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Icaew Assurance 2024 Course Notes

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Course notes
ICAEW Certificate Level
Assurance
For exams in 2024

Tutor details

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ii I n t ro d u c t i on A s s ur a nc e

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A s s ur a nc e I n t ro d u c t i on iii

1B Contents
Page

1 The ACA qualification and Assurance v

2 Accessing the First Intuition online content vi

1: Concept of and need for assurance 1

1 What is assurance? 2
2 The Statutory Audit 3
3 Why is assurance important? 5
4 Why can assurance never be absolute? 6
5 Introduction to sustainability and assurance 7

2: Process of assurance: Obtaining an engagement 9

1 Obtaining an engagement 10
2 Accepting an engagement 10
3 Agreeing terms of an engagement 14

3: Process of assurance: Planning the assignment 17

1 Planning 18
2 Analytical procedures 20
3 Materiality 21
4 Audit risk 22
5 Fraud and Error 24

4: Process of assurance: Evidence and reporting 27

1 Evidence 28
2 Reporting 30

5: Introduction to internal control and Information flows 35

1 What is internal control? 36

2 Components of internal control 36
3 Information about controls 40

6: Revenue system 43

1 Controls in a revenue system 44

2 Control objectives 45
3 Deficiencies 46

7: Purchases system 49

1 Controls in a purchase system 50

2 Deficiencies 52

8: Employee costs 53

1 The wages and salaries system 54

2 Deficiencies 56

9: Internal audit 57

1 What is internal audit? 58

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2 What does the internal audit function do? 59

10: Documentation 61

1 Purpose of documentation 62
2 Form and content of documentation 62
3 Safe custody and retention of documentation 65
4 Ownership of and right of access to documentation 66

11: Evidence and sampling 67

1 Evidence 68
2 Selecting items to test 70
3 Drawing conclusions from sampling 73
4 Evaluation of misstatements 74
5 Remote auditing and pandemic considerations 75

12: Written representations 77

1 Written representations as assurance evidence 78

2 When other written representations are required 78

13: Substantive procedures – key financial statement figures 81

1 Non-current assets 82
2 Inventory 84
3 Receivables 87
4 Bank 89
5 Payables 91
6 Long-term liabilities 93
7 Statement of profit or loss items – substantive tests 94

14: Codes of professional ethics and regulatory issues 97

1 Professional ethics 98
2 IESBA (IFAC) Code 99
3 ICAEW Code 99
4 FRC Ethical Standard for Auditors 100

15: Integrity, objectivity and independence 101

1 Integrity, objectivity and independence 102

2 Threats and safeguards 102
3 Resolving ethical conflicts 107
4 Conflicts of interest for the accountant 108

16: Confidentiality 111

1 Importance of confidentiality 112

2 Safeguards to confidentiality 112
3 Disclosure of confidential information 112

17: Answers to interactive questions and class examples 115

18: Appendix 127

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A s s ur a nc e I n t ro d u c t i on v

1 The ACA qualification and Assurance

There are 15 modules that can be taken in any order with the exception of the Case Study which you
must be attempt last. You must pass every exam (or receive credit) – there are no options. Once
qualified, all ICAEW Chartered Accountants have a consistent level of knowledge, skills and experience.

Certificate Level
The six certificate level modules introduce the fundamentals of accountancy, finance and business.
Each has a 1.5-hour computer-based assessment which can be sat at any time. You may be eligible for
credit for some modules if you studied accounting, finance, law or business at degree level or through
another professional qualification.
The six certificate modules are also available as a stand-alone certificate, the ICAEW Certificate in
Finance, Accounting and Business (ICAEW CFAB). On successful completion, you can use CFAB as a
stepping stone to study to the ACA.
Specification grid and Weightings for Assurance
The aim of the Assurance module is to ensure that students understand the assurance process and
fundamental principles of ethics and are able to contribute to the assessment of internal controls and
gathering of evidence on an assurance engagement.
The grid below shows the weightings of subjects within Assurance and should guide your relative study
time. In each assessment, the marks available equate to the weightings.

Weighting (%)
The concept, process and need for assurance 20
Internal controls 25
Gathering evidence on an assurance engagement 35
Professional ethics 20
100

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Method of assessment
Assurance is assessed by a 1.5 hour computer-based exam. The exam is comprised of 50 questions
worth 2 marks each. The questions are presented in the form of multiple choice.
The pass mark is 55%

2 Accessing the First Intuition online content

You have access to FIs online course which includes recorded lectures, question debriefs, your mock
exams and step by step guidance to help you succeed in the exam.
A link to FI Learn should have been sent to you by your centre, giving full access to the online content.
When you access the link for the first time you will be prompted to create a password. Please contact
your centre if you have not received the link to access the course.
If you are an online learner, it is important that you log in and listen to the introductory videos in the
getting started pod of the course. These videos explain the Assurance exam and the resources you
have to help you pass.
Good Luck with your studies!
The FI Team

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Concept of and need for

assurance

Topic List
1. What is assurance?
2. The statutory audit
3. Why is assurance important?
4. Why can assurance never be absolute?

Learning Objectives
 Understand the concept of assurance
 Recognise the criteria which constitute an assurance engagement
 Recognise subject matter suitable to be the subject of an assurance engagement
 Understand the different levels of assurance that can be provided in an assurance engagement,
including reasonable assurance
 Understand the need for professional accountants to carry out assurance work in the public
interest
 Understand the meaning of 'a true and fair view'
 Understand why users desire assurance reports and recognise examples of the benefits gained
from them such as to assure the quality of an entity's published corporate responsibility or
sustainability report
 Compare the functions and responsibilities of the different parties involved in an assurance
engagement
 Understand the issues which can lead to gaps between the outcomes delivered by the
assurance engagement and the expectations of users of the assurance reports
 Identify how these 'expectation gaps' can be overcome

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1 What is assurance?
1.1 Definition
Assurance could be described as an assurance firm’s satisfaction as to the reliability of an assertion
being made by one party for the use of another party. This assurance is expressed in an “assurance
report” with a negative or positive conclusion given.
An assurance engagement is one in which a practitioner expresses a conclusion designed to enhance
the degree of confidence of the intended users other than the responsible party about the outcome of
the evaluation or measurement of a subject matter against criteria.
The key elements of an assurance engagement are as follows:
 Three party relationship
(i) The practitioner
(ii) The intended users
(iii) The responsible party
 A subject matter (financial statements / internal controls / corporate governance etc)
 Suitable criteria
 Sufficient appropriate evidence to support the assurance opinion
 A written report providing an opinion on the subject matter

INTERACTIVE QUESTION 1: ASSURANCE ENGAGEMENT

You are an accountant who has been approached by Jamal, who wants to invest in Company X. He has
asked you for assurance whether the most recent financial statements of Company X are a reliable
basis for him to make his investment decision.
Identify the key elements of an assurance engagement in this scenario, if you accepted the
engagement.
SOLUTION

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1.2 Levels of assurance

There are two types of assurance engagement conducted by practitioners:
 Reasonable assurance engagement
 Limited assurance engagement
The key distinction between the 2 is the sufficiency of the evidence sought and the type of opinion
given.
Engagement Evidence sought Opinion given Example
Reasonable Assurance Sufficient and Positive opinion The financial statements show a
appropriate true and fair view in all material
respects
Limited Assurance Sufficient and Negative conclusion Nothing has come to our attention
appropriate (less that make us believe that the
intrusive) subject matter is misstated

Note: It is not practical to give absolute assurance (ie 100%) assurance

1.3 Examples of assurance engagements

The key example of an assurance engagement in the UK is a statutory audit. We shall look briefly at
the nature of this engagement in the next section.
Other examples of assurance engagements include:
Those required by regulators:
 Bank audits
 Pension scheme audits
 Charity audits
 Solicitors’ audits
Voluntary engagements:
 Environmental audits
 Due diligence (where a report is requested on an acquisition target)
 Internal audit
 Fraud investigations
 Internal control reports
 Reports on business plans or projections
Different levels of assurance will be given for different assurance engagements. For example, only
limited assurance could be given for a report on a business plan as the data contained in that
document would be based on forecast figures.

2 The Statutory Audit

2.1 Statutory Audit
In the UK, all companies of a certain size must have an audit by law.
The objective of an audit of financial statements is to enable the auditor to express an opinion
whether the financial statements are prepared, in all material respects, in accordance with an
applicable financial reporting framework.
NOTE The audit fits into the key elements of an assurance engagement, since an audit engagement is a
type of assurance engagement.

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In the UK, the auditor will normally express his audit opinion by reference to the ‘true and fair view’,
which is an expression of reasonable assurance.
Whilst this term is at the heart of the audit, ‘true’ and ‘fair’ are not defined in law or audit guidance.
However, for practical purposes the following definitions are generally accepted.
True: Information is factual and conforms with reality, not false. In addition the information conforms
with required standards and law. The accounts have been correctly extracted from the books and
records.
Fair: Information is free from discrimination and bias in compliance with expected standards and
rules. The accounts should reflect the commercial substance of the company’s underlying transactions.

2.2 Auditors in the UK are subject to both legal and professional

requirements.
The Companies Act 2006 requires that auditors are members of a Recognised Supervisory Body (RSB).
The ICAEW is an RSB.
The RSB is responsible for ensuring:
 Only Individuals holding an appropriate qualification or Firms controlled by qualified persons
can conduct audits
 Those individuals or firms are monitored on a regular basis
In the UK, the responsibility for monitoring the accounting profession and issuing auditing standards is
delegated to the Financial Reporting Council (FRC) which it does through its Codes and Standards
Committee, which has adopted international standards on auditing, augmented for UK requirements.
The FRC is also responsible for issuing Ethical Standards in relation to the objectivity and integrity of
auditors.
These standards set professional requirements for auditors detailing their approach to audit.

2.3 Overall Objectives of the Auditor

ISA 200 (UK and Ireland) Overall Objectives of the Independent Auditor states that the auditor should:
(a) Obtain reasonable assurance about whether the financial statements as a whole are free from
material misstatement, whether due to fraud or error.
(b) Report on the financial statements, and communicate as required by the ISAs, in accordance
with the auditor’s findings.
In order to do this, the auditor must:
 Comply with relevant ethical requirements
 Plan and perform the audit with professional scepticism – a questioning mind, being alert to
conditions which may indicate possible misstatement and maintain critical assessment of audit
evidence
 Exercise professional judgement – application of relevant training, knowledge and experience in
making decisions
 Obtain audit evidence that is both sufficient and appropriate, from which reasonable
conclusions may be drawn, on which the auditor’s opinion is then based

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2.4 Stages of an audit

Obtaining the engagement

- Chapter 2

Planning - Chapter 3

Performing procedures -
Chapter 6, 7, 8

Review and completion -

Outside of Assurance Paper

Reporting - Chapter 4
(True & Fair Only)

3 Why is assurance important?

3.1 Users
In the key assurance service of audit, which we looked at above, the users were the shareholders of a
company, to whom the financial statements are addressed. In other cases, the users might be the
board of directors of a company or a subsection of them.

3.2 Benefits of assurance

To shareholders
The key benefit of assurance is the independent, professional verification being given to the users.
To third parties
Although an assurance report may only be addressed to one set of people, it may give additional
confidence to other parties in a way that benefits the business. For example, audit reports are
addressed to shareholders, but an opinion on the truth and fairness of the financial statements may
give the bank more confidence to lend money to that business, in other words, it enhances the
credibility of the information.
To the board of directors
The existence of an independent check might help prevent errors or frauds being made and reduce the
risk of management bias. In other words, the fact that an assurance service will be carried out might
make people involved in preparing the subject matter more careful in its preparation and reduce the
chance of errors arising. Therefore it can be seen that an assurance service may act as a deterrent.

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3.3 Audit exemption in the UK

Small companies are not required to have an audit in the UK (except in some particular situations).
How do we tell if a company is small enough? We have the Companies Act 2006 requirements. A
company must meet two of three of the following criteria, for both this financial year and the last
financial year:
Turnover No more than £10.2m
Total assets No more than £5.1m
Number of employees 50 or fewer on average

4 Why can assurance never be absolute?

Assurance can never be absolute. Assurance providers will never give a certification of absolute
correctness due to the limitations set out below.

4.1 Limitations of assurance

The limitations of assurance services include:
Testing and sampling
 The fact that testing is used – the auditors do not oversee the process of building the financial
statements from start to finish.
 The fact that assurance providers would not test every item in the subject matter (this would be
too expensive for the responsible party, so a sampling approach is used – see Chapter 11).
Reliance on controls
 The fact that the accounting systems on which assurance providers may place a degree of
reliance also have inherent limitations
 The fact that the client’s staff members may collude in fraud that can then be deliberately
hidden from the auditor or misrepresent matters to them for the same purpose.
Nature of the financial statements
 The fact that most audit evidence is persuasive rather than conclusive.
 The fact that some items in the subject matter may be estimates and are therefore uncertain.
It is impossible to conclude absolutely that judgemental estimates are correct.
Quality of auditor judgements
 The fact that assurance provision can be subjective and professional judgements have to be
made (for example, about what aspects of the subject matter are the most important, how
much evidence to obtain, etc).

4.2 The expectations gap

This is the difference between what users think the auditor does and what the auditor actually does.
This is often because users are not aware of the nature of the limitations on assurance provision, or do
not understand them and believe that the assurance provider is offering a service (such as a guarantee
of correctness) which in fact he is not.
For example, some people believe that the auditor’s report certifies that the financial statements are
“correct” or that the auditor’s principal duty is to detect fraud. In reality, the auditor’s primary duty is
to form an opinion on the financial statements.

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In essence it is this lack of understanding which constitutes the expectations gap

Assurance providers need to close this gap as far as possible in order to maintain the value of the
assurance provided for the user. This is done in a variety of ways, for example:
 issuing an engagement letter spelling out the work that will be carried out and the limitations of
that work (which we shall look at in the next chapter) and
 by regularly reviewing the format and content of reports issued as a result of assurance work.

5 Introduction to sustainability and assurance

Sustainability is increasingly a factor for consideration in business and therefore assurance.

5.1 Definition and implications

Sustainability is 'meeting the needs of the present without compromising the ability of future
generations to meet their own needs.’ (UN Bruntland Commission 1987)
Increasing awareness of sustainable practice is influencing corporate governance (ESG):
 Environmental: Counter the impact of climate change and reduce an organisation’s impact on
the environment (sometimes referred to as its environmental footprint).
 Social: Consider the well-being and impact of their operations on society and their stakeholders
and creating a good working environment for its employees.
 Governance: Implement good governance practices from the top down, so it is well positioned
to meet environment and social requirements by providing its goods and services in a
sustainable way and offers employment with good working conditions in the long term.

5.2 Sustainability and ICAEW

Sustainability is at the core of what chartered accountants do and sustainability impacts every ICAEW
paper. In Assurance, ICAEW states that sustainability impacts:
 Risk management
 Assurance
 Governance
 Sustainability metrics and targets

HOME STUDY
Reflect on how each element listed here may be impacted.

5.3 Current developments

This is an area where guidance is rapidly increasing. Be aware of:
 Development of sustainability standards by the ISSB (International Sustainability Standards
Board) which has recently been formed to sit alongside the IASB
 Publications such as ‘FRC Climate Thematic Audit’ (FRC) and ‘The consideration of climate
related risks in an audit of financial statements (IAASB) which make recommendations on
auditing climate related risks. This is likely to be a rapidly developing area.

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 Required company reporting, eg UK companies are required to report on issues relating to

sustainability in the strategic report and the director’s report
You are not required to have detailed understanding of these developing standards but must consider
how these issues could impact on assurance services including implications of sustainability issues for
audit, for example, on inherent risk (see Chapter 3).

Question practice

BENEFITS OF ASSURANCE [DIFFICULTY LEVEL: EXAM STANDARD]

Which three of the following are benefits of assurance work?

A An independent, professional opinion
B Additional confidence given to other related parties
C Testing as a result of sampling is cheaper for the responsible party
D Judgements on estimates can be conclusive
E Assurance may act as a deterrent to error or fraud

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No

Do you understand what assurance is?

Can you explain why assurance is important?

Can you explain the inherent limitations of assurance services?

Can you explain how sustainability may influence the provision of assurance services?

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Process of assurance:
Obtaining an engagement

Topic List
1. Obtaining an engagement
2. Accepting an engagement
3. Agreeing terms of an engagement

Learning Objectives
 Be aware of how assurance firms obtain work
 Understand the key issues practitioners must consider before accepting engagements
 Know what a letter of engagement is and what it does

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1 Obtaining an engagement
How assurance firms obtain clients is an important practical question, but it is largely outside the
scope of this syllabus. In brief, you should be aware that:
 Accountants are permitted to advertise for clients within certain professional guidelines, the
details of which you do not need to know.
 Accountants are often invited to tender for particular engagements, which means that they
offer a quote for services.

2 Accepting an engagement
This section covers the procedures that the auditors must undertake to ensure that their
appointment is valid and that they are clear to act.

2.1 Appointment considerations

Before a new audit client is accepted, the auditors must ensure that there are no independence or
other *ethical issues likely to cause significant problems (*Chapter 14 & 15).
Furthermore, new auditors should ensure that they have been appointed in a proper and legal
manner.
The new auditors must carry out the following acceptance procedures.
Procedure Reason
Ensure professionally Consider whether disqualified on legal or ethical grounds, for example if
qualified to act there would be a conflict of interest with another client. We will look in more
detail at ethical issues later in these notes.
Ensure existing resources Consider available time, staff and technical expertise.
adequate
Obtain references Make independent enquiries if directors not personally known.
Communicate with present Enquire whether there are reasons behind the change which the new
auditors auditors ought to know, also as a matter of courtesy.
Consider the integrity of This will be of great importance, as management could mislead the auditor
those managing the into giving the wrong opinion
company

The audit firm will also consider whether the client is likely to be high or low risk to the firm in terms
of being able to draw an appropriate assurance

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INTERACTIVE QUESTION 1:

Suggest some factors that could indicate an audit client was high risk.
SOLUTION

In order to know the prospective client and the risks attached the auditor will need to gain certain
information about the client

INTERACTIVE QUESTION 2:

Suggest sources of information that could be sought about new clients.

SOLUTION

Prospective auditors should seek the prospective client’s permission to contact the previous
auditors. If this permission is not given, the prospective auditors should normally decline the
appointment. Normally permission will be given, so the prospective auditors can write to the outgoing
auditors.

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Example: Appointment decision chart

Approached by potential
new audit client

yes
Is this the first audit? Prospective auditor can
make own decision

no

no

Does client give permission

to contact old auditor?

yes

Prospective
auditor should
Write for all info required to
act normally
decline the
appointment

Does client give old auditor no

permission to reply?

yes
yes ACCEPT
or
REJECT
Does old auditor provide all Give old auditor due notice
relevant info? no
then decide on basis of
knowledge obtained
otherwise

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INTERACTIVE QUESTION 3: ACCEPTING APPOINTMENT [DIFFICULTY LEVEL: EASY]

Identify whether the following are true or false. The audit firm should consider the following factors
when determining whether to accept an engagement.
True False

Whether the firm is ethically barred from acting.

Whether the firm has sufficient resources to carry out the

engagement.

Whether the firm can make sufficient profit from the engagement.

Whether the client is new to the firm.

Whether the client gives permission to contact the outgoing

auditors.

2.2 After acceptance

The following procedures should be carried out after accepting nomination.
 Ensure that the outgoing auditors’ removal or resignation has been properly conducted in
accordance with national legislation.
 Ensure that the new auditors’ appointment is valid.
 Set up and submit a letter of engagement to the directors of the company.
 Do Money laundering checks (see below)

2.3 Money laundering regulations

In order to comply with the Money Laundering Regulations, assurance firms must keep certain
records about clients and undertake what is known as client due diligence.
It is mandatory to check the identity of all clients before any work is undertaken:
 when an ongoing relationship is envisaged
 or where a one-off transaction(s) greater than €15,000 will take place
The following identification checks should be undertaken, and copies kept until 5 years after the
relationship with the client has ended:
For Individuals For Companies
Photograph Certificate of Incorporation
Full name Registered address
Permanent address Confirmation Statement (Annual Return) for Directors &
Shareholders
Ie a passport & utility bill Previous financial statements

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3 Agreeing terms of an engagement

3.1 Audit engagement letters
ISA 210 Agreeing the terms of audit engagements requires that the auditor and the client agree on the
terms of the engagement in writing. This is the letter of engagement.
The auditors should send an engagement letter to all new clients soon after their appointment as
auditors and before the commencement of the first audit assignment.
The following items MUST be included in the engagement letter.
 The objective of the audit of financial statements.
 The scope of the audit, which could include reference to applicable legislation, regulations
 The auditor’s responsibility.
 The reporting framework that is applicable for the financial statements being prepared, for
example International Financial Reporting Standards.
 Management’s responsibility to prepare the financial statements and to provide the auditor
with unrestricted access to whatever records, documentation and other information is
requested in connection with the audit.
 Confirmation of audit output and form of any reports
When relevant, the following points COULD also be made:
 Arrangements regarding the planning of the audit.
 Expectation of receiving from management written confirmation of representations made
in connection with the audit.
 Basis on which fees are computed and any billing arrangements.
 Arrangements concerning the involvement of other auditors and experts in some aspects
of the audit.
 Arrangements concerning the involvement of internal auditors and other client staff.
 Any restriction of the auditor’s liability when such possibility exists.

Question practice

CLIENT DUE DILIGENCE [DIFFICULTY LEVEL: EASY]

Drew Brothers, chartered accountants, has recently accepted appointment as the auditor of Abysin
Ltd. In terms of client due diligence, they should check which two of the following documents?
A Certificate of incorporation
B Passport
C Utilities bills
D Confirmation Statement (Annual Return)

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ENGAGEMENT LETTERS [DIFFICULTY LEVEL: EASY]

Which three of the following must be contained within a letter of engagement?

A Responsibilities of the auditors
B Responsibilities of the directors
C The names of the staff assigned to the engagement
D The scope of the audit

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you explain the acceptance procedures to be carried out BEFORE accepting a new
client?

Can you explain the acceptance procedures to be carried out AFTER accepting a new
client?

Can you give examples of documents to check as part of client due diligence?

Can you remember the obligatory features of an engagement letter?

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17

Process of assurance:
Planning the assignment

Topic List
1. Planning
2. Analytical procedures
3. Materiality
4. Audit risk
5. Fraud and error

Learning Objectives
 Define overall audit strategy and audit plan
 Define professional scepticism
 Understand the need to obtain an understanding of the entity and its environment
 Be aware how such an understanding is obtained
 Understand what analytical procedures are
 Understand the use of analytical procedures at the planning stage
 Define materiality
 Understand the concept of planning materiality and how it is set
 Define audit risk and its individual components
 Understand how auditors use the risk model
 Be able to identify and classify risks
 Recognise the characteristics of fraud and distinguish between fraud and error

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1 Planning
1.1 Planning an Audit of Financial Statements
ISA 300 states ‘The objective of the auditor is to plan the audit so that it will be performed in an
effective and efficient manner’.
Objectives of planning:
 Ensure appropriate attention is devoted to important areas of the audit
 Identify potential problems and resolve them on a timely basis
 Ensure that the audit is properly organised and managed
 Assign work to engagement team members properly
 Facilitate direction and supervision of engagement team members
 Facilitate review of work

1.2 Audit strategy

The formulation of the general strategy for the audit, which sets the scope, timing and direction of
the audit and guides the development of the audit plan.

1.3 Audit plan

An audit plan is more detailed than the strategy and sets out the nature, timing and extent of audit
procedures to be performed by engagement team members in order to obtain sufficient
appropriate audit evidence.

The overall audit strategy includes:

Understanding the Understand locations, company structure, experience and integrity of
entity’s business management

Understanding the Understand economic and industry conditions

entity’s environment

Understanding the Understanding client accounting policy choices

entities accounting and Understand the reliability of clients’ systems for detecting and preventing
related internal control accounting fraud and error
systems

Materiality and risk The basis and calculation of materiality and results of risk assessment.

Resources Team members involved, budgeted hours, timing and fee

1.4 Understanding the entity

ISA 315 (UK and Ireland) Identifying and Assessing the Risks of Material Misstatement through
Understanding the Entity and its Environment states that ‘the objective of the 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.

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Why do this?

How is it done?

What’s Involved?

Nature of
the entity

Industry,
regulatory & Objectives
external & strategies
factors
Understanding
the entity and
its environment

Entity's
Internal
financial
Control
performance

1.5 Professional scepticism

Professional scepticism is an attitude that includes a questioning mind, being alert to conditions
which may indicate possible misstatement due to error or fraud, and a critical assessment of audit
evidence.
Professional scepticism does not mean that auditors should disbelieve everything they are told;
however, they must have a questioning attitude.

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2 Analytical procedures
2.1 Analytical procedures in planning the audit
Analytical procedures MUST be used at the risk assessment stage as part of Understanding the Entity
and its Environment.
The aim is to look for relationships between sets of data both financial and non-financial. Comparisons
usually involve reviewing:
 Prior Periods
 Budgets
 Ratio Analysis (see below)
 Non-financial information
 Industry information
Here are the key ratios used:

Ratio Formula Purpose

Performance
Return on capital Profit before interest and tax Effective use of resources
employed Capital employed
Gross profit margin Gross profit Assessment of profitability
× 100
Revenue
Cost of sales percentage Cost of sales Relationship of costs to
× 100
Revenue revenue
Operating cost Operating costs Relationship of costs to
× 100
percentage Revenue revenue
Net profit margin Profit before interest and tax Assessment of profitability
× 100
Revenue
Liquidity
Current ratio Current assets Assess ability to pay current
current liabilities liabilities
Quick ratio Receivables + current investments + cash Assess ability to pay current
current liabilities liabilities
Long term solvency
Gearing Net debt Assess reliance on external
× 100
Equity finance
Interest cover Profit before interest payable Assess ability to pay interest
Interest payable charges
Efficiency
Net asset turnover Revenue Assess revenue generated
Capital employed by assets
Inventory period Inventory Assess inventory levels held
× 365
COS
Trade receivable period Trade receivables Assess ability to turn
× 365
Revenue revenue into cash
Trade payable period Trade payables Assess ability to pay
× 365 suppliers
COS

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INTERACTIVE QUESTION 1: ANALYTICAL PROCEDURES [DIFFICULTY LEVEL: EXAM STANDARD]

Here is some budget financial information for Fleming plc, contrasted with the management results for
the 12 months under review.
Budget 20X6 (£) Actual 20X6 (£)
Sales 1,350,000 1,339,588
Cost of sales 850,000 994,663
Gross margin 500,000 344,925
Salaries 245,000 243,873
Repairs and renewals 7,500 24,983
Depreciation 7,500 7,551
Motor expenses 25,750 14,678
Other costs 44,000 43,968
Which four of the following areas would you be most likely to investigate further as a result of
carrying out analytical procedures on the above?
A Sales
B Cost of sales
C Salaries
D Depreciation
E Repairs and renewals
F Motor expense

3 Materiality
3.1 Materiality
A matter is material if its omission or misstatement could influence the economic decisions of users
taken on the basis of the financial statements.
ISA 320 (UK and Ireland) Materiality states that ‘materiality and audit risk are considered throughout
the audit, in particular, when:
 Identifying and assessing the risks of material misstatement
 Determining the nature, timing and extent of further audit procedures
 Evaluating the effect of uncorrected misstatements
Note that the auditors will often calculate a range of values, such as those shown below, and then take
an average or weighted average of all the figures produced as the preliminary materiality level.
However, different firms have different methods and this is just one of the available approaches.
Value %
Profit before tax 5 – 10
Revenue ½–1
Total assets 1–2
However, bear in mind that materiality has qualitative, as well as quantitative, aspects. For example,
transactions relating to directors are considered material by nature regardless of their value.
Ultimately materiality is a matter of judgement.

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3.2 Performance materiality

Performance materiality: is the amount or amounts set by the auditor at less than materiality for the
financial statements as a whole to reduce to an appropriately low level the probability that the
aggregate of uncorrected and undetected misstatements exceeds materiality for the financial
statements as a whole.

3.3 Review of materiality

The level of materiality must be reviewed constantly as the audit progresses and changes may be
required because:
 Draft accounts are altered (due to material error and so on) and therefore overall materiality
changes.
 External factors may cause changes in risk estimates.

4 Audit risk
Auditors follow a risk-based approach to auditing. In the risk-based approach, auditors analyse the
risks associated with the client’s business, transactions and systems which could lead to
misstatements in the financial statements, and direct their testing to risky areas
Audit risk: The risk that the auditor expresses an inappropriate audit opinion when the financial
statements are materially misstated.

4.1 Risk of material misstatement in the financial statements

Inherent risk: The susceptibility of an assertion about a class of transaction, account balance or
disclosure to a misstatement that could be material, either individually or when aggregated with other
misstatements, before consideration of any related controls.
Control risk: The risk that a misstatement will not be prevented, or detected and corrected, on a
timely basis by the entity’s internal control.
Detection risk: The risk that the procedures performed by the auditor to reduce audit risk to an
acceptably low level will not detect a misstatement that exists and that could be material, either
individually or when aggregated with other misstatements.
Detection risk is made up of 2 components:
 Sampling risk – due to the fact that the auditor does not sample 100% of transactions
 Non sampling risk – risk that material misstatement is not discovered due to other factors

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Audit risk = Inherent risk × Control risk × Detection risk

Examples:

Inherent Risk Control Risk Detection Risk

A factor that increases the The risk that the internal The risk that audit procedures
susceptibility of an assertion controls fail to prevent and fail to detect a material
to material misstatement detect material misstatement misstatement
(Chapter 5)
 Cash based business Sampling Risk
 Regulated industry Control Environment
 Due to not testing 100% of
 Management under  Integrity and competence the population
pressure of employees
 Company being sold  Active role of management Non-Sampling Risk
 Company trying to raise  Existence of policies and  Recent appointment
finance procedures  Rush job
 Estimates by  Poor approach
management Control Activities
 Lack objectivity &
 Remuneration of  Physical or logical controls professional scepticism
management  Authorisation
 Risk of not complying  Segregation of duties
with accounting  Reconciliations
standards
 Verifications
 Information processing and
general IT controls

INTERACTIVE QUESTION 2: AUDIT RISK [DIFFICULTY LEVEL: EXAM STANDARD]

Audit risk can be split into three components: inherent risk, control risk and detection risk. For each of
the following examples, indicate the type of risk illustrated.
(1) The organisation has few employees in the accounts department
(2) The organisation is highly connected with the building trade
(3) The assurance firm may do insufficient work to detect material errors
(4) The financial statements contain a number of estimates

4.2 Identifying and assessing the risks

ISA 315 says that ‘the objective of the 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.

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It requires the auditor to take the following steps:

Step 1 Step 2 Step 3

Identify risks Consider
throughout the
Assess the
whether the risks Step 4
identified risks
process of are of a Design tests to
and relate them
obtaining an magnitude that respond to the
to what can go
understanding of could result in a risks identified
wrong at the
the entity and its material
assertion level
environment misstatement

INTERACTIVE QUESTION 3: IDENTIFYING RISKS [DIFFICULTY LEVEL: EXAM STANDARD]

You are involved with the audit of Tantpro Ltd, a small company. You have been carrying out
procedures to gain an understanding of the entity. The following matters have come to your attention.
The company offers standard credit terms to its customers of 60 days from the date of invoice.
Statements are sent to customers on a monthly basis. However, Tantpro Ltd does not employ a credit
controller, and other than sending the statements on a monthly basis, it does not otherwise
communicate with its customers on a systematic basis. On occasion, the receivables ledger clerk may
telephone a customer if the company has not received a payment for some time. Some customers pay
regularly according to the credit terms offered to them, but others pay on a very haphazard basis and
do not provide a remittance advice. Receivables ledger receipts are entered onto the receivables
ledger but not matched to invoices remitted. The company does not produce an aged list of balances.
Which one of the following is the risk most likely to arise out of the above scenario?
A Inventory may be overstated
B Inventory may be understated
C Purchases may be overstated
D Purchases may be understated
E Trade receivables may be overstated
F Trade receivables may be understated

5 Fraud and Error

KEY TERMS
Fraud is an intentional act that may result in the financial statements being misstated
Errors are unintentional

5.1 Characteristics of fraud

There are two types of fraud causing material misstatement in the financial statements:

Fraudulent financial reporting Involves the intentional misstatement or omissions with the aim
to deceive the users of the financial statements
Misappropriation of assets Involves theft or misuse of the entity’s assets

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5.2 Responsibilities in relation to fraud

Management’s Responsibilities Auditors Responsibilities
Management are responsible for both preventing The auditor is responsible for obtaining reasonable
and detecting fraud and error. assurance that the financial statements are free
They do so by putting in place internal controls and from material misstatement.
creating a culture of honesty and ethical behaviour The auditors’ objectives in relation to fraud are:
 Identify and assess the risks of material
misstatement due to fraud
 Design and implement appropriate tests in
response
 Respond appropriately to actual or suspected
fraud identified

Question practice

QUESTION 1: THE OVERALL AUDIT STRATEGY [DIFFICULTY LEVEL: EXAM STANDARD]

Which three of the following would ordinarily be contained in the overall audit strategy?
A The contract between the audit firm and the client
B The results of audit risk assessment
C Calculation of preliminary materiality
D Detailed plan of audit procedures to be carried out
E List of staff to be involved with the audit

QUESTION 2: UNDERSTANDING THE ENTITY [DIFFICULTY LEVEL: EXAM STANDARD]

In order to obtain an understanding of the entity, auditors must use a combination of which four of
the following procedures?
A Inspection
B Observation
C Enquiry
D Analytical procedures
E Computation

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Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you distinguish between an audit strategy and audit plan?

Can you explain the reason why an auditor gains an understanding of the entity and its
environment and how they might do this?

Can you calculate the key ratios used in analytical procedures and understand factors
that could lead to inconsistency year on year?

Do you understand the concept of materiality and performance materiality?

Can you explain the components of audit risk?

Can you distinguish between managements and auditors’ responsibilities regarding

fraud?

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27

Process of assurance:
Evidence and reporting

Topic List
1. Evidence
2. Reporting

Learning Objectives
 Define the assurance process, including obtaining evidence
 Identify when tests of controls and substantive procedures will be used
 Understand that assurance may be positive or negative
 Know the contents of the audit report
 Be aware of the other types of report that may be issued after an assurance engagement

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1 Evidence
1.1 Evidence
The objective of an assurance engagement is to enable practitioners to express an opinion whether
the subject of the assurance engagement is in accordance with the identified criteria.
Audit evidence: Information used by the auditor in arriving at the conclusions on which the auditor’s
opinion is based.
There are potentially two types of test which they will carry out:
(1) Tests of controls: Audit procedures designed to evaluate the operating effectiveness of controls
in preventing, or detecting and correcting material misstatements at the assertion level.
(2) Substantive procedures: Audit procedures designed to detect material misstatements at the
assertion level. Substantive procedures comprise:
 Tests of details (of classes of transactions, account balances and disclosures).
 Substantive analytical procedures.

1.2 Tests of control or substantive testing?

The auditor will always assess the adequacy of the entity’s internal controls first. And where they
appear strong the auditor will test their effectiveness.
If the controls are strong: the auditor can reduce the level of substantive testing and place greater
reliance on the internal controls
If the controls are weak there is a greater chance of fraud and error therefore more detailed
substantive testing will be required.
Note, substantive tests are performed on all audits. It is just the level of substantive testing that
changes. It is never appropriate to just do tests of control and no substantive testing.

1.3 Sufficient appropriate audit evidence

ISA 500 (UK and Ireland) Audit Evidence requires auditors to ‘obtain sufficient and appropriate audit
evidence to be able to draw reasonable conclusions on which to base the auditor’s opinion’.
 Sufficient – enough to support the audit opinion
 Appropriate – relevant and reliable

Sufficient Relevant Reliable

Impacted by: Evidence gathered must cover External better than internal
the assertion being tested
Risk assessment Written better than oral
Adequacy of control systems Originals better than copies
Materiality of an item Auditor generated better than
client generated
Results of audit procedures
Experience from previous
audits

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Evidence gathering procedures (AEIOU)

There are several different ways evidence can be obtained by the auditor:
 Analytical Procedures – evaluation of financial information by studying possible relationships
among financial and non-financial data
 Enquiry – ask a relevant person for information
 Inspection – of a document such as an invoice
 Observation – of a process such as an inventory count
 RecalcUlation – check the mathematical accuracy of a document
 Reperformance – verification managements approach by the auditor
 Confirmation – relates to evidence from a third party source

1.4 Financial statement assertions

Financial statement assertions: are the representations by management that are embodied in the
financial statements.
When performing substantive tests, the auditor needs to gather evidence that proves various
assertions relating to the account balance being tested.
Assertions used by the auditor
Assertions about classes of Occurrence: transactions and events that have been recorded or
transactions and events, and disclosed have occurred and pertain to the entity.
related disclosures, for the Completeness: all transactions, events and disclosures that should have
period under audit been recorded have been recorded.
Accuracy: amounts and other data relating to recorded transactions and
events have been recorded appropriately and disclosures accurately
described.
Cut-off: transactions and events have been recorded in the correct
accounting period.
Classification: transactions and events have been recorded in the proper
accounts.
Presentation: transactions are appropriately aggregated or
disaggregated. Disclosures are understandable and in line with IFRS
requirements.
Assertions about account Existence: assets, liabilities and equity interests exist.
balances, and related Rights and obligations: the entity holds or controls the rights to assets
disclosures, at the period end and liabilities are the obligations of the entity.
Completeness: all assets, liabilities and equity interests that should have
been recorded have been recorded, and disclosures that should have
been included have been included.
Valuation, accuracy and allocation: assets, liabilities, and equity
interests and any related disclosures are included in the financial
statements at appropriate amounts.
Classification: assets, liabilities, and equity interests have been recorded
in the proper accounts.
Presentation: assets, liabilities, and equity interests are appropriately
aggregated or disaggregated. Disclosures are understandable and in line
with IFRS requirements.

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INTERACTIVE QUESTION 1: TYPES OF PROCEDURE [DIFFICULTY LEVEL: EASY]

For each of the following statements, indicate whether they are true or false.
True False

Tests of controls are tests designed to give evidence whether the

controls in a company are operating effectively or not.

Analytical procedures are a type of substantive procedure.

A lack of credit control activities would affect the valuation assertion

for a trade receivable.

2 Reporting
2.1 Types of opinion (recap of chapter 1)
There are two types of assurance engagement conducted by practitioners:
 Reasonable assurance engagement
 Limited assurance engagement
The key distinction between the 2 is the sufficiency of the evidence sought and the type of opinion
given.
Engagement Evidence Procedures Opinion
Reasonable Assurance Sufficient and Consider the internal Positive opinion
Engagement appropriate (intrusive) controls, then use The financial statements
ie a statutory audit AEIOU to confirm the show a true and fair view
assertions in all material respects
Limited Assurance Sufficient and Procedures tend to be Negative conclusion
Engagement appropriate (less limited to analytical Nothing has come to our
ie a review of company intrusive) procedures and enquiry. attention that make us
cash flows (AE) believe that the subject
matter is misstated

2.2 Content of the audit report

In this syllabus, you are only concerned with cases where the auditor finds that he can conclude that
the financial statements give a true and fair view. Such an audit report is referred to as an
‘unqualified’ audit report.
The Companies Act 2006 requires the auditors to state explicitly whether in their opinion the annual
accounts give a true and fair view, meaning:
 Financial statements have been properly prepared in accordance with the Companies Act
 Financial statements have been properly prepared in accordance with the relevant financial
reporting framework
 The information in the directors’ report is consistent with the financial statements

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Although not explicitly stated it is implied that:

 Adequate accounting records have been kept.
 Returns adequate for the audit have been received from branches not visited.
 The financial statements are in agreement with the accounting records and returns.
 All information and explanations have been received as the auditors think necessary
 Auditors have had access at all times to the company's books, accounts and vouchers.
 Details of directors' emoluments and other benefits have been correctly disclosed in the
financial statements.
These are reported only by exception (ie if the above have not been met)
The audit report should include the following basic elements, usually in the following layout but
tailored to the circumstances of each engagement.
 Title
 Addressee
 Auditor’s opinion section comes first, expressing an opinion on the financial statements
 Basis for opinion section gives reason and detail surrounding the above opinion
 Conclusions relating to going concern section, includes work we did to ascertain the company’s
ability to continue as a going concern and where applicable includes discussion of any significant
uncertainties facing the company.
 Our Approach to the audit section, (listed companies) the auditor highlights significant matters
such as:
Key Audit Matters How our scope addressed this matter
 Areas of high risk of material misstatement Explanation of how the scope addressed each
in the financial statements key audit matter
 Areas requiring significant auditor
judgement such as auditing estimates
 The effects of significant events or
transactions that occurred in the year

 Our application of materiality section, discussed how materiality was established, what the
threshold is and how it was applied.
 Other information section, discusses auditors’ responsibilities for other information in the
financial reports, we consider its consistency and where inconsistent report such.
 Opinion on other matters prescribed by the Companies Act 2006, for example:
– The Companies Act requires confirmation of whether the Directors Report and strategic
report are consistent with the financial statements.
 Matters on which the auditor is required to report on by exception: For example, identify if:
– If adequate accounting records have not been kept
– If all information and explanations required for the audit have not been received
– If financial statements are not in agreement with the underlying accounting records
– If details of directors’ emoluments have not been properly disclosed in the financial
statements

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 Responsibilities of directors for the financial statements, ie to prepare the financial statements
following applicable standards, in line with the Companies Act and apply correct going concern
basis.
 Auditor’s responsibilities for the audit, ie
– Explain our objective to do a reasonable assurance engagement in accordance with ISAs.
– The auditor may provide a link to the FRC website which describes their responsibilities.
 Name of engagement partner
 Signature of engagement partner
 Auditors address
 Date of the report

REAL LIFE
An example audit report can be found in chapter 18 for your review only

2.3 Level of assurance and the expectations gap

The expectation gap, as discussed in chapter 1, is the difference between what the auditor does and
what’s perceived by 3rd parties, examples include:
Misunderstanding of the nature of audited financial statements
 The balance sheet provides a fair valuation of the reporting entity
 The amounts in the financial statements are stated precisely
 The audited financial statements will guarantee that the entity will continue to exist
Misunderstanding as to the type and extent of work undertaken by auditors
 All items in financial statements are tested
 Auditors will uncover all errors
 Auditors should detect all fraud
Misunderstanding about the level of assurance provided by auditors
 The auditors provide absolute assurance that the figures in the financial statements are correct
(therefore ignoring materiality)

2.4 Other reports – awareness only

The main assurance report is addressed to users of the assurance material. The international standard
on assurance engagements requires that an assurance report must have the following components:
 Title
 Addressee
 An identification and description of the subject matter
 Identification of the criteria
 A statement restricting the use of the assurance report to those intended users or that purpose
 A statement to identify the responsible party
 A statement that the engagement was performed in accordance with International Standards
on Assurance Engagements (ISAEs)

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 A summary of the work performed

 The practitioner’s conclusion (positive or negative, depending on the level of assurance being
given and the work carried out)
 The assurance report date
 Signed the name of the firm or practitioner

Question practice

INTERACTIVE QUESTION: AUDIT REPORT [DIFFICULTY LEVEL: EASY]

Which three of the following are reported by exception in the audit report?
A All information and explanations required for the audit have been received
B Adequate accounting records have been kept
C The directors’ report is consistent with the financial statements
D The financial statements have been prepared in accordance with the Companies Act 2006
E Details of directors’ emoluments have been properly disclosed in the financial statements

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No

Can you distinguish between tests of control and substantive procedures?

Can you explain the characteristics of good quality audit evidence?

Can you explain the financial statement assertions and identify which ones relate to
balances and transactions?

Can you identify the order of sections in the auditor’s report?

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35

Introduction to internal
control and information flows

Topic List
1. What is internal control?
2. Components of internal control
3. Information about controls

Learning Objectives
 Understand the role of internal control within a business
 Understand the limitations of internal control
 Identify the components of internal control
 Understand how the auditor obtains and records information about internal controls

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1 What is internal control?

1.1 Definition
Internal control: ‘The process designed, implemented and maintained by those charged with
governance, management, and other personnel to provide reasonable assurance about the
achievement of an entity’s objectives with regard to:
 Effectiveness and efficiency of operations
 Reliability of financial reporting,
 Compliance with applicable laws and regulations.

1.2 Reasons for internal controls

The reasons for internal controls include:
 Minimising the company’s business risks
 Ensuring the continuing effective functioning of the company
 Ensuring the company complies with relevant laws and regulations

1.3 Limitations of internal controls

Internal controls have some limitations. In other words, the internal controls cannot eliminate risk of
fraud and error entirely.
Limitation Explanation
Expense Controls can be expensive and there may be no cost benefit of operating. The
benefit of the control may outweigh the cost of the risk
Human element Some controls are only as good as the people operating them. If a mistake is
made on implementing the control, the control may be ineffective
Collusion Two or more people working together to bypass a control
Unusual transactions Controls are generally designed to deal with what routinely happens. For an
unusual transaction the control may not be relevant or exist

2 Components of internal control

2.1 The control environment
Control environment: The control environment includes the governance and management functions
and the attitudes, awareness and actions of those charged with governance and management
concerning the entity’s internal control and its importance in the entity. The control environment sets
the tone of an organisation, influencing the control consciousness of its people.
The control environment is therefore very important to the auditors and they will evaluate it as part
of their risk assessment process. If the control environment is strong, then auditors will be more
inclined to rely on the controls system in the entity than if it is weak.

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2.1.1 Audit committees

The audit committee is an important aspect of the control environment of the company. It is a
subcommittee of the board of directors responsible for overseeing an entity’s internal control
structure, financial reporting and compliance with relevant laws and regulations.

Review objectivity of
external auditor
- Length of service
Responsible for ensuring - Remuneration
the integrity of the - Review non audit
financial statements services offered
(Make use of external
auditor)
Audit Committee Recommend
appointment and
A must have for a Listed removal of external
company and best auditors
practice for a large
company.
Made of of NEDs Responsible for ensuring Monitor and review the
internal controls and risk effectiveness of the
management systems internal audit
are robust - Skill/experience
(Make use of internal - Resources
auditor) - Independence

2.2 The entity’s risk assessment process

This process involves identification of the business risks the organisation faces.
Business risk: 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.
Those charged with governance should establish the following process:

Identification of Estimate Assess Actions to

business risks impact likelihood manage

Auditors are interested in business risk because issues which pose threats to the business may in
some cases also be a risk of the financial statements being misstated.

2.3 The information system and communication

A component of internal control that includes the financial reporting system. This consists of the
procedures by which transactions are initiated, recorded, processed, corrected and reported. How
information systems capture events and transactions. And the process of preparing the financial
statements. The auditor will be concerned with the reliability of these systems.

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2.4 Control activities

Are those activities initiated by those charged with governance to safeguard the company assets by
detecting and preventing fraud and error.
Each particular internal control may also prevent an error occurring (preventative control), or may
identify that an error has occurred and correct it (detective control).

2.4.1 Types of control activity

ISA 315 gives examples of the following types of control activity:
Control activity Explanation Examples
Authorisation and Approval of Overtime should be approved by departmental
approvals transactions/documents managers, purchase orders by the purchasing
manager.
Reconciliations Comparing two or more data Comparing transactions in the bank statement
elements with those recognised in the accounting system.
Verifications Comparing an item with a policy Comparing monthly expenditure to a budget
and will involve a follow up action (being the policy), resulting in investigation of
where there is a problem differences.
Segregation of Using different individuals for The staff who record the transactions should not
duties authorising, processing and carry out the related reconciliations.
maintaining custody of assets
Physical or logical Physical counting, locking and Ensuring the company safe is locked at all times.
controls security of assets Physical count of petty cash or inventory.
Sequence checks of documents such as sales
invoices is an example of logical control
Information The internal controls in a Controls to check the accuracy, completeness
processing and computerised environment and authorisation of transactions. See below.
General IT controls includes both manual procedures
and procedures designed into
computer programs.

2.4.2 Information processing controls

Information processing controls: Manual or automated procedures that typically operate at a
business process level. Information processing controls can be preventative or detective in nature and
are designed to ensure the integrity of information (completeness, existence and accuracy)
Information processing controls relate to input, processing or output data
Examples of information processing controls
Controls over input completeness For example, one-for-one checking of processed output to source
documents and running exception reports
Controls over input Programs to check data fields, for example
accuracy/integrity  Digit verification (eg reference numbers are as expected)
 Reasonableness test (eg VAT to total value)
 Existence checks (eg customer name)
 Character checks (no unexpected characters used in reference)
 Permitted range (no transaction processed over a certain value)
Controls over input authorisation Manual & automatic checks to ensure information input was:
 Input by authorised personnel (ie digital signature/password)

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Examples of information processing controls

Controls over processing of inputs For example, screen warnings can prevent people logging out before
processing is complete
Controls over master files and For example, reviewing payroll records to individual employee
standing data personnel files

2.4.3 General controls

General controls: Policies and procedures that relate to many applications and support the effective
function of the information processing controls by helping to ensure the continued proper operation
of information systems.

Examples of general controls

Development of Standards over systems design, programming and documentation
computer applications  Full testing procedures prior to use
 Approval by computer users and management
 Training of staff in new procedures
Prevention or detection  Password protection of programs so that access is limited to computer
of unauthorised changes operations staff
to programs  Restricted access to central computer by locked doors, keypads
 Virus checks on software: use of anti-virus software and policy
prohibiting use of non-authorised programs or files
Testing and  Complete testing procedures
documentation of  Documentation of new systems
program changes  Approval of changes by computer users and management
Controls to prevent Such as passwords to prevent unauthorised entry, built in controls to permit
unauthorised changes
amendments to data files
Controls to ensure  Storing extra copies of programs and data files off-site
continuity of company  Protection of equipment against fire and other hazards
operations  Back-up power sources
 Back-up copies of programs being taken and stored in other locations
 Emergency procedures
 Disaster recovery procedures, eg availability of back-up computer
facilities
 Maintenance agreements and insurance

2.5 The entity’s system to monitor the system of internal controls

An entity should review its overall control system to ensure that it still meets its objectives, it still
operates effectively and efficiently and that necessary corrections to the system are made on a timely
basis. If it does not, then the control system may not be operating optimally. This is often a role
undertaken by a company’s internal audit department, as we shall see in Chapter 9.
Auditors will often produce a management report at the end of an audit, outlining any deficiencies
they have observed in internal controls. Auditors are also required by ISAs to identify control
deficiencies observed to those charged with governance.

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3 Information about controls

Auditors will obtain information about internal controls from a variety of sources.
 The company may have manuals of internal controls and copies of internal controls policies,
or minutes of meetings of the risk assessment group.
 Auditors should have a record of what the controls were in previous years and therefore
any prior deficiencies
 The auditors will also obtain knowledge by talking to the people involved with internal
control at all stages and asking them what the controls are and why they have been
implemented.
 Observation – the auditor will watch operations at a company to identify the control
activities being put into action.

3.1 Recording of internal controls

Auditors shall record the internal controls that they see.
There are broadly three types of document which are used for recording the understanding of the
business:
Narrative notes Questionnaires and checklists Diagrams
These are good for things like: These are: Things like:
 Short notes on simple  Good as aide memoires to  Flowcharts for complex
systems ensure you have all the systems
 Background information bases covered  Organisational charts
They are less good when things But  Family trees relating the
get more complex when diagrams  Mechanical approach related party transactions
tend to take over. meaning important extra
question is never asked
 Tick boxes often get ticked
whether the brain is engaged
or not

3.2 Walk through testing

Once the auditor has documented the internal controls they should check their understanding of these
by performing walk-through tests.

KEY TERMS
Walk-through tests – involve tracing a few transactions through the financial reporting
system from order to payment.

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Question practice

INTERACTIVE QUESTION 1: INTERNAL CONTROL [DIFFICULTY LEVEL: EXAM STANDARD]

Which one of the following is a reason that organisations have effective systems of control?
To assist the organisation in:
A Maximising profitability
B Maximising operating efficiency
C Reducing time required for the statutory audit
D Minimising audit risk

INTERACTIVE QUESTION 2: CONTROL ACTIVITIES [DIFFICULTY LEVEL: EXAM STANDARD]

The following are examples of internal controls which operate at Searson plc.
For each example, select the one type of control activity which it illustrates.
Authorisation Reconciliation Information Physical
processing
(1) The financial controller
investigates the exception
report of unmatched
transactions from the
electronic banking system

(2) Searson regularly counts

its high risk/high value
inventory on a monthly
basis and compared with
amounts in the accounts
(3) Searson regularly
compares its trade
payable ledger to supplier
statements, discrepancies
are resolved to make sure
they agree

INTERACTIVE QUESTION 3: IT CONTROLS [DIFFICULTY LEVEL: EXAM STANDARD]

Most entities use IT systems for financial reporting and operational purposes. Controls operating in an
IT environment can be split into general controls and information processing controls.
Which two of the following are information processing controls?
A Permitted range
B Digit verification
C Passwords
D Virus checks

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Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Do you know the purpose of an internal control?

Can you explain the limitations of internal controls?

Can you distinguish information processing controls from general controls?

Can you give examples of control activities?

Can you explain three types of documents that are used for documenting internal
controls and evaluate each?

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43

Revenue system

Topic List
1. Controls in a sales system
2. Control objectives
3. Identifying deficiencies

Learning Objectives
 Identify relevant controls to mitigate risk
 Identify tests of those controls
 Identify risks in a sales system
 Recognise weaknesses in a sales system

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1 Controls in a revenue system

 Pre-numbered sequential standardised
order forms created to ensure orders not
Receipt of lost
customer order  Credit checks completed on new (and
existing) customers to prevent bad debts
 Credit limits set (and reviewed regularly)
to minimise impact of bad debts

 Pre-numbered sequential goods dispatch

Dispatch of notes (GDN) created as goods leave the
goods to the warehouse to identify what was sent,
customer could sign a copy to
customer
acknowledge receipt of goods
 Checks on quality and quantity of good
prior to dispatch to prevent later disputes

 Creation of a sequential pre-numbered

sales invoice to help ensure completeness
Invoice the
customer  Sales invoice matched to GDN to confirm
units sent and match to order form to
confirm price to ensure correct invoicing.

 Send out statements to customers to

remind them to pay!

 Match funds received against the invoice

Receipt of being paid. This will leave only unpaid
payment from invoices on the system
the customer  Record and bank any cash and cheques
promptly to detect and prevent
misappropriation

 Note: segregation of duties should exist between those who take the order, fulfil the order,
invoice the customer and handle receipts to prevent fraud.
For example; being responsible for recording a sale and having access to remittances could give
the opportunity for fraud or being responsible for invoicing and credit control could lead to a
self-review issue.

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A s s ur a nc e 6: R e v e n u e s ys t e m 45

2 Control objectives
A control objective is the aim or goal or intention of the internal control. For example, what it is trying
to ensure and what risk it aims to prevent.
For instance, for sales systems:
 Ensure sales are only made to credit worthy customers
 Ensure orders can be fulfilled before accepted
 Ensure invoicing is correct
 Ensure the sale is recorded in the correct period
These are not internal controls themselves, so when asked to identify internal controls from a
question, ‘objectives’ can be ignored.

INTERACTIVE QUESTION 1: ORDERING [DIFFICULTY LEVEL: EXAM STANDARD]

MC plc is a company that has had a number of inquiries from potential new customers in recent
months. The sales director is excited at this potential sales growth, but the financial controller is
concerned that the company could be exposed to the risk of increased bad debts.
Which two of the following internal controls will mitigate the risk of bad debts arising from new
customers?
A Obtaining a credit reference for new customers
B Matching of customer orders with despatch notes
C Quoting the correct prices to customers making orders
D Authorisation of new customers by a senior staff member
E Authorisation for changes in customer data

INTERACTIVE QUESTION 2: DESPATCH AND INVOICING [DIFFICULTY LEVEL: EXAM STANDARD]

Which three of the following controls will help to mitigate the risk of goods being despatched but not
invoiced?
A Pre-numbering of goods despatched notes and regular checks on sequence
B Pre-numbering of invoices and regular checks on sequence
C Matching of goods despatched notes with orders and invoices
D Regular review of despatch notes not matched with invoices

INTERACTIVE QUESTION 3: RECORDING OF SALES [DIFFICULTY LEVEL: EXAM STANDARD]

The auditor at Icy Limited, a wholesaler of frozen goods, has discovered that the receivables ledger
clerk has not matched receipts with invoices when processing receipts onto the ledger.
Which two of the following are potential risks arising from this failure?
A The clerk could be siphoning off individual receipts and defrauding the company
B Old outstanding invoices could be left unpaid
C Sales might be recorded in the wrong supplier’s accounts
D Sales may not be recorded properly in the sales account

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INTERACTIVE QUESTION 4: CASH RECEIPTS [DIFFICULTY LEVEL: EXAM STANDARD]

Which two of the following controls would help to ensure that money received is banked?
A Matching cash receipts with invoices
B Monthly bank reconciliations
C Daily banking of money received
D Investigation of shortages and surpluses of cash in the business

3 Deficiencies
Identifying deficiencies in a system is a key exam technique.

INTERACTIVE QUESTION 5: SALES DEFICIENCY [DIFFICULTY LEVEL: EXAM STANDARD]

The following describes the sales system in operation at Jinbob Company. For each process indicate
whether the process indicates a strength or a deficiency in the system.
Strength Deficiency
Written orders are received in the sales office. Orders are
processed into the sales system with no further action being
taken.
The order generates a production note which is forwarded to the
production department on the basis of which they fulfil the order.
Completed goods are despatched with a delivery note, a copy of
which is matched with the production note and sent to the
invoicing department.

Unfulfilled production notes are placed in a pending file which is

reviewed weekly and completed as soon as possible.

HOME STUDY
 Go back to the sales cycle and consider how you would test the internal controls to
verify they took place in the year under review.

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A s s ur a nc e 6: R e v e n u e s ys t e m 47

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you identify and classify risks relating to sales ordering, dispatch, invoicing and
cash collection aspects of the sales cycle?

Can you explain control objectives for sales ordering, dispatch, invoicing and cash
collection aspects of the sales cycle?

Can you give examples of control activities relating to sales ordering, dispatch,
invoicing and cash collection aspects of the sales cycle?

Can you distinguish between a systems strengths and weaknesses?

EXAM SMART
This chapter represents a very practical element of the Assurance syllabus. Key to building
confidence in the area is lots of question practice. It’s important in these questions to not
only identify the correct answer, but to be able to confidently disregard the wrong ones too.

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48 6: R e v e n u e s ys t e m A s s ur a nc e

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49

Purchases system

Topic List
1. Controls in a purchase system
2. Identifying deficiencies

Learning Objectives
 Identify risks in a purchases system
 Identify relevant controls to mitigate risk
 Identify tests of those controls
 Recognise weaknesses in a purchases system

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1 Controls in a purchase system

 Purchase orders (PO) are created on
pre-numbered, sequential forms that are
A purchase authorised by responsible official
order is raised  Approved supplier lists are maintained
with only authorised suppliers (and
restricted access to this)
 If no authorised supplier exists a tender
process is started

 A pre-numbered/sequential goods
The goods are received note (GRN) is raised when
received by the goods received and matched to the
company original purchase order to check quantity
and validity
 Goods are checked for quality on receipt
and returned if substandard
 Inventory system is updated so goods
are available for sale

 The purchase invoice is matched to the

A purchase GRN and PO to ensure invoice contains
invoice is correct quantity and price
received from
the supplier

 Supplier statements received should

be reconciled to the payable ledger to
ensure all invoices are complete

 Payments are authorised by responsible

official prior to payment
The purchase  The purchase ledger is updated promptly,
invoice is paid or Invoices are stamped ‘PAID’ to
prevent paying twice
 Due dates of invoices are monitored to
avoid interest or missing early payment
discounts

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A s s ur a nc e 7: P u rc h as e s s yst e m 51

INTERACTIVE QUESTION 1: ORDERING [DIFFICULTY LEVEL: EXAM STANDARD]

The directors of Lyton Limited (LL) have just uncovered a fraud being perpetrated by the stores
manager. He was in charge of ordering, had raised a number of false orders to non-existent suppliers,
raised goods received notes in respect of non-existent deliveries and forwarded an invoice to the
accounts department, which was then paid.
Which two of the following controls could have prevented this fraud?
A Approved list of suppliers
B Check of goods inward by person other than orderer
C Pre-numbered order forms
D Blank order forms locked in a safe

INTERACTIVE QUESTION 2: GOODS INWARD AND INVOICES [DIFFICULTY LEVEL: EXAM STANDARD]

Weezy plc is a company that has a large number of deliveries daily.

Which one of the following internal controls is most likely to prevent Weezy plc paying for goods that
have not been received?
A Locked stores
B Matching of purchase invoices with goods received notes
C Authorisation of invoice payment
D Safeguarding of blank order documents

INTERACTIVE QUESTION 3: PURCHASE RECORDING [DIFFICULTY LEVEL: EXAM STANDARD]

Rhonda posts the invoices to the payables ledger.

Which one of the following would help prevent suppliers from being overpaid?
A Posting invoices to the receivables ledger
B Examining the purchase ledger for unusual entries
C Authorisation of payments
D Bank reconciliations

INTERACTIVE QUESTION 4: CASH PAYMENTS [DIFFICULTY LEVEL: EXAM STANDARD]

Which two of the following control activities are most likely to reduce the risk of payments being
made twice for the same liability?
A Stamping ‘Paid’ on invoices that have been paid
B Prompt dispatch of cheques
C Authorisation of payments
D Checking supplier statements before payments are made

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2 Deficiencies

INTERACTIVE QUESTION 5: DEFICIENCIES IN THE PURCHASES SYSTEM [EXAM STANDARD]

The auditor of Sunny plc has identified that there is no procedure to track purchase invoice due dates.
Which one of the following is the most likely consequence which might arise as a result of that
deficiency?
A Prompt payment discounts may not be obtained
B Goods not actually received may be paid for
C Inferior goods may be purchased
D Payments may be made to fictitious suppliers

HOME STUDY
 Go back to the purchase system and consider how you would test the internal controls
to verify they took place in the year under review.

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you identify and classify risks relating to purchase ordering, dispatch, invoicing
and cash collection aspects of the purchases cycle?

Can you explain control objectives for purchase ordering, dispatch, invoicing and cash
collection aspects of the purchases cycle?

Can you give examples of control activities relating to purchase ordering, dispatch,
invoicing and cash collection aspects of the purchases cycle?

Can you distinguish between a systems strengths and weaknesses?

EXAM SMART
This chapter represents a very practical element of the assurance syllabus. Key to building
confidence in the area is lots of question practice. It is important in these questions to not
only identify the correct answer, but to be able to confidently disregard the wrong ones too.

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53

Employee costs

Topic List
1. Controls in a wages and salaries system
2. Identifying deficiencies

Learning Objectives
 Identify risks in a payroll system
 Identify relevant controls to mitigate risk
 Identify tests of those controls
 Recognise weaknesses in a payroll system

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54 8: E mp l o ye e c os t s A s s ur a nc e

1 The wages and salaries system

 Starters and leavers are authorised by senior managers or
Calculation of human resources (HR)
wages, salaries  Time sheets or clocking in and out arrangements exist for
and taxes those paid per hour
 Personnel files are maintained for all employees and
regularly reviewed to the payroll information
 Qualified/trained staff calculate payroll, restricted access to
the payroll system and reliable software is used

Recording of
wages and
 Payroll reconciliations performed using a control account
salaries in the
accounting
system

 Segregation of duties between those preparing

Payment of payroll and those distributing payments
wages, salaries  For cash payments identification should be
and taxes provided prior to payment
 For BACs payments there should be a review and
authorisation prior to payment by HR

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A s s ur a nc e 8: E mp l o ye e c os t s 55

INTERACTIVE QUESTION 1: CALCULATING PAY [DIFFICULTY LEVEL: EXAM STANDARD]

The following system of time records exists at Shepherd Limited. Staff members are required to fill in a
manual timesheet as they arrive, stating the time of arrival and as they leave, stating the time of
departure. Staff members are then paid an hourly rate on the basis of this record.
Which two of the following outcomes could arise from this system?
A Employees may be paid at an inappropriate rate
B Employees may be paid for work they have not done
C Employees are paid for the hours they have worked
D Employee deductions may be inappropriate

INTERACTIVE QUESTION 2: RECORDING PAY [DIFFICULTY LEVEL: EXAM STANDARD]

Personnel and wages records at Simonston Brothers Limited are maintained by Sam, the wages clerk,
on a personal computer. Sam calculates the hours worked by each employee on a weekly basis, based
on that employee’s clock cards and enters them on the computer. The payroll program, using data
from personnel records in respect of wage rates and deductions, produces the weekly payroll and a
payslip for each employee.
Sam prepares a cheque requisition for the total net pay for the week, which is sent to the company
accountant together with a copy of the payroll. The accountant draws up the cheque, made payable to
cash, and has it countersigned by a director. The wages clerk takes the cheque to the bank and uses
the cash to prepare the wage packets.
Which two of the following are deficiencies which exist in the wages system at Simonston Brothers
Limited?
A Sam records the salaries and organises the pay packets
B There is no authorisation of the payroll
C The wages cheque is countersigned by a director
D The payroll and the time recording system are separate

INTERACTIVE QUESTION 3: PAYMENT OF WAGES [DIFFICULTY LEVEL: EXAM STANDARD]

Which two of the following control activities will reduce the risk of employees who have left being
made up a pay packet which is collected by the leaver or an accomplice?
A Check that each employee only collects one pay packet
B Supervision of pay-out by a member of staff
C Authorisation of payroll by the HR Manager
D Comparison of payroll with wage packets to ensure that they match

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2 Deficiencies

INTERACTIVE QUESTION 4: DEFICIENCIES IN A PAYROLL SYSTEM [EXAM STANDARD]

Strength Deficiency
(1) Employees each have an electronic card to swipe in order to
enter and leave the factory premises. This ‘swipe’ system
automatically updates time records in the payroll system.

(2) There is no personnel department. Employees are engaged

by department heads with the verbal consent of a director.

(3) On leaving, employees are required to return their swipe

cards.

(4) The payroll has a variance function which reports items

within the payroll falling outside the expected conventions
which must be resolved by an authorised member of staff
before the payroll can be finalised. The ability to resolve this
report is controlled by a secret password.

HOME STUDY
 Go back to the wages system and consider how you would test the internal controls to
verify they took place in the year under review.

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No

Can you explain risks associated with a wages system?

Can you provide examples of controls to mitigate risks of a wages system?

Can you distinguish between a wage’s systems strengths and deficiencies?

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Internal audit

Topic List
1. What is internal audit?
2. What does the internal audit function do?

Learning Objectives
 Understand the role that internal audit plays in internal control
 Distinguish between the role of the internal auditor and the external auditor

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1 What is internal audit?

Internal audit function: An appraisal activity established or provided as a service to the entity. Its
functions include, amongst other things, examining, evaluating and monitoring the adequacy and
effectiveness of internal control.

1.1 Distinction between internal and external audit

Internal Audit External Audit
Reason  Help the Directors safeguard the  Conduct a reasonable assurance
assets of the company engagement
 Review the efficiency and  Give an opinion on the financial
effectiveness of the operations statements
of the company
 Appraise the adequacy of
internal controls including those
relating to financial reporting
 Appraise compliance with laws
and regulations
Reporting to  Those charged with governance  The shareholders of the company via
 Best is the audit committee the auditor’s report
 Worse would be the finance  The board via the management
director letter
Work relates to  Internal controls  The financial statements of the
 Financial reporting issues company
 May provide assistance to the
external auditor doing tests of
controls and substantive testing
 Review of efficiency of
operations
 Value for money audits through
review of economy – efficiency –
effectiveness
Relationship with  Often employees so objectivity  Must always be independent
the company could be an issue, but can be
outsourced

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2 What does the internal audit function do?

The activities of the internal audit function usually involve:

Examining
financial and
operating
information
Review of
Special
compliance
investigations,
with laws,
for instance,
regulations and
into suspected
other external
fraud
requirements
Internal
Audit
Evaluating Function
significant
exposures to risk
Monitoring
and
internal
recommending
controls
where
improvements Review of the
can be made economy,
efficiency and
effectiveness
of operations

NOT to get involved with: CAN get involved with:

 Identifying risk re operational matters  Examining
 Developing controls  Reviewing
 Designing controls  Monitoring
 Implementing controls  Testing
 Authorising  Giving accounting advice

INTERACTIVE QUESTION 1: INTERNAL AUDIT ACTIVITIES [DIFFICULTY LEVEL: EXAM STANDARD]

Lightening plc has an organisational structure which includes accounting, human resources, internal
audit and audit committee. Which department should not be involved in determining pay rises?
A Accounting
B Human resources
C Internal audit
D Audit committee

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Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you explain what an internal audit function is?

Can you explain four factors that distinguish an internal audit from the external audit?

Can you explain the principal activities of an internal audit function?

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10

Documentation

Topic List
1. Purpose of documentation
2. Form and content of documentation
3. Safe custody and retention of documentation
4. Ownership of and right of access to documentation

Learning Objectives
 Understand the nature of working papers
 Understand the form and content of working papers
 Understand why assurance providers record their work
 Understand why and how assurance providers keep these records

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1 Purpose of documentation
Audit documentation (working papers): is the record of procedures performed, relevant evidence
obtained and conclusions the auditor reached.
All assurance work must be documented: the working papers are the tangible evidence of the work
done in support of the conclusion. Audit documentation or working papers provides:
(a) Evidence for the auditor’s basis for a conclusion about the achievement of the overall objectives
of the auditor; and
(b) Evidence that the audit was planned and performed in accordance with ISAs and applicable
legal and regulatory requirements.
In addition, particularly in relation to audit, assurance providers record their work to:
 Assist the audit team to plan and perform the audit
 Assist relevant members of the team to direct and supervise work
 Enable the audit team to be accountable for its work (prove adherence to ISAs)
 Retain a record of matters of continuing significance to future audits
 Enable an experienced auditor to carry out quality control reviews
 Enable an experienced auditor to conduct external inspections

2 Form and content of documentation

Documentation should be sufficient to enable an experienced auditor, having no previous connection
with the audit, to understand the nature, timing and extent of audit procedures performed to comply
with the ISAs and applicable legal and regulatory requirements, the results of audit procedures
performed and the audit evidence obtained, and significant matters arising during the audit, the
conclusions reached thereon and significant professional judgements made in reaching those
conclusions.
Working papers should show:
 The name of the client  How any sample was selected
 The reporting date  The sample size determined
 The file reference of the working paper  The work done
 The name of the preparer  A key to any audit ticks or symbols
 The date of preparation  Appropriate cross-referencing
 The subject of the working paper  The results obtained
 The name of the reviewer  Analysis of errors
 The date of the review  Other significant observations
 The objective of the work done  The conclusions drawn
 The source of information  The key points highlighted

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Worked example: Working paper

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KEY
1 The name of the client 8 The date of the review
2 The reporting date 9 The objective of the work done
3 The file reference of the working paper 10 The sources of information
4 The name of the person preparing the 11 The work done
working paper
12 A key to any audit ticks or symbols
5 The date the working paper was prepared
13 The results obtained
6 The subject of the working paper
14 Analysis of errors or other significant
7 The name of the person reviewing the observations
working paper
15 The conclusions drawn

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2.1 Automated working papers

Automated working paper packages have been developed which can make the documenting of audit
work much easier. Such programs aid preparation of working papers, lead schedules, trial balance and
the financial statements themselves. These are automatically cross referenced, adjusted and balanced
by the computer.
The advantages of automated working papers are as follows.
 The risk of errors is reduced.
 The working papers will be neater and easier to review.
 The time saved will be substantial as adjustments can be made easily to all working papers
 Standard forms do not have to be carried to audit locations.
 Audit working papers can be emailed or faxed for review.
These days most documents can be scanned and stored electronically rather than in paper form.

2.2 Filing working papers

Firms should have standard referencing and filing procedures for working papers, to facilitate their
review. For recurring audits, working papers may be split between permanent and current audit files
Permanent audit files contain information of Current audit files contain any information of
continuing importance to the audit relevance to the current year’s audit
 Engagement letters  Financial statements
 New client questionnaire  Accounts checklists
 The memorandum and articles of association  A summary of unadjusted errors
 Other legal documents such as prospectuses,  Report to partner including details of
leases, sales agreements significant events and errors
 Details of the history of the client’s business  Audit planning memorandum, time budgets
 Board minutes of continuing relevance and summaries, risk assessments
 Previous years’ signed accounts and analytical  Written representations from management
procedures  Notes of board minutes
 Accounting systems notes, previous years’  Communications with third parties such as
control questionnaires experts or other auditors
 A lead schedule including details of the figures
to be included in the accounts
 Details of tests of detail and tests of control
and conclusions drawn

3 Safe custody and retention of documentation

It is important that firms have good security procedures over their retained working papers. Paper
documents must be kept securely, in locked premises. Electronic documents should be protected by
electronic controls.
The ICAEW requires all firms should have a document retention policy and Registered Auditors to
keep all audit working papers required by auditing standards for at least six years from the end of the
accounting period to which they relate.

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4 Ownership of and right of access to documentation

Working papers are the property of the assurance providers. The audit report becomes the property
of the client once it has been issued.
Assurance providers must follow ethical guidance on the confidentiality of working papers. As
working papers belong to the firm, the assurance providers are not required to show them to the
client, only at the auditors’ discretion.
Information should not be made available to third parties without the permission of the client. An
example of when working papers might be shared with a third party is when a new firm is taking over
an audit from the existing auditors.

INTERACTIVE QUESTION 1: DOCUMENTATION [DIFFICULTY LEVEL: EXAM STANDARD]

The auditor will prepare documentation in relation to the fieldwork carried out on an assurance
engagement.
Indicate whether the following are, or are not, valid reasons for preparing such documentation.
Valid Not valid

(i) To comply with the law.

(ii) To provide a record of matters of continuing significance to

future audits.

(iii) To facilitate review by senior staff.

(iv) To prove adherence to ISAs in a litigious situation.

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you explain the reasons why the auditor keeps audit documentation?

Can you identify standard contents of audit working papers?

Can you distinguish between items that should be contained in the permanent and
current audit files?

Do you know who owns working papers and how long they should be retained by the
auditor?

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11

Evidence and sampling

Topic List
1. Evidence
2. Selecting items to test
3. Drawing conclusions from sampling
4. Evaluation of misstatements

Learning Objectives
 Understand the procedures for obtaining evidence
 Identify when tests of controls and substantive procedures will be used
 Recognise the strengths and weaknesses of particular forms of evidence
 Understand how much evidence to obtain
 Recognise when sufficient appropriate evidence has been obtained such that a conclusion can
be drawn

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1 Evidence
1.1 Overview of evidence from Chapter 4
There are two types of test; tests of controls (we have looked at in detail in Chapters 5 to 9) and
substantive procedures (we will look at in more detail in Chapters 12 and 13).
ISA 500 states that evidence must be sufficient and appropriate.
 Sufficiency is the measure of the quantity of audit evidence.
 Appropriateness is the measure of the quality or relevance and reliability of the audit evidence.

1.2 Procedures to obtain evidence

Procedure Explanation Weakness of procedure
Analytical Evaluation of financial
Procedures information by studying
possible relationships among
financial and non-financial
data

Enquiry Ask a relevant person for

information

Inspection Of a document such as an

invoice or a physical asset

Observation Of a process such as an

inventory count

Recalculation Check the mathematical

accuracy of a document

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1.3 Computer assisted audit techniques

With so many accounting systems now held on computer, the assurance provider may wish to make
use of computer assisted audit techniques (CAATs).
 Test data
 Audit software
 Data analytics
Test data Audit software Data analytics
Test data – this is where the Audit software – this is where the Using IT to help identify patterns
auditor tests the integrity of the auditor uses his own computer or trends this may allow the
client’s system by posting data programmes to substantively test auditor to review 100% of the
onto the client’s computer system a balance or transaction. population.
to see if the transactions are Examples Examples
posted as they should be.
The most commonly used form of Analyse sales trends by product or
Examples audit software is the spread sheet, region
Password controls – to see if which can check the correct Auditors could also ‘mine’ the
unauthorised users can access key casting (addition) of a set of client’s systems to identify
areas of the system numbers or facilitate sample unusual events, anomalies and
selection and ratio calculations. red flags
Review staff emails within the
entity helping identify risk of fraud
via key words
Using external information such as
a flurry of ‘Tweets’ on Company X
helping identify an environmental
issue affecting the company!

1.4 Analytical procedures

ISA 520 (UK and Ireland) Analytical Procedures states that analytical procedures should be used at the
planning stages and as part of substantive procedures.

Planning stage
Analytical procedures should be used at the risk assessment stage. Possible sources of information
about the client include:
 Interim financial information
 Previous financial statements
 Budgets
 Management accounts
 Non-financial information
 Board minutes

Substantive procedures
ISA 520 describes how the auditor must decide whether using substantive analytical procedures will
be effective and efficient in reducing audit risk to an acceptably low level.
There are a number of factors that the auditors should consider when using analytical procedures as
substantive procedures:
 Objective of the analytical procedures (for example analytical procedures may be good at
indicating whether a population is complete)

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 Suitability of analytical procedures

 Reliability of the data
When analytical procedures identify significant fluctuations or relationships that are inconsistent with
other relevant information, or that are not the results that were expected, this must be investigated
further.

1.5 Directional testing

For any item in the final statements which is being tested there are two possibilities. It could be fairly
stated or misstated. If it is misstated there are again two possibilities. It could be:
 Overstated
 Understated
When testing for overstatement (or existence/occurrence) a different approach is used from testing
for understatement (or completeness).

INTERACTIVE QUESTION 1: EVIDENCE [DIFFICULTY LEVEL: EXAM STANDARD]

In respect of an assurance engagement, which one of the following is the least persuasive method of
gathering evidence?
A Inspection of a purchase invoice
B Inspection of a sales invoice
C Inspection of inventory by the auditor
D Re-performance of a supplier statement reconciliation undertaken by the client

1.6 Audit of accounting estimates

The auditor often has to audit estimated figures, such as those for product warranties, depreciation,
inventory or receivables provisions, where the values included in the financial statements are not the
result of transactions with third parties (which are fairly reliable) but result from judgements made by
management. Yet these figures can have a very significant effect on reported profits.
There is a risk that management may be biased in the judgements it makes when calculating estimated
figures. The auditor must therefore approach these values with professional scepticism regarding the
judgements made.
Common audit procedures used to test estimates include:
 Review the process used by management to develop the estimate for reasonableness
 Use an independent expert to make an estimate for comparison
 Review the accuracy of prior year’s estimates compared to the final actual results
 Review subsequent events for events that help to confirm the accuracy of the estimate

2 Selecting items to test

2.1 The concept of sampling
Assurance providers do not normally examine all the information available to them; it would be
impractical to do so and using sampling will produce valid conclusions provided it is carried out
properly.

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KEY TERMS
Audit sampling: The application of audit procedures to less than 100% of items within
a population of audit relevance such that all sampling units have a chance of selection
in order to provide the auditor with a reasonable basis on which to draw conclusions
about the entire population.
Population is the entire set of data from which a sample is selected and about which an
auditor wishes to draw conclusions.

Statistical sampling:
An approach to sampling that has the following characteristics:
(i) Random selection of the sample items; and
(ii) The use of probability theory to evaluate sample results, including measurement of sampling
risk.

Non-statistical sampling:
A sampling approach that does not have characteristics (i) and (ii) is considered non-statistical
sampling.

2.2 Design of the sample

ISA 530 requires that the auditor ‘shall select items for the sample in such a way that each sampling
unit in the population has a chance of selection’.
The population from which the sample is drawn must be appropriate and complete for the specific
audit objectives. Auditors must define the sampling unit in order to obtain an efficient and effective
sample to ensure no misstatement or error.

KEY TERMS
Sampling units are the individual items constituting a population.
Misstatement: a difference between the amount, classification, presentation, or
disclosure of a reported financial statement item and the amount, classification,
presentation, or disclosure that is required for the item to be in accordance with the
applicable financial reporting framework. Misstatements can arise from error or fraud.
Error: an unintentional misstatement in financial statements, including the omission of
an amount or a disclosure.

2.2.1 Factors affecting sample sizes

ISA 530 gives examples of factors which influence sample sizes. The following factors would INCREASE
sample sizes:
 An increase in the auditor’s assessment of the risk of material misstatement
 An increase in an auditor’s desired level of assurance
 An increase in the amount of misstatement the auditor expects to find in a population
 A decrease in the use of analytical procedures to test the same balance.

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2.3 Selecting the sample

Sample method Explanation Example
Random selection Ensures that all items in the By use of random number tables
population have an equal chance or computerised generator
of selection
Systematic selection Involves selecting items using a Every 10th sales invoice
constant interval between
selections
Haphazard selection An alternative to random Auditor uses their judgement to
selection provided assurance choose sample, but risk of bias!
providers are satisfied that the
sample is representative of the
entire population
Sequence or block selection Sequence sampling may be used A sample of 50 consecutive
to check whether certain items cheques to check whether
have particular characteristics cheques are signed by authorised
signatories rather than picking
50 single cheques throughout the
year
Monetary Unit Sampling (MUS) This is a selection method that Worked example below
ensures that every £1 in a
population has an equal chance of
being selected for testing

WORKED EXAMPLE: MUS

You are auditing trade accounts receivable. Total trade account receivables is £500,000 and materiality
is £50,000. You will select the balances containing each 50,000th £1 from the following ledger.
Customer Balance Cumulative Selected?
total

A 30,000 30,000 No Material items are shown in bold and

B 35,000 65,000 Yes have all automatically been selected.
C 45,000 110,000 Yes The cumulative column shows you
D 52,000 162,000 Yes when the next 50,000th £1 has been
E 13,000 175,000 No reached.
F 50,000 225,000 Yes
G 23,000 248,000 No
H 500 248,500 No
I 41,500 290,000 Yes
J 47,000 337,000 Yes
K 54,000 391,000 Yes
L 17,000 408,000 Yes
M 80,000 488,000 Yes
N 12,000 500,000 Yes
Total 500,000

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INTERACTIVE QUESTION 2: SAMPLING

When determining a sample size for tests of detail there are a number of factors that an auditor
should take into account.
For each of the following factors, select whether it would cause the sample size to increase or
decrease.
Increase Decrease

(i) Decrease in the assessed level of tolerable misstatement.

(ii) Increase in the assessed risk level.

(iii) Discovery of more misstatements during testing

3 Drawing conclusions from sampling

When the auditors have tested a sample of items, they must then draw conclusions from that sample.
The purpose of audit sampling is to enable conclusions to be drawn from an entire population on the
basis of testing a sample drawn from it.
The auditors must project the misstatement results from the sample onto the relevant population. The
auditors will estimate the probable misstatement in the population by extrapolating the
misstatements found in the sample.
If the projected population misstatement exceeds or is close to tolerable misstatement, they shall
consider extending auditing procedures or performing alternative procedures.

WORKED EXAMPLE: EVALUATING SAMPLE RESULTS

When auditing trade receivables the following was noted:

Value of population £1,000,000
Sample value £100,000
Errors found £10,000
Calculate the expected error in the population
SOLUTION
10,000/100,000 × 1,000,000 = 100,000
If tolerable error was £60,000 – this expected error would cause some concern and require the
sample size to be increased.

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INTERACTIVE QUESTION 3: DRAWING CONCLUSIONS FROM SAMPLING [EXAM STANDARD]

Danielle has carried out a receivables circularisation on Donothing plc to gain evidence about the
receivables balance stated in the draft balance sheet. Identify whether the following conclusions
drawn by her are correct or not.
True False
An amount disagreed by Lazy Limited because an invoice had been
paid two days before the year end and cleared shortly after the year
end, did not constitute a misstatement for the purposes of drawing a
conclusion for the whole population.
An amount disagreed by Sloth Limited because a credit note had been
issued by Donothing plc a month before the year end did not
constitute a misstatement for the purposes of drawing a conclusion
for the whole population.
An amount disagreed by Busy Limited because they had paid the
balance some time earlier, which further enquiry revealed had been
posted to a different customer account, did constitute a
misstatement for the purposes of drawing a conclusion for the whole
population.

4 Evaluation of misstatements
The auditor is required to evaluate the effect of identified misstatements on the audit in ISA 450 (UK
and Ireland) Evaluation of Misstatements Identified during the Audit.
Under this ISA, the auditor must also evaluate the effect of any uncorrected misstatements on the
financial statements. During the audit, auditors must accumulate any non-trivial misstatements
identified and determine whether as a whole these are material?
In determining whether misstatements are material, the auditor must consider the size and nature of
the misstatements, along with the particular circumstances of their occurrence. Certain circumstances
may cause the auditor to evaluate misstatements as material, even if they are lower than materiality
for the financial statements as a whole.
Examples of circumstances include,
 Affects compliance with regulatory requirements
 Affects compliance with debt covenants or other regulatory requirements
 Masks a change in earnings or other trends
 Affects ratios used to evaluate the entity’s financial position
 Involves management’s compensation

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5 Remote auditing and pandemic considerations

The pandemic saw an enforced change in auditing practices due to lockdown. While it has been
possible to return to traditional methods of auditing since, it seems some elements of remote auditing
may remain, and the pandemic has raised different audit considerations than might have otherwise
been the case. ICAEW has issued guidance in relation to this.
 It is permissible to use electronic signatures on documents, including the auditor’s report
 Video-conferencing may be used, but should be secure
 Related audit risk factors must be considered, for example, pandemic will influence
consideration of going concern
 Consideration of impact of client home working arrangements on client’s internal control
systems
 Impact on possibility of fraud and need for continued/heightened professional scepticism
(regardless of associated sympathy). Post pandemic conditions could lead to individuals doing
what they would not otherwise have done.

INTERACTIVE QUESTION 4: MATERIAL MISSTATEMENTS [DIFFICULTY LEVEL: EXAM STANDARD]

Which two of the following should be determined as material uncorrected misstatements?

A An isolated misposting between two supplier accounts which is below materiality
B A misstatement which is below materiality and results in director’s bonus targets being met
C An immaterial misstatement of assets which results in a debt covenant not being breached
D The monthly bank reconciliation was not prepared in August as the cashier was on holiday

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.
Confirm your learning Yes/No

Can you explain and distinguish between different methods of obtaining audit
evidence and their limitations?

Can you explain audit data analytics/audit software and test data?

Can you explain and distinguish between different sampling techniques and when
each may be relevant?

Can you identify factors that would influence a sample size?

Can you explain four methods of auditing an estimate?

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12

Written representations

Topic List
1. Written representations as assurance evidence
2. When other written representations are required

Learning Objectives
 Understand the purpose and nature of written representations from management
 Understand when oral representations should be confirmed in writing
 Understand how reliable these written representations are as a form of assurance evidence

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1 Written representations as assurance evidence

ISA 580 Written Representations covers this area. Written representations (or “management
representations”) are a form of audit evidence. They are contained in a letter, written by the auditor,
signed by the company’s directors on entity letter headed paper, prior to the completion of audit work
and before the audit report is signed.

1.1 General matters

Written representations are required for general matter, for example where those charged with
governance confirm they have
 Fulfilled their responsibility for the preparation of the financial statements in accordance with
the applicable financial reporting framework
 Provided the auditor with all relevant information and to all accounting records
 Recorded and reflected all transactions in the financial statements
 Management acknowledge that the aggregated uncorrected misstatements are immaterial to
the financial statements
The written representations are dated as near as possible, but not after, the date of the auditor’s
report on the financial statements.

2 When other written representations are required

Some forms of audit evidence are normally unavailable because knowledge of the facts is confined to
management or the matter is one of judgement or opinion.
E.g. a warranty provision is essentially an estimate as to how many goods will need to be repaired
under warranty in the future. By its very nature, this figure will be an estimate for which independent
third party evidence is unlikely to be available.
Obtaining representations does not mean that other evidence does not have to be obtained. Audit
evidence will still be collected and the representation will support that evidence. Any contradiction
between sources of evidence should, as always, be investigated.

2.1 Unreliable representations

There may be occasions when there are doubts over the reliability of written representations. If the
auditor has concerns over the competence, integrity, ethical values or diligence of management, the
auditor shall determine the effect that such concerns may have over the reliability of representations.

2.2 Inconsistent representations

If written representations are inconsistent with other audit evidence, the auditor shall perform audit
procedures in an attempt to resolve the matter. If the matter remains unresolved, the auditor shall
reconsider its assessment of management and determine the effect that this may have on the
reliability of representations

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INTERACTIVE QUESTION: WRITTEN REPRESENTATIONS [DIFFICULTY LEVEL: EXAM STANDARD]

Which two of the following are purposes of a written representation letter?

A Confirmation that management has received the signed audit report
B Confirmation that management has fulfilled its responsibility for the preparation of the financial
statements
C Confirmation of all representations made by management in the course of the audit
D Confirmation that management has recorded and reflected all transactions in the financial
statements
E Confirmation that management understands the terms of the engagement

REAL LIFE
An example written representation letter can be found in chapter 18 for your review only

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you give examples of the typical contents of a written representation letter?

Can you explain who writes and who signs the written representation letter?

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13

Substantive procedures – key

financial statement figures

Topic List
1. Non-current assets
2. Inventory
3. Receivables
4. Bank
5. Payables
6. Long-term liabilities
7. Statement of profit or loss items

Learning Objectives
 Understand the nature of tests on balances carried out by assurance providers and the
objectives of those tests
 Identify suitable tests in a given business scenario
 Understand when a matter should be referred to a senior member of staff

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1 Non-current assets
1.1 Tangible non-current assets
You should be aware of the major classes of tangible non-current assets from your Accounting studies.
Examples of tangible non-current assets include land, buildings, plant, vehicles, fittings and equipment.

Risk of misstatement due to: Assertion

The company not actually owning the assets Rights and obligations
The assets not actually existing or having been sold by the company Existence
Omission of assets owned by the company Completeness
The assets being undervalued, by not including an appropriate Valuation
revaluation in a policy of revaluation or by overcharging depreciation
The assets being overvalued, either by inflating cost or valuation, or by Valuation
undercharging depreciation
The assets being incorrectly presented in the financial statements Presentation and disclosure

The objective of assurance tests in respect of non-current assets is therefore to prove that these
assertions about the assets are correct. There are several sources of information about non-current
assets that can be used:
 The non-current asset register
 Purchase invoices for assets purchased within the year
 Sales invoices for assets sold within the year
 Registration documents or other documents of title such as title deeds for property
 Valuations carried out by employees or third-party valuers
 Leases or hire purchase documentation in respect of assets
 Physical inspection of the assets themselves by the auditor
 Depreciation records or calculations (these are often kept with the asset register)

1.2 Intangible non-current assets

Examples of intangible assets include licences, development costs and purchased brands.
Risk of misstatement due to: Assertion
Expenses being capitalised as non-current assets inappropriately Existence
Intangible assets being carried at the wrong cost or valuation due to inflating the Valuation
cost or valuation
Intangible assets being carried at the wrong cost or valuation due to charging Valuation
inappropriate amortisation, wrongly amortising or not amortising
Intangible assets being carried at the wrong cost or valuation due to impairment Valuation
reviews not being carried out appropriately

The objective of tests in respect of intangible non-current assets is therefore to prove that these
assertions about the assets are correct. The following sources of information can be used:
 Accounting standards for what constitutes an intangible asset
 Purchase invoices or documentation (particularly for, say, purchased intangibles)
 Client calculations and schedules (R&D)
 Specialist valuations

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1.3 Audit of Non-current assets

Non-current Asset Register Year End 31st December 20X1

Depreciation Depreciation Carrying Current year Carrying

Asset no. Date Discription Cost B/fwd Additions Disposals Cost C/fwd To Date on Disposal Value B/fwd Depreciation Value C/fwd

Office Equipment 3 years Straight Line

1 Jan 20X0 Photocopier 1500 1500 500.00 1000.00 500.00 500.00

2 Jan 20X0 Laptop 1000 1000 333.33 666.67 333.33 333.33
4 Jan 20X0 Laptop 1000 -1000 0 333.33 -333.33 666.67 0.00 0.00
3 Jan 20X0 Computer 1500 1500 500.00 1000.00 500.00 500.00
5 Jan 20X0 TV 450 450 150.00 300.00 150.00 150.00
6 Jan 20X1 Laptop 1200 1200 0.00 0.00 400.00 800.00

5450 1200 -1000 5650 1816.67 -333.33 3633.33 1883.33 2283.33

Fixtures and fittings 10% Reducing Balance

7 Jan 20X0 Desks 3000 3000 300.00 2700.00 270.00 2430.00

8 Jan 20X0 Reception desk 3000 3000 300.00 2700.00 270.00 2430.00
9 Mar 20X0 Shelves 1000 1000 100.00 900.00 90.00 810.00
10 Jun 20X0 Cupboards 1500 1500 150.00 1350.00 135.00 1215.00

8500 0 8500 850 0 7650 765 6885

Motor Vehicles 25% Reducing Balance

11 Jan 20X0 Golf YH68ZXZ 15000 15000 3750 11250 2812.5 8437.5
12 Mar 20X0 Mazda RE67WEW 23000 23000 5750 17250 4312.5 12937.5

38000.00 0.00 0.00 38000.00 9500.00 0.00 28500.00 7125.00 21375.00

Agree to Financial Statements 51950.00 1200.00 -1000.00 52150.00 12166.67 -333.33 39783.33 9773.33 30543.33

Goods Goods Mazda

Purchase Sales
received dispatch registration
Invoice Invoice
note note document

AUDIT OF NON-CURRENT ASSETS EXAMPLE

Using the above Non-current asset register and sources of information identify tests of:
Existence, rights and obligations, completeness and valuation

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INTERACTIVE QUESTION 1: NON-CURRENT ASSETS [DIFFICULTY LEVEL: EXAM STANDARD]

Which three of the following might an auditor vouch when testing the rights and obligations of a
company in respect of a vehicle?
A A purchase invoice
B A registration document
C A hire-purchase agreement
D An asset register

2 Inventory
The major risks of misstatement of the inventory balance in the financial statements are due to:

Risk of misstatement due to: Assertion

Inventory that does not exist being included in the financial statements Existence
Not all inventory that exists being included in the financial statements Completeness
Inventory being included in the financial statements at full value when it is Valuation
obsolete or damaged
Inventory being included in the financial statements at the wrong value, whether Valuation
due to miscalculation of cost or the fact that cost has been used although net
realisable value is lower than cost
Inventory that actually belongs to third parties being included in the financial Rights
statements and obligations
Inventory which has actually been sold is included in the financial statements Cut-off/ Rights
and obligations

The objective of assurance tests in respect of inventory is therefore to prove that these assertions
about the assets are correct. The following sources of information can be used:
 The company’s controls over inventory counting
 The auditors’ attendance at the annual inventory count
 Confirmations with third parties holding inventory on behalf of entity
 Purchase invoices for inventory
 Work-in-progress records for inventory
 Post-year-end sales invoices for inventory
 Post-year-end price lists for inventory
 Post-year-end sales orders

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2.1 Inventory count

Attendance at an inventory count can be very important. In order to confirm the amount of inventory
in existence, rather than undertake a count itself, assurance providers usually rely on the controls
that a company has in operation over its annual inventory count.
In terms of inventory counts, the assurance provider will be looking for the following sorts of controls.
Observation of the inventory count
Organisation of Supervision by senior staff, including senior staff not normally involved with
count inventory
Restriction and control of the production process and inventory movements during
the count
Identification of damaged, obsolete, slow-moving, third party and returnable
inventory
Counting Systematic counting to ensure all inventory is counted
Teams of two counters, with one counting and the other checking, or two
independent counts
Recording Serial numbering, control and return of all inventory sheets
Inventory sheets being completed in ink and signed
Recording of quantity, conditions and stage of production of work-in-progress
Recording of last numbers of goods inwards and outwards records and of internal
transfer records
Reconciliation with inventory records and investigation and correction of any
differences

2.2 Cost v NRV

List 4 examples of when NRV is likely to be less than cost.
(1)

(2)

(3)

(4)

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2.3 Audit of Inventory

YE 31st December 20X1
Inventory Sheet No 1 of 1

Discription
Of Item Quantity Value (£) Total Cost NRV if lower

A's 1343 10 13430

B's 134 3.5 469
C's 762 6 4572 Purchase
Goods
received
Invoice
D's 463 7.5 3472.5 note

E's 100 12 1200 500

F's 562 5.5 3091
G's 985 4.75 4678.75
H's 625 8 5000 Sales Goods
dispatch
I's 13 7 91 Invoice
note
J's 359 9 3231
K's 762 10 7620
L's 13 5.5 71.5
M's 86 2.5 215
Attendance at the
inventory count
47141.75 500

Inventory Value 46441.75

Agrees to Financial Statements

AUDIT OF INVENTORY EXAMPLE

Using the above Inventory count sheet and sources of information identify tests of:
Existence, rights and obligations, completeness and valuation

INTERACTIVE QUESTION 2: INVENTORY [DIFFICULTY LEVEL: EXAM STANDARD]

Which one of the following procedures should be undertaken to confirm the existence of inventory?
A Attendance at inventory count
B Follow up of inventory count sheets to final inventory sheets
C Trace items of inventory to purchase invoices
D Cast the final inventory sheets

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3 Receivables
Risk of misstatement due to: Assertion
Debts being uncollectable Valuation
Debts being contested by customers Existence, rights and obligations

The objective of assurance tests in respect of receivables is therefore to prove that these assertions
about the assets are correct. The following sources of information can be used:
 Receivables ledger information
 Confirmations from customers
 Cash payments received after the year end

3.1 Confirmations from customers

The verification of trade receivables by external confirmation is a means of providing relevant and
reliable audit evidence to satisfy the objective of checking whether customers exist and owe bona fide
amounts to the company (existence and rights and obligations).
The letter is on the client’s paper, signed by the client and the reply is sent directly to the auditor in a
pre-paid envelope.
When confirmation is undertaken the method of requesting information from the customer may be
either ‘positive’ or ‘negative’.
Positive method Negative method
The customer is requested to give the balance or The customer is requested to reply only if the
to confirm the valuation of the balance shown or amount stated is disputed. (This method generally
state in what respect he is in disagreement. provides less reliable audit evidence than the
positive method as a lack of response could mean
that the customer does not dispute the balance, or
it could mean that the customer did not receive
the confirmation request, or ignored it.)

For these reasons, a positive confirmation request provides more reliable audit evidence than a
negative confirmation.
The negative method should only be used when:
 Assessed risk of material misstatement is low
 The relevant controls are operating effectively
 A large number of small balances is involved
 A substantial number of errors is not expected
 The auditor has no reason to believe that customers will disregard the request
Assurance providers will normally only contact a sample of customers, when constructing the sample,
the following classes of account should receive special attention:
 Material, risky accounts
 Old unpaid accounts
 Accounts written off during the period under review
 Accounts with credit balances
 Accounts settled by round sum payments
 Accounts with nil balances
Assurance providers will have to carry out further work in relation to those receivables who:
 Disagree with the balance stated (positive and negative confirmation)
 Do not respond (positive confirmation only)

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Differences arising that merely represent invoices or cash in transit (normal timing differences)
generally do not require adjustment, but disputed amounts, and errors by the client, may indicate that
further substantive work is necessary to determine whether material adjustments are required.

3.2 Alternative procedures to verify existence/rights and obligations

Alternative procedures may include the following.
Check receipt of cash after date
Examine the account to see if the balance outstanding represents specific invoices and confirm their
validity to despatch notes
Test company's control over the issue of credit notes and the write-off of bad debts

3.3 Bad debts

A significant test of bad debts will be reviewing the cash received after date. This will provide evidence
of collectability of debts (and hence valuation).

3.4 Audit of Trade Receivables

Year end 31st December 20X1
Trade Receivables

Customer Total Current 30 Days 60 Days 90 Days Older

Appy Ltd 3499.96 999.99 999.99 999.99 499.99

Aardvark Ltd 44337.59 11356.87 10532.87 12573.87 9873.98
Butterfly Ltd 553.4 100.53 452.87
Dandy Plc -300 -300
Duck Ltd 457.27 457.27
Freddie Co 12201.39 2765.87 5134.87 3763.98 536.67
Great Inc 2314.98 2314.98
Happy Plc 1218.3 564.87 653.43
Long Life Ltd 25111.37 4523.76 10431.73 4523.65 5632.23
Octopus Plc 562.65 562.65
Percy Ltd 335.12 100.45 234.67
Ronald 541.56 541.56
Stevies Undies Ltd 117.76 563.52 -445.76
Thomas 1023.9 456.23 567.67
Wessex Ltd 123.87 123.87

Agrees to Financial Statements 92099.12 20534.01 29571.62 22435.65 17042.87 2514.97

Customer Goods
Sales Credit
confirmation dispatch
Invoice note
+ and - note

Cash received post year end

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AUDIT OF TRADE RECEIVABLES EXAMPLE

Using the above Trade Receivable ledger and sources of information identify tests of:
Existence, rights and obligations, completeness and valuation

INTERACTIVE QUESTION 3: AUDIT OF RECEIVABLES [DIFFICULTY LEVEL: EXAM STANDARD]

Which one of the following procedures should be undertaken to confirm the rights and obligations of
trade receivables?
A Review of cash received after date
B Tests of controls over ordering
C Receivables external confirmation
D Recalculation of specific allowance for doubtful debts

4 Bank
Risk of misstatement due to: Assertion
Not all bank balances owned by the client being disclosed Rights and obligations/completeness
Reconciliation differences between bank balance and cash Valuation
book balance being misstated
Material cash floats being omitted or misstated Completeness/existence

The objective of tests in respect of bank is therefore to prove that these assertions about the assets
are correct. The following sources of information can be used:
 Cash book
 Confirmation from the bank
 Bank statements
 Bank reconciliation carried out by the client

4.1 Direct confirmation with bank

Testing of bank balances will need to cover completeness, existence, rights and obligations and
valuation. All of these elements can be tested directly through the device of obtaining third party
confirmations from the client’s banks and reconciling these with the accounting records, having regard
to cut off.
Banks often hold securities and other items in safe custody on behalf of customers. A request letter
may thus ask for confirmation of such items held by the confirming bank.
The procedure is simple but important.
 The banks will require explicit written authority from their client to disclose the information
requested.
 The assurance providers’ request must refer to the client’s letter of authority and the date
thereof. Alternatively it may be countersigned by the client or it may be accompanied by a
specific letter of authority.

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 The request should reach the branch manager at least two weeks in advance of the client’s
year end and should state both that year-end date and the previous year-end date.
 The bank confirmation should be sent directly from the bank to the assurance provider.

4.2 Bank reconciliation

Care must be taken to ensure that there is no window dressing as an attempt to overstate the liquidity
of the company by:

Example Impact on F/S Audit by

Keeping the cash book Thus enhancing the balance at The assurance providers should
open to take credit for bank and reducing receivables, as examine the paying in slip to ensure
remittances actually cash is more liquid than debt. that the amounts were actually paid into
received after the year- the bank on or before the balance sheet
end, date.
Recording cheques paid Thus decreasing the balance at The assurance providers should check
in the period under bank and reducing payables. This whether these were cleared within a
review which are not can contrive to present an reasonable time in the new period. If
actually despatched until artificially healthy looking current not, this may indicate that despatch
after the year-end, ratio. occurred after the year-end.

4.3 Audit of Bank

Year ending 31st December 20X1
Bank Reconciliation

Balance per bank statement at 31st December 20X1 156,567.89

Add outstanding lodgements:

27/12/20X1 Duck Ltd 5432.87

28/12/20X1 Freddie Co 456.98
29/12/20X1 Great Inc 523.65
29/12/20X1 Happy Plc 542.76
6956.26

Less outstanding cheques:

20/12/20X1 100134 Ratty Rags Inc 567.12

20/12/20X1 100135 Cuthburt Co 7823.98
20/12/20X1 100136 Dandy doodle 10000.00
20/12/20X1 100137 Jenny Ltd 563.98
-18955.08

Agrees to Financial Statements 144,569.07

Cheque book Paying in book

Bank
confirmation Bank Remittance
letter statements advice

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AUDIT OF BANK EXAMPLE

Using the above Bank reconciliation and sources of information identify tests of:
Existence, rights and obligations, completeness and valuation

INTERACTIVE QUESTION 4: BANK BALANCE [DIFFICULTY LEVEL: EXAM STANDARD]

Which one of the following will be confirmed by obtaining a bank letter from a specific bank?
A That the bank balance stated on the bank reconciliation is correct.
B That the unpresented cheques listed on the bank reconciliation were sent out pre year-end.
C That the company possesses only the bank accounts it declares.
D That the cash floats of the company are fairly stated.

5 Payables
Risk of misstatement due to: Assertion
The entity understating its liabilities in the financial statements Completeness
Cut-off between goods inward and liability recording being incorrect rights and
obligations
Non-existent liabilities being declared (rare) Existence, rights
and obligations

The objective of tests in respect of payables is therefore to prove that these assertions about the
liabilities are correct. The following sources of information can be used:
 Payables ledger records
 Confirmations from suppliers

5.1 Supplier statements

The most important test when considering trade payables is comparison of suppliers’ statements with
payables ledger balances.
When selecting a sample of payables to test, assurance providers must be careful not just to select
suppliers with large year-end balances. Remember, it is errors of understatement that assurance
providers are primarily interested in when reviewing payables, and errors of understatement could
occur equally in payables with low, nil or negative balances as with high.

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5.2 Audit of Trade Payables

Year end 31st December 20X1
Trade Payables

Supplier Total Current 30 Days 60 Days 90 Days Older

Andy Ltd 1555.52 786.98 768.54

All The Way Plc 4148.74 765.98 3258.98 123.78
Bobby Ltd 1773.96 789.09 984.87
Eat Fresh Ltd 854.88 754.89 99.99
Hungry Plc 9570.08 236.76 6543.78 2789.54
Giant BLT Ltd 1672.52 564.65 564.89 542.98
Full Ltd 9864.87 9864.87
Tea Time plc 896.52 784.87 67.87 43.78
Kettle Ltd 10845.65 5432.76 5412.89
Sugar Ltd 10876.65 10876.65
No Thanks Plc 543.89 543.89
Cup or Mug Inc 6445.91 6543.98 -98.07
Night Inc 1551.85 897.09 654.76
Morning Plc 123.45 123.45
Stop Ltd 2345.87 2345.87

Agrees to Financial Statements 63070.36 31446.91 18256.58 3502 0 9864.87

Supplier Goods Purchase Credit

Statement received Invoice note
note

AUDIT OF TRADE PAYABLES EXAMPLE

Using the above Trade Payables ledger and sources of information identify tests of:
Existence, rights and obligations, completeness, and valuation

5.3 Other payables/accrued expenses

Companies may have other payables and the tests carried out on them will vary according to what the
nature of that account is. Remember that you are primarily testing for understatement. Consider if you
can obtain third party evidence about the balance.

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INTERACTIVE QUESTION 5: AUDIT OF PAYABLES [DIFFICULTY LEVEL: EXAM STANDARD]

Indicate whether the following statements are true or false.

True False
Supplier statements are a strong source of evidence as they are third
party evidence; however, as the assurance provider receives them
through the medium of the client, the assurance provider must treat
supplier statements with professional scepticism.

Payables may be tested by cash payments after date as these give an

indication that debts were owed and the value of those debts has not
been understated.

6 Long-term liabilities
We are concerned here with long-term liabilities comprising debentures, loan stock and other loans
repayable at a date more than one year after the year-end.
Risk of misstatement due to: Assertion
That not all long-term liabilities have been disclosed Completeness
That interest payable has not been calculated correctly and included in the correct Accuracy and Rights
accounting period and obligations
That disclosure is incorrect Presentation and
disclosure

The following sources of information exist:

 Schedule of loans and client calculations
 Loan agreements
 Bank letter and direct confirmations from other lenders
 Cash book
 Board minutes

Long-term liabilities
Completeness
Analytical procedures to prior year
Inspect board minutes
Existence
Obtain and inspect confirmation from banks
Rights and obligations
Obtain and inspect confirmation from banks
Valuation
Recalculate – agreeing B/fwd to prior year and movements to any 3rd party documentation
Disclosure
Inspect classification, Current Liability vs Long Term Liability
Appropriate written disclosures ie securities

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7 Statement of profit or loss items – substantive tests

7.1 Revenue
Analytical procedures, seasonal, yearly comparisons, enquiry if unusual
Analytical procedures, predictable relationships with other items in the financial statements, notably
receivables,
Inspect sample of individual transactions to sales invoices to ensure existence

7.2 Purchases
Analytical procedures due to the strong relationships that purchases has with other items in financial
statements, notably inventory and payables.
Inspect a sample of transactions, invoices, tracing them through the system to ensure completeness.

7.3 Payroll costs

Analytical procedures are often carried out on payroll costs as there are strong relationships between
numbers of staff, pay rates and overall costs and also tax/NI rates and pay.
Inspect a sample of payroll records, ensuring that time worked has been correctly included (to clock-
cards), employees exist (personnel records) and are being paid at the correct rate (contracts/personnel
records)
Recalculate a sample of payroll employees to ensure correctly calculated
Inspect a sample of payments to the employees and tax authorities by verifying to bank statements.

7.4 Interest paid/received

Inspecting bank statements or confirmations from other lenders to ensure interest correctly paid or
received

7.5 Expenses
Analytical procedures, by looking at year on year comparisons and enquiring if anything spotted is
unusual
Inspect specific transactions to purchase invoices.

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Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you identify audit procedures to audit non-current assets relating to existence,
completeness, valuation and rights/obligations?

Can you identify audit procedures to audit inventory relating to existence,

completeness, valuation and rights/obligations?

Can you identify audit procedures to audit trade receivables relating to existence,
completeness, valuation and rights/obligations?

Can you identify audit procedures to audit trade payables relating to existence,
completeness, valuation and rights/obligations?

Can you identify audit procedures to audit the bank balance relating to existence,
completeness, valuation and rights/obligations?

Can you identify audit procedures to audit long-term liabilities relating to existence,
completeness, valuation and rights/obligations?

Can you identify procedures to audit key items in the profit or loss account?

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97

14

Codes of professional ethics

and regulatory issues

Topic List
1. Professional ethics
2. IESBA (IFAC) Code of ethics
3. ICAEW Code of ethics
4. FRC Ethical Standards for Auditors

Learning Objectives
 Be aware of the key ethical codes to which ICAEW members are subject and the sources that
influence them
 Understand the difference between principles and rules based systems
 Understand why ethics are important to accountants
 Know the key features of IESBA and ICAEW Codes
 Know the fundamental principles of IESBA and ICAEW Codes

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1 Professional ethics
1.1 Need for ethics
Professional accountants have a responsibility to consider the public interest and maintain the
reputation of the accounting profession. Personal self-interest must not prevail over these duties.
The key reason accountants need to have an ethical code is that people rely on them and their
expertise. It is important to note that this reliance extends beyond clients to the general community.
Auditors claim to give an independent view. It is therefore critical that auditors are independent.
A set of ethical guidelines gives protection to accountants as well, as they cannot be accused of
behaving differently from other accountants.

1.2 Sources of ethical guidance

ICAEW Code ICAEW members (and trainees) and employees of member firms are subject to
the ICAEW Code of Ethics.
IESBA Code The ICAEW code is influenced by the guidance of IESBA (IFAC) (the
International Federation of Accountants, of which ICAEW is a member).
FRC Ethical Standards Auditors practicing in the UK also must adhere to the FRC Ethical Standards
(see section 4.)

1.3 Rules or principles-based guidance?

The ethical guidance we shall look at tends to be in the form of a principles-based framework.
There are a number of advantages of a framework of principles over a system of ethical rules, which
are outlined in the following table.

Factor Explanation
Active consideration A framework of principles places the onus on the accountant to actively
and demonstration of consider objectivity for every given situation, rather than just agreeing a
conclusions checklist of forbidden items.
Broad interpretation of A principles-based framework prevents auditors interpreting legalistic
ethical situations requirements narrowly to get around ethical requirements. There is an
element to which rules encourage deception whereas principles encourage
compliance.
Individual situations A principles-based framework allows for the variations that are found in
covered individual situations. Each situation is likely to be different.
Flexible to changing A principles-based framework can accommodate a rapidly changing
situation environment, such as the one that assurance providers are involved in.
Can incorporate However, a principle-based framework can contain certain prohibitions where
prohibitions these are necessary.

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2 IESBA (IFAC) Code

2.1 Fundamental principles
The fundamental principles are:
Principle Explanation
Integrity A professional accountant should be straightforward and honest in all professional
and business relationships and being uncorrupted by self-interest.
Objectivity A professional accountant should not allow bias, conflict of interest or undue
influence of others to override professional or business judgements
Professional A professional accountant has a continuing duty to maintain professional knowledge
competence and skill at the level required to ensure that a client or employer receives competent
and due care professional service based on current developments in practice, legislation and
techniques. A professional accountant should act diligently and in accordance with
applicable technical and professional standards when providing professional services
Confidentiality A professional accountant should respect the confidentiality of information acquired
as a result of professional and business relationships and should not disclose any such
information to third parties without proper and specific authority unless there is a
legal or professional right or duty to disclose
Professional A professional accountant should comply with relevant laws and regulations and
behaviour should avoid any action that discredits the profession

2.2 Safeguards
There are two general categories of safeguard identified by the Code:

Safeguards created by the profession, Safeguards in the work environment:

legislation or regulation
Examples Examples
 Educational training and experience  Involving an additional professional
requirements for entry into the profession accountant to review the work done
 Continuing professional development  Consulting an independent third party
requirements  Rotating senior personnel
 Corporate governance regulations  Disclosing to those charged with governance
 Professional standards the nature of services provided and extent of
 Professional or regulatory monitoring and fees charged
disciplinary procedures  Declaration of independence
 External reviews

3 ICAEW Code
The ICAEW Code implements the IESBA (IFAC) Code above so that following it ensures compliance with
the IESBA (IFAC) Code.
The ICAEW Code states that ‘professional accountants are expected to follow the guidance contained
in the fundamental principles in all of their professional and business activities whether carried out
with or without reward and in other circumstances where to fail to do so would bring discredit to the
profession.’

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Therefore the Code may apply not only to the job of the professional accountant but also to the life of
the professional accountant, particularly if he is involved in matters relevant to his profession, such as
keeping the books for a private club of which he is a member.

4 FRC Ethical Standard for Auditors

The FRC has its own ethical standard, made up of 2 parts, that applies to UK auditors who must comply
when carrying out UK audits. They are as follows:

Part A
Part A covers the fundamental concepts of integrity, objectivity and independence.

Part B
 Section 1: General requirements and guidance
 Section 2: Financial, Business, Employment and Personal Relationships
 Section 3: Long Association with the Audit Engagement
 Section 4: Fees, Remuneration and Evaluation Policies, Litigation, Gifts and Hospitality
 Section 5: Non-Audit Services/Additional services
 Section 6: Provisions Available for Audits of Small Entities

INTERACTIVE QUESTION 1: ETHICAL CODES [DIFFICULTY LEVEL: EXAM STANDARD]

There are two main approaches to a code of professional ethics: a rules based ethical code and a code
based on a set of principles.
Indicate whether the following statements are true or false.
True False
(a) A code based on a set of principles rather than rules is more
flexible in a rapidly changing environment.

(b) ICAEW's Code of Ethics is principles based.

(c) A code based on a set of rules requires accountants to evaluate

and address threats to independence.

Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter?

Confirm your learning Yes/No

What are the main differences between rules and principles-based guidance?

Can you identify and explain the 5 fundamental principles?

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15

Integrity, objectivity and

independence

Topic List
1. Integrity, objectivity and independence
2. Threats and safeguards
3. Resolving ethical conflicts
4. Conflicts of interest for the accountant

Learning Objectives
 Understand the concepts of integrity, objectivity and independence
 Recognise the importance of integrity, objectivity and independence
 Identify threats to integrity, objectivity and independence
 Identify safeguards for integrity, objectivity and independence
 Be able to suggest sensible measures to resolve ethical conflicts
 Be able to suggest how conflicts of interest between employee duty and professional duty may
be resolved

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1 Integrity, objectivity and independence

1.1 Why do independence and objectivity matter so much?
Independence and objectivity matter because of:
 The expectations of those directly affected, particularly the members of the company. The audit
should be able to provide objective assurance that the directors can never provide on the
financial statements.
 The public interest. Companies are public entities, governed by rules requiring the disclosure of
information.

2 Threats and safeguards

2.1 Self-interest threat
Example and explanation Safeguards
Financial interests
It is prohibited that:  Disposing of the interest
 The assurance firm  Removing the individual from the team
 Keeping the client’s audit committee informed
 Any partner  Using an engagement quality control reviewer
 Any person in position to influence
assurance engagement outcome
 Immediate family members of such
persons (spouse or dependent)
To have direct financial interest or an indirect
material financial interests in a client
Close business relationship
Examples of when an assurance firm and an An assurance provider should not participate in such
assurance client have an inappropriately close a venture with an assurance client unless immaterial
business relationship include: and insignificant:
 Joint venture The assurance provider should end the assurance
 Combining products provision or to terminate the business relationship.
 Leases between the parties There should be no business relationships except for in
ordinary course of business at an arm’s length

Gifts and hospitality

Unless the value of a gift is clearly insignificant, The firm should have a policy on gift acceptance.
or hospitality is reasonable in terms of its A firm or a member of an assurance team should not
frequency, nature and cost accept gifts.

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Example and explanation Safeguards

Loans and guarantees
If a lending institution client lends an An assurance firm or member of the assurance team
immaterial amount to an audit firm or should not enter into any loan or guarantee
member of assurance team on normal arrangement with a client that is not a bank or similar
commercial terms, there is no threat to institution.
independence. A suitable safeguard is likely to be an independent
If the loan was material it would be review re material loan from a lending institution
necessary to apply safeguards to bring the
risk to an acceptable level.

Overdue fees
The assurance provider runs the risk of, in The payment of overdue fees should be required
effect, making a loan to a client. before the assurance report for the following year can
be issued.
High percentage of fees
When total fees generated by an assurance Safeguards in these situations might include:
client represent a large proportion of a firm’s  Monitor fee income – Warning bells at 5% Listed Co
total fees. & 10% Unlisted Co
FRC ES Section 4 states – If annual fee income  Discussing breaches with the audit committee
from all services to a client regularly exceed  Disclose breaches to ethics partner
10% for a Listed Company (15% Unlisted) of  Taking steps to reduce the dependency on the client
gross practice income, such reliance could
 Obtaining external/internal quality control reviews
constitute a self-interest threat
 Consulting a third party such as ICAEW
Total non-audit fees must be no more than
 Resignation is a last resort (if regularly above upper
70% of the average audit fee from the last 3
limit)
years.
NOTE
IFAC (IESBA) Code states where client is a public interest
entity and fees exceed 15% of total firm fees over 2
consecutive years the firm shall:
 Disclose to those charged with governance
 Conduct quality control reviews of the 2nd and
subsequent years both before or after the opinion is
issued

Lowballing
When a firm quotes a significantly lower fee If the firm’s tender is successful, the firm must apply
level for an assurance service than would safeguards such as:
have been charged by the predecessor firm,  Maintaining records such that the firm is able to
there is a significant self-interest threat. demonstrate that appropriate staff and time are
The size of a fee must not be influenced by spent on the engagement
the provision of non-audit services to the  Complying with all applicable assurance standards,
entity. guidelines and quality control procedures

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Percentage or contingent fees

Fees based on the outcome or result of a A firm should not enter into any fee arrangement for an
transaction or the result of the work assurance engagement under which the amount of the
performed fee is contingent on the result of the assurance work

2.2 Self-review threat

Example and explanation Safeguards
Service with an assurance client
Audit firm members who have been a Members should not be assigned to the assurance team
director or employee of the client, and (until 2 years following leaving the client)
were in a position to exert significant
influence over the financial statements
Internal audit services
Providing internal audit services to an audit client is absolutely prohibited, as a result of the 2019
revisions of the FRC Ethical Standard. This prohibition applies to all audits, whether of a listed or an
unlisted company.
Preparing accounting records and financial statements
There is clearly a significant risk of a self-  Using staff members other than assurance team
review threat if a firm prepares accounting members to carry out work
records and financial statements and then  Requiring the source data for the accounting entries
audits them. to be originated by the assurance client
Note that audit firms should NOT prepare  Requiring the underlying assumptions to be
accounts records for listed clients. originated and approved by the assurance client
Valuation services
If an audit firm performs a valuation that Audit firms should not carry out valuations which has a
will be included in financial statements material effect on a listed company’s financial
audited by the firm, a self-review threat statements or involve a significant degree of subjective
arises and also a management threat might judgement
arise. If acceptable safeguards include:
 Second partner review
 Confirming that the client understands the valuation
and the assumptions used
 Ensuring the client acknowledges responsibility for
the valuation
 Using separate personnel for the valuation and the
audit
Tax services
Tax return preparation  Management must take responsibility for the returns
Tax calculations for accounting entries  For unlisted companies use separate staff
 For listed companies this is prohibited if material
Tax planning  Acceptable where advice is clearly supported by
precedent. If subjective and material it is prohibited
Assistance in dispute resolution  For unlisted companies use separate teams and
consider use of external consultation.
 For listed companies this is prohibited if material

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2.3 Advocacy threat

An advocacy threat arises in certain situations where the assurance firm is in a position of taking the
client’s part in a dispute or somehow acting as their advocate. The most obvious instances of this
would be when a firm offered legal services to a client and, say, defended them in a legal case.
If the firm carried out corporate finance work for the client; for example, if the audit firm were
involved in advice on debt restructuring and negotiated with the bank on the client’s behalf.
Relevant safeguards might be using different departments in the firm to carry out the work and
making disclosures to the audit committee.

2.4 Familiarity threat

Example and explanation Safeguards
Long association with assurance clients
It can be a significant threat to independence Rotating senior staff off the assurance team and
if senior members of staff at an audit firm involving engagement quality control reviews.
have a long association with a client. For listed companies, the Code of Ethics has more
stringent rules:
 No one shall act as the audit engagement partner
for more than five years and then not subsequently
participate in the audit engagement until a further
period of five years has elapsed.
 Other key partners should not act for a period of
longer than 7 years.
For unlisted companies, where the partner has been in
position for ten years the 3rd party test should be
applied:
‘Would a reasonable and informed third party consider
the audit firm’s objectivity impaired?’
Where there are family and personal relationships between client/firm
Family or close personal relationships The individual should be removed from the assurance
between assurance firm and client staff could team.
seriously threaten independence. Each A firm may wish to establish quality control policies and
situation has to be evaluated individually. procedures under which staff should disclose if a close
Factors to consider are: family member employed by the client is promoted
 The individual’s responsibilities on the within the client.
assurance engagement
 The closeness of the relationship
 The role of the other party at the
assurance client

2.5 Intimidation threat

The most obvious example of an intimidation threat is when the client threatens to sue, or indeed
sues, the assurance firm for work that has been done previously. The firm is then faced with the risk of
losing the client, bad publicity and the possibility that they will be found to have been negligent, which
will lead to further problems.

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The following safeguards could be considered:

 Disclosing to the audit committee the nature and extent of the litigation
 Removing specific affected individuals from the engagement team
 Involving an additional professional accountant on the team to review work
However, if the litigation is at all serious, it may be necessary to resign from the engagement

2.6 Management threat

A management threat arises when the audit firm undertakes work involving making judgements and
taking decisions that are the responsibility of management. There is a significant cross-over with self-
review threat here. Only the FRCs Ethical Standards acknowledge the management threat.

INTERACTIVE QUESTION 1: TYPE OF THREAT [DIFFICULTY LEVEL: EXAM STANDARD]

In each of the following cases, indicate the principal threat that the assurance firm is facing.
(a) Peter Perkins recently resigned as finance director of Assiduous Limited. Peter joined the
assurance firm that provides the audit to Assiduous after his notice period of six months.
 Self Interest threat
 Self Review threat
 Intimidation threat
 Advocacy threat
 Familiarity threat
(b) Artifice Limited has suggested to the engagement partner that a qualified audit report would be
unacceptable in the current year because the company is considering a flotation.
 Self Interest threat
 Self Review threat
 Intimidation threat
 Advocacy threat
 Familiarity threat
(c) Anonymous Limited has requested that the audit team should not be changed from the
previous year as they got on well with client staff.
 Self Interest threat
 Self Review threat
 Intimidation threat
 Advocacy threat
 Familiarity threat

2.7 Accepting new clients

In addition, the assurance firm must consider whether there appear to be any factors at the client that
could be a threat to the firm’s integrity or professional behaviour. These are likely to arise from:
 Illegal activities of the client
 Apparent dishonesty of the client
 Questionable accounting practices of the client

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INTERACTIVE QUESTION 2: ENGAGEMENT ACCEPTANCE [DIFFICULTY LEVEL: EXAM STANDARD]

Notable Co is a small assurance firm that has been asked to take on the statutory audit of the following
two companies. For each of the companies, indicate on what basis the audits could be accepted, if at
all.
Notorious Limited is a small company that has had a number of HMRC investigations in recent years.
The company has had to pay a number of back taxes where incorrect figures had been declared.
Recently a director was banned from being a director for five years for wrongful trading. This person
has left Notorious and a new managing director has been appointed, who has intimated to the firm
that improved corporate governance is at the top of his agenda.
A Do not accept
B Accept with safeguards
C Accept with no safeguards
Pristine plc is a listed company that has good references from all parties whom the firm made
enquiries of. It has requested that Notable Co both prepare and audit the financial statements. It does
not feel that these services are divisible.
A Do not accept
B Accept with safeguards
C Accept with no safeguards

3 Resolving ethical conflicts

The ICAEW Code sets out a framework that professional accountants can follow when seeking to
resolve ethical problems. It states that the professional accountant should consider:
 The relevant facts
 The relevant parties
 The ethical issues involved
 The fundamental principles related to the matter in question
 Established internal procedures
 Alternative courses of action
The accountant should then consider which is the course of action that most aligns with the
fundamental principles.

INTERACTIVE QUESTION 3: AUDIT TRAINEE ISSUES [DIFFICULTY LEVEL: EASY]

You are a trainee in the audit department of Harris Brothers & Co. You have recently started your
training, have not attended any courses and have attended one audit, where you carried out some
simple audit tests under supervision from the audit senior.
An audit manager has asked you to attend the inventory count of Brox Bros, which has a large amount
of inventory, which is subject to an annual inventory count. There are very few other controls over the
inventory at Brox Bros. Inventory is highly material to Brox Bros’ financial statements. No other audit
staff will be attending the inventory count.
Which of the following is the most appropriate course of action for you to take:
A Perform the work
B Refer to training partner
C Contact ICAEW

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4 Conflicts of interest for the accountant

It is important to remember that accountants in a non-practice environment are subject to the same
fundamental principles as accountants in practice are. However, an accountant in business (as
opposed to practice) may find that he is faced with implicit or explicit pressure to:
 Act contrary to law or regulation
 Act contrary to technical or professional standards
 Facilitate unethical or illegal earnings management strategies
 Lie to or mislead auditors or regulators
 Issue or be associated with published reports (for example, financial statements, tax
statements) that materially misrepresent the facts
The accountant in question should evaluate the threats that such situations bring (for example, the
accountant may face severe intimidation and self-interest threats if he could lose his job by not
complying). Available course of action should be applied as follows:
 First, resolve internally (if possible) using a formal dispute resolution process or audit
committee (if the employing organisation has one)
 Second, obtain advice from the ICAEW
 Third seek legal advice
 As a last resort, resign

INTERACTIVE QUESTION 4: CONFLICT OF INTEREST [DIFFICULTY LEVEL: EXAM STANDARD]

Imo is a qualified accountant. She has recently moved out of practice and taken up the position of
financial controller of a small, non-listed company, Lavender Lane Limited. The company has a short
term cash flow problem.
Imo was recently called into the board meeting and asked if she could defer some income from the
previous financial year so as to influence when the tax (both VAT and corporation tax) would be due
on those sales. The directors were insistent that such deferral was necessary and that she should
consider this request more in the nature of an order.
Which two of the following possible courses of action are likely initially to be the most appropriate in
this situation?
A Report her concerns to the audit committee of the board of directors
B Seek advice from ICAEW
C Take steps in line with the company’s formal dispute resolution process
D Take advice from her legal advisors
E Resign her job

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Knowledge diagnostic
Before you move on to the next chapter, complete the following knowledge diagnostic and check you
are able to confirm you possess the following essential learning from this chapter. If not, you are
advised to revisit the relevant learning from this chapter.

Confirm your learning Yes/No

Can you give 2 examples for each of the following threats: self-interest, self-review,
intimidation, familiarity and advocacy?

Can you explain what should be considered when resolving an ethical conflict?

Can you explain the main safeguards available for accountants in business who are
faced with an ethical conflict?

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111

16

Confidentiality

Topic List
1. Importance of confidentiality
2. Safeguards to confidentiality
3. Disclosure of confidential information

Learning Objectives
 Understand the nature and importance of confidentiality
 Recognise risks to confidentiality
 Identify steps to prevent accidental disclosure of information
 Understand when information may be disclosed
 Understand when information must be disclosed

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1 Importance of confidentiality
Confidentiality is a fundamental principle of both the IESBA (IFAC) and ICAEW Codes of Ethics, as set
out in Chapter 14.
Accountants are required to keep client information confidential. This is an important aspect of the
trust between client and accountant, as, to do their job, accountants require access to information
about their business that clients would not want made public externally to the business, and, in some
cases, such as where it relates to pay or future intentions of the directors, internally to the business!

2 Safeguards to confidentiality
There is probably a greater risk of accidental disclosure of information that is confidential within the
business than external to the business. Such risk arises where client staff members are exposed to
confidential information by overhearing audit staff conversations or by seeing documents that would
normally be kept away from them.
However, there is also a risk of information passing outside the business if assurance providers work
on a different client’s file at another client’s premises, or by losing or leaving files unprotected (for
example, in a car, which might be stolen) or through lack of electronic controls (for example, by
computer hacking).
The following security procedures are probably wise to prevent accidental disclosure of information:
 Do not discuss client matters with any party outside of the accountancy firm (for example,
friends and family, even in a general way)
 Do not discuss client matters with colleagues in a public place
 Do not leave audit files unattended (at a client’s premises or anywhere)
 Do not leave audit files in cars or in unsecured private residences
 Do not remove working papers from the office unless strictly necessary
 Do not work on electronic working papers on systems that do not have the requisite
protection

3 Disclosure of confidential information

3.1 When disclosure is allowed
Information acquired in the course of professional work should only be disclosed where:
 Consent has been obtained from the client, employer or other proper source, or
 There is a public duty to disclose, or
 There is a legal or professional right or duty to disclose.
Where disclosure is required by the law.
 Where the auditor has uncovered an employee fraud and the client is in agreement that the
matter should be referred to the police.
 Reporting clients involved in terrorist activities to the police.
 Reporting directly to regulators such as the Financial Conduct Authority on regulatory breaches
in respect of financial service and investment businesses or the Charity Commission in respect
of charities.

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 The reporting of suspected money laundering (for example tax evasion) to the National Crime
Agency.

3.2 Money laundering

Money laundering is defined as the process by which criminal proceeds are sanitised to disguise their
illicit origins. It also includes and gain from non-compliance with laws and regulations.
Examples of money laundering in this context could include
 Keeping customer overpayments (theft?)
 Offences under the Companies Act that are criminal
 Offences that involve a saved cost (such as failure to meet environmental regulations about
disposal and dumping waste instead)
The following issues therefore may give rise to suspicions of money laundering:
 Credits on the receivables ledger
 Unusual related party transactions
 Lack of expected costs in profit or loss
 High number of cash transactions without genuine business reason
 The existence of a complicated group structure with no obvious business reason
Accountants are subject to laws concerning money laundering. The following are criminal offences
accountants need to avoid:
 Failure to report a suspicion of money laundering
 Tipping off a suspected money launderer that a report has been made
Therefore, accountants must report suspicions of money laundering with discretion to the appropriate
authority, and this disclosure will not constitute a breach of confidentiality.
Firms must have a Money Laundering Nominated Officer (MLNO) and a Money Laundering Compliance
Principle (MLCP).
Money Laundering Nominated Officer (MLNO) Money Laundering Compliance Principal (MLCP)
Responsible for receiving reports regarding Responsible for ensuring the Firms compliance with
suspected money laundering Money Laundering Regulations
Responsible for reporting to the National Crime For example:
Agency (NCA)  Training
 Document retention
 Client due diligence
It is possible that both of these roles of MLNO and MLCP could be held by the same person

An audit team member will never be required to make a report to the authorities personally. It will
always be appropriate for him to make the report of the suspicion to the MLNO, and having made a
report to the MLNO is a defence against the criminal offence of failing to report a suspicion of money
laundering.

3.3 Conflicts of interest

Firms should have in place procedures to enable them to identify whether any conflicts of interest
exist and to take all reasonable steps to determine whether any conflicts are likely to arise in relation
to new assignments involving both new and existing clients
There is nothing improper in a firm having two clients whose interests are in conflict provided that the
activities of the firm are managed so as to avoid the work of the firm on behalf of one client adversely
affecting that on behalf of another.

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Where a firm believes that a conflict can be managed, the following safeguards may be applicable:
 Disclosure of the circumstances of the conflict to each client
 Obtaining the informed consent of each client to act
 The use of confidentiality agreements signed by employees
 Establishing information barriers
 Regular review of the application of safeguards by a senior individual not involved with the
relevant client engagement
Information barriers include:
 Ensuring that there is no overlap between different teams
 Physical separation of teams
 Careful procedures for where information has to be disseminated beyond a barrier and for
maintaining proper records where this occurs
Where a conflict cannot be managed the firm should not act.

INTERACTIVE QUESTION 1: CONFIDENTIALITY [DIFFICULTY LEVEL: EXAM STANDARD]

During the course of an assurance engagement, Aleem, a member of the assurance team from Goose
Brothers & Co discovers that Dave Milton, the owner of D Manufacturing Limited, has told certain
customers to write cheque payments out in favour of DM, rather than the full company name. Mr
Milton has then been amending the cheques to read D Milton, and paying them into his personal
account rather than the company’s, reducing the company’s overall tax liability.
Which one of the following is the most appropriate action for Aleem to take in respect of this matter?
A Discuss the matter with the client and advise him of the legal position
B Report the matter to HM Revenue and Customs
C Obtain the client’s permission to report the matter to the MLNO within the firm
D Report the matter to the MLNO within the firm

Knowledge diagnostic
Finally, complete the following knowledge diagnostic and check you are able to confirm you possess
the following essential learning from this chapter. If not, you are advised to revisit the relevant
learning from this chapter.
Confirm your learning Yes/No

Can you explain why confidentiality is important?

Can you explain 3 situations where confidential information can be disclosed?

Can you explain what money laundering is and your responsibilities relating to it?

Can you explain what a conflict of interest is and how it can be managed?

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17

Answers to interactive
questions and class examples

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Chapter 1
Interactive question 1
(1) Three party involvement:
 Jamal (the intended user)
 You (the practitioner)
 The directors of Company X as they produce the financial statements (the responsible
party)
(2) Subject matter
The most recent financial statements of Company X are the subject matter
(3) Relevant criteria
It is most likely in this instance that the criteria would be accounting standards, so that Jamal
was assured that the financial statements were properly prepared and comparable with other
companies’ financial statements
(4) Evidence
You would have to agree the extent of procedures in relation to this assignment with Jamal so
that he knew the level of evidence you were intending to seek. This would depend on several
factors, including the degree of secrecy in the proposed transaction and whether the directors
of Company
X allowed you to inspect the books and documents
(5) Report
Again, the nature of the report would be agreed between you and Jamal, however, it would be
a written report containing your opinion on the financial statements
Answers to Question practice at end of chapter

End of chapter question practice

(1) A, B, E

Chapter 2
Interactive question 1
Sources of risk include:
Past frauds, internal control weaknesses, company trying to raise finance, company trying to float or
directors trying to sell shares, industry is volatile with constant PEST changes impacting the company,
new management, cash based business, poor corporate governance, management lack integrity.

Interactive question 2
References from solicitors and financers, if possible, Professional clearance from prior auditor or
accountant if possible, publicly available information from web searches, information from Companies
House search such as past financial statements, auditors report, confirmation statements

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Interactive question 3
True, true, true, false, true

End of chapter question practice

(1) A, D
(2) A, B, D

Chapter 3
Class discussion examples
Why?
To identify and assess the risks of material misstatement in the financial statements.
To enable the auditor to design and perform further audit procedures.
To provide a frame of reference for exercising audit judgement, for example, when setting audit
materiality
What?
Industry, regulatory and other external factors, including the reporting framework.
Nature of the entity, including selection and application of accounting policies.
Objectives and strategies and relating business risks that might cause material misstatement in the
financial statements.
Measurement and review of the entity's financial performance. Internal control
How?
Inquiries of management and others within the entity. Note – this is internal inquiries only
Analytical procedures (which we shall look at in the next section of this chapter).
Observation and inspection.
Prior period knowledge.
Discussion of the susceptibility of the financial statements to material misstatement among the
engagement team.

Interactive question 1
A Sales
B Cost of sales
E Repairs and renewals
F Motor expenses
On the face of it, sales do not appear to have fallen much below what was anticipated for the year, but
the fact that the gross margin has changed so much (from 37% to 26%) indicates that there may be a
problem somewhere in sales and cost of sales, hence rather than focus on one or the other (you might
have selected cost of sales only, due to the fact that the major difference from budget is here) it would
be best to look at the whole issue together. Gross margin may look wrong because sales are
understated in error – and sales were actually much better for the year than anticipated.

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Depreciation, as you might expect, appears to have been predicted accurately and is low risk.
Problems with depreciation if they existed would probably be uncovered by an analysis of the balance
sheet.
Repairs and renewals and motor expenses vary substantially from budget, so are worth further
investigation.

Interactive question 2
(1) Control – the fact that there are few employees in the accounts department means that
segregation of duties will be limited (see Chapter 5 for more details in this area)
(2) Inherent – this is a naturally risky industry
(3) Detection – this is in essence the definition of detection risk
(4) Inherent – there is a risk that estimates may be inappropriate

Interactive question 3
The key risk arising from the above information is that trade receivables will not be carried at the
appropriate value in the financial statements, as some may be irrecoverable. Where receipts are not
matched against invoices in the ledger, the balance on the ledger may include old invoices that the
customer has no intention of paying.
It is difficult to assess at this stage whether this is likely to be material. Trade receivables is likely to be
a material balance in the financial statements, but the number of irrecoverable balances may not be
material. Analytical procedures, for example, to see if the level of accounts receivable has risen year
on year, in a manner that is not explained by price rises or levels of production, might help to assess
this.
A key factor that affects the likelihood of the material misstatement arising is the poor controls over
the receivables ledger. The fact that invoices are not matched against receipts increases the chance of
old invoices not having been paid and not noticed by Tantpro Ltd. It appears reasonably likely that the
trade receivables balance is overstated in this instance.

End of chapter question practice

(1)
B The results of audit risk assessment.
C Calculation of preliminary materiality.
D List of staff to be involved with the audit.
The contract between the firm and client is generally found in the engagement letter which is a
separate document. Detailed plan of audit procedures to be carried out would be contained in
the audit plan.
(2)
A Inspection
B Observation
C Inquiry
D Analytical procedures
Although the auditor may use computation, particularly when carrying out analytical
procedures, it is not a required tool, whereas a combination of the procedures outlined above is
required by the ISA.

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Chapter 4
Interactive question 1
True Test of controls test the effectiveness of a control at detecting and preventing fraud and
error
True Substantive procedures are made up of tests of detail and analytical procedures
True A lack of credit control mean that trade receivables could be overstated due to bad debts

End of chapter question practice

A All information and explanations required for the audit have been received
B Adequate accounting records have been kept
E Details of directors’ emoluments have been properly disclosed in the financial statements

Chapter 5
End of chapter question practice
(1) B, as good internal controls prevent the inefficiency of corrective actions. Not A as internal
controls can be expensive. C & D are not valid reasons to have internal controls, although are a
good by product of having them.
(2) 1 Information processing – reviewing exception reports will ensure information
completeness
2 Physical – as it covers the act of counting
3 Reconciliation – as this covers the comparing of 2 items with the aim to bring into
agreement.
(3) A Permitted range
B Digit verification

Chapter 6
Interactive question 1
(1) A Obtaining a credit reference for new customers
(2) D Authorisation of new customers by a senior staff member

Interactive question 2
A, C, D
Pre-numbering of invoices helps to ensure that invoices are sent out and recorded, but does not
necessarily ensure that all goods despatched are invoiced. The other controls all contribute to ensuring
that all despatched goods are invoiced.

Interactive question 3
A, B

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The clerk could be siphoning off individual receipts and defrauding the company. (This is a fraud called
‘teeming and lading’ which can be successful if the outstanding balance on the account does not look
unusual and the actions of the receivables ledger clerk are not checked.)
Old outstanding invoices could be left unpaid. This is because if the invoices are not matched then it is
not clear which invoices are outstanding, and yet the overall balance outstanding looks reasonable,
thus older invoices, which should be being chased up by the company may not be paid and ultimately
may be forgotten about.

Interactive question 4
B, C
Matching cash receipts with invoices and an investigation into shortages and surpluses are unlikely to
ensure that monies received on a day to day basis are banked. A bank reconciliation will identify
amounts recorded in the cash account but not banked and daily banking will reduce the risk of
misappropriation of money received.

Interactive question 5
Deficiency (because the customer’s credit status is not checked before the order is processed)
Strength (because the invoices are generated from goods despatched information)
Strength (because production is kept up to date by weekly review of outstanding orders)

Chapter 7
Interactive question 1
A Approved list of suppliers.
B Check of goods inward by person other than orderer. Because the stores manager is entitled to
make orders, pre-numbered order forms and safekeeping of order forms would have made no
difference in this case.

Interactive question 2
B Matching of purchase invoices with goods received notes.

Interactive question 3
C Authorisation of payments.

Interactive question 4
A Stamping ‘Paid‘ on invoices that have been paid.
C Authorisation of payments.
Although checking supplier statements will help, the timing differences between the statement date
and payments made may mean that this method is not foolproof.

Interactive question 5
A Prompt payment discounts may not be obtained.

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Chapter 8
Interactive question 1
B, C
Shepherd has a simple control over how much work is being done by its employees. Therefore,
employees should be being paid for the hours they have worked.
However, it is a very simple control, which relies on the integrity of the employees in recording the
correct times they arrived and left the premises. There does not appear to be a supervisory control
ensuring that employees are writing the correct times. Nor is there any provision for times when the
employees are not working, for example, lunch hour or slack periods. Therefore it is possible that
despite the presence of this control, employees may be paid for work they have not done.

Interactive question 2
A, B
Sam records the salaries and organises the pay packets, there is no authorisation of the payroll.

Interactive question 3
A, C
Check that each employee only collects one pay packet. Authorisation of payroll.
Comparison of the payroll with the pay packets will only be effective if the payroll has been properly
updated for the leaver. Supervision by a member of staff who knows all the staff will be necessary if
the employees are not required to show identification to pick up wages, but will not necessarily stop a
leaver picking up a wage packet if the supervisor does not know the staff member has left.

Interactive question 4
(1) Strength. The fact that employees cannot access the factory to work without updating the time
records automatically is a strength in the system.
(2) Deficiency. It appears that the recruitment process is casual and there is not necessarily any
written documentation resulting from the appointment of an employee. This could lead to
errors in pay rates and payroll production that could be eliminated if written notice of an
employee’s start was given to the payroll department.
(3) Strength. The fact that employees are required to return their cards when they leave means
that they are effectively excluded from the time recording system and in practice cannot
continue to be paid after they have left.
(4) Strength. The fact that the payroll has parameters beyond which it seeks authorisation means
that mistakes should be corrected before the payroll is finalised. In addition, there are
information processing controls over correction of the payroll, strengthening this control.

Chapter 9
Interactive question 1
C The internal audit function must not become involved in operational activities

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Chapter 10
Interactive question 1
(i) Not valid. It is not a legal requirement for the auditor to prepare working papers
(ii) Valid
(iii) Valid
(iv) Valid

Chapter 11
Procedure Weakness of procedure
Analytical Procedures Validity and accuracy of benchmark
Enquiry Integrity of person enquired to.
Inspection Internal paperwork can be forged.
Observation Only confirms procedure is correct when watched, not throughout the
year.
RecalcUlation Only confirms the sum of the items not their accuracy, validity,
completeness or existence.

Interactive question 1
B A sales invoice is an internally generated document and therefore provides a poor source of
evidence. It would be better to obtain information about sales from the customers.

Interactive question 2
They would all cause the sample size to increase.

Interactive question 3
(a) True – this is just a timing difference.
(b) False – this indicates that the credit note may not have been processed to the sales ledger,
which would be an error that could also be true of other potential credits due on the ledger.
(c) False – this error does not affect the overall balance on the ledger.

Interactive question 4
B, C
Although these two items are below materiality, the particular circumstances surrounding their
occurrence make them material misstatements. D relates to a test of controls.

Chapter 12
Interactive question
B, D

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Chapter 13
Class examples
Assets
Completeness
Sample of physical asset to asset register
Existence
Sample from asset register to physical asset
Rights and obligations
Sample from Asset register to ownership documents ie title deeds
Valuation
Sample from asset register to purchase invoice, enquire about any further costs incurred in purchase of
asset
Presentation and disclosure
Review F/S ensure minimum disclosures meet (IAS16) ie Depreciation rates

Inventory
Completeness
Sample physical inventory and trace to the inventory count sheets
Existence
Attend the inventory count
Inspect a sample of items from the inventory sheets and trace to the physical item
Rights and obligations
Enquire about consignment stock and inspect 3rd party confirmations
Inspect purchase invoices for ownership
Valuation
Inspect purchase invoices for costs
Where client has WIP inspect labour, overheads and material costs

Trade Receivables
Completeness
3rd party confirmation of a sample of nil balances
Analytical procedures
GDN dates prior to y/e
Existence
3rd party confirmation of a sample of old balances
Analytical procedures
Payments received post y/e
Rights and obligations
3rd party confirmation – confirms balance is owed (but not that it will be paid!)
Inspect a sample of sales invoices

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Valuation
Recalculate TR schedule to see if casts and balance agrees to F/S
Inspect all confirmations for discrepancies

Trade Payables
Completeness
Trace a sample of low, nil, negative balances to supplier statements/conformations
Analytical procedures
Inspect a sample of GRN around the y/e to confirm appropriate inclusion of invoices
Existence
Inspect a sample of balance to supplier statements
Rights and obligations
Inspect purchase invoices that make up a sample of balances on trade payables ledgers
Agree balances to 3rd party confirmation
Valuation
As above

Interactive question 1
A, B, C
A purchase invoice, a registration document and a hire-purchase agreement

Interactive question 2
A Attendance at inventory count

Interactive question 3
C Receivables external confirmation

Interactive question 4
A That the bank balance stated on the bank reconciliation is correct. The others are incorrect for
the following reasons:
 That the un-presented cheques listed on the bank reconciliation were sent out pre year-
end. (These will not be accounted for in the bank’s year-end balance; only post-balance
sheet bank statements will indicate whether these may have been held back.)
 That the company possesses only the bank accounts it declares. (As the company may
have bank accounts with a different bank.)
 That the cash floats of the company are fairly stated. (As cash floats at the company are
not within the scope of the bank letter.)

Interactive question 5
(i) True. Assurance providers must always behave with professional scepticism, not assuming that
documents such as supplier statements have been tampered with, but bearing in mind that it is
a possibility if indications arise supporting that suggestion.

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(ii) False. Cash payments after date do not prove that the balance is not understated, as the client
may control the payments it makes and conceal correspondence from suppliers requesting full
payment.

Chapter 14
Interactive question 1
(a) True – it is an advantage of the principles based approach
(b) True – it implements the IESBA (IFAC) Code, which is principles based
(c) False – a rules based system tends to remove the need to evaluate, as accountants can just
check whether certain rules are being met or not, rather than applying the principles to given
situations.

Chapter 15
Interactive question 1
(a) Self-review
(b) Intimidation
(c) Familiarity (however, unless any of the members of the team have been on the team for a
significant period of time or have close personal relationships with any client staff, this risk is
probably insignificant)

Interactive question 2
B Notorious Limited could be accepted with safeguards. The key safeguard is that the managing
director has expressed an intention of improving corporate governance. This safeguard would
be strengthened if the audit firm obtained this intention from him in writing.
A Pristine plc should not be accepted. This is because the self-review threat associated with
preparing the accounts and then auditing them for a listed company is considered too great.

Interactive question 3
B You should refer this matter to the training partner. You have no experience or training to
undertake this work. The risks attaching to the audit tests being carried out are high. The person
allocating the work must have allocated you in error.

Interactive question 4
B, D
It is unlikely to be appropriate to make disclosure to the audit committee in this case, as Lavender
Lane Limited, a small, unlisted company, is unlikely to have one. Given the instructions have come
from the board of directors, it will be fruitless to take steps in line with the company’s formal dispute
resolution process. Thus, resolving the situation internally is not possible in this situation.
Imo should seek advice from ICAEW and then take advice from her legal advisors. Resigning her job is
not an initial option and should only take place if the other options have been unsuccessful.

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Chapter 16
Interactive question
D The appropriate thing is to make a report to the MLNO. C is inappropriate, because it could
constitute a crime to warn Dave Milton that a report has been made about his money
laundering. A is therefore also inappropriate. B might be an appropriate act, but it is better
practice for assurance team members always to make reports to the MLNO and let them take
responsibility for determining whether a report should be made.

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18

Appendix

1. Example Audit Reports

2. Example Engagement Letter
3. Example Written Representation Letter

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WORKED EXAMPLE: AUDITORS REPORT EXAMPLES

Tesco Audit Report – page 102 of link below:

https://www.tescoplc.com/media/u1wlq2qf/tesco-plc-annual-report-2023.pdf
Marks and Spencer Audit Report – page 111 of link below:
https://corporate.marksandspencer.com/investors/our-performance-updates/2023-annual-
report

WORKED EXAMPLE: AUDIT ENGAGEMENT LETTER (EXTRACT)

To the Board of Directors of ABC Company
ACTING AS AUDITORS UNDER THE COMPANIES ACT 2006
RESPONSIBILITIES AND SCOPE FOR AUDIT SERVICES
Your responsibilities as directors
As directors of the company, you are responsible for preparing financial statements which give a true
and fair view and which have been prepared in accordance with the Companies Act 2006 (the Act). As
directors you must not approve the financial statements unless you are satisfied that they give a true
and fair view of the assets, liabilities, financial position and profit or loss of the company.
In preparing the financial statements, you are required to:
 Select suitable accounting policies and then apply them consistently;
 Make judgements and estimates that are reasonable and prudent; and
 Prepare the financial statements on the going concern basis unless it is inappropriate to
presume that the company will continue in business.
You are responsible for keeping adequate accounting records that set out with reasonable accuracy at
any time the company’s financial position, and for ensuring that the financial statements comply with
International Financial Reporting Standards (IFRSs) as adopted by the European Union and with the
Companies Act 2006 and give a true and fair view.
You are also responsible for such internal control as you determine is necessary to enable the
preparation of financial statements that are free from material misstatement whether due to fraud or
error.
You are also responsible for safeguarding the assets of the company and hence for taking reasonable
steps to prevent and detect fraud and other irregularities.
You are responsible for ensuring that the company complies with laws and regulations that apply to its
activities, and for preventing non-compliance and detecting any that occurs.
You have undertaken to make available to us, as and when required, all the company’s accounting
records and related financial information, including minutes of management and shareholders’
meetings, that we need to do our work. You have also undertaken to provide us with unrestricted
access to any persons from whom we deem it necessary to obtain audit evidence. Each director is
required to take all steps that he ought to take as a director in order to make himself aware of any
relevant audit information and to establish that we are aware of that information.
Our responsibilities as auditor
We have a statutory responsibility to report to the members as a body, whether in our opinion the
financial statements have been properly prepared in accordance with IFRSs, whether they have been
prepared in accordance with the Companies Act 2006 and whether they give a true and fair view. We

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are also required to report whether the information given in the directors’ report is consistent with
the financial statements. In arriving at our opinion, we are required to consider the following matters,
and report on any that we are not satisfied with:
(a) Whether the company has kept adequate accounting records, and whether branches that we
have not visited have sent in returns adequate for our audit;
(b) Whether the company’s individual accounts are in agreement with the accounting records and
returns; and
(c) Whether we have obtained all the information and explanations which we consider necessary
for the purposes of our audit.
We may also need to deal with certain other matters in our report. If the company prepares accounts
and reports in accordance with the small companies regime when in our opinion it is not entitled to do
so we are required to state that fact in our report.
We have a professional responsibility to report if the financial statements do not significantly comply
with applicable financial reporting standards, unless we believe there is a good reason for the
noncompliance.
In deciding whether or not this is the case, we consider:
(a) Whether the non-compliance is necessary for the financial statements to give a true and fair
view; and
(b) Whether the non-compliance has been clearly disclosed.
We also have a professional responsibility to consider whether other information in documents
containing audited financial statements is consistent with those financial statements.
Scope of audit
We will carry out our audit in accordance with the International Standards of Auditing (UK and Ireland)
issued by the Financial Reporting Council. Those Standards require that we comply with ethical
requirements and plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatements. An audit involves performing procedures to
obtain audit evidence about the amounts and disclosures in the financial statements. The procedures
selected depend on the auditors’ judgment, including the assessment of the risks of material
misstatement of the financial statements, whether due to fraud or error. An audit also includes
evaluating the appropriateness of accounting policies used and the reasonableness of accounting
estimates made by management, as well as evaluating the overall presentation of the financial
statements. Because of the test nature and other inherent limitations of an audit, together with the
inherent limitations of any accounting and internal control system, there is an unavoidable risk that
even some material misstatements may remain undiscovered.
We shall obtain an understanding of the accounting and internal control systems in order to assess
their adequacy as a basis for the preparation of the financial statements and to establish whether
adequate accounting records have been maintained by the company. We shall expect to obtain such
appropriate evidence as we consider sufficient to enable us to draw reasonable conclusions there
from. In addition to our report on the financial statements, we will provide you with a separate letter
concerning any significant deficiencies in accounting and internal control systems which come to our
notice.
The nature and extent of our audit will vary according to our assessment of the company’s accounting
system and, where we wish to rely on it the internal control system, and may cover any aspect of the
business’s operations that we consider appropriate. Our audit is not designed to identify all significant
deficiencies in the company’s systems and internal controls but, if we detect significant deficiencies we
will report them to you in writing.

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As part of our normal audit procedures, we may ask you to confirm in writing representations you
have made to us during the audit. In particular, where misstatements in the financial statements that
we bring to your attention are not adjusted, you must state your reasons. In connection with
representations and the supply of information to us generally, we draw your attention to section 501
of the Companies Act 2006 under which it is an offence for anyone to recklessly or knowingly supply
information to the auditors that is false or misleading and to fail to promptly provide information
requested.
To help us examine your financial statements, we will ask to see all documents or statements that are
due to be issued with the financial statements. We are also entitled to receive details of all written
resolutions that are to be circulated to members, to attend all the company’s general meetings and to
receive notice of them all.
You are responsible for safeguarding the company’s assets and for preventing and detecting fraud,
error and non-compliance with law or regulations. We will plan our audit so that we can reasonably
expect to detect significant misstatements in the financial statements or accounting records (including
those resulting from fraud, error or non-compliance with law or regulations), but you cannot rely on us
finding all such errors.
In respect of the expected form and content of our report, we refer you to the most recent bulletin on
auditors’ reports published by the Auditing Practices Board at http://www.frc.org.uk/apb. The form
and content of our report may need to be amended in the light of our findings.
Once we have issued our report, we have no further responsibility in relation to the financial
statements for that financial year. However, we expect that you will inform us of any material event
occurring between the date of our report and the date the financial statements are sent out in
accordance with section 423 Companies Act 2006 which may affect the financial statements.
We look forward to full cooperation from your staff during our audit.
[Other relevant information]
[Insert other information, such as fee arrangements, billings and other specific terms, as appropriate.]
XYZ & Co.
Acknowledged and agreed on behalf of ABC Company by
(signed)
......................
Name and Title

WORKED EXAMPLE: WRITTEN REPRESENTATION LETTER

(Entity Letterhead)
(To Auditor) (Date)
This representation letter is provided in connection with your audit of the financial statements of ABC
Company for the year ended December 31, 20X1 for the purpose of expressing an opinion as to
whether the financial statements are presented fairly, in all material respects, (or give a true and fair
view) in accordance with International Financial Reporting Standards.
We confirm that (to the best of our knowledge and belief, having made such inquiries as we
considered necessary for the purpose of appropriately informing ourselves):
Financial Statements
We have fulfilled our responsibilities, as set out in the terms of the audit engagement dated [insert
date], for the preparation of the financial statements in accordance with International Financial

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Reporting Standards; in particular the financial statements are fairly presented (or give a true and fair
view) in accordance therewith.
Significant assumptions used by us in making accounting estimates, including those measured at fair
value, are reasonable. (ISA 540)
Related party relationships and transactions have been appropriately accounted for and disclosed in
accordance with the requirements of International Financial Reporting Standards. (ISA 550)
All events subsequent to the date of the financial statements and for which International Financial
Reporting Standards require adjustment or disclosure have been adjusted or disclosed. (ISA 560)
The effects of uncorrected misstatements are immaterial, both individually and in the aggregate, to
the financial statements as a whole. A list of the uncorrected misstatements is attached to the
representation letter. (ISA 450)
Any other matters that the auditor may consider appropriate.
Information provided
We have provided you with:
– Access to all information of which we are aware that is relevant to the preparation of the
financial statements such as records, documentation and other matters;
– Additional information that you have requested from us for the purpose of the audit; and
– Unrestricted access to persons within the entity from whom you determined it necessary to
obtain audit evidence.
All transactions have been recorded in the accounting records and are reflected in the financial
statements.
We have disclosed to you the results of our assessment of the risk that the financial statements may
be materially misstated as a result of fraud. (ISA 240)
We have disclosed to you all information in relation to fraud or suspected fraud that we are aware of
and that affects the entity and involves:
– Management;
– Employees who have significant roles in internal control; or
– Others where the fraud could have a material effect on the financial statements. (ISA 240)
We have disclosed to you all information in relation to allegations of fraud, or suspected fraud,
affecting the entity’s financial statements communicated by employees, former employees, analysts,
regulators or others. (ISA 240)
We have disclosed to you all known instances of non-compliance or suspected non-compliance with
laws and regulations whose effects should be considered when preparing financial statements.
(ISA 250A)
We have disclosed to you the identity of the entity’s related parties and all the related party
relationships and transactions of which we are aware. (ISA 550)
Any other matters that the auditor may consider necessary.

…………………
Management

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