Chapter 1 - Audit

Question 1

Why are audit performed?

Answer 1

To ascertain the validity and reliability of information and also provide an assessment of systems internal control

Question 2

What is the definition of an external audit?

Answer 2

Independent examination and expression of opinion on the financial statements of an entity

Question 3

Who is the audit opinion prepared for?

Answer 3

the shareholders

Question 4

What is a true and fair view included in the audit opinion?

Answer 4

True - information in the financial statements is factual and complies with accounting standards

Fair - referes to information being clear, impartial and unbiased (reflecting substance of transactions, rather than the legal form)

Question 5

What is the three party relationship needed for an assurance engagement?

Answer 5

1) A practitioner (accountant) who will review the subject matter and provide the assurance

2) A responsible party, which is the organisation responsible for preparing the subject matter

3) Intended user, who is the person who requires the assurance report

Question 6

What are the 5 elements of an assurance engagement?

Answer 6

1) Three party relationship
2) Appropriate underlying subject matter
3) Suitable criteria that the subject matter is compared to - accounting standards
4) Sufficient appropriate evidence has been obtained by the practitioner
5) A written assurance report given by practitioner to intended user and responsible party

Question 7

When might a review engagement be facilitated?

Answer 7

Six monthly figures, interim financial statements, annual financial statements where an audit is not required and forecast figures

Question 8

how does a review engagement differ to an external audit?

Answer 8

Procedures undertaken not as comprehensive as audit with emphasis on analytical review and enquiry used extensively and the practitioner does not need to comply with ISAs. Normally give a ‘Limited level of assurance’

Question 9

What does an auditor have to do before they can accept a new appointment?

Answer 9

1) Check if the audit firm is independent of client
2) Check firm resources (staff numbers and time)
3) Assess the risk attached to new client (nature of industry, assessing integrity of key staff and credit search)
4) Ensure there are no conflicts of interest (clients in same industry sector)

Question 10

What 5 steps does the auditor need to take after the four initial checks have been completed?

Answer 10

1) Ask client for permission to contact outgoing auditor
2) If client denies this permission, audit must be rejected
3) Contact outgoing auditor to discuss any relevant matters (client paid promptly, acted with integrity)
4) Outgoing auditor should also contact client to seek permission to respond the incoming auditors requests
5) If permission is denied, new auditor should be informed

Question 11

What 6 rights does an auditor have once appointed?

Answer 11

1) Access to company’s books, accounts and vouchers
2) Recieve all information or explanations they think necessary for the performance of their duties as auditors
3) Recieve all communication relating to written resolutions
4) Recieve all notices of, and communication relating to, general meetings
5) Attend general meeting and be heard at general meeting
6) rights relating to removal and resignation

Question 12

How can an auditor be removed?

Answer 12

Only by shareholders at a general meeting with a majority vote.

Question 13

What must an auditor do if the shareholders vote to remove them?

Answer 13

They must produce a statement of circumstances and if there are no circumstances that need to be raised to shareholders, they must produce statement of no circumstance

Question 14

What can an auditor request should they wish to resign?

Answer 14

an extraordinary general meeting.

Question 15

What are some limitations with an external audit?

Answer 15

1) rely heavily on integrity of client management
2) Financial reporting involves management judgement and subjective decisions which is not possible to conclude absolutely are correct
3) Limited amount of time on clients premises, testing only a sample of items due to the fact that there is a cost/benefit element to auditing
4) Auditors plan their work to detect material errors and frauds, so minor errors and frauds may not be detected.

Question 16

What branch of the International Federation of Accountants is most important for the Audit profession?

Answer 16

International Audit and Assurance Standards Board (IAASB)

Question 17

What is the most important pronouncements that the IAASB release?

Answer 17

International Standards on Auditing (ISAs) - contain basic principles and essential procedures together with related guidance in the form of explanatory material and appendices. An auditor may depart from ISA, but will need to justify.

Question 18

What are ISA’s not designed to do?

Answer 18

To overrule specific requirements of an individual country, so if conflict arises the country regulation should be applied.

Question 19

What does a strong system of corporate governance give to a company’s financial statements?

Answer 19

credibility

Question 20

Which type of company follows the ‘UK Corporate Governance Code’?

Answer 20

Listed companies

Question 21

What are the 6 key recommendations that the UK Corporate Governance Code recommends?

Answer 21

1) Board Leadership and Company Purpose
2) Division of responsibilities
3) Composition, succession and evaluation
4) Audit, risk and internal control
5) Remuneration
6) Independence of NEDS

Question 22

What are the details of board leadership and company purpose as outlined by UK Corporate Governance Code?

Answer 22

1) Board must be effective and entrepreneurial
2) Board should establish company’s purpose, values and strategy
3) Board should ensure that the necessary resources are in place to meet objectives and measure performance - effective controls which enable risk to be assessed and managed

Question 23

What are the details of Division of duties as outlined by UK Corporate Governance Code?

Answer 23

1) Objective judgement
2) That at least half the board should be independent non-executive directors
3) Non Execs should have sufficient time to meet their board responsibilities

Question 24

What are the details of composition, succession and evaluation as outlined by UK Corporate Governance Code?

Answer 24

1) Appointments should be formal, rigorous and transparent
2) Appointments and succession should be based on merit and objective criteria - should promote diversity in gender social and ethnic background
3) Annual evaluation of board should consider composition, diversity and how effectively members work together

Question 25

What are the details of audit, risk and internal control as outlined by UK Corporate Governance Code?

Answer 25

1) Form transparent procedures and policies to promote integrity in FS - done through an audit committee of independent non-executive directors

Question 26

What are the details of remuneration as outlined by UK Corporate Governance Code?

Answer 26

1) Executive remuneration should be aligned to company purpose and values and clearly linked to successful of company's long term strategy 2) Remuneration outcome should be done by a remuneration committee

Question 27

What are the details of independence as outlined by UK Corporate Governance Code?

Answer 27

A non-execs independence could be compromised if: 1) Been an employee of the company or group within the last 5 years 2) Within the last three years a material business relationship with the company either directly or as a partner, shareholder, director or senior employee 3) Part of additional remenuration schemes: Pension, performance, share options 4) Close family ties with any of companys advisors, directors or senior employees 5) Holds cross-directorships or has significant links with other directors through involvement in other companies or bodie 6) Represents a significant shareholder 7) Has served on the board for more than 9 years from the date of their first appointment

Question 28

What are the 8 key responsibilities of an audit committee?

Answer 28

1) Monitor integrity of the FS (and other formal announcements relating to financial performance) and review significant reporting judgements 2) Provide advice (as required) on whether annual report and accounts are fair, balanced and understandable 3) Review companys internal financial controls and risk mgmt and internal control systems 4) Monitor and review effectivness of internal audit function 5) Conduct tender process and make recommendations to board re appointment/remuneration of external auditor (submitted to shareholders for approval) 6) Review and monitor independence/objectivity of external auditor and the effectiveness of audit process 7) Develop and implement policy on use of external auditor to provide non-audit services 8) Report to the board on how the audit committee has discharged its responsibilities

Question 29

8 advantages of an audit committee?

Answer 29

1) Non-Execs performing part time role, so more time to focus on key documents such as auditors report 2) Increased public confidence in credibility and objectivity of published financial information 3) Shareholders may view the committee as a form of 'internal control' leading to a stronger control environment 4) Assist board by checking compliance with appropriate accounting standards 5) Variety of diffferent background (potential) bringing skills and knowledge 6) Easier and cheaper to raise finance if good perception of corporate governance 7) Acts as bridge between external auditor and board - promoting independence 8) Internal audit can report to audit committee too ensuring their independence too

Question 30

What are four limitations of an audit committee?

Answer 30

1) not easy to find independent non-executives with relevant knowlegde of corporate governance and the company itself 2) Board may see NEDs as having too much power and effectively 'running company' 3) Slower decision making 4) Cost of the NEDS

Question 31

What are the three key business risks that directors are responsible for?

Answer 31

1) Financial risks - entity's cash flow such as movement in interest rates and exchange rates 2) Compliance risks - relating to laws and regulations 3) Operational risks - risks relating to day-to-day operations of business (loss of staff)

Question 32

What responibilites does a person who is 'charged with governance have'?

Answer 32

1. Strategic direction of entity 2. Obligations relating to accountability of entity, including overseeing Financial Reporting process (Highest level of mgmt, including exec and non-exec directors)

Question 33

What matters must be communicated by the auditor to those charged with governance?

Answer 33

1) That they are responsible for forming and expressing an opinion on FS 2) Planned scope and timing of audit 3) Changes in accounting policies 4) Material risks and exposures (pending litigation) 5) Audit adjustments 6) Material uncertainties (going concern) 7) Disagreements with mgmt 8) Expected modifications 9) Material weakness in internal control

Question 34

What are the 5 fundamental principles of ACCA's code of ethics and conduct?

Answer 34

Integrity Objectivity Professional competence and due care confidentiality Professional behaviour

Question 35

When does an auditor have a obligatory responsibility to disclose client information without needing the clients permission?

Answer 35

Client has committed money-laundering, drug trafficking, terrorist offences, court order or summons

Question 36

When does an auditor have a voluntary discloser to disclose client information without needing the clients permission?

Answer 36

If auditor feels it is in best interest for the public, mgmt are involved in fraud or to defend against claim of negligence or if suing for unpaid fees

Question 37

What to do when a public interest company makes up more than 15% of total fees earned by firm?

Answer 37

1) perform engagement quality review before issuing audit opinion on second years FS and seek other clients to reduce self interest threat 2) Seek other clients to reduce self interest threat 3) Consider resigning - mandatory after 5th consecutive year/opinion unless in public interest to maintain

Question 38

What to do when a non-public interest company makes up more than 30% of total fees earned by firm?

Answer 38

1) Obtain a review by a professional accountant who is not a member of the audit team prior to the 5th year audit opinion being issued 2) Prior to the 6th year audit opinion being issued, obtain an external quality review on the 5th year audit work

Question 39

When might a self review threat occur?

Answer 39

1) Member of the audit team recently employed by client and is therefore reviewing own work 2) Preperation of FS on behalf of an audit client - not allowed for listed client. 3) Calculation of tax figure for inclusion in FS of an audit client - not allowed for listed client 4) Provision of internal audit services to external audit client - not allowed for listed clients and only allowed for other entities if audit team members are not involved in audit engagement team

Question 40

When might an advocacy threat arise to an auditor?

Answer 40

1) Acting as advocate on behalf of client in litigation or dispute 2) Promoting stock exchange listing 3) Attending bank meeting to give explanations about FS

Question 41

When might a familiarity threat arise for an auditor?

Answer 41

1) Having a family/personal relationship with director of client 2) Acceptance of gifts/hospitality from the client unless modest in value 3) Long association with client 4) Staff from audit firm joining the client

Question 42

How long should engagement partners be rotated on listed companies and what threat does this mitigate?

Answer 42

Every 7 years at minimum and familiarity threat

Question 43

Four examples of safeguards an audit firm can put in place?

Answer 43

1) Use different staff to avoid familiarity or self-review threats (one team prepare, another team audits) 2) Rotate engagement partners 3) Second partner to review completed audit file (hot review) 4) Declines offers to carry out additional services if already the auditor

Question 44

List two sources of conflict of interest threat?

Answer 44

1) Accountant performs service in competition with client 2) Accountant approached by clients competitor in industry

Question 45

How to mitigate the conflict of interest arising by accountant performing a service in competition with client?

Answer 45

Accountant must inform client of conflict of interest

Question 46

How to mitigate conflict of interest arising from account being approached by clients competitor?

Answer 46

1) Notify both clients of approach by competitor and get consent from both 2) Advise both clients to seek additional indepedant advice 3) Use different engagement teams 4) Apply physical controls (passwords etc) 5) Using confidentiality signed by employees and partners of firm