Notesale: Turn your study into money

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Week 1 - Introduction to Auditing
Chapter 1
What is an audit?
- shareholders own the business
- Managers (or directors) manage the business
- Shareholders need an independent expert to give an opinion on whether the accounts of their company - which the
managers prepare - show a ‘true and fair view’
...
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
...


Stewardship and Accountability
Directors act as agents for the shareholders
...
This can benefit them personally - bonuses, share options, etc
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The impact of the company’s operations on the community and the environment
The desirability of the company maintaining a reputation for high standards of business conduct
The need to act fairly as between members of the company

Reporting
Companies (miscellaneous reporting) regulations 2018 sets out the requirements for the Strategic Report required to be
included in the financial statements of listed companies
...
The revised UK Corporate Governance Code (the ‘2018’ code) also contains a similar
reporting requirement
...
They now have to consider a host of other factors
contained in section 172 and report on the usual comply or explain basis
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They are in a special position of trust charged with preserving the assets of the business and running it for the benefit of the
shareholders so that it increases shareholder value and pays them some dividend
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What does the auditor do?
The auditor’s job is to gather evidence to prove that:
● Profits and losses are properly stated
● Assets and liabilities belong to the company and are shown at their correct values
● Accounting entries are properly recorded in the correct accounting period
To do this they:
● Review the accounting records and controls
● Ask for explanations
● Obtain details from third parties
Other Benefits of the Financial Audit
During the course of their work auditors may be involved in:
● Discovering weaknesses in financial systems
● Checking compliance with laws and accounting standards
● Discovering frauds and errors
Advantages of an Audit

Disadvantages of an Audit

The provider of finance, e
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a bank usually requires
audited accounts
...


An audit is only for compliance and doesn’t assist
management in running the business - it is simply ‘red
tape’
...


The costs of the audit represent a non-productive expense
and the money could be better used elsewhere
...

Banks and other lenders, including suppliers, can make
their own conditions for lending and don’t really need
historical audited accounts
...

they may require regular monthly management info
- Suppliers will deal on a pro-forma basis (i
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cash
It provides reassurance for directors that the figures they
before supply) until a depth of trust has been
are using are reliable
...

can be up to 9 months old when they become
An audit is useful to company management
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Operational audit - check if management procedures are
followed
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This work may be done by an internal auditor who is most
likely a company employee
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Rights, Duties, and Responsibilities of Auditors
Rights
● Information and explanations
● Access to company records
● Receive notice of meetings, attend, and speak
● In case of removal
● Make representations to stay
● Attend meetings
Duties
Report to shareholders whether accounts show a true and fair view and comply with Companies Act and other relevant
legislation
...

I
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Further auditors should not seek to raise those expectations by any more
than the work they do justifies
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The Philosophy of Auditing - Mautz and Sharaf
Auditing is based on scientific logic where the auditing process is a rational process of examination, observation and
evaluation of evidence
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Does not consider risk or accountability between parties
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Philosophy and Principles of Auditing - Flint
Expanded on Mautz and Sharaf
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Audit Relevance
Regulators require an improved standard of information, in terms of accuracy and timeliness, in order to protect investors
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Increased corporate governance requirements have led to increased accountability and disclosure
...
The 2 approaches conflict, which has caused problems where the US
jurisdiction and compliance requirements clash with non-statutory approaches to audit regulation
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Audit and Globalisation
A strong auditing profession is important to global markets because:
● Reliable financial reporting promotes confidence and stability in the market
● Markets need the confidence and the assurance that a strong audit function can bring order to enable participants in
the market, including the entities themselves, investors and potential investors, to make informed decisions
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● Corporate failures, particularly those involving fraud by senior management reduces confidence and creates
instability
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● The concepts of agency require an auditing profession which is able to enforce standards of accountability on
company managers through the mechanism of the auditor’s report
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● Growth of online trading, which has challenged conventional audit approaches
● Audit firms are being increasingly required to carry out assurance type assignments for clients which require a
lower standard of evidence than does an audit
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● The development of auditing mega-firms who claim are the only firms which have the resources to audit modern
corporate behemoths (auditing is dominated by the big 4)

Chapter 3 - the statutory framework for auditing
The Statutory Audit - who is it for?
● Small Companies
○ private Ltd companies, which are not part of a larger group and are not banking/insurance companies
○ Their turnover must be £6
...
36m or less
○ Employ fewer than 50 people
Small companies who do not fulfil the £ requirements do not have to have a statutory audit
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● Small Groups - same limits apply to small groups except that reference can be made to net or gross amounts
○ Turnover £6
...
8m gross)
○ Balance sheet total £3
...
9m gross)
○ Number of employees should not be more than 50
Groups can’t be eligible for exemption if any member of the group falls within one of the criteria above
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26+ and an income of £250k+
● Dormant Companies: companies which have not carried out any transactions in the financial period
● Organisations which aren’t public, banking or insurance companies
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The Auditor’s Role
Auditors have to obtain sufficient reliable evidence to ensure financial statements comply with relevant laws and
regulations
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Auditors should conduct an audit with a degree of professional scepticism (ISA 250) recognising that the audit may reveal
non-compliance or areas where non-compliance could occur
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● People who have a connection with the company, or where the company has a connection with an associate of
theirs of any description
● People who are ineligible to act as auditors of a particular company are also ineligible to act as auditors of a parent,
subsidiary, or fellow subsidiary of that company
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○ Directors can recommend auditor to fill vacancies
○ Removal by shareholders vote at a company meeting
○ Resignation by written notice to company at any time, or by not seeking re-election at the next AGM
Auditor’s Responsibilities
● Audit the financial statements
● Review compliance with UK Corporate Governance Code
● Review other information in accounts - ISA 720 other information in documents containing audited financial
statements
Annual Report Responsibilities
As well as the audit of the numbers auditors have additional responsibilities for the Annual Report:
● Review narrative statements to ensure not misstated or misleading
● Listed companies - UK Corporate Governance Code provisions - including:
○ Board decision responsibilities
○ Audit committee requirements and membership
○ Review of internal controls by directors
● Report on truth and fairness of report on directors’ remuneration (including policy and remuneration package)
● Review directors’ assumption that the company is a going concern and report
● Review the strategic report
Reporting
● Note that the auditor's relationship is set out in a letter of engagement (ISA 210 Terms of Audit Engagement)
● For listed companies this includes the additional reviews
● Both the directors and auditors report on their respective responsibilities in accounts
● Note that the auditors can report by exception, i
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only report if something is not done
Non-Compliance
If the UK Corporate Governance Code is not complied with, the auditor adds an ‘other matter’ paragraph to their report
detailing the non-compliance:
The listing rules of the LSE require us to report any instances when the
company has not complied with certain of the disclosure requirements set out
in the rules
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Compliance and Internal Control
Remember, directors are responsible for the whole system of internal control, including any internal audit function
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○ Except for ordinary retail sales - i
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over the counter sales - statements of all goods purchased and sold,
showing buyers and sellers and identifying them with invoices
● Sales and purchases day books
● Where the company deals in goods then:
○ Statements of inventory held at each year
● Where the company carries out a rolling inventory or perpetual inventory count:
○ Statements of inventory counts from which the year end inventories figure is to be calculated
Statutory Books
A company should keep the following statutory books, in addition to the accounting records
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● Register of members
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● Public companies must keep a register of info received from any person to whom they have sent a notice requiring
them to disclose whether or not they have an interest in the company’s voting shares
Accounts to Be Prepared
● Statement of comprehensive income
● SFP as at the accounting reference date
● If the company is a holding company, then group accounts should be prepared
● Notes attached to and forming part of the accounts:
○ Director’s report
○ Director’s remuneration report
IAS 1 sets out similar detailed requirements and students should be aware of these
Other Accounting Requirements
● Every company must set an accounting reference date
● CA 2006 and IAS set out form and content of accounts - students should be familiar with these
● Exemptions are available for smaller entities
● There are time limits for preparing and submitting accounts to shareholders
● Accounts must be filled at companies house and are available for inspection by the public
Accounting Principles
1
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Consistency
3
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Accruals
True and Fair Override
In the event that compliance with the law meant that accounts did not show a true and fair view, section 396 has the
answer:
- the concept of a ‘true and fair view’ takes precedence over the strict legal requirements of the reporting rules
- This is closely tied to the doctrine of substance over form
- It has to be stressed that application of the true and fair override is quite rare, and only to be used in exceptional
circumstances
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It is not a licence
for non-compliance
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Reasonable assurance engagement
The practitioner:
● Gather sufficient appropriate evidence
● Does enough work to be able to draw reasonable, but not absolute conclusions
● Concludes that the subject matter conforms in all material respects with identified suitable criteria
● Gives a report in the form of a positive statement of opinion (in our opinion…
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g
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Limited assurance engagement
The practitioner:
● Gathers sufficient appropriate evidence to be satisfied that the subject matter is plausible in the circumstances
● Give a report in the form of a negative statement of opinion (nothing has come to our attention)
● The level of assurance given is moderate
● E
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review of financial statements (ISRE 2400), risk assessment reports, performance measurement reports,
reviews of internal controls, reports on socials and environmental issues
UK Regulation - FRC
● The FRC issues the UK version of ISAs
● It’s supported by a technical advisory group
● It’s responsible for discipline and auditing standards
● It issues a code of ethics which is similar to those of the RSBs

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● It will investigate audit matters including the causes of major corporate failures and will report on the conduct of
those audits
● It issues reports on audit quality with recommendations for improvement

IAASB
Auditing standards issued by the APB are derived from international standards developed by the IAASB - part of the
international federation of accounts (IFAC)
The IAASB issues 2 main types of pronouncements:
● International standards on auditing (ISA) - to be implemented in each country according to local conditions
● Practice Statements - to provide practical assistance in implementing the board’s standards and to promote good
practice
Work of the IAASB
● Establishing auditing standards and guidance for financial statement audits of a high quality
● Establishing high-quality standards and guidance for other types of assurance services on both financial and
non-financial matters
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● Establishing quality control standards covering the scope of services addressed by the board
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International Standards on Auditing
● Each country tailors ISAs to their local conditions - in the UK they are issued by the FRC
● Auditors are bound by ISAs
● Must be able to justify any departure in exceptional circumstances
Other Publications
● The FRC also issues practice notes and bulletins on specific topics
● Practice notes generally relate to specific audits of more specialised bodies such as banks or insurance companies
● Bulletins give advice on specific audit issues
Accounting Standards
● Financial statements must comply with a relevant accounting framework such as IAS2 or IFRS
● Auditors need to be familiar with these to validate compliance
● Most audit firms use a checklist approach to ensure compliance

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