Learning Objectives

Phase II
Planning the Audit
Objective: Determine the amount and type of evidence and review required to give the auditor assurance that there is no material missatement of the financial statements.

Procedures:

1. 
   Obtain industry, company, legal, related party and financial background information.
   
2. 
   Perform procedures to obtain an understanding of internal control.
   
3. 
   Assess the risks of material misstatements of the financial statements.
   
4. 
   Determine materiality.
   
5. 
   Prepare the planning memorandum and audit program (audit plan), which contains the auditor’s response to the identified risk.
   

Phase III
Testing and Evidence
Objective: Test for evidence supporting internal controls and the fairness of the financial statements.

Procedures:

1. 
   Tests of controls.
   
2. 
   Substantive tests of transactions.
   
3. 
   Analytical procedures.
   
4. 
   Tests of details of balances.
   
5. 
   Search for unrecorded liabilities.
   

Phase IV
Evaluation and Reporting Objective: Complete the audit procedures and issue an opinion.

Procedures:

1. 
   Evaluate governance evidence.
   
2. 
   Perform procedures to identify subsequent events.
   
3. 
   Review financial statement and other report material.
   
4. 
   Perform wrap–up procedures.
   
5. 
   Prepare Matters for Attention of Partners.
   
6. 
   Report to the board of directors.
   
7. 
   Prepare Audit report.
   

INTRODUCTION


Introduction

The audit is not over until the audit report is signed. And even then it may not be over if facts are discovered after the balance sheet date and before the next report. After the field- work is almost complete, a series of procedures are generally carried out to “complete the audit.” The intent of these procedures is to review the audit work, get certain assurances from the client, uncover any potential problems, check compliance with regulations, and check the consistency of the material that is to be presented to the users of financial statements.

In this text so far we have followed the standard audit process model (Illustration 11.1) through its phases – for client acceptance (Phase I), planning (Phase II), and elements of testing and evidence (Phase III). In this chapter, we will discuss the last phase, Phase IV, evaluation and reporting.
The procedures for completing this audit phase are: evaluate governance evidence; do procedures to identify subsequent events; review financial statements and other report material; do wrap-up procedures, prepare Matters for Attention of Partners; report to the board of directors and prepare audit report (which will be discussed in Chapter 12 Audit Reports and Communication). These procedures and the objective of the evaluation and reporting phase are shown in Illustration 11.2.


ILLUSTRATION 11.2


Objective: Complete the audit procedures and issue an opinion.

Procedures

1. 
   Evaluate governance evidence.
   
2. 
   Perform procedures to identify subsequent events.
   
3. 
   Review financial statements and other report material. 4 Perform wrap-up procedures.
   

5 Prepare Matters for Attention of Partners. 6 Report to the board of directors.
7 Prepare Audit report.
Audit Process Model – Phase IV Evaluation and Reporting

The initial audit procedure in the closing cycle is usually to evaluate governance evidence, the evidence pertaining to the company and management. This means obtaining a legal letter and a management representations letter. Next in the governance evaluation is to look at contingent liabilities and related parties.

Discovery of subsequent facts and events may be essential to a correct opinion. The auditor must consider events up to the date of the auditor’s report and between the balance sheet date and the issuance of the statements. Discovery of facts after the financial statements’ issuance are not generally as crucial.
Of course, the auditors must review financial statements and financial statement disclosures, but they must also review other information contained in the annual report.

Other information that needs looking into is the board of directors’ report, corporate governance disclosures (where applicable) and all other information in the annual report to shareholders.

The last work of the closing cycle is wrap-up procedures, matters for supervisors, report to the audit committee, and the audit report itself. Wrap-up procedures include:

• 
  analytical procedures,
  
• 
  review working papers,
  
• 
  evaluation of going concern,
  
• 
  client approval of adjusting entries.
  

Reporting and evaluation of matters for supervisory attention includes reports to managers and partners.

Prior to the final audit report the auditors will usually discuss their findings with the audit committee especially irregularities, illegal acts and reportable conditions. The final step in the closing cycle is the audit report, discussed in Chapter 12 Audit Reports and Communication.
Quality Control

According to International Standard on Quality Control 1 (ISQC 1), ¹ the audit firm should establish a system of quality control designed to provide it with reasonable assurance that the firm and its personnel comply with professional standards and regu- latory and legal requirements, and that reports issued by the firm or engagement partners are appropriate in the circumstances.

• 
  Elements of a System of Quality Control
  

The elements of quality control policies adopted by an audit firm normally incorporate policies related to general firm activities and personnel. General firm activities for which quality control policies and procedures are required include leadership responsibilities for quality within the firm, acceptance and retention of clients, engagement performance, and monitoring. Quality controls applied to human resources include ethical require- ments. The quality control policies and procedures should be documented and communicated to the firm’s personnel.

• 
  Quality Control Leadership
  

The firm should establish policies and procedures designed to promote an internal culture based on the recognition that quality is essential in performing engagements. Such policies and procedures should require the firm’s chief executive officer (or equiva- lent) or, if appropriate, the firm’s managing board of partners (or equivalent), to assume ultimate responsibility for the firm’s system of quality control. That person should have sufficient and appropriate experience and ability to assume the responsibility.

• 
  Ethical and Independence Requirements
  

The firm should establish policies and procedures designed to provide it with reasonable assurance that the firm and its personnel comply with relevant ethical requirements and maintain independence where required by the IFAC Code and national ethical require- ments. The firm should establish policies to insure that it is notified of breaches of independence requirements, and to enable it to take appropriate actions to resolve such situations. At least annually, the firm should obtain written confirmation of compliance with its policies and procedures on independence from all applicable firm personnel.
The audit firm should establish policies and procedures: ²

• 
  setting out criteria for determining the need for safeguards to reduce the familiarity threat to an acceptable level when using the same senior personnel on an assurance engagement over a long period of time;
  
• 
  for all audits of financial statements of listed entities, requiring the rotation of the engagement partner after a specified period in compliance with the IFAC Code and national ethical requirements that are more restrictive.
  

• 
  Acceptance and Continuance of Client Relationships and Specific Engagements
  

The firm should establish policies and procedures for the acceptance and continuance of client relationships and specific engagements, designed to provide it with reasonable assurance that it:

• 
  has considered the integrity of the client and does not have information that would lead it to conclude that the client lacks integrity;
  
• 
  is competent to perform the engagement and has the capabilities, time and resources to do so;
  
• 
  can comply with ethical requirements.
  

When deciding to continue an existing engagement or accept a new engagement with an existing client, and where difficult issues have been identified, the firm should document how the issues were resolved. Where the firm obtains information that would have caused it to decline an engagement if that information had been available earlier, the firm should consider the professional and legal responsibilities that apply to the circumstances and the possibility of withdrawing from the engagement or from both the engagement and the client relationship.
An evaluation of prospective clients and a review, on an ongoing basis, of existing clients should be conducted. The continued adequacy and operational effectiveness of

quality control policies and procedures require monitoring. The firm’s general quality control policies and procedures should of course be communicated to its personnel.

• 
  Engagement Quality Control Review
  

The audit firm should establish policies and procedures for an engagement quality control review that provides an objective evaluation of the significant judgments made by the engagement team. ³ Firms should require an engagement quality control review for all audits of financial statements of listed entities. They should set policies for assurance and related services engagements, and all other audits and reviews of historical financial information.
The work performed by each person in the audit team may be reviewed by personnel of at least equal competence to consider whether:

• 
  The work has been performed in accordance with the audit program.
  
• 
  The work performed and the results obtained have been adequately documented.
  
• 
  All significant audit matters have been resolved or are reflected in audit conclusions.
  
• 
  The objectives of the audit procedures have been achieved.
  
• 
  The conclusions expressed are consistent with the results of the work performed and support the audit opinion.
  

• 
  Monitoring
  

The firm should establish policies and procedures to see that quality control systems are relevant, adequate, operating effectively, and complied with in practice. Such policies and procedures should include ongoing evaluation and a periodic inspection of a selection of completed engagements.
At least annually, the firm should communicate the results of the monitoring of its quality control system to engagement partners and other appropriate individuals within the firm. Such communication should include the following: ⁴

• 
  a description of the monitoring procedures performed;
  
• 
  the conclusions drawn from the monitoring procedures;
  
• 
  where relevant, a description of systemic, repetitive or other significant deficiencies and of the actions taken to resolve or amend those deficiencies.
  

Supervisory personnel should:

1. 
   Monitor the progress of the audit to consider whether:
   

a assistants have the necessary skills and competence to carry out their assigned tasks; b assistants understand the audit directions;
c the work is being carried out in accordance with the overall audit plan and the audit program.

2. 
   Become informed of and address significant accounting and auditing questions raised during the audit, by assessing their significance and modifying the overall audit plan and the audit program as appropriate.
   
3. 
   Resolve any differences of professional judgment between personnel and consider the level of consultation that is appropriate.
   

• 
  Human Resources
  

The firm should establish policies and procedures to insure that it has sufficient personnel with the capabilities, competence, and ethical commitment to perform its engagements in line with professional standards and regulatory and legal requirements. The firm should assign responsibility for each engagement to an engagement partner with the appropriate capabilities, competence, authority, and time to perform the role. The firm should also assign appropriate staff with the necessary capabilities.

Presently two IAASB standards apply to audit quality: International Standards on Quality Control (ISQC) and ISA 220, ⁵ “Quality Control For Audit Work.” IAASB issues International Standards on Quality Control (ISQCs) as the standards to be applied for all services falling under the Standards of the IAASB (i.e. ISAs, International Standards on Assurance Engagements (ISAEs), and International Standards on Related Services (ISRSs)). ⁶
ISA 220 establishes standards and provides guidance on specific quality control proce- dures only for audit engagements. ISA 220 includes specific requirements for an engage- ment quality control reviewer to perform an objective evaluation of compliance with applicable professional standards. The responsibilities of the engagement partner under ISA 220 are shown in Illustration 11.3.

• 
  The Sarbanes-Oxley Act Quality Control and Audit Review
  

The Sarbanes-Oxley Act (SOX) addresses overall review procedures required of the auditor such as quality control, second partner review, and partner rotation. It also dis- cusses the client’s audit committee responsibilities and inspection by the Public Company Accounting Oversight Board (PCAOB). ⁷
SOX applies not only to US audit firms, but also to audit firms throughout the world. ⁸ Any foreign public accounting firm that prepares or furnishes an audit report on a company publicly traded in the US is subject to SOX, in the same manner and to the same extent as a public accounting firm that is organized and operates under the laws of the USA or any state. The PCAOB may determine that a foreign public accounting firm, even though it does not issue audit reports, plays such a substantial role in the preparation and furnishing of such reports that it should be treated as a public accounting firm subject to SOX. ⁹

Quality Control Policies

The Sarbanes-Oxley Act ¹⁰ (SOX) requires that every registered public accounting firm auditing publicly traded companies include in their quality control policies standards relating to:

• 
  monitoring of professional ethics and independence from issuers on behalf of which the firm issues audit reports;
  
• 
  consultation within such firm on accounting and auditing questions;
  
• 
  supervision of audit work;
  
• 
  hiring, professional development, and advancement of personnel;
  
• 
  the acceptance and continuation of audit engagements;
  
• 
  internal inspection;
  
• 
  such other requirements as the Public Company Accounting Oversight Board (PCAOB) may prescribe.
  

PCAOB Inspections
In order to insure quality control, the PCAOB conducts a continuing program ¹¹ of inspections ¹² to assess the degree of compliance of the audit firm’s performance of audits and issuance of audit reports with the rules of the PCAOB and professional standards. The PCAOB evaluates the sufficiency of the quality control system of the firm, and the manner of the documentation and communication of that system by the firm; and performs such testing as appropriate of the audit, supervisory, and quality control procedures of the firm.



The PCAOB is required to inspect a registered public accounting firm under SOX, section 104. The PCAOB will inspect and review selected audit and review engagements of the firm (which may include audit engagements that are the subject of ongoing litigation or other controversy between the firm and one or more third parties). A written report of the findings of the PCAOB is transmitted to the appropriate regulatory authorities. The report is made available in appropriate detail to the public, (except that the quality control portions of the report may not be made public under certain considerations). ¹³
Ex-Employee Conflicts of Interest
In determining the acceptance and continuation of audit engagements the audit firm must consider ex-employee conflicts of interest and audit partner rotation. An account- ing firm cannot perform any audit service for a firm if a chief executive officer, controller, chief financial officer, chief accounting officer, or equivalent position, was employed by that accounting firm and participated in any capacity in the audit of that issuer during the one-year period preceding the date of the initiation of the audit. ¹⁴ The audit partner must be rotated away from that client every five years.