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Assignment 1 is compulsory and due 21 August 09 (study guide topics 1 – 4)
- counts towards final module mark
Aue2601
AUE2601 th
Assignment 2 is compulsory and due 25 September 09 (study guide topic 5)
- counts towards final module mark
Detailed Summarised
Detailed summarisedNotes & past
notes &
Assignment 3 is NOT compulsory and doesn't count towards final mark – self assessment

papers (from Past


pg 104)
papers Exam = 2 hours, consisting of :
70% - questions at Level 1 (knowledge and comprehension)
30% - questions at Level 2 (application)

INTRODUCTION TO AUDITING THEORY & AUDIT PRACTICE

PART A – INTRODUCTION TO AUDITING THEORY

Study Topic 2 (text book pg 1/2)


2.1 The need for Auditing Services
Jackson & Stent Chapter 1
ISA 200 – Objectives and general principles governing an audit
ISA 610
International Framework for Assurance Engagements
External auditors – express an independent opinion if the AFS’s of a company fairly present the financial position and
results of the company’s operations. NOT an employee of the company. Basically enhances the degree of confidence
which users of the financial statements will have of the information they received from the financial statements.

Internal auditors – perform independent assignments on behalf of senior management of the company – normally to
evaluate the efficiency, economy and effectiveness of the company’s internal control systems and business activities.
Enhances management’s degree of confidence that the company’s systems are functioning as intended. Employee of
the company, but should be independent of the department, division or subsidiary which they are auditing.

Government auditors – evaluate and investigate the financial affairs of government departments and report their
findings to senior government therefore increasing the degree of confidence which they have in their departments.
Employee of the government, but must be independent of the government department they are auditing.

Forensic auditors – concentrate on investigating and gathering evidence where there has been alleged financial
mismanagement, theft or fraud. Work independent of the entity under investigation and increases the degree of
confidence the investigating body has in the evidence which is presented.
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Special purpose auditors – specialise in a particular field such as environmental auditors and VAT auditors. Enhance
the confidence people have in the “correctness” of the information that is being presented.
MUST BE INDEPENDENT OF THE ENTITY BEING AUDITED.

Auditor required to observe the fundamental ethical principles of :


· integrity (straightforward, honest, moral)
· objectivity (impartial, fair, non-biased and non-prejudicial)
· professional competence and due care – maintaining professional knowledge and skill at the required level and
performing work diligently
· professional behavior – comply with laws and regulations and avoid action which discredits the profession
· confidentiality – respecting the confidentiality of client information.
Financial reporting system is the entire process by which the management of a business entity compiles and
discloses financial information concerning their financial position and the results of the entity’s operations.
All this information is communicated to external parties in the entities financial statement at the end of each accounting
period and the financial reporting process must address the needs of users of the financial information (investors,
lenders, suppliers and employees). Information must be understandable, relevant, and reliable and prepared on a basis
that is comparable with that used by other business entities.
Objective of financial statements = to provide information about the financial position, performance and changes in
financial position of an enterprise that is useful to a wide range of users in making economic decisions. (From the
conceptual accounting framework in the International Standard – IAS).

Auditing vs. accounting :


Management responsibility to prepare the financial statements in accordance to International Financial Reporting
Standards (IFRS’s) and also to :
· maintain an appropriate accounting system and
· design and implement adequate internal controls to ensure the reliability and integrity of the accounting system
Accounting = the series of tasks and records of an entity by which transactions are processed as a means of
maintaining financial records.
Auditing = examining audit evidence to find sufficient evidential matter to support the comments of
management contained in the financial statements, in order to express an opinion in the auditor’s report as to
whether or not the financial statements fairly present the affairs of the entity in accordance with International
Financial Reporting Standards and the relevant statutory requirements.
AUDITOR THEREFORE EXPRESSES AN OPINION ON MANAGEMENT’S FINANCIAL STATEMENTS.

Engagement of auditing can either be because of statutory requirements (e.g. companies) or on a voluntary basis :
Statutory audits – audits required in terms of an Act – e.g. Companies Act which state that all companies must be
audited on an annual basis. These acts normally spell out the statutory duties and responsibilities of the auditor.
Non-statutory audits – audits that are requested by clients but are not obligatory in terms of legislation – e.g. if
member wants audit of a CC.

Either engaged for :


Audits – auditing engagements
Related services – review engagements or engagements where agreed-upon procedures are carried out and
compilation engagements.

Objective of :
Audit engagement – to enable the auditor to express an opinion as to whether the financials statement are prepared
(in all material respects) in accordance with an applicable financial reporting framework
Review engagement – to enable the auditor to state whether or not anything has come to the auditor's attention that
causes the auditor to believe that the financial statements are not prepared (in all material respects) in accordance with
an identified financial reporting framework. A review engagement is conducted on the basis of procedures that do not
provide all the evidence that would be required in an audit.
Agreed-upon-procedures engagement – for the auditor to carry out procedures of an audit nature to which the auditor
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and the entity and any appropriate 3 parties have agreed and to report on the factual findings
Compilation engagement – to use accounting expertise as opposed to auditing expertise to collect, classify and
summarise financial information.

OBJECTIVE OF A FINANCIAL AUDIT (AUDIT OF FINANCIAL STATEMENTS) – to provide users of the financial
statements of companies with a high degree of assurance about the creditability of the assertions made by the
management of the company in its financial statements. The assurance is in the form of an expression of an
opinion in the auditor’s report as to whether or not the financial statements are a fair presentation of the
company’s operating activities.
The determination of fair presentation relates to the financial statements taken as a whole. Fair presentation is
determined based on the auditor reporting on the information on the financial position (balance sheet), performance
(income statement) and any changes in the financial position of the company (cash flow statement).
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ISA 200 – OBJECTIVE AND GENERAL PRINCIPLES GOVERNING AN AUDIT OF FINANCIAL
STATEMENTS
Auditor must comply with relevant ethical requirements relating to audit engagements.
Audit must be conducted in accordance with International Standards on Auditing, but will also have to comply with other
professional, legal or regulatory requirements - ISA’s do not override local laws and regulations.
Auditor should also plan and perform an audit with an attitude of professional skepticism realising that there may be
circumstances resulting in the financial statements being materially misstated.
Auditor conducting an audit in accordance with ISA’s has reasonable assurance that the financial statements taken as a
whole are free from material misstatement (due to fraud or error). Reasonable assurance allows the auditor to conclude
that there are no material misstatements in the financial statements taken as a whole.
Management is responsible for identifying risks to the business however the auditor is only concerned with risks that
may effect the financial statements.
Audit risk = the risk that an auditor may express an inappropriate audit opinion when the financial statements are
materially misstated (risk of material misstatement).
Detection risk = the risk that the auditor will not detect misstatement of the financial statements. The auditor performs
audit procedures to assess the risk of material misstatement and sees to limit detection risk by performing further audit
procedures based on that assessment. Risk is a function of the effectiveness of an audit procedure and its application
by the auditor and can never be reduced to zero because the auditor never examines the full class of transactions,
account balances or disclosure or other factors (e.g. auditor may select an inappropriate audit procedure, misapply an
appropriate audit procedure or misinterpret the audit results.) Can normally be addressed through adequate planning,
proper assignment of personnel of the engagement team, application of professional skepticism and supervision and
review of the audit work performed. Relates to the nature, timing and extent of the auditor’s procedures that are
determined by the auditor to reduce audit risk to an acceptably low level. FOR GIVEN LEVEL OF AUDIT RISK - THE
ACCEPTABLE LEVEL OF DETECTION RISK BEARS AN INVERSE RELATIONSHIP WITH THE RISK OF MATERIAL
MISSTATEMENT AT THE ASSERTION LEVEL, so the greater the risk of material misstatement that the auditor
believes exists, the less the detection risk that can be accepted AND the less risk of material misstatement the auditor
believes exists, the greater the detection risk that can be accepted.
The audit should be planned and preformed to reduce audit risk to an acceptably low level, by designing and performing
audit procedures to obtain sufficient appropriate audit evidence to draw reasonable conclusions on which to base an
audit opinion. Reasonable assurance is obtained when the auditor has reduced audit risk to an acceptably low level.
The auditor is concerned with material misstatements and isn’t responsible for detecting misstatements that are not
material to the financials as a whole. Auditor must consider risk of material misstatements on two levels :
· overall financial statement level – refers to risks of material misstatement relating pervasively to the financial
statements as a whole and that potentially affect many assertions. These risks often relate to the entity’s control
environment (e.g. management’s override of internal controls) but could also be declining economic conditions, but
are mainly relevant due to the risk of material misstatement arising from fraud. Auditor must use knowledge, skill
and ability of personnel assigned significant engagement responsibilities, appropriate levels of supervision and if
there is any event or condition that may cast significant doubt on the entity’s ability to continue as a going concern.
· in relation to classes of transactions, account balances and disclosures and related assertions – assists in
determining the nature, timing and extent of further audit procedures at the assertion level. Auditor must have
sufficient appropriate audit evidence at class of transactions, account balance and disclosure level so that the
auditor at completion of the audit can express an opinion on the financial statements taken as a whole at an
acceptably low level of audit risk (can use a model that expresses the general relationship of the components of
audit risk in mathematical terms to arrive at an appropriate level of detection risk).
Risk of material misstatement at the assertion level consists of :
· inherent risk = susceptibility of an assertion to a misstatement that could be material (either alone or in total with
other misstatements) assuming that there are no related controls. Greater in some assertions and related classes
of transactions, account balances and disclosure (e.g. complex calculations are more likely to be misstated then
simple calculations, and accounts estimates subject to significant measurement uncertainly pose greater risks then
accounts that have relatively routine factual data.) External circumstances giving rise to business risks can also
influence inherent risk (e.g. technological developments can made a product obsolete therefore causing inventory to
be susceptible to overstatement). Factors in the entity and its environment can also influence the inherent risk
related to a specific assertion (e.g. lack of sufficient working capital to continue operations or declining industry
characterised by a large number of business failures.)
· control risk = risk that misstatement could occur in an assertion that could be material, either individually or in total
with other misstatements, and will not be prevented or detected an corrected by the entity’s internal control system.
Some risk will always exist because of the inherent limitations of internal control – and control risk is a function of
the effectiveness of the design and operation of internal control in achieving the entity’s objectives relevant to the
preparation of the financials.
Inherent and control risks are risks of the entity – they exist independently from the audit of financials. The auditor is
required to assess the risk of material misstatement at the assertion level as a basis for further audit procedures, but
that assessment is a judgment rather then a precise measurement of risk. The assessment of the risk of material
misstatement can be expressed in quantitive terms (e.g. percentages) or in non-quantitive terms.
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Auditor’s responsibility = forming and expressing an opinion on the financial statements
Management responsibility = preparing and presenting the financial statements in accordance with the applicable
financial reporting framework. Must identify that framework and must :
· design, implement and maintain internal controls that are free from material misstatement (from either fraud or error)
· select and apply appropriate accounting policies
· make accounting estimates that are reasonable in the circumstances
Financial statements = structured representation of the financial information which are derived from accounting
records and are intended to communicate the entity’s economic resources or obligations at a point in time (or changes
therein) for a period of time in accordance with a financial reporting framework, normally including notes.
FOLLOWING MIGHT NOT YET BE APPLICABLE (ISA notes say to be implemented at future date) : auditor should
determine if the financial reporting framework that management has used in preparing the financial statements is
acceptable.
Acceptable financial reporting frameworks for general purpose financial statements normally show :
· relevance
· completeness
· reliability
· neutrality
· understandability
If auditor makes comparison of the entity’s financials against the requirements of an existing framework and differences
are identified, then must consider the reasons for the difference and if the application of the accounting convention
could result in misleading financials. If auditor decides that the framework used by management is not acceptable –
then must consider the implications in relation to engagement acceptance and the auditor’s report.
Expressing an opinion on the financials – refer to ISA 700 (revised), 701 and 800 when expressing an opinion, but
th
ISA is only effective for audits of financials on or after 15 December 2005!
Amendment to ISA 200 states that auditor can (in exceptional circumstances) depart from a basic principle or an
essential procedure in order to achieve the objective of the audit. In that case the auditor may still represent compliance
with ISA’s provided the departure is appropriately documented.

Advantages of audit of financial statements – assures the creditability of the financial statements to various users
such as:
· banks and loan giving companies
· SARS for tax collection
· investors who base investment decisions on auditing info
· employers relying on audited info when taking decisions affecting employee benefits
· creditors for decisions regarding the extending of trade credit
· settlement of claims e.g. insurance claims
Audit helps auditor to advise the company on :
· improvements to the accounting system if necessary
· ways of increasing efficiency and profits

Auditors offer either assurance engagement or non-assurance engagement services :


Assurance engagements
In terms of International Framework for Assurance Engagements an assurance engagement is where a
professional accountant (auditor) expresses a conclusion that will enhance the degree of confidence in the intended
users about the outcome of the evaluation or measurement of subject matter against the criteria. i.e. the registered
auditor assures the shareholders that the directors responsible for the AFS’s have compiled accurate results of
operations and that the financial position of the company complies with the International Financial Reporting Standards.
· audit of financial statements – assurance engagements – registered auditor gathers sufficient appropriate
evidence to pass an opinion on whether the directors have applied the International Financial Framework
appropriately in present fairly the financial position, performance and cash flow of the company for the financial year
· other assurance engagements :
Ø to report on the effectiveness of a client’s internal control system (must measure against the criteria)
Ø to report on whether the client is complying with the requirements of the Sarbannes-Oxley Act 2002 relating to
corporate governance
Non-assurance engagement
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Any other engagements that don’t meet the definition of an assurance engagement – e.g. might not be a 3 party
involved or there may not be any suitable criteria (benchmarks) against which to measure the subject matter of the
engagement. So therefore the auditor will not express an opinion or comment on the subject matter of the engagement.

Reasonable assurance – auditor doesn’t certify or confirm the absolute correctness of financial information, instead
expresses an opinion on its fair presentation (cos audit is to provide reasonable assurance that the financial statements
taken as a whole are free of material misstatement NOT that they are 100% correct.
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ISA – Objective and General Principals provides list of factors :
· use of testing – auditor cannot examine every single transaction in the business so does “test check” (check a
sample of transactions and balances). Obviously If has only test checked then can’t say that everything is 100%
correct cos hasn’t tested everything.
· inherent limitations of account and internal control systems – auditor has to rely on the client’s systems to
provide financial information and these systems will have limitations which may result in failure to detect errors or
frauds (so information that auditor is using to supply an opinion may be flawed.)
· audit evidence is usually persuasive rather then conclusive – auditor can only be “persuaded” that an event or
transaction took place by looking at the documents or information that management provides. Didn’t actually
witness the event
· subjectivity in the financial statements and in the auditor’s approach to the audit – many account balances in
the financials contain balances which are subjective (fixed) and many current assets are affected by estimates
(subjective) of depreciation impairment, stock obsolescence and bad debts. Cos impossible for auditor to know
which debtors will not pay or which stock will become obsolete so the auditor’s decisions as to which type of tests
and the timing and extend of those tests will all be subjective – i.e. one auditor will not necessarily conduct the audit
in the same way as another auditor.
Assurance engagements broken up into :
· reasonable assurance – objective is reduction in assurance engagement risk to an acceptably low level in the
circumstances of the engagement as the basis for a positive form of expression of the practitioner’s conclusion
· limited assurance engagements – objective is reduction in assurance engagement risk to a level that is
acceptable in the circumstances of the engagement, but where the risk is great then for a reasonable assurance
engagement as the basis for a negative form of expression of the practitioner’s conclusion.

Differences between reasonable assurance engagements and limited assurance engagements


Reasonable Assurance Engagements Limited Assurance Engagements
Reduction in the assurance engagement risk to a
Reduction in assurance engagement risk to an level that is acceptable in the circumstance of the
acceptably low level in the circumstances of the engagement, but where the risk is greater then for
Objective engagement as the basis for a positive form of a reasonable assurance engagement as the basis
expression of the practitioner’s conclusion for a negative form of expressing of the
practitioner’s conclusion
Sufficient appropriate evidence obtained as part
of a systematic engagement process including :
· obtaining understanding of the engagement Sufficient appropriate evidence is obtained as part
circumstances of a systematic engagement process that includes
Evidence · assessing the risks obtaining an understanding of the subject matter
gathering · responding to the assessed risks and other engagement circumstances, but in
procedures · performing further procedures using which procedures are deliberately limited relative
combination of : to a reasonable assurance engagement
Ø inspection
Ø observation
Ø confirmation
Ø recalculation
Ø re-performance
Ø analytical procedures
Ø inquiry
using substantive procedures including
corroborating information and tests of the
operating effectiveness of controls if
necessary
· evaluating the evidence obtained
Assurance Description of the engagement circumstances Description of the engagement circumstances and
report and a positive form of expression of the a negative form of expression of the conclusion
conclusion
Read International Framework for Assurance Engagements Elements of an Assurance Engagement
pgs 287-300 for definitions and information on the following elements :
· three party relationship (practitioner, responsible part and intended users)
· subject matter
· criteria (benchmarks with relevance, completeness, reliability, neutrality and understandability)
· evidence (taking into account professional skepticism, sufficiency and appropriateness of evidence,
materiality, assurance engagement risk, nature and timing and extent of evidence-gathering procedures
and quantity and quality of available evidence)
· assurance report
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Audit therefore provides REASONABLE assurance that the financial statements taken as a whole are free from
material misstatement, but cannot provide ABSOLUTE assurance that the financial statements are free from
any misstatements.
Always limitations on an audit cos of :
· use of testing / sampling
· inherent limitations of any accounting and internal control system
· audit evidence is often persuasive rather then conclusive
· auditor’s work is governed by his judgment, especially regarding :
Ø gathering of audit evidence (nature, extent and timing of audit procedures)
Ø drawing of conclusions based on the audit evidence gathered
· other limitations that can affect the persuasive force of available evidence – e.g. transactions between related
parties.

Auditing postulates (auditing basis of thinking or starting point of auditing) :


· no conflict of interest between the auditor and management / employees of the entity being audited – so
everyone wants the audit to prove that the financial statement are a fair presentation, but that if management
doesn’t want a fair presentation (i.e. to hide fraud or to make the company appear more favourable financially) then
it is impossible for a normal audit. Therefore the auditor may have to view management’s integrity with professional
skepticism and should not just take what is said by management as being the truth
· auditor must act exclusively as an auditor in order to offer an independent and objective opinion on the fair
presentation of financial information (i.e. the auditor’s opinion can only be relied upon if is free of bias
(independent) and has devoted all his energy to the audit
· professional status of the independent auditor imposes commensurate professional obligations –
professional auditor has to live up to expectations of due care, service before personal interest, efficiency and
competence and have responsibility as professional practitioner
· financial data if verifiable – difficult to verify paperless transactions or e-commerce transactions and therefore
cannot get a level of assurance by verifying the financial data so can’t form opinion on fair presentation of the
financial information
· internal controls reduce the probability of errors and irregularities – so the better the internal controls and
checks the higher the chance that the financial information is “truthful”. If no internal controls then auditor might be
forced to refrain from offering an opinion or to conduct an extremely detailed audit examination. Without internal
control the financial data is not verifiable
· application of IRFS results in fair presentation – so if stick to the suggested framework then there will be fair
financial presentation. Auditor’s opinion is therefore based on a generally accepted standard and not on personal
preferences and the auditor has something against which to judge the fairness of the financial information for the
audit
· that which held true in the past will hold true in the future (in the absence of contrary evidence) – historical
evidence is crucial. Decisions about the future are made and accounted for on the basis of historical information
and could even say that the integrity of the entity’s director do not alter from year to year. Auditor has to draw on
past experience when assessing judgments about the future, but that doesn’t mean that things don’t change
· financial statements submitted to the auditor for verification are free of collusive and other unusual
irregularities – so the auditor take assume that management has taken adequate steps to ensure that the
statements are “correct” and that employees and members of the management team haven’t colluded in the
presentation of the financial statements. Cynical view now might be that managers and employees are not always
honest and that this postulate is no longer true, however if the auditor didn’t assume that the financial statements
are “correct” then the objective and the focus of the audit would change from an opinion on fair presentation to a
search for fraud and other irregularities.

SA Institute of Chartered Accountants (SAICA) says professional has certain characteristics including :
· mastery of a particular intellectual skill acquired by training and education
· acceptance of duties to society as a whole in additional to duties to the client or employer
· outlook which is essentially objective and
· rendering personal services to a high standard of conduct and performance.

SA Institute of Chartered Accountants (SAICA)


Independent Regulatory Board for Auditors (IRBA)
In terms of Auditing Professional Act, anyone wanting to offer auditing services must be registered with IRBA.
People registered with IRBA are then “registered auditors”. Only people registered in terms of the Auditing Professions
Act 2005 can practice as independent auditors.
see definition of audit on pg 1/13 of text book
AUDIT OBJECTIVE IS TO EXPRESS OPINION ON WHETHER THE FINANCIAL STATEMENTS ARE FAIRLY
PREPARED IN ACCORDANCE WITH THE FINANCIAL REPORTING FRAMEWORK.
AUDITOR’S OPINION IS NOT ASSURANCE OF THE FUTURE VIABILITY OF THE ENTITY OR THE EFFICIENCY OF
MANAGEMENT IN RUNNING THE AFFAIRS OF THE ENTITY
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NOT OBJECTIVE TO DISCOVER OR PREVENT FRAUD OR TO ENSURE COMPLIANCE WITH THE LAW
(management’s responsibility)

Companies Act states that all companies (public and limited interest companies – i.e. private companies) must be
audited. Shareholders must appoint directors and also an auditor. Act regulates who may be appointed as directors
and auditors and also how they can be dismissed or may resign and also provides legal backing for the financial
reporting standards.
Also requires the appointment of an audit committee to enhance the audit function and provides the auditor with the
right to access the company’s records. Also gives requirements which must be fulfilled by the auditor before he can
report an opinion to the shareholders (e.g. if the financial statements are in agreement with the accounting records) and
places a duty on the auditor to report to the shareholders. Act also stipulates that the auditor’s report must contain the
auditor’s opinion on whether the report of the directors to the shareholders fairly presents the financial position of the
company at the specified date and the results of its operation for the period ending on that date.
Assertions of management in the AFS’s (i.e. their representations about the company’s assets, equity, liabilities,
transactions and events). As laid down in ISA 500 – Audit Evidence
· completeness – all assets, liabilities, transactions or events which should have been recorded have been recorded
· occurrence – a transaction or event which has been recorded took place and pertains to the entity
· existence – asset, liabilities and equity interest exist at a given date
· cut off – transaction and events have been recorded in the correct accounting period
· accuracy – amount and other date relating to recording transactions and events have been recorded appropriately
· classification – transactions and events have been recorded in proper accounts
· rights and obligations – entity holds or controls the rights to assets, and liabilities are the obligations of the entity
· valuation and allocation – assets, liabilities and equity interest are included in the financial statements at
appropriate amounts and any resulting valuation or allocation adjustments (e.g. depreciation or obsolescence) are
appropriately recorded
· presentation and disclosure
Ø occurrence and rights and obligations, disclosed events, transactions and other matters have occurred and
pertain to the entity
Ø completeness – all disclosures that should have been included in the financial statements have been included
Ø classification and understandability – financial information is appropriately presented and described and the
disclosures are clearly expressed
Ø accuracy and valuation – financial and other information is disclosed fairly and at appropriate amounts
see example pg 1/16 of text book in 5.2
Auditor’s responsibility to obtain sufficient appropriate evidence that the assertions in the financial statements are fairly
presented.

Different auditing services are :


· independent (external) audits
· internal audits
· operational audits
· management audits
· comprehensive audits
· forensic audits
· governmental audits (audit work in the public sector)

Operational audit – appraises the effectiveness with which managements objectives are being carried out, identifies
shortcomings and makes recommendations to management. Achieved by weighing up the effectiveness and operation
of sections within the entity against corporate and industry standards
Management audit – evaluates the entity’s management systems and determines if the management systems are
operating effectively and if not, what are the risks for the entity.
Comprehensive auditing – combined operational and management audit is performed instead of an external audit.
Therefore evaluates the effectives and functions of management objectives and management systems, identifies
shortcomings and makes recommendations to management.
Forensic audit – combination of accounting, auditing and investigative expertise is used to gather evidence of criminal
conduct and the financial implications of this conduct. Can be asked to assist with the determination or rebuttal of
possible claims for damages
Governmental audit – Auditor General performs audits on all government and State revenue and expenses and
reports to parliament. Normally uses independent auditors to do so.

ISA 610 – CONSIDERING THE WORK OF THE INTERNAL AUDIT


(Providing standards and provide guidance to external auditors in considering the work of internal
auditing)
Internal auditing = appraisal activity established within an entity as a service to the entity, and also includes monitoring
controls.
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Factors influencing the scope and objectives of internal auditing – dependent on the size and structure of the
entity and the requirements of management :
· monitoring of internal controls – establishing adequate internal controls as well as review and monitor the
operation and recommend improvements
· examine financial and operating information – including reviewing how information is identified, measured,
clarified and reported and also involving detailed testing of transactions, balances and procedures
· review the economy, efficiency and effectiveness of operations – including non-financial controls of the entity
· review compliance with laws and regulations – and also with management policies and directives and other
internal requirements.

Differences between internal and external auditing :


Internal auditing External auditing

management function (objectives vary according to attestation function (auditing function)


management’s requirements)

reports to management & including the audit committee reports to shareholders

functions independently within the organisation, but independent, external auditors


remains part of the organisation

mandate from management / audit committee regulated by legislation

Understanding and preliminary assessment of internal auditing :


· external auditor should obtain a sufficient understanding of the internal audit activities to identify and assess the
risks of material misstatement of the financial statements and perform other audit procedures
· effective internal auditing will allow the external auditor to modify the nature of and reduce the timing and extent of
his auditing process, but cannot eliminate them entirely.
· external auditor’s assessment of the internal audit function will influence his judgment about the use he makes of
internal auditing in modifying the nature, timing and extent of external audit procedures
· external auditor should perform an assessment of the internal audit function if the internal auditing is relevant to the
external audit
· to obtain an understanding and perform an assessment of the internal audit function must use :
Ø organisational status – specific status of internal auditing in the entity and the effect this has on its
objectiveness. Ideal situation is that internal auditing reports to the highest level of management and is free
from any other operating responsibility (any constraints or restrictions placed on internal auditing by
management need to be carefully considered). Internal auditors must be able to freely and fully communicate
with the external auditor
Ø scope of function – nature and extent of internal auditing assignments performed. External auditor also needs
to consider if management acts on internal audit recommendations and how this is proved
Ø technical competence – is internal auditing performed by persons with adequate technical training and
proficiency? (external auditor may have to review the policy for hiring and training internal auditing staff and
their experience and professional qualifications)
Ø due professional care – is internal auditing properly planned, supervised, reviewed and documented?
Existence of audit manuals, work programmes and working papers is a clue.

Timing of liaison and co-ordination


External auditor needs to consider the internal auditor’s tentative plan for the period if planning to use his work. If need
to use his work then need to have a timing of the work, extent of the audit coverage, proposed methods of sample
selection, documentation of the work performed and the review and reporting procedures.
Meetings should be held at appropriate intervals during the period – external auditor will need to be advised of and have
access to relevant internal auditing reports and to be informed of any significant matter that comes to the internal
auditor’s attention. External auditor would also have to inform the internal auditor of any significant matters that may
effect internal auditing.

Evaluating the work of the Internal Auditor


Before using the work of the internal auditor, the external auditor should evaluate the work and confirm it adequacy.
Evaluation can consider the adequacy of the scope of work and related programmes and if the assessment of the
internal auditing remains appropriate.
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Must consider if :
· work is preformed by people with adequate technical training and proficiency as internal auditors and the work of
assistants is properly supervised, reviewed and documented
· sufficient appropriate audit evidence is obtained to be reasonable
· conclusions reached are appropriate in the circumstances and any reports prepared are consistent with the results
of the work performed
· any exceptions or unusual matters disclosed by internal auditing are properly resolved
Nature, timing and extent of the specific work of internal auditing will depend on the eternal auditor’s judgment as to the
risk of the area concerned and the assessment and evaluation of the specific work by internal auditing. (Can test by re-
examining items already examined by internal auditing, examining similar items and observing internal auditing
procedures.)
External auditor must record conclusions regarding the specific internal auditing work that has been evaluated.
If external auditor is deciding if the work of internal audit can be relied on, then must use the following criteria :
· organisational status :
Ø does the internal auditor report to the highest authority (influences the internal auditor’s independence and
objectivity)
Ø are there any restrictions placed on the work of the internal auditors
Ø are the internal auditors free to communicate fully with the external auditors
· scope of the function :
Ø the nature and extent of internal audit assignments performed
Ø effects of reports / management reaction to recommendations
· technical competence :
Ø adequacy of technical training and proficiency as internal auditors
Ø employment policy (hiring and training) of internal auditors
Ø internal auditor’s experience and professional qualifications
· due professional care :
Ø proper planning, supervision, reviewing and documentation of internal audit work
Ø adequacy of audit manuals, work programmes and working papers.

Study Topic 2.2 – The Audit Practice


AUDITING PROFESSIONAL ACT 26 of 2005 – SECTIONS 37 to 40
Individual will not be registered as an auditor if he :
· has been removed from an office of trust for misconduct
· has been convicted of theft, fraud, forgery or perjury and has been sentenced to imprisonment without the option of
a fine
· is declared by a competent court to be of unsound mind or unable to manage his own affairs
· is disqualified under a sanction imposed by the Act
· is an unrehabilitated insolvent or has been provisionally sequestrated.

Registration of different business types of registered auditors :


· partnership where all partners are registered auditors
· sole proprietors (if proprietor is registered auditor)
· company applying with the following :
Ø company is unincorporated and registered in terms of the Companies Act, must have share capital and the
memorandum of association must provide that all present and past directors are jointly and severally liable
together with the company, for all debts and liabilities contracted during their periods of office
Ø only natural persons who are public accountants and auditors can be members or shareholders of the company
Ø if the company ceases to conform to either of these then it will immediately cease to engage in public practice
· shareholders and directors of company :
Ø each shareholder will be a public accountant and auditor
Ø each shareholder must be a director of the company i.e. ONLY shareholders can serve as directors
Ø company’s articles of association must provide that a member of the company may not appoint a person who is
not a member of the company to attend any meeting of the company in his stead, or to speak or vote in his
stead
· if a shareholder dies or no longer qualifies to be a public accountant :
Ø he or his estate can continue to hold the relevant shares for interest for 6 months from the date he ceased to
conform to the requirements or from date of death (or from a longer date if approved by the Board)
Ø no voting rights are attached to any of these shares for 6 months and the shareholder may not act as a director
of the company and cannot received director’s fees or remuneration or participate in the income or profits
earned by the company
· shares in the company :
Ø company can purchase any shares held in it without its authorised share capital being reduced if its articles of
association allow it, and on its own conditions
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Ø shares in the company which have been purchased must be available for allotment in terms of the company’s
articles of association.

Structure of an audit practice


Controlled by auditors in partnership, each of which is registered as an accountant and auditor with the Independent
Regulatory Board for Auditors. Partners elect a managing partner.
Partnership appoints audit managers who are members of staff with certain academic levels and expertise and they are
responsible for planning, performance, control and completion of specific audits. Audit partners are responsible for the
auditor’s report and so co-operate closely with the audit managers on each audit. Audit clerks and trainee accountants
are appointed in terms of a training contract to assist the audit managers.
Normally divided into audit section and specialist sections.
Staff employed to perform audits and report on financial information of the practice’s clients. Specialists normally
provide clients with taxation, computer and management consultation services.

Typical set up of an audit practice :

Control in an audit practice


It is important that practitioners manage their practices in a cost effective and efficient manner and put in the correct
procedures to ensure the quality of audit work. Controls in the audit practice include :
· control over staff of an audit practice – performance of every member of staff from junior to senior level must be
monitored on a regular basis and stuff must receive continuous training
· control over costs and the time spent on auditing – must have time and cost budgets for all audit work- actual time
spent and costs incurred must be frequently checked against the budgets and clients must be informed if the
budgets are exceeded and the reason why)
· control over the maintenance of professional standards – audit practice must introduce internal quality control
mechanisms in order to control the standards of auditing work performed on individual audits and monitor the
professional conduct of individual auditors of the firm. The auditors in the firm are jointly and individually liable for
any negligence in respect of work done by their colleagues so need to formulate quality control policies and
procedures for the continuous assessment of the quality of auditing work by each auditor to maintain proper
professional standards.
do questions in section 2.1 of tutorial 102 and check answers in the key of section 2.1 of tutorial 103
do questions in section 2.2 of tutorial 102 and check answers in the key of section 2.2 of tutorial 103

PART B – INTRODUCTION TO AUDIT PRACTICE


Study Topic 3.1 – History & Development of the auditing profession
Jackson & Stent pg 1/10 to 1/13
SAICA Code of Professional Conduct (preface),
IRB Manual of Information (Chapter 2)
Auditing Professional Act 2005 – section 7, 37, 39 to 41

Jackson & Stent - Pronouncements regulating the profession


If high standards of ethics, conduct and skill must be set and maintained by all professional accountants or public
confidence will be undermined.
Legislation, regulation and standards are set out in the following pronouncements :
· Auditing Professional Act 2005
· Companies Act 1973
· Constitution and By-laws of SAICA
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· IFAC Code of Ethics for Professional Accountants
· Code of Conduct and Disciplinary Rules of IRBA
· International Standards of :
Ø Auditing – ISA
Ø Review Engagements – ISRE
Ø Assurance Engagements – ISAE
Ø Related Services – ISRS
· International Auditing Practice Statements (IAPS)
· SA Auditing Practice Statements (SAAPS)
Responsibility for developing and issuing high quality standards on auditing, assurance and related service
engagements and quality control stands for use around the world rests with the International Auditing and Assurance
Standards Board.
Financial statement audit engagement – assurance engagement and must be conducted by registered auditor.

SAICA Code of Professional Conduce (Preface) states : that professional are characterised by :
· mastery of a particular intellectual skill – acquired by training and education
· acceptance of duties to society as a whole in addition to duties to the client or employer
· an essentially objective outlook
· personal services rendered of a high standard of conduct and performance.
The code is established on the basis that unless a limitation is stated, then these objectives and fundamental principles
are valid for all professional accountants if they are in public practice, business, public sector or education.

IRB Manual of Information – Chapter 2 states :


In terms of Auditing Profession Act of 2005 registration as an Registered Auditor (RA) can only take place once the
person has complied with the education, training and competency requirements of the Independent Regulatory Board
for Auditors (IRBA) and that registration will only take place after the person has passed the Public Practice
Examination (PPE).
Admission requirement for the Public Practice Examination – must complete :
· recognised academic programme and
· recognised core assessment programme
· recognised training programme – registered with IRBA at least 18 months before the first day of the month in
which the exam is to be done. Only training programmes recognised by the IRBA are training contacts in public
practice administered by SAICA and registered with IRBA
· recognised education programme – valid for 5 calendar years starting the year in which the programme was
completed
· recognised academic programme – CTA or equivalent from SAICA accredited universities for admission to Part 1
of the Qualifying Exam of SAICA
· recognised core assessment programme – evaluation conducted by professional body to assess the core
competence of a candidate (such as Part 1 of the Qualifying Exam of SAICA)
· recognised training programme – training programme of professional body that develops professional
competence appropriate to the practice of an RA in a public practice environment (training contracts administered
by SAICA and registered with IRBA)
· recognised education programme – education programme of professional body that develops professional
competence of a student to a standard appropriate to the practice of an RA at entry point (auditing specialism
courses accredited by SAICA)

Recognition principles
General principles applying to the recognition of academic, core assessment, training and education programmes by the
IRBA :
· recognition – status granted by the Board to academic, core assessment, training and education programmes of
certain professional bodies that meet the recognition standards defined by the IRBA (minimum requirements
necessary to achieve the objectives of the programme and if person achieved the standard is assessed by the
Public Practice Examination
· applications for accreditation – in terms f the accreditation model prescribed by the IRBA
· relationships with regard to recognition and monitoring – no direct relationship between the IRBA and the
various institutions that provide recognised programmes.
· monitoring recognised programmes – must continue to meet the recognition standards as defined by the IRBA.
If professional body uses various institutions to deliver the recognised programme then IRBA will monitor the
professional body NOT the providers of the programme.

Membership of professional bodies - simply passing the PPE doesn’t automatically mean that membership is granted
to any professional body – admission requirements for membership is are determined by each specific professional
body.
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Recognition guidelines
IRBA monitors programmes that lead to registration as a registered auditor through co-operation with professional
bodes and uses the following guidelines as basis for application of the accreditation model :
· accreditation is partnership between IRBA and professional bodies where their programmes lead to registered
auditor registration
· recognition process not based on prescription of specific and consistent quantitative measures but rather
encourages diverse and coherent learning programmes that lead to registration of registered auditor
· recognition process aim is to proved access to and progression within the auditing profession for those who want to
and have ability to register as registered auditors
· recognition seeks to achieve and maintain constant high standards in learning programmes
· Registered auditors should be professionally competent people who can adapt to change and are committed to
lifelong learning process in order to enable them to make a meaningful contribution to the profession
· standards of programmes that lead to registration must be on par with international standards

Structure of accreditation model


Components of learning path to ensure admission to
PPE and registration as a registered auditor
· recognised academic programme
· recognised core assessment programme
· recognised training programme
· recognised education programme
Objectives to be achieve in each of these components
are defined in each of these policy statements :
· academic policy
· core assessment policy
· training policy
· education policy
so sections of the training path that enables admission
to the PPE are like this

Programmes in the learning path to registration as a Registered Auditor :

Auditing Professional Act of 2005 – Section 7 (pg 1-10) states that :


Regulatory Board must :
· either recognise or withdraw the recognition of the educational qualifications or programmes in the auditing
profession of educational institutions and accredited professional bodies, either in full or part
· either recognise or withdraw recognition of any accredited professional body to conduct a qualifying exam
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If does withdraw recognition for either of above, then must give notice of withdrawal in writing to the educational
institution or accredited professional body of intention to withdraw and reasons therefore, and must give them no
less then 21 day and not more then 30 days to give reasons why the recognition shouldn’t be withdrawn.
If found that the withdrawal of recognition would not in the best interests of the public then can implement whatever
conditions it considers appropriate in order for the institution or professional body to remain recognised.
Regulatory Board must publish the withdrawal of recognition
· prescribe requirements for and conditions of continued education, training and professional development
· prescribe training requirements for the period of training and the form of the training contracts
· approve and register training contracts entered into by prospective registered auditors
· prescribe competency requirements and
· recognise or withdraw the recognition of registered auditors as training officers either conditionally or unconditionally

Regulatory Board may :


· establish mechanisms for registered auditors to gain recognition of qualifications in other countries and enter into
agreement with professional bodies outside SA for this purpose
· establish and administer an education fund for the purpose of training, professional development and continued
education for auditors and hopeful auditors
· advise, assist or consult with any statutory or professional body regarding the training, educating or professional
development of registered auditors and hopeful auditors

Auditing Professional Act of 2005 – Section 37 (pg 1-24) states that :


Individuals must apply to the Regulatory Board for registration on the prescribed application form and if Board is
satisfied that applicant :
· has complied with prescribed education, training and competency requirements for registered auditor
· has arranged for his continual professional development (if not member of an accredited professional body)
· is resident in SA
· is a fit and proper person to practice the profession
· has met any additional requirements under section 6
Then Board must register the applicant, put his name in the register and issue him a certificate of registration once
prescribed fee has been received.
CANNOT register someone if person :
· has been removed from office of trust because of misconduct
· has been convicted (either in SA or anywhere else – but Board should take congnisance of the circumstances if in
foreign country) of fraud, theft or forgery or any other act involving dishonesty and was sentenced to imprisonment
without the option of a fine
· has been declared to be of unsound mind or unable to manage his own affairs
· is disqualified by a sanction imposed under this act
· MAY decline to register unrehabilitated insolvent who has entered into compromise with creditors or has been
provisionally sequestrated.

Auditing Professional Act of 2005 – Section 39 (pg 1-26) states that :


Board must cancel the registration of any registered auditor who :
· after registration becomes subject to any of the disqualifications in section 37
· whose registration was made in error or by using information which is subsequently proved to be false
· prior to registration, was guilty of improper conduct which causes the Board to think that he is not a fit and proper
person to be registered
· whose estate is sequestrated or provisionally sequestrate or who enters into a compromise with creditors
· ceases to be a member of an accredited professional body and doesn’t provide written proof within 6 months that
he has made arrangements for his continuing professional development
Prior to canceling his registration, the Board must give notice in writing to the registered auditor concerned of the
intention to cancel and the reasons for the cancellation and give him not less then 21 and not more then 30 days to
submit grounds for not proceeding with the cancellation.
If registration is of a registered auditor as partnership, sole proprietor or company then that automatically lapses as well.
Registration will automatically lapse if auditor doesn’t pay the prescribed free prescribed by the Regulatory Board.
At written request the Board must remove the registered auditor’s name from the register, but this removal doesn’t affect
any liability he has incurred prior to the removal date.
Cancellation or removal of registration doesn’t mean that that Board can’t institute disciplinary proceedings for
misconduct prior to the cancellation or removal.
Once registration has been cancelled or removed the Board must publish a notice of the cancellation or removal
specifying the auditor’s name.

Auditing Professional Act of 2005 – Section 40 (pg 1-26) states that :


Registered auditor must apply in prescribed manner for renewal of his registration – any auditor de-registered in terms
of Section 39 or cancelled in terms of Section 51 may apply for re-registration in a manner prescribed by the Board
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Auditing Professional Act of 2005 – Section 41 (pg 1-27) states that in terms of the conduct by and liability of
registered auditors in practice :
only a registered auditor can engage in public practice or use the description “registered auditor, public
accountant, certified public accountant, registered accountant and auditor, accountant and auditors in public
practice” or any other description that will create an impression of being a registered auditor in public practice.

Person who is NOT registered in terms of this Act CANNOT :


· perform any audit
· pretend to be a person registered in terms of the Act
· use the name of any registered auditor
· perform any act indicating or calculated to lead persons to believe that he is registered in terms of this Act
NOT prohibited in terms of Act :
· any person performing an audit under the control or direction of or in association with a registered auditor who is
responsible for the performed audit
· any using the title “internal auditor” or “accountant”
· any member of a not-for-profit organisation or club from acting as the auditor of that body if he doesn’t get paid or
received any other consideration for the audit
· the Auditor General from appointing any person who is not a registered auditor from carrying out on his behalf any
audit in terms of Public Audit Act 25 of 2004.
Unless consented by the Board a registered auditor cannot not knowingly employ :
· any person who is suspended from public practice under any provision of this Act
· any person who is no longer registered as a result of this termination of registration in terms of Section 39 or
cancellation of his registration in terms of Section 51
· any person who applied for registration under Section 37 but whose application was declined
Registered auditor who is not in public practice as an individual practitioner can only practices as a member of a firm if
the firm itself is a registered auditor.
Registered auditor MAY NOT :
· practice under a firm name or title unless on every letterhead with the firm’s name and title there is :
Ø the registered auditor’s name (or initials) and surname
Ø if partnership – names of managing partners or active partners
Ø if company – the names of the directors as required by the Companies Act 61 of 1973
· sign any account, statement or report that purports to represent an audit by that registered auditor unless the audit
WAS performed by that registered auditor / under the personal supervision or direction of that registered auditor or
was under the supervisors or direction of one of his partner’s co-directors or co-members in accordance with the
prescribed auditing standards (unless previous auditor was unable complete an audit due to death, disability or
other unforeseen circumstances and the auditor has been engaged to complete the audit). Registered auditor can
also sign the firm name or title under which the registered auditor practices.
· perform audits unless adequate risk management practices and procedures are in place
· engage in public practice during any period in respect of which the registered auditor has been suspended from
public practice or
· share any profit derived from performing an audit with a person that is not a registered auditor
· engage in public practice unless has paid all the applicable prescribed fees.

Study guide pg 38
Professional person generally have superior skills or expertise in their field and their work is based on the knowledge
and skills that they have – not just working for a source of income.
Skills offered to the general public by professional based on intellectual skills and expertise that is members possess –
they attain a high level of formal education qualifications and technical competence that gives them superior skills
Characteristics of a professional :
· collective organisation – professionals are self-regulated rather then being regulated by the State, which assumes
that the are capable of organizing, controlling and regulating themselves by co-operative and collective means.
Professionals work together to form voluntary institutions or boards that interact on their behalf with the general
public and the State
· credentialling – superior expertise of professionals is accredited by professional body that has a system of
credentialling, which sets them apart from unqualified people who may offered the services on a more casual basis
· professional standards and disciplinary control – need for autonomy in performing professional work as area of
work is complete and requires judgment (so cannot be completely standardised). Board has responsibility for
setting out the standards of performance for the work carried out by its members and needs to have appropriate
mechanisms in place to monitor compliance with standards and to exercise disciplinary control over it’s members
· ethical element – professionals have public respect and trust and in return have to undertake to organise, educate
and train their members to proved a competent and ethical service – professional standards and disciplinary control
can only succeed if Board has integrity in the marketplace
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Principals or criteria of professionals are applicable to auditing profession in SA :
· specialist knowledge and skills – people wanting to be admitted by the Board have to have formal educational
qualifications and must pass the Public Practice Examination in Accounting and Auditing and serve the applicable
period under a training contract
· collective organisation only persons registered with the IRBA (statutory board governing accounting and auditing
profession) can function and represent themselves as auditors. Also have professional instructions that promote
the interests of the profession by maintaining programmes that establish appropriate standards for professional
work as well as monitoring adherence to those standards and laying down the codes of professional conduct for
their members.
SOUTH AFRICAN INSTITUTE OF CHARTERED ACCOUNTANTS (SAICA) currently has largest proportion of
registered members of the accounting and auditing profession, but there are 14 other professional institutes and
only members of these institutes who are registered auditors can carry out the external or public auditing function in
terms of statutory requirements
· credentialling – only people registered as accountants and auditors in terms of the Auditing Professional Act of
2005 can use the designation Registered Accountant and Auditor (RAA).
Members of SAICA can use the designation “Chartered Accountant (SA) or CA(SA)
· professional standards and disciplinary control – in SA, the Auditing Standards Committee of SAICA and
International Auditing and Assurance Standards Board (IAASB) establish appropriate standards for the performance
of the audit function – called International Standards of Auditing (ISA’s). Only registered auditors are permitted to
audit companies in SA and an annual audit is mandatory for every company that conducts business in SA
· ethical element – Code of Professional Conduct and Disciplinary Rules of the IRBA governs the professional
conduct of registered accountant and auditors. SAICA has its own Code of Conduct which is parallel to the IRB
ones. The ethical principals contained in these Codes govern member’s professional conduct to ensure the
integrity of the profession and ensure the esteem and trust of the general public.

IRBA has set the following admission requirements for the Public Practice Examination (PPE) :
· recognised academic programme – CTA or equivalent offered by universities accredited by SAICA for purposes
of admission to Part 1 of the qualifying exam
· recognised core assessment programme – Part 1 of the qualifying exam of SAICA
· minimum of 18 months of a recognised training programme registered with the IRBA (currently training
contracts administered by SAICA and registered with the IRBA)
· recognised education programme – currently the Auditing Specialisation Course administered by the IRBA valid
for 5 calendar years after the calendar year in which the education programme was successfully completed.

Jackson & Stent - Accounting bodies in SA pg 1/11 to 1/13


Main accounting bodies in SA are :
· Independent Regulatory Board for Auditors (IRBA) – bought into being by the Auditing Professional Act 26 of 2005
and
· South African Institute of Chartered Accountants (SAICA)
and both are closely linked.

SAICA is registered with International Federation of Accountants (IFAC) and looks after the interest of professional
accountants either as professional accountant in public practice or professional accountant in business.
To qualify as a member of SAICA must :
· pass recognised qualification from accredited university
· pass Part I and II of the SAICA qualifying exam and
· serve a training contract either :
Ø TOPP – training outside of public practice in Approved training Organisation (ATO)
Ø TIPP – training in public practice in auditing firm such as Deloittes
Can then join SAICA and use the designation CA (SA)
Professional accountant in public practice is an accountant in a firm (can be sole practitioner) who provides,
accounting, auditing, taxation, management consulting or financial management services e.g. partner at Price
Waterhouse
Professional accountant in business is employed or engaged in areas like commerce, industry, service, public sector
or education e.g. financial director at listed company
NO INDIVIDUAL OR FIRM CAN OFFER ACCOUNTING SERVICES UNLESS IT IS REGISTERED WITH IRBA in terms
of the Auditing Professional Act.
So if not registered with IRBA CANNOT :
· perform any audit
· pretend to be registered in terms of Act
· use the designation “registered auditor, public accountant, certified public accountant, registered accountant and
auditor, accountant and auditors in public practice” or any other description that will create an impression of being a
registered auditor in public practice.
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IRBA looks after the professional interests of the auditors and deals with things like registration, education and training,
accrediting professional bodies (e.g. SAICA) for membership and prescribing the standards of competence and ethics.
Also protects the public and disciplines IRBA members who don’t follow the rules.
To register as member of IRBA must :
· satisfy all the educational requirements of SAICA (obtain recognised university qualification and pass Parts I and II
of the SAICA qualifying exam)
· complete a training contract in public practice
· obtain an audit specialism qualification
If registered with IRBA then can use the title “registered auditor”
Note : IRBA is not responsible for educating prospective registered auditors – only sets the Professional Practice Exam
(Part II of the SAICA qualifying exam). IRBA only accredits other professional bodies (currently only SAICA) who satisfy
the registration requirements of the accredited body.

Study guide pg 41
Structure of the auditing profession in SA :
IRBA – Independent Regulatory Board is the main statutory body and regulates and controls the auditing profession in
SA. Cannot practice as a public accountant and auditor unless registered with the Board and IRBA also determines the
qualifications and training that is needed to be registered with them and thus be public accountant and auditor
SAICA – SA Institute of Charted Accountants. Voluntary institute in SA that promotes the rights of auditing profession.
Can only use the designation Chartered Accountant (SA) if you have passed the SAICA professional qualifying exams.
Other professional institutes / bodies :
· ICFASA – Institute of Commercial and Financial Accountants of Southern Africa
· ICB – Institute of Certified Bookkeepers
· ICSA – SA Institute of Chartered Secretaries and Administrators
· IAC – Institute of Administration and Commerce of Southern Africa
· IIA – Institute of Internal Auditors
· IMTA – Institute of Municipal Treasurers and Accountants

Cannot do any auditing unless registered as an auditor and accountant – if offer services for this then must be
registered for “public practice’.

International auditing profession


IFAC – International Federation of Accountants is worldwide representative organisation for the accountancy
profession. All SA professional bodies are members of IFAC.
IFAC’s mission is to develop and enhance the profession so that it can provide consistently high quality of service to the
public – more then 80 countries are members.
IAASB – International Audit and Assurances Standards Board is the standing
committee of the IFAC and issues International Standards on Auditing (ISA’s)
which are used in different countries. All the professional institutes that are IFAC
members of the IFAC have committed to reduce the differences in accounting Int Federation of Accountants
and auditing practices throughout the world and also to bring their own standards
in line with international standards (as far as possible – obviously different standing committee = IAASB
economic and statutory circumstances in different countries). - issues all ISA's
so :
IRBA
statutory board
Study Topic 3.2
Procedures for regulating the profession and standards
SAICA
Jackson & Stent pg 3/59 & 3/60 & 6/2
- Chartered Accountant (SA)
Auditing Professional Act 2005 – chapter 1 & 2
ISA 200 – paragraph 1 – 9

Study guide pg 46
Accountability of the auditing progression
Fundamental principle of auditing is that auditor is held accountable for the quality of his work and his opinion on the
quality of the financial statements published by the audited entity (report is addressed to the owners of the entity -
stakeholders).
Secondary stakeholders – other people who have interests in the entity (e.g. lenders, employees or creditors) but
audit doesn’t address their needs and auditor doesn’t report to them and is generally not accountable to them in law.

Auditor held accountable for the quality of work and opinions expressed by :
· internal quality control mechanisms within auditing firms – audit firms required to set up internal controls to
control the standards of audit work performed for individual audits (such as internal peer review) and to monitor the
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professional conduct of individual auditors of the firm. AUDITORS WITHIN A FIRM ARE JOINTLY AND
SEVERALLY LIABLE FOR ANY NEGLIGENT WORK ON THE PART OF THEIR COLLEAGUES. Auditors are
required to maintain adequate quality control processes according to auditing standards
· disciplinary processes of professional bodies – professional bodies hold their members accountable for the
quality of their work and their conduct by means of a disciplinary process (ensures that the profession is
accountable to the society {general public} that it serves).
Disciplinary measures include :
Ø reprimands or warnings
Ø imposition of fines
Ø suspension from practice for a specified period of time
Ø cancellation of membership or registration
Ø qualified, temporary or permanent disqualification of membership / registration
· courts of law – auditors can be called to account for the quality of their work and their opinions in legal actions in
court :
Ø civil action – plaintiff institutes lawsuit seeking damages for alleged negligent work done by auditor. Action
normally tries to prove that the auditor’s work wasn't according to professional auditing standards. Action can
be brought by :
§ company itself (the body of shareholders) in terms of the contract that exists between the client and the
auditor to provide audit services
rd
§ 3 parties such as individual shareholders of the company, creditors etc who also have the right to institute
legal action for damages on the basis of some form of illegal act or wrongful conduct by the auditor
Ø criminal proceedings – if auditor is accused of performing engagement dishonestly or fraudulently

Regulation of auditing profession to ensure :


· auditing services are provided on cost-effective basis
· ethical conduct is adhered to
· auditors have appropriate education and training standards are maintained (quality and uniformity)
· people guilty of offences are punished.

Regulated by :
· professional bodies
Ø SA Auditing Standards (SAAS)
Ø Code of Professional Conduct
Ø Disciplinary Rules
· statutory laws
Ø Public Accountants and Auditors Act
Ø Companies Act 1973

Professional regulations necessary to :


· control the standards of education and training of their members
· control the process of qualification for membership
· influence the content of audit work through promulgation of professional standards
· control the quality of member’s work and standards of professional conduct through the operation of disciplinary
processes
Powers of professional bodies are part of self-regulatory nature of auditing profession – self regulation imposes
corresponding obligation to profession to develop and maintain standards of professional behavior.

Statutory regulations
Audit work is monitored by and controlled through different legislation and is changed by according to regulatory or
legislated requirements.
Auditing Professional Act of 2005 contains important legislation governing auditing activities in SA and :
· restricts auditing to only people who are registered in terms of the Act
· determines the education and training requirements for persons wishing to enter auditing profession
· lays down powers and duties of auditors in relation to the audit function
· describes offences in connection with auditing practice and specifies penalties for these offences
· provides for creation of regulations concerning the rules of professional conduct and disciplinary processes
Provides for inspections by the Independent Regulatory Board for Auditors (where practitioners performing audits
undergo practical evaluation on their compliance to ISA’s.)
Companies Act 61 of 1973 provides for compulsory annual audit of AFS for all companies in SA.

Auditing Professional Act 2005 – chapter 1 & 2


Chapter 1 – definitions, including :
· auditing pronouncements and
· reportable irregularity
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Objects of the Auditing Professional Act :


· to protect the public by regulating audits performed by registered auditors
· to provide for the establishment of Independent Regulatory Board for Auditors
· to improve development and maintenance of internationally comparable ethical standards and auditing standards
for auditors that promote investment as a consequence of employment in SA
· to set out measures to advance the implementation of appropriate standards of competence and good ethics in the
auditing profession
· to provide for procedures for disciplinary action in respect of improper conduct

Chapter 2 – Independent regulatory board for auditors


Part 1 – establishment and legal status of Regulatory Board
IRBA is a juristic person and must obey this Act and any other relevant laws. Is subject to the Constitution and the law
– especially the Public Finance Management Act.
Part 2 – functions of Regulatory Board
General functions :
· must promote the integrity of the auditing profession including :
Ø investigating alleged improper conduct
Ø conducting disciplinary hearings
Ø imposing sanctions for improper conduct and
Ø conducting practice reviews or inspections
· protect the public in their dealings with registered auditors
· prescribe standards of professional competence, ethics and conduct of public auditors
· encourage education and research into anything affecting the auditing profession
· prescribe auditing standards
· Regulatory Board can :
Ø participate with international bodies whose main purpose is to develop and set auditing standards and to
promote the auditing profession
Ø publish a journal, newsletters or circular containing information and guidelines relating to the auditing profession
Ø co-operate with international regulators relating to audits and auditors
Ø take any measures necessary for the proper performance and exercise its functions and duties to achieve the
objects of this Act
Functions with regard to accreditation of professional bodies :
· must prescribe the minimum requirements for accreditation of professional bodies
· consider and decide on any application for accreditation and grant it either fully or partially
· state the period of validity of the accreditation
· keep a register of accredited professional bodies and decide on the register to be kept as well as maintenance and
review of the register
· terminate the accreditation of professional bodies
Functions with regard to the registration of auditors :
· must prescribe minimum qualifications, competency standards and requirements for the registration of auditors
· consider and decide on any application for registration as an auditor
· state the period of validity of the registration
· keep a register of registered auditors and decide on the register to be kept as well as maintenance and reviewing of
the register
· ensure that the register is open to the public at all reasonable times
· terminate the registration of registered auditors in terms of the Act
· prescribe the minimum requirements for the renewal of registration and re-registration.
Functions with regard to education, training and professional development :
· either recognise or withdraw the recognition of the educational qualifications or programmes in the auditing
profession of educational institutions and accredited professional bodies, either in full or part
· either recognise or withdraw recognition of any accredited professional body to conduct a qualifying exam.
If does withdraw recognition for either of above, then must give notice of withdraw in writing to the educational
institution or accredited professional body of intention to withdraw and reasons therefore and must give them no
less then 21 day and not more then 30 days to give reasons why the recognition shouldn’t be withdrawn.
If found that the withdrawal of recognition would not in the best interests of the public then can implement whatever
conditions it considers appropriate in order for the institution or professional body to remain recognised.
Regulatory Board must publish the withdrawal of recognition
· prescribe requirements for and conditions of continued education, training and professional development
· prescribe training requirements for the period of training and the form of the training contracts
· approve and register training contracts entered into by prospective registered auditors
· prescribe competency requirements and
· recognise or withdraw the recognition of registered auditors as training officers either conditionally or unconditionally
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· establish mechanisms for registered auditors to gain recognition of qualifications in other countries and enter into
agreement with professional bodies outside SA for this purpose
· establish and administer an education fund for the purpose of training, professional development and continued
education for auditors and hopeful auditors
· advise, assist or consult with any statutory or professional body regarding the training, educating or professional
development of registered auditors and hopeful auditors
Functions with regard to fees and charges :
· Regulatory Board must prescribe :
Ø accreditation, registration, renewal of registration and re-registration fees
Ø annual fees
Ø date on which fee is payable
Ø fees payable in respect of any examination conducted by any accredited professional body or the IRBA (Section
37)
Ø any fees payable for the purposes of the education fund (Section 7)
Ø fees payable for an inspection or review undertaken by the Regulatory Board (in terms of Section 47)
Ø fees payable for any other service rendered by the IRBA
· can also grant exemption from the payment of any fees.

Jackson & Stent pg 3/59 & 3/60 & 6/2


Auditing Professional Act 26 of 2005 designed to :
· provide for establishment of IRBA
· provide for education, training and professional development of registered auditors
· provide for the accreditation of professional bodies
· provide for the registration of auditors
· regulate the conduct of registered auditors and
· to repeal the Public Accountants and Auditors Act

Summary of Chapters of Act :


Chapter 1 – Interpretation and objects of the Act
· protect the public by regulating audits performed by registered auditors
· provide for the establishment of IRBA
· improve the development and maintenance of internationally comparable ethical standards and auditing standards
for auditors
· set out measures to advance the implementation of appropriate standards of competence and good ethics in the
auditing profession
· provide for procedures for disciplinary action in respect of improper conduct.

Chapter 2 – Independent Regulatory Board for Auditors :


· Part 1 – establishes the IRBA as a juristic person and orders that it must exercise its functions in accordance with
the Auditing Professional Act and any other law. Also states that IRBA is subject to the Constitution.
· Part 2 – spells out the function of the IRBA, including accreditation and registration, education, member fees etc
· Part 3 – gives IRBA general powers and its powers to make rules. General Powers give IRBA power to appoint
staff, enter into agreements. Power to make rules allows IRBA execute responsibilities in terms of Act
· Part 4 – lays out the governance requirements of the Regulatory Board.
· Part 5 – lays out government requirements of the Regulatory Board, such as matters of appointment of members of
the Board, their terms of office, disqualification from membership, meeting and the role of the CEO.
· Part 5 – deals with committees of the Regulatory Board and states must establish :
Ø committee for auditor ethics
Ø committee for auditing standards
Ø education, training and professional development committee
Ø inspection committee
Ø investigating committee
Ø disciplinary committee.
· Part 6 – deals with funding and financial management of the Board and covers collection of fees, annual budget
and strategic plan and preparation of financial statements.
· Part 7 – deals with national government oversight and executive authority – Minister of Finance is the executive
authority for IRBA and IRBA is accountable to the Minister.

Chapter 3 – Accreditation and Registration


Part 1 – deals with accreditation of professional bodies. Individual can only register with IRBA if satisfies the
prescribed education, training, competency and professional development requirements which the IRBA
outsourcers to accredited professional bodies (only SAICA at the moment) and if individual satisfies SAICA’s
requirements then can registered with the IRBA.
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SAICA offers two specialism routes – either auditing or financial management. Only individuals who have
followed the auditing specialism can register with the IRBA (i.e. must have served their training contracts in
public practice (TIPP) and written and passed the Professional Practice Examination.
Part 2 – deals with the registration of individuals and firms as registered auditors and deals with :
· Section 37 – registration of individuals as registered auditors
· Section 38 – registration of firms as registered auditors
see Jackson and Stent pgs 3/60 to 3/69 for the rest of the Auditing Professional Act 26 of 2005 chapter by
chapter.

Jackson & Stent pg 6/2


COMPLETE AUDIT PROCESS :

Preliminary Engagement Activities :


· decide if want to establish or continue a relationship with the client
· assess the firm’s competence and availability of resources
· consider the ethical requirements (e.g. independence)
· formulate terms of the engagement

Planning (overall audit strategy and audit plan) :


· understand the entity including the internal controls
· assess the risk of material misstatements in the financial statements
· determine materiality
· establish the overall audit strategy
· develop the audit plan

Put the plan into action :


· conduct tests of controls and other ISA procedures (substantive) to respond to :
Ø risks at financial statement level (overall response)
Ø risks at assertion level
Ø significant risks

Conclude :
· evaluate audit evidence
· report accordingly

ISA 200 – OBJECTIVE AND GENERAL PRINCIPLES GOVERNING AN AUDIT OF FINANCIAL


STATEMENTS
paragraph 1 – 9
Introduction – purpose of International Standard on Auditing (ISA’s) is to establish the standards and provide guidance
on the objective and general principles governing an audit of financial statements.
States that management is responsible for the preparation and presentation of the financial statements and also for
identifying the financial reporting framework used to prepare the financial statements.
Objective – to enable the auditor to express an opinion as to whether the financial statements (in all material aspects)
are prepared in accordance with an applicable financial reporting framework. Audit is also an assurance engagement –
as described in the International Framework for Assurance Engagements, so basically ISA’s apply the Framework in the
context of an audit of financial statements and conditions the basic principles and essential procedures to be applied in
such an audit. Auditor can only accept an assurance engagement if the criteria is suitable and available to the intended
users
Ethical requirements relating to an audit of financial statements – auditor MUST comply with all relevant ethical
requirements relating to the audit engagement. ISA 220 (Quality Control for Audits of Historical Financial Information)
identifies the fundamental principles of professional ethics stated in Parts A & B of the International Federation of
Accountant’s Code of Ethics for Professional Accountants (IFAC Code) and sets out the engagement partner’s
responsibilities with respect to the ethical requirements.
Conduct of an audit of financial statements – the audit MUST be conducted in accordance with International
Standards of Auditing (ISA’s) and also considers International Auditing Practice Statements (IAPS’s).
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Scope of an audit of financial statements – “scope of an audit” = the audit procedure that in the auditor’s judgment
and based on the ISA’s is deemed to be the best way in the circumstances to achieve the objective of the audit.
WHEN DETERMINING THE AUDIT PROCEDURES TO BE PERFORMED IN CONDUCTING AN AUDIT IN
ACCORDANCE WITH ISA, THE AUDITOR MUST COMPLY WITH EACH ISA THAT IS RELEVANT TO THE AUDIT.
However, ISA’s don’t override local laws or regulations so auditor MUST comply with other professional, legal or
regulatory requirements in addition to the ISA’s, but then auditor CAN’T REPRESENT COMPLIANCE WITH ISA
UNLESS IT IS COMPLETELY COMPLIANT WITH ISA.

Study guide pg 50
Nature and objectives of ISA’s
In auditor’s interest to establish and maintain the appropriate professional standards for audit work on a continual basis
– auditing standards must be kept up to date so that they change in accordance with the way different areas of an audit
practice change.
But must note :
· auditing standards that are applied are only a framework and each individual audit will have different standards.
The auditor must exercise professional judgment on a continual basis to apply the standards as much as is practical
· standards are not the force of law – they have some authority as persuasive indicators of the quality of audit work
(i.e. the standard of the audit work), but are not conclusive evidence that the audit is competent. Basically ISA’s are
the minimum standards of performance and quality for audit work
· professional auditing standards are formulated in response to public expectations concerning the quality of the
auditing function – basically a mix of research on, studying of auditing and past experience of actual audit practice
conditions.

Business ethics
In 1930’s Rotary International developed ethical code which uses the following questions to address any ethical issue
that a business might have to face :
· is it the truth?
· is it fair to everyone involved?
· will it prompt goodwill and friendships?
· would it be beneficial to all involved?
Ethical conduct = the general nature of moral values and choices made by an individual in his relation with others.
Individual should ensure that his daily decisions have high ethical standards by using :
· ethical commitment – taking decisions to behave in an ethical manner
· ethical awareness – the ability to foresee the ethical consequences of a matter
· ethical competence – capacity for sound moral reasoning and to develop a practical problem-solving strategy.
Should use this general model when making ethical decisions :
· obtain or identify all the necessary facts on the matter that gave rise to the ethical question
· consider who is affected
· consider an alternative course of action
· consider the possible consequences of each alternative course of action
· compare the courses of action with the norms for the respective ethical questions
· choose a course of action.
Members of the auditing profession are expected to exercise self discipline and also comply with the
requirements of codes and rules. Codes of Professional Conduct recognise the auditing profession’s
responsibility towards the public, clients and colleagues.

Code of Professional Conduct – ethic principles governing the conduct of auditors in the profession are summarised
in :
· SAICA’s Code of Professional Conduct – in the SAICA Member’s Handbook
· IRBA’s Code of Professional Conduct – in the IRBA Manual of Information.

Jackson & Stent pg 2/3 to 2/45


SAICA Code of Professional Conduct
th
From 30 June 2006 SAICA adopted the IFAC’s Code of Ethics for Professional Accountants which basically states that
the Code cannot be a comprehensive list of rules covering every ethical situation, but is basically a methodology for
accountants to identify, evaluate and address any threats to the fundamental principles.
5 ethical principles of ethical behavior have been identified and professional accountants have an obligation to protect
themselves against threats to their adherence to these principles.

General guidance – Ethics and Professional Conduct


Impossible to establish on set of hard and fast rules cos of different religions, races, cultures and backgrounds but
should be able to answer yes to the following :
· is the decision honest and truthful?
· by making this decision – am I acting in a way that I would like others to act towards me?
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· will this decision build goodwill and result in the greatest good for the greatest number?
· Would I be comfortable explaining my decision to people that I respect for their moral values?

In professional context will have to answer the following :


· have I acted truly independently?
· should I use client’s confidential information for my own advantage?
· should I report a client for evading tax?

SAICA / IFAC Code applies to anyone registered with SAICA, irrespective if he is in public practice (i.e. in a firm that
provides professional accounting services) or in business (professional accountant employed or engaged in commerce,
industry or public sector.)
Partner in auditing firm required to register with IRBA in order to get licence to practice and will normally also register
with SAICA, and although a financial accountant working in business normally won’t register with IRBA, he will probably
still register with SAICA.
Also applies to trainee accountants as if have a formal training contract which is registered with SAICA then is bound by
the code – so if you breach the code you are disciplined.

IFAC CODE OF ETHICS FOR PROFESSIONAL ACCOUNTANTS


Part A – General Application of the Code
Part B – Professional Accountant in Public Practice
Part C – Professional Accountants in Business
Part D – Professional Accountants in SA

PART A – GENERAL APPLICATION OF THE CODE


Conceptual framework – Basis of the Code :
5 basic fundamental principles with which professional accountants MUST comply :
· integrity
Ø must be straightforward, honest, fair and truthful in professional and business relationships
Ø must not be associated with information that they believe to be false, misleading (either by inclusion or
omission) or recklessly provided
· objectivity
Ø must not compromise their professional or business judgment because of bias, conflict of interest or undue
influence of others
· professional competence and due care
Ø professional accountants required to :
v maintain professional knowledge and skill at a level which ensures that clients or employers receive
competent professional service
v act diligently in accordance with applicable technical and professional standards when providing
professional services
Ø maintain professional competence by staying abreast of relevant technical, professional and business
developments
Ø act diligent (with due care) by acting carefully, thoroughly and in accordance with the requirements of the
assignment
Ø professional accountant must ensure that those working under his authority in professional capacity have
appropriate training and supervision
· confidentiality
Ø must maintain confidentiality in a social environment and mustn’t unintentionally disclose confidential
information to friends or family etc
Ø must ensure that staff also maintain confidentiality
Ø even if relationship between auditor and client ends, still has the duty of confidentiality
Ø professional accountant MUST NOT :
v disclose confidential information received as result of professional or business relationship without authority,
unless there is a legal or professional duty to do so
v use confidential information acquired as a result of professional and business relationships to their own
rd
personal advantage or the advantage of 3 parties.
Ø disclosure of confidential information ONLY permitted if :
v it is permitted by law and authorised by the client
v required by law e.g.
! during legal proceedings or
! if disclosing infringements of the law to the appropriate public authority
v there is a professional duty or right to disclose e.g.
! when reporting on the quality review of a member body
! in response to enquiry or investigation by a member body or regulatory body
! to protect the professional interest of a professional accountant in legal proceedings or
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! to comply with technical standards or ethical requirements.
Ø when deciding to disclose confidential information then professional accountant must consider :
v if the interests of all parties can be unnecessarily or unjustly harmed by the disclosures
v whether all the relevant information is known and substantiated (cos disclosing unsubstantiated facts or
incomplete information can be unfairly damaging to other parties and is unprofessional)
v whether the method or type of communication is appropriate and the recipient of the information is
appropriate.
· professional behaviour – professional accountants must :
Ø comply with relevant laws and regulations
Ø avoid any action that can discredit the profession
Ø market and promote themselves in an honest and truthful way
Then provides an approach that should be adopted to ensure that professional accountant complies with the
fundamental principals.
Professional accountants MUST :
· identify threats to their compliance with the fundamental principals
· evaluate if the threat is clearly insignificant and
· if not, they must adopt safeguards to eliminate or reduce the threat to an appropriate level.

Threats
Self interest threats – occur as a result of financial or other interests of either the auditor or immediate or close family
e.g. auditor has shares in a company which is about to become an audit client
Self-review threats – occur when previous work needs to be re-evaluated by the professional account responsible for
that work e.g. auditor has written up the accounting records of a client for which he has also been appointed to audit
Advocacy threats – occur when auditor promotes a position or opinion to the point that he subsequent objectivity may
be compromised e.g. professional accountant values a client’s shares and then leads the negotiations of the sale of the
client’s company
Familiarity threats – occur when auditor becomes sympathetic to the interest of others due to a close relationship e.g.
when auditor doesn’t disclose fraud cos the client is a close friend
Intimidation threats – occur when professional accountant doesn’t act objectively cos of actual or perceived threats
e.g. auditor fails to report fraud by employer cos scared will be dismissed if does so.

Safeguards
Unless the threat is CLEARLY insignificant the professional accountant must apply safeguards to eliminate or reduce
the threat to an acceptable level.
Can only decide if the threat is clearly insignificant by :
· professional judgment
· taking into account the public interest (if public interest is affected the threat is significant)
rd
· decision should be one that a reasonable and informed 3 party having knowledge of all the relevant information
would make.
2 categories of safeguards - either :
· created by professional, legislation or regulation e.g. Companies Act prevents professional accountant from
being a director in his own client’s company
· or safeguarded in the work environment – company has sound procedures which protect an employed
professional accountant from intimidatory threats from his manager.
If no suitable safeguard can be put in place then professional accountant will have to withdraw from the engagement or
employment contract.

PART B – PROFESSIONAL ACCOUNTANTS IN PUBLIC PRACTICE


SECTION 200 – INTRODUCTION
Threats can vary depending on the services that is provided – either ;
· assurance engagements – where professional accountant expresses a conclusion which is intended to enhance
the degree of confidence of a user of the information on which the conclusion has been expressed (e.g. audit of
financial statements)
· non-assurance engagements – engagement where the professional accountant doesn’t express a conclusion of
information (e.g. either procedure or compilation engagements).
Assurance engagements more likely to have significant threats – especially threats of objectivity.

Important to remember that with safeguards :


· sound leadership in the firm and of the engagement team is essential
· policies and procedures must be documented and conveyed regularly to employees
· disciplinary mechanism must be effective
· firm employees should have a procedure for raising ethical issues with senior personnel and feel safe to do so
· clients structures (audit committees or corporate governance policies) should be used wherever possible.
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see examples of threats to a professional accountant and some of the safeguards that can be used on pgs 2/9
to 2/11 of the text book – NB to learn for exam!!

SECTION 210 – PROFESSIONAL APPOINTMENT


Client acceptance
Professional accountant in public practice is required to consider if accepting a new client would threaten compliance
with the fundamental principles.
Threats would probably mainly threaten fundamental principles of :
· integrity and professional behaviour – if client is dishonest, involved in questionable business e.g. second hand car
parts or is socially and morally questionable e.g. porn movies.
· objectivity – if auditor is not independent to the client.
Safeguards :
· thoroughly screening of client prior to acceptance of client
· all auditing firms must have control procedures which address the acceptance of new clients – must consider :
Ø integrity of the principle owners or those charged with governance
Ø if the firm and engagement team can comply with the ethical requirements (i.e. if there are independence
problems will professional behaviour be satisfied.)
Normally obtained by :
v discussion with management, financial director or audit committee
v discussion with professional accountants who have provided services to that client in the past
rd
v discussions with other 3 parties (e.g. bankers)
v background searches of the relevant database e.g. internet
Engagement acceptance
Is auditing firm or professional accountant competent to perform the proposed engagement to the required standard.
Threats are to the fundamental principles of professional competence and due care (also indirectly professional
behaviour). If accept the engagement without being competent then that is also a self-interest threat.
Safeguards :
· quality control policies and procedures adopted by the firm
· all auditing firms must have procedures to evaluate if the firm has the capabilities, competence, time and resources
to undertake the new engagement, including
Ø thoroughly investigating the client’s business and complexities
Ø ensuring the engagement team consists of correct mix of skills to perform to standards
Ø hiring other experts (after suitable screening)
Ø setting realistic time frames
Changes in professional appointment
If professional accountant is asked to replace another accountant then must determine if there are any reasons not to
accept the engagement (professional or otherwise).
Both auditors must realise they have responsibilities to each other – previous auditor cannot be angry at being replaced
and refuse to co-operate with new auditor.
Existing auditor is bound by confidentiality.
Threats are quite similar to simply taking on a new client – (fundamental principles of professional competence,
due care, professional behaviour and integrity.) Existing auditor could fail to comply with confidentiality principal if
divulges information to new auditor or professional behaviour if criticise the client or the proposed auditor.
Safeguards for new auditor also similar to those of accepting a new client as well as :
· should discuss the client’s affairs fully and freely with the existing auditor (should get client’s permission in writing –
if refuses then suggests that there is something the client is trying to hide i.e. significant threat)
· ask the old auditor if he is aware of any facts or circumstances the new auditor should know about before accepting
the engagement
Safeguards for old auditor :
· should get clients permission to discuss the affairs in writing & also define the boundaries of what may be discussed
· provide the new auditor with information honestly and unambiguously
· put a senior experienced partner in charge to avoid negative emotive issues from being introduced (e.g. critism) and
ensure that a difficult situation is handled professionally.

SECTION 220 – CONFLICTS OF INTEREST


Where the interests of the firm or auditor may be in conflict with the interest of the client. see examples pg 2/13 of text
book. Threats :
· if auditor competes in the same market as a client then there is a threat to the accountant’s objectivity,
confidentiality and professional behaviour
· where auditor has 2 clients who are in direct competition with each other then there is a threat to the objectivity and
confidentiality
Safeguards :
· must notify all the partners of the potential conflict and obtain consent to continue with the service (if no consent
then auditor must chose which client to keep if has 2 clients in competition)
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· or can use separate engagement teams
· clear guidelines for members of the engagement tea on confidentiality and professional behaviour
· confidentiality agreements signed by employees and partners of the firm.
SECTION 230 – SECOND OPINIONS
If asked to provide second opinion for an entity that is not an existing client then has ethical responsibilities to himself
and also the existing auditor.
Threats could include :
· threat to professional competence and due care if new accountant doesn’t have the full facts or evidence and may
be giving an opinion not based on full extent of various conditions and he then appears incompetent and his opinion
is discredited
· professional behaviour threat if the second opinion differs as it may look like criticism of the original opinion
· also client may be trying to implicate new accountant into discrediting the original accountant by seeking evidence
for a court action or questioning his compliance with integrity or professional behaviour
Safeguards :
· obtaining written precise explanation from the client as to why a second opinion is needed
· obtaining client’s permission to contract the provider of the first opinion to discuss the matter (if won’t give
permission then warning sign)
nd
· commit all communications to writing and let a 2 party in the firm review them
· senior personnel only should deal with matters like this.

SECTION 240 – FEES AND OTHER TYPES OF REMUNERATION


Normal fees
Professional accountant is entitled to be remunerated fairly but must charge appropriate fees
Threats :
· in order to secure engagement auditor may quote a fee that is so low that it will be difficult to perform the
engagement in accordance with applicable standards – threat to professional competence and due care and also
integrity (not honest way to do things) and objectivity (low fee may influence the nature and extent of the test
performed)
· also applies to a fixed free for a service which may result in the amount of time being spent on the engagement
being too high or too low.
Safeguards :
· provide the client with the basis on which fees are charge – no fixed fee
· alert the client in writing that the total time budgeted to be spend on the engagement may vary if unexpected
problems arise (e.g. to resolve audit issues)
· discuss the terms of the engagement with the client
· assign appropriation time and suitably qualified staff to the engagement.
Contingent fees
(Fees that are calculated on a pre-determined basis relating to the outcome of the work performed or as a result of a
transaction which arises from the service).
Acceptable for a wide range of non-assurance engagements and can be charged in accordance with business norms –
NOT allowed for assurance engagements.
Threats :
· charging contingent fees can give rise to a self-interest threat to objectivity – an i.e. auditor becomes more
interested in the fee that can be earned rather then the quality of the service offered.
· can be threat to integrity and professional behaviour if the accountant does anything illegal or contrary to honest
business practice in an attempt to maximize the contingent fee.
Safeguards :
· obtain a written agreement with the client as to the basis and detail of fees to be charged in advance
· there should be a committee within the firm that authorises all engagements giving rise to contingent fees prior to
their acceptance
· disclosure to intended users of the work performed and of the contingent nature of the remuneration
rd
· review by an objective 3 party (committee) of the work performed by the professional accountant to counter any
claims that the professional accountant was only interest in maximizing the fee.
Referral fees / commissions
Professional accountant can receive or pay a fair referral fee or commission but must ensure that it doesn’t compromise
the fundamental principals.
Threats :
· to objectivity, professional competence and due care and possible integrity.
· might result in clients being referred to other companies that are not necessary the most suitable for that client, but
might pay the highest referral fee
· could also refer client to someone cos of the commission that auditor will receive and not necessarily because it is
the best thing for the client.
Safeguards :
· disclose all the details of the referral fee to the client who can then take up or reject the offer as they want
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· if it is commission then disclose in advance to the client that the auditor has an interest in the transaction
· committee within the auditing firm should authorize referrals relating to services and products

SECTION 250 – MARKETING PROFESSIONAL SERVICES


Auditor can obtain additional work through marketing his services, but must advertise in such a way that it does not
discredit the profession in any way e.g. no advertising in bad taste or making extravagant claims etc.
Threats :
· principles of integrity and professional behaviour threatened by marketing that is dishonest, exaggerated,
obnoxious, in bad taste or that criticizes other firms
Safeguards :
· quality control procedure which requires all proposed advertising is reviewed and authorised by a suitable technical
committee within the firm
· written communication with partners and employees as to what is acceptable and what is not acceptable in respect
of promoting the firm

SECTION 260 – GIFTS AND HOSPITALITY


Auditor can receive gifts and hospitality from clients provided they are clearly insignificant (as judged by reasonably
rd
informed 3 party) BUT may NOT accept gifts which may alter the relationship between client and accountant.
Threats :
· if not clearly insignificant then the gift threatens fundamental principle of objectivity (e.g. did he give gift to expect a
favour in return? Is the relationship now familiar and no longer professional? Is it given so that can threaten auditor
with disclosure if doesn’t comply with gift makers wishes?)
Safeguards :
· policy prohibiting partners and staff from accepting gifts or hospitality from clients
· accepted gift can only be approved by the firm’s quality control committee
· notification to all clients that employees and partners may not accept any gifts or hospitality that is not clearly
insignificant.

SECTION 270 – CUSTODY OF CLIENT ASSETS


Auditor can take custody of a client’s assets but must ensure that in doing so the assets do not come from illegal
sources and not used for purposes other then what they were intended. Also must be kept separately identifiable.
Threats :
· custody of client’s assets can threaten the fundamental principles of integrity, professional behaviour and objectivity
e.g. auditor with client’s money might be tempted to use it to enrich himself (i.e. make speculative deals using
client’s money)
· client may be trying to launder illegal money through the firm
· auditor can be accused of misuse of the client’s assets
safeguards :
· all client assets MUST be kept separate from the firm assets (e.g. client’s money should not be kept in the auditor’s
bank account)
· before accepting the assts, the firm must agree in writing as to what the assets can be used for
· records accounting for any movement in the value of the assets must be maintained and available for inspection
(i.e. income earned)
· before accepting the assets the firm must establish that they do not come from illegal sources
· establish that any bank accounts are FICA compliant.

SECTION 280 – OBJECTIVITY (ALL SERVICES)


Preamble to Section 290 regarding independence of assurance engagements – NB cos independence is “cornerstone
of the profession” and any opinion that is expressed where the auditor is not independent of the client is compromised.
Objectivity obviously used in different engagements at different levels. Professional accountants MUST NOT
compromise their professional judgment cos of bias, conflict of interest or undue influence of others.

SECTION 290 – INDEPENDENCE ASSURANCE ENGAGEMENTS


rd
Public accountant expresses opinion on the client’s information to enhance the degree of confidence of 3 parties in
that information, so if auditor is not clearly independent of the client or information then the credibility / confidence will
not be achieved.
Auditor also carries out lots of assurance engagements – auditing financials is normally the most common assurance
engagement. IFAC code states the importance of independence and provides a conceptual framework for dealing with
independence issues.
Definitions / Terminology
Assurance = adding credibility to information provided by another person (e.g. by expressing an independent opinion)

Assurance and non-assurance engagements can be either :


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· assurance engagements – when professional accountant is engaged to report on the financial information in way
that the credibility of the information is enhanced. 3 parties in assurance engagement – the professional auditor,
party responsible for the information being reported on (client) and user of the information. INDEPENDENCE IS
MORE IMPORTANT IN ASSURANCE ENGAGEMENTS THEN FOR NON-ASSURANCE ENGAGEMENTS.
· non-assurance engagements – engagements where auditor doesn’t enhance credibility but rather performs a
predefined task (e.g. prepares tax return or financial information). Doesn’t give an opinion, just presents the facts.
· assertion based assurance engagements are split between “financial statement audit engagements” and “other
assertion based assurance engagements” so other matters can be the subject of an assurance engagement
(provided there is criteria against which the subject matter can be tested).
REGARDLESS OF THE TYPE OF ASSURANCE ENGAGEMENT – INDEPENDENCE IS VERY IMPORTANT.

Financial statement audit engagement = reasonable assurance engagement where professional accountant in public
practice expresses an opinion as to whether the financial statements are prepared (in all material respects) in
accordance with an identified reporting framework. (e.g. statutory audit ordered by the Companies Act)

Assurance team =
· all members of the engagement team for the assurance engagements (management, staff and any experts
contracted by the firm for the audit)
· all others within the firm who can directly influence the outcome of the assurance engagement (e.g. IT providers)

Independence :
· independence of mind – state of mind that permits the provision of an opinion without being affected by influences
that compromise professional judgment and allow auditor to act with integrity, objectivity and professional
skepticism
· independence in appearance – avoidance of facts and circumstances that are so significant that a reasonably
rd
informed 3 party with all the relevant information would reasonably conclude that the auditor’s integrity, objectivity
or professional skepticism had been compromised
· state of mind & in appearance – both are very important as even if auditor with financial interest in client might
have actually performed his duties with the highest level of independence (state of mind) he may NOT be perceived
by another party who know of his financial interest in the client of being independent (appearance). So auditor must
not only be independent but must also be seen to be independent.

Conceptual approach applied to independence


Impossible for Code to have a rule for every ethical issue and also can’t define and list every single situation where
auditor’s independence may be threatened so Code gives auditor’s a conceptual approach that helps auditor to :
· identify threats to independence
· evaluate if the threats are clearly insignificant and
· if they are NOT clearly insignificant, helps auditor to apply appropriate safeguards to eliminate or reduce the threat
to an acceptable level.
Threat can only be determined to be “clearly insignificant” by using professional judgment – cos every threat has
different circumstances difficult to measure the significance of the threat but can use following questions to aid in the
decision :
· is there a threat that overriding requirement to ensure that auditor is independent in mind and appearance might be
questioned?
· has the extent of public interest been addressed? (significance of the threat can be increased where there is high
public interest in the assurance client – e.g. in a listed company, pension or unit trust company. If listed company
with threat then audit firm may have to resign from the audit if the threat is large enough)
rd
· would a reasonably informed 3 party with knowledge of all the relevant information think that there is a threat?
CLEARLY INSIGNIFICANT = TRIVIAL AND INCONSEQUENTIAL.

Financial interest = interest in an equity or other security, debenture, loan or other debt instrument of an entity
(including rights and obligations to acquire such an interest)
Direct financial interest = financial interest owned directly by or under control of auditor or audit entity or financial
interest beneficially owned through an investment vehicle (unit trust, mutual fund) that is controlled by auditor or audit
entity.
Indirect financial interest = financial interest beneficially owned through a collective investment vehicle (e.g. unit trust,
mutual fund) estate or trust over which the auditor or audit entity has NO control
Immediate family = spouse or dependent
Close family = parent, child or sibling who is not an immediate family member
Listed entity = company whose shares or debt (debentures) are listed on a recognised stock exchange e.g. JSE
Network firm = entity under common control, ownership or management with the firm or any entity that a reasonable
rd
informed 3 party would reasonably conclude was part of the firm nationally or internationally. So basically threats of
independence must be considered by the firm as a whole and not just a single geographical office or branch.
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see the illustrative examples on pages 2/21 to 2/35 of Jackson & Stent where specific situations, circumstances
or relationships where independence may be threatened.
Primary threat is objectivity.

PART C – PROFESSIONAL ACCOUNTANTS IN BUSINESS


SECTION 300 – INTRODUCTION
Professional accountant in business involved with the preparation and reporting of financial and other information and
can also provide financial management or business advice.
Expected to encourage ethics based culture in their entity and themselves have an obligation to comply with the
fundamental principles of integrity, objectivity, confidentiality, professional competence and due care and professional
behaviour.
Would still use the Code to help auditor to :
· identify threats to independence
· evaluate if the threats are clearly insignificant and
· if they are NOT clearly insignificant, helps auditor to apply appropriate safeguards to eliminate or reduce the threat
to an acceptable level.
Category of threats :
· self-interest
· self-review
· advocacy
· familiarity
· intimidation
safeguards in business are more restricted and rely mainly on the entity’s governance procedures.

SECTION 310 – POTENTIAL CONFLICTS


Professional accountant in business has professional obligation to comply with the fundament principals but sometimes
these may result in conflict with the interests of the company BUT MUST COMPLY WITH THE FUNDAMENTAL
PRINCIPALS.
Threats
Cos auditor relies on entity for livelihood can be difficult if there are conflicts of interest – might intimidated to act or
behave in ways that threaten their compliance with all the fundamental principles such as might be pressured to :
· act contrary to law or regulation e.g. fail to pay over the PAYE deducted from employees
· act contrary to technical or professional standards e.g. award a tender to a company on the basis of a threat from
senior management rather then the merits of the tender which may be to the entity’s detriment
· facilitate unethical or illegal earnings strategies e.g. provide false documents to conceal the purchase or sale of
illegal products
· lie or intentionally mislead other auditors or regulators (including remaining silent about things) e.g. produce false
evidence to support fictitious sales or lie to custom officials about the nature of the imported goods to reduce import
charges
· issue or be associated with either financial or non-financial reports that materially misrepresent facts e.g. assist in
manipulating the financials to reflect certain ratios that will ensure continued support of a creditor or understate the
number and earnings of employees to reduce skills or UIF levies.
Can also face other threats and auditor has responsibility to recognise these and take action to prevent them (e.g. may
have access to confidential information from which he could benefit – only safeguard here would be the auditor’s
personal integrity which might be emphasised by the disciplinary measures that could be taken by the employer).
Safeguards
In place to protect professional accountant from any negative effects of doing right thing (assumed that auditor doesn’t
want to do anything unethical). Can :
· have access to those charged with corporate governance e.g. independent non-executive director or audit
committee
· obtain advice from professional body e.g. SAICA or a legal advisor
· should have formal dispute resolution process in entity
If auditor happily uses unethical means and ignores fundamental principals then won’t be interested in safeguards
unless trying to work out how to get around the ones already in place in the entity.

SECTION 320 – PREPARATION AND REPORTING OF INFORMATION


Professional accountant in business involved with preparation and reporting of information must present it fairly,
honestly and in accordance with the relevant standards (e.g. financials should comply with the international financial
reporting standards)
Threats :
· intimidation or self-interest threats to objectivity, integrity and professional competences can arise when auditor is
pressured by internal or external parties
· personal gain if auditor manipulates reported profits to earn additional bonuses
Safeguards :
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· have access to those charged with corporate governance e.g. independent non-executive director or audit
committee
· obtain advice from professional body e.g. SAICA or a legal advisor
· should have formal dispute resolution process in entity
Professional accountant in business MUST put into practice preventative measures to ensure that they are not
accused of looking after their own interests.

SECTION 330 – ACTING WITH SUFFICIENT EXPERTISE


Must only take on tasks for which auditor has necessary training or expertise, and if not, then has responsibility to obtain
it from someone else.
Threat :
Professional accountant may not comply with the fundamental principle of professional competence and due care.
Safeguards :
· obtain additional training or seek advice from
Ø supervisors in the entity
Ø independent experts
Ø relevant professional body
· ensuring that there is sufficient time to perform the task.

SECTION 340 – FINANCIAL INTERESTS


If auditor, immediate or close family has a financial interest in the employment organisation then must ensure he
complies with the fundamental principles.
Threats
Self interest threat to objectivity or confidentiality – especially where auditor or immediate or close family member :
· holds direct or indirect financial interest in the employment organisation and the value of the interest can be directly
influenced by decisions made by the professional accountant
· is eligible for a profit related bonus and the value of the bonus is directly effected by decisions made by the
professional accountant
· holds share options in the employment organisation and the value of these share options can be effected by
decisions made by the professional accountant
· engages in insider trading (i.e. using price sensitive confidential information to trade in shares for personal gain)
Safeguards - depending on the significance of the threat :
· policy which requires all employees to disclose to the company any financial interest in the company (including
immediate and close family interest)
· remuneration committee to determine remuneration for senior management
· internal and external audit procedures to review critical decisions made by the professional accountant
· communication of the legal position and consequences of insider trading and similar acts to employees on a regular
basis

SECTION 350 – INDUCEMENTS


RECEIVING OFFERS
Professional accountant, immediate or close family may be offered gifts, hospitality, preferential treatment etc to try and
encourage him to act in an illegal or dishonest way or to reveal confidential information. Has responsibility to comply
with the fundamental principles and not be influenced the inducement.
Threats :
· self interest threats to objectivity and confidentiality
· intimidation threats to objectivity, confidentiality, integrity and professional behaviour can follow if the gifts etc are
accepted (giver may threaten to blackmail the auditor to make the inducement public knowledge)
Safeguards :
· as soon as receives the inducement must immediately inform his superior or the company’s governance structure
rd
· inform 3 parties of the offer (e.g. the employer of the person who made the office) but should FIRST seek legal
advice
· inform his supervisor of potential sources of inducements (e.g. where immediate family are employed by
competitors or potential suppliers e.g. could offer to promote family member in return for confidential information
MAKING OFFERS
rd
Professional accountant should not offer an inducement to improperly influence the judgement or behaviour of a 3
party – pressure could be placed on the auditor to do so from a superior or from external sources (e.g. bribe of overseas
holiday in return for a business deal)
Threat :
Making an offer like that would threaten the auditor’s compliance with the fundamental principles of objectivity, integrity
and professional behaviour
Safeguards :
· company policy which prohibits employee from offering inducements
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0
· procedure that enables the professional accountant to report to the company’s governance structures internal and
external attempts to pressure him into offering an inducement.

PART D – PROFESSIONAL ACCOUNTANTS IN SOUTH AFRICA


INTRODUCTION
Member bodies of the International Federation of Accountants can add their own ethical requirements to the Code
provided they are not less strict then those stated in the IFAC Code.
SAICA adopted the following :
· sections of general application and
· sections of professional accountants in public practice

SECTIONS OF GENERAL APPLICATION


SECTION 400 – JOINT AND VICARIOUS LIABILITY (places shared responsibility on the member to ensure that
anyone connected with him complies with the code)
Professional accountant may be held responsible for breaches in the Code committed by persons who are :
· in his employ
· under his supervision
· his partner
· fellow shareholders, directors or employees of company or CC that offers professional services to the public and
which is controlled by the professional accountant or his partners
(Note : deemed to be in control of company if holds directly or indirectly more then 50% of the voting rights attached to
the shares of the company, or if owns more then 50% of the member’s interest or he de facto (in reality) controls the
manner in which the company carries on business.)
Professional accountant may not circumvent (get around) provisions of the Code by acting through or hiding behind
another entity such as body corporate or person. So what cannot be done by a person also cannot be done through a
body corporate.
Professional accountant also cannot permit others to beach the Code on his behalf in an attempt to avoid responsibility.

SECTION 410 – TAX PRACTICE


Professional accountants who render professional tax services may end up in difficult situation if client tries to avoid tax.
Client may request that auditor summits false returns on their behalf or may withhold information from the auditor to try
and avoid tax.
Paying tax CANNOT be avoided and professional accountant cannot not be associated with any tax return or
communication if he has reason to believe that it :
· contains false or misleading statements
· contains statements or information that are recklessly furnished or without any real knowledge of whether they are
true or false
· omits or obscures information required to be submitted and such omission or obscurity would mislead the revenue
authorities
Threats :
To assist with tax invasion will result in non-compliance with the fundamental principals of objectivity, integrity and
professional behaviour.
Safeguards – guidelines to tax matters :
· the professional accountant must put forward the best position for the client provided it is done :
Ø with professional competency, integrity and objectivity
Ø and is within the bounds of the law
· auditor must ensure the client / employer understands that :
Ø tax services and advice offered can be challenged by SARS if they are based on opinion rather then fact
(normal)
Ø responsibility for the content of the tax return rests with the client / employer even when the return has been
prepared by the auditor
· matters relating to tax advice / opinions given to client / employer should be recorded in writing (to prevent client
that is accused of tax evasion from claiming that he was given advise by the auditor)
· when preparing the tax return the professional accountant can rely on information given by the client / employer
provided :
Ø information seems reasonable
Ø professional accountant makes use of the prior years returns where feasible
Ø professional accountant makes reasonable enquires when information appears incorrect or incomplete
· professional accountants encouraged (NOT required) to :
Ø request the supporting documents
Ø make reference to the relevant books and records of the business operations
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· when professional accountant discovers material errors or omissions relating to returns submitted in respect of prior
years then must :
Ø notify client of the error or omission
Ø advise the client to make full disclosure of the error or omission to SARS
Ø advise the client of the powers of the revenue authorities to obtain information (e.g. seize client’s books and
records) and to impose penalties (double the amount of tax payable)
If client is aware of the omission or error and doesn’t want to disclose or correct it then professional accountant
might be associated with the incorrect return. Fundamental principle of confidentiality says that professional
accountant may not inform SARS without permission as this is breach of confidentiality, but Section 410 of Code
says that member must not be associated with a false return.
SAICA advises anyone associated with a false return that has been submitted and which the client refuses to rectify
must then notify SARS that his association with the return can no longer be relied on (of cos they will then realise
there is a problem and will follow up on it). Should get legal advice before notifying SARS.
· professional accountant associated with a return when he has :
Ø consented to the use of his name in the return
Ø submitted (with or without a covering letter) a return which he or his practice has prepared or assisted in
preparing (even if his name is not on the submission that doesn’t mean that his association is negated).
· professional accountant should not continue an association with a dishonest client and should be aware the in
terms of the Income Tax Act the Commissioner can report a member to SAICA for unprofessional conduct.

SECTION 420 – INSOLVENCY PRACTICE


Covers all services and work rendered and performed by auditor in the exercise of their duties or function in the capacity
as trustees, liquidators, judicial managers, curators, or any other fiduciary capacity in respect of any insolvent estate.
Threats :
Insolvency practice is very emotional for those involved as shareholders and creditors stand to lose money and there is
often conflict with different parties, which may result in pressure being exerted on the auditor to look after the interest of
all parties equally. Objectivity, integrity, confidentiality, professional competence and professional behaviour may be
threatened.
Safeguards :
· appointments relating to insolvency practice – professional accounting may NOT :
Ø accept an appointment if disqualified in terms of statue or any other reason
Ø induce any person to vote for his appointment directly or indirectly either by misrepresentation or reward
Ø induce any creditor to vote for their appointment
Ø make false claims of expert or specialised knowledge in respect of insolvency
Ø obtain confidential information in an irregular manner to assist in obtaining an appointment
· performance of services relating to insolvency practice – professional accountant required to :
Ø act in best interests of all creditors
Ø diligently investigate affairs and transactions prior to date of sequestrations / liquidation and (if possible) set
aside all impeachable transactions
Ø immediately report any conduct by a joint appointee that might prejudice the estate or creditors to the Master
· may NOT in performance of services relating to insolvency practice :
Ø accept any benefit or share commission from any person engaged to render services in connection with the
estate
Ø acquire any asset from the estate unless acquisition is approved by the High Court – including auditors’
partners, fellow directors, employees or spouse
Ø share any fees earned in respect of insolvency practice with anyone other then their fellow partners or co-
directors
Ø enter into an agreement to grant any debtor or creditor any benefit not provided by law
Ø delay payments due to other parties without lawful reason
Ø transfer any surplus funds after winding-up the estate into any other accounts without the Master’s prior written
consent
Ø persuade any person to use any particular accountant, attorney etc without good reason
Ø divulge confidential information unless legally obliged to do so

SECTION 430 – DISCRIMINATION


Code says may not discriminate on bases of race, colour, religion, sex, marital status, age or origin.

SECTION 440 – CROSS BORDER ACTIVITIES


Professional accountants working in foreign countries should adhere to local professional requirements, but in none are
recognised then the IFAC Code should be adhered to.
If ethical requirements of that country are LESS STRICT then the IFAC Code – then the Code must be used
If ethical requirements of that country are STRICTER then the IFAC Code then must use the stricter code.

SECTION 450 – PUBLICITY, ADVERTISING AND SOLICITATION


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Advertising and publicity – permitted as long as conforms to accepted norms of legality, decency, honesty and
truthfulness. Professional accountant has sense of responsibility to the profession and to the public and so advertising
must be in formative, objective and in GOOD TASTE (i.e. CANNOT be racist, shocking, belittling, and offensive to
certain religions or make fun of public figures.)
Advertisements should NOT state hourly rates or prices, however can state the basis on which the professional fees are
calculated . Should also not contain testimonials or endorsements.
Solicitation (direct mailing or cold calling) is permitted but ONLY by professional accountant in business who can tell
potential customers and clients about the company’s services or products, but professional accountant in public practice
MAY NOT cold call.

SECTION 460 – RESPONSIBILITIES TO COLLEAGUES


Professional accountant should attempt to promote co-operation and good relations between fellow auditors.
Should assist each other in complying with the Code and should co-operate with disciplinary authorities if they are
applying the Code. Serious faults by a fellow professional accountant that are not intended, may be detrimental to the
welfare of the profession as a whole if they are allowed to continue.
Professional accountant mustn’t criticise another professional account irresponsibly. If called to testify in court against a
fellow auditor then must do so honestly and professionally – person being testified against should behave graciously
and professionally towards the person who is testifying.
If professional accountant is seeking new clients then must ensure doesn’t displace fellow auditor who might be able to
provide better technical skills etc.
Professional accountant mustn’t act in any way that reflects negatively on fellow professional accountants.
Should also extend the same professional consideration and courtesy to non-auditors as he would to auditors.
If person resigns as accounting officer of a CC then must state in the letter of resignation why he is resigning and
person who proposes to accept the appointment as accounting officer must have the opportunity to ascertain if there are
any reasons why he should not accept the appointment.
If professional accountant has accepted the appointment as accounting officer then should inform the outgoing
accounting officer in writing as a professional courtesy.

SECTION 470 – RECRUITING


Educational institutions – bursaries, prizes and professorial chairs can be offered and named after the auditor or the
auditor’s firm.
Professional accountant should not offer employment to employee of another professional accountant without talking to
him first.
If employee of another professional accountant approaches you for employment in response to an advertisement or on
own initiative then can employ him provided have informed his employer.

SECTIONS APPLICABLE ONLY TO PROFESSIONAL ACCOUNTANTS IN PUBLIC PRACTICE


SECTION 480 – SIGNING OF REPORTS OR CERTIFICATES
CANNOT delegate signing of reports of certificates unless to a partner or under grave emergencies (only if reported to
the client and IRBA.)

SECTION 490 – STATIONERY AND LETTERHEADS


Should include only normal letterhead information and should be of an acceptable professional standard (i.e. not look
like an advertisement).
MAY also include :
· partner’s names
· names of professional assistances registered with IRBA
· names of other employees or consultants (but must be clear that they are not registered with IRBA and are not
partners)
· names of other persons, firms or other organisations with whom auditor is associated (even if not registered with
IRBA)

SECTION 495 – INCLUSION OF THE NAME OF A PROFESSIONAL ACCOUNTANT IN PUBLIC PRACTICE IN A


DOCUMENT ISSUED BY A CLIENT
Any publication issued by a client which includes auditor’s report or comments should be reviewed completely by the
professional accountant prior to publication. Context in report must not be misleading.
If auditor is associated with an organisation in his private capacity then MUST NOT be misrepresented so that people
might believe that there is a professional connection with that organisation.

Study guide pg 52
Objectives of accountancy profession :
· strive for the highest standards of professionalism
· attain the highest level of performance
· meet the public interest requirement
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Status of the Code of Professional Conduct
Code contains the objectives and fundamental principles for the auditing and accountancy professions and also gives
detailed guidelines on the proactive application of these in a number of typical situations that occur in the profession.
see notes and Do 1-3 questions on pgs 53 to 62.
MAKE SURE KNOW ANSWERS TO DO QUESTIONS AND READ ALL THE SECTIONS IN CODE.

IRB Manual of Information – Chapter 4 states :


Practitioner is held responsible for breach of IRB code or failure to comply with the code by :
· his employees
· anyone under his supervision
· his partners
· fellow shareholders, directors or employees of a company controlled by the practitioner/s (if practitioner holds more
then half of the voting right – either directly or indirectly – and can carry on the de facto right to control the manner
in which the business of the company is carried on) who do professional work for the public
· fellow practitioners or employees of CC (where practitioner/s have controlling interest of CC) and do professional
work for the public
Partnership, company, CC or any other entity cannot do anything that practitioner would not be permitted to do as
individual.
Practitioner cannot permit other to carry out acts on his behalf either for remuneration or not, that would be a
contravention of the code if he did them.
Practitioners must observe fundamental principles :
· integrity – practitioner should be straightforward and honest and integrity should be ensured by adherence to
standards of conduct and good moral behavior
· objectivity – impartial attitude. Must be fair and not prejudiced or biased
· independence – free from obligation or interest in the client in both fact and appearance
· professional competence and due care – knowledge, skill and experience of practitioner is applied with
reasonable care and diligence. Should not perform any services for which they are competent. Practitioner has
continuing duty to maintain professional knowledge and skill at the required level in practice, legislation and
techniques
· confidentiality – of all information acquired during the course of performing professional services and cannot
disclose any information without permission unless there is a legal or professional right for disclosure
· professional behavior – must act in a manner consistent with good reputation of the profession and should
conduct himself with courtesy and consideration towards clients, other practitioners and employees. Cannot
discriminated against anyone in relation to employment, promotions and training etc
Integrity and objectivity - practitioner must avoid relationships or interests (directly or indirectly) which influence,
impair or threaten their capacity to act with integrity and objectivity.
Conflicts of interest – must be free from any influence, interest or relationship which can be regarded as being
incompatible with integrity, objectivity and independence. If a situation does exist that may be a conflict of interest he
must disclose it immediately and where a material conflict of interest exists the practitioner must decline to act.
If conflict exists but practitioner can act objectively then can accept the engagement if :
· nature of the conflict is fully explained to each party and
· the parties agree in writing that the practitioner may act
Independence – reasonable observer would doubt the practitioner’s independence if there was :
· fiduciary or financial involvement with affairs of clients
· financial involvement with a client who the practitioner has to report such as :
Ø direct or indirect financial interest in the client (or practitioner’s spouse or dependent child)
Ø fiduciary interest in client
Ø loans to or from the client or any member of client company by practitioner, his spouse or dependent child. Ok
if from bank if made under normal lending procedures
Ø holding financial interest in joint venture with a client or employee of a client – unless the practitioner could not
reasonably be expected to have knowledge of the financial interest or relationships involving the joint ventures
Ø financial interest in a non-client that has an investor or investee relationship with the client
rd
Ø holding or advising on investing in shares in an audit client on behalf of a 3 party (e.g. trust) as responsibilities
rd
to the 3 party can conflict with the responsibilities to the audit client
Ø practitioner cannot be the trustee of a trust that he is auditing – if requested should only be minority trustee.
Cannot be personally involved in audit of a company in which the trust has a material shareholding
Ø if practitioner has inherited shares or marries shareholder or take-over situation, then should dispose of the
shares immediately or decline any further reporting assignment for that company
Ø must be independent of a client, it parent, subsidiary and affiliated companies
· practitioner’s independence NOT compromised by :
Ø holding securities in a public company in which securities are widely held provided that the holding is not
material (including practitioner’s spouse and dependent child)
Ø making deposits with or accepting loans from clients who are registered financial institutions as long as these
loans are at the same terms as available to the general public
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Ø making investments in loan stock of public utility corporation clients or municipal clients
Ø making indirect investments in clients through the holding of units in mutual funds, insurance policies or
retirement funding investments
Ø indebtedness arising out of normal trading transactions on the same terms as would be applicable for the
general public.
· practitioner cannot be either :
Ø member of the board or an officer or employee of the company
Ø partner of or under employment of a member of the board
of the engagement company, either within the period under review or immediately preceding the assignment (ideally
not less then 2 years preceding the assignment)
· practitioner carrying out attest functions should NOT perform any management functions or make any management
decisions, but can offer skill and advice in financial and management services (as it would adversely affect the
companies if they didn’t have the right to obtain other services from their auditor.) Also have to examine the system
of internal control which would involve giving suggestions for the future, but these need to remain as advisory
services and NOT usurp the management functions.
· if practitioner is requested to prepare accounting records for smaller client then needs to ensure :
Ø practitioner doesn’t have any relationship with client or any conflict of interest where independence and integrity
would be compromised
Ø client must accept responsibility for the statements
Ø practitioner should not assume the role of employee or of management
Ø staff who prepare the accounting records shouldn’t participate in the examination of the records
Ø just cos practitioner has processed or maintained records doesn’t eliminate the need for audit tests
· if large part of practitioner’s gross revenue is recurring fees from a client or a group of connected clients then the
practitioner has a dependent relationship with that client and there are doubts of independence
· in the same way fees due from a large client which have not been paid for an extended period of time could also
signal preference to one client
· if the branch office is auditing the financial statements of a client of the practice as a whole, and that client forms a
major part of the business of the branch office, then professional services for that client should be reviewed by a
partner from another office
· receiving goods or services from a client (including undue hospitality) is a threat to independence
· if practitioner resigns from partnership and takes up a job with a client of the auditing practice then an audit on that
client, then the independence would not be impaired if :
Ø any outstanding payments to be made to the former partner are fixed in both dates and amounts and the
amounts owed are not enough to cause doubt about the practice’s ability to continue as a going concern
Ø former partner doesn’t participate in the practice’s business, whether paid for it or not (participation includes
provision of office space and related amenities to the former partner of the practice).
· litigation involving the practitioner and a client will affect the normal relationship with the client and will impair the
practitioner’s independence and objectivity. Threat of action by practitioner of legal action alleging fraud or deceit
buy the officers of the company may effect management’s willingness to disclose relevant information to the
practitioner
Professional competence
If not competent to carry out any assignment, then practitioner should obtain advice and assistance – client is entitled to
assume that the practitioner is professionally competent to perform any engagement which he has undertaken.
Must also ensure that stays up-to-date with new regulations and statutory requirements and should ensure a
programme of professional education.
Confidentiality
Practitioner cannot disclose information acquired in the course of work unless legally or professionally obliged to do so
rd
and may not use the information either for personal advantage or for the advantage of a 3 party. (Also applies to
practitioner’s staff).
This duty of confidentiality continues after the completion of an assignment.
Doesn’t apply to information in the discharge of the practitioner’s duties under any law including :
· reporting material irregularities
· giving evidence in course of legal proceedings
· in terms of the income tax and inspections by SARS
Can also disclose information needed in order to comply with technical standards and ethical requirements such as :
· qualifications in audit reports
· reports laid before the investigation or disciplinary committees
· disclosure made in connection with a practice review conducted in terms of the Act.
If case of legal proceedings then practitioner can disclose information to protect his professional interests.
If required to disclose information then the practitioner should inform the client and take care to ensure that no more
information then is strictly necessary is made available.
Practice matters
Practitioner can practice as sole practitioner or any form of partnership or entity or can carry out non-audit work in any
way either.
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Practitioner can render professional tax services and advise the client of the best position in his favour provided the
service is rendered with professional competence, integrity and objectivity and is consistent with the law. However
client should be aware the of the limitations of the tax advice and services and should not think that the tax return and
advice is beyond challenge. If any doubt then resolved in favour of the client.
Client should also understand that the responsibility for the return rests with him and NOT the practitioner, however the
return should be prepared properly on the basis of the information received.
If tax advice or opinions of material consequence are given to a client then these should be in the form of a letter or a
memo and a copy should be filed.
Practitioner can not be associated with any return or communication which he believes :
· contains a false or misleading statement
· contains reckless statements or information furnished without any knowledge of truth or falseness
· has information omitted or obscured which should be submitted and when the omission or obscurity would mislead
authorities.

Practitioner can prepare tax returns using estimates if that is a generally accepted practice or if impractical in
circumstances to obtain exact data. Estimated amounts must also be reasonable in the circumstances.
If preparing a tax return then practitioner can rely on information furnished by the client provided the information
appears reasonable – if possible the practitioner should make provision on supporting data. Should also use the client’s
prior year returns if feasible and make reasonable inquires if the information appears incorrect or incomplete and should
make reference to the records of the business.
If practitioner finds material error or omission in a tax return of a prior year then has an obligation to advise the client
and recommend that SARS be told. Practitioner NOT obligated to inform SARS and CANNOT inform then without
permission and if client doesn’t correct the error within reasonable time, then practitioner should :
· inform the client that he cannot act for them in connect with that return or any other related information submitted to
the authorities and
· consider if he continue to be associated with that client in any professional capacity.
If practitioner concludes that he can continue the professional relationship with the client then must take all reasonable
step to ensure that the error is not repeated in future tax returns.
Client’s monies
Practitioner entrusted with client’s monies should have a designated bank account and should :
· keep that money separate form personal or firm monies
· use the money only for the purpose for which it is intended
· be ready at all times to account for those monies – a detailed book of accounts should be available as a record of
practitioner’s dealings with the client’s monies and a statement of account should be provided to the client at least
once a year
· deposit the money without delay to the credit of a client’s account or safeguard any documents or titles to money
against unauthorised use
Practitioner should not hold client’s monies if there is reason to believe they were obtained from or used for illegal
activities.
Money can only be drawn from the client’s account on the instructions of the client and fees owning to the practitioner
can only be withdrawn with the client’s permission.
Payments from the clients account cannot be more then the balance of the money being held for the client.
If client’s monies held for a significant period of time then the practitioner should place the monies in an interest-bearing
account within a reasonable time and all interest on client’s monies should be credited to the client’s account.
Foreign assignments
Practitioners working in another country should adhere to local professional or legal requirements even if they are not in
accordance to this Code.
If the profession is not controlled in the foreign country then the guidance of the Code should be followed unless there is
a recognised, well established and reputable local standard.

Firm names
Practitioners can practice under any name that has been approved by the PAAB in order to prohibit any names that
could be offensive to the average person or could attempt to secure an unfair competitive advantage.
Normally practice under the names of past or present members of the firm but if general non-purpose name used then
must not be misleading or not in profession good taste (must be consistent with the dignity of the profession and should
not impair or compromise the good name of the profession)
Name cannot be :
· misleading – cannot be described as international just cos one partner was overseas. Cannot allow any confusion
with the name of an existing firm
· use of “And Associates” “And Co” “And Partners” acceptable provided names of all members are on all firm
stationery
· name cannot contain “Chartered Accountant, Registered Accountant and Auditor, Business Advisor, Consultant” as
part of the name however practitioners qualifications should be on all firm stationery and all practitioners should
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have “Registered Accountant and Auditor” under their name on the signature line of any professional
correspondence and on audit reports
Multiple firms
Practitioner can be a member of more then one audit firm or of an audit firm and some other type of professional firm.
Can also practice under different names from different offices as long as it is not misleading and there must be a clear
distinction if there are different accounting firms.
Stationery
Practitioner’s stationery should be of a professional standard.
Should contain all the company details and information and can also include the names of the partners and assistants
who are qualified as well as the names of other employees, associates or consultants who are not partners or qualifies
provided it is clear that they are not so.
Accountants signing reports or certificates
Practitioner cannot delegate to anyone who is NOT a partner the power to sign audit or other reports or certificates,
unless there are extraordinary circumstances and the need for the delegation has been reported to the client and to the
Board.

Jackson & Stent pg 2/46


Fees for professional services
Should be a fair reflection of the value of the professional service performed for the client and should take in to account :
· the skill and knowledge required for the type of professional service involved
· the level of training and experience of the person engaged in performing the services
· time necessarily taken by each person engaged in performing the professional service
· degree of responsibility that performing the service entails and
· level and extent of investment in technology
Practitioner may not prepare an original or amended tax return for a contingent fee.

Client’s monies
· practitioner cannot hold client’s monies if has reason to believe that they are obtained from illegal activities
· practitioner entrusted with client’s monies in course of professional work must :
Ø keep the monies separate from personal or firm monies
Ø use the monies only for the purpose for which they are intended
Ø at all times be ready to account for these monies
· practitioner should have a designated bank account for client’s monies
· client’s monies must be deposited without delay to the credit of the client’s account
· money may only be drawn from a client account on instruction of the client
· fee due from a client may only be drawn from client’s monies provided the client has agreed to the withdrawal
· payments from a client account shall not exceed the balance of the credit of the client
· when it seems likely that client’s monies will remain in the client account for a significant period of time then
practitioner should place monies in an interest bearing account with the agreement of the client
· all interest earned on the client’s monies must be credited to the client’s account
· practitioner must keep books of account to establish clearly all dealings with client’s monies in general and the
monies of the individual clients in particular. Must give client statement of account at least once a year.
Remember – IRBA code applies to all registered auditors but if auditor is also a SAICA member then must also comply
with the IFAC (SAICA) Code.

Disciplinary Rules (IRBA Manual of Information pgs 3-23 to 3-27)


Auditor will be guilty of improper conduct if he :
· contravenes or fails to comply with any provision of the Act or any other Act
· commits any offence involving dishonesty and particularly theft, fraud, forgery, perjury, bribery or corruption
· is dishonest in the performance of any work or duties either for :
Ø any work commonly performed by an auditor or
Ø any office of trust which he has undertaken or accepted
· without reasonable cause or excuse fails to perform any work or duties commonly performed by a practitioner or
does not perform them with the required degree of care and skill that is expected
· evades or assists any other person to evade any tax, duty, levy or rate by :
Ø knowingly or recklessly preparing or assisting in the preparation of a false statement either orally or in writing
Ø signing any false statement recklessly or by knowing it to be false
Ø knowingly or recklessly prepares or maintains a false book of accounts or other records
· fails to maintain an account or accounts with an institution for client monies separate from his own account
· fails to separate any other client property from his own property (especially if in the capacity of administrator,
trustee, curator or agent)
rd
· divulges any confidential information either orally or in writing to any 3 party that has been obtained in the course
of his professional relations with any client, unless the client has consented to the information being divulged or
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auditor is obliged by law to divulge it. Or unless divulges it to the Board in good faith so that Board can consider if is
should exercise any of the powers it has from the Act
· makes or recovers or enters into agreement for the purpose of any fee, charge or consideration for professional
service unless it is :
Ø fees fixed or taxed by the proper authority in respect of compulsory liquidation or judicial management of any
company or estate
Ø commission paid to an executor, trustee, administrator or agent based on the income collected by him
Ø fees paid to a director of a company based on dividends declared or the profits earned by that company
Ø remuneration paid to the manager of a business based on percentage of the earnings or profits of that company
Ø commission paid in respect of any type of insurance business or for sale of movable or immovable property or
for the collection of debtors or raising of loans
Ø charging of fees which are contingent upon the result of a professional service where the charging of fees is
permitted by the Code
rd
· accepts a fee stipulated for or received from 3 party for any regard for anything done by him in connection with a
client except with the knowledge of this client
· allow his name to be used in connection with any estimate of earnings contingent on future transactions in a way
which might lead to the belief that he vouches for the accuracy of the estimate
· tries, either before or during the period of training, of a trainee accountant to impose any restraint that will apply
after the termination of training period, or tries to enforce any restraint (doesn’t include restraint of the trainee
accountant for more less then 1 year after the date of the end of employment by the practitioner and preventing
trainee from soliciting for professional work from existing client or accepting an engagement from existing clients
unless the practitioner confirms in writing that there are no reasons why he should not accept the engagement).
· directly or indirectly receives or stipulates any form of payment, reward or consideration for agreeing to canceling
the training contract (doesn’t include amounts which must be reimbursed regarding payments made to the Board for
the training contract being cancelled)
· fails to answer or deal appropriately with any correspondence or communication from the Board or any other person
who needs a reply
· fails to comply within a reasonable time with an order, requirement or request of the Board
· fails to resign from a professional appointment without reasonable cause after requested to do so by the client
· fails after demand to pay any subscription or fee, levy or charge to the Board
· abandons his practice without previous notice to his clients without arranging for the dispatch of their business or
the care of their property
· solicits or advertises or canvasses for work in a manner not permitted by the Code
· contravenes or fails to observe any of the provisions of the Code without reasonable cause or excuse
· conducts himself in a manner which is improper, discreditable, unprofessional, dishonorable or unworthy and which
will bring the accounting profession into disrepute.

Jackson & Stent pg 2/47


Registered auditor found guilty of improper conduct can be charged in respect of each offense that he is found
guilty of and sentenced to :
· caution or reprimand
· fine not exceeding R 100 000
· suspension of the right to practice for a specific time
· cancellation of registration and removal of the practitioner’s name from the register of auditors
Sentences can be :
· suspended
· made public by the Board or
· registered auditor can be ordered to pay reasonable costs

Improper conduct summarised as :


· contravention of :
Ø Auditing Professional Act
Ø any other Act which should be complied with i.e. Companies Act
· dishonesty in :
Ø form of any offense especially theft, fraud, perjury, bribery and corruption
Ø carrying out work and duties
Ø relation to any office of trust held by registered auditor
· failure to perform work with reasonable care and skill or failure to perform the work at all
· evasion of any tax, duty, levy or rate or assisting others to evade these by knowingly or recklessly making, signing
or preparing false statements or records
· failing to account separately for client’s processions :
Ø client’s money should be kept in an appropriately designated separate bank account
Ø other client property should be recorded and dealt with so that it is readily identifiable as belonging to the client
· divulging confidential information – unless :
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Ø consent is given by the client or
Ø auditor is obliged by law to divulge the information or
Ø information is divulged to the IRBA in good faith in terms of the body’s investigatory powers
· contingent fees are prohibited unless :
Ø law prescribes that the fee is contingent
Ø services for which the fee is charged will not be adversely affected by a lack of objectivity. The following
contingent fees ARE permissiable :
v prescribed fees for liquidations, judicial management or administration of deceased / insolvent / estates
under legal disability
v commissions to executors, trustees, administrator or agents based on income collected
v fees to a director based on dividends paid or profits
v commission in respect of any insurance business, sale of property (moveable or immovable), collection of
debts or raising of loans
v where the Code permits such fees
rd rd
· accepting any reward from a 3 party in connection with services rendered by that 3 parity to a client unless the
client has prior knowledge
· vouching for accuracy of forecasts – auditor’s name cannot be used in such a manner that suggests the registered
auditor vouches for the accuracy of the forecast (incorrectly adds creditability to the forecast)
· contravention in respect of trainee accountants by :
Ø imposing or attempting to impose any kind of restraints that will take place after the traineeship
Ø wanting compensation for cancellation of a training contract except in respect of actual expenses paid to IRBA
in respect of the training contract
but can impose a restraint on the trainee to prevent then soliciting practitioner’s existing clients for a period of 1 year
after the trainee ceases to the employed by the practitioner.
· failing to comply with his responsibilities to the IRBA and other persons by :
Ø failing to respond promptly to communications, requirements or requests
Ø failing to pay fees or other charges due to the IRBA after receiving a demand
· contraventions in respect of relinquishing engagements by :
Ø failing to resign without reasonable cause when a client requests that the practitioner do so
Ø abandoning his practice without giving notice to client and making the necessary arrangements for them to
obtain the services they require
· soliciting, adverting or canvassing for work in a way not permitted by the Code
· contravention of any other provisions of the IRBA Code
· any conduct that is improper, discreditable, unprofessional, dishonorable or which brings the profession into
disrepute.

Jackson & Stent pg 3/67 to 3/69


Auditing Professional Act – Section 46 (Limitation of Liability)
Auditor shall, in respect of any opinion expressed or report of statement made, incur no liability to a client or
rd
3 party unless it is proved that such opinion / report of statement was made maliciously, fraudulently or
pursuant to a negligent performance of the auditor’s duties.
rd
If proven that was negligent then auditor will only be liable to 3 parties if it is proved that at the time of the negligence
the registered auditor knew that (or could have reasonably been expected to know) that :
rd
· his client would use the opinion to induce a 3 party to act or refrain from acting or
rd
· 3 party would rely on the opinion for the purpose of acting or refraining from acting in some way
Note :
rd
· if opinion given and auditor told 3 party that it was correct while at the same time he knew or would reasonably
rd rd
been expected to know that the 3 party would rely on the opinion, then he will be liable to the 3 party if they
suffered a loss because of reliance on auditor’s opinion
· just cos registered auditor performed the duties of an auditor isn’t proof that he could “have reasonably have been
expect to know” (just cos you are auditor doesn’t mean that you are expected to know or foresee anything that
could happen to the client)
rd
· liability of auditor hinges on NEGLIGENT performance of auditor – is ONLY liable to client or 3 party if proven
information was given maliciously, fraudulently or negligently.

Liability to clients – based upon breach of contract or delict (i.e. client can sue auditor for financial loss on grounds
that auditor didn’t meet the terms of the engagement contract or in delict on the grounds that the auditor didn’t meet his
duty of care.)
rd rd
Liability to 3 parties – NOT breach of contract as not engagement contract between auditor and 3 party so can only
be delictual action against the auditor to prove that :
· auditor was negligent in expressing the opinion or report
rd
· 3 party relied on the opinion or report
rd
· 3 party suffered a loss as result of the reliance and
· auditor knew or could reasonably have been expected to know
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rd
· that 3 party would reply on the opinion or report.

Study guide pg 64
Negligence proved when auditor’s work is compared to auditing standards and if there is a deviation then auditor must
prove that the deviation did not result in failure to achieve the generally accepted auditing standards.
Decided in court of law by evaluating the auditor’s performance against professional auditing standards against the
public interest.
Basis for legal decisions is a combination of the relevant common law and statutory law provisions and also precedents
from prior case law on auditors’ liability for fraud or negligence.
Common law – legal principles that are handed down from decided cases (in SA based on Roman-Dutch law) and is
not derived from legislation.
Statute law – law from legislation.

Auditor’s legal liability from either common or statute law – duties imposed by these laws may result in auditor being
held liable if he either fails to perform them or fails to perform them with due care and skill.

Duty to act with due care and skill


Auditors are not infallible so can only expect them to carry out engagements in manner of a reasonable, competent
professional auditor – this is the essence of the auditor’s duty of professional care in terms of common law.
If alleging negligent conduct then plaintiff must first establish that the auditor owed a duty of professional care and that
the auditor failed to perform the audit work with the requisite degree of care and skill.
Duty can normally be discarded by adhering to professional standards and ethic rules, but overseas the legal
interpretation of the auditor’s duties have been more what society expects of the audit function. Cos of this uncertainly
in the matter of auditor’s professional liability, auditors have to be proactive and should regard professional standards
and ethical rules as simply minimum standards to be maintained in audit work.

Wrongful conduct :
· fraud – if auditor’s opinion on the financial statements is intentionally false or misleading. So auditor has knowingly
failed to express the appropriate opinion indicating that the financial statements are misstated when it was his duty
to do so, and the auditor knew of it at the time the audit report was issued. Basically amounts to issueing a report
on the financial statements with the intent to deceive users of that report
· gross negligence – if the auditor’s opinion on the financial statements is intentionally false or misleading then the
evidence necessary to prove fraud may be lacking but the auditor’s actions may be so grossly negligent that the
users of the audit report were mislead. Conduct like that is considered to be fraudulent (auditor has issued an audit
opinion without any genuine belief in the truth of the opinion which is an act of dishonesty)
· ordinary negligence – plaintiff must prove that the auditor failed to carry out the audit work with the degree of care
and skill that can reasonably be expected from a professional auditor.

Auditing Professional Act contains provisions regulating the auditor’s legal liability with the following effects :
rd
· auditor shall incur no liability to his client or any 3 party unless it is proved that the auditor’s opinion was expressed
maliciously or pursuant to a negligent performance of his dies (no-fault liability)
rd
· extent of auditor’s liability to 3 parties for negligent conduce must be determined within specific boundaries of the
rd
foreseeability of the 3 parties reliance on the auditor’s report.

Jackson & Stent pgs 3/68 to 3/69


Impact of reportable irregularities on the audit opinion
If reportable irregularity DOES affect fair presentation then the auditor must qualify the report in accordance with ISA
701 (modifications to the Independent Auditor’s Report.)
If reportable irregularity DOES NOT affect fair presentation (but does exist) then the audit report must be modified by
including an extra paragraph in the audit report. Paragraph headed Report on Other Legal and Regulatory
Requirements. Even when the reportable irregularity existed but has already been rectified or resolved it cannot be
ignored for audit purposes.
If auditor has reported a reportable irregularity and it turns out not to be a reportable irregularity then it shouldn’t be
mentioned in the audit report.

Consequences for the auditor for failing to report a reportable irregularity


· individual registered auditor may face investigation and disciplinary action by the IRBA (investigation into improper
conduct and can be punished by :
Ø caution or reprimand
Ø fine not exceeding R 100 000
Ø suspension of the right to practice for a specific time
Ø cancellation of registration and removal of the practitioner’s name from the register of auditors
rd
· can face a civil claim for damages by 3 party (i.e. someone who suffered a loss as a result of the auditor failing to
report the irregularity)
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· may face criminal charges resulting in jail time not exceeding 10 years and / or a fine (if auditor is satisfied that a
reportable irregularity exists but intentionally or deliberately doesn’t pursue it then he may face criminal charges).

Registered auditor cannot through an agreement or in any other way limit or reduce the liability that an auditor may incur
in terms of this section.

Auditor’s civil liability towards clients – legal action can be instituted against an auditor by a client cos of the
contractual relationship they have. Terms of the relationship depends on the terms of the contract they have (audit
engagement letter) and so any breach in terms of the contract can be addressed by the client suing the auditor for
breach of contract under the law of contract.

Client may rather decide to institute legal proceedings


against auditor who has committed a wrongful or illegal
act on the basis of a delictual action (to claim damages
for economic loss suffered as a result of the auditor’s
wrongful or illegal act)
rd
Auditor’s civil liability to 3 parties – legal action can be
rd
instituted against an auditor by a 3 party (user of the audit
report).
rd
No contractual relationship between auditor and 3 party so
can only sue for delict claim. Strength of the legal claim will
be determined by the type of relationship between auditor
rd
and the 3 party.
rd
Mainly 3 parties of a financial statements audit of a company
are the company’s shareholders (audit is carried out for their
benefit and the audit report is addressed to them).
rd
In order to determine the legal liability of the auditor other 3
parties such as lenders, creditors and investors are treated
on the basis of how much their use and reliance on the audited
financial statements could reasonably have been foreseen by
the auditor at the time of issuing the audit report.
Basically it is this question of foreseeability that determines if
rd
the auditor owes a duty of care to these 3 parties and is a
critical determination of the auditor’s legal liability towards the
rd
3 parties.
rd
3 party that has suffered economic loss due to the auditor’s
negligent conduct can then bring a claim of delictual action
against the auditor.

Onus of proving an auditor’s liability rests with the plaintiff


Irrespective of whether the plaintiff is the auditor’s client or
rd
a 3 party.

Proof needed in the case of breach of contract :


· auditor acted in a way that cased a breach of the terms of the
contract with the client (e.g. he failed to perform the audit with
the required degree of skill and care)
· audit report was misleading as a result of auditor’s negligent
performance of the audit which resulted in failure to detect
the fact that the financial statements were misstated
· client relied on the auditors report for purposes of acting in a
particular way and suffered financial loss because of doing so.

Proof need in the case of a delictual action :


· auditor acted wrongfully (e.g. by acting negligently the auditor breached the common law duty of care owed to the
rd
client or 3 party)
· audit report was misleading as a result of the auditor’s negligent performance of the audit which resulted in failure to
detect the fact that the financial statements were misstated
rd
· plaintiff / 3 party relied on the auditor’s report contained in the financial statements for purposes of dealing with the
client in a particular way and suffered financial loss as a result of doing so.

Study Topic 3.3


The Role of the Professional Auditor
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Jackson & Stent pg 3/63 to 3/67
Auditing Professional Act 2005 – section 44, 45 & 47
ISA 200 – Objective and general principles governing an audit

Jackson & Stent pg 3/63 to 3/67


Main duty of the auditor in audit of financial statements is to express an opinion as to whether or not the financial
statements are presented fairly and whether all material matters have been adequately disclosed in the financial
statements.
Auditing Professional Act is statue that regulates the duties of the auditor and other acts such as the Companies Act.

Auditing Professional Act – Chapter 44, 45 & 47


Section 44 – Duties in relation to an audit
When a firm accepts the engagement then must make a decision as to which individual registered auditor in the firm will
be responsible and accountable for the audit – name of this auditor must be conveyed to the client and also made
available to the IRBA on request. (NB cos isolates responsibility and provides the IRBA with an individual against
whom action can be taken if there are offences – not the whole firm)
Registered auditor MAY NOT express an opinion without qualifying that the financial statements :
· fairly present in all material respects the financial position of the entity and the results of its operations and cash
flow
· are properly prepared in all material respects in accordance with the basis of accounting and financial reporting
framework as disclosed in the financial statements
UNLESS :
Ø audit has been carried out free of restriction
Ø in compliance with applicable auditing pronouncements
Ø the registered auditor has satisfied himself of the existence (that they are real) of all assets and liabilities shown
in the financial statements (auditor must test all assertions applicable to the asset and liability account
balances)
Ø proper accounting records have been kept in at least one of the official languages
Ø all information, vouchers and other documents which are necessary for the proper performance of the auditor’s
duties have been obtained
Ø registered auditor hasn’t needed to report a reportable irregularity to the Regulatory Board
Ø registered auditor has compiled with all laws relating to the entity and
Ø registered auditor is satisfied as to the fairness of the financial statements
If auditor also kept the books, records or accounts of an entity then these dual roles must be included in the report,
Ditto if the record keeping was done by another member of the firms (so that users know that the auditor is not
independent of the information he was given).
Registered auditor with conflict of interest cannot conduct an audit of that entity.

Section 45 – Duty to report Irregularities


Section places significant responsibility on the registered auditor.
Reportable irregularity = any unlawful act or omission committed by any person responsible for the management of an
entity which has caused or is likely to cause financial loss to the entity or its users, or is fraudulent or amounts to theft or
represents a material breach of any financial duty owed by such a person to the entity or its members under any law
applying to the entity or the conduct of management thereof.

Duty to report irregularities – auditor who knows or has reason to believe that a reportable irregularity has taken or is
taking place must immediately send a written report of the irregularity to the IRBA and must notify the management
board of the entity in writing within 3 days of sending the report and must give management a copy of the report.

Registered auditor must as soon as possible, but within 30 days from the date that the report was sent to the IRBA take
all reasonable measures to discuss the report with the management board of the entity and afford the management
board the opportunity to make representations in respect of the report.
Auditor must also send another report to IRBA including statement from auditor to say that :
· no reportable irregularity has or is taking place (including detailed information supporting this) or
· that the suspected irregularity is no longer taking place and that adequate steps have been taken to prevent or
recover any loss or
· the reportable irregularity is continuing.
Once IRBA has been informed that the reported irregularity is continuing then must notify a regulator in writing with the
details and give regulator a copy of the report. Regulator can be any authority or agency but if it is a criminal act then
IRBA will report to Director or Public Prosecutions and will then be investigated by SAPS – auditor obliged to hand over
documents to SAPS as there is no legal privilege between practitioner and client and there is no confidentiality clause.
Should seek legal advice.

Unlawful act or omission = any act that is :


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· contrary to any law passed by a government
· contrary to regulation
· contrary to accepted common law principles
· arisen out of negligence or intentionally done (negligence = when the person should have known that the act or
omission was unlawful)
· auditor not legal expert and not required to introduce additional audit procedures to detect unlawful acts, but should
be capable of recognising where non-compliance with laws and regulations will materially affect fair presentation.

If employee commits an unlawful act under direction or with knowledge of any person responsible for management then
the auditor will regard this as an unlawful act committed by management.
If lawful act or omission is committed by management which has caused or is likely to cause loss to any of the
shareholders or stakeholders then it is reportable.
If won’t cause financial loss then it doesn’t have to be reported in terms of this, but might still be reportable in terms of
fraud / theft or breach of fiduciary duty. (e.g. company submits and is paid out on false insurance claim).
If loss is material is matter of professional judgement – doesn’t relate to materiality levels set for the audit, but the
absolute and relative size of the loss must be considered. But even if immaterial, must still be reported if as a result of
an unlawful act. Not the same as audit materiality.
Only inconsequential or trivial breaches are regarded as non-material.
If benefit has been received cos of unlawful act then it cannot be offset against the loss that has been incurred (e.g.
company pays a R 1 million bribe which means that the company gets R 20 million contract so cannot say that the bribe
resulted in a R 19 million increase for the good of the company).
Fiduciary duties directors owe to the entity include ;
· preventing conflict of interest between themselves and the company
· not exceeding the limitations of their powers (ultra vires)
· considering the affairs of the company in an objective manner and in best interests of the company (unfettered
discretion)
· exercising their powers for the purpose for which they were granted.

In order to report an irregularity, registered auditor doesn’t need absolute or irrefutable proof that a reportable act has
taken place – only has to be satisfied or have reason to believe. If challenged will have to show that there were
sufficient grounds to report the irregularity BUT THERE IS NO LEGAL PROTECTION FOR THE AUDITOR IF HE
REPORTS THE IRREGULARITY WITHOUT SUFFICIENT GROUNDS.
rd
Not a breach of confidentiality if use information from other sources (i.e. another company or from a 3 party) as it is a
legal requirement that the registered auditor considers all information.
In terms of engagement of “agreed upon procedures” (no opinion given for this sort of engagement) then not required to
report suspected fraud as is not a reportable irregularity, BUT if also an audit client then would have to report it.

Auditing Professional Act 2005 – section 44, 45 & 47


Section 44 – Duties in relation to an audit (additional)
Auditor who has been chosen to do the audit of entity cannot not express an unqualified audit opinion unless these
requirements have been complied with ;
· auditor must carry out the audit free of any restrictions
· entity being audited must have maintained proper accounting records so as to reflect and explain all its transactions
and record all its assets and liabilities correctly and adequately
· auditor must obtain all information, vouchers and other documents which in his opinion are necessary for the proper
performance of his duties
· if it is an entity that is regulated by any law then the auditor must have complied with all the requirement of that law
· auditor must satisfy himself by reasonably appropriate methods as to the existence of all assets and liabilities
shown in the entity’s financial statements
· auditor must be satisfied as to the fairness of the financial statements to the extent that it is reasonably practicable
in view of the nature of the undertaking and the audit that has been carried out
· any material irregularity that the auditor has discovered or had reason to believe occurred in the conduct of the
affairs of the entity which caused, or is likely to cause financial loss to the entity itself (or it’s members or creditors)
has (at the date of the auditor’s report) been adjusted to the auditor’s satisfaction.
These requirement MUST be done before the auditor can express an unqualified opinion in the audit report. Basically
they are the powers of the auditor that enable him to carry out a proper audit.
Auditor has to perform statutory duties such as issuing an audit report within the period prescribed in the Act and
compliance with certain training responsibilities.
ALTHOUGH THE AUDITOR EXPRESSES AN OPINION ON THE FAIR PRESENTATION OF THE FINANCIAL
STATEMENTS THIS IS NOT ANY FORM OF GUARANTEE THAT THE FINANCIAL STATEMENTS ARE FREE OF
MATERIAL MISSTATEMENTS OR THAT THE COMPANY’S ACCOUNTING RECORDS ARE ADEQUATE. Auditor’s
duty is ONLY to express an opinion as to the fair presentation of the financial statements as a whole.

Section 47 – Inspections
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Regulatory Board or any authorised person can inspect or review the practice of a registered auditor and any training
contracts and may make copies of any documentation – must be done at least every 3 years if it is a public interest
company. Costs of the inspection can be recovered from the registered auditor.
Registered auditor must submit annually any information or returns that the Regulatory Board may request.
Auditor may not refuse Regulatory Board access to any information even if he is of the opinion that it contains
confidential information about a client – if acts in good faith by producing information then auditor may not be held liable
criminally or under civil law.
Subject to the Constitution and any other law, a person who is involved in this inspection CANNOT disclose any
information obtained except ;
· for the purpose of an investigation or hearing under this chapter
· if it is being supplied for the performance of functions under this Act
· when ordered to by a court of law
· at the written request of any appropriate regulator who requires it for an investigation, disciplinary action or criminal
prosecution or
· at the written request of any appropriate international regulator of audits or auditors

Study Guide pg 73
Auditor’s professional duties are mainly set out in :
· Code of Professional Conduct
· Disciplinary Rules
· International Standards on Auditing (ISA’s)

Society expectations regarding the responsibilities of professional auditors :


Auditor’s responsibilities in terms of professional standards differ from those in terms of case law (professional
standards are not as exacting as case law cos the auditing profession wants to limit the extent of its member’s potential
liability so that their members are happier.) Auditor’s risk of professional liability will increase in relation to the increase
in the responsibilities he is willing to accept.)
Expectation gap = the difference between the high expectations of society against the amount of responsibility
that auditors are prepared to accept for the audit of financial statements. Expectation gap exists in the following :
· detection of fraud and error
· reporting on adequacy of internal controls
· reporting on adequacy of management
· reporting on the future viability of the entity’s operations
· reporting of the adequacy of the entity’s accounting records and processes.
Lot of pressure on auditing profession to expand the auditor’s responsibilities so that can meet more of the needs of the
users of the audit services.

Jackson & Stent pgs 7/30 to 7/41


ISA 240 - The Auditor’s Responsibility to Consider Fraud in an Audit of Financial Statements
Objective of the auditor is to :
· consider fraud when identifying and assessing risk of material misstatement
· response to assessed, identified or suspected risk.

Error = unintentional act which results in misstatement in the financial statements including :
· mistake in gathering or processing date from which financial statements are prepared (e.g. mathematical or
clerical misstates or omission of a transaction)
· oversight or misinterpretation of facts (e.g. charging incorrect rates of interest cos didn’t understand terms of the
loan agreement)
· misapplication of accounting policies (e.g. capitalising an operating least cos doesn’t understand GAAP).
rd
Fraud = intentional act by either management, someone charged with governance, employees or 3 parties
involving the use of deception to obtain an unjust or illegal advantage.

Fraud risk factors = events or conditions that indicate an incentive or pressure to commit fraud or provide an
opportunity to commit fraud

Management fraud = fraud by management or those charged with governance

Employee fraud = fraud by only employees NOT management or those charged with governance

Fraudulent financial reporting = involves intentional misstatements (including omissions) in the financial
statements meant to deceive financial statement users. Normally by management or those charged with
governance and could be done by :
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· manipulation, falsification or alternation of the account records or supporting documentation underlying the financial
records
· misrepresentation in or intentional omission from the financial statements of events, transactions or other significant
information
· intentional misapplication of accounting principles to amounts, classification manner of presentation or disclosure
· management override (especially where controls are operating effectively)
see text book pg 7/31 for examples.

Misappropriation of assets = theft of an entity’s assets by either employees or management including :


· embezzlement
· theft of physically assets or intellectual property
· causing the entity to pay for goods and services not received
· using the companies assets for personal use
see text book pg 7/31 & 7/32 for examples

Essential difference between fraud and error is INTENTION – not always easy to determine intention, but auditor would
use his assessment of the integrity of management as a consideration.

Responsibility of management and those charged with governance


Responsibly for the prevention and detection of fraud and error lies with those charged with governance and
management. Should be controlled by the implementation and continued operation and monitoring of internal control.
Management also needs to create and maintain a culture of honesty and ethics so that there is a strong control
environment, and management also responsible for conscious assessment of the risk that the financial statements may
be materially misstated as result of fraud.

Responsibility of the auditor


Auditor must :
· maintain professional skepticism – must not be naïve and believe that the intentions of the client are always
honest and that, even if in the past the management has acted with integrity, doesn’t mean that they will continue to
do so.
· facilitate the discussion of the client’s susceptibility to material misstatement due to fraud amongst the
audit team – each member of the teams should be aware of the circumstances / factors which may indicate fraud
and should know what to look for
· obtain information that can be used to identify the risk of material misstatement due to fraud – auditor
should ask management about :
Ø their assessment of the risk that their financial statements will be materially misstated due to fraud
Ø their processes for identifying fraud including details of any fraud already identified or which management
considers likely
Ø their processes for responding to alleged fraud
Ø how management communicates it stance on ethical behavior to employees
· make enquires of management to determine if they know of any actual, suspected or alleged fraud
· obtain an understanding of how management exercises their responsibility to oversee management’s
processes for identifying and responding to the risk of fraud by :
Ø attending meetings where the matter is addressed
Ø reading minutes of those meetings
Ø direct enquiries to those charged with governance
· consider unusual or unexpected relationships when performing analytical procedures to obtain an
understanding of the entity and its environment (e.g. unexpected fluctuations in the gross percentage ratio may
increase fraudulent misstatement of the figures used to calculate the ratio)
· consider information from other sources (e.g. from previous audit engagement at the same client)
· consider whether the information gained when obtaining an understanding of the entity and its environment
indicates that one or more fraud risk factors are present.
· identify and assess the risk of material misstatement due to fraud at financials statement level and at assertion
level (account balance / transaction level)
· determine an overall (audit) response to address the risk of material misstatement due to fraud at financial
statement level and assertion level.

Responses to the risk of material misstatements due to fraud


At financial statement level auditor must :
· consider the assignment and appropriate staff :
Ø competent and technically skilled (experts)
Ø experienced
Ø strongly independent (can’t be bullied by client)
Ø able to adopt the correct degree of professional skepticism
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· consider the accounting policies adopted by management :
Ø appropriate and properly applied or
Ø indicative of fraudulent financial reporting chosen to manipulate earning or to fraudulently influence the
perception of users
· incorporate an element of unpredictability in determining nature, timing and extent of testing. Management
will generally have some kind of idea of what the auditor will do so changing the nature, timing and extent of the
tests may upset their attempts at concealing fraud

At assertion level auditor should :


· consider the nature, timing and extent of testing necessary to reduce the risk of material misstatement due to
fraud being present to an acceptably low level
· decide on what tests to do (nature), when to do them (timing) and how to do (extent) - tests and procedures
which the auditor has available in compiling the auditor plan to address the risk of fraud are not different to those
which are used to respond to the risk of unintentional material misstatement, but when addressing appropriate
response to fraud auditor needs to remember :
Ø people doing the fraud will try to hide it therefore making it more difficult for the auditor to find
Ø most reliable and relevant evidence must be sought – severe consequences arising out of fraud and auditor
needs to be on firm ground before deciding if there is or isn’t fraud
· nature of testing is likely to become more inclusive (e.g. observation supported by inspection and analytical
review that provides more corroborative evidence coupled with extensive testing.) Auditor may then decide on :
Ø substantive testing due to management override
Ø eternal or auditor-generated evidence must be found – not relying on the representations of the management of
other internally generated evidence
Ø use of experts is necessary (e.g. identifying fake goods)
Ø CAATS need to be used to extensively interrogate databases (searching for anomalies such as duplicate ID
numbers or duplicate bank account in an employee masterfile where suspicion of fictitious employees)
Ø changing the timing of tests – introducing surprise visits e.g. arriving unannounced to count cash, stock or
conduct a physical verification of employees.

Management override auditor should :


· test the appropriateness of journal entries and other adjustments made in preparation of the financial
statements (remember even a system that produces valid, accurate and complete data can be overridden by the
passing of a journal entry to manipulate the balances or totals produced by the system.) When deciding which
entries or adjustments to select for testing, auditor must consider :
Ø presence of any fraud risk factors which might indicate journal entries related to fraud (e.g. an assessed risk
that proceeds from debtors are being stolen and concealed by writing the debtor off as a bad debt)
Ø effectiveness of the client’s controls over the authorisation of all journal entries and concentrate on those which
are inadequately authorised
Ø whether the characteristics of fraudulent journal entries are present – such as :
v entries made to unrelated, unusual or seldom used accounts
v passed by individuals who do not normally make journal entries
v not supported by adequate reasons, explanations or descriptions
v not posted to specific ledger accounts – rather directly to amounts in the financial statements (loss of audit
trail)
v contain round amounts or consistent ending numbers
Ø nature and complexity of the accounts used in the entry e.g. fraudulent journal entries made to accounts
which are complex or unusual and not reconciled regularly or which seem to have no specific purpose (such as
slush funds)
Ø journal entry is outside normal course of business (i.e. non-recurring, cos not normally addressed by
internal control system so greater chance they are fraudulent)
· review accounting estimates for biases which could result in material misstatement due to fraud (e.g. deliberate
understate provisions such as obsolete stock, bad debts or depreciation to intentionally manipulate earnings
figures)
· obtain an understanding of the business reasons of significant transactions outside of the normal course of
the company’s business or anything that appears to be unusual (e.g. the company suddenly purchases another
company which manufactures a completely different and unrelated product to that which the company
manufactures.)

Evaluation of evidence auditor must :


· consider whether the assessment of material misstatement at assertion level remains appropriate once the
initial planned audit procedures have been concluded – while carrying out the planned audit procedures the auditor
may be alerted to the possibility of fraud by the existence of numerous situations of circumstance.
ISA 240 gives list of these circumstances with individually or combined can indicate that possibility that the financial
statements may contain material misstatement resulting from fraud. Examples are :
Ø discrepancies in accounting records :
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v bank and other reconciliations are not conducted timeously
v unauthorised transactions (e.g. unauthorised travel expense)
v evidence of employees access to systems and records out of the level of access they should have (e.g.
factory foreman has access to the employee masterfile)
v tips or complaints to the auditor about alleged fraud
v last minute adjustments that significantly affects financial results
Ø conflicting or missing evidence :
v missing documents (e.g. purchase transactions selected for testing are not supported by purchase orders or
supplier delivery notes)
v unexplained items on reconciliations
v documents that appear to be altered
v unavailability of documents other then photocopied or electronically transmitted documents when there
should be original documents
v significant unexplained items on reconciliations
v large numbers of credit entries and other adjustments to the account receivable records
v unexplained or inadequately explained differences between the accounts receivable sub-ledger and the
control account or between customer statements and the accounts receivable sub-ledger
v missing or non-existent cancelled cheques which should be returned to the entity with the bank statement
v unexplained changes in trends, ratios or relationships (e.g. increase in sales commission payments but no
increase in sales)
v missing inventory or physical assets – revealed by existence testing
v inconsistent, vague or implausible responses from management or employees to enquiries or analytical
procedures
v payments for services (e.g. lawyers, consultants or agents) that seem excessive in relation to the services
provided
v unusual discrepancies between entity’s records and external confirmation replies (including either fewer
responses to confirmations or greater then anticipated)
Ø problematic or unusual relationships between the auditor and management :
v denial of access to records, facilities, certain employees or customers
v undue time pressures imposed by management to resolve complex or contentious issues or unrealistic
audit deadlines
v management complaints about conduct of audit or intimidation of engagement team members (especially in
connection with the auditor’s critical assessment of audit evidence or in the resolution of potential
disagreements with management)
v unusual delays by the entity in providing requested information
v unwillingness to agree to the reasonable use of CAAT’s
v unwillingness to address identified weaknesses in internal control on a timely basis
v general lack of co-operation
v denial of access to key IT operations staff and facilities (including security operations and systems
development personnel)
v unwillingness by management to permit the auditor to meet privately with those charged with governance
v unwillingness to add or revise disclosures in the financial statements to make them more complete and
understandable
v changes in accounting estimates that do not appear to result from changed circumstances
v accounting policies that are different to industry norms
v frequent changes in accounting estimates that do not appear to result from changes in circumstances
v tolerance of violations of the entity’s code of conduct
Ø consider whether an identified misstatement (not initially thought to be fraud) is in fact fraud. This would
be an assessment of whether the misstatement is intentional and if so, auditor should consider the effect of this
fraud on the rest of the audit especially other representations made by management

Management representations – auditor must obtain written representations from management relating to fraud.
Representations should :
· contain management’s acknowledgment that management is responsible for the design and implementation of
internal control to prevent and detect fraud
· state that management has disclosed to the auditor the results of the assessment of the risk that the financial
statements may be materially misstated as a result of fraud
· state the management has disclosed to the auditor it’s knowledge of fraud involving management and employees
· state that management has disclosed to the auditor any allegations of fraud or any suspected fraud affecting the
entities financial statements communicated by employees, former employees, analysts, regulators etc.

Fraud risk factors


When gaining understanding of the entity and its environment and assessing the risk of material misstatement due to
fraud, the auditor must consider whether the information obtained indicates the presence of fraud risk factors – either ;
· risk factors relating to misstatement resulting from fraudulent financial reporting or
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· risk factors relating to misstatements resulting from misappropriation of assets
Both these categories should be looked at from the perspective of :
· incentives for / pressure on management to report fraudulently or for management or employees to
misappropriate assets
· opportunities for fraudulent financial reporting of misappropriation of assets and
· does the attitude and rationalizations (behavioral manner of management and employees) suggest an
environment conductive to fraudulent reporting or misappropriate on assets?

Examples of fraudulent financial reporting :


Incentives / pressures factors :
· financial stability or profitability is threatened by economic or industry of entity’s operating conditions :
Ø high degree of competition accompanied by declining margins
Ø high vulnerability to rapid changes (changes in technology, product obsoleteness or interest rates)
Ø operating losses threatening going concern
Ø new accounting, statutory or regulatory requirements (e.g. deliberate omission or contravention of
environmental transgressions)
rd
· excessive pressure exists for management to meet the requirements or expectations of 3 parties due to :
Ø profitability or trend level expectations of investment analysts, institutional investors, significant creditors or
other external parties
Ø need to obtain additional debt or equity financing to stay competitive (e.g. manipulating financial statements
used to support a loan application)
Ø difficulty in meeting debt repayment or other debt requirements (e.g. manipulating the financials to maintain
prescribed financial ratios specified in a loan agreement)
Ø perceived or real adverse effects of reporting poor financial results on significant pending transactions such as a
merger or the awarding of a contract (e.g. construction company reporting on financial losses having recently
tendered for a large contract to construct an office block)
· information which indicates that the personal financial situation of management is threatened by the entity’s
financial performance arising from the following :
Ø significant personal financial interest in the entity (e.g. management holds significant number of shares)
Ø significant portions of their compensation (e.g. bonuses or stock options are contingent on receiving aggressive
targets for stock price)
Ø personal guarantees of debts of the entity (e.g. by directors)
· excessive pressure on management to meet financial targets established by those charged with governance
(including sales or profitability incentive goals)
Opportunity factors :
· nature of the industry or the entity’s operations :
Ø significant related-party transactions particularly where the related party is not audited by the same firm
Ø strong financial presence or ability to dominate a certain industry sector that allows the entity to dictate terms or
conditions to suppliers or customers that may result in non-arm’s length transactions
Ø assets, liabilities, revenues or expenses based on significant estimates that involve subjective judgements or
uncertainties that are difficult to corroborate which can be used to manipulate results
Ø significant, unusual or highly complex transactions which can be used to manipulate results
Ø use of business structures or business methods for which there appears to be no clear business justification
(e.g. importing goods indirectly through a neighboring country)
· ineffective monitoring of management :
Ø domination of management by a single person or a small group in non-owner managed business without
compensating controls
Ø ineffective oversight by those charged with governance over the financial reporting process and internal control
· there is a complex or unstable organisational structure as evidenced by :
Ø difficulty in determining the organisations or individuals who have a controlling interest in the entity
Ø overly complex organisational structure involving unusual legal entities or managerial lines of authority
Ø high turnover of senior management, legal counsel or those charged with governance
· internal control components that are deficient cos of :
Ø inadequate monitoring of controls
Ø high turnover rates or employment of ineffective accounting, internal audit or IT staff
Ø ineffective accounting and information systems
Attitudes / rationalisations
Indicate that management might be predisposed to fraudulent financial reporting :
· ineffective enforcement of the entity’s values or ethical standards by management standards
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· non-financial management with high level participation in accounting policies or significant estimates (suggests they
might have personal financial interest in the reported earnings)
· fraud or violations of laws and regulations against management (e.g. insider trading)
· excessive interest by management in maintaining or increasing share price or earnings trend
· interest by management in using inappropriate means to minimize reported earnings for tax-motivated reasons (e.g.
understating sales)
· owner-manager makes no distinction between personal and business transactions (e.g. personal holiday charged to
the company).
see ISA 240 (redrafted) for more examples

Fraud risk factors relating to misstatements resulting from misappropriation of assets


Incentives / Pressures
Factors that might cause management and employees to misappropriate assets :
· personal financial problems
· adverse relationships between entity and employees or management e.g. anticipated retrenchments or
unhappiness with compensation or conditions of service
Opportunities – caused by nature of the entity’s assets :
· large amounts of cash on hand
· inventory characteristics – e.g. small size with high value and demand (e.g. jewellery & iPods)
· easily convertible assets (e.g. bearer bonds or diamonds)
· fixed assets characteristics such as small size, marketability or lacking in ownership identification (e.g. hand-held
power tools)
Opportunities – caused by lack of internal controls :
· inadequate segregation of duties (e.g. storeman can access and change stock records)
· lack of appropriate management supervision (e.g. no-one controls goods taken in or from stores)
· lack of procedures to screen applicants for positions where employees have access to assets that are susceptible
to misappropriation
· inadequate record keeping or no reconciliation of assets (comparison of theoretical to actual)
· lack of appropriate system of authorisation and approval of transactions (e.g. acquisition of and payment for
purchases)
· poor physical safeguards over cash or inventory
· lack of timely and appropriate documentation for transactions (e.g. customer takes goods but paperwork only
completed later)
· lack of mandatory vacations for employees performing key control functions
· inadequate authorisation and review of senior management expenses (e.g. travel claims)
· inadequate management understanding of IT so IT employees have access to all levels of data (e.g. can change
debtors balances in the masterfile)
Attitudes / Rationalisations
Factors indicating a relaxed or negative attitude towards control over misappropriation of assets :
· poor control environment (ignoring theft or overriding controls)
· changes in behaviour or lifestyle that might suggest assets have been misappropriated
· negative behaviour from management or employees showing displeasure or dissatisfaction with the entity or the
way staff are treated.
see ISA 240 (redrafted) for more examples

Communication regarding fraud with management, those charged with governance and others
If auditors identifies misstatement due to fraud then must take action, but should first consider :
· confidentiality – auditor cannot simply inform everyone cos of confidentiality issue (cannot go directly to SAPS etc)
· management could be involved in the fraud – auditor must take care in deciding whom to report the fraud to (if
unsure if anyone on top of the ladder can be trusted – i.e. Chairperson of the Board – then could consider reporting
it to IRBA as a “reportable irregularity”
· absolute evidence of fraud – auditor doesn’t have to have absolute proof of fraud, but should have sufficient
appropriate evidence and should not make direct accusations, MUST document the whole matter

Parties with whom the auditor can communicate concerning fraud :


· management (other then Board of Directors) – normally fraud should be reported to the level of management
above the level at which the fraud is occurring. Auditor must decide :
Ø if level above is high enough to report (in case of major fraud should go hirer then immediate supervisor)
Ø if level above might be involved in the fraud
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· those charged with governance of the company – ultimately the Board of Directors or audit committee
(Companies Act stipulates that public interest companies have to appoint audit committees). Auditor will have to
decide if necessary to report fraud to the Board and audit committed – generally the auditor should report :
Ø material weakness in internal control (management are not meeting their responsibility and so risk of fraud is
greater)
Ø questions regarding management integrity
Ø fraud involving management
Ø other fraud that results in material misstatement of financial statements

Regulatory and enforcement authorities


rd
Auditor’s duty of confidentiality stops him reporting fraud or error to a 3 party unless :
· reportable irregularity is reported to IRBA in terms of Section 45
· court or statute states that information has to be disclosed
· client gives their permission
Should auditor who has resigned or is about to be replaced disclose details of fraud or suspected fraud to the new
auditor? Code of Professional Conduct says that existing auditor should communicate with the successor auditor to say
if it is appropriated for the new auditor to accept the engagement.
Would depend on if the client has given existing auditor permission to discuss their affairs, but if permission not granted
then may not discuss the client with the new auditor, but should rather convey that client’s permission has been refused.
Fraud and retention of clients
If company has a high incidence of fraud there is high audit risk and so not in best interests of auditor or auditing firm to
retain that client, especially if those charged with governance don’t take decisive action to stop the fraud.
But if auditor resigns as auditor cos of fraud then must be careful of Section 280 of the Companies Act which states that
if audit intends resigning (either at end of term of office or at any other time) then has to deliver to the company and
Registrar written notification that he has no reason to believe that there is a reported irregularity at the company except
one that has already been reported to IRBA.)
Therefore if auditor wanted to resign simply cos didn’t want to have to follow up on fraud issue then will have to consider
if the fraudulent activities are a reportable irregularity and if they are then MUST report them to IRBA BEFORE
resigning (also in terms of Section 45 of AP A).
Auditor should also act professionally and with honest and integrity and should fulfill his duty to finish his reporting
obligations (that is why he was hired).

Jackson & Stent pgs 17/8 to 17/9


Consideration of laws and regulations in an audit of financial statements
Auditor’s responsibility regarding client’s non-compliance with laws and regulations governing that business (e.g. taxes
& health and safety etc) :
Auditor not expected to have in-depth knowledge of all these laws and regulations but should know for which ones lack
of compliance will have a material effect on the financial statements. Important ones are Companies Act and Income
Tax Act, but others may impact that specific business. Auditor is not expert in legal matters and may not be able to
determine if client is non-compliant but there are procedures to be carried out and auditor should get a legal opinion.
Auditor’s duties, responsibilities and procedures in terms of laws and regulations
Auditor has not responsibility to prevent non-compliant – it is the directors who are responsible.
When designing and performing audit and evaluating the evidence then auditor should consider the risk of material
misstatement if client is non-compliant with laws and regulations (should use principle of professional skepticism
throughout the audit).
While gaining an understanding of the entity and its environment, the auditor must obtain a general understand of the
laws and regulations which govern the client. Once has an idea then must do tests specifically to identify non-
compliance.
During performance of the audit, must be alert to evidence that could indicate non-compliance, such as :
· government or regulatory body investigation of the client’s affairs
· payment of fines or penalties
· material transactions for which there is inadequate or insufficient supporting documentation (e.g. large payments to
government employees – bribes to cover non-compliance)
· unusual transactions (trying to get around the law?)
· large cash payments (bribes, stolen money?)
· purchases at non-market prices (why would company pay more then market price?)
· excessive salesperson or agents commission
If auditor thinks there might be non-compliance then should gather sufficient evidence to evaluate :
· potential financial consequences such as fines, damages, litigations
· if adjustments to or disclosure in the financial statements is required
· if failure to adjust or disclose financial consequences of non-compliance will result in management’s failure to
achieve fair presentation of the financial statements
All findings should be documented and discussed with management.
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Reporting non-compliance – to various bodies :


· to management and those charged with governance – should report as soon as practically possible to the audit
committee, board of directors and senior management. Should be reported at level higher then where the non-
compliance has occurred, but if management believes that management is intentionally failed to comply with laws
and regulations then must consider if the non-compliance is a reportable material irregularity in terms of Auditing
Profession Act Section 45.
· users of the financial statements – if auditor decides that non-compliance that had a material effect on financials
has not been adequately sorted out then the audit report must be modified to state that. (Audit report is the
rd
appropriate medium to report to the users and cannot communicate with 3 parties as that would be breach of
confidentiality)
rd
· regulatory and enforcement agencies – normally confidentiality duty prevents auditor from reporting to 3 parties,
but in terms of certain statutes can be overridden, but auditor should seek legal council before giving any details of
non-compliance of the client.
ISA 250 – Consideration of Laws and Regulations in an Audit of Financial Statements
Management’s responsibility to ensure that the entity’s operations are in accordance with laws and regulations –
responsibility for prevention and detection of non-compliance rests with management.
Management can prevent and detect non-compliance by :
· monitoring legal requirements and ensuring that operating procedure meet these requirements
· instituting and operating appropriate internal controls
· developing, publicizing and following a code of conduct
· ensuring employees are properly trained and understand the code of conduct
· monitor compliance with the code of conduct and discipline employees who don’t comply with it
· engage legal advisors to assist in monitoring legal requirements
Audit is subject to unavoidable risk that some material misstatements of financial statements will not be detected even if
the audit is properly planned and performed in accordance with ISA’s. Risk is higher for material misstatements cos of
non-compliance of laws and regulations cos of :
· many laws and regulations relating to the operating aspects of an entity that do not have a material effect on the
financials and so are not part of the entity’s internal systems
· effectiveness of the audit procedure is affected by the inherent limitations of the internal control and use of testing
· most of audit evidence is persuasive rather then conclusive
· non-compliance involves conduct designed to hide the non-compliance (e.g. collusion, forgery, failure to record
transactions, management overriding controls or lying to auditor)
Auditor would get understanding of the laws and regulations for that particular entity by :
· using existing knowledge of entity’s industry
· asking managements what the entity’s policies and procedures for compliance with laws and regulation are
· ask management which laws and regulations may be expected to have a fundamental effect on the operations of
the entity
· discuss with management what policies or procedures are adopted to identify evaluate and account for litigations
claims and assessments
· discuss the legal and regulatory framework with auditors of subsidiary in other countries
· asking management if the entity is compliant with laws and regulations
· inspect correspondence with the relevant licensing or regulatory authority.
Auditor should obtain written representation that management has disclosed all know actual or possible non-compliance
with laws and regulations as necessary when preparing the financials.
In absence of auditor evidence to the contrary auditor is entitled to assume that the entity is in compliance.
If auditor is stopped by the entity from obtaining sufficient audit evidence to evaluate if non-compliance may be material
to the financial, then should express his qualified opinion in audit report, or should add a disclaimer of opinion cos of the
limitations on the scope of the audit.
Auditor might decide that has to withdraw from engagements if entity doesn’t take remedial action (even if not material
to financial statements). Auditor may also decide that the highest authority is involved which would effect the reliability
of management representation, but auditor should seek legal advice before coming to conclusion.
Remember that if new auditor asks existing auditor if there are any professional reasons why the new auditor should
accept the appointment, then must have client’s permission to discuss it. If client hasn’t given permission then old
auditor should tell new auditor that cannot discuss it.

Study Guide pg 77 to 81
Auditor’s responsibility regarding detection of non-compliance with laws and regulations :
Reasonable assurance that the financials being audited are free of material misstatement

Understanding of the legal and regulatory framework :


In order to plan the audit need to obtain a general understanding of the legal and regulatory framework applicable to
the entity and the industry, and of how the entity is complying with the framework.
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Specific statutory audit requirements :


Determine whether there are specific statutory requirements that make the auditor report on compliance with certain
provisions of laws and regulations as part of the audit of financial statements of an entity (so can plan audit to meet
these requirements)

Detection of non-compliance :
Ø design and carry out audit procedures in order to identify instances of non-compliance with laws and regulations
that should be taken into account when preparing the entity’s financial statements
Ø obtain audit evidence about compliance with the relevant laws and regulations which affect the determination of
material amounts and disclosure in the entity’s financial statements.
Reasons why the auditor doesn’t have a duty to prevent non-compliance with laws and regulations and why he
only has a limited responsibility to detect non-compliance
Any audit is subject to the unavoidable risk that some material misstatements of the financial statements will not be
detected – even if the audit is properly planned and is performed in accordance with SA Auditing Standards.
Risk of material misstatements cos of non-compliance is higher when :
· auditor cannot be expected to evaluate compliance with laws and regulations in every area of the entity’s operations
- there are laws and regulations relating mainly to the operating aspects of the entity that do not normally have a
material effect on the financials and are not identified by the accounting and internal control systems
· effectiveness of audit procedures is affected by the inherent limitations of the accounting and internal control
systems and by the use of testing
· most of the evidence obtained by the auditor is persuasive rather then conclusive in nature
· non-compliance may involve conduct designed to conceal it (collusion, forgery, failure to record transactions,
overrides and lying by management)
· auditor is not a law specialist.

AUDITOR ONLY TAKES INTO CONSIDERATION THE LAWS AND REGULATIONS THAT AFFECT THE FORM AND
CONTENT OF THE FINANCIAL STATEMENTS AND ALSO LAWS AND REGULATIONS THAT CAN HAVE A
FUNDAMENTAL INFLUENCE ON THE OPERATIONS OF AN ENTITY.

Steps to be followed if auditor becomes aware of a possible non-compliance with laws and regulation :
· obtain understanding of the nature of the act and the circumstances in which it occurred
· obtain an understanding of sufficient other information to evaluate the possible effects on the financial statements
· document the findings
· discuss the findings with managements (or with entity or entity’s lawyers if necessary)
· consider the effect on the auditor’s report (especially if couldn’t obtain sufficient information)
· consider the implications for other aspects of the auditor – especially reliability of management representations.
do questions in section 3.3 of tutorial 102 and check answers in the key of section 3.3 of tutorial 103

TOPIC 4 - FUNDAMENTAL AUDITING CONCEPTS & PRINCIPALS


Study Topic 4.1 – Audit Assurance
ISRS 4410 – Engagements to compile financial statements
ISRS 4400 – Engagements to perform agreed upon procedures
International Framework for Assurance Engagements
Jackson & Stent pgs 1/4 to 1/6
Jackson & Stent pgs 19/1to 19/10
ISRS 2400 – Engagements to review financial statements

Jackson & Stent pgs 1/4 to 1/6 – Assurance and non-assurance engagements
Assurance engagements – “expresses a conclusion designed to enhance the degree of confidence of the intended
users, other then the responsible party about the outcome of the evaluation or measurement of a subject matter against
the criteria” (International Framework of Assurance Engagements)

Elements of Assurance Engagement :


Element Example
· three party relationship
Ø professional accountant Ø registered auditor
(practitioner) Ø directors responsible for the financials
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Ø responsible party Ø shareholders
Ø intended user

· subject matter · financial position, results of operations etc.

· suitable criteria · International Financial Reporting Standards (IFRS’s)


.

· sufficient appropriate evidence · the evidence the practitioner needs to be in a position to conclude
that the financial statements are free of material misstatement

· written assurance report (conclusion) · audit report on fair presentation

Audit of financial statements – assurance engagements – registered auditor gathers sufficient appropriate evidence
to be in a position to pass an opinion on whether the directors (who are responsible for the financial statements) have
applied the International Financial Reporting Framework appropriately in presenting fairly the financial position, financial
performance and cash flow information of the company for the financial year.
Other assurance engagements – if all evidence is as above then there can be other types of engagements that are
classified as an assurance engagement e.g. :
· engagement to report on the effectiveness of a client’s internal control system (provided there are criteria against
which this can be measured)
· engagement to report on whether the client is complying with the requirements of the Sarbannes-Oxley Act 2002 )
relating to corporate governance

Non-assurance engagement – professional accountant DOESN’T express an opinion or comment on the subject
rd
matter of the engagement, no 3 party involved or there are no benchmarks to measure the subject matter against, e.g.
:
· auditor has to compile (collect, classify and summarise) info for client, but not to express opinion
· auditor prepares company’s tax return without expressing an opinion on it

Reasonable Assurance – auditor only provides reasonable assurance that the financial statements (as a whole) are
free of material misstatement NOT that they are 100% correct cos of :
· use of testing
· inherent limitations of accounting and internal control systems
· audit evidence usually persuasive rather then conclusive
· subjectivity in the financial statements and also in the auditor’s approach to the audit

Assurance Engagements either :


· reasonable assurance engagements – where a positive form of expression of opinion is given and extensive
procedures are carried out or
· limited assurance engagements – negative form of expression of opinion is given and less extensive procedures
are carried out.

Statutory assurance engagements – engagements conducted cos of statute (Act of Parliament) e.g. Companies Act
Non-statutory assurance engagements – NOT cos of legal requirements but rather specifically for that entity (e.g.
bank wants assurance that the business’s financials are compliant with corporate governance requirements before
granting loan)

Jackson & Stent pgs 19/1to 19/10


Other types of engagements :
· review engagements
· agreed upon procedure engagements
· compilation engagements

Review Engagements
Standards - ISRE 2400 Engagements to review financial statements

ENGAGEMENT

Assurance engagements Non-assurance engagements

audit review agreed upon compilation


procedures
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reasonable moderate no no
assurance assurance assurance assurance

Review engagements are assurance engagements - limited assurance engagements in terms of International
Framework for Assurance Engagements (IFAE).
Review engagement provides moderate assurance that the information subject to review is free of material
misstatement (expressed as negative assurance)
Objective of the review is to provide a limited (moderate) assurance but general principles of a review engagement are
virtually identical to those of an audit.

General principles of review engagements:


· auditor must comply with the Code of Professional Conduct issued by IFAC (SAICA / IRBA) and must be guided by
the ethical principles governing his professional responsibility (i.e. independence, integrity, objectivity, professional
competence and due care, confidently, professional behaviour and technical standards) :
Ø review must be conducted in accordance with ISRE 2400
Ø auditor must adopt an attitude of professional skepticism
Ø for purpose of expressing negative assurance in the review report the auditor must obtain sufficient appropriate
evidence through enquiry and analytical procedures to be able to draw conclusions

Terms of engagement :
ISRE 2400 requires that an engagement letter needs to be obtained for review engagements – must include :
· objective of the service being performed
· managements responsibility for the financial statements
· scope of the review, including reference to the ISRE statement
· unrestricted access to whatever records, documentation and other information is requested for the review
· sample of the report expected to be rendered
· must state that the engagement cannot be relied on to disclose errors, illegal acts or other irregularities (e.g. fraud
or defalcations)
· statement that an audit is not being performed and that an audit opinion will not be expressed (to clarify, should
rd
perhaps mention that review engagement will not satisfy any statutory or 3 party requirements for an audit)
· basis of fees
· deadlines

Objective
To enable auditor to state whether or not (on basis of procedures – less evidence then for full audit) anything
has come to auditor’s attention that causes the auditor to believe that the financial statements are not prepared
in accordance with the identified financial reporting framework and statutory requirements, in all material
requirements.
This is a negative assurance.
Review procedures are limited and not as comprehensive as full audit procedures so only a moderate assurance is
given.

Positive and negative assurance


Level of assurance in the report is expressed in different ways :
· Audit = positive assurance. Reasonable level of assurance cos auditor uses phrase “in my opinion” and includes
the description of the scope of engagement which conveys to the user that comprehensive procedures were
conducted
· Review = negative assurance. Moderate level of assurance cos auditor DOESN’T use phrase “in my opinion” but
says “nothing came to my attention that causes me to believe that the financial statements are not fairly presented”.
This is supported by the scope paragraph that conveys that limited procedures were carried out and that an audit
was not conducted and so no opinion was expressed.

Scope of the review engagement


Scope of a review engagement is unrestricted – so auditor NOT client decides on the nature, timing and extent of the
procedures to be conducted. Procedures normally limited to enquiry and analytical review and not normally assessment
rd
of accounting and internal control systems, test of detail and 3 party confirmations.
But auditor must do what he believes is necessary to be in a position to express the moderate assurance.
see ISRE 2400 for list of procedures which can be performed on a review engagement

Planning and documentation – engagement must be properly planned and work must be documented. Reporting
considerations are :
· standards and structure – report given for the review engagement must be to standards of reporting and structure
will be the same as the audit report. All the modification opinions which are available for audit reports are also
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applicable to review reports (i.e. report can be qualified “except for” and an adverse opinion, disclaimer of opinion or
emphasis of matter can be given). Rules for reporting are the same as for audit reports
· title of report – “Review Report to the directors of … entity…” Can include independent auditor and report can be
addressed to other parties
· introduction paragraph – must :
Ø state clearly that a review has been carried out NOT an audit
Ø identify the information on which the review has been conducted and
Ø lay out the responsibility of the preparers and reviewers
· scope paragraph – must convey :
Ø nature of the procedures conducted
Ø fact that the intention was for moderate assurance only
Ø that audit was NOT carried out
Ø that no opinion was expressed
· review opinion paragraph (termed conclusion paragraph) – will vary depending on what is being reviewed but
auditor must convey negative assurance and NOT positive assurance
· modified review reports – auditor may need to qualify the assurance he is giving or provide an emphasis of
matter. Exactly the same considerations are applied when qualifying a review report as when qualifying an audit
report (is there a matter which warrants consideration for qualification? does the matter affect the auditor’s opinion
or not? is it based upon disagreement or scope limitation? is it material or material and pervasive? if auditor
decides that a qualification is required then :
Ø explanation paragraph will be added before the conclusion paragraph – termed ‘basis for qualified conclusion or
adverse conclusion”
Ø working of the review opinion will be amended
· emphasis of matter may be appropriate – then same principles apply to emphasis that particular matter and there
will be a paragraph under the review opinion paragraph which will describe the matter to be emphasised
· signing off – name, Registered Auditor, Charted Accountant (SA), date, place
see text book pgs 19/5 & 19/6 for examples of paragraphs and reports

“Agreed up Procedure” engagements


International Standard on Related Services (ISRS) 4400 – Engagements to perform agreed upon procedures regarding
financial statements.

Objective
Auditor is engaged to carry out procedures (usually of audit nature) which have been agreed upon by the
parties involved and he reports only on the facts as found – NO OPINION or ASSURANCE is given and the
users of the reports have to draw their own conclusions from the presented facts.

Compliance with standards


Same general principles of integrity and objectivity, professional competence and due care (technical standards),
confidentiality and professional behaviour, as well as complying with ISRS 4400 and the engagement must be properly
planned and documented.

Terms of engagements – must be clear to all parties and client must understand that no opinion will be given. Terms
should be set out in an engagement letter and must :
· include clear indication that the engagement doesn’t constitute an audit or review and that no assurance will be
given
· give nature, timing and extent of the specific procedures
· include the purpose of the engagement
· identify the financial information to which the agreed upon procedures will be applied
· the anticipated form of the report of factual findings
· limitations on the distribution of the report.

Reporting considerations :
· title – Independent Auditor’s report to the directors of …entity … on factual findings
· scope (including procedures used)
· opinion paragraph – NO assurance given – basically just an inclusion of the results of the procedures that were
carried out

Qualified reports – NO opinion and NO assurances is given so NO qualification report – results are presented
WITHOUT opinion or comment

Closing off – must add paragraph which states the report is solely for the purpose of the scope of the report and for
information and NOT to be used for any other purposes or to be distributed to any other parties. Report relates only to
the accounts and items specified above and doesn’t extend to the financial statements taken as a whole.
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Signed, Registered Auditor, Charted Accountant (SA), date, place.
see text book pgs 19/7 & 19/8 for examples of paragraphs and reports

Compilation engagements
ISRS 4410 – Engagements to compile financial statements.

Objective – in compilation accounting or audit firm is engaged to use accounting expertise and not auditing expertise to
collect, classify and summarise financial information. No testing is conducted and no assurance is given. Compilation
engagements often including compiling financials, the principles that are applicable involve compiling financial
information on behalf of the client.

Compliance with standards - same general principles of integrity and objectivity, professional competence and due care
(technical standards), confidentiality and professional behaviour, as well as complying with ISRS 4410 and the
engagement must be properly planned and documented.

Terms of engagement
Must be clear to client and practitioner and must be set out in engagement letter including :
· clear indication of the nature of the engagement (including fact that neither audit or review will be carried out and
that no assurance will be given
· statement that engagement cannot be relied on to disclose errors, unlawful acts etc
· nature of the information to be supplied by the client
· fact that management is responsible for the accuracy and completeness of the information supplied
· basis of accounting on which the information is to be compiled
· intended use of the compiled information
· form of the report
· acknowledgment from management of their responsibilities

Procedures – overall objective to collect, classify and summarise the date provided by the client, but accountant must :
· obtain a general knowledge of the business and operations of the client
· become familiar with the accounting principles and practices of them in use with which the client operates
· be familiar with the form and content of the financial information required
· consider if the compiled information is free from obvious errors / misstatements
NOT necessary to :
· assess the reliability of the information provided by the client
· assess internal controls
· verify anything (any matters)
· verify explanations
but MUST maintain a degree of professional skepticism and must query unusual or unexpected information. If
management is uncooperative then practitioner can withdraw from the engagement.

Reporting considerations
· title – Compilation Report to the members of … CC
· introductory paragraph
· no scope paragraph, but should indicate the limited nature of the engagement by saying “ we have not audited or
reviewed these financial statements and accordingly express no assurances thereon”
· must emphasise the limited reliance that the report has by using words “unaudited” or “compiled without audit or
review” on each page of the financial information.

NO assurance paragraph cos NO assurance given

NO assurance so NO qualification report is given, but can add an additional paragraph to the report if :
· accountant that performed the compilation is not independent of the entity
· there was material departure from the reporting framework in terms of the information that was compiled (e.g.
financial leases not capitalised in terms of the International Accounting Standards.

see :
ISRS 4410 – Engagements to compile financial statements
ISRS 4400 – Engagements to perform agreed upon procedures
International Framework for Assurance Engagements
ISRS 2400 – Engagements to review financial statements

Study guide pg 86
In financial statements management states explicitly to that the financial information reflected in the statements
complies with certain assertions :
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· completeness
· occurrence
· existence
· accuracy
· cut-off
· classification
· valuation and allocation rights and obligations
· presentation and disclosure
Auditor then carries out series of procedures and activities to collect audit evidence to enable him to express an
opinion on the financial statements – audit evidence is normally collected for every assertion in the financials and
enables him to reach the conclusions on which the audit opinion is based.
At end of audit the auditor expected to give the client a degree of assurance that the information is free of material
misstatements (no absolute level cos the inherent limitations)

Auditor’s desired level of assurance = degree of satisfaction obtained and level of assurance provided is determined
by the audibility of the financial information, nature and extent of the procedures carried out and results obtained.
Positive assurance – high (but NOT absolute level of assurance) that the audited information is free of material
misstatement and expressed in the audit report as reasonable assurance.
Negative assurance – moderate level of assurance that the review information is free of material misstatement and is
expressed in the auditor report as a form of negative assurance
No assurance – no assurance expressed in the report.

Cannot guarantee absolute level of assurance cos :


· most of work that auditor performs before giving an opinion is based on auditor’s professional judgement (especially
in respect of collection of audit evidence and conclusions based on that evidence)
· auditor uses testing and sampling cos impossible to check absolutely everything
· inherent limitations in the accounting and internal control systems (e.g. possibility of conclusion)
· most of the evidence auditor uses is persuasive rather then conclusive in nature
· number of other limitations that influence the persuasiveness of evidence (e.g. transactions between related parties)

Differences between various types of audits and the objectives and levels of assurance for each :
Type of engagement Objectives Level of assurance given

Audit To enable auditor to express an opinion as to whether Positive assurance in the audit report –
engagement the financial statements, in all material respects, fairly high but NOT absolute that the
represent the financial position of the entity at a information subject to the audit is free of
specific date and the results of its operations and cash material misstatement.
flow information for the period ended on that date

Review To enable the auditor to state whether anything has Auditor’s satisfaction is expressed in form
engagement come to his attention which has caused him to believe of a negative assurance – auditor
that the financial statements have not been compiled provides only moderate level of
in accordance with an identified financial reporting assurance that information subject to the
framework in all material respects. Review audit is free of any material misstatement.
engagement is based on procedures that don’t proved
all the evidence required for an audit

Agreed-upon To enable the auditor to report on factual finding on Auditor reports only on factual findings
rd
procedures certain procedures that the auditor, client and any 3 and expresses NO assurance that
engagement party have agreed on information is free of material
misstatement

Compilation Auditor uses accounting expertise and NOT auditing Auditor is acting as an accountant –
engagement expertise in order to collect, classify and summarise auditors involvement in drafting the
financial information financial statements enhances the
creditability of the statements, BUT
auditor provides NO assurances in the
report
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Preparation and presentation of financial statements is the responsibly of management of entity – audit of financial
statements is the responsibility of the management of the entity and audit doesn’t relieve any of management’s
responsibly.
Expression by the auditor of an audit opinion on the financial information enhances the credibility of the financial
statements, but doesn’t provide assurance regarding the future viability of the entity or the competence or efficiency with
which the entity is managed.

ISA 200 – Objective and General Principles governing an Audit of Financial Statements 33 to 36
33. Auditor’s responsibility = forming and expressing an opinion on the preparation and fair presentation of the
financial statements
34. Financial statements = structured representation of the financial information (including notes) derived from
accounting records and communicates entity’s economic resources or obligations at a point in time or the changes
therein for a period of time, in accordance with a financial reporting network.
35. Requirements of the financial reporting framework determine the form and content of the financial statements
and what constitutes a complete set of financials. (e.g. IPSAS – International Public Sector Accounting Standard –
says that primary financial statements is a statement of cash receipts and payments. IFRS – Financial Reporting
Standards – says needs information about financial position, performance and cash flows and so need balance
sheet, income statement, statement of changes in equity, cash flow statement and notes.
36. Management responsibility = preparing and presenting of the financial statements in accordance with the
applicable financial reporting framework. Must identify that framework and also :
· design, implement and maintain internal controls that are free from material misstatement (from either fraud or
error)
· select and apply appropriate accounting policies
· make accounting estimates that are reasonable in the circumstances

ISA 200 – Objective and General Principles governing an Audit of Financial Statements 37 to 48
Determining the acceptability of the financial reporting framework
37. Auditor should determine whether the financial reporting framework adopted by management in preparing the
financials is acceptable (normally taken into account when considering whether to accept the audit engagement)
38. Auditor determines if financial reporting framework adopted by management is acceptable in view of the nature of
the entity and the objective of the financial statements.
39. financial statements designed to meet the financial information needs of specific users – so needs of users
determines the applicable financial reporting framework.
40. financial statements designed to meet the common financial information needs of a wide range of users – called
general purpose financial statements
41. currently no objective and authoritative basis recognised globally to judge the acceptability of financial reporting
frameworks for general purpose financial statements, so use IFRS’s, IPSAS’s and GAAP
42. some jurisdictions may have legislative and regulatory requirements supplementing a financial reporting framework
with additional requirements for the preparation and presentation of financial statements. If the additional
requirements conflict with the applicable financial reporting framework then the auditor discusses the nature of the
requirements with management and decides if the additional requirements can be met through additional
disclosures – if not possible then auditor must decide if must modify the auditor’s report
43. if entity is registered or operating in jurisdiction that doesn’t have authorised or recognised standards then entity
must identify an applicable financial reporting framework.
44. acceptable financial reporting frameworks for general purpose financial statements normally have the following :
· relevance (info in the financials if relevant to the nature of the entity and objective of the financial statements )
· completeness – ensure transactions and disclosures etc that could affect the fair presentation of the financial
statements aren’t omitted
· reliability – info in financials :
Ø reflects economic substance of events and transactions and not merely their legal form
Ø results in reasonably consistent evaluation, measurement, presentation and disclosure when used in similar
circumstances
· neutrality – free from bias
· understandability – info is clear and comprehensive and not subject to significantly different interpretation
45. CANNOT use mixture of accounting conventions devised to suit individual preferences – NOT acceptable financial
reporting framework for financials intended to address common information needs of wide range of users
46. description of the financial reporting framework in the financials must include information about the basis of
preparation and the accounting policies selected and applied for significant transactions and other significant events
47. auditor may decide to compare accounting conventions to the requirements of an existing framework. If done and
differences are identified then must decide if accounting contraventions adopted by management constitute an
acceptable financial reporting framework or if could result in financial statements that are misleading
48. if auditor concludes that the financial reporting framework adopted by management is not acceptable then auditor
must consider the implications in relation to the engaging acceptance and the auditor’s report.
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Study guide pg 90
If financial statements are a fair presentation in all material respects then means that statements regarding the entity’s
financial position, result of its operations and its cash flow are a reasonable indication of the true state of affairs and
have been drafted in accordance with an identified financial reporting framework and / or statutory requirements.
Companies Act 61 of 1973 section 286 states that company has a “duty to make out annual financial statements and lay
them before the annual general meeting” and that they should conform with GAAP and fairly present the state of affairs
of the company and its business.
Section 4 specifies the disclosure requirements in respect of balance sheet and income statement items in the financials
of company – if financial statements drafted in terms of GAAP and other statutory requirements then they should fairly
represent the company’s operations.

Professional judgement = auditor’s professional opinion and involves his choices and decisions during the
performance of various aspects of audit work. Used to determine how they will proceed in order to achieve auditing
objectives, what kind and how much evidence they will need and the extend of their procedures and what conclusion
they reach on the basis of the audit evidence they have collected.
Auditors must have knowledge of information systems, Companies Act, accounting statements, auditing standards and
GAAP as well as knowledge of human nature.
Legislation and auditing standards give the auditor guidelines and boundaries within which he can exercise his
professional judgement, but ability to judge and reason relies on auditor’s education, training, knowledge and
experience.
Professional judgement essential at every stage of auditing process – but especially during planning (auditor
establishes priorities) and evaluation (auditor forms an opinion)
do questions in section 4.1 of tutorial 102 and check answers in the key of section 4.1 of tutorial 103

Study Topic 4.2 – Audit Evidence


ISA 500 – Audit Evidence
ISA 330 – The Auditor’s Procedures in Response to Assessed Risks
Jackson & Stent pgs 5/3 to 5/17

So as to be able to express an audit opinion on the fair presentation of the financial statements the auditor collects audit
evidence in support of the assertions in the financial statements and in support of his audit opinion. Collects audit
evidence by carrying out a series of procedures and activities – obtained from various sources and every document
used as audit evidence must be assessed for appropriateness, reliability and sufficiency.

Jackson & Stent pgs 5/3 to 5/17


Internal Controls
Before carrying out effective audit need to have thorough understanding of the client’s internal control systems cos
accounting system and internal controls produce the balances and totals reflected in financials, so if the controls and
accounting system are “good” then the information will also be “good” (i.e. valid, accurate, complete and timeously
produced.)
Internal controls = process effected by the company’s directors, management and staff and is designed to
provide reasonable assurance regarding the achievement of objectives in :
· economy, efficiency and effectiveness of operations
· internal financial control
· compliance with applicable laws and regulations.

Important aspects of internal control :


· internal control is a process – a means to an end and NOT the end itself – simply a collection of policies and
procedures adopted by management to achieve certain goals and is not the goal itself
· internal control is effected by people – people at every level involved in various tasks (not just policies and
procedure manuals)
· internal control provides only reasonable, not absolute assurance that management’s goals will be
achieved – has inherent build in limitations so things can go wrong
· internal controls set out to achieve objectives (economy, efficiency and effectiveness of operations, internal
financial control & compliance with applicable laws and regulations) which are separate but interlinked – so
together will assist in running an efficient and effective business.

Internal controls consist of :


· control environment – entity’s governance and management functions and the attitudes, awareness and actions
of those responsible for governance
· entity’s risk assessment process – process for identifying the business risks relevant to the financial reporting
objectives and how they are addressed (what controls are in place to ensure all cash sales are recorded and the
cash is adequately protected)
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· information system – procedures and records established by the entity to initiate, record, process and report
transactions
· control activities – policies and procedures that ensure controls are in place to achieve internal control objectives
(e.g. authorization, segregation of duties, reconciliation, physical controls)
· monitoring of controls – process in place to assess the effectiveness of internal controls over time (e.g.
management may set up an Internal Audit Department).

Internal control objectives – to ensure :


· management polices are adhered to in all aspects of the business (i.e. applicable laws and regulations)
· safeguarding of assets such as stock, cash and equipment against theft / damages
· prevention and detection of fraud and error
· accuracy and completeness of accounting records timely preparation of reliable financial and other information
necessary to run the business.

Limitations of internal controls


Control procedures and policies do not provide absolute assurances that the objectives of the internal controls will be
met – management may design perfect control system, but because of inherent limitations absolute assurances that the
objectives will be achieved is not possible.
Limitations are :
· cost / benefit - requirement that the cost of internal control does not exceed the expected benefit to be derived
· internal controls are directed at routine transactions rather then non-routine transactions
· potential for human error due to carelessness, distraction, mistakes of judgment and misunderstanding of
instructions
· possibility of circumvention of internal controls through collusion of management or employee with other parties
either inside or out of the company
· person responsible for exercising the internal control could abuse the responsibility (e.g. management overriding an
internal control)
· procedures become inadequate due to changes in conditions and so compliance with procedure may deteriorate

Accounting system
Is the foundation that enables management to achieve the objectives of internal financial control – series of tasks and
records by which transactions are processed to create financial records. Accounting system identifies, assembles,
analyses, calculates, classifies, records, summaries and reports transactions and other events.
Main elements of account system are :
· people – who carry out the procedures and or can use computer system
· paper – which facilitates the recording of the transactions. to replace people and paper

Accounting system alone CANNOT achieve internal financial control – need control procedures to ensure that financial
information is valid, accurate, complete and timeously produced.

Who is interested in what part?


Internal control for the
Internal
business as a whole
auditors
interested in Management
ALL interested and
categories involved in
and perform Operations : internal compliance with ALL
audits and - economy financial laws and categories of
investigations - efficiency control regulations internal control
for every part - effectiveness - responsible
(internal audit for running the
is an business
internal
accounting control
control
procedure) systems plus procedures

External auditor mainly interested in accounting system and related


control procedures. Must have knowledge of operations of business
but not concerned if operations is most efficient or strategies are correct.
Also concerned with laws and regulations that have a direct
effect on the company’s financial reporting
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Characteristics of good internal controls


Control environment – sets the tone of the organisation and influences the control consciousness of its staff. Attitude
and awareness of the directors and managers to internal controls and their importance to the entity (directors and
managers should promote an environment where adherence to controls is very important by their actions and
behaviour)
Good control environment characterised by :
· communication and enforcement of integrity and ethical values throughout the organisation
· commitment by management to employ competent staff
· positive influence generated by those charged with governance of the entity – (e.g. non-executive directors and
chairman – do they display integrity and ethical commitment?)
· management philosophy and operating style that includes leadership. Sound judgement, ethical behaviour etc
· organisational structure which provides clear framework for proper planning, execution control and reviews
· policies, procedures and an organisation structure that clearly defines authority, responsibility and reporting
relationships throughout the entity
· sound human resource policies and practices which result in the employment of competent ethical staff, provide
training and development as well as fair compensation and benefits.
Competent, trustworthy staff – achieved through implementation of proper recruiting, training and personnel policies.
Segregation of duties – most important objective of internal control is safeguarding company’s assets. Segregation of
duties ensures that different people have access to different procedures.

Transaction has 4 stages :


Authorising
(can be combined with executing)

Executing
(can be combined with authorising)
Should all
Custody of the asset be separate
(should be separated from recording) duties
(i.e. different
people)
Recording
(should be separated from custody)

Companies cycles (e.g. acquisitions and payments) should be divided into functions and then duties within the functions
should be separated further.

Isolation of responsibility – for internal control to work effectively people involved in the system must be fully aware of
their responsibilities and must be accountable for their performances. Staff should acknowledge writing that they have
performed the task or control procedure (sign it off) or should transfer responsibility from one person to another (e.g.
signing to receive goods to signify acknowledgment of physical transfer and also to isolate responsible person).
Access / custody controls – designed to :
· prevent damage to or deterioration of physical assets (e.g. proper storage and treatment of assets)
· prevent deterioration of non-physical book assets (e.g. controls to ensure debtors don’t get behind in their
payments)
· prevent unauthorised use / theft / loss of physical assets (e.g. security measures)
· prevent unauthorised use / theft or loss of non-physical book assets (e.g. limiting number of personnel who have
signing powers to transfer cash or sell investments or preventing debtors ledger form being altered or destroyed.)
Source document design – paper controls should promote accuracy and completeness of recorded transactions by
being :
· pre-printed in a format that leaves minimum amount of information to be manually filled in
· pre-numbered – identifies missing documents
· multi-copied, carbonised and designed for multiple use
· designed in manner that is logical and simple to complete
· contain blank blocks or girds which can be used for authorizing or approving the document – facilitates isolation of
responsibility.
Comparison and reconciliation – good control system should be frequently and timeously compared and reconciled
by different staff then the one who completed functions and recorded the transactions. Must compare and reconcile :
· stock and fixed assets (physical) to the records (theoretical)
· bank and investment records to external bank statements
· records of creditors to supplier statements
· subsidiary ledgers to the general ledger (e.g. debtors ledger to general ledger)
Reconciliations should be reviewed by senior personnel and reconciling items followed up
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Audit evidence
Fundamental to audit function and auditor has duty to gather SUFFICIENT appropriate audit evidence to be able to
draw reasonable conclusions on which to base the audit opinion.
Sufficient appropriate evidence
Sufficient evidence – quantity of audit evidence that is gathered. Auditor must evaluate if there is enough evidence to
support an opinion – important as auditors do not examine every transaction only samples.
Evidence is cumulative in nature and evidence about an assertion is not gathered by performing a single procedure but
by performing a number of procedures each of which contribute some evidence. Auditor has to balance the extent of
each procedure performed.
Statistical models assist in determining sample sizes but auditor still has to make subjective decisions. Quality of audit
evidence relates to the extent of testing which is a component of audit plan (other components = nature and timing of
tests) but audit plan is only decided upon once the full exercise of devising the overall audit strategy has taken place.
Planning process also includes subjective decisions – e.g. evaluating inherent risk and auditor is left using professional
expertise to determine if (in light of prevailing circumstances surrounding the audit) there has been enough evidence
gathered.
Appropriate evidence – quality of audit evidence. Made up of relevance of evidence to the assertion which is being
audited and the reliability of the evidence (source and nature).

Reliability – hierarchy of reliability for audit evidence is :


· most reliable = evidence developed by the auditor – e.g. auditor inspects stock to obtain evidence of its existence
rd rd
· reasonably reliable evidence = evidence provided directly by a 3 party (NOT client) provided the 3 party is
independent of the client and is reputable and competent (e.g. info received from client’s attorneys)
rd
· less reliable = evidence obtained from 3 party but which has been passed through the client as might have been
tampered with (e.g. bank statement or certificate of balance not sent directly to auditor)
· more reliable = evidence generated through the client’s system when the related internal controls are effective
· least reliable = evidence provided by the client cos it isn’t independent (i.e. provided by the person who is
responsible for the assertion for which the evidence is required)
· more reliable = written evidence rather then oral evidence as easy to deny or misinterpreted oral evidence
· more reliable = evidence provided by original documents rather then provided by photocopies or facsimiles.
Auditor will have to rely on evidence from all of these sources so has to use his experience – client’s evidence may well
be very reliable if the accounting systems and internal controls are strong and the directors and employees are
competent, reliable and trustworthy.

Relevance – to the assertion which is being audited. Important that the auditor understands exactly to which assertion
the evidence relates as if not understood then incorrect conclusions may be drawn.
see stock example pg 5/11 of text book.
When performing tests of control the auditor attempts to determine whether the major objective of the accounting
system and related internal controls is producing valid, accurate and complete information. While doing this the auditor
obtains evidence relating to the :
· occurrence
· accuracy
· cut-off
· classification and
· completeness of assertions relating to the transactions processed through that accounting system.
Single procedure will not necessarily be relevant to only one assertion – procedure may provide evidence relevant to a
number of assertions.

Influencing factors to determine whether sufficient appropriate evidence has been obtained :
· assessment of inherent risk and control risk at the client – if higher level of risk relating to a particular assertion
then more evidence from the most reliable source will be needed
· materiality of the item being examined – so what is most material will be more important to gather sufficient
appropriate evidence then for items that are less material (cos more material items will probably have more material
misstatements)
· experience gained during previous audits – as auditor develops relationship with his client so knowledge of
potential problem areas will help to guide the auditor in where to focus the audit
· results of audit procedures already conducted – if initial tests on some sections prove highly successful then
auditor may deceived to perform less additional tests then originally planned and visa versa
· source and reliability of the information available – auditor will want to use the best evidence available, but if it
is not reliable then auditor will be forced to gather more evidence from a number of less reliable sources to be in a
position to form an opinion of a particular assertion
· persuasiveness of the audit evidence – evidence gathered on one section of the audit which is supported or
corroborated by evidence from another section will be more persuasive then if it is contradictory.
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Financial statement assertions
Financial statements are just assertions of the directors to the shareholders concerning the financial positions and
results of operations of the company (in a prescribed format).
ISA 500R states that auditor should use assertions for classes of transactions, account balances and presentation and
disclosure in sufficient detail to form a basis for the assessment of risks of material misstatement and the design and
performance of further audit procedures.
Assertions are categorised as follows :
· assertions about classes of transactions and events – e.g., sales, purchases, interest received
· assertions about account balances – e.g. accounts receivable, property plant and equipment, accounts payable
· assertions about presentation and disclosure – e.g. notes which support balance sheet account headings,
contingent liabilities

Assertions about classes of transactions and events for the period under audit :
· occurrence – transactions and events that have been recorded have occurred and pertain to the entity
· completeness – all transactions and events that should have been recorded have been recorded
· accuracy – amounts and other data relating to recorded transactions and events have been recorded properly
· cut-off – transactions and events have been recorded in the correct accounting periods
· classification – transactions and events have been recorded in the proper accounts

Assertions about account balances at the period end :


· existence – assets, liabilities and equity interest exist
· rights and obligations – the entity holds or controls the rights to assets and liabilities are obligations of the entity
· completeness – all assets, liabilities and equity interests have been recorded
· valuation and allocation – assets, liabilities and equity interest are included in the financial statements at
appropriate amounts and any resulting valuation or allocation adjustments are appropriately recorded.

Assertions about presentation and disclosure :


· occurrence and rights and obligations – disclosed events, transactions and other matters have occurred and
pertain to the entity
· completeness – all disclosures have been included in the financials
· classification and understandability – financial information is appropriately presented and described, and
disclosures are clearly expressed
· accuracy and valuation – financial and other information is disclosed fairly and at appropriate amounts.

Auditor’s duty is to gather sufficient appropriate evidence to support the assertion that is being audited – especially
those that present a risk of material misstatement (that might lead the auditor to express an inappropriate opinion on the
financials if it is not detected).
Auditor must identify the assertions for which evidence should be gathered and then design an audit approach which
will provide enough relevant and reliable evidence on which to base an opinion.
see examples on pgs 5/13 and 5/14 of text book – NB!

Auditor’s Toolbox
Auditor has two sets of tests or procedures that can be used to gather sufficient appropriate evidence for financial
statement assertions :
· tests of control – used to test whether the control procedures relating to the accounting system have been
complied with and
· substantive procedures – used to verify (substantiate) transactions and balances.

Transactions flow through accounting system :

accounting system & balances


Transactions related control
procedures totals

If the accounting systems and related control procedures are ok, then the balances and totals produced will be ok and
so auditor who is interested in the fair presentation of balances and totals can test the accounting system and control
procedures to find out if they will produce reliable balances and totals. These are tests of controls.
If these tests reveal that the accounting system and related controls are sound then auditor will be confident that
balances and totals are fair and will spend less time substantiating / verifying the balances and totals.
Tests of controls are performed to obtain evidence of :
· if controls are suitable designed to prevent or detect and correct material misstatements
· if these controls operated effectively throughout the period that is being audited.
Satisfactory results from tests of controls reduce control risk and hence audit risk.
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CANNOT ONLY PERFORM TESTS OF CONTROLS! Even if accounting system and related control procedures are
excellent :
· internal control systems have inherent limitations which mean they are not totally efficient
· internal control system may have been excellent at the time that auditor performed the tests, but not at other times
during the year
· there is still the inherent risk to consider.
Successful tests of controls will reduce the extent and maybe change the nature of substantive tests, BUT CANNOT
eliminate the need to perform substantive tests.

Categories of tests of controls :


· reperformance – auditor repeats (either wholly or in part) the same internal control procedures that were previously
performed by the client (e.g. reperforming the reconciliation of a bank account)
· inspection of records or documents supporting transactions and other events will provide audit evidence if internal
controls have operated effectively (e.g. verifying if a transaction has been authorised – by checking if signed)
· enquiry by seeking information from people who use the internal controls to determine if they are operating
effectively. (e.g. determining who actually performs each function and precisely what they do – NOT just getting the
information from management as to what functions are supposed to be performed)
· observation – looking at process or procedure being performed by employee (e.g. what receiving clerk does when
supplier delivers goods)

Substantive procedures
Financial statements consisting of collection of balances (Balance Sheet) and summary of totals (Income Statement)
and accompanying notes – tests of control cannot provide auditor with sufficient appropriate evidence pertaining to
balances, totals and disclosures, so auditor must perform procedures of a substantive nature.
Substantive procedures can be performed on balances and totals themselves or on the individual transactions which
make up the balance or total. Either tests of detail or analytical procedures.
Substantive procedures seek to provide evidence to support the financial statement assertions :
· balances – completeness, existence, valuation, rights and obligations, presentation and disclosure
· transactions – completeness (totals), occurrence, measurement, presentation and disclosure

Categories of substantive procedures :


· reperformance – auditor repeats (either wholly or in part) the same internal control procedures that were previously
performed by the client (e.g. reperforming the age analysis of stock and debtors)
· recalculation checks the arithmetical accuracy of source documents and accounting records (e.g. checking
depreciation totals) auditor can also compute figures which have not been computed by client.
· inspection of records or documents or tangible assets (e.g. inspecting fixed assets to confirm their existence or
inspecting a confirmation of balance certificate from a long term loan creditor)
· analytical procedures relating to the analysis of significant ratios and trends and include resulting investigation of
fluctuations and relationships that are inconsistent with other relevant information or which deviate from permitted
amounts.
· enquiry and confirmation by seeking information from knowledgeable persons inside or outside the entity.
rd
Enquiries might be formal written enquires addressed to 3 parties or informal oral enquires to staff. Enquires will
either give the auditor new information or will corroborate audit evidence that he already has.
Confirmation is procedure of obtaining a response to an enquiry to corroborate information contained in accounting
records (e.g. auditor sees confirmation of the existence of a debtor by direct confirmation with the debtor).

Vouching and verifying


Vouching relating to audit transactions collection of different
Verifying relates to balances substantive procedures

Duel purpose tests


Note that even though certain tests appear in the same categories difference evidence will be gather in different tests.
e.g. when auditor reperforms client’s bank reconciliation he does :
· test of control – obtaining evidence that the control procedure of reconciling has taken place and
· substantive control – gather substantive evidence about the ‘cash at bank” balance.

ISA 500 – Audit Evidence


ISA 330 – The Auditor’s Procedures in Response to Assessed Risks
Auditor should obtain sufficient appropriate audit evidence to be able to draw reasonable conclusions on which to base
the audit opinion. Nature of audit evidence is persuasive rather then conclusive and it is cumulative in nature.
Audit evidence is normally obtained regarding each financial statement assertion in respect of identified classes of
transactions and account balances.

Assertions are considered and applied in following categories :


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Audit evidence is more reliable when :


· it is obtained from independent sources outside the entity
· controls related to internal information are effective
· it is obtained directly by the auditor
· it is in documentary form (either paper or electronic)
· it is an original document and not photocopy or fax.

Basic principals to adhere to when obtaining certain types of audit evidence or when performing certain types of audit
procedures :
· when using information produced by the entity then must obtain audit evidence about the accuracy and
completeness of information. Use :
Ø test of controls over the production and maintenance of the information
Ø obtained as an integral part of the relevant audit procedure itself
Ø specific additional audit procedures
· if audit evidence from one source is inconsistent with audit evidence from another source, then auditor must
consider what additional audit procedures are needed to resolve the inconsistency
· CANNOT omit a necessary procedure during audit just to save costs
· auditor must always perform risk assessment procedures BUT not enough to provide sufficient appropriate audit
evidence and must be supplemented by tests of control and substantive procedures
· tests of control needed when :
Ø auditor’s risk assessment includes an expectation that internal controls are functioning effectively (operating
effectiveness) – control risk at a level less then high
Ø substantive procedure alone do not provide sufficient appropriate audit evidence
· substantive procedures are always required to obtain sufficient appropriate audit evidence for material classes of
transactions, account balances and disclosures – cos the assessed risks of material misstatement (assessed levels
of inherent risk and control risk) can never be zero cos of the judgmental nature of the auditor’s risk assessment
and limitations of internal control.
· conclusions of the auditor in forming his opinion with regard to each individual audit item as well as financial
statements as a whole are based on the audit evidence obtained
· in forming audit opinion the auditor evaluates the sufficiency and appropriateness of the audit evidence obtained – if
unable to obtain sufficient appropriation audit evidence in respect of a material financial statements assertion then
must express a qualified opinion or disclaimer of opinion.

Auditor’s response to assessed risks at the financial statement level


Risk assessment procedures identify risks of material misstatement at the financial statements level – auditor should
determine overall responses that may include :
· emphasizing to the audit team the necessity to maintain an attitude of professional skepticism in gathering and
evaluating audit evidence
· assigning more experienced staff to the audit
· assigning specialised skilled staff
· making use of the experts
· providing more supervision
· making general changes to the nature, timing and extent of audit procedures
Part of auditor’s overall response at financial statements level is to decide on general audit approach :
· general substantive approach (emphasis on substantive procedures)
· general combined approach (tests of control and substantive procedures)
Primary consideration in determining overall audit approach is how the auditor understands the entity’s control
environment. Weakness in the entity’s control environment would prompt the following responses from the auditor :
· seek more evidence from substantive procedures
· conduct more procedures as at the period end rather than at an interim date
· obtain more persuasive audit evidence
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· increase the number of locations to be included in the audit scope
Auditor must document his overall responses to address assessed risks at financial statements level in accordance with
the basic principles and essential procedures of ISA 230.

Auditor’s response to assessed risks at assertions level including considerations regarding nature, timing and
extent of audit procedures
Risk assessment procedure performed by the auditor identifies risks of material misstatement at the assertions level –
auditor should design and perform further audit procedures to respond to these risks.
Auditor must design and perform audit procedures whose nature, timing and extend are responsive to assessed risks at
the assertions level :
· nature of audit procedures – refers to purpose and type of procedures that include inspection, observation,
inquiry, confirmation, recalculation, reperformance and analytical procedures
· timing of audit procedures – refers to when an audit procedure is performed or the period or date to which the
audit evidence applies
· extent of audit procedures – refers to quality of specific procedure to be performed
Valid audit conclusions are possible by using sample basis.

see pgs 49 to 54 of ISA 330 & ISA 500 – obtaining Audit Evidence of Financial Statements (Summary
and Interpretations, incorporating aspects of general audit theory)

Study guide pg 94
Assertions are made by management when presenting the financial statements. Categories of the financials statement
are the balance sheet, income statement, cash flow statement and notes.
Simply by presenting financials management is saying that all the assets, liabilities, income and expenditure are
complete, did occur, did actually exist, have been correctly recorded, at the correct value and the rights and obligations
have been correctly presented and disclosed.
When performing audit, auditor obtains audit evidence for every assertion in the financial statements.

Summary of the assertions or statements that management makes with regard to balances and transactions
contained in the balance sheet or income statement of an entity :
Income Statement & Balance Sheet
Balance Sheet (asset & liabilities
Assertion (transactions) balances)
Completeness X X
Occurrence X
Accuracy X
Cut-off X
Classification X
Existence X
Valuation & Allocation X
Rights & Obligations X
Presentation & Disclosure X
see Do 1 examples on pg 96 of study guide (examples of describing assertions)

Tests of control are carried out in order to collect audit evidence regarding the design of accounting and
internal control systems and the operation of the systems during the audit.
Tests of control can be following :
· description of the accounting and internal control systems
· control questionnaire aimed at identifying poor and good control measures
· tests of control
· conclusions
· recommendations

Substantive procedures are carried out to support assertions in the financial statements
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ISA 500 emphasises that MUST obtain auditor evidence in respect of each assertion for balance sheet and income
statement transactions and balances. – CANNOT obtain audit evidence for one assertion and not obtain audit evidence
for another assertion.
e.g. if obtaining audit evidence on debtors : existence would be proven by comparing the monthly statements with the
balances in the debtor’s ledger – but won’t prove that all the debtors have been completely accounted for. To
check the completeness of the debtors, the auditor should check the reconciliations between the debtor’s ledger,
list of debtors and the debtor’s control account.
Some kinds of audit evidence can also support more then one assertion – e.g. obtaining a management certificate in
respect of debtor’s balances provides supplementary audit evidence in respect of the existence, completeness, value,
rights and presentation and disclosure of debtors – BUT just cos have management certificate regarding all the
assertions doesn’t mean that auditor doesn’t have to carry out further audit procedures in support of the specific
assertions.

Sufficiency of audit evidence determines how MUCH audit evidence is required and should be obtained by the auditor.
Is influenced by :
· nature and level of inherent risk
· assessment of the control risk
· materiality of items
· experience gained by auditors during previous audits
· results of audit procedures
· source and reliability of audit evidence.

Sources of audit evidence influence evidence’s reliability. Sources can be :


· external sources
· internal sources
· audit evidence obtained by the auditor directly.
Can be in form of documents, oral statements or written statements.

Appropriateness of audit evidence measures the quality of audit evidence and its relevance to a particular assertion.
Appropriateness also depends on the extent to which it will help the auditor achieve the set audit objectives which are
based on the assertions with regard to certain income statement and balance sheet transactions and balances which
the auditor intends to investigate.
Auditor should weigh up the cost of obtaining audit evidence against the usefulness of such evidence – degree of
difficulty and cost do not in themselves constitute a valid reason for failing to carry out the necessary audit procedures.

Reason’s why an auditor may decide not to rely on a client’s internal controls :
· preliminary investigation of the internal control system for a specific type of transaction indicated that the system
cannot be relied on
· volume of transactions of that type is insufficient to justify tests of controls
· risks of material misstatement at the assertion level can be reduced to an acceptable low level with audit evidence
obtained from substantive procedures.

Influence of auditor’s decision not to rely on the internal controls on the audit process means that he will NOT perform
tests of controls, but should rather carry out more extensive substantive procedures – BUT must still keep audit risk at
an acceptable level.

Professional judgement used by auditor to determine what audit evidence he needs :


· to achieve his audit objectives
· how reliable the evidence is
· whether evidence is persuasive
· if collection is cost-effective

Auditor uses his professional judgement in evaluating the audit evidence what has been collected regarding the
assertions in the financial statements. Influenced by :
· significance of the potential misstatement in the assertion and the likelihood of its material effect on the financials
(either individually or aggregated with other potential misstatements)
· effectiveness of management’s responses and controls to address the risks
· experience gained during previous audits with respect to similar potential misstatements
· results of audit procedure performed (including whether these audit procedures identified specific instances of fraud
or error)
· source and reliability of the available information
· persuasiveness of audit evidence
· understanding of the entity and its environment – including its internal control
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If auditor has not obtained sufficient appropriate audit evidence for a material financial statement assertion and is
unable to obtain sufficient appropriate audit evidence then he should express a qualified opinion or disclaimer of
opinion.

Auditor should document the overall responses to address the assessed risks of material misstatement at the financial
statement level and the nature, timing and extent of further audit procedures and the linkage of these procedures with
the assessed risks at the assertion level and the results of the audit procedures.
If auditor plans to use audit evidence about the operating effectiveness of control obtained in prior audits then should
document the conclusions reached with regard to replying the control that were tested in a prior audit.
see full ISA 330 – Auditor’s Procedures in Response to Assessed Risks
do questions in section 4.2 of tutorial 102 and check answers in the key of section 4.2 of tutorial 103

Study Topic 4.3 – Materiality and Audit Risk


ISA 320 – Audit Materiality
Jackson & Stent pgs 7/15 to 7/22

So as to be able to express an audit opinion on the fair presentation of the financial statements in all material aspects,
the auditor must determine what is material using professional judgement. Materiality depends on the size of the item
or error in relation to the particular circumstances in which it was omitted or misstated.
Audit risk is the risk that the auditor may express an inappropriate audit opinion when the financial statements
have been materially misstated.
In order to estimate audit risk and design audit procedures to keep the risk at an acceptable low level – auditor must first
have a suitable knowledge of the accounting and internal control system so as to plan the audit and develop an effective
audit approach.
When audit carried out, auditor should consider the question of materiality and its relationship to audit risk.

Jackson & Stent pgs 7/15 to 7/22


Concept of Materiality
Materiality fundamental concept in auditing – audit report is statement by auditor that the financial statements do not
contain any material misstatement (in his opinion). Although accepted that there may be errors or uncertainly in
financials it has to be an acceptable level of uncertainly or financials are worthless. Once misstatement falls outside
acceptable margin it becomes material and will effect user’s decisions.
Something will be material if a reasonable user of financial statements should know about it when making a decision
based on the financials (reasonable user = user who has a reasonable knowledge of business and economic activities
and accounting and a willingness to study the information with reasonable diligence.)

Planning materiality and final materiality


Auditor should consider materiality at :
· planning stage when determining nature, timing and extent of testing (planning materiality)
· at final stage in audit process when evaluating the effects of misstatement (final materiality)
(so used first as guideline in planning the audit and then as a guideline in evaluating unresolved matters at the end of
the audit).

Nature of materiality
· materiality is very subjective – largely decided by professional judgement and so different auditors will have
different decisions when setting up a materiality level (level of acceptable misstatement) at planning stage or
deciding if a particular matter is material to fair presentation at the evaluating stage.
· materiality is relative, not absolute – what is material will vary from user to user and from client to client and what
might be material to small company won’t be material to large company. Need to establish bases against which
materially can be measured so some auditing firms set a planning materiality level which can use percentages of
account headings as a starting point or rule of thumb.
Most important point is that most misstatements affect the income statement and the balance sheet BUT CAN BE
MATERIAL TO ONE AND NOT THE OTHER. So better to use the net income before tax as a basis to measure the
materiality of the misstatement as it is “truer” figure and so materiality will be more relevant to the company.
Note : ISA 320 doesn’t set any percentages to be used for setting materiality levels so auditor needs to use his
professional judgement.
· materiality is both quantitative and qualitative :
Ø quantitatively material amount is one that exceeds the amount which the auditor has determined is material
(so that is the amount of misstatement what would influence the decisions of a user)
Ø qualitatively material amount is one which is regarded as material when judged against a factor other then an
amount – so if an important disclosure is omitted from the financials and the omission would influence a user.
Both the quantitative and qualitative aspect of materiality should be considered by the auditor as something might
be material in respect of one and not the other.
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Planning materiality
Dealt with differently be different audit firms – can either use a Rand amount based on guideline percentages or can
work with set formulas, or can just use concept to focus audit in a general way to get an idea of what is important.
Using planning materiality in a general way
Basically auditor will identify account headings or classes of transactions that appear important in relation to the other
accounts. Once have largest amounts will use majority of audit resources (time and expertise) to assess the risk of
misstatement and then carrying out the audit procedures on these account headings. This is basic audit strategy and
audit plan in general way
Setting planning materiality levels
Actually quantifying the amount of misstatement which can be in the financial statements without it affecting fair
presentation. (What amount of misstatement is acceptable?)
Once done then will be to consider the amount of misstatement that is acceptable within an account heading or class of
transaction – decision as to what amount will influence the fair presentation of the financials will have a direct effect on
the extent of the testing and the nature and timing of audit testing. Also remember that what might not be material
against a large account like stock or property, plant and equipment may be high against net profit before tax.
Inverse relationship between materiality and audit risk. So lower the materiality level the higher the audit risk, and
more amount of testing. Higher materiality level the less audit risk but less amount of testing that has to be done.
Materiality level Extent of testing Audit risk
Lower materiality level Greater Greater

Higher materiality level Less Less


Planning for qualitative misstatement
Qualitative misstatement deals with disclosure – once have a thorough understanding of the entity and its environment
and before auditor considers materiality he should have a good idea about disclosures which could influence user if they
are omitted or inadequately presented.
Could be :
· inadequate or improper decisions of accounting policies which could mislead the user
· litigation in which the client is involved or
· failure to disclose the possible cancellation of a manufacturing license
Factors to be considered when planning materiality :
· use of preset guidelines
· importance of specific information to users – if there is a special importance for one specific account that will
give rise to a stricter planning materiality level e.g. bank has provided loan to client provided current ratio is
maintained. This would them meant that the bank would be specifically relying on the fair presentation of the
current assets and current liabilities and auditor would plan the audit to ensure that they are fairly presented
· legal requirements – any specific legal requirement would be carefully and thoroughly audited to ensure that
misstatement (quantitative or qualitative) is kept at an acceptable level e.g. figure that must be specifically disclosed
in terms of the JSE Securities Exchange regulations
· preliminary judgements about materiality based on draft or preliminary figures – auditor will have to consider
if planning materiality needs to be adjusted in the client’s final figures differ from the draft figures.

Final materiality
Planning materiality is done before audit and the risk of misstatement is assessed and then the auditor forms the audit
plan (nature, timing and extent of testing that will be done). Auditor then carries out the selected audit procedures which
are normally samples of different accounts (populations). Errors will be found in the samples and as audit conclusions
are drawn from the populations where the sample came from the auditor, must analyze and project the error in the
sample over the population that has been sampled either by :
· using statistical basis – if has used statistical basis for selecting the sample then must use the appropriate
statistical method for projecting the error in the sample over the population
· proportional method – to obtain an idea of the extent that the population is misstated :
error value in sample x total value of population
total value of sample
Whichever method of projection is used – if the projected misstatement for the population is unacceptable then the
auditor must decide if further tests should be carried out by the audit team or if the client should be asked to
check the population in detail for further errors.
Auditor will then discuss all misstatements with management in an attempt to have them rectified. If
management won’t correct the misstatement then auditor left with unresolved audit differences and this is when use
final materiality.
Management might refuse to correct misstatements because they may :
· disagree that there is a misstatement – client thinks that their estimation of stock obsolescence is fair but auditor
thinks that it is too low
· not regard the misstatement as material – i.e. it would not influence a user
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· have ulterior motives – e.g. directors want to achieve particular ratios which are based on figures in the financial
statements and if the auditor’s adjustments are made then the ratios will not be achieved
· regard it as “too much hassle” to make the changes – e.g. adjustment would mean changing the income
statement, balance sheet, consolidation etc
· be unconcerned about receiving a qualified audit opinion
Auditor must decide if the unresolved audit differences are immaterial (so will not influence the decision of the user) or if
they are material (so failure to correct them will result in financial statements which contain more misstatement then is
acceptable i.e. some of the financials will not be fairly presented and the auditor will have to give a qualified opinion.)
Decision is not just deciding that final materiality should be equal to planning materiality and anything over that would be
material – still have to consider various factors at the evaluation stage.

Factors to be considered in evaluating unresolved audit differences :


· known errors and likely errors ;
Ø known error is a misstatement that the auditor and client can clearly identify and substantiate with supporting
evidence (e.g. sales invoice in the wrong period). Auditor can be more forceful in requesting that the error is
correct and if management refuses then the auditor is on strong grounds when he decides to qualify the audit
opinion
Ø likely error is misstatement that the auditor is unable to specifically quantify and substantiate because there is
a level of subjectivity or uncertainty associated with the error (e.g. provision for doubtful debts). Auditor has to
be less forceful and more open to discussion and negotiation when insisting that the correction is done and
qualifying the report because the error is of a subjective nature.
So main difference is the way in which the attitude or stance of the auditor differs when dealing with these two
errors.
· misstatements should not be considered in isolation – must be aggregated and trends or patterns of
misstatement should be carefully evaluated. e.g. if general trend of understating provisions then are the directors
trying to manipulate the financials?
· statutory or other contractual obligations – auditor will not tolerate quantitative or qualitative errors in accounts
that must be specifically disclosed e.g. directors emoluments
· nature of the misstatement :
Ø error in principle is more important then misallocation of an expense – i.e. auditor will be strict regarding
incorrectly applied financial reporting standards
Ø misstatement due to dishonesty of director is regarded as serious, not just ignored as it may not be
quantitatively material
Ø in subjective misstatements auditor can be a bit less strict cos these are essentially estimates e.g. allowance for
obsolete stock
· impact of the misstatement – auditor must assess the impact of the misstatement with ‘common’ figures or ratios,
e.g. earnings per share as that is a figure commonly used so auditor must ensure it is presented as fairly as
possible
· absolute and relative size of the misstatement – auditor will consider the size of the misstatement in its absolute
form – e.g. known error of R 1 mill is unacceptable just by virtue of its size. Misstatement must also be considered
relative to other accounts (i.e. error may be material in debtors but not relative in current assets).
In making decision as how to decide if unresolved audit difference is material auditor may be influenced by the
difficulty or inconvenience of rectifying the misstatement, however this is professionally unacceptable (e.g.
misstatement in depreciation means correcting IS, BS, cash flow and notes so client will not be happy).

ISA 320 – Audit Materiality


Auditor needs to consider the possibility that small errors could have a material effect on the financials e.g. an error in a
month end procedure could be repeated 12 times in financials and have potential to be a material misstatement.
Auditor’s assessment of materiality and audit risk can be different at the time of initially planning the engagement to the
time of evaluating the results of audit procedures. Could be because of :
· change in circumstances
· change in auditor’s knowledge as result of performing audit procedures
· having actual figures (in planning prior to end of year the auditor anticipates the results of operations and the
financial position – if actual results are substantially different then assessment of materiality and audit risk may have
to change
· auditor setting the acceptable materiality level at the lower level during planning then he intends to use to evaluate
the results of the audit so that likelihood of undiscovered misstatements is reduced and auditor has margin of safety
when evaluating the effect of misstatements during the audit.
When evaluating the financials (i.e. are they prepared in all material respects in accordance with an applicable financial
reporting framework) auditor must assess if the aggregate of uncorrected misstatement that have been identified during
the audit is material.
Aggregate of incorrect misstatements comprises :
· specific misstatements identified by the auditor including net effect of uncorrected misstates identified during the
audit of previous periods
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· auditors best estimate of other misstatements that cannot be specifically identified (projected errors)
If auditor concludes that the total of uncorrected misstatements is material then auditor needs to consider reducing the
audit risk by extending audit procedures or requesting that management adjusts the financial statements.
If aggregate of uncorrected misstatements that has been identified by auditor is close to materiality level then auditor
needs to consider if it is likely that the undetected misstatements plus the total uncorrected misstatements could exceed
the materiality level. If it is likely that it does then the auditor must consider reducing audit risk by performing additional
audit procedures or by requesting that management adjust the financial by the identified misstates.

Study Guide pg 104


Audit materiality = an omission or statement where the influence of this omission or statement will have an
effect on the economic decisions of users based on the information of the financial statements.

Reasons why it is important for the auditor to consider materiality :


· to plan audit procedures so that possible errors can be detected where those errors could be material (individually
or in total) for the financial information under audit
· to determine the extent of the audit procedures – limited or no further auditor procedures will be carried out if the
item is not considered to be material after evaluation
· to assess the audit difference at the end of the audit – auditor should request that management adjust the financial
information if material errors have occurred in order to ensure fair presentation in the financials
· contribute to audit efficiency and cost effectiveness
· to help with the formulation of an opinion regarding the reasonableness of the financial statements

Purpose of making a preliminary assessment of materiality during the planning of an audit to :


· enable auditor to plan audit evidence in such a way that he will examine sufficient audit evidence to detect possible
errors which could (individually or in total) be material for the financial information under audit
· enable the auditor to choose audit procedures which could collectively reduce the audit risk to an acceptably low
level
· help the auditor in the case of accounting balances and transactions classes to decide which items should be
investigated and if sampling and analytical procedures should be applied.

Reasons why planning materiality can differ from the auditor’s assessment of final materiality
Auditor usually considers materiality for planning purposes even before the financial information to be audited has been
compiled – so materiality is merely being estimated on the basis of provisional, forecasts / budgets etc from previous
periods
During evaluation and conclusion stage of auditor, materiality is established on the actuals on which he is reporting, so
final materiality (actuals) may differ from planning materiality (estimated).
Auditor may also set planning materiality at a lower level then the expected final materiality in order to ensure that they
have based the audit procedures on a conservative estimate of materiality.

Factors to be taken into account to determine materiality :


· that the two major elements are present in each item – the amount (quantitative) and the nature (qualitative)
· auditor must take into account not just the total amount of an item but also the relationship this amount bears to the
financial information as a whole (or to the total of the group of items that it was taken)
· in determining materiality auditor should select an element (or combination of elements) of the financial statements
that best represents the size of the entity as a percentage (or percentage group) of that element. When selecting
an appropriate element must take the following into account :
Ø which elements (or combination of elements) of the financials are the best indicators of the size of the entity
(e.g. share capital, assets, income etc)
Ø the stability of the appropriate elements over a periods (e.g. turnover is likely to be less variable then income)
Ø if balance sheet or income statement elements are the best indicators of the size of the entity (e.g. in leasing
company then income statement elements will be best indicator, in financial institution balance sheet elements
are best indicators)
· auditor should consider if the item in best related to :
Ø overall amount of the financial information or
Ø total of associated items or
Ø corresponding item in previous years
· if item relates to both income statement and the balance sheet then auditor should take care to choose the
comparison that correlates best with materiality (e.g. bad debts written off and provided for will relate closer to sales
then the provision alone will relate to accounts receivable)
· accuracy with which an item is calculated can also play a part in assessing its materiality (e.g. will expect precision
in a bank balance but less precision expected in estimated provision for doubtful debts)

Calculating materiality
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Normally matter for professional judgment but can use following as guidelines :
· pre-tax income – between 5% and 10%
· total assets or gross profit – between 1% and 2%
· average of total assets and income – percentage used or statistical procedures (such as regression analysis)
Auditor can use any basis for calculating materiality as long as he can give reasons for his decisions in respect of that
specific client.

In evaluating the fair presentation of the financials auditor also has to decide if the total of uncorrected misstatements
(both qualitatively and quantitatively) that were detected in the course of the audit are material or not.
If material then auditor should consider :
· reducing the audit risk by carrying out further audit procedures or
· requesting management to correct the financials.
see example of how to calculate the materiality figure on pg 108/109 of study guide

ISA 320 – Audit Materiality


ISA 200 – paragraph 22 to 32
Jackson & Stent pgs 7/23 to 7/29

Jackson & Stent pgs 7/23 to 7/29


Assurance engagement risk = risk that the practitioner expresses an inappropriate conclusion when the financial
statements are materially misstated.
Risk that the auditor will give an unqualified opinion when should have given a qualification (or disclaimer).

Auditor identifies the financial statement assertions which may be at risk of misstatement and tries to counteract the risk
by designing an audit strategy and audit plan that reduces the risk that there are material misstatements that won’t be
detected to an acceptable level.
If auditor fails to identify the factors that give rise to the risk of material misstatement and fails to respond to them then
audit risk increases.
If auditor doesn’t understand the entity and the entity’s environment then more likely to fail in identify potential risk and
therefore audit risk is increased.

ISA 200 identifies 3 components of audit risk :


· inherent risk
client’s risk
· control risk
· detection risk – auditor’s risk

Inherent risk (“built in” risk)


Susceptibility of an assertion to a misstatement that could be material (either individually or in total) assuming
there are no related controls. (so complex calculations are inherently more likely to be misstated then simple
transactions). Also more inherent risk in valuing stock which has inherent characteristics that make it more difficult to
identify (e.g. diamonds) so auditor may have to call in expert to value these goods.

Control risk
Risk that a misstatement that could occur in an assertion and that could be material (individually or in total) will
not be prevented or detected and corrected on a timely basis by the entity’s internal controls. (So if internal
control system doesn’t detect the error then high chance that there will be misstatement that the auditor is not aware
off).
Basically control risk dependent on the design and operation of the internal controls achieving its objectives but because
of the inherent limitations of the internal controls the control system will not be perfect and there will be some control
risk.
Inherent limitations of the internal control system :
· management’s requirement that the cost of the internal control doesn’t exceed the expected benefits to be
derived (cost / benefit)
· most internal controls are directed at routine transactions rather then non-routine transactions
· potential for human error due to carelessness, distraction, mistakes of judgement and misunderstanding
instructions
· possibility of circumvention of internal controls through collusion of a member of management or employees
with parties either inside or outside the company
· possibility that person responsible for the internal control will abuse that responsibility (e.g. management
overriding a control)
· possibility that procedures may become inadequate due to changes in conditions and compliance with control
procedures may deteriorate
Control activities can be put in place by a client to achieve internal control objectives such as :
· strong control environment
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· efficient risk monitoring system must be evaluated
· segregation of duties by auditor
· physical and logical access controls
Not just sufficient for the auditor simply to identify the weaknesses in the internal control system – auditor also has to
evaluate the effect on the financials assertions.

Detection risk
Risk that auditor will not detect a misstatement that exists in an assertion that could be material, either
individually or in total with misstatements in other assertions.
Detection risk relates to the effectiveness of an audit procedure and how the audit procedure is applied. Can arise cos
auditor :
· selects an inappropriate audit procedure
· misapplies an appropriate procedure
· misinterprets the results of a test
All these should be kept to absolute minimum.
Detection risk has inverse relationship to the combined level of inherent risk and control risk. (So when inherent and
control risks are assessed as being high then the acceptable level of detection risk must be low so that audit
risk is kept to an acceptably low level)
Acceptable level
Inherent Risk Control risks of detection risk
Low
High High (audit risk must
also be kept low)
If inherent risk and control risk at a client evaluated as being high there is a strong possibility of material misstatement in
the financial statements. Auditor must minimize the chance of expressing an inappropriate opinion on financials so
must therefore reduce the audit risk to an acceptable level.
Done by adopting an appropriate audit strategy and plan and assigning the right staff (competent and experienced) and
by getting the nature, timing and extent of the audit procedures right. By doing this you reduce the risk of failing to
detect the misstatements which you expect (cos of high inherent and control risks) to an acceptable level which is
therefore a low detection risk.
Auditor has no control over inherent built-in risks and management is responsible for internal control, but auditor can
respond to those risks by reducing the detection risk.
Detection risk is controlled by the auditor.

Risk at financial statement level and at assertion level


ISA 200 states that material misstatement must be assessed at 2 levels :
· overall financial statement level and
· assertion level.

Risk at financial statement level


Risk which effects the financial statements as a whole and which filters down into the account balances and
totals of the financials. Risks of this nature normally related to client’s control environment and not necessarily
identifiable with specific assertions at transaction, account balance or disclosure level e.g. if management lacks integrity
then audit as a whole is more risky as management may attempt to manipulate the account balances and totals and
therefore this will effect the financials.
Auditor’s response at financial statement level will be of a general nature and will include :
· assigning staff with appropriate experience and skills
· providing more supervision
· emphasizing (with engagement team) the need for professional skepticism
· incorporating additional elements of unpredictability (e.g. surprise visits to a client)
· make changes in the way the audit has been conducted in the past
Situations or conditions that may affect risk at financial statement level :
· integrity of management
· management experience and knowledge (e.g. inexperience of management can effect preparation of financials)
· unusual pressures on management (e.g. circumstances that may cause management to misstate financials such as
entity doesn’t have sufficient capital)
· nature of entity’s business (e.g. :
Ø potential for technological obsolescence of its products and services
Ø complexity of its capital structure
Ø significance of related parties
Ø number of locations and geographical spread of its production facilities
· factors affecting the industry in which entity operates (e.g. economic and competitive conditions identified by
financial trends and ratios, changes in technology and consumer demand)
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Risk at assertion level


Auditor will have to respond to risk by introducing specific detailed procedures into the audit plan.
Situations or conditions that may affect risk at assertion level :
· susceptibility of accounts to misstatement (e.g. accounts that involve a high degree of estimation)
· complexity of underlying transactions making up the account balance or class of transaction balances (e.g. sale
and leaseback / contract accounting)
· degree of judgement involved in determining account balances
· susceptibility of assets to loss or misappropriation (e.g. cash or other assets that are highly moveable –
completeness of cash from cash sales)
· completion of unusual and complex transactions, especially at or near year end (i.e. are they real or are they an
attempt to manipulate the financials)
· transactions not subjected to routine processing
Once auditor has decided that there may be a risk then must assess how this risk may affect the assertions that are part
of the financials. (Note : auditor will also address the risk at financial statement level as well e.g. by assigning an
experienced member of the audit team to the higher risk area).
Vital to understand the client and client’s environment, including the internal controls to be able to identify the numerous
factions that affect risk. Also vital is ability to evaluate which assertions are effected and how they are affected.

Risk and materiality


Whenever risk assessment is performed then materiality must be considered – i.e. if account heading or class of
transactions is immaterial then it cannot attract any audit risk.
If found that there is an immaterial error or omission then auditor’s risk of expressing an inappropriate opinion is minimal
but auditor cannot simple ignore the weakness – must be reported to company in management letter.
Assessment of audit risk
When risk is assessed there is normally a comparison and level of risk is directly affected by circumstances at the client.
So if there is a complicated transaction then more chance that there would be assertion error then for simple
transaction.
see example of risk of leased assets compared to purchased assets on pg 7/28 of text book.

Levels of risk
Difference ways of describing risk – can either be :
· high, medium or low
· pervasive or
· increased or decreased
Only level of audit risk in the auditing standards is significant risk, but impossible to say what constitutes significant risk
or how significance risk changes to non-significant risk cos of differences in every audit, so have to rely on experience
and professional judgement that are used to assess risk and potential severity of material misstatement.
Nature of the risk is part of classifying if risk is significant and following all suggestions that significant risk is
present and that special consideration should be given if risk :
· is risk of fraud (e.g. manipulation of financial data)
· is related to recent significant accounting or other developments and therefore requires special attention (e.g.
introduction of IFRS’s
· arises from the complexity of certain transactions (e.g. complex merger or acquisition)
· involves related parties (e.g. inter-company transactions within group)
· non-routine, unusual, infrequently occurring transactions (e.g. BEE transactions)
Main issue is what procedures auditor puts into place to reduce the risks to an acceptable level.

Study guide pg 109


Auditor should conduct the audit in such a way that audit risk is kept down to a level which in his professional judgement
is acceptable for the auditor to express an opinion on the financial information.
Always possibility of audit risk so important that auditor identity’s risks that could cause the financial statements to be
materially misstated and then adjusts his audit approach to reduce the audit risk to an acceptable level.

Assessment of inherent risk is a question of professional judgment and auditor can use standard questionnaires or
reviews of what factors should be taken into account when assessing the inherent risk.

Auditor assesses the control risk by carrying out tests of control in order to obtain audit evidence in respect of :
· effective design of the accounting and internal control system and
· effective operation of the internal controls throughout the entire period under review.
Tests of control are :
· inspection
· observation
· confirmation
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· recalculation
· reperformance
· analytical procedures
Influence of high estimate of control risk on detection risk, audit risk and the nature and extent of the audit procedures to
be performed – high control risk implies that the internal controls may be limited or completely absent, or that the set up
internal controls are not working the way they should be.
If high estimate of control risk then auditor must take the following actions and decisions :
· after preliminary evaluation of internal controls the auditor may decide not to rely on them
· auditor would not plan to carry out tests of control
· would only carry out substantive procedures to achieve acceptable level of audit risk (detection risk will be low cos
of inverse relationship with control and inherent risk)
· extent of substantive procedures will be expanded
· cos of increase in extent of substantive procedures the audit risk will be reduced to an acceptable level.
If low control risk then good internal controls have been implemented and they are functioning in the way that they
were designed to. Auditor will then decide to take the following actions and decisions in response to the low
assessment of control risk :
· after preliminary evaluation auditor would decide to rely provisionally on internal controls
· tests of controls will be carried out and depending on the results and conclusion the auditor will determine to what
extent it is possible to rely on the internal controls
· if the results of the tests of controls indicate that the internal controls have not functioned the way they were
designed to then auditor would assess the level of control risk as high and would then carry out more
comprehensive substantive procedures
· if the results of the tests of controls indicate that the internal controls have function in the way they were designed to
then the auditor can reduce the extent of the substantive procedures
· cos of reduction in the substantive procedures audit risk will be high (cos of inverse relationship with control and
inherent risk)
· because of the reduction in the extent of the substantive procedures the audit risk will be reduced to an acceptable
level

Auditor can limit his detection risk by performing substantive procedures to reduce the risk of material management.

Components of audit risk are inherent risk, control risk and detection risk.
Inherent and control risks are independent of the audit, but detection risk relates to the efficiency of the auditor’s
substantive procedures.
Auditor must first assess inherent and control risk and this will then directly influence the nature, timing and extent of the
substantive procedures he will carry out. Higher the inherent and control risk the more audit evidence the auditor
will obtain by means of substantive procedures in order to reduce his audit risk.
Interaction between components of audit risk can be expressed as :
audit risk = inherent risk x control risk x detection risk
Inverse relationship between detection risk and the combined level of inherent and control risk – when inherent and
control risk are high the acceptable level of detection risk must be low in order to reduce the audit risk to an acceptably
low level (so more substantive procedures must be carried out).
But if inherent and control risk are low then the auditor can accept a higher detection risk and still reduce the audit risk
to acceptably low levels cos the client’s internal controls, accounting and internal systems are so good that they prevent,
identify and timeously correct any material errors or omissions and so the auditor can accept a higher detection risk and
carry out less extensive substantive procedures.
see pgs 112/113 of study guide for practical example of system evaluation.

Audit risk in small businesses


No matter the size of the entity under audit the auditor should obtain the same level of assurance before expressing an
unqualified opinion on the financial statement
Small business have the following characteristics :
· small number of employees
· limited segregation of duties
· domination by senior manager or the owners of the business
· few owners or shareholders
· main source of income derived from one industry
· simple accounting systems.
This can lead to the following risks :
· record-keeping is informal or inadequate
· major risk that the financial statements are inadequate or incomplete
· auditor often helps to compile the accounting records and financial statements (management could incorrectly think
they are not responsible for that)
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· risk that management could circumvent internal controls
· effectiveness or success of internal control dependent on the personality of the owners or management.

Inverse relationship between audit risk and materiality


· higher the assessment of audit risk the lower the amount that would be specified as the material amount in order to
avoid failing to detect any possible misstatements in the financials
· lower the audit risk the higher the amount at which materiality would be fixed (only a very small chance that material
misstatement could occur and remain undetected).

Materiality directly influences the nature, extent and timing of the audit procedures
if audit risk is high = low materiality figure should be established
if audit risk is low = higher materiality figure can be accepted

e.g. entity has a pre-tax profit of R 1 million


· if auditor assesses the audit risk as high :
auditor would establish materiality at a lower level, say 5% which would mean a materiality rate of R 50 000 so
any errors (individual or in total) in excess of R 50 000 would be considered material.
Smaller amount of materiality would therefore increase the change of detecting material errors
· if auditor assesses the audit risk as low :
auditor would accept a higher materiality figure – say 10% which would mean a materiality rate of R 100 000 so
any errors (individual or in total) in excess of R 100 000 would be considered material.
High materially figure would reduce the chances of detecting material misstatements.

do questions in section 4.3 of tutorial 102 and check answers in the key of section 4.3 of tutorial 103
TOPIC 5 – THE PRACTICAL APPROACH TO AN AUDIT
Study Topic 5.1 – Risk Management and Internal Control
ISA 315 – Understanding the entity and its environment and assessing the risks (including appendix
1 to 3)
Jackson & Stent pgs 5/1 to 5/9
Jackson & Stent pgs 7/4 to 7/14

Study Guide pg 120


Risk management is the identification and evaluation of actual and potential risk areas as they pertain to the company
as a total entity, followed by process of either termination, transference, acceptance (tolerance) or mitigation of every
risk.
Internal control is the process designed to offer reasonable assurances that the objectives of management are being
achieved (including risk management)
Auditor must contain sufficient understanding of the accounting system and internal controls to enable him to plan the
audit and develop an efficient auditor approach. Auditor should document his understanding of the accounting system
and internal controls and the assessment of control risk in the audit working papers.

Internal control environments

Control environment
· sets tone of organisation – influencing control consciousness of its people
· factors including integrity, ethical values, competence, authority, responsibility
· foundation of all other components of control

Risk assessment
· identification and analysis of relevant risks to achieving the entity’s objectives
– forming the basis for determining control activities

Control activities
· policies / procedures that ensure management directives are carried out
· range of activities, including approvals, authroisations, verificiations,
recomendaitons, performace reviews, asset security and segregation of duties

Information and communication


· pertinent information identified, captured and communicated in timely manner
· access to internal and externally generated information
· flow of information that allows for successful control actions from instructions on
responsibilities to summary of findings for management action

Monitoring
· assessment of a control system’s performance over time
· combinations of ongoing and separate evaluation
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Jackson & Stent pgs 7/4 to 7/14


Understanding the entity and its environment
Business risk – risk resulting from significant conditions, events, circumstances, actions or inactions that might
adversely affect the entity’s ability to achieve its objectives and execute its strategies
Internal control – process designed and effected by those charged with governance, management and other personnel
to provide reasonable assurance about the achievement of the entity’s objectives regarding reliability of financial
reporting, effectiveness and efficiency of operations and compliance with applicable laws and regulations.
Material weakness – weakness in internal control that could have a material effect on the financials
Risk assessment procedures – audit procedures performed to obtain an understand of the entity (including internal
controls) and its environment to identify and assess the risks of material misstatement due to fraud or error at financial
statement and assertion levels
Significant risk – risk of material misstatement that in the auditor’s judgment requires special audit consideration

Risk assessment procedures


Carried out by auditor to evaluate the risk of the presence of material misstatement in the financials. Once has been
done then procedure to address the risks can be formulated.
Intention is to gather information about the client. Risk assessment procedures normally include :
· inquires from management and others – especially financial personnel, those charged with governance (i.e. audit
committee), internal audit, IT personnel, legal personnel, sales and production personnel
· observation and inspection of :
Ø operations
Ø business premises
Ø company documents
Ø management reports
Ø minutes of meetings
· analytical procedures – ratio and trend analysis, comparison (prior year and industry) and evaluation of unusual or
unexpected relationships (e.g. increase in sales but decline in gross profit)
· other audit procedures – reviewing external sources of information, inquires of external parties who render
services to the client (lawyers, banks etc), consulting previous audit team.

Entity and its environment


Auditor should have an understanding of :
· relevant industry factors
Ø risk profile
Ø cyclical or seasonal
Ø government monetary policy
· regulatory factors
Ø accounting principles
Ø legal and regulatory framework
· other external factors

Nature of the entity


· products, markets, suppliers and operations
Ø nature of business
Ø location of all facilities
Ø labour and employment
Ø products and markets
Ø stock locations, quantities and types
Ø franchises, licenses and patents
Ø research and development
Ø internal trading
· ownership and governance
Ø structures
Ø BEE
Ø management philosophy
Ø board of directors
Ø operating management
Ø internal audit
· investments and financing activities
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Ø acquisition, mergers etc
Ø investments
Ø sources of finance
Ø group structures (e.g. subsidiaries)
Ø debt structure
· financial reporting
Ø reporting environment
Ø specifically relevant accounting practices

Auditors will also want to know :


· how client accounts for unusual transactions
· policies adopted for controversial or new issues for which there is no standard
· reasons and appropriateness of changes the client has made to accounting policies
· how the client adopts and implements new standards

Entity’s financial performance


Evaluation of client’s financial performace provides a better overall understanding of the client’s business and can also
highlight instances where management may try to misstate / manipulate the financials.
When evaluating financial performance the auditor should consider
· financial and non-financial performance indicators, ratios and trends
· comparable financial information (e.g. month by month, division to division industry to industry)
· budgets, forecasts
· employee performance measure
· employee incentive schemes (incentive to misstate)

Components of client’s internal control


Control environment – sets the tone of the organisation and influences the control consciousness of its staff. Attitude
and awareness of the directors and managers to internal controls and their importance to the entity (directors and
managers should promote an environment where adherence to controls is very important by their actions and
behaviour)
Good control environment characterised by :
· communication and enforcement of integrity and ethical values throughout the organisation
· commitment by management to employ competent staff
· positive influence generated by those charged with governance of the entity – (e.g. non-executive directors and
chairman – do they display integrity and ethical commitment?)
· management philosophy and operating style that includes leadership. Sound judgement, ethical behaviour etc
· organisational structure which provides clear framework for proper planning, execution control and reviews
· policies, procedures and an organisation structure that clearly defines authority, responsibility and reporting
relationships throughout the entity
· sound human resource policies and practices which result in the employment of competent ethical staff, provide
training and development as well as fair compensation and benefits.
Evidence about control environment gathered by observation of management and employees, inquiry of management
and employees and inspection of documents

Entity’s risk assessment process


Process entity has in place for
· identifying business risks
· estimating the significance of each risk
· assessing the likelihood of its occurrence
· responding to the risk
Information about the risk assessment process gathered mainly by inquiry and inspection of documents

Information system
Auditor needs to obtain an understanding of the information system relevant to financial reporting and communication,
must have thorough understanding of :
· classes of transactions in the client’s operations that are significant to the financial statements (e.g. sales, wages)
· procedures of how both IT and manual systems record, process, correct and transfer transactions to the GL and
financials
· related accounting records, supporting information and special accounts in the financials
· how info system captures events and conditions
· financial reporting process used to prepare entity’s financials including significant accounting estimates and
disclosures
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· control over the passing of non-standard journal entries used to record non-recurring unusual transactions or
adjustments
· manner in which financial information is conveyed to management, board, audit committee and external bodies
see text book pg 7/11 & 7/12 for specific examples of IT information and risks
Details of information system gathered by :
· inspection of flowcharts of the system
· observation of the system in action
· inquiry of staff and the completion of internal control questionnaires
· discussions with prior year audit staff, management and outsiders (e.g. software suppliers)
· discussions with internal audit staff and review of internal audit workpapers
· tracing information through the information system.

Control activities
Policies and procedures that are implemented to ensure management’s objectives are carried out – e.g. :
· authorisation of transactions
· segregation of duties
· physical control over assets
· comparison and reconciliation
· access controls
· custody controls over blank / unused documents
· good document design
· sound general and application controls in IT systems

Monitoring of controls
Auditor must find out how client monitors the control activities and how problems are identified and resolved. Normally
regulated by internal audit departments but can include employee performance reviews.
Important control activity.
Information about monitoring can be gathered by inquiry of management and staff, working with internal audit and
inspecting documentation related to monitoring process or performance reviews.

Significant risks
Risks that require special audit consideration. Could be :
· risk of fraud
· risk related recent significant economic, accounting or other developments that requires special attention
· risk arising out of complex transactions
· risk involving significant transactions with related parties
· degree of subjectivity in the measurement of financial information related to the risk.
· risk involves significant transactions that are outside the normal course of business for the entity or otherwise
appear to be unusual.

Communicating with those charged with governance and management – as soon as possible auditor must make the
people charged with governance and management aware of material weaknesses in the design or implementation of
internal controls that have come to the auditor’s attention (including weaknesses in the client’s risk assessment
process).

Documentation
General requirement is that auditor must document his work – procedures conducted, information gathered and
conclusions reached must be clearly and concisely recorded.

ISA 315 – Understanding the entity and its environment and assessing the risks
(including appendix 1 to 3)
Auditor should perform the following risk assessment procedures to obtain an understanding of the entity and its
environment including its internal control :
· inquiries of management and others within the entity
· analytical procedures (e.g. risk assessment procedures) and
· observation and inspection
Minimum requirements for risk management at an entity ??

Documentation – auditor should document :


· discussion with the engagement team regarding susceptibility of the entity’s financial statements and the significant
decisions that were reached
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· key elements of the understanding obtained regarding each of the aspects of the entity and its environment
(including each of the internal control components), the sources of information from which the understanding was
obtained and the risk assessment procedures
· identified and assessed risks of material misstatement at financials level and at assertion level
· risks identified and related controls that were evaluated.

see ISA 315 for detail.

Study guide pg
5 essential components that must be present to implement an effective and efficient internal control system :
· control environment
· risk assessment
· information and communication
· control activities
· monitoring
see study guide pg 122 for list of what should be noted from studied information

Inherent limitations of internal controls can be counteracted by :


· continuous study and adaptation by management
· selection of staff
· segregation of duties
· training of staff
· utilisation of internal reports
· establishment of an internal auditing department – supports the internal controls and assists management
· specific contribution of the external auditor – recommendations of external auditor on material weaknesses in the
design and operation of the accounting and internal control systems
· complete utilisation of the system of double entry accounting in the case of
· supervision by management on an intensive scale smaller entities
Tasks and responsibilities regarding the internal control of an entity for :
· management
· internal auditors
· external auditors

what is bottom-up and top-down audit approaches – study guide pg 124?

Inherent limitations of internal controls and the reasons why they exist :
Limitations Reason for existence
Control is inefficient if the cost of the internal control exceeds the advantages that
Cost of internal control can be obtained from it

Usually the result of carelessness, interruptions, errors of judgment and


Human error misinterpretation of instruments

Problems with Internal controls are usually designed with a view to routine transactions
non-routine transactions
2 or more person could conspire with parties inside or outside the entity to
Collusion circumvent certain internal controls

Occurs because conditions change continually and the internal controls are not
Procedures may be come always adapted accordingly. Compliance with procedures may be relaxed after a
inadequate time

Abuse of responsibilities Responsible official could abuse his position

Once auditor has an understanding of the accounting system and tests of controls then he must make a preliminary
assessment of control risk – involves evaluating the effectiveness of the entity’s accounting and internal controls in the
prevention or detection and rectifications of material misstatements.
Control risk is always present cos of inherent limitations of any accounting and internal control system.

Control risk = risk that material misstatement could occur in an account balance or class of transaction (either
individually or totaled with other misstatements) and will not be prevented or detected and timeously corrected by the
accounting and internal control systems
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Tests of controls = carried out in order to obtain audit evidence about the suitability of design and effective operation
of the account and internal control systems and their operations throughout the period which is subject to audit.
Made up of :
· inspection
· observation
· confirmation
· recalculation
· re-performance
· analytical procedures

Design and performance of test controls


If auditor plans to rely on the internal controls, then tests of controls must be carried out to obtain evidence that the
internal controls are working the way that they should and have functioned over the whole financial period.
If auditor doesn’t plan to rely on internal controls then he should increase his substantive procedures to increase the
change of detecting material misstatements.
Tests of controls therefore carried out to obtain audit evidence on the efficiency of the design and how the accounting
and internal control systems are operating.
see various points to be studied from the information pgs 124 to 127 of the study guide

Study Topic 5.2 – Quality control in auditing


ISA 220 – Quality Control for Audits of Historical Financial Information
Jackson & Stent pgs 17/5 to 17/7

Jackson & Stent pgs 17/5 to 17/7


ISA 220R places a collective responsibility on the engagement team to conduct a quality audit within the context of the
firm’s system of quality control. Engagement partner must take responsibility for the audit engagement and he sets the
tone of the audit by his actions and direct communication with the team.
Must emphasise the importance of :
· performing work which complies with professional standards and regulatory and legal requirements and complies
with firms quality control policies and procedures
· issuing auditor’s reports that are appropriate
· element of quality in all respects of the audit

Ethical requirements
Engagement partner responsibility to encourage and develop ethical behaviour on the audit and must also watch for
non-compliance of this by the engagement team. If occurs then must be followed up on, dealt with and then
documented.

Independence
Engagement partner needs to “form a conclusion” on how the audit engagement complied with independence
requirements. Engagement partner must :
· obtain information from the firm to identify and evaluate circumstances and relationships that would create a threat
to independence
· evaluate any threats that may be significant
· take appropriate actions to eliminate or reduce the threat to an acceptable level
· document conclusions on the independence of the audit team.

Acceptance and continuance of client relationships


Firm should have quality control procedures in place for accepting and retaining clients – e.g. procedures to determine if
the directors of a potential audit client have integrity.
In addition – engagement partner (on continuous basis) has to evaluate :
· integrity of the owners, management and those charged with governance of the entity
· if engagement team is competent to perform the audit and has the necessary time and resources
· if firm and engagement team complies with the ethical requirements
If finds any information that would have meant declining the audit only after the audit is underway – them firm must
resign its appointment once it has complied with any statutory duties.

Assignment of engagement teams


Engagement partner must know that the engagement team has the appropriate capabilities, competence and time to
perform audit of quality. Capabilities and competence include :
· understanding of and practical experience with audit engagements of a similar nature and complexity
· understanding professional standards and regulatory and legal requirements
· appropriate technical knowledge – including knowledge of information technology
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· knowledge of relevant industries in which client operates
· ability to apply professional judgement
· understanding of firms quality control policies and procedures

Engagement performance
Engagement partner is responsible for the direction and supervision of audit and review of audit performance –
objective is to ensure audit has been carried out with compliance to professional standards, regulatory and legal
requirements and that enough audit evidence has been obtained to support the audit opinion that was given.
Key areas :
· direction – engagement partner informs engagement team of :
Ø their responsibilities (e.g. maintaining objective, professional skepticism, ethics etc)
Ø nature of entity’s business
Ø risk-related issues and potential problems
Ø detailed audit strategy and audit plan
· supervision :
Ø monitoring progress on the audit
Ø considering capabilities and competence of each member of the team (do they have time? do they understand
instructions? are they carrying them out in accordance with the audit strategy and plan?)
Ø addressing significant issues that arise on the audit and modifying the strategy and plan accordingly
Ø identifying matters for consultation or consideration by more experienced members of audit team
· review – more experienced team members review work performed by less experienced team members e.g. :
Ø is work performed in accordance with professional standards, regulatory and legal requirements?
Ø have significant matters been raised for further consideration?
Ø have appropriate consultations taken place? (were recommendations put in place and documented?)
Ø is there a need to revise the nature, timing and extent of audit work?
Ø does work performed support the conclusions reached and is it adequately documented?
Ø is the evidence obtained sufficient and appropriate to support the auditor’s report?
Ø have the objectives of the audit procedure been achieved?
Consultation and differences of opinion
If differences occur then engagement partner has to ensure that they are resolved by consulting with appropriate
persons and that the nature, scope and conclusions of the consultation are documented, confirmed and implemented.
Firm’s policies and procedures for settling the difference must be followed.

Engagement quality control review


If audit of a listed entity then the firm should appoint an engagement quality control reviewer.
Must be person with sufficient and appropriate experience and authority to objectively review :
· significant judgements made by the engagement team and
· conclusions reached in formulating the auditor’s report
Matters that must be considered by the reviewer :
· independence of the audit team
· identification of risk and the team’s responses (e.g. risk of fraud)
· judgements made in respect of materiality and risk
· outcome of consultations in respect of contentious or difficult audit issues and the conclusions arising from these
consultations
· significance and treatment of corrected and uncorrected misstatements identified on the audit
· issues to be communicated to management and those charged with governance or other parties (e.g. IRBA)
· if audit documentation reflects the work performed and supports the conclusions reached
· appropriates of the auditor’s report to be issued.

Monitoring
Auditing firms required to monitor their quality control procedures to ensure they are :
· relevant
· adequate
· operating effectively
· complied with during audit engagements.

High quality audit is the best defense against accusations of negligence. Partners in an audit firm jointly and individually
responsible for negligent performance of work by staff.

Study guide pg 130


Main purpose of a quality control system of an auditing firm
Quality control system = policies and procedures laid down for the firm as a whole and designed to provide
reasonable assurance that firm and personnel are complying with professional standards and regulatory and legal
requirements and that the auditor’s reports are appropriate.
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Objective is to provide reasonable assurance that all audits performed by the firm are in accordance with GAAP, ISA
and the firm’s own quality control standards.

read though ISA 220 and the 1996 appendix (showing illustrative examples of quality control procedures in
audit firm).

Audit direction – given to assistants when work is delegated.


Consists of information on :
· assistant’s responsibilities
· objectives of the procedures they must follow
· nature of the entity’s business
· possible accounting and auditing problems which could influence the nature, timing and extent of audit procedures
in which they are involved

Help that can be used for communication of audit direction :


· audit programme
· time budgets
· overall audit plan

Functions performed by audit partner :


· monitoring progress of the audit to decide if :
Ø assistants have the necessary skills and competence to carry out their tasks
Ø assistances understand the audit direction
Ø if work is carried out in accordance to the overall audit plan and the audit programme
· dealing with accounting and auditing questions by assessing their importance and modifying the overall audit plan
and audit programme
· resolving any difference of professional opinion between personnel

Work performed by assistance must be reviewed to see if :


· work is performed according to audit programme
· work performed and results obtained have been adequately documented
· significant audit matters have been resolved or are reflected in audit conclusions
· objectives of the audit procedures have been achieved
· conclusions expressed are consistent with the results of the work performed and they support the audit opinion

Aspects of an audit that need to be reviewed on a timely basis :


· overall audit plan and audit programme
· assessment of inherent and control risks – including results of tests of control and any modifications made to the
audit plan and audit programme cos of these tests of control
· documentation of the audit evidence obtained from substantive procedures and conclusions
do questions in section 5.3 of tutorial 102 and check answers in the key of section 5.3 of tutorial 103

Study Topic 5.3 – Documentation of audit work


ISA 230 – Documentation
Jackson & Stent pgs 17/18 to 17/19

Jackson & Stent pgs 17/18 to 17/19


Compliance with documentation standards
ISA 230 requires that the auditor should on a timely basis prepare audit documentation that provides :
· sufficient and appropriate record of the basis for the auditor’s report
· evidence that the audit was performed in accordance with ISA and applicable legal and regulatory requirements.

Audit documentation also :


· assists the audit team to plan and perform the audit
· facilitates direction, supervision and review on the audit
· makes members of the audit team accountable (i.e. what they have done is evidenced in workpapers)
· facilitates audit quality control reviews – from partners in firm to SAICA
· provides a record of matters of audit significance such as :
Ø an experienced auditor with no previous connection with the audit should be able to understand :
v the nature timing and extent of the audit procedures
v the results obtained
v significant matters and the conclusions of them
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Ø that when documenting the nature, timing and extent of the audit procedures the auditor should record the
identifying characteristics of the item or matters that were tested e.g.
v document description and number
v name of person, date, time and subject matter of enquires
v journal entry numbers, dates reviewer must be able to tie the workpapers
v starting points for samples and sampling intervals to specific documents, people, functions etc
v subject matter being observed
Ø that significant matters identified on the audit must be documented – particularly :
v significant risks (and the audit response to risk)
v results of audit procedures which indicate the financials could be materially misstated
v responses to risks
v circumstances that cause the auditor difficultly in applying necessary audit procedures
v findings that could lead to modification of the auditor’s report
v any departures from basic principles or essential procedures (e.g. ISA’s and reasons for the departure)
Ø that the names of the preparer and reviewer and the dates on which they conducted the procedures should also
be on the workpaper.

ISQC 1 requires that the firm must establish policies and procedures :
· for engagement teams to put together finalised engagement files on a timely basis – i.e. set deadlines, review and
sign off files
· designed to maintain confidentiality, safe custody, integrity (no tampering or contamination), accessibility and
retrievably of engagement documentation e.g.
Ø use of password on computerised workpapers
Ø back up routines
Ø controls over the distribution of workpapers (e.g. signing a register)
Ø physical controls over hardcopy and electronic work papers (e.g. archive room with library routines)
· for retention of engagement documentation for as long as needed (not less then 5 yrs from date of auditor’s report).

Audit documentation is the property of the firm and firm doesn’t have to make it available to the client or any other party
unless required by law.
Audit documents can be in various medias – either written, digital or recorded. Heading of workpapers example
Client :
Workpapers should : Financial year end :
· be correctly headed regardless of their form Date :
· contain conclusions of the preparer of the working paper Section of Audit :
Prepared by :
· include adequate legends / keys to symbols on the workpaper Reviewed by : Date :
· display adequate cross referencing to other workpapers
· contain written and commentary on any usual or exceptional maters and how they were dealt with
· contain sufficient information concerning the matter to which the workpaper relates to enable the person reviewing
the work paper to judge if the tests were performed satisfactorily and to agree or disagree with the conclusion
reached as a result of the tests.

ISA 230 - Documentation


Audit documentation for a specific audit engagement is assembled in an audit file.
Form, content and extent of the audit documentation will depend on :
· nature of the audit procedures to be performed
· identified risks of material misstatement
· extend of judgment required in performing the work and evaluating the results
· significance of the audit evidence obtained
· nature and extent of exceptions identified
· need to document conclusion or the basis for a conclusion to be determined from the documentation of the work
performed or the audit evidence obtained and
· audit methodology and tools used.

Auditor may prepare a completion memorandum (summary) describing significant matters that were identified during the
audit and how they were addressed. Can facilitate effective and efficient reviews and also cross reference to other
supporting audit documentation.

Auditor should document discussions of significant matters with management and others on a timely basis.
If information identified that contradicts or is inconsistent with final conclusion regarding a significant matter - then
auditor must document how he addressed the contradiction or inconsistency when forming the final conclusion.
If auditor judges necessary to depart from a basic principle or essential procedure in exceptional circumstances then
must document how the alternative audit procedure were performed and how they achieved the objective of the audit as
well as the reasons fro the departure.
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Under exceptional circumstances can change documentation after the date of the auditor’s report, but must then
document :
· circumstances encountered
· new or additional audit procedures that were performed, audit evidence obtained and the conclusions that were
reached
· when and by whom the resulting changes were made and who reviewed them
(Exceptional circumstances may have been something that existed at the date of the auditor’s report that would have
affected the auditor’s report if the auditor had been aware of it).

Study guide pg 135


Auditor should keep a record of all the procedures he has applied, information he obtained and the conclusions he
came to in order to have grounds for the audit opinion he expressed regarding the financials.
Audit papers help the auditor with :
· planning and conducting the audit
· continuity from one audit to another
· supervision and review of audit work (with control in the area of audit fieldwork)
· purpose and content of current audit working paper files
Working papers must be systematic, complete and clear.
Should be numbered in a logical manner and properly cross referenced between various working papers indicating the
flow between various working papers.

Puttick and van Esch say principals of preparation for working papers are :
· heading
· signature and date
· referencing
· cross referencing
· audit tickmarks
· audit conclusions
Auditor responsible for maintaining procedures for safeguarding audit files and they are solely for the use of the auditor.
Also required to ensure that the information remains confidential.
Sections of working papers can be made available to the client for use – but cannot replace the client’s accounting
records.
do questions in section 5.4 of tutorial 102 and check answers in the key of section 5.4 of tutorial 103

TOPIC 6 – THE AUDITING PROCESS


To achieve objective of auditor expressing an opinion on the financial information of the client the auditor has to carry
out audit procedures which when combined together are called the audit process.
Must follow systematic approach to performing the audit procedures :

Commencement and planning of the audit


· considerations prior to the acceptance of the audit engagement
· conditions of audit engagements
· knowledge of the business
· formulation of the overall audit plan

Obtaining and evaluating audit evidence and concluding the audit


· audit procedures
· evaluation of audit findings
· drawing conclusions on the audit results

Reporting on the audit


· issuing the auditor’s report

Terms of engagement must be determined and agreed on by auditor and client,


Audit planning essential if audit is to be efficient and effective.

Study Topic 6.1 – Commencement and Planning of the Audit


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Jackson & Stent pgs 6/1 to 6/10
ISA 210 – Terms of Audit Engagement
ISA 300 – Planning an Audit of Financial Statements
ISA 315 – Understanding the Entity and its Environment and Assessing the Risks of Material
Misstatement
ISA 320 – Audit Materiality
ISA 330 – Auditor’s Procures to Assessed Risks

Jackson & Stent pgs 6/1 to 6/10


Stages of the audit process :
Stage 1 Preliminary engagement activities :
· performing procedures to determine if the audit firm wants to establish new client or continue with existing
client relationship
· establish if client can be appropriately helped with audit
· evaluate if firm can comply with the ethical requirements relating to the engagement
· establish understanding of the terms of the engagement
Stage 2 planning :
· establishing the overall audit strategy
· developing an audit plan – audit team will need to :
Ø obtain understanding of the entity and its environment including internal control
Ø assess the risk of material misstatement and
Ø determine materiality guidelines
Stage 3 audit strategy and putting plan into action :
· responding to assessed risk at financial statement level – e.g. assigning more experienced staff
· responding to assessed risk at assertion level – e.g. tests of controls and substantive tests to gather
sufficient appropriate evidence to reduce the risk to an acceptable level
Stage 4 conclusions :
· evaluating and concluding the audit evidence gathered
· formulating the audit report.

COMPLETE AUDIT PROCESS :

Preliminary Engagement Activities :


· decide if want to establish or continue a relationship with the client
· assess the firm’s competence and availability of resources
· consider the ethical requirements (e.g. independence)
· formulate terms of the engagement

Planning (overall audit strategy and audit plan) :


· understand the entity including the internal controls
· assess the risk of material misstatements in the financial statements
· determine materiality
read Jackson & · establish the overall audit strategy
Stent pgs 6/3 to · develop the audit plan
6/11 to get more
info on these
procedures.
Put the plan into action :
· conduct tests of controls and other ISA procedures (substantive) to
respond to :
Ø risks at financial statement level (overall response)
Ø risks at assertion level
Ø significant risks

Conclude :
· evaluate audit evidence
· report accordingly
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Extracts from those pages :


Terms of the engagement – must formalise the terms of the engagement into an engagement letter spelling out the
aspects and terms of engagement. Should include :
· objective of the service being performed
· managements responsibility for the financial statements (preparation of financials, maintenance of accounting
records and internal control and selecting accounting policies and safeguarding assets)
· scope of the review – outline of what is to be done and reference to the applicable legislation, regulation or other
pronouncement that auditor must adhere to (ISA’s)
· form of any reports or other communication of results of the engagement
· the inherent limitations of the audit / internal controls means that there will be unavoidable risk that some material
misstatement may be undetected
· confirmation of the auditor’s independence – auditor will decide what tests are necessary and explaining that needs
to get access to whatever documentations and information that is needed for the auditor
· responsibility of management to prevent irregularities and illegal acts and explanation of auditor’s duties
· auditor’s expectation of receiving written confirmation of oral representations
· indication that significant weaknesses and illegal acts will be brought to management’s attention
· involvement of other parties in the audit (other auditors / predecessor auditor, experts, internal audit)
· name of designated auditor / firm or the name of the individual registered auditor responsible for the audit
· arrangements regarding planning and performance of the audit (e.g. meetings, stock count dates)
· deadlines
· basis of fee computation and any invoicing arrangements
Client must confirm the terms of engagement by signing the letter.
If not just option of audit but also other services like vat returns then letter should spell out that if auditor submits returns
late cos client didn’t have the information in time then auditor cannot be held liable.

Proper planning means :


· appropriated attention is devoted to important areas of audit (e.g. significant risks are identified and addressed)
· competent audit team (and experts) is assembled and appropriately assigned
· potential problems are identified and resolved on a timely basis
· appropriate direct and supervision of the audit team and proper review of their work is facilitated
· work is completed on time.

Overall audit strategy


Sets the scope, timing and direction of the audit and guides the development of the audit plan
Engagement team must :
· determine the characteristics of the engagement that define its scope – (is it a statutory audit? is entity listed?
other industry specific requirements) as well as :
Ø financial reporting standards on which the financial’s information has been prepared
Ø expected audit coverage (e.g. divisions, storage locations etc)
Ø involvement of other auditors (internal) and availably of their work and extent that auditor can rely on that work
Ø need for specialised knowledge
Ø effect of IT on audit procedures (availability of data and use of computer-assisted audit techniques)
· determine reporting objectives of the engagement to determine the timing of the audit – (deadline) and :
Ø companies timetable for reporting (e.g. interim and year-end deadlines)
Ø schedule of meetings with management and those charged with governance to discuss nature, extent and
timing of audit work
Ø expected type and timing of reports to be issued
Ø communication with other auditors / experts / internal auditor regarding expected types and timing of reports to
be issued as result of their work on the audit
Ø size, complexity and number of locations of the client (timing of visits)
Ø extent and complexity of computerization at client
· consider important factors that will determine the focus or direction of the audit – (materiality levels, risk
factors, material account headings) and also :
Ø presence of significant risks
Ø determination of materiality levels
Ø impact of the assessed risk of material misstatement on direction, supervision and review
Ø evidence of management’s commitment to the design and operation of sound internal control
Ø volume of transactions (if high then more efficient to rely on internal controls)
Ø significant business developments affecting the entity (changes in IT, key management, industry regulations)
· consider any aspects that may affect the audit plan such as :
Ø audit plan much more detailed then overall strategy – must have :
v description of nature, timing and extent of planned risk assessment procedures sufficient to assess the risks
of material misstatement
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v description of nature, timing and extent of planned further audit procedures at the assertion level for each
material class of transactions, account balance and disclosure
v any other procedures to comply with ISA’s
Ø can’t do any of this without lots of information about the client company – only once have the understanding can
we assess the risks of material misstatement and plan the nature, timing and extent of procedures to respond to
the risk
· ascertain the resources necessary to perform the engagement :
Ø resources to be allocated to specific audit areas – e.g. level of staff experience required / use of experts
Ø amount of resources to be allocated – e.g. number of staff and extent of review procedures
Ø timing of the allocation – e.g. at interim stage
Ø how the resources are to be managed, directed and supervised – e.g. meetings, evaluations, quality control
reviews
· determine what is material

Documentation
Audit strategy and audit plan as well as any changes to either must be carefully documents – documents will record key
decisions made, be a source of reference for the audit team and proof of the proper planning and performance of the
audit.

Putting the audit plan into action (responding to risk)


Overall responses at financial statement level
To reduce audit risk auditor should determine overall response to assessed risk at financial statement level and then
design and perform further audit procedures to respond to assessed risk relating to assertions (at transaction / balance
level). Overall responses can be :
· emphasizing professional skepticism to team members (if integrity of client’s management is suspected)
· assign staff with special skills or assign more experienced staff
· provide more supervision
· incorporate additional elements of unpredictability (e.g. surprise visits to client)
· make general changes to the nature, timing and extent of audit procedures (basically do things that the client may
not expect)
Audit procedures to respond to material misstatement of the assertions
Procedures must be carried out to address the risk of material misstatement pertaining to the assertions to various
account headings and classes of transaction which are backbone of financial statements (e.g. valuation of stock, plant
and equipment, existence of debtors, completeness of sales)
Auditor must respond to the risks by getting the nature, timing and extent of tests of controls and substantive tests
correct so as to reduce audit risks to an acceptable level using tools :
· inspection
· observation
· inquiry and confirmation
· recalculation
· analytical procedures (analyzing significant rations and trends including resulting investigation of fluctuations and
relationships that are inconsistent with other relevant information or which deviate from predicted amounts – e.g.
preparing current ratio to the prior year ratio and explanation for the difference)
· re-performance

General observations relating to nature, timing and extent of testing


· nature of audit procedure relates to its purpose
· tests of controls can only be carried out where the system is “worthy” of being tested (i.e. if system is not effective
cos of weaknesses in its design or implantation then no point in testing it)
· single test of control is never sufficient – e.g. observation of one correct procedure doesn’t mean that it is done
correctly auditor not there
· if auditor wants to get evidence of the effective functioning of controls over a period of time then tests of controls
have to be conducted at various times during the period. Some factors can reduce the risk that controls are not
working effectively over time :
Ø strong ongoing control environment
Ø extensive monitoring of controls that have taken place during the period
Ø strong general controls (specially in computerised systems)
Ø minimal changes in the business
· irrespective of the assessed risk of material misstatement auditor must design and perform substantive tests for
each material class of transaction, account balance and disclosure. Tests of controls alone cannot provide
sufficient appropriate evidence
· where significant risks are identified auditor must perform substantive tests which specifically address the risk –
tests must include tests of detail and cannot be purely analytical procedures
· auditor’s substantive procedures must include following for financial statement closing process :
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Ø agreeing or reconciling the financials with underlying accounting records
Ø examining material journal entries and other adjustments made during the course of preparing the financials
· timing of test frequently dictated by key dates at the client and the objective of the test e.g. :
Ø tight audit deadline may result in comprehensive interim audit supplemented by “roll forward” tests
Ø attendance at stock count determined by the date client does year-end stock count
Ø subsequent events can only be audited in post-balance sheet period
Ø availability of IT staff can affect the timing of using CAAT’s
· greater risk of material misstatement will result in more testing :
Ø where internal controls prove to be ineffective the extent of substantive testing will increase
Ø extent of testing usually expressed in terms of sample size (determined by professional judgement or sampling
plans)
Ø use of CAAT’s will enable auditor to test far more extensively cos of power, versatility and speed of computers
and audit software.
· effective audit plan is combination of tests of control and substantive tests as well as mix of the types of tests – i.e.
inspection, analytical review etc.

Study guide pg 143


When auditor acts for client he is exposed to 2 different kinds of risk :
· audit risk
· business risk
Business risk is risk of loss or prejudice to auditor’s professional practice owing to litigation, unfavourable publicity or
other events which arise in relation to financials which the auditor has examined and reported on (even if done in
accordance to ISA’s and if done properly)
Other business risk is that client may not pay auditing fees and there might be a negative effect on auditor’s reputation
cos of connection with certain clients.

Statutory audits – objective and scope of audit and auditor’s obligations are laid down by law. Extent of the
engagement can be extended but not limited.
Non-statutory audits – extent of audit is agreed with the client and is subject to the condition that the auditor would not
accept an engagement if it cannot be carried out in accordance with IAS’s.
Audit engagement letter purpose is to document and confirm the auditor’s acceptance of the appointment as well as
objective and extent of the audit, the extent of the auditor’s responsibilities towards the client and the format of the
reports.
When auditor accepts audit engagement from client then a contractual relationship arises between auditor and client (so
special obligations and responsibilities should be put in writing).

Acceptance of a change in engagement


Before auditor has completed audit engagement sometimes requested by client to change engagement to one that
provides a lower level of audit reassurance. Before agreeing to change must first consider the circumstances of the
request and also if the request is really justified as well as the legal and contractual implications of the change.
Request to change can be due to :
· change in circumstances affecting the need for the service
· misunderstanding as to the nature of audited originally requested
· restriction on the scope of engagement either imposed by management or caused by circumstances.
If auditor concludes that there is reasonable justification to change the engagement and will still conform with ISA’s then
report that is issued will be for the revised terms of engagement and won’t include reference to the original engagement
or any procedures that may have been performed in the original engagement.
If change terms of engagement then auditor and client must agree on new terms.
Cannot agree to change the engagement if not reasonable justification for doing so or if client is merely trying to avoid a
qualified audit opinion or disclaimer of opinion cos auditor can’t obtain sufficient appropriate audit evidence.
If auditor is unable to agree to a change of the engagement and is not permitted to continue the original engagement
then auditor should withdraw and consider if there is any obligation (contractual or otherwise) to report to other parties
(board of directors, shareholders etc).

Sources auditor can use to obtain knowledge of the business :


· previous experience of the entity and the type of business
· discussions with internal audit personnel and checking internal audit reports
· publications relating to the industry (trade journals and financial reports)
· legislation and regulations which affect the entity significantly
· management, strategic plans and policy manuals and other documents (systems of control manuals, management
accounts, minutes of meetings and internal reports by internal auditors)
· people within the entity – discussions with directors, senior operating personnel, members of audit committee
· people outside the entity – legal and other advisers of the entity, other auditors, recognised industrial experts
· inspection of the entity’s premises and facilities.
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Audit materiality is information that is material if its omission or misstatement could influence the economic decisions
of users taken on the basis of the financial statements
Inverse relationship between materiality and level of audit risk – so higher the materiality level the lower the audit risk
and visa versa.
Auditor may initially assess the acceptable audit materiality at a lower level during the planning stage then at the
finalisation stage of the audit to reduce the probability of undetected misstatements and so give auditor a safety margin
when considering the effect of any misstatements detected during the audit. (So basically the auditor therefore bases
all his audit procedures on more conservative materiality figure)

5 advantages of adequate audit planning – helps to ensure that :


· necessary attention is given to the important areas of the audit
· that potential problems are identified
· that the work is completed rapidly
· proper assignment of work is given to assistants
· work done by the other auditors and experts is co-ordinated.

Knowledge of the business

Evaluation of audit materiality


& audit risk
Overall Audit
· preliminary assessment of materiality plus audit equals programme
plan (detailed audit
· assessment of inherent risk
procedures)
· obtaining understanding of accounting
and internal control systems
· preliminary assessment of control risk

Preliminary assessment of materiality


During planning stage auditor should make a preliminary assessment of materiality in order to plan the audit in such a
way that sufficient evidence is obtained to reach conclusion as to whether the financial statements are fairly presented.
Preliminary judgement = planning materiality and is usually quantified.

Assessment of inherent risk


When developing an overall audit plan the auditor should first assess inherent risk at financials level. Auditor objective
in assessing inherent risk are :
· identify possible high-risk areas of the client’s business that require specific attention during the audit
· assess possibility that material error is present in the financial information that is being audited.
Auditor could accept inherent risk as high and then carry out extensive substantive procedures to reduce the detection
risk to a level which would make the audit risk acceptable – BUT would only be applicable if auditor thinks that the effort
that would be required to assess inherent risk would be greater then the possible benefits of reducing the substantive
procedures.

Obtain an understanding of the account and internal control systems


Knowledge and understanding of the accounting and internal control systems will include specific information
concerning the control environment and specific control procedures and should be documented in the audit working
papers. This knowledge should be sufficient to develop an overall plan.
If sufficient evidence is obtained to indicate that the systems were functioning reliably during the year then auditor can
provisionally rely on assumption that the account and internal control system produced reliable financial information
during the year.
see ISA 315 paragraphs 54 to 56

Preliminary assessment of control risk


As soon as auditor understands the accounting and internal control systems then must make a preliminary assessment
of control risk according to the assertions for every material accounting balance or class of transaction. Auditor’s
assessment based on identification of effective internal controls for preventing, detecting and rectifying any material
misstatements that could affect the financial information under audit (and auditor would then accept the approach of
relying on accurate functioning of these controls when any relevant assertions are audited).
Important principle is that overall assessment of internal control in accounting systems NOT adequate basis for design
of auditing procedure – auditor must consider each internal control procedure and how it is applicable to individual
assertions to determine if it can be relied on.

Auditor’s assessment of control risk for an assertion in financials :


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Control risk Reason Action
Internal controls related to the assertion are present If auditor thinks control risk is low then he
Low which : should carry out test of control to obtain audit
· should prevent material misstatements or evidence that the internal control procedures
operated the way that they were designed.
· should detect and rectify them

High Accounting and internal control systems are ineffective


If auditor thinks control risk is high then he
must determine what errors or irregularities
could possible occur as a result of the
Auditor has decided not to rely on the internal controls cos weaknesses in the accounting and internal
High they don’t appear to be effective and has decided to carry control systems, and then decide on
out extensive substantive procedures instead, to reduce appropriate substantive procedures to detect
the general audit risk to an acceptable level. these errors.

Development of overall audit plan


Once auditor has :
· knowledge of the client’s business
· made a preliminary assessment of materiality (planning materiality)
· assessed inherent risk
· gained understanding of the accounting and internal control systems and
· preliminary assessment of control risk
then should decide on the audit approach or audit plan that he will follow when performing the audit.

Overall audit plan = strategy where the auditor achieves the overall audit objective (i.e. acquisition of sufficient
appropriate audit evidence to make it possible to draw reasonable conclusions on which to base the audit opinion)
Developed by evaluating sources of information and assessing risks related to material account balances and classes of
transactions in the financials. Once all information gathered then that, plus the overall audit decisions taken during the
early planning stage of the audit, are combined into the overall audit plan.
When drawing up audit plan then must pay attention to :
· deciding on stages at which audit will be carried out
· allocating personnel to the audit so that various audit tasks can be assigned to competent people.

Advantages for the development and documentation of overall audit plan for engagement are :
· preparation of the overall audit plan helps auditor to analyze factors that influence audit decisions comprehensively
and systematically
· audit plan provides framework to help auditor to evaluate efficiency and effectiveness and completeness of the
planned audit procedures for achieving overall audit objective
· effective way of introducing audit approach to members of the audit team.

Some of the overall audit plan may have to be revised when auditor becomes aware of matters that mean that the audit
procedures may have to change – e.g. new information could be found that would mean more testing.
Any changes should be documented along with the reason why.

Auditor then develops an approach to how he is going to audit every material account / group of transactions and
balances in the financials – called planned audit approach and reflects the general nature, timing and extent of the
necessary audit procedures for every accounting balance or class of transactions.
Approach to each section of the audit must be outlined in the overall audit plan in sufficient detail to serve as the basis
for the development and preparation of the audit programme.
Exact form and content of overall audit plan different for each audit engagement cos of :
· size of the business
· complexity of the audit
· specific audit methodology and technology that auditor is using.
see example of overall audit plan pgs 152 / 153 of study guide

Relationship between preliminary reliance on internal controls, control risk & audit procedures
Reliance on
internal controls Control risk Tests of controls Substantive procedures
High Low Will be carried out Reduced extent of testing

Low High None Increased extent of testing

Audit programme
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To implement the overall audit plan the auditor must draw up and document an audit programme that details the nature,
timing and extent of the planned audit procedures that will be carried out.
Audit programme for tests of control and substantive procedures must be drawn up for every material account / groups
of transactions and are supported by working papers that document the audit procedures that have to be carried out
and other information that has to be compiled or collected in course of the audit.

Auditor must also apply the assessment of inherent risk and preliminary assessment of control risk and materiality (got
from compiling audit plan at level of financials) at the level of the accounting balances and transaction classes.
Advantages from the development and documentation of audit programme is :
· changes the audit approach or audit plan into a comprehensive description of work that has to be carried out
· results in a document that has to be checked and approved before audit work can begin
· provides direction to personnel on how audit should be conducted and so reduces the risk that important
procedures will be left out or that incorrect procedures will be applied by inexperienced staff
· enables the auditor to check the adequacy of subsequent audit work.
Proper planning ensures cost-effective audit as well as audit work of a high standard.
do questions in section 6.1 of tutorial 102 and check answers in the key of section 6.1 of tutorial 103

Study Topic 6.2 – Obtaining and Evaluating Audit Evidence and Concluding the Audit
Jackson & Stent pgs 5/15 to 5/17
Jackson & Stent pgs 7/20 to 7/41 covered in other
ISA 240 – Auditor’s Responsibility to Consider Fraud in an Audit sections of notes
ISA 320 (paragraph 12 – 16) – Audit Materiality
Main classes of audit procedures consist of

Substantive procedures :
Tests of controls
· analytical procedures
· tests of details of transactions
· tests of details of balances and disclosures
Study guide pg 159
Tests of control = tests that are carried out in order to obtain audit evidence on the suitability of the design and
effective operation of the accounting and internal control systems and on their operation throughout the period
Substantive procedures = tests that are carried out in order to obtain audit evidence to support the financial
statements – auditor is interested in balances and transactions
Audit risk = risk that auditor may express an inappropriate audit opinion when the financial statements have been
materially misstated

Components of audit risk :


· inherent risk = susceptibility of an account balance or class of transactions to misstatement that could be material
(either individually or when totaled with other misstatements) in the balances or classes – assuming there were no
related internal controls
· control risk = risk that misstatement could occur in an account balance or class of transactions and that it could be
material (either individually or when totaled with other misstatements) and will not be prevented or detected and
corrected on a timely basis by the accounting and internal control systems
· detection risk = risk that an auditor’s substantive procedures will not detect a misstatement that exists in an
account balance or class of transactions that could be material (either individually or when totaled with other
misstatements) in other balances or classes.

Sequence in which test of controls and substantive procedures are carried out :
AFTER THE PRELIMINARY ASSESSMENT AUDITOR DECIDES :

RELY ON INTERNAL CONTROLS?

YES NO

TESTS OF CONTROL - MATERIALITY


- INHERENT RISK

EVALUATE INTERNAL CONTROLS

DETERMINE CONTROL RISK


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- DETERMINE DETECTION RISK
(REDUCE) (REDUCE AUDIT RISK)
- DETERMINE NATURE, TIMING AND EXTENT OF :
SUBSTANTIVE PROCEDURES
Explaining diagram :
Materiality is determined during the course of the planning stage and is taken into account throughout the performing of
the audit in order to determine if the audit differences are material or not.
After preliminary study of design and efficient operation of the accounting and internal control systems, auditor decides
provisionally if he can rely on the internal controls

If decides YES can rely on internal controls : If auditor decides NOT to rely on internal
controls :
· auditor carries out tests of controls to evaluate the internal
controls · if preliminary investigation indicates that
internal controls didn’t function as should
· if tests of controls indicate that the internal controls have
then auditor will carry out no tests of
done as they should then auditor decides on low level of
controls
control risk
· control risk is then estimated as high
· cos control risk is reduced, inherent risk or detection risk
must be increased in order to bring the audit risk to · cos control risk has increased the inherent
acceptable level risk or detection risk must be reduced to
bring audit risk to acceptable level
· inherent risk is independent of the internal controls, but
(inherent risk is independent so auditor
directly related to transactions and balances – auditor
can’t do anything to change it)
assesses inherent risk and bears it in mind during the audit
but cannot do anything about it · detection risk must therefore be reduced to
bring the audit risk to an acceptable level.
· detection risk must therefore be increased in order to bring
To reduce detecting risk the extent of
audit risk to an acceptable level. To increase detection risk
substantive procedures must be increased
the extent of the substantive procedures is reduced (and
(so more substantive procedures will be
fewer substantive procedures are required).
required)
Interaction between the components :
Inverse relationship between detection risk and the combined level of inherent and control risk. e.g. when inherent and
control risk are high then the acceptable level of detection risk must be low so as to reduce audit risk to an acceptably
low level (so should carry out more substantive procedures).

Difference between tests of controls and substantive procedures is the purpose for which they are carried out and NOT
their nature. Some procedures serve a duel purpose in that they comply with the objectives of both tests of controls and
substantive procedures.

Auditor obtains audit evidence by carrying out a number of audit procedures by :


· inspection
· observation used when carrying out tests of controls and substantive procedures
· enquires and confirmation
· re-performance
· recalculation
· analytical procedures used when carrying out substantive procedures
· vouching

Substantive procedures are carried out to detect material misstatements in the financials – consist of :
· audit of transactions (transaction audit)
· audit of balances and disclosures in the financials
· analytical procedures.

Method used to identify substantive procedures related to activities in an accounting system for different
transactions or items in the financials statements :
· identify the authorisation for the transaction in question
· identify the source documents used to record the transaction
· identify the information in the source documents that can be used for checking the transaction
· identify the accounting records used in bringing the transaction to book (subsidiary journals / ledgers)
· identify the accounting entries used in bringing the transactions to book
· identify the way in which ledger balance are dealt within the accounting system until they are disclosed in the
financial statements.

Transaction audit - procedures and activities to be investigated with regard to the flow of a transaction :
Authorisation of transaction :
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· completion of source documents – such as invoices / receipts
· information from source documents recorded in :
Ø subsidiary journals (cash book, general journal etc)
Ø inventory records
Ø fixed asset register
· transactions are updated from subsidiary journals to the ledgers :
Ø general ledger
Ø sub-ledgers (e.g. debtor’s and creditors)

Audit of balances in the financial statements – would investigate procedures / activities of the flow of the transaction :
· calculate ledger balances
· draw up trail balance
· make a list of the balances in the sub-ledger
· reconcile total of the list of balances with the control account in the general ledger
· apply the correct cut-off to related transactions (unless done during audit of transactions)
· account for information according to the applicable accounting policy
· compare tangible assets with accounting records
· draw up financials

Audit of transactions – must check :


· authorisation of transactions
· capturing of data (e.g. invoices / receipts)
· information of source documents recorded in different journals / ledgers
· inventory records
· fixed asset register
· master file update
· transaction posted from subsidiary books to the ledger
· documents and exception reports
Audit of balances and disclosures in the financials would mean auditing :
· calculation of ledger balances
· reconciliation of accounting records and control accounts
· fairness of all relevant assertions (completeness, existence, valuation and rights & obligations)

Examples of substantive procedures that can be performed :


· confirmation – auditor sends out debtor’s letters of confirmation
· reperformance – auditor calculates the provisional tax payable
· analytical procedures – auditor calculates the monthly gross profit percentage
· observation – auditor attends the annual stock take
· recalculation – auditor calculates the rebate on an invoice
· enquires – auditor asks and establishes if there were any strikes during the year.
Formulation of substantive procedures is very important and the procedures need to be given as an instruction to the
audit staff.

Audit procedure sequence is very important to prevent over-auditing or wasting time. When auditor determines the
timing of the audit procedures must take into account that certain related items have to be audited simultaneously.
Timing of the audit procedures depends on the kind of audit that is being performed, either :
· continuous audit or
· final audit.
Final audit is carried out at year end after all the entries have been made in the accounting records and the draft
annual financials have been drawn up by the client. Normally smaller client where accounting records only have to be
audited once a year.
Continuous audit – one or more interim audits and then a final audit. For big clients where there is large amount of
testing so necessary to start the audit on an interim basis. Interim audits are arranged with the client for interim periods
during financial year (i.e. quarterly, monthly). Normally do most of the transaction tests during the interim audit and
remainder of transaction tests and financial statement tests are performed at year-end during final audit.

Objective of auditing financial statements – to express opinion on the following :


v whether the financial statements are a fair presentation in all material respects
v of the financial position of the business at a specific date and
v of the results of its operations and cash flow for the period ended on that date and
v are in accordance with the identified reporting framework (GAAP) and statutory requirements.
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4
Auditor must achieve audit objective while complying with audit standards so that can provide reasonable assurance to
the users of the financial statements that they are free from material misstatement when taken as a whole.
When results of audit procedures are evaluated then auditor follows a number of steps and comes to a conclusion on
each material account balance or transaction class in the financials. Auditor considers the total of the audit differences
and then assesses the risk that the financial statements have been materially misstated.
Audit differences = amounts that are in the financials and the amounts that the auditor has substantiated (by carrying
out substantive procedures). Audit differences arise from :
· erroneous representations
· misapplication of GAAP either intentionally or unintentionally
· unreasonable accounting estimates.
Audit procedures results are evaluated by using steps :
· analysis of the errors detected during the audit procedures
· quantification of the errors
· preparation of a summary of audit differences
· evaluation of audit differences by comparing them with materiality figures
· drawing of conclusions.

Auditor tries to determining the cause of any errors detected during the audit procedures and considers the possible
influence on the financials.
If auditor is convinced errors are unintentional then will try to establish the underlying cause – could be :
· failure to understand the prescribed procedures
· inadequacy of the prescribed procedures
· human factors e.g. fatigue or carelessness.
If failure to understand then error could be compounded during the year – auditor needs to consider probability that
similar errors have taken place and that the result could be a material error in the financials. Must also consider if the
risk assessment of the accounts in question should be revised (adjustment of the nature, timing and extent of the audit
procedures) and if the audit programme needs to be modified. If error is large enough then it should be reported to
management.
If thinks error is intentional then must establish how the error took place (what level of personnel is involved and what
weakness in the accounting and internal control system was responsible).
Auditor must consider the total amount of audit evidence obtained and then use judgment to determine if reason to
suspect could be fraud – if fraud suspected then auditor’s risk assessment must be reconsidered.

DIFFERENCES BETWEEN AUDIT


DIFFERENCES AND MISSTATEMENTS

Errors can be quantified by :


· specific detection during performance of audit procedures
· projecting sample result back onto the population (accounts) from which the sample was drawn
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· differences in judgement in the account estimates in financials (e.g. difference between client’s estimate of the
provision for doubtful debts and the auditor’s nearest reasonable estimate)
see do 4 on pgs 169 / 170 of study guide showing calculation of audit differences.

Preparation of summary of audit differences


Auditor accumulates audit differences identified by the audit in the case of every material accounting balance /
transaction class in order to consider the total influence on the financials. Errors in recorded amounts and differences of
judgment in accounting estimates which the client hasn’t rectified are documented and summarised – auditor then
evaluates the materiality of the total influence on the financials.

Total of the differences (net differences after the client has made corrections) will then include the following :
· specific errors in amounts included in the financials and detected (e.g. tests of key items and other detailed tests of
balances / transactions)
· total projected errors for all representative samples for accounting balances / transaction classes
· any amount where the amount in an accounting estimate in the financials differs from the amount the auditor
considers is a reasonable estimate.
Net effect of the unrectified audit differences of the previous year must also appear on the summary of audit differences
as can still influence the evaluation of the current year’s financials.

Evaluation of audit differences


Requires professional judgment and must take the following consideration into account :
· risk that there are additional differences that are undetected – as amount of the total audit differences
increases then the risk that the financial statements are materially misstated cos of undetected differences
(detection risk) also increases
· nature of the audit differences – are they results of identified errors or differences in judgement regarding
accounting estimates?
Auditor will normally discuss accurate / possible differences with management in order to confirm the existence of the
differences and to give the client the chance to rectify them. When finalising the audit the auditor considers if the total of
the uncorrected misstatements is material or not, as well as the risk that the financials could be materially misstated as
result of the undetected audit differences. Depending on the result of this evaluation the auditor may carry out modified
/ additional audit procedures to reduce overall audit risk to an acceptable level.
see do 5 on pgs 171 / 172 of study guide showing calculation of materiality on audit differences
ISA 200 – Objective & General Principles Governing and Audit of Financial Statements
ISA 240 – Auditor’s Responsibility to Consider Fraud
ISA 320 – Audit Materiality
ISA 500 – Obtaining Audit Evidence during Audit of Financial Statements
ISA 700 – Auditor’s Report on Financial Statements

ISA 700 – Auditor’s Report on Financial Statements


Paragraph 2
Auditor should review and assess the conclusions drawn from the audit evidence obtained as the basis for the
expression of an opinion on the financials.

Study guide pg 172


Auditor forms an audit opinion as to whether the financial statements in total are free from material misstatement on the
basis of the level of satisfaction that the collected audit evidence provides.
Auditor arrives at a final assessment of the general level of audit risk and decides if the audit procedures that were
carried out to verify every material assertion in the financials are sufficient to reduce the audit risk to an acceptably low
level.
If audit cannot come to the conclusion that the total of non-rectified audit differences isn’t material then should consider
modifying the auditor’s report on the financials.
Auditor should also consider modifying the auditor’s report if management refuses to adjust the financials in accordance
with the audit findings and the total of unrectified audit differences is still material.

When finalising the audit the auditor examines conclusions drawn from the collected audit evidence and evaluates them
as the basis for expressing an opinion on the financials.
Must also consider the general presentation of the financials including :
· general influence of any qualitative material misstatement on the financials
· whether the financial statements have been prepared in accordance to GAAP
· whether they comply with the relevant statutory provisions

Influence of material misstatements :

Extended audit procedures


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Financial statements indicate that the
adjusted by misstatements are / Influence on
management are not material auditor’s report

Adjusted material None

Not adjusted Not material None

Not adjusted material Must be adjusted

do questions in section 6.1 of tutorial 102 and check answers in the key of section 6.1 of tutorial 103

Study Topic 6.3 – Reporting on the Audit


Jackson & Stent pgs 18/2 to 18/3
ISA 200 – Objective and General Principles Governing an Audit of Financial Statements
ISA 700 – Auditor’s Report on Financial Statements
Auditing Professional Act 2005 – section 44

Jackson & Stent pgs 18/2 to 18/3


ISA 700 – Standard Audit Report
see example of opening paragraph of auditor’s report on pg 18/3 of text book
Use of word “independent” in the title confirms that auditor has satisfied all the relevant ethical requirements regarding
independence.
Report addressed to shareholders in compliance to the Companies Act – or could be addressed to the Board of
directors if they have requested the audit.
Introductory paragraph must identify the entity that is being reported on and must specify the date and period which is
covered by the financials.

see example of management’s responsibility of auditor’s report on pg 18/3 of text book


This emphasises that management is responsible for the financials (similar to what is found in the letter of engagement)

see example of auditor’s responsibility of auditor’s report on pg 18/3 of text book


Gives a broad sense of what the audit is about and the auditor’s responsibility. Emphasises that no expression of
opinion is given about internal controls and also that the audit report is not a verification that the financials are 100%
correct.

see example of auditor’s opinion of auditor’s report on pg 18/3 of text book


Report must be signed off with the name of the designated auditor as well as the date of the audit report and the
auditor’s address.
Before signing auditor must ensure that a COMPLETE set of financials have been prepared and that management has
accepted responsibility for them.
Date of the audit report should be no earlier then the date on which the auditor obtains sufficient appropriate evidence
that he bases his opinion of the financials on – this means that the auditor will have to consider the effects of events and
transactions on the financials up to the date of signing.

Modification of the auditor’s report


If insufficient appropriate evidence of some matters was not gathered then the auditor report may have to be modified.
Can be changed for 2 reasons :
· matters that do not affect the auditor’s opinion or
· matters that do affect the auditor’s opinion.

Matter’s that do not affect the auditor’s opinion


So basically the auditor’s opinion on fair presentation is not affected by the matter, but it does need to be brought to the
attention of the users of the report – called emphasis of matter.
Emphasis if matter used when there :
· auditor wishes to highlight a matter that is already dealt with in the financials but which is important to
users – company has an ongoing concern but it has been adequately disclosed in the financials
· there is significant uncertainty of something and it will only be resolved by a future event and it may effect
the financials – e.g. the company is involved in litigation and the outcome will be material but is unsure at the
moment
· there is a material inconsistency in “other information” included in a document containing audited
financials (usually annual report) – e.g. Chairman’s Report is inconsistent with the financials and the directors
refuse to remove the inconsistency.
Note :
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· if there is an emphasise of a matter then there has to be disclosure of the matter by the director in the notes –
otherwise the auditor will have to give a qualified opinion – just cos there is an emphasis of matter doesn’t mean
that it is a substitute for a qualification
· where there are additional legal or regulatory reporting requirements there must be an additional paragraph that
says “other legal or regulatory requirements”
· where auditor has carried out the audit and done the accounting then this must be disclosed in the audit report as
per Companies Act – this is not emphasis of matter.

see example of emphasise of matter of auditor’s report on bottom pg 18/5 of text book
Must be positioned under the opinion paragraph and must open with the words “without qualifying our opinion above ..”

Matter’s the do affect the auditor’s opinion


Auditor CANNOT express an unqualified opinion if either of the following is applicable AND in auditor’s judgement the
effect of the matter may be material in the financials :
· there is a limitation on the scope of the auditor’s work – where auditor is prevented from performing the
procedures he believes are necessary to obtain sufficient appropriate evidence and therefore cannot form an
opinion. Auditor can try to carry out alternative procedures to obtain sufficient appropriate evidence, but not at the
expense of maintaining standards
· there is a disagreement with management – if auditor based on evidence gathered on the audit disagrees with
either one or more assertions made by the directors in the financials. Disagreements relate to :
Ø selection of accounting policies
Ø application of an accounting policy
Ø appropriateness of disclosure in the financials

Material matters – if knowledge of the matter would be likely to influence the economic decisions of the user of the
financials.
Material and pervasive – when the auditor has decided that an unresolved matter is sufficiently material to warrant a
qualification to the auditor report then audit also has to decide if the matter is material and pervasive in the context of
fair presentation. If it is then an adverse opinion or disclaimer of opinion on the financials as a whole will be required.
Examples :
· a scope limitation is material and pervasive if the limitation has resulted in the auditor being unable to obtain
sufficient appropriate evidence and so he is unable to express any opinion
· disagreement becomes material and pervasive when its impact on the financials is so great that fair presentation
as a whole is undermined and that an “except for” qualification doesn’t adequately convey the misleading or
incomplete nature of the financials

Nature of the materiality of the matter giving rise to the qualification, adverse or disclaimer of opinion are both important.
ALL material matters (either based on disagreement or limitation of scope) will give rise to “except for” qualifications.
Material and pervasive limitations of scope can only result in disclaimers of opinion and
Material and pervasive disagreements can only result in adverse opinions

Adverse opinion states that the financials statements do not fairly present the state of the company
Disclaimer states that the auditor cannot say if financials fairly present the state of company or not (can’t form an
opinion)
MODIFICATION OF THE STANDARD AUDIT REPORT

MATTERS THAT DO NOT AFFECT MATTERS THE DO AFFECT


THE AUDITOR’S OPINION THE AUDITOR’S OPINION

EMPHASIS OF MATTER MATERIAL MATERIAL &


PERVASIVE

DISCLAIMER ADVERSE
OF OPINION OPINION
Types of audit opinions
Once auditor has decided that an unqualified opinion cannot be given then must decide which type of qualified opinion
he must give :
· qualified opinion - except for limitation of scope – given when an unqualified opinion cannot be given due to a
limitation of scope, but that the limitation is not so material and pervasive that a disclaimer of opinion must be given
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· disclaimer of opinion - limitation of scope – when possible effect of a limitation of scope is so material and
pervasive that the auditor has not been able to obtain sufficient appropriate evidence and accordingly is not able to
express an opinion
· qualified opinion - “except for disagreement – when an unqualified opinion cannot be given due to a
disagreement (with directors about accounting policies selected, method of their application or the adequacy of
disclosures) which is not so material and pervasive as to require an adverse opinion
· disagreement - adverse opinion – when the effect of a disagreement is so material and pervasive to the financial
that the auditor concludes that a qualification of the report is not adequate to disclose the misleading or incomplete
nature of the financials.

Auditing Professional Act – Section 44


States that auditor may not without qualification express and opinion to the effect the financials :
· fairly present in all material respects and
· are properly prepared in terms of the financial reporting standards
unless auditor has NOT reported a reportable irregularity to the IRBA or if a report was sent but the matter has since
been satisfied.
see examples of various situations of reportable irregularities pgs 18/12 & 18/13 of text book

ISA 700 – Auditor’s Report on Financial Statements


Auditor’s report must include the following basic elements :
· title
· addressee
· opening or introductory paragraph
Ø identification of the financial statements audited
Ø statement of the responsibility of the entity’s management and the responsibility of the auditor
· scope paragraph (describing the nature of the audit)
Ø reference to the ISA’s or relevant national standards or practices

Ø description of the work the auditor has performed including :


§ examining, on a test basis, evidence supporting the amounts and disclosures in the financials
§ assessing the accounting principles used and significant estimates made by management and
§ evaluating the overall financial statement presentation
· opinion paragraph
Ø reference to the financial reporting framework used to prepare the financials
Ø expression of opinion on the financials
· date of report
· auditor’s address
· auditors signature

Study guide pg 176


Auditor’s Report - Framework on opening paragraph
· identification of the annual financial statements
Ø accompanying balance sheet of …..
Ø income statement, statement of changes in equity and cash flow statement
Ø set out on pages … to …
· identification of the financial period
Ø as of … (year)
Ø ended …..
· responsibility
Ø management (financial statements)
Ø auditor (opinion expressed)

Framework of scope paragraph


· performed in accordance with International Standards on Auditing
· planned and performed to obtain reasonable assurance
· examination of evidence
· assessing of the accounting principles
· assessing of significant estimates
· evaluation of overall presentation of the financial statements
· provide a reasonable basis for opinion

Framework of a standard auditor’s report


· in our opinion the financial statements present fairly the following :
Ø financial position as of …
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Ø financial performance and
Ø cash flow for the year then
· in accordance with either :
Ø International Accounting Standards statutory
Ø The Companies Act 1973 of South Africa audit
OR
· in accordance with
Ø International Accounting Standards non-statutory audit

Modified auditor’s report


Unqualified report – unqualified opinion expressed if the auditor concludes that the financial statements are fairly
presented in all material respects in accordance with the applicable financial reporting framework, and also indicates
that any changes in accounting principles or the method of their application and the effect thereof have been properly
determined and disclosed in the financials.
Modified report – auditor would modify his report if concludes that financials statements are not fairly presented in all
material respects with the applicable financial reporting framework and changes in accounting principles or the method
of their application and the effects thereof have not been properly determined and disclosed in the financials.

4 classes of modified auditor’s reports that can be issued


· unqualified auditors report with emphasis of matter
· qualified auditor’s report
· disclaimer of opinion
· adverse opinion

If auditor concludes that he cannot issue an unqualified auditor’s report then need to decide which form of modified
report to use. Would first ask himself if his opinion is affected by the matter in question? :
· if no – auditor can issue an unqualified auditor’s report with emphasis of matter paragraph
· if yes – auditor must then decide if the opinion was included cos of limitation on the scope or auditor’s work or
because of a difference of opinion with management.

Then must decide if the matter is pervasive or not (i.e. is it pervading – spread throughout the financials)

TYPES OF
AUDITOR’S
REPORTS :
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Before an auditor expresses an audit opinion in the auditor’s report he should review and assess all the conclusions that
he has drawn from the audit evidence as a basis for the formations of his audit opinion.
Once has formed his audit opinion on the financials as a whole he expresses his opinion in the auditor’s report.

If matter that has occurred because of limitation on the scope of the Auditor’s work :
Influence of the matter Influence on the audit opinion
Not material Unqualified opinion

Not so material and pervasive Qualified opinion

Material and pervasive Disclaimer of opinion

Auditing Professional Act 2005 – section 44


Duties in relation to audit
Registered auditor may not express an opinion on the financials unless :
· the auditor has carried out the audit free from any restrictions and in compliance with the auditing pronouncements
relating to the conduct of the audit
· that the registered auditor has satisfied himself of the existence of all assets and liabilities shown in the financials
· that proper accounting records in at least 1 official language of SA have been kept in connection by the entity that
reflect and explain all the transactions and record all entity’s assets and liabilities correctly and adequately
· that the registered auditor has obtained all information, vouchers and other documents which are necessary for the
proper performance of his duties
· that the registered auditor hasn’t sent a report to the IRB relating to a reportable irregularity, or that if the report was
sent then the registered auditor has been able to send a second notice to the Board to say that the reportable
irregularity has been corrected and is no longer taking place
· that the registered auditor has complied with all the laws relating to the audit of that entity
· that the registered auditor is satisfied (as far as reasonably practicable regarding the nature of the entity and of the
audit carried out) as to the fairness or correctness of the financials.
If registered auditor or a member of registered auditor’s firm kept the books of the audited entity then this must be
reported in any report (doesn’t include just doing the closing entries, adjusting entries or framing the financial
statements)
Registered auditor may not conduct the audit of any entity if he has a conflict of interest in respect of that entity (as
prescribed by the Board).

do questions in section 6.3 of tutorial 102 and check answers in the key of section 6.3 of tutorial 103

Auditing Professional Act 26 of 2005


Chapter 11 – appointment of members of the Regulatory Board
Regulatory Board must consist of not less then 6 and not more then 10 non-executive members appointment by the
Minister. Must be competent people including registered auditors to effectively manage and guide the activities of the
Regulatory Board based on their knowledge and experience.
Appointments must be based on need for transparency and representivity of the broader demographics of SA
population (all races) and the availability of people to serve on the Board.
Before making appointments the Board must invite nominations from members of the public in the Government Gazette.
Minister can appoint an alternate member for every member of the Board and the alternate member can attend and take
part in any meeting which the original member is absent.
Not more then 40% of the members may be registered auditors.
After appointment of members the Regulatory Board must publish the names of every appointed member, date at which
the appointment takes place and the period for which the appointment is made.

go through all the assessment criteria at the start of each study unit – make sure can do all points.

go through all the self assessments at the end of each study unit – make sure can answer all the questions.

Questions from old exam papers


Factors that facilitate the issuing of a new engagement letter for a recurring audit engagement :
· indication that the client misunderstands the objective and scope of the audit
· any revised or special terms of the engagement
· recent change of senior management or those charged with governance
· significant change in ownership
· significant change in the nature or size of the client’s business
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· legal or regulatory requirements
· change in the financial reporting framework adopted by management in preparing the financial statements.

Responsibilities of audit management :


· planning
· performance
· control
· completion of specific audits

Inherent risk = susceptibility of an assertion to a misstatement that could be material (either separately or when
aggregated with other misstatements) assuming that there are no related controls.

High inherent risk assessment for a debtors account could be because of :


· integrity of management is of such a nature that they cannot be relied on to produce accurate values in respect of
the account
· declining industry characterised by a large number of business failures
· lack of sufficient working capital to continue operations
· difficult calculations in accounting for accounts receivable.

Quality control procedures :


· supervision
· direction
· review

Auditor should obtain an understanding of the entity and environment to understand :


· industry, regulatory and other external factors (including applicable financial reporting framework)
· nature of the entity (including entity’s selection and application of accounting policies)
· objectives and strategies and the related business risks that can result in material misstatements of the financials
· measurement and review of the entity’s financial performance
· internal controls relevant to the audit

System of quality control in a firm is designed to provide reasonable assurance that the firm and its staff comply with
professional standards as well as regulatory and statutory requirements and that the auditor’s reports issued by the firm
or engagement partners are appropriate in the circumstances.

5 essential aspects of control that MUST be present in order to implement an effective and efficient internal control
system :
· control environment
· control activities
· monitoring of controls
· entity’s risk assessment process
· information system (information and communication)

Reportable irregularity = any unlawful act or omission committed by any person responsible for the management of
the entity which :
· has caused or may cause material financial loss to the entity or any user of the entity
· is fraudulent or amounts to theft
· represents a material breach of any fiduciary duty to the entity

Audit risk = risk auditor may express an inappropriate audit opinion when the financials are materially misstated (risk of
material misstatement)

Objective of audit = enable auditor to express opinion as to whether or not the financials fairly present (in all material
respects) the financial position of the entity at that specific date and the results of its operations and cash flow in
accordance with IFRS and the Companies Act.

Audit function = provides users with a high degree of assurance regarding the creditability of the assertions made by
management in the financials.

Audit documentation :
· assists audit team to plan and perform the audit
· facilitates supervision and review on the audit
· enables audit team to be accountable for their work
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· retains record of matters for future audits
· facilitates audit quality control reviews
· means experienced auditor will be able to conduct external inspections in accordance with applicable legal,
regulatory or other requirements.

Advantages of an audit :
· enhances creditability of the financials
· allows auditor to advise the company on how to :
Ø improve the accounting system
Ø increase efficiency and profits.

Auditor must obtain understanding of client’s accounting and internal control system to :
· assess the suitability of the system as a basis for compiling accurate financial information
· formulate a suitable audit approach
· design appropriate audit procedures
· express an opinion on the financials with an acceptable audit risk.

Detection risk = risk that auditor won’t detect a misstatement in the account balances or classes of transaction that
could be material (either individually or when aggregated).

Fundamental principals :
· integrity
· professional competence and due care
· professional behaviour
· objectivity
· confidentiality

Purpose of engagement letter to document and confirm :


· auditor’s acceptance of the appointment
· objective and scope of the audit
· extent of the auditor’s responsibilities towards the client
· format of any reports

Objective of adequate quality control policies :


· professional requirements
· skills and competence
· allocation
· delegation
· consultation
· acceptance and retention of clients
· monitoring

Internal control = process designed, implemented and maintained by management and other staff to provide
reasonable assurance about the achievement of the entity’s objectives regarding the reliability of financial reporting.

Overcoming inherent limitations and shortcomings of internal controls :


· continuous adaptation and monitoring by management
· proper selection of staff
· segregation of duties
· isolation of responsibilities
· access / custody controls
· source document design
· comparison and reconciliation

Types of engagements : review, audit, agreed upon and compilation

Threats :
· self interest
· self review
· advocacy (auditor promotes a position or opinion and is therefore no longer objective)
· familiarity
· intimidation
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Tests of control categories :
· reperformance
· observation
· enquiry
· inspection

Substantive tests categories :


· reperformance
· recalculation
· inspection
· analytical procedures
· enquiry and confirmation
· verifying and vouching

Audit materiality = omission or statement where influence of this omission or statement will effect the economic
decisions of users based on information in the financials

Emphasis of matter :
· highlights matter that is already in financials but that would be important to users
· significant uncertainty about something in the future
· material if inconsistency in some part of the financials that management refuses to change.

Qualified opinion if :
· limitation on scope of auditors work
· disagreement with management.
Material and pervasive limitation of scope = disclaimer of opinion
Material and pervasive disagreement with management = adverse opinion
Disclaimer of opinion = auditor cannot say if financials fairly present the state of company or not (no opinion)
Adverse opinion = auditor states that financials do not fairly present the state of the company
rd
Fraud = intentional act by one or more people among management, employees or 3 parties with the intent to obtain an
unjust or illegal advantage

Risk management = identification and evaluation of actual and potential risk areas pertaining to the company where
risks are either terminated, transferred, accepted or mitigated.

Overall audit plan = strategy where the auditor achieves the overall audit objective (i.e. acquisition of sufficient
appropriate audit evidence to make it possible to draw reasonable conclusions on which to base the audit opinion)

Glossary
Professional accountant = auditor

Engagement = auditing job

Test check = check sample of transaction

Postulate = something that is claimed as a basis for reasoning (e.g. a starting point)

Assertion = statement or point regarding an entry in the financials

Populations = samples of different accounts.


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AUE2601 FINAL REVISION OLD EXAM PAPERS& GRADED QUESTIONS 2012-2013

PUBLIC COMPANY CLOSE CORPORTION AND


INTEREST OWNER MANAGED
SCORE COMPANIES
Less than 100 Review No assurance required

100 to 349 Audit if AFS internally compiled Audit if internally compiled


Review if AFS externally compiled No assurance required

350 and above Audit Audit

It is an obligation for certain other companies to have their annual financial statements audited, regardless
of their public interest score. These are:
· Public companies (LTD) and state owned companies
· A company which holds assets (exceeding R5m) in the ordinary course of its primary activities in a
fiduciary capacity for persons not related to the company
The reason for these specific requirements is obvious, there is a strong element of public interest.

Safeguards are actions or other measures that may eliminate threats or reduce them to an acceptable level (SAICA
Code of Professional Conduct, sec 100.13). For example, if you are an auditor and have shares in a public company,
you will have to sell the shares if you become the engagement partner on the audit.(Threat to independence)

Chartered accountants are required to:


· Identify threats to their compliance with the fundamental principles
· Evaluate the significance of the treats and
· Apply appropriate safeguards when necessary, to eliminate or reduce the threat to an appropriate level, and
ensure their compliance with the fundamental principles is not compromised

To be able to apply the approach, the chartered accountant must understand:


1. The fundamental principles
2. The types of threat which may arise
3. The safeguards which may be applied

List and briefly explain the five fundamental principles of professional conduct which should be adhered to by auditors
(chartered accountants and registered auditors).
· Integrity – straight forward, honest, fair and truthful in their professional and business relationship
· Objectivity – CA’s should not be associated with information they believe to be false, misleading (by
conclusion or omission) or recklessly provided
· Professional competence and due care (J&S p 2/6) – the chartered accountant must act carefully, thoroughly
and in accordance with the requirements of the assignment. Maintain professional knowledge and skills
· Confidentiality (J&S p 2/6) – CA should not disclose confidential information to any third party
· professional behaviour (J&S p 2/6) – the CA must comply with relevant laws and regulations, avoid any action
that my bring discredit to the profession. Professional behaviour i.r.o. publicity, advertising, solicitation,
recruitment and responsibilities to colleagues.

Threats – circumstances which can threaten compliance with the fundamental priciples:
1. Self-interest threats
2. Self-review threats
3. Advocacy threats
4. Familiarity threats
5. Intimidation threats

Safeguards
Unless the threat is CLEARLY insignificant the professional accountant must apply safeguards to eliminate
or reduce the threat to an acceptable level.

Can only decide if the threat is clearly insignificant by :

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· professional judgment , taking into account the public interest (if public interest is affected the threat is
significant), decision should be one that a reasonable and informed 3rd party having knowledge of all the
relevant information would make.
·

There are six inherent limitations of internal control; namely


1. Cost of internal control does not exceed the expected benefit to be derived (cost/benefit)
2. possibility of evasions of internal controls through the collusion of a member of management, or an employee,
with parties outside or inside the company
3. tendency for internal controls to be directed at routine transactions rather than non-routine transactions
4. The potential for human error due to carelessness, distraction, mistakes of judgment and the
misunderstanding of instructions.
5. internal control could abuse responsibility eg. a member of management overriding an internal control
6. procedures may become inadequate due to changes in conditions and, therefore, compliance with procedures
may deteriorate

Control risk is the risk that misstatements could occur without the internal control system of an organisation
preventing them, detecting them or fixing them

What factors will have an influence on control risk?


If the internal control system does not do its job, there is a strong possibility that misstatement of which the auditor
may not be aware will occur.

Inherent risk refers to the susceptibility of an assertion to a misstatement that could be material, either individually or
when aggregated with other misstatements, assuming that there are no related controls. Some accounts, assertions,
transactions, disclosures and industries pose greater risks for misstatement than others.

What factors have an influence on inherent risk?


The "built in" risk which accounts balance, class or transaction or disclosure might have. For example, there is more
inherent risk relating to the valuation assertion for an inventory of diamonds in a jewellery business, than to the
valuation assertion of an inventory of cricket bats

Explain when materiality must be considered during an audit


In summary, materiality is considered:
· when planning the audit,
· when performing the audit,
· when evaluating the effect of uncorrected misstatements and
· when forming an opinion

List and describe the assertions applicable to inventory balance.


· Applied to inventory: Completeness^ - all inventory owned by the company, is included in the balance
reflected in the financial statements.√ ^
· Applied to inventory: Existence^ - all inventory included in the balance, existed at year end date.√ ^
· Applied to inventory: Valuation and allocation^ - the inventory has been reflected in the statement of financial
position at appropriate amounts√^; this means that reasonable adjustments have been made for damages
and/or obsolescence.
· Applied to inventory: Rights^ - the company has (holds or controls) the right of ownership to the inventory
reflected in the statement of financial position (any encumbrances on that ownership must be disclosed) √^

ISQC 1 requires that the firm must establish policies and procedures :
· for engagement teams to put together finalised engagement files on a timely basis – i.e. set deadlines, review
and sign off files
· designed to maintain confidentiality, safe custody, integrity (no tampering or contamination), accessibility and
retrievably of engagement documentation e.g.
! use of password on computerised workpapers
! back up routines
! controls over the distribution of workpapers (e.g. signing a register)
! physical controls over hardcopy and electronic work papers (e.g. archive room with library routines)
! for retention of engagement documentation for as long as needed (not less then 5 yrs from date of
auditor’s report).

Explain in relation to the element “monitoring”, as one of the elements of quality control in accordance with ISQC
1, what it should include in the monitoring process
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1. The firm shall establish a monitoring process designed to provide it with reasonable assurance that the
policies and procedures relating to the system of quality control are relevant, adequate, and operating
effectively. This process shall:

2. Include an ongoing consideration and evaluation of the firm’s system of quality control√^ including, on a
cyclical basis, inspection of at least one completed engagement for each engagement partner√^.

Outline, in terms of section 45 of the Auditing Profession Act, 2005, the procedures that the auditor should follow due
to the existence of a reportable irregularity
Duty to report on irregularities Section 45 - J&S p3/84
This section stipulates that the individual registered auditor who:
· Is satisfied or has reason to believe that
· A reportable irregularity has taken or is taking place must
· Without delay
· Send a written report, giving particulars of the irregularity to the Regulatory board and must
· Within 3 days, notify the management board of the entities writing of the sending of the report, and must
provide management with a copy of the report

State the procedure to be followed by the board of directors of following the resignation of the company’s
registered auditors.
The following procedure should be followed when a vacancy arises:
· The board of directors must propose to the audit committee, within 15business days, the name of at least one
registered auditor to be consideredfor appointment.
· The audit committee has five business days after the proposal has beendelivered to it, to reject the proposed
replacement auditor in writing, ifthey so wish, otherwise the board of directors may make the appointment.
· Whatever the situation, a new auditor must be appointed within 40 businessdays of the vacancy arising.

List the requirements of the audit committee regarding the independence of the new auditor to be appointed.
The person appointed as the auditor must be acceptable to the company’s audit committee as being independent of
the company. To this end, the audit committee must
· ascertain that the auditor does not receive any direct or indirect remuneration except
! as an auditor or
! for rendering other nonaudit services which have been determined by the audit committee
· consider whether the auditor’s independence may have been prejudiced
! as a result of any previous appointment as auditor or
! having regard to the extent of any consultancy, advisory or other work undertaken by the auditor for
the company
· consider whether the auditor complies with the “rules and regulations” of the IRBA, for example, the Code of
Professional Conduct, in relation to independence and conflict of interest
· The audit committee must evaluate the independence of the auditor in the context of the company itself, and
within the group of companies, if the company is a member of a group

1.5.2 List three (3) duties of the audit committee in connection with the appointment of external auditors
1. To nominate, for appointment as auditor of the company under section 90, a registered auditor who, in the opinion of the
audit committee, is independent of the company;
2. to determine the fees to be paid to the auditor and the auditor’s terms of engagement;
3. to ensure that the appointment of the auditor complies with the provisions of this Act and any other legislation relating to
the appointment of auditors;
4. to determine, the nature and extent of any non-audit services that the auditor may provide to the company, or that the
auditor must not provide to the company, or a related company;
5. to pre-approve any proposed agreement with the auditor for the provision of non-audit services to the company;

The auditor issues an engagement letter to the client at the BEGINNING of the audit, this engagement letter will
explain certain aspects to the client regarding the audit. When an auditor accepts an audit engagement from a client, a
contractual relationship arises between the auditor and the client. As stated in ISA 210 (para A22), it is in the interests
of both the entity and the auditor that the latter should send an audit engagement letter prior to commencing the audit
to help avoid any misunderstandings in the audit.

2.1 List four (4) aspects that should be included in an audit engagement letter in terms of International Standards on
Auditing.
1. objective of the engagement, clearly stated i.e. to express an opinion on the financial statements
2. The scope of the engagement – an outline of what is to be done and, where appropriate, reference to
applicable legislation, regulation or other pronouncements to which the auditor adheres eg ISAs
3. The form of any reports or other communication of results of the engagement

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4. The auditors expectation of receiving written confirmation of oral representations


5. An indication that significant weakness in internal control will be brought to management’s attention
6. The name of the designated auditor, in the audit firm responsible for the audit
7. Any audit deadlines
8. The basis of fee computation and any invoicing arrangements, e.g. fees to be charged monthly
9. The letter should conclude with a request for the client to confirm the terms of the engagement letter by
signing the letter

2.2 Explain the differences between a reasonable assurance engagement and a limited assurance engagement

Review engagement provides moderate assurance that the information subject to review is free of material
misstatements, which is expressed in the form of negative assurance. Positive and negative forms of opinion are
discussed when a review is conducted, procedures are limited and not as comprehensive as audit procedures;
consequently only moderate assurance is given i.r.o. the fairness of the financial information.

Review engagements are classified as:


1. Assurance engagements and
2. Sub-classified as (a) limited assurance engagements (b) reasonable assurance engagements

Reasonable assurance engagement: audit engagements where a positive form of expression of opinion is given;
extensive procedures carried out. Reasonable assurance engagement arises out of an audit engagement.

Limited assurance engagement: review engagements, where a negative form of expression of opinion is given; less
extensive procedures carried out. Limited assurance arises out of a review engagement.
Reasonable Assurance Engagement Limited Assurance Engagement
A reduction in assurance engagement risk to an A reduction in assurance engagement risk to a level that
acceptably low level is acceptable in the circumstances of the engagement,
but where that risk is greater than for a reasonable
assurance engagement
A positive form of expression of the practitioner’s A negative form of expression of the practitioner’s
conclusion conclusion
An audit engagement A review engagement
Sufficient appropriate evidence is gathered as part of a Procedures for gathering sufficient appropriate evidence
systematic engagement process are deliberately limited relative to a reasonable assurance
engagement.

2.3.1 List the five (5) components of internal control


· Control environment
· The entity’s information system and related business processes
· The entity’s risk assessment process
· Control activities
· Monitoring of controls

2.5 Define the term “test of controls ".


If auditor thinks control risk is low then he should carry out test of control to obtain audit evidence that the internal
control procedures operated the way that they were designed.
Testing and confirming the company controls in place

The examples of audit procedures given cannot be categorised simply asa risk assessment procedure, test of control
or substantive procedure. Theprocedure will be categorised in terms of what the auditor is in fact trying toachieve.
Inspection - Inspection involves examining records, documents (physical files or electronic
storage media) or tangible assets. Example: inspecting a lease agreement to determine whether it has been signed by
an authorised signatory (test of control and/or substantive procedure)
Observation - Observation entails looking at a process or procedure being performed by the client’s staff. Example:
attending the annual inventory count to observe the performance of
the counters (substantive procedure)
Inquiry - Inquiry involves seeking information from knowledgeable persons in or outside the entity. Inquiries may
range from formal written inquiries addressed to third parties to informal oral inquiries addressed to persons inside the
entity. Example: inquiring from the warehouse controller about the methods of identifying obsolete or damaged
inventory (test of control)
Recalculation - Recalculation entails checking the arithmetic accuracy of source documents and accounting records.
Example: recalculating depreciation on plant and equipment (substantive procedure)
Analytical procedures - Analytical procedures relate to the analysis of significant ratios and trends and the resulting
investigation of fluctuations and relationships that are inconsistent with other relevant information or deviate from
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predicted amounts. Example: Ratio analysis is conducted on the turnover and compared to the ratios for prior years
(risk assessment procedure and/or substantive procedure).
Reperformance - Reperformance entails the auditor repeating, either wholly or in part, the same procedures
performed by the client. Example: reperforming the bank reconciliation at the financial year-end (substantive
procedure).
External confirmation - External confirmation involves obtaining a direct written response from a third party to a
request/query from the auditor to that third party. Example: confirming an accounts receivable balance (debtor’s
balance) directly with a debtor (substantive procedure).

The procedure will be categorised in terms of what the auditor is trying to achieve E.G.:
Ask (inquire) the credit manager for details of procedures followed for the granting of credit and authorisation of sales
– test of control.
Perform analytical review procedures of sales per month and obtain explanations for extraordinary fluctuations –
substantive procedure.
Inspect duplicate sales invoices for the authorising signature of the sales manager – test of control.
Observe procedures followed regarding gate control at the inventory store – test of control.
Reperform the leave pay accrual at year-end – substantive procedure.
Perform a debtor’s confirmation at year-end on selected large debtors, requiring the debtors to confirm the balance at
year-end – substantive procedure.

Test of Control - correct test of control to be performed by the auditor in order to test the operating effectiveness
thereof .

2.9 Name the components of audit risk


There are only three components of audit risk:
1. Inherent risk
2. Control risk
3. Detection risk

Understand the relationship of the components of audit risk and how they have an impact on each other.
As stated in ISA 200: A42, there is an inverse relationship between detection risk and the combined level of inherent and control
risk. When inherent and control risk are high, for example, the acceptable level of detection risk must be low in order to reduce the
audit risk to an acceptably low level (additional audit procedures must be conducted).

What is Control risk?


Control risk is a function of the efficiency of the client’s system of internal controls
(see ISA 200: A39). If the system of internal controls is functioning poorly, there is
a major risk of the occurrence of fraud and error, which could cause the financial statements to be materially misstated. (The
system of internal controls is discussed in study unit 3.2.)

What is Detection risk?


Detection risk is the risk that the procedures performed by the auditor will not detect a material misstatement that exists in the
financial statements (see ISA 200:13(c)). Detection risk is determined by the effectiveness of the audit procedures and how well the
auditor applies them.

What is inherent risk?


This risk refers to the susceptibility of an assertion to a misstatement that could be material, either individually or when aggregated
with other misstatements, assuming that there are no related controls. Some accounts, assertions, transactions, disclosures and
industries pose greater risks for misstatement than others

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Types of Auditor
· Registered external auditors – who express an independent opinion
· Internal auditors – who perform independent assignments on behalf of the board of the company
· Government auditors – perform a role similar to that of the internal auditor, but within the government
departments, reporting their findings to senior government
· Forensic auditors – concentrate on investigating and gathering evidence where there has been alleged
financial mismanagement, theft or fraud
· Special purpose auditor – specialise in a particular field such as environmental auditors, or VAT auditors

1.2.2. Describe the overall objective of the auditor in terms of ISA 200
· To obtain reasonable assurance about whether the financial statements as a whole are free from material
misstatement, whether due to fraud or error, thereby enabling the auditor to express an opinion on whether
the financial statements are prepared, in all material respects, in accordance with an applicable financial
reporting framework; and
· To report on the financial statements, and communicate as required by the ISAs, in accordance with the
auditor’s findings
· In all cases when reasonable assurance cannot be obtained and a qualified opinion in the auditors report is
insufficient in the circumstances for purposes of reporting to the intended users of the financial statements,
the ISAs require that the auditor disclaim an opinion or withdraw/resign from the engagement, where
withdrawal is possible under applicable law or legislation.

1.3.1. Explain five (5) uses of audit documentation to the auditor


· assists the audit team to plan and perform the audit
· facilitates direction, supervision and review on the audit
· makes members of the audit team accountable (i.e. what they have done is evidenced in workpapers)
· facilitates audit quality control reviews – from partners in firm to SAICA
· provides a record of matters of audit significance such as :
Ø an experienced auditor with no previous connection with the audit should be able to understand :
v the nature timing and extent of the audit procedures
v the results obtained
v significant matters and the conclusions of them
Ø that the names of the preparer and reviewer and the dates on which they conducted the procedures
should also be on the workpaper.

Assertion = statement or point regarding an entry in the financials

Assertions pertaining to salaries


Occurrence: All salary expenses are genuine expenses and pertain to the entity.
Accuracy: Salary amounts have been recorded appropriately.
Cut-off: Salaries have been recorded in the correct accounting period.
Classification: Salaries have been recorded in the proper accounts.
Completeness – All transactions that should have been recorded have been recorded

1.5.1 Define the term “control activities”


Control activities are the policies and procedures that help ensure that management directives are carried out.
Examples include authorisation, performance reviews, information processing, physical controls and segregation of
duties (ISA 315, para A88).

Control activities = policies and procedures that ensure controls are in place to achieve internal control
objectives e.g.
Types of control activities

· Approval, authorisation
· Segregation (division) of duties
· Isolation of responsibility
· Assess/custody (security)

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· Comparison and reconciliation


· Performance reviews

substantive procedures – used to verify (substantiate) transactions and balances

Substantive procedures

Financial statements consisting of collection of balances (Balance Sheet) and summary of totals (Income
Statement) and accompanying notes – tests of control cannot provide auditor with sufficient appropriate
evidence pertaining to balances, totals and disclosures, so auditor must perform procedures of a
substantive nature.

Substantive procedures can be performed on balances and totals themselves or on the individual
transactions which make up the balance or total. Either tests of detail or analytical procedures.

Substantive procedures seek to provide evidence to support the financial statement assertions :

· balances – completeness, existence, valuation, rights and obligations, presentation and disclosure
· transactions – completeness (totals), occurrence, measurement, presentation and disclosure

The sources and procedures the auditor could use to obtain preliminary information on the business are as follows:
· the previous auditor: communication with the previous auditor (in compliance with the Code of Professional
Conduct)
· those charged with governance: discussion with the client’s directors, senior financial personnel, audit
committee and so on
· external sources: inquiries from the firm’s bankers, legal counsel and so on (permission would have to be
sought)
· external information: background searches of relevant databases (eg the internet)
· internal documentation: review of any documentation, either public or made available by the prospective client
(eg group or management reports)
· the auditor’s firm: regarding independence, inquiry and analysis of the status of the firm and its employees in
relation to the potential client
· the financial press: searches in financial magazines for relevant information

Independence :

· independence of mind – state of mind that permits the provision of an opinion without being affected
by influences that compromise professional judgment and allow auditor to act with integrity, objectivity
and professional skepticism
· independence in appearance – avoidance of facts and circumstances that are so significant that a
reasonably informed 3rd party with all the relevant information would reasonably conclude that the
auditor’s integrity, objectivity or professional skepticism had been compromised
· state of mind & in appearance – both are very important as even if auditor with financial interest in
client might have actually performed his duties with the highest level of independence (state of mind) he
may NOT be perceived by another party who know of his financial interest in the client of being
independent (appearance). So auditor must not only be independent but must also be seen to be
independent.

the differences between an independent review and an external audit.


External Audit Independent review
A reduction in assurance engagement risk to an A reduction in assurance engagement risk to a
acceptably low level level that is acceptable in the circumstances of
the engagement, but where that risk is greater
than for a reasonable assurance engagement

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A positive form of expression of the practitioner’s A negative form of expression of the practitioner’s
conclusion conclusion
Procedures for gathering sufficient appropriate Procedures for gathering sufficient appropriate
evidence are deliberately more compared to a evidence are deliberately limited relative to a
limited assurance engagement. reasonable assurance engagement.

More evidence is gathered as part of a Sufficient appropriate evidence is gathered as


systematic engagement process. part of a systematic engagement process

3.2.1 Identify four (4) control weaknesses regarding control activities in (e) to (k) in the scenario;

3.2.2 For each identified control weakness, describe what control could be put in place to overcome the
weakness in the control activity.
3.2.1Control weakness 3.2.2 Control
e) The person who performs the There should be proper segregation
bank reconciliation also of duties implemented
authorises the payments that
are made.
f) The creditors reconciliations inadequate review by senior
are not signed off by the management
financial manager after review
g) It was detected that the Inadequate comparison and
individual creditors accounts are reconciliation
not compared to the creditor’s
statements when the creditors
reconciliation is prepared
h) Management of Anytime acts Management supervision should be
with integrity and enforces this put in place to review the
throughout the whole performance of each of the
organisation employees
i) There are no background Procedures must be put in place to
checks performed on pilots that screen pilots employed by Anytime
are employed by Anytime
k) Entry to the aircraft Strict access controls should be put
warehouse is not strictly in place
controlled and anybody can
enter

Reportable irregularity = any unlawful act or omission committed by any person responsible for the
management of the entity which :

· has caused or may cause material financial loss to the entity or any user of the entity
· is fraudulent or amounts to theft
· represents a material breach of any fiduciary duty to the entity

Audit documentation – general points and basic requirements


· audit documentation may be in various media e.g. written, digital, recorded
· audit documentation is the property of the firm, and the firm is in no way obliged to make it available to the
client or any other party, unless required to do so by law
· work papers should be correctly headed regardless of their form e.g.
! Client: full name

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! Financial year end date:


! Date:
! Section of Audit:
! Prepared by:
! Reviewed by:
! Date of review:
· Work papers should contain sufficient information concerning the matter at hand
· Work papers should contain explanatory and commentary on any unusual or exceptional matters and how
they were dealt with
· Work papers should contain the conclusion of the preparer of the working paper
· Work papers should include adequate legends/ keys to symbols on the working paper
· Working papers should display adequate cross referencing to other work papers

List and describe the assertions applicable to turnover (turnover) in the working paper
· Occurrence: ^ All the turnover included relates to genuine sales/ turnover of the entity (i.e: not

· Completeness: ^ All turnover/ sales


· Accuracy: ^ All turnover/ sales
· Cut-off: ^ All turnover/ sales
· Classification: ^ The turnover

In this question, 2 November 2013 is the most appropriate date to issue an audit report.
The auditor’s report should be dated no earlier than the date on which the auditor has obtained sufficient appropriate
audit evidence on which to base his or her opinion.
Before an auditor can sign the auditor’s report, all the statements comprising the financial statements, including the
relevant notes, must have been prepared, and those with the recognised authority must have accepted responsibility
for the financial statements.
Subsequent events should be performed for the dates 30 October to 2 November

ASSIGNMENT 1

A sample of printers was selected from the administration offices and was traced to the fixed asset listing. = satisfies
the completeness assertion as it provides evidence that all printers that are on the premises have been recorded
completely in the fixed asset listing.

A sample of items on the inventory count sheet was selected and these were compared to the physical inventory on
hand. = the auditor has satisfied himself/herself that inventory that was recorded on the inventory count sheet actually
exists

A sample of goods delivery notes were matched to the corresponding sales invoice and to the entry in sales journal =
satisfies the completeness assertion as it provides evidence that all sales made have actually been recorded in the
accounting records

Inspected the title deeds of the property to determine whether there were any encumbrances on the property =
satisfies the assertion of rights and obligations relating to the property registered in Jody’s name
An unregistered person may be appointed by the Auditor General to carry out on his behalf any audit which he is, in
terms of the Public Audit Act, required to undertake. = The Auditor General may appoint a person who is not a
registered auditor to carry out anaudit in terms of the Public Audit Act, 2004 on his behalf.

A person who is not a registered auditor may not accept an appointment as an auditor, actas an auditor or engage in
public practice as an auditor in terms of sec 41 of the AuditingProfession Act, 2005. Options 1, 2 and 4 are, therefore,
prohibited.

The Independent Regulatory Board for Auditors (IRBA) has specific goals as described in the IRBA Manual of
Information
1 To register an auditor who meets the registration requirements.
2 To monitor the compliance of registered auditors against professional standards.

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3 To develop and maintain shareholder relationships and enhanceperformance, accountability and public confidence
is one of the IRBA’s goals.
4 To investigate and take appropriate action against registered auditors in respect of improper conduct.

of the shareholders of a company.


They receive the annual financial statements and can provide finance for the business.

It is the responsibility of the auditor to gather sufficient and appropriate audit evidence to be in a position to give
an independent opinion on whether the annual financial statements issued by the directors to the shareholders
present fairly, the financial position and results of operations of the company in terms of the applicable financial
reporting framework.

Directors are responsible for running the business and reporting the results of their management to the
shareholders in the annual financial statements

Directors are responsible for preparing the financial statements in terms of an appropriate financial reporting
framework.

Finance costs are reflected on the statement of profit and loss and other comprehensive income. Which of
the financial statement assertions are relevant to the disclosure of finance costs?
There are three categories of management assertions, namely:
• Assertions about classes of transactions and events for the period under audit (Statement of profit and loss and
other comprehensive income line items)
• Assertions about account balances at the period end (Statement of financial positions line items)
• Assertions about presentation and disclosure

First ask yourself under which category the disclosure of finance costs falls. We are addressing the disclosure of
finance costs and the assertions relating to presentation and disclosure will, therefore, apply, as stated in option 4. To
answer a question of this nature it is imperative that you understand which assertions fall under the three categories.
You also need to bear in mind that finance cost is a class of transaction and assertions pertaining to class of
transaction will apply.

Internal auditing is a management function which functions independently within an organisation, but remains part of
the entity. the internal auditors still remain part of the organisation even though they function independently. The
internal auditors report to the management of an entity, receive a mandate from management and they perform a
management function and not an external attest function.

A postulate is a foundation on which a discipline is built and there are certain underlying principles or postulates,
which serve as the basis of auditing theory
Postulate = something that is claimed as a basis for reasoning (e.g. a starting point)

1. no conflict of interest between the auditor and management / employees of the entity being audited
2. auditor must act exclusively as an auditor in order to offer an independent and objective opinion on
the fair presentation of financial information
3. professional status of the independent auditor imposes commensurate professional obligations
4. financial data if verifiable
5. internal controls reduce the probability of errors and irregularities
6. application of IRFS results in fair presentation
7. that which held true in the past will hold true in the future (in the absence of contrary evidence)
8. financial statements submitted to the auditor for verification are free of collusive and other unusual
irregularities

inherent limitations of an audit


· The preparation of financial statements involves judgment by management in applying the requirements of the
entity’s applicable financial reporting framework.
· Many financial statement items involve subjective decisions or assessments or a degree of uncertainty
(estimates).
· The occurrence of non-compliance with laws and regulations.
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The fact that that the auditor’s work is governed by regulatory bodies is not an inherent limitation of an audit; it merely
means that the conduct of registered auditors is regulated. Consult the reference for a comprehensive guideline on the
inherent limitations of an audit.

The financial reporting framework is the framework adopted by management in the preparation of the financial
statements that is acceptable in view of the nature of the entity and the objective of the financial statements.

description of a financial reporting system.


The financial reporting framework is the series of tasks and records of an entity by which transactions are processed
as a means of maintaining financial records.

internal control: The financial reporting framework provides direct support to the entity’s management
and provides a strong internal control environment within the entity for monitoring
compliance with established policies and procedures and reporting to management.

procedures performed by an auditor.


The financial reporting framework examines evidence to find sufficient evidential matter to support the assertions of
management contained in financial statements, in order to express an opinion thereon.

An auditor will not be guilty of improper conduct if prescribed fees are received.

improper conduct on the part of a registered auditor in public practice in terms of the rules regarding
improper conduct of the Independent Regulatory Board for Auditors (IRBA)
· failure to perform work with a degree of professional competence, due care and skill is not
permitted as it contravenes rule 2.7. (Failure to perform work with reasonable care and skill.)
· permitting a registered auditors name to be used in connection with any estimate in a manner
which may lead to the belief that the registered auditor vouches for the accuracy of the estimate
contravenes rule 2.9. (A registered auditor vouching for the accuracy of forecast results which
were estimated by management of the company being audited)
· a registered auditor may not receive a payment from a trainee auditor, who has been serving a
training contract for agreeing, to cancel the contract. The only compensation which may be
claimed is in respect of a reimbursement actually made to IRBA if satisfactory proof can be
produced to the satisfaction of IRBA. (Requiring compensation from a trainee auditor for
cancellation of a training contract except for actual expenses paid to the Independent
Regulatory Board for Auditors (IRBA) in respect of the training contract)

South African Institute of Chartered Accountants (SAICA’s) Code of Professional Conduct


1 A practitioner entrusted with monies belonging to others, in the course of professional work, should keep such
monies separate from firm monies.
2 Clients’ monies received by a practitioner should be deposited without delay to the credit of a client account.
3 Monies may only be drawn from the client account on the instructions of the client.
Not permitted = Fees due from a client may be drawn from clients’ monies without the client’s consent
= An auditor may only use the assets of a client for the purposes for which they were intended. By
drawing money to pay audit fees without the client’s consent the SAICA Code of Professional Conduct
has been contravened

when can the shareholder hold the auditor responsible for negligence in terms of the Auditing
Profession Act:
The auditor will be liable to the shareholder if at the time when the negligence occurred the registered
auditor knew or could reasonably have been expected to know that the shareholder would rely on the
opinion in order to enter into a transaction

The shareholder will have to bring a delictual action against the auditor and, amongst other things,
prove that the auditor knew or reasonably could have been expected know that the third party would
rely on the opinion
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Take note that there is a distinction between the liability to clients and to third parties. An auditor’s
liability to a client may be based on breach of contract. An auditor generally has no contract with third
parties and breach of contract cannot, therefore, be used as a basis for liability to third parties.

Inventory to the value of R67 256 was purchased by Hamiltoon Ltd and is disclosed in the Purchases
account in the statement of profit and loss and other comprehensive income. By including this amount
in the statement of profit and loss and other comprehensive income, management declares amongst
other things that: all inventory purchases are recorded, and that all inventory purchases are recorded
in the proper accounts. Which two management assertions are being addressed with these
statements? Classification and completeness

Purchases of inventory are classified as transactions and events for the period under audit. The assertions relating to
classes of transactions and events will, therefore, apply. In this question we specifically asked you which assertions
relate to “all purchases are recorded” (Completeness), and “all purchases are recorded in the proper accounts”
(Classification). It is thus very important that you understand what is meant by the assertions in each of the three
categories.

Threats
A close family member of the assurance team has a direct or material interest in an assurance client.
This may create a self interest threat

The audit partner has been involved with a client over a long period of time. This may create a
familiarity, self-interest and/or self-review threat

Not a threat
The audit partner advises the audit client on accounting principles and disclosure = These activities are
considered to be part of the audit and are considered appropriate means to promote the fair
presentation of the financial statements.
An audit client gives each member of the engagement team an inexpensive pen bearing the
company’s logo, at the completion of the annual audit.The gift is insignificant

Requirements for trading as registered auditors company


· Every shareholder must be a registered auditor.
· Only natural persons who are registered auditors may be members or shareholders of the
company
· The company’s articles of association (memorandum of incorporation according to the
Companies Act, 2008) must provide that a member of the company shall not appoint a person
who is not a member of the company to attend, or speak or vote, in his/her stead at any
meeting of the company

In a review engagement a moderate level of assurance is expressed in a negative form

a reasonable level of assurance is expressed in an audit engagement.

no assurance is expressed in a compilation engagement

no assurance is expressed in an agreed upon procedures engagement.

element of a quality control system


· Engagement performance
· Monitoring.

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· Human resources.
· Leadership responsibilities for quality in the firm
· Relevant ethical requirements (including independence)
· Acceptance and continuance of client relationships and specific requirements

The objective of the firm in establishing a system of quality control is to provide the firm with
reasonable assurance that the firm and its personnel comply with professional standards and
applicable legal and regulatory requirements and that reports issued by the firm or engagement
partners are appropriate in the circumstances.

Management assertions are representations by management, explicit or otherwise, that are embodied
in the financial statements, as used by the auditor, to consider the different types of potential
misstatements that may occur.

Graded questions

differences between a reasonable assurance engagement and a limited assurance engagement.


Reasonable assurance engagement Limited assurance engagement

• A reduction in assurance engagement risk to an • A reduction in assurance engagement risk to a


acceptably low level. level that is acceptable in the circumstances of the
engagement, but where that risk is greater than
for a reasonable assurance engagement.

• A positive form of expression of the practitioner’s • A negative form of expression of the


conclusion. practitioner’s conclusion.
• An audit engagement. • A review engagement.
• Sufficient appropriate evidence is gathered as • Procedures for gathering sufficient appropriate
part of a systematic engagement process. evidence are deliberately limited relative to a
reasonable assurance engagement.

13.6 What is a public interest score?


● A public interest score is the sum of the points allocated to certain attributes applicable toall
companies, e.g. one point is allocated to every one million rand or part thereof, ofturnover. √
●The public interest score is used as a gauge of the interest the public at large (society)has in the
company. √
●The company will be required to satisfy various conditions, dependent upon its publicinterest score,
e.g. a company with a score of at least 350 points, will have to beexternally audited.

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State 3 matters which will be affected by the company’s public interest score.
●Whether the company is audited or reviewed and who must carry out the independent review. √
●Which financial reporting standard the company must use to prepare its annual financial statements.

●The level of financial rescue practitioner who would be engaged, if the company needed financial
rescue. √

Factors that DO NOT AFFECT a company’s public interest score


3.1 - Location, the number of directors (executive and non-executive), √ and
3.6 - number of years in operation √ do not affect the public interest score.

Factors that DO AFFECT a company’s public interest score


· Number of non-executive directors
· Number of directors
· Turnover
· Assets held in trust by the company

All companies and close corporations must, calculate their public interest score. √

Tech (Pty) Ltd Master (Pty)


Ltd
6.1 Turnover 8^ 136 ^
6.2 Directors N/A ^ N/A ^
6.3 Average employees for the 62 ^ 201 ^
year
6.4 Amounts owed to third 2^ 20 ^
parties
9^ 22 ^
6.5 Individuals with direct or
indirect interest in each
company's shares
Total 81 Total 379
points√ points√

What are the various threshold categories set by the Regulations for public interest scores?
· Equal to or above 350 points √
· Equal to 100 or above, but less than 350 points √
· Below 100 points. √

Public interest score must be calculated annually. ^

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Note: There are other regulations that can change the above mentioned decision table.

a) Postulates in the context of auditing


A postulate provides a basis or framework √ for thinking about problems and arriving atsolutions. √ A
postulate is a starting point for thinking about a discipline. √In the context of auditing the postulates are
the foundations√ on which the subject (discipline) isbuilt. (Max 3)

b) Statements that are regarded as postulates


The following of the mentioned statements are generally regarded as the postulates of auditing:
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Statement 2 ^: Essentially this postulate says that if the auditor is going to give an opinion√^that is
worthwhile to users, he must be free of any bias (independent) √^. Furthermore theauditor must not
compromise his audit independence by offering the client other services whichmay impinge in any way
on his independence. √^ (Max 3)

Statement 5 ^: This postulate proposes that it is to verify the client’s financial data√^ i.e. thatthere will
be evidence (documentary or otherwise) which will enable the external auditor to“verify” the
transactions recorded in the client’s books√^. If financial information is not verifiablethere can be no
audit. √^ (Max 3)

Statement 6 ^: This postulate suggests that a company without internal controls provides theauditor
with little chance of conducting an efficient or economical audit. √^ If a company is not“controlling” its
activities e.g. no division of duties, no proper documentation etc, a positive auditoutcome is not
feasible. √^ (Max 3)

Statement 8 ^: This postulate suggests that in business “things generally stay the same”. √^Obviously
businesses develop, expand, contract etc, but generally from year to year the coreactivities and
philosophy of the business remain the same. √^ Hence, historical informationabout a client is important
to the auditor. √^ The postulate in a sense also alerts the auditor tothe fact that if there has been
change, the effect of the change must be considered for thepurposes of the audit. √^ (Max 3)

Statement 10 ^: This postulate simply means that the auditor must understand that theprofessional
status which the audit profession and its members have, brings with it aresponsibility to meet their
professional obligations, √^ e.g. auditors must ensure they keep upto date, act with objectivity and
integrity etc. √^ (Max 3)
(Max 15)
c) Statements which are not postulates
Statement 1: True. ^ The assertions are the representations which the directors are makingabout the
assets, liabilities, transactions and disclosures in the financial statements. Thus theyform the basis of
the financial statements. √^ (Max 2)
Statement 3: False. ^ An unqualified opinion is a statement that the financial statements“present fairly”
the financial position etc of the company. √^ It is not a statement that the annualfinancial statements
are 100% correct. √^ The auditor can never be in a position to “certify” due to inter alia, the limitations
of the audit function and the extensive use of judgment and
estimates in financial statements. √^ (Max 2)
Statement 4: True. ^ One of the fundamental principles of professional conduct is that an auditor is
required to “maintain professional knowledge and skill” √^and “act in accordance with applicable
technical and professional standards”. √^ Furthermore, an opinion arising from an audit conducted by
an incompetent audit team will be worthless.√^ (Max 2)
Statement 7: True. ^ In South Africa the individual must be registered with the Independent
Regulatory Board for Auditors (IRBA). √^ (Max 2)
Statement 9: True. ^ Although the auditor expresses an independent opinion it is very important that
there is communication and co-operation with the client’s directors/management. √^ The auditor audits
the assertions of the directors, and evidence is frequently required from individual directors or
members of the management team. √^ For example, a detailed explanation about a major transaction
may be required from the financial director; if he will not co-operate, the auditor may not be able to
“audit” the transaction to determine whether it has been fairly presented in the financial statements. √^

13.3 Graded Questions


(a.) identify and comment briefly on each of the matter which you would have considered in
satisfying yourself that a Reportable Irregularity has taken place
I would have satisfied myself that …
– the company has breached the Income Tax Act by claiming
(intentionally) VAT to which it was not entitled, this is also fraud √^

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Franschoek (Pty) Ltd √– fraud was


perpetrated by the financial director and managing director, the only two executives on the Board and
who effectively manage the company √^
– SARS will suffer loss as will the company
(penalties) √^

‫כ‬
‫כ‬ any,
shareholders, etc. √
(Max 5)

(b) outline the procedure which you would have followed on satisfying yourself that a
reportable irregularity was taking place
I would have …
· “without delay” have sent a written report to the IRBA, giving particulars of the reportable
irregularity √
· within 3 days of this report, notified the Board of Franschoek (Pty) Ltd in writing of the sending
of the report to the IRBA √
· as soon as reasonably possible but within 30 days of sending the first report √ …
! have taken all reasonable measures to discuss the report with the Board of Franschoek
(Pty) Ltd and √
! have sent another report to the IRBA which included a statement that I am of the opinion
that √
- no reportable irregularity is taking or has taken place √
- the reportable irregularity is no longer taking place and that adequate steps have
taken place for the prevention or recovery of any loss or √
- the reportable irregularity is continuing. √(Max 7)

c. Changed circumstances
(i) It would make no difference √, the Section applies to unlawful acts conducted by persons
responsible for the management of the company √. The fact that they are also shareholders is not a
factor. √ (Max 2)
(ii) I would still submit my first report √. If within 30 days thereof I am satisfied that the directors have in
fact taken adequate steps to “make good”; √ I would notify the IRBA accordingly i.e. the process must
still be followed. √ (Max 2)
(iii) If Franschoek (Pty) Ltd is an audit client √ it does not matter that the unlawful act was identified
whilst conducting other work. √ (Max 2)
(iv) It would probably not be a reportable irregularity but this would depend on the interpretation of a
“person responsible” for the management of the entity √. The financial director is partially responsible
but does not make up the “management board”. √
The matter could possibly be dealt with as an employee type fraud which could be reportedto the
Board. √ If the Board does not take appropriate action then it would definitelybecome a reportable
irregularity. √ (Max 2)

d. Duty to report if it is not an audit

dited by a “registered auditor”. √

including Sec 45 (reportable irregularities). √

3.4 in Graded Questions


Identify where applicable the category into which each of the threats fall and suggest appropriate
safeguards which should be put in place to reduce the threat to an acceptable level if possible.

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1. VishBhogal has been the lead engagement partner on the audit of Kybher Ltd, a listed company
for the past five consecutive year-end audits
Familiarity threat. √
Safeguard:Auditor rotation as required by the Companies Act. √^

2. The audit firm of Ajax and Real are asked to provide internal audit services to Clarkson Ltd, one
of its audit clients
Self review threat √ where the services relate to internal accounting control/financialsystems.
However, this situation would not be acceptable to the audit committee interms of King III.
Safeguard:Only safeguard is not to accept this appointment. √^
Probably no threat √ where the services relate to operational (non-financial) systems
Safeguard:The safeguard would be for the audit committee to approve the appointment.
Thecommittee would only approve if the auditor’s independence was not threatened. √^

3. Ngcobo and Zwane, an audit firm, has been requested by one of its audit clients to lend it (the
audit client) two trainee accountants to work in its accounting department for a period of six
weeks
Self review threat √ and potential familiarity threat √ as trainees become friendly with client
accounting staff.
Safeguards:
! Trainees should not make any “management” decisions. √^
! Trainees should not exercise discretionary authority to commit the client, e.g. sign a
purchase order or write off a bad debt. √^
! Trainees should not be assigned to the audit. This will be particularly effective in
addressing any familiarity threat. √^

4. Jessie James and Com, a firm of auditors, has been approached by Odeon (Pty) Ltd a large
audit client, to recruit a financial director on its behalf
Self interest threat, √ familiarity threat. √
Safeguards:
! Limiting the service to reviewing the suitability of the client against a list of criteria drawn
up by the client. √^
! Proposing not just one individual but rather two or three potential appointees and leaving
the final decision to the client (the board will appoint the individual as a director). √^
! Ensuring the service is rendered by a professional at the firm who is not part of the audit
team. √^

5. The fee for the assignment (in 4) will be equal to 15% of the remuneration package of the
financial director for 1 year. The remuneration package will be negotiated between your firm
and the successful candidate
Self interest threat. √
Safeguards:
! Odeon (Pty) Ltd sets the fee prior to the assignment. √^
! Fairness of the fee should be reviewed by independent 3rd party or “industry norms”. √^

6. Flyfast(Pty) Ltd, a travel agency, offers Thyse Burger and Lewey Koen, the partner in charge
and manager of its external audit team, free airline tickets to Europe to watch the tour de
France. The tickets are part of a Flyfast (Pt) Ltd sales promotion
Self interest threat√ and familiarity threat√ (possibly future intimidation).
Safeguard:
! Offer should not be accepted. (The fact that it is part of a sales promotion has no
bearing.) √^

7. Carter Brown, the senior-in-charge of the audit of Finsbank, obtains a loan from the bank to
finance the purchase of his new BMW
No threat (provided loan is given under normal terms and conditions.) √
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If the loan has preferential terms there will be a self-interest threat.


Safeguard:
! Loan should not be accepted. √^

Graded Questions 3.8

1. Kingston Jones, a chartered accountant in public practice, was found guilty of bribing a government
official in the provincial traffic department in connection with a speeding fined he had received. Does
this amount to a breach of the SAICA Code of Professional Conduct? Discuss.

1. ● The question here is whether the Code Of Professional Conduct relates to Kingston Jones’
behaviour outside of his practice.
● The fundamental principle of integrity requires that a chartered accountant behonest in all
professional and business relationships. Is it implied that thisextends to honesty in all aspects of
his life? √
● The fundamental principle of professional behaviour requires a charteredaccountant to comply
with relevant laws. Does this mean relevant only to hisbusiness dealings? √
● This fundamental principle also states that the chartered accountant must avoid anyaction which he
knows may discredit the profession. √
● Furthermore being a member of the accounting profession creates a responsibility toact in the public
interest. √
● Bribing a traffic official is a form of corruption and is neither an act “in the public”interest or an act
which would reflect positively on the profession, as honesty is anessential feature of the profession
and (theoretically at least) a government officialworks within the public interest. √

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2. Harvey Goosen a charted accountant in public practice, was approached by one of his clients to
sign a statement reflecting expenses incurred by the client. The statement was used by the client to
obtain a reduction in taxes payable to the local authority under which his business fell. As he was not
giving an opinion on the statement Harvey Goosen glanced briefly at it, checked the additions and
signed it in his capacity as a chartered accountant. The statement was false. Could Harvey Goosen be
found guilty of breaching the SAICA Code of Professional Conduct? Justify your answer.

● Whilst it does not appear that Harvey Goosen has been intentionally dishonest in signing a false
statement (which would be a breach of the fundamental principles of integrity√ and professional
behaviour) √, he has failed to recognise a threat to his compliance with the fundamental principle of
professional competence and due care. √
● Even though he is not giving an opinion on the statement, he should have realised that:
1. The statement could be false (the client stands to benefit from it). √
2. His signature will convey a level of “certification”/assurance to the local authority (signed by a
CA(SA)). √
● Harvey Goosen has not acted diligently or exercised sound judgement in applying professional
knowledge and skill and thus is in breach of the fundamental principle of professional competence
and due care. √

3. Raj Reddy a chartered accountant, was surprised one morning to see that an electronic funds
transfer of R500 000 had been made into his firm’s bank account. His secretary informed him two days
earlier when Raj Reddy had been out, one of the firm’s clients Benny Marks had phoned and
requested the firm’s banking details so that he could make the transfer. The secretary had provided
the banking details as requested and Benny Marks had indicated that he would phone Raj Reddy “in a
day or so”. Later that morning Benny Marks phoned Raj Reddy and requested that Raj Reddy take
custody of the money until further notice. Discuss the action which Raj Reddy should take with regard
to the R500 000 so as to comply with the Code of Professional Conduct.

● This situation requires that Raj Reddy comply with Section 270 – Custody of client assets. √ Failing
to do so may constitute a threat to his compliance with the fundamental principles of integrity, √
professional behaviour √ and objectivity. √
● Raj Reddy must therefore put the following safeguards in place:
* Satisfy himself, by discussion with Bennie Marks and or other means, that the money (R500 000) is
not from an illegal source. √^
* Determine why Bennie Marks wishes to place the money in the custody of Raj Reddy’s firm and to
what purposes the money must be put. √^
* If satisfied, Raj Reddy must promptly transfer the money out of the firm’s bank account and into an
account
● In an entity registered in terms of the Bank Act 1990 √^Designated as a client account under the
control of Raj Reddy’s firm, e.g. Reddyclient Trust account. √^
* If Raj Reddy, for any reason, does not wish to hold these funds, the money shouldbe transferred
back to Bennie Marks immediately. √^
* Proper up to date detailed records of the money held in trust and any movementson the balance (e.g.
Interest, withdrawals) must be recorded and the records mustbe available for inspection. √^

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4. Zuma and Patterson is a firm of chartered accountants in public practice operating in a small country
town. They offer many kinds of financial services, conduct tow audits and sell property. During the
current year they received, inter alia:
4.1. fee income calculated as a percentage of the selling price of a farm which they sold for a client
4.2. 15% if the value of an insurance claim paid to a client. Zuma and Patterson had prepared the
claim to the insurers on behalf of the client
4.3. audit fees from the two audits. These fees are calculated at 1% of the audited net profit after tax
for the year. This basis applied ot both clients
Discuss whether the basis on which each of these fees was charged, satisfies the requirements
of the SAICA Code of Professional Conduct?

4.1 All of the fees mentioned are contingent fees, i.e. they are based on the outcome of a
transaction or service. √ Zuma and Patterson should, in terms of Sec 290 – Contingent Fees,
recognise that with all contingent fees there is a self-interest threat √ to their independence and that
safeguards must be put in place. √ With regard to the sale of the property, the normal method of
remuneration for the selling agent is a percentage of the selling price. Zuma and Patterson should
have agreed the percentage they would charge with the client before the sale was made. They appear
not to be in breach of the COPC. √
4.2 With regard to the insurance claim, this is not a “regulated method of charging” and does not
appear to be commensurate with the value of the service offered, and is not a defendable basis of
charging. √ However, the client may have agreed to this basis, in which case Zuma and Patterson
must be quite sure that …
* the fee equates fairly to the skill and time involved in providing the service √
* they do not compromise their objectivity and integrity by falsifying the amount claimed to increase
their fee √
* the client understands exactly the basis of charging and is satisfied with it. √
4.3 With regard to the basis of charging audit fees, the firm is in breach of the COPC. √ The COPC
states categorically that a contingent fee cannot be charged for assurance engagements, as the self-
interest threat to the chartered accountant cannot be adequately addressed by other appropriate
safeguards. √ Assurance engagement fees should be charged on a defendable basis relating to the
time and expertise employed on the audit. There is no justification for linking the audit fee to the net
profit! √

5. Skip Skoombie, a chartered accountant in public practice, operates a small practice which offers
assurance services and general business advice to small enterprises, as he does not bother to keep
up to date with the tax legislation, he refers all of his clients tax matters to a friend who runs a tax
practice. Sometimes he tells his client that he is doing so but sometimes he doesn’t. for every client he
refers to his friend, Skip Skoombie receives a fee which his friend determines. Discuss Skip
Skoombie’s actions in terms of the SAICA Code of Professional Conduct.
There are a number of COPC considerations:
● In terms of Section 130 – Professional competence and due care √, all chartered accountants are
obliged to maintain professional knowledge at a level required to ensure that clients receive competent
professional service, so firstly Skip Skoombie should be considering whether he is in breach of this
requirement by not bothering to keep up to date. √ For example, if he does not keep up to date he may
well fail to pick up tax issues which should be referred to his "tax expert".√
● In terms of Sec 130, he is entitled to obtain advice and assistance externally to carry out
engagements satisfactorily, √ but is this a realistic long-term solution, as his clients may be losing out
over tax issues which Skip Skoombie has not even recognised as a potential benefit for his clients?
● In terms of Section 140 – Confidentiality, √ Skip Skoombie should not be disclosing client information
to 3rd parties without the client’s permission. √ So in the cases where he does not tell the client that he
is referring tax work to a friend, he would be in breach of the COPC. √
● In terms of Sec 240 – Fees and other types of remuneration, √ Skip Skoombie may receive a referral
fee from his friend for the tax work he refers, but this presents a self-interest threat √to his compliance
with the fundamental principles of objectivity √ and professional competence. √

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● To reduce this threat to an acceptable level, Skip Skoombie should disclose in advance, in writing,
the arrangement to obtain a referral fee. He does not do this. √

Graded questions 3.9


1. Identify the fundamental principles on which the SAICA Code of Professional Conduct is based,
and provide a brief explanation of each
1. Integrity: ^
Chartered accountants should be straightforward, honest, fair and truthful in their
professional/business relationships. √
2. Objectivity: ^
Chartered accountants should not compromise their professional or business judgment
because of bias, conflict of interest, or undue influence of others. √
3. Professional competence and due care: ^
Chartered accountants are required to maintain professional knowledge and skill √and at the
level required to ensure that a client receives competent professional services based on current
developments in practice, legislation and techniques, and act diligently and in accordance with
applicable technical and professional standards. √
4. Confidentiality: ^
Chartered accountants should not disclose or use confidential information acquired as a result
of a professional or business relationship √, unless they have permission to do so √ or unless
there is a legal obligation to do so. √
5. Professional behavior: ^
Chartered accountants must comply with relevant laws and regulations √ and avoid actions
which bring discredit to the profession. √

2. In the context of the chartered accountant’s independence, explain the following


a. Familiarity threats
A familiarity threat arises where, because of a long or close relationship, a chartered
accountant becomes too sympathetic to the interests of others √, or too accepting of
theirwork √ and as a result, may act in a manner which he or she might not otherwise
haveacted thereby compromising his/her independence. √

b. Self-interest threats
A self-interest threat arises where the chartered accountant has a relationship or
financial involvement with a client which √ may give rise to the professional accountant
looking after his/her own interests rather than taking an independent stance. √ The
relationship or financial involvement will inappropriately influence the chartered
accountants judgment or behaviour. √

c. Intimidation threats
A self-interest threat arises where the chartered accountant has a relationship or
financial involvement with a client which √ may give rise to the professional accountant
looking after his/her own interests rather than taking an independent stance. √ The
relationship or financial involvement will inappropriately influence the chartered
accountants judgment or behaviour. √

3. Identify the types of threat to Marcus Login’s compliance with the fundamental principles of
professional conduct, to which the situation in 1 above give rise. Justify your answer
1. There is a familiarity √ threat brought about by the relationship between Marcus Login and
Fred Spiral. Justification:
● The two of them are close friends, and as Fred Spiral is the financial director and Marcus
Login the audit manager, they will be working closely together on the audit. √^
● Due to this close relationship Marcus Login’s independence will be (and will be seen to be)
compromised, for example, problems on the audit may be ignored. √^

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2. There is a self-interest √ threat brought about by the fact that Marcus Login has a lucrative
sponsorship which runs for three years.
Justification:
2.1 This amounts to financial involvement with an audit client which threatens Marcus Login’s
independence. √^
2.2 He is far less likely to follow up questionable practices/transactions etc on the audit or
“make waves” in case he falls out with Skyhi (Pty) Ltd and loses his sponsorship. √^

3. There is an intimidation √ threat arising out of the sponsorship Marcus Login enjoys.
Justification:
● In a sense, Fred Spiral now has a hold over Marcus Login. He can threaten (directly or
indirectly) to have Marcus Login’s sponsorship taken away unless Marcus Login does what
Fred Spiral requires with regard to the audit, e.g. overlook discrepancies etc. √^
● This presents a direct threat to Marcus Login’s independence. √^ This is not a fundamental
principle.

4. Discuss the scheme proposed by the financial director to settle the audit fee of Bills and Co as
laid out in situation 2, in terms of the SAICA Code of Professional Conduct
1. In terms of the Code of Professional Conduct, this arrangement would amount to improper
conduct. √
2. In terms of Section 240 – Fees, Bills and Co are entitled to negotiate a fee but must charge
appropriate fees. √
● To simply add on R22 000 “fictitious” audit fees would be a breach of this section as well as a
breach of the fundamental principle of professional behaviour (even though the client has
proposed it). √^
3. In terms of Section 290 – Independence, the long - term loan would amount to Bills and Co
having a direct financial interest in an assurance client. √
● This would pose a self-interest threat to the firm. √^
● As there is no safeguard to reduce this threat to an acceptable level, the arrangement
proposed by the financial director should be rejected. √^

5. Discuss the conduct of Davey Jones in terms of the SAICA Code of Professional Conduct –
situation 3
1. Davey Jones has failed to recognise, or chosen to ignore, a self-interest threat to his
compliance with the fundamental principle of confidentiality √ and professional behavior. √
● By disclosing to his, estate agent wife, confidential information (purchase of properties and
prices the client is prepared to pay), acquired as a result of his professional relationship with
Chickentogo (Pty) Ltd, Davey Jones has breached Section 140 – Confidentiality, of the
COPC.√^
● Whether or not he was aware that she would use it to the owners of the properties advantage
is not relevant (she will earn commission on the inflated price which Chickentogo (Pty) Ltd is
prepared to pay). √^
● Davey Jones’ actions have harmed the client and placed them at a disadvantage when
negotiating the purchase of the properties. In doing what he did, he has compromised his
professional behaviour and discredited himself and his firm. √^

4.14 Graded Questions


Internal control can be defined as the process designed, implemented and maintained to provide
reasonable assurance about the achievement of an entity’s objectives with regard to the effectiveness
and efficiency of the entity’s operations, its compliance with law and the reliability of its financial
reporting

Internal control is a dynamic process

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Component of internal control


· Control environment
· The entity’s information system and related business processes
· The entity’s risk assessment process
· Control activities
· Monitoring of controls
In terms of ISA 315, this is a component of internal control:
The risk assessment process and the information system relevant to finance reporting

Communication and enforcement of ethical values are part of the control environment, which is a
component of internal control

Part of the control environment component of internal control


· The organisational structure
· Commitment to competence
· Human resource policies and practices

Regarded as control activities:


· Segregation of duties
· Isolation of responsibilities
· Reconciliation of physical assets with recorded assets
· Assessing whether internal controls are effective over time

Control activities can be categorised:


· By type e.g. isolation of responsibilities
· As general or application controls
· As preventive, detective or corrective

Graded questions 4.19

Hysbak (Pty) Ltd is a large company which manufactures all kinds of lifting equipment e.g. elevators,
hydraulic jacks. Each of the following procedures or conditions takes place or exists at the company:

1. Any employee who is found guilty of unauthorised use of company assets or theft, is dismissed
immediately =Control environment. √
2. Expensive spares and components are kept in a secure area in the warehouse = Control
activity √ – (iii) Custody control (physical control). √
3. All employees working on accounting applications on the company’s local area network are
subject to user identification, password and user profile controls = Control activity √ (iii)
Access controls and segregation of duties (user profile) √
4. The buying clerks are required to sign all purchase orders (in designated block) and before
sending the order to the supplier, must have the order authorised by the chief buyer (who must
also sign in the designated block) = Control activity√ - (i& ii & iv) Isolation of responsibility,
segregation of duties andauthorisation. √
5. Management adopt a management philosophy which places emphasis on leadership sound
judgement and ethical behaviour= Control environment. √
6. The production manager approves all overtime hours to be worked before they are worked=
Control activity √ - (iv) Authorisation √
7. The company conducts regular inventory cycle counts, all differences between physical
inventory and recorded inventory quantities are carefully followed up= Control activity √ - (v)
Comparison and reconciliation (in this case between actual and theoretical inventory). √
8. All company cheques must be signed by two authorised signatories= Control activity √ - (iii)
Custody control (protecting the cash in bank). √

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9. The senior creditors clerk reconciles each creditors statement with the creditors account in the
creditors ledger on a monthly basis. Selected reconciliations are reperformed by the financial
accountant, before payment is made. All reconciliations reperformed are signed by the financial
accountant.= Control activity √ (v) Comparison and reconciliation, division of duties and
isolation of responsibility. √
10. Receiving clerks are required to count goods received and must sign all GRN’s they make out =
Control activity √ (v & ii) Comparison/reconciliation (goods against order/supplier
delivery note) and isolation of responsibility. √

control activities include:


- Authorisation
- Performance review
- Information processing
- Physical controls
- Segregation of duties
- Comparison and reconciliation

Graded Questions 4.2

In terms of ISA 500 the Audit Evidence, the auditor is required to obtain sufficient, appropriate
evidence

Factors that will influence the auditor in determining whether he has gathered the necessary evidence
to support his audit opinion
· The source of the evidence gathered
· The persuasiveness of the evidence gathered
· The quantity of evidence gathered

The following factors will influence the auditors decision on how much evidence he must gather
pertaining to a particular assertion
· The inherent risk applicable to the assertion
· The materiality of the account heading to which the assertion relates
· The auditors experience gained on previous audits of the clients company’s financial
statements

When deciding on the appropriateness of audit evidence gathered the auditor will consider the
relevance and reliability of the evidence

When deciding on the reliability of audit evidence gathered, the auditor will consider the nature and
source of the evidence gathered

Most reliable evidence pertaining to existence of a clients inventory is a physical inspection of the
clients inventory by the audit team

A piece of evidence obtained on one section of the audit which supports another piece of evidence on
another section of the audit is described as corroborative evidence

Assertions in the context of auditing


· Occurrence
· Accuracy
· Completeness
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Assertions relating to current liabilities


· Completeness
· Obligation
· Existence

Assertion relating to presentation and disclosure


· Classification
· Accuracy and valuation
· Completeness

The term “further audit procedures” includes: substantive tests and tests of control

Test of control
· Inquiry
· Observation
· Inspection

Graded questions 4.10

Explain the term “assertions” in the context of the annual financial statement of a company
· The annual financial statements are in effect the report (in a prescribed format) of the directors
of a company to the shareholders of the company. √
· In the financial statements the directors convey information to the shareholders with regard to
the assets, liabilities, transactions and events pertaining to the company at the financial year-
end and for the year then ended. √
· The assertions are a convenient categorisation of what the directors are representing to the
shareholders about the assets, liabilities, transactions, etc, and the disclosures included in the
financial statements. √ For example, when the directors include anamount of say, R10m for
plant and equipment, they are asserting (representing)that …
! the plant and equipment included in the R10m exists and is owned (rights) by
thecompany
! R10m is an appropriate value for the plant and equipment and
! all plant and equipment owned by the company is included (completeness).
· Different assertions apply in respect of account balances, transactions and events,and
presentation and disclosure. √

Assertions applicable to an asset account balance


! Completeness
! Rights
! Existence

Occurrence is a transaction assertion

Assertions applicable to repairs and maintenance expense account


! Cut-off
! Accuracy
! Completeness

Existence is an account balance assertion

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Contingent liability: the company is currently engaged in a court case with Trident Ltd pertaining to the
malfunction of a machine manufactured by JomoC (Pty) Ltd and purchased by Trident Ltd Trident Ltd
alleges that the malfunction cuased extensive damage to its production line. JomoC (Pty) Ltd is being
sued for R5 000 000

Explain what a user of the financial statements may infer from the note pertaining to the contingent
liability at JomoC (Pty) Ltd

4. Contingent liabilities √
A user may infer the following:
Assertions pertaining to account balances:
Completeness^ - the contingent liability arising from the Trident Ltd case is the only contingent liability
(and all necessary information pertaining to the contingent liability, has been disclosed) √^
Existence^ - the contingent liability, existed at year end date.√ ^
Valuation and allocation^ - the contingent liability has been reflected in the statement of financial
position at appropriate amounts√^
Rights^ - the company has (holds or controls) the right of ownership to the contingent liability reflected
in the statement of financial position√^
Assertions pertaining to presentation and disclosure:
Occurrence ^ – the underlying event (court case) giving rise to the contingent liability, has been set in
motion (it is not fictitious). √^
Right and Obligation ^ – the contingent liability is a potential liability of JomoC (Pty) Ltd and no other
party. √^
Completeness ^ – the contingent liability arising from the Trident Ltd case is the only contingent
liability (and all necessary information pertaining to the contingent liability, has been disclosed) √^
Accuracy ^ – the information has been fairly disclosed and the amount of R5m is accurate. √^
Classification and understandability^ – the contingent liability has been correctly classified (i.e. it
should not have been classified as a provision) and the details pertaining to the contingent liability
have been clearly expressed to reflect the true situation. √^

Explain the link between audit evidence and the assertions


! The financial statements are an embodiment, of the assertions (representations of the
directors). √^
! The auditor is required to express an opinion on the fair presentation of the financial
statements, so in effect, the auditor is expressing an opinion on the assertions. √^

When conducting risk assessment procedures, the auditor does not consider the assertions. True or
False? Justify your answer
False. ^
● Risk assessment procedures are conducted so that the auditor is in a position toevaluate the risk of
material misstatements in the financial statements at financialstatement level, at account balance,
class of transaction level. √^
● To do this effectively, the auditor will consider each of the assertions, and based onthe results of his
risk assessment procedures, assess the risk of materialmisstatement applicable to each assertion
within an account heading/transaction.For example, the auditor may decide, on the basis of the
information gathered by therisk assessment procedures, that there is a high risk that the company’s
inventorymay be materially overstated by the inclusion of non-existent inventory, and theinclusion of
inventory-in-transit for which the risks and rewards of ownership have notyet passed to the company.
√^

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Indicate whether each of the following statements is true or false. Justify.

1. physical inspection of the company’s vehicles confirms that the company owns the vehicles and
can contribute evidence as to the valuation of the vehicle
● False: ^ Physical inspection simply proves that the vehicles exist, not that the company owns
them. (Physical inspection does provide evidence relating to the valuation of the vehicle,
specifically whether there is any impairment of the vehicles for which a write down is required.)
√^

2. inspection of the title deeds to the company’s property provides evidence as to the company’s
rights (ownership) of the property
● True: ^ Title deeds provide evidence of ownership, and will also provide evidence of any
encumbrances on the property which the company must disclose in the AFS. √^

3. from an audit perspective, the completeness assertion relating to trade creditors is generally far
more important than the existence assertion relating to trade creditors
● True: ^ In general terms a company is far more likely to understate its trade creditors balance
than to overstate it, as an understated creditors balance “improves” the statement of financial
position in the AFS. √^ (The auditor will not accept this as a fact; he will assess the risks of
understatement or overstatement based on his risk assessment procedures.)

Explain the term “direction of testing” in the context of the assertions


Direction of testing describes whether the auditor is testing from the accounting records to a document
or physical asset, or from the document to the records. √^ The direction of testing will depend on which
assertion and account heading the auditor is seeking evidence √^ e.g. to test existence of an asset
the auditor tests from the accounting records to the supporting evidence (such as a physical asset).
To test completeness of an asset account, the auditor tests from the supporting evidence (the
physical asset) to the accounting records to establish whether the physical asset has been included in
the accounting records.

Graded questions 6.13

1. Discuss materiality in the context of the preparation and presentation of financial statements
● Misstatements, including omissions, are considered to be material √ if they, individually or in
aggregate, √ could reasonably be expected to influence the economic decisions of users taken
on the basis of the financial misstatements. √ Expressed slightly differently, if the misstatement
is something which the user “should know about” then it will be material.
● Judgements about materiality are made in the light of surrounding circumstances, and are
affected by the size √ or nature √ of a misstatement, or a combination of both. √ In effect this
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means that there is no “one size fits all” for materiality and that there are both qualitative and
quantitative aspects to materiality.

2. The auditor’s determination of materiality is a matter of professional judgement and is affected


by the auditor’s perception of the needs of users. In determining materiality, it is generally
accepted that it is reasonable for the auditor to make assumptions about users. Briefly describe
these assumptions
The auditor may reasonably assume that;
! Users have a reasonable knowledge of business, economic activities and accounting,
and a willingness to study the information in the financial statements with reasonable
diligence. √
! Users understand that financial statements are prepared, presented and audited to
levels of materiality. √
! Users recognize the uncertainties inherent in the measurement of amounts based on the
use of estimates, judgement and the consideration of future events. √
! Users make reasonable economic decisions on the basis of the information in the
financial statements. √

3. Explain the difference between using the concept of materiality at the planning stage of the
audit and at the evaluating stage of the audit
! Using the concept of materiality at the planning stage amounts to the auditor setting
materiality limits or levels which provide a basis for planning and conducting risk
assessment procedures as well as further audit procedures. √ Unless the audit team has
an idea of what amount is considered material, they will be unable to identify and
address “material” misstatement. √
! Using the concept of materiality at the evaluation stage amounts to the auditor setting
amounts by which the auditor believes an account heading in the financial statements
can be misstated by uncorrected misstatements before it will affect the user. √ The
auditor measures uncorrected misstatements against the final materiality limit to
determine whether the financial statements will require qualification if the misstatement
is not corrected. (There will also be a qualitative evaluation at this stage.) √

4. Identify five factors to be considered when quantifying “planning” materiality


! The use of preset guidelines (benchmarks). √
! The importance of specific information to users (relating to an account heading). √
! Legal or regulatory requirements applicable to the account heading. √
! Cost/benefit considerations. √^
! The key disclosures in relation to the industry in which the entity operates. √
! The opinions, views and expectation on materiality of those charged with
governanceand the audit committee. √
! Historical information – prior year materiality limits. √
! The level of assessed risk at both financial statement and assertion levels. √^
! Management integrity and attitude towards controls. √^

5. Distinguish between planning materiality and performance materiality


! Planning materiality is an overall guideline to the audit and is the auditor’s judgement as
to the amount of misstatement in the financial statements which a user of the financial
statements can “live with”. √
! Performance materiality is the amount (or amounts) set when the auditor sets tests on
specific account balances or classes of transactions to provide a guideline as to the
extent (and nature) of tests on the relevant account heading. √^
! If the materiality limit is set more strictly √^than in prior years it means that the auditor
wants to ensure that less misstatement goes undetected, hence, to gain this objective
more testing will have to be carried out. √^

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6. What effect is a significant risk, identified during the “identifying and assessing the risk of
material misstatement” stage of planning. Likely to have on the performance materiality limit?
Significant risks increase the auditor’s assessment of the risk of misstatement. √ Thus the
auditor will set a stricter (lower) planning materiality limit to ensure that an unacceptable amount
of misstatement does not go undetected. √ The extent of audit work will be increased. √

7. Explain the term “qualitatively material”. Give an example


If a matter is qualitatively material it means that it has some characteristics which make it
important to users other than its amount. √^ For example, the disclosure of a contingent liability
including a clear description of its nature is an important disclosure and its disclosure will be
material to users. √^ It has a qualitative aspect to it which makes it material.

8. When the auditor identifies misstatements, he or she should discuss all the misstatements with
the client in an attempt to have them rectified. However management may decide not to correct
the misstatement. Provide four reasons why the client may choose not to correct the
misstatements.
! The client may disagree with the auditor that there is a misstatement i.e. the client thinks
the figures presented are “correct”. √^
! The client may regard the misstatement as immaterial. √^
! The client may have ulterior motives, e.g. the client may be trying to present a particular
set of ratios which would not be achieved if the misstatement was recognized as a
misstatement and an adjustment made. √^
! The client may regard it as “too much hassle” to amend the financial statements, e.g.
changing income statement, notes, supporting schedules, etc. √^
! The client may be unconcerned about receiving a qualified opinion. √^

9. Identify four factors to be considered in evaluating the materiality of uncorrected misstatements


9.1 Whether it is a “known” or “likely” error. √^
9.2 The aggregation of all audit differences. √^
9.3 Statutory or other contracted obligations (misstatement is in an account heading
whichaffects a specific loan covenant.) √^
9.4 The nature of the misstatement (error in principle is more material than an
expensemisallocation). √^
9.5 The impact of the misstatement (the misstatement may affect a popular figure or ratio;
theauditor would want this figure presented as fairly as possible). √^
9.6 The absolute and relative size of the misstatement. √^(Max 3)

Comments:
It is imperative to refer back to ISA 320 to obtain an in depth understanding of the concept of
materiality. Remember in the determination of materiality different aspects must be considered, as
entity’s risk assessment, control environment and the objective assessment of the auditor. The method
to determine materiality must be properly documented.

Graded questions 5.2 The preliminary engagement stage

Preliminary engagement activities


· Establishing whether the prospective client can be appropriately serviced
· Agreeing the terms of the engagement with the prospective client
· Evaluating whether the firm is able to comply with ethical requirements relating to the
engagement

In terms of ISAs an audit engagement can only be accepted if; the auditor has established with the
client that the preconditions for an audit are present

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Preconditions for an audit


· The acknowledgement by management that it understands its responsibilities to provide
unrestricted access to persons within the company from howm the auditor determines it is
necessary to obtain audit evidence
· The financial statements are prepared in terms of an acceptable financial reporting framework
· An acknowledgement by management that it is responsible for such internal control as it
(management) determines is necessary to enable the preparation of financial statements which
are free from material misstatements

If management attempts to impose a material limitation on the scope of the auditor’s work prior to the
acceptance of an audit engagement, the auditor: should decline the engagement

The engagement letter must contain reference to the financial reporting framework to be adopted for
the preparation of the annual financial statements

The audit plan is best described as the nature, timing and extent of planned risk assessment
procedures, “further” and “other” procedures

Part of the Audit Strategy


· Deciding to engage the services of an expert to assist in the valuation of work-in-progress
· Deciding to make use of statistical sampling techniques
· Deciding to conduct an interim audit two months prior to year-end

Planning materiality for an audit is a judgement made by the auditor about the size of misstatements in
the financial statements that will be considered material

Auditors responsibility when carrying out the concluding stage of the audit process
· Evaluating whether the financial statements adequately disclose the significant accounting
policies selected and applied
· Evaluating whether the terminology used in the financial statements is appropriate
· Evaluating whether sufficient, appropriate evidence has been obtained to reduce audit risk to an
acceptable level

Graded questions 5.5 The planning stage

Continue graded questions p 104 (5.5 nr 1) and AUE 2601 TL 103 page 26

Graded questions 5.5

What is the objective when planning an audit of financial statements?


The auditor should plan the audit work so that the audit will be performed in an effective manner (ISA
300). √

Once the audit strategy and plan are formulated, they should not be changed.
False. ^ Neither the audit strategy nor the audit plan is static (fixed). √ They can and should be
changed as the audit develops. √ A strategy and plan are based on what is expected to occur on the
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audit, based on knowledge about the client that the auditor has at the start of the audit and the risk
assessment results. √ If this expectation changes, so must the strategy and plan. √ Information which
was used in formulating the strategy and plan may be superseded by new information e.g. substantive
tests may reveal that the risk of material misstatement in a particular account heading is greater than
originally thought, necessitating a change in the strategy and/or plan. √

What is the overall audit strategy?


The overall audit strategy
· sets the scope, √ timing √ and direction √ of the audit
· guides the development of the more detailed audit plan. √

does the process of setting the audit strategy assist the auditor in determining the resources necessary
for the audit?
Yes. ^ The process of setting the audit strategy assists with
1. Deciding on the nature of resources required e.g. Levels of staff, use of experts. √
2. Deciding on when and where audit resources will be deployed, e.g. Numbers of staff required to
conduct branch inventory counts. √
3. The timing of the visits to the client, e.g. The strategy may require two interim visits and the
year-end visit, and the determining resources necessary to undertake the interim and year end
visits. √
4. Establishing appropriate standards of managing, directing and supervising the audit resources
e.g. If the strategy calls for the use of experts, how and when will the expert be appointed,
supervised and evaluated. √

The availability of audit resources should be a major factor in determining the audit
False. ^ This is theoretically unsound and “back to front”! The audit firm does not say “we have the
following resources available so we will adopt the following audit strategy and plan”. The firm
formulates a strategy and plan to perform an effective audit based on the auditor’s knowledge of the
client, √ the risk assessment etc, and then asks the question, what resources do we need to implement
the strategy and plan? √strategy and plan.
The audit firm does not say “we have the following resources available so we will adopt the following
audit strategy and plan”. The firm formulates a strategy and plans to perform an effective audit by
gathering sufficient√^, appropriate, evidence √^and then asks the question, what resources do we
need to implement the strategy and plan? √^

Do preliminary engagement activities form part of planning?


No. ^ Preliminary engagement activities take place in deciding whether to retain a client or accept a
new client, √ planning starts after this decision has been made. √ Where it is an ongoing audit, some
planning for the following year’s audit may take place in anticipation that the client will be retained, but
this is not a preliminary engagement activity.

In what way does adequate planning benefit the audit of financial statements?
· Proper audit planning benefits the audit by helping the auditor:
· To identify important areas of the audit to ensure appropriate time is devoted to them. √
· To ensure that potential problems are promptly identified, and resolved on a timely basis. √
· To ensure that the audit is properly organised and managed so that it is performed inan
effective and efficient manner. √
! The work is completed expeditiously (deadlines are met). √
! To ensure proper assignment of work (cost effective, efficient). √

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· In the selection of engagement team members with appropriate levels of capabilities and
competence. √
· To facilitate the direction and supervision of engagement team members and the review of their
work. √
· In co-ordination of work done by other auditors and experts. √

What is the audit plan and what does it include?


· The audit plan is the detailed document of the procedures to be performed in order to obtain
sufficient, appropriate audit evidence to reduce audit risk to an acceptably low level. √
· The audit plan will include:
! A description of the nature, timing and extent of planned risk assessment procedures. √
! A description of the nature, timing and extent of further audit procedures at the assertion
level for each material class of transaction, account balance and disclosure. √
! Such other procedures required to comply with the ISA’s e.g. communicating with the
client’s attorneys. √
! Details of the nature, timing and extent of direction, supervision and review procedures
relating to the audit team and its work. √

Should the audit strategy and plan be discussed with the audit client?
Yes. ^ Aspects of the strategy and plan may well be discussed with the audit committee as well as
relevant directors and senior financial personnel, as an audit cannot be carried out in isolation. √
However, care must be taken not to compromise the effectiveness of the audit by forewarning the
client of any procedures which require an element of unpredictability. √

Comment:
The strategy and audit plan is fundamental to any audit. These documents should be detailed.
Although aspects of the strategy and plan can be discussed with the audit committee as well as senior
management, care must be taken not to compromise the effectiveness of the audit by forewarning the
client of any procedures which require an element of unpredictability.

Explain why it is necessary to set a (preliminary) planning materiality level before conducting risk
assessment procedures.
· When the auditor conducts risk assessment procedures, his objective is to identify and evaluate
the risk of material misstatements in the financial statements. √
· If he has no guideline as to what misstatement would be material, the above procedures cannot
be effectively carried out. √

7. The purpose of audit planning is:


7.1 To identify important areas √^of the audit to ensure appropriate time is devoted to them. √^
7.2 To ensure that potential problems are promptly identified√^, and resolved on a timely basis. √^
7.3 To ensure that the audit is properly organised and managed so that it is performed in an effective
and efficient manner. √^
• the work is completed expeditiously (deadlines are met). √^
• to ensure proper assignment of work (cost effective, efficient). √^
7.4 To assist in the selection of engagement team members with appropriate levels of capabilities and
competence. √^
7.5 To facilitate the direction and supervision of engagement team members and the review of their
work. √^
7.6 To assist in co-ordination of work done by other auditors and experts. √^ (Max 3)

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12. Solution to question 6.9 in Graded Questions 30 Marks – page 126


References: - Jackson & Stent (2012:7/7-7/14, 6/11-6/12, 7/19-7/20)
- ISA 315 (paragraph 1, 6, 11-24, A14, A6-A11)
- Study guide (Study unit 3.4)
1. ● John Dillinger’s “removal” increases √ the risk of material misstatement at financialstatement level.
The fact that the newly appointed chairman has requested theresignation of the person who is most
influential in the “fair” presentation of thecompany’s financial performance is concerning, particularly as

* John Dillinger was well respected and had been at the company for some years √^
* the point of contention was the implementation of accounting policies which wouldhave improved the
financial performance of the company as reflected in the AFSbut in John Dillinger’s opinion were
inappropriate for the company. √^
● This strongly suggests that the newly appointed chairman, who obviously hassignificant influence in
the company, is quite prepared to manipulate the financialstatements to present an “improved”
performance. √^
2. ● The risk is increased √ by the appointment of Floyd Nelson at financial statementlevel. Being a
chartered accountant suggests that he has the necessary technicalskills to oversee the presentation of
the financial statements in terms of IFRS.However,
* his youth and lack of experience √^

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* combined with the fact that he was recruited by the chairman √^suggests that he will be significantly
influenced by the chairman in financial mattersincluding the selection of accounting policies and the
“manipulation” √^ of the financialstatements.
● The apparent decline in the application of sound corporate governance increases √the risk of
material misstatement at financial statement level
* in terms of sound corporate governance principles, the chairman should be anindependent non-
executive director and should not be involving himself in suchmatters as (unilaterally) “requesting” the
resignation of the financial director,making their working relationship untenable, recruiting a new
financial director,and setting up joint ventures and other business √^
* furthermore, Floyd Nelson should not be a member of the audit committee andcertainly not the
chairman. This appointment (by Edgar Hoover) further suggeststhat Edgar Hoover intends to control
what goes into the financial statements and22take any measures which could prevent this, e.g. by
neutralising (controlling) theaudit committee. √^
3. ● The introduction of joint ventures and other business alliances increases √ the risk ofmaterial
misstatement at financial statement level. The risk of non-armslengthtransactions having occurred, is
increased as these are now more related parties andrelated party transactions. √^ The increase in
related parties provides an opportunityto manipulate the financial statements. √^
● The fact that the documentation relating to the entities which have been set up andthe transactions
with them appears to be minimal, √^ also increases the risk ofmaterial misstatement potentially in any
account heading affected by the transaction.It is also an indicator that manipulation of the financial
statements may have takenplace. √^
4. ● The attitude displayed by Floyd Nelson with regard to the auditors and valuation ofinventory (“the
auditors don’t make the rules…..”) suggests that he doesn’t placemuch importance on the audit
function and will do whatever suits himself and thechairman with regard to accounting matters and the
AFS. √^ The risk of materialmisstatement at the financial statement level is increased. √
● This is emphasised by the fact that Floyd Nelson is also chairman of the auditcommittee; we as
auditors have no “independent” client committee with which we canresolve audit issues. √^
5. ● Chemtrade (Pty) Ltd manufactures and trades in a product which has high inherentrisk, i.e.
chemicals. From the audit perspective there is a high √ risk of materialmisstatement in the account
heading for the following reasons.
* The auditor will often not know one chemical from another. This increases the riskrelating to
existence (does the chemical listed in the inventory records actuallyexist, or is the auditor being
shown some other chemical?). √^ Alternatively, therisk may relate to valuation (if the auditor cannot
identify the chemical, he can’tvalue it).
* Chemicals in their various forms (e.g. raw materials, finished goods) frequentlyhave a shelf life which
can render the chemical obsolete. √^ It is very difficult forthe auditor to “identify obsolescence” which
directly affects the valuation assertion√^ as there is the risk of material misstatement in the form of the
understatementof the write-off/allowance for obsolescence.
* The process of manufacture of chemicals can be reasonably complex, which couldresult in material
misstatement of work-in-progress. √^
● In prior years the response to these risks was that Chemtrade (Pty) Ltd insisted thatthe auditors work
with an independent chemical specialist. The fact that Floyd Nelsonhas rejected this policy increases √
the risk of material misstatement of inventory in itsvarious forms.
● The risk is further increased by the fact that the company has a large stockpile of arange of
chemicals which is manufactured only for export to Europe, but for whichorders have virtually dried up.
√^ The problem is so severe that no manufacture of theproduct has taken place for seven months and
there are no plans to commenceproduction. There is a risk that the stockpile of this range of products
is notsaleable/obsolete and should be written down (valuation inventory). √^
● There is also an increase √ in the risk of material misstatement of plant andequipment. As
mentioned in 5.3 above, the company has certain plant andAUE2601/10323equipment which has been
lying idle for seven months and for which there is no planto re-commence use. √^ Furthermore this
plant and equipment cannot be adapted forthe manufacture of other chemicals.
● The risk is that no impairment loss (or an inadequate impairment loss) will berecognised. This relates
to the valuation assertion for plant and equipment. √^

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● Misstatement at assertion level. Increase √ in the risk of overstatement of thevaluation of accounts


receivable due to an inadequate allowance for bad debt. √^The evidence suggests that more foreign
debt may go “bad”.
● This is emphasised by the fact that orders for a range of chemicals from Europe havedried up. This
suggests that these companies (Chemtrade (Pty) Ltd’s customers)may be going out of business and
may never pay. √^
6. ● There are two potential material lawsuits against the company. This could give rise tomaterial
misstatement in the manner in which they are presented. This risk relatesto the assertions relating
to presentation and disclosure (and potentiallycreditors):
* There is a risk that the R5m claimed by John Dillinger could be misclassified as acontingent liability
when, in fact, it should be provided for in the AFS. √^ This is aclaim from a former financial director
who is conservative and well respected, whoin all probability, knows exactly what is owed to him.
* The other claim brought by the environmental agency is for a material sum andlooks to be potentially
serious for the company. √^ The risk is firstly that thecontingent liability is not disclosed at all
(completeness) or that it is inadequatelydescribed and the consequences are ignored or understated
(completeness andunderstandability). √^
7. Although there appears to be no direct evidence that the company is facing going concernissues,
there is a risk that the going concern basis could be inappropriate for thepresentation of these financial
statements, √^ e.g. loss of the European market, idle plant,the perceived threat of manipulation of the
financials to possibly cover up problems,environmental issues which could result in withdrawal of
important licenses. √^
General:
When there is a risk of material misstatement at financial level, the effect can filter down tonumerous
account headings. √^ For example the increase in related parties increases the riskrelating to any
account heading associated with the related party, i.e. the related party could beused as a vehicle to
create fictitious sales which would relate to the occurrence of sales and theexistence of debtors.
Overall the risk of material misstatement at both financial statement leveland at assertion level is
present and will have to be appropriately responded to by the auditor.
Comment:
Please make sure that you understand what is meant by an “increase” or a “decrease” in therisk of
material misstatement. Although this questions did not request you to indicate whetherthere was an
increase or decrease but it can be asked. Students sometimes get them mixed upand marks are
unnecessarily lost. Also, take note that 1.5 marks are awarded for the reasonand identifying the
component of audit risk. It is important to read the questions carefully so thatyou understand exactly
what is required of you.

Assignment 2 – 1st Semester 2013

1.1. Describe the different functions of external auditors, internal auditors and
forensic auditors.

External auditor
• The function of the external auditor is to give an independent opinion on whether thefinancial
statements of a company fairly present the financial position and results of thecompany’s
operations. À
• The external auditor gathers evidence in support of the assertions made by managementin the
financial statements. ÀMax 2

Internal auditor
• The internal auditor performs independent assignments on behalf of the board of directorsÀ
• The internal auditor is concerned with the efficiency, effectiveness and economy of
thecompany’s internal control (and related) procedures. À Max 2

Forensic auditor

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• Forensic auditors concentrate on investigating and gathering evidence in the event ofalleged
financial mismanagement, theft or fraud. À
• Forensic auditors need to be independent of the entity under investigation. À
Max 2

1.2 In-house training


1.2.1 Identify which of the statements in (h) to (l) are regarded as auditing postulates. An
explanation for each of the identified postulates must be given.

Statement (i): ^ Financial data is verifiable.


According to this postulate, it is possible to verify the client’s financial data, that is, evidence
(documentary or otherwise) exists that will enable the external auditor to “verify” the transactions
recorded in the client’s books. •^ If this were not the case, it would be impossible to perform an
audit. •^ Max 2.5
Statement (l): ^ Internal controls reduce the probability of errors and irregularities.
According to this postulate, a company without internal controls provides the auditor with
littlechance of conducting an efficient or economical audit. •^ The postulate suggests that
theauditor should make use of the benefits of good internal control. •^Max 2.5

1.2.2 Describe the overall objectives of the auditor in terms of ISA 200.
1.2.2 Overall objectives of the auditor
• To obtain reasonable assurance about whether the financial statements as a whole arefree from
material misstatement, whether due to fraud or error, À thereby enabling theauditor to express an
opinion on whether the financial statements are prepared, in allmaterial respects, À in
accordance with an applicable financial reporting framework.À
• To report on the financial statements and communicate as required by the ISAs, inaccordance
with the auditor’s findings.À
(1 x 4 = 4)

1.3 Audit documentation


Explain five (5) uses of audit documentation to the auditor.
1.3 Audit documentation
Reference: SAICA Handbook 2012/2013 in ISA 230 paragraph 2–3
• Provides evidence of the auditor’s basis for a conclusion about the achievement of the overall
objectives of the auditor.À
• Provides evidence that the audit was planned and performed in accordance with ISA’s and
applicable legal and regulatory requirements.À
• Assists the audit team in planning and performing the audit. À
• Assists members of the audit team responsible for supervision to direct and supervise the audit work,
and to discharge their review responsibilities in terms of ISA220. À
• Ensures that members of the audit team are accountable for their work.À
• Enables the conduct of quality control reviews and inspections.À
• Provides a record of matters of continuing audit significance to future audits. À
• Enables the conduct of external inspections in accordance with applicable legal, regulatory and other
requirements.À (1X8=8) Max 5

1.4 Assertions
1.4.1 For each assertion mentioned in the working paper for salaries,explain whether you agree
with the applicability of the mentionedassertion to salaries.
1.4.1 Applicability of the assertions

Existence: This assertion does not apply À to salaries, as it is an assertion relevant to account
balances at period end or year end. À

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Classification: This assertion applies À to salaries, as it is an assertion relevant to classes of


transactions and events. À

Obligation: This assertion does not apply À to salaries, as it is an assertion relevant to account
balances at period end or year end. À Max 6

1.4.2 List and describe the other management assertions applicable tosalaries that are not
mentioned in the working paper.(6)(8)
1.4.2 Additional assertions applicable to salaries
The other assertions applicable to salaries for the period under audit are as follows:
Occurrence: ^ All salaries included are genuine salaries of the entity (they are not fictitious). À^
Completeness: ^ All salaries that should have been recorded have been recorded. À^
Accuracy: ^ All salaries have been recorded at the correct amount. À^
Cut-off: ^ All salaries have been recorded in the correct accounting period. À^
(.5 x 4 = 2)
(1.5 x 4 = 6)
Max 8

51.5 Internal control


1.5.1 Define the term "control activities".
Control activities are the policies and proceduresÀ that help ensure that management directives are
carried out. À

1.5.2 List and describe three (3) examples of activities that may beclassified as control activities
in terms of ISA 315.(2) (6)
1.5.2 Examples of control activities
Approval/Authorisation ^
Management authorise employees to perform certain tasks within certain parameters. À^
Isolation of responsibility ^
For any internal control system to work effectively, the people involved in the system must be fully
aware of their responsibilities and must be held accountable for their performance. À^
Performance reviews ^
These include reviews and analyses of actual performance versus budgets, forecasts and prior period
performance; relating different sets of data to one another; comparing internal data with external
sources of information; and reviewing of performance. Reviewing of performance provides a basis for
identifying problems. À^
Information processing^
These are controls in a computerised environment, which include general and application controls. À^
Access/Custody/Physical controls ^
Control activities include actions, policies and procedures that protect the company’s assets. À^
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Segregation of duties ^
Different people are assigned the responsibilities of authorising transactions, recording transactions
and maintaining custody of assets. À^
Comparison and reconciliation ^
Reconciliation is a comparison of two different sets of recorded information. The objective is to identify,
investigate and resolve differences. À^

61.6 Audit procedures


1.6.1 Define the term Substantive procedures
Substantive procedures are audit procedures designed to detect material misstatements À at
the assertion level. À Substantive procedures comprise tests of detail À and substantive
analytical procedures. À (1 x 4 = 4) Max 2

1.6.2 Define the term "tests of control".


Tests of control are audit procedures designed to evaluate the operating effectiveness of controls
À in preventing, or detecting and correcting material misstatements at the assertion level.
À (1 x 2 = 2)

1.6.3 Identify, from the information given in (a) to (g) of the scenario,which audit procedures are
classified as substantive procedures.
a) Analytical review procedures of salaries per month have been performed and explanations have
been obtained for extraordinary fluctuations. À
b) The calculation of the leave pay accrual at year end was reperformed. À f) The bonus payments to
management at year end were recalculated. À
g) The amount per the electronic funds transfer for December was confirmed by agreeing it to the
amount on the payroll for December. À (1 x 4 = 4)

OTHER ASSESSMENT METHODS TL 101 – 2013

1.1 List and describe the assertions applicable to the inventory balance in the statement of financial
position. (7)
Assertions related to inventory balance
· Completeness^ - all inventory owned by the company, is included in the balance reflected in the
financial statements.√ ^
· Existence^ - all inventory included in the balance, existed at year end date.√ ^
· Valuation and allocation^ - the inventory has been reflected in the statement of financial
position at appropriate amounts√^; this means that reasonable adjustments have been made
for damages and/or obsolescence.
· Rights^ - the company has (holds or controls) the right of ownership to the inventory reflected in
the statement of financial position (any encumbrances on that ownership must be disclosed) √^

1.2 Explain in relation to the element “monitoring”, as one of the elements of quality control in
accordance with ISQC 1, what Alpha and Co. should include in the monitoring process. (3)
Monitoring the Firm’s Quality Control Policies and Procedures
Include an ongoing consideration and evaluation of the firm’s system of quality control√^ including, on
a cyclical basis, inspection of at least one completed engagement for each engagement partner√^.
The firm shall establish a monitoring process designed to provide it with reasonable assurance that the
policies and procedures relating to the system of quality control are relevant, adequate, and operating
effectively.

PS: ISQC1 establishes a firm’s responsibility for its system of quality control while
ISA 220 provides guidance on the quality control for audit engagements.

1.3 SAICA Code of Professional Conduct


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1.3.1 Based on scenario 1, identify and explain in terms of the SAICA Code of Professional Conduct
(COPC) the fundamental principles that were violated by David Mabola.
1.3.1 Scenario 1
• Section 130 – Professional competence and due care√, all chartered accountants are obliged to
maintain professional knowledge√^ at the level required to ensure that the client receives competent
professional service. David Mabola did not maintain his professional knowledge by not keeping up to
date with the tax legislation.√^Since David is a tax consultant and recently qualified, Hlakudihis
knowledge of the tax legislation should be up to date. √^
• Section 140 – Confidentiality√, chartered accountants should not disclose client information to 3rd
parties without the client’s permission. √^ David Mabola disclosed Utopia’s tax information to his friend
who runs a tax practice and thus disclosed confidential information without obtaining permission from
Utopia. √^

1.3.2 Based on scenario 2, describe in terms of the SAICA Code of Professional Conduct (COPC), the
threats to the fundamental principles and recommend safeguards to eliminate or reduce thethreats
to an acceptable level. (7)
1.3.2 Scenario 2
• Self interest threat√ to Objectivity, Integrity, Professional behaviour^ (max .5)
This threat is created by accepting a free membership at the golf estate which is not available to the
general public√^. The partner may overlook issues√^ that arise during the audit so as not to
jeopardise the offer or future gifts.
• Familiarity threat√ to Objectivity, Professional competence and due care^(max .5)
This type of situation changes the professional relationship between the audit partner and the client
from professional to “familiar”. √^ In return the directors may expect “favours” from the audit partner or
this may affect the independence of the auditor in relations to the client.√^
Safeguards:
!Victor Adams should not accept the membership.√^
!Remove Victor Adams from this specific engagement if he accepts the membership.√^
!Implement a firm policy which forbids the acceptance of gifts and hospitality which are anything other
than clearly insignificant. √^
!Notify the audit committee of the situation and put safeguards in place. √^
!The membership must not be accepted if not available on the same terms as offered to the general
public. √^

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1.4 Auditing Profession Act, 2005


1.4.1 Discuss whether or not the failure to pay over the PAYE is considered to be a reportable
irregularity as defined in section 1 of the Auditing Profession Act, 2005.
Reportable irregularity
It is considered to be a reportable irregularity√ for the following reasons:
• Unlawful act or omission √ - The non-payment of PAYE is an unlawful act.√ ^
• Committed by any person responsible for the management of an entity√ - The board were aware of
the nonpayment of PAYE.√^
• Has caused or is likely to cause material financial loss to the entity; √ - The penalties that may incur,
will have a material financial loss to the entity.√^
• Is fraudulent or amounts to theft; √or – The nonpayment of PAYE is defrauding SARS√^
• Represents a material breach of any fiduciary duty√ - The directors are not acting in the best
interests of the company, therefore they are in material breach of their fiduciary duty√^

1.4.2 Outline, in terms of section 45 of the Auditing Profession Act, 2005, the procedures that the
auditor should follow due to the existence of a reportable irregularity.
Duty to report a reportable irregularity
• The auditor must send, without delay, a written report to the Independent Regulatory Board for
Auditors (IRBA). √
• The report must give particulars of the reportable irregularity and must include such other information
and particulars as the auditor considers appropriate. √
• Within 3 days√ of sending the report to the IRBA the auditor must notify the members of the
management board of the entity in writing of the sending of the report to the IRBA and supply them
with a copy of the report sent to the IRBA.√
• As soon as possible, but within 30 days√ after the date on which the report was sent to the
Regulatory Board;
(a) The auditor must take all reasonable measures to discuss the report with the members of the
management board of the entity, and √

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(b) Give the members of the management board of the entity the opportunity to make representations
in respect of the report. √
(c) Send another report to the Regulatory Board√, which must include a statement that the registered
auditor is of the opinion that:
- no reportable irregularity has taken place or is taking place; √ or
- the suspected reportable irregularity is no longer taking place and
- that adequate steps have been taken for the prevention or recovery of any loss as a result thereof√;
or
- the reportable irregularity is continuing.√

1.5 Companies Act, 71 of 2008


1.5.1 Discuss in terms of the Companies Act, No. 71 of 2008 what is required by the Act with regards
to “rotation” of auditors.
Current auditor
• In terms of section 92 of the Companies Act, the same individual may not exceed five consecutive
financial years as the auditor or designated auditor of a company. √
• If an individual has served as the auditor or designated auditor of a company for two or more
consecutive financial years and then ceases to be the auditor or designated auditor, the individual may
not be appointed again as the auditor or designated auditor of that company until after the expiry of at
least two further financial years. √
• If a company has appointed two or more persons as joint auditors, the company must manage the
rotation required by this section in such a manner that all of the joint auditors do not relinquish office in
the same year. √

1.5.2 List five (5) duties of the audit committee in connection with the appointment of external
auditors.
Duties of the Audit committee in connection with the auditor
An audit committee of a company has the following duties:
(a) To nominate, for appointment as auditor of the company under section 90, a registered auditor
who, in the opinion of the audit committee, is independent of the company; √
(b) To determine the fees to be paid to the auditor √
(c) To determine the auditor’s terms of engagement; √
(d) To ensure that the appointment of the auditor complies with the provisions of this Act and any other
legislation relating to the appointment of auditors;√
(e) To determine, subject to the provisions of this Chapter, the nature and extent of any nonaudit
services that the auditor may provide to the company, or that the auditor must not provide to the
company, or a related company; √
(f) To pre-approve any proposed agreement with the auditor for the provision of non-audit services to
the company; √

2.1 List two (2) aspects that should be included in an audit engagement letter in terms of International
Standards on Auditing. (Note: You are not required to draft the engagement letter.) (2)
Matters to be included in an audit engagement letter
• The objective and scope of the audit of the financial statements.À
• The responsibilities of the auditor.À
• The responsibilities of management.À
• Identification of the applicable financial reporting framework for the preparation of the financial
statements.À
• Reference to the expected form and content of any reports to be issued by the auditor and a
statement that there may be circumstances in which a report may differ from its expected form and
content.À
• Arrangements concerning the involvement of other auditors and experts in some aspects of the
audit.
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• Arrangements concerning the involvement of internal auditors and other staff of the entity.
• Arrangements to be made with the predecessor auditor, if any, in the case of an initial audit.
• Any restriction of the auditor’s liability when such possibility exists.
• A reference to any further agreements between the auditor and the entity
• Any obligations to provide audit working papers to other parties.

2.2 Explain the differences between a reasonable assurance engagement and a limited assurance
engagement. (6)

2.3 Based on the information given regarding the entity’s internal control:
2.3.1 List the five (5) components of internal control.
Internal control components
Control environmentÀ
The entity’s risk assessment processÀ
The information systemÀ, including the related business processes, relevant to financial reporting, and
communication
Control activitiesÀ
Monitoring of controlsÀ

2.3.2 For each of the policies described in (a) to (f) in the scenario, identify the relevant component of
internal control. Complete your answer in the following format:
Policies relating to internal control components

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2.4 State whether each of the identified factors in (g) to (j) in the scenario willincrease or decrease the
risk of material misstatement at the overall financialstatement level. Give reasons for your answer.
(10)
Assessment of risk at the financial statement level
g) The risk of material misstatement will be increased À– This may indicate a going concern
problemÀ^.
h) The risk of material misstatement will be decreased À – This may indicate that the business is
sustainable and impact the ability of the entity to continue as a going concern in the foreseeable
futureÀ^.
i) The risk of material misstatement will be decreased À - Most of the directors have been with the
company for many years which suggests that they will be experienced in the industry and hence able
to cope with the difficult trading conditionsÀ^.
j) The risk of material misstatement will be increased À – This may indicate an incentive for the
directors to manipulate the accounting records/financial statements to reflect improved performanceÀ^.

2.5 Define the term “test of controls ". (3)


An audit procedure designed to evaluate the operating effectiveness of controlsÀin preventing, or
detecting and correctingÀ material misstatements at the assertion levelÀ.

2.6 For each of the procedures in (l) to (o) above formulate a test of control tobe performed by the
auditor in order to test the operating effectivenessthereof.
k) Reperformanceof the monthly bank reconciliation to confirm that thebalance per the statement of
receipts and payments reconciles to the balance per the bank statement.
l) Inspection of a sample of purchase orders over R50 000 for an authorised signature. À^
m) Observation or inquiry of the procedures actually conducted by warehouse personnel when
receiving goods ordered for comparison with the written procedures. À^
n) Recalculation of the depreciation on computer equipment. À^
o) Inquiry from the warehouse controller as to the methods of identifying obsolete or damaged
inventory. À^

2.7 State whether you agree or disagree with the following statement andmotivate your answer:
“Performance materiality is set by the auditor at a higher level than planningmateriality for the financial
statements as a whole." (4)
Performance materiality and materiality for the financial statements as a whole.
DisagreeÀ
Performance materiality is set by the auditor at lower than planning materiality for the financial
statements as a wholeÀ^ to reduce to an appropriate low level the probability that the aggregate of

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undetected and uncorrected misstatements exceeds materiality for the financial statements as a
wholeÀ^.

2.8 Define audit risk.


Audit risk is the risk that the auditor expresses an inappropriate audit opinionÀwhen the financial
statements are materially misstatedÀ.

2.9 Name the components of audit risk. (3)


Audit risk is a function of the risk of material misstatement À and detection risk À.The risk of
material misstatement consists of two components: inherent risk À and control risk. À AR = IR x
CR (Risk of material misstatement) X DR

2.10 Assuming that the “risks of material misstatement” has been assessed as high and that the
auditor requires an acceptable level of audit risk. Explain the relationship between the components of
audit risk and how the auditor can achieve an acceptable level of audit risk. (3)
The relationship between the components of audit risk
For a given level of audit risk, the acceptable level of detection risk bears an inverse relationshipÀ^ to
the assessed level of the risk of material misstatement at the assertion level.
As a result of the high assessment of the risk of material misstatement, the auditor can accept less
detection riskÀ^ and, accordingly, the audit evidence required by the auditor will have to be more
persuasiveÀ^.The lower detection risk will result in an acceptable level of audit risk À^.
ASSIGNMENT 2 – 2013 SEMESTER 2

1.1 Quality control


Discuss what Heuer and Lex aims to achieve by implementing policies and procedures relating to the
acceptance of new client relationships. (3)
In terms of ISQC1, such policies and procedures are carried out to provide the firm with reasonable
assurance that it will only undertake an engagement where the firm …
• is competent to perform the engagement and has the capabilities, including time and resources, to
do so. À
• can comply with relevant ethical requirements. À
• has considered the integrity of the client, and does not have information that the client lacks integrity.

The six (6) elements of a system of quality control are;


• Leadership responsibilities for quality in the firm.
• Relevant ethical requirements (including independence).
• Acceptance and continuance of client relationships and specific requirements.
• Human resources.
• Engagement performance.
• Monitoring.

1.2 Audit risk assessment of Nuke Ltd


1.2.1 Describe the audit terms “inherent risk”, “control risk” and “detection risk”.
Inherent risk
Inherent risk is the susceptibility of an assertion about a class of transactions, account balance or
disclosure to misstatement that could be material, individually or when aggregated with other
misstatementsÀ, assuming that there are no related internal controls. À

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Control risk
Control risk is the risk that a misstatement that could occur in an assertion about a class of transaction,
account balance or disclosure and that could be material, either individually or when aggregated with
other misstatements Àwill not be prevented, or detected and corrected, on a timely basis by that
entity’s internal control. À

Detection risk
Detection risk is the risk that the procedures performed by the auditor to reduce audit risk to an
acceptably low level will not detect a misstatement that existsÀ and that could be material, either
individually or when aggregated with other misstatements. À

1.2.2 Classify each of the four (4) above-mentioned risks in (a) to (d) as inherent risk, control risk or
detection risk.
Classification of audit risk
a) The company trades in nuclear energy – Inherent risk. À
b) The company has decided to retrench its internal auditors in an attempt to save costs – Control risk.
c) There was a problem with the assignment of personnel to the audit and as a result no members of
the audit team have had previous experience with the company – Detection risk. À
d) The financial accountant resigned two months before year end and as a result the bank
reconciliations were not up to date – Control risk. À

1.3 Independence
1.3.1 Describe the two (2) requirements for independence in terms of the SAICA Code of Professional
Conduct.
Independence requires the following:
· Independence of mind ^
This is the state of mind that permits the expression of a conclusion without being affected by
influences that compromise professional judgment, À thereby allowing an individual to act with
integrity, and to exercise objectivity and professional skepticism. À
· Independence in appearance ^
This is the avoidance of facts and circumstances that are so significant À that a reasonable and
informed third party would be likely to conclude, weighing all the specific facts and circumstances,
that a firm’s or a member of the audit team’s, integrity, objectivity or professional skepticism has
been compromised. À

1.3.2 Describe, with reasons, the threats to independence that Heuer and Lex may face by
continuing to perform the audit of Zigzag Ltd. Indicate what safeguards should be implemented to
ensure that such threats are reduced to an acceptable level.
Threats to independence

• The audit manager’s wife is the financial director of Zigzag. This may create a selfinterest threat,
À familiarity threat À or intimidation threat. À
Safeguard to be implemented
!The audit manager must be removed from the audit engagement team. À^

• The fee income that is being earned from Zigzag represents 80% of the total fee incomeof Jackie
Jovaras, the engagement partner. This may create a self-interest threat À oran intimidation threat.
À
Safeguards to be implemented
!Reduce the dependency on the audit client. À^
!Have a chartered accountant review the work or otherwise advise as necessary. À^
!Ensure regular independent internal or external quality reviews of the engagement. À^

• Heuer and Lex have lent a trainee auditor to Zigzag to assist in the accounting department. This may
create a self-review threat. À
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Safeguards to be implemented
!The trainee may not take any management decisions or exercise discretionary authority that will
commit the client. À^
!The trainee on “loan” should not be given audit responsibility for any function he or she has
performed whilst on loan. À^
!The audit client must acknowledge its responsibility for directing and supervising the “onloan trainee”.
À^

• Jackie Jovaras is currently providing tax planning and advisory services that can affect matters to be
reflected in the financial statements. This may create a self-review threat.
Safeguards to be implemented
!Use professionals who are not members of the audit team to perform the service. À^
!Have a tax professional, who was not involved in providing the tax service, advise the audit team on
the treatment and review of the financial statements. À^
!Obtain advice on the service from an external tax professional À^
!Obtain pre-clearance or advice from the tax authorities. À^

1.4 Auditing Profession Act


1.4.1 State four (4) criteria in terms of the Auditing Profession Act, which must be satisfied by a
registered auditor before an unmodified (unqualified) audit opinion can be expressed.
Duties in relation to an audit
An unmodified/unqualified opinion cannot be given unless …
• the audit has been carried out free from any restriction. À
• the designated auditor has satisfied himself/herself of the existence of all assets and liabilities shown
in the financial statements. À
• proper accounting records have been kept (in at least one of the official languages) and all
information, vouchers and other documents, which in the auditor’s opinion, were necessary for the
proper performance of his or her duties, were obtained. À
• the auditor has obtained all information, vouchers and other documents which in the auditor’s opinion
were necessary for the proper performance of the registered auditor’s duties. À
• the auditor has not had occasion to report a reportable irregularity to the IRBA. À
• the auditor has complied with all laws relating to the audit of that entity. À
• the auditor is satisfied about the fairness or the correctness of the financial statements. À

1.4.2 Determine whether the purchase of the BMW would constitute a reportable irregularity. Give
reasons for your answer. (13)
Reportable irregularity
To qualify as a reportable irregularity, the following criteria must be satisfied:
1. The act must be committed by a person(s) responsible for management of the
entity. À
The financial director, who is responsible for the financial management of Phantom Ltd, claimed
personal expenses through the entity. À^
2. The act must be an unlawful act. À
This act amounts to defrauding SARS, by reducing normal taxation of the entity by claiming non-
business-related expenditures À^ and not paying PAYE on director’s remuneration. À^
3. The act must result in material financial loss. À
This criterion is satisfied, as the financial director is claiming a personal expense. SARS is likely to
have suffered financial loss for unpaid tax. À^ The profits available for distribution have been reduced
because a non-deductible expense was claimed. À^
4. The act is fraudulent or amounts to theft. À
Money has been misappropriated from the company to fund the purchase of a BMW for the financial
director. À^
5. The act represents a breach of fiduciary duty. À
This act amounts to a breach of fiduciary duty by the financial director to the entity. À^
This will therefore constitute a reportable irregularity. À
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ASSIGNMENT 1 – TL101 OF 2012 SEMESTER 2

1. Indicate the correct assertions that, amongst others relate to the audit of the following transaction:
- Credit sale transaction: Invoice 222 to the value of R42 030
1 The credit sale transaction took place during the period under review; was recorded at the proper
amount; and the transaction was recorded in the correct period (occurrence, accuracy and cut-off).

2. Section 41 of the Auditing Profession Act, 2005, prohibits an unregistered person from practising as
a registered auditor. Which one of the following appointments is not prohibited by this Act?
3 An unregistered person may be appointed by the Auditor General to carry out on his behalf any audit
which he is, in terms of the Public Audit Act, required to undertake.

Comment: A person who is not a registered auditor may not accept an appointment as an auditor, act
as an auditor or engage in public practice as an auditor in terms of sec 41 of the Auditing Profession
Act, 2005.

3. The Independent Regulatory Board for Auditors (IRBA) has specific goals as described in the IRBA
Manual of Information.Goals of the IRBA
· To register an auditor who meets the registration requirements.
· To monitor the compliance of registered auditors against professional standards.
· To investigate and take appropriate action against registered auditors in respect of improper
conduct.

4. Auditors, directors and the shareholders are the various parties involved in an audit engagement.
Consider the following statements in respect of the role of the directors of a company. The role of the
directors?
Reporting the results of their stewardship (management) to the shareholders of thebusiness.

Comments
1. The shareholders receive the annual financial statements from the directors and provide finance for
the business.
2. It is the responsibility of the auditor to gather sufficient and appropriate audit evidence to be in a
position to give an independent opinion on whether the annual financial statements issued by the
directors to the shareholders present fairly, the financial position and results of operations of the
company, in terms of the applicable financial reporting framework.
3. Directors are responsible for running the business but don’t appoint auditors, the latter is the
responsibility of the shareholders.

5. The management of a company includes an amount of R1 426 589 under the line item “Trade and
other receivables” in the company’s financial statements. Which financial statement assertions underlie
this line item?
Completeness; existence; valuation and allocation; rights and obligations.

Trade and other receivables is an account balance at year end and all the assertions relating to an
account balance will therefore apply. The other assertions of cut-off, accuracy, occurrence and
classification only apply to classes of transactions and events for the period under audit. Separate
assertions are given for presentation and disclosure.

6. Internal auditing
Internal auditing is a management function which functions independently within an organisation, but
remains part of the entity.
Comment:

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The internal auditors still remain part of the organisation even though they function independently. The
internal auditors report to the management of an entity, receive a mandate from management and they
perform a management function and not an external attest function.

7. A postulate is a foundation on which a discipline is built and there are certain underlying principles
or postulates, which serve as the basis of auditing theory. Examples of an auditing postulate
· An auditor must act exclusively as an auditor in order to be able to offer an independent and
objective opinion on the fair presentation of financial information.
· Effective internal controls reduce the probability of errors and irregularities.
· The financial statements submitted to the auditor for verification are free of collusive and other
unusual irregularities.

8. The following are possible descriptions of the different types of auditors that are found and the
different audit procedures that they can perform:
Auditors who express an independent opinion on whether the annual financialstatements fairly present
the financial position and results of the company’s operationare called external auditors.
Auditors who specialise in a particular field are called special purpose auditors.
Auditors concentrating on investigation and gathering evidence where there has beentheft or fraud are
called forensic auditors.

9. Correct Statement:In the case of an audit engagement the auditor expresses a high, but not
absolute level of assurance.

Comment:
The auditor expresses a high, but not absolute level of assurance in an audit engagement; this is as a
result of the inherent limitations of an audit.

10. Inherent limitation does affect the inherent limitations of an audit


· The preparation of financial statements involves judgment by management in applying the
requirements of the entity’s applicable financial reporting framework.
· Many financial statement items involve subjective decisions or assessments or a degree of
uncertainty (estimates).
· The occurrence of non-compliance with laws and regulations.

Comment:
The fact that that the auditor’s work is governed by regulatory bodies is not an inherent limitation of an
audit it only means that the conduct of registered auditors is regulated. Refer to the reference for a
comprehensive guideline on the inherent limitations of an audit.

11. Description for the applicable financial reporting framework, in terms of ISA 200
The financial reporting framework is the framework adopted by management in the preparation of the
financial statements that is acceptable in view of the nature of the entity and the objective of the
financial statements.
Comment:
The management of an entity is required to prepare the financial statements based on the applicable
financial reporting framework.

12. Which one of the following acts/omissions of an auditor will constitute improper conduct in terms
of the Rules regarding Improper Conduct of the Independent Regulatory Board for Auditors (IRBA)
and/or South African Institute of Chartered Accountants (SAICA’s) Code of Professional Conduct?
If an auditor seeks before the commencement of the period of training of a trainee auditor to impose a
restraint on the trainee concerned which will apply after the date of termination of the training period.
Comment:
An auditor is guilty of improper conduct if any restraints are placed upon trainee auditors after the date
of termination of their training contract (Rules regarding Improper Conduct 2.10). Options 1 (SAICA
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Handbook Sec 240.7), 2 (SAICA Handbook Sec 140.7), and 3 (Rules regarding Improper Conduct Sec
2.11) are all permitted in terms of the Code of Professional Conduct and/or the Rules Regarding
Improper Conduct.

13. The following are possible fundamental ethical principles contained in the SAICA’s Code of
Professional Conduct governing the auditor’s professional responsibilities: Ethical principles governing
the auditor’s professional responsibilities according to International Standards on Auditing?
· Professional competence and due care.
· Professional behaviour.
· Confidentiality.

14. Statements in terms of the South African Institute of Chartered Accountants (SAICA’s) Code of
Professional Conduct
· A practitioner entrusted with monies belonging to others, in the course of professional work,
should keep such monies separate from firm monies.
· Clients’ monies received by a practitioner should be deposited without delay to the credit of a
client account.
· Monies may only be drawn from the client account on the instructions of the client.
Comment:
An auditor may only use the assets of a client for the purposes for which they were intended.By
drawing money to pay audit fees without the client’s consent the SAICA Code ofProfessional
Conduct has been contravened.

15. Indicate the correct instance when the shareholder can hold the auditor responsible for negligence
in terms of the Auditing Profession Act:
The auditor will be liable to the shareholder if at the time when the negligence occurred the registered
auditor knew or could reasonably have been expected to know that the shareholder would rely on the
opinion in order to enter into a transaction.
Comment:The shareholder will have to bring a delictual action against the auditor and amongst other
things prove that the auditor knew or reasonably could have been expected know that the third party
would rely on the opinion. Take note that there is a distinction between the liability to clients and to the
3rd parties. An auditor’s liability to a client is based on breach of contract.

16. Inventory to the value of R45 762 was purchased by BullSharks Ltd and is included in purchases in
the statement of comprehensive income. By including this amount in the statement of comprehensive
income, management declares amongst other things that: all inventory purchases are recorded, and
that all inventory purchases are recorded in the proper accounts. Which two management assertions
are being addressed with these statements?
Classification and completeness.
Comment:
Purchases of inventory are classified as transactions and events for the period under audit and the
assertions relating to classes of transactions and events will therefore apply. In this question we
specifically asked you which assertions relate to “all purchases are recorded” – Completeness and “all
purchases are recorded in the proper accounts” – Classification.

17. Indicate which one of the following individuals’ applications for registration as a registered auditor,
accompanied by the prescribed fee, will be approved by the Independent Regulatory Board for
Auditors (IRBA).
Margot Simpson, a resident of Cape Town, is twenty-eight years old. She completed her training
contract and passed the Board’s public practice examination at the age of twenty-four. Directly
thereafter, she changed her occupation to that of a housewife. She now lodges a written application for
registration as a registered auditor with the Board.

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18. A registered auditor and auditor’s practice may be conducted as a company provided that certain
requirements are complied with. The following are possible requirements:
· Every shareholder must be a registered auditor.
· Only natural persons who are registered auditors may be members or shareholders of the
company.
· The company’s articles of association must provide that a member of the company shall not
appoint a person who is not a member of the company to attend, or speak or vote, in his/her
stead at any meeting of the company.

19. In one of the types of engagements referred to in The International Framework for Assurance
Engagements, a moderate level of assurance is expressed for this type of engagement and the auditor
expresses a negative form of assurance in the report. Indicate which one of the following types of
engagements is associated with the objective of providing the level of assurance described above.
A review engagement.
Comment:
· In a review engagement a limited level of assurance is expressed negatively.
· No assurance is expressed in an agreed upon procedures engagement.
· A reasonable level of assurance is expressed in an audit engagement.
· No assurance is expressed in a compilation engagement.

20. Elements of a quality control system?


· Relevant ethical requirements.
· Monitoring.
· Human resources.
Comment:
Assertions are representations by management, explicit or otherwise, that are embodied inthe
financial statements, as used by the auditor to consider the different types of
potentialmisstatements that may occur.

ASSIGNMENT 2 – TL101 OF 2012 SEMESTER 2

1.1 Components of internal control - Match relevant aspects from the above planning scenario to
the applicable components of internal controls in a tabular format

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Note the following: Management is responsible for internal control. Managers establish
policies and processes to help the organisation achieve specific objectives. Auditors are
responsible for identifying risks and to provide management with the assurance that the
controls in place are in fact effective and efficient.

1.2 Mention six (6) INHERENT LIMITATIONS OF AN INTERNAL CONTROL SYSTEM. (9)
· Management’s usual requirement is that the cost of internal control does not exceed the
expected benefit to be derived (cost vs benefit). √^
· The tendency is for internal controls to be directed at routine transactions rather than non-
routine transactions. √^
· The potential exists for human error due to carelessness, distraction, mistakes of judgement
and misunderstanding of instructions. √^
· The possibility exists of circumvention of internal controls through the collusion of a member of
management, or an employee, with parties outside the company. √^
· The possibility exists that a person responsible for exercising an internal control could abuse
that responsibility, for example, a member of management overriding an internal control. √^
· The possibility exists that procedures may become inadequate due to changes in conditions
and, therefore, compliance with procedures may deteriorate. √^
· There may be an error in the design of, or in the change to, a control. √^
· Operation of a control may not be effective, such as where information produced for the
purposes of internal control is not effectively used because the individual responsible for
reviewing the information does not understand its purpose or fails to take appropriate action.
(Exception reports) √^

Note the following: Internal control, no matter how effective, can provide an entity with onlylimited
assurance about achieving the entity’s financial reporting objectives. The likelihood oftheir
achievement is affected by inherent limitations of internal control. These include therealities that
human judgement in decision-making can be faulty and that breakdowns ininternal control can occur
because of human error.

1.3 Give two (2) reasons why the auditor may change the materiality level as the audit progresses. (3)
· The auditor shall revise materiality for the financial statements as a whole (and, if applicable,
the materiality level or levels for particular classes of transactions, account balances or
disclosures):
· In the event of becoming aware of new information during the audit, that would have caused the
auditor to have determined a different amount (or amounts) initially. √^
· Change in circumstances that occurred during the audit. (For example, decision to dispose of a
major part of the entity’s business) √^
· Change in the auditor's understanding of the entity and its operations as a result of performing
further audit procedures. (For example, if during the audit it appears as though actual financial
results are likely to be substantially different from the anticipated period end financial results

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that were used initially to determine materiality for the financial statements as a whole, the
auditor revised that materiality. √^

Note the following: In determining materiality, various aspects need to be taken into
account, such as the entity's risk assessment, control environment as well as the objective
judgement of the auditor. The method of determining materiality should be properly
documented.

1.4 From the above scenario (audit evidence) indicate for each type of evidence the level of reliability:
Most reliable/ more reliable/ least reliable

Note the following:


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• All information gathered during the audit becomes evidence.


• The appropriateness (reliability and relevance) and the sufficiency of evidence need to be
substantiated – obtain written/documentary evidence.
• This is especially important when considering the fact that the auditor might be called upon to deliver
evidence in a court of law, where the absence of documentary evidence could call the integrity of the
auditor into question.

1.5
Draw up a working paper in which you document the following:
1.5.1 List and describe MANAGEMENTASSERTIONS that relate to the inventory balance in the
Statement of Financial Position.(10)

· Existence √ - Inventory existed at the end of the financial year end. √^


· Rights and obligation √ - the entity holds or control the right to that inventory. √^
· Completeness √- the entire inventory that should have been recorded has been recorded. √^
· Valuation and allocation √ – the inventory balance is included in the financial statements at
appropriate amounts and any resulting adjustments are appropriately recorded. √^

Note the following: Assertions refer to management representations embodied in the financial
statement “declaration”, for example, that revenue presented on the face of the statement of
comprehensive income (income statement) is complete and that all assets presented on the face of
the statement of financial position exist.

1.5.2 List the 7 (seven) types of AUDIT PROCEDURES that can be performed to obtain audit
evidence.(7)
• Inspection √
• Observation √
• External confirmation √
• Recalculation √
• Reperformance √
• Analytical procedures √
• Inquiry √

Tutorial Letter 102/3/2012


1. Solution to question 1.11 in Graded Questions 28 Marks (Study unit 1.3)
Statements
1. Assertions form the basis of the financial statements
2. An auditor must act exclusively as auditor in order to be able to offer an independent and
objective opinion on the fair presentation of financial information
3. An unqualified opinion is in effect a certification of the accuracy of the financial statements
4. An audit should only be conducted by an audit team which has the necessary technical
competence
5. Financial data is verifiable
6. Internal controls reduce the probability of errors and irregularitites
7. To be appointed as auditor for a statutory audit, the auditor must be registered with a regulatory
body
8. In the absence of any contrary evidence, that which held true in the past will hold true in the
future
9. For the external audit function to be effective, co-operation with the client’s directors /
management is essential

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10. The professional status of the independent auditor imposes commensurate professional
obligations on the auditor

(a) Explain the term POSTULATE in the context of auditing


A postulate provides a basis or framework for thinking √^about problems and arriving at solutions. √^ A
postulate is a starting point for thinking about a discipline. √^
In the context of auditing the postulates are the foundations√^ on which the subject (discipline) is built.
(Max 3)

(b. Indicate which of the above statements (1 to 10) are regarded as postulates of auditing.
Explain briefly each of the postulates you have idenditfied
The following of the mentioned statements are generally regarded as the postulates of auditing.

Statement 2: Essentially this postulate says that if the auditor is going to give an opinion√^ that is
worthwhile to users, he must be free of any bias (independent) √^. Furthermore the auditor must not
compromise his audit independence by offering the client other services which may impinge in any
way on his independence. (Max 3)

Statement 5: This postulate proposes that it is to verify the client’s financial data√^ i.e. that there will
be evidence (documentary or otherwise) which will enable the external auditor to “verify” the
transactions recorded in the client’s books√^. If financial information is not verifiable there can be no
audit. (Max 3)

Statement 6: This postulate suggests that a company without internal controls provides the auditor
with little chance of conducting an efficient or economical audit. √^ If a company is not “controlling” its
activities √^e.g. no division of duties, no proper documentation etc, a positive audit outcome is not
feasible. √^ (Max 3)

Statement 8: This postulate suggests that in business “things generally stay the same”. √^ Obviously
businesses develop, expand, contract etc, but generally from year to year the core activities and
philosophy of the business remain the same. √^ Hence historical information about a client is important
to the auditor. √^ The postulate in a sense also alerts the auditor to the fact that if there has been
change, the effect of the change must be considered for the purposes of the audit. √^ (Max 3)

Statement 10: This postulate simply means that the auditor must understand that the professional
status which the audit profession and its members have, brings with it a responsibility to meet their
professional obligations, √^ e.g. auditors must ensure they keep up to date, act with objectivity and
integrity etc. √^ (Max 3)

(c) For each of the above statements which you have not identified as a postulate, state
whether the statement is true or false. Justify your choice

Statement 1: True. ^ The assertions are the representations which the directors are making about the
assets, liabilities, transactions and disclosures in the financial statements. Thus they form the basis of
the financial statements. √^ (Max 2)

Statement 3: False. ^ An unqualified opinion is a statement that the financial statements “present
fairly” the financial position etc of the company. √^ It is not a statement that the Annual Financial
Statements are 100% correct. √^ The auditor can never be in a position to “certify” due to inter alia, the
limitations of the audit function and the extensive use of judgment and estimate in financial statements.

Statement 4: True. ^ One of the fundamental principles of professional conduct is that an auditor is
required to “maintain professional knowledge and skill” √^and “act in accordance with applicable
technical and professional standards”. √^ Furthermore, an opinion arising from an audit conducted by
an incompetent audit team will be worthless.√^ (Max 2)
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Statement 7: True. ^ In South Africa the individual must be registered with the Independent
Regulatory Board for Auditors (IRBA). √^ (Max 2)

Statement 9: True. ^ Although the auditor expresses an independent opinion it is very important that
there is communication and co-operation with the client’s directors/management. √^ The auditor audits
the assertions of the directors, and evidence is frequently required from individual directors or
members of the management team. √^ For example, a detailed explanation about a major transaction
may be required from the financial director; if he will not co-operate, the auditor may not be able to
“audit” the transaction to determine whether it has been fairly presented in the financial statements.
√^(Max 2)

Study unit 1.4 The Accounting profession


2. Solution to question 1.13 in Graded Questions 10 marks
· The external audit of a public company… is an assurance engagement.
· One of the major distinctions between a lawyer or doctor and an auditor… is the independent nature of
the relationship with their clients.
· One of the postulates of auditing is that internal controls ….. reduce the possibility of errors and
irregularities.
· A review of a company’s annual financial statements ….. provides negative assurance only.
· A professional accountant who wishes to use the designation CA(SA) ….. must register with SAICA.
· The audit opinion given on a company’s annual financial statements ….. is not an assurance of the
future profitability of the company.
· A professional accountant who wishes to offer audit services ….. must register with IRBA.
· Another of the postulates of auditing is that financial data ….. is verifiable.
· The representations of the directors contained in the financial statements are…. referred to by the
auditors as the assertions.
· An assurance engagement is defined as one in which a practitioner ….. expresses a conclusion
designed to enhance thedegree of confidence of the intended user.

Study unit 1.5 The financial statement audit engagement


3. Solution to Question 1.13(incorrect question nr) in Graded Questions 13 marks (Study unit
1.5)
Elements of an assurance engagement (SG p9)
(a)
(i) The three parties:
• The professional accountants - Hendricks and Co. √
• The responsible party - the management/directors/owners of the shops. √
• The intended users are the shareholders ofPropcorp (Pty) Ltd. √ (Max 3)

(ii) The subject matter


The financial position, results of operations and cash flow
The total rental payment made by the shop owners based on turnover. √^ (Max 1)

(iii) Other elements of assurance engagement


Suitable criteria √
• The rental agreement which lays out the terms and conditions of the rental payment. √^
• Hendricks and Co will familiarize themselves with the terms and conditions of the rental to be paid. In
effect these are the criteria for the calculation of the rent. √^ (Max 2)
Sufficient appropriate evidence √– Hendricks and Co must gather sufficient appropriate evidence to
pass an opinion on whether the figures presented by the shop owners are fairly presented for the
purposes of calculating the rental due in terms of the rental agreement. √^ This would probably include
such procedures as inspection of invoices, credit notes, cash sales records, etc. √^ (Max 2)

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Written assurance report√ – this is the conclusion which Hendricks and Co will draw as a result of
gathering evidence. The conclusion (whether or not the information provided by the shop owners is
fair) will be reported to Propcorp (Pty) Ltd. √^ (Max 2)

b) The importance of the clause which allows access to accounting records


1. A very important aspect of an assurance engagement is that the practitioner (Hendricks andCo)
forms an independent opinion on the subject matter if the opinion is to be of any use toPropcorp (Pty)
Ltd. √^
2. To achieve independence, the practitioner must be given access to whatever informationfrom the
client he deems necessary. √^The clause in the rental agreement allowing accessto the accounting
records facilitates this. √^(Max 3)
Comments:
This type of engagement is classified as an assurance engagement, and must be conducted by a
registered auditor.

TOPIC 2: REGULATION OF THE AUDITOR


Study unit 2.1 The Auditing Profession Act, 2005
4. Solution to question 13.2 in Graded Questions (Incorrect Question nr) correct 13.1

1. The Auditing Profession Act 2005 applies only to those registered auditors who performs audits of public
companies not private companies. True or False? Justify
False^ The Act applies to any individual who is registered with the IRBA √^(i.e. registered auditor). To
conduct an audit of any company the individual must be aregistered auditor in terms of the Auditing
Profession Act 2005. √^

2. The MOI of a company may include a clause which requires that if a reportable irregularity is discovered
by the external auditor, it should be reported to the shareholders and not the IRBA provided the external
auditor agrees to this at the time of discovering the reportable irregularity. true or false? Justify
False^
2.1 Such a clause in the Memorandum of Incorporation (MOI) would have no affect whatsoever.√^ The
auditor’s duty to report a reportable irregularity to the IRBA is laid down in theAuditing Profession Act
2005, and a Memorandum of Incorporation (MOI) cannot simplydisregard this duty created by the law. √
2.2 Obviously the auditor cannot agree to such a clause as he/she is duty bound to follow theprocedure
for reportable irregularities stipulated in the Act. √^

3. The designation, chartered accountant (SA) is restricted to auditors registered with the IRBA. Comment
3.1 This is not correct. ^The designation CA (SA) is the designation of those individualsregistered with
SAICA. √^ The designation “registered auditor” is restricted to thoseregistered with the IRBA.√^
3.2 To be registered with the IRBA it is not a requirement that the individual be registered withSAICA (i.e.
CA (SA)). √^

4. Mohammed Mubarak offers internal audit services to various companies. He is not registered with the
IRBA. He wishes to advertise his consultancy in one of the following ways. Indicate whether or not each
of these are permissible. Justify
a. “Mohammed Mubarak Consultants – registered internal auditors”
b. “Mohammed Mubarak Consultants – financial advisors and auditors”
c. “Mohammed Mubarak Consultants – internal auditors and accountants

The essence of Section 41 of the Auditing Profession Act 2005 is that a person may notpretend to be a
registered auditor (mislead the public) or use any description which createsthe impression that they are
registered with the IRBA or not. √ ^
· The description in 4.1 of the question would be unlikely to be a contravention as Sec 41 allows
the use of the description “internal auditor”. Presumably Mohammed Mubarak is registered with
the Institute of Internal Auditors and he doesn’t appear to be “pretending” to be registered with
IRBA. √ ^

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· The description in 4.2 is likely to be unacceptable, whilst the financial advisor part is no problem,
the description creates the impression that his consultancy carries out audits i.e. that they are
registered auditors√ ^ (Note: only a registered auditor in public practice may perform audits).
· The description in 4.3 is perfectly acceptable. In terms of Sec 41 both internal auditor and
accountant are acceptable descriptions.√ ^

5. Mildred Tiles is the designated auditor of BuildwithBricks (Pty) Ltd a large brick and paver wholesaler.
The company has elected in its MOI to have its AFS audited externally every year. Whilst conducting the
current year’s audit, she discovered a reportable irregularity. However, she intentionally decided not to
report it to the IRBA. Indicate whether each of the following would be a justifiable reason for not reporting
to the IRBA as required by the AP Act:
a. As BuildwithBricks (Pty) Ltd is audited because its MOI requires it to be, and not because its
public interest score requires it, there is no duty on Mildred Tiles to report it to the IRBA
of the question is not an acceptable reason. ^ The Auditing Profession Act states clearly
thatwhere a registered auditor conducts an audit, he or she will have an obligation to report
areportable irregularity.√^ The fact that BuildwithBricks (Pty) Ltd is a private company is
notrelevant; once the company has engaged a registered auditor to perform an audit,
theregistered auditor must adhere to the Auditing Profession Act. √^

b. The financial director requested Mildred Tiles no to report to the IRBA as the consequences of
doing so could result in dismissals and other job losses at the company
is not an acceptable reason.^ Whilst it is possible that there will be negative consequencesfor the
company as a result of the reportable irregularity, the auditor (Mildred Tiles) mustcarry out her
duties in terms of the Auditing Profession Act. √^ It is as a result of the directors’actions that
employees may lose their jobs; it is not the fault of Mildred Tiles. √^

c. Mildred Tiles did not want to spend the hours following up on the reportable irregularity, writing
reports, attending hearings etc, as she was under audit deadline pressure at a number of her
other audits
is not an acceptable reason. ^ It is true that the reportable irregularity may result in MildredTiles’
having to put in more hours than she wishes. √^ However,
· she has a duty to comply with the Auditing Profession Act√^
· she is facing a serious threat to compliance with the fundamental principles of
integrity,objectivity, professional competence and due care, and the only realistic
safeguardwould be to comply with her duty. √^

6. Freeloites and Co, a large audit firm wishes to employ the following individuals to work on the audit of
Anglotec Ltd, a listed company. Each of the individuals has a particular audit expertise required on the
audit:Discuss Freeloites and Co’s intentions to employ Hendrik Hertz and JabuMotaung with reference to
the Auditing Profession Act 2005. Indicate whether the two individuals could become partners at the firm
a. Hendrik Hertz, who does not have an auditing background but is a computer fraud expert.
Hendrik Hertz was convicted five years ago for his involvement in a computer based fraud and
has served a three year sentence. Since completing his sentence he has offered his services as
a fraud investigator
In terms of the Auditing Profession Act, Hendrik Hertz cannot be registered with IRBA
(notqualified) and could therefore not become a partner of Freeloites and Co but the fact that
heis not specifically qualified as an auditor, does not mean he cannot be employed byFreeloites
and Co. √^
· The requirement is that the audit be conducted by or under the direction of a
registeredauditor. √^
· Thus it would appear that in terms of the Auditing Profession Act, there is nothing
toprevent Freeloites from employing Hendrik Hertz to work on the audit. √^ Whether
itwould be a wise employment/business decision would be for the partners to decide.

b. JabuMotaung, who was registered with the IRBA before spending ten year in New York as a
stock trader, during which time he allowed his registration with the IRBA to lapse.
Again the fact that JabuMotaung is not registered with the IRBA means that he could not be
made a partner at this point but he could be employed by Freeloites.√^
· as he has previously been registered with the IRBA he must have the basic educationand
training requirements but he would have to show that he has the necessarycompetency
requirements as he has not practiced for some time (10 years). √^
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7. Maggs and Mabhida, a medium sized firm of registered accountants and auditors, wishes to incorporate
(form itself into a company) the propose shareholders will be: (Comment on the proposed appointment of
each of the above as shareholders of the new company, Maggs and Mabhida Incorporated)

a. Archie Angel: the current senior partner of the firm- Archie Angel: currently a partner in an audit
firm therefore must be registered with the IRBA, can become a shareholder, and must be a director
(Sec 38). √^

b. SydSithole CA (SA): currently a senior member of an international bank who will leave the
bank and join Maggs and Mabhida -SydSithole: does not appear to be registered with the IRBA, is
registered with SAICA so must have basic education and training requirements with IRBA but may
have to prove his competency for public practice; must also be appointed a director. √^

c. Monty Maggs: Registered Auditor and CA (SA): he is the son of the founding partner of
Maggs and Mabhida. He currently has his own audit practice but will join Maggs and Mabhida
to become the executive director of the new company- MontyMaggs: may become a
shareholder and executive director, has all qualifications and requirements as he is currently
practicing. √^

d. AravindaSilv: currently the other partner in Monty Maggs’ audit firm who will also join the new
company, but will not be a director – Aravinda Silva: as he is currently in public practice he
satisfies all the requirements to become a shareholder but he must be appointed a director as well.
√^

e. Stix martin: an attorney who has expertise in company law - Stix Martin: may not become a
shareholder or a director. Section 38 limits these appointments to registered auditors. As Stix Martin
is a lawyer he cannot register with the IRBA as his qualifications do not meet the requirements. √^

f. The three other existing partners of Maggs and Mabhida - The three other existing partners may
all be appointed shareholders and must be appointed directors as well. √^

g. Finance (Pty) Ltd, the company which will provide the initial finance for the new company to
get started e.g. office lease, overdraft, purchase of computers etc (5% holding only) - Finance
(Pty) Ltd may not be shareholders; the company is not an individual, cannot be registered with the
IRBA and cannot be a director. √^

Study unit 2.3 Ethical principles regulating the profession


5. Solution to question 3.5 in Graded Questions

1. A conceptual framework approach to professional conduct is confusing; there should be just


a fixed set of rules to regulate professional conduct. Comment.
False. ^Any individual registered with SAICA (a chartered accountant) is subject to therequirements of
the Code of Professional Conduct (COPC). √^ (Such an individual is referredto by the Code as a
“chartered accountant in business”, and the Code of ProfessionalConduct (COPC) has, in addition to
the section on general application of the code whichapplies to all chartered accountants, a section
applicable to chartered accountants inbusiness. √^

2. It is not necessary to have a Code of ProfesisonalConuct as chartered accountants should


know how to act ethically and professionally. State whether you agree or disagree. Justify.
False. ^Objectivity is a fundamental principle and therefore applies to all services offered bya chartered
accountant. √^ Independence which is closely linked to objectivity, is moresignificant for assurance
engagements, √^but a chartered accountant must bring objectivityto all services he or she renders.
√^(Max 3)

3. from Graded questions 3.7 Intimidation threats can affect the auditor’s objectivity and
integrity.
False.An auditor must be both independent in mind and appearance. √^
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Users of audit services must perceive that the auditor is independent. Even if the auditoracts with the
highest level of independence of mind, if he is in some way linked with the cliente.g. a minor
shareholder, he will not appear to be independent. The auditor must be, and beseen to be,
independent. √^(Max 3)

4. from Graded questions 3.7 The Spouse of a chartered accountant in public practice is
regarded as a close family member for purposes of applying the Code of Professional Conduct.
True. ^ for both spouse and dependents. √^(Max 2)

5. (can’t find question referred to in Graded questions) True. ^provided Carter Repson obtains the
loan under the same procedures, conditions andinterest rates that are applicable to members of the
public, √^ i.e. he receives no preferentialtreatment.(Max 2)

6. (can’t find question referred to in Graded questions) False. ^as the advertising manager, Lolly
Patrick is not “in a position to exert direct andsignificant influence over the subject of the audit, √^i.e.
the financial statements”, PeterPatrick is not automatically in breach of the Code as his independence
is not likely to beimpaired. √^(Max 2)

7. (can’t find question referred to in Graded questions)True. ^ Desai & Co may advertise their
services during this time slot provided the contentand presentation of the advertisements does not
threaten their compliance with thefundamental principle of professional behavior. √^ This has been
interpreted as meaning theadvertisement should be in good taste and conform with the accepted
norms of legality,decency, honesty and truthfulness, and reflect a due sense of responsibility to the
professionand the public. √^ The advertisement must not bring the profession into disrepute, √^
andmust not contain exaggerated claims about services, qualifications or experience. √^ It mustnot
make disparaging references or unsubstantiated comparisons to the work of another. √^(Max 3)

8. Question 9 Graded Questions3.7: if a chartered accountant in business is faced with a


situation where his compliance with the fundamental principles of the Code of Professional
Conduct conflicts with the interests of the company which employs him, he must comply with
the fundamental principles. True. ^ The Code of Professional Conduct (COPC) requires this. It is
important that this isdone so that the proposed accountant can determine whether he/she is making a
soundbusiness decision, √^ and whether he/she will be able to comply with the fundamentalprinciples
if he/she accepts the appointment. √^(Max 2)

9. (can’t find question referred to in Graded questions)True. ^ Chivanga and Skeate should
provide de Villiers and Grant with information about theclient (assuring permission has been granted)
but are under no obligation to discuss theiraudit strategy or plan. √^ They may do so if they wish.

10. (can’t find question referred to in Graded questions)True. ^ This amounts to financial
involvement with the audit client which may lead to selfinterest(or intimidation) threats to the firm’s
independence. √^(Max 2)

11. (can’t find question referred to in Graded questions)False. ^Gomez and Pillay are not in full
compliance. √^
11.1 The money must be placed in a separate bank account suitably designated, with aninstitution
registered in terms of the Banks Act 1990. √^
11.2 The money must be deposited without delay. √^
11.3 Gomez and Pillay must check the source of the money they are given to ensure that themoney is
legal and not being laundered. √^
11.4 Gomez and Pillay must be able to account for the money, any interest it has earned and
anyexpenditures made at all times. √^(Max 3)

12. (can’t find question referred to in Graded questions)False. ^If a client wishes to get other
opinions on its financial information it can do so – theclient owns the information! √^ However, in this
situation the chartered accountant who is toprovide the second opinion should obtain the client’s
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permission to discuss the matter fullywith the chartered accountant who provided the first opinion as
there is a threat tocompliance with the fundamental principles. √^(Max 2)

13. False. ^If John Jarvis is faced with a threat to his compliance with the fundamental principles,he is
still required to evaluate the threat and only if it is not significant, may he ignore it. √^ Ifthe threat is not
acceptable, he must put suitable safeguards in place√^, if possible whetheror not it is in his employer’s
best interest. √^

Study unit 2.3 Ethical principles regulating the profession


6. Solution to question 3.4 in Graded Questions(already done)

Study unit 2.3 Ethical principles regulating the profession


8. Solution to question 3.9 in Graded Questions(already done)

General

1. In an assurance engagement (such as an audit) a chartered accountant reports on financial


information prepared by the client with the intention of enhancing the credibility of the information
(making it more reliable from the perspective of a user).√^
2. If the chartered accountant is not independent √^ (and not seen to be independent) of the client, a
user is unlikely to accept that the credibility of the information has been enhanced. √^ The client and
the chartered accountant will be seen as one.
3. In the case of a non-assurance engagement, the chartered accountant does not enhance
credibility of information but rather sets out to perform a predetermined task (such as compiling
financial information) without expressing an opinion thereon. √^ A user of the information does not
require an independent opinion on the information and does not make a distinction between the
chartered accountant and the chartered accountant’s client. √^

1. In an assurance engagement (such as an audit) a chartered accountant reports on financial


information prepared by the client with the intention of enhancing the credibility of the information
(making it more reliable from the perspective of a user).√^
2. If the chartered accountant is not independent √^ (and not seen to be independent) of the client, a
user is unlikely to accept that the credibility of the information has been enhanced. √^ The client and
the chartered accountant will be seen as one.
3. In the case of a non-assurance engagement, the chartered accountant does not enhance
credibility of information but rather sets out to perform a predetermined task (such as compiling
financial information) without expressing an opinion thereon. √^ A user of the information does not
require an independent opinion on the information and does not make a distinction between the
chartered accountant and the chartered accountant’s client.

Situation 1
!independence would be threatened and on two counts.^
!Overdue fees could give rise to a self-interest threat. √^
Explanation: If there are already substantial fees outstanding, the firm may not put the necessary
resources and time into any future audit work because the partner/manager does not expect the fee to
be paid promptly, if at all. √^ This external factor may create bias which will affect audit performance.
(Professional competence is threatened). √^
!The issue of shares to the partners would amount to a self-interest threat. √^
Explanation: Being shareholders in an audit client amounts to the partners having a direct financial
interest in the audit client. √^
!The firm would not be independent in mind or appearance e.g. because he has a personal
investment in the client, the partner in charge of the audit may “turn a blind eye” to matters which he
may otherwise have followed up more diligently. √^ The auditor may not hold shares in an audit client.
√^ (Max 5)

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Situation 2
!independence would be threatened in a number of ways. ^
!This arrangement could give rise to a self-interest^ and/or intimidation threat^ in respect of the
trainee.
Explanation: A financially needy trainee accountant who is receiving money from a client becomes
dependent on that client. √^
Acting out of self-interest, the trainee, not wanting to jeopardize the financial support, may overlook
certain matters on the audit which he or she may otherwise take further action on. √^
On the other hand the client may “threaten” the trainee with withdrawal of the financialsupport (if the
trainee does not act as the client wishes) giving rise to an intimidationthreat. √^

!Where a trainee accountant fails a year, he or she becomes a debtor of the client (thefees paid must
be repaid) which amounts to direct financial involvement. ^
Explanation: Although this situation may not give rise to an obvious threat toindependence, it is
unlikely that the trainee (or the firm) will be seen to be independent(appearance). √^ In addition, will a
trainee who owes an audit client money, be totallyimpartial (in mind)? √^

!From the perspective of the firm, this amounts to indirect financial involvement with aclient which
could give rise to a self-interest^ or intimidation threat^.
Explanation: In effect the audit client is funding the audit firms’ employees. Thissituation is highly
beneficial to the audit firm, and may result in a favor from the auditclient, and likewise providing the
audit client with some power over the firm, i.e. theclient threatens to stop the arrangement.√^

Note: It could be argued that if the trainee is not actually a member of the audit team forthis specific
client, the threat to independence (for that trainee) is reduced. However, thearrangement would still
severely compromise the firm’s independence and should not beagreed to.

Situation 3
!independence would be threatened. ^
!This situation would give rise to (potential) self-interest,^ intimidation ^and familiarity threats.^
!"Explanation: The threat is that Rudolf Nel will, whilst conducting Quickies (Pty) Ltd’s audit, view
himself as an employee of Quickies (Pty) Ltd and may not wish to act in a manner which may
jeopardize his appointment √^as financial accountant (selfinterest)^ e.g. he may overlook contentious
audit issues. √^

!"As it is likely that the client’s accounting staff, as well as other senior staff will be aware of the
pending appointment of Rudolf Nel, it is probable that they will not treat Rudolf Nel as an “independent
auditor” √^during the current year’s audit, seeing him rather as one of them (familiarity)^.

!There is also the possibility that Quickies (Pty) Ltd could place pressure on Rudolf Nel to overlook
contentious issues√^ on the audit by “threatening” not to appoint him as financial accountant. √^

Note: After Rudolf Nel takes up the position of financial accountant, some threat to independence will
remain, most likely a familiarity or intimidation threat. Having been the senior on the audit, Rudolf Nel
may be friendly with the audit team or may be able to intimidate junior members of the team.

Study unit 3.2 Internal Control


9. Solution to question 4.15 in Graded Questions 32 marks – Question 4.16

a) Define the Term Business risk:


A business risk is a risk resulting from significant conditions, events, circumstances, actions or
inactions √^ that could adversely affect an entity’s ability to achieve its objectives and execute its
strategies.√^ (Max 2)

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b) List the other four components of Internal control, other than that the entity’s risk
assessment process
· Control environment ^
· The information system^, including the related business processes relevant to financial reporting
and communication.
· Control activities^
· Monitoring of controls. ^

c) Briefly explain the term Control Environment


The control environment is about the tone of the organization relating to control consciousness of the
employees. √^It is governed by the attitudes, awareness and actions of those charged with
governance and management concerning the company’s internal controls and its importance. √^
Simply stated, if management sets a poor example with regard to internal control, employees will soon
follow suit and adopt a slack attitude with regard to carrying out control activities for which they are
responsible. √^

d). Discuss whether the external auditor is directly interested in all the business risks which are
identified by the company’s risk process.
The external auditor’s objective is to form an opinion on the fair presentation of the financial
statements of the company. √^ The financial statements are a product of the financial reporting system
which in turn is part of the company’s information system. √^
!The auditor must obtain an understanding of the information system and therefore will be directly
interested in any business risk which might affect the financial reporting information system and the
control activities which are implemented by management to address the risks. √^
!It is probably fair to say that the auditor is at least indirectly interested in all business risks
(sometimes to a very minor degree) as this knowledge will help the auditor in obtaining a better overall
understanding of the client’s business. √^ (Max 3)

e). Describe briefly the elements which make up that part of a company’s information system
which is relevant to a company’s financial reporting system
The classes of transactions in the entity’s operations that are significant to the company’s financial
statements, e.g. sales, purchases, salaries, etc. √^
!"The procedures (both computerized and manual), by which these transactions are initiated,
processed, recorded, corrected and transferred to the general ledger and reported in the financial
statements, e.g. place and order, receive the goods, transfer the goods to the warehouse, etc. √^
!The related accounting records and supporting information and documentation relating to the
transaction, e.g. purchase order, goods received note, creditors ledger, etc. √^
!How the information system captures events and conditions other than transactions, e.g. subsequent
events, litigation. √^
!The financial reporting process used to prepare the entities financial statements including significant
accounting estimates and disclosures√^ e.g. who draws financial statements up, who checks
compliance with accounting statements, etc. √^
!The control around the passing of journal entries, including non-standard journal entries, e.g. an
impairment loss. √^ (Max 6)

f). State, using four key words in your answer, the objective which management aims to
achieve in an accounting (financial reporting ) system by implementing application control
procedures
The production of valid^, accurate^ and complete ^data timeously.^

g). Discuss each of the following in relation to internal control:

Strong control environment (component: control environment)


A good internal control system requires that directors and management have the proper attitude to and
awareness of the importance of internal controls. √^ By their actions and behaviour they must instill in
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staff the importance of internal control √^e.g. they should not ignore controls themselves, should act
with integrity, provide leadership etc. √^ Where there is a strong control environment, internal controls
are effective. √^ max2

Sound personnel practices (component: control environment)


An internal control system is as good as the staff involved; therefore a good system of internal control
requires honest, competent staff, √^ e.g. if staff are dishonest, internal controls may be circumvented
by collusion. √^ Sound personnel practices will include proper recruitment and training of staff, fair
remuneration and acceptable working conditions. √^ max2

Appropriate and comprehensive segregation of duties (component: control activities)


Perhaps the most important principle; the intention of segregation of duties is to “break up” a
transaction into its various functions as follows:
!Authorisation of the transaction: e.g. the purchase of inventory.√^
!Executing the transaction; placing the purchase order with a supplier.√^
!Recording the transaction e.g update the perpetual inventory records.√^
!Maintaining custody of the result of the transaction. √^ (Max 2)

Isolation of Responsibility (component: control activities)


This principle requires that the staff member be allocated specific (control) tasks √^and that the staff
member indicates that the control has been exercised, usually by signature. √^This is particularly
important where two or more people are required to fulfill a particular function. √^ (Max 2)

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Comprehensive access control (component: control activities)


Sound internal control requires that access to data, assets, the business itself be controlled to prevent
unauthorised people gaining access √^which could lead to fraudulent losses, destruction of data or
property, theft of data or property √^etc. (Max 2)

Good document design (component: control activities)


An integral part of an accounting system (which is part of the internal control system) is the gathering
of data.√^ Good document design will promote control and minimise errors in the gathering of data.√^
Documents should be numerically sequenced. √^Good document design contributes to valid, accurate
and complete processing. √^ (Max 2)

Regular and frequent comparison and reconciliation (component: control activities)


A good internal control system will be characterized by frequent and timeous comparison and
reconciliation, √^e.g. physical assets with theoretical assets. Reconciliations and comparisons reveal
differences which in turn must be followed up and rectified. √^

Comments:
Internal control, despite how effective it is, in an entity may provide only reasonable assurance
regarding the achievement of the entity’s financial reporting objectives. The likelihood of achieving
them is affected by the inherent limitations of internal control. These include the realities that human
prejudice in decision-making can be faulty and error-operation in internal control can occur because of
human error.

Study unit 3.3 Audit evidence


10. Solution to question 4.5 in Graded Questions 20 marks
Sufficient audit evidence means that a satisfactory amount (qty) of audit evidence has been gathered;
appropriate audit evidence means that the evidence is reliable and relevant i.e. it has the necessary
quality which the auditor requires.

1. Extracted a sample of items from the inventory sheets and performed test counts at the
annual inventory count
(a) Source - evidence obtained from the client. √
(b) Less reliable√
· The evidence is not obtained from a source independent of Bathlight Ltd, it isinternally
generated. √^
· The opinions of the credit manager and sales director only constitute an informedestimate as to
what amounts will ultimately be recovered. √^
· Neither party is “independent” of the information they are giving – they will notwant to admit that
debts can’t be collected as they originally extended the credit bymaking the sale.
· Their evidence will need to be corroborated, it will not be sufficient on its own. √^(Max 4)

2.Reviewed the report of an electronics expert who was engaged (by the audit firm) to value
work-in-progress at year-end
(a) Source - evidence developed by the auditor. √
(b) Highly reliable (primarily as a test of control) √
· Observation of the client’s cycle count procedures constitutes direct personalknowledge
acquired by the auditor. √^
· Although the counters were not independent of the company they wereindependent of inventory
custody and were competent; there should therefore beno question as to the independence (or
quality) of the source of the evidence. √^(Max 4)

3. Reviewed the minutes of the monthly directors meetings and recorded all important
decisions in the audit workpapers
(a) Source - evidence obtained from third parties. √
(b) Moderately reliable √
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· Although acknowledgement of receipt is provided by a source external to theclient’s


organisation, such evidence is not transmitted directly to the auditor. √^
· Since the delivery note is available to (and provided by) the client, and becausethe source
document is internally generated, the possibility of manipulation (e.g.creating a signed fictitious
delivery note) does exists. √^
· The difficulty in verifying the signature as being that of a bona fide customer is afurther
consideration. √^(Max 4)

4. Discussed the allowance for bad debts with the credit controller
(a) Source - evidence obtained from sources outside the entity√
(b) Highly reliable √
· The certificate does not pass through the hands of the client but is sent directly tothe auditor. √^
· Hence it is not subject to manipulation by the client. √^
· It is reasonable to assume that banks constitute an independent source ofevidence. √^
· There is also a basic assumption that the bank official providing the confirmation isauthorised
and competent to do so. √^(Max 4)

5. Observed the control procedures taking place in the receiving bay whilst goods are being
delivered by a supplier
(a) Source - evidence developed by the auditor√
(b) Moderately reliable√
· Although the auditor will have verified the major components of the computationand despite the
fact that such evidence falls within the direct knowledge of theauditor, √^ analytical procedures
provide general substantive evidence rather thanspecific evidence. √^
· The analysis of the difference will also be influenced by information andexplanations
provided/produced by the company itself√^ and although the auditorcomputed the ratio and
performed the analysis, only the outcome can be regardedin an overall light and cannot be
relied upon as irrefutable evidence of anything. √^(Max 4)

Comments:
Remember that all information obtained through the audit is evidence.The relevance (reliability and
relevance) and the sufficiency of evidence must be substantiated –obtain written/ documentary
evidence.

11. Solution to question 4.8 (a & b) in Graded Questions (not the correct question as per Unisa)

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b) Assertions applicable to presentation and disclosure


1. Occurrence^ and rights and obligation^ (disclosed events, transactions and other mattershave
occurred and pertain to the entity).√
2. Completeness^ (all disclosures which should have been disclosed have been included). √
3. Classification^ and understandability^ (financial information is appropriately presented
anddescribed and disclosures are clearly expressed). √
4. Accuracy^ and valuation^ (financial and other information is disclosed fairly and atappropriate
amounts). √(Max 5)

Comments:
The purpose of this question is to revise your understanding of the assertions as set out in ISA315 par
A111. It is imperative to know and understand the assertions to enable you the apply
yourunderstanding and knowledge in any type of question.

Study unit 3.4 Risk assessment and audit procedures


12. Solution to question 5.15 (a-c) in Graded Questions 38 marks

a. Describe the procedures you will conduct to assist you in your assessment of “Procedures to
Assess the Risk of Material Misstatement in the Financial Statements. Give examples of the
information you would be seeking for each procedure
a) Assessment of the risk of material misstament

1. At financial statement level – High risk√


1.1 The future of the company’s financial support from its bank (and thus probably the future of the
company itself) is partially dependent on what appears in the AFS to be discussed at the meeting with
the bank on 21 March 2012. √^ This provides a clear incentive for Metalman (Pty) Ltd to manipulate
the financial statements to reflect a better financial picture. √^ (Max 2)

2. The internal control system has been significantly weakened. √^


2.1 A number of the accounting staff have left which is likely to weaken control activities, √^e.g.
reconciliation, authorisation, etc and will definitely weaken the division of duties. √^
2.2 The financial director has left the company which is likely to weaken the control environment as the
accounting function has lost its “leader”. √^ The result of this is that there is a much greater risk of
material misstatement in the financial statements and their presentation than in prior years. √^ (Max 2)
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3. Ben Burger has the incentive and opportunity to manipulate the financial statements to reflect a
better financial position.√^
3.1 As both Ben Burger and Louis Green (operations director) have shares in the company, it is in their
interests to keep the company going√^, and as they are the only directors remaining, the governance
oversight which the board should provide is meaningless in this situation. √^
3.2 The financial accountant Miles Julius who is not experienced in financial statement presentation,
will probably follow Ben Burger’s instructions without query as he will not be keen to lose his job and
may not know any better. √^
3.3 Ben Burger who is in any event aggressive, can override anything Miles Julius believes should be
included/excluded in the presentation of the financial statements. √^
3.4 As Ben Burger has some knowledge of accounting from his many years in business, he is probably
able to manipulate the financial statements to suit his needs. √^ (Max 4)

4. There is a high risk associated with the presentation of the financial statements on the going
concern basis. √^
4.1 Prices on the world market are falling; Metalman (Pty) Ltd sells mainly into this market. √^
4.2 The local scrap market is unstable and in decline. Even though only 30% of sales are local, there
seems little chance of increasing this. √^
4.3 The company is facing a severe liquidity crisis to the extent that the bank appears to be
considering withdrawing its financial support. √^
4.4 Important employees, who are best suited to addressing the financial crisis, have left the company,
e.g. the financial director. √^
4.5 Recoverability of overseas accounts receivable appear to be in question which will have a further
negative effect on cash flow. √^
4.6 The company has a very narrow customer base (Taiwanese industrialists) so any decline in that
country’s economy will be felt by Metalman (Pty) Ltd. √^ (Max 3)

5. Tight deadline√
5.1 All of the above are compounded by the fact that there is an important deadline for theaudited
financial statements. √^
5.2 Those responsible for the preparation of the AFS are going to be placed under extremepressure
brought about by a lack of staff, and insufficient knowledge and experience. √^
Errors are likely to be made and the manipulation is made easier to facilitate. √^
5.3 We will be under pressure to carry out the audit properly for the same reason and due to thefact
that the short “post balance sheet period” limits our opportunity to perform good qualitytests on
confirming year end balances. √^(Max 2)

6. Ben Burger has indicated that the financial statements will “show what the bank needs tosee”. √^
This suggests strongly that he will see to it that the financial statements will reflect afinancial position
more positive than it is, and that fraudulent reporting is likely to take place.√^ (Max 2)
(Total 15 marks)

b. Evaluate the risk of Risk of Material Misstatement in the Financial Statement Level
Overall response to the high risk of misstatement at financial statement level will be to:
1. Assign staff to the audit who are experienced in the ways and means of fraudulent
financialreporting, √^ and who have the personal attributes to deal with an aggressive director who
isunder pressure. √^
2. Emphasise to the audit team the high risk of manipulation, √^ and the need to maintainprofessional
skepticism. √^
3. Provide more supervision on the audit as this is not going to be a clean, neat,straightforward audit.
√^
4. Incorporate some elements of unpredictability into the audit. √^
5. Concentrate on verifying balances at year end particularly those which could bemanipulated to
improve the financial statements. √^(Max 5)

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c. Comment on your overall response to the Risk of Material Misstatement in the Financial
Statement Level
Risk relating to assertions at transaction level/account heading – medium to high√^
1. There is a reasonably high risk of misstatement occurring in the recording of transactions(accuracy,
cut off, occurrence, classification) √^
1.1 Control activities have been placed under strain. √^
1.2 The company is involved in foreign transactions which require the application of
accountingstandards with which the remaining accounting staff may not be familiar. √^(Max 3)

2. The risk relating to transactions is mitigated by the fact that there are not a great number of
suppliers or customers. √^ This makes it more difficult to manipulate (overstate) sales/debtors and
(understate) purchases/creditors. √^ (Max 2)

3. The risk relating to sales is medium. √^


3.1 The circumstances of the company would suggest that Ben Burger could try to increase profits by
increasing sales (occurrence). √^
3.2 This is not that easy to do as fictitious exports would require the falsification of transport, export
and shipping documentation. √^ Falsifying local sales may be a little easier. √^
3.3 Furthermore, local sales account for only 30% of sales and are mainly cash sales; these sales
could be overstated but it will not be easy because the overstating of these sales might help a bit but
either the cash would have to be accounted for (very difficult) or a fictitious debtor would have to be
raised. √^
3.4 Looking at this aspect from another perspective, there could be a risk with the completeness of
cash sales. √^ Although it is not going to improve the balance sheet, Ben Burger could be taking
money out of the business by ensuring that cash sales are not accounted for. √^ Fair presentation
would still be affected and we still need to address this risk even though it appears not to be the
dominant risk relating to sales. √^ (Max 3)

4. There is at least a medium risk of misstatement of accounts receivable (valuation and existence). √^
4.1 As discussed above, there is a risk with the existence of debtors, as the “other half” of any fictitious
sales entry. √^
4.2 There is also the risk that the allowance for bad debts will be understated. There are already
delays in payment from overseas debtors and this coupled with falling prices on world markets, must
bring the recoverability of these debts into question. √^ (Max 3)

5. The risk relating to the inventory balance is very high. √^


5.1 This would be the easiest balance to manipulate, and manipulation could have a significant effect
on the financial statements, profit, assets, ratios, etc. √^
5.2 Due to the nature of the inventory, it is difficult to establish the quantity (weight) of scrap on hand at
year end and, as a whole and in its different metal types (existence). √^
5.3 Difficulty can also be expected in determining the value of the scrap (matching cost to type) and
determining whether the net realizable value of the scrap is greater than its cost (valuation) especially
in the light of falling prices and a decline in the market. √^
5.4 With inventory being shipped in containers to Taiwan, there may be some risk relating to:
• The ownership (rights) to any inventory in transit at year end. √^
• Accounting for shipments near year end in the correct accounting period, as Ben Burger may attempt
to include a shipment as both inventory in transit and as a sale. √^
5.5 The inventory balance is extremely material which means that material misstatement could be
“hidden” in the balance. √^ (Max 4)

6. Overstatement of liabilities. √^
6.1 As mentioned earlier, the financial statements could be manipulated to an extent by failing to raise
a creditor, √^e.g. record the purchase from a mine as inventory but do not raise the mine as a creditor.
√^
6.2 This risk does exist but is mitigated by the fact that there are not many suppliers, so “hiding” this
manipulation may be difficult. √^ (Max 3)
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(Total 18 marks)

Comments:
Question c is of a high standard, and was given to you to provide some insight on answering a
question relating to risk assessment at the assertion level. In this question the following was dealt with:
(1)&(2) Risks relating to recording of transactions (transaction & event)
(3) Risks relating to sales (transaction & event)
(4) Risks relating to accounts receivable (account balance)
(5) Risks relating to inventory balance (account balance)\
(6) Risks relating to liabilities (account balance) In an exam this type of question would specifically
identify the category to be dealt with.

Always remember that one of the main objectives of an auditor is to identify and assess the risks of
material misstatement, whether due to fraud or error, at the financial statement and assertion levels,
through understanding the entity and its environment, including the entity’s internal control, thereby
providing a basis for designing and implementing responses to the assessed risks of material
misstatement.

13. Solution to question 6.8 in Graded Questions

a) Importance of the “identifying and assessing the risks of material misstatement”


1. The object of planning is to formulate an audit strategy and plan which reduces audit risk to an
acceptable level in the most cost effective, resource efficient and professional manner. √^
2. The audit strategy and plan are the auditor’s response to the assessed risk of material misstatement
going undetected. √^ (Identifying and assessing the risk of material misstatement is very important. If it
is not carried out properly, risks will be missed or inadequately evaluated and the audit strategy and
plan will be ineffective.).
3. In the planning of the audit, the auditor is also required to set materiality limits and gain an
understanding of internal controls. √^ The aspects of planning are again dependent on the proper
identification and assessment of the risk of material misstatement. √^ (Max 4)

b) Assessment of risk at the financial statement level


1. There are a number of factors which increase risk at financial statement level:
1.1 The company is operating under "difficult trading conditions"√^ caused by poor demand for its
products on world markets. Although this does not mean conclusively that the company has a going
concern problem, the risk that presentation on the going concern basis may be in appropriate √^or that
related disclosures are inadequate, must be carefully considered.
√^
1.2 Pressure is being exerted on the directors to "improve performance"√^ which may lead
to"manipulation" of the financial statements to reflect "improved performance".√^

1.3 The Wool Company Ltd is a reasonably complex business√^. It imports, exports, hasprocessing
facilities and operates across a wide geographical location and operates in avolatile world market. √^

2. Risk at financial statement level which increased by the above factors would be reduced asa result
of the following:
2.1 Most of the directors have been with the company for many years which suggests that theywill be
experienced √^in the industry and hence able to cope with the difficult tradingconditions√^.
2.2 Our relationship with them suggests that the directors have integrity√^ which means thatthey would
be less inclined to "manipulate" (misstate) the financial statements. √^(Max 6)

c) Evaluate the risk of material misstatement


. Assertion: Rights^
1.1 The risk associated with this assertion should probably be regarded as medium^ due to the fact
that inventory is imported, exported and held at premises not owned by The Wool Company Ltd√^.
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Tests should be conducted to determine that the rights of ownership for all inventory included in the
financials has actually transferred to the company√^, e.g. (Max 5)

2. Assertion: Existence^
2.1 The risk associated with this assertion should be regarded as high^ for the following reasons:
2.1.1 At year end the company may have "raw material" inventory at multiple locations √^ which will
make physical inspection difficult for the auditor and provides opportunity for the company to overstate
its inventory. √^
2.2 This problem is compounded by the fact that due to the nature of the company’s product, both raw
and processed, the auditor will not really know what he or she is looking for. √^
2.3 Initial analysis of inventory levels reflects an increase in inventory (over previous year) which could
indicate the presence of overstatement by the inclusion of fictitious inventory. √^ (Max 8)

3. Assertion: Completeness^
3.1 For the same reasons as above (2.2) there is a risk that some inventory which should be included
in the year-end figure will be omitted. √^
3.2 However, this risk will be significantly reduced (and can probably be regarded as low) ^ by the fact
that the directors, under pressure to reflect the best possible financial performance√^, would endeavor
to ensure that all inventory is included, i.e. the tendency will be to overstate (existence) rather than
understate (completeness). √^ (Max 5)

4. Assertion: Valuation^
4.1 The risk associated with this assertion will be high.^ Inventories should be valued at the lower of
cost or net realiasable value √^and both of these figures may be difficult to verify. √^ (Max 3)

General
The following points increase the risk on the account heading as a whole:
1. Inventory is material to the financial statements (R110m) and an important account balance in a
trading company. √^The balance is large enough to possibly contain material misstatement which in
turn could have a significant effect on the fair presentation of the financial statements. √^ (Max 4)
(Total 25 marks)

Comments:
In a question of this nature, please note that you must read the required part of the question carefully.
The question focused on a specific group of assertions and not all as well as the risk on financial
statement level. Note that there is a difference.

Study unit 3.5 Materiality


14. Solution to question 6.13 in Graded Questions (already done)

4 TOPIC 4: THE AUDIT PROCESS


Study unit 4.1 Stages of the audit process
15. Solution to question 5.1 in Graded Questions

When conducting an audit, the entire audit process can be broken down into distinct but interlinked
stages which are described as follows:
1. Preliminary engagements
2. Planning
3. Responding to assessed risks
4. Concluding

1. Preliminary activities
1.1 This stage provides the opportunity for the audit firm to assess whether a professional relationship
with the prospective client should be accepted or whether the relationship with an existing client should
be continued.√^

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1.2 It is during this stage that the audit firm must consider:
• The integrity of the client’s principal owners, key management and those charged with governance.
√^
• Whether the firm is competent to perform the engagement i.e. does the firm have the necessary
skills, resources and time; √^
• Whether the ethical requirements can be completed with e.g. no conflicts of interest with the client,
no independence threats. √^
1.3 The final step in this stage is to formalise the relationship by both parties signing an engagement
letter. √^ (Max 4)

2. Planning
2.1 Planning is a vital stage in the process as it leads to the manner in which the audit is to be
conducted. √^
2.2 It is during this stage that the overall audit strategy and audit plan are developed/established. √^
2.3 Establishing the audit strategy sets the scope, timing and direction of the audit. √^
2.4 Establishing the audit plan amounts to determining the nature, timing and extent of procedures to:
√^
• identify and assess the risks of material misstatement;√^
• respond to the risks identified (further audit procedures); √^
• to comply with any other procedures required by the ISAs; √^
2.5 At the planning stage, planning materiality is also considered. √^ (Max 4)

3. Putting the plan into action

3.1 Identifying and assessing risk of material misstatement


a) At this stage the auditor carries out the procedures which were planned to identify and assess the
risk of material misstatement. √^
b) This is achieved by conducting procedures which will provide the auditor with a thorough
understanding of the entity and its environment, including the entity’s internal control. √^
c) The types of procedure carried out normally consist of:
• inquiry of management and others√^
• analytical procedures and√^
• observation and inspection and should include√^
• discussion with the engagement team about the susceptibility of the client’s financial statements to
material misstatement. √^
d) The risk of material misstatement will be assessed at both financial statement level and assertion
level.√^
e) At this stage any significant risks should be identified as well. √^ (Max 5)

3.2 Responding to assessed risks


a) Having assessed the risk of material misstatement, the auditor now sets about implementing an
audit plan which responds to the risks assessed. √^
b) Risk at the financial statement level is responded to by:
• putting in place an audit team with the necessary levels of competence and professional
skepticism. √^
• providing the necessary levels of supervision. √^
• incorporating elements of unpredictability into the audit procedures to be conducted and √^
• making general changes to the nature, extent and timing of procedures from previous audits. √^
c) Responses at assertion level will be a combination of tests of controls and substantive tests.
(Max 5)

4. Concluding

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4.1 This stage of the audit process is concerned with evaluating the audit evidence √^to determine
whether sufficient (enough), appropriate (relevant and reliable) √^, evidence has been gathered on the
audit for an opinion to be expressed. √^
4.2 It is also the stage at which the auditor evaluates whether misstatements (which have not been
corrected) result either individually or in aggregate, in a material misstatement of the financial
statements, and if there is material misstatement, what the appropriate modification of the audit report
would be. √^
4.3 Finally, the auditor evaluates whether the financial position, financial performance, cash flows, etc
are fairly presented (see 4.2) and draft the report. √^ (Max 4)

Study unit 4.2 The preliminary engagement stage


16. Solution to question 5.8 in Graded Questions (this is question 5.9 not 5.8 per Unisa)

You are required to indicate whether your firm should accept the invitation to make a presentation for
the audit of Foil (Pty) Ltd based on the contents of the letter from Gregory Grace, the financial director.
Your answer must explain fully, all the reasons for your decision

Weaknesses indentified:
1. The letter is undated.√^
2. It does not indicate to which year’s audit the terms of engagement apply.√^
3. It should be addressed to the directors of the board. √^
4. It is addressed to the shareholders and to the chairman in different places. √^
5. The letter suggests it should be signed by the audit manager. In fact it should be signed bythe
“Designated Auditor”, i.e. the partner who takes responsibility for the audit (See AuditingProfession Act
2005). √^
6. There is no identification of the designated auditor. √^
7. Auditors do not “certify”, they give an opinion on fair presentation. √^
8. The letter should not be imposing a deadline on this, our first audit. √^
9. The point relating to the limitations of the audit is poorly expressed – it looks as though thefirm is
“making excuses” before the audit has even started.√^
10. Basing the fees on prior years, particularly in the case of a first audit, is not an appropriatemethod
of fee charging; √^ fees will be negotiated with the audit committee based on time,skill, experience,
etc. This is particularly true as we were not the auditors in the prior year.
11. No explanation as to why the client must sign the letter (acknowledge the terms of
theengagement). √^
12. An unqualified report can never be guaranteed, for many reasons, not simply the limitationsof the
audit. √^
13. It is in appropriate to open the letter with “we have carried out an investigation” – this has
anegative connotation, and there is no need to refer to preliminary procedures which do not
constitute an investigation into Vortex (Pty) Ltd. √^
14.
14.1 The letter contains no indication that the objective of the audit will be for us to express
anopinion√^ on the financial statements which comprise the balance sheet, the incomestatement,
statement of changes in equity and cash flow statement, and a summary ofsignificant accounting
policies and other explanatory information. √^
14.2 There is also no indication as to why this audit is required√^. As a private company, Vortex(Pty)
Ltd is not required to be audited in terms of the Companies Act 2008; √^so the lettershould indicate
whether it is an audit at the request of the Board, the Memorandum ofIncorporation, √^ or at the
request of a third party. √^
15. Our responsibilities as auditor are also inadequately explained. √^ No reference to
15.1 the fact that the audit will be conducted in accordance with ISAs. √^
15.2 compliance by us with ethical requirements. √^
15.3 planning and performing to obtain reasonable assurance the financial statements are free of
material misstatement. √^
15.4 the fact that procedures selected depend on the auditor’s judgement. √^
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15.5 risk assessment evaluation of policies estimates and overall presentation. √^


16. The letter does not alert the client to the fact that because of the inherent limitations of an audit
together with the inherent limitations of internal control, there is still the unavoidable risk that some
material misstatement may not be detected, even though the audit is properly planned and performed.
√^
17. Management’s responsibilities are also inadequately explained. No reference to their
acknowledgement that they are responsible for: √^
17.1 the preparation and presentation of the financial statements in accordance with (e.g.) South
African GAAP and the IFRSs√^
17.2 the internal control necessary to enable the preparation of financial statements that are free from
material misstatement, whether due to fraud or error. √^
18. Although management’s responsibility for providing us with access is mentioned, it is poorly
worded and incomplete. There should be mention of access to: √^
18.1 all information relevant to the preparation of the financial statements such as records and
documents. √^
18.2 any additional information we may require. √^
18.3 persons within the entity from whom we determine it necessary to obtain audit evidence.
19. With regard to internal controls, there is no indication that we will communicate any significant
deficiencies to Vortex (Pty) Ltd. √^
20. In addition the letter does not include any reference to:
20.1 the fact that we will seek written confirmation of representations made to us during the audit. √^
20.2 the fact that we will make use of the expert should it be appropriate to do so with the audit of
inventory √^and that we will make use of the work of internal auditors as appropriate. √^
21. There is no reference to the expected form and content of the auditor’s report or that the report
may have to be amended in terms of our audit findings. √^
22. Finally there is no indication of our Auditing Profession Act 2005 Sec 45, reporting duties.√^Max25

Comments:
ISA 210 par 10 states that the letter of engagement should include:
(a) The objective and scope of the audit of the financial statements
(b) The responsibility of the auditor
(c) The responsibilities of management
(d) Identification of the applicable financial reporting framework for the preparation of the financial
statements; and
(e) Reference to expected form and content of any reports to be issued by the auditor and a statement
that there may be circumstances in which a report may differ from its expected form and content.

It is imperative to agree on the terms of the engagement before commencing with the audit.

Study unit 4.3 The planning stage


17. Solution to question 5.3 in Graded Questions (already done)

TOPIC 5: SOLUTIONS TO THE SIMULATED EXAMINATION


Question 1 - Question in Graded Questions

Identify and explain the fundamental principles on which the Code of Professional Conduct is based
and with which chartered accountants must comply

Explain the conceptual framework on which the Code is based

Discuss each of the situations in terms of the Code of Professional Conduct. Where you believe a
threat or potential threat to compliance with the fundamental principles exists, you should identify the
nature (category) of the threat

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Comment:
The fundamental principles of professional conduct is a cornerstone of the auditing profession, acrucial
element in the statutory corporate reporting process and a key prerequisite for the addingof value to an
audited financial statement. You should obtain in depth understanding andknowledge of these threats
and safeguards to enable you to apply the knowledge in any scenario.

Question 2 - Question 4.10 in Graded Questions (it is actually question 4.11)

Indicate whether your first year trainee’s is understanding of financial statement assertions is good,
reasonable or weak. Justify your answer.

It is clear that the trainee accountant does not understand the assertions! √^
1. Repairs and Maintenance
This account reflects the amount spent on repairs and maintenance transactions; the applicable
assertions are therefore completeness^, occurrence^, accuracy^, cut-off^ and classification^.

With specific reference to the trainee’s response


!Existence - this assertion has nothing to do with transactions and even less to do with the existence
of the assets on which the amounts were expended. √^

He is probably confused with the “occurrence” assertion which represents that the repairs and
maintenance transactions making up the amount of R173 291 were valid (not fictitious) repairs and
maintenance transactions pertaining to Rizone (Pty) Ltd. √^
!Obligation - this assertion relates to liabilities (balances) √^and represents that the liabilities included
in the balance sheet pertain (are obligations of) Rizone (Pty) Ltd and not someone else. √^
!Valuation - this assertion relates to balances not transactions. √^
He is confusing it with accuracy, cut-off and classification which represents that repairs and
maintenance have been appropriately recorded at the proper amount in the correct period, and in the
proper accounts. √^

In addition the trainee does not appear to know of the other assertion for transactions
!Completeness - this represents that all repairs and maintenance transactions which should have
been recorded have been recorded. √^

Note: As there are no disclosures relating to repairs and maintenance the assertions relating to
presentation and disclosure are not applicable.

2. Trade Creditors
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This account reflects the amount (balance) owed by Rizone (Pty) Ltd to its trade creditors; the
applicable assertions are therefore completeness, existence, obligation and valuation.

With specific reference to the trainees response:


!Accuracy - this assertion applies to transactions, not balances. He appears to be muddled up
between accuracy, cut-off and classification and valuation. √^ The valuation assertion represents that
trade creditors are recorded at the appropriate carrying value i.e. R1 426 819. √^
!Rights - the rights assertion has nothing to do with Rizone (Pty) Ltd’s right to pay creditors as it
wishes, it represents that the company has the right to the assets included in the balance. √^ (Any
encumbrances on this right must be disclosed).

Assertion relating to creditors is the obligation assertion which represents that the trade creditors
included are valid obligations of Rizone (Pty) Ltd and nobody else. √^
!"Completeness - this assertion represents that all amounts owed by Rizone (Pty) Ltd to its trade
creditors are included in the balance not only those creditors who have supplied invoices, i.e. all
creditors which should have been recorded have been recorded. √^
In addition the trainee does not appear to know of the other assertion applicable to the account
heading. √^
!Existence - this assertion represents that all the creditors included in the balance actually exist i.e.
they are not fictitious. √^
Note: It is not necessary to mention the assertions relating to presentation and disclosure unless
specifically stated in the question. (Max 15)

Comments:
As stated in ISA315 the auditor use assertions to consider different types of potential misstatements
that may occur in balances, transactions or in the presentation and disclosure of financial information.
As mentioned previously it is important to obtain sufficient knowledge about assertions.

Question 3 - Question 6.4 in Graded Questions 18 marks(not question 6.4 unsure which one)

(a) I would assess the risk at financial statement level, as high^ (8)
!The financial accountant and financial director are not at all co-operative. √^ As they arethe two
people most responsible for the financial information we audit, a very difficultsituation will arise in our
gathering of sufficient appropriate evidence√^
!There could also be a more sinister reason for their lack of co-operation, e.g. are theymanipulating
the figures in some way? √^
!The company does a lot of work outside of the country, in other jurisdictions and isinvolved in major
foreign transactions. √^
!These factors will filter down to assertion level, but overall they create an inherentlymore risky
environment. √^We will need to be familiar with the business risks ofoperating in foreign countries and
will have to understand the relevant legislation ofthese countries. √^ Furthermore many neighboring
states are rife with corruption andgraft, e.g. insisting on bribes to get contracts etc. This may be the
reason behind thefinancial director and financial accountant being unco-operative, not wishing to
divulgeinformation about certain contracts etc. √^ The complex journal entries may be a meansof
hiding irregular transactions. √^
!"The fact that there are numerous complex journal entries being put through at year endincreases
the risk of fraudulent financial reporting by manipulation of various accountheadings. √^
!"The fact that supporting documentation is minimal increases this risk as it makes it verydifficult for
us as auditors to evaluate the validity (and accuracy) of the journal entries.√^
!Authorisation of the entries by the financial director does not reduce the risk at financialstatement
level √^as manipulation/fraudulent financial reporting would involve thefinancial director himself, so he
is in effect “authorizing” his own actions. √^(Max 8)

(b) I would assess the risk of material misstatement at assertion level, as high ^
!Existence^, completeness^ and valuation^ of operating equipment^ (accountbalance).
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!60% of the company’s plant and equipment is in remote areas and other countries,making physical
verification very difficult. √^
!For the same reason, checking its condition for wear and tear and any impairmentlosses will also be
difficult. √^
!As some of the equipment is leased on long-term contracts, there is the added risk thatequipment
which should have been capitalized (finance lease), has been omitted. √^
!Completeness^ and valuation^ of long-term liabilities^ (account balance).
!If leases which are not finance leases and have not been capitalized, long-termliabilities will be
understated. √^
!As the lease is likely to be in foreign currency, there is a risk that the incorrecttransaction rates could
have been used in the capitalization calculations. √^
!Completeness^/occurrence^ of contract revenue (revenue recognition) ^(transactionand event)
!As contracts can last up to five years, material misstatement may occur in the timing ofrevenue
recognition. √^
!Due to the complexity of such contracts and the location of the contracts, we willprobably have to rely
on an “expert” in the employ of the company to provide thenecessary evidence. √^

Note: If revenue is prematurely raised there will be a corresponding misstatement in accounts


receivable.

!Valuation^/completeness^ of contract work in progress^(account balance)


!As the contracts will be in various stages of completion, are long term, and in remote areas/countries,
it will be very difficult to inspect the contract site for physical verification of the site. √^ This makes it
much harder to evaluate the stage at which the contract is, at year end. √^ (Max 10)

Comments:
Based on the information given in this question only certain of the assertions were included in part (b)
of the solution.
Please note that we will be very clear about the class of account balance/ transaction and event or
presentation and disclosure. For example, we would indicate operating equipment, long-term liabilities
or revenue.

It is important to ensure that you obtain sufficient knowledge and understanding regarding risks of
material misstatement at financial statement and assertion level. Theoretical knowledge is not enough
and you should be in a position to apply your knowledge.

Question 4 - Question 4.3 in Graded Questions (NOT 4.3 BUT 4.6)

To gather the evidence which is required pertaining to the assertions, the auditor conducts procedures
which have been developed and refined to meet the audit objective. The various procedures which will
be conducted by the auditor will be mixed but balanced – no single procedure will supply all the
evidence needed.
The procedures can be categorised as follows:
1. Inspection
2. Observation
3. Inquiry
4. Recalculation
5. Analytical Procedures
6. Reperformance
7. External confirmation

Required:
a. Explain each of the above procedures
b. Indicate whether each procedure can be applied as a substantive test, or a test of controls or
both
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c. Give one example for each category of test (1 to 7 above). Your example can be a substantive
test or a test of controls

1. Inspection
a) Inspection consists of examining records, documents (physical files or electronic storage media), or
tangible assets. √^
b) It can be a Substantive procedure ^ or a test of controls.^
c) Examples:
Inspect a lease agreement to determine whether it has been signed by an authorised signatory. √^
Inspect the date on a supplier’s delivery note to confirm that goods received close to the year-end
have been accounted for in the correct financial period. √^ (Max 1!)

2. Observation
a) Observation consists of looking at a process or procedure being performed by the client's staff. √^
b) Normally a test of control ^but could be a substantive procedure.^
c) Examples:
Attendance at the annual inventory count to observe the performance of the counters (may be
substantiating quantities). √^
Observing a receiving clerk accepting goods being delivered by a supplier. √^ (Max 1!)

)!"
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3. Inquiry
a) Inquiry consists of seeking information of knowledgeable persons inside or outside the entity.
Enquiries may range from formal written enquiries addressed to third parties to informal oral inquiries
addressed to persons inside the entity. √^
b) Substantive procedures^ or a test of controls.^
c) Examples:
Inquiring of the warehouse controller as to the methods of identifying obsolete or damaged inventory.
√^
Inquiring of the orders clerk as to what procedures are followed when an order is received from a
customer. √^ (Max 1!)

4. Recalculation
a) Recalculation consists of checking the arithmetical accuracy of source documents and accounting
records. √^
b) Substantive procedures^ or a test of controls.^
c) Examples:
Casting the payroll for a particular week. √^
Recalculating depreciation on plant and equipment. √^ (Max 1!)

5. Analytical procedures
a) Analytical procedures consist of the analysis of significant ratios and trends and the resulting
investigation of fluctuations and relationships that are inconsistent with other relevant information or
which deviate from predicted amounts. √^
b) Substantive procedure ^as well as a risk assessment procedure. ^
c) Examples:
Ratio analysis is conducted on the gross profit and compared to prior year ratios. √^
The current years bad debts are analysed and compared to prior years. √^ (Max 1!)

6. Reperformance
a) Reperformance involves the auditor repeating, either wholly or in part, the same procedures
performed by the client. √^
b) Substantive procedures^ or a test of controls.^
c) Examples:
Reperforming the bank reconciliation at the financial year-end. √^
Reperforming the procedures/calculations pertaining to interest owed on loans at year-end. √^ (Max
1!)

Note: computation and reperformance are very similar, computation may however, result in new
totals/computations i.e. nothing is being reperformed.

7. External confirmation
a) External confirmation involves obtaining a direct written response from a third party to a
request/query from the auditor to that third party. √^
b) Usually substantive procedure ^ but where a third party forms part of an internal control the
application could be tested by confirmation with that 3rd party. √^
c) Examples:
Obtaining a bank confirmation (balance etc) √^
Confirming a debtor’s balance. √^ (Max 1!)

d. State whether the above procedures can be used by the auditor when identifying and assessing
the risk of material misstatement. Explain.
Yes^, these procedures are used when identifying and assessing risk. √^ For example, the
auditormight observe the manufacturing process to assess the risk of misstatement of year-end work-
in progress. √^The auditor may perform analytical procedures on the gross profit percentages to obtain
insight into problems which may have resulted in the decline of the percentage since the prior year. √^
(Max 2)
)#"
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Comments:
It is important to always start a procedure with the proper verb; it will give structure to your procedure.
This will also give the opportunity to earn the maximum marks for a question relating to setting
procedures.

Question 5 - Question 1.4 in Graded Questions (1&3)(NOT QUESTION 1.4 UNSURE WHICH
QUESTION IT IS)

1. Reason why auditors needed in society


• Reason: The split between ownership and management. √^
Explanation: In many businesses, the owners (shareholders) do not actually run (manage) the
business; they appoint directors to do this. √^ The directors are then required to report to the
shareholders on how the company has performed. √^To make sure that management reports fairly, the
shareholders appoint independent auditors to audit the accounting records.
√^
• Reason: Society needs confidence in financial information. √^
Explanation: Society (the general public) is affected in many ways by financial information√^ e.g. for
paying taxes, making investments, receiving government services and if society is to run efficiently and
effectively, √^the financial information on which government and individuals rely, must be credible and
fair. √^Independent auditors, whether they be external or internal or government auditors, contribute
significantly to the quality of this financial information. √^
• Reason: Society requires that those who have responsibility for financial matters must be
accountable.√^
Explanation: The government is accountable to the public for the manner in which it spends tax
money, √^directors are accountable to their shareholders and the public for the manner in which they
run their companies√^ e.g. control pollution, train staff etc. Independent auditors (of any type) provide a
mechanism to evaluate and report on whether those who should be financially accountable are acting
and reporting appropriately. √^ (Max 9)
2. Inherent limitations of an audit (Question 1.4.3 in Graded Questions)
• Limitation: The use of testing√^
As the auditor does not examine every transaction (impossible) he can never be in a position to certify
the information being audited as 100% correct. √^
• Limitation: Audit evidence is usually persuasive rather than conclusive. √^
Unless an auditor is actually present to personally witness a transaction, decision or internal control he
must rely on the word of others and documentation √^to “persuade” him that the transaction, decision
or internal control took place. √^
• Limitation: Subjectivity in the financial statements and in the auditors approach to the audit. √^
Financial statements contain many accounts which are valued subjectively √^– e.g. provisions are
made for bad debts, obsolescence etc. √^ These accounts cannot be certified therefore as 100%
correct. √^Similarly the auditors approach to what he will test (scope), when he will test (timing) and
how much (extent) he will test, are very subjective. √^ (Max 8)

Comments:
Always remember that every audit will have specific limitations which should be taken in consideration
throughout the whole audit and not only at the planning stage of the audit. Refer to ISA 200 para A45-
A52 for more detail on the inherent limitations of an audit.

)$"

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