Completion and review p7

Exam focus


One of the questions in the exam will focus on completion, review and reporting. Recent events may result in adjustments to the financial statements. Information that has recently been made available might need to be included in the financial statement disclosures. The auditor will also evaluate the effect of any uncorrected misstatements as these may lead to a modified auditor’s report. In the exam you may have to evaluate misstatements and suggest additional audit procedures to be performed to reach a conclusion on such matters before stating the impact to the report if the issues are not resolved.


1      Subsequent events


ISA 560 Subsequent Events, requires the auditor to:


Obtain sufficient appropriate audit     about whether events occurring between the date of the financial statements and the date of the auditor’s report, that require adjustment or disclosure are appropriately reflected in accordance with the applicable financial reporting framework.


Respond appropriately to facts that become known to the auditor after the date of the auditor’s report.


[ISA 560, 4]


IAS 10 Events After the Reporting Period identifies two types of event after the reporting period:







Illustration 1 – Adjusting and non-adjusting events


Adjusting events


These are events that provide additional     relating to conditions existing at the reporting date. Such events provide new information about the items included in the financial statements and hence the financial statements should be adjusted to reflect the new information.


Examples of adjusting events include:


Allowances for damaged inventory and doubtful receivables.


Amounts received or receivable in respect of insurance claims which were being negotiated at the reporting date.


The determination of the purchase or sale price of non-current assets purchased or sold before the year-end.


Agreement of a tax liability.


Discovery of errors/fraud revealing that the financial statements are incorrect.


Non-adjusting events


These are events concerning conditions which arose after the reporting date. In order to prevent the financial statements from presenting a misleading position, disclosure is required in the notes to the financial statements indicating what effect the events may have. Such events, therefore, will not have any effect on items in the statements of financial position or statement of profit or loss for the period.


Examples of non-adjusting events include:


Issue of new share or loan capital.


Major changes in the composition of the group (for example, mergers, acquisitions or reconstructions).


Losses of non-current assets or inventory as a result of fires or floods.


Strikes, government action such as nationalisation.


Purchases/sales of significant non-current assets.


(IAS 10 Events After the Reporting Period)


Auditor responsibilities

Between the date of the financial statements and the date of the auditor’s report


The auditor should perform procedures to identify events that might require adjustment or disclosure in the financial statements.


[ISA 560, 6]


If material adjusting events are not adjusted for, or material non-adjusting events are not disclosed, the auditor will ask management to make the necessary amendments to the financial statements.


If the identified adjustments or disclosures necessary are not made then the auditor should consider the impact on the auditor’s report and whether a modification is necessary.


Subsequent events procedures


Enquiring of the directors if they are aware of any events, adjusting or non-


adjusting, that have not yet been included or disclosed in the financial statements.


Enquiring into management procedures/systems for the identification of events after the reporting period.


Reading minutes of members’ and directors’ meetings.


Reviewing accounting records including budgets, forecasts, cash flows, management accounts and interim information.


[ISA 560, 7]


Obtaining a written representation from management confirming that they have informed the auditor of all subsequent events and accounted for them appropriately in the financial statements. [ISA 560, 9]


Inspection of correspondence with legal advisors.


Reviewing the progress of known risk areas and contingencies.


Considering relevant information which has come to the auditor’s attention, from sources outside the entity, including public knowledge, competitors, suppliers and customers.


Inspecting after date receipts from receivables.


Inspecting the cash book after the year-end for payments/receipts that were not accrued for at the year-end.


Inspecting the sales price of inventories after the year-end.


Between the date of the auditor’s report and the date the financial statements are issued


The auditor is under no obligation to perform audit procedures after the auditor’s report has been issued, however, if they become aware of a fact which would cause them to issue a modified report, they must take action. [ISA 560, 10]


This will normally be in the form of asking the client to amend the financial statements, auditing the amendments and reissuing the auditor’s report.


If management do not amend the financial statements and the auditor’s report has not yet been issued to the client, the auditor can still modify the opinion. [ISA 560, 13a]


If the auditor’s report has been provided to the client, the auditor shall notify management and those charged with governance not to issue the financial statements before the amendments are made.


If the client issues the financial statements despite being requested not to by the auditor, the auditor shall take action to prevent reliance on the auditor’s report. [ISA 560, 13b]


After the financial statements are issued


The auditor is under no obligation to perform audit procedures after the financial statements have been issued, however, if they become aware of a fact which would have caused them to modify their report, they must take action.


The auditor should discuss the matter with management and consider if the financial statements require amendment.


[ISA 560, 14]


Management must also take the necessary actions to ensure anyone who


is in receipt of the previously issued financial statements is informed. [ISA 560, 15b]


The auditor should perform audit procedures on the amendments to ensure they have been put through correctly. [ISA 560, 15a]


Issue a new auditor’s report including an emphasis of matter or other matter paragraph to draw attention to the fact that the financial statements and auditor’s report have been reissued. [ISA 560, 16]


If management refuses to recall and amend the financial statements, the auditor shall take action to prevent reliance on the auditor’s report.


[ISA 560, 17]


2      Going concern


Going concern is the assumption that the entity will continue in business for the foreseeable future.


Responsibilities Management

Going concern is a fundamental principle in the preparation of financial statements. [ISA 570 Going Concern, 4]


Management are responsible for preparing the financial statements and must make a specific assessment of the entity’s ability to continue as a going concern. This requires making judgments about the future outcome of events or conditions which are inherently uncertain. [ISA 570, 5]


Management must prepare the financial statements on the most appropriate basis – going concern or break-up basis.


The ‘break up’ basis requires that all assets and liabilities are reclassified as ‘current’ and revalued at net realisable value. Further provisions for liquidation, such as redundancy and legal costs, may also be required.


If management are aware of any material uncertainties which may affect this assessment, IAS 1 Presentation of Financial Statements requires them to disclose such uncertainties in the financial statements.




ISA 570 Going Concern states that the auditor must:


Obtain sufficient appropriate     regarding the appropriateness of management’s use of the going concern basis of accounting in the preparation of the financial statements.


Conclude on whether a material uncertainty exists about the entity’s ability to continue as a going concern.


Report in accordance with ISA 570.


[ISA 570, 9]


Going concern procedures


Audit procedures to assess management’s evaluation of going concern


Evaluate management’s assessment of going concern. [ISA 570, 12]


Assess the same period that management have used in their assessment and if this is less than 12 months, ask management to extend their assessment. [ISA 570, 13]


Consider whether management’s assessment includes all relevant information. [ISA 570, 14]


Audit procedures to perform where there is doubt over going concern


Analyse and discuss cash flow, profit and other relevant forecasts with management.


Analyse and discuss the entity’s latest available interim financial statements.


Review the terms of debentures and loan agreements and determining whether any have been breached.


Read minutes of the meetings of shareholders, the board of directors and important committees for reference to financing difficulties.


Enquire 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.


Confirm 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.


Review subsequent events to identify those that either mitigate or otherwise affect the entity’s ability to continue as a going concern.


Review correspondence with customers for     of any disputes


that might impact recoverability of debts and affect future sales.


Review correspondence with suppliers for     of issues regarding payments that might impact the company’s ability to obtain supplies or credit.


Review correspondence with the bank for indication that a bank loan or overdraft may be recalled.


[ISA 570, A16]


Obtain written representations from management regarding its plans for the future and how it plans to address the going concern issues.


[ISA 570, 16e]


Exam tip


Audit procedures should focus on cash flows rather than profits. A company can continue to trade as long as it can pay its debts when they fall due. Therefore identify procedures to obtain     about the amount of cash that is likely to be received and the amount of cash that it likely to be paid out and consider whether there is any indication of cash flow difficulties.




Disclosures relating to going concern are required to be made by the directors in the following circumstances:


  • Where there is any material uncertainty over the future of a company, the directors should include disclosure in the financial statements.

A material uncertainty exists when the magnitude of its potential impact and likelihood of occurrence is such that disclosure of the nature and implications of the uncertainty is necessary for the fair presentation of the financial statements and for the financial statements not to be misleading. [ISA 570, 18]


The disclosure should explain:


– the principal events or conditions that cast significant doubt on the entity’s ability to continue as a going concern and management’s plans to deal with them.


– the company may be unable to realise its assets and discharge its liabilities in the normal course of business.


[ISA 570, 19]


  • Where the directors have been unable to assess going concern in the usual way (e.g. for less than one year beyond the date on which they sign the financial statements), this fact should be disclosed.


  • Where the financial statements are prepared on a basis other than the going concern basis, the basis used should be disclosed.


Audit conclusions and reporting


Based on the audit     obtained, the auditor should determine if, in their judgment:


  • A material uncertainty exists that may cast significant doubt on the entity’s ability to continue as a going concern.


  • The basis of preparing the financial statements is or is not appropriate in the circumstances.



Situation Impact on audit Impact on auditor’s
opinion report
No material uncertainty Unmodified – Financial INT syllabus: Unmodified
exists regarding going statements give a true UK syllabus: The auditor
concern and fair view will report by exception in a
section headed
‘Conclusions Relating to
Going Concern’ whether
they have anything to add
or draw attention to in
relation to the directors’
statement about the
appropriateness of the use
of the going concern basis.
Material uncertainty Unmodified – Financial Modified with a section
exists and is adequately statements give a true headed:
disclosed by and fair view ‘Material Uncertainty
management Related to Going Concern’.
Material uncertainty Modified – Qualified or Modified. Basis for
exists which is not adverse qualified/adverse opinion
adequately disclosed or explaining the going
is omitted altogether concern issues
management have failed to
disclose adequately.
Company is not a going Unmodified – Financial Modified with Emphasis of
concern and has statements give a true Matter paragraph.
prepared the financial and fair view
statements on the break
up basis appropriately
and made adequate
disclosure of this fact
Company is not a going Modified – adverse Modified. Basis for adverse
concern and has opinion opinion explaining the
prepared the FS on the going concern issues
going concern basis management have failed to
account for appropriately.
The period assessed by Modified – qualified or Modified. Basis for
management is less disclaimer due to an qualified/disclaimer opinion
than twelve months inability to obtain explaining that sufficient
from the statement of sufficient appropriate appropriate     was
financial position date audit not obtained to form a
(INT) / less than twelve regarding the use of the conclusion on the going
months from the date of going concern concern assumption.
approval of the financial assumption
statements (UK) and
management is
unwilling to extend the


Indicators of going concern risk


Auditors should consider the following indicators as possible reasons for doubt over the going concern assumption:


Rapidly increasing costs Shortages of supplies

Adverse movements in exchange rates


Business failures amongst customers or suppliers Loan repayments falling due in the near future


High gearing


Approaching borrowing limits Loss of key staff

Loss of key suppliers or customers


Technical obsolescence of product range


Impact of major litigation


Other fundamental uncertainties


Significant changes to laws and regulations affecting the entity Deteriorating financial ratios


The foreseeable future


The auditor should remain alert to the possibility of events or conditions that will occur beyond management’s period of assessment that may bring into question the appropriateness of the going concern assumption. However, due to the uncertainty surrounding such distant events, the indicator needs to be significant to prompt the auditor into further action. If such an event is identified the auditor should request that management consider the significance of the event of condition. [ISA 570, A14]


Other than enquiry, the auditor has no other responsibility to perform any other procedures to identify events or conditions beyond the period assessed by management (i.e. at least 12 months from the financial statements date). [ISA 570, A15]


UK syllabus: FRC Bulletin 2008/01


During times of economic hardship, particularly during recession, there is always an increase in the number of failed businesses. This does not just include small businesses, even significant institutions fail, for example Lehman Brothers, a large Wall Street investment bank, filed for    11 bankruptcy protection in September 2008.


During such times auditors must be aware that there is a heightened risk that companies may not be a going concern and that the basis of preparing the financial statements and the nature of disclosures relating to uncertainty must be closely scrutinised.


In response to the economic crisis, several bulletins have been issued to provide guidance to auditors.


FRC Bulletin 2008/01 – Audit issues when financial market conditions are difficult and credit facilities may be restricted (January 2008)


The bulletin focuses on the risks and uncertainties relating to companies that may not be a going concern due to difficulties obtaining finance as a result of the credit crunch and the risk associated with the valuation of investments where the company invested in may have significantly curtailed its operations or may have ceased trading.


Difficulties obtaining credit


Whilst the credit crunch mostly affects financial institutions, risks of material misstatement are also higher in other types of company as credit facilities are significantly more difficult to obtain which may cast significant doubt over the going concern assumption.


The audit partner must have particular regard to:


his own involvement in the direction, supervision and performance of the audit


the capabilities and competence of the audit team


consultation with other professionals on difficult and contentious matters


the nature and timing of communications with those charged with governance.


Where there is an inability to obtain confirmation of borrowing facilities, this must be disclosed in the financial statements in order to give a true and fair view. The auditor’s report may also need to be modified due to insufficient appropriate    .


Valuation of investments


Auditors should evaluate whether the significant assumptions used by management are a reasonable basis for the fair value measurements and disclosures, including whether the assumptions reflect current market conditions and information.


Disclosure requirements include:


Management judgments in the application of accounting policies. Information about key assumptions concerning the future.

As required by IFRS 7 Financial Instruments: Disclosures.



UK syllabus: FRC Bulletin 2008/10


FRC Bulletin 2008/10 – Going Concern Issues During the Current


Economic Conditions (December 2008)


This bulletin, along with IAASB practice alert Audit Considerations in Respect of Going Concern in the Current Economic Environment (January 2009), explains the particular challenges the current economic conditions create including the need for increased disclosure about going concern and liquidity risk. It aims to raise auditors’ awareness about matters relevant to the consideration of the use of the going concern assumption.



UK syllabus: Going concern and liquidity risk


FRC Going Concern and Liquidity Risk: Guidance for Directors of


UK Companies 2009


Requires directors to:


Make a rigorous assessment of whether the company is a going concern by preparing budgets and forecasts and ensure they have adequate borrowing facilities in place.


Consider all available information for a period of at least 12 months from the date of approval of the financial statements.


Make balanced, proportionate and clear disclosures about going concern.


UK syllabus: ISA (UK) 570 Going Concern


ISA (UK) 570 Going Concern requires management to assess going concern for a period of at least one year from the (expected) date of approval of the financial statements (rather than 12 months from the reporting date).


The Companies Act 2006 requires company directors to include a business review which describe the principal risks and uncertainties the company faces in the directors’ report. The review should be balanced and comprehensive analysis of the development and performance of the business and the position of the company at the year-end. This review will include risks and uncertainties surrounding the going concern status of the company.


For companies that report on compliance with the UK Corporate Governance Code, the auditor shall determine whether they have anything material to add or to draw attention to in the auditor’s report on the financial statements in relation to the directors’ disclosures on:


The assessment of the principal risks facing the entity including those that would threaten its business model, future performance, solvency or liquidity.


How the risks are mitigated.


The assessment of the going concern basis and identification of material uncertainties related to going concern.


How they have assessed the prospects of the entity, over what period they have done so and why they consider that period to be appropriate.


The auditor should auditor consider whether they are aware of information that would indicate that the annual report and accounts taken as a whole are not fair, balanced and understandable.


3      Final analytical procedures and review

Before forming an opinion on the financial statements and deciding on the wording of the auditor’s report, the auditor should conduct an overall review.



The auditor should perform the following procedures:


  • Review the financial statements to ensure:


– Compliance with accounting standards and local legislation disclosure requirements. This is sometimes performed using a disclosure checklist.


–    Accounting policies are sufficiently disclosed and to ensure that they

are in accordance with the accounting treatment adopted in the financial statements.


– They adequately reflect the information and explanations previously obtained and conclusions reached during the course of the audit.


  • Perform analytical procedures to corroborate conclusions formed during the audit and assist when forming an overall conclusion as to whether the financial statements are consistent with the auditor’s understanding of the entity. [ISA 520, 6]


  • Review the aggregate of the uncorrected misstatements to assess whether a material misstatement arises. If so, discuss the potential adjustment with management.


Analytical procedures at the completion stage


Final analytical procedures performed at the completions stage involve similar procedures to those performed at the planning stage. Differences to note between the two stages:


At the completion stage the financial statements are almost finalised and therefore there should be no further changes to the figures. At the planning stage the figures were draft and still subject to change.


The audit work is almost complete and therefore the auditor should have a full understanding of the client’s performance during the year. When analysing the figures, the reasons for the movements should be documented on the audit file and as a result this analysis should be confirming what the auditor already knows.


If something new is identified, or if a relationship between balances is not understood, it will highlight that further work is necessary and the auditor does not yet have sufficient appropriate     for the opinion.


The auditor will calculate the movements from year to year and will check that the justifications for any unusual fluctuations are on file.


Key ratios such as GPM, receivables days, payables days, inventory days will be calculated and reasons for movements tied through to the audit file to ensure the outcome is consistent with what is recorded on file.


A review of the financial statements as a whole will be performed to ensure the presentation complies with the applicable financial reporting framework.


The purpose of review procedures


Review forms part of the engagement performance   procedures covered in the     .


As part of the overall review, the auditor should assess whether:


The audit work was performed in accordance with professional standards.


Significant matters have been raised for further consideration and appropriate consultations have taken place.


There is a need to revise the nature, timing and extent of the work performed.


The audit     gathered by the team is sufficient and appropriate to support the audit opinion and report.


[ISA 220, A17]


The auditor should ensure that initial assessments made at the start of the audit are still valid in light of the information gathered during the audit and that the audit plan has been flexed to meet any new circumstances.


4      Evaluation of misstatements


The auditor must consider the effect of misstatements on both the audit procedures performed and ultimately, if uncorrected, on the financial statements as a whole. Guidance on how this is performed is given in ISA 450 Evaluation of


Misstatements Identified During the Audit.


In order to achieve this the auditor must:


Accumulate a record of all identified misstatements, unless they are clearly trivial. [ISA 450, 5]


Consider if the existence of such misstatements indicates that others may exist, which, when aggregated with other misstatements, could be considered material. [ISA 450, 6a]


If so, consider if the audit plan and strategy need to be revised. [ISA 450, 6]


Report all misstatements identified during the course of the audit to an appropriate level of management on a timely basis and request that all misstatements are corrected. [ISA 450, 8]


If management refuses to correct some or all of the misstatements the auditor should consider their reasons for refusal and take these into account when considering if the financial statements are free from material misstatement. [ISA 450, 9]



Evaluation of uncorrected misstatements


If management have failed to correct all of the misstatements reported to them, the auditor should:


Revisit their assessment of materiality to determine whether it is still appropriate in the circumstances. [ISA 450, 10]


Determine whether the uncorrected misstatements, either individually or in aggregate, are material to the financial statements as a whole, considering both the size and nature of the misstatements and the effect of misstatements related to prior periods (e.g. on corresponding figures, comparatives and opening balances). If an individual misstatement is considered material it cannot be offset by other misstatements.


[ISA 450, 11]


Report the uncorrected misstatements to those charged with governance and explain the effect this will have on the audit opinion. [ISA 450, 12]


Request a written representation from those charged with governance that


they believe the effects of uncorrected misstatements are immaterial. [ISA 450, 14]



Evaluating misstatements – example


You are at the completion stage of the audit of a client. The PBT for the year is $8 million and total assets are $35 million. The following matters have not been corrected by management and have been left for your attention:


  • A major customer has gone into liquidation owing an amount of $200,000 which has not been written off.


  • A provision of $300,000 has not been recognised.


The irrecoverable debt of $200,000 represents 2.5% of PBT and 0.57% of total assets therefore is not material.


The provision of $300,000 represents 3.75% of PBT and 0.86% of total assets therefore is not material.


Cumulatively they have a bigger effect on the financial statements:


$500,000 represents 6.25% of PBT and 1.4% of total assets which is material. The two amounts will need to be adjusted to avoid a modified opinion.


The auditor should ask for both issues to be corrected in accordance with ISA 450.


5      Written representations


The value of written representations from management


ISA 580 Written Representations requires the auditor to obtain written representations from management:


That they have fulfilled their responsibilities for the preparation of the financial statements.


That they have provided the auditor with all relevant information.


That all transactions have been recorded and reflected in the financial statements.


To support other audit     relevant to the financial statements or specific assertions if deemed necessary by the auditor.


As required by specific ISAs.


[ISA 580, 6]


However, as a form of    , representations are low down in the order of reliability because they are internally produced.


On their own, written representations do not provide sufficient appropriate     about any of the matters with which they deal. [ISA 580, 4]


If, having received the representations considered necessary to gather sufficient appropriate    , the auditor concludes that there is sufficient doubt about the integrity of management to the extent that the representations are unreliable, then the auditor shall disclaim an opinion in accordance with ISA 705 Modifications to the Opinion in the Independent Auditor’s Report. [ISA 580, 18]



 The limitations of written representations


When asked for procedures or     in the exam be careful not to suggest written representations for all areas of testing. The examiner has stated this is a common concern with weaker students who do not appreciate the nature of ‘appropriate’     and that it detracts from the quality of an answer. Written representations are only appropriate for matters where better     is not available. This is generally areas requiring judgment of management.


Other written representations


The typical subjects of other representations include:


Whether the selection and application of accounting policies are appropriate.


Whether the following matters have been measured, presented and disclosed in accordance with the relevant financial reporting framework:


– Plans or intentions that may affect the carrying value or classification of assets and liabilities.


–    Liabilities, both contingent and actual.


–    Title to, or control over, assets.


– Aspects of laws, regulations and contractual agreements that may affect the financial statements, including non-compliance.

That the directors have communicated all deficiencies in internal control to the auditor.


Specific assertions about classes of transactions, accounts balances and disclosures requiring management judgment.


[ISA 580, A10]


Written representations required by specific ISAs


Other ISAs that require subject matter specific written representations:


ISA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of Financial Statements – All known and suspected frauds have been communicated to the auditor.


ISA 250 Consideration of Laws and Regulations in an Audit of Financial Statements – All instances of non-compliance with laws and regulations have been communicated to the auditor.


ISA 450 Evaluation of Misstatements Identified During the Audit – Management and those charged with governance consider any uncorrected misstatements to be immaterial.


ISA 501 Audit     – Specific Considerations for Selected Items – All known actual or possible litigation claims have been disclosed to the auditor and appropriately accounted for.


ISA 540 Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures – Significant assumptions used in making the estimates are reasonable.


ISA 550 Related Parties – All related parties and related party transactions have been disclosed.


ISA 560 Subsequent Events – All subsequent events have been appropriately accounted for.


ISA 570 Going Concern – Matters affecting going concern have been disclosed.

[ISA 580, Appendix 1]


Approach to exam questions: Completion


One of the questions in the exam will focus on completion, review and reporting. The scenario will state that the audit is nearly complete and / or the auditor’s report is due to be signed soon. This informs you that the majority of the audit work will have been performed and only the last remaining issues need to be resolved. These will be issues that have been left for your attention as the audit manager.


The requirement may ask you to consider several things:


Matters to consider to enable you to reach a conclusion.


Whether sufficient appropriate     has been obtained and documented to be able to reach a conclusion.


What     you should expect to find on file when you perform your review of the audit work.


Further procedures that should be performed to be able to reach a conclusion.


Matters to consider to enable you to reach a conclusion


This involves:


Materiality assessment – calculate whether the issue is material.


Accounting treatment – state what the relevant accounting standard requires and whether the client is complying with that treatment.


If they are not compliant, state what they are doing wrong.


Risk of material misstatement – state which balances or disclosures in the financial statements will be materially misstated as a result.


Whether sufficient appropriate     has been obtained


This requirement links back to   and also requires you to exercise professional scepticism.


Firstly, consider whether all of the procedures you would expect to be performed have been performed.


Consider whether the procedures performed are appropriate in the circumstances. In particular, consider whether too much reliance has been placed on enquiries with management or management representations.


Consider whether sufficient testing was performed. If the sample sizes included in the audit plan have not been tested sufficient     is unlikely to have been obtained.


Consider whether the auditor performing the work has demonstrated sufficient professional scepticism.


    you should expect to find on file


refers to the audit     that should have been obtained and put on file by the auditor performing the work.     is essentially an audit procedure but without the action e.g.


Copies of board minutes to identify management discussions about the legal provision.


Copies of bank statements to verify the payment was made by the client during the year.


Notes of discussions with management regarding their approach for determining the estimate.


Note how the examples above still describe the reason for obtaining the documentation.


Further procedures that should be performed


Further procedures refers to procedures not already carried out. The purpose of these procedures is to provide new information that will enable you to form a conclusion. Make sure you suggest audit procedures that need to be carried out at this stage of the audit and not audit procedures that have already been performed.


Procedures should be an action, applied to a source, to achieve an objective e.g.


Review the most recent board minutes to identify management discussions about the legal provision.


Inspect recent bank statements to identify whether a payment has been made by a customer since the last after date cash testing was performed.


Discuss with management whether any progress has been made in relation to the legal claim e.g. agreement of an out of court settlement.


In most cases the question will go on to ask for the reporting implications if the issue or issues are not resolved. Reporting is covered in the next   .


Test your understanding 1


You are the manager responsible for the audit of Phoenix, a private limited liability company, which manufactures super alloys from imported zinc and aluminium. The company operates three similar foundries at different sites under the direction of Troy Pitz, the chief executive. The draft accounts for the year ended 31 March 20X4 show profit before taxation of $1.7 million (20X3 – $1.5 million). The audit senior has produced a schedule of ‘Points for the Attention of the Audit Manager’ as follows:


  • A trade investment in 60,000 $1 ordinary shares of Pegasus, one of the company’s major shipping contractors, is included in the statement of financial position at cost of $80,000. In May 20X4, the published financial statements of Pegasus as at 30 September 20X3 show only a small surplus of net assets. A recent press report now suggests that Pegasus is insolvent and has ceased to trade. Although dividends declared by Pegasus in respect of earlier years

have not yet been paid, Phoenix has included $15,000 of dividends

receivable in its draft accounts as at 31 March 20X4.                                                                                                                        (6 marks)


  • Current liabilities include a $500,000 provision for future maintenance. This represents the estimated cost of overhauling the blast furnaces and other foundry equipment. The overhaul is

planned for August 20X4 when all foundry workers take two weeks

annual leave.                                                                                                                        (7 marks)


  • All industrial waste from the furnaces (‘clinker’) is purchased by Cleanaway, a government-approved disposal company, under a five-year contract that is due for renewal later this year. A recent


newspaper article states that ‘substantial fines have been levied on Cleanaway for illegal dumping’. Troy Pitz is the majority shareholder

of Cleanaway.                                                                                                                        (7 marks)




For each of the above points:


  • Comment on the matters that you would consider; and


  • State the audit  that you would expect to find, in

undertaking your review of the audit working papers and financial

statements of Phoenix.                                                                                                              (Total: 20 marks)



Test your understanding 2


You are the manager responsible for the audit of Aspersion, a limited liability company, which mainly provides national cargo services with a small fleet of aircraft. The draft accounts for the year ended

30 September 20X3 show profit before taxation of $2.7 million

(20X2: $2.2 million) and total assets of $10.4 million (20X2: $9.8 million).


The following issues are outstanding and have been left for your attention:


  • The sale of a cargo carrier to Abra, a private limited company, during the year resulted in a loss on disposal of $400,000. The aircraft cost $1.2 million when it was purchased nine years ago and was being depreciated on a straight-line basis over 20 years. The


minutes of the board meeting at which the sale was approved record that Aspersion’s finance director, Iain Joiteon, has a 30%


equity interest in Abra.                                                                              (7 marks)


  • As well as cargo carriers, Aspersion owns two light aircraft which were purchased at the end of 20X0 to provide business passenger flights to a small island under a three year service contract. It is now


known that the contract will not be renewed when it expires at the end of March 20X4. The aircraft, which cost $450,000 each, are

being depreciated over 15 years.                                                       (7 marks)


  • Deferred tax amounting to $570,000 as at 30 September 20X3 has been calculated relating to tangible non-current assets at a tax rate

of 30% using the full provision method (IAS 12 Income Taxes) . On 1 December 20X3, the government announced an increase in the corporate income tax rate to 34%. The directors are proposing to adjust the draft accounts for the further liability arising. (6 marks)




For each of the above points:


  • Comment on the matters that you should consider; and


  • State the audit  that you should expect to find, in undertaking your review of the audit working papers and financial


statements of Aspersion.                                                        (Total: 20 marks)


Test your understanding 1


  • Trade investment


  • Matters


Assuming that Pegasus is insolvent (e.g. a receiver or liquidator has been appointed) this is an adjusting event (IAS 10 Events After the Reporting Period).


As the recoverable amounts of the investment and dividends receivable are likely to be nil, they should be written off.


The total expense of $95,000 represents 5.6% of draft profit before tax and is therefore material. As is it not expected to recur, separate disclosure (IAS 1 Presentation of Financial Statements) may be appropriate to explaining Phoenix’s performance for the year.


There is a risk that investments and receivables are overstated if these amounts are not written off.


As the adjustments are material, a qualified opinion would need to be issued with the ‘except for’ wording.


  • Audit


– A copy of the press report confirming the liquidation of Pegasus.


– The audited accounts of Pegasus for the year ended 30 September 20X3 showing whether there are assets with market values in excess of book values.


– The receiver’s (or liquidator’s) statement of affairs indicating whether any distribution is possible.


– If a meeting of the shareholders of Pegasus has been held to consider the company’s state of affairs, a copy of the minutes (may be obtained by Phoenix).


– Notes of discussions with the client as to who, if anyone, has replaced Pegasus as one of their major shipping contractors. Also, whether any consignments have been held up while negotiating for an alternative shipping contractor.



  • Future maintenance


  • Matters


The provision represents 29% of draft profit before tax and is therefore material.


This provision does not appear to meet the definition of IAS 37 Provisions, Contingent Liabilities and Contingent Assets which requires there to be an obligation at the year-end to make payment which is probable and can be measured reliably.


Overhaul expenditure to restore or maintain the future economic benefits expected from the plant and equipment should normally be recognised as an expense when it is incurred.


The components (blast furnace interiors) which require replacement are separate assets that should be depreciated over the replacement cycle. To the extent that the $500k includes the cost of replacing separate assets, it represents future capital cost.


It is not clear whether an obligation exists at the year-end, for example if there was industry legislation requiring the overhaul to take place within a certain timescale.


If the provision is not allowable under IAS 37 and is not released, provisions will be overstated and profits will be understated.


Draft profit before tax ($1.7m) shows a 13% increase on the previous year. If adjustments are made for points (1) and (2), profit will be increased by at least $400,000 (i.e. (1) $95k decrease plus (2) $500k increase). Profit before tax of $2.1m would be a 40% increase on the prior year.


The management of Phoenix may have decided that $1.7m is what is to be reported. Management may have made the future maintenance provision as a way of ‘setting aside’ a reserve. For example, in anticipation of increased costs expected to arise in respect of waste disposal in (3).


Tutorial note: It is a higher skill to be able to demonstrate an ability to stand back from the individual items and take an overall view in this part of the question, considering the overall impact on the draft profit.


  • Audit


–    Client’s schedule showing the make-up of provision.


– Notes of discussions with senior management about their reasons for having made the provision and whether any costs have been contracted for.


– External tenders or quotes for subcontracted work (and/or internal costings) to verify the amount.


– Prior year working papers (and/or the permanent audit file) showing the cost and frequency of overhauls in previous periods (whether all sites done at once or on a cyclical basis).


  • Cleanaway


  • Matters


The matter is likely to be material as all Phoenix’s industrial waste is disposed of by Cleanaway. The issue is material by nature as Cleanaway is a related party through Troy Pitz. Troy Pitz has authority and responsibility for Phoenix’s operational activities (as chief executive) and a controlling interest in Cleanaway.


IAS 24 Related Party Disclosures requires the following to be disclosed in the notes to the financial statements:


–    Nature of the related party relationship


–    Amount of the transactions entered into


–    Balances outstanding at the year-end.


Whether Phoenix has been implicated in Cleanaway’s illegal dumping (e.g. by Phoenix’s clinker having been dumped, or by Troy Pitz’s relationship with the two companies).


Whether the integrity of Troy Pitz has been questioned (either by the media or other key personnel in Phoenix) and, if so, its impact on the audit. For example, any assessment of control risk as less than high should be reassessed in the light of his role in the control environment.


If the contract is not renewed a legal alternative will need to be found for disposal of clinker, for example, another approved provider of waste disposal services or a suitable landfill site (taxes may be substantial), otherwise there may be doubts about going concern.


Possible consequences for Phoenix of the contract being renewed:


– A substantial increase in costs of disposal, e.g. because terms were last agreed five years ago.


– Loss of customer goodwill through associations with Cleanaway.


– Risk of investigation by a government agency into the company’s environmental practices.


  • Audit


–    A copy of the contract, in particular whether:


– early termination could be an option for Phoenix (in the light of Cleanaway’s illegal activities).


– any clauses are relevant to its renewal (e.g. restricting price increases).


– Newspaper articles including any editorial comment or letters from Cleanaway or Troy Pitz regarding the issue.


– Notes of discussions with senior management (Troy Pitz and others) whether a suitable alternative service provider exists.


– Prior year working papers and financial statements to identify the disclosure made last year.


– Copies of board minutes to indicate what action, if any, management propose to take to mitigate the adverse publicity surrounding Cleanaway.



Test your understanding 2


  • Related party transaction – sale of cargo carrier


  • Matters


The $400,000 loss represents 15% of profit before tax and is therefore material. Disclosure as a separate line item may therefore be appropriate.


The cargo carrier was in use for 9 years and would have had a carrying value of $720,000 at 30 September 20X2.


Abra appears to be a related party as Iain:


– is one of the key management personnel of Aspersion (being the finance director), and


– has an equity interest in Abra which is presumed to constitute significant influence (being greater than 20%).


The related party relationship and the sale of the cargo carrier to Abra should be disclosed in a note to the financial statements for the year to 30 September 20X3. The elements of such a material transaction which are likely to be necessary (for an understanding of the financial statements) are:


–    the amount(s) involved (i.e. sale proceeds and loss)


–    any outstanding balance of amounts due from Abra


–    the nature of the relationship.


If suitable disclosure is not made, there will be a material misstatement with regard to non-compliance with IAS 24


Related Party Disclosures.


The reason for the loss on sale should also be considered e.g. whether the:


– sale was below market value (if the sale to the related party was not at arm’s length)


– aircraft had a bad maintenance history (or was otherwise impaired)


–    useful life of a cargo carrier is less than 20 years.


If the latter, it is likely that non-current assets are materially overstated in respect of cargo carriers still in use. This would lead to a risk of overstatement of non current assets and profits as the depreciation policies may not be appropriate and compliant with IAS 16 Property, Plant and Equipment.


  • Audit


–    Copy of bank statements confirming the sales proceeds.


– Copy of sales invoice confirming the party it was sold to and the amount.


– Copy of board minutes authorising the disposal at the low value.


– Notes of discussions with management regarding the appropriateness of depreciation policies for other assets.


– Documentation of analysis of profits/losses on disposal in previous years to obtain further     that depreciation policies are not appropriate.


– Documentation noting whether the related party transaction has been disclosed in the financial statements.



  • Impairment – light aircraft


  • Matters


The annual depreciation charge for each of these two aircraft is $30,000 (1/15 × 450,000). The aircraft have been depreciated for only 2 ½ years to 30 September 20X3 (assuming time apportionment in 20X1 when the aircraft were brought into use) and have a total carrying amount of $750,000 (2 × [450,000 – (21/2 × 30,000)]). This represents 7.2% of total assets and is therefore material.


Tutorial note: Alternatively it could be assumed that a full year’s depreciation was charged in the year to 30.9.X1 (i.e. three years’ accumulated depreciation to 30.9.X3).


The aircraft were purchased for a specific use which will cease six months after the reporting date. The value of the aircraft may be impaired and Aspersion should have made a formal estimate of their recoverable amount (IAS 36 Impairment of Assets).


The auditor should consider management’s intentions, for example:


–    to sell the aircraft


– to find an alternative use for the aircraft (e.g. providing other business or pleasure flights).


If the client can sell the aircraft for more than the current carrying value or if the aircraft can be used in another part of the business, the assets may not be impaired.


There is a risk that non-current assets and profits are overstated if an impairment charge is necessary but hasn’t been made.


Additional point: If the passenger business constitutes a business segment, cessation of the contract may result in a discontinued operation (IFRS 5 Non -current Assets Held for Sale and Discontinued Operations).


  • Audit


– A copy of the service contract confirming expiry in March 20X4.


– Physical inspection of aircraft (    of existence and condition at 30 September 20X3).


– Notes of discussions with Aspersion’s management concerning negotiations for:


–    the sale of the aircraft, or


–    obtaining new service contracts.


– Extracts from any correspondence regarding any new contract or sale.


–    A copy of any (draft) agreement for:


–    the sale of the aircraft after the contract expires


–    new business or pleasure contracts.


– Discounted cash flow projections for any proposed new venture/contracts (i.e. value in use).


– Comparison of projected cash flows with budgets and assumptions (e.g. aircraft days available and average daily utilisation per aircraft).


  • Deferred tax – change in tax rate


  • Matters


The total provision amounts to 21% of PBT and is therefore material. (However the deferred tax expense/income for the year may not have been material.)


The increase in liability if calculated at 34% ($570,000 (34/30 – 1) = $76,000) represents 2.8% of PBT. Considered in isolation, this amount is not material.


Under IAS 12 Income Taxes the tax rate in force at the reporting date should be used for the calculation. The increase in tax rate announced on 1 December is a non-adjusting event (IAS 10 Events After the Reporting Period).


If the directors adjust the draft accounts there will be non-compliance with IAS 10 and IAS 12. The tax expense and associated liability will be misstated as a result.


  • Audit


–    A copy of the computations of:


–    deferred tax liability (SFP)


–    current tax expense (SPL)


–    deferred tax expense/income.


–    Agreement of tax rate(s) to tax legislation.


– Reconciliation between tax expense and accounting profit multiplied by the applicable tax rate.


– Schedules of carrying amount (i.e. cost of revalued amounts net of accumulated depreciation) of non-current assets agreed to:


–    the asset register (individual assets and in total)


–    general ledger account balances (totals).


– Completed audit program for non-current assets (e.g. inspecting invoices for additions, agreeing depreciation rates to prior year accounting policies, etc).


–    Client’s schedules of tax base agreed to:


–    the asset register (for completeness)


– prior year working papers (completeness and accuracy of brought forward balances).


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