pens Audit & Assurance For ICAB Application Level aa Syed M Hog ACCAAudit & Assurance Contents Chapter 1: Reintroduction to Audit and Assurance. x Chapter 2: Respo i cata i CRON cor NniadiderrearTnennsaiaueaniade Chapter 3; Professional Standards. AS Chapter 4: Professional Ethics.. if Chie ii ite th tie etree ieee Chapter 6: Accepting Engagements. 33 wns Chapter 7; Planning... Chapter 8: Understanding the Entity and its Environment.. Chapter % Risk Assessment.. Ghapter 10: Ainalie A ppRO Rl opyencpecornymeremienanmnenneresnynnynrmineyseniemanymnmsrnerenmeraonrenarimnneymn SSB Chapter 11: Audits of Different Types of Entity 68 Chapter 12: Audit Completion . si Chapter 13: Reporting... Key Facts... 109 Syed M Hog, ACCA ([email protected]) Page 1Audit & Assurance Chapter 1: Reintroduction to Audit and Assurance Chapter Summary 1.1 Assurance Engagement: An assurance engagement is one in which a practitioner expresses a conclusion designed to enhance the degree of confidence of the intended users other than the responsible party about the outcome of the evaluation or measurement of a subject matter against criteria, Elements of assurance engagemen ‘The elements can be remembered using the mnemonic CREST: * Criteria Report x Evidence Suitable Criteria ¥ Three Party Relationships 1.2. Levels of Assurance: There are two types of assurance engagement on the basis of level of assurance that can be given: x Reasonable assurance engagement: a high but not absolute level of assurance, sufficient & appropriate evidence, positive conclusion given x Limited assurance engagement: sufficient & appropriate evidence at lower level, negative conclusion given 1.3 Benefit of Assurance: ‘The benefits are x Independent professional verification is being given Itenhances the credibility of the information An assurance service may act as a deterrent to fraud and error In increases investor’s, creditors’ confidence in the business 14 Audit Defined: The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements is prepared, in all material respects, in accordance with an applicable financial reporting framework The auditor will normally express his audit opinion by reference to the “true and fair view’ which is an expression of reasonable assurance. True: Information is factual and conforms with reality, not false. In addition the information conforms with required standards and law. The accounts have been correctly extracted from the books and records Fair: Information is free from discrimination and bias and incompliance with expected standards and rules. The accounts should reflect the commercial substance of the company’s underlying transactions, 15 Limitation of assurance (reasons for not providing absolute assurance): The limitations of assurance service include: X The fact that testing is used — the auditors do not oversee the process of building the financial statements from start to finish X The fact that the accounting systems on which assurance providers may place a degree of reliance also have inherent limitations Syed M Hog, ACCA ([email protected]) Page 2Audit & Assurance The fact that most audit evidence is pervasive rather conclusive The fact that assurance providers would not test every item in the subject matter 3 The fact that client’s staff member may collude in fraud that can then be deliberately the auditor or misrepresent matters to them for the same purpose The fact that assurance provision can be subjective and professional judgments have to be made K The fact that assurance providers rely on the responsible party and its staff to provide correct information, which in some cases may be impossible to verify by other means The fact that some items in the subject matter may be estimates and are therefore uncertain Question Bank Q.1 How do you differentiate Audit and Assurance Engagement? Explain the implications of laws, standards and other requirements relating to assurance work, [Dec’13, June’12, Dec’ 11, Dec’ 10] Assurance engagement is a broad concept and audit engagement is a part of it, Professional accountants provide statutory audit, management advisory services, tax and other services to their clients based on the nature of engagements. All these services termed as assurance engagement. In AGM professional accountants have been appointed by shareholders to form an independent opinion on the truth and fairness of the financial statements that engagement is termed as audit engagement. So, it is clear that audit engagement is a part of assurance engagement. The auditor is required by BSA 250 to obtain evidence about compliance with laws and regulations. It states that the auditor should Make enquiries of management Inspect correspondence with relevant licensing or regulatory bodies Ask those charged with governance if they are on notice of any non-compliance. The auditor should obtain written representations that management has disclosed all known instances of actual and possible non-compliance with laws and regulations. Q2 Why the level of assurance provided by a report on profit and cash flow forecasts differs from the level of assurance provided by an audit report on financial statement? [Dec”13] ‘The reasons for which the level of assurance provided by a report on profit and cash flow forecasts differs from the level of assurance provided by an audit report on financial statements are as follows: s& Anaudit conducted in accordance with auditing standards provides a high level of assurance which is reasonable but not absolute. The delay between the balance sheet date and the date of the audit report means that even items such as provisions/estimates can often be substantiated. se A review of forecasts is only likely to provide a moderate level of assurance. This is because the financial statements are based on historical information, and forecasts are based on assumptions which are subject to uncertainty. Q.3 What are the elements of an assurance engagement and what benefits can be derived from an assurance service? [June’12] ‘The elements can be remembered using the mnemonic CREST: Criteria Report Evidence X Suitable Criteria Three Party Relationships sssional verification is being given X Ttenhances the credibility of the information Am assurance service may act as a deterrent to fraud and error Syed M Hog, ACCA ([email protected]) Page 3Audit & Assurance X In increases investor’s, creditors’ confidence in the business Q4 Generally a firm is engaged for an audit but may also be engaged by management to provide additional non-statutory and non-assurance services. Write down at least four non-assurance jobs, outside audit and assurance, generally performed by our firms in Bangladesh. [June 12] ‘The following services may be performed: © Internal audit © Due diligence © Business valuation © Tax services Q.5 Mr. Ibrahim, the managing director of your client Bashundhara Lid., a real estate development company, has written to you saying that during the last 5 years there has been a sharp growth in the company’s operating activities. He has been considering setting up of an internal audit department to ‘overview the operational activities with greater focus on internal control. But he heard from his brother, who is also a director of the company, that the company would be better off abandoning this idea and getting the extemal auditor to do some assurance work instead. Advise Mr. Ibrahim explaining the objectives, characteristics and responsibilities of internal audit, external audit and assurance. /June’I2] Internal audit It is an appraisal or monitoring activity established within an entity as a service to the entity. Its functions include, amongst other things, examining, evaluating, and reporting to management and the directors in the adequacy of components of the accounting and internal control systems. Objectives: The objectives of internal audit are to: * Minimize the company’s business risk; sure the continuing functioning of the company; and Ensure compliance with relevant laws and regulations. Characteristics: © Itis an appraisal or monitoring activity It focused on the operations of the entire business Ivis designed to add value and improve and organization's operations Internal audit reports to the Board or the audit committee Internal auditors are very often employees of the organization, though sometimes, it may be outsourced Responsibili Internal audit activities usually involve: Monitoring internal controls Examining financial and operating information Review of the economy. Efficiency and effectiveness of operations Review of compliance of laws, regulations and other external requirements Special investigations, for instance, into suspected fraud ee ‘The intemal audit department has a two-fold role in relation to risk management %* Monitoring the company’s overall risk management policy to ensure it operates effectively % Monitoring the strategies implemented to ensure that they continue to operate effectively Syed M Hog, ACCA ([email protected]) Page 4Audit & Assurance External Audit — Objectives: ‘The objective of an audit of financial statements is to enable the auditor to express an opinion whether the financial statements is prepared, in all material respects, in accordance with an applicable financial reporting framework ties: * Itis focused on the financial statements * They report to the shareholders of a company on the truth and faimess of the financial statements © Their works relate to the financial statements. They are concerned with the financial records that underlie these © They are independent of the company and its management, They are appointed by the shareholders. Responsibili It is the responsibility of an extemal auditor to provide an opinion whether the provide true and fair view: * in the case of the balance sheet, of the state of the company’s affairs as at the end of its financial year; © inthe incial statements of the profit and loss account, of the profit or loss for its financial yea Its also the responsibilities of the external auditor to state whether: (a) They have obiained all the information and explanations which to the best of our knowledge and belief were necessary for the purposes of our audit and made due verification thereof. (b) In their opinion, proper books of account as required by law have been kept by the company so far as it appeared from our examination of those books and (where applicable) proper returns adequate for the purposes of our audit have been received from branches not visited by us, (©) The company’s balance sheet and profit and loss account dealt with by the report are in agreement with the books of account and returns. (d) The expenditure incurred was for the purposes of the company’s business. As per BSEC guidelines on corporate governance published on 07 August 2012, every listed company must have a head of internal audit for conducting internal audit services and accordingly report to the audit committee of the Board. So, if the company is a listed one, then they may need to set a separate internal audit department. Q6 Jot down four benefits those could be achieved through financial statements being audited. [Dec*11] ‘on is being given ty of the information service may act as a deterrent to fraud and error In increases investor's, creditors’ confidence in the business Q.7 What are the limitations, if any, of a financial statement audit The limitations of financial statements audit include: X The fact that testing is used ~ the auditors do not oversee the process of building the financial statements from start to finish X The fact that the accounting systems on which assurance providers may place a degree of reliance also have inherent limitations ‘The fact that most audit evidence is pervasive rather conclusive ‘The fact that assurance providers would not test every item in the subject matter The fact that client’s staff member may collude in fraud that can then be deliberately hidden from the auditor or misrepresent matters to them for the same purpose [Dec'10 nO Syed M Hog, ACCA ([email protected]) Page 5Audit & Assurance Chapter 2: Responsibilities Chapter Summary 2.1 Management’s Responsibilities: Management is responsible for: Managing the business so as to achieve company objectives Assessing business risks to those objectives being achieved Safeguarding the company’s assets ~ Keeping proper accounting records Preparing company financial statements and delivering them to the Registrar — Ensuring the company complies with applicable laws and regulations Itis not the responsibility of the auditors of a company to do any of the above. 2.2. Director’s Responsibilities Under the Companies Act 1994 The directors’ statutory duties primarily come from the responsibilities laid out in the Companies Act. It is important that the directors of a company fully understand these, as in some cases there are criminal consequences for failing to carry them out correctly. The main responsibilities of the Directors are summed up below: “Safeguarding assets: Itis the directors who have the legal responsibility for safeguarding the assets of the company. It is therefore for them to take reasonable steps for the prevention and detection of fraud and other irregularities. To carry out this responsibility they need to implement systems and controls to safeguard the company’s assets and they then need to ensure that the systems and controls operate effectively. Such procedures may include: Y The safekeeping of documents of title to land and buildings and other assets, Y The setting of authority limits, ie. the limitation of what any one individual ean do without consulting someone else. Implementing other procedures to prevent fraud and reduce the likelihood of error. ct Books and records of the company It is also the directors who are legally responsible for keeping proper accounting records which disclose with reasonable accuracy at any time the financial position of the company. This requires records of: ¥ All cash payments and receipts ¥ All sales and purchases of goods by the company Y The assets (including non-current assets and inventory) and liabilities of the company ¥ In case of a company engaged in production, distribution, marketing, transportation, processing, manufacturing, milling, extraction, and mining activities, such particulars relating (o utilization of material, labour and other items of overhead cost. +t Preparation and delivery of company financial statements: Company law also places on the directors the obligation to prepare financial statements for each financial period (usually a year). These statements must give a true and fair view of the affairs of the company at the end of the accounting period and of the profit or loss of the company for that period. In preparing those financial statements, the directors are required to: ¥ Select suitable accounting policies and then apply them consistently Y Make judgements and estimates that are reasonable and prudent ¥ Comply with applicable accounting standards Y Prepare the financial statements on the going concem basis unless it is inappropriate to presume that the company will continue in business. Syed M Hog, ACCA ([email protected]) Page 6Audit & Assurance 2.3 Assurance Providers’ Responsibilities: The responsibility of the extemal provider of assurance services is determined by: X The requirements of any legislation or regulation under which the engagement is conducted, and/or X The terms of engagement for the assignment, which will specify the services to be provided Ethical and professional standards * Quality control standards The legal requirements are currently contained in the Companies Act 1994. In the case of an audit of financial statements under the Companies Act 1994, it is the external auditor's responsibility to: X= Form an independent opinion on the truth and fairness of the accounts X Confirm that the financial statements comply with applicable sections of the Companies Act 1994 To achieve these objectives the auditor has to ensure that: X The audit is planned properly Sufficient appropriate audit evidence is gathered The evidence is properly reviewed and valid conclusions drawn, 2.4 Internal Controls: Internal Control is a process designed and effected by those charged with governance, management, and other personnel to provide reasonable assurance about the achievement of the entity's objectives with regard to reliability of financial reporting, effectiveness and efficiency of operations and compliance with applicable laws and regulations. It follows that internal control is designed and implemented to address identified business risks that threaten the achievement of any of these objectives. Internal controls are designed in part to prevent errors occurring in financial information, or to detect errors and correct them. Reporting on Internal Control Weaknesses: BSA 260 Communication of Audit Matters with Those Charged with Governance sets out that auditors should ‘consider audit matters of governance interest that arise from the audit of the financial statements and communicate them with those charged with govemance’ The BSA specifies that material weaknesses in internal control would constitute such a matter. A material weakness in internal control is a ‘deficiency in the design or operation’ which could adversely affect the entity's ability to record, process, summarise and report financial and other relevant data, and could result in a material misstatement in the financial statements. Y Auditors are responsible for detecting material errors in the financial statements, which they may do by carrying out tests of control or tests of details. Management are responsible for internal control systems capable of preventing or detecting error. Y Auditors are responsible for assessing whether that system is capable of preventing or detecting error ¥ If the material weaknesses are found, auditors are responsible for reporting these to management and Carrying out additional tests of details to uncover any potential errors as a result of the weakness 2.5 Fraud (BSA 240): For audit purposes, BSA 240, The Auditor's Responsibility to Consider Fraud in an Audit of Financial Statements, identifies two types of risk of misstatement which ean arise from fraud: ¥ Misstatements arising from fraudulent financial reporting ig from misappropriation of assets Syed M Hog, ACCA ([email protected]) Page 7Audit & Assurance Responsibilities of Management regarding fraud: The BSA 240 states that the primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and with management. To fulfil this responsibility, s actions can be taken including: ¥ Demonstrating that management follow a culture of honesty and ethical behaviour and communicating that they expect all employees to adhere to this culture Establishing a sound system of internal control From the point of view of those charged with governance, ensuring that management implement policies and procedures to ensure, as far as possible, the orderly and efficient conduct of the company’s business. Responsibilities of Auditor regarding fraud: The BSA states that the auditor must obtain reasonable assurance that the financial statements, taken as a whole, are free from material misstatement, whether caused by fraud or error. The auditor does not therefore offer complete assurance that the financial statements are free from fraud and/or error as audit testing is not designed to provide this a Where Fraud is Suspect: If the auditors identify misstatements which might indicate that fraud has taken place, they should consider the implications of this for other aspects of the audit, particularly management representations which may not be trustworthy if fraud is indicated. This may lead to a limitation in the scope of the audit vario <4 surance, Management Representation: Auditors are required to obtain particular written representations from management that management acknowledges its responsibility to design and implement internal controls to prevent and detect fraud and that management has disclosed any known or suspected frauds by management, employees with a significant role in internal control, or any other frauds which might have a material impact on the financial statements to the auditor. In addition, management confirm in writing that it has disclosed the results of its own assessment of whether the financial statements may be materially affected by fraud. Reporting Fraud or Suspected Frauds: The BSA requires that the auditors should discuss suspected or actual fraud with the directors and make the appropriate reports, as set out below: Management If they actually discover fraud FI they suspect fraud © they discover substantial error If they think the suspected fraud casts doubt on the integrity of the directors @_Onlyif fraud or error causes the financial statements to not give a true and fair view or there is a fundamental uncertainty —in which case it should be included in the audit report in the usual way Third Parties If itis in the public interest to report a fraud to the proper authorities and the directors refuse to do so Shareholders 2.6 Compliance with Laws and Regulations (BSA 250): Auditors are interested in two categories of law and regulations: X Those with a direct impact on the financial statements, for example, the Companies Act, 1994 X Those which provide a legal framework within which the company operates Syed M Hog, ACCA ([email protected]) Page 8Audit & Assurance The auditor is required by BSA 250 Consideration of Laws and Regulations in an Audit of Financial Statements to obtain evidence about compliance with laws and regulations. It states that the auditors should: 3 Make inquiries of management Inspect correspondence with relevant licensing or regulatory bodies Ask those charged with governance if they are on notice of any non-compliance, Non-Compliance Suspected: When the auditors suspect non-compliance, they should document findings and discuss them with management. If the auditors cannot obtain sufficient appropriate evidence about the suspected noncompliance, this might represent a limitation on the scope of the audit, which will result in the auditors not being able to give an unqualified opinion. The appendix to BSA 250 gives the following list of indicators of non-compliance: ¥" Investigation by a government department ¥ Payment of fines or penalties ¥ Payments for unspecified services or loans to consultants, related parties, employees or v government employees Sales c sions or agents’ fees that appear excessive in relation to those normally paid by the entity or in its industry or to the services actually received Purchasing at prices significantly above or below market price Unusual payments in cash, purchases in the form of cashiers’ cheques payable to bearer or transfers to numbered bank accounts Complex corporate structures including offshore companies where ownership cannot be identified Unusual transactions with companies registered in tax havens Tax evasion such as the wider declaring of income and over claiming of expenses Payments for goods or services made other than to the country from which the goods or services originated Payments without proper exchange control documentation Existence of an accounting system that fails, whether by design or by accident, to provide adequate audit trail or sufficient evidence Unauthorised transactions or improperly recorded transactions Media comment ‘Transactions undertaken by the entity that have no apparent purpose or that make no obvious economic sense Where those charged with governance of the entity refuse to provide necessary information and explanation to support transactions and other dealings of the company SS KS SKK SAN Reporting of Non-Compliance: The BSA requires that the auditors should communicate discovered instances of non-compliance with laws and regulations to those charged with governance (the directors) without delay, and make appropriate reports, as set out below: Management If the auditors suspect non-compliance with laws and regulations If the suspected non-compliance causes them not to have confidence in the integrity of the directors Shareholders @Z Only if non-compliance causes the financial statements to not give a true and fair view or there is a fundamental uncertainty —in which case it should be included in the audit report in the usual way If there is a statutory duty to report without undue delay If it is in the public interest to report the non-compliance to the proper authorities and the directors refuse to do so ‘Third Parties ga Syed M Hog, ACCA ([email protected]) PageAudit & Assurance 2.7. Related Parties (BSA 550): Transactions with related parties may be carried out on terms which may not be the same as in an arms length transaction with an independent third party. The approach adopted in financial reporting standards is to disclose the relevant amounts and relationships so that the reader of the financial statements can decide for themselves whether such transactions have led to a manipulation of the ancial statements. Related parties are those people or companies that might have, or be expected to have, an undue influence on the company being audited. So as examples (but the full list is much longer), the directors and key management of a company, together with their families, are regarded as related parties of that company, as are other companies controlled by them, other companies in the same group, and so on, BSA 550 Related Panies details the audit work required in respect of related party transactions. The work can be split into the three main stages of the audit: ¥ Planning ¥ Detailed work v Review ‘The Planning Stage: The auditor needs to consider the risk of there being undisclosed material related party transactions. This is an extremely difficult area, because the materiality rule for related party transactions is not just the normal one. The normal rule judges materiality by reference to the company being audited, whereas material related party transactions are judged both by that and by reference to the individual related party. ‘The detailed testing stage: BSA 550 sets out specific procedures that should be carried out: X Detailed tests of transactions and balances (such as would ordinarily be carried out on audits) X Reviewing minutes of meetings of shareholders and directors to observe if any related parties or transactions with them become apparent X Reviewing records for large or unusual tansactions or balances, particularly those recognised near the end of the reporting period x Reviewing confirmation of loans receivable and payable and confirmations from banks (which might indicate guarantor relationships) * Reviewing investment transactions, for example, when the company has invested in another company Audit evidence in relation to related parties and transactions with them may be limited and restricted to representations from management. Due to this, the auditor should try carry out procedures such as. = Di if the purpose of the transactions with managemenvdirectors Confirming the terms and amount of the transaction with the related party Inspecting information in the possession of the related party Corroborating the explanation of the transactions with the related party Obtaining information from an unrelated third party if possible Confirming information with persons associated with the transaction, such as banks, solicitors, guarantors and agents RAR Where related party transactions are found the auditor checks that the appropriate disclosures are made in the accounts. Remember that all transactions with related parties need to be disclosed, even if they are at a normal market rate. However, any disclosures should include information that is needed for a proper understanding of the transaction and this would, of course, include whether the trans or was not at a market rate. on was Syed M Hog, ACCA ([email protected]) Page 10Audit & Assurance 2.8 Money Laundering: Money laundering is defined as a wide range of activities in relation to criminal property, including -quiring, concealing and removing from the country, using, The purpose of money laundering is to: X Disguise the origins of funds derived from illicit sources, and Enable illicit funds to be used by those who control them, If an auditor finds any transaction of source of fund, income and expenses which is not properly substantiated, the auditor should report the item into the audit report and if necessary, into the letter of weaknesses to management. According to BSA 310, para 2, the auditor should obtain a knowledge of the business sufficient to enable the auditor to identify and understand the events, transactions and practices that, in auditor's judgement, may have a significant effect on the financial statements or on the examination or audit report, One of the key principles stressed by the authorities dealing with Money Laundering in Bangladesh and worldwide is KYC - know your client, ¥ The firm will need to have checked the client's identity, when they first became a client and will need to keep the evidence on file for a sufficient period afier they cease to be a client ¥ Where does the money come from? Auditors should think about the real nature of the business's sales, but also about the source of the start-up capital and any other equity and loans raised ¥ Remember the money launderer wants to overstate income and loves paying tax on the excess, which goes against the grain of the way most auditors think. 2.9 Expectations Gap: It means that there is a gap between what the assurance provider understands he is doing and what the user of the information believes he is doing. It may be defined as the difference between the apparent public perceptions of the responsibilities of auditors on the one hand and the legal and professional reality on the other. The following specific points can be highlighte: Y Misunderstanding of the nature of audited financial statements Y Misunderstanding as to the type and extent of work undertaken by auditors Y Misunderstanding about the level of assurance provided by auditors Assurance provider needs to close this gap in order to maintain the value of the assurance provided for the user. This can be done by M By issuing an engagement letter spelling out the work that will be carried out and the limitations of that work H Regularly reviewing the format and content of reports issued as a result of assurance work. Question Bank Q.8 What is money laundering? What is your responsibilities and duty to report, as auditor when you suspect or find any issue of money laundering? [Dec’13, Dec’11] Money laundering is the process of making dirty money clean. Money laundering is defined asa wide range of activities in relation to criminal property, including using, acquiring, concealing and removing from the country. ‘The purpose of money laundering is to: Disguise the origins of funds derived from illicit sources, and Enable illicit funds to be used by those who control them, Syed M Hog, ACCA ([email protected]) Page 11Audit & Assurance If an auditor finds any transaction of source of fund, income and expenses which is not properly substantiated, the auditor should report the item into the audit report and if necessary, into the letter of weaknesses to management The auditor should obtain a knowledge of the business sufficient to enable the auditor to identify and understand the events, transactions and practices that, in auditor’s judgement, may have a significant effect on the financial statements or on the examination or audit report. One of the key principles stressed by the authorities dealing with Money Laundering in Bangladesh and worldwide is KYC know your client. ¥ The fim will need to have checked the client's identity, when they first became a client and will need to keep the evidence on file for a sufficient period after they cease to be a client ¥ Where does the money come from? Auditors should think about the real nature of the business's sales, but also about the source of the start-up capital and any other equity and loans raised ¥ Remember the money launderer wants to overstate income and loves paying tax on the excess, which goes against the grain of the way most auditors think. Duty to report: If an auditor finds any transaction of source of funds, income and expenses which is not properly substantiated, the auditor should report the item into the audit report and if necessary, into the letter of weakness to management. Moreover, in accordance with Money Laundering Act 2012, as a reporting agency, professional accountants shall have to report/inform to Bangladesh Bank immediately if they find any indication of money laundering during their audit in a client, Q.9 You are the Team Leader of the Audit Team of Butterfly Pvt.) Limited. When performing audit procedures you found that there are several unidentified balances in the bank reconciliations provided by the Accountant. You also found that the debtors schedule has not been agreed to the ledger and the client has not reconciled these amounts as of the year end. The debtor confirmations received during the year did not agree with the ledger balances, and the Accountant claims it is the debtors’ records that are in error. The audit partner is being pressurized by Finance Manager to finalize the audit procedures within a very short period compared to last year, due to the budgeting process that is scheduled to commence in a couple of weeks. Required [Dec*13]: i) Identify the factors that indicate possible frauds in the above scenario ii) The audit manager has identified debtors as an area prone to fraud in the entity, List the procedures you may perform to address the fraud risk relating to debtors. “An audit may act as a deterrent to fraud but does not certify that one has not occurred”. Explai i) When performing audit procedures the team leader of the audit team of Butterfly (Pvt.) Limited found the following indication of possible frauds: The accountant provided bank reconciliation statement with several unidentified balances. That means, there may be some debit balances existed in the Bank Book (ledger maintained by the company) but no corresponding credit balances in the Bank Statement. It can be happened due to not depositing the cheques (e.g. cash cheque) in the Company’s Bank Account. If this is the case, cheques might be deposited to personal bank account of designated employees or en-cashed directly which indicates possible frauds. © The debtors schedule has not been agreed to the ledger balance and no reconciliation has been made in this regard, Moreover, the debtors’ confirmation received by auditors did not agree with ledger balances. It indicates that manipulation made by management to record debtors in the ledger which indicates possible frauds. Syed M Hog, ACCA ([email protected]) Page 12Audit & Assurance * Toconceal the identified frauds or diverting the attention of auditors to other areas, Finance Manager is insisting on the audit partner to finalize the audit job within a very short period ‘compared to last year. He is mentioning the commencement of budgeting process in a couple of weeks. Starting of budgeting process might not be the acceptable reason to pressurize auditors to complete their job and management is not in a position to do so. ii) The following audit procedures may be performed to address the fraud risk relating to debtors: © Cross-check debtors lisschedule with the debtor ledger and identify the discrepancies/mismatches * Send confirmation letter to debtors specially those debtors whose balances do not match, with the ledger balance * After agreeing confirmation, check which balance the debtors confirmed and check the same with debtors list and ledger balance. © Cross check with sales ledger and sales invoie balances do not match with the ledger balances. © Examine the delivery challan to confirm the quantity delivered to debtors and cross check the same with sales invoices * Examine the cash/hank book whether any posting is pending wh in the debtors’ list/schedule. s regarding the debtors’ balances whos His required to update Based on the evidence gathered from the above procedures the auditors shall have to draw their opinion, If they have found frauds with adequate supporting documents, they have to modily audit report based on the materiality and pervasiveness of the identified fraud cases. iii) The objective of an audit of financial statements is to enable the auditor to express an opinion whether the Financial Statements are prepared, in all material respects, in accordance with an identified financial reporting framework. An audit conducted in accordance with BSAs is designed to provide reasonable assurance that the financial statements taken as a whole are free from material misstatements, whether caused by fraud or error. The fact that an audit is carried out may act as a deterrent, but the auditor is not and cannot be held responsible for the prevention of fraud and error. An audit does not guarantee all material misstatements will be detected because of such factors as the use of judgement, the use of testing, the inherent limitations of internal control and the fact that much of the evidence available to the auditor is persuasive rather than conclusive in nature. The risk of not detecting a material misstatement resulting from fraud is higher than the risk of not detecting a material misstatement resulting from error because fraud may involve cophisticated and carefully organized schemes designed to conceal it, such as forgery, deliberate failure to record transactions, or intentional misrepresentations being made to the auditor. Such attempts of concealment may even be more difficult to detect when accompanied by collusion. Q.10 You are the audit senior on the external audit of Dug Ltd. (Dug) for the year ended 31 January 2012. In January 2012 Dug sold some office equipment to the wife of Dug’s Managing Director. The audit junior has noted that the sale has not been disclosed in the note to the financial statements detailing related party transactions and has suggested the inclusion of an emphasis of matter paragraph in the audit report to highlight this issue. Comment on the suitability or otherwise of the audit junior’s suggestion. [Dec?12] Failure to disclose a material related party transaction results in a disagreement over the preparation of the financial statements. Therefore, the audit opinion should be modified with a qualified (except Syed M Hog, ACCA ([email protected]) Page 13,