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TOPIC 1
ASSURANCE AND NON-ASSURANCE ENGAGEMENTS
QUESTION 1
December 2023 Question One A
You are the Audit Manager of Baraka and Company LLP, who are the auditors of Miradi Ltd. for the year ended 30 June 2023. The company has net assets of Sh.150 million. The audit has been completed but there is a matter that has not yet been resolved on depreciation of buildings. The directors of Miradi Ltd. have resolved that depreciation on buildings will not be provided for in the financial statements. The buildings were acquired in the year 2020 and no depreciation has been provided since.
Required:
(i) Describe SIX additional audit procedures and actions that you could take with respect to the above matter. (6 marks)
(ii) Assume that, according to your workings, the depreciation charge on the buildings for the year ended 30 June 2023 should be Sh.4,200,000 based on the straight line method of depreciation at an annual rate of 5%.
Required:
Discuss the implications of the above on the financial statements, clearly indicating its effect on the audit report. (8 marks)
Answer
(i) Additional Audit Procedures and Actions:
- Review of Documentation:
- Examine the documentation related to the acquisition of buildings in 2020 to ensure the accuracy of the cost and useful life estimates.
- Confirm the basis on which the useful life was determined and whether it aligns with industry standards and the company’s historical practices.
- Physical Inspection and Condition Assessment:
- Physically inspect the buildings to assess their current condition and determine if there are any indicators of impairment or changes in the expected useful life.
- Consider engaging a building or construction expert if needed.
- Compare Depreciation Policy:
- Compare the company’s depreciation policy with industry benchmarks and accounting standards to assess its reasonableness.
- Evaluate whether the company’s policy aligns with the requirement to reflect the consumption of the buildings’ economic benefits over time.
- Subsequent Events Review:
- Evaluate subsequent events occurring after the balance sheet date to identify any developments or conditions that may impact the decision on providing or not providing depreciation.
- Specifically, inquire about any plans for major renovations, changes in use, or technological obsolescence that could impact the buildings’ economic usefulness.
- Assess Management’s Intentions:
- Engage in discussions with management to understand their rationale for not providing depreciation and assess whether their intentions are reasonable and consistent with the company’s long-term strategy.
- Document the discussions to have a clear understanding of management’s perspective.
- Evaluate the Impact on Financial Ratios:
- Assess the impact of not providing depreciation on key financial ratios, such as return on assets and profitability.
- Consider the potential effects on the company’s compliance with debt covenants, if applicable.
(ii) Implications on Financial Statements and Audit Report:
Financial Statements:
- Overstatement of Net Assets: The exclusion of depreciation will lead to an overstatement of net assets by Sh.4,200,000, misrepresenting the financial position of Miradi Ltd.
- Distortion of Profitability: The omission of depreciation expense will result in an understatement of expenses and an overstatement of profit for the year, misleading users about the company’s performance.
- Non-compliance with Accounting Standards: The financial statements will not be prepared in accordance with applicable accounting standards, raising concerns about their reliability and comparability.
Audit Report:
- Qualified Opinion: If the directors refuse to adjust the financial statements for depreciation, the auditor will be unable to express an unqualified opinion due to the material misstatement.
- Emphasis of Matter Paragraph: The auditor will likely include an emphasis of matter paragraph in the audit report, highlighting the issue and its impact on the financial statements.
- Disclaimer of Opinion: If the directors’ decision significantly impairs the auditor’s ability to form an opinion on the fairness of the financial statements, the auditor may disclaim an opinion altogether.
Additional Considerations:
- Auditor’s Responsibility: The auditor has a responsibility to report material misstatements discovered during the audit and ensure the financial statements are presented fairly in accordance with accounting standards.
- Communication and Transparency: The auditor should clearly communicate the implications of the directors’ decision to Miradi Ltd.’s stakeholders, including the potential legal and financial consequences.
QUESTION 2
August 2023 Question Two B
Discuss FIVE types of audit opinions, specifying the circumstances under which each opinion may be ideal. (10 marks)
Answer
Types of audit opinions, specifying the circumstances under which each opinion may be ideal
Audit opinions represent the auditor’s conclusion on the fairness of the financial statements and the reliability of the underlying financial information. Here are five types of audit opinions, along with the circumstances under which each opinion may be ideal:
- Unqualified Opinion (Clean Opinion):
- Circumstances: An unqualified opinion is issued when the auditor concludes that the financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows of the company in accordance with the applicable financial reporting framework (e.g., Generally Accepted Accounting Principles – GAAP).
- Ideal Circumstances: The financial statements are free from material misstatements, and the auditor has obtained sufficient appropriate audit evidence to support their opinion. This opinion provides the highest level of assurance to stakeholders and indicates a high level of confidence in the company’s financial reporting.
- Qualified Opinion:
- Circumstances: A qualified opinion is issued when the auditor concludes that overall the financial statements are fairly presented, except for a specific departure from GAAP or a limitation in the scope of the audit.
- Ideal Circumstances: The departure from GAAP or limitation in scope is material but not pervasive enough to require a disclaimer of opinion or an adverse opinion. The auditor can provide a qualified opinion after disclosing the nature and extent of the departure or limitation in the audit report.
- Adverse Opinion:
- Circumstances: An adverse opinion is issued when the auditor concludes that the financial statements as a whole are materially misstated, and the misstatements are both material and pervasive, meaning they affect the overall fairness of the financial statements.
- Ideal Circumstances: The misstatements identified by the auditor are significant and widespread throughout the financial statements, such that they cannot be adequately corrected or disclosed. An adverse opinion alerts users that the financial statements are not reliable and should not be relied upon for decision-making.
- Disclaimer of Opinion:
- Circumstances: A disclaimer of opinion is issued when the auditor is unable to obtain sufficient appropriate audit evidence or is unable to complete the audit due to significant limitations in scope, such as lack of access to records or restrictions imposed by management.
- Ideal Circumstances: When the auditor encounters circumstances beyond their control that prevent them from forming an opinion on the financial statements, such as when management refuses to provide necessary information or when there are significant uncertainties that cannot be resolved.
- Qualified Disclaimer of Opinion:
- Circumstances: A qualified disclaimer of opinion is issued when the auditor is unable to obtain sufficient appropriate audit evidence to form an opinion on the financial statements as a whole due to a pervasive limitation in the scope of the audit, but the auditor concludes that the financial statements are not materially misstated.
- Ideal Circumstances: When there is a pervasive limitation in the scope of the audit that prevents the auditor from obtaining sufficient audit evidence to form an opinion on the financial statements, but there is no evidence of material misstatements. This opinion provides limited assurance and indicates that users should exercise caution when relying on the financial statements.
QUESTION 3
August 2023 Question Three A (i) and (ii)
As an audit practitioner, you have been invited by your local accountancy institute to provide insights to aspiring accountants on audit engagements, review of financial statements and the distinction between these two engagements.
In the context of the above, prepare your explanatory notes on the following:
(i) Purpose of review engagements in relation to financial statements. (3 marks)
(ii) THREE features that distinguish review engagements from audit engagements in relation to financial statements. (6 marks)
Answer
(i) Purpose of Review Engagements in Relation to Financial Statements:
Review engagements are conducted to provide limited assurance on the financial statements rather than the high level of assurance provided by audit engagements. The primary purpose of review engagements is to enable the auditor to express a conclusion on whether, based on their review, they are aware of any material modifications that should be made to the financial statements for them to be in accordance with the applicable financial reporting framework (such as Generally Accepted Accounting Principles – GAAP). Reviews are typically conducted for entities where stakeholders require some level of assurance on the financial statements but do not require the comprehensive procedures and level of assurance provided by an audit.
(ii) THREE Features that Distinguish Review Engagements from Audit Engagements in Relation to Financial Statements:
| Review Engagements | Audit Engagements | |
| Level of Assurance | The auditor provides limited assurance on the financial statements, meaning they perform limited procedures to assess whether the financial statements are plausible and free from material misstatement | Provide a higher level of assurance, where the auditor performs extensive procedures to obtain reasonable assurance that the financial statements are free from material misstatement |
| Scope of Work | Involve performing analytical procedures and making inquiries to obtain a general understanding of the entity and its transactions. However, the procedures performed in reviews are less comprehensive than those performed in audits | Involve a detailed examination of the financial statements, including tests of controls, substantive procedures, and verification of transactions and account balances. |
| Reporting Requirements | The auditor provides a conclusion as to whether they are aware of any material modifications that should be made to the financial statements. This conclusion is expressed in a review report. | The auditor expresses an opinion on whether the financial statements present fairly, in all material respects, the financial position, results of operations, and cash flows in accordance with the applicable financial reporting framework. This opinion is expressed in an audit report. |
QUESTION 4
April 2023 Question One A
As the partner in charge of the internal quality review and control envisaged by International Standard on Quality Management (ISQCM) 1, you are required to prepare a brief for training the engagement team in your firm.
Required:
In light of the above statement:
(i) Explain the difference between “assurance” and “non-assurance” services as provided by external auditors. (4 marks)
Answer
(i) Difference between Assurance and Non-Assurance Services:
- Assurance services are professional services that improve the quality of information for decision-makers. These services provide an independent opinion on the reliability of financial information, compliance with regulations, or effectiveness of internal controls. External auditors typically provide assurance services, such as financial statement audits, where they express an opinion on whether the financial statements are free from material misstatement.
- On the other hand, non-assurance services are professional services that do not involve providing an opinion on the reliability of information. These services may include consulting services like tax advisory, internal audit co-sourcing, or IT advisory. Non-assurance services do not involve expressing a conclusion on the accuracy or reliability of the information being reviewed.
QUESTION 5
April 2022 Question Three B
Discuss the procedures and nature of reporting adopted by auditors when engaged in compilation engagements of the prospective clients. (8 marks)
Answer
Procedures and Reporting for Compilation Engagements of Prospective Clients
When auditors are engaged in compilation engagements for prospective clients, the procedures and nature of reporting differ from traditional audit engagements. Compilation engagements involve the preparation of financial statements based on information provided by the client, without the need for the auditor to provide any assurance on the accuracy or completeness of the information. Here are the procedures and nature of reporting adopted by auditors in compilation engagements:
Procedures:
- Understanding the Client’s Business: Obtain an understanding of the client’s business, industry, and the purpose of the financial statements to be compiled.
- Client Inquiry: Communicate with the client to gather relevant financial information, including details about assets, liabilities, income, and expenses.
- Documentation and Verification:
- Document the information provided by the client and verify its mathematical accuracy and consistency.
- Ensure that the information is complete, in compliance with accounting standards, and free from obvious errors.
- Adjustments and Disclosures:
- If discrepancies or errors are identified during the compilation process, propose adjustments to correct them.
- Recommend necessary disclosures in the financial statements to ensure compliance with accounting principles.
- Reviewing the Financial Statements: Review the compiled financial statements to ensure they present the client’s financial position, results of operations, and cash flows in accordance with the applicable financial reporting framework.
- Communicate with Management:
- Discuss any significant issues or discrepancies identified during the compilation process with the client’s management.
- Obtain management’s representation that the financial information provided is accurate and complete.
Nature of Reporting:
- Compilation Report:
- The auditor issues a compilation report, which clearly states the limited nature of the engagement and the auditor’s lack of responsibility to provide assurance on the accuracy of the financial information.
- The report emphasizes that the compiled financial statements are the representation of management and that the auditor has not performed any audit or review procedures to express an opinion.
- Scope Limitation:
- The report explicitly states that the auditor’s involvement is limited to compiling the financial information provided by management.
- It notes that no audit or review procedures were performed and, therefore, the auditor does not express any assurance on the financial statements.
- Disclaimer of Opinion:
- The report includes a disclaimer of opinion, making it clear that the auditor does not express any form of assurance on the financial statements.
- This disclaimer protects the auditor from being associated with the financial information beyond the scope of the compilation engagement.
- Restricted Use: The report may include language restricting the use of the compiled financial statements to specific users. This is to prevent the unintended reliance on the financial statements by third parties who may not be aware of the limitations of the engagement.
