Ringkasan Audit 2

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012)

PENGAUDITAN II CHAPTER 1 Why are Auditors needed ?

Auditing Auditing has become headline news after recent corporate scandals, and the competence and independence of auditors have been questioned, focusing attention on the purpose of audit and the way in which companies are managed. Several important auditing issues are considered: (a) the distinction between the position of manager and of owner not involved in management; (b)audit as a search for evidence; (c)the use of simple procedures to test management assertions (d) the idea that information breeds information; (e) the importance of management integrity; (f) professional scepticism; (g) the distinction between personal and business expenses; (h) the role of the accounting system in achieving accurate bookkeeping (i) the use of information from an independent source; (j) actual personal experience as a valuable source of evidence.

The insurance hypothesis suggests that the auditor can provide insurance to people relying upon the audited information, as they can recover damages from negligent auditors. A successful damages claim against the auditor is effectively the equivalent of a successful claim against an insurance company.

Accuracy of accounts Difficulties in proving the accuracy of accounts include: (a)insufficient (a)insufficient evidence; (b)judgement involved in the preparation of accounts in such matters as: useful lives of fixed assets;saleability or usability of stock; collectability of debtors;and profit to be taken up on a long-term contract. The most that can be expected is that financialstatements give a reasonable picture; what isreasonable depends on viewpoint and theinformation available to the user. In most bookkeeping areas accuracy is expected : (a) debtors properly recorded; (b)stock accurately counted; and (c)trade creditors and fixed assets accurately determined.

completely

and

Justifications Justifications of audit Three justifications of audit are: the information hypothesis; agency theory; the insurance hypothesis.

Truth and fairness is not easily defined but we expect accounts: (1) not to mislead the reader; (2) to contain a certain degree of accuracy; (3)to be supplemented by explanatory notes; (4)to give a reasonable view of financial affairs and results; (5)to be proved true and fair (or not) on the basis of sufficient, appropriate audit evidence.

The information hypothesis suggests auditors are needed because information becomes more reliable as the result of audit, and is therefore more useful to decision makers. Agency theory suggests audit is justified because providers of resources cannot trust managers to use resources properly on their behalf .Basic ideas behind of agency theory are:

Framework of audit assignment assignment The typical basis framework for a larger audit assignment comprises: (1) preliminary stages; (2) systems work and transaction testing; (3) preparation for final work; (4) final work..

(a)principals and agents both try to maximize their own wealth; (b) a monitoring mechanism in the form of a financial report is required, and is advantageous to both principals and agents; (c) different groups of rational individuals have different information, allowing informed individuals to profit at other’s expense; (d)agents recognize that principals will be more willing to believe performance reports if verified by an independent party; (e) professional external auditors are the most costeffective monitoring device.

AUDIT PROCESS Preliminary stages

  

ata u a

30 March 2006 Firm asked to carry out work. 3 April 2006 Meeting to discuss terms of reference; forms the basis for the letter of engagement. 24 –28  –28 April 2006 Visit company to familiarize audit firm with industry and company. Meet with management. Prepare first (global) plan and free estimate.

a n yang e um a a n a an s ay a u p ate w ww w w .a . a u n a n s a n s n s . wo wo r p r es e s s .c .c o m   Contact me : [email protected] /@firmanmhmd (Line)

836

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) 2 May 2006 Write confirming fee estimate and proposed dates for carrying out examinations. Issue a memo assessing any matters that need attention Systems work and transactions testing 3 weeks from 9 October 2006 Interim examination of the firm’s accountin g and internal control systems. Work directed towards this area. 15 November 2006 Memo on internal control / ‘management letter’. This can be delayed until the final audit but if there are serious weaknesses it would be wiser not to delay.

Final preparation 4 –5  –5 December 2006 Review arrangements for end-of-year stock counts and accounts; discuss any known problems and any new financial reporting standards 30 December 2006 Attend stock count, observe company procedures, make test counts and write stock count memo for working papers. Event.

Final work 3 weeks from 12 March 2007 Carry out a review of new draft accounts and verification procedures on assets and liabilities, including post-balance sheet events work. 2 April 2007 Review working papers, discuss audit results with management and include amendments, obtain a management representations letter, check records agree with the accounts. Directors sign financial statements.Issue audit report. 2 May 2007 Send note of charges for audit and other professional work.Event.

Role of audit Audit may have specific roles in relation to many different organizations: Examples might include : local authorities universities water companies hospitals nuclear power stations charities      

 An audit is an investigation investigation or a search for evidence to ‘ An enable an opinion to be formed on the truth and fairness of  financial and other information by a person or persons independent of the preparer and persons likelyto gain directly from the use of the information, and the issue of a report on that information with the intention of increasing its credibility and therefore its usefulness.’ 

Another, from the Audit of Financial Statements, is: ‘An exercise whose objective is to enable Auditorsto enable  Auditorsto express an opinion whether the financial statements statements give a true and  fair view … of the entity’s affairs at the period end end and of its  profit or loss (or income and expenditure) expenditure) for the period then ended and have been properly prepared in accordance with the applicable reporting framework (for example relevant legislation and applicable accounting standards)’.

Fundamental Fundamental Principles P rinciples of Independent Independent Auditing The ‘Nine Fundamental Principles of Independent Auditing’ cover the following areas and comprise the Auditor’s Code (1)accountability; (2)integrity; (3)objectivity and independence; (4) competence; (5) rigour; (6) judgement; (7) clear communication; (8) association; (9) providing value EXERCISE 1. Which of the following people do you think would wish to be certain that the financial statements of a major public company had been properly prepared? (a) The ordinary shareholders. (b) The employees. (c) People thinking of buying shares in the company. (d) The Inspector of Taxes responsible for the tax affairs of the company. (e) A member of the public. (f) A supplier of goods to the company. (g) The government (h) The council of the local Stock Exchange. 2. If Andrew and James in our simple case had said that motor expenses amounted to £4000, suggest: (a) What kinds of expenditure would probably be included in the heading ‘motor expenses’. (b) How you would satisfy yourself that the amount of each expenditure heading was reasonably accurate.

Assurance services’ are usually held to mean a broad set of services deigned to improve quality of information. Auditors are in a good position to provide services such as these but this may pose a threat to independence. Important issues are:

3. Why do you consider that audit might be seen to be necessary in the case of an engineering company whose employees operate dangerous machinery? Suggest appropriate audit objectives, but do not restrict yourself  just to to financial financial audit.

(a) users value reliable accounts; (b)auditors must be competent; (c)audit is a search for evidence; (d)auditors should adopt an attitude of professional scepticism.

ANSWERS

There have been many definitions of audit. One is:

ata u a

1. The simple answer to this question is 'all of them'. Let us go through the list one by one and justify this answer: (a) The shareholders are the providers of capital and they are entitled to know how successfully the directors have been running the company. The accounts should also aid

a n yang e um a a n a an s ay a u p ate w ww w w .a . a u n a n s a n s n s . wo wo r p r es e s s .c .c o m   Contact me : [email protected] /@firmanmhmd (Line)

837

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) 2 May 2006 Write confirming fee estimate and proposed dates for carrying out examinations. Issue a memo assessing any matters that need attention Systems work and transactions testing 3 weeks from 9 October 2006 Interim examination of the firm’s accountin g and internal control systems. Work directed towards this area. 15 November 2006 Memo on internal control / ‘management letter’. This can be delayed until the final audit but if there are serious weaknesses it would be wiser not to delay.

Final preparation 4 –5  –5 December 2006 Review arrangements for end-of-year stock counts and accounts; discuss any known problems and any new financial reporting standards 30 December 2006 Attend stock count, observe company procedures, make test counts and write stock count memo for working papers. Event.

Final work 3 weeks from 12 March 2007 Carry out a review of new draft accounts and verification procedures on assets and liabilities, including post-balance sheet events work. 2 April 2007 Review working papers, discuss audit results with management and include amendments, obtain a management representations letter, check records agree with the accounts. Directors sign financial statements.Issue audit report. 2 May 2007 Send note of charges for audit and other professional work.Event.

Role of audit Audit may have specific roles in relation to many different organizations: Examples might include : local authorities universities water companies hospitals nuclear power stations charities      

 An audit is an investigation investigation or a search for evidence to ‘ An enable an opinion to be formed on the truth and fairness of  financial and other information by a person or persons independent of the preparer and persons likelyto gain directly from the use of the information, and the issue of a report on that information with the intention of increasing its credibility and therefore its usefulness.’ 

Another, from the Audit of Financial Statements, is: ‘An exercise whose objective is to enable Auditorsto enable  Auditorsto express an opinion whether the financial statements statements give a true and  fair view … of the entity’s affairs at the period end end and of its  profit or loss (or income and expenditure) expenditure) for the period then ended and have been properly prepared in accordance with the applicable reporting framework (for example relevant legislation and applicable accounting standards)’.

Fundamental Fundamental Principles P rinciples of Independent Independent Auditing The ‘Nine Fundamental Principles of Independent Auditing’ cover the following areas and comprise the Auditor’s Code (1)accountability; (2)integrity; (3)objectivity and independence; (4) competence; (5) rigour; (6) judgement; (7) clear communication; (8) association; (9) providing value EXERCISE 1. Which of the following people do you think would wish to be certain that the financial statements of a major public company had been properly prepared? (a) The ordinary shareholders. (b) The employees. (c) People thinking of buying shares in the company. (d) The Inspector of Taxes responsible for the tax affairs of the company. (e) A member of the public. (f) A supplier of goods to the company. (g) The government (h) The council of the local Stock Exchange. 2. If Andrew and James in our simple case had said that motor expenses amounted to £4000, suggest: (a) What kinds of expenditure would probably be included in the heading ‘motor expenses’. (b) How you would satisfy yourself that the amount of each expenditure heading was reasonably accurate.

Assurance services’ are usually held to mean a broad set of services deigned to improve quality of information. Auditors are in a good position to provide services such as these but this may pose a threat to independence. Important issues are:

3. Why do you consider that audit might be seen to be necessary in the case of an engineering company whose employees operate dangerous machinery? Suggest appropriate audit objectives, but do not restrict yourself  just to to financial financial audit.

(a) users value reliable accounts; (b)auditors must be competent; (c)audit is a search for evidence; (d)auditors should adopt an attitude of professional scepticism.

ANSWERS

There have been many definitions of audit. One is:

ata u a

1. The simple answer to this question is 'all of them'. Let us go through the list one by one and justify this answer: (a) The shareholders are the providers of capital and they are entitled to know how successfully the directors have been running the company. The accounts should also aid

a n yang e um a a n a an s ay a u p ate w ww w w .a . a u n a n s a n s n s . wo wo r p r es e s s .c .c o m   Contact me : [email protected] /@firmanmhmd (Line)

837

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) them to some extent in the decision to hold onto or to sell their shares, although in practice they would be wise to seek further advice before doing so. (b) The employees are intimately connected though their employment and rate of pay is likely to be dependent on the success of the company. It would seem, therefore, that they too have an interest in properly prepared accounts. (c) These people are potential shareholders and they want to make a decision as to whether to buy shares or not. One of the sources of information available to them will be the company's financial statement so they are clearly interested in those financial statements being properly prepared. Again, it would be wise to seek further information about the company before doing so. (d) The starting point of the tax computation of taxable income is the accounting profit before taxation. The inspector is clearly interested in properly prepared financial statements. (e) As an example of a major public company, British Telecommunications plc is an important UK company. Its success or failure has a vital bearing on the success of the UK economy and in view of this, all residents of the UK are concerned in the proper preparation of financial statements by the company. (If you are not a resident of the UK, take an example from important companies in your own economy). (f) Suppliers of goods to a company are interested in the health of that company; in the short term they wish to be paid for goods supplied; in the longer term to know if the customer is a valuable long-term business partner. The same kind of considerations apply to customers and to competitors, all members of what the Corporate Report refers to as 'the business contact group'). (g) The Government of any country is concerned with the success or failure of the component parts of the economy. In addition, in so far as governmental statistics are often based on accounting information, it will also be interested in the validity of that information. (h) Taking BT as an example again, its published accounting information has a direct bearing on the quoted price of shares, and the stock exchange has a very clear interest in valid accounting information. Students should refer to the Corporate Report published by the Accounting Standards Steering Committee in 1975 for a discussion of these matters. 2. This is a question that is designed to start you thinking about the audit process. Andrew has stated that the motor expenses amount to £4,000; the duty of the auditor would be to prove that the assertion was a valid one. Th e first step would be to consider the types of expenditure that would be included under this heading. Suggestions are: (a) Vehicle licence fee (b) Insurance (c) Petrol (d) Servicing Vehicle licence fee and insurance would be quite easily dealt with. An inspection of the relevant invoice and policy would readily provide information about the charge to the profit and loss account and the amount of prepayment, if any. If there has been servicing of the lorry during the sixmonth period, an inspection of invoices would reveal the amount. It is to be hoped that Andrew has kept the invoices, although his system for recording income would not give us much reason to suppose that that he has done this in ata u a

all instances. This may be particularly the case with regards to petrol. We would have to question Andrew about distances travelled and miles per gallon. Experienced auditors would probably be able to determine whether the figure appeared reasonable or not, although, without more information, it is difficult to say whether they would be able to report that the motor expenses figure was acceptable. However, the above suggestions do give an idea as to how auditors might proceed. 3. Companies whose employees operate dangerous machinery are required by law to have proper safety procedures in force. In this case the audit helps to ensure compliance with the law and identifies hazards that aid the protection of employees. Audit objectives would include: - ensuring that the company has proper rules concerning the use of the dangerous machinery - ensuring that the company has training schemes for employees in the operation of the machinery and in the understanding of safety measures, such as protective screens - ensuring that staff are aware of the procedures to be adopted in the case of accident - being satisfied that the incidence of accidents is at a minimum.

CHAPTER 2 An Overview of the postulates and concepts of Auditing

Definiton of postulate Theories underpin practice. Mautz and Sharaf (1961) suggest that a philosophyhas three aspects of value: (1) it gets back to first principles; (2) systematic organization of knowledge; (3) provides a basis for moulding and understanding social relationships Postulates are essential to the development of an intellectual discipline and are the foundation for any theoretical structure. Postulates are not theories but are the necessary basis for theory; assumptions that do not lend themselves to direct verification, but are a basis for inference, even if susceptible to challenge later.. The chapter discusses two postulates formulatedby Flint: (a) The subject matter of audit is susceptible to verification by evidence (b)Essential distinguishing characteristics of audit are the independence of status and freedom from investigatory and reporting constraints. Postulate may not hold good for ever. One example from Mautz and Sharaf, that may no longer be valid: valid: There is no necessary conflict of interest between the auditor and the management of the enterprise under audit  Flint’s audit postulat po stulates es

a n yang e um a a n a an s ay a u p ate w ww w w .a . a u n a n s a n s n s . wo wo r p r es e s s .c .c o m   Contact me : [email protected] /@firmanmhmd (Line)

838

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) 1 The primary condition for an audit is that there is a relationship of accountability or a situation of public accountability. 2 The subject matter of accountability is too remote, too complex and/or of too great a significance for the discharge of the duty to be demonstrated without the process of audit

Credibility Credibility is about whether people believeauditors when they report. Credibility concepts concern the personal qualities of auditors: competence,independence, competence,independence,integrity integrity and ethics .

3 Essential distinguishing characteristics of audit are the independence of its status and its freedom from investigatory and reporting constraints. 4 The subject matter of audit, for example, conduct, performance or achievement or record of events or state of affairs or a statement of fact relating to any of these, is susceptible to verification by evidence 5 Standards of accountability, for example, conduct, performance, achievement and quality of information,can be set for those who are accountable: actualconduct, etc. can be measured and compared withthese standards by reference to known criteria andthe process of measurement and comparison requires special skill and judgement 6 The meaning, significance and intention of financialand other statements and data, which are audited,are sufficiently clear that the credibility given theretoas a result of audit can be clearly expressed andcommunicated. 7 An audit produces an economic or social benefit. Mautz and Sharaf also suggest that: Concepts provide a basis for advancement in the field of knowledge by facilitating communication about it and its  problems.

Concepts of auditing

Process Ethical dilemmas arise where damage will be caused to someone whatever you do; they require analysis of the situation, consideration of possible actions and consequences, and a firm decision.Auditors should comply with ethical guidanceissued by their relevant professional bodies. Process is concerned with how audits areperformed, with: (a) seeking evidence to prove assertions by management; (b) evaluating the risk; (c) making judgements and assessments of significant matters.

There are four parties to the accountability /audit process: 1)preparer/source; 2)users of accounting information; 3)auditor; and 4)regulatory framework. There is a close relationship between accountability and audit, as accounts cannot become a tool of accountability until an independent auditor has examined and reported on them. ata u a

Communication Communication concerns the manner in which and to whom auditors communicate their views to other parties, whether formally or informally. Truth and fairness is an important element, but has never been defined; basically it is about the validity of the message given by the financial statements....KEY POINTS  –pp.45  –pp.45 –46Performance  –46Performance concerns several issues that auditors are expected to perform their work with due care; in accordance with accepted standards and; with rigour (encompassing (encompassing „professional scepticism‟). scepticism‟ ). Performance

a n yang e um a a n a an s ay a u p ate w ww w w .a . a u n a n s a n s n s . wo wo r p r es e s s .c .c o m   Contact me : [email protected] /@firmanmhmd (Line)

839

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) The Audit expectations gap is used to describe The difference between the expectations of thosewho rely upon audit reports concerning whatauditors do and what they are perceived to do. The gap consists of: 1)reasonableness gap; 2)performance gap. The reasonableness gap arises because people expect more of audit than is possible practically.The performance gap is that between what canreasonably be expected of auditors and what theyare perceived to do, and has two components: 1)deficient standards gap; 2)deficient performance gap.

Layers of regulation and control Layers of regulation and control are described under two headings: (a)external environment; (b) internal environment.

companies control themselves.The external environment is also vital in influencing the kinds of controls, and management‟s approaches a pproaches to them, within the internal environment of a company EXERCISE 1. Identification of management assertions in respect of figures in the financial statements is a vital part of the audit process. State whether you agree with this statement, giving practical examples. 2.Explain what is meant by the principle of auditor integrity. How do you think we should ensure that the principle is adhered to? 3. Auditors are expected to approach their work with thoroughness and with an attitude of professional scepticism. What do you think that professional scepticism means in practice? 4 .You are auditing a company that shows a loss for the year of £700 000. This figure is after charging impairment of property, plant and equipment of £1 500 000. As a part of your work you note that in the Directors’ Report a profit of £800 000 is quoted as profit for the year. What are your responsibilities in respect of this matter? ANSWERS

Layers of regulation and control indicate thatregulation and control operate at different levels both outwith and within a company. The external environment includes all commercial relationships the company has with competitors, customers and suppliers.It includes other companies with which it cooperates, and providers of funds. The external environment is a vitally important factor influencing the kinds of controls and management‟s approaches to them within the internal environment of companies.Corporate governance refers to structures within a company or imposed by society to control how companies are governed The regulatory framework comprises controls imposed by a wide range of bodies including parliament, stock exchanges, accounting and other bodies of the European Union, or even from outside the European Union. Commercial pressures in the external environment are important because the way the market behaves will have an impact on company performance and the way in which ata u a

1 .Whether managers actually prepare a list of assertions that they make about figures in the financial statements or on the quality of internal controls is perhaps doubtful. However, there are many implied assertions made by management when they include balances or figures in the financial statements. Thus, examples of what management is implying in relation to trade receivables are: a) Balances are genuine, that is, they represent amounts legally due to the company for goods in respect of which property has passed or for services rendered before the balance sheet date. b) The amounts stated as due to the company in respect of trade receivables will be received in full, the implied assertion here being that full provision for bad and doubtful debts has been made. c) All customers balances on credit are reflected in the trade receivables figure in the financial statements. The value to the auditor of identifying the assertions is that the evidence search can be conducted with specific objectives in mind. Thus, in respect of a) above, the auditors will direct their attention to proving that credit sales are completely and accurately recorded. This work would include obtaining assurance that sales and inventory cut-off is accurate to ensure that trade receivables represent amounts due at the balance sheet date. Specific tests would include a credit customers’ circularisation. The evidence search in respect of collectability would start from the assumption that amounts recorded are legally receivable. The objective in this case would be to prove that the valuation of trade receivables is valid. To this end, the auditor will examine credit customers’ ageing statements and look at the past record of payment by them. Other procedures would include examining payments by credit

a n yang e um a a n a an s ay a u p ate w ww w w .a . a u n a n s a n s n s . wo wo r p r es e s s .c .c o m   Contact me : [email protected] /@firmanmhmd (Line)

840

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) customers after the balance sheet date and testing for adherence to properly determined credit limits.The above argument leads to the conclusion that the statement is valid. Basically, identification of assertions is important from the point of view of both the effectiveness and efficiency of the audit process. 2 .The Auditors’ Code suggests that the principle of integrity means that auditors fulfil their responsibilities with honesty, fairness, candour, courage and confidentiality. The problem with words like integrity, honesty, fairness, candour, courage and confidentiality is that they are all intangible qualities and therefore difficult to assess. In practice, the only way that we can assess whether, for instance, people are honest and fair is to observe their behaviour. We might conclude that some circumstances hinder honesty in the performance of an auditor's duties. Such circumstances might include the holding of shares in the company or being a personal friend of the managing director. This means that apart from highlighting integrity as an important personal quality of the auditor, it is necessary to back up the principle by giving guidance to auditors on how integrity can be achieved. The question of appearance is a very important one and the profession has recognised for some time that being seen to be independent is just as important as being independent. The same applies to integrity. It can be argued, of course, that auditor reputation is so important that auditors will strive to maintain their integrity and independence as a matter of course. Integrity is certainly a quality that a profession would expect to see in its members and it could be argued that by publishing the principle of integrity APB is merely emphasising a general professional requirement. 3. You will have noted that the Auditors’ Code says that auditors assess critically the information and explanations obtained in the course of their work and such additional evidence as they consider necessary for the purposes of their audit. The word 'critically' is in fact the important word in helping us to understand what is meant by professional scepticism. The expression does not mean that auditors should approach their work with undue suspicion, but that they should not accept statements by management or documentation at face value. By way of example, let us assume that you are auditing a publishing company and that you have noted that the warehouse contains 20,000 unbound copies of one particular book. You raise the matter with management and they inform you that 15,000 copies have been sold to wholesalers after the balance sheet date, showing you orders from the wholesalers to support their assertion. You should not assume that management is misrepresenting the position to you, but as auditor you would need to look for evidence to prove their assertion. You might check, for instance, that the unbound copies are in respect of a current edition. 20,000 copies of the 4th edition of The Audit Process might not be saleable when the 5th edition is already available. One important point to emphasise is that audit work does not take place in a vacuum. If you have already concluded that management quality and trustworthiness is high and that there are no indications that the company might be in financial trouble, the audit work would be carried out in a different context a ta u a

than if you had not formed these conclusions. 4 . This matter is covered by the principle of Association. The directors appear, on the face of it, to be misleading the readers of the Directors' Report and there certainly seems to be conflict between the profit shown in that report and the loss shown in the Financial Statements. The readers would probably be very confused in the case cited and this might cause them to form the opinion that the auditor has not been competent. The auditors would ask the directors to change the Directors' Report, and if they refuse they would have to refer to the matter in the Audit Report, probably as an emphasis of matter.

CHAPTER 3 The Meaning and Importance of Auditor Independence

Principle of independent auditing A fundamental principle of independent auditing isthat: Auditors are objective. They express opinions independently of the entity.‟Flint suggests that audit is part of the public and private control mechanism of monitoring and securing accountability. Two elements are present if a true bond of accountability is to exist: (a)an account; (b)a holding to account. But financial statements are only an accountability document if credibility is added by an independent auditor.There are five broad classifications of accountability: (1) political; (2) public; (3) managerial; (4) professional; (5)personnel. Lee suggests the need for independence derives from the remoteness gap‟ between managers and stakeholders. The independent and competent auditor with adequate powers bridges the gap between them..Mautz and Sharaf identified two types of independence. 1. Practitioner independence (a state of mind comprising programming, investigative and reporting independence). 2. Profession independence (the existence of „built-in anti-independence factors‟). Practitioner independence is basically a state of mind with three dimensions: 1)programming independence; 2)investigative independence; 3)reporting independence.

Dimensions of practitioner independence Three dimensions of practitioner independence are : Programming independence 1a Freedom fromany managerial interference aimed at changing the outcome of the audit

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

841

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) 2a Freedom fromanyinterference with regard to the application of procedures 3a Freedom fromattempts to subject the audit to review other than that provided for

Shockley produced a conceptual model to aid researchers and regulators, based on factors that may impact on the auditor‟s ability to withstand pressure as shown below :

Investigative independence 1b Direct and free access to all necessary information and individuals 2b Active cooperation frommanagement during the course of the examination 3b Freedom from managerial attempts to control what is audited and establish the acceptability of evidential matter 4b Freedom from personal interests or relationships leading to exclusion from or limitation of any part of the report Reporting Independence 1c Freedom from loyalty or obligation to external parties 2c Avoidance of the need to exclude matters from the formal report in favour an informal report Reporting independenceInvestigative independence 3c Avoidance of the use of ambiguous language when stating or interpreting facts, opinions and recommendations 4c Freedom from any attempt to overrule the auditor‟s  judgement as to the appropriate content of the report Regarding profession independence, Mautz and Sharaf suggest that auditing suffers from „built -in antiindependence factors‟. Features that may affect perception of a practitioner as a member of the auditing profession are outlined in Table below : Reasons to question auditor independence :

Watts and Zimmerman discuss auditors‟ monitoring activities in the context of manager-agents‟ contracts with owner-principals. To be of value the auditors must report significant matters of concern. The probability of this taking place is likely to be high because of adverse effects on reputation should their failure to report comes to light. Goldman and Barlev identify possible areas of conflict:  between auditor and client;  between professional duty and self-interest;  between managers and shareholders; between client organization and third parties.  a ta u a

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

842

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) 4. 5. 6. 7. 8.

size; accounting flexibility; professional sanctions; legal liability; fear of losing clientele, reputation.

Lee meanwhile suggests that independence depends on the nature of the relationship between auditor and auditee and principally on the relative size of the participants .

The fundamental principles of the IFAC Code are:. integrity; 1. objectivity; 2. professional competence and due care; 3. confidentiality; and 4. professional behaviour. The factors Shockley identified are as follows: 1. MAS; 2. competition; 3. tenure; a ta u a

Potential threats to objectivity Threat Self-interestthreat Self-reviewthreat  

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

843

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012)   

Advocacy threat Familiarity or trust threat Intimidation threat

Other organizations issuing guidance on independence include: 1. European Commission 2. IFAC 3. IOSCO 4. OECD 5. SEC The SEC has approved several important changesto independence rules (i) bookkeeping or accounting services; (ii) audit of client‟s information system; (iii) appraisal or valuation services; (iv) actuarial service affecting amounts in financial statements; (v) internal audit services relating to internal accounting and financial controls or statements (vi) acting as director or employee or performing a decisionmaking or supervisory function for the client; (vii) acting as a broker, dealer, investment adviser or investment banker; (viii) legal services; (ix) providing expert opinions on litigation or regulatory proceedings or investigation....CHAPTER SUMMARYThis chapter has demonstrated: EXERCISE 1. Assume that you are a partner in a two partner practice with total practice income of £250,000. One of your clients (a private limited company with a turnover of £10 million and with some 80 employees) pays ongoing fees to you amounting in total to £35,000. Do you think that your independence might be threatened? What steps would you take in a situation like this? (b) Assume that you are partner in charge of an office of your firm. You are engagement partner of a major client whose fees of £150 000, represent 2 per cent of the total gross practice income of your firm, but 20 per cent of the income of your office. Consider the implications in the light of the IFAC Code and APB Ethical Standards (c) Assume that you are a partner with a number of clients for whom you are personally responsible. One of these clients is much larger than the others and you have to spend about 40 per cent of your time on the assignment. The fees receivable represent about 4 per cent of the gross practice income of your firm. Your own income is not based on fees receivable from this client. Consider the implications of this situation. 2. You have been asked by your audit partner to be senior in charge of the audit of a small public limited company. Unbeknown to the partner, you hold 1,000 of the 100,000 shares in the company. Do you think that you could remain unbiased in relation to this client? 3.You have just been telephoned by the chief accountant of a listed company client  –  Randerston plc  – to tell you that there has been a computer breakdown and that some parts of the data concerning construction contracts have been lost. He asks if two senior members of the firm’s engagement team could be loaned to enable reconstruction a ta u a

of the data to be made on a timely basis. The deadline would be in 30 days time when the draft financial statements are due to be finalized. What issues would you consider and what would be your response? ANSWERS 1 a) In this case, the fees are less than 15% of gross practice income, but they are far in excess of the 10% and you would no doubt not wish to lose this income. ES4 certainly suggests that this situation might threaten independence. You might feel yourself that you are professional person and could maintain your independence, but you should remember that it is the perception of independence that is  just as important as actual independence. There are two important matters in relation to the scenario outlined, namely, that the audit client is not a small entity, but your firm has less than three partners and cannot fulfil the requirement that an ethics partner should perform a hot review of the audit procedures, documentation and conclusions before the audit report is finalized. However, you should certainly discuss the key issues affecting the audit of your client with your fellow-partner, and perhaps even ask an outside firm to perform the hot review for you. You should also inform those charged with governance of the audit client of the significance of the fee issue, and you might even consider giving up some of the non-audit work, if any, particularly if the fees are likely to rise above 15% of your gross practice income b) The problem here is that losing this client might mean that the office would lose its viability and your objectivity might be threatened in consequence. The threat to your independence would be particularly grave if your remuneration was based, at least to some extent, on the fees generated by your office. This is clearly a situation where the matter should be referred to the ethics partner. However, as your remuneration is based to some extent on the fees of this client this looks as if your firm might have to consider resigning from the audit of this client, unless your firm can assign this client to another part of the firm c) You are clearly spending a great deal of time with the client in question, and your objectivity might be threatened because of the closeness of the relationship, that is, there may well be a familiarity threat. Although the fee income is below the limits specified in ES4 and though your own remuneration is not affected specifically by the fees received from this client, your firm would have to have policies and procedures in force to ensure that the familiarity threat was countered. The matter should be referred to the ethics partner, who might perform a hot review of the audit procedures, documentation and conclusions, considering in particular the key inherent and control risks facing the client. Consideration should also be given to the period of time that you have been involved with the client and in the circumstances it might be wise to consider rotation even if your period of engagement does not exceed the limits specified in ES3 (5 years for a listed company client and 10 years for a non-listed client). 2. You might think that holding 1,000 shares from 100,000 would be a matter of little importance as it represents only 1% of the total. However, holding of shares in the auditee company is one particular risk to integrity, objectivity and independence that ES2 regards as an insurmountable self-

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

844

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) interest threat. You might regard yourself as a fairly lowly member of staff and that, as your work is reviewed and controlled by others, there would be no threat as far as your audit firm is concerned. However, being senior in charge, you are likely to have an influence on the conduct and outcome of the audit and you should inform the audit partner of your holding. The likely action by your firm is concerned would be to remove you from the audit, and, if you have already been engaged in some audit work, to have this work subjected to independent review. This is because there are no safeguards to counter a financial interest of this nature (see paragraph 8 of ES2. You could, of course, dispose of your shares if you wish to continue as senior on the assignment, but even then, you might be excluded temporarily (see paragraph 13 of ES2.

4. wish to avoid public criticism if failure occurs. Audit’s self-regulation The concept of self-regulation is common in the Englishspeaking world for historical reasons (mainly the early establishment of the accounting bodies in the British Isles). The idea is not common in many other parts of the world however, principally on the continent of Europe, for example Germany

Functions of the Institut derWirtschafts-prüfer (IdW) and the Wirtschaftsprüferkammer

3.The general rule is that accounting services should not be provided to listed company clients (see paragraph 117 of ES 5). However, this is clearly an emergency as contemplated in paragraph 121 and one that might have unfortunate consequences for Randerston plc, if it meant that it missed filing financial statements on a timely basis, or if obtaining further lines of credit was dependant on timely preparation of those statements. In these circumstances you could accede to the request of Randerston’s chief accountant, but you have to warn him that the two members of staff seconded to the company would not be able to take any part in the audit engagement. You might suggest that two other members of staff with IT and accounting backgrounds could perform the work instead. You should also say that the help that the audit firm’s staff would be of a technical nature and that they should not take part in any activity which would be the province of management, such as making decisions on such matters as stage of completion and any profits or losses to be taken up.

CHAPTER 4 Audit regulation

Audit dan regulation In many countries the auditing profession and its associated bodies have considerable powers to determine how their work is performed, The profession may be said to be selfregulated. But government does not leave it completely to them to determine all aspects of regulation. List reasons why there is a need for Reasons for regulation include: (a)most professions are regulated in some way; (b) it provides some assurance to users that certain standards are met; (c) setting standards helps reduce the risk for users; (d) regulation helps to enhance confidence and substitutes for the element of trust. The power the state cedes may be dependent on: 1. attitude towards particular forms of political economy; 2. opinion of the expertise, integrity and stage of development of the professional body; 3. whether it believes a (private) professional body is likely to be a more efficient regulator; and a ta u a

Role of the accounting bodies The role of the accounting bodies in regulating auditing was enhanced by the Companies Act 1989, which established two types of body: (1) Recognized Supervisory Bodies (RSBs); (2) Recognized Qualifying Bodies (RQBs). The main accounting bodies in the UK all have RSB and RQB status. The role of an RSB is to maintain and enforce rules as to:

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

845

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) (a) eligibility of persons to seek appointment as company auditors; (b) the conduct of audit work The role of an RQB is to enforce rules, such as those relating to: (a)admission to or expulsion from a course of study leading to a qualification; (b)the award or deprivation of a qualification; (c) the approval of a person for the purposes of giving practical training or the withdrawal of such approval. Some commentators have suggested existing systems of audit regulation would be improved by setting up an independent Office for Auditing to oversee the framework for large company audit appointments, auditor remuneration and audit practice of the major accounting firms. This would represent a clear departure from the system of self-regulation The UK regulatory system remained in force until major changes in 2003. However major changes in audit regulation also took place prior to 2003. Examples include: (1) recommendations of an ICAS paper of 1995 (2) a new regulatory regime The new regulatory regime was based on six key principles: (1)independence; (2) public interest and integrity; (3) transparency and openness; (4) proficiency and commitment; (5) relevance; (6) review. Regulatory system in force until 2003

The Accountancy Foundation had three mainfunctions: . 1)to appoint board members to its various bodies; 2)to act as the channel for finance and funding; 3)to be the key point of contact with government, the accountancy profession and others. The main purposes of these bodies is as follow :  The Review Board was to monitor the regulatory structure and ensure it was meeting the public interest, overseeing the work and the responsibilities of the various accountancy bodies. The Ethics Standards Board was to set the agenda  and principles that underpin the ethical standards set by the bodies and to approve them before issue. The IDB was expected to take over responsibility of the Joint Disciplinary Scheme and to investigate members of accounting bodies where there was a public interest element. Monitoring of audit firms by JMU or by ACCA is to ensure that companies are complying with audit regulations and auditing standards. The JMU ceased to exist at the end of 2003 Following various scandals in the USA, the UK government decided to review the audit and accountancy regulatory regime and set up two major reviews: (1) „Review of the Regulatory Regime of the Accountancy Profession‟ (RRRAP); (2) „Co-ordinating Group on Audit and Accounting Issues‟ (CGAA The main recommendations of RRRAP concerned the roles of: (a) the Financial Reporting Council (FRC); (b) APB; (c) Professional Oversight Board (POB); (d) IDB APB would be responsible for setting standards relating to independence, objectivity and integrity.POB would oversee the audit function, approve professional RSBs and RQBs and have responsibility for ethical issues remaining with professional bodies. A new Audit Inspection Unit would report directly to POB.IDB would hear significant public interest cases. The main reasons for the proposed changes were: (a)existing system too complex and functions and responsibilities overlapped; (b) the Accountancy Foundation did not have a sufficiently authoritative voice; (c) one regulator should cover accounting and auditing, including setting of standards; (d) regulatory regime should be independent. APBis a successor body to APC, which was criticized for serving the interests of large firms rather than the public and because its guidelines were not authoritative. APB is more independent (half of its members are non-auditors) and issues auditing standards in its own right, which must be followed by members of an RSB. APB objectives (2003) indicate its wide role: (a) lead in establishing auditing standards; (b) advance public understanding of the roles and responsibilities of auditors;

a ta u a

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

846

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) (c) take an active role in the development of statutes, regulations and accounting standards that alter the conduct of auditing; (d) support international developments in auditing

Auditing standards and audit quality APB believes auditing standards will enhance audit quality; reduce incidence of audit failure; increase the confidence of users. Such standards will set a minimum level of performance and provide a benchmark by which the quality of audit work can be measured. Auditing standards contain prescriptions with which auditors are required to comply. It may not be easy to determine compliance as standards may lack specificity and be open to interpretation. Practice notes and bulletins are issued to assist with application and provide auditors with timely advice on new or emerging issues Regulatory structure from 2003

Other matters covered include (c) statutory relationships between auditors and shareholders; (d) the statutory relationships between shareholders and directors; (e) the practical relationships between auditors and directors.Figure below provides a diagrammatical outline Legal and practical relationships

The main concerns for CGAA were: (a)auditor independence; (b) corporate governance and the role of the audit committee; (c) transparency of audit firms; (d) financial reporting standards and enforcement; (e) monitoring of audit firms; (f) competition implications. Further regulationincludes provisions in CA 1989. The legal rules encompass such matters as: (a)the individuals and firms who are permitted to act as auditors; (b)the period for which the auditor is appointed. Period of auditor appointment and accounting reference period and date

a ta u a

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

847

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) CHAPTER 5 The Risk-based approach to audit : Audit Judgement

Audit Risk Audit risk (AR), the risk that auditors may give an inappropriate audit option, has three components: (a)Inherent risk; (b) Control risk; (c) Detection risk. Two further elements to audit risk are: (a)engagement risk, arising from (i) competitive tendering by audit firms; (ii) inherent risk factors not known to the potential auditors when tendering; (b) independence in fact risk, or the risk that auditors may fail to report material misstatements in the financial statements, detected by their audit procedures). 





Business risk results from significant conditions, events, circumstances, actions or inactions that could affect the entity‟s ability to achieve its objectives. Business risk is broader than the risk of material misstatement of the financial statements. Business risk may arise from change or complexity or through a failure to recognize the need for change.

Examples of risks Examples of risks include: (i)Changes in operating environment; (ii)New personnel; (iii)New or revamped information systems; (iv)Rapid growth; (v)New technology; (vi)New business models, products or activities; (vii)Corporate restructurings; (viii)Expanded foreign operations; and (ix)New accounting pronouncements.

risk, particularly if the auditor is unaware of management deficiencies and / or unusual pressures on them Tendering for audit services has become important and is accompanied by lower audit fees. This possibly results in policies to reduce the amount of audit work carried out.Another risk factor related to lower audit fees is that auditors become more reliant on non-audit services, with a consequent threat to independence.

Business risk assessment Examples of business objectives are: 1. attaining a certain level of profitability; 2. maximizing shareholder wealth; 3. ensuring efficiency and effectiveness of operations; 4. meeting a desired market share; 5. giving customer satisfaction; 6. maintaining a desired level of liquidity; 7. maintaining reputation; 8. meeting the challenge of changes; 9. adherence to accepted principles of corporate governance. Business risk assessment is a management technique. Objectives may change as circumstances change so assessment should take place regularly. The approach has been adapted to allow auditors to provide business risk assessments as consultancy exercises to audit clients. There are similarities between business andinherent risk approaches: (a)both use a „top-down‟ approach; (b) factors that increase inherent and control risk may make it less likely that business objectives will be obtained; (c) analysis of both helps auditors to prove that financial statements give a true and fair view. Dissimilarities are: (a)auditors consider inherent risks in relation to the impact they may have on financial statements, but the business risk approach considers risks inhibiting the company in achieving objectives; (b) business objectives and audit objectives are so dissimilar that the above factors cannot create a similarity.

Components of audit risk The three components of audit risk are related:

Benefits of the business risk approach are that it:

Audit risk (AR) = inherent risk ×(IR) ×control risk (CR) ×detection risk (DR).

(a)improves the basic audit of financial statements and makes erroneous conclusions less likely; (b) makes audit more efficient and therefore more profitable; (c) expands potential for giving assurance to management to „add value‟ and to create additional sources of income.

DR relates to acquiring confidence . If the auditorneeds a low detection risk, more transactions andbalances are tested substantively, and the moreconfident the auditor is that all are valid. Auditors decide initially the level of audit risk acceptable to them. Some auditors assess risk in qualitative terms –low, medium and high –but the principle is clear that if you wish audit risk to be low and you know that inherent risk and control risk are both high, detection risk will have to be low. Engagement risk is when incoming auditors have little indepth knowledge of new clients.This is likely to enhance a ta u a

This leads in turn to: (d) expanded audit, which has the potential to contribute to corporate governance arrangements and disclosures; (e) a better understanding of a client‟s business and its risks, thus reducing auditors‟ engagement risk Another potential benefit is : (f) advances in IT have resulted in company records being inherently more reliable, leaving more scope for audit effort to be devoted to higher level assessments.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

848

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) Business risk approaches Business risk approaches mean much planning work is performed by experienced staff. But knowledge about management allows auditors to form views on the reliability of management and the control environment, and on analytical evidence.This may lead to a loss of independence and, by cutting down on over-auditing in non-risk, to underauditing

The letter of engagement The letter of engagement provides the audit framework and contains:

Analytical procedures are defined in ISA 520 as:

The time and fee budgets are directly dependent on evaluation of risk, which determines the extent of substantive procedures. The most important resource used is the time of partners and staff of the audit firm. The time budget is designed to give sufficient time to reduce audit risk to acceptable levels

Evaluations of financial information made by a study of  plausible relationships among both financial and non financial data. Analytical procedures also encompass the investigation of identified fluctuations and relationships that are inconsistent with other relevant information or deviate significantly from predicted amounts

Judgement Judgement is one of the „enduring principles of auditing‟, but it is intangible in nature. The relationship between  judgement and risk is direct, as judgement is exercised in the context of risk. In forming judgements the auditor makes initial risk assessments, but modifies them on the basis of controls in existence and on the validity of figures in the accounting records In managing the audit process there are two basic related objectives: (a)being professionally effective; (b) making a fair profit in performing professional duties. The starting point for effective management of the audit process is to create a logical structure within the firm and to allocate responsibilities to partners, managers, seniors and assistant auditors, ranging from overall professional effectiveness to performing detailed audit work Schematic diagram of an audit firm

(a)responsibilities of directors and auditors; (b) scope of audit; (c) other services; (d) fees.

EXERCISE 1. Consider the following statements and whether they might be true or false. Provide explanations with your answers. a) The directors of the client company sign the audit engagement letter. (b) The auditor must always discover fraud and other irregularities. (c) Fees of the auditor are based on the time taken and the grade of staff involved in the assignment. (d) A business risk approach by auditors is wider than the audit risk approach. 2. The audit firm consists of a collection of individuals with varying degrees of experience and expertise. Briefly describe the role that individual staff members play in achieving audit objectives. 3. You are the senior in charge of the audit of a local newspaper and have been asked by your audit assistant to explain what kinds of income and expenditure can be expected to arise in the company. She is also anxious to know if there are any particular problems that might be faced by management and, therefore, the auditor. Think of problems such as reporting on circulation of the newspaper to government or independent bodies and maintenance of circulation. 4. Discuss briefly the following statements (a) Audit risk is the risk that control systems will not detect material misstatements in the financial statements subject to audit. (b) Cumulative client knowledge enables the auditor to be more efficient and aids effectiveness in the audit process. Explain what you understand by cumulative client knowledge. Ask yourself what information about an organization would be useful to you on a permanent basis. (c) The letter of engagement is of little value, as most clients will not understand what it means.

ANSWERS 1. a) True The important thing is that both auditors and client are aware of, indeed have a full understanding of, the nature of the assignment and the rights and duties under it. The statement is, of course, only partially true. The fact is that both directors and auditor should sign the letter, the a ta u a

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

849

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) auditor at the time of sending the letter and the directors or their representative, at the time of returning it. There is no reason why the client should not send the letter in the first place, but normally it is better that it be drafted by the professional firm. It would, of course, be necessary to discuss it in detail with the directors before it is finalised. b) False There is much discussion about the auditor's duty with regard to detection of fraud and other errors .Basically, the auditor is required to focus on areas where there is risk of material misstatement because of fraud, including management fraud and to maintain an attitude of professional scepticism throughout the audit. However, the primary responsibility for the prevention and detection of fraud rests with both those charged with governance of the entity and with management. (See paragraph 4 of ISA 240 The Auditor’s Responsibilities relating to f raud in an Audit of Financial Statements). c) True The basis of charging fees must be such that the auditor is, and is seen to be, independent. The preferred basis for charging fees is time taken and grade of staff engaged. Some firms charge on the basis of a so- called ‘balanced audit team’. Recently there has been much more openness in setting fees with large firms tendering at fee levels considerably less than only a few years ago. d) True To some extent inherent risks, which form one component of audit risk, are similar to business risks in that they need to be subjected to management controls to alleviate their impact. Business risks are those risks that may make it difficult to achieve management objectives. For instance, an hotel might have a preferred room occupancy rate to achieve desired levels of profitability. We have already seen in this chapter that management may introduce management information systems on such matters as rooms currently unoccupied and peaks and troughs of occupancy. This information is a form of control and would be used to inform potential customers whether rooms are available and to enable them to put in a strategy to increase room occupancy at less busy times. For auditors, knowledge about how the company controls business risk in this area, would be an important element in work designed to prove that accommodation income appearing in the profit and loss account was true and fair in the context of the financial statements taken as a whole. However, inherent risk approaches are more limited than business risk approaches as they are directed to the financial statements in the context of the auditors' opinion on the financial statements. However, business risk approaches are designed to aid management in achieving business objectives, of which the preparation of fairly presented financial statements would only be one. Thus, it is true to say that a business risk approach by auditors is wider than the audit risk approach. 2. There are individuals and functions involved in the provision of audit work. These include the members of the engagement team comprising: ● the Engagement Partner (who has overall responsibility for the assignment) ● Manager in charge of the assignment (who has ove rall responsibility for supervising the assignment, staying in a ta u a

close contact with the Engagement Partner and the other members of the Engagement Team) ● Other audit staff, including people with varying degrees of experience  –  the senior in charge who will be present throughout the assignment - and staff with less experience such as semi-senior or junior staff whose work will be closely supervised. ● Other professional staff with special skills, including IT and tax experts, who will be used at particular points of the audit work. Apart from members of the Engagement Team, there are other individuals and functions that play a role in achieving audit objectives. These include: ● Staff providing a technical advisory services, such as advice on the application of accounting and auditing standards ● Ethics Partner who advises the Engagement Partner on possible threats to independence, including possible breaches of the firms ethical guidelines. ● Engagement Quality Control Reviewer who is there to ensure that high standards are maintained during and at the end of the audit process. This person may review working papers and act as intermediary in the event of disagreement between the Engagement Partner and the Ethics Partner. ● Others in the Audit Firm’s chain of co mmand, including those at the top of the firm who are responsible for the Firm’s Control Environment. It is important to note that the activities of the firm must be organised to produce the professional service when it is required. It is quite likely, for instance, that there will be a partner in charge of the computer/IT services and of the taxation services. In preparing the audit plan, approaches will have to be made to the specialist services to ensure that their staff will be available when required. It will also be desirable that the person in charge of the typing services is aware of deadlines and other reporting requirements (for instance, complicated diagrams and layouts) on a timely basis. 3. Typical income in a company publishing a newspaper: - Sale of newspapers: Office sales, Newsagent sales, Street sales - Sale of advertising: Classified advertising, Block advertising (Prominent advertising of commercial and official material) - Sale of photographs - Games and competitions entered by the readership Typical expenditure of a company publishing a newspaper: - Newsprint - Inks of various colours - Sundry printing costs, including repair and maintenance of printing machinery - In a company using the latest technology, we would expect to find both capital and revenue costs associated with the technology - Salary and wage costs of: Editorial staff, Reporters, Photographers, Copy readers, Delivery people. Advertising department staff (including classified advertising staff dealing direct with the public, and designers and setters of larger advertisements), Administration staff - Expenses connected with obtaining stories and photographs - Distribution costs, including delivery van costs (petrol, servicing, depreciation of vans etc.) - Payments to free-lance writers

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

850

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) - Payment of prizes to the winners of games and competitions. Possible problem areas for management and auditor: - Reporting on circulation of the newspaper to government or independent bodies. The average sales over a period of time represent actual sales (not print runs), so it is important to reconcile print runs with recorded sales. Typical reasons for differences between print run and quantities sold will be: copies given to editorial and other staff, free copies given to libraries and other organisations, copies not sold, either by own staff or newsagents. There should thus be control over copies returned for pulping. The auditor would have to find out if it is company policy not to charge newsagents for returned copies. - Maintenance of circulation. This normally has a correlation with advertising and the auditor would find circulation and advertising statistics produced by management for their own purposes, useful sources of evidence. - Control of advertising to the newspaper. Classified advertising consists of many hundreds of transactions each time the newspaper is produced. The control of advertising is complicated by the fact that there are often special rules where an advertisement is placed several times in the paper: 'One free for every three placed', for instance. Management will have to institute tight systems of control, not only to ensure that the advertisement appears in the correct form and in the desired issue of the paper, but also that the income has been completely and accurately recorded. The auditor will investigate the operation of the control system, but, like management, should be able to substantiate total advertising revenue on a global basis. Each page of classified advertising should be valued for each issue and reconciled to revenue. The auditor can do this sort of check on a test basis. - Control over expenses of reporters, photographers and other members of staff will require the drawing up of detailed rules and internal checks to ensure that the rules are adhered to. The auditor would test the system of control to ensure it is working properly and check a selection of expense reports to ensure the expenditure has been incurred by the staff member, that the amounts are in accordance with predetermined rules and that they have been agreed by responsible officials. This review of newspaper income, expenditure and management and control problems has touched upon typical matters and is not intended to be complete. What is important for the auditor is to understand how to approach audit assignments, even in unusual industrial and commercial sectors. 4 a) Failure by control systems to detect material misstatements in the financial statements subject to audit will of course increase audit risk, but audit risk is affected not only by control risk, but also inherent and detection risk. The statement in the question was designed to help you to understand the nature of audit risk. As we made clear in the text, audit risk is a concept that has been receiving greater notice in recent years and it is important that you should understand its significance. The statement is therefore incomplete. Control systems should be a ta u a

designed to mitigate the impact of inherent risk and the auditor should review control systems to ascertain whether they are likely to detect material error and irregularity deriving from inherent risk. After considering the levels of inherent risk and control risk, the auditor determines the scope of examination in order to reduced detection risk to acceptable proportions. b) Cumulative client knowledge is all the continuing useful information about the Client Company, collected by the auditor during association with the company. Much of this information will be included in working papers and correspondence files, but some of it will be in the minds of people. Typical useful knowledge will include: - Key personnel: details of position, experience and background; personality and management style History of company, its position in the industry/commercial sector and its strategy to reduce risk and to meet the problems of the industry - Products and their nature, major customers and suppliers - Particular audit problem areas and how the problems were solved in the past - Details of systems in use and the number of transactions they process during an average week/month/year. All audit firms try to keep permanent records of cumulative client knowledge, by, for instance, requiring the senior to copy all matters of permanent interest from the current year's working file and correspondence files to a permanent file. Correspondence between the client company and the bank on new and stringent arrangements for control of the bank overdraft would be a typical item to be kept permanently. It must be said that keeping the permanent file up to date and uncluttered with irrelevant material needs considerable discipline on the part of the auditor, although this is probably easier where the audit firm is using computerised audit files. It is human nature to move to the next assignment without dotting the i's and crossing the t's on the previous one. That cumulative client knowledge is important is not to be doubted. To acquire knowledge is an expensive business, and if you are collecting the same knowledge year after year, you not only run the risk of upsetting the client staff, you also make the audit process much less efficient and profitable than it should be. The other matter of importance is the question of effectiveness. The raison d'etre of the external auditor is the professional one of giving an opinion on the truth and fairness of financial information. In attaining the professional objective, the auditor has to obtain sufficient, appropriate (relevant and reliable) information. If the audit firm has not maintained cumulative client knowledge properly in previous years it is likely that the auditor will be less effective in the current year. c) If the client does not understand the letter of engagement and can prove that the auditor did not explain it properly to them, the letter might indeed be said to be of little value. A court might well take the view that the auditor had merely produced a document to protect him or her and that the client had a legitimate expectation that the auditor had not fulfilled. The letter of engagement should be seen as the document setting the scene for the future relationship between

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

851

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) auditor and management. It should be relevant to the company being audited and should be discussed paragraph by paragraph with the client before signature. The client should have the opportunity to suggest amendments and to have any matter explained that is not understood. The statement in the question should be rejected

CHAPTER 6 The Search of Evidence Explained

Search for evidence The audit process is a search for evidence to forman opinion, based on a whole series of conclusionswith regard to: (a)accuracy and dependability of the accounting records; (b) validity of figures in financial statements; (c) compliance with legislation and accounting and reporting standards. Relevant ISAs in the area are:  ISA 500 –Audit evidence ISA 501  –Audit evidence: additional considerations  for specific items. The purpose of these standards is „to establish standards and to provide guidance on what constitutes audit evidence in an audit of financial statements, the quantity and quality of audit evidence to be obtained, and the audit procedures that auditors use for obtaining that audit evidence. Evidence supporting reasonable conclusions

Sufficient and Appropriate Evidence The words sufficient an appropriate are interrelated, appropriate having two further elements: (a) Relevant, that is, pertinent to the matter in hand; (b)Reliable, that is, trustworthy, with some grades of evidence more reliable than others. Evidence is persuasive rather than conclusiveand auditors seek evidence from different sources to support the same assertion (that is, to corroborate it). There is a link between persuasiveness and quantity as auditors seek to be a ta u a

persuaded that objectives have been met by accumulating evidence Evidence is the cornerstone of the audit process –a prerequisite for forming an opinion.Collecting and assessing it needs considerable imagination; the relevant evidence is frequently difficult to find, being often concealed (whether intentionally or unintentionally

Management assertions Management assertions may be classified in thefollowing three ways: (1) genuine; (2)accurate; (3) complete. Trade debtors exist and owe the amounts stated in the debtors ledger to the company. Trade debtors‟ balances are fully collectible.All amounts owed by the trade debtors are included in the amount attributed to trade debtors in the financial statements and relate to the correct period. This approach enables auditors to set objectivesand place evidence search in a suitable context.Guidelines for assessing evidence are as follows: (a)Audit evidence is more reliable when it is obtained from independent sources outside the entity; (b) Audit evidence that is generated internally is more reliable when the related controls imposed by the entity are effective; (c) audit evidence obtained directly by the auditor is more reliable than audit evidence obtained indirectly or by inference; (d) audit evidence is more reliable when it exists in documentary form; (e) audit evidence provided by original documents is more reliable than audit evidence provided by photocopies or facsimiles (f) evidence created in the normal course of business is better than evidence specially created to satisfy the auditor; (g) the best informed source of audit evidence will normally be management of the company but m anagement‟s lack of independence reduces its value as a source of such evidence; (h) Evidence may be upgraded by the skilful use of corroborative evidence

Business risk approaches Business risk approaches have resulted in greater reliance on management. As auditors align them-selves more with management, they begin to feel that they can judge individuals‟ integrity. This trust can result in a reduction in substantive testing, with a consequent reduction in audit cost to counterbalance the increased cost of time spent at the planning stage. This approach might not be justified in the light of Enronand WorldCom, and the agency theorists may be rightthat it would be unwise for auditors to accept the wordof management, without obtaining considerable corroborativeevidence from elsewhere. But auditors do not start from a presumption that managements lack integrity. A major issue is that business risk may bring the auditor so close to management that independence may be threatened

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

852

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) Audit Engagement Professional accountants carry out engagement in relation to financial engagements may result in lower levels collected, so that a „true and fair‟ form be given.. Such audits are likely to be nonetheless.

many kinds of information.Many of evidence being of opinion cannot of value to users

Examples of such engagements are: 1. compilation engagement; 2. limited assurance engagement; 3. agreed-upon procedures engagement. Compilation engagement is when professional accountants prepare financial statements using data and information provided by management and a compilation report is issued that gives no assurance as to truth and fairness, nor compliance with CA 1985 and accounting standards Limited assurance engagement is not a full audit but the professional accountant forms an opinion on the reasonableness of financial statements and obtains limited assurance that the financial statements comply with the CA 1985 and accounting standards. The review report contains a negative form of opinion Agreed upon procedures engagementis similar to a review except that certain detailed procedures would be performed, as agreed with management, requiring the accountant to seek evidence that the items subject to the agreed procedures have been stated appropriately

EXERCISE 1. Consider the truth or falsity of the following statements: (a) Sufficient evidence for the auditor means having enough to form a conclusion that an assertion made by management may be accepted. (b) Relevant evidence for the auditor would include the following: (i) The dates that the chief accountant goes on holiday. (ii) A file of recognized suppliers. (iii) The place that the chief accountant chooses for his or her holiday. (iv) Credit limits of customers buying on credit (c) Reliable evidence means evidence that has been vetted by the company’s directors. (d) Written evidence from a bank manager is reliable evidence. (e) Written evidence from within the company is not reliable. (f) If differing types of evidence are consistent with each other, the auditor can reduce the amount of evidence collected and examined. (g) Physical inspection by the auditor of a non-current asset provides the auditor with reliable evidence as to its existence, but not as to its ownership, cost or value. 2. You are the auditor of Oakshaw Ltd and are searching for evidence to prove that the figures for purchases and related creditors are true and fair in the context of the accounts, taken as a whole. You have extracted the following information from the accounts at 31 December 2010: Change dates to 2010 and 2009 respectively and change stock (twice) to Inventories’. a ta u a

Your audit work has revealed the following: (i) Discussions with management and other tests show that selling prices have been increased by more than the cost of purchases with the result that gross profit has improved by 1 percentage point. (ii) The company maintains the following records: ● Purchase requisitions from stores to the purchasing department (this is the request that goods be purchased). ● Purchase orders made out by the purchasing department on the basis of purchase requisitions and files of information about suppliers (the purchase order is a request to a supplier of goods to deliver them). ● Goods received notes made out by the goods receiving department when goods are received. ● File of purchase invoices received from a supplier. ● Inventory records showing quantities of receipts, issues and balances of inventory on hand. ● Purchase journal in which all invoices are recorded. ● Purchase ledger containing personal accou nts for each supplier. ● General ledger accounts, containing, among other things, purchase accounts and trade payables control account. (iii) As a result of your systems work you have concluded that each of the above records are held by different people and that they are carefully and properly controlled. Required : (a) Describe the kinds of evidence that can be used to upgrade the various documents and records. (b) Explain how the systems work and the review of the accounts may help you to accept the f igure of ‘purchases’. 3 Below is a list of sources of audit evidence: (i) The chief accountant, who is a member of CIMA, explains why inventory levels are higher at the end than at the beginning of the year. (ii) A storeman in the main store explaining how the store control system operates. (iii) An invoice from a supplier of electricity. (iv) A trainee accountant, presently studying for professional accounting examinations, explaining the reason why telephone charges were lower this year than last. (v) A letter to the auditor from a lawyer confirming that, as far as he is aware, there are no legal matters of material significance. (vi) A confirmation from a credit customer agreeing that a balance in the books of the entity is correct. (vii) A calculation of tax charge and liability made by the auditor. (viii) Inventory count sheets, the count having been observed by the auditor. (ix) The company’s order book, showing orders received from customers. This book is required for company planning purposes. (x) Estimates of useful life of newly acquired plant, made by the production director. Required : (a) Suggest which sources may be regarded as reliable, explaining why this is so. (b) Suggest how you might upgrade the evidence, if

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

853

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) required. 4 Explain the meaning of the following terms: (i) Interim examination. (ii) Final examination. (iii) Inconsistent audit evidence. (iv) Systems-based evidence. (v) Third-party evidence. (vi) Persuasive evidence.

ANSWERS 1 a) True The statement is true in itself, although it is incomplete. Auditors must clearly have enough evidence to form their conclusions. For instance, management might claim that the credit control department has checked all sales orders to ensure that the customer is likely to pay for goods and services ordered. Auditors may wish to satisfy themselves on this point and will test enough sales orders for evidence of credit control to ensure that the risk they have not been checked appears low. However, sufficiency of evidence is only one aspect. It is necessary also that it be relevant and reliable. It certainly appears to be relevant to ensuring within reason the credit worthiness of customers. b) i) True The dates that the chief accountant goes on holiday may well be relevant. For instance, if he or she exercises an important control function, care must be taken to ensure that, when on holiday, proper cover exists. The auditor might wish to test the holiday period in greater detail. ii) True The purchasing officer needs a file of recognised suppliers, when deciding who should supply goods and services to the company. As the list would need to be accurate for this purpose, the auditor would find it reliable in determining whether all liabilities have been reflected in the accounts. A typical audit question might be: 'I see that Runcorn Ltd is on your list of suppliers of Product X, but this company does not appear in the purchases record this year. Do you owe this company any money at the year- end?' Clearly, the list would be relevant as well as being reliable evidence. iii) False We have suggested that the statement is false and to the extent that the chief accountant went on holiday to one seaside resort last year and to another this year, it would not be particularly relevant. If, on the other hand, the holiday was more expensive and the chief accountant's general standard of living higher than salary would appear to justify, the auditor might wish to consider whether he or she might be misappropriating funds from the company. iv) True Debtor's credit limits may be very relevant evidence. If limits are much exceeded, for instance, this might indicate that credit control is inadequate and that more work will be required to prove that the trade receivables are collectible. c) False While vetting by company directors may add to the reliability of evidence (for instance, directors' comments on a legal claim against the company), care should be taken in accepting it too readily. Evidence originating from directors a ta u a

or controlled by them is not as reliable as evidence obtained from independent third parties or created by the auditor himself. It may, of course, be substantiated by evidence from other sources. d) True The written evidence from the bank manager is good evidence and is reliable because it comes from an independent and professional source. However, the bank manager might not be aware of all bank accounts owned by the company if they had been made secret by putting them in the name of a specified individual. e) False While written evidence from within the company is not of itself reliable because it comes from a dependent source, it comes from a very well informed source and if it is derived from sound systems, it can also be very reliable. f) True Consistency is the basis for upgrading audit evidence, as evidence corroborated by other evidence is strengthened. For instance, the signature of an employee in a personnel record will provide evidence that a payroll entry bearing the same signature is accurate, each signature adding to the value of the other. This, of course, would be dependent on the personnel record being held by individuals other than those preparing the payroll. This is an example of synergy or a situation where 2 + 2 may equal 5. Conversely,inconsistent evidence may result in evidence previously collected not being accepted as of value. Thus, if the company's lawyer suggests that on the basis of previous case law, the company has a good chance of defending successfully a case brought against it, this apparently good evidence may be nullified if a second lawyer contradicts the first view. The auditor would then have to seek further evidence to confirm or refute either view. g) True If the auditor physically inspects the fixed asset, quite clearly this will prove that it exists. The question of ownership, cost and value can only be answered by looking for other kinds of evidence, such as original invoice for the asset, its entry in the fixed asset register and valuers' reports. 2 a) Oakshaw purchases and trade payables audit trail indicates the upgrading process and you should study it carefully. Remember the various rules we discussed in the text, to which you should refer if you have any difficulty. b) The brief answer to this question is that the auditor obtains satisfaction from a number of different sources. If the systems for controlling purchase transactions is proved to be sound, this will give some confidence that the purchases figure is valid. Similarly, if the review of the financial statements reveals nothing that is strange in relation to what the auditor knows about the company (that is, all the figures appear consistent with each other), this work can also support the purchases figure. Detailed matters of significance are as follows: 

Systems: We are told that different people control the purchase and trade payables records. We shall see later in this book that this is a very important control feature. Also the auditor's work has

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

854

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012)



revealed that the records are carefully and properly controlled. Both of these conclusions will help the auditor to conclude that the purchases figure is acceptable Review of accounts: The gross profit percentage in 2007 is 30% compared with 29% in 2006 and the auditor would discuss this trend in the company with management to determine if demand for the company's products is inelastic enough to allow increases in selling prices unaccompanied by increases in costs. The auditor should supplement this work by comparing the company's margins with those of competitors. If the increase in margin appears to make sense in the light of this work, the auditor would be more inclined to accept the figure of purchases, although other more detailed tests on the purchases figure would be necessary.

3. a) i) The chief accountant is a well-informed officer of the company. For this reason, evidence emanating from him or her is good evidence. However, he or she is internal to the organisation and the auditor would seek corroborative evidence that the statement is acceptable. For instance, if the auditor finds that sales forecasts indicate a higher level of sales in the coming year than in the year just ended, this might help to prove the chief accountant's statement. ii) The storeman is again internal to the organisation and his statements should perhaps be viewed with caution. However, such officials are frequently a very useful source of evidence as they may be very well informed about a small segment of the company's activities and may, indeed, be much better informed about them than the chief accountant. For instance, the chief accountant may believe that inventory control officials check physical inventory against inventory records at regular intervals, whereas the storeman knows that this is not the case. On the other hand, it must be said that often people in organisations are not aware of the whole picture so that care must be taken in evaluating statements made by them. For instance, inventory control officials may carry out inventory counts at night when the storeman is not on duty. It would therefore be necessary to corroborate the statements made by the storeman. iii) An invoice from a supplier of electricity is a document in the hands of the company emanating from a third party. It may be regarded as a particularly reliable document for the following reasons:  – Electricity invoices are normally issued at regular intervals during the year and can be easily compared with previous electricity invoices, although there is a possibility that they may be forged.  –  The electricity usage will be metered and meter readings can easily be tested by the auditor.Electricity charges may be corroborated in general terms by assessing general levels of activity. iv) Invoices of the Telephone Company will support the telephone charges and these invoices are as reliable as the electricity invoice referred to above. The explanations for the charges being lower this year depends upon whether they appear reasonable in the light of what the auditor knows about the company. For instance, if company sales are much lower because of a downturn in economic activity, telephone charges may be lower if they are correlated to a ta u a

sales. Analytical review of activity levels could thus help to corroborate telephone charges. Your view of the trainee accountant's ability may also affect the credence given to his statements. v) The letter from the lawyer would be regarded as good evidence in itself because it comes from an independent professional person and has been sent direct to the auditor. The main problem for the auditor is identifying which legal advisors the company had used. In particularly difficult cases involving perhaps complex legal matters, the auditor might wish to corroborate the opinions of the company's legal advisor(s) by seeking a second opinion. vi) The letter from the debtor is also good evidence, coming as it does from an independent third party direct to the auditor. We would be inclined to regard it as less reliable than that from the lawyer, however, for the reasons outlined in the text. Confirmations from credit customers would not normally be the sole evidence sought by the auditor in confirming trade receivables balances and sales invoices. Other corroborative evidence would include all the supporting evidence . vii) Most qualified auditors will have knowledge of taxation, although it is an area in which one may get rapidly out of date. Assuming that the auditor is a tax expert or has called upon expert help from within his firm, the computation of tax charge and liability would be reliable evidence for the auditor, especially if the computation is checked by others within the firm. Although the computation has been done by the auditor, it would be necessary to ensure that management was in agreement with it. viii) Inventory count sheets are prepared as a result of a physical count carried out by company staff. If the system that the company has established to control the inventory count is good and the auditor's observation has confirmed that the count has been properly carried out, the inventory count sheets may be regarded as good evidence, particularly if supported by the auditors own count sheets (that would serve to corroborate the company's figures). Remember that inventory count sheets prepared by the company are internal documents and may therefore be subject to manipulation. ix) The company requires the order book for its own planning purposes and in the normal course of business. Such evidence is better than evidence prepared on an ad hoc basis and may be used by the auditor for testing such matters as the saleability of inventory. Provided that the auditor can corroborate its accuracy by reference to correspondence from customers, salesmen’s' records etc., the order book may be good evidence. x) The estimate of useful life is a more difficult matter as it relates to the future and the future is notoriously cloudy. In itself the estimate by the production director is poor quality evidence, but it may be upgraded on the basis of past experience, manufacturer's specifications, experience of others in the industry and so on. Remember also that, within the company, the production director may be the best qualified to estimate the useful lives of production plant. The auditor should certainly discuss the matter with him or her.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

855

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) 4 i) The term 'interim examination' is used for that part of the audit carried out prior to the year-end. Normally, the interim will be used to review and test the operation of systems and to test the accuracy and completeness of the recording of transactions. The results of this work and the conclusions drawn therefore will be used during the final examination in planning and in supporting conclusions on the final work. In the case of large assignments, there may be more than one interim examination, and indeed for very large engagements, auditors may be present in the company and its various locations throughout the year.

course obtain sufficient confidence on the basis of the persuasiveness of the evidence in the context of tolerable error

ii) Final examination' is the term given to the work on the financial statements after the year-end. Note that in the case of small assignments, the systems, transaction testing and work on the final financial statements are likely all to be carried out in the same period.

Objective of company systems External auditors make a preliminary assessment of control risk for material financial statement assertions, and plan and perform tests of control to support that assessment. A major objective of company systems is the reduction of risk Controls are designed to prevent, detect or correctevents the company does not wish to happen, andto ensure that data and information are as required.Basic elements of control in the internal environmentare:

iii) 'Inconsistent audit evidence' is evidence that does not support other evidence, thereby downgrading it and rendering it of less value. It may reveal that the auditor has initially formed a view that is not sustainable. For instance, let us assume that you are auditing a roofing company, which makes provision for customer claims on the basis of 3% of turnover per annum. The auditors may have satisfied themselves that 3% is adequate on the basis of past experience, but a recent article in the trade press has suggested that rate of claims is likely to rise because of problems in the use of new materials. In this case the reliability of evidence based on past experience would be reduced because it is inconsistent with more up-to-date evidence.

CHAPTER 7 System work : Basic Ideas 1

(a) control environment and related components; (b) accounting and quality assurance/control systems. Example of a matrix organizational chart

iv) 'Systems-based evidence' is evidence that has been produced or influenced in some way by the accounting and control system in use by the company. For instance, a supplier's invoice which has been checked by company officials and stamped to indicate agreement with purchase order and goods received note has been checked by the system. A sound system of control tends to make such evidence more reliable. v) 'Third party evidence' is evidence emanating from persons or organisations external to the company and therefore possesses the important quality of independence. It is usual to distinguish between third party evidence coming from: - Professional people such as lawyers or other accountants - Non-professional people such as customers and suppliers - Third party evidence coming direct to the auditor such as a letter from a bank manager confirming a bank balance, and third party evidence in the hands of the company, such as the suppliers invoice referred to above. On the whole third party evidence is reliable as far as the auditor is concerned. vi) The use of the term ‘persuasive’ in relation to audit evidence indicates that often (normally) the evidence collected by the auditor is not conclusive. For instance, if the auditor checks 10 items of inventory on hand with the inventory count sheets and finds that the sheets are correct in each case, this may well persuade the auditor that the inventory count is being properly conducted and that the inventory sheets are reliable. Auditors would, however, be very unwise to draw the conclusion that the inventory count was 100% correct on the basis of their test. They may of a ta u a

Auditors obtain an understanding of accounting system sufficient to identify and understand : a) major classes of transactions; b) how transactions are initiated; c) significant accounting records, supporting documents and accounts d) the accounting and financial reporting process

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

856

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) Classifications of control There are two broad control classifications: (1) general controls over the environment in which the company operates –extension of the control environment; (2) application controls, to ensure an individual application runs smoothly and accurately General controls include: (a) systems development/maintenance controls; (b) organizational controls; (c) security; (d) quality assurance Raw data to information

If systems development/maintenance controls are strong, it is easier to control individual applications. Important elements are :  organizational structure to ensure high standards during development.  documentation of development process, complete enough to allow informed persons to understand how the system works;  testing at critical stages;  agreement in writing at each stage;  parallel developments, including staff training, preparation of forms and file conversions;  a reliable system for reporting system malfunctions after implementation;  steps to ensure unauthorized changes are not made to programs;  user agreement at critical development points, particularly of user interfaces. Note that the same principles apply also to smaller systems but the process is truncated. Programme for the development of computer application in a large-scale system

The information/audit trail should be maintained, allowing transactions to be traced forwards and backwards through the system

Organizational controls Organizational controls include: (a)organization charts; (b) segregation of duties; (c) authorization and approval; (d) supervision controls.

a ta u a

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

857

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012)

Organization chart

(a)physical controls; (b) controls over data. Physical controls include controls to reduce theimpact of: (a)fire damage; (b)water damage; (c)energy variations or power failure; (d)pollution; (e)intrusion by unauthorized personnel. Controls over security of data include: (a)restriction of access to data; (b)information/audit trails; (c)file and program libraries; (d)holding data and programs in secure places outside of the computer complex; (e)use of grandfather, father, son (GFS) or file dumping systems. Troston payroll master file update

Segregation of duties includes the segregation of: (a)authorization of transactions; (b) execution of transactions; (c) custody of assets; (d) recording of transactions and assets. In modern computer systems, segregation includes: (a)operation of programs segregated from ability to change them; (b) alteration of master file data by responsible officials; Finally, where control is dependent on segregationof duties within a particular function, managementallocates duties appropriately and instigates rotationof duties within departments. Authorization and approval is closely linked to segregation of duties to responsible persons, the limitations on whose authority is specified. Allocation of authority and responsibility is difficult in modern computer systems, particularly where many users share a single database Supervision controls are direct controls by authorized officials over day-to-day transactions and their recording, distinguished from management controls, concerned with global or overall supervision of the control environment.If people work together  –collude –segregation of duties may be ineffective, making fraud difficult to detect. Measures to ensure that directors and other employees act with integrity are important Security of information system assets is vital, whether physical assets or software and data. The company should have a security policy and identify assets at risk and the likelihood of risks occurring.Potential threats may be accidental or deliberate.Security controls include: a ta u a

Quality of information systems is often critical to an organization‟s survival. Poor information systems and inadequate user interfaces have an adverse effect on staff morale and on the general effectiveness of systems. The quality assurance function is to ensure developed software meets user needs, is reliable, easy to use, and efficient in terms of resources and ease of maintenance The function is also concerned that documentation is clear and complete and that staff are effective.Auditors consider effectiveness factors, including:

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

858

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) (a) support of top management; (b) high status within the organization; (c) adequate resources to perform the function properly.

is no one in the entity who has any specialized knowledge of computers. How would you advise him? What do you think might be the key risks in such a entity?

Auditors examine reports of the function, discuss its work with major users and consider quality of staff

ANSWERS 1 Internal control is defined in Paragraph 4 (c) of ISA 315: The process designed, implemented and maintained by those charged with governance, management and other personnel to provide reasonable assurance about the achievement of an entity’s objectives with regard to reliability of financial reporting, effectiveness and efficiency of operations, and compliance with applicable laws and regulations. The term “controls” refers to any aspects of one or more of the components of internal control. Note its aims: (a) To ensure within reason that financial reports are valid and reliable (b) To ensure within reason, that operations are effective and efficient (c) To ensure within reason that applicable laws and regulations are adhered to (d) To address identified business risks that may threaten the objectives in (a) to (c) above. The main elements (or components) of internal control are: (a) The control environment. (b) The entity’s risk assessment process. (c) The information system, including the related business processes, relevant to financial reporting, and communication. (d) Control activities. (e) Monitoring of controls. The reason that the auditor is interested in the effectiveness of internal control and its components is that good control systems reduce audit risk by mitigating the impact of inherent risk. The auditor’s main interest, of course, is in determining that the financial statements give a true and fair view, and the existence of strong internal control within the organization will increase the likelihood that financial reporting is valid and reliable. If control risk is low the auditor will be able to reduce the amount of detailed substantive testing.

QUESTION

2 Integrity and ethical values are important factors in ensuring that internal control, including the control environment is effective in reducing risk and in helping management to achieve objectives. Do you think that these are just meaningless words or are they really important in the business context? Why do you think that auditors look for integrity and ethical values in management and throughout the organization?

2. We saw in the text that the control environment can only be effective if integrity and ethical values permeate the organisation. However, they CAN be just meaningless words unless management makes sure that staff know what integrity means in the context of the organisation. For instance, management of an electrical retailer would effectively be saying to customers that goods purchased were safe to use. This would mean that statements about safety would have to be properly backed up by a proper testing regime. If not, the company would expect to suffer loss of reputation and to incur damages as the result of court cases. An example like this can show us that integrity and ethical values have a practical significance and are not  just meaningless words.

3.You have recently become auditor of a small trading entity whose system is based on a series of networked microcomputers, using bought-in software for basic accounting functions. During the initial meeting with management, the managing director told you that he is really scared of all ‘this computer stuff’, particularly as there

As far as auditors are concerned, they have to decide if they can rely on company systems in achieving their own objectives, the main one of which is to give an opinion on the truth and fairness of the financial statement. Management is responsible for putting in systems and creating a control environment that will ensure that all of

1 Explain the importance of internal control within organizations. What are the main elements and what is the auditor’s interest in them?

a ta u a

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

859

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) their objectives will within reason be met, including preparing financial statements that truly and fairly represent the results of the organisation and its state of affairs. If management possesses integrity and ensures that company staff are aware of the ethical values needed in the context of the company, the auditor will be more confident that the control environment and associated detail controls can be relied on. In this connection, there have been a number of well-publicised case of whistle-blowing by people internal to organisations, who have objected to the way that the organisations behave. Very often these objections are legitimate and organisations should have a stated policy in respect of whistle-blowing, including a system that enables employees to discuss their misgivings to independent people within the organisation. 3. You might have preferred not to start from here, but rather to have been involved when the decisions were made to install the computer system. The key risks would be as follows: a) Physical risks affecting the microcomputers, the network server and the people operating systems. You might suggest to the managing director that he should ensure that physical equipment should only be used by authorised people and be kept secure particularly outside working hours. It might be useful to employ someone with basic computer skills to help staff when problems arise and to make sure that the server is working properly when needed. It might also be desirable to shut down the server outwith normal working hours. This person might usefully draw up a code of conduct for computer users, including a restriction in the time that people sit at the keyboard. b) Risk that the system has not been developed properly in the first place. You should ask the managing director to see the documentation prepared at the time the system was developed, including any feasibility studies, documentation concerning the desired characteristics of the systems, and testing that was carried out, and by whom, prior to putting the system into use. You would be particularly interested in discovering if the bought-in software performs in the way expected, for instance, whether appropriate information/audit trails are recorded. Is double entry properly carried through in all cases? You should also ask what kind of training staff received at the time the system was introduced and what kind of ongoing training is provided. For instance, was staff informed of the need to respond to error messages, to keep passwords private, and to report bugs in the system. c) Risks of loss of programs and data. The managing director might be particularly concerned about loss of (say) trade receivables, trade payables and inventory records, and information used to manage the business. We are not told much about the system but we would recommend simple security measures, such as keeping back up copies of programs and data outside the operating areas, supported by the use of grandfather, father, son and dumping systems as appropriate. You should advise the managing director to establish degrees of access to data if this has not been done already, supported by the use of appropriate passwords. You might also suggest that one person keep master copies of programs and of back-up copies of data in a computer library, together with a booking in/out system.

a ta u a

d) Risk that the company does not observe appropriate organisational controls. For instance, does the company have a system for allocating responsibility? Are duties appropriately segregated? You might reassure the managing director that in a small company where there is little computing knowledge among staff and where systems analysts and programmers are not employed there is a lower risk that people will interfere with the proper operation of programs.

CHAPTER 8 System work : Basic Ideas 2

Objectives of application controls Broad objectives of application controls are: (1) data collected is genuine, accurate and complete; (2) data accepted is processed so it remains genuine, accurate and complete; (3) data stored temporarily or permanently is genuine, accurate and complete; (4) output data/information is genuine, accurate and complete and goes to the intended recipient; information/audit trail is complete. ...KEY POINTS  – Application controls include: (a) data capture/input controls; (b) processing controls; (c) output controls; (d) database controls; (e) e-commerce controls

Boundary of controls Boundary controls include the following : (i) cryptographic controls (ii) plastic cards; (iii)personal Identification numbers (PINs) (iv) digital signatures; (v) passwords;and(vi) firewalls. Password systems have the following features: (a)degrees of access; (b)at least eight alphanumeric digits and combinations easy to remember; (c)avoidance of passwords associated with users; (d)staff training on keeping passwords secret. (e)regular and frequent changes;and (f)shutdown of terminals when incorrect passwords entered. Access controls are important when distantterminals are used to transmit data. A password system is an important control, but other controls include: (a)limit the use of terminals to particular functions; (b)record which terminals and employees access the system and review by responsible persons; (c)restrict use of terminals to normal working hours (not appropriate in e-commerce environment).

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

860

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) Where the national telephone system is used totransmit data, additional controls are necessary: (a)telephone numbers to be ex-directory; (b)private lines; (c)telephone numbers restricted to certain parts of the system; (a)call-back system; (b)encryption of data.

Audit trail The first records of the information/audit trail are at the boundary where identity and authenticity of the user is first recorded. Records include data to which access is requested, actions users wish to take, terminal at which access is sought, record of access decision, number of signon attempts and time of starting/finishing Input subsystem accepts data and ensures softwareis valid. Examples of controls are: (a)design of source documentation; (b)design of product, customer and other codes; (c) use of check-digits; (d) sequence checking; (e) limit or reasonableness tests; (f) one-for-one checking for critical data items; (g) batch controls. Batch controls are supported by appropriateorganizational controls, including: (a)formal transfers of data between data preparation departments and data control section; (b)segregation of user departments and computer department; (c)user department retention of control over data in nondatabase systems; (d) investigation of differences between predetermined control and actual totals; (e)early verification of inputs. In database systems, batching of actions by a useror terminal. Controls over applications include: (a) run-to-run controls to ensure continuity; (b) secondary storage media should contain both external and internal labels; (c) master file data must be genuine, accurate and complete before processing; (d) programs must be tested at the development stage and on a continuing basis; (e) the information/audit trail should be updated to record all processing actions from the time input data is received to the time it is despatched as output; (f) sequence checks; (g) limit or reasonableness tests; (h) casts and crosscasts, where appropriate

Database systems Database systems provide the same data toeveryone in the company having authority to access them, but special controls are needed: 

loss of control over data by data preparation personnel may be countered by giving ownership of a particular sub-schema to designated users;

a ta u a









after-the-event authorization is a necessary feature of database systems; excessive power in the hands of DBA makes supervision of DBA staff essential, including rotation of duties and regular review of recorded actions affecting the database technical features to secure safety in processing, such as “roll-back‟, tend to reduce control, so complete record of use required; information/ audit trail is particularly important and a record of all interventions affecting the database should be kept.

Control over E-Commerce E-commerce presents particular control problems.Degree of risk depends on how the organizationuses the internet: (a) making information available to outsiders; (b) exchanging information with customers and other trading partners; (c) using the internet to transact business; (d) full integration of the business systems with ecommerce conducted through the internet, making access controls particularly important. Management has to decide whether businessconducted over the internet is separate from thecompany‟s main business or whether it is fullyintegrated. Particular risks relate to: (a)security; (b)residence for legal and taxation purposes; (c)business and accounting risks; (d) e-commerce as a 24-hour business; (e) risks associated with complex technology. Legal and taxation matters are important because the internet is international and it may not be clear which legal or taxation jurisdiction applies. The applicable jurisdiction should be stated when the transaction is entered into, or business might be restricted to residents of particular legal or taxation jurisdictions. Arrangements for double tax relief might have to be made Other practical business and accounting problemsinclude: (a)is the company acting as principal or agent; (b)cutoff; (c) system for dealing with return of goods and claims under product warranties; (d) recording bulk discounts and special offers; (e) payment other than by monetary transfer, such as advertising set-off; (f) browsing should not be confused with placing an order; (g) making sure that all aspects of a transaction are properly followed through to “back office‟ systems

Systems objectives Auditor ust have a structured approach to examining systems and clear objectives. Systems objectives should be broken down into stages and objectives determined for each . There are six stages in a sales system: (1) receipt of order; (2) authorization of order; (3) despatch of goods and entry in stock records;

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

861

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) (4) invoicing of goods despatched and entry in sales record; (5) entry in debtors ledger or bank records; (6) entry in general or nominal records.

1. organization charts; 2. flowcharts of various kinds. 

System objectives may be equated with management assertions about entries in theaccounting records and whether they are genuine,accurate and complete. The audit approach to thefinancial statements comprises: (a) identification of components and related assertions, inherent risks and controls; (b) estimating level of control risk; (c) determination of audit detection procedures to reduce total audit risk.





Data flow diagram: customer order system







Organization chartsshow the flow of authority through the organization and are vital if segregation of duties is to be effective, but are only a guide to power within an organization. Information/ audit trail flowcharts may be useful in tracing data through the system and where breaks in the trail occur. Document flowchartsshow where documents are prepared, who prepares them, their characteristics, where they are filed, how many copies are prepared, where they are sent, any action taken on their basis, and how they are modified. They have become less useful as so many functions now take place electronically. Data flow diagrams are useful for determining what happens to data when it is entered at the interface and then passes through the various subsystems. System flow chartsshow data flow through a system, but concentrate more on the way data are affected by the various programmed routines and how they relate to other data input to the routines. Program flowchartsshow detailed decision making internal to programs

The advantages of flowcharts are that they: (a)enable understanding of systems by auditors and client staff; (b)force the auditor to understand how the company controls operations; (c)pinpoint unnecessary procedures or documents. The disadvantages of flowcharts are that: (a)They can be time-consuming to prepare and may be difficult to alter; (b)in simple systems, narrative descriptions may be more appropriate; (c)there is considerable variation in use of symbols; (d)They may not be useful in the hands of inexperienced audit staff; (e)in complex situations flowcharts may be too simplistic to aid genuine understanding. Questionnaires and checklists enable auditors toform views about the system in use in a logical way. They include:

Collection System Information Collection of information about systems needs considerable powers of enquiry. Auditors interview a wide range of people involved with the system from those responsible for development to users and operators. Recording of systems may be by narration, visual description, or questionnaires and checklists Narrative description can be useful in small systemsand may be useful support to other means ofrecording.Visual descriptions include: a ta u a

(a)internal control questionnaires; (b)internal control evaluation questionnaires; (c)EDP/IT checklists.

EXERCISE 1. Consider the following statements and explain why they may be true or false: (a) ICQs are questionnaires used to record the system in use. (b) ICQs are questionnaires used to evaluate the system in use.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

862

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) (c) ICEQs are questionnaires used to record the system in use. (d) The basic requirement of an accounting system is that it meets the needs of the business for which it is designed. (e) In a small organization it is impossible to have a good system of internal control. (f) In modern systems, a data flow diagram is more useful than a document flowchart. 2. Assume that Ann Paterson, an established customer, has telephoned asking that she be supplied with three recently published books. She has been passed to a sales clerk who deals with her order. Suggest controls that should be in force before her order is accepted. 3. Assuming that the order is accepted and that the books will be supplied on credit, explain what records will be affected by the transaction and the information/audit trail details that should be recorded.

ANSWERS 1 a) True ICQs are questionnaires designed to help the auditor to understand how an accounting and internal control system operates, as well as aiding evaluation. They are not always useful in complex systems. b) True This statement is also true. ICQs are not merely used to record the operation of systems; they are also used to evaluate the systems. ICQs are usually designed so that 'No' answers will indicate a weakness in the systems in use. c) False ICEQs, unlike ICQs, are not used to record the systems in use, but to evaluate using key questions, supported by subsidiary questions. d) True Accounting systems do not have to be sophisticated if the demands of the business do not require it. In the case of a small trading company, it is possible that the only records required will be an analysed cash book and invoice and bank statement files. You should not forget that the more complicated the accounting system, the greater the degree of expertise required to operate it. Many small businesses cannot afford to employ a trained accountant and rely on professional accountants to prepare financial statements for them. e) False While it is true that sound systems of internal check based upon segregation of duties is often not possible in small companies, the internal controls may be good because of supervisory controls exercised by proprietors or owner directors. There may be problems for the auditor, however, as there may be no certainty that directors are not overriding controls. f) True In modern computer systems many actions are occurring electronically within the company's systems, which do not result in a flow of documents, so it is more useful to show how data flows through the system. Auditors use the diagram to prove the audit trail and to identify control points. This does not mean that document flow charts do not have a role, as documents are still produced both a ta u a

before and after the computer. .2 As Ann Paterson is an established customer of the company, she would be able to identify herself and authenticate her status as a valued customer. She might already have given her credit card number and expiry date and an identifying word to the sales clerk before the order was processed. The clerk would either complete a hardcopy form or a form called up on the monitor screen. If the latter is the case, important controls would be : (a) form design enabling easy completion (b) non-acceptance unless all fields on the form were complete. Further controls would be procedures to ensure that the clerk knows if the books are available and when they would be despatched, that calculated the amount of the invoice and compared Ann's credit limit with the outstanding balance, adjusted for the new transaction. The clerk would be prompted to inform Ann whether the order had been accepted, and if accepted, to read the terms of the order and amount of the invoice to her. The system should send a copy of the accepted order to her, and, if not accepted, a letter detailing reasons for nonacceptance. Further controls would be numbering of the orders processed by the sales clerk and the preparation of control totals for all transactions entered by the clerk during the day (the clerk would also need to be identified and authenticated). We would expect sequence checking of orders entered by the sales clerk. Apart from these controls the auditor would be interested in the completeness of the information/audit trail 3 We made the assumption above that the sale was on credit. If so the following records would be affected by the transaction: (a) The transaction should give rise to hard copy documents - order form (numbered), despatch note (numbered) and sales invoice (numbered) (b) the following permanent records would be affected: sales transactions record (assuming that the company sells in its own name rather than on a commission basis); inventory record (assuming that this company keeps books on hand rather than having them supplied by a third party); debtors ledger for transaction and amended balance (c) the information audit trail should include the following features: customer name, identification word, authentication and credit card details; clerk and terminal handling the transactions; confirmation of inventory on hand requested by clerk; calculation of invoice; the sum of existing balance and transaction and comparison with credit limit; acceptance or non-acceptance of order together with reasons; record of order number; update of inventory record (and despatch note number) and debtors ledger (before and after balances in each case) and invoice details including number and duration of transaction.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

863

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) CHAPTER 9 Testing and Valuation of Systems

Identification of financial statements Auditors identify components of financial statements and related systems. They identify control points and assess the appropriateness of controls, using key and subsidiary questions to assist evaluation. Some components may be regarded as being of low risk to auditors, who may reduce audit work on them Auditors obtain information to record systems by discussing their operation with a wide range of individuals, from quality control staff to users at the system interfaces. They inspect a limited number of documents of each type from inception to final entry in the records, but as the scope of work is limited, they cannot be sure that the system always operates in the manner recorded. So, the auditor performs compliance tests (tests of control) to confirm whether or not internalcontrols are satisfactory and whether they can be relied upon

Compliance test Compliance tests include: (a)extended walk-through tests of the information/audit trail; (b) block testing one aspect of the system; (c) interviews with company staff; (d) observing staff at work; (e) re-performance of control procedures; (f) examination of management reviews. Auditing Computer systems There are various ways that auditors approach auditing computer systems: (a)round the computer; (b)through the computer; (c)with the computer. When auditing round the computer auditors see the computer as a black box and audit activity concentrates on comparing inputs and outputs and using techniques such as analytical reviews.This approach was satisfactory in the early days of computing when information/audit trails were easy to maintain As systems developed in complexity auditors moved towards „auditing through the computer‟, seeing the computer as a tool in their hands, the audit being computer-assisted.The computer may be used for (i) testing the system (ii) testing data held on computer file, but the audit planning stage becomes more important. Where auditors use the computer to manage the audit process they audit with the computer

Test data Test data are assembled by the auditor and passed through the system to determine if the data are processed as expected. The process can be very time-consuming and will be used only in systems critical for the auditors.Test data must be representative of real data, which must be systematically analysed to determine its nature. Some auditors use computer-generated test data. Test data may be processed during a normalprocessing run („live‟ test data) or outside normal processing („dead‟ test data), but problems are: 1. if used during normal processing runs, the test data will corrupt company files unless corrective action is taken; 2. if used outside of normal processing, the results may be artificial because of the difficulty of creating normal conditions.

Program code comparison Program code comparison is used to compare the program being tested with a program known to be the authorized version. Interpreting the results needs considerable expertise in deciding if the discrepancies are critical or not. The discrepancies might reveal that unauthorized changes have been made to programs, but do not detect defective programs Concurrent auditing Concurrent auditing techniques involve embedding audit facilities that allow continuous review of data and their processing. Programs created by the auditor flag critical events as they occur for immediate or delayed review. They can be useful in tracing the information/audit trail. All data types and conditions are taken into account in establishing the embedded audit facility and must be updated regularly. They are expensive and need considerable expertise, but may be useful in high risk situations. Two types of embedded audit facilities are: (a) integrated test facility (ITF); (b) systems control and review file (SCARF The auditor, having evaluated and tested the operation of systems, concludes on their efficacy. If systems and audit objectives have been properly set, and evidence has been properly collected, concluding upon results of systems work should follow logically. When forming conclusions on systems, the auditor states the consequences of particular strengths or weaknesses in the system and may suggest changes in scope in respect of them

Code reviews Code reviews are designed to determine if there are defects in programs that will cause incorrect processing of data, but tend to be costly in time and need expert knowledge, so are only used in critical areas a ta u a

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

864

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) CHAPTER 10 Substantive Testing , Computer-assisted audit techniques and audit programmes

Substantive procedures Substantive procedures are: Tests to obtain auditevidence to detect material misstatements in thefinancial statements and are generally of two types: (a)analytical procedures; (b) other substantive procedures, such as tests of details of transactions and balances, review of minutes of directors‟ meetings and enquiry. Data may be tested by tests of control or by substantive tests of details. In a financial statements audit, auditors are principally interested in whether figures in financial statements give a true and fair view. They carry out tests on data to prove transactions and balances are genuine and accurately and completely recorded, whatever the system in use Regardless of assessed levels of inherent and control risks, auditors perform some substantive procedures for financial statement assertions of material account balances and transaction classes. Substantive tests are limited or extended depending on whether accounting and control systems are deemed ineffective or effective, and may include tests of detail as well as analytical procedures

Audit plan The audit plan might change in light of feedback, as more knowledge of the company is gained as the audit progresses, causing risk assessments to change and affecting scope of examination. Substantive procedures are intended to prove that transactions and balances are genuine, accurate and complete, but even extended tests may be insufficient to allow auditors to say with confidence that financial statements give a true and fair view Discuss the extent to which the interim audit programmes should take account of the interim results of Powerbase plc Auditors must be clear as to what they wish to achieve before designing a programme of substantive tests.

Audit software Auditors use specially designed forsubstantive tests of details, including: (a)generalized audit software; (b)software for use in specific industries; (c)statistical analysis software; (d)expert system software.

audit

software

Generalized audit software and software developed for specific industries are interrogation tools used to access, examine and manipulate data and information on file. Used for substantive tests of detail, they can test the effectiveness of systems and company personnel, as well as interrogate data held on a company‟s own files, or on the auditor‟s own system. Audit staff can be relatively easily trained in the use of such programmes

a ta u a

The software can: (a)access files with different characteristics and manipulate the data on them; (b)select data on the basis of predetermined criteria and perform arithmetical functions; (c)analyse selected data statistically and stratify it into desired categories; (d)cause files to be created and updated from company files; (e)produce reports for the auditor in desired format.

Statistical Analysis Statistical analysis software is used to extract important ratios and balances from company records for comparison with previous periods and external data, and can be used to select data statistically. Software packages with regression analysis capabilities may enable auditors to form views about company and industry trends. Generalized audit software is a useful supplement to statistical sampling techniques as it audits by exception, interrogating files and pulling out items possessing characteristics the auditor has selected Audit software is particularly useful when there arelarge amounts of data. The major disadvantage isthe cost of development, but, once developed, itcan be economical in audit resources and canachieve quick results Other disadvantages are: (a)generalized audit software can only be used after the event; (b)although systems weaknesses can be discovered using audit software, it isdifficult to assess the likelihood of error; (c) as audit software is not used continuously, any system weaknesses may not be discovered timeously; (d) audit software may not be useful in detecting where system breakdowns are likely to occur Expert systems can be useful in certain instances.They make expertise available to persons who arenot experts themselves and are used both forevidence collection and evaluation. They have been devised to: (a)evaluate risk, and the strength of systems; (b)suggest appropriate audit programme steps based on evaluation of systems; and (c)check compliance with the Companies Acts and accounting standards.

Directional Testing Directional testing is a form of substantive testing, which tests debit balances for overstatement and credit balances for understatement. It is useful as it introduces an organized element to setting audit objectives, but a global approach should also be adopted to ensure that the debits and credits give a true and fair view when taken together Management Letter The management letter is an important means of communication between auditor and those charged with governance and is used to inform them of matters significant to them. When material weaknesses in accounting and control systems have been identified, auditors should report them in writing to the directors, the audit committee or an appropriate level of management timeously.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

865

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) Directional testing example

(e) review and reporting activities; (f) keeping manuals and checklists on file

Data Security Security of data held by the auditor on computer file is vital. Access controls, including use of passwords, should be in place to make corruption of data less likely and to prevent files falling into the wrong hands. Back-up copies should be made to avoid loss of data, and printouts of hard copies of key working papers made regularly Spreadsheets can be invaluable tools but preparation needs careful control. The spreadsheet should be described and the intended purpose explained. The use of macros must always be carefully explained, documented and tested

Questions 1 Consider the following statements and explain why they may be true or false: (a) Tests of controls are those tests designed to check that the accounting and control systems are effective. (b) Substantive tests are different in nature from tests of control. (c) Audit programmes should be designed to take account of the strengths and weaknesses of the individual entity. (d) Audit programmes are developed before the scope decision is made. (e) Directional tests are tests of control. 2. Assuming that your audit programme for the purchase of non-current assets has been completed and that your programme objectives have been met, draft a suitable audit conclusion for audit work carried out in respect of the period from 1 January 2010 to 30 September 2011.

Solutions 1 a) True Tests of control are tests directed towards checking the operation of systems. The objective of using them is to prove that the auditor's assessment of control risk is proper

Audit Automation Increasingly, auditors use computer technology to manage the audit process and to increase audit efficiency and effectiveness.„Audit automation‟ frees up staff to perform  judgemental work rather than being engaged in repetitive activities.

Examples of use are: (a)expert systems for recording and evaluating potential problem areas; (b)risk assessment, planning and allocation of staff and other resources, using analytical review packages, spreadsheets, packages for allocating staff time and word processing software; (c) information retrieval and analysis; (d) interpretation and documentation of results; a ta u a

b) False While the role of substantive testing differs from that of tests of control in that it is directed not towards systems but towards proving that transactions and figures are completely and accurately recorded, the nature of the tests may be very similar. Thus, selecting goods despatch notes to prove that the entry to inventory records is accurate may be used to both to test the operation of the inventory and purchases systems AND in substantive testing to prove that inventory records and purchases are complete and accurate. c) True Audit programmes should be tailor-made to the circumstances of the particular organisation. For instance, if the auditor discovered that credit control procedures were weak, the audit programme should emphasise steps to prove collectability of the recorded trade receivables. d) False Audit programmes give effect to the scope decision and therefore must be drawn up after the scope decision has been made.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

866

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) e) False The purpose of directional tests are to test for over- and under- statement of transactions or figures or balances and such tests should therefore be regarded as substantive tests of details.

(a)transactions not subjected to the same internal controls throughout the period; (b)balances with widely different values. Because of lack of homogeneity, it is commonpractice to stratify populations and to treat eachstratum as a different population.

2. Suggested audit conclusion on the purchase of fixed assets :

A sample must be taken from the whole populationand may be selected in various ways: 1. random; 2. systematic or interval; 3. block or cluster; 4. haphazard sampling.

On the basis of the work performed on the purchase of fixed assets as set out in the fixed assets audit programme on working paper F100, as supported by working papers F101 to F105, I can conclude that, within reasonable limits, all purchases of fixed assets in the period from 1 January 2011 to 30 September 2011 have been fully and accurately recorded and that such purchases have been made on the basis of properly prepared budgets duly authorised at appropriate levels within the company. The audit programme was prepared on the basis of scope decisions recorded in working paper F10, supported by systems notes in the permanent audit files (Section F).

CHAPTER 11 Sampling and Materiality

Audit Sampling In performing the evidence search, auditors carry out sufficient appropriate work to be reasonably certain that audit conclusions are soundly based and at a reasonable cost. At the outset auditors decide what approach they will use and when it is likely to be appropriate to use audit sampling, taking into account the criteria of sufficiency, relevance and reliability Audit sampling may be either non-statistical or statistical. In statistical sampling, probability theory determines sample size. Random selection ensures each item or £1 value has the same chance of selection as any other. Non-statistical samplingis more subjective, typically using haphazard selection and placing no reliance on probability theory Careful planning of the sampling process isessential: 1. testing a sample increases the risk the auditors will fail to detect matters of significance, this „sampling risk‟ being part of detection risk; 2. the characteristics of the population must be clearly identified.

Non-statistical Sampling Non-statistical sampling is often termed judgemental sampling. Case study 11.1 gives an example of this.The sample can be used as the basis for substantive testing of balances or testing the operation of the system. Judgement is a feature of statistical sampling too, but there may be a reduction in judgement required

Sample size Audit evidence must be sufficient, so sample size isimportant. Size of samples is dependent on: (a)level of confidence required; (b)expected error rate; (c)tolerable error rate. Level of Confidence Level of confidence is influenced by assessment of inherent and control risks. If auditors have obtained evidence from other relevant audit tests, such as analytical review, the confidence they require from sampling is correspondingly reduced The expected error or deviation rate The expected error or deviation rate is an important determinant of sample size, whether using the sample for substantive or compliance testing. The greater the expected error rate or amount, the greater the sample size needed to conclude that the actual error rate or amount is less than tolerable error rate or amount. Auditors must define an error or deviation beforehand Tolerable error rate Tolerable error rate or amount is the maximum error rate or amount auditors are prepared to accept.When testing controls, tolerable error rate is the maximum deviation rate in the sample the auditors are willing to accept and still conclude their initial evaluation of control risk is valid. When testing for amounts, tolerable error is related to the level of materiality set. The lower the tolerable error rate or amount the greater the sample size Evaluation of sample First stage in evaluation is to determine the number of errors in the sample. The next is to estimate, on the basis of sample results and given level of confidence, the upper error rate (UER) in the population, using reliability factors and sample size Auditors decide on appropriate action on the basis of sample results, such as placing less reliance on controls and extending scope of substantive procedures. Auditors are also concerned with the nature of the errors identified Reliability factors (extract

Population A population is homogeneous if all items have thesame characteristics. Factors causing lack of homogeneity include:

a ta u a

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

867

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) the increased use of risk-based auditing, with more emphasis given to analytical review and investigation of large or unusual transactions or balances, detected using audit software. There is also more emphasis on evaluating the effectiveness of the control environment Other statistical sampling methods are: (a)discovery sampling; (b) variables sampling, The latter includes: (i) mean per unit method; (ii) ratio and difference method.

Population size has little effect on sample size.

Attribute sampling Attribute sampling in testing internal control systems is important, but the amount by which an account balance is in error is of greater importance Monetary Unit Sampling (MUS) Monetary unit sampling (MUS) is used to estimate the amount by which an account balance is in error. Auditors decide the maximum value of errors they are prepared to accept and use MUS to estimate the most likely error (MLE) and the likely upper error limit (UEL, or monetary precision) in monetary terms. There are two basic ideas underlying MUS: (1)the population is divided into £1 units; (2) should an error be found in the transaction or balance to which the £1 is attached, the transaction or balance is held to be “tainted‟. Auditors specify confidence level and tolerable error,and these, together with estimate of likely error areused to determine the appropriate sample size. When evaluating sample results auditors calculate MLE, supplemented by calculating an estimate of UEL. If UEL is less than tolerable error, the auditors can accept the population. If not, the auditors may adjust UEL for any errors found to determine if that reduces UEL below tolerable error. If UEL remains above the tolerable error, the auditors carry out extended or alternative procedures

Statistical Sampling An advantage of statistical sampling is that it requires auditors to make explicit their judgements on confidence level, expected error rate and tolerable error rate. Sample size is based on statistical principles and therefore can be  justified, and sampling risk and the evaluation of results is quantified and more precise Statistical sampling has several disadvantages: (a)it is time-consuming and costly; (b) it requires documents or account balances to be held in a manner enabling separate identification; (c) it is more difficult to understand for non-statistician, although specialized computer statistical sampling packages are available. Since the early 1990s the use of statistical sampling has decreased and is more likely to be used in specialized audit situations. The reason for the decrease may be attributed to a ta u a

We know come to “ materiality”, the expression of the relative significance or importance of a particular matter in the context of the financial statements as a whole.A matter is material if its omission or misstatement would reasonably influence the decisions of a user of the financial statements

Determining materiality level Users of financial statements may be sophisticated and knowledgeable, or unsophisticated and naive.Auditors therefore need to have a way of measuring when misstatements or omissions are material enough to cause financial statements not to give a true and fair view  –a  judgemental area Auditor often direct attention to the profit before tax figure when determining materiality level, setting materiality levels in terms of a percentage of the figure, often on an average basis over a number of years.Auditors look at nature and extent of “errors‟ and company context before taking a final decision about materiality. The materiality level set and the amount of evidence auditors need are related; the lower the materiality level the greater the quantity of evidence required.Auditors will set materiality levels for other figures too, including turnover, total assets and net assets and, in practice, normally calculate materiality levels based on several criteria and then decide on appropriate materiality levels for different aspects of the audit Auditors may give greater emphasis to testing for over statements rather than understatements and may consider other matters relating to profit: 1. trend in profits; 2. effect of profit figure on ratios; 3. external influences; 4. poor performance and difficulties in raising finance. Auditors set materiality levels at the audit planning stage to put audit risk into context, as there is a strong relationship between risk and materiality. Most risks relate to specific financial statement headings and auditors assign a materiality level to components of the financial statements Factors likely to influence determination of themateriality level for components include: 1. importance of the heading; 2. nature of item; 3. auditors‟ past experience;and 4. trend in the account balance.

Individual materialty levels

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

868

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) Setting individual materiality levels is important because it influences the nature and scope of workon individual account balances. Auditors record themateriality levels and reasons therefor.During the audit auditors may change their viewsabout appropriate materiality levels because of: (1) changes to draft accounts; (2) evidence gathered during audit testing The effect of any misstatements found are evaluated and an estimate made of the amount of potential errors in the components of the financial statements and in the financial statements taken as a whole. If auditors find their estimate of the misstatements is less than the materiality levels set, they can conclude that the financial statements are not materially misstated

Consideration in evaluating misstatements Auditors will consider the nature of „errors‟ and, if management decide not to adjust, the auditors should determine the reasons. If auditors believe „errors‟ may be material they extend the scope of audit tests. In evaluating misstatements auditors consider the following features : 1. size and incidence; 2. whether „errors‟ exhibit a pattern; 3. whether „errors‟ relate to factual matters or matters of opinion; 4. whether the „errors‟ relate to illegal matters; 5. whether there is suspicion of fraud; 6. whether similar „errors‟ were discover ed in previous year; 7. whether misstatements affect only balance sheet items or the profit and loss account too. Qualitative issues to be considered are: (a)whether the item is required to be disclosed; (b)whether accounting policies are improperly disclosed; (c)where there is improper classification. CHAPTER 12 Final Work : General Principles , analytical review of financial statements, fixed aasets,and debtors

Pre-final work Discussions are held with management near the year-end to ensure that preparation of financial statements runs smoothly and timetables are met.Auditors maintain regular contact with management to detect problems earlyon in the process. Potentially problematic areas include: (a) known problems; (b) stocktaking instructions; (c) timetable for preparation of year-end financial statements; (d) circularizations; (e) requirements of accounting and reporting standards; (f) new legislation; (g) requirements of auditing standards

Balance sheet date work. Typical audit work includes: (a) bank confirmations; (b) stock count observation;

(c) stages of completion of long-term contracts/assets in course of construction; (d) letters to other professionals. Some time elapses between interim and final examinations and auditors should ascertain whether conclusions formed earlier are still valid and whether systems operated as expected during the whole year This is know as bridging work

Analytical procedures. ASB has adopted a balance sheet approach when defining assets and liabilities and less attention is paid to matching and accruals and to the profit and loss account. It may mean that it becomes more difficult to interpret profit and loss account and income/expense headings The search for audit evidence is conducted on a global and detailed basis and within a clearly understood risk context. Analytical review is useful when reviewing the financial statements taken as a whole at the conclusion of the audit Specifically, auditors determine whether:  (a)financial statements have been prepared using consistent and appropriate accounting principles;  (b)information published with the financial statements is compatible with them;  (c)presentation and disclosure are as required by law and by regulatory bodies and achieve truth and fairness;  (d)conclusions drawn from tests and overall review of the financial statements enable an opinion to be formed.

Ratio Analysis Auditors use ratio analysis and other interpretativetools. Significant changes in figures revealed byanalytical reviewmay result from: (a) errors; (b) changes in accounting practice c) changes in management policy; (d) changes in general commercial factors; (e) changes in commercial factors affecting the client only; (f) fraud In the examination room the best approach is: (a) look at the figures broadly, before calculating ratios; (b) calculate selected ratios to confirm initial impression; (c) remember many ratios are interrelated; (d) analysis of financial statements directs audit effort. Ratio analysis can be useful, but must be handled with care as ratios are meaningless unless compared with other ratios. Auditors should ensure industry statistics have been prepared in the same way as ratios used for the company and be aware of special measures of success or performance indicators used in a particular industry Other analytical tools include: (a)graphs; (b)regression analysis and multiple regression analysis; (c)Z-scores.

True and Fair view of Financial statements a ta u a

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

869

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) Accounting standards are designed to aid the preparation of financial statements that give a true and fair view. Members of accounting bodies acting as auditors or reporting accountants should justify significant departures to the extent that their concurrence with the departures is stated or implied. Financial statement assertions in respect of assets, claims against assets, and related revenues and costs are grouped under the headings 1. genuine 2. accurate 3. complete prompting questions about existence, condition, ownership, valuation and disclosure/presentation.

Tangible fixed assets These vary in nature within companies andbetween industries. Inherent risk factors include: (a) technological changes; (b) closure of part of business; (c) difficulties in making estimates of useful lives; (d) revaluation of fixed assets; (e) existence of significant idle fixed assets; (f) significant fixed assets in course of construction; (g) own construction of fixed assets; (h) moveable, high value assets. Specific control to minimise control risk A part from a satisfactory control environment,specific controls are necessary to minimise control risk over: 1. acquisitions, revaluation, impairment; 2. safeguarding; 3. disposals; 4. maintenance, insurance; 5. authorization of depreciation charges and accumulations. Main control documents for acquisitions are fixed assets budgets  –long, medium and short term.The main accounting record for fixed assets is the fixed assets register. To be a good control document it should be held by persons independent of those using and having custody of the fixed assets, and be compared periodically with physical assets and vice versa Using recorded details, fixed assets should be reconciled by the company at least annually to cost/valuation, accumulated depreciation and depreciation charge figures in the financial statements. If a fixed assets register is not kept or the register is found to be subject to error, control risk will be increased and auditors may have to extend substantive tests of detail Proceeds of sale of fixed assets may be misappropriated if controls are not in place.Disposals should be authorized in writing by individuals with appropriate authority after careful assessment of continuing value, with directors to issue guidelines for making assessments Analytical procedures on fixed assets might be directed to: 1. significant additions and disposals; 2. profits/losses on disposal; 3. revaluations; a ta u a

4. significant repairs; 5. maintenance charges. Financial Statement assertions On revaluation of fixed assets, financial statement assertions include: 1. Genuine: revaluation has taken into account real conditions; selected basis is appropriate;„ 2. Accurate: calculation of current values appropriately reflects underlying value in accordance with relevant accounting principles; 3. Complete: all fixed assets in a particular class have been revalued Substantive procedures include that the valuer isproperly qualified and that the valuer‟s scope ofwork is appropriate, including: (a) objectives and scope; (b) clear statement of the matters to examine; (c) why work is being carried out; (d) information provided to the valuer, and its reliability (from local planning and similar authorities; and from client officials and solicitors); (e) assumptions and methods used; (f) timing of valuation.A second valuation may be appropriate if significant For disposals of fixed assets, determine thereasons if significant and whether an impairmentreview of the remaining assets is necessary.Substantive procedures include: (1) check number sequence of disposal approvals and to the fixed assets register; (2) select random sample of approvals and check authorization signature and trace to sales despatch notes.

Depreciation Audit work on depreciation is closelyallied to work on the fixed assets. Specific matters of interest are: 1. useful economic lives and appropriateness of depreciation method; 2. residual values; 3. depreciation on revalued fixed assets. Trade debtors Trade debtors are normally classified as current assets. It is important to determine the point at which the property in goods is transferred or service performed. Sales of goods and services cause trade debtors to come into existence or increase cash balances, so audit work on sales cannot be divorced from work on the assets accounts The auditor would expect to see a satisfactorycontrol environment and control over: (1) creation and clearance of trade debtors balances; (2) safeguarding of trade debtors. Important elements when safeguarding tradedebtors are as follows: (a) the rapid billing of customers; (b) regular preparation of statements and reminder letters; (c) offer of cash discounts; (d) approval of entries reducing the stated amount of debtors‟ balances ,(e) ageing statement; (f) credit limits

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

870

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012)

Substantive approaches cover: (a) creation of trade debtors‟ balances; (b) proving trade debtors are genuine, accurate and complete; (c) proving reasonable relationships between trade debtors/sales and other figures in the financial statements; (d) checking cut-off; (e) proving clearing entries are genuine, accurate and complete, especially write-offs of balances (f) proving accounting methods for determining sales and related debtors are acceptable and consistent; (g) proving that debtors represent customers who exist and amounts owed to the company; (h) proving debtors‟ balances are collectable; (i) checking proper disclosure of debtors receivable in the short, medium and long term, and those subject to encumbrances Two useful tests are to : (1)circularize debtors (2) to test after-date receipts Testing after-date receipts may be more usefulthan circularization as replies from debtors maynot always be trustworthy and debtors may noteven reply.

Factoring Factoring means that ownership passes to third party, even though the initial sales transaction had been with the company. The auditor would examine the factoring agreement, test the system for recording factored debtors and obtain confirmation from the third party of debtors‟ balances transferred. Questions 1 Consider the following statements and explain why they may be true or false. (a) The audit approach to any asset will involve the auditor in a consideration of condition. (b) If the analytical review discloses no variations from the previous year, the auditor need not enquire further. (c) Analytical review is an evidence-gathering procedure performed as part of substantive procedures. (d) Planning feedback means that audit plans are altered to take account of changed circumstances. (e) A genuine transaction is one that has been authorized by an independent responsible official 2. Consider the following items of income and expense and state: whether they bear a relationship to each other or not; if they are related in any way, in what way they should move in relation to each other; the reasons for your answer in each case. (a) Sales of manufacturing concern: ● Bank interest ● Administrative expense ● Commission to sales personnel ● Distribution cost ● Production royalties (b) Cost of production of a manufacturing concern: ● Trade receivables ● Cost of non-current assets in use a ta u a

● Loss on disposal of factory equipment ● Inventory levels ● Directors’ emoluments (c) Gas company income ● Number of units of gas used ● Temperature in winter months ● Electricity company prices ● Number of employees.

Solutions 1 (a) True Condition must be considered in respect of any asset. Thus, an item of inventory or equipment should be in a condition to be sold or used within the organisation. A trade receivables balance should be valued in the financial statements at the lower of its monetary value recorded initially in the accounts and its realisable value (being the recorded amount less bad debts provision). A trade receivables balance against which a provision of this nature has been made is clearly not in good condition. The auditor looks for evidence of collectability by assessing the 'condition' of trade receivables balances. Even cash can have a condition that renders it of less value. Consider a company having cash balances in a country that forbids remittances or taxes remittances to the company's home country. b) False The analytical review is only one of several forms of substantive procedure. Normally, it will not stand on its own but will be interpreted in the light of other evidential matter, including the strength of the entity’s control systems. Lack of variation from prior years may cause the auditor to enquire further if variations were expected. c) True Analytical review is normally a very important part of substantive procedures, the objective of which is to substantiate transactions and figures and the analytical review will aid the auditor in this respect. d) True Planning feedback is the term used to indicate the alteration of original plans because of changes in circumstances or of events unexpected at the time the plan was originally conceived. e) False This is an incomplete statement. Authorisation is an important procedure to ensure that recorded transactions are genuine, but it is only part of the story. Thus approval of purchase orders is an important control, but proof is also needed that goods have been received in the quality and quantity required and that purchase invoices agree with orders and goods received notes. 'Genuine' in this case means that a recorded purchase represents real goods or services received, in other words that a real event has caused the purchase invoice to be prepared. 2 i) The following items are likely to bear a direct or partially direct relationship to sales of a manufacturing concern: 1. Commission to sales personnel (normally bearing direct relationship to sales on commission) 2. Distribution expense, except to the extent that

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

871

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012)

3. 4. 5.

6.

there is a fixed cost element The following are not likely to be directly related to sales, although there may be some relationship: Administrative expense (normally containing overhead unaffected by sales levels). Bank interest (This is a finance expense not normally directly related to sales, although if turnover is expanding rapidly additional finance may be required to finance expansion). Royalties payable for use of a production process (If royalties are paid on the basis of product sales, the relationship would be a direct one. In this case, however, they are related to production and not to sales, although there might be a relationship if production was made to order or if finished inventory levels were constant).

ii ) The following are likely to bear a direct relationship to cost of production of a manufacturing concern: 1. Cost of fixed assets in use (Depreciation of production fixed assets will be an element of cost of production and bears, therefore, a direct relationship.However, there are many more costs in cost of production than depreciation and you would need to analyse the cost of production figure to establish whether the depreciation charge seemed reasonable). 2. Inventory levels (Inventory levels of raw materials and components are likely to be determined on the basis of production needs and the relationship is therefore a direct one. Levels of finished goods are more likely to be related to sales needs). The following are not likely to be directly related to production cost: 1. Trade receivables (Related to sales) 2. Loss on disposal of factory equipment (This loss is likely to be affected by the market for second- hand equipment and the skill of the person disposing of it). 3. Directors' emoluments (The production director's salary is likely to be a component of production cost and there may be a direct relationship if his bonus is production-related but directors' emoluments generally are not likely to bear a relationship to cost of production). The following are likely to bear a direct relationship to Gas company income: 1. Number of units of gas sold 2. Temperature in winter months (This will tend to cause a higher rate of consumption of gas and have a direct bearing on income. However, cold weather in January and February may not have an effect until March or April, when the gas usage is billed to customers). 3. Electricity company prices. (Electricity is an alternative energy source to gas and the price charged to the consumer may, therefore, have an effect on gas prices and on income of a gas company. The price of energy is often a matter of political significance and the gas company may feel it necessary to keep its prices in line with other energy sources, even if consumers are tied to the company because of (say) investment in gas central heating. a ta u a

It is not likely that the total number of employees will in the short run have a relationship to income from gas sales, as most employees will not have a direct role in generating income.

CHAPTER 13 Final Work : Specific Problems, Related to stocks, Longterm contracts and Trade creditors

Determinig Cost of stocks Stocks are normally a significant asset of manufacturing companies with direct effect on profit. They vary in character and pose a variety of problems for auditors.The examples used here are taken from the mineral oil industry and the manufacture of television sets The costing system is important in determining cost of stocks and long-term contracts and auditors pay particular attention to ensuring costs are genuine, accurate and complete. Some costs are easily allocated to products, but overheads may be allocated on some arbitrary but reasonable basis, and on the basis of production levels, which are „normal, taking one year with another‟. Some products may be „main‟ products, whereas others may be by-products, with income on disposal being treated as reduction in cost of main products. Net realizable value may not be easy to determinebecause stocks may not be used or sold orcompleted until after audit field work is complete. Inherent risks affecting stocks include: (a)changes in demand for the company‟s products; (b)changes in production levels; (c)defects in product lines; (d) stocks can be attractive and easily transportable; (e) complex production process; (f) joint products; (g) significant variances from standard costs; (h) competitors providing more risky environment; (i) complex calculation of overheads 









Acquisitions: it is important to determine the point at which title passes, particularly in e-commerce relationships. Safeguarding stocks: this includes physical safeguards and restriction of access via documentation. Disposals of stocks: normal sales are more likely to be controlled than abnormal disposals. Determining existence, condition and ownership at period-ends: physical stock counts, timely reconciliation to stock records and investigation of significant differences. Valuation of stocks: the basic principle is the lower of cost and net realizable value, with controls to ensure costing and other records are reliable and prepared consistently

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

872

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012)

Substantive testing of stocks Substantive testing of stocks and related production costs address: 1. existence; 2. condition; 3. ownership; 4. cut-off; 5. production costs (genuine accurate and complete); 6. production costs (properly allocated to stocks on hand, and amount attributed to stocks is genuine, accurate and complete) Normal audit practice to attend stock counts to ensure the stocktaking system is operating satisfactorily and to perform compliance and substantive tests. Cut-off procedures are performed at external and internal cut-off points Procedures to ensure stock is properly countedand recorded are as follows: (a) issue of stocktaking instructions; (b) person with overall responsibility, independent of stores personnel; (c) balanced stock count teams; (d) stores neat and tidy; (e) arrangements for cut-off; (f) issue of pre-numbered stock sheets and completeness check; (g) stock names and reference numbers on the stock sheets; (h) members of count teams count stock independently until agreement reached; (i)count sheets signed by two members of the count team; (j) count teams comment on items in poor physical condition; (k) responsible officials to investigate significant discrepancies between stock records and count; (l) count teams responsible for manageable quantities of products; (m) logical system for recording stock names and reference numbers; (n) test counts by responsible officials; (o) marking stock counted; (p) identification of goods held for or by third parties; (q) auditors available for advice; (r) briefing sessions with count teams to ensure instructions properly understood

Stock count observation, purposes and procedures. Auditors attend the count to check if instructions are properly followed, and to make test counts to ensure procedures and internal controls are satisfactory.Auditors select items from count records and physical count and compare to gain assurance as to completeness and accuracy of count records, giving particular consideration to high value stocks Level of substantive tests of details depends on theauditors‟ view of the quality of stocktaking instructionsand how they are applied. Stock counts may becarried out during the year and stock quantities takenfrom records only if: (a)controls over stock records are adequate; (b)stock records are accurate and complete; (c)significant differences between stock records quantities counted are investigated and corrected. a ta u a

and

Audit procedures include: (a) stock count observations during the year; (b) test the accuracy of stock records; (c) test for cut-off at count date and balance sheet date; (d) if necessary, conduct a restricted test count at the balance sheet date. There are particular problems affecting work inprogress, stocks held at third parties and at branches.

The basis of stock valuation is the lower of cost and net realizable value. Basic rules for calculating costinclude: (a) for different categories of stock, not for the stocks as a whole; (b) comprises cost of purchase and costs of conversion; (c) cost of purchase comprises direct costs, less cost reductions; (d) cost of conversion comprises: direct costs; o production overheads based on normal o level of activity, taking one year with another; other overheads incurred in bringing a o product or service to its present location and condition; (e) costs may be allocated to production using an arbitrary method, such as FIFO and AVCO. Net realizable value Net realizable value is actual or estimated selling price less all further costs of production and costs yet to be incurred in marketing, selling and distributing Long-term contract long-term contract may be defined as: A contract entered into for the design, manufacture or construction of an asset or provision of a service or a combinationsuch that the contract activity usually falls into different accounting periods. The major problem is that the construction period overlaps accounting periods, so a decision must be made as to whether profits and losses should be taken up before completion. This is subjective and auditors assess the validity of management judgements. There are nine judgemental points, each assertion involving an audit evidence search and testing (1) costs incurred to date are genuine, accurate and complete; (2) stages of completion and related costs are properly determined; (3) invoices issued to customers are calculated in accordance with contract and certified by the surveyor; (4) cash received from debtors is genuine, accurate and complete and properly allocated to contracts (5) estimated total costs are genuine, accurate and complete; (6) contract prices are genuine, accurate and complete (7) when attributable profits on contracts are taken up, it is sufficiently complete to give adequate assurance that the outcome of the contract is certain; losses should be provided for when recognized

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

873

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) (8) the profitability of different stages of the contact has been properly determined; (9) the method employed in taking up profits is comparable with prior years, unless appropriate and the effect of change is disclosed.

Trade creditors Trade creditors are normally classified as amounts payable in the short term. They come into existence as the result of purchase of goods or the performance of services by third parties, so audit work on purchases and related assets cannot be divorced from each other Inherent risks affecting trade creditors include: (a) new or material transactions or events; (b) material variances from standard costs; (c) suppliers experiencing difficulties; (d) significant changes in terms of trade; (e) a material increase in the age of trade creditors; (f) major changes in the nature of purchases; (g) above-average returns of goods purchased Apart from a satisfactory control environment,auditors expect to see controls over: 1. the creation of trade creditors; 2. recorded trade creditors at year-end; 3. payment of trade creditors. For creation of trade creditors, expected controls include: (a) preparation of integrated purchases budget and investigation of variances (b) record the point at which title in goods acquired passes and services rendered are complete (c) for goods accepted on sale or return, a clear statement of company obligations to suppliers (d) where title remains with the supplier there may be special disclosure requirements; (e) purchases not in the normal purchases system to be kept to a minimum, and specially authorized; g) investigation of reasons for significant returns; (h) cut-off procedures For recorded trade creditors at the year-end,expected controls include: (a) appropriate division of duties; (b) regular review of suppliers‟ statements; (c) system for adhering to and renegotiating supplier credit limits; (d) a system for detecting unrecorded liabilities; (e) a system for enquiry into unusual features For payment of trade creditors balances, expected controls include: (a) independent matching operation; (b) calculations on purchase invoices checked for accuracy (c) evidence of controls performed (d) cheque signatories to see supporting documentation (e) blank cheques never to be signed. Substantive approaches cover: (a)creation of trade creditors‟ balances, including re performing matching operation (b) recorded trade creditors at year-end (c) search for unrecorded liabilities

Questions a ta u a

1. Consider the following statements and explain why they may be true or false: (a) The omission of a short-term liability from the balance sheet will result in the acid test ratio showing that the company is less liquid than it really is. (b) Trade payables may be regarded as complete once auditors have carried out their search for unrecorded liabilities. (c) Accurate cut-off means that trade payables are genuine. (d) In valuing inventories it is permissible to include an element of administrative expense. (e) In planning work on construction contracts the auditor should identify the points where management is exercising  judgement. 2. You are auditing a company that operates a computercontrolled warehouse. There is no human entry to the warehouse except when essential maintenance is carried out and products are taken into the store and taken out on pallets controlled by an operator using a desktop computer. Suggest how you might approach that section of your audit where you are seeking to prove existence and condition of inventory. 3. The following is a record of inventory movements and recorded sales of Whygate Ltd, a company buying and selling products on credit with a December 2011 year-end. Consider these figures and then attempt the following questions. Figures as on page 528’ (a) Assuming that inventory was determined by count at 3 1 December 2011 state the adjustment required to sales and debtors and indicate the effect on profits of the adjustment. (b) Assuming that inventory was determined on the basis of recorded inventory movements, state the adjustment required to sales and trade receivables and indicate the effect on profits of the adjustment. The company carries out periodic inventory counts. You may assume in both cases that purchases have been recorded in the correct period. (c) What action would you take as auditor to prove that sales/inventory cut-off was accurate? 4. You are responsible for the audit of trade payables and purchases of Powerbase for the year ended 31 May 2011. You carried out interim audit work on purchases and trade payables at 30 November 2010 and concluded that purchases were being properly processed although you were somewhat concerned that delays in processing were occurring. Your concern was heightened by a comment by a member of the accounting staff: ‘I don’t know what you are worried about. If we ha ven’t recorded a liability, the supplier will soon remind us!’ You have now been given the following figures (including some ratios) and aim to ensure that the purchases and trade payables at 31 May 2011 are fairly stated. Design substantive programme steps that will help you to accomplish this aim. You should refer to our comments on the Powerbase case study (10.1 on page 361). Figures as on page 528.

Solutions 1 a) False The omission of a short-term liability from the balance sheet will cause liabilities to be understated, and the company will appear more liquid than it really is.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

874

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012)

b) Nor True or false The auditor's search procedures are designed to prove that trade payables are complete, so the statement is true as far as the auditor is concerned. However, management may well have formed this conclusion earlier as a result of their own procedures to ensure that all liabilities, including trade payables have been detected. (c) False Cut-off is usually regarded as an accuracy matter as it is one measure to ensure that trade payables have been identified at the balance sheet date. Of course, it is also true that cutoff procedures will be designed to prove that trade payables represent genuine transactions. d) Nor True or false Generally it is not permissible to include administrative expense in the valuation of inventory at cost as such expense is not directly related to current production or to getting the goods for sale to their present condition and location. However, it may be difficult to decide in practice how costs are to be classified (for instance as production overhead or administrative expense). Note also that in certain circumstances it may be permissible for administrative expense to be included in overheads (where, for instance, a large project is using a significant proportion of the company's resources. e) True Judgment has to be exercised in many accounting situations and long-term contacts are no exception. Sometimes  judgment is about the genuineness, accuracy and completeness of accounting records, such as the allocations of costs to individual contacts, but frequently judgment has to be exercised in relation to accounting estimates. An example from long-term contacts is estimated costs to be incurred in completing the contact. The auditor has to identify the points where management exercises judgment, as it is at these points that management is asserting that accounting treatments are valid. As we made clear in the text, these assertions become audit objectives that set the scene for the efficient and effective evidence search. 2 . Computer controlled warehouse The auditors are faced with an unusual situation where technology is being used to do a task formerly performed by human beings. The first task of the auditors would be to find out how the company satisfied itself that the goods in the warehouse were in existence and in good condition. It may be, for instance, that the company withdraws complete inventories of goods on a rotation basis for test checking. If the company does this, the auditors should enquire into the results of the counts and any other investigations the company carried out into discrepancies between count and inventory records. The auditors would also wish to ascertain that the system for controlling inventory movements was satisfactory. For instance, they would wish to find out if movements could only take place as the result of properly authorised documentation and if there was segregation of duties between computer operations, custody of goods and inventory control. The auditors may decide that a test count will also be appropriate, in which case arrangements should be made a ta u a

with top management for them to be provided with proper authority (The auditors may decide to do this on a surprise basis). The test count should be carried out by company personnel in the presence of the auditors, immediate comparisons made with inventory records and investigation of differences conducted. 3. (a) Inventory determined by count At the time of the inventory count the auditors would have noted that the last despatch note number was 1460 and would test that sales attributable to that and prior numbers were recorded in 2011 and to subsequent numbers in 2012. The following adjustments would be required:

In making the above calculation we have assumed that inventory despatched on 31 December 2011 has not been included in inventory. The auditor would enquire into this. The journal entry would be: Debit trade receivables Credit sales

£18,945 £18,945

The effect of this adjustment would be to increase profit by £18,945. The auditor would wish to determine why sales despatch note number 1464 had been used to record a movement at 31 December 2011. If it transpired that the movement had occurred in 2012 the sales and trade receivables would be increased by £18,945 less £5,995 = £12,950 (b) Inventory determined from inventory records The inventory records will have been updated for transactions up to and including 1460, dated 31 December 2011. Inventory records should be adjusted to include despatch note 1464, assuming the movement was genuinely in 2011. The sales record should be amended to record 1457, 1460 and 1464 in sales of 2011 and to remove 1461 from the sales record. Cut-off adjustments are identical to those required for inventory determined by count. Cut-off must be tested whether inventory is determined by count at the year-end or taken from the inventory records. (c) Sales/inventory cut-off. Cut-off should be tested to ensure all sales in the year have been recorded in that year and that no sales in the subsequent period are included. A useful procedure would be to record the last inventory despatch note number for subsequent matching to sales invoices. A suitable substantive test would be to select a number of despatch notes before the critical number and ensure that sales invoices have been prepared and recorded before the year-end. This is an important completeness test because it helps to ensure that all the sales had been recorded and in the correct period. Of course the test would also help to prove that the sales transactions are genuine because it will show that a genuine movement of goods to customers has occurred.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

875

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) Further, comparing the quantities on the despatch note and invoices will be an accuracy test. A selection of despatch notes after the year-end should be checked to sales invoices to ensure they are included in the following year. Tests may also be performed from invoices to despatch notes to ensure that a despatch note has been raised for each invoice issued. We looked at this in some detail when we discussed inventory count procedures earlier. The auditor should ascertain that a responsible official is given the task of considering cut-off matters at the time of the inventory count. Sometimes the company may have a system of continuous inventory taking throughout the year, taking year-end quantities from inventory records. This is acceptable provided that inventory records can be shown to be accurate. Accurate cut-off must be established at the time of count AND at the balance sheet date. 4. Powerbase plc. The gross profit percentage of 53.64% at 31 May 2011 is much higher than the previous year-end, and some 3 points higher than at 30 November 2010 (See comments on case study 9.2), so it may be that many liabilities remain unrecorded. This conclusion is supported by the higher number of days that inventory bears to cost of sales at 31 May 2011 (84 compared to 75 for the previous year), which suggests that inventory may have been received without a corresponding purchase being recorded. You will remember that we decided at the interim that delay was occurring in recording liabilities and at the final examination we should direct particular audit effort to testing for unrecorded trade payables. Interestingly, the relationship between trade payables and cost of sales does not provide a warning signal. Appropriate programme tests at the year-end would include the following: Assertions to be tested: All trade payables are properly recorded in the accounting records (all purchases of goods and services have been recorded.) Trade payables represent amounts due at the balance sheet date (purchases of goods and services have been recorded in the right period) (1) Perform bridging tests similar to those performed at the interim date to ensure purchases are being properly processed in the whole year. This would include obtaining assurance that goods received notes are complete. (2) Search for unrecorded liabilities by selecting all invoices recorded for one month after 31 May 2011 and checking to goods received notes to ensure that none should have been accrued at 31 May 2011. (3). Carry out a similar search in the cash book to ensure that no payments are in respect of items purchased in the period prior to 31 May 2011, unless in respect of purchases recorded in the prior period or accrued. (4) Reconcile credit suppliers statements to suppliers balances outstanding in the accounting records. If management have already done this you may test their reconciliation work. (5) Circularise selected suppliers and ask them to inform you of the balance outstanding at 31 May 2011 and of invoices issued 14 days prior to and after 31 May 2011.

CHAPTER 14 Final Work : Specific Problems, Related to stocks, Longterm contracts and Trade creditors

Stage 18 of the audit process is when auditors pull together evidence gathered and conclusionsarrived at earlier to form a view on the financialstatements as a whole They also perform the following tasks: (a)post-balance sheet date work; (b)audit work on provisions and contingencies; (c) final working sheet review; (d) reviews of validity of the going-concern concept; (e) review work of other auditors. Finally, they obtain the management ofrepresentation.

letter

Post-balance sheet events This is when auditors routinely assess: 1. debtors collectability; 2. NRV of stocks; 3. useful lives of fixed assets; 4. potential unrecorded liabilities. Auditors review the post-balance sheet period toascertain whether any matters should be reflectedin the accounts or disclosed in the audit report. The period after the balance sheet date may be subdivided into periods as follows. Each period has its own characteristics and problems for auditors (1) between balance sheet date and completion of draft accounts. (2) from completion of draft accounts to completion of audit fieldwork. (3) from completion of audit fieldwork to date of issuing financial statements. (4) after the financial statements have been issued but before the AGM; (5) after the AGM Events occurring in periods (1) and (2) are known by both directors and auditors as they occur before the signing of the accounts and completion of audit fieldwork. Regarding (3), auditors, becoming aware of a material event, establish if financial statements need amendment, discuss with directors and consider the implications for their report. Regarding (4), auditors have no obligation to perform procedures or make enquiries, but if they become aware of an event that might have caused them to issue a different report, they consider whether the financial statements need amendment, discuss with directors and consider the implications for their report. Regarding (5), auditors will not be expected to be aware of an event in the period after the AGM, but, if they do obtain knowledge of it, the matter should be discussed with the directors and action, if any, they intend to take, determined

Provisions, contingent liabilities and contingent assets a ta u a

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

876

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) Some events, occurring either before or after the balance sheet date, have uncertain outcomes  –provisions and contingencies as defined by FRS Is there a legal or constructive obligation, the latter evidenced by policies or other authoritative statements from management in the past, and whether the company is taking any action in respect of the event; The auditor should determine if a reliable estimate be made of the amount of the obligation. Potential losses from claims may be particularly difficult to ascertain. 2Provisions must be properly disclosed in accordance with FRS 12, sufficient to enable the reader to understand the nature of the obligation, the expected timing of transfers of economic benefits, and the uncertainties about amount or timing If the event does not give rise to a present obligation, or there is no probable outflow of economic benefits or it is not possible to evaluate the timing and amount of the obligation, it may be treated as a contingency. FRS 12 and IAS 37 distinguish between contingent liabilities and contingent assets

Contingent liability (a)A possible obligation that arises from past events and whose existence will be confirmed only by the occurrence of one or more uncertain future events not wholly within the entity‟s control. (b)A present obligation that arises from past events but is not recognized. In Part (b) the obligation may not be recognizedfor the following reasons: (i)it is not probable that a transfer of economic benefits will be required to settle an obligation; (ii) the amount of the obligation cannot be measured with sufficient reliability

Contingent asset A possible asset that derives from past events and whose existence will be confirmed only by the occurrence of one or more uncertain future events not wholly within the entity‟s control.... Contingencies, like provisions, are problematicbecause of the varying degrees of certainty fromremote to probable. Note that: (a) directors consider estimates of outcome and the financial effect of contingencies; (b) directors review events occurring after the balance sheet date up to the date of signing the financial statements; (c) accounting treatment of a contingency depends on its expected outcome and nature....

Going concern During the final review period the auditor considers the validity of assuming that the company is a going concern. Audit work to detect post-balance sheet events and contingencies (a) determine company procedures to detect material postbalance sheet events/ contingencies; a ta u a

(b) examine minutes of meetings: shareholders, directors and audit/executive committee; (c) examine management accounts/accounting records (d) examine profit and cash flow forecasts; (e) Enquire of legal department and external legal representatives (f) review known risk areas; (g) review correspondence/memoranda; (h) confirmation from third parties; (i) review information in the public domain; (j) management interviews

Questions 1. Consider the following statements and explain why they may be true or false: (a) Audit working sheets should be a record of all evidence collected by auditors in forming the audit opinion. (b) Auditors’ responsibility ceases at the date they sign the audit report. (c) The financial statements signed by directors on or slightly before the date of the audit report must be identical with the financial statements submitted to shareholders. (d) Oral evidence from management that can be confirmed from other sources need not be acknowledged in writing in the letter of representation. (e) If management refuse to sign the letter of representation, auditors will be unable to form an opinion as to whether the financial statements give a true and fair view. (f) FRS 12 and IAS 37 apply to provisions for accrued electricity and telephone usage and provisions for doubtful debts. 2. Show how the following events should be reflected in the accounts at 31 December 2011 and describe audit procedures you would carry out to verify them: (a) Company A estimated that the profits on a construction contract that was 75 per cent complete at 31 December 2011 would amount to £100 000 and had taken up £75 000 in the profit and loss account on the portion of the contract certified as complete by a qualified surveyor. On completion on 21 February 2012, company records show profit on the contract amounted to £30 000. (b) Company B acquired non-current assets for £500 000 on 31 January 2012. The financial statements at 31 December 2011 showed non-current assets at cost less depreciation amounting to £250 000. (c) Company C has shown in its financial statements at 31 December 2011 an investment in another company at cost of £750 000. On 1 March 2012 there is a significant decline in prices on the Stock Exchange resulting from unexpected foreign exchange movements. (d) Company D is in dispute with a supplier as to the quality of goods supplied and has provided for the amount it believes to be correct (£100 000). The supplier has sued for the full amount invoiced (£150 000) but on 12 March 2012 the company and supplier agree the liability out of court at £120 000. (e) Company E had prepared draft financial statements at 30 November 2011, showing an acid test ratio of 0.85 to 1.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

877

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) (The normal acid test ratio in its industry is 1 to 1.) Shortly before 31 December 2011, the company sold trade investments for £450 000, incurring a loss of £100 000 and this had the effect of increasing the acid test ratio to 0.98 to 1. On 16 January 2012, the company repurchased the trade investments for £500 000. 3. Bandon Limited acquired a subsidiary, Gateside Limited, ten years ago and goodwill on consolidation is being written off over 20 years. Gateside made good profits until two years ago, but in the year to 31 December 2010, made a small loss and in the year to 31 December 2011 made a significant loss. Do you think that this would provide good grounds for an impairment review? What audit steps would you perform to satisfy yourself that the results of the impairment review are valid? 4. During an audit of the cost records of Roberton Ltd at 31 March 2011 you discover that Prospect Limited has sued the company, claiming that it is using a manufacturing process which has been patented by Prospect. However, the directors of Roberton say that the manufacturing process used is sufficiently different from the one patented and that no disclosure of any potential liability is required. Discuss the accounting and auditing implications of this matter.

Solutions 14.1 a) True Audit working papers should be a synopsis of the assignment. This means that all important evidential matter should be included in them, the basic rule being that they should be self-explanatory. To give only one example, if the auditor has discovered that not all sales orders have been subjected to a credit control check, the working papers should contain identifying references to the documents in question and ideally should contain copies of some if not all of them. There should also be a reference to the impact on control risk and to the scope decision on the nature and extent of substantive tests b) False While it is generally true that auditors' responsibilities cease on the date the audit report is signed (that is, they are not expected to search for evidence of balance sheet after that date), ISA 560 - Subsequent events - makes clear that, should auditors become aware of such events they do have certain responsibilities. Read paragraphs 10 and 14 of ISA 560. c) Nor True or False As a matter of practicality the financial statements signed by the directors may not be in the precise printed or typewritten form submitted to members. However, auditors should satisfy themselves that the approved financial statements are complete in all material respects with those subsequently issued to members. d) True Auditors would certainly not wish to overload the written representations from management on matters about which there is little uncertainty. For instance, if management has explained orally to the auditors that the reason for a reduction in gross profit percentage has been a decision not to increase prices to match cost increases, it would probably a ta u a

be possible for them to confirm this by checking sales invoices and cost records and no reference would be needed in the letter of representation. On the other hand, if the auditors were aware that there was a pending legal case the auditors might have concluded that the matter had been appropriately dealt with in the financial statements with as a provision of disclosure as a contingent liability. They would probably ask management that there were no other legal claims against the company. You should note too that paragraph 6 of ISA 580 makes clear that the auditors should obtain written representations from management and, where appropriate, those charged with governance that they believe that they have fulfilled their responsibility for the preparation of the financial statements and for the completeness of the information provided to the auditor. e) Nor true or false It is unlikely that the auditor would be able to form conclusions in the absence of a letter of representation from management. See paragraphs16 to 20 of ISA 580. It might be possible for the auditor to form conclusions as to truth and fairness by reference to other sources particularly where the areas of contentious judgement were slight, but we would not be too sanguine about this. A refusal to sign the letter might indicate a breakdown in the working relationship between auditor and management or of problems in the company that management wish to hide. f) False The word 'provision' was often used by accountants to mean the setting up of an accrual or for amounts deducted from assets, such as trade receivables and fixed assets. FRS 12 and IAS 37, however define a 'provision' in a very particular and restrictive way, but exempts a number of items from its application, including so-called executory contracts, except where the contract is onerous. Contracts of this kind are defined as contracts under which neither party has performed any of its obligations or both parties have partially performed their obligations to an equal extent. They generally relate to the delivery of future services, including electricity and telephone. This means that this kind of accrual is not covered by FRS 12 and IAS 37. 2 a) Company A. The discovery that the profit on the longterm contract amounted to £30,000 and not £100,000 is an adjusting event in the terms of IAS 10 and FRS 21 as it gives more information about a condition that existed at the balance sheet date. It would therefore seem appropriate to take up a profit of £22,500 and not £75,000. The auditor would determine why the company had been so wrong about the estimated profits on this contract and might consider examining the records of the company to determine extent of completion at the balance sheet date, including the reports from the qualified surveyor. The costing records in the old and new period should be tested to ensure costs (including overhead costs) and income have been properly allocated to the contract in question. The matter should be fully discussed with management, and in addition, whether there were implications for other contracts not complete at the balance sheet date. b) Company B. The acquisition of the fixed assets does not appear to be a matter providing more information about

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

878

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) conditions existing at the balance sheet date. The acquisition does seem to be very material and disclosure should be made in the notes to the financial statements that it has been effected. CA 2006 does require capital commitments to be stated in the notes and there seems to be a good case for indicating the actual date of acquisition in this note. The auditors would examine the contract for the supply of the fixed assets, the purchase invoice and the entry in the fixed assets register. They would ensure that all related costs (such as installation costs) had also been determined and, in view of the significance of the amount, may feel that a physical inspection would be appropriate. c) Company C. The decline in stock market prices seems to be a further example of a non-adjusting event, but if material the reduction in market value by £200,000 should be disclosed in the notes to the accounts. The auditors would need to obtain the stock market quotation at the audit report date and ensure the disclosure in the notes reflected it. If the stock markets are volatile (that is, see- sawing up and down or moving downwards or upwards) the auditors may feel the need to ensure that the quoted value of the investment is made known to the shareholders at the AGM. To this end they should discuss the matter with the directors to determine the action they intend to take. They may also consider making a statement to the shareholders at the AGM, depending on the materiality of the matter. d) Company D. This event has the hallmark of an adjusting event as it gives more information about conditions that existed at the balance sheet date and the amount of the provision should therefore be adjusted to £120,000. The auditors would wish to inform themselves of the background of the dispute and to examine the agreement between the two parties. e) Company E. This scenario looks very much like deliberate window dressing by the company to improve the appearance of liquidity. The auditor should look carefully into the circumstances of the sale and repurchase, considering in particular if the transaction was other than arms length to a related party. Transactions with related parties should be disclosed and, if they are not, the auditor would wish to qualify the audit report. The sale and repurchase might need to be the subject of an ‘emphasis of matter in the audit report. We discuss audit qualifications and emphases of matter in Chapter 16. 3. Clearly, any asset only has value if it can generate profits and positive cash flow, so a downturn in profits and the occurrence of losses might indicate that impairment has occurred. Unlike tangible assets, goodwill cannot be sold, so an impairment review would concentrate on value in use within the company, unless the decision was made to dispose of the whole subsidiary, in which case net realisable values for goodwill might be appropriate if it were to be sold as a going concern. The auditors would discuss the future of Gateside and its operations with management. To assist in these discussions, the auditors would establish the trend of profits over the last ten years. It seems that the trend into a loss-making situation has been evident in 2010 a ta u a

and 2011. If this trend continues, Gateside may be in even more trouble in the year to 31 December 2012 and the auditor would determine what actions the directors of Bandon are taking to remedy the situation of their subsidiary. What are their views on why the downward trend has occurred? For instance, has a new competitor entered the market, or has there been new legislation that has made the company less viable, or have one or more key employees left Gateside, rendering the company less well managed. The auditors would ask management if they have a response to these matters that might turn the company round. They may find that the directors have decided to change product lines and management structures, in which case it may become clear that the existing goodwill has little to do with the 'new' company, in which case write down or even complete write-off of the goodwill might follow the impairment review. The carrying amount of the investment in Gateside in Bandon's own financial statements should probably be written down. This is clearly a subjective matter, but the auditors should find as much external evidence as possible by reviewing industry trends, reading business news and specialist industry news-sheets. 4 . The auditors are clearly concerned that the third party will be successful in an action against the company and that material damages may become payable. From the accounting point of view the auditor has to decide if this is: - A provision in the terms of FRS 12 and IAS 37 that is an event has occurred (the use of the patent registered by a third party) that creates a present obligation (either legal or constructive) that is expected to result in the outflow of economic benefits that can be assessed with sufficient reliability. -A contingent liability that is not remote and should therefore be disclosed under the terms of FRS 12 and IAS 37. This is clearly both a legal matter and a technical matter. If the patent has been infringed, then legally the company may well be liable. However, if there is doubt that the patent has been technically infringed, Prospect may not be able to make a successful claim for damages in court. The first step for the auditors would be to determine the facts. They would examine a copy of the patent held by Prospect and determine the nature of the claims made. There would be a need to determine the nature of the manufacturing process concerned and the technical matters that are involved in its operation. The auditor might seek expert advice about the patent and about the process and whether the latter has or has not been using the former. The process may prove to be in the public domain, in which case the claim for damages would be unlikely to be successful and the success of the court case regarded as remote. If, however, thecontingency is other than remote, the decision must be taken whether to it is a provision in the terms of FRS 12 and IAS 37 or merely a disclosable contingent liability. Legal advice should also be sought once the technical matters have been clarified.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

879

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) CHAPTER 15 Assurance engagements and Internal Audit

Standard audit reports Standard audit reports give reasonable assurance that financial statements are free from material misstatement Review and other reports give a level of assurance lower than „reasonable assurance‟, using a negative expression of opinion because evidence-gathering is limited The International Framework for Assurance Engagements defines an assurance engagement as follows: an engagement in which a practitioner expresses a conclusion designed to enhance the degree of confidence that intended users other than the responsible party can have about the outcome of the evaluation or measurement of a subject matter (subject matter information) against criteria.

Elements of an assurance engagement Five elements of an assurance engagement are:( 1) the three -part relationship involving a practitioner, responsible party and intended users; (2) appropriate subject matter; (3) suitable criteria; (4) sufficient appropriate evidence; (5) the written assurance report in the form appropriate to a reasonable assurance or a limited assurance engagement. Users might wish to rely on many kinds of matter, other than financial statements: (a) effectiveness of local authority programmes; (b) systems and processes (c) corporate governance issues (d) environmental matters (e) compliance with human rights legislation (f) compliance with contractual terms. Parties other than external auditors can provide useful degrees of assurance to users.Examples of such parties include internal auditors and bodies such as the Consumers‟ Association. Characteristics of suitable criteria are: 1. relevance; 2. completeness; 3. reliability; 4. neutrality; and 5. understandability. The amount and quality of evidence determines conclusions practitioners can draw and the report they can issue. Basic differences between reasonable assurance and limited assurance engagements are as follows

Reasonable assurance Assurance engagement risk at an acceptably low level as the basis for a positive form of expression of the practitioner‟s conclusion. Sufficient appropriate evidence is obtained through understanding of the engagement circumstances; a ta u a

assessing risks; responding to assessed risks; performing further procedures (inspection, observation, confirmation, recalculation, reperformance, analytical procedures and inquiry), involving substantive procedures.

Limited assurance Assurance engagement risk is greater than for a reasonable assurance engagement as the basis for a negative form of expression of the practitioner‟s conclusion. Sufficient appropriate evidence is obtained as part of a systematic engagement process, including obtaining an understanding of subject matter and other engagement circumstances, but in which procedures are deliberately limited relative to a reasonable assurance engagement Assurance reports Basic elements of an assurance report comprise: 1. title clearly indicating it is an independent assurance report; 2. addressee; 3. identification and description of subject matter information and, where appropriate, subject matter; 4. identification of criteria; 5. description of any inherent or significant limitation associated with evaluation or measurement of the subject matter against the criteria; 6. when the criteria are available only to specific intended users, or are relevant only to a specific purpose, a statement restricting use of the assurance report; 7. statement to identify responsible party and to describe responsible party‟s and practitioner‟s responsibilities; 8. statement that the engagement was performed in accordance with ISAEs; 9. summary of work performed; 10. practitioner‟s conclusion (positive or negative); 11. assurance report date; Examples of reports receiving different levels ofassurance are: 1. no assurance; 2. limited assurance; 3. long-form report with limited assurance or other degrees of assurance; and 4. positive assurance. No assurance: (a)compilation report; (b) preparation of tax returns where no conclusion is given on acceptability. Limited assurance: (a)report on review of interim financial statements (b) agreed-upon procedures (c) consulting engagements where the nature and scope of the work is agreed between the practitioner and management (d) comfort letters (e) report on corporate governance statement.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

880

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) Long-form report with limited assurance or other degrees of assurance Long-form report on internal control highlighting limitations of internal control, commenting on weaknesses identified, but using generally accepted auditing standards. Positive assurance (a)statutory audit of financial statements;(b) report on internal control using generally accepted auditing standards. Certain of the examples do not meet the definitionof an assurance engagement in the Framework,but some consulting engagements may meet thedefinition. Matters to be considered before accepting anassurance engagement: (a)relevant ethical requirements; (b) whether the engagement has: (i)appropriate subject matter (ii) suitable criteria available to intended users; (iii) availability of sufficient appropriate evidence to support the desired conclusion; (iv) practitioners‟ conclusion that will be contained in a written report; (v) rational purpose for the engagement

Importance of assurance engagements Assurance engagements have assumed importance because: (a) many companies have merged so the pool of large audit clients has reduced considerably; (b) substantial downward pressure on audit fees; (c) business is significantly more complicated, and more risky, as a result of mergers, the technological revolution and use of complex financial instruments (d) audit firms have taken the opportunity to open up new markets to increase their profitability As a result of such factors audit firms haveadopted strategies to reduce audit risk and havestarted to adopt a business risk approach, which involves gaining deep understanding of a company and its industry, of company objectives, of business risks that may inhibit achievement of objectives, and the way in which management attempts to reduce the impact of risks This approach brings auditors into close contact with management and often results in the identification of problem areas that the firm can address. It may also lead to the provision of assurance services. 1. Compliance auditing determines whether the company conducts business in accordance with rules and regulations. 2. Efficiency auditing determines whether resources are being used optimally within the bounds of feasibility. 3. Effectiveness auditing is wider and directed towards determining if resources are used to proper effect Other types of internal audit include: (i)operational; (ii) management; (iii)value for money (VFM); (iv) evaluation (a further class of appraisal activity). a ta u a

Operational auditing Operational auditing concerns itself with the whole organization and not just with finance and accounting. Management auditingdetermines whether management is acting effectively. In VFM audits, the auditor enquires into economy, efficiency and effectiveness, a particular requirement of public sector auditing Evaluation auditing Evaluation auditing involves internal auditors when they are engaged in participative auditing.Evaluation has developed along different lines, from the other types of audit, independence not being so important. Instead the evaluator brings together interested stakeholders, attempting to find a mutually acceptable solution Role of Internal Auditors Internal auditors play an important role in the public sector. Types of audit they and external auditors perform include: 1. financial; 2. legality; 3. regularity audits; 4. systems examinations; 5. probity; 6. VFM; 7. performance audits. Factors tending to make internal audit effective are: 1. support of top management; 2. independence of internal auditor from parts of the organization being audited; 3. a strong ethical culture in the company and department; 4. appointment of motivated staff with good educational backgrounds, enquiring mindsets and ability to communicate well; (f) continuing education and training; (g) good staff appraisal system; (h) good leadership; (i) good communication links with all parts of the organisation; (j) steps to ensure that staff behave in a professional way; (k) to ensure high job satisfaction. One factor reducing effectiveness is the “short-stay syndrome‟.

Role of External Auditor External auditors still have full responsibility for their audit opinion, even if they rely on the work of internal audit. If external auditors are to rely on internal audit work they assess effectiveness of internal audit, taking into account: (a) organizational status; (b) scope of function; (c) technical competence; (d) due professional care. External auditors fully document decisions to use internal audit work, when they intend to rely on it. Generally, external auditors audit all material matters in the accounts particularly where there is significant risk of misstatement. If external auditors rely on internal audit work, they agree the timing and extent of the work with the chief internal auditor. Once external auditors have decided to rely oninternal audit work they consider:

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

881

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012)

(1) staffing, planning, supervision and review; (2) comparison of results of internal and external audit work in similar areas; (3) whether exceptions or unusual matters in internal audit reports have been resolved; (4) whether the response by management to internal audit reports has been satisfactory ;(5) whether the internal audit programme can be completed in the time available; (6) whether the work of internal audit is carried out with economy, efficiency and effectiveness.

CHAPTER 16 The Auditor’s Report

Communicationg Audit Opinion Auditors communicate their views on accounts in the audit report. If they are satisfied the accounts give a true and fair view and comply with legislation, they give an unqualified opinion, but, if dissatisfied, a qualified opinion may be appropriate. Auditing standards require „reasonable assurance‟ but other engagements may provide only „limited assurance‟. The current audit report is an „expanded‟ or „long -form‟ report

Unqualified report An unqualified audit report for an unlisted company has the following sections: (a) addressee; (b) scope and identification of subject matter (c) responsibilities; (d) basis of opinion; (e) opinion; (f) name and address of auditors; (g) date of audit report Auditors must identify the published information upon which they are reporting. Auditors check that information not audited does not conflict with the view given by the financial statements. If they believe there is an inconsistency or incorrect information auditors consider whether an amendment to the other information or the financial statements is required.

Responsibility of an audit opinion Auditors state their responsibility to form an opinion onthe financial statements. Directors‟ responsibilitiesinclude: (a)preparation of financial statements that give a true and fair view; (b) selection of suitable consistently applied accounting policies; making prudent and reasonable judgements and estimates; following applicable accounting standards; determining appropriateness of the going-concern assumption; (c) ensuring the entity keeps proper accounting records; safeguarding the assets; taking appropriate action to prevent and detect fraud and other irregularities. Responsibilities statements are to make clear toreaders the a ta u a

extent and scope of the respectiveresponsibilities of the directors and auditors, and toremove misconceptions that users may have had.

Basis of Opinion sector The basis of opinion section refers to: (a) conformity of audit work to auditing standards; (b) basis of the audit opinion, including that the auditors had: (i) examined evidence on a test basis; (ii) formed assessments of significant estimates and  judgements; (iii) determined whether the accounting policies are appropriate, consistently applied and adequately disclosed In the opinion section auditors express an opinionand not a guarantee  –an opinion of value becauseit is given by independent and competent experts.The opinion is directed towards two basic matters: (1)the truth and fairness of the accounts; (2) compliance with CA 1985. CA 1985 requires companies to state whether accounts have been prepared in accordance with applicable accounting standards and, where there is material departure from standards, that details, together with financial effect, are given with reasons. In very exceptional circumstances companies may depart from a provision of CA 1985 in order to give a true and fair view, but the reasons for departure and the effect should be disclosed. Exercise of judgement is very important where it involves uncertainty, particularly when it relates to the outcome of a future event. Uncertainty only becomes a major problem when the extent of the uncertainty and potential effect is fundamental to the view given by the financial statements

Consideration of Inherent uncertainty magnitude In assessing the magnitude of an inherentuncertainty auditors consider: (1)the risk an estimate may be subject to change; (2) the range of possible outcomes; (3) the consequence of outcomes on financial statements. If an item affected by fundamental uncertainty has been adequately accounted for and disclosed, auditors issue an unqualified audit report with an explanatory paragraph in the basis of opinion Where auditors believe the directors‟ estimate of the likely outcome is materially misstated or disclosures are inadequate, they may issue a qualified audit report for disagreement.

Dissatisfaction statement on Audit Report Qualifications in the audit report indicate there arematerial matters about which the auditors are notcompletely satisfied. Dissatisfaction could be because of: (a) limitation in audit scope; (b) auditors‟ disagreement with treatment or disclosure. Limitation of scope arises if auditors are unable to obtain sufficient appropriate evidence. If the possible effect is so material or pervasive that they cannot form an opinion, they issue a disclaimer, but if not they issue an “except for‟

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

882

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) opinion. The audit report includes a description of factors that lead auditors to give a qualified opinion so users can more fully appreciate the implications of the limitation of scope and why qualification is necessary.

Forms of Qualification Matrix

(1)the nature of audited financial statements (2) the type and extent of work undertaken by auditors (3) the level of assurance provided by auditors. The listing rules require the auditors‟ report on the financ ial statements to cover the disclosure of certain items affecting directors.They also require auditors to describe their reporting responsibilities in the corporate governance report. Auditors are not currently required to report publicly on whether the directors‟ statement on internal control covers all risks and controls.Nor are they required to report on the effectiveness of corporate governance procedures or its risk and control procedures However, in reviewing the directors‟ statement oninternal controls, auditors: (a)determine how directors reviewed the effectiveness of the system of internal control; (b)review and evaluate documentation prepared for the directors; (c) determine if the directors‟ statement accords with the auditors‟ knowledge of the  system of internal control and of the company.

Disagreement on Management opinion and Adverse Opinion Disagreement arises when the auditors form an opinion on a specific matter that differs from the opinion of management. An adverse opinion is given when the effect of the disagreement is so material or pervasive that the financial statements are seriously misleading. An „except for‟ opinion is used where disagreement about an item is material but not seriously misleading. Disagreement can arise from: (1)use of an inappopriate accounting base; (2) disagreement with client as to facts or amounts; (3) non-compliance with relevant legislation. ISA 260 requires auditors to report their findingsto those charged with governance. Examples of matters that would be reportedinclude: (a) expected modifications to the audit report; (b) any misstatements that have not been adjusted by management in preparing the financial statements. Where the financial statements are not adjusted for misstatements the auditors obtain written representations from those charged with governance as to why they were unwilling to make the necessary adjustments. Even where management have adjusted the financial statements auditors may communicate details to those charged with governance for their consideration.

Auditors are not currently required to report publicly on whether the directors‟ statement on internal control covers all risks and controls, or on the effectiveness of corporate governance procedures or its risk and control procedures.They also require auditors to describe their reporting responsibilities in the corporate governance report.

Post Financial Report Companies often post financial reports on theweb.This raises problems for auditors because: (1)information on the web is easily changed; (2) it may not be readily apparent what information has been subject to audit (3) information on the web can be accessed in many different countries. Where a client intends to distribute its financialstatements electronically auditors should: (a)review the process by which the electronic financial statements are derived; (b)check that the proposed electronic version is identical in content with the manually signed accounts; (c) check that the conversion of the manually signed accounts into an electronic form has not distorted overall presentation.

CHAPTER 17 Fraud and Going Concern

Recent addition to the wording of the standard audit report is a paragraph disclaiming responsibility to third parties, arising from the Bannerman case.Adding this wording has become common practice among the Big Four.

Audit expectations gap APB introduced the expanded audit report as anattempt to close the audit expectations gap and reduce misunderstandings relating to:

a ta u a

Auditor’s responsibility for detecting fraud Auditors responsibility for detecting fraud has generated considerable controversy and it is popularly believed that auditors are responsible for detecting fraud. Detection of fraud and error was at one time an important function of audit, but today auditors concentrate on assessing the

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

883

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) integrity and competence of management, and the effectiveness of internal control, using analytical procedures, and largely restricting detailed audit work to high risk areas. The auditing standard on fraud states that it is not the auditors‟ function to prevent fraud and error, but that auditors plan, perform and evaluate their audit work in order to have a reasonable expectation of detecting material misstatements arising from error or fraud. Management has prime responsibility to prevent and detect the occurrence of fraud through appropriate systems of internal control and other means.

Obtaining audit evidence Problems in obtaining audit evidence arise where: (a)external or auditor-generated evidence is not available (b) the lack of evidence relates to material or unusual or complex transactions; (c) the lack of evidence results from managerial action. Once auditors have ascertained that fraud mightbe taking place they decide on appropriate action: (a)confirm understanding of facts, nature of fraud and likely magnitude to aid determination of additional audit tests; (b) discuss the fraud or error with senior management, directors or audit committee.

Auditors do plan and conduct audit tests to limit the possibility that material fraud and irregularities go undetected. This process starts at the planning phase when auditors consider the company and its environment and the risks facing it.

If fraud has been discovered, auditors should: (i)ask directors to consider changing financial statements; (ii) ask management to determine the extent of fraud or error; (iii) assess the impact on other audit work.

Auditors limitation Auditors argue they cannot guarantee detection ofall frauds and errors because of: (1) inherent limitations in audit techniques and tests; (2) deceit, collusion and other means to conceal fraud make detection difficult; (3) audit evidence is that required to form an opinion and not specifically to find fraud. .

If auditors suspect non-directors may be implicated, they should discuss the matter with the directors. If directors may be involved, they should consider reporting to the audit committee. They might also seek legal advice and, in some circumstances, report their suspicions to third parties.

Motives and Indicators of Fraud Identification of motives and indicators of potential significant fraud are important. Pressure to misrepresent financial performancemay be high.In such circumstances auditors might change theiraudit approach to reflect higher risk. . Reasons behind misrepresentation might be: (a) the company has performed badly or is under pressure from markets; (b) directors wish to show continuing growth; (c) where the company expands by acquisition, directors may wish to inflate profits to show success, and to sustain the share price; (d) there are liquidity problems. Characteristics of personnel, the management team and its structure may provide helpful indicators as to when and where a fraud is likely: 1. particular directors are autocratic and authoritarian; 2. staff are poorly qualified or lack motivation; 3. individuals are paid by results; 4. individuals are allowed too much authority or power; 5. turnover of staff is high Relevant individual characteristics include: (i)integrity and sense of ethics; (ii)extent to which motivated by greed (iii) degree of loyalty exhibited by individuals. Weaknesses in systems may: 1. reduce the reliability of accounting information; 2. allow employees to commit fraud; 3. allow management to avoid or override controls.

a ta u a

If directors do not take appropriate action, it may be difficult to determine the full extent of the fraud or error, may have implications for the audit report, and may cause the auditors to re-evaluate the integrity of management and the control environment.

Audit Process documentation Auditors should document the process until issatisfactorily resolved, including: (a) initial grounds for suspicion; (b) additional audit work; (c) details of what, when and to whom they reported; (d) management‟s response and any action; (e) implications for audit work.

it

Board of Directrs and Internal Controls Board of directors responsibilities include maintaining sound internal controls to safeguard shareholders‟ investment and company assets, including prevention and detection of fraud and error. Means to achieve these include: 1. developing an appropriate control environment; 2. establishing a strong and effective system of internal control; 3. encouraging a strong ethical environment and developing a code of conduct; 4. establishment of an audit committee; 5. reporting on the effectiveness of the company‟s internal control system. Auditors may report to third parties that they have found a fraud, or suspect it is taking place, if it is in the public interest to do so. They would normally discuss the issue with the board of directors and the audit committee first, unless they believe the directors may be implicated or are aware of it. Only after discussion, and if the directors do not inform an appropriate authority, will auditors report the fraud.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

884

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) Auditors must use professional judgement to determine if the matter is in the public interest, perhaps seeking legal advice, especially as the duty of confidentiality may be breached.

The Audit Agenda The Audit Agenda: Next Steps did not proposechanges in auditors‟ responsibilities for detectingfraud, but recommended that: (1) auditors should report to the board and audit committees of listed companies on the appropriateness and adequacy of control systems; (2) training and education to improve understanding of fraud and its detection; (3) directors to commission forensic audits. The Audit Agenda highlighted the difficulty of detecting fraud where it is well planned, ingenious or involving collusion or top management, but noted that auditors can contribute to the prevention of fraud by informing management of weaknesses in the control systems.It also referred to the limited nature of penalties imposed on directors if they mislead auditors. ICAEW Audit Faculty has recommended that auditors be prepared to take a more active role in detecting fraud, and has made suggestions as to the knowledge auditors should have. It was suggested that a Fraud Advisory Panel be established. APB has admitted it is difficult to detect management fraud, but has made proposals regarding potential ways in which audit could be made more effective.

Audit standard and Fraud management Some auditing standards might be amended but APB says that a significant increase in the likelihoodof detecting management fraud requires radical change, including: (a) increased emphasis on professional scepticism; (b) tighter rules on acceptable audit evidence; (c) reporting material matters in the financial statements that are supported only by management‟s representations. APB considers that expanding the auditors‟ rolecould be helpful in preventing and detecting fraud,perhaps by: (a) reporting to boards and audit committees on controls to prevent and detect fraud; (b) forensic fraud review; (c) more reporting of suspected frauds

Obligations for Auditors Obligations here for auditors include: (a) understanding relevant laws and regulations and how the entity ensures compliance; (b) inspecting correspondence with relevant authorities; (c) determining if management are aware of noncompliance; (d) obtaining from directors written confirmation they have disclosed non-compliance and the actual or potential consequences. When auditors become aware of possible non-compliance they determine its nature and conclude on the potential effect on the financial statements. The outcome of discussions with management and legal representatives may influence auditors‟ judgement of management‟s

a ta u a

integrity. Auditors may consider including the matter in their audit report Financial statements are usually prepared on the goingconcern basis because measures based on break-up values tend not to be relevant to users.Users assume that, if there is no comment to the contrary, the company will survive beyond the short-term. Directors‟ responsibilities include determining whether a company is a going concern. Auditors must satisfy themselves that the going-concern basis is appropriate and disclosures in the financial statements are sufficient. They should determine how directors concluded the company is a going concern, and assess the logic, rationale and strength of information used. To do so auditors should: (i) make enquiries of directors and examine appropriate available financial information; (ii) having regard to the future period to which the directors have paid particular attention, plan and perform procedures specifically designed to identify any material matters that could indicate concern about the entity‟s ability to continue as a going concern. When planning, auditors should: (1)assess business/inherentand control risk; (2)perform analytical procedures.

Assestment of Inherent and control risk Assessment of business/inherent riskrequiresauditors to be knowledgeable about the company,its products, main suppliers, competitors and itsenvironment.Assessment of control risk is important because it gives guidance on reliability of historical andbudgeted financial information. Means to predict the future include: (1)cash flow budgets or forecasts; (2) forecast profit and loss accounts and balance sheets; (3) information on forecast sales, costs and products. Indicators that might suggest going-concernproblems are: negative cash flows; 1. significant losses; 2. substantial debts difficult to service; 3. substantial overdraft and overdraft limit exceeded; 4. net current liabilities; 5. loan repayments or overdraft facilities renegotiated; 6. reduction in dividends; 7. longer creditor payment period; 8. company has made employees redundant and/or has had to reorganize/rationalize its operations; 9. declining market and/or out-of-fashion products; 10. forced sale of fixed assets. Auditors obtain written confirmation directors‟representations about going concern.

of

Where financial statements are prepared on a goingconcern basis, the entity is assumed to continue in existence for the foreseeable future, the extent of which varies from entity to entity influenced by the nature of the entity‟s business, its business risk and external influences.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

885

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) Directors judge what is an appropriate period for them to look into the future. If this period is less than one year, additional disclosures in the financial statements may be required, and the auditors refer to this in the audit report even where there is little doubt about going-concern status. If there is no doubt, neither directors nor auditors need refer specifically to going concern in the financial statements or audit report. However, the Combined Code states that “the directors should report that the businessis a going concern, with supportingassumptions or qualifications as necessary‟ Where there are doubts, auditors will consider if the directors have included sufficient appropriate disclosures such that the financial statements give a true and fair view. If so, they need not issue a qualified audit opinion, even where there is fundamental uncertainty, but include an explanatory paragraph on the going-concern problems, referring to the note disclosure in the audit report. .

CHAPTER 18 The Audit Expectation Gap and Corporate Governance

Element in Audit Expectation Gap The common element in various definitions of the audit expectations gap is that auditors are performing in a manner at variance with the beliefs and desires of others who are party to or interested in the audit. The gap comprises several gaps between the views of auditors and those of a number of stakeholders, some of whom are powerful, others weak, lacking economic power. Powerful stakeholders can exercise political power over company directors. Often powerful stakeholders are better informed about the nature of auditing and the audit role, so expectations differ considerably. Other interested parties include politicians, regulators and academics. 





Politiciansmay feel independent auditors are necessary where the public needs protection Regulators alter relationships by imposing duties on some and giving rights to others. Academicsmay have influenced what the public think about professional bodies and auditors. The gap is long-standing.

Components of the audit expectations gap Components of the audit expectations gap are: (1)performance gap, which can be split into (i) deficient performance; (ii) deficient standards; (2) reasonableness gap. Two possible reasons for deficient performanceare: (1) lack of competence; (2) lack of practitioner independence. Lack of competence includes lack of care, lack of knowledge and lack of experience. Practitioner independence a ta u a

comprises programming,investigative independence.

and

reporting

Responses of the profession to apparent lack ofcompetence include: (a)rules on issue of practising certificates; (b) post-qualifying education; (c) monitoring audit activity; (d) disciplinary procedures. A major problem is the increasing complexity of business and internal relationships, making management of the audit process difficult, especially if top management lack integrity.Strengthened internal audit may be one response to the complexities, another the careful assessment of business and audit risk. Effects of lack of competence and lack of practitioner independence may be difficult to separate. Remedies for deficient performance include those that enhance practitioner independence, such as monitoring. An independent Office for Auditing has been suggested to oversee the framework for large company audits, auditor remuneration and audit practice of major accounting firms.

Deficien standards gap The deficient standards gap is the gap between what auditors can be reasonably expected to do and what the profession and the law asks them to do. It is difficult to assess what is reasonable, particularly as views may change over time. Two issues causing most concern have been fraudand going concern, both of which have seen considerable changes in approach by auditors. ISA 240 suggests that auditors‟ responsibility for fraud detection is limited, despite planning to detect material misstatements, and that management have prime responsibility for prevention and detection. Critics argue the standard is deficient because, despite problems in finding carefully hidden fraud, the public expect auditors to find material fraud and report its existence. Unfortunately procedures to give a higher chance of detecting fraud are costly, suggesting the gap will never be closed. Until the issue of SAS 130, auditors were not required to search actively for evidence that companies were going concerns.Critics argued that auditors were too passive because standards were deficient. SAS 130 introduced a more active approach, but whether the expectations gap will be closed as a result is less certain, particularly if companies continue to collapse after avoidance of qualification where a „fundamental uncertainty‟ exists.Positive developments include requirements for directors to give their view on goingconcern status and an increasingly active role for audit committees. Many commentators believe the professional bodies are insufficiently independent of their own members, that they cannot both protect members and ensure that society is best served by those members, suggesting that the regulatory role should be removed from them. There is a perception of closeness between leaders of the profession and big business, although steps were been taken to counter this with the establishment of FRC, ASB and APB.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

886

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) Reasonability of Audit expectations Expectations can only be reasonable if they are compatible with the auditor’s role in society and cost-beneficial to perform.But the role of the auditor is not clearly defined, contributing to lack of societal awareness  –should it be for stewardship purposes or to achieve wider accountability to society?

A dialogue should also be established withshareholders. Three main principles affect the responsibilities of institutional shareholders, to: (1) enter into dialogue with companies; (2) evaluate companies‟ corporate governance arrangements; (3) make considered use of votes.

Audit procedures might be unreasonable if benefits are less than cost. Costs may be relatively easy to determine, but benefits are intangible and difficult to measure. Costs and benefits may change over time because of changes in technology and in societal attitudes

The board‟s responsibility is to present a balanced and understandable assessment, including interim and other price-sensitive public reports. Even unaudited interim reports give information to users and will be used for decision making.

It is difficult to assess how components will change. As the audit role becomes more clearly defined, some existing duties might go, and the reasonableness gap may narrow because of greater awareness, or widen because of new expectations.

Audit committees may enhance auditorindependence by providing independent bodieswithin companies. For effectiveness, two elementsare: (1) high quality non-executive directors; (2) proper authority and clearly defined duties

Existing duties may widen because of regulatory and informal pressures. Regulation may cause improvement in actual and perceived performance. Increased sophistication of society may cause the reasonableness gap to diminish, but new expectations may widen it. Technological change may affect costs..

The Code makes recommendations about theconduct of the board: (a) regular meetings; (b) division of responsibilities at the head of a company; (c) nonexecutive directors of sufficient calibre and number; (d) a formal schedule of matters specifically reserved for its decision; (e) an agreed procedure for directors to take independent professional advice; (f) directors to have access to advice and services of the company secretary.

Corporate governance Corporate governance is closely related to the audit expectations gap, but is wider as it relates to structures to control how companies are governed. The Combined Code requires auditors to report on a number of corporate governance matters and contains principles of good governance. The principles of good governance included inthe Code are listed under: A.Directors; B. Remuneration; C. Accountability and audit; D. Relations with shareholders. Recommendations on the effectiveness of theboard: (a)division of duties; (b)non-executive directors of sufficient calibre and number; (c) timely high quality information for the board; (d) annual performance evaluation of the board, committees and directors. The Code accepts more light should be thrown on directors‟ remuneration and how it is determined. A significant proportion of directors‟ remuneration should be linked to corporate and individual performance, overseen by the directors‟ remuneration committee. Under the principles of accountability and audit,the board should: (a)present a balanced and understandable assessment of the company position and prospects; (b)maintain a sound system of internal control; (c) apply financial reporting and internal control principles and maintain an appropriate relationship with the company‟s auditors and the audit committee.

Effective non-executive directors and auditcommittees require willing support throughout the company. Suggested roles and responsibilities for the auditcommittee are: (a) financial reporting, including review of important issues/judgements; (b) audit matters, including recommending appointment, terms of engagement and external audit fees; and being involved in developing policy on the provision of non-audit services. The directors‟ statement of responsibilities makesIt clear that the directors have primaryresponsibility for preparing financial statementsthat give a true and fair view..

Internal Control and Corpotate objectives The Turnbull Guidance, divided into four parts,notes the importance of internal control inmanaging risks and achieving corporateobjectives: (1) maintaining sound system of internal control; (2) reviewing the effectiveness of internal control; (3) the board‟s statement on internal control; (4) internal audit. CHAPTER 19 The Auditor and Liability under the Law

Auditor and Law liability In recent years the prime concern of auditors in civil liability cases has been liability to third parties, because of: a ta u a

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

887

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) (a) the cost of obtaining indemnity insurance; (b) the many actions brought against auditors; (c) the level of damages; (d) bad publicity from auditor negligence courtcases. Although rare, accountants and auditors could be liable to criminal charges under the Theft Act 1968, Fraud Act 2006 or CA 1985. Auditors who give a clean opinion on accounts that turn out not to be true and fair may be sued by users who lose because of reliance on those accounts to compensate them for any loss they have suffered as a result of negligent work. Much attention has been focused recently on auditor responsibility for negligence.For a negligence action to succeed, it must be shown that the auditors owed a duty of care to the person bringing the action. Where a contractual relationship has been established, a duty of care exists and auditors can be sued by the company under contract law, for instance, when the auditors fail to detect a material fraud in the company owing to purported negligence. The determination of whether an auditor owes a duty of care to third parties under tort has been a controversial matter that has received considerable media attention and it is necessary to understand how the law has developed and the consequences for auditors

Auditor case of Law in US Early case law seemed to suggest that if there was no contract between accountants/auditors and third parties, no duty was owed.This is despite Donaghue vs Stevenson in 1932, which had established that physical injury claims against persons with whom no contractual relationship existed could succeed) This early view is typified in Candler vCrane Christmas & Co. (1951)In this case an action against accountants failed because there was no contractual arrangement between the plaintiff and defendants. However, the case of Hedley Byrne & Co. vs Heller and Partners Ltd. (1964) established the principle that an action can be brought by a third party (a party other than the shareholders) and that the third party can expect a duty of care from auditors, among others, the judgement emphasizing the concept of reliance. For auditors this meant that it must be reasonable for a person to place reliance on the auditors‟ report and that the auditors were aware or should have been aware that the person would rely upon it..

Users of Financial Statement and Law liabilities Parties who might have a legitimate interest in financial statements, other than shareholders, are: 1. investors/potential investors; 2. lenders; 3. employees; 4. government agencies; 5. competitors; 6. suppliers; 7. investment analysts/stockbrokers/share tipsters; 8. pressure groups.

a ta u a

Following Hedley Byrne, counsel for ICAEW indicated auditors would be liable if they had been negligent and the third party had relied on the financial statements, “where the accountants knew or ought to have known that the reports, accounts or financial statements … were being prepared for the specific purpose or transaction which gave rise to the loss, and that they would be shown to and relied on by third parties in that particular connection‟.

JEB Fasteners Case In the JEB Fasteners case the judge held that a duty of care would be owed by the defendants if they: “reasonably should have foreseen at the time the accounts were audited that a person might rely on those accounts for the purpose of deciding whether or not to take over the company and therefore could suffer loss if the accounts were inaccurate‟ It seemed that if use of accounts plays a substantial part in inducing the plaintiff‟s decision, persons associated with negligent preparation/audit could be held liable. JEB Fasteners also emphasized the concept of foreseeability but this seems to lead to the notion of unlimited liability. However, the judgement also made clear that specific circumstances need to be considered, so auditors‟ liability was not as extensive as first appeared. The concept of foreseeability was further emphasised in the Twomax case. The court noted that the auditors should have foreseen that the financial statements would be used to assist in the acquisition of additional capital. It was found that the plaintiffs had relied on the financial statements and hence the defendants were found negligent The next major development in the law of negligence affecting accountants occurred as the result of the Caparo case (Caparo Industries plc vs Dickman and Others 1989). This was a very complex case and it went through a number of hearings right up to the House of Lords before the final  judgement was made. The final decision implied that the courts had gone too far in extending auditor liability in the JEB Fasteners and Twomax cases, or, at least had advanced the law too precipitously, and that the auditors should not be held liable. 1. During the course of the judgement the followingimportant points were made: 2. there is a close and direct relationship between auditors and shareholders, but any duty owed is to shareholders as a class rather than as individuals; 3. on grounds of justice and fairness, liability should not be imposed on the defendants as this would lead to liability which was indeterminate as to quantum, as to time and as to the identity of its beneficiaries; 4. examination of company legislation shows that the primary purpose of annual accounts was to enable those with a proprietorial interest to exercise their given rights, and that, although annual accounts could be used for making investment decisions, the legislation was not drafted with that purpose in mind.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

888

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) The determination of whether foreseeability is present does not appear to be a particularlystringent test, but on the concept of proximity no one particular test can perhaps be applied. The judgement in the House of Lords raised the issue of the purpose of financial statements.The judges considered that it was for shareholders to exercise control over the company, but there may be two answers to the question concerning the function of the accounts:. (1) to enable shareholders to exercise their statutory rights; (2) to provide information to enable shareholders to decide whether they should sell, retain or increase their holding of shares. The House of Lords viewpoint may be out of linewith commercial practice.

Cases involving alleged auditor negligence Several cases involving alleged auditor negligence have been heard since Caparo. Although thesehave not changed the law relating to whom the auditors owe a duty of care in general, they are useful because they illustrate ways in which plaintiffs attempt to distinguish between the case they have brought and the Caparo case. Cases include: 1. James McNaughton Paper Group Ltd. vs Hicks Anderson & Co. (1991); 2. Morgan Crucible Co. plc vs Hill Samuel Bank Ltd. (1991); 3. Galoo Ltd. and Others vs Bright Grahame Murray (1994); 4. ADT Ltd. vs Binder Hamlyn (1996); 5. Andrew and Others vs Kounnis Freeman (1999). A further recent case is the Royal Bank of Scotland vs Bannerman Johnstone Maclay and Others (2002).This has resulted in action by the profession. One important aspect of this case was that if the defendants, on learning that the plaintiffs had a right to see the audited accounts for the purposes of their lending decision, had issued a disclaimer for the consequences of any reliance the plaintiffs placed on the accounts, it would have been impossible to infer that the auditors had assumed responsibility to the plaintiffs. Shortly afterwards the Audit and Assurance Faculty of ICAEW recommended that the audit report should include a paragraph disclaiming any responsibility to third parties, a recommendation that has been adopted by all the Big Four firms Compliance with auditing standards would seem to be a logical first step if auditors are to resist a claim for damages. CA 1989 required RSBs to “have rules and practices as to the technical standards to be applied in company audit work and as to the manner in which these standards are to be applied in practice‟. RSBs have adopted statements of auditing standards to meet this requirement.

a ta u a

Limitations to the use of standards as a means ofdefence are: (a)they do not cover all areas of auditing; (b)they only contain general guidance, leaving scope for interpretation and implementation; (c) they are the auditing profession‟s view of good practice but what the courts believe to be good practice is what matters. As well as being subject to criminal and civil proceedings auditors can also be disciplined by their own professional body, because, if accountants or auditors are to be trusted by clients, they must be seen to be honest and persons of integrity. . The accounting profession has shown considerableconcern about the extent of liability to third parties,Producing two major reports in recent years: (1)Likierman Report (1989) (2)Feasibility Investigation of Joint and Several Liability (1996) The Likierman Report looked into problems faced in respect of liability for negligence by three professions including that of auditing.The Feasibility Investigation of Joint and Several Liability was to determine “whether a full Law Commission project on the law of joint and several liability should be undertaken‟. Other representations and reports argue forchanges relating to professional negligence. The professions claim that a major problem with the present law is the concept of  joint and several liability, one effect being that if some parties are insolvent or have limited resources the defendant (often the auditor) with the resources is left to shoulder the complete burden (the „deep pocket syndrome‟). A possible solution would be to introduce proportionate liability, but this is rejected because it might leave innocent parties bearing some of the loss they have incurred. CA 1989 allows companies to purchase insurance for their directors, officers or auditors, but this is not compulsory and the purchase of insurance only applies to claims made against the directors and auditors by the company itself and not third parties. The Company Law Review Steering Group recommended that auditors should be allowed to cap their liability, but only if the amount of the limit was published and approved by the shareholders. But, under joint and several liability auditors would still remain fully liable up to the amount of their cap. An argument against this proposal is that it could result in the plaintiff not recovering losses in full because the agreed cap is less than the loss

Concept of contributory negligence The concept of contributory negligence applies where a plaintiff can be said to have contributed to the loss they have suffered and can be applied in cases of tort, but the scope for its application to negligence claims brought under contract is less clear. The Company Law Review Steering Committee recommended that where directors or employees breach

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

889

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) their duties to assist auditors, this should give rise to civil liability and might indicate contributory negligence. In cases brought under tort, it may be difficult to convince a court that a third party contributed to their own loss when the latter are relying on financial statements and the auditors‟ opinion. Since CA 1989, accounting firms have been able to change their form of organization from partnerships to limited liability companies, with shareholders only liable for unpaid share capital.This might save individual partners from bankruptcy, although substantial damages could force the firm itself into liquidation. Only a small number of firms have chosen to incorporate, possibly for tax and disclosure reasons. However, accounting firms have argued that the LLP should be introduced, in which partners would not be personally liable for the partnership liabilities, and the resources available to meet successful negligence claims would be limited to the assets of the partnership. After much argument and threats by large accounting firms to relocate to Jersey, the Limited Liability Partnership Act came into force in the United Kingdom in 2001. Relatively few partnerships have taken advantage of the Act, but all Big Four accounting firms have done so.

CHAPTER 20 Criticism and developments in Auditing

Regulations of Auditing There has been much criticism of audit practice and of the auditing profession, critics being concerned with exposing the audit profession as self-interested and arguing that their own purpose is to bring about changes beneficial to society.Regulation of auditing takes a number of different forms including the legal framework and other arrangements. Regulation of auditing is currently in a transitional phase. A number of attempts have been made to set up bodies to issue auditing standards before the current regime (still in the process of development) came to existence, including APC. Critics saw APC as not being independent of accounting firms, who were setting the agenda, and criticized lack of transparency in the standard-setting process. ASB is seen by them as being dominated by accountants. The disciplining of members is either carried out by individual accounting bodies or through the joint disciplinary scheme (JDS), and penalties can be levied on members. JDS has been criticized for similar reasons to those invoked for APC and APB; it will be superseded by the Investigation and Discipline Board. Following CA 1989, accounting bodies set upstructures to monitor the performance ofaccounting firms. JMU was established, concentrating on accountingfirms auditing listed companies where there ismost public concern. It has been criticized for narrow focus on rules and procedures a ta u a

rather than on other more important operational aspects of firm‟s work.

Measures to enhance Auditor Independence Various measures have been taken to enhance auditor independence, matters of concern being the weakening of a strong professional audit culture and the increase in lucrative non-audit work. Accounting bodies stress the importance of serving the public interest, but critics suggest accounting firms look after their own self-interest rather than that of the public The Enron/Andersen scandal resulted in the Sarbanes-Oxley Act in the United States. Critics were scathing of the relationship between Arthur Andersen and Enron, suggesting that pursuit of recurring fees played a major part in the Enron frauds and associated audit failures. Following Enron, audit firm rotation, as a means to enhance auditor independence, again came to the fore, although the profession believes it would increase the likelihood of the auditors failing to detect material errors and misstatements. In practice, rotation is being increasingly enforced on firms as companies put their audits out to tender, the current auditor not necessarily being selected

Criticism of Regulation in auditing Critics have made various suggestions as to theway forward: (1)auditors must act exclusively as auditors; (2) auditors must be socially accountable; (3) the institutions of accountancy must be reformed. The accounting profession responded vigorously to criticisms of the regulation of auditing, citing the large number of non-accountants on APB and regulatory and disciplinary committees. They claim that the profession does pay due regard to the public interest, and that the accounting bodies encourage technical competence and objectivity which will further the public interest They note also that audit firms and their clients have to be reasonably close if auditors are to perform competent audits. Responses to the charge that auditors lack independence include: 1. accepting the principle of rotation of the reporting partner; 2. a second partner checking decisions of the reporting partner; 3. instigation of rigorous quality control procedures. The profession points out that audit failure is rare, and that business failure and audit failure should be distinguished. They emphasize that the profession has supported the review of accounting and auditing recently carried out at the behest of the government and are supportive of new regulatory structures proceeding through parliament

Audit Agenda : Standard proposals The Audit Agenda: Next Steps, issued by APBmade several proposals, some of which have beenpartially or fully implemented: (a)audit scope for listed companies/major entities and unlisted owner-managed companies should differ;

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

890

Disusun oleh : Muhammad Firman (Akuntansi FE UI 2012) (b) the audit of listed companies should include assurance that all textual information accompanying the financial statements is consistent with the view given by them; in addition auditors should report to the board and audit committees on corporate governance issues; (c) steps be taken in respect of fraud; (d) audit reports to be signed by engagement partners in their own name as well as that of the audit firm; (e) audit committees of listed companies should be responsible for the appointment and remuneration of auditors and approval of non-audit services; (f) APB should seek to limit auditors‟ liability when reporting on certain corporate governance issues. Auditing Into the Twenty-First Century published in1993 by ICAS was an attempt to address theExpectations gap. Proposals included: (a) listed companies should have a strong internal audit department to provide the board with reassurance about management information/ internal control systems; (b) internal audit reports should be directed to a financial reporting and audit committee (FRAC) as well as the chief executive, with the FRAC to approve the appointment/termination of employment of the chief internal auditor; (c) external auditors to be called external assessors, less concerned with detailed testing and procedures and more with judgemental issues (d) appointment/termination of employment of external assessors and remuneration to be determined by an audit review panel (with input from company directors);As well as these duties it was suggested that theaudit review panel be responsible for a number ofothers

(1) the cost of obtaining indemnity insurance is very expensive; estimates of the cost of meeting lawsuits vary from 8% (audit firms) to 2.7% (critics) of auditing income; (2) risks of bankruptcy discourage high calibre individuals from wanting to become audit partners. .Auditors‟ claims for reform of the law on professional negligence and liability rests on two major assertions: Critics note that individual partners are well rewarded for such risks.

Critiques of the concept of Audit A fundamental critique of the concept of audit has been made by Michael Power, writing on the „audit society‟. Power sees an increase in the use of „audit‟ in many aspects of everyday life, and questions why there has been such enthusiasm to adopt a particular term and style of activity. Power argues that the „new‟ forms of audit are influenced by the nature of financial audit by accounting firms, and that they may emphasize those aspects of performance which can be measured and verified, rather than attempting to consider what is the best or most appropriate measure of performance. He also argues that financial audit emphasizes the relationship between principals and agents in a restricted sense so that other potential principals, such as society, are not considered. Power‟s work has been welcomed by many but others argue that we do not live in so much an audit society as a „performance measurement society‟.

(i)receiving a report from assessors on audit work; (ii) considering requests from stakeholders for assessors to perform additional work; (iii) asking assessors to carry out additional work; (iv) discussing with assessors the need for them to report to a third party suspicions of fraud/illegal activity by directors; (v) reporting on the panel‟s activity in the year;

Power offers three reasons for the large increase inthe quantity of activities termed auditing: (1)new form of management in the public sector; (2) increased demand by society for greater accountability by organizations; (3) increased use of quality management practices and changes in regulatory style.

Finally, directors were to report on the following: (i) the company‟s going-concern status; (ii) whether the company has sufficiently relevant and reliable management information and internal control systems.

Power notes that organizations have come to rely increasingly on control systems and that it is assumed that their existence demonstrates compliance with rules, procedures, processes and practices with audit seen as a control of controls.This move is seen by Power as undesirable because what becomes important is the existence of a system and its auditability rather than what the particular system is supposed to achieve.

The external assessors would express an opinion on truth and fairness of financial statements and report on the appropriateness of the directors‟ assurances in r espect of management information and internal control systems, and going concern, relying on the work of the internal audit team. The external assessors would only be legally liable to the primary stakeholders, and to the extent that they were negligent.

Auditor Liability Auditor liability is a major concern of the profession and critics claim it campaigns to limit its responsibilities without regard to the public interest, despite significant losses sustained by stake-holders in celebrated cases involving audit failure.

a ta u a

Auditors themselves are instrumental in determining what is audited, but at the same time it is unclear what level of assurance auditors provide in their reports. The problem is that an audit only „captures‟ those risks that can be identified by audit procedures and Power concludes that the profound irony of the audit society is that “where auditing may be most desirable, it is least possible Power‟s work is beneficial because it helps to illuminate and challenge accepted practice, but it is worth examining Power‟s claim that „auditing systems‟ is not the same as „auditing the transactions‟ themselves.

a n yang e um a a n a an s a y a u p a te w ww .a u n a n s a n s n s . wo r p r es s .c o m   Contact me : [email protected] /@firmanmhmd (Line)

891