7 - going concern and internal audit

Question 1

what is the going concern basis as per ISA 570?

Answer 1

Under the going concern basis of accounting, the financial statements are prepared on the assumption that the entity is a going concern and will continue its operations for the foreseeable future. General purpose financial statements are prepared using the going concern basis of accounting, unless management either intends to liquidate the entity or to cease operations, or has no realistic alternative but to do so

Question 2

what basis is used if going concern is not appropriate?

Answer 2

if going concern basis not appropriate, financial statements are prepared on break-up basis. this is used to signify that an entity is at a stage where its assets are being realised or are about to be realised as part of the process of liquidating the entity.

Question 3

what are the duties of an auditor under the going concern basis?

Answer 3

to obtain sufficient appropriate audit evidence regarding, and conclude on appropriateness of management’s use of going concern basis of accounting

conclude whether material uncertainty exists related to events or conditions that may cast significant doubt on entity’s ability to continue as a going concern.

report in accordance with ISA 570

Question 4

what are the financial going concern indicators?

Answer 4

net liability or net current liability position

fixed-term borrowings approaching maturity without realistic prospects of renewal or repayment, or excessive reliance on short-term borrowings to finance non-current assets

indications of withdrawal of financial support by creditors

negative operating cash flows

adverse key financial ratios (high gearing, low current ratio, poor profit margins)

substantial operating losses or significant deterioration in the value of assets used to generate cash flows

arrears or discontinuance of dividends

inability to pay creditors on due dates

inability to comply with the terms of loan agreements

change from credit to cash-on-delivery terms with suppliers

inability to obtain new financing

Question 5

what are the operational going concern indicators?

Answer 5

management intention to liquidate the entity of cease operations

loss of key management without replacement

loss of a major market, key customers, licence or principal supplier

labour difficulties

shortages of important supplies

emergence of a highly successful competitor

Question 6

what are the ‘other’ indicators of going concern issues?

Answer 6

non-compliance with capital or other statutory requirements

pending legal or regulatory proceedings against the entity that may, if successful, result in claims that are unlikely to be satisfied

changes in legislation or government policy expected to adversely affect the entity

uninsured or under-insured catastrophes when they occur

Question 7

what steps should the auditor take once going concern issues are identified?

Answer 7

request management to make its assessment where this has not been done

evaluating mgments plans for future action

evaluating reliability of underlying data used to prepare cash flow forecast and considering assumptions used to make the forecast

considering whether any additional facts or information have become available since the date management made its assessment

requesting written representations from mgment and those charged with governance about plans for future action and the feasibility of these plans.

Question 8

how should the audit procedure be changed once going concern issues have been identified?

Answer 8

analysing and discussing cash flow, profit and other relevant forecasts with mgment

analysing and discussing entity’s latest available interim financial statements

reading terms of debentures and loan agreements and determining if any have been breached

reading minutes of meetings with shareholders, TCWG, relevant committees for reference to financing difficulties

enquiring of entity’s lawyer about existence of litigation and claims, and reasonableness of mgment’s assessments of their outcome and estimate of their financial implications

confirming existence, legality and enforceability of arrangements to provide or maintain financial support with related and third parties and assessing the financial ability of such parties to provide additional funds

considering entity’s plans to deal with unfilled customer orders

reviewing events after period end to identify those that either mitigate or otherwise affect the entity’s ability to continue as going concern

obtaining and reviewing reports or regulatory actions

Question 9

what are written representations and what do they include?

Answer 9

written statements by mgment provided to auditor to confirm certain matters or to support other audit evidence. includes the financial statements, assertions or supporting books and records.

presentation should relate to matters supporting audit evidence.

Question 10

what is the role of internal audit?

Answer 10

to provide independent assurance that an org’s risk management, governance and internal control processes are operating effectively.

unlike external auditors, they look beyond financial risks and statements to consider wider issues such as org’s reputation, growth and impact on environment and the way it treats its employees.

Question 11

what are the types of internal audit?

Answer 11

value for money audits
IT audits
financial audits
compliance audits
fraud investigations
customer experience audits
operational audits

Question 12

what is a value for money audit?

Answer 12

Value for money (VFM ) audits : determine whether the optimal combination of goods/ services have been obtained for the lowest level of resources.

economy - buying resources needed at the cheapest cost

efficiency - using resources purchased as wisely as possible

effectiveness - doing the right things and meeting the org’s objectives.

Question 13

what is an IT audit?

Answer 13

examination and evaluation of org’s info tech infrastructure, policies and operations. IT audits determine whether IT controls protect corporate assets, ensure data integrity and are aligned with business’ overall goals. IT auditors examine physical security controls, but also overall business and financial controls that involve IT systems. because operations at modern companies increasingly computerised, IT audits used to ensure info-related controls and processes are working properly.

Question 14

what are the primary objectives of an IT audit

Answer 14

Evaluate the systems and processes in place that secure company data.

Determine risks to a company’s information assets, and help identify methods to minimize those risks.

Ensure information management processes are in compliance with IT-specific laws, policies and standards.

Determine inefficiencies in IT systems and associated management.

Question 15

what is a compliance audit?

Answer 15

Compliance audits are checks put in place to ensure that an organisation meets any legal requirements or internal guidelines, such as corporate bylaws, controls and policies. An audit report will cover the strength of compliance preparations, security policies, risk management procedures, and user access controls throughout the audit.

Question 16

what are the benefits of a compliance audit?

Answer 16

Providing a safe working environment and promoting a secure and stress-free workspace

Preventing penalties and avoiding any legal issues and consequences

Establishing a good reputation and gaining public trust and dominating your industry by staying aligned with industry protocols

Ensuring continuous operation and avoiding disruptions or cessation of operations.

Question 17

what is the definition of fraud?

Answer 17

Illegal act characterised by deceit, concealment, or violation of trust. These acts are not dependent upon the threat of violence or physical force. Frauds are perpetrated by parties and organisations to obtain money, property, or services; to avoid payment or loss of services; or to secure personal or business advantage.

Question 18

what should internal audit be able to pick up on in terms of fraud?

Answer 18

Identify red flags indicating fraud may have been committed.

Understand the characteristics of fraud and the techniques used to commit fraud, and the various fraud schemes and scenarios.

Evaluate the indicators of fraud and decide whether further action is necessary or whether an investigation should be recommended.

Evaluate the effectiveness of controls to prevent or detect fraud.

Question 19

what is the operational audit? what are the primary outcomes of a successful operational audit?

Answer 19

The financial and operational audit refers to the process of evaluating a company’s operating activities – both on a day-to-day level and a broader scale.

The primary outcomes of a successful operational audit:
Maximize efficiency: Gain a greater understanding of how future policies and procedures can boost effectiveness.

Understand risks: Businesses run many operational risks, ranging from health and safety issues to cyber threats. A full operational audit identifies risks like these, as well as potential problems related to fraud and compliance.

Finetune internal controls: By examining each step of the operational process, an audit can dive deeper into the impact of any changes to internal controls.

Question 20

what are the independence limitations of internal audit?

Answer 20

internal auditors should be independent of the activities they audit. shouldn’t be involved in designing, installing and operating systems.

internal audit departments should be granted sufficient status to achieve independence from the various company functions

internal auditor’s reports should be considered appropriately by directors and recommendations acted upon

internal auditors must have a reporting line that is independent of the function they are auditing - highest level of management/audit committee

Question 21

what skill and care issues should be considered with internal audit?

Answer 21

need for internal auditors to have wide-ranging skills

need for multi-disciplinary internal audit team

need for ongoing training

adherence to internal audit quality control manuals/procedures

work should be planned, documented, supervised and reviewed

Question 22

what are the advantages of outsourcing the internal audit function?

Answer 22

a company can benefit from the services provided by an internal audit function without incurring the time and cost involved with recruiting staff

outsourcing the internal audit function may well increase their independence as the role will be performed by a third party rather than employees who may fear losing their jobs if they report adversely on the company’s management

there will be no need for the company to train internal audit staff as those providing the service will be trained by their own employer

as well as buying in regular services, it may be able to take advantage of ad hoc engagements provided that the company to which services are outsourced has spare capacity

internal auditors supplied by a bespoke outsourcing company are likely to possess relevant accounting and auditing skills which will increase the reliability of internal auditors’ work

Question 23

what are the disadvantages of outsourcing the internal audit function

Answer 23

if a company already has an internal audit function and makes them redundant in order to outsource the function, the redundancies may prove very expensive. furthermore, the company would lose in-house skills. also, remaining staff may oppose outsourcing if it has come about as a result of colleagues being made redundant. this could reduce staff morale.

the staff that come to perform the regular internal audit services may vary from month to month. this will mean that staff from the company will need to spend more time explaining systems and processes to them than if the internal audit function were company employees

the outsourced staff may lack specific knowledge of the company

outsourcing will require company to allow third party access to commercially sensitive data. despite fact that any engagement letter would stipulate that confidentiality be maintained, data would still be lost or disclosed

the cost of outsourcing the internal audit function may well increase over time and become more expensive than employing own staff

Question 24

what is the role of the internal vs external auditor?

Answer 24

external - statutory duty to give an opinion as to whether the financial statements present fairly the activities of the business. conducted in accordance with ISAs

internal - assist board in achieving corporate objectives

Question 25

what are the objectives of the internal vs external auditor?

Answer 25

external - give opinion as to whether financial statements present fairly the activities of business and proper accounting records have been kept

internal - varied and wide ranging
determined by mgment/board, but may include:
review of accounting/internal control systems, examination of financial/operating info, VFM reviews, special investigations

Question 26

who does the internal auditor report to? who does the external auditor report to?

Answer 26

internal - board of directors/audit committee

external - shareholders of company

Question 27

what qualifications does an internal vs external auditor need?

Answer 27

external:
audit partner will be qualified and hold practising certificate as registered auditor.
not all team members will be qualified

internal:
no formal qualifications required

Question 28

what are the external auditors’ responsibilities for fraud and error as per ISA 240?

Answer 28

no responsibility for prevention

responsibility to consider the risk of material misstatement in the financial statements due to fraud and error

provide reasonable reassurance that financial statements are free from material misstatement

responsibility to detect fraud and error which has a material impact on the financial statements

Question 29

what are the internal auditors’ responsibilities for fraud and error as per ISA 240?

Answer 29

directors responsible for prevention and detection

internal audit can assist directors with prevention of fraud and error by assessing effectiveness of internal control systems

existence of IA dept may act as deterrent

can contribute to detection by reporting suspicions

may be called on to investigate suspected fraud