ti audit assurance 20142015 inspection copy

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The Institute of Chartered Accountants in England and Wales

Audit and AssuranceAdvanced Stage Technical Integration Level

Study Manual

For exams in 2014 – July 2015

www.icaew.com


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Audit and AssuranceThe Institute of Chartered Accountants in England and Wales

ISBN: 978-0-85760-869-7

Previous ISBN: 978-0-85760-472-9

First edition 2007Seventh edition 2013

All rights reserved. No part of this publication may be reproduced, stored in aretrieval system or transmitted in any form or by any means, electronic,mechanical, photocopying, recording or otherwise, without the prior writtenpermission of the publisher.

British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library

Printed in the United Kingdom by Polestar Wheatons

Polestar Wheatons

Hennock RoadMarsh BartonExeterEX2 8RP

Your learning materials are printed on paper obtained from traceable,sustainable sources.

© The Institute of Chartered Accountants in England and Wales


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iii

Welcome to ICAEW

I am delighted to welcome you as a student studying our chartered accountancy qualification, the ACA.

The ACA will open doors to a highly rewarding career as a financial expert or business leader. Once youare an ICAEW member, you will join over 138,000 others around the world who work at the highestlevels across all industry sectors, providing valuable financial and business advice. Some of our earliermembers formed today's global Big Four firms, and you can find an ICAEW Chartered Accountant on

the boards of 80% of the UK FTSE 100 companies. We are here to help you every step of the way. As part of a worldwide network of over 19,000 students, you will have access to a range of resources including the online student community, where you caninteract with fellow students, and our student support team. Take a look at the key resources on page ix.

I wish you the very best of luck with your studies and look forward to supporting you throughout yourcareer.

Michael IzzaChief ExecutiveICAEW


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Contents

• Introduction vii• Audit and Assurance viii• Key Resources ix• Skills assessment guide ix• Faculties and Special Interest Groups xvi• ICAEW publications for further reading xvi

Professional practice and ethics

1 Role and context of modern auditing 1

2 Ethics 37

3 Governance 79

The modern audit process

4 Planning and risk assessment 121

5 Audit evidence 183

6 Audit completion – review and reporting 273

Other services

7 Assurance and related services 331

8 Environmental and social auditing 375

9 Internal auditing 405

Audit issues

10 Fraud and auditor liability 435

11 Auditing in an IT environment 493

12 Auditing fair values 511

Business scenarios

13 Small company audits 559

14 Business structures and global enterprises 593

15 Insolvency 643

Index 675


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Introduction vii

1 Introduction

1.1 What is Audit and Assurance and how does it fit within the ACA AdvancedStage?Structure

The ACA syllabus has been designed to develop core technical, commercial, and ethical skills and

knowledge in a structured and rigorous manner.The diagram below shows the twelve modules at the ACA Professional Stage, where the focus is on theacquisition and application of technical skills and knowledge, and the ACA Advanced Stage whichcomprises two technical integration modules and the Case Study.

The knowledge level

The aim of the Assurance module is to ensure students understand the assurance process and fundamental principles of ethics and are able to contribute to the assessment of internal controls andgathering of evidence on an assurance engagement.

Progression to ACA application level

The knowledge base put into place at Assurance is taken further in the application level module, Auditand Assurance. The aim is to enable students to understand the critical aspects of managing anassurance engagement. This includes acceptance, planning, managing, concluding and reporting.

Progression to ACA Advanced StageThe advanced level papers – Business Reporting (BR) and Business Change (BC) – then take things

further again, the aims being that students can apply analysis techniques, technical knowledge andprofessional skills to resolve real-life assurance issues faced by businesses.


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Audit and Assuranceviii

2 Audit and Assurance

2.1 Module aimThe aim of the Business Reporting paper is:

To ensure that candidates can apply analysis techniques, technical knowledge and professionalskills to resolve real-life compliance issues faced by businesses.

Candidates may be put, for example, in the role of a preparer of financial statements, or other corporatereports such as on sustainability and corporate responsibility, an advisor or in an assurance role facingbusiness issues where there are reporting implications. Compliance issues relating to taxation will also

feature in this module.

Candidates will be required to use professional judgement to identify and evaluate alternatives anddetermine the appropriate solution(s) to compliance issues, giving due consideration to the commercialimpact of their recommendations.

The aim of the Business Change paper is:

To ensure that candidates can provide technical advice in respect of issues arising in businesstransformations, mergers, acquisitions, alliances and disposals.

Candidates will be required to analyse and interpret both external and internal financial and non- financial data in order to plan for change and provide advice. In undertaking this analysis students willbe expected to evaluate the impact of stakeholder influences on the data, including the impact ofchoice of reporting policies.

Taxation and practical business techniques are particularly important in this module, where businesstechniques include aspects of business strategy, business finance, performance management andcosting. There will also be financial reporting, assurance, ethical and legal implications to be consideredwhen developing and assessing strategic and business plans.

2.2 Specification gridThis grid shows the relative weightings of subjects within each module and should guide the relativestudy time spent on each. Over time the marks available in the assessment will equate to the weightingsbelow, while slight variations may occur in individual assessments to enable suitably rigorous questionsto be set.

BR BC Weighting (%) Weighting (%)

Ethics and law 5 – 10 5 – 10Taxation 20 – 30 25 – 35

Audit and assurance 30 – 40 10 – 20 Corporate reporting 30 – 40 15 – 25 Business analysis 0 30 – 35


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Introduction ix

3 Key ResourcesSTUDENT SUPPORT TEAMT +44 (0)1908 248 250 E [email protected]

STUDENT WEBSITE

icaew.com/students student homepageicaew.com/exams exam applications, deadlines, regulations and moreicaew.com/cpl credit for prior learning/exemptionsicaew.com/examresources examiners comments, syllabus, past papers, study guides and moreicaew.com/examresults exam results

TUITION

If you are receiving structured tuition, make sure you know how and when you can contact your tutors for extra help.

If you aren't receiving structured tuition and are interested in classroom, online or distance learningtuition, take a look at our tuition providers in your area on icaew.com/exams

ONLINE STUDENT COMMUNITY

The online student community allows you to ask questions, gain study and exam advice from fellow ACA and CFAB students and access our free webinars. There are also regular Ask an Expert and Ask aTutor sessions to help you with key technical topics and exam papers. Access the community aticaew.com/studentcommunity

THE LIBRARY & INFORMATION SERVICE (LIS)

The Library & Information service (LIS) is ICAEW's world-leading accountancy and business library. Youhave access to a range of resources free of charge via the library website, including the catalogue,LibCat. icaew.com/library

4 Skills assessment guide

4.1 Introduction As a Chartered Accountant in the business world, you will require the knowledge and skills to interpret financial and other numerical and business data, and communicate the underlying issues to your clients.In a similar way to the required knowledge, the ACA syllabus has been designed to develop yourprofessional skills in a progressive manner. These skills are broadly categorised as:

Assimilating and using information Structuring problems and solutions Applying judgement Drawing conclusions and making recommendations


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Audit and Assurancex

4.2 Assessing your professional skills

BR

BC

Professional Stage

knowledge level

Professional Stageapplication level

Advance Stagetechnical integrationTAX FR

FA A&A

FM

BS

ETHICSCase Study

Initial Professional Development

Skills

Technical

The work experience requirements for students provide a framework to develop appropriate workexperience, completion of which is essential in order to qualify for membership. Work experience is alsoan essential component for examination preparation.

The work experience framework is built around five key skills:

Business awareness – being aware of the internal and external issues and pressure for change facingan organisation and assessing an organisation's performance.

Technical and functional expertise – applying syllabus learning outcomes and where appropriate, further technical knowledge to real situations.

Ethics and professionalism – recognising issues, using knowledge and experience to assessimplications, making confident decisions and recommendations.

Professional judgement – making recommendations and adding value with appropriate, targetedand relevant solutions.

Personal effectiveness – developing, maintaining and exercising skills and personal attributesnecessary for the role and responsibilities.

The examinations, and in particular the Advanced Stage, embrace all of these skills.

The link between work experience and the examinations is demonstrated by the skills developmentgrids produced by the examiners.

This will help students see that their practical knowledge and skills gained in the workplace feed backinto the exam room and vice-versa.

4.3 Assessment gridsThe following pages set out the learning outcomes for Audit and Assurance that are addressed undereach of the four skills areas. In addition, for each skills area, there is a description of:

The specific skills that are assessed How these skills are assessed

Using these grids will enable you to determine how the examination paper will be structured and toconsider whether your knowledge of Audit and Assurance is sufficiently strong to enable you to apply itin the required manner.


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Introduction xi


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Audit and Assurancexii

4.4 Technical knowledgeThe table contained in this section shows the technical knowledge covered in the ACA Syllabus bymodule.

For each individual standard the level of knowledge required in the relevant Professional Stage moduleand at the Advanced Stage is shown.

The knowledge levels are defined as follows:

Level D An awareness of the scope of the standard.

Level C

A general knowledge with a basic understanding of the subject matter and training in its applicationsufficient to identify significant issues and evaluate their potential implications or impact.

Level B

A working knowledge with a broad understanding of the subject matter and a level of experience in theapplication thereof sufficient to apply the subject matter in straightforward circumstances.

Level A

A thorough knowledge with a solid understanding of the subject matter and experience in theapplication thereof sufficient to exercise reasonable professional judgement in the application of thesubject matter in those circumstances generally encountered by Chartered Accountants.

Key to other symbols:

→ The knowledge level reached is assumed to be continued


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Introduction xiii

Audit and Assurance

Certificate &Professional

Levels

Title

A s s u r a n c e

A u

d i t

&

A s s u r a n c e

A d v a n c e

d L e v e

l

The International Auditing and Assurance Standards Board D C

The Authority Attaching to Standards Issued by the International Auditing and Assurance Standards Board C A

The Authority Attaching to Practice Statements Issued by theInternational Auditing and Assurance Standards Board A

Discussion Papers C

Working Procedures C

International Standards on Auditing (UK and Ireland)

200 Overall Objectives of the Independent Auditor and the Conduct ofan Audit in Accordance with International Standards on Auditing

B A

210 Agreeing the Terms of Audit Engagements B

220 Quality Control for an Audit of Financial Statements B

230 Audit Documentation B A

240 The Auditor's Responsibilities Relating to Fraud in an Audit ofFinancial Statements

B A

250 A Consideration of Laws and Regulations in an Audit of FinancialStatements B A

250 B The Auditor's Right and Duty to Report to Regulators in theFinancial Sector

C

260 (Revised October 2012) Communication with Those Charged withGovernance

B A

265 Communicating Deficiencies in Internal Control to Those Chargedwith Governance and Management

B A

300 Planning an Audit of Financial Statements B A

315 Identifying and Assessing the Risks of Material MisstatementThrough Understanding the Entity and its Environment

C A

320 Materiality in Planning and Performing an Audit C A

330 The Auditor's Responses to Assessed Risks B A

402 Audit Considerations Relating to an Entity Using a ServiceOrganisation

C B

450 Evaluation of Misstatements Identified during the Audit C A

500 Audit Evidence B A

501 Audit Evidence – Specific Considerations for Selected Items B A

505 External Confirmations B B A

510 Initial Audit Engagements – Opening Balances B A


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Audit and Assurancexiv


Levels

Title

A s s u r a n c e

A u

d i t &

A s s u r a n c e

A d v a n c e

d L e v e

l

520 Analytical Procedures B A A

530 Audit Sampling B B A

540 Auditing Accounting Estimates, Including Fair Value AccountingEstimates and Related Disclosures

C B A

550 Related Parties B A

560 Subsequent Events B A

570 Going Concern A

580 Written Representations C B A

600 Special Considerations – Audits of Group Financial Statements(including the Work of Component Auditors)

C A

610 Using the Work of Internal Auditors C A

620 Using the Work of an Auditor's Expert C A

700 (Revised October 2012) The Auditor's Report on FinancialStatements

B A

705 (Revised October 2012) Modifications to the Opinion in theIndependent Auditor's Report

A

706 (Revised October 2012) Emphasis of Matter Paragraphs and Other

Matter Paragraphs in the Independent Auditor's Report

A

710 Comparative Information – Corresponding Figures andComparative Financial Statements

B A

720 A (Revised October 2012) The Auditor's Responsibility Relating toOther Information in Documents Containing Audited FinancialStatements

B A

720 B The Auditor's Statutory Reporting Responsibility in Relation toDirectors' Reports

A

International Standards on Auditing

800 Special Considerations – Audits of Financial Statements prepared in

Accordance with Special Purpose Frameworks

B

805 Special Considerations – Audits of Single Financial Statements andSpecific Elements, Accounts or items of a Financial Statement

B A

810 Engagements to Report on Summary Financial Statements B A

International Auditing Practice Note (IAPN)

1000 Special Considerations in Auditing Financial Instruments C

International Standards on Review Engagements (ISREs)

2400 (Revised September 2012) Engagements to Review HistoricalFinancial Statements

C B

2410 Review of Interim Financial Information Performed by theIndependent Auditor of the Entity

B


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Introduction xv


Levels

Title

A s s u r a n c e

A u

d i t &

A s s u r a n c e

A d v a n c e

d L e v e

l

International Standards on Assurance Engagements (ISAEs)

3000 Assurance Engagements Other than Audits or Reviews ofHistorical Financial Information

C B

3400 The Examination of Prospective Financial Information C B

3402 Assurance Reports on Controls at a Service Organisation C A

3410 Assurance Engagements on Greenhouse Gas Statements C

International Standards on Related Services (ISRSs)

4400 Engagements to Perform Agreed-upon Procedures RegardingFinancial Information

B

4410 Compilation Engagements (Revised March 2012) B

IFAC Statements

ISQC1 Quality Control for Firms that Perform Audits and Reviews ofFinancial Statements, and Other Assurance and Related ServicesEngagements

C B

Other Guidance

2010/2 (Revised March 2012) Compendium of illustrative Auditor'sReports on UK Private Sector Financial Statements

B B

FRC Briefing PaperProfessional Scepticism – establishing a common understanding andreaffirming its central role in delivering audit quality

C B

Ethics Codes and Standards

Ethics Codes and Standards Level Professional Stage modules

IFAC Code of Ethics for Professional Accountants(parts A, B and C and definitions)

A

ICAEW Code of Ethics A

AssuranceBusiness and FinanceLaw

Principles of Taxation Audit and AssuranceBusiness StrategyFinancial ReportingTaxation

APB Ethical Standards 1–5 (revised)Provisions Available to Small Entities (revised)

A Assurance Audit and Assurance


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Audit and Assurancexvi

5 Faculties and Special Interest Groups (SIGs) The faculties and special interest groups are specialist bodies within ICAEW which offer membersnetworking opportunities, influence and recognition within clearly defined areas of technical expertise.

As well as providing accurate and timely technical analysis, they lead the way in many professional andwider business issues through stimulating debate, shaping policy and encouraging good practice. Theirvalue is endorsed by over 40,000 members of ICAEW who currently belong to one or more of the seven

faculties:

Audit and Assurance Corporate Finance Finance and Management Financial Reporting Financial Services Information Technology Tax

The special interest groups provide practical support, information and representation for charteredaccountants working within a range of industry sectors, including:

Charity and Voluntary sector Entertainment and Media Farming and Rural Business Forensic Healthcare Interim Management Non-Executive Directors Public Sector Solicitors Tourism and Hospitality Valuation

Students can register free of charge for provisional membership of one special interest group andreceive a monthly complimentary e-newsletter from one faculty of your choice. To find out more and toaccess a range of free resources, visit icaew.com/facultiesandsigs.

6 ICAEW publications for further readingICAEW produces publications and guidance for its students and members on a variety of technical andbusiness topics. This list of publications has been prepared for students who wish to undertake furtherreading in a particular subject area and is by no means exhaustive. You are not required to study thesepublications for your exams. For a full list of publications, or to access any of the publications listedbelow, visit the Technical Resources section of the ICAEW website at icaew.com

ICAEW no longer prints a Members Handbook. ICAEW regulations, standards and guidance areavailable at icaew.com/regulations This area includes regulations and guidance relevant to the regulatedareas of audit, investment business and insolvency as well as materials that was previously in the

handbook.The TECH and AUDIT series of technical releases are another source of guidance available to membersand students. Visit icaew.com/technicalreleases for the most up-to-date releases.

Audit and Assurance Faculty – icaew.com/aaf Right First Time with the Clarified ISAs , ICAEW 2010, ISBN 978-0-85760-063-9

Clarified ISAs provide many opportunities for practitioners in terms of potential efficiencies, betterdocumentation, better reporting to clients, and enhanced audit quality overall.

This modular guide has been developed by ICAEW's ISA implementation sub-group to helpmedium-sized and smaller firms implement the clarified ISAs and take advantage of theseopportunities. This modular guide is designed to give users the choice of either downloading thepublication in its entirety, or downloading specific modules on which they want to focus.

An international edition is also available.


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Introduction xvii

Quality Control in the Audit Environment , ICAEW 2010, ISBN 0-497-80857-605-5

The publication identifies seven key areas for firms to consider. Illustrative policies and proceduresare provided for selected aspects of each key area, including some examples for sole practitioners.The guide also includes an appendix with answers to a number of frequently asked questions onthe standard.


The Audit of Related Parties in Practice, ICAEW 2010, ISBN 978-1-84125-565-6

This practical guide to the audit of related party relationships and transactions is set in the contextof the significant change in approach that is required under the revised ISA and highlights theimportance of planning, the need to involve the entire audit team in this, to assign staff with theappropriate level of experience to audit this area and upfront discussions with the client to identifyrelated parties.


Alternatives to Audit ICAEW, 2009, ISBN 978-1-84152-819-9

In August 2006, the ICAEW Audit and Assurance Faculty began a two-year consultation on a newassurance services (the ICAEW Assurance Service), an alternative to audit based on the idea oflimited assurance introduced by the International Auditing and Assurance Standards Board (IAASB).

This report presents findings from the practical experience of providing the ICAEW AssuranceService over the subsequent two years and views of users of financial information that help inassessing the relevance of the service to their needs.

Companies Act 2006 – Auditor related requirements and regulations third edition – March2012 ICAEW, 2012, ISBN 978-0-85760-442-2

This third edition of the guide provides a brief summary of the key sections in the Companies Act2006 (the Act) which relate directly to the rights and duties of auditors. It covers the various typesof reports issued by auditors in accordance with the Act. It is designed to be a signposting tool forpractitioners and identifies the other pieces of guidance issued by ICAEW, APB, FRC, POB andothers to support implementation of the Act.

Auditing in a group context: practical considerations for auditors ICAEW, 2008, ISBN 978-1-84152-628-7

The guide describes special considerations for auditors at each stage of the group audit's cycle. While no decisions have been taken on UK adoption of the IAASB's clarity ISAs, the publication alsocovers matters in the IAASB's revised and redrafted 'ISA 600 Special Considerations - Audits ofGroup Financial Statements (Including the Work of Component Auditors)'. The revised publicationcontains suggestions for both group auditors and component auditors.

Corporate Finance Faculty – icaew.com/corpfinfac Private equity demystified – an explanatory guide Second Edition, Financing Change Initiative,

ICAEW, March 2010, John Gilligan and Mike Wright.

This guide summarises the findings of academic work on private equity transactions from aroundthe world. Hard copies of the abstract and full report are free and are also available by download

from icaew.com/thoughtleadership

Best Practice Guidelines

The Corporate Finance Faculty publishes a series of guidelines on best-practice, regulatory trendsand technical issues. Authored by leading practitioners in corporate finance, they are succinct andclear overviews of emerging issues in UK corporate finance. icaew.com/corpfinfac

Corporate Financier magazine , ISSN 1367-4544

The award-winning Corporate Financier magazine is published ten times a year for members,stakeholders and key associates of ICAEW's Corporate Finance Faculty.

Aimed at professionals, investors and company directors involved in corporate finance, it covers awide range of emerging regulatory, commercial and professional development issues.


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Audit and Assurancexviii

The magazine includes features, news, analysis and research, written by experts, experiencededitors and professional journalists.

In 2011, three major themes were introduced: Innovation & Corporate Finance; FinancingEntrepreneurship; and Deal Leadership.

Corporate governance – icaew.com/corporategovernance The UK Corporate Governance Code 2010

The UK Corporate Governance Code (formerly the Combined Code) sets out standards of goodpractice in relation to board leadership and effectiveness, remuneration, accountability andrelations with shareholders. All companies with a Premium Listing of equity shares in the UK arerequired under the Listing Rules to report on how they have applied the UK Corporate GovernanceCode in their annual report and accounts.

The first version of the UK Corporate Governance Code was produced in 1992 by the CadburyCommittee. In May 2010 the Financial Reporting Council issued a new edition of the Code whichapplies to financial years beginning on or after 29 June 2010.

The UK Corporate Governance Code contains broad principles and more specific provisions. Listedcompanies are required to report on how they have applied the main principles of the Code, andeither to confirm that they have complied with the Code's provisions or – where they have not – toprovide an explanation.

Internal Control: Revised Guidance on Internal Control for Directors on the Combined Code(now the UK Corporate Governance Code)

Originally published in 1999, the Turnbull guidance was revised and updated in October 2005, following a review by the Financial Reporting Council. The updated guidance applies to listedcompanies for financial years beginning on or after 1 January 2006.

The FRC Guidance on Audit Committees (formerly known as The Smith Guidance)

First published by the Financial Reporting Council in January 2003, and most recently updated in2010. It is intended to assist company boards when implementing the sections of the UKCorporate Governance Code dealing with audit committees and to assist directors serving on audit

committees in carrying out their role. Companies are encouraged to use the 2010 edition of theguidance with effect from 30 April 2011.

The UK Stewardship Code

The UK Stewardship Code was published in July 2010. It aims to enhance the quality ofengagement between institutional investors and companies to help improve long-term returns toshareholders and the efficient exercise of governance responsibilities by setting out good practiceon engagement with investee companies to which the Financial Reporting Council believesinstitutional investors should aspire.

A report summarising the actions being taken by the Financial Reporting Council and explaininghow the UK Stewardship Code is intended to operate was also published in July 2010.

Corporate responsibility – icaew.com/corporateresponsibility Sustainable Business January 2009

The new thought leadership prospectus acts as a framework for the work that ICAEW do insustainability/corporate responsibility. It argues that any system that is sustainable needs accurateand reliable information to help it learn and adapt, which is where the accounting profession playsan important role. A downloadable pdf is available at icaew.com/sustainablebusiness

Environmental issues in annual financial statements ICAEW, May 2009, ISBN 978-1-84152-610-2

This report is a joint initiative with the Environment Agency. It is aimed at business accountantswho prepare, use or audit the financial statements in statutory annual reports and accounts, orwho advise or sit on the boards of the UK companies and public sector organisations. It offers

practical advice on measuring and disclosing environmental performance. A downloadable pdf isavailable at icaew.com/sustainablebusiness


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Introduction xix

ESRC seminar series – When worlds collide: contested paradigms of corporate responsibility

ICAEW, in conjunction with the British Academy of Management, won an Economic and SocialResearch Council grant to run a seminar series which aims to bring academics and the businesscommunity together to tackle some of the big challenges in corporate responsibility.icaew.com/corporateresponsibility

The Business Sustainability Programme (BSP)

The Business Sustainability Programme is an e-learning package for accountants and businessprofessionals who want to learn about the business case for sustainability. The course is spreadacross five modules taking users from definitions of sustainability and corporate responsibility,through case studies and finally towards developing an individually tailored sustainability strategy

for their business. The first two modules are free to everyone. For more information and todownload a brochure visit icaew.com/bsp

Ethics – icaew.com/ethics Code of Ethics

The Code of Ethics helps ICAEW members meet these obligations by providing them with ethicalguidance. The Code applies to all members, students, affiliates, employees of member firms and,

where applicable, member firms, in all of their professional and business activities, whetherremunerated or voluntary.

Instilling integrity in organisations ICAEW June 2009

Practical guidance aimed at directors and management to assist them in instilling integrity in theirorganisations. This document may also be helpful to audit firms discussing this topic with clientsand individuals seeking to address issues in this area with their employers.

Reporting with Integrity ICAEW May 2007, ISBN 978-1-84152-455-9

This publication brings ideas from a variety of disciplines, in order to obtain a more comprehensiveunderstanding of what is meant by integrity, both as a concept and in practice. Moreover, becausethis report sees reporting with integrity as a joint endeavour of individuals, organisations andprofessions, including the accounting profession, the concept of integrity is considered in all thesecontexts.

Finance and Management Faculty – icaew.com/fmfac Finance's role in the organisation November 2009, ISBN 978-1-84152-855-7

This considers the challenges of designing successful organisations, written by Rick Payne, wholeads the faculty's finance direction programme.

Investment appraisal SR27: December 2009, ISBN 978-1-84152-854-4

This special report looks at the key issues and advises managers on how they can contributeeffectively to decision making and control during the process of investment appraisal.

Starting a business SR28: March 2010, ISBN 978-1-84152-984-2

This report provides accountants with a realistic and motivational overview of what to considerwhen starting a business.

Developing a vision for your business SR30: September 2010, ISBN 978-0-85760-054-7

This special report looks at what makes a good vision, the benefits of having one, the role of the FDin the process, leadership, storytelling and the use of visions in medium-sized businesses.

Finance transformation – the outsourcing perspective SR31: December 2010, ISBN 978-0-85760-079-0

The authors of this outsourcing special report share their expertise on topics including service levelagreements, people management, and innovation and technology.


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Audit and Assurancexx

The Finance Function: A Framework for Analysis September 2011 , ISBN 978-0-85760-285-5

This report is a source of reference for those analysing or researching the role of the finance function and provides a foundation for considering the key challenges involved, written by RickPayne, who leads the faculty's finance direction programme.

Financial Reporting Faculty – icaew.com/frfac EU Implementation of IFRS and the Fair Value Directive ICAEW, October 2007, ISBN 978-1-

84152-519-8

The most comprehensive assessment to date of compliance with the requirements of IFRS and theoverall quality of IFRS financial reporting.

The Financial Reporting Faculty makes available to students copies of its highly-regarded factsheetson UK GAAP and IFRS issues, as well as its journal, By All Accounts , at icaew.com/frfac

Financial Services Faculty – icaew.com/fsf Audit of banks: lessons from the crisis, (Inspiring Confidence in Financial Services initiative)

ICAEW, June 2010 ISBN 978-0-85760-051-6

This research has looked into the role played by bank auditors and examined improvements thatcan be made in light of lessons learned from the financial crisis. The project has included thepublication of stakeholder feedback and development of a final report.

Measurement in financial services, (Inspiring Confidence in Financial Services initiative) ICAEW,March 2008, ISBN 978-1-84152-546-4

This report suggests that more work is required on matching measurement practices in the financial services industry to the needs of different users of financial information, despite the factthat the financial services industry has the greatest concentration of measurement and modellingskills of any industry. A downloadable pdf is available at icaew.com/thoughtleadership

Skilled Persons' Guidance – Reporting Under s166 Financial Services and Markets Act 2000(Interim Technical Release FSF 01/08)

This interim guidance was issued by ICAEW in April 2008 as a revision to TECH 20/30 to assistchartered accountants and other professionals who are requested to report under s166 FinancialServices and Markets Act 2000. A downloadable pdf is available at icaew.com/technicalreleases

Information Technology Faculty – icaew.com/itfac The IT Faculty provides ongoing advice and guidance that will help students in their studies and theirwork. The online community ( ion.icaew.com/itcountshome ) provides regular free updates as well as alink to the faculty's Twitter feed which provides helpful updates and links to relevant articles. The

following publications should also be of interest to students:

Make the move to cloud computing ICAEW, 2012, ISBN 978-0-85760-617-4

Cloud computing in its purest form is pay-as-you-go IT, online and on demand. The IT capabilitiesprovided as a service to businesses include: single software applications or software suites; onlinesoftware development platforms; and virtual computing infrastructure, ranging from data storageto computer grids.

Bringing employee personal devices into the business – a guide to IT consumerisation ICAEW,2012, ISBN 978-0-85760-443-9

The gap between business and consumer technology has been growing over the last few years,with the consumer market now leading in terms of ease of use and portability.

Making the most of social media – a practical guide for your business ICAEW, 2011, ISBN 978-0-85760-286-2

This guide will enable the business manager to develop a philosophy that allies social media's

potential with the business's objectives and capabilities, to set objectives and protect againstpitfalls, and then to take the first practical steps in a mass communications medium very different from any that British business has encountered before.


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Introduction xxi

Tax Faculty – icaew.com/taxfac The Tax Faculty runs a Younger Members Tax Club which provides informal presentations, discussionsand socialising. All young professionals interested in tax are welcome to attend. See the website formore details icaew.com/taxfac

Tax news service

You can keep up with the tax news as it develops on the Tax Faculty's news siteicaew.com/taxnews . And you can subscribe to the free newswire which gives you a weekly roundup. For more details visit icaew.com/taxfac

Demystifying XBRL

This booklet, produced jointly by KPMG, the Tax Faculty and the Information Technology Faculty,explains exactly what iXBRL is all about and what must be done in order to e-file corporation taxreturns using the new standard.

Implementing XBRL

This booklet, produced jointly by Thompson Reuters, the Tax Faculty and the InformationTechnology Faculty, is a practical guide for accountants in business and practice, and follows on

from Demystifying XBRL.

TAXline Tax Practice series of detailed briefings on current topics:

TAXline Tax Practice 27Let property – a brief guide by Rebecca Cave (published November 2011)

TAXline Tax Practice 26The new pension rules by Anne Redston (published July 2011)

TAXline Tax Practice 25Tax Credits by Robin Williamson (published April 2011)

TAXline Tax Practice No 23HMRC Powers – an overview of the new powers and penalties regime by Paula Clemett (publishedOctober 2010)


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Audit and Assurancexxii


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1

CHAPTER 1

Role and context of modernauditing

IntroductionTopic List

1 Role of auditing2 The audit process3 Statutory audit requirement4 Legal responsibilities

5 International standards on auditing6 Quality control7 Documentation

Summary and Self-testTechnical reference

Answers to Self-test Answers to Interactive questions


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Audit and Assurance2

Introduction

Learning objectives Tick off•

Explain the role of the auditor in providing assurance to shareholders• List the main stages of the audit process

• State which companies need an audit under Companies Act legislation

• Explain the legal responsibilities of directors and auditors

• Explain the role of International Standards on Auditing

• Discuss the quality control procedures that the audit firm will carry out within the audit firm and for each individual audit

• State the documentation required on an audit and explain the importance of thatdocumentation


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Role and context of modern auditing 3

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1 Role of auditing

Section overview• The audit provides assurance to shareholders

• The audit enables the auditor to form an opinion as to whether the financial statements give atrue and fair view

• An expectation gap may exist between what shareholders expect the audit to achieve and what itis designed to achieve

1.1 Purpose of the audit Audits serve a fundamental purpose in helping to enforce accountability and promote confidence in financial reporting. Directors are delegated responsibility for managing the affairs of the company bythe owners, in effect they act as trustees for the shareholders. The audit provides a mechanism forshareholders to help ensure that the directors are acting in the company's best interests and thereforeplays a fundamental stewardship role .

ISA (UK and Ireland) 200 Overall Objectives of The Independent Auditor and the Conduct of an Audit inAccordance with International Standards on Auditing (UK and Ireland) sets out the purpose of an audit as

follows:

'The purpose of an audit is to enhance the degree of confidence of intended users in the financialstatements. This is achieved by the expression of an opinion by the auditor on whether the

financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework.'

1.2 Part of the economic infrastructureThe audit is also a vital function of economic activity. For that economic activity to continue to flourishthere has to be trust.

While the audit has a crucial role to play in providing assurance to shareholders it cannot be seen inisolation. For example, the directors of the company have a role to play in the preparation of financialstatements that show a true and fair view. The audit has to be seen in the context of a range ofinterwoven laws, regulations, and guidance, all of which promote good corporate governance. (We willlook at corporate governance in detail in Chapter 3.)

1.3 The expectation gapThe primary role of the auditor is to perform an independent examination of the financial statementsand to form an opinion. You should be very familiar with this concept from your earlier studies. Theaudit opinion will provide reasonable assurance that the financial statements give a true and fair view;it does not provide a certificate that they are completely accurate and free from every error or fraud, nomatter how small. ISA 200 explains that absolute assurance is not possible due to inherent limitations ofthe audit including those resulting from the following factors:

• The nature of financial reporting; many items involve judgement and assessments of uncertainties• The use of testing• Inherent limitations of internal control• The fact that most evidence is persuasive rather than conclusive• The impracticability of examining all items within a class of transactions or account balance• The possibility of collusion or misrepresentation for fraudulent purposes• The fact that the work undertaken by the auditor is permeated by judgement

In some instances this ' expectation gap ' can lead to difficulties arising from the difference betweenwhat shareholders expect an audit to achieve and what it is designed to achieve. The public increasingly

expect the following types of questions to be answered:


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• Is the company a going concern?• Is the company managed effectively?• Is there an adequate system of controls?• Is the company susceptible to fraud?

1.4 The audit opinionThe key judgement made by the auditor is whether the financial statements give a true and fair view.

While there is no legal definition for these terms, 'true' and 'fair' are normally taken to mean the following:

Definition

True : The information in the financial statements is not false and conforms to reality.

In practical terms this means that the information is presented in accordance with accountingstandards and law . The financial statements have been correctly extracted from the underlyingrecords and those records reflect the actual transactions which took place.

Definition

Fair : The financial statements reflect the commercial substance of the company's underlyingtransactions and the information is free from bias.

You will have come across examples of the application of substance over form in your financialreporting studies eg the treatment of a finance lease.

The problem with making judgements such as these is that they can be called into question, particularlywhere others have the benefit of hindsight. The major defence that the auditor has in this situation is toshow that the work was performed with due skill and care and that the judgements made about truthand fairness were reasonable based on the evidence available at the time. We will look at quality controlin Section 6 of this chapter. Auditor liability is covered in Chapter 10.

2 The audit process

Section overview• This section provides brief revision of the audit process

2.1 Overview

You will have covered the audit process in your earlier studies. The following diagram summarises thekey points you should be familiar with. Chapters 4 – 6 of this study manual cover the audit in moredetail.


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Client acceptance/continuance

Establish/ re-evaluate

Plan the audit

Develop the auditapproach

Audit internalcontrol

Audit businessprocesses

Evaluate results

Issue auditreport

ConsiderationsLegalEthicalPractice

Letter of engagement

Obtain an understanding of the entityEvaluate internal control

Assess risksEstablish materiality

Audit strategy Audit planning

Tests of controlsSampling

Analytical proceduresTests of detailsSampling

Analytical procedures Additional procedures?

Consider other reportingrequirements

Point to note:

ISA 200 requires that the audit should be planned and performed with an attitude of professionalscepticism . Professional scepticism is covered in detail in Chapter 4.

3 Statutory audit requirement

Section overview• All companies, except those meeting exemption criteria must have an audit

3.1 The audit thresholdThe basic principle is that all companies registered in the UK should be audited. However, in the early1990s certain very small companies were granted an exemption . In September 2012 the UKGovernment announced that, for accounting periods ending on or after 1 October 2012, the auditexemption criteria would be aligned with the small company criteria. An ICAEW Helpsheet summarisesthe situation in the following diagram:


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Structure ofFRCAuditand Assurance Pronouncements

InternationalStandardsonQualityControl(UKandIreland)

The

Auditors'

Code

Ethical

Standardsfor

Auditors

International

Standards

onAuditing

(UKandIreland)

Ethical

Standards

For

Reporting

Accountants

Standards

for

Investment

Reporting

Statements

ofStandards

forReporting

Accountants

PracticeNotes

andBulletins

Bulletins

Bulletins

Audits

Investment

Circulars

Other

Assurance

Engagements

QualityControl

Standards

Frameworkof

Fundamental

Principles

Ethicaland

Engagement

Standards

Guidance

Notice however, even if a small company met these criteria, it must still have its accounts audited if thisis demanded by a member, or members, holding at least 10% of the nominal value of the issued sharecapital or holding 10% of any class of shares; or – in the case of a company limited by guarantee – 10%of its members in number. The demand for the financial statements to be audited should be in the formof a notice to the company, deposited at the registered office at least one month before the end of the

financial year in question. The notice may not be given before the financial year to which it relates.

In addition, a company should have an audit, irrespective of size, if

• It is a regulated company such as Financial Services Authority regulated businesses and insuranceproviders (S478), or

• A public company.


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Points to note:

1 The criteria use UK accounting terminology rather than IFRS terminology as they are required byUK law.

2 so that any company which meets the small company criteria can choose to be exempt from audit(ie if the company meets two out of the three following criteria: no more than 50 employees, nomore than gross assets of £3.26 million, less than £6.5m in turnover).

4 Legal responsibilities

Section overview• The Companies Act sets down the responsibilities of the directors and auditors

4.1 Companies Act 2006The legal responsibilities regarding directors and auditors are currently contained in the Companies Act2006. The majority of the auditing requirements of the Act came in to force for periods on or after 6

April 2008.

4.2 Directors' responsibilitiesThese duties are as follows:

• 'Enlightened shareholder value' duty

The Companies Act 2006 requires directors to act in a way that they consider, in good faith wouldbe most likely to promote the success of the company for the benefit of its members as awhole . In doing so they should consider such factors as:

– The likely long term consequences– The interests of employees– Relationships with customers and suppliers– The impact of the company's operations on the community and the environment– The desirability of maintaining a reputation for high standards of business conduct– The need to act fairly as between members of the company

• Duty of skill and care

Directors have the responsibility to take reasonable steps to ensure the safeguard, insurance, etcof the company's assets.

A director is required to

– Exhibit a degree of skill that can reasonably be expected– Take such care as an ordinary man might be expected to take on his behalf

• Conflicts of interest

Directors should not place themselves where their personal interest conflicts with their duty to thecompany. Directors will be personally liable to the company for any loss suffered by the company(Regal (Hastings) Ltd v Gulliver).

If a director has an interest in a contract to which his company is party, the company may incertain circumstances void the contract.

• Fraudulent trading

Directors will be responsible should the company trade with the intent to defraud creditors if theyare knowingly party to such conduct. Responsibility will arise whether or not the company is in thecourse of winding up. This is covered in Chapter 15.


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• Wrongful trading

Where a company is in the course of winding up the provisions of wrongful trading may apply . An action may be brought against the director if at some time before the commencement of thewinding up the person knew or ought to have concluded there was no reasonable prospect ofavoiding liquidation. Again, this is covered in Chapter 15.

• Theft

If a company obtains property or pecuniary advantage by deception and the director hasconsented, then the director will be liable as well as the company .

• Accounting records

A company is required to keep adequate accounting records , which are sufficient to show andexplain the company's transactions. Failure to do so may render every officer of the company liableto a fine or imprisonment.

In addition to the statutory requirement, the directors have an overriding responsibility to ensurethey have adequate information to enable them to fulfil their duty of managing the company'sbusiness.

• Annual accounts

Directors have a number of responsibilities with regard to the annual accounts. The directors arerequired to

– Select suitable accounting policies and apply them consistently

– Make judgements and estimates that are prudent

– State whether applicable accounting standards have been followed, subject to any materialdepartures disclosed and explained in the financial statements

– Prepare the financial statements on a going concern basis unless it is an inappropriateassumption

– Ensure the financial statements are delivered to Companies House within the specified time.

A statement of directors' responsibilities should be included in the financial statements.

• Directors' and officers' insurance

Generally a company cannot indemnify a director against a liability arising from an act ofnegligence, default or breach of duty. However, this statutory provision does not prevent acompany from buying and maintaining insurance against such a liability.

• Safeguarding the assets

Responsibilities to safeguard the assets of the company includes the prevention and detection offraud . One of the main ways in which this duty can be carried out is to implement an effectivesystem of controls .

4.3 Directors' loans and other transactions4.3.1 Background

The Companies Act 2006 imposes restrictions on dealings between a company and its directors in orderto prevent directors taking advantage of their position. These restrictions are probably the main legalsafeguard available against directors abusing their position in a company. The disclosures ensure thatshareholders and other stakeholders will be informed about all the significant transactions entered intoby a company with its management that might benefit those individuals.

This is an important area for the auditor because he has a specific duty to disclose details of directors'transactions in the audit report if not disclosed elsewhere. The information is very sensitive, and it isdifficult to audit due to materiality, complexity and the potential lack of any formal documents.


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4.3.2 Definitions

The following definitions are relevant to your understanding of this issue.

Definitions

Persons connected with a director . These include:

• Directors' spouses, minor (including step) children•

A company with which a director is associated (ie controls > 20% voting power)• Trustee of a trust whose beneficiaries include the director or connected person• Partner of the director or connected person

Loan . A sum of money lent for a time to be returned in money or money's worth.

Quasi-loan . The company agrees to pay a third party on behalf of the director, who later reimburses thecompany (eg personal goods bought with company credit card).

Credit transaction . A transaction where payment is deferred (eg goods bought from company oncredit terms).

4.3.3 Members' approval

The following rules apply to all companies :• Loans > £10,000 must be approved by the members of the company. In order for the resolution to

be passed members must be provided with details of the nature of the transaction, the amount ofthe loan and the purpose for which it is required and the extent of the company's liability.

• Advances for legitimate business expenditure do not require approval. However the value of anytransaction is not allowed to exceed £50,000.

The following rules apply to public companies (or companies associated with public companies):

• Loans > £10,000 made to persons connected with a director must be approved by the members ofthe company

• Quasi loans > £10,000 made to directors or connected persons must be approved by the membersof the company

• Credit transactions > £15,000 for the benefit of a director or a connected person must beapproved by the members of the company

Where transactions are entered into without the required approval the transaction is voidable at theinstance of the company.

4.3.4 Disclosure

For all loans etc to directors• Its amount• An indication of the interest rate•

Principal terms• Any amounts repaid

4.3.5 Other transactions and contractsDirectors' interests in contracts

Directors may have a personal interest in contracts planned or made by company, eg because they arealso directors of another company.

Directors must declare interests in contracts to board of directors at earliest opportunity.

Substantial property transactions between company and directors also require approval by members. Atransaction is substantial if

• Value > £100,000, or• Value > 10% of company's net assets (per latest accounts).


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Exception: the transaction is not substantial if < £5,000 ( de minimis limit).

If not approved the transaction is voidable by the company.

Service contracts

Members must approve long service contracts for directors (> two years).

Service contracts must be open to inspection by members.

In examining directors' service contracts, auditors should check particularly that

• Company and each director are complying wholly with terms of contract

• Terms themselves comply with Companies Act requirements and are consistent with company'sarticles.

4.4 Auditors' responsibilitiesUnder the Companies Act 2006, it is the external auditor's responsibility to:

• Form an independent opinion on the truth and fairness of the financial statements

• Confirm that the financial statements have been properly prepared in accordance with therelevant financial reporting framework and the Companies Act 2006

• State in their audit report whether in their opinion the information given in the directors' report isconsistent with the financial statements.

The auditor will also report by exception on the following. Whether:

• Proper returns, adequate for audit purposes, have been received from branches• The accounts agree with the underlying records• Adequate accounting records have been kept• All necessary information and explanations have been obtained

In the case of a quoted company whether the auditable part of the directors' remuneration report hasbeen properly prepared.

If the accounts (or directors' remuneration report) omit or incorrectly disclose information on directors'emoluments, loans and other transactions, the correct disclosure must be included in the auditor'sreport (due to the particularly sensitive nature of this information and its importance to users of theaccounts).

The auditor also has a duty towards other information in documents containing audited financialstatements in accordance with ISA (UK and Ireland) 720A The Auditor's Responsibilities Relating to OtherInformation in Documents Containing Audited Financial Statements (see Chapter 6) .

Point to note:

The scope of an audit under UK law and ISAs is now set out in formal guidance that can be cross-referred to from auditor's reports (see Chapter 6).


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5 International standards on auditing

Section overview• The structure of the FRC has been revised

• The International Auditing and Assurance Standards Board issues International Standards on Auditing

• The IAASB has reissued its ISAs as a result of its Clarity Project

• These have been adopted by FRC (previously APB) in the UK

5.1 FRCIn June 2012 the UK Parliament approved a proposal to revise the structure of the FRC. This becameeffective from 2 July 2012. The revised FRC structure is summarised in the diagram below:

Executive Committee

FRC Board

Financial ReportingReview Panel

Codes & StandardsCommittee

Accounting Council Actuarial Council

Audit & AssuranceCouncil Tribunal

Case ManagementCommittee

ConductCommittee

MonitoringCommittee

FRC Structure

5.1.1 FRC Board

The revised role of the FRC Board is as follows:

• To set high standards of corporate governance through the UK Corporate Governance Code• To set standards for corporate reporting and actuarial practice• To monitor and enforce accounting and auditing standards• To oversee regulatory activities of the actuarial profession and professional accountancy bodies• To operate independent disciplinary arrangements for public interest cases

The FRC Board is supported by three committees, the Codes and Standards Committee, the ExecutiveCommittee and the Conduct Committee.

Point to note:

The FRC is now responsible for Auditing Standards. Previously these were issued by APB.

5.1.2 Codes and Standards Committee

The Codes and Standards Committee is responsible for advising the FRC Board on maintaining aneffective framework of UK Codes and standards for Corporate Governance, Stewardship, Accounting,

Auditing and Assurance and Actuarial technical standards. The Codes and Standards Committee alsoadvises on influencing the wider regulatory framework and on the FRC's research programme. It advisesthe FRC Board on the Annual Plan for Codes and Standards work and for making appointments to, andoverseeing the work of, the Councils.

It comprises FRC Board members together with others with particular technical expertise, includingpractising professionals. The FRC Board and the Codes and Standards Committee are advised by three


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Councils covering Accounting, Audit and Assurance and Actuarial work (see Sections 5.1.5 and 5.1.6below).

5.1.3 Executive Committee

The basic purpose of the Executive Committee is to provide day to day oversight of the work of the FRC.In particular it:

• Recommends the strategic direction to the FRC Board

• Oversees the implementation of the FRC business plan

• Advises the FRC Board on the budget, business plan, Board agenda and management of theorganisation

• Advises the FRC Board and its Committees on requirements to establish new advisory groups todeal with specific issues

• Debates and resolves issues affecting the Codes and Standards and Conducts divisions

• Ensures consistency and connectivity between the various divisions and decides which part of theFRC should lead in cross-cutting issues

5.1.4 Conduct Committee

The Conduct Committee is responsible for overseeing the FRC's Conduct Division. Its responsibilitiesinclude overseeing:

• Monitoring of Recognised Supervisory and Recognised Qualifying Bodies• Audit Quality Reviews• Corporate reporting reviews• Professional discipline• Oversight of the regulation of accountants and actuaries

The Conduct Committee is supported by two sub-committees: the Monitoring Committee and the CaseManagement Committee (see Sections 5.1.7 and 5.1.8).

FRC's Conduct Division

The Conduct division encompasses the FRC's monitoring, oversight and disciplinary functions through anumber of teams. For example, the Audit Quality Review Team monitors the quality of the audits oflisted and other major public interest entities and the policies and procedures supporting audit quality atthe major audit firms.

5.1.5 Audit and Assurance Council

The Audit and Assurance Council is responsible for:

• Providing strategic input and thought leadership on audit and assurance matters

• Considering and advising the FRC Board on draft Codes and Standards (or amendments thereto)

• Considering and commenting on proposed developments in relation to international Codes andStandards and regulations

• Considering and advising on research proposals and other initiatives

No more than half of the members can be practising members of the auditing profession.

5.1.6 Accounting Council and Actuarial Council

The role of the Accounting Council and the Actuarial Council is essentially the same as that of the Auditand Assurance Council but in relation to accounting and financial reporting and actuarial mattersrespectively.


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5.1.7 Monitoring Committee

The Monitoring Committee helps ensure the consistency and quality of the FRC's monitoring work. Its functions include:

• Agreeing the assessment of the standard of audit work for individual audits reviewed

• Approving letters summarising the key findings from reviews of individual audit engagements

• Agreeing the contents of public reports on individual firms in relation to audit quality

• Determining conditions or sanctions for acceptance by auditors or audit firms (and referringmatters to an independent tribunal if not accepted)

• Requiring RSBs to implement conditions or sanctions accepted by an auditor or audit firm , ordetermined by a sanctions tribunal

• Appointing a Financial Reporting Review Group

• Referring matters to the Conduct Committee with a view to an investigation leading to a possibledisciplinary action

5.1.8 Case Management Committee

The Case Management Committee advises on the handling of disciplinary cases.

5.2 Interaction between FRC and IAASB StandardsThe system in the UK currently works as follows:

ISA

ISA asused byUK

Auditors

FRC (previously APB)Modifies

IAASBIssues

FRC(previously

APB) Adopts

5.3 International Auditing and Assurance Standards Board5.3.1 Pronouncements

IAASB was set up by the International Federation of Accountants (IFAC), which nominates a majority ofits members – others are nominated by the forum of firms – to issue professional standards. It issues the

following standards:• International Standards on Auditing (ISAs)

• International Standards on Assurance Engagements (ISAEs) (applicable to assuranceengagements which are not audits)

• International Standards on Related Services (ISRSs) (applicable to other, non-assuranceengagements)

• International Standards on Quality Control (ISQCs) (applicable to all engagements carried outunder any of the IAASB's standards)

• International Standards on Review Engagements (ISREs) (are to be applied in the review of

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It also issues the following practice statements:

• International Auditing Practice Notes (IAPN). This is a new category of pronouncement for use inissuing non-authoritative material. They provide practical assistance to the auditor and may helpthe auditor in:

– Obtaining an understanding of the circumstances of the entity, and in making judgementsabout the identification and assessment of risks of material misstatement;

– Making judgements about how to respond to assessed risks, including judgements aboutprocedures that may be appropriate in the circumstances; or

– Addressing reporting considerations, including forming an opinion on the financial statementsand communicating with those charged with governance.

To date one IAPN has been issued, IAPN 1000, Special Considerations in Auditing FinancialInstruments . This is covered in Chapter 12.

• International Review Engagement Practice Statements (IREPSs),International AssuranceEngagement Practice Statements (IAEPSs), and International Related Services PracticeStatements (IRSPSs) are issued to serve the same purpose for implementation of ISREs, ISAEs andISRSs respectively.

Point to note:

All International Auditing Practice Statements (IAPS) have now been withdrawn.

5.3.2 Authority of ISAs

ISAs are to be applied in the audit of historical financial information .

In exceptional circumstances , an auditor may judge it necessary to depart from an ISA in order tomore effectively achieve the objective of an audit. When such a situation arises, the auditor should beprepared to justify the departure.

5.3.3 Working procedures

The working procedures of the IAASB can be summarised as follows.

• Public Interest Activity Committee (PIAC) identifies potential new projects based on a review ofnational and international developments.

• A project task force is established to develop a new standard based on research and consultation.

• There is transparent debate as the proposed standard is presented at an IAASB meeting which isopen to the public.

• Exposure drafts are posted on the IAASB's website for public comment.

• Comments and suggestions are discussed at a further IAASB meeting, which is open to the publicand if substantive changes are made a revised exposure draft is issued.

• The final ISA is issued after approval by IFAC's Public Interest Oversight Board, which reviews

whether due process has been followed and clears the ISA for publication.

5.4 Clarity ProjectIn March 2009 the IAASB completed its Clarity Project, during which they reissued existing ISAs, withthe aim of making the requirements within them clearer.

Under this project, each ISA has:

• A stated overall objective• Clarified obligations, by use of the word 'shall' where a requirement of the ISA is set out• Less ambiguity• Improved readability

These standards are effective for audits of financial statements for periods beginning on or after 15December 2009.


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5.5 FRC5.5.1 FRC pronouncements

The following summary diagram is provided in the FRC Scope and Authority of FRC Audit and AssurancePronouncements .

Structure ofFRCAuditand Assurance Pronouncements

InternationalStandardsonQu

alityControl(UKandIreland)

The

Auditors'

Code

Ethical

Standardsfor

Auditors

International

Standards

onAuditing

(UKandIreland)

Ethical

Standards

For

Reporting

Accountants

Standards

for

Investment

Reporting

Statements

ofStandards

forReporting

Accountants

PracticeNotes

andBulletins

Bulletins

Bulletins

Audits

Investment

Circulars

Other

Assurance

Engagements

QualityC

ontrol

Standards

Frameworkof

Fundam

ental

Principles

Ethicaland

Engagement

Standards

Guidance


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5.5.2 Relationship between ISAs and UK standardsInternational Accounting Standards (IAS) have been adopted by all EU listed companies foraccounting periods commencing on or after 1 January 2005.

Since that time the EU has been working towards the adoption of ISAs for the audit of all EU financialstatements. In the UK the APB (now FRC) decided to replace all its own standards – Statements of

Auditing Standards (SASs) – with the equivalent ISAs for audits of financial statements coveringaccounting periods beginning on or after 15 December 2004.

The adoption of the ISAs at that time did not mean that the substance of UK auditing standards wasabandoned. In areas where SASs were more advanced than ISAs, or where there were additional UKlegal requirements, additions to the ISA text were made to add enhanced requirements,considerations or procedures. This was indicated in their title – 'International Standards on Auditing (UKand Ireland)'. This additional material was clearly differentiated from the international standards, andover time, the APB (now FRC) hoped to be able to withdraw such supplementary material as relevantISAs were revised by IAASB.

5.5.3 Harmonisation – Clarity standards for UK and Ireland

When the APB (now FRC) first issued the ISAs (UK and Ireland) in December 2004, these standards werebased on the IAASB ISAs in issue at that time. The APB Work Programme highlighted the need for the

APB to be at the forefront of international developments by contributing to IAASB work projects and, inparticular, the development of European-wide auditing standards following recent amendments to the8th EC Directive, resulting in EU statutory auditors being required to carry out audits in accordance withInternational Standards on Auditing.

It is expected that the EU will adopt the clarified standards as a requirement for all audits throughoutthe EU. During 2008, an APB consultation produced support for the APB view that the clarifiedstandards were more rigorous and clearer than the existing ISAs and that they should be implementedin the UK and Ireland as soon as possible, rather than waiting for the EU decision.

The APB contributed to the Clarity Project and many of its recommendations were accepted and, as aresult, the number of supplementary requirements needed for the ISAs (UK and Ireland) has beensignificantly reduced.

The Clarified ISAs (UK and Ireland) were issued as exposure drafts in April 2009 and the final versionswere issued in October 2009. These standards apply to audits of accounting periods ending on or after15 December 2010.

Point to note:

Unless indicated otherwise this manual refers to the clarified ISAs (UK and Ireland).

6 Quality control

Section overview• Quality control procedures should be adopted:

– At the firm level– On an individual audit

• Professional bodies also have a responsibility to develop quality control standards and monitorcompliance

6.1 Principles and purpose Audit quality is not defined in law or through regulations, nor do auditing standards provide a simpledefinition.


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Although each stakeholder in the audit will give a different meaning to audit quality, at its heart it isabout delivering an appropriate professional opinion supported by the necessary evidence and objectivejudgements.

Many principles contribute to audit quality including good leadership, experienced judgement,technical competence, ethical values and appropriate client relationships, proper working practices andeffective quality control and monitoring review processes.

The standards on audit quality provide guidance to firms on how to achieve these principles.

6.2 Quality control at a firm levelThe fact that auditors follow ISAs provides a general quality control framework within which auditsshould be conducted. There are also specific quality control standards. ISQC (UK and Ireland) 1: QualityControl for Firms that Perform Audits and Reviews of Financial Statements and other Assurance and RelatedServices Engagements deals with quality control at a firm level. You have studied ISQC 1 in Audit and

Assurance at the Professional level. A summary of the key points is provided below.

6.2.1 Objective of ISQC 1

The objective set by ISQC 1 is for the firm to establish a system of quality control designed to provideit with reasonable assurance that the firm and its personnel comply with professional standards andregulatory and legal requirements, and that reports issued by the firm or engagement partners areappropriate in the circumstances.

6.2.2 Elements of a system of Quality Control

ISQC 1 identifies the following six elements of the firm's system of quality control:

(1) Leadership responsibilities for quality within the firm

The standard requires that the firm implements policies such that the internal culture of the firm isone where quality is considered essential. Such a culture must be inspired by the leaders of the

firm, who must sell this culture in their actions and messages. In other words, the entire businessstrategy of the audit firm should be driven by the need for quality in its operations.

The firm's managing partners are required to assume ultimate responsibility for the firm's system ofquality control. They may appoint an individual or group of individuals to oversee quality in the

firm. Such individuals must have:

• Sufficient and appropriate experience and ability to carry out the job• The necessary authority to carry out the job

(2) Ethical requirements

Policies and procedures should be designed to provide the firm with reasonable assurance that the firm and its personnel comply with relevant ethical requirements and in particular independencerequirements.

The policies and procedures should be in line with the fundamental principles, which should bereinforced by:

• The leadership of the firm• Education and training• Monitoring• A process to deal with non-compliance

At least annually, the firm should obtain written confirmation of compliance with its policies andprocedures on independence from all firm personnel required to be independent by ethicalrequirements.

(3) Acceptance and continuance of client relationships and specific engagements

A firm should only accept, or continue with, a client where:

•

It has considered the integrity of the client and does not have information that the clientlacks integrity


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• It is competent to perform the engagement and has the capabilities, including time andresources, to do so

• It can comply with ethical requirements including appropriate independence from the client

(4) Human resources

The firm's overriding desire for quality will necessitate policies and procedures on ensuringexcellence in its staff , to provide the firm with 'reasonable assurance that it has sufficientpersonnel with the competence, capabilities and commitment to ethical principles necessary toperform engagements in accordance with professional standards and applicable and regulatoryrequirements, and to enable the firm or engagement partners to issue reports that are appropriatein the circumstances'.

These will cover the following issues:

• Recruitment • Performance evaluation

• Capabilities • Competence

• Career development • Promotion

• Compensation • The estimation of personnel needs

The firm is responsible for the ongoing excellence of its staff, through continuing professionaldevelopment, education, work experience and coaching by more experienced staff.

The assignment of engagement teams is an important matter in ensuring the quality of anindividual assignment.

This responsibility is given to the audit engagement partner. The firm should have policies andprocedures in place to ensure that:

• Key members of client staff and those charged with governance are aware of the identity ofthe audit engagement partner

• The engagement partner has appropriate capabilities , competence , authority to performthe role

• The responsibilities of the engagement partner are clearly defined and communicated to thatpartner

The engagement partner should ensure that he assigns staff of sufficient capabilities, competenceand time to individual assignments so that he will be able to issue an appropriate report.

(5) Engagement performance

The firm should take steps to ensure that engagements are performed correctly, that is, in accordancewith standards and guidance. Firms often produce a manual of standard engagement procedures togive to all staff so that they know the standards they are working towards. These may be electronic.

Ensuring good engagement performance involves a number of issues:

• Direction• Supervision• Review• Consultation• Resolution of disputes

Many of these issues will be discussed in the context of an individual audit assignment (see below).

The firm should have policies and procedures to determine when a quality control reviewer will benecessary for an engagement. This will include all audits of financial statements for listedcompanies. When required, such a review must be completed before the report is signed .

The firm must also have standards as to what constitutes a suitable quality control review.


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In particular the following issues must be addressed:

• Discussion of significant matters with the engagement partner• Review of the financial statements or other subject matter information of the proposed report• Review of selected engagement documentation relating to significant judgments the

engagement team made and the conclusions it reached; and• Evaluation of the conclusions reached in formulating the report and considering whether the

proposed report is appropriate.

For listed companies in particular the review should include:

• The engagement team's evaluation of the firm's independence in relation to the specificengagement

• Significant risks identified during the engagement and the responses to those risks• Judgements made, particularly with respect to materiality and significant risks• Whether appropriate consultation has taken place on matters involving differences of opinion

or other difficult or contentious matters, and the conclusions arising from those consultations• The significance and disposition of corrected and uncorrected misstatements identified during

the engagement

• The matters to be communicated to management and those charged with governance and,where applicable, other parties such as regulatory bodies

• Whether documentation selected for review reflects the work performed in relation to thesignificant judgements and supports the conclusions reached

(6) Monitoring

The standard states that firms must have policies in place to ensure that their quality controlprocedures are:

• Relevant• Adequate• Operating effectively

In other words, they must monitor their system of quality control . Monitoring activity should bereported on to the management of the firm on an annual basis.

There are two types of monitoring activity, an ongoing evaluation of the system of quality controland cyclical inspection of a selection of completed engagements. An ongoing evaluation mightinclude such questions as, 'has it kept up to date with regulatory requirements?'

An inspection cycle would usually fall over a period such as three years, in which time, at least oneengagement per engagement partner would be reviewed.

The people monitoring the system are required to evaluate the effect of any deficiencies found.These deficiencies might be one-offs. Monitors will be more concerned with systematic orrepetitive deficiencies that require corrective action. When evidence is gathered that aninappropriate report might have been issued, the audit firm may want to take legal advice .

Corrective action

• Remedial action with an individual• Communication of findings with the training department• Changes in the quality control policies and procedures• Disciplinary action, if necessary

Point to note:

All quality control policies and procedures should be documented and communicated to the firm'spersonnel.


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6.2.3 Practical application

The ICAEW Audit and Assurance Faculty publication Quality Control in the Audit Environment: A practicalguide for firms on implementing ISQC (UK and Ireland) 1 recommends that firms take the following keysteps to give them confidence that they are compliant with ISQC 1:

• Document the operation of the quality control system

• Lead from the top giving a consistent message on the importance of quality control

• Always act ethically in accordance with relevant Standards and pronouncements• Accept only those engagements where the firm is confident it can provide a service in compliance

with requirements with particular emphasis on integrity and competencies

• Recruit, develop and support capable and competent staff giving due attention to the firm's humanresources policies and procedures

• Deliver quality audits consulting when needed and meeting requirements for engagement qualitycontrol review

• Monitor and seek continuous improvement of the firm's system of quality control and carry out aperiodic objective inspection of a selection of completed audit engagements

6.3 Quality control on an individual audit You will have studied ISA (UK and Ireland) 220 Quality Control for an Audit of Financial Statements in theprevious Audit and Assurance paper. A summary of the key points is provided below.

6.3.1 Policies and procedures

ISA 220 states that the objective of the auditor is to implement quality control procedures at theindividual engagement level. The engagement partner is ultimately responsible for quality control onan individual engagement.

The policies and procedures for quality control on individual audits parallel those for the firm outlinedabove. For example ethical requirements must be considered. I