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Notes
ACCA Paper F8 (INT)
Audit and Assurance
For exams in 2011

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ExPress Notes
  ACCA F8 (INT) Audit and Assurance

Contents
About ExPress Notes 3

1. Audit Reports 7

2. Ethics 12

3. Auditor Appointment 15

4. Audit Letters 19

5. Audit Risk 23

6. Internal Control 26
Internal Control & Audit in a Computer
7. 29
Environment
8. Internal Audit 32

9. Audit Evidence 34

10. Inventory 37

11. Subsequent Events 40

12. Going Concern 43

13. Corporate Governance 46

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Chapter 1

Audit Reports

START
Big Picture

The one thing all statutory audits of limited liability companies have in common is that at the
end of the day an independent auditor has to issue a report to the shareholders as the
owners of the company.

The auditors must report their opinion in respect of two main issues:

1. Whether the financial statements give a ‘true and fair view’ (or present fairly in all
material respects) the company’s financial position and performance, and

2. Whether the financial statements have been ‘properly prepared’ in accordance with
any relevant professional recommendations and/or statutory provisions.

Although the auditor’s report is produced after all the detailed field work has been
completed, it is perhaps important to give it consideration at a fairly early stage in your
studies. After all, if you know exactly what you are aiming at, it is perhaps that much easier
to hit the target!

Exam questions relating to audit reports occur on a regular basis and so this should be seen
as a fairly high priority area in your studies. Such questions may be purely knowledge based
or of a more practical nature, whereby you are asked to recommend an appropriate form of
report to be issued based on a given client scenario.

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Alternatively, the examiner may give you a draft audit report and ask you to identify and
explain in what respects the report is not satisfactory.

KEY TERMINOLOGY

ISA 700 The Auditors Report on Financial Statements identifies the key elements of the
auditor’s report (these must be learned and you should be prepared to give a brief
explanation of the purpose of each element):

1. Title
2. Addressee
3. Introductory paragraph
4. Statement of responsibilities of management
5. Statement of responsibilities of the auditors
6. Scope paragraph
7. Opinion
8. Auditor’s signature
9. Date of report
10. Auditor’s address

KEY KNOWLEDGE
Modified Audit Reports

The standard audit report may be modified, such modification may or may not result in the
auditors giving a qualified opinion. It is important to remember that modification of the
audit report will only be required if there is some material issue.

With the practical type of question always make sure that you use any information available
in the scenario to help you assess materiality in a sensible way, vague references to the fact
that you would ‘consider materiality’ will NOT impress the examiner.

For example, let us say you are given the information that a company’s profit before tax
(PBT) is $1,000,000 and that the company has failed to make provision for a known bad
debt of $150,000. State the obvious by saying that at 15% of PBT the bad debt is material,
in that a standard benchmark would be to consider an item impacting on PBT as being
material if it is in the range of 5% to 10% of such PBT.

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It is also important when assessing materiality to remember that this must be considered so
far as the user and not the preparer of financial statements is concerned. A useful working
definition of materiality may be taken as

‘transactions and other events are likely to be seen as material in the context of a company’s
financial statements if their omission, misstatement or non-disclosure would matter to a
proper understanding of such financial statements on the part of a potential user.’

KEY KNOWLEDGE
Modified Audit Reports with Unqualified Opinion

Sometimes there may be matters relating to the financial statements which, whilst fully and
adequately disclosed within the financial statements, the auditor considers worthy of
bringing to the particular attention of users.

The auditor achieves this by including in the audit report an additional paragraph known as
an ‘emphasis of matter’ paragraph. This paragraph will be ‘self-contained’ and will NOT
otherwise impact on the standard wording of an unmodified report.

Key points to remember in relation to the use of such paragraph are:

 it should have a separate heading


 it should be positioned AFTER the opinion paragraph
 it must be made clear that the audit opinion is not qualified and so this paragraph
should start with words such as ‘Without qualifying our opinion we draw attention to
....’

Past examiners’ reports have indicated that many candidates have been unclear as to how
and when to make proper use of an emphasis of matter paragraph. It is important,
therefore, that you are totally happy with this aspect of audit reports.

Examples of where the use of such paragraph would be appropriate include:

 where there the financial statements have been prepared on a going concern basis,
but this is dependent upon some significant uncertainty which is fully and adequately
disclosed in the notes to the financial statements

 where there is a material inconsistency between the financial statements and the
Directors’ Report and the adjustment required to remove the inconsistency would
need to be made in the Director’s Report but the directors are not prepared to make
such adjustment.

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KEY KNOWLEDGE
Modified Audit Reports with Qualified Opinion

According to ISA 700, there are two main circumstances which might give rise to the
auditors deciding that is necessary for them to qualify their audit opinion:

1. Limitation on scope which arises where the auditor has been unable to carry out
some audit work which normally they would have expected to perform and/or where
the circumstances are such that audit evidence which the auditor would normally
expect to be available for some reason does not exist.

2. Disagreement exists between the auditors and client management in relation to


some aspect of the financial statements.

The type of qualified opinion to be given will depend not just on the circumstances as
indicated above, but also on how serious the limitation on scope or disagreement is namely
is it:

1. Material but not pervasive, that is to say that the limitation on scope or disagreement
is confined to one particular aspect of the financial statements, such that the auditor
is able to say that ‘except for’ this matter the financial statements give ‘a true and
fair view etc’.

2. Material and pervasive, that is to say that the nature of the limitation on scope or
disagreement is such that it will impact on the overall view given by the financial
statements. In such situation if it is caused by limitation on scope, the auditor should
give a Disclaimer of Opinion, whereas if it is because of disagreement, they should
give an Adverse Opinion.

The circumstances giving rise to a qualified audit opinion should be described in a separate
paragraph which appears BEFORE the opinion paragraph. Wherever possible, the auditor
should quantify the qualification circumstances as this should make it easier for the reader
to appreciate its significance.

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SUMMARY DIAGRAM OF APPROACH TO PRACTICAL AUDIT REPORT QUESTIONS

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Chapter 2

Ethics

START
Big Picture

Ethics is at the heart of the ACCA examination syllabuses featuring to a greater or lesser
extent in over half of the papers that you take on route to qualification as a Chartered
Certified Accountant.

Whilst not necessarily appearing as a question every time in the real exam, it must be seen
as a key area for your studies.

The fundamental principles of professional ethics as outlined by IFAC have been adopted by
ACCA and must be learned. It is important to appreciate that ACCA have adopted a
principles based approach to ethics so whilst there are specific recommendations in some
areas (which must be learned) if you are faced with a practical question where you are not
aware of any specific guidance having been issued, you must always go back to basics and
apply the fundamental principles.

Of particular importance to the auditor are the provisions relating to auditor independence.

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KEY TERMINOLOGY

The fundamental principles of professional ethics as outlined in the IFAC Code of Ethics is a
very important TOPIC. You might like to use TOPIC as a useful mnemonic to help you
remember these principles.

Technical (professional) competence and due care must be exercised by all members at all
times. Members have a responsibility to act in accordance with best practice and to keep
themselves technically up to date.

Objectivity must be demonstrated by not allowing personal interest or influence of others to


effect a member’s professional judgement.

Professional behaviour must be demonstrated by members at all times, in both their private
and business life, so as not to be seen to take any action which might bring the profession
into disrepute.

Integrity requires that members are always honest and do not knowingly allow themselves
to be associated with anything dishonest so far as others are concerned.

Confidentiality requires that under normal circumstances members should at all times
respect confidentiality with regard to a client’s affairs so far as third parties are concerned
and that members should not make use of client information for personal gain.

KEY KNOWLEDGE
Threats to Ethical Behaviour

The ACCA Code of Ethics recognises a number of threats to a member’s ethical professional
behaviour. Whilst such threats apply generally, they are particularly relevant when
considering the question of auditor independence.

It is always worth remembering the following “It will never be sufficient for an auditor to
claim that he was independent in fact, he must always be clearly seen to have been
independent in practice.”

The five threats are:

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1. Self-interest - e.g. owning shares in a client company
2. Self-review – e.g. providing accounting services to an audit client
3. Familiarity – e.g. acting as auditor to a company where a close relative is the CEO
4. Intimidation – e.g. continuing to act as auditor to a company which has started legal
proceedings against the audit firm
5. Advocacy – e.g. acting on a client’s behalf in negotiations to raise new finance for
the company

Safeguards against threats

As part of its quality control procedures, a professional firm must establish its own
formalised procedures for the identification and management of such threats. Additionally,
general safeguards may be seen as being:

 Those created by the ACCA e.g. requirement for potential members to complete an
ethics module
 Those created by members themselves e.g. ensuring that CPD requirements are met

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Chapter 3

Auditor Appointment

START
Big Picture

In that you are taking the International variant of Paper F8, you are not required to have a
knowledge of any specific company law requirements relating to auditors.

However, it should be borne in mind that your examiner is also examiner for the UK variant,
and being UK based whilst not requiring specific knowledge of UK legislation, tends to take
this as an example of good practice generally!

You need to be aware of provisions relating to:

 Appointment of auditors
 Auditors’ rights
 Auditors’ duties
 Auditors’ resignation
 Removal of auditors

Page | 15
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KEY KNOWLEDGE
Appointment of Auditors

Key points to note are:

 Normally made by members at company’s AGM


 Often provision made for initial appointment to be made by directors, who may also
fill a casual vacancy
 Under corporate governance provisions approval of audit committee required
 If previous auditors, ‘professional clearance’ should be obtained
 Before accepting nomination auditors should consider quality control matters such as
independence, potential conflicts of interest, professional competence etc

KEY KNOWLEDGE
Auditor Rights

Often provided under local statute, where not, sort of thing that should be covered by
engagement letter, usual matters covered being rights to:

 have access to all company books, records etc at all times


 obtain all information and explanations considered necessary from company
management and staff
 receive notice of, to attend and be heard at all general meetings of the company on
matters relating to the financial statements and/or their own appointment
 to resign and request directors to convene GM of company where there are
‘surrounding circumstances’ connected with the resignation
 to make representations to shareholders where there is attempt to remove them
from office with which they do not concur

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KEY KNOWLEDGE
Auditors’ Duties

Once again may vary from country to country, but main duties and responsibilities would
normally be seen as being:

 to report to shareholders whether financial statements give a true and fair view and
have been properly prepared in accordance with relevant legislation and/or relevant
accounting standards
 to consider implications for audit reporting on financial statements of consistency of
‘other financial information’ published together with the financial statements
 to review and report on effectiveness of company’s internal control systems under
corporate governance /stock exchange provisions in the case of listed companies
 to qualify audit opinion where necessary
 to provide proper notice on resignation
 to detect material fraud and other irregularities
 to maintain independence

KEY KNOWLEDGE
Auditors’ Resignation

The main concern here is that auditors should not be able to just ‘fade away quietly’ in order
to avoid an awkward situation, leaving shareholders and others who place reliance upon
their work, in the dark about important issues of which the auditors are aware.

Taking UK provisions as an example therefore, the key points are:

 auditors must deposit formal written notice of their resignation at the company’s
registered office
 such notice must be accompanied by a positive/negative statement as to whether in
their opinion there are any surrounding circumstances requiring communication to
the members or loan creditors of the company
 where there are surrounding circumstances, the auditors may request the directors
to convene a GM so that the members may have the opportunity of questioning
them further

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KEY KNOWLEDGE
Removal of Auditors

Once again we can take the UK provisions as being a good example of good practice:

 special notice must be given of the resolution proposing a change in auditors


 auditors must be notified of resolution and, if they wish to contest, have the right, at
the company’s expense, to pre-circularise their representations to the members as to
why they should remain in office
 at the meeting auditors may again put forward their position before the vote takes
place
 removal will require the passing of an ordinary resolution (simple majority)

Page | 18
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Chapter 4

Audit Letters

START
Big Picture

There are a number of what we might call standard audit situation letters through which the
auditors will communicate with those responsible for corporate governance within a client
company. These are:

1. Engagement letter
2. Management letter
3. Management representation letter

Whilst it is highly unlikely that you would ever be asked to reproduce one of these letters in
full, it is quite common to find a question on one or other of them where you are to explain
its nature and purpose and to perhaps outline its typical main contents. It is possible that
you might be asked to produce an extract from one of these letters. In the case of the
Management Representation letter on occasions the examiner has asked what action the
auditor should take if client management refuse to provide such letter.

You should also give some thought in your studies to situations where the auditors
communicate with third parties seeking direct confirmation from them as part of the process
of gathering audit evidence, principally from:

Page | 19
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1. Banks
2. Customers
3. Suppliers
4. Selling agents
5. Consignees
6. Legal representatives

KEY KNOWLEDGE
Engagement Letter

Purpose

Serves as a contractual agreement between the auditor and client. Helps to avoid future
misunderstanding about mutual roles and responsibilities.

Frequency

At commencement of any new audit assignment following prior discussion and agreement of
terms of engagement with client management. Thereafter new engagement letter should be
sent whenever terms are materially varied. In practice new engagement letter is usually sent
if significant changes in composition of client senior management.

Content

Typical content of an audit engagement letter would include reference to the following:

 Audit objectives
 Management responsibilities
 Relevant legislation
 Relevant professional standards
 Audit procedures
 Liaison with internal audit
 Risk assessment
 Use of experts
 Auditor access rights
 Auditor/client communications
 Deadlines
 Reporting format
 Fee basis
 Dispute settlement procedures
 Request for confirmation

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KEY KNOWLEDGE
Management Letter

Purpose

To report to management where the auditor has identified weaknesses in the company’s
internal control systems. Such weaknesses may be:

1. Inherent weaknesses identified by the auditor when initially evaluating the client’s
control systems; or
2. Weaknesses identified where the auditor’s tests of control reveal that a system is not
working as intended.

Frequency

Whenever it is considered necessary by the auditor, but usually it will be produced on an


annual basis.

Content

Normal content of such letter would include:

 Details of material weaknesses identified


 Identification of possible consequences of such weaknesses
 Auditors’ recommendations to eliminate weaknesses
 Caveat
 Disclaimer

KEY KNOWLEDGE
Management Representations Letter

Purpose

The main purposes of such letter may be seen as:

 It serves as a useful reminder to management that it is their responsibility to


produce financial statements giving a true and fair view and complying with relevant
regulations and standards
 To provide audit evidence where no alternative sources may be available
 To comply with best practice

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Frequency

Management representations will have been obtained at various stages during the conduct
of the audit, but the formal documentation of these should be obtained on an annual basis,
as close as possible to the signing off of the audit report.

Content

Typical content will include the following:

 Confirmation of directors responsibilities for financial statements


 Confirmation that all necessary information and explanations have been provided to
the auditors
 Confirmation of facts, where knowledge of such facts is confined to management
 Confirmation of directors’ estimates and judgement used in the preparation of the
financial statements

Steps to be taken if directors refuse to provide representation letter

1. Discuss with management reasons for refusal and try to resolve any contentious
area.
2. If management still not prepared to provide, ask if they would be prepared to minute
acceptance of auditors’ version.
3. If not prepared to do this, consider whether any further audit work required.
4. If auditor feels that there is insufficient audit evidence without management
representations should consider possibility of qualifying audit opinion on grounds of
limitation on scope.

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Chapter 5

Audit Risk

START
Big Picture

As noted elsewhere, an auditor must as part of his assessment of a client’s internal control
systems consider the risks to which a client’s business is exposed and the extent to which
there maybe some material misstatement in the client’s financial statements as a
consequence of not identifying and managing such risks in an appropriate manner.

Consideration of risk is therefore to be seen as an integral part of a modern day audit. Not
surprisingly, risk related questions have been and are likely to continue to be a regular
feature in the exams.

Some questions in the past have given marks simply for giving appropriate definitions for
key terms, whilst others have asked you to identify risks relating to a given scenario.

On the practical questions it is important to note carefully the verb used by the examiner in
the question requirement. If you are asked to list the risks that you can see in the scenario,
then mere identification will get you the marks. On the other hand, if you are asked to
explain the risks, then mere identification may start the mark earning process, but will not
get you all of the marks on offer as you must state clearly why it is a risk.

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KEY TERMINOLOGY

AUDIT RISK is very simply the overall risk that the auditor gives an inappropriate audit
opinion in his report.

Eg. if an auditor gave an unqualified opinion, when in fact the company was not a going
concern, then shareholders and others placing reliance on this report in making economic
decisions relating to their dealings with the company might suffer financial loss.

Audit risk is seen as being made up of 3 elements:

AUDIT RISK = INHERENT RISK x CONTROL RISK x DETECTION RISK

The auditor must assess inherent risk and control risk but cannot influence them, they are
what they are. The only element which the auditor can influence directly is detection risk,
which he must do in order to have overall an acceptable level of audit risk.

Inherent risk is the risk that there may be material errors or misstatements in the client’s
financial statements, before giving consideration to any internal controls that may have been
established.

Eg. in a high tech company there is high risk of obsolescent inventory which if not
recognised could result in a material overstatement of both profits and asset values.

Control risk is the risk that the client’s internal control systems will fail to prevent or detect
material errors or misstatements.

Eg. if there is not effective segregation of duties then there is a much higher risk of
employee fraud, without the need for collusion, going undetected.

Detection risk is the risk that the auditor’s tests and enquiries will fail to detect material
errors or misstatements in the transactions and balances reflected in the client’s financial
statements.

Eg the detection risk is always greater with a new client because the auditors have had less
time to build up their knowledge and understanding of the client’s business and the risks to
which it is exposed.

Detection risk is seen to include the elements of:

1. Sampling risk – eg. if the auditor selects too small a sample size, it may not be
representative of the population from which it is drawn, resulting in the auditor
reaching an invalid conclusion about that population.

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2. Non-sampling risk – is any other risk that might result in the auditor arriving at the
wrong audit conclusion eg. if client management were to deliberately provide the
auditor with misleading information and explanations.

From an exam point of view it is important not to confuse audit risk with Business Risk.

Business risk is the risk that a company will fail to meet its strategic objectives or that the
policies adopted will be inappropriate. Business risk is to a large extent tied up with the
fundamental accounting assumption of going concern.

Business risk may also be seen as being made up of 3 main elements:

1. Operational risk – eg. shortage of essential raw materials for manufacturing process
2. Financial risk – eg. foreign exchange losses when trading internationally
3. Compliance risk – eg. payment of fines for breach of anti-pollution legislation

It is important to note carefully the question requirement as to what type of risk you have
been asked to consider when analysing a given scenario.

So if the question scenario makes it clear that the company is trading in different currency
zones then:

1. Business risk = foreign exchange losses reduce company’s profitability


2. Audit risk = overstatement of profit if foreign exchange losses are not properly
recognised

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Chapter 6

Internal Control

START
Big Picture

In practice, the client’s system of internal control is very much one of the foundation stones
upon which the audit is based. Not surprisingly therefore in almost every exam you are likely
to find that your knowledge and understanding of some aspect of internal control will be
tested.

In terms of practical questions, you should, as always, read the question scenario carefully,
but in the absence of any clear indication to the contrary, the following assumptions should
normally be applied:

 You are dealing with the audit of a large limited liability company, with all that this
would imply in terms of the formalised internal control systems you could expect to
be in place.

 That you work for a large professional firm of accountants, with all that this would
imply in terms of the knowledge, experience and resources you would expect to be
available to you.

 That the client has a computerised accounting system, with all that this would imply
in terms of the general and application internal controls that you would expect to be
in place and the extent to which you would consider making use of CAATs in your
audit work.

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It should also be noted carefully that in the light of recent developments in corporate
governance frameworks, the many corporate scandals and the current world-wide economic
recession that nowadays an integral part of any effective internal control system is that it
should include an effective system for risk identification and risk management. This in turn
has led to auditors more frequently adopting a risk based approach to auditing.

KEY TERMINOLOGY

ISA 315 Identifying and Assessing the Risks of Material Misstatement Through
Understanding the Entity and Its Environment states that there are 5 components of internal
control:

1. The control environment


2. The entity’s risk assessment process
3. The information system
4. Control activities
5. Monitoring of controls

The IIA have provided the following useful definition:

“An internal control is any action taken by management to enhance the likelihood that
established objectives and goals will be achieved. Management plans, organises and directs
the performance of sufficient actions to provide reasonable assurance that objectives and
goals will be achieved. Thus, control is the result of proper planning, organising and
directing by management.”

The UK Turnbull report gives us a useful summary of the main purposes of an internal
control system, by stating that internal control consists of “the policies, processes, tasks,
behaviour and other aspects of a company that taken together:

 Facilitate its effective and efficient operation by enabling it to respond to


significant business, operational, financial, compliance and other risks to
achieving the company’s objectives. This includes safeguarding the assets
from inappropriate use or from loss and fraud and ensuring that liabilities are
identified and managed.

 Help to ensure the quality of internal and external reporting.

 Help ensure compliance with applicable laws and regulation, and also with
internal policies with respect to conduct of business.

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Essential features of any good system of internal control

As a useful aide memoire when asked to evaluate a described system of internal control
within a question scenario, you could make use of the mnemonic PCRAM.

Plan of organisation

Custody procedures

Recording procedures

Authorisation procedures

Management supervision

NB. When evaluating any system of internal control, it is important to recognise that part
of the whole system which we call internal control should include what we call internal check
(segregation of duties) and also internal audit.

Steps in auditor’s consideration and approach to a client’s internal control


systems

1. Ascertain details of clients systems (interview, ICQs, etc).


2. Record details of client systems (narrative notes, flowcharts, etc).
3. Confirm details of client systems (walk through test).
4. Evaluate the client systems. If system is assessed as being sound then proceed to
step 5. If system is assessed as being inherently weak, then there is no purpose to
carrying out tests of control in that area. Such weaknesses should be discussed with
client management and formally documented in a management letter. In this area of
the client’s activities it will then be necessary to design and carry out an extended
programme of substantive testing.
5. Test the client systems (tests of control).
6. Assess the results of tests of control. If tests of control confirm that the system is
working satisfactorily then proceed to step 6. If tests of control reveal that a system
evaluated as being sound in theory is not working satisfactorily in practice then
proceed as in step 4 where system was evaluated as being inherently weak.
7. Design and carry out limited programme of substantive testing.

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Chapter 7

Internal Control & Audit in


Computer Environment

START
Big Picture

As indicated in the section on internal control, in the exam room you should assume that
client has a computerised accounting system, unless clearly told otherwise.

In recent times where the examiner has set questions specifically referring to auditing in a
computer environment, his subsequent reports have suggested that he has been
disappointed with the general standard of candidates’ answers!

Clearly, therefore, this is an area which you need to study quite carefully as it is likely to be
revisited on a fairly regular basis.

KEY TERMINOLOGY

The basic requirements for an effective system of internal control do not of course change
simply because a computer is brought into the business environment. However, computers

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bring with them their own additional control considerations. Specifically, internal control in a
computer environment is normally considered under 2 main headings:

1. General Controls These relate to the environment within which computer systems
are developed, operated and maintained. They will therefore be relevant to all
applications. They are often sub-divided into administration controls and systems
development controls. They may be either manual or programmed.

2. Application Controls These relate to those activities which have been


computerised and are concerned with the completeness and accuracy of the
processing of authorised data and the maintenance of computer files. As with
general controls, they may be either manual or programmed.

Essential features of any good system of internal control in a computer


environment

To help you in learning some of the important practical aspects of internal control systems in
a computer environment we can again perhaps make use of a series of mnemonics.

GENERAL CONTROLS – ADMINISTRATION CONTROLS (DOFF)

Division of duties and responsibilities eg. between IT and user department staff

Operator controls eg. use of passwords

File controls eg. regular file back-ups

Fire precautions and standby arrangements eg. contingency planning

GENERAL CONTROLS – SYSTEMS DEVELOPMENT CONTROLS (CAST)

Conversion procedures eg. parallel running

Authorisation, acceptance and amendment procedures eg. sign off procedures

Standardisation eg. use of SSADM

Testing eg program logic checks

APPLICATION CONTROLS (IPOF)

Input controls eg. data verification by means of double-keying

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Processing controls eg. data validation by means of check digit

Output controls eg. actioning of error reports

File maintenance controls eg. checking amendments to standing data

Alternative audit approaches

There are generally seen as being 3 main alternative approaches to the audit of a
computerised accounting system:

1. Auditing around the computer


Here the concentration of audit effort is on the inputs to and outputs from the
client’s computer system.

2. Auditing through the computer


Making use of CAATs, principally:
 Test data
 Audit software eg. selection of data for further testing
3. Auditing within the computer
Making use of embedded audit facilities such as:
 ITF – Integrated Test Facility
 SCARF – Systems Control and Review File

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Chapter 8

Internal Audit

START
Big Picture

Whilst no longer specifically included in the title of the paper, as it was under the old
syllabus, questions relating to internal audit have and are likely to continue to appear in the
real exam on a regular basis.

So far as listed companies are concerned, corporate governance frameworks would normally
expect the establishment of an internal audit function as a key element of a company’s
internal control systems, where it does not exist, management should reassess the need for
it on an annual basis.

KEY TERMINOLOGY

The IIA defines internal auditing as follows>

“Internal auditing is an independent, objective assurance and consulting activity designed to


add value and improve an organisation’s operations.

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It helps an organisation accomplish its objectives by bringing a systematic disciplined
approach to evaluate and improve the effectiveness of risk management, control and
governance processes.”

FUNDAMENTAL DIFFERENCES BETWEEN INTERNAL AND EXTERNAL AUDITORS

Both internal auditors and external auditors will have a major interest in the effectiveness of
a company’s internal control systems. Both are assurance providers and as such will make
use of similar techniques and procedures.

The external auditor should approach internal audit as any other aspect of internal control
before placing any reliance upon the work of internal audit to perhaps reduce the level of
some of their own testing. Key factors to consider in assessing the potential reliability of the
work of internal audit will include such matters as:

 Qualifications
 Experience
 Quality of audit documentation
 Independence
 Management response to internal auditor recommendations

Effective co-operation between the two sets of auditors can help to avoid unnecessary
duplication of effort, with a consequent benefit of time and cost savings. However, it is
important for the external auditor to always be aware of certain fundamental differences as
indicated below:

INTERNAL AUDITOR EXTERNAL AUDITOR


SCOPE MANAGEMENT ISAs + REGULATIONS
APPROACH MANAGEMENT ISAs + REGULATIONS
RESPONSIBILITY MANAGEMENT SHAREHOLDERS

NB under Corporate Governance provisions, the head of internal audit should be appointed
by and report to the Audit Committee. The Audit Committee should also be responsible for
determining the nature and scope of the work of internal audit.

TYPICAL AREAS OF INTERNAL AUDIT INVOLVEMENT

These would include, but not be restricted to the following (any of which you need to be
prepared to write briefly about):

 VFM audits (the 3 Es)


 IT audit
 Financial audit
 Operational audit

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Chapter 9

Audit Evidence

START
Big Picture

Examination questions relating to audit procedures and evidence are a regular feature in all
examinations. Whilst the majority of marks are likely to be awarded for demonstrating your
ability to apply knowledge in a practical way, some marks may well be available for purely
theoretical knowledge. It also perhaps goes without saying that you need to know the
theory as the critical start point in your studies.

KEY KNOWLEDGE
Financial Statement Assertions

In the production of financial statements, the client management are in fact making a
number of assertions. The auditors need to obtain audit evidence that these assertions are
reasonable if they are to form an opinion as to whether the financial statements give a true
and fair view and comply with relevant statutory and other obligations in relation to their
form and content.

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ASSERTIONS RELATING TO TRANSACTIONS AND EVENTS

 OCCURRENCE
 COMPLETENESS
 ACCURACY
 CUT-OFF
 CLASSIFICATION

ASSERTIONS RELATING TO ACCOUNT BALANCES

 EXISTENCE
 RIGHTS AND OBLIGATIONS
 COMPLETENESS
 VALUATION AND ALLOCATION

ASSERTIONS RELATING TO PRESENTATION AND DISCLOSURE

 OCCURRENCE AND RIGHTS AND OBLIGATIONS


 COMPLETENESS
 CLASSIFICATION AND UNDERSTANDABILITY
 ACCURACY AND VALUATION

KEY KNOWLEDGE
Audit Evidence

In accordance with ISA 500, the auditors must always look to obtain SUFFICIENT
APPROPRIATE audit evidence on which to base their opinion. When considering what is
appropriate audit evidence, this breaks down into whether the evidence is relevant and
reliable.

SUFFICIENT

What will be seen as sufficient is a matter of professional judgement and will be influenced
by such factors as the nature of the business, the size of the business, the auditors’ past
knowledge and experience of that client etc.

RELEVANT

What is relevant will depend upon the nature of the item being tested and the financial
statement assertion being considered.

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RELIABLE

In most instances, the auditors will base their opinion upon a variety of evidence rather than
a single source. In considering the comparative reliability of the different forms of evidence
which may be available the following general rules may be applied:

1. Documentary evidence will be more reliable than oral evidence.


2. Putting the different forms of documentary audit evidence in ascending order of
comparative reliability, they may be seen as:
(i) Client originated and client maintained eg. inventory records
(ii) Third party originated but client maintained eg. supplier invoice
(iii) Evidence obtained directly from third party eg. bank confirmation letter
(iv) Auditor generated eg. any audit working paper detailing audit work
performed and conclusion reached

AUDIT PROCEDURES RELATING TO AUDIT EVIDENCE

ISA 500 indicates 8 procedures some combination of which may be adopted by auditors in
order to obtain audit evidence:

1. Inspection of records or documents


2. Inspection of tangible assets
3. Observation
4. Enquiry
5. Confirmation
6. Recalculation
7. Reperformance
8. Analytical procedures

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Chapter 10

Inventory

START
Big Picture

The area of inventory has always been a popular area for examination questions. In practice
inventory is often one of the most significant items in the client’s financial statements. If
inventory is a material item and it is materially misstated, then it will impact directly both on
the Income Statement and the Statement of Financial Position.

Over the years there have been many frauds relating to inventory manipulation, quite simply
because if management are so inclined it is one of the easiest areas to fiddle!

Exam questions might test your knowledge and understanding of internal control
considerations or audit procedures or valuation requirements or perhaps some combination
of these.

Although we are looking here specifically at inventory, because of its popularity with
examiners over the years, remember you could be asked what audit procedures you would
carry out with any of the items typically appearing in a company’s financial statements.

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KEY KNOWLEDGE
Main Audit Considerations

The main internal control considerations relating to inventory will require that effective
authorisation, recording and custody procedure exist to control the movements in inventory
and that there should be regular checking of physical quantities against the stock records.

Where inventory is a material item in the client’s financial statements and whenever it is
practicable to do so, the auditors must satisfy themselves as to the effectiveness of the
client’s stocktaking procedures, by observation on a test basis whilst stocktaking is in
progress.

It is important to recognise that it is not part of the auditors’ duty to take stock nor to value
it, but they do have a responsibility to consider the effectiveness of the client’s stocktaking
procedures and the reasonableness of the subsequent inventory valuation.

To a large extent, therefore we can usefully consider what work we might do BEFORE,
DURING and AFTER the client’s stocktaking. As a useful exercise when you have a spare 5
minutes take a blank piece of paper and under these 3 headings see if (in point form) you
can come up with the following sort of ideas.

BEFORE

 Review previous year working papers


 Obtain and review client stocktaking instructions
 Consider sales method
 Consider stock locations
 Consider need for independent experts
 Confirm date and timing of stock count
 Liaise with internal auditors
 Allocate and brief own staff

DURING

 Observe procedures
 Test counts
 Re-counts
 Note third party inventories
 Notes re cut-off
 Notes re condition

Page | 38
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AFTER

 Follow up on attendance notes


 Routine tests on inventory records
 Analytical procedures
 Test valuation
 Review disclosure
 Obtain management representations

The above is not necessarily a fully comprehensive list but should give a good flavour for the
level of detail that might be required.

KEY KNOWLEDGE
Valuation of Inventory

It is important to remember that accounting knowledge assumed for Paper F8 is that


examined in Paper F7. It is an important part of your preparation therefore, to as necessary
revise those Accounting Standards which are examinable under F7.

The aggregate figure for inventories in the Statement of Financial Position (classified under
appropriate headings) should be shown at the lower of cost AND net realisable value.
However, when looking at individual items of inventory, or groups of similar items, the test
should be made for the lower of cost OR net realisable value.

COST should include all expenditure incurred in getting the item in question to its present
location and condition up to the stage where it is in a saleable condition. Cost should as
necessary include ‘costs of conversion’, given production at a normal level of capacity.
Whatever method is used to determine cost, it should give as close as possible an
approximation to the actual cost.

NET REALISABLE VALUE should be taken as the estimated proceeds of sale less ALL
estimated further costs to be incurred.

In the exam room be prepared to do some fairly basic calculations to demonstrate that you
properly understand the principles involved.

Page | 39
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Chapter 11

Subsequent Events

START
Big Picture

Subsequent events is another of the classic question areas which may well require you to
combine your assumed accounting knowledge with auditing knowledge. Whilst pure
knowledge questions must not be ruled out, the attraction of this syllabus area to the
examiner has perhaps always been the fact that it is an area which readily lends itself to a
very practical scenario based question.

KEY TERMINOLOGY

Subsequent Events

Relate to events occurring or facts emerging after the accounting period end, but before
formal approval of the financial statements by a company’s management.

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Adjusting Events

Are those which relate to an item or condition existing at the SOFP date, where the
subsequent events assist in forming an opinion as to the amount properly attributable to
such item or condition, where at the SOFP date there was some doubt about the value.

Eg. making provision at the year end because of the subsequent insolvent liquidation of a
customer, where the amount outstanding at the year end was still unpaid at the time of the
subsequent liquidation.

Non-adjusting Events

Are those which do not alter the year end position, but which would have had a material
impact on the financial statements if they had occurred prior to the year end. Such non-
adjusting events should be communicated by way of notes to the financial statements.

Eg. The destruction by fire shortly after the year end of one of a company’s warehouses.

As auditors we should give careful consideration to those events which at first sight may
appear to be non-adjusting, but which might be seen to impact on going concern, which
could mean that in fact they need to be treated as adjusting events.

KEY KNOWLEDGE
Audit Approach – Proactive Period

Up to the date of signing the audit report , the auditor must be proactive in seeking out
audit evidence relating to subsequent events, in order to consider whether or not the client
has dealt with such events in an appropriate manner.

Typical audit procedures

During the period where best practice requires the auditor to be proactive in relation to
subsequent events typical procedures would include, but not necessarily be restricted to:

 Discussions with management and subsequent review of company procedures for


dealing with subsequent events
 Examining minutes of board and board committee meetings
 Review of management forecasts, budgets and management accounts
 Routine audit work which naturally takes auditor into subsequent period eg. tests
relating to sales and purchases cut-off
 Obtaining management representations

Page | 41
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KEY KNOWLEDGE
Audit Approach – Reactive Period

After signing the audit report, the auditor need only be reactive to subsequent events. In
other words, if there is some late event which if the auditor had known about it earlier
would have impacted on the financial statements and/or the auditor’s opinion thereon, he
must react by taking appropriate action.

What constitutes appropriate action will obviously depend on the actual nature and timing
of events, but might include:

 Discussions with management on their proposed reaction


 Revision/withdrawal of earlier report
 Addressing company AGM/GM
 Seeking further advice

Page | 42
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ExPress Notes
  ACCA F8 (INT) Audit and Assurance

 
Chapter 12

Going Concern

START
Big Picture

You will be aware from earlier financial reporting studies, that going concern is one of the
fundamental assumptions underlying the preparation of all general purpose financial
statements.

Appropriate application of this assumption is vital if the financial statements are to give a
true and fair view.

In the current economic climate, with many businesses failing every day this is certainly a
topical issue from an exam point of view.

Examination questions in this area often have an element relating to audit reporting. In
practice, a going concern qualification is perhaps one of the most difficult for an auditor to
give, because of the very real danger that the audit report may become a self-fulfilling
prophesy. Usually when such questions have appeared the examiner has expressed
disappointment with the standard of many candidates’ answers.

Going concern considerations may also apply when dealing with questions relating to audit
risk and also subsequent events.

Page | 43
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  ACCA F8 (INT) Audit and Assurance

 
KEY TERMINOLOGY

Going concern

The concept of going concern is based upon the assumption that the business will continue
to exist as a viable commercial entity for the foreseeable future, without the need for any
significant cut-back in its present level of activity.

Foreseeable future is normally taken as being a minimum of 12 months from the current
accounting date. If for any reason, management consider a shorter period, then there
should be a note to the financial statements indicating what that shorter period is and
management’s reasons for choosing it.

KEY KNOWLEDGE
Audit Approach

The auditor should always be alert to possible indicators of going concern problems. A
useful starting point for consideration of such indicators may be to relate to the elements of
Business Risk (= Operational Risk x Financial Risk x Compliance Risk) as considered
previously.

It is important that when risks are identified that the auditor also considers the possibility of
mitigating factors which might counter balance the indicator of possible going concern
problems. See examples in following table:

RISK POSSIBLE INDICATOR POSSIBLE MITIGATING


FACTOR
OPERATIONAL Shortage essential raw R & D Dept close to finding
materials for manufacturing synthetic alternative
process
FINANCIAL Material FOREX losses New hedging policy
COMPLIANCE Numerous fines for breach of New more environmentally
anti-pollution legislation friendly manufacturing
process about to come on
line

Specific audit procedures would include:

Page | 44
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  ACCA F8 (INT) Audit and Assurance

 
 Assessment of current and projected economic environment in which company
operates

 Assessment of state of industry sector in which company operates

 Review of correspondence files and board minutes for evidence of significant


disputes

 Review of subsequent period cash flow and profit forecasts

 Discuss management procedures and review and obtain management


representations

KEY KNOWLEDGE
Audit Report Considerations

As always, the type of audit report to be issued will be dependent upon the circumstances
and the auditor’s assessment of materiality of the issues involved. The following table
provides a useful summary of the most likely scenarios.

CIRCUMSTANCES REPORT IMPLICATIONS


Going concern basis used and considered None
appropriate with no related significant
uncertainty
Going concern basis used but Unqualified opinion but use emphasis of
appropriateness dependent upon some matter paragraph to draw attention to
significant uncertainty which is fully and disclosure of significant uncertainty
adequately disclosed
Going concern basis used but Qualified opinion on grounds of
appropriateness dependent upon some disagreement, probably adverse rather than
significant uncertainty which is either not except for
disclosed at all or inadequately disclosed
Going concern basis used but in auditor’s Qualified opinion on grounds of
opinion not appropriate disagreement, probably adverse rather than
except for
Going concern basis inappropriate but Unqualified opinion but use emphasis of
financial statements prepared on acceptable matter paragraph to draw attention to
alternative basis which is adequately unusual circumstances
disclosed

Page | 45
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ExPress Notes
  ACCA F8 (INT) Audit and Assurance

 
Chapter 13

Corporate Governance

START
Big Picture

This is not the first time (F4 Corporate and Business Law) you will have come across this
topic and it will not be the last (P1 Professional Accountant)!

Perhaps because of the fact that corporate governance is at the very heart of the later P1
paper, questions nowadays are perhaps more likely to be knowledge based, but you should
not rule out entirely the prospect of a practical scenario based question.

Corporate governance is a very topical issue and you can read about important issues on
almost a daily basis in the financial press.

Many countries have developed corporate governance frameworks in response to major


corporate scandals (eg. Enron, Barings, Parmalat etc etc). Some of these frameworks are
rules based such as the Sarbanes-Oxley Act in the US, whilst others are principles based
such as the Combined Code in the UK.

Key points to learn are the main features which are nowadays generally seen as being
indicative of potentially affective corporate governance.

Page | 46
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ExPress Notes
  ACCA F8 (INT) Audit and Assurance

 
KEY TERMINOLOGY

WHAT IS CORPORATE GOVERNANCE?

Various definitions have been provided such as:

1. “Corporate governance is the system by which organisations are directed and


controlled.” (Cadbury Report)
2. “Corporate governance is a set of relationships between a company’s directors, its
shareholders and other stakeholders. It also provides the structure through which
the objectives of the company are set, and the means of achieving those objectives
and monitoring performance, are determined.” (OECD)

KEY KNOWLEDGE
Features of Effective Corporate Governance

Balanced Board

Ideally, there should be a balance between executive directors (EDs) and independent non-
executive directors (NEDs) excluding the chairman (independent).

Separation at the top

Ideally, the roles of Chairman and Chief Executive (CEO) should not be combined, but rather
the Chairman should run the board, whilst the CEO runs the company.

Board Committees

The establishment of the following main board committees is indicative of good corporate
governance practices:

1. Audit Committee – all NEDs


2. Remuneration Committee – all NEDs
3. Appointments Committee – majority NEDs
4. Risk Committee – majority NEDs

Director training

There should be an effective induction programme for all new directors and thereafter the
company should ensure that there is an on-going programme for CPD for all directors.

Page | 47
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Internal Control

The directors will be responsible for establishing and maintaining an effective system of
internal control. This system should be assessed and reported on by management on an
annual basis. In particular management in such review should give consideration to:

 Internal audit
 Enterprise risk management
 Corporate ethical culture
 Corporate social responsibility
 Whistleblowing facility

Communication with shareholders

Management should encourage smaller investors to participate in company GMs, especially


the AGM, and have a regular dialogue with institutional investors. Institutional investors in
their turn are expected to exercise their voting power responsibly.

Financial reporting

The board needs to present a balanced and understandable assessment of the company’s
past performance, present position and future prospects.

(end of ExPress Notes)

Page | 48
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