been criticised by regulators and external reviewers for merely obtaining written representations from clients and using such representations as sole audit evidence.  ISA (UK and Ireland) 580 does acknowledge at paragraph four that written representations, on their own, do not provide sufficient appropriate audit evidence about any of the matters with which they deal.  Therefore auditors should ensure that written representations support other audit evidence gathered.

Emphasis of matter paragraphs

An emphasis of matter paragraph must always be included immediately after the opinion paragraph, not before.  In addition, some file reviewers have complained that an emphasis of matter paragraph has not correctly cross-referenced the matter giving rise to the emphasis of matter paragraph to the relevant disclosure within the financial statements themselves.  ISA (UK and Ireland) 706 Emphasis of Matter Paragraphs specifically require such a cross-reference at paragraph 7 (c).  In addition, the auditor must also ensure that the emphasis of matter paragraph indicates that the opinion is not modified in respect of the matter emphasised (paragraph 7 (d)).

Related parties

Inspectors are still complaining that documentation concerning related party issues are sometimes incomplete, and to a certain extent this issue is quite an old chestnut.  However, some file reviewers are complaining that audit firms do not appear to be applying paragraph 14 to ISA (UK and Ireland) 550 Related Parties which requires the auditor to inquire of management and others within the entity, as well as performing other risk assessment procedures as the auditor deems necessary in order to obtain an understanding of the controls (if any) that management has established to:

• identify, account for, and disclose related party relationships and transactions in accordance with the applicable financial reporting framework;
• authorise and approve significant transactions and arrangements with related parties; and
• authorise and approve significant transactions and arrangements outside the normal course of business.

Subsequent events

Many inspectors and file reviewers complain that audit firms are not doing sufficient work where subsequent events are concerned.  In addition, the period of the subsequent events review work did not extend up to the date of the auditor’s report.  Paragraph six to ISA (UK and Ireland) 560 Subsequent Events requires the auditor to perform procedures which are designed to obtain sufficient appropriate audit evidence that all events occurring between the date of the financial statements and the date of the auditor’s report that require adjustment (adjusting events), or require disclosure (non-adjusting events) in the financial statements have been identified.

Professional scepticism

The clarified UK and Ireland ISAs have brought with them more emphasis on the need for auditors to exercise professional scepticism. Some reviewers have expressed concern that audit files appear to be demonstrating a lack of professional scepticism in areas such as fraud and related parties.  Where the latter is concerned, ISA (UK and Ireland) 550 Related Parties does acknowledge that related party relationships may present a greater opportunity for collusion, concealment or manipulation by management, hence ISA (UK and Ireland) 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with International Standards on Auditing (UK and Ireland) at paragraph 15 mandates the auditor to plan and perform the audit with professional scepticism.

Going concern

This area of the audit appears to be quite high on the hotspot list of regulators and external reviewers, presumably because of the challenging economic times.  Many inspectors are complaining that firms are simply not doing enough audit work to ensure that the going concern presumption is appropriate in the entity’s specific circumstances.  In one (more serious) case, no audit work had been undertaken and (perhaps unsurprisingly) the reviewer suffered a sense of humour failure.

It is important that sufficient appropriate audit evidence is obtained to corroborate management’s assertion that the going concern presumption is appropriate having regard to the company’s individual circumstances.  The objective of ISA (UK and Ireland) 570 Going Concern at paragraph 9(b) is 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.  Paragraph 9(c) then requires the auditor to determine the implications for the auditor’s report.

It also appears that some audit firms are applying the mainstream ISA 570 where the assessment of going concern is concerned. The UK and Ireland version of ISA 570 requires the period of assessment by those charged with governance to be at least one year from the date of approval of the financial statements and not one year from the date of the financial statements (the year- / period-end).

Where the auditor concludes that management’s use of the going concern presumption is inappropriate, the opinion expressed must be an adverse opinion.

Category: Audit