REVIEW PROCEDURES
An auditor must perform and document an overall review of the financial statements before making an audit opinion. This review, along with the conclusions drawn from other audit evidence obtained, gives the auditor a reasonable basis for his opinion on the financial statements. It needs to be carried out by a senior member of the audit team, who has the appropriate skills and experience.
Compliance with accounting regulations
The auditor should consider whether the financial statements are in accordance with statutory requirements and whether the accounting policies are in accordance with accounting standards. In addition, the policies should be appropriate to the entity, properly disclosed and consistently applied.
When assessing the accounting policies used by the entity, the auditor should consider policies adopted in specific industries, standards and guidelines, the need for a true and fair view and the need to reflect substance over form.
Review for consistency and reasonableness
The auditor needs to consider whether the financial statements are consistent with his knowledge of the entity’s business and with the evidence accumulated from other audit procedures, and that the manner of disclosure is fair.
The auditor will consider:
- Information and explanations received during the audit,
- New factors which may affect presentation and/or disclosure requirements,
- Results of analytical procedures applied,
- Undue influence by directors,
- The potential impact of the aggregate of uncorrected misstatements identified.
Analytical procedures
Analytical review procedures are used as part of the overall review procedure. This review should cover accounting ratios, changes in products/customers, price and product mix changes, wages changes, variances, trends in production and sales, changes in material/labour content of production and variations caused by industry or economy factors. Significant fluctuations and unexpected relationships must be investigated.
Summarise errors
During the course of the audit of financial statements, there will be material and immaterial errors uncovered. The client will normally adjust the financial statements to take account of these errors. At the end of the audit however, there may be some outstanding errors and the auditors will summarise these unadjusted errors.
The summary of errors will not only list errors from the current year, but also those that exist from previous years. This allows errors to be highlighted that are reversals of errors from previous years, such as in the valuation of closing/opening stock. The auditor should show both the balance sheet and the profit and loss effect of these errors.
Evaluating the effect of misstatements
As part of the standard on materiality (ISA 320) in evaluating whether the financial statements are prepared in accordance with an applicable financial reporting framework, the auditor should assess whether the aggregate of uncorrected misstatements that have been identified during the audit is material.
The aggregate of uncorrected misstatements are:
- Specific misstatements identified by the auditor, including ones identified during the audit of the previous period if they affect the current period and
- The auditor’s best estimate of other misstatements which cannot be quantified specifically.
If the aggregate of misstatements is material, the auditor must consider reducing audit risk by carrying out additional testing. Otherwise, he may request management to adjust the financial statements for the identified misstatements which the latter may wish to do anyway.
If the aggregate of the misstatements approaches the level of materiality, the auditor should consider whether it is likely that undetected misstatements, when taken with the aggregated uncorrected misstatements, could exceed the materiality level. If so, he should consider reducing the risk by performing additional testing or as before requesting management to adjust the financial statements for the identified misstatements.
Completion checklists
Auditors frequently use checklists as control documents and evidence, that all final procedures have been carried out and that all material amounts are supported by sufficient appropriate audit evidence. The checklists should be signed off.
OPENING BALANCES
Opening balances are based on the closing balances of the prior period and reflect transactions of and accounting policies applied to the prior period.
ISA 510 provides guidance on when the financial statements of an entity are audited for the first time and when the financial statements for the prior period were audited by another auditor.
For initial audit engagements, the auditor should obtain sufficient appropriate audit evidence that:
- The opening balances do not contain misstatements that materially affect the current period’s financial statements;
- The prior period’s closing balances have been correctly brought forward to the current period or, when appropriate, have been restated; and
- Appropriate accounting policies are consistently applied or changes in accounting policies have been properly accounted for and adequately presented and disclosed.
Appropriate sufficient audit evidence will depend on matters such as:
- The accounting policies,
- Whether the prior periods financial statements were audited and if so whether the auditors’ report was qualified,
- The nature of the accounts and the risk of misstatement in the current period,
- The materiality of the opening balances relative to the current period balances.
Where the prior period’s financial statements were audited by other auditors, the current auditor may be able to obtain sufficient appropriate audit evidence regarding opening balance by reviewing the other auditor’s working papers. The current auditor should consider the professional competence and independence of the other auditor. If the previous audit report was qualified, the auditor should pay particular attention in the current period to those matters that resulted in the qualification.
Where the prior period accounts were not audited or where the auditor has not obtained sufficient appropriate evidence, he must perform other procedures. Examples would include:
- In respect of current assets and liabilities, some audit evidence can usually be obtained as part of the current periods audit procedures such as the collection of opening debtors during the current period. This will provide some evidence of their existence, rights and obligations, completeness and valuation at the beginning of the period.
- The opening stock position may require observing a current physical count and then reconciling it back to the opening position, testing the valuation of the opening stock items and carrying out testing on gross margins and cut off procedures.
- For non-current assets and liabilities, the auditor may be able to obtain external confirmation of opening balances with third parties e.g. long term debt and investments.
If, after performing audit procedures, the auditor is unable to obtain sufficient appropriate audit evidence concerning opening balances, the auditor’s report should include:
- A qualified opinion or
- A disclaimer of opinion or
- In those jurisdictions where it is permitted, an opinion which is qualified or disclaimed regarding the results of operations and unqualified regarding financial position.
If the opening balances contain misstatements which could materially affect the current financial statements, the auditor should inform management and, after having obtained management’s authorisation, the previous auditor, if any. If the effect of the misstatement is not properly accounted for and adequately presented and disclosed, the auditor should express a qualified opinion or an adverse opinion, as appropriate.
If the current period’s accounting policies have not been consistently applied in relation to opening balances and if the change has not been properly accounted for and adequately presented and disclosed, the auditor should express a qualified opinion or an adverse opinion as appropriate.
If the entity’s prior period auditor’s report was qualified, the auditor should consider the effect on the current period’s financial statements. For example, if there was a scope limitation, such as one due to the inability to determine opening inventory in the prior period, the auditor may not need to qualify or disclaim the current period’s audit opinion. However, if a modification regarding the prior period’s financial statements remains relevant and material to the current period’s financial statements, the auditor should modify the current auditor’s report accordingly.
COMPARATIVES
ISA 710 establishes the standards and provides guidance in this area.
The auditor should determine whether the comparatives comply in all material respects with the financial reporting framework applicable to the financial statements being audited. Different countries have different reporting frameworks.
The auditor should obtain sufficient appropriate audit evidence that amounts derived from the preceding period’s financial statements are free from material misstatements and are appropriately incorporated in the financial statements for the current period.
Corresponding figures are amounts and other disclosures for the preceding period that are included as part of the current period financial statements, and are intended to be read in relation to the amounts and other disclosures relating to the current period. These corresponding figures are not presented as complete financial statements capable of standing alone, but are an integral part of the current period financial statements intended to be read only in relationship to the current period figures.
Comparative financial statements are amounts and other disclosures for the preceding period that are included for comparison with the financial statements of the current period, but do not form part of the current period financial statements.
Comparatives are presented in compliance with the applicable financial reporting framework.
The essential audit reporting differences are that:
- For corresponding figures, the auditor’s report refers only to the financial statements of the current period whereas
- For comparative financial statements, the auditor’s report refers to each period for which financial statements are presented.
Corresponding figures
The auditor should obtain sufficient appropriate audit evidence that the corresponding figures meet the requirements of the applicable financial reporting framework. The extent of audit procedures performed on the corresponding figures is significantly less than for the audit of the current period figures.
The auditor should obtain sufficient appropriate audit evidence that:
- The accounting policies used for the corresponding amounts are consistent with those of the current period and appropriate adjustments and disclosures have been made,
- The corresponding amounts agree with the amounts and other disclosures presented in the preceding period and are free from errors in the context of the financial statements of the current period,
- Where corresponding amounts have been adjusted as required by relevant legislation and accounting standards, appropriate disclosures have been made.
Reporting
When the comparatives are presented as corresponding figures, the auditor should issue an audit report in which the comparatives are not specifically identified because the auditor’s opinion is on the current period financial statements as a whole, including the corresponding figures.
Where the auditor’s report on the prior period, as previously issued, included a qualified opinion, disclaimer of opinion, or adverse opinion and the matter that gave rise to the modification is:
- Unresolved, and results in a modification of the auditor’s report regarding the current period figures, the auditor’s report should also be modified regarding the corresponding figures or
- Unresolved, but does not result in a modification of the auditor’s report regarding the current period figures, the auditor’s report should be modified regarding the corresponding figures only, or
- Resolved and properly dealt with in the financial statements, the current report does not need a reference to the previous modification. However, if the matter is material to the current period, the auditor may include an ‘emphasis of matter’ paragraph dealing with the situation.
During the course of the current audit the auditor may become aware of a material misstatement that affects the prior period financial statements on which an unqualified report had been previously issued.
- If the prior period financial statements have been revised and reissued with a new auditor’s report, the auditor should obtain sufficient appropriate audit evidence that the corresponding figures agree with the revised financial statements or,
- If the prior period financial statements have not been revised and reissued, and the corresponding figures have not been properly restated and/or appropriate disclosures have not been made, the auditor should issue a modified report on the current period financial statements modified with respect to the corresponding figures included therein.
- If prior period financial statements have not been revised and an auditor’s report has not been reissued, but the corresponding figures have been properly restated and/or appropriate disclosures have been made in the current period financial statements, the auditor may include an ‘emphasis of matter’ paragraph describing the circumstances and refer to the appropriate disclosures.
In some jurisdictions, the incoming auditor is permitted to refer to the previous auditor’s report on the corresponding figures in the incoming auditor’s report for the current period. When the auditor decides to refer to another auditor, the incoming auditor’s report should indicate:
- That the financial statements of the prior period were audited by another auditor,
- The type of report issued by the previous auditor and, if the report was modified, the reasons for the qualification and
- The date of that report.
When the prior period financial statements are not audited, the incoming auditor should state in the auditor’s report that the corresponding figures are unaudited. The making of such a statement does not relieve the auditor of his responsibilities to perform appropriate audit procedures regarding the opening balances.
If the auditor is not able to obtain sufficient appropriate audit evidence regarding the corresponding figures or, if there is not adequate disclosure, the auditor should consider the implications for his report.
In situations where the incoming auditor identifies that the corresponding figures are materially misstated, the auditor should request management to revise the corresponding figures or if management refuses to do so, appropriately modify the report.
Comparative financial statements
The auditor should obtain sufficient appropriate audit evidence that the comparative financial statements meet the requirements of the applicable financial reporting framework. This involves evaluating whether:
- Accounting policies of the prior period are consistent with those of the current period,
- Prior period figures agree with the amounts and other disclosures presented in the prior period and
- Appropriate adjustments and disclosures have been made.
Reporting
When the comparatives are presented as comparative financial statements, the auditor should issue a report in which the comparatives are specifically identified because the auditor’s opinion is expressed individually on the financial statements of each period presented.
Since the auditor’s report on comparative financial statements applies to the individual financial statements presented, the auditor may express a qualified or adverse opinion, disclaim an opinion or include an ‘emphasis of matter’ paragraph with respect to one or more financial statements for one or more periods, while issuing a different report on the other financial statements.
When reporting on the prior period financial statements in connection with the current year’s audit, if the opinion on such prior period financial statements is different from the opinion previously expressed, the auditor should disclose the substantive reasons for the different opinion in an emphasis of matter paragraph. This may arise when he becomes aware of circumstances or events that materially affect the financial statements of a prior period during the course of the audit of the current period.
When the financial statements of the prior period were audited by another auditor:
- The previous auditor may reissue the audit report on the prior period with the incoming auditor only reporting on the current period or
- The incoming auditor’s report should state the prior period was audited by another auditor, the type of report issued by the other auditor (if qualified – the reasons) and the date of that report.
In the course of the current audit the incoming auditor may become aware of a material misstatement that affects the prior period accounts on which the previous auditor had previously unqualified.
In these circumstances, the incoming auditor should discuss the matter with management and, after having obtained management’s authorisation, contact the previous auditor and propose that the prior period financial statements be restated. If the previous auditor agrees to reissue the audit report on the restated financial statements of the prior period, the auditor should only report on the current period.
If the previous auditor does not agree with the proposed restatement or refuses to reissue the audit report on the prior period financial statements, the introductory paragraph of the current auditor’s report should indicate that the previous auditor reported on the financial statements of the prior period before restatement. In addition, if the incoming auditor applies sufficient audit procedures to be satisfied as to the appropriateness of the restatement adjustment, he may include a paragraph in his report.
When the prior period financial statements are not audited, the incoming auditor should state in the auditor’s report that the comparative financial statements are unaudited. This statement does not relieve the auditor of the requirement to carry out appropriate audit procedures regarding opening balances.
In situations where the incoming auditor identifies that the prior year unaudited figures are materially misstated, the auditor should request management to revise the prior year’s figures or if management refuses to do so, appropriately qualify the report.
OTHER INFORMATION
Other information is financial and non-financial other than that included in the audited financial statements.
ISA 720 states that an auditor should read the other information to identify material inconsistencies with the audited financial statements.
If, as a result of reading the other information, the auditor becomes aware of any apparent misstatements therein, or identifies any material inconsistencies with the audited financial statements, the auditor should seek to resolve them.
A ”material inconsistency” exists when other information contradicts information contained in the audited financial statements. A material inconsistency may raise doubts about the audit conclusions drawn from audit evidence previously obtained and, possibly, about the basis for the auditor’s opinion on the financial statements.
An entity issues on an annual basis its audited financial statements together with the auditor’s report thereon. This document is frequently referred to as the ”annual report.” In issuing such a document, an entity may also include other financial and non-financial information.
Examples of other information include a report by management on operations, financial summaries or highlights, employment data, planned capital expenditures, financial ratios, names of officers and directors and selected quarterly data.
In certain circumstances, the auditor has a statutory or contractual obligation to report specifically on other information. In other circumstances, the auditor has no such obligation.
However, the auditor needs to give consideration to such other information when issuing a report on the financial statements, as the credibility of the audited financial statements may be undermined by inconsistencies which may exist between the audited financial statements and other information. The credibility of the audited financial statements may also be undermined by misstatements within the other information.
Some jurisdictions require the auditor to apply specific procedures to certain of the other information, for example, required supplementary data and interim financial information. If such other information is omitted or contains deficiencies, the auditor may be required to refer to the matter in the auditor’s report.
When there is an obligation to report specifically on other information, the auditor’s responsibilities are determined by the nature of the engagement and by local legislation and professional standards.
Access to other information
In order that an auditor can consider other information included in the annual report, timely access to such information will be required. The auditor therefore needs to make appropriate arrangements with the entity to obtain such information prior to the date of the auditor’s report. In certain circumstances, all the other information may not be available prior to such date. In these circumstances, the auditor would need to consider his options.
Material inconsistencies
If, on reading the other information, the auditor identifies a material inconsistency, he should determine whether the audited financial statements or the other information needs to be amended.
If the auditor identifies a material inconsistency he should seek to resolve the matter through discussion with management.
If the auditor concludes that the other information contains inconsistencies with the financial statements and the auditor is unable to resolve them through discussion with management, he should consider requesting management to consult with a qualified third party, such as the entity’s legal counsel and consider the advice received.
If an amendment is necessary in the audited financial statements and the entity refuses to make the amendment, the auditor should express a qualified or adverse opinion.
If an amendment is necessary in the other information and the entity refuses to make the amendment, the auditor should consider including in the auditor’s report an ‘emphasis of matter’ paragraph describing the material inconsistency or take other actions.
The actions taken, such as not issuing the auditor’s report or withdrawing from the engagement, will depend upon the particular circumstances and the nature and significance of the inconsistency. The auditor would also consider obtaining legal advice as to further action.
Material misstatements of fact
While reading the other information for the purpose of identifying material inconsistencies, the auditor may become aware of a material misstatement of fact.
A ”material misstatement of fact” in other information exists when such information, not related to matters appearing in the audited financial statements, is incorrectly stated.
If the auditor becomes aware that the other information appears to include a material misstatement of fact, the auditor should discuss the matter with the entity’s management.
When discussing the matter with the entity’s management, the auditor may not be able to evaluate the validity of the other information and management’s responses to the auditor’s inquiries and would need to consider whether valid differences of judgment or opinion exist.
The auditor should consider whether the other information requires to be amended.
When the auditor still considers that there is an apparent misstatement of fact, the auditor should request management to consult with a qualified third party, such as the entity’s legal counsel and should consider the advice received.
If the auditor concludes that there is a material misstatement of fact in the other information which management refuses to correct, the auditor should consider taking further appropriate action. The actions taken could include such steps as notifying management in writing of the auditor’s concern regarding the other information and obtaining legal advice.
Availability of other information after the date of the auditor’s report:
Where all the other information is not available to the auditor prior to the date of the auditor’s report, the auditor should read the other information at the earliest possible opportunity thereafter to identify material inconsistencies.
If, on reading the other information, the auditor identifies a material inconsistency or becomes aware of an apparent material misstatement of fact, the auditor should determine whether the audited financial statements or the other information need revision.
When revision of the other information is necessary and the entity agrees to make the revision, the auditor should carry out the audit procedures necessary under the circumstances. The audit procedures may include reviewing the steps taken by management to ensure that individuals in receipt of the previously issued financial statements, the auditor’s report thereon and the other information, are informed of the revision.
When revision of the other information is necessary but management refuses to make the revision, the auditor should consider taking further appropriate action. The actions taken could include such steps as notifying management in writing of the auditor’s concern regarding the other information and obtaining legal advice
SUBSEQUENT EVENTS
The auditor should consider the effect of subsequent events (events after the balance sheet date) on the financial statements and on the auditor’s report.
Events after the balance sheet date deals with the treatment in financial statements of events, both favourable and unfavourable, that occur between the balance sheet date and the date when the financial statements are authorised for issue and identifies two types:
- Those that provide evidence of conditions that existed at the balance sheet – adjusting events – and
- Those that are indicative of conditions which arose after the balance sheet date – non adjusting events.
Events occurring up to the date of the auditor’s report
The auditor should perform audit procedures designed to obtain sufficient appropriate audit evidence that all events up to the date of the auditor’s report that may require adjustment of, or disclosure in, the financial statements have been identified.
These procedures are in addition to procedures that may be applied to specific transactions occurring after period end to obtain audit evidence as to account balances as at period end, for example, the testing of stock cut-off and payments to creditors. The audit procedures to identify events that may require adjustment would be performed as near as possible to the date of the auditor’s report. Such audit procedures would take into account the auditor’s risk assessment and include the following:
- Reviewing management procedures to ensure that subsequent events are identified.
- Reading minutes of the meetings of shareholders and directors held after the period end and inquiring about matters discussed for which minutes are not yet available.
- Reading the entity’s latest available interim financial statements and, as considered necessary and appropriate, budgets, cash flow forecasts and other related reports.
- Inquiring of the entity’s legal counsel concerning litigation and claims.
- Inquiring of management as to whether any subsequent events have occurred which might affect the financial statements such as the following specific matters:
- The current status of items based on preliminary or inconclusive data,
- New commitments, borrowings or guarantees,
- Major sales or acquisition of assets occurred or planned,
- Issue of new shares or debentures or an agreement/plans to merge or liquidate,
- Assets appropriated by government or destroyed by fire or flood,
- Developments regarding risk areas and contingencies,
- Unusual accounting adjustments made or contemplated,
- Any events occurring or likely to occur which will bring into question the appropriateness of accounting policies used in the financial statements.
When the auditor becomes aware of events that materially affect the financial statements, he should consider whether such events are properly accounted for and adequately disclosed.
Facts discovered after date of the auditor’s report but before the financial statements are issued
The auditor does not have any responsibility to perform audit procedures or make any inquiry regarding the financial statements after the date of the auditor’s report. During the period from the date of the auditor’s report to the date the financial statements are issued, the responsibility to inform the auditor of facts that may affect the financial statements rests with management.
Where after the date of the auditor’s report but before the financial statements are issued, the auditor becomes aware of a fact that may materially affect the financial statements, the auditor should consider whether the financial statements need amendment. He should discuss the matter with management and should take the action appropriate in the circumstances.
When management amends the financial statements, the auditor would carry out additional audit procedures and should issue a new report on the amended financial statements. The new report would be dated not earlier than the amended financial statements are signed or approved by management.
When management does not amend the financial statements in circumstances where the auditor believes they need to be amended and the auditor’s report has not been released to the entity, the auditor should express a qualified opinion or an adverse opinion.
When the auditor’s report has been released to the entity, the auditor would notify management not to issue the financial statements and the auditor’s report thereon to third parties. If they are subsequently released, the auditor needs to take action to prevent reliance on the audit report. The action taken will depend on the auditor’s legal rights and obligations and the recommendations of the auditor’s lawyer.
Facts discovered after the financial statements have been issued
After the financial statements are issued, the auditor has no obligation to make any further inquiry.
When, after the financial statements have been issued, the auditor becomes aware of a fact which existed at the date of the auditor’s report and which, if known at that date, may have caused the auditor to qualify his report, the auditor should consider whether the financial statements need revision, should discuss the matter with management and should take the action appropriate in the circumstances.
Where the auditor becomes aware of a fact relevant to the audited financial statements that did not exist at the date of the auditor’s report there are no statutory provisions for revising financial statements. The auditor should discuss with management whether they should withdraw the financial statements and where management decides not to do so the auditor may wish to take advice on whether it might be possible to withdraw their report. A possible course of action may include making a statement by management or the auditor at the annual general meeting. In any event legal advice may be helpful.
When management revise the financial statements, the auditor should carry out the audit procedures necessary in the circumstances and should review the steps taken by management to ensure that anyone in receipt of the previously issued financial statements together with the auditor’s report thereon is informed of the situation. The auditor should issue a new report on the revised financial statements.
The new auditor’s report should include an emphasis of a matter paragraph referring to a note to the financial statements that more extensively discusses the reason for the revision of the previously issued financial statements and to the earlier report issued by the auditor. The new auditor’s report would be dated not earlier than the date the revised financial statements are approved.
When management does not take the necessary steps to ensure that anyone in receipt of the previously issued financial statements together with the auditor’s report thereon is informed of the situation and does not revise the financial statements in circumstances where the auditor believes they need to be revised, the auditor should notify management that action will be taken by the auditor to prevent future reliance on the auditor’s report. The action taken will depend on the auditor’s legal rights and obligations and the recommendations of the auditor’s lawyers.
GOING CONCERN
When planning and performing audit procedures and, in evaluating the results, the auditor should consider the appropriateness of management’s use of the going concern assumption in the preparation of the financial statements.
Going concern is viewed as continuing in business for the foreseeable future with neither the intention nor need to cease trading. Assets and liabilities are recorded on the basis that one can realise assets and discharge liabilities in the normal course of business.
When preparing the financial statements, management should make an assessment of the company’s ability to continue as a going concern.
Management’s assessment of the going concern assumption involves making a judgment, at a particular point in time, about the future outcome of events or conditions that are inherently uncertain. The following factors are relevant:
- The degree of uncertainty associated with the outcome of an event or condition increases significantly the further into the future a judgment is being made about the outcome of an event or condition.
- Any judgment about the future is based on information available at the time at which the judgment is made. Subsequent events can contradict a judgment that was reasonable at the time it was made.
- The size and complexity of the entity, the nature and condition of its business and the degree to which it is affected by external factors all affect the judgment regarding the outcome of events or conditions.
Possible indicators of going concern problems:
Financial
- Net liability or net current liability position,
- Necessary borrowing facilities have not been agreed,
- Borrowings approaching maturity without realistic prospects of renewal or repayment,
- Excessive reliance on short-term borrowings to finance long-term assets,
- Major debt repayment falling due where refinancing is necessary,
- Major restructuring of debt,
- Indications of withdrawal of financial support by debtors and other creditors,
- Negative operating cash flows and adverse key financial ratios,
- Substantial operating losses or significant deterioration in the value of assets used to generate cash flows,
- Major losses or cash flow problems that have arisen since the balance sheet date,
- Arrears or discontinuance of dividends,
- Inability to pay creditors on due dates,
- Inability to comply with the terms of loan agreements,
- Reduction in normal terms of trade credit by suppliers,
- Change from credit to cash-on-delivery transactions with suppliers, Inability to obtain financing for essential new product development,
- Substantial sales of fixed assets not intended to be replaced.
Operating
- Loss of key management and staff without replacement,
- Loss of a major market, franchise, licence, or principal supplier,
- Labour difficulties or shortages of important supplies,
- Fundamental changes in the market or technology to which the entity is unable to adapt adequately,
- Excessive dependence on a few product lines where the market is depressed,
- Technical developments that render a key product obsolete.
Other
- 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
- Issues which involve a range of possible outcomes so wide that an unfavourable result could affect the appropriateness of the going concern basis
The significance of such events or conditions can often be mitigated by other factors:
- The effect of an entity being unable to make its normal debt repayments may be counterbalanced by management’s plans to maintain adequate cash flows by alternative means, such as by disposal of assets or rescheduling of loan repayments.
- Similarly, the loss of a principal supplier may be mitigated by the availability of a suitable alternative source of supply.
Auditor’s responsibilities
The auditor’s responsibility is to consider:
- The appropriateness of management’s use of the going concern assumption in the preparation of the financial statements, and
- Whether there are material uncertainties about the entity’s ability to continue as a going concern that need to be disclosed in the financial statements.
In obtaining an understanding of the entity, the auditor should consider whether there are events or conditions and related business risks that may cast significant doubt on the entity’s ability to continue as a going concern. In addition, he should remain alert for audit evidence of events or conditions in performing audit procedures throughout the audit and consider whether any identified affect his assessment of the risks of material misstatements.
Management may have already made a preliminary assessment when the auditor is performing risk assessment procedures. If so, the auditor should review that assessment to determine whether management has identified events or conditions and what plans they have to address them. If management has not yet made a preliminary assessment, the auditor should discuss with management the basis for their intended use of the going concern assumption, and inquires of management whether events or conditions exist.
The auditor should evaluate management’s assessment of the entity’s ability to continue as a going concern. He should consider the same period as that used by management in making its assessment under the applicable financial reporting framework. If management’s assessment of the entity’s ability to continue as a going concern covers less than twelve months from the balance sheet date, the auditor should ask management to extend its assessment period to twelve months from the balance sheet date.
In evaluating management’s assessment, the auditor should consider
- The process management followed to make its assessment, The assumptions on which the assessment is based and
- Management’s plans for future action.
There is no need for a detailed assessment by management and extensive review by the auditor if the company has a good history of profitable operations and access to sufficient financial resources.
The auditor does not have a responsibility to design audit procedures other than inquiry of management. However, he may become aware of such known events or conditions during the planning and performance of the audit, including subsequent events procedures. He should therefore inquire of management as to its knowledge of events or conditions beyond the period of assessment used by management that may cast significant doubt on the entity’s ability to continue as a going concern.
Since the degree of uncertainty associated with the outcome of an event or condition increases further into the future the indications of going concern issues will need to be significant before the auditor considers taking further action. The auditor may need to ask management to determine the potential significance of the event or condition on their going concern assessment.
Additional audit procedures
When events or conditions have been identified which may cast significant doubt on the entity’s ability to continue as a going concern, the auditor should:
- Review management’s plans for future actions based on its going concern assessment,
- Gather sufficient appropriate audit evidence to confirm or dispel whether or not a material uncertainty exists through carrying out audit procedures considered necessary, including considering the effect of any plans of management and other mitigating factors and
- Seek written representations from management regarding its plans for future action.
Such audit procedures may include:
- Analysing and discussing cash flow, profit and other forecasts with management,
- Analysing and discussing the entity’s latest available interim financial statements,
- Reviewing terms of loan agreements and determining whether any were breached,
- Reading minutes of the meetings of shareholders, directors, management and relevant committees for reference to financing difficulties,
- Inquiring of the entity’s lawyer regarding the existence of litigation and claims and the reasonableness of management’s assessments of their outcome and the estimate of their financial implications,
- Confirming the 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 the 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 a going concern.
When analysis of cash flow is a significant factor in considering the future outcome of events or conditions the auditor should consider:
- The reliability of the entity’s information system for generating such information,
- Whether there is adequate support for the assumptions underlying the forecast and
- The comparability of prospective financial information with historical results and results to date.
Audit Conclusions and Reporting
Based on the audit evidence obtained, the auditor should determine if, in his judgment, a material uncertainty exists related to events or conditions that alone or in aggregate, may cast significant doubt on the entity’s ability to continue as a going concern.
If the use of the going concern assumption is appropriate but a material uncertainty exists, the auditor considers whether the financial statements:
- Adequately describe the principal events or conditions that give rise to the significant doubt on the entity’s ability to continue in operation and management’s plans to deal with these events or conditions and
- State clearly that there is a material uncertainty and thus be unable to realise its assets and discharge its liabilities in the normal course of business.
If adequate disclosure is made in the financial statements, the auditor should express an unqualified opinion but modify the auditor’s report by adding an ‘emphasis of matter’ paragraph that highlights the existence of a material uncertainty and draws attention to the note in the financial statements.
If adequate disclosure is not made in the financial statements, the auditor should express a qualified or adverse opinion. The report should include specific reference to the fact that there is a material uncertainty that may cast significant doubt about the entity’s ability to continue as a going concern.
If, in the auditor’s judgment, the entity will not be able to continue as a going concern, the auditor should express an adverse opinion if the financial statements have been prepared on a going concern basis regardless of whether or not disclosure has been made.
If management is unwilling to make or extend its assessment when requested to do so by the auditor, the auditor should consider the need to qualify the auditor’s report as a result of the limitation on the scope of the auditor’s work.
When there is significant delay in the signature or approval of the financial statements by management after the balance sheet date, the auditor should consider the reasons for the delay. When the delay could be related to events or conditions relating to the going concern assessment, the auditor should consider the need to perform additional audit procedures.
COMPLIANCE WITH INTERNATIONAL FINANCIAL REPORTING STANDARDS
Financial statements must give a true and fair view under the relevant reporting framework. Auditors must ensure that this is so.
Companies report on their financial statements compliance with international standards and their own national accounting framework. It would not be acceptable to issue an unqualified report in respect of compliance with international standards where there is divergence from national standards.
Financial statements prepared in accordance with IFRSs
In order to comply with IFRSs, the financial statements must comply with each standard. Where there is a note specifying certain departures or partial compliance, then it is inappropriate to give an unqualified opinion.
Financial statements prepared in accordance with more than one reporting framework Unless there is significant convergence of national standards with international standards, it is unlikely that a set of financial statements can comply with two frameworks. It might be better to report on one framework only. If both are required to be reported on, the auditors will have to qualify their opinion in respect of one of the frameworks.
It should be noted that Article 254 of Law 7/2009 of 27/04/2009 relating to companies states that “The financial statements of a company shall comply with international standards”.
Financial statements in accordance with another acceptable financial reporting frame work
In this case the financial statements are probably prepared in accordance with national standards and may contain a note showing a reconciliation to international standards. The note should give a true and fair view and therefore the auditor should accumulate sufficient and appropriate evidence in respect of this note.
Question 8.1
You are the audit senior of EX electronics. They are involved in the assembly of microcomputers and sell them along with associated equipment to retailers. Many of the supplies are bought from the far-east. These computers are used by businesses for a variety of services such as accounting and word processing.
The audit partner has asked you to consider the firm’s audit responsibilities in relation to subsequent events after the balance sheet date and any necessary audit work you might carry out.
You are required to:
- Describe the responsibilities of the auditor for detecting errors in the accounts during the following periods:
- From period end to date of audit report
- Date of audit report to issue of financial statements
- After financial statements are issued
- List the audit work you will carry out in period 1 considering subsequent events.
- Describe the work you will carry out in period 2 to ensure that no adjustments are required to the accounts.
Question 8.2
Identify enquiries which may be made of management when reviewing for subsequent events.
Question 8.3
Briefly describe what issues analytical review may focus on.
