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Main changes about the audit clarity project PDF Print E-mail

The Clarified Auditing Standards

 

Steve Collings presents a summary of the main changes to come out of the audit clarity project.

In 2004, the International Auditing and Assurance Standards Board (IAASB) undertook a programme to enhance the clarity of its ISAs. The IAASB said that the overall aim of its clarity project was to make the ISAs more easily understandable to enable them to be more consistently applied, which would in turn improve audit quality on a worldwide level.

All of the ISAs have been rewritten and are effective for audits of financial statements commencing for periods beginning on or after 15 December 2009 (essentially December 2010 year ends). Each standard is now structured in a new way, with clear objectives, definitions and requirements, together with application and other explanatory material. The structure of the new standards makes it easier to understand what is required and what is purely guidance. In addition, ISQC 1 has also been rewritten and the revised guidance on quality control procedures will also become effective at the same time as the clarified ISAs.

A summary of the clarity project:

  • 19 ISAs and ISQC 1 ‘Quality Control for Firms that Perform Audits and Reviews of Financial Statements and Other Assurance and Related Service Engagements’ have been redrafted. You will see ‘(redrafted)’ contained after the ISA/ISQC 1 number.
  • 16 ISAs have been both revised and redrafted. You will see ‘(revised and redrafted)’ contained after the ISA number.
  • Two new standards have been issued: one relating to communication – ISA 265 ‘Communicating Deficiencies in Internal Control to Those Charged with Governance and Management’, and another relating to the evaluation of misstatements: ISA 450 ‘Evaluation of Misstatements Identified During the Audit’.
  • ISA 540 ‘Audit of Accounting Estimates’ and 545 ‘Auditing Fair Value Measurements and Disclosures’ have both been combined in ISA 540 (revised and redrafted) ‘Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures’.

Each redrafted standard contains a new structure as follows:

  • Introduction
  • Objective
  • Definitions
  • Requirements
  • Application
  • Other explanatory material

Whilst all the ISAs have been rewritten, the main areas of audit work that are affected by the changes to clarified ISAs are outlined below.

ISA 600 (revised and redrafted) The Audit of Group Financial Statements
The revised ISA covers a wider scope than the previous standard and sets out new requirements in respect of the relationship between the group engagement team and the component auditors. It will affect audit firms who are not the auditor for the entire group.

The clarity project has given rise to the following areas which are likely to require additional thought and documentation:

  •  
  • Consideration of whether the engagement is a group audit within the scope of ISA 600 (revised and redrafted).
  • Scoping the group audit, including determining significant components in the group.
  • Gaining an understanding of the group-wide internal control environment and the consolidation process.
  • Determining materiality and performance materiality for the group and its components.
  • Obtaining an understanding of the component auditors involved in the work.

ISA 550 (revised and redrafted) Related Parties
Related parties have always been a ‘bone of contention’ because of their subjective nature. This revised ISA contains a number of new specific requirements which place a much greater emphasis on a risk-based approach to auditing related parties.

This revised and redrafted standard recognises that risks of material misstatement are higher when related parties are involved. This clarified standard requires related party relationships and transactions to be considered explicitly in the engagement team’s fraud discussion and an understanding of controls relevant to related parties to be obtained.

The standard requires that where controls are not present in this area, the auditor may be required to report the fact to those charged with governance. In addition, the updated standard requires the auditor to challenge any management assertion that transactions with related parties are on an arm’s length basis.

ISA 540 (revised and redrafted) Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures
This ISA brings with it new requirements for the auditor to adopt a higher degree of professional scepticism where accounting estimates, fair value estimates and related disclosures are concerned, with particular emphasis placed on management bias. As mentioned earlier, ISA 545 has been combined with ISA 540 (revised and redrafted). The ISA now also includes new requirements in respect of:

  • Specific matters for the auditor to gain an understanding of in order to assess risk.
  • Evaluation of estimation uncertainty and determining any significant risks.
  • Requirement to perform substantive procedures to respond to significant risks.

The scope of this standard has been updated to be extended to fair values.

ISA 265 Communicating Deficiencies in Internal Control to Those Charged with Governance and Management
This is a new ISA which is designed to address the way in which auditors’ report control deficiencies to those charged with governance. The main objective is to increase the quality of the communication to management and also to focus on the definition of a significant deficiency in internal control and/or a missing control which requires notification to management and/or those charged with governance.

It is important that auditors’ risk assessments include consideration of the types of control they would expect to find at an audit client taking into consideration its size, complexity and nature. If relevant controls are missing, their absence should be reported to the appropriate level of management or to those charged with governance even if they do not directly impact on the planned audit procedures.

In some entities, management and those charged with governance may be two separate groups of people (particularly those entities with a large hierarchy). This standard requires the auditor to consider whether two ‘letters of comment’ are appropriate to address findings that may be dealt with by management and those findings which are required to be notified to those charged with governance.

ISA 450 Evaluation of Misstatements Identified During the Audit
This is another new standard and is derived from the revisions to ISA 320 on audit materiality. Amongst other things, it requires accumulating misstatements, reassessment of materiality and specific documentation. Both ISA 450 and ISA 320 require the auditor to reconsider their materiality determinations if information comes to light that would have changed their determination of materiality if they had known about the information at the planning stage of the audit.

ISA 530 Audit Sampling
The clarified ISAs provide a foundation for risk-based auditing which means that the auditors will plan their procedures using a risk assessment which is in turn built on an understanding of the entity and the environment in which it operates.

The clarified ISA emphasises the point that it would be extremely rare for any deviation or misstatement identified in a sample to be considered an anomalous error and not representative of the whole population. In circumstances where the auditor concludes that the misstatement is anomalous, then the standard requires the auditor to obtain sufficient appropriate audit evidence to support this conclusion.

Significant difficulties
Two-way communication issues are already dealt with in ISA 260 paragraph17.2 and the revised standard emphasises the importance of effective two-way communication. Where the auditor encounters significant difficulties during the course of an audit, then the auditor is required to notify such significant difficulties to the appropriate level of management or those charged with governance. The auditor should also consider their ability to accept reappointment if they conclude that the two-way communication has been inadequate.

ISA 570 Going Concern
ISA 570 has not been revised, but it has been redrafted in a way which has now given rise to a significant number of elevations - in particular, where events or conditions cast significant doubt on the entity’s ability to continue as a going concern. Auditors should obtain evidence concerning management’s assertion where they conclude that the going concern basis is appropriate in their particular circumstances by evaluating management’s plans for future actions and consideration must be made by the auditor as to whether those plans are feasible.

Auditor’s reports
ISAs 700, 705 and 706 deal with reporting matters. Different jurisdictions will have different formats of auditors’ reports. Where auditors consider a modification of an auditor’s report, or where an emphasis of matter paragraph is deemed to be appropriate, care should be taken over the form and content of the report. ISA 705 Modifications to the Opinion in the Independent Auditor’s Report and ISA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Auditors’ Report should be consulted.

Conclusion
Getting to grips with the new standards for the first time will increase costs and audit firms are encouraged to prepare for the revised standards which can be adopted early. With sufficient planning and a good understanding of the clarified ISAs, audit firms will keep increases in costs to a minimum. However, the only way to fully understand the requirements of the clarified ISAs is to read them!

Steve Collings FMAAT FCCA DipIFRS is the audit and technical director at Leavitt Walmsley Associates Ltd and a partner in AccountancyStudents.co.uk. He is also the author of ‘The Core Aspects of IFRS and IAS’ and lectures on financial reporting and auditing issues.
 
  
 
ACCA on screen marking PDF Print E-mail

ACCA on screen marking

 The following information is very important if you are sitting an exam this sitting.

You must start each question on a new page and the question number should be bubbled in the section at the top of the page.

You must use a black ball point pen. Anything else may not/will not be picked  up by the scanning technology and could result in questions not being marked correctly.

Cross out incorrect answers. DO NOT USE  correction fluid.

Do not write in the margins or  across the middle of the booklet. The answers will NOT be read.

 

You will find the vital information on your examination docket.
 
Accounting for Intangible Assets PDF Print E-mail

Accounting for Intangible Assets

 

Steve Collings looks at the fundamental principles in accounting for goodwill and intangible assets and also looks at some fundamental differences between current UK GAAP, IFRS and the proposed IFRS for SMEs.

 

As accountants we are all aware that an intangible asset does not have any physical form and accounting for such assets has always been a major issue for the accounting profession for many years.  Goodwill particularly has always posed problems.

 

Goodwill

Goodwill can primarily take two forms: purchased goodwill and internally-generated goodwill.  Goodwill is accounted for under the provisions in FRS 10 ‘Goodwill and Intangible Assets’ and IFRS 3 ‘Business Combinations’. 

 

Under IFRS 3 and FRS 10, internally-generated goodwill cannot be capitalised.  This also applies to internally-generated brands such as mastheads, publishing titles, customer lists etc in substance.  They should, instead, be treated as either research or development costs in accordance with the principles in IAS 38 ‘Intangible Assets.

 

FRS 10 allows internally-generated intangible assets to be capitalised only if there is a readily ascertainable market value and specifically prohibits the capitalisation of internally-generated goodwill.  Where readily ascertainable values are not available then costs incurred should be written off to the profit and loss account as incurred. 

 

Measurement

FRS 10 requires purchased intangible assets to be capitalised at cost and amortised over its estimated useful life.  FRS 10 defines the useful economic life of an intangible asset as:

 

‘the period over which the entity expects to derive economic benefits from that asset’. 

 

In some respects, goodwill and other capitalised intangible assets may be deemed to have an indefinite useful economic life or a useful economic life of more than 20 years.  A useful economic life of more than 20 years can only be chosen if two criteria are met:

 

  • The lifespan of the intangible asset(s) can be demonstrated to be longer than 20 years; and
  • The intangible asset is capable of continued measurement in order that annual impairment reviews can be undertaken.

 

For all intangible assets that have been deemed to have either an indefinite life or a lifespan of more than 20 years, annual impairment reviews must be undertaken in accordance with IAS 36 ‘Impairment of Assets’ or FRS 11 ‘Impairment of Fixed Assets and Goodwill’.  If the impairment test reveals an impairment, then the asset should be written down to its recoverable amount.

 

Recoverable Amount

Assets carried in the balance sheet (statement of financial position) should never be carried at anymore than their recoverable amount.  IAS 36 ‘Impairment of Assets’ and FRS 11 ‘Impairment of Fixed Assets and Goodwill’ are similar in their determination of recoverable amount.

 

Under both standards, recoverable amount is the HIGHER of:

 

  • Fair value less costs to sell; and
  • Value in use.

 

Fair value less costs to sell is the amount obtainable from the sale of an asset or cash-generating unit in an arm’s length transaction between knowledgeable, willing parties, less the costs involved in the disposal.

 

Value in use is the present value of the future cash flows expected to be derived from an asset or cash-generating unit.

 

A cash-generating unit is the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets.

 

Revaluation of Intangible Assets

FRS 10 prohibits the revaluation of intangible assets after their initial recognition at cost or fair value on acquisition.  Only in rare situations can intangible assets be revalued and such situations are where there are readily ascertainable market values.  Where such readily ascertainable market values are available, then all intangible assets within the same class of intangible assets must be revalued. 

 

Disclosures

The following are required to be disclosed in an entity’s financial statements in relation to intangible assets:

 

  • Valuation method.
  • For each class of intangible asset:
  1. The cost or revalued amount at the start of the accounting period.
  2. The cumulative provisions for amortisation or impairment at the beginning and end of the period.
  3. A reconciliation of the movements, showing additions, disposals, revaluations, transfers, amortisation, impairment losses and reversals of past impairment losses.
  4. Carrying amount at the reporting date.
  • The method of amortisation together with the reasons for choosing the method of amortisation.
  • The reasons for, and the effect of, changing useful economic lives.
  • The reasons for, and the effect of, changing amortisation methods.
  • Where an intangible asset is amortised over more than 20 years, or has an indefinite life and is therefore not amortised, the reasons for rebutting the 20 year presumption. 

 

Where intangible assets have been revalued:

 

  • The year in which the revaluation took place and the basis of valuation.
  • The original cost or fair value and the amount of any amortisation provisions that would have been recognised if the intangible asset had not been subject to revaluation.
  • The name and qualifications of the person who valued the intangible asset.

 

UK GAAP versus IFRS

Under the provisions in IFRS 3 ‘Business Combinations’ goodwill amortisation is prohibited, whereas FRS 10 permits goodwill amortisation if the useful economic life of the purchased goodwill is less than 20 years.  IFRS 3 requires annual impairment tests, whereas FRS 10 requires annual impairment tests on goodwill if the useful economic life of the goodwill is more than 20 years.

 

The proposed IFRS for SMEs allows amortisation of goodwill if the expected useful life of goodwill is less than 10 years.   If it is more than 10 years, then annual impairment tests are required.  In contrast, FRS 10 refers to an expected useful economic life of more than 20 years.

 

 

Steve Collings FMAAT FCCA DipIFRS is the audit and technical director at Leavitt Walmsley Associates Ltd and a partner in AccountancyStudents.co.uk.  He is also the author of ‘The Core Aspects of IFRS and IAS’ and lectures on financial reporting and auditing issues.

 

 
 
Advice from Ali Rahmani, Part qualified ACCA student PDF Print E-mail
- Difference between Academic exam vs. Professional exam which is more
about Applying knowledge vs. Knowing knowledge

One of the main differences between a professional exam like ACCA and an
academic exam is the time pressure. In an ACCA exam you have a limited
time to apply all your knowledge and cover all requirements examiner has
set. In other words you can be an expert in all subject matters but if
you don't know how to apply them quickly you can easily fail. So what is
the solution? It's all about practice. In my opinion if I take an ACCA
paper after reading whole text book I may get maximum 20 marks (out of
100). The other 80% of marks is come to me through practice, practice
and practice (or in other word Application, application and application
of knowledge). 

- What is the role of a mentor

Have you ever thought what is the difference between a student who
studied everything in business and another person who had a mentor and
learned everything through him. When you read a text book you learn
about everything in a separate chapter and usually isolated from other
subjects. However all the chapters in a book are connected at a higher
(or big picture level). Successful application of knowledge depends on
who well you can understand the link between different chapters and as
you progress through your ACCA exams this skill becomes more and more
necessary.
One of the benefits of having a Mentor in life is he/she helps you to
connect the dots better. You may have more technical knowledge than your
mentor, but they the insight. 
PassACCA.net downloads play the same mentorship role in your studies.
They are really the missing mentor that as a distance learning student
you need to fill in. During my ACCA exams (except for P2) I never took a
course and I was always looking for somebody to complete the big picture
for me (whether a partner in the firm, or a friend). 

- Different stages in ACCA study

As we go through different stages in our study (from reading text books
to final revision), the advice that we need is different.
In first step we need to understand the key syllabus areas and this is
where listening to KSA (Key syllabus areas) podcasts ensure we fully understand key areas we
need to focus more on. When is the best time to start listening to KSA
podcast? Before staring your studies and during planning stage. I always
listen to KSA podcast at least twice a week on my drive to work and back
home. It helps to stick the key points into my mind.

As you start your revision phase, this is when your application of
knowledge skill comes to play and with more and more practice you can
improve your skills but then again what provides a breakthrough in your
application is to look at revision from a different perspective which is
what Q&E (Question and exam technique)podcast can provide you. Also podcasts on past exam papers
provide a mentor perspective on how to read, analyse and plan your
answer. Again try to listen to these podcasts at least twice a week.

- Practice, practice, practice

Don't forget that passing an exam is all about practice, practice and
practice and podcasts are the easiest way you can practice even when you
are on the bus or driving.

Ali Rahmani, Part qualified student, Canada 
 
Financial Due diligence PDF Print E-mail

Financial Due Diligence

 

Students of auditing papers will often come across the concept of ‘financial due diligence’ and may be asked to compare and contrast due diligence with that of statutory audit.

 

This article looks at the basics of due diligence and discusses how it differs from statutory audit.

 

Due Diligence

Due diligence is the investigation of the affairs of an entity by, or on behalf of, a potential investor or purchaser before the transaction is completed.  The primary purpose of due diligence is to enable the potential investor to make informed decisions concerning the balance of risks present and the opportunities available should the transaction complete. 

 

Financial due diligence is completed prior to the transaction being completed and the amount of financial due diligence to be completed will often vary according to the knowledge of the purchaser or investor, the size and complexity of the target and the degree of risk involved.

 

Financial due diligence is often undertaken by a reporting accountant who will undertake the work on behalf of the purchaser.

 

Regulatory environment

Due diligence is primarily an assurance engagement and the reporting accountant will be required to have an understanding of both accounting and auditing standards.  Whilst the reporting accountant, carrying out a due diligence assignment, is not expected to an express an opinion as to the truth and fairness of the financial statements in terms of audit, the reporting accountant may undertake a certain degree of the financial due diligence by applying International Standards on Auditing (ISAs). 

 

Knowledge of accounting standards is required to ensure that transactions and events have been properly accounted for in annual financial statements and any interim financial statements that the reporting accountant may use in his/her review.

 

Planning

As with any assurance engagement, sufficient planning is crucial to enable the reporting accountant to carry out the procedures necessary and to carry out the assignment to the highest standards. 

 

In many cases, the reporting accountant may be required to undertake a due diligence exercise on an entity which they may not necessarily have any past experience or dealings.  In such circumstances it is vital that the reporting accountant plans the due diligence carefully and obtains an understanding of the target entity and the environment in which it operates.  The reporting accountant may, therefore, consult the provisions in ISA 315 (redrafted) ‘Understanding the Entity and its Environment and Assessing the Risks of Material Misstatement’. 

 

Information Gathering

Once instructions have been taken from the client, the terms of the engagement have been agreed and sufficient planning has taken place, information can be gathered to enable the reporting accountant to report back to the client. 

 

The gathering of the information for the due diligence assignment has to be carried out systematically and carefully having regard to the size, complexity and degree of risk associated with the target.  The reporting accountant will have carried out the planning in such a way as to identify the areas of the target entity which are material and those areas which can be safely ignored. 

 

The reporting accountant is not expected to express an opinion on the financial statements, unlike an auditor, and therefore the extent of verification of information will largely depend on the requirements of the client and the scope of the engagement.  However, examples of the types of information the reporting accountant would need in order to gather information is given as follows:

 

  • Accounting records.
  • Interim financial statements/management accounts.
  • Latest set of audited/unaudited financial statements, together with supporting analysis.
  • Tax computations.
  • Employee files.
  • Minute books.
  • Correspondence files.
  • Statutory information such as the Articles of Association, Annual Returns, List of Directors/Shareholders.
  • Details of the group structure (where applicable).
  • Access to management to hold discussions and to corroborate any issues flagged up during the planning.

 

Working Papers

Work undertaken during the due diligence should be documented in accordance with the firm’s procedures.  Again, whilst the due diligence exercise is not an audit, compliance with ISA 230 (revised) ‘Audit Documentation’ may be considered appropriate by the reporting accountant. 

 

Indeed, a working paper file relevant to a due diligence assignment should be structured in such a way that it facilitates cross-referencing of material items.  It also facilitates the cross-referencing of the planning memorandum to the detailed working papers (especially where certain areas identified at the planning stage of the assignment are judged critical).

 

Finally, a well-structured due diligence file will help answers questions asked by the client swiftly, especially in face-to-face meetings.

 

Reporting

The form of reporting should be agreed at the outset of the assignment. The purpose of the due diligence exercise is to provide the potential investor with the information and professional commentary they need in order to be able to make informed decisions about the target entity.

 

Many due diligence assignments will be biased towards negative reporting.  In other words, the client will require the reporting accountant to provide assurance that nothing has come to the reporting accountant’s attention which would cast doubt on the credibility of the information reviewed by the reporting accountant during the due diligence assignment, which may result in the abandonment of the potential investment.

 

In most cases, the form of report will be written and generally most firms have an ‘in-house’ style and the contents of the report may have been agreed at the outset of the engagement.  However, reports should be professionally written and concise and the information contained within the report should not be ambiguous or contradictory.  Conclusions should also be made in the report.

 

In some, more simple due diligence assignments, it may be appropriate to simply restrict a report to just reporting by exception where problems, shortcomings or other matters which may be of particular relevance to the potential investor may be documented in the report. 

 

However, where the client is looking for a broad range of information, then a more fuller and more comprehensive report may be required which may be quite lengthy.  Many firms have standard templates which may cross-reference various points within the report (such as the executive summary and conclusions sections) to appendices.  Typically such reports would consist of:

 

  • Scope of the engagement.
  • Executive summary.
  • History of the target.
  • Nature of the target including its business, group structure, internal processes, principal activities etc.
  • Statutory information held with (say) the Registrar of Companies.
  • Details of the internal structure of the target.
  • Financial reporting and accounting controls.
  • Critical accounting policies.
  • Summary of the latest approved financial statements and a summary of any available up-to-date management/interim accounts.
  • Review of the financial position of the target (balance sheet).
  • Details of any fixed and/or floating charges or preferential creditors.
  • Details of mortgages and financing.
  • Commentary relating to the entity’s cash flow.
  • Taxation issues.
  • Reviews of budgeted information and projections.
  • Future plans for the business.
  • Other relevant matters.

 

Due Diligence versus Audit

As mentioned above, the primary objective of the due diligence assignment is not to express an opinion on the truth and fairness of a target’s financial statements; it is merely to provide a potential investor with crucial information, gathered as a result of the due diligence assignment, to enable the potential investor to make informed decisions about the potential investment/acquisition of a target entity.

 

Reporting accountants may perform certain aspects of the due diligence assignment in accordance with ISAs, but in contrast to statutory audit, the scope of the due diligence assignment is very much driven by the nature, size, complexity and client-requirements.

 

Statutory audit is concerned with expressing an opinion as to whether an entity’s financial statements give a true and fair view and must be undertaken in accordance with ISAs.  The outcome of the statutory audit is the expression as to whether the financial statements give a true and fair view and the auditor’s opinion is expressed as:

 

  • Unqualified.
  • Qualified.
  • Adverse.
  • Disclaimer.

 

Conclusion

It is important that a clear distinction is made between the objectives of a due diligence assignment and audit because there is a vast difference between the objectives of the two.

 

Due diligence may apply certain aspects of auditing standards, but an audit assignment must apply all applicable auditing standards.

 

 

Steve Collings FMAAT FCCA DipIFRS is the Audit and Technical Manager at LWA Ltd and a partner in AccountancyStudents.co.uk.  He is also the author of ‘The Core Aspects of IFRS and IAS’ and lectures on financial reporting and auditing issues.

 
 
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