Auditing Chap 12
Chapter 12 – Completion and reporting on the audit
REVIEW QUESTIONS
12.1 What is the process of ‘engagement wrap-up’? Why is it important?
The process of engagement wrap-up involves the auditor finalising an open items before issuing their audit report. The finalisation process could include completing additional audit procedures to ensure that sufficient and appropriate evidence is held on which to base the audit opinion. The process usually includes work in the following areas: 1. Review planned audit procedures for proper and complete execution. 2. Determine that all necessary matters have been appropriately considered. 3. Revisit open review notes, ‘to-do’ items and any audit procedures not yet completed. The auditor determines if any additional work is needed or the matter is no longer relevant. 4. Determine that all unnecessary documentation, drafts and review notes have been removed from engagement files. In some cases, the auditor notes that the item is no longer required and the reason, in other cases the item is removed along with any references to it. 5. For multi-location engagements, determine that all documents requested from other audit teams have been obtained and reviewed. 6. Remove all documents from the working papers that do not provide audit evidence supporting the auditor’s conclusions. 7. Consider the amount used for materiality. In some cases, revise the amount used for materiality when evaluating audit misstatements. Consider if additional procedures are required to support the changed materiality. 8. Reconsider the assessments of internal control at the entity level and the risk of fraud. Their conclusions about the effectiveness of internal control could be affected by control exceptions found during testing. Consider whether any material misstatements indicate fraud. 9. Revisit planning documentation to determine that all significant issues identified during the planning phase have been addressed. 10. Perform subsequent events procedures.
The engagement-wrap up process is important because it ensures that the auditor considers all matters that are relevant to finalising the documentation on the audit and ensuring enough evidence is held to support the audit opinion.
12.2 What is the accounting assumption of ‘going concern’? Why is it of interest to auditors?
Going concern is an assumption that the entity will remain in business for the foreseeable future. The entity has neither the intention nor the need for liquidation, ceasing trading or seeking protection from creditors pursuant to laws or regulation. The going concern assumption supports the recording of assets and liabilities on the basis that the entity will be able to realise its assets and discharge its liabilities in the normal course of business. An auditor must consider the entity’s ability to continue as a going concern as part of an audit (ASA 570).
The auditor must also consider the financial reporting framework when performing an audit. AASB 101 requires management of the entity to make an assessment of the entity’s ability to continue as a going concern. If management is aware of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern those uncertainties shall be disclosed. Therefore, the auditor has a specific requirement to consider management’s assessment of the going concern basis, and the relevant disclosures, because of AASB 101.
12.3 Explain the difference between the two types of subsequent events. Discuss the auditor’s responsibility for detecting subsequent events (a) prior to the completion of field work, (b) prior to signing the audit report, and (c) between the date of the audit report and the issuance of the financial report.
AASB 110 and ASA 560 both explain that there are two types of subsequent events.
Type 1: events that provide additional evidence with respect to conditions that existed at year-end. These events can affect the estimates inherent in the financial report or indicate that the going concern assumption is not appropriate. Where appropriate, the financial report should be amended to recognise the event. For example, the entity had made an insurance claim which was still in negotiation at year end. Subsequent to the year-end, the claim was settled. The settlement provides a certain amount that can be recognised in the accounts. In some cases, the subsequent event provides additional evidence about a matter that was disclosed in the notes to the financial report rather than the accounts. In these cases, the note is updated to reflect the new information.
Type 2: events that provide evidence with respect to conditions that developed subsequent to year-end. These events do not result in changes to amounts in the financial report because they are new events. However, they may be of such significance as to require disclosure in the financial report. For example, an uninsured loss of plant or inventories as a result of a fire or flood subsequent to year-end. This event does not affect the value of the asset at year-end, but it would be important to users of the financial report to know that the asset has been destroyed. The disclosure is made through a note to the financial report.
The auditor’s responsibility for detecting these events is explained in ASA 560.
Prior to completing field work the auditor the auditor shall consider their risk assessment relating to identifying subsequent events. The risk assessment shall include obtaining an understanding of any management procedures to identify subsequent events.
Prior to signing the audit report the auditor will perform procedures to gather evidence to cover the period from the date of the financial report to the date of the auditor’s report. These procedures include enquiring of management as to whether any subsequent events have occurred, and reading relevant minutes of meetings held after the date of the financial report and latest interim financial results.
After the date of the auditor’s report the auditor has no obligation to perform any audit procedures regarding the financial report. However, the auditor could become aware of a fact, that if it had been known to the auditor at the date of the auditor’s report, may have caused the auditor to amend the auditor’s report. In this case the auditor shall discuss the matter with management, determine whether the financial report needs amendment, and if so, enquire how management intends to address the matter in the financial report. If the financial report is amended, the auditor could carry out the necessary audit procedures on the amendment and extend the subsequent event procedures to the date of the new auditor’s report and provide a new auditor’s report.
If management do not amend the report, the auditor would take action to prevent the release of the report or to prevent reliance on the auditor’s report
After the financial report has been issued, the auditor has no obligation to perform any audit procedures. However, if a fact becomes known to the auditor that, had it been known to the auditor at the date of the auditor’s report, may have caused the auditor to amend the auditor report, the auditor follows the procedures outlined above. If management do not amend the report, the auditor would take action to prevent the release of the report or to prevent reliance on the auditor’s report
In both cases, the auditor should include an emphasis of matter paragraph in the new auditor’s report referring to the subsequent event matter disclosure in the financial report.
12.4 What options does an auditor have when material errors are found? Do these options vary for current-year misstatements and prior-year misstatements?
An error is an unintentional audit misstatement in the financial report, and includes the omission of an amount or a disclosure. The auditor should try to understand why the error or exception has arisen. One response could be to increase the sample to ensure that there are no other errors. The auditor should continue testing until the error can either be accurately quantified or the balance has been fully tested to an extent that proves a material error can no longer exist within the balance. The auditor should evaluate whether the error causes the financial report to be materially misstated or requires additional disclosure.
If the error relates to the current year, the auditor will prepare a working paper for all misstatements uncorrected by the client to consider the aggregate effect, and whether the error is material in isolation or in aggregate. The auditor will consider both qualitative and quantitative considerations.
If the error relates to the prior year(s) the auditor should consider whether the error ‘turns around’. For example, if there is a cut-off error in one year that causes the balance of an account to be overstated, the error turns around in the following period and causes the balance to be understated. If the problem is due to judgemental differences between the client and the auditor, it may not turnaround. For example, the overvaluation of an asset due to a judgement about fair values would persist if the asset was still held and valued in the same way. The auditor is required to use professional judgement in these cases to determine the appropriate response.
12.7 Explain the difference between limitation of scope and disagreement with those charged with governance.
A limitation of scope of an audit occurs when the auditor is unable to obtain the necessary evidence to resolve a significant uncertainty. The auditor is unable to perform procedures due to the circumstances (such as a natural disaster or the passage of time) or due to an imposition by the entity (such as not making certain records, documents, or personnel available to the auditor).
A disagreement with those charged with governance occurs when the auditor has a different view about matters such as acceptability of accounting policies selected, the method of their application, or the adequacy of disclosures in the financial report. If the client’s management will not change the financial report to resolve the disagreement, the auditor will consider qualifying the audit opinion (either qualified or adverse opinion depending on the pervasiveness of the issue).
The difference between these circumstances is that the auditor is unable to obtain sufficient appropriate evidence in the case of a limitation of scope, but has sufficient evidence on which to base a conclusion that the financial report is misleading where there is a disagreement with those charged with governance.
Professional application question
12.6 Audit reports and other communication at the end of an audit
Required
a) Discuss Sven’s audit report options and recommend the appropriate wording for the audit report.
b) What matters would Sven include in the letter to those charged with governance at Kingston Catering?
(a) The missing files create a limitation on the scope of the audit. There is the possibility that the auditor is not able to gather sufficient appropriate evidence on which to base an opinion. It appears that the circumstances were beyond the control of the client, and mainly affect sales revenue and debtors valuation.
The reporting possibilities in these circumstances are: - unqualified if the problem is not material - qualified if the problem is material but not pervasive - disclaimer of opinion if the problem is pervasive.
Critical issues for the audit opinion decision include: - evidence that the problem was confined to a defined period. The information is that the problem began four months into the year, and appears to be corrected. - ability to perform alternative procedures, such as using subsequent cash receipts to verify sales for the period. - Confidence in the value of debtors at the end of the financial period – if the problem has been corrected the debtors at the end of the period should be unaffected by problems which occurred at the start of the year.
The most likely audit opinion is qualified because the problem is not pervasive to the financial report, but is material.
The audit report would contain the usual paragraphs identifying the subject of the audit, management and auditor’s responsibilities, then the following:
Basis for qualified opinion
As disclosed in note xx to the financial report, the entity’s sales for the eight months to the end of the year are stated at $xxx and for the first four months of the year are stated at $xxx. We were unable to obtain sufficient appropriate audit evidence about the sales for the first four months of the year because we were unable to gain access to the financial records for this period. Consequently, we were unable to determine whether any adjustments to these amounts were necessary.
Qualified opinion
In our opinion, except for the possible effects of the matter described in the Basis for Qualified Opinion paragraph, the financial report of Kingston Catering is in accordance with the Corporations Act 2001, including:
a) giving a true and fair view of the company’s financial position as at 30 June 20XX and of its performance for the year ended on that date; and
b) complying with Australian Accounting Standards and the Corporations Regulations 2001
Signature etc
(b) The letter to those charged with governance would contain a full description of the matter giving rise to the audit qualification, including details of difficulties in performing the usual audit procedures and the evidence obtained. The letter would explain why the auditor had to qualify their audit opinion.
The auditor would also make a recommendation for internal control changes to prevent a similar problem arising again, including details of the deficiencies in the previous systems that allowed this problem to occur.
Other matters would include the usual explanation of significant audit findings, views on appropriateness of accounting policies, independence issues if any, and other matters that are relevant to future successful audits.
REVIEW QUESTIONS
12.1 What is the process of ‘engagement wrap-up’? Why is it important?
The process of engagement wrap-up involves the auditor finalising an open items before issuing their audit report. The finalisation process could include completing additional audit procedures to ensure that sufficient and appropriate evidence is held on which to base the audit opinion. The process usually includes work in the following areas: 1. Review planned audit procedures for proper and complete execution. 2. Determine that all necessary matters have been appropriately considered. 3. Revisit open review notes, ‘to-do’ items and any audit procedures not yet completed. The auditor determines if any additional work is needed or the matter is no longer relevant. 4. Determine that all unnecessary documentation, drafts and review notes have been removed from engagement files. In some cases, the auditor notes that the item is no longer required and the reason, in other cases the item is removed along with any references to it. 5. For multi-location engagements, determine that all documents requested from other audit teams have been obtained and reviewed. 6. Remove all documents from the working papers that do not provide audit evidence supporting the auditor’s conclusions. 7. Consider the amount used for materiality. In some cases, revise the amount used for materiality when evaluating audit misstatements. Consider if additional procedures are required to support the changed materiality. 8. Reconsider the assessments of internal control at the entity level and the risk of fraud. Their conclusions about the effectiveness of internal control could be affected by control exceptions found during testing. Consider whether any material misstatements indicate fraud. 9. Revisit planning documentation to determine that all significant issues identified during the planning phase have been addressed. 10. Perform subsequent events procedures.
The engagement-wrap up process is important because it ensures that the auditor considers all matters that are relevant to finalising the documentation on the audit and ensuring enough evidence is held to support the audit opinion.
12.2 What is the accounting assumption of ‘going concern’? Why is it of interest to auditors?
Going concern is an assumption that the entity will remain in business for the foreseeable future. The entity has neither the intention nor the need for liquidation, ceasing trading or seeking protection from creditors pursuant to laws or regulation. The going concern assumption supports the recording of assets and liabilities on the basis that the entity will be able to realise its assets and discharge its liabilities in the normal course of business. An auditor must consider the entity’s ability to continue as a going concern as part of an audit (ASA 570).
The auditor must also consider the financial reporting framework when performing an audit. AASB 101 requires management of the entity to make an assessment of the entity’s ability to continue as a going concern. If management is aware of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern those uncertainties shall be disclosed. Therefore, the auditor has a specific requirement to consider management’s assessment of the going concern basis, and the relevant disclosures, because of AASB 101.
12.3 Explain the difference between the two types of subsequent events. Discuss the auditor’s responsibility for detecting subsequent events (a) prior to the completion of field work, (b) prior to signing the audit report, and (c) between the date of the audit report and the issuance of the financial report.
AASB 110 and ASA 560 both explain that there are two types of subsequent events.
Type 1: events that provide additional evidence with respect to conditions that existed at year-end. These events can affect the estimates inherent in the financial report or indicate that the going concern assumption is not appropriate. Where appropriate, the financial report should be amended to recognise the event. For example, the entity had made an insurance claim which was still in negotiation at year end. Subsequent to the year-end, the claim was settled. The settlement provides a certain amount that can be recognised in the accounts. In some cases, the subsequent event provides additional evidence about a matter that was disclosed in the notes to the financial report rather than the accounts. In these cases, the note is updated to reflect the new information.
Type 2: events that provide evidence with respect to conditions that developed subsequent to year-end. These events do not result in changes to amounts in the financial report because they are new events. However, they may be of such significance as to require disclosure in the financial report. For example, an uninsured loss of plant or inventories as a result of a fire or flood subsequent to year-end. This event does not affect the value of the asset at year-end, but it would be important to users of the financial report to know that the asset has been destroyed. The disclosure is made through a note to the financial report.
The auditor’s responsibility for detecting these events is explained in ASA 560.
Prior to completing field work the auditor the auditor shall consider their risk assessment relating to identifying subsequent events. The risk assessment shall include obtaining an understanding of any management procedures to identify subsequent events.
Prior to signing the audit report the auditor will perform procedures to gather evidence to cover the period from the date of the financial report to the date of the auditor’s report. These procedures include enquiring of management as to whether any subsequent events have occurred, and reading relevant minutes of meetings held after the date of the financial report and latest interim financial results.
After the date of the auditor’s report the auditor has no obligation to perform any audit procedures regarding the financial report. However, the auditor could become aware of a fact, that if it had been known to the auditor at the date of the auditor’s report, may have caused the auditor to amend the auditor’s report. In this case the auditor shall discuss the matter with management, determine whether the financial report needs amendment, and if so, enquire how management intends to address the matter in the financial report. If the financial report is amended, the auditor could carry out the necessary audit procedures on the amendment and extend the subsequent event procedures to the date of the new auditor’s report and provide a new auditor’s report.
If management do not amend the report, the auditor would take action to prevent the release of the report or to prevent reliance on the auditor’s report
After the financial report has been issued, the auditor has no obligation to perform any audit procedures. However, if a fact becomes known to the auditor that, had it been known to the auditor at the date of the auditor’s report, may have caused the auditor to amend the auditor report, the auditor follows the procedures outlined above. If management do not amend the report, the auditor would take action to prevent the release of the report or to prevent reliance on the auditor’s report
In both cases, the auditor should include an emphasis of matter paragraph in the new auditor’s report referring to the subsequent event matter disclosure in the financial report.
12.4 What options does an auditor have when material errors are found? Do these options vary for current-year misstatements and prior-year misstatements?
An error is an unintentional audit misstatement in the financial report, and includes the omission of an amount or a disclosure. The auditor should try to understand why the error or exception has arisen. One response could be to increase the sample to ensure that there are no other errors. The auditor should continue testing until the error can either be accurately quantified or the balance has been fully tested to an extent that proves a material error can no longer exist within the balance. The auditor should evaluate whether the error causes the financial report to be materially misstated or requires additional disclosure.
If the error relates to the current year, the auditor will prepare a working paper for all misstatements uncorrected by the client to consider the aggregate effect, and whether the error is material in isolation or in aggregate. The auditor will consider both qualitative and quantitative considerations.
If the error relates to the prior year(s) the auditor should consider whether the error ‘turns around’. For example, if there is a cut-off error in one year that causes the balance of an account to be overstated, the error turns around in the following period and causes the balance to be understated. If the problem is due to judgemental differences between the client and the auditor, it may not turnaround. For example, the overvaluation of an asset due to a judgement about fair values would persist if the asset was still held and valued in the same way. The auditor is required to use professional judgement in these cases to determine the appropriate response.
12.7 Explain the difference between limitation of scope and disagreement with those charged with governance.
A limitation of scope of an audit occurs when the auditor is unable to obtain the necessary evidence to resolve a significant uncertainty. The auditor is unable to perform procedures due to the circumstances (such as a natural disaster or the passage of time) or due to an imposition by the entity (such as not making certain records, documents, or personnel available to the auditor).
A disagreement with those charged with governance occurs when the auditor has a different view about matters such as acceptability of accounting policies selected, the method of their application, or the adequacy of disclosures in the financial report. If the client’s management will not change the financial report to resolve the disagreement, the auditor will consider qualifying the audit opinion (either qualified or adverse opinion depending on the pervasiveness of the issue).
The difference between these circumstances is that the auditor is unable to obtain sufficient appropriate evidence in the case of a limitation of scope, but has sufficient evidence on which to base a conclusion that the financial report is misleading where there is a disagreement with those charged with governance.
Professional application question
12.6 Audit reports and other communication at the end of an audit
Required
a) Discuss Sven’s audit report options and recommend the appropriate wording for the audit report.
b) What matters would Sven include in the letter to those charged with governance at Kingston Catering?
(a) The missing files create a limitation on the scope of the audit. There is the possibility that the auditor is not able to gather sufficient appropriate evidence on which to base an opinion. It appears that the circumstances were beyond the control of the client, and mainly affect sales revenue and debtors valuation.
The reporting possibilities in these circumstances are: - unqualified if the problem is not material - qualified if the problem is material but not pervasive - disclaimer of opinion if the problem is pervasive.
Critical issues for the audit opinion decision include: - evidence that the problem was confined to a defined period. The information is that the problem began four months into the year, and appears to be corrected. - ability to perform alternative procedures, such as using subsequent cash receipts to verify sales for the period. - Confidence in the value of debtors at the end of the financial period – if the problem has been corrected the debtors at the end of the period should be unaffected by problems which occurred at the start of the year.
The most likely audit opinion is qualified because the problem is not pervasive to the financial report, but is material.
The audit report would contain the usual paragraphs identifying the subject of the audit, management and auditor’s responsibilities, then the following:
Basis for qualified opinion
As disclosed in note xx to the financial report, the entity’s sales for the eight months to the end of the year are stated at $xxx and for the first four months of the year are stated at $xxx. We were unable to obtain sufficient appropriate audit evidence about the sales for the first four months of the year because we were unable to gain access to the financial records for this period. Consequently, we were unable to determine whether any adjustments to these amounts were necessary.
Qualified opinion
In our opinion, except for the possible effects of the matter described in the Basis for Qualified Opinion paragraph, the financial report of Kingston Catering is in accordance with the Corporations Act 2001, including:
a) giving a true and fair view of the company’s financial position as at 30 June 20XX and of its performance for the year ended on that date; and
b) complying with Australian Accounting Standards and the Corporations Regulations 2001
Signature etc
(b) The letter to those charged with governance would contain a full description of the matter giving rise to the audit qualification, including details of difficulties in performing the usual audit procedures and the evidence obtained. The letter would explain why the auditor had to qualify their audit opinion.
The auditor would also make a recommendation for internal control changes to prevent a similar problem arising again, including details of the deficiencies in the previous systems that allowed this problem to occur.
Other matters would include the usual explanation of significant audit findings, views on appropriateness of accounting policies, independence issues if any, and other matters that are relevant to future successful audits.