Unit 1 - Audit Framework and Regulation Flashcards
(42 cards)
What is an audit, and the most important words in the definition?
The independent examination of and expression of opinion on the financial statements of an entity by a duly appointed auditor in pursuit of that appointment.
Independence and Opinion.
What are the five elements of an assurance engagement?
1 - A three party relationship involving a practitioner, a responsible party, and intended users.
2 - Appropriate subject matter
3 - Suitable criteria
4 - Sufficient appropriate evidence
5 - A written assurance report in the form appropriate to a reasonable assurance engagement or a limited assurance engagement
What is the three party relationship?
Practitioner e.g. the auditor - responsible for determining the nature, timing and extent of procedures, and is required to pursue anything that leads the practitioner to question whether a material modification should be made to the subject matter information.
A responsible party - the person responsible for the information and assertions.
The intended users are the persons for whom the practitioner prepares the assurance report. The responsible party can be one of the intended users.
Examples of subject matter?
Financial Performance
Non-financial performance
Physical characteristics
Systems and processes
Behaviour
Appropriate subject matter criteria
Identifiable, and capable of consistent evaluation or measurement against the identified criteria
Such that the information about it can be subjected to procedures for gathering sufficient appropriate evidence.
What are suitable criteria, and examples of them?
The benchmarks used to evaluate/measure the subject matter
When reporting on F/S - IFRS
Internal control - Internal control framework
Compliance - Applicable law, regulation or contract.
What five characteristics do suitable criteria exhibit?
Relevance - Relevant criteria contribute to conclusions that assist decision-making by the intended users.
Completeness - Criteria are sufficiently complete when they include all relevant factors that could affect the conclusions.
Reliability - Reliable criteria allow reasonable consistent evaluation of the subject matter.
Neutrality - Neutral criteria so that conclusions are free from bias.
Understand-ability - Conclusions that are clear, comprehensive, and not subject to significantly different interpretations.
Evaluation/measurement of a subject matter on the basis of the practitioner’s own expectations, judgements and individual experience would not constitute suitable criteria.
They need to be available to the intended users to allow them to understand how the subject matter has been evaluated or measured.
Sufficient appropriate evidence? What attitude should the auditor adopt?
The practitioner plans and performs an assurance engagement with an attitude of professional scepticism to obtain sufficient appropriate evidence about whether the subject matter information is free from material misstatement. An attitude of professional scepticism means the practitioner questions the validity of evidence and is alert to evidence that brings into question the reliability of documents or representations.
What is professional scepticism?
Scepticism means you don’t know. It doesn’t mean that the practitioner assumes everyone is dishonest or that figures have been deliberately misrepresented. Nor does it mean that you believe all figures and statements are correct. it means you are aware that we can all be subject to optimism, human error, giving quick answers, misunderstanding. It also recognises that sometimes people are deliberately misleading or dishonest.
Scepticism means that evidence is required to test statements/assumptions. You could almost summarise assurance in the phrase ‘collect evidence that supports everything that is being claimed.’
What is sufficiency of evidence? Appropriateness of evidence?
Sufficiency - measure of quantity
Appropriateness - measure of quality - relevance and reliability, it is influenced by its source and by its nature, and dependent upon the individual circumstances under which it was obtained.
Assurance report
Reasonable assurance?
Limited assurance?
In a reasonable assurance engagement the practitioner’s conclusion is worded in the positive form e.g. “In our opinion internal control is effective, in all material respects, based on XYZ criteria.”
In a limited assurance engagement, the conclusion is worded in the negative form, e.g. “Based on our work described in this report, nothing has come to our attention that causes us to believe that internal control is not effective, in all material respects, based on XYZ criteria.”
Examples of positive assurance?
The F/S show a true and fair view.
The value of inventory lost is £x
AKA Reasonable assurance, an auditor cannot give a guarantee.
Examples of negative assurance?
We have discovered nothing wrong with the F/S
The basis of the forecast is not unreasonable.
There is no evidence of discrimination in the appointment.
AKA limited assurance
Why wouldn’t an auditor express a conclusion?
There is a limitation on the scope of the practitioner’s work (ie sufficient appropriate evidence cannot be obtained)
The assertion is not fairly stated (in all material respects or the subject matter information is materially misstated.
Why is Corporate Governance needed?
Corporate governance is the system by which companies are directed and controlled.
The problem with bad corporate governance is that although the shareholders own companies, the day-to-day management and direction of companies is given to the board of directors. In large companies many shareholders are relatively passive and the board of directors is given more or less free rein to make whatever decisions they wish.
Auditing was instituted so at least once a year, when the financial statements were presented to the members of the company, the auditors would examine them and give some expression of pinion to the members of the company as to whether the financial statements were true and fair. Without that assurance the members of the company really would have a little idea whether or not the information could be relied on. The auditors therefore examine the financial statements and this adds credibility to those statements, the shareholders have a much better idea of the performance of the directors and the company.
Note that the shareholders appoint the auditors as well as the directors. The problem is that once directors were appointed, shareholders often don’t take much further interest in what the directors were doing and there were annual gaps between financial statements being issued. This hands-off approach has recently been found entirely inadequate and additional safeguards have been instituted to try to ensure that directors act in the best interests of the members of the company. Directors should at for the shareholder but often acted for themselves – the agency problem. In agency terms, the shareholders are the principals and the directors are their agents. Agents should act in the best interests of their principals.
UK Corporate governance code principles
Board Leadership and Company Purpose
Division of Responsibilities
Composition, Succession and Evaluation
Audit, Risk and Internal Control
Remuneration
What is comply or explain?
The code has no force in law and is enforced on listed companies through the stock exchange. Listed companies are expected to “comply or explain” and this approach is the trademark of corporate governance in the UK.
Listed companies have to state that they have complied with the code or else explain to shareholders why they haven’t. this allows some flexibility and non-compliance may be acceptable in some cases.
Board leadership and company purpose
Every company should be headed by an effective board which is collectively responsible for the long term success of the company.
All directors must act with integrity, lead by example and promote the desired culture.
Division of Responsibilities
There should be a clear division between the running of the board and the executive responsibility for the running of the company’s business. No one individual should dominate decision making. This means that the roles of CEO and chairman should not be performed by one person as that concentrates too much power in one person.
The chairman is responsible for leadership of the board.
Non-executive directors (NEDs) must be appointed to the board and they should constructively challenge and help develop proposals on strategy. NEDs sit in at board meetings and have full voting rights, but do not have day to day executive or managerial responsibility. Their function is to monitor, advise and warn the executive directors.
Composition, Success and Evaluation
Appointments to the board should be subject to a formal, rigorous and transparent procedure led by a nomination committee. A majority of the committee should be independent NEDs .
The board and its committees should have a combination of skills, experience and knowledge. The length of service of the board as a whole should be considered and membership regularly refreshed. The post of chairman should not be held beyond nine years.
The board should undertake a formal and rigorous annual evaluation of its own performance and that of its committees and individual directors.
All directors should be submitted for re-election annually.
Audit, Risk and Internal Control
The board should establish formal and transparent policies and procedures to ensure the independence and effectiveness of internal and external audit and the integrity of financial statements.
The board should present a fair, balanced and understandable assessment of the company’s position and prospects. The financial statements should state whether the board considered the appropriateness of the going concern basis of accounting and identify any material uncertainties for at least 12 months from the date of approval of the financial statements.
The board should establish procedures to manage risk, oversee internal controls and determine the nature and extent of the principal risks the company is willing to take to achieve its long-term strategic objectives.
Remuneration
In essence, remuneration should be sufficient to attract, retain and motivate directors of sufficient quality… but avoid paying more than is necessary.
A significant proportion of executive directors’ remuneration may be structured to link rewards to corporate and individual performance. In other words, profit related pay is encouraged. Directors should not receive high pay irrespective of company performance.
There should be a formal and transparent procedure for developing policy on executive remuneration and for fixing the remuneration packages of individual directors. No director should be involved in deciding his or her own remuneration. This means that a remuneration committee (NEDs) should be formed to fix directors’ remuneration.
Main roles/responsibilities of AC
Monitoring and reviewing the effectiveness of internal audit. Companies don’t have to have an internal audit department, but the need for one must be reviewed annually.
Monitoring the integrity of the financial statements and reviewing significant financial reporting judgements.
Review the internal financial controls and risk management systems (unless there is a separate risk committee/board that does this)
Making recommendations to the board about the appointment, reappointment and removal of the external auditors and agreeing the terms of the engagement. (note that the external auditors are appointed by members in the general meeting, but the board puts forward the nomination.)
Annually assessing the independence, objectivity and effectiveness the external auditors including confirming that there are no self-interest or familiarity issues and that partners and staff are rotated properly.
Acting as a forum to link directors and auditors. Auditors will typically write to the audit committee about any problems they may be having on the audit or obtaining all of the information they require. If the auditors are worried in some way about the financial statements they will raise those concerns with the AC.
Developing and implementing policy on the engagement of the external auditor to supply non-audit services: skills, approval and non-approval for certain services, ensuring any threats to independence and objectivity are reduced to acceptable levels and monitoring the fees for those services and the total fee for all services provided for by the external auditor.
What are the auditor’s rights?
They have access to all records they require
They have a right to receive information and explanations of all transactions
They have a right to attend and receive notice about general meetings and they have right to speak at general meetings on relevant matters.
A general meeting is where the shareholders of the company come together, and the AGM ensures that there should be at least one every year. The auditors have the right to receive advance info about any resolutions proposed at these GMs.
They also have the right to require that the company’s FS should be presented at the GM – as, if the F/S contained info they wanted to keep hidden, they would delay presenting them.
Their right to informed about, attend and speak at general meetings gives the auditors an opportunity to communicate directly with the shareholders – by whom they have been appointed and for whom they are acting.
