KnS School of Business Studies

ACCA F8 - Audit & Assurance

Summary Notes by S.K

Index of ACCA F8 Handouts

S. No. Description Page No.

1. ISA 500 - Audit Evidence 2
2. ISA 210 – Engagement Letter 17
3. ISA 320 – Materiality 31
4. ISA 230 - Working Papers 44
5. ISA 300 - Planning an Audit 53
6. ISA 315 - Audit Risk (Theoretical Part) 61
7. ISA 315 - Audit Risk (Practical Part) 67
8. Audit Risk plus Accounting Ratios 78
9. (ISA 300 + 315) Understanding the Entity 91
10. Internal Audit Department 100
11. Internal Control 115
12. Internal control of a Small Company 122
13. Documentation of Accounting and Internal Control System 126
14. ISA 610 - Using the Work of Internal Auditors 138
15. ISA 620 - Using the Work of an Expert 147
16. Audit Report 157
 ISA 700 - Audit Report
 ISA 701 - Audit Report
 ISA 705 - Audit Report
 ISA 706 - Audit Report
17. ISA 701 - Key Audit Matters (KAM) 206
18. ISA 560 – Subsequent Event 225
19. ISA 570 – Going Concern 241
20. Non-profit Organizations (NPO) 256

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

ISA 500 – ‘Audit Evidence’

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

Expected questions on Audit Evidence – ISA 500

1. Define audit evidence and what are the 02 MAIN types of audit evidence /
methods to obtain audit evidence?

2. Briefly explain the financial statements assertions for balance sheet, profit &
loss and P&D?

3. List and explain the audit procedures to obtain audit evidence?

4. What procedures / techniques are performed by an external auditor to obtain

Audit evidence?

5. What are the factors that influence the reliability of audit evidence?

6. What are the factors that influence the auditor’s judgment concerning the
sufficiency of Audit evidence obtained?

7. Explain the term “Sufficient and Appropriate Audit Evidence”?

8. Explain the concept of Relevance in the context of ISA 500 along with
examples.

9. Direct and Indirect questions along with substantive procedures

(to be discussed later)

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

Concept of Audit Evidence (ISA 500)

Definition of Audit Evidence:

Audit evidence is all the information used/gathered by the External auditor in arriving at the
conclusions on which the audit opinion is based, and includes information contained in the accounting
records (G.L, Trial balance and other records) underlying the financial statements.

Audit evidence, which is cumulative in nature, includes audit evidence obtained from audit procedures
performed during the course of the audit and may include audit evidence obtained from other sources
such as previous years audit working papers (ISA 230) of the same audit client.

Audit evidence in simple words can be defined as any piece of information which assists the auditor to
reach a conclusion on the truth and fairness of the financial statements of the company.
Audit evidence is obtained from: (might include information other than below mentioned list)
 Documents / supporting documents such as purchase orders, payment and receipt vouchers,
invoices, receipts, employee time sheets, customer orders, letters, bank statements, contracts
and other legal documents (Memorandum, Articles etc. )

 Entries in accounting records. (Journal Entries)

 Entries / postings in Cash Book, Profit and Loss account, Balance Sheet etc.

 Answers/Replies from management to questions raised by the auditor.

 Information or confirmations received from external parties such as debtors, creditors,

banks, legal advisors, tax consultants and other stake holders.

 Computations produced by the client or by the auditor himself, for example depreciation
calculations, reconciliations, computations of accruals and prepayments etc.

 Evidence gained from the auditors physical counting of stock at the balance sheet data (stock
counting of Raw Material / W.I.P / Finished Goods)
Important thing to note:
Audit evidence requires that the auditor obtains Sufficient Appropriate Audit Evidence to be
able to draw reasonable conclusions on which to base the audit opinion.

Sufficient and Appropriate Audit Evidence

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Sufficient Appropriate Audit Evidence ……… IMP
Sufficiency relates to the QUANTITY of audit evidence and appropriateness relates to the QUALITY of Audit
Evidence which includes BOTH Relevance AND Reliability of evidence.

Appropriateness = Quality

Relevance Reliability

Appropriateness is the measure of quality of audit evidence which has 2 elements: Relevance and
Reliability.

RELEVANCE

(To be discussed Later after substantive procedures)

Factors which influence the sufficiency and appropriateness of audit evidence (both quantity and
quality factors covered)

1. The assessment of audit risk involved.( more risk = more evidence required )
2. The nature of the accounting and internal control systems. ( Weak Controls = More
evidence required)
3. The materiality of the item involved.(E.g. Stock ,fixed assets and debtors are
material items in the F/S)
4. The auditor’s past and current knowledge and experience of the business.
5. The source and reliability of the information available (from 3rd parties or M.I.S of
the company)
6. Size of the organization (a small company is less likely to have as tight control as a large
organization) = more evidence
7. The sampling method that the auditor will use to obtain the audit evidence because the chosen
method will also affect the size of the audit sample.

Reliability Factors…….. (IMP )

1. Evidence is more reliable when it is obtained from independent sources outside the
entity.(i.e. 3rd party confirmations )
2. Evidence that is generated internally is more reliable when the related controls
imposed by the entity are effective (e.g. Evidence obtained from Unilever,
Siemens).
3. Written evidence (documented) is more reliable than verbal evidence
4. Evidence obtained directly by E. Auditors is more reliable.
5. Original documents are more reliable than photocopies etc

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Quantity of audit evidence is effected by the auditors assessment of risk i.e. The higher the risk the more
the evidence will be gathered, similarly the higher the quality, the less may be required, obtaining more
audit evidence, however may not compensate for its poor quality.
(Professional judgment is exercised by the External Auditor)

There are 02 methods to obtain audit evidence or say that Audit evidence can be gathered by the
following two methods:

Test of control (T.O.C): ( To be covered while studying TOC Topic)

Tests performed to obtain evidence about the operating effectiveness of controls in preventing, detecting
and correcting material misstatements. TOC should be designed to check that the control procedures/
S.O.P are being applied and that the objectives are being achieved. Test of control includes two things:

 Design: Design test means to ensure that the system is properly designed i.e. proper accounting
system is designed or in place or that proper internal controls are designed to ensure
that material misstatements will be detected.

 Operation: This test means to check that whether the controls were operating effectively
throughout the period or not

Substantive Procedures S.P (also called Detailed Testing / Verification of F/S)

These tests are to obtain audit evidence to detect material misstatements in the financial statements.

Definition of S.P:
Substantive procedures (or substantive tests) are procedures performed by the auditor to detect material
misstatement (either via fraud or error) at the assertion level.

Assertion Level
P&L, B/S and P&D items.

They are generally of two types:

 Substantive Analytical procedures (ratio analysis and comparison analysis from last year to the
current year ) to be discussed in detail in ISA 520

 Other substantive procedures (Tests of Details) such as tests of detail of transactions and balances
e.g.
(Verification of documents such as purchase orders, invoices, receipts, employee time sheets,
customer orders, letters, bank statements, contracts and other legal documents, review of minutes of
director meetings and other committees)

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

Audit Procedures
1. Inspection of Assets:
By inspection of assets we mean that External Auditor verifies/ inspects the Inventory (Raw Material
/ W.I.P / Finished Goods) and tangible assets of the Company. External Auditor also verifies /
counts cash in hand at the Balance Sheet date.

Normally External Auditor physically counts the inventory / Fixed Assets and cash in hand at the
end of Financial Year (Balance Sheet Date)

2. Inspection of Records:
By inspection of records we mean verifying or inspecting the following documents of the Audit client.
 Invoices
 Purchase Orders
 Bank Reconciliations
 General Ledger
 Good Receive Note (GRN)
 Bank Statements
 Cash book
 Supplier statements
 Delivery Challan etc.

3. Inquiry:
By inquiry we mean verifying / obtaining information from client personally e.g. obtaining
information from senior Management (e.g. GM finance, Internal Auditor, CEO, CFO & other
relevant personnel), as the External Auditor thinks appropriate.
This inquiry can be done from people outside the organization e.g. external lawyer / consultants &
other experts.

4. Re-performance:
By re-performance we mean performing the procedures / calculation by External Auditor’s own
methodologies (E.g. re-performing the calculation of depreciation & amortization & re-performing
the Provision for doubtful debt for the year).

5. Re-calculation:
By re-calculation we mean simply re-calculation / rechecking the calculations done by the client e.g.
re-checking the totaling of depreciation & amortization and re-calculating the total of bank
reconciliation.
6. Observation:
In this procedure, External Auditor simply observes a process being performed by others (E.g.
Observing the inventory counting process and cash counting process and observing the process of
inspection of inventory on arrival in the factory.

7. External Confirmation: (To be discussed in detail in ISA 505)

External confirmation is a procedure by which an external auditor verifies a respective balance or
transaction or terms of an agreement, directly from a 3RDparty
e.g. (Dispatching confirmation directly to a debtor, creditor or a Bank)

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
This procedure provides more reliable audit evidence to the external auditor.
There are various types of 3rd party confirmations and commonly 2 methods of external confirmation.
(Positive and Negative method)

Examples of third-party confirmations Please

 Debtor confirmation Learn…!
 Creditor confirmation
 Tax confirmation
 Lawyer confirmation
 Loan confirmation
 Third party stock confirmation
 Bank confirmation
 Any other third-party confirmation to verify the terms & conditions of an agreement / contract.

8. Analytical Procedures:
Definition and explanation will be covered when covering ISA 520 separately

Examples of Analytical Procedures:

1. Comparison from last year’s numbers

2. All kinds of ratio analysis
3. Comparison of actual numbers with budgets/Forecasts.
4. Comparison of actual numbers with predicted / expected amounts (this is called predictive test)
5. Comparison of Financial information with Financial information
6. Comparison of Non-Financial with Financial information.
7. Comparison with industry norms (similar industry).
8. Comparison with overall economic growth of the country.
(for that particular sector or industry)

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
REVISED F/S Assertions (to be covered after Audit Risk)
(Total 12 Assertions)

Financial Statement Assertions Substantive Procedures

Assertions used by the auditor in considering the different types of potential misstatements that may occur
may fall into the following categories:

a. Assertion about classes of transactions, events, and related disclosures, for the
period under audit: ( P&L Items)

i. Occurrence ------- transactions and events that have been recorded or disclosed, have occurred, and
such transactions and events pertain to the entity.

(eg Sales and Purchases during the year have occurred and that the transactions actually took
place during the year, expenses that are recorded also occurred during the year………)

ii. Completeness ------- all transactions and events that should have been recorded have been
recorded, and all related disclosures that should have been included in the financial statements
have been included.

(expenses have been recorded completely and all sales that occurred during the year have been
recorded completely recorded in the F/S )

iii. Accuracy ------- amounts relating to recorded transaction and events have been recorded
appropriately.

(Sales, purchases and expenses have been recorded at the accurate amounts & Debtors and
creditors have been accurately recorded in the B/S)
iv. Cutoff------- transactions and events have been recorded in the correct accounting period.
(Sales and purchases have been recorded in the correct accounting period and expenses pertain to
the current year)

v. Classification ------- transactions and events have been recorded in the proper accounts (Expenses
have been classified in the correct G.L and there is no misclassification Depreciation and Rent
expense have been correctly classified in the correct G.L).

vi. Presentation ------- transaction and events are appropriately, aggregated or disaggregated and
clearly described and related disclosures are as per the applicable financial reporting framework.

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
b. Assertion about account balances, and related disclosures, at the period end:
(B/S Items)

i. Existence ------- assets, liabilities and equity interests exist

(Fixed assets and inventory exists in the company’s warehouse and debtors exist at the balance
sheet date.)
ii. Right and obligations ------- the entity holds or controls the rights to assets and liabilities are the
obligation of the entity

(Company has right to use cash, right to use fixed assets, the company has the right to receive
amount from debtors and trade payables and Loans are its obligation to pay)

iii. Completeness ------- all assets, liabilities and equity interests that should have been recorded have
been recorded, and all related disclosures that should have been included in the financial
statements have been included.

(All Assets and liabilities have been completely recorded in the F/S)

iv. Accuracy, valuation and allocation ------- assets, liabilities, and equity interests have been included
in the financial statements at appropriate amounts and any resulting valuation or allocation
adjustment have been appropriately recorded, and related disclosures have been appropriately
measured and described

(Debtors and creditors are recorded at accurate closing amounts and valuation or allocation of
any provisions (other adjustments) are also accurately recorded at the b/s date.)

v. Classification ------- assets, liabilities and equity interests have been recorded in the proper
accounts

(All assets and liabilities have been classified accordingly i.e. between current and non-current
assets and between current and non-current liabilities)

vi. Presentation------assets, liabilities and equity interests are appropriately aggregated or

disaggregated and clearly described, and related disclosures are as per the requirements of the
applicable financial reporting framework.

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

ACCA F8 & CA CAF 8 Practice Questions on Audit Evidence

S. No. Attempt Marks

ACCA Questions

1 Q.2 Mar/June 2016 10 marks

2 Q.6 a Sep/Dec 2015 4 marks

3 Q.71 June 2007 4 marks

4 Q.2 b Dec 2013 3 marks

5 Q.58 Dec 2009 4 marks

6 Q.3 June 2011 10 marks

ICAP Questions

7 Q.8 a March 2022 5 marks

8 Q.7 Sept 2010 4 marks

9 Q.1 Sept 2013 18 marks

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 KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
ACCA F8 June 2007 (4 marks)
71 Metcalf
ISA 500 Audit evidence states that the auditors objective 'is to design and perform audit procedures in
such a way as to enable the auditor to obtain sufficient appropriate audit evidence to be able to draw
reasonable conclusions on which to base the auditor's opinion'.

Required
a. Describe the factors which will influence the auditor's judgement concerning the sufficiency of audit
evidence obtained

---------------------------------------------------------------------------------------------------
Answer 71:
a. Factors concerning the sufficiency of audit evidence
(Plz learn from my Handout of ISA 500)
Source of evidence
The auditor will be concerned about the source of the evidence, that is, whether it is generated by the
entity being audited or by a third party or if it is auditor-generated evidence.

Materiality of the amount

More audit evidence would be required when examining more material balances, and the lower the level
of materiality set

Inherent and control risks

The higher these risks are, the more audit evidence will be required in order to provide assurance over
figures in the financial statements.

Accounting and control systems

Depending on whether the systems in place are reliable or not, this will influence the amount of audit
evidence required to support various audit assertions.
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ACCA F8 December 2009 (4 marks)
a. ISA 500 Audit Evidence requires audit evidence to be reliable.

Required:
List FOUR factors that influence the reliability of audit evidence
Answer:
a. Reliability of audit evidence
Reliability is influenced by source and the nature of the information, including the controls over its
preparation and maintenance. Four specific factors that influence reliability are:
 Audit Evidence from external sources is more reliable than that obtained from the entity’s
records because it is from an Independent source.
 Evidence obtained directly by auditors is more reliable than that obtained indirectly
 Evidence in form of documents (paper or electronic) or written representations reliable than more
reliable than oral representations can be retracted.

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
 Original documents are more reliable than photocopies or facsimiles, which can easily be altered
by the client.
--------------------------------------------------------------------------------------------------
ICAP CAF 8 March 2022 (5 marks)
Question 8 a
State the factors which may assist the auditor in assessing the reliability of audit evidence.

Answer:
Reliability of audit evidence is dependent on the following factors:
 Audit evidence is more reliable when it is obtained from independent sources outside the entity
under audit.
 Internally generated audit evidence is more reliable when the related controls are effective.
 Audit evidence obtained directly by the auditor is more reliable than audit evidence obtained
indirectly or by inference.
 Audit evidence is more reliable when it exists in documentary form.
 Audit evidence provided by original documents is more reliable than audit evidence provided by
photocopies
--------------------------------------------------------------------------------------------------
ICAP CAF 8 Sept 2010 (4 marks)
Question 7
Explain the term “Sufficient and Appropriate Audit Evidence.”

Answer:
The sufficiency and appropriateness of audit evidence are interrelated.

(i) Sufficiency is the measure of the quantity of audit evidence.

(ii) The quantity of an audit evidence needed is affected by the auditors assessment of the risks of
misstatement (the higher the assessed risks, the more audit evidence is likely to be required) and
also by the quality of such audit evidence (the higher the quality, the less may be required).
(iii)Appropriateness is the measure of the quantity of audit evidence; that is, it is relevance and its
reliability in providing support of the conclusions on which the auditor’s opinion is based.
--------------------------------------------------------------------------------------------------
ICAP CAF 8 Sept 2013 (18 marks)
Question 1

a. Briefly describe the steps that an auditor should take in order to establish whether preconditions of an
audit are present. (ISA 210)
(6 marks)
b. Briefly explain any six methods for collecting audit evidence. (12 marks)
Answer:
a) Steps that an auditor should take in order to establish whether preconditions of an audit are
present:
In order to establish whether the preconditions for an audit are present, the auditor shall:
 Determine whether the financial reporting framework to be applied in the preparation of the
financial statements is acceptable, and

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
 Obtain the agreement of management that it acknowledges and understands its responsibility:
 For the preparation of the financial statements in accordance with the applicable financial reporting
framework, including where relevant their fair presentation;
 For such internal controls as management and, where appropriate, those charged with governance
determine is necessary to enable the preparation of financial statements that are free from material
misstatement, whether due to fraud or error, and
 To provide the auditor with:
 Access to all information of which management is aware that is relevant to the preparation of the
financial statements such as records, documentation and other matters;
 Additional information that the auditor may request from management for the purpose of the
audit; and
 Unrestricted access to persons within the entity from whom the auditor determines it necessary to
obtain audit evidence.
b) Methods of Collecting Audit Evidence:
 Physical Examination:
Physical examination means physical verification of an asset, such as stocks, investment
certificates and fixed assets, as an evidence of its existence and its condition Third party
confirmation: Confirmation of an amount or other information shown in the client’s records
by an independent third party provides a reliable evidence of the existence of the amount and
correctness of the information, as the case may be. For example, receivables, payables,
contingent liabilities, stock with third parties etc.

 Examination of original records:

Original records like ownership documents, bills, notices etc. provide a reliable and
conclusive evidence of the legal claims, transactions, balances etc.

 Recomputation:
Recomputation technique is applied to prove arithmetical accuracy of a transaction and to
verify that the computation is in accordance with the rules, procedures and acceptable
practices. The areas where recomputation techniques are generally applied include
depreciation commutations. bonus calculations, provision etc.

 Enquiry:
Enquiry consists of seeking information from knowledgeable persons, both financial and
non-financial, within the entity or outside the entity. The enquiry may not provide
conclusive audit evidence but it may give some form of clue which may lead to further
verification.

 Analytical Procedures
Analytical procedures consist of evaluations of financial information through analysis of
plausible relationships among financial as well as non-financial data. Analytical procedures
also encompass investigation of identified fluctuations or relationships that are inconsistent
with other relevant information or that differ from expected values by a significant amount.

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Student Notings

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Student Notings

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

ISA 210 – ‘Engagement Letter’

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 KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

Summary Diagram Preconditions for an

Audit

Definition of an Factors to be considered for

Engagement letter Recurring Audits

Engagement
Letter

Importance of an Acceptance of change in

Engagement Letter term of an Engagement
Letter

Contents of an Engagement
Letter

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 KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Engagement Letter (ISA 210)
Purpose of Engagement Letter (Importance / Benefits)
Engagement letter is a formal written agreement of the terms and conditions between the
external auditor and the client.
The auditor and the client should agree on the terms of the engagement before the audit
commences.
It is in the interest of both client and auditor that the auditor sends an engagement letter,
preferably before the commencement of the engagement, to help in avoiding
misunderstanding/potential for argument with respect to the engagement.
The engagement letter documents and confirms the auditor’s acceptance of the appointment,
the objective and scope of the audit, the extent of the auditor’s responsibilities to the client
and the form of any reports.
The agreed terms must be in writing and will take the form of a Formal engagement letter
(it is written on Audit firm’s letter head duly acknowledged by Client as a confirmation to their
understanding of the same …..)
Please Learn!
Contents of an Engagement Letter
1. The objective of the audit of financial statements.
2. Scope of an External audit.
3. Management’s responsibility for the preparation financial statements
4. Management’s responsibility for making judgments and estimates that are reasonable and
prudent so as to give a true and fair view of the entities state of affairs and working results.
5. External auditors’ responsibility for expressing reasonable assurance. (Already covered)
6. The fact that because of the test nature and other inherent limitations of an audit, together
with the inherent limitations of an internal control, there is an unavoidable risk that even
some material misstatement may remain undiscovered.
7. Unrestricted access to whatever records, documentation and other information requested
by the auditor.
8. Description of any other letters/reports the auditor expects to issue to the audit client.
(Management Letter – M.L or any other report as agreed by the audit client)
9. Basis on which audit fees will be determined. (based on the number of hours to be worked
at the audit client)
10. Arrangements regarding the planning and performance of the audit. (will be covered in
ISA 300)
11. Arrangements concerning the involvement of internal auditors and other client staff.
12. Arrangements to be made with the predecessor auditor, in the case of an initial audit
(initial audit means where last year audit was conducted by another auditor / audit firm)
13. Any restriction of the auditor’s liability when such possibility exists.

Extra Point:
Provision of all necessary information to be provided by Management including management
representations (ISA 580 – will be discussed later)

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
Recurring Audits (The audit that is done year after year)

In the case of recurring audits, the auditor should consider whether circumstances require the
terms of the engagement to be revised and whether there is a need to remind the client of the
existing terms of the engagement. The auditor may decide not to send a new engagement letter
every year.

However, under the following circumstances, a new/revised engagement letter MAY be

appropriate:

1. Any indication that the client misunderstands the objective and scope of the
engagement.
2. Any revision of terms of the engagement or introduction of special terms.
3. (scope widened or any special requests by the client increasing the audit work)
4. A recent change of senior management or board of directors, or in ownership. (New
CFO)
5. A significant change in the nature or size of the client’s business.
6. (Subsidiary acquired)
7. Any new significant legal/regulatory/Financial reporting framework/other
requirement (Engagement letter required every year)
8. Change in ownership. (Takeover by Parent company)

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
Engagement Letter (ISA 210) ….Extra Cheetahpun
Content of the engagement letter
The engagement letter should include details of the following:
 The objective and scope of the audit.
 The responsibilities of the external auditor.
 The responsibilities of management and TCWG.
 Identification of the underlying financial reporting framework.
 Reference to the expected form and content of any reports to be issued (normally audit report and
Management letter)

In addition to the above, the auditor may feel that it is appropriate to include additional points in the
engagement letter, such as:
 more details on the scope of the audit, such as reference to applicable legislation, regulations, ISAs,
ethical requirements.
 the form of any other communication of results of audit engagement. (Other deliverables)
 the requirement for the auditor to communicate key audit matters in the auditor’s report in
accordance with ISA 701
 the fact that because of the inherent limitations of an audit, and the inherent limitations of internal
control, there is an unavoidable risk that some material misstatements may not be detected even
though the audit was properly planned and performed in accordance with ISAs; E.g.:
 arrangements regarding the planning and performance of the audit, including the composition of the
audit team;
 the expectation that management will provide written representations;(ISA 580)
 the expectation that management will provide access to all information that is relevant to the
preparation of the financial statements and its disclosures
 The agreement of management to make available to the auditor draft financial statements, including
all information relevant to their preparation, whether obtained from within or outside of the general
and subsidiary ledgers (including all information relevant to the preparation of disclosures), and the
other information if any, in time to allow the auditor to complete the audit in accordance with the
proposed timetable. Eg:
 the basis on which fees are computed and any billing arrangements;
 a request for management to acknowledge receipt of the engagement letter and to agree to its terms;
 arrangements concerning the involvement of other auditors, predecessor auditor, experts (ISA 620)
or internal auditors (or other staff of the entity) Eg:
 any restriction of the auditor’s liability when such possibility exists (where our
liability is excluded)
Any obligations to provide audit working papers to other parties. (keeping in view the
requirements of confidentiality.

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 KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

Summary Diagram Preconditions for an Audit

Whether the F.R.F is acceptable or Not
Preconditions for an Audit
Obtain Management's Agreement that it acknowledges
& understands its responsibilities for:

Preparation of F/S as per IFRS

Internal Controls to prepare these F/S

Present Providing Information as follows:

Yes No All Information

Any Additional Information

Sign the
Refuse to
Engagement Un Restricted access to entity staff
Letter continue
(where Auditor thinks necessary)

(Unless required by law or regulation to do so..)

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 KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Preconditions for an External Audit
The objective of the auditor, as per ISA 210 is to accept or continue an audit engagement only
when the basis upon which it is to be performed has been agreed. This is done by:
 Establishing whether the preconditions for an audit are present; and
 Confirming that there is a common understanding between the external auditor and
management.
8 Baten!
Preconditions are:
1. Whether the financial reporting framework to be used in the preparation of the F/S is
acceptable, for example IFRS & IAS and
2. Obtain the agreement of management that it acknowledges & understands its responsibility
for: (This is the PREMISE of an Audit)
 For the preparation of the financial statements;
 For internal controls to ensure that the financial statements are not materially misstated;
and
 To provide the auditor with information as follows:
i. All information
ii. Any relevant and additional information (for the purpose of the audit) and
iii. Unrestricted access to all personnel. (where auditor deems necessary)

(Please learn the above 8 points)

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Response if preconditions are NOT present
If the preconditions for an audit are not present, the auditor shall discuss the matter with
management. The auditor should explain what the preconditions are and request to comply
with ISA 210.
The auditor should also explain that one of the purposes of the preconditions is to avoid
misunderstanding about the respective responsibilities of management and the EXTERNAL
auditor.
Unless required by law or regulation to do so, the auditor shall NOT accept the proposed
audit engagement where:

1. the financial reporting framework to be used is unacceptable, or

2. management do not agree to the above responsibilities (the ‘premise’) stated in the
preconditions.
3. There is a limitation on scope by the mgmt. such that the auditor would not be able to
express an opinion on the FS and the auditor concludes that the possible effect on the FS of
undetected misstatements cud be both material and pervasive (i.e Withdrawal in this case if
allowed by local laws & regulations)

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
(The only exception allowed by ISA 210 for accepting or continuing the engagement to the
above is when law or regulation requires the auditor to do so.

Acceptance of change in the terms of engagement

The entity might, in certain circumstances, ask the auditor to change the terms of the audit
engagement. This might result from a genuine …….change in circumstances affecting the need
for the service………… from a misunderstanding as to the nature of an audit as originally
requested and …………..a Restriction on the scope of an audit engagement.
(Restriction on scope of the External Auditor)

(The entity might then ask for the audit engagement to be changed to a review engagement to
avoid a qualified opinion or a disclaimer of opinion.)

Factors to be considered by the Auditor before accepting the change in terms of engagement
1. Contractual and legal implications of the change
2. Justification by mgmt. / otherwise for changing the terms of the engagement.
3. The information given by mgmt. / TCWG for the change
ISA 210 requires the auditor to consider the justification for the request and whether it is
“reasonable”.

1. If the auditor considers that it is a reasonable request from the management /

circumstances then revised terms should be agreed and recorded by both the parties.

Steps that the auditor can take, if he is unable to agree to a change in terms of engagement
letter.
2. External auditor to discuss the matter with management and explain the circumstances
with respect to change in terms
3. If the auditor is unable to agree to a change of terms he should withdraw (i.e. Resign) from
the engagement (where possible under applicable law) and
4. Consider whether there is any obligation (contractual or otherwise) to report the
circumstances to other parties such as those charged with governance, owners or regulators
(SECP & ICAP)

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

CA CAF 8 Practice Questions on ISA 210

S. No. Question Attempt Marks

1 Q.9 September 2012 6 marks
2 Q.1 September 2014 5 marks
3 Q.6 (a) March 2017 4 marks
4 Q.1 (b) March 2018 5 marks
5 Q.6 (a) March 2019 4 marks

ACCA F8 Practice Questions on ISA 210

S. No. Question Attempt Marks

1
2
3
4
5
6

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
ICAP CAF 8 September 2012 (6 marks)
Question 9
List the important matters that are required to be included in an audit engagement letter.
Answer:
Key Components of Audit engagement letter:
 The objective and scope of the audit of financial statements;
 The responsibilities of the auditor;
 The responsibilities of management;
 Identification of the applicable financial reporting framework for the preparation of the financial
statements;
 Reference to the expected form and content of any reports to be issued by the auditor and;
 A statement that there may be circumstances in which a report may differ from its expected form
and content.
--------------------------------------------------------------------------------------------------
ICAP CAF 8 September 2014 (5 marks)
Question 1
Khanewal Limited (KL) has requested your firm to submit engagement letter for KL’s statutory audit.
The engagement partner has asked you to establish whether preconditions for the audit of KL are
present.
Required:
What matters would you consider in order to ensure that preconditions for the audit exist?

Answer:
In order to establish whether the preconditions for an audit are present, I will:
i. determine whether the financial reporting framework to be applied in the preparation of financial
statements is acceptable;
ii. obtain the agreement of management that it acknowledges and understands its responsibility:
 for the preparation of the financial statements in accordance with the applicable financial
reporting framework.
 for such internal control as management determines is necessary to enable the preparation of
financial statements that are free from material misstatement, whether due to fraud or error.
 to provide us with all relevant and requested information and unrestricted access to all
personnel.
--------------------------------------------------------------------------------------------------
ICAP CAF 8 March 2017 (4 marks)
Question 6 a
List any four situations that may require revision in the terms of audit engagement letter.
Answer:
Situations that may require revision in the terms of engagement letter are as follows:
 Any indication that the entity misunderstands the objectives and scope of the audit;
 Any revised or special terms of the audit;
 A recent change in the senior management/ ownership;
 A significant change in nature or size of the entity’s business;
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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
ICAP CAF 8 March 2018 (5 marks)
Question 1 b
State the matters which an auditor should consider to establish whether the pre-conditions for an audit
are present.

Answer:
To establish if the preconditions for an audit are present, the auditor shall:
 establish if the financial reporting framework to be used in the preparation of the financial
statements is acceptable; and
 obtain the agreement of management that it acknowledges and understands its responsibility (the
‘premise’):
for the preparation of the financial statements in accordance with the applicable financial
reporting framework, including where relevant their fair presentation;
 for internal controls to ensure that the financial statements are not materially misstated; and to
provide the auditor with all relevant and requested information and unrestricted access to all

--------------------------------------------------------------------------------------------------

ICAP CAF 8 March 2019 (4 marks)

Question 6 a
You are the audit manager in a firm of chartered accountants. Your firm has been appointed as the
auditor of a listed company, Rustam Raees Limited (RRL) for the year ending 31 December 2019. RRL
has been publishing their annual financial statements within one month of the year end and have set
strict deadlines for the completion of audit. Further, this year, RRL has changed its accounting policy
relating to property, plant and equipment, from historical cost to revaluation model.

Required:
List the matters (related to the given scenario only) which you would like to include in the engagement
letter, along with their justification.

Answer:
Matters to be included in engagement letter
 Being the first year of audit for our firm, arrangements concerning the involvement of predecessor
auditor would be necessary.
 Use of auditor’s expert may be required as RRL has changed its accounting policy from historical
cost convention to revaluation model.
 Due to strict deadlines:
 It should be included in the engagement letter that management would make available the draft
financial statements along with all relevant information in time to allow for the completion of
audit in accordance with the proposed time table.
 We need to communicate the planning and performance of the audit, including the composition
of the audit team.
 We may also consider using RRL’s internal audit department and this fact may have to be
communicated through the engagement letter.

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Student Notings
I

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
Student Notings

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

ISA 320 – ‘Materiality’

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Expected Questions on ISA 320 (Materiality)

Page 32 of 272 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Concept of Materiality (ISA – 320)
Definition
‘Misstatements, including omissions are considered to be material if they, individually or in the
aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis
of the financial statements’
OR
“Information is material if its omission or misstatement could influence the economic decisions of
users (shareholders & stakeholders) taken on the basis of the financial statements, materiality also
depends on the size of the item or error judged in the particular circumstances (depends upon
professional judgement)”

Judgments about materiality are made in the light of surrounding circumstances and are affected by the
size or nature of a misstatement or a combination of both

EXPLANATION
The assessments of what is material is ultimately a matter of the auditor’s professional judgment, and is
affected by the auditor’s perception of the financial information needs of users and the perceived level of
risk; the higher the risk, the lower will be the level of overall materiality.

(IMP)
In assessing materiality, the auditor to consider that a number of errors each with a small value may, when
aggregated, may amount to a material misstatement.
The assessment of what is material is ultimately is a matter of auditors professional judgement and is affected by the
auditors perception of the financial information needs of users of the financial statement

PERFORMANCE MATERIALITY
When establishing the overall Audit Strategy (in chapter # 3 ISA 300), the auditor shall determine
materiality for the F/S as a whole (called Planning materiality –P.M).If in the specific circumstances of
the entity, there is one or more particular classes of transaction, account balances for which
misstatements of lesser amounts than materiality for the financial statements as a whole….. are expected
to influence the users of the F/S……. than External auditor shall also calculate Performance
Materiality.
The auditor will set performance materiality, which is LOWER than materiality for the financial
statements as a whole. Performance materiality is defined……. as the amount less than materiality for
the financial statements as a whole. Performance materiality is normally set at a lower level than overall
materiality and is used for testing individual transactions, account balances and disclosures.
As per ISA 320 ‘MATERILITY is often calculated using benchmarks such as 5% of PBT or 1% of gross revenue,
these are starting points for the auditor to calculate materiality.
(Performance Materiality or Tolerable Error –T.E --- is normally 50% of planning materiality).

Benchmarks (Variable) for calculating Planning Materiality……..

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Basic Example for Audit Students
E.g Planning Materiality is calculated as follows:
(0.5% of Sales / Revenue ,

This is Planning materiality ------------------or say materiality for F/S as a whole

(Suppose its 500 K)

For testing particular class of transactions (P&L Items), account balances (B/S Items), we further
calculate Tolerable error (Performance Materiality) which is normally 50% of planning materiality ---------
in our example it will be 250K)
Balance Sheet as on Dec 31,2017

E.g. Debtors – 650 K (exceeds T.E—will be tested) ____________________________

Inventory –150 K (below T.E – will not be tested) ___________________________

IMP
However, note that, even if an item is below performance materiality, auditor may still perform audit
procedures by performing analytical procedures + Inquiry from the audit client.
Remember: The levels of materiality may be revised during the course of the audit and this may result in
further audit procedures (CAIRO) being performed by the auditor.

Relationship between Audit Risk and level of Materiality …. IMP

Choice of Benchmark / Variable

It is a matter of professional judgment for the External Auditor to decide the benchmark
Following factors are considered when identifying an appropriate benchmark:

 Nature of entity (e.g. if profit oriented, materiality will be based on net profit but if not-for-profit,
materiality will be based on total assets/expenses)
 Which items are focused by shareholders (e.g. for banks… users focus on total assets otherwise its
PBT)
 Volatility of benchmark / variable (the less volatile, the better it is for an external auditor)

Page 34 of 272 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
TYPES OF MATERIALITY

 QUANTITATIVE MATERIALITY
Planning and
Performance Materiality

 QUALITITATIVE MATERIALITY (Other than Numbers)

QUALITATIVE MATERIALITY

These qualitative factors are:

 NATURE OF THE ITEM INVOLVED:
Many items in financial statements are by their nature subject to a high degree of subjectivity OR are
material to the users of the F/S such as Provision for warranty / Lawsuit, Legal and Professional
Charges, Auditors remuneration, Bad debts expense etc.

 IMPACT OF THE ITEM INVOLVED:

Errors which may not be material in number may have a major impact on the financial statements
understanding for the shareholders / users OR in the near future to come.
E.g. would be inadequate or improper description of an accounting policy when it is likely that user
of the financial statement would be misled by that description. And

Failure to disclose a lawsuit against the company by its customers when it is likely that the
consequent imposition of penalty will significantly impair operating capability and will raise going
concern issue for the company in the near future….

 CONCEPTUAL ERROR:
Typically, a conceptual error is one where the amount is incorrectly treated even though the amount is
correct. For example, a non-current asset purchased has been written off to profit and loss completely
in the year of purchase rather than being Capitalized and then depreciated over its useful life
Similarly….. treating finance lease as operating lease and vice versa and the amount is immaterial in
the context of F/S as a whole …

Other Examples of Qualitative Misstatements…….

Page 35 of 272 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

IMP
Why the External Auditor does needs to consider Materiality??
External Auditor needs to consider the level of materiality at the following stages / phases of an audit:

a) At the PLANNING STAGE (to be linked with ISA 300)

b) While PERFORMING the audit procedures (checking items > materiality threshold)
c) At the END of the Audit / Reporting Stage (Reaching an appropriate audit opinion)

a) At the Planning Stage / Risk assessment stage and during the audit (ISA 300)
In deciding where audit attention will be more focused, the auditor will plan to spend more audit time
(perform more substantive procedures) on areas which are material and are more risky in the F/S.
And will than perform more audit procedures to obtain S.A.A.E in respect of material balances.

b) At the end of the audit / When reaching an audit opinion:

Auditors will need to assess and evaluate the impact of material misstatements identified, on the F/S
taken as a whole and thereby on the truth and fairness of the financial statements in order to issue an
appropriate audit report to the shareholders.

Explanation
The auditor needs to consider whether the aggregate of uncorrected misstatements is material, if the
auditor concludes that the aggregate is material, the auditor needs to consider reducing the risk by
extending the audit procedures and requesting management to adjust the financial statements. (E.g. total
of uncorrected misstatements exceed Planning materiality………. this is material now and auditor should
propose adjustments in the F/S to the Management and mgmt. must make adjustment to the F/S)

(Further discussion after ISA 580)

WHAT IF MANAGEMENT REFUSES TO ADJUST THE FINANCIAL STATEMENTS …?

If management refuses to adjust the financial statements and the results of extended audit procedures DO NOT
enable the auditor to conclude…… that the aggregate of uncorrected misstatements is not material (i.e its material..!
), than the auditor should consider the appropriate modification to the audit OPINION…

i.e. (Impact on the Audit Report) (TO BE DISCUSSED LATER …….)

Can the External Auditor Revise the Planning and Performance Materiality during
the audit?

Page 36 of 272 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

ACCA F8 & CA CAF 8 Practice Questions on Materiality

S. No. Attempt Marks

ICAP Questions

1 Q. 7 a March 2019 3 marks

2 Q. 7 a Sept 2017 2 marks

3 Q. 6 Sept 2014 5 marks

ACCA Questions

4 Q. 17 (a) March / June 2019 4 marks

5 Q. 3 (a) June 2013 5 marks

6 Q. 2 (b) June 2010 5 marks

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
ICAP CAF 8 March 2019 (3 marks)
Question 7a
Discuss the term 'performance materiality' and the purpose for which it is used (3 marks)

Answer
Performance materiality means the amount or amounts set by the auditor at less than materiality for the
financial statements as a whole or at less than the materiality level for particular classes of transactions,
account balance or disclosures.

Performance materiality is set to reduce to an appropriately low level the probability that the aggregate
of uncorrected and undetected misstatements in the financial statements or in classes of transactions,
account balance or disclosures exceeds the materiality as a whole.
--------------------------------------------------------------------------------------------------

ICAP CAF 8 Sept 2017 (2 marks)

Question 7 a
Apart from profit before tax, list any four benchmarks which can be used to determine the materiality at
the financial statement level. (2 marks)

Answer:
The following can be the benchmark for determining materiality:

 Gross profit
 Total expenses
 Total equity
 Total assets
 Total revenue
--------------------------------------------------------------------------------------------------

ICAP CAF 8 Sept 2014 (5 marks)

Question 6 c

You are the training manager in a firm of chartered accountants. Prepare brief presentation for newly
inducted trainees, on the following:
c. Materiality and Performance Materiality. (5 marks )

Answer
c. Materiality:

Information is material if its omission or misstatement could influence the economic decisions of users
taken on the basis of financial statements. The auditor keeping in view the concept of materiality gives
his opinion i.e. whether the financial statements present fairly in all material respects the financial
position and performance of the entity.

Page 38 of 272 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

Performance Materiality:
Performance materiality means the amount or amounts set by the auditor at less than materiality for the
financial statements as a whole to reduce to an appropriately low level the probability that the aggregate
of uncorrected and undetected misstatements exceeds materiality for the financial statements as a whole.

If applicable, performance materiality also refers to the amount or amounts set by the auditor at less
than the materiality level or levels for particular classes of transactions, account balances or disclosures.

Performance materiality recognizes the fact that errors/omissions detected in a particular area may not
breach the overall materiality level but when all the errors/omissions in all the areas is combined or
added together, the overall materiality could be breached.
--------------------------------------------------------------------------------------------------

ACCA F8 June 2010 (5 marks)

Question 2b

ISA 320 Materiality in Planning and Performing an Audit provides guidance on the concept of materiality in
planning and performing an audit.

Required:
Define materiality and determine how the level of materiality is assessed.

Answer
Materiality is defined as follows:

‘Misstatements, including omissions, are considered to be material if they, individually or in the

aggregate, could reasonably be expected to influence the economic decisions of users taken on the basis of
the financial statements.’

In assessing the level of materiality there are a number of areas that should be considered. Firstly the
auditor must consider both the amount (quantity) and the nature (quality) of any misstatements, or a
combination of both. The quantity of the misstatement refers to the relative size of it and the quality
refers to an amount that might be low in value but due to its prominence could influence the user’s
decision, for example, directors’ transactions.

In assessing materiality the auditor must consider that a number of errors each with a low value may
when aggregated amount to a material misstatement.

The assessment of what is material is ultimately a matter of the auditors’ professional judgement, and it is
affected by the auditor’s perception of the financial information needs of users of the financial statements.

In calculating materiality the auditor should also consider setting the performance materiality level. This
is the amount set by the auditor, it is below materiality, and is used for the particular classes of
transactions, account balances and disclosures.
As per ISA 320 materiality is often calculated using benchmarks such as 5% of profit before tax or 1% of
gross revenue. These values are useful as a starting point for assessing materiality.

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Student Notings

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

Student Notings

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Student Notings

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Student Notings

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

ISA 230 – ‘Working Papers’

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Expected questions on Working Papers / Audit
Documentation

1. Define working papers & explain the benefits / objectives of working papers
/ audit documentation?
2. List the advantages of working papers / audit documentation?
3. Explain permanent audit file & list the contents of a permanent audit file?
4. List the features / _______________/______________ of a good working
paper?
5. List the contents of working paper file / audit documentation?
6. Explain the factors that may affect the form & content of working papers?
7. Explain the term standardized & automated working papers? Explain with
examples.
8. Briefly explain current audit file & list the contents of a current audit file?
9. Briefly explain the difference between permanent & temporary working
papers with examples?
10. Identify and explain errors in the above working paper extract?
11. List the advantages of automated working papers?

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K

Class Lecture Noting

Page 46 of 272 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Audit Documentation / Audit Working Papers (ISA 230)
The auditor should document matters on a timely basis matters which are important in providing audit
evidence to enable the auditor to express an independent audit opinion on the financial statements.
“Documentation means the working papers prepared by and retained by the External
auditor in connection with the performance of the audit. Working papers may be in the
form of data stored on paper or on electronic media.”

Nature of Working Papers

Advantages/Objectives of Audit working papers:

1. Assist in the planning of the audit. (ISA 300)

2. Assist in the performance of the audit.
3. Assist in the timely supervision and review of the audit by the manager and partner.
(they verify all work done i.e. review audit evidence gathered during the audit)
4. Helps to maintain a complete & detailed record of the audit evidence gathered during the
audit process to support the auditor’s opinion. (by performing CAIRO ) ISA 500
5. Helps for future reference in the upcoming years and to protect the auditors as evidence in
the case of any legal action.
6. Enabling the audit team to be accountable for its work
7. It enables quality control reviews (both Internal and External )
8. Retaining a record of matters of continuing significance to future audits

Working papers should be prepared…..

 On a timely basis,
 should be such detailed and complete enough so that it is useful for another auditor in the next
year (Other audit team from the same audit firm) that has no previous experience with the audit or
the audit of such an organization,
 to provide understanding of the work performed during the audit.
 To drive conclusions drawn from the audit procedures performed

(Remember: It’s the professional judgment of the Auditor to decide what to include and what not to
include in the working papers…! )

Note: Working papers not to include documents that have been superseded/ replaced by new and
corrected working papers + W.Ps are not a substitute for oral explanations by the client (though they
provide clarification)

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Form and content of working papers: Please Learn!

Are affected by matters such as:

1. Nature of the engagement. (Audit or Compilation Engagement)
2. Nature, size & complexity of the business. (the bigger the co. the more w.papers)
3. Complexity of the entities internal control. (more complex – more w.papers)
4. Nature of audit procedures to be performed
5. The extent of judgement involved in performing the audit work.
6. Significance of audit evidence obtained (more working papers are required for testing material
balances)
7. Specific audit methodology and technology used in the course of the audit.( use of checklists by
the auditors and other automated tools / C.A.A.T reducing the audit documentation in a smart
manner)
8. The identified risk of material misstatement (more is the risk more is the work)
9. Nature and extent of exceptions identified (more exceptions identified = more w.papers)

Contents of Working Papers: (Imp ) Please Learn!

 Information obtained during the audit for understanding the entity and its environment
(___________)
 Information and documentation of the internal control system of the audit client.
 Extracts or copies of important legal document (____________________________________ )
 Documentation for making audit strategy
 Determination of materiality level (cutoff for testing transactions– chapter 6)
 Analysis of significant transactions & balances.( e.g Inventory and Receivables) and key ratios
 Substantive procedures performed during the audit __________
 Engagement letter for the year ( )
 Management letter (or Management Report)
 3rd party confirmations dispatched during the audit (Debtors / creditors etc and their replies)
 Key agreements and contracts. ( ________________________________)
 Important calculations like depreciation, amortization etc
 Copies of financial statements (Draft and Final accounts)
 Auditor’s report for the current year
 Written representations received from the audit client.________

Working papers should clearly identify the following: (also called Features of Working
Papers)
Please Learn!
 Name of the client
 Year end (B/S Date)
 Subject (Account head of B/S or P&L)
 Objective of the work done (F/S Assertion)
 Who performed the work & date (Audit Junior/Senior)
 Who reviewed the work & date (Audit Manager and the Partner)
 Identification of audit procedures carried out (e.g Inspection of assets etc.)
 Any issues identified
 Conclusion / key points of the work performed (was the audit evidence obtained, satisfactory or
not)

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
 Audit ticks (identifying the procedures performed)
 Working paper reference (C 23/64)

E.g: of Audit Ticks used on the working papers….

T-casting checked
TT-cross casting checked
G.L-verified from G.L
C - Confirmation dispatched
¢ - calculation checked & P – Physically observed (Any tick can be used by the
auditor)

In the case of recurring audits ,some working paper files may be classified as ‘permanent ‘ audit files
which contain information of continuing importance and are updated with the new information every
year.(after every audit )

Others are classified as ‘current’ audit files which contain information relating primarily to the audit
of that particular period ( period of audit ), which means that all audit evidence and documentation
done for that particular year is filed in the current audit file.(Current audit files are maintained every
year for each client)

Examples of Permanent working papers Plz Learn ..!

Example of Current / Temporary Working Papers

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Summary Notes by S.K
Other Sources of Information
Annual Report, Management Reports, Budgets and Forecasts, Organization charts , list of company
employees, list of company warehouses and stores, Last year working papers and Trade journals.

Retention and Confidentiality of working papers Audit working papers are the property of External
auditors and should therefore be properly retained for the number of years by them as per the local
requirements or the audit firms practice.
(ISA recommends min 5 Yrs --- from the date of report) (Local laws states: 10 yrs )

Similarly the responsibility of the confidentiality of the audit working papers is also of the External
auditors. However, certain working papers may be given (copies) to the audit client, at their request,
but these are not a substitute of clients working papers/accounting records.
----------------------------------------------------------------------------------------------------------
Automated and Standardized working papers

Automated working paper packages have been developed which can make the documentation of audit
work much easier. They make preparation of working papers, lead schedules more easy.

Automated W. papers =either prepared via Microsoft Office tools (Ms. Word and Excel) or any Audit
Software (to be discussed in C.A.A.T)

Advantages of Automated Working Papers

 The risk of errors is reduced.

 The working papers will be neater and easier to review by seniors
 The time saved will be substantial as adjustments in the F/S can be made easily to all working
papers via accounting software or Ms Excel.
 Standards working paper forms/formats do not have to be carried to audit locations.
 Audit working papers can be transmitted for review via email

Standardized working papers

The use of standardized working papers may improve the efficiency of audit work but they can be
dangerous because they may lead to mechanical approach i.e. Audit team might work without using
their professional judgment during the audit……
 Stand Confirmations (Debtor confirmation, creditor confirmation etc)
 Stand Checklists and Questionnaires
 Stand Audit Programs (List of audit procedures)
 Stand stock count sheet and cash count sheet.

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Summary Notes by S.K
Student Notings

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
Student Notings

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ACCA F8 - Audit & Assurance
Summary Notes by S.K

ISA 300 – ‘Planning an Audit’

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KnS School of Business Studies
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Summary Notes by S.K
Audit Strategy and Audit Plan
Expected questions on Audit Strategy and Audit Plan
1. Define Audit Strategy & detailed Audit Plan?
2. What are the advantages / purpose /importance of planning an Audit? / Audit
Planning?
3. List the contents of an overall Audit Strategy?
4. What are the matters to be considered by the Auditor while making an Audit Strategy?
5. What are the matters to be included in a detailed Audit Plan? OR
6. List the contents of the detailed Audit Plan?
7. List the contents / Matters to be included in an / of an Audit Strategy & provide
relevant example for the given case? (Scenario based Question) ………..Most Imp!
8. Explain the difference/ tabulate the Difference between Audit Strategy and Audit
Plan?
--------------------------------------------------------------------------------------------------------------------------------------------
Planning an Audit – ISA 300
ISA 300 requires the auditor to: (Overall Objectives of ISA 300)
1. Involve the whole engagement team in planning the audit
2. Establish an understanding of the terms of the engagement required by ISA 210 (Ch 2)
3. Establish an overall strategy for the audit that sets the scope, timing and direction of
the audit and that guides the development of the audit plan
4. Develop an audit plan which includes a description of planned risk assessment procedures and
planned further audit procedures (CAIRO)
5. Document the overall audit strategy & the audit plan, including any significant changes made
during the audit.

Introduction to Planning:
The auditor should plan an audit so that the engagement will be performed in an effective manner.
Planning an audit involves establishing the overall audit strategy for the engagement and developing
an audit plan.
Planning involves the engagement partner and other key members of the engagement team to benefit
from their experience and insight (understanding) and to enhance the effectiveness and efficiency of
the planning process.
Advantages / Benefits of Planning/Need for Planning

1. It ensures that appropriate attention is devoted to important areas of the audit

(E.g______________________________________________________________ etc)
2. It ensures that potential problems are identified (Misstatement in _____________)
3. It ensures that such problems (Audit and accounting issues) are resolved on a timely basis.
4. It ensures that audit engagement is properly organized and managed.
5. Planning also assists in the proper assignment of work to engagement team members.
6. Planning facilitates the direction, supervision of engagement team members and review of their
work.( managers review the work done by the audit team)
7. Proper utilization of assistants. ( ______________________________)

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Summary Notes by S.K
Attitude of Professional skepticism to be exercised during Planning and performing an Audit
When planning and performing an audit, the auditor should adopt an attitude of professional
skepticism. Professional skepticism is:
“An attitude that includes a questioning mind, being alert to conditions which may indicate possible
misstatement due to error or fraud, and a critical assessment of audit evidence”.
(Please refer to P.S handout studied earlier)

Involvement of Key Engagement Team Members

ISA 300 requires the engagement partner and other key members of the engagement team to be
involved in planning the audit, including participating in the discussion among engagement team
members.
Depending on the size of client, complexity and any other relevant factors, this may involve the
engagement partner and other key members of the engagement team.

Planning Activities……. (Main heading)

The overall Audit Strategy
The auditor should establish the overall audit strategy for the audit. The overall audit strategy sets the
scope, timing and direction of the audit and guides the development of a more detailed audit plan.

Contents of the overall audit strategy / Consideration in Establishing the

Overall Audit Strategy / Matters to be included within the Audit strategy
document
Learn 3 points from
Main Characteristics of the Engagement each heading

The audit strategy should consider the main characteristics of the engagement which defines its scope.
1. Understanding the entity and its environment (Banking / Trading or Manufacturing Industry) /
The nature of business
2. The applicable financial reporting framework (relevant Int. Accounting standards or any other acc.
stands) on which the F/S to be audited has been prepared.
3. The availability of key client personnel & internal auditors (if any)
4. The expected audit coverage. (Sample coverage)
5. Use of Experts eg Lawyers and service organizations (eg Payroll services are outsourced)
6. Whether C.A.A.T will be used and its effect on audit procedures

Reporting Objectives, timing of the audit and nature of communications

The objective here is to plan the timings of the and the nature of communications required for e.g.:
1. Communications with 3rd parties (eg Debtors / creditors etc)
2. Ascertaining the reporting objectives of the engagement and the timing of the audit (timetable for
audit) and deadlines to be met.( e.g. Completion of Audit and Delivery of Audit Report )
3. Meetings and discussion with those TCWG to discuss significant audit issues arising.
4. When audit meetings will take place and when their work will be reviewed.

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Summary Notes by S.K
Significant factors during the Audit
Factors to be considered which in the auditor’s professional judgement are significant, for eg:
1. Determination of appropriate materiality levels.eg Calc. of Planning and Performance materiality
(ISA 320)
2. The need to maintain professional skepticism in gathering and evaluating audit evidence.
3. The need to maintain professional judgement in gathering and evaluating audit evidence.
4. Identification of material components / significant items in B/S and P&L(E.g. Debtors &
Inventory)
Preliminary engagement activities and knowledge gained on other engagements
It should consider the results of preliminary audit planning activities and other knowledge gained on
other engagements for eg:
1. Significant changes in the financial reporting framework
2. Whether audit will be conducted via TOCs or substantive procedures
3. Conclusions on the effectiveness of internal controls based on earlier testing.
4. Significant business (changes in I.T or Business processes) and industry developments
(E.g. New regulations or new material or new practices etc.)
Nature, timing and extent of resources
1. How AUDIT resources are managed, directed and supervised.
2. Selection of audit engagement team and assignment of audit work to experienced team members
where there may be higher risks of material misstatement.
3. Total man hours required for the job and setting up the audit budget. (e.g. 1000 hours)
Once the overall audit strategy has been established, the auditor is able to start the development of
a more detailed audit plan to address the various matters identified in the overall audit strategy.
Although the auditor ordinarily establishes the overall audit strategy before developing the detailed
audit plan, the two planning activities are not necessarily discrete (distinct) or sequential process but
are closely inter related.
The Audit Plan: (to be linked with T.O.C and S. P’s)
The auditor will take the overall audit strategy and convert it into a more detailed audit plan. The plan
includes the nature, timing and extent of audit procedures to be performed by engagement team
members in order to obtain sufficient appropriate audit evidence to reduce audit risk to an acceptably
low level.
Contents of a Detailed Audit Plan
1. Description of planned risk assessment procedures – as per ISA 315
2. Description of Audit procedures / Audit tests to verify Profit & loss and Balance sheet and P& D
items assertions
3. Other planned procedures as per ISAs (e.g. ISA 560 Subsequent Events & ISA 570 Going Concern
etc.)

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Summary Notes by S.K
Examples:
 A timetable of planned audit work.
 Details of the allocation of work to audit team members.
 Audit procedures for B/S and P&L (e.g. inventory, receivables, cash etc.)
 Materiality for the financial statements as a whole and performance materiality
The audit plan is MORE detailed than the overall audit strategy and includes audit procedures
(application of Tests of Controls and Substantive Procedures) to be performed by engagement team
members in order to obtain sufficient appropriate audit evidence to reduce audit risk to an
ACCEPTABLY LOW LEVEL.

Documentation in the case of ISA 300

 Audit Strategy
 Audit Plan &
 Any significant changes made during the audit engagement to the overall strategy or the detailed
audit plan along with reasons for it.

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Summary Notes by S.K

ACCA F8 Practice Questions on Planning an Audit

S. No. Attempt Marks

ACCA Questions

1 Q.18 (a) Sept / Dec 2017 4 marks

2 Q.1 (a) Dec 2014 5 marks

3 Q.1 (c) Dec 2013 4 marks

4 Q.17 (b) Sept/Dec 2017 3 marks

5 Q. 2 (a) June 2012 4 marks

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Summary Notes by S.K
Student Notings

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
Student Notings

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Summary Notes by S.K

ISA 315 – ‘Audit Risk’

(Theoretical Part)

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 KnS School of Business Studies
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Summary Notes by S.K Summary Diagram of Audit Risk

Audit Risk (A.R) = Risk of Material Misstatement (R.O.M.M) * Detection Risk (D.R)

Audit Risk

Audit Risk is the risk that the an

At the Financial Statement Level At the Assertion Level Detection Risk has further 02 Components
external auditors may give a
wrong opinion on the
financial statements. i.e. It’s the Risk at the F/S Level refers Sampling Risks
risk that an auditor expresses an to the risk of M.M that 1. Inherent Risk
incorrect / wrong Audit opinion pervasively effects F/S Non -Sampling Risks
when the financial statements are as a whole and potentially 2. Control Risks
materially misstated. affects many assertions in the F/S
Pls Note:
It does not mean Auditor's own
Business risk or the business risk It’s the RISK that has an overall They are NOT related to the external audit
that is unrelated to the financial impact on the F/S… and they both exist independently of the
statements of the company. Audit i.e
Also Note: Egs from Handout .2 They exist prior to the External Audit ……
Audit risk can never be zero
(They are not in the control of the
because of inherent limitations of
an audit. External auditors)

The objective of an External External auditors can ONLY assess

Auditor is to reduce the Audit risk Inherent and
to an acceptably low level which Control Risks
depends upon the Professional
judgement of the external auditor.

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Summary Notes by S.K
ISA 315 Audit Risk
Risk at the Financial Statement and at the Assertion Level
Risk at the F/S Level
It relates to the risks of material misstatement that pervasively affects F/S taken as a whole &
potentially affect many assertions of the F/S.
i.e. It’s the risk that has an impact on the financial statement overall.
Examples of RISK at the F/S Level:
1. Management override of controls.
2. Risk of fraud (ISA 240)
3. Deficient control environment (e.g. Weak corporate Governance)
4. Managements lack of competence.
5. Management integrity. (Management cannot be trusted)
6. Conditions & reliability of entity’s record.
7. Declining economics conditions. (or changing Industry conditions)
8. Going Concern Risk. (ISA 570)
Response of RISK at the F/S Level by the External Auditor
(To be covered while studying ISA 240 Fraud & Error)
These include:
1. Emphasizing to the audit team the need to maintain and exercise an attitude of professional
skepticism during the audit.
2. Assigning more experienced audit staff at the client.
3. Increased supervision of audit staff
4. The use of experts (E.g. Lawyers, Environmental Experts, Tax experts etc.)
5. Incorporating more unpredictability into the audit procedures
Explanation:
Incorporating an element of unpredictability in the audit procedures to be performed is important as
individuals within entity who are familiar with the audit procedures normally performed on
engagements may be more able to conceal fraudulent financial reporting.
This can be achieved by, for example.
Performing substantive procedures on selected account balances assertions not otherwise tested due to
their materiality or risk.
(Example: verification of Rent expense or Short-term loan or Marketing expenses.)
 Adjusting the timings of audit procedures from that otherwise expected
(Example: Dispatching debtor and creditors confirmation before the balance sheet date or
counting stock before the B/S date)
 Using different sampling methods.
(Using statistical sampling Method rather than Non-statistical method or using random method
rather than haphazard method)
 Performing audit procedures at different locations or at locations on an unannounced basis.
(Counting inventory in stores / warehouses on locations not counted previously or informing the

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audit client on the very last moment or counting physical cash on different branches for the current
year audit)

 Changing the nature, timing and extent of audit procedures (to be discussed in future)
Inherent Risk
Inherent risk is the risk that items in the F/S may be misstated as a result of their inherent
characteristics/ feature.
When inherent risk is high, this means that there is a high risk of misstatement of an item in the
financial statements. (P& L, B/S or P&D)
Inherent Risk is the susceptibility of an assertion about a class of transaction, account balance or
disclosure to a misstatement which could be material, either individually or when aggregated with
other misstatements, before consideration of any related controls.
Examples of Inherent risk (I.R):

1. Complex calculation of provisions (+ Accounts involving high degree of

estimations
e.g. Provisions made under IAS 37)
2. Technological developments based on Industry having significant variations.
( )
3. Declining industry resulting in reduced sales & Debtors. (tough competition)
4. Theft & misappropriation of portable assets (e.g. Cash and portable inventory)
5. Pending litigations against the company.
6. The nature of the entity and the industry in which it operates.

E.g. 1: A company in the cement industry operates in a volatile and high-risk environment, and items
in its financial statements are more likely to be misstated than items in the financial statements of
companies in a more low-risk environment, such as a service industry.
Control Risk (C.R)
Control Risk is the risk that a misstatement which could occur in assertion about a class of transaction,
account balance or disclosures and which could be material, either individually or when aggregated
with other misstatements, will not be prevented, or detected and corrected, on a timely basis by the
entity’s internal control.’
Examples of Control Risk (C.R):
1. Possibility of human errors/mistakes. (wrong punching of sales invoices)
2. Collusion between employees. (employees conducting fraud together)
3. Management override of controls.
4. Inadequate/inappropriate SOP’s/Deficiencies in Internal Controls.
5. Non-Routine transactions. (Procuring assets on Leasing)
6. Lack of Qualified & inexperienced Staff.
7. Changes in Key Personnel (E.g. CFO, Senior Manager Finance etc).
8. Changes in I.T Environment (Change of software).

The initial assumption should be that control risk is very high, and that existing internal controls are
insufficient to prevent the risk of material misstatement.

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Summary Notes by S.K
Detection Risk (D.R)
Detection Risk is the risk that the procedures performed by the auditor to reduce audit risk to an
acceptably low level will not detect a misstatement which exists and which could be material, either
individually or when aggregated with other misstatements. (Detection risk is affected by sampling and
non-sampling risks.)

The risk that the procedures performed by the auditor to reduce audit risk to an acceptably low level
will not detect a misstatement that exists and that could be material, either individually or when
aggregated with other misstatements.

Detection risk is the risk that the EXTERNAL AUDITOR’s procedures will fail to detect
a MATERIAL misstatement in a transaction or in an account balance

Detection risk can be lowered by carrying out more tests/ procedures in the audit. For example, to
reduce the detection risk from 10% to 5%, the auditor should carry out more tests. (MORE
PROCEDURES)

In other words, the detection risk can be managed by the auditor in order to control the overall audit
risk. Inherent risk and Control risk CANNOT be controlled by the external auditor
Examples of Detection Risk (D.R)
1. First year of audit
2. No past Audit experience of the audit client
3. Integrity of Management (We cannot trust the Management representations /statements)
4. Unreliable data and information (The Information System of the client is not
reliable)
D.R can be INCREASED by OR say Factors that increase D.R:
1. Inadequate planning by the External Auditor
2. Inappropriate assignment of personnel to the engagement team
3. Failure in applying professional skepticism during the Audit
4. Inadequate supervision and review
5. Incorrect sampling techniques (ISA 530)
6. Inappropriate/incorrect sample size
D.R is the risk that audit procedures performed by the External Auditor will fail to detect material
misstatement. It relates to the inability of the auditor to examine all evidence. Audit Evidence is
usually persuasive rather than conclusive (covered in Basic concepts) therefore some D.R will
always exist, allowing the external auditor to seek/express reasonable level of assurance.

Conclusion:
The auditor’s inherent and control risk assessment influences the extent of substantive procedures
required to reduce the D.R and thereby reducing the audit risk to an acceptably low level. D.R
however, can only be reduced and not eliminated, because of the inherent limitations of an audit.
Accordingly, some D.R will always exist.

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Summary Notes by S.K

Index of ACCA Audit Risk

Practice Questions (Theoretical Part)
S. No. Question Attempt Marks
ACCA Questions
1
2
3
4
5

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Summary Notes by S.K

ISA 315 – Audit Risk

(Practical Part)

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Audit Risks kay cheetay Points …. 

(Practical Points that affect Audit Risks)
1. Incurred revenue & capital expenditure during the year OR increase in capital expenditure during
the year. OR question says X amount of expenditure has been capitalized during the year.

2. Increase in subsequent expenditure during the year.

RISKS: There is a risk of incorrect classification between revenue and capital expenditure as per
IAS 16, resulting in both P.P.E and profit being overstated OR understated.
As per IAS 16 …. only purchase price plus directly attributable costs are part of the cost of the
asset. (Other future costs e.g. servicing and maintenance costs are amortized over the period
accordingly)
________________________________________________________________________

3. Increase in research & development cost (IAS 38)/Expenditure on Brands incurred during the year
e.g. Costs capitalized as development costs.
RISKS: There is a risk of incorrect classification between research and development expenditure
as per IAS 38, resulting in both I.A and profit being over stated and understated.
In case, question ONLY mentions that cost has been capitalized as development costs than in that
case ……. There is a risk of overstatement of Intangible asset and overstatement of profit.

4. Various provisions made during the year e.g. Provision for lawsuit / warranty or restructuring
RISK: There is a risk that because of wrong estimates and judgement (both Intentional and
unintentional), provision could be both undervalued or overvalued in the F/S.

5. There are pending cases against the company OR new cases filed on the Co. during the year OR
The sector in which the company operates is highly regulated / Fines Penalties might be imposed
on the organization.
RISK: There is a risk of completeness of provisions or inadequate or no disclosure in the F/S as
per IAS 37.

(If it is probable that company will make a payment, a provision is required. If the payment is
possible rather than probable, a contingent liability disclosure would be necessary.

Both drafting’s are correct:

a) There is a risk over the completeness of any provisions or contingent liabilities.) or

b) There is a risk of provision being over / under valued and risk of inadequate or no
disclosure in the F/S as per IAS 37.

6. Imposition of new laws & regulations on the company

RISK: There is a risk of penalty not being recorded in the F/S resulting in profit being overstated
OR Risk of liabilities being understated OR risk of incorrect disclosures in the F/S.

7. Inadequate Internal controls/SOP’s / or lack of controls in Sales or Purchase department

RISK: There is a risk of controls not being operating effectively leading to overall
ROMM in the F/S or sales and debtors & purchases and payables being overstated or understated

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8. During the year employees were made redundant e.g. Branch office was closed (Part of
restructuring)
RISK: There is a risk that because of wrong estimates the provision could be both overvalued or
undervalued. (OR SAY …There is a risk of completeness of Provision in the F/S.)

9. Bank Loan obtained for 5 / 10 years

RISK: There is a risk of incorrect classification between current and long-term portion of long-
term loan & risk of incorrect disclosure of security provided against bank loan in the F/S.

10. Bank Loan increased as compared to last year.

RISK: There should be additional interest costs therefore there is a risk that this has been omitted
from profit and loss a/c leading to understated finance costs and overstated profit.

11. Bank loan has loan covenants attached, plus the company is facing cash flow problems or faces
liquidity issues.
RISK: There is a risk that if these loan covenants (profit or assets targets) are breached and the
loan becomes repayable immediately than the company will face going concern risk. (ISA 570)
In addition, there is a risk of manipulation of profits and net assets to ensure that bank covenants
are met.

12. Interest / Finance cost increased during the year because of increase in bank loan.
RISK: There is a risk that interest costs will be understated to manipulate profits especially if there
are profit based bonuses for senior management.

13. Introduction of new accounting software during the period and run in parallel during the year
RISK: There is risk of data being lost & balances being misstated if they have not been transferred
completely and accurately, therefore there is a risk of overall R.O.M.M in the F/S.

14. Senior management joins the organization with different prior experience (CFO has joined a
BANK who was previously CFO in a pharmaceutical company)
RISK: There is a risk that there will be overall errors in making judgements and estimates leading
to overall R.O.M.M in the F/S

15. Hiring of unqualified /incompetent / inexperienced staff in the finance department

RISK: There is an inherent as well as control risk that there will be overall R.O.M.M in the F/S.

16. Revaluation of assets during the year (treatment of IAS 16)

RISK: There is a risk that if the treatment of revaluation is not done as per IAS 16 than both PPE
and profits will be over or under-stated.

17. New product has been manufactured by the company but it won’t be allowed to be sold by the
company or its expected that a new law will be imposed which will stop the sales of the product.
RISK: There is risk of going concern for the company plus if stock is not written
down than profit and inventory will be overstated.

18. Top Management/Senior Management from the finance dept. has left the Company very close to
the balance sheet date.
RISK: There is an inherent risk of increased work load for the finance team resulting in
control risks (C.R) for the auditor leading to misstatements in the F/S.

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Alternative Drafting
There is an inherent risk of increased work load for the finance team resulting in control risks
(C.R) as there will be errors within the accounting records by the over -worked finance team and
there is no supervision from senior mgmt.

IMP

19. Default of major customer/receivable during the year OR

20. Receivables balance is increasing over the years as compared to last year or collection in days has
increased as compared to last year.
RISK: There is a risk that if receivables are not recoverable and adequate provisioning is not done
than debtors will be overvalued.
---------------------------------------------------------------------------------------------------------------------------

21. Out of court settlement with the customers / suppliers (before or after the B/S date)
RISK: There is a risk that resulting provision or liability will be over or under valued. (also termed
as completeness of provisions and disclosures)

22. Excess inventory & fixed assets in the warehouse.

RISK: There is a risk of Increased theft & misappropriation of assets resulting in loss of sundry
income leading to profit being understated.

23. First year of audit or it’s a new audit client

RISK: There is a risk of not detecting the errors in the F/S being the first year resulting in
detection risk (D.R) for the external auditor.
(As the team is not familiar with transactions and balances, there will be an increased detection
risk on the audit.)

24. Proper disclosures as per I.F.R.S or local laws are required in the F/S
RISK: There is a risk of incorrect or inadequate disclosures in the F/S.

25. Sales related bonus / incentive being offered to employees.

RISK: There is a risk of sales and debtors being overstated in the F/S by inaccurate sales cutoff.
26. Subsequent fraud discovered by senior management after leaving the organization.
RISK: There is a risk that if previous fraud is not adjusted, than F/S will be materially
misstated. (or say overall R.O.M.M in the F/S will increase)
Alternative: There is a risk that if the impact of the fraud has not been quantified and corrected in
the statement of profit or loss or any other frauds have not been uncovered, the financial
statements could be misstated.

27. Risk of improper/ incorrect classification between current and non-current assets, current and non-
current liabilities.

28. Disposal of fixed assets during the year

RISK: There is a risk of wrong calculation of profit on disposal leading to profit being over
and understated.

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
29. Abnormal gain / loss on disposal of fixed assets during the year.
RISK: There is a risk of unreasonable depreciation policy (accounting estimate) leading to both
P.P.E and profit being under or overstated.
30. The company has both owned & rented assets.
RISK: There is risk that if rented assets are classified as owned assets than assets will be
overvalued and profit will be overstated.
31. Sudden conversion of accumulated losses into profits in the current year.
RISK: There is a risk of admin expenses being understated and profits being overstated.
32. Management bonus is linked on the total assets of the company. (IMP)
RISK: There is a risk that management will manipulate assets of the company via estimates and
provisions and this will lead to assets being overvalued in order to increase their personnel bonus.

33. Management bonus is linked on the profits of the company (IMP)

RISK: There is a risk that management will manipulate profits of the company via estimates and
provisions and this will lead to profits being overstated in order to increase their personnel bonus.

34. Sudden decrease in Admin expenses without any change in company’s operations.
RISK: There is a risk of profit being overstated.

35. Company has Intangible assets under IAS 38 (Patent, license, Franchise etc.)
RISK: There is a risk that if treatment is not done as per IAS 38 than both Intangible assets and
profits could be over/under stated.

INVENTORY

36. Assets/Inventory ordered/procured with no certainty that they will be received at the yearend or
not.
RISK: There is a risk of inaccurate cutoff leading to stock/purchases and payables both being
overstated at the B/S date.
OR there is a risk that if inventory / fixed assets are recorded before they physically exist than both
inventory / fixed assets and payables will be over-stated in the F/S.

IMP
37. There are various locations / stores for inventory counting at the B/S date and company / client
management is willing to get 100 per % stock counted at the B/S date.

Please note :100% verification of inventory at all locations is not always practically possible for the
external auditor.

RISK: There is a risk that auditor will not be able to obtain S.A.A.E over the existence and
completeness of inventory locations not visited by the auditor at the B/S date.

38. Company values its inventory at the lower of cost and net realizable value. Cost includes both
production and general overheads.
RISK: If general overheads are included in inventory cost, then this will result in inventory being
over-valued.

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
39. Inventory is destroyed by fire / flood BEFORE the B/S Date
RISK: There is a risk that inventory is damaged and not valued as per IAS 2 resulting in closing
stock being overvalued.

40. The company is planning to undertake the full year-end inventory count after the B/S date and
then adjust for inventory movements from the year end.
RISK: If the adjustments are not completed accurately, then the year-end inventory could be
under or over-valued.

41. Stock returned after / or before the B/S date being damaged or expired or product recalled by the
company. (inventory was at the B/S date)
RISK: There is a risk that if inventory is not valued as per IAS 2 then closing stock would be
overvalued plus refunds will need to be made to the customers and sales will have to be reversed,
which if not done, then revenue will be overstated and liabilities will be understated.

42. Closing stock balance has increased as compared to last year. (or turnover in days have increased)
RISK: There is a risk that stock is old fashioned / or out of demand and not being sold resulting in
its NRV being lower than cost and if not adjusted as per IAS 2, will result in closing stock being
overvalued.

43. In the case of W.I.P, expert service must be obtained

RISK: There is a risk of W.I.P being under or overvalued.
(The level of work in progress needs to be assessed at the year end. Assessing the percentage of
completion for partially constructed inventory can be very subjective, and an expert should
undertake this. If the percentage of completion is not calculated correctly, the inventory valuation
may be under or over-valued.

44. Useful life of assets or depreciation rates have been reassessed or reviewed by the management
during the year.
RISK: There is a risk that this has been done to manipulate the profits or to achieve some kind of
profit targets resulting in profit and PPE being overstated.

45. Contingent assets as per IAS 37 should only be recorded when virtually certain.
RISK: There is a risk that assets are not virtually certain and are recorded as assets resulting in
assets being overvalued in the F/S.

To comply with IAS 37 contingent assets should not be recognized until the receipt is virtually
certain. If recorded there is a risk of assets and profits being over-stated.

46. The client is requesting to complete the audit early quickly than last year.
RISK: This will result in detection risk for the external auditor plus there will be less time for the
finance team to prepare the financial statements leading to an inherent risk that F/S will me be
materially misstated.
47. Bank reconciliations are not made on timely basis.
RISK: There is a risk that differences will not be reconciled resulting in the risk of bank balances
being over /under valued.

48. Physical stock is not reconciled with General ledger or book records.
RISK: There is a risk that closing stock could be over/under valued.

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
49. If physical cash is not reconciled with General ledger (Cash Book cash column)
RISK: There is a risk that cash balance would be over / under valued.

50. New technology has been introduced by the company because of which old & existing P & M have
been impaired.
RISK: There is a risk that if impairment treatment is not done as per IAS 36 than both P & M and
profits will be overstated.

51. Sales ledger and creditors ledger were closed 10 days after the B/S date
RISK: There is a risk of incorrect cutoff in both sales and purchases leading to over / under sales
and debtors as well as purchases and payables.

52. No supplier statement or purchase ledger control account reconciliations have been performed
during the period.
RISK: There is an increased risk of errors within trade payables and the year-end payables balance
may be under or over-valued.

53. A patent / franchise has been purchased by the company for X no of years and if the management
has expensed the full amount in the current year P&L than…..
RISK: There is a risk that as the sum has been fully expensed and not treated in accordance with
IAS 38 than both intangible assets and profits are understated.
(In accordance with IAS 38 Intangible Assets, this should have been included as an intangible asset
and amortized over its useful life accordingly )

54. The company has raised new finance / equity through issuing of shares at a premium. This needs to
be treated correctly, with adequate disclosures made and proper allocation between share capital
and share premium in the B/S.
RISK: If this is not done, then there is a risk that accounts may be misstated due to a lack of
disclosure as well as share capital and share premium will be misstated.

55. During the year, company outsourced its ABC department / function to an external service
organization / service provider.
RISK: A detection risk arises as to whether sufficient and appropriate evidence is available at the
audit client to verify the completeness and accuracy of controls over that ABC function /
transactions and balances at the year-end.

56. Because of market competition, selling price has been reduced OR abnormal discounts are given to
customers.
RISK: There is a risk of inventory being over-valued / risk of revenue being over-stated / risk of
profit being over-stated.

57. Raw material is imported from other country

RISK: There is a risk of Risk of Trade payables / trade creditors may be under / over valued and
exchange gains and losses may also be over – under stated.

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
Few Accounting standards to be covered for Audit Risk Topic….

IAS 2,16,10,36,37,38 and IFRS 15

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
*Accounting Ratios and Audit Risks to be covered separately

Indicators for Risk of GOING CONCERN

Indicators of FRAUD RISK

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ACCA F8 - Audit & Assurance
Summary Notes by S.K

Index of ACCA Audit Risk

Practice Questions

S. No. Question Attempt Marks

ACCA Questions
1 Q.1 b (Minty Co) ACCA Dec 2013 12 marks
2 Q.3 (Recorder Co) ACCA June 2014 10 marks
3 Q.2 (Seagull & Co) ACCA Dec 2014 10 marks
4 Q.18 (Chania & Co) ACCA Sept 2016 12 marks
5 Q.17 c (Cupid & Co) ACCA Sept/ Dec 2017 14 marks
6 Q.17 b (Daffodil & Co) ACCA Mar/ June 2019 14 marks

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Test Question-Audit Risk
Question 1
It is 1 July 20X5. You are audit supervisor with Morph & Co responsible for planning the final audit of
a new client, Hart Co, for the year ending 30 September 20X5. Hart Co specializes in the design and
construction of customized playgrounds. The audit manager recently met with Hart Co’s finance
director and has provided you with the following notes:
Planning meeting notes
Hart Co has a forecast profit before tax of $12.2m (20X4: $9.8m) and total assets are expected to be
$28.5m (20X4: $24.3m). The finance director has indicated that the directors are very pleased with the
forecast performance for the year as the directors are paid a bonus based on a percentage of profit
before tax.
Hart Co is undertaking the construction of playgrounds at 16 sites in various locations across the
country. All playgrounds are constructed to specific customer specifications. Customers pay a 25%
deposit on signing the contract, with the balance payable when control of the playground is transferred
to the customer.

The balance of work in progress (WIP) at 30 June 20X5 is $7.6m in respect of the playgrounds under
construction. A WIP count and valuation will be carried out at all the sites on 30 September 20X5.
Arrangements have been made for the audit team to attend only five of the WIP counts. Hart Co offers
its customers a warranty at no extra cost, which guarantees that the playgrounds will function as
expected for a period of three years. The warranty provision for the current year has been calculated as
2% of revenue. In the previous year the warranty was based on 6% of revenue. The finance director has
made this change despite no significant difference in construction techniques or the level of claims in
the year.
Hart Co has incurred expenditure of $1.8m relating to the research and development of a new type of
environmentally-friendly building material. $0.6m of the expenditure to date has been written off to the
statement of profit or loss. The remaining $1.2m has been capitalized as an intangible asset. No
amortization has been recognized to date as the material has not yet been brought into use.
In June 20X5, the company contracted to purchase new machinery costing $2.4m. It paid $1m on
signing the contact to secure the machinery, which was due to be delivered in July 20X5. Due to a
supplier problem, the delivery is delayed and is now scheduled to be delivered in October 20X5. In
order to finance the research and development costs and the machinery purchase, Hart Co made a
rights issue to existing shareholders at a price of $0.75 for each $0.50 share.
Hart Co's payroll function is outsourced to an external service organization, Chaz Co, which is
responsible for all elements of payroll processing and maintenance of payroll records.
Hart Co's directors correctly disclosed their remuneration details in the forecast financial statements in
line with IFRS Standards. However, local legislation in the country in which Hart Co is based, requires
more extensive disclosure. The directors have stated that they consider this onerous and so do not
intend to provide the additional information.

Requirements:
Describe eight audit risks and explain the auditor’s response to each risk in planning the audit of
Hart Co. (16 marks)

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ACCA F8 - Audit & Assurance
Summary Notes by S.K

‘Audit Risk plus Accounting Ratios’

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Audit Risk plus Accounting Ratios
This explanation is for the questions where audit risks is examined along with an extract of P&L and
B/S (in this case key accounting ratios are calculated and audit risk is explained from the same along
with other information given in the question)

1.Debtors / Receivables

Average debtors
Debtors Turn Over = * 365
Credit sales
Comment:
If debtor’s turn over in days has increased as compared to last year and no adequate provision for
doubtful debts has been made than there is a risk that company will be recording debtors that are not
recoverable i.e. There is a risk that debtors have been overvalued in the F/S.
(or say increased Risk of Recoverability of receivables)
(Also refer to the information given in the question e.g. management has increased the credit terms for
their customers…this information will NOW be linked with the debtors turn over in days calculated
from the question)
2.Inventory / Closing stock
Average F goods
Inventory Turn Over = * 365
Cost of goods sold

Comment:
If inventory turnover in days has increased as compared to last year than there is a risk that stock is
becoming obsolete or out of fashion/ or slow moving ….leading to the risk that its NRV will be lower
than its cost & if not valued as per IAS 2 correctly, than closing stock will be overvalued in the F/S
(Also refer to the information given in the question e.g. Closing stock has increased as compared to last
year…this information will NOW be linked with the inventory turnover in days calculated from the
question)
3.Interest Cover

P.B.I.T (in times)

Interest cover =
interest charges

Comment:
If bank covenant is breached & penalty is imposed by the bank than there is a Risk of penalty not being
recorded in the F/S leading to risk of profit being overstated and in the case of contingent liability
(lawsuit filed by the bank )there is a risk of incorrect/inadequate or no disclosure in the F/S.

4.Cash flow + Liquidity risks

Current assets Quick assets

Inventory Turn Over = Current Liabilities & Quick Ratio =
Current Labilities

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
FIRST calculate current and quick ratio for both years, in case these ratios have gone negative or
declined as compared to last year THAN also compare the cash and bank balance from last year,
incase this balance has gone down (decreased from last year) or converted into bank O.D balance
PLUS….also
…Calculate creditors turn over in days and if number of days have increased as compared to last year
i.e increased from 60 to 80 days, this further indicates that company is facing cashflow problems and is
not able to pay its creditors on a timely basis / due dates.
NOTE:
In case sales, gross profit and operating margin has also declined as compared to last year than this
decline can also be added here as point to refer to cashflow and liquidity problems.

How To Draft Audit Risk Point

Negative or declined liquidity ratios along with negative or declined cash & bank balance plus
increased creditors turn over in days indicates cash flow and potential liquidity problems for the
company leading to the risk of Going concern difficulties for the company. (i.e. Going concern
assumption might now NOT be valid or appropriate)

NOTE: (Also refer to any further information given in the scenario / question)

5.Sales / Revenue and Cost of Sales comparison

Compare Revenue and cost of sales of both years and then comment
If revenue has increased by large % and cost of sales has decreased or increased by a lower percentage …than there is a
Risk that revenue has been overstated or cost of sales has been understated in the F/S.

6.Gross Profit margin and Operating margin

Compare gross profit margin and operating margin for both years and then comment
If GP margin has increased by large % and operating margin has decreased as compared to last year or O.M margin
has increased by a lower percentage …there is a Risk that cost of sales has been understated and admin expenses
have been overstated or there is a risk of reclassification of expenses btw cost of sales and admin expenses
/ operating expenses. understated

7. Creditors turnover
Creditors / Trade Payables
Creditors Turn Over = *365

If creditors number of days has decreased as compared to last year and in comparison, sales has
increased in the current year as compared to last year than there is a risk that creditors / trade payables
have been undervalued in the F/S.
Other Noting’s from class lecture

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ACCA F8 - Audit & Assurance
Summary Notes by S.K

ACCA F8 Practice Questions on Analytical Procedure

ACCA Questions
1 Q3 c Dec 2010 (covered with Audit Risk & Ratio) 15 marks
2 Q.79 June 2008 20 marks
3 Q.5 a June 2012 3 marks
4 Q.3 b June 2013 15 marks
5 Q.5c Sept/ Dec 2015 3 marks
6 Q.16 Sept/ Dec 2018 3+ 3+ 16 marks

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
ACCA F8 December 2010 (15 marks)
Question 3c

You are the audit senior of White & Co and are planning the audit of Redsmith Co for the year
ended 30 September 2010. The company produces printers and has been a client of your firm for two
years; your audit manager has already had a planning meeting with the finance director. He has
provided you with the following notes of his meeting and financial statement extracts.

Redsmith’s management were disappointed with the 2009 results and so in 2010 undertook a number
of strategies to improve the trading results. This included the introduction of a generous sales-related
bonus scheme for their salesmen and a high profile advertising campaign. In addition, as market
conditions are difficult for their customers, they have extended the credit period given to them.

The finance director of Redsmith has reviewed the inventory valuation policy and has included
additional overheads incurred this year as he considers them to be production related. He is happy
with the 2010 results and feels that they are a good reflection of the improved trading levels.

Financial statement extracts for year ended 30 September

DRAFT ACTUAL
2010 2009
$m $m
Revenue 23.0 18.0
Cost of Sales (11.0) (10.0)
Gross profit 12.0 8.0
Operating expenses (7.5) (4.0)
Profit before interest and taxation 4.5 4.0
Inventory 2.1 1.6
Receivables 4.5 3.0
Cash — 2.3
Trade payables 1.6 1.2
Overdraft 0.9

Required:
Using the information above: Calculate FIVE ratios, for BOTH years, which would assist the audit
senior in planning the audit; and (5 marks)
From a review of the above information and the ratios calculated, explain the audit risks that arise and
describe the appropriate response to these risks. (10 marks)

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
Answer 3c:
i. Five ratios for 2010 and 2009 to assist in planning

Ratio 2010 2009

Gross margin (gross profit/revenue x 100%) 52.2% 44.4%
Operating margin (PBIT/revenue x 100%) 19.6% 22.2%
Inventory days ([inventory/COS] x365) 70 days 58 days
Receivable days ([receivables/revenue] x 365) 71 days 61 days
Current ratio (Current assets/current liabilities) 2.6 5.8
Top tips: Other ratios you may have used include payable days (53 in 2010, 44 in 2009), the quick ratio
(1.8 in 2010, 4.4 in 2009), inventory turnover (5.2 in 2010, 6.3 in 2009) and
operating expenses as a percentage of revenue (33% in 2010, 22% in 2009).

ii. Audit risks and responses

Audit risks Responses
Redsmith's management may be biased in The audit team must be alert to the increased risk
financial statement areas involving judgement of bias and focus on financial statement estimates
because 2009 results were disappointing. They that require management to exercise judgement.
may use accounting estimates to artificially Careful review must be undertaken of any such
improve presented results. area.

The introduction of a sales related bonus. scheme Increase the sample sizes for any substantive sales
may incentivise employees to push post year-end cut off testing and extend the time period from
sales back into the current year, overstating which the sample is selected.
revenue for 2010.
Receivables balances may not be recoverable A review of aged receivable balances should be
given that receivable days have increased by 10 carried out and there will be an increased focus on
days and credit periods for customers have recoverability through extended post year end cash
increased. receipts testing.
The current ratio decreases by 55%, lack of cash Increased emphasis on a detailed going concern
(an overdraft in 2010) and sales increase indicates review. Discussions with management as to the
potential liquidity problems due to overtrading, ability of Redsmith to continue as a going concern
which could impact on the company's ability to and careful attention paid to the post year end
continue as a going concern. period.

Inventory could be overvalued as a result of the Review the inventory calculations to identify the
new policy to include more overheads in overheads included and ensure they are valid
inventory. This is consistent with the 10 day production overheads. Discuss the reasons for
increase in inventory days. including them with the finance
director.
Top tips: Five well explained risks and responses would have been sufficient here, bit you may have
also come up with the following:
Costs of sales may have been omitted or Cost of sales and operating expenses to be
incorrectly included as operating expenses. This compared to prior year and expectations on a line

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 KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
may be the reason for gross margin increasing by by line basis to identify any instances of change
7.8% but operating margin in classification of expenses.
decreasing by 2.6%.
--------------------------------------------------------------------------------------------------

ACCA F8 June 2008 (20 marks)

Question 79

a. With reference to ISA 520 Analytical Procedures and ISA 315 Identifying and assessing the risks of
material misstatement through understanding the entity and its environment explain:
b. i..what is meant by the term ‘analytical procedures’; (2 marks)
ii..the different types of analytical procedures available to the auditor; and (3 marks)
iii..the situations in the audit when analytical procedures can be used. (3 marks)

Zak Co sells garden sheds and furniture from 15 retail outlets. Sales are made to individuals, with
income being in the form of cash and debit cards. All items purchased are delivered to the customer
using Zak’s own delivery vans; most sheds are too big for individuals to transport in their own motor
vehicles. The directors of Zak indicate that the company has had a difficult year, but are pleased to
present some acceptable results to the members.

The statements of profit or loss for the last two financial years are shown below:

Statement of profit or loss

31 march 2008 31march 2007

Income statement $'000 $'000
revenue 7,482 6364
cost of sales (3,520) (4,253)
Gross Profit 3,962 2,111

Operating expenses (1235) (1320)

Administration (981) (689)
Selling and distribution (101) (105)
Interest payable 145
Investment income 1790 (3)
Profit / (loss) before tax

Financial statement extract 253 (950)

Cash and bank

Required:

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 KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
As part of your risk assessment procedures for Zak Co, identify and provide a possible explanation for
unusual changes in the statement of profit or loss. (9 marks)

Confirmation of the end of year bank balances is an important audit procedure.

Answer 79:
Analytical procedures

i. Analytical procedures consist of the analysis of significant ratios and trends including the resulting
investigations of fluctuations and relationships that are inconsistent with other relevant
information or which deviate from predictable amounts.

ii. Types of analytical procedures

 The consideration of comparisons with similar information for prior periods, anticipated
results of the client from budgets or forecasts, predictions prepared by the auditor, and
industry information
 Analytical procedures between elements of financial information that are expected to
conform to a predicted pattern based on the client's experience, such as the relationship of
gross profit to sales
 Analytical procedures between financial information and relevant non-financial
information, such as the relationship of payroll costs to the number of employees

iii. Use of analytical procedures

Analytical procedures can be used at all stages of the audit, and must be used at:

 The planning stage in accordance with ISA 315 identifying and assessing the risks of material
misstatement through understanding the entity and its environment and;
 The final review stage in accordance with ISA 520 Analytical procedures.
During the audit planning stage, analytical procedures are used as a risk assessment procedure to
obtain an understanding of the entity and its environment and to help determine the nature, timing
and extent of audit procedures.

Analytical procedures can be used as substantive audit procedures during audit fieldwork when their
use can be more effective or efficient than tests of details in reducing the risk of material misstatement
at the assertion level to an acceptably low level.

Analytical procedures must be used at the final review stage of the audit where they assist the auditor
in forming an overall conclusion as to whether the accounts are consistent with his understanding of
the entity.

b) Zak Co Revenue
Revenue
Although the directors have indicated that the company has had a difficult year, revenue has increased
from the previous year by 18%. The auditors need to establish the reason for this increase as it does
not correlate with the directors' comments.

Cost of sales

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
Cost of sales has fallen by 17% in comparison to the previous year- this is strange given that revenue
has increased, as one would expect cost of sales to similarly increase. The reason for this decrease
needs to be ascertained. It could be as a result of closing inventory being undervalued.

Gross profit
Gross profit has increased dramatically by 88% in comparison to the previous year. The reason for this
needs to be examined, given that revenue has increased but cost of sales has decreased.

Administration costs
Administration costs have fallen slightly by 6%.This appears unusual given that revenue has increased
from the previous year, as one would expect the increased revenue to lead to increased administration
costs. Expenditure in this area may be understated perhaps as a result of incorrect cut-off being
applied.

Selling and distribution costs

Selling and distribution costs have increased significantly by 42%. An increase is expected given that
revenue has also increased, however the increase is not comparable. There may have been a
misallocation between administration and selling and distribution costs - again this will need to be
investigated thoroughly.

Interest payable
It is surprising that Zak has a reasonable cash surplus this year but still continues to pay a similar level
of interest. The interest payable may be overstated and the reasons for interest payments not
decreasing despite the absence of the large overdrawn balance seen last year must be established. One
explanation for this might be a cash injection immediately prior to the year end.

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Business Risk – Something Extra 
Business Risk
Business risks are the factors that could prevent or hinder the achievement of organizational goals and
objectives. It is the risk inherent to the company in its operations. (i.e every company faces business
risks ..)
IMPORTANT POINT
When required to identify or highlight Business risk in a question, plz do not think of urself as
an external auditor, instead think as DIRECTOR or C.E.O of the company.
As part of B.O.D / senior management you should understand and be aware that the
company faces a lot of risks and these risks could be from both internal and external factors.
Examples of business risks include:
 Loss of customers or
 Decrease in sales
 Increase in production costs
 Cash-flow problems
 Decline in product demand or
 Increase in market competition or
 New competitor
 Litigations and claims (Non-compliance with laws and regulations) or
 Penalties being imposed as a result of Non-compliance
 Technological obsolescence
 Heavy investments required (e.g. High Tech or Pharma industry where there is
constant need of research)
 Decrease in profitability (via reduces sales price or decline in margins)
 Political and economic instability
 Inadequate financing
 Risk of fraud
 Risk of theft and misappropriation
 Loss of major supplier
 Loss of key employees
 Trade union strikes etc.

PLEASE NOTE (BUSINESS RISKS ARE BROADLY CATEGORIZED INTO 3 CATEGORIES:

1) Financial Risks 2) Operational Risks 3) Compliance Risks
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Summary Notes by S.K
Test Question-Understanding the Entity
Question 2
Your firm is the auditor of Adventure Travel (Private) Limited (APL) which offers a wide range of
adventure sports services such as paragliding, parasailing and scuba diving. APL follows high safety
standards to avoid any unfortunate events. However, during the year, one of its paragliding trips was
affected due to bad weather which caused severe injuries to its clients. Immediately after this unfortunate
incident, APL has invested heavily in further upgrading its equipment to prevent happening of such
incident in future. The entire investment has been financed through a bank loan.

You have been informed that due to overwhelming response towards adventure trips, number of tour
operators have launched the same services at significantly low prices as compared to APL; however, all
these new tour operators are not following as high safety standards as are being followed by APL.

Considering the increased competition, APL has recently widened its scope of business and introduced:
 booking of air tickets and hotel rooms on behalf its clients at a discounted rate. APL is entitled to a
commission, if bookings are made through APL. The commission on booking is recorded when the
payment has been received.
 “Book now and Pay later” instalment scheme for all of its services.

Required:
a) Identify the matters that you will consider while obtaining an understanding of APL and its
environment. (5 marks)
b) Identify and discuss the business risks and the related audit risks from the above scenario. (9 marks)

(14 marks)

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Summary Notes by S.K
Student Notings

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
Student Notings

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ACCA F8 - Audit & Assurance
Summary Notes by S.K

ISA 315 (Revised), ‘Identifying and Assessing

the Risks of Material Misstatement through
Understanding the Entity and Its Environment’

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Expected Questions … (ISA 300 + 315)
1. Explain the reasons for an external auditor to obtain understanding of the audit client before the
start of the audit.

2. Explain/ discuss the purpose of risk assessment procedures performed by the external auditor at
the planning stage of the audit.

3. What are the sources/ HOW will the external auditor obtain evidence for risk assessment
procedures.

4. Identify sources of information relevant to obtaining / gaining understanding of the audit client
AND describe how this information will be used by the auditor.

5. Explain the procedures to obtain understanding of the entity & its environment as per ISA 315 at
the risk assessment stage.

6. Describe the term significant audit risk and list few examples.

7. Explain the importance of risk assessment at the planning stage of an audit.

8. Explain the term Audit Risk and briefly explain its components.

9. Define Inherent and control risk and list few examples.

10. Explain how detection risk can be controlled / reduced by the external auditor.

11. Scenario based question on audit risk …………(Most Imp)

 Describe / explain (05) audit risks from the given scenario and explain the auditor’s response
to each risk in planning the audit of ABC & co.
 From the given scenario / points, categorize between Inherent, control and Detection risk
 From the given points / information, classify inherent, control and detection risk between high
and low risk

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ACCA F8 - Audit & Assurance
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Planning an Audit = Audit Strategy + Detailed Audit Plan
Audit Strategy includes ……………….……

1) Understanding the Entity and its Environment (ISA 315)

2) Assessing the Risk of Material Misstatement (R.O.M.M)

Detailed Audit Plan includes ……

3) Responding to the Assesses Risk of Material Misstatement (R.O.M.M)

1. Understanding the Entity and its Environment (ISA 315)

The objective of the auditor under ISA 315 is to identify and assess the risks of misstatement,
whether due to fraud or error, through understanding the entity and its environment, including its
internal controls.
3 MAIN Expected Questions in this regard are:
 WHY (why obtain the understanding of the entity and its environment?)
 WHAT (what are the matters to be considered when obtaining the understanding of the entity)
 HOW (what procedures are to be performed by the auditor to obtain understanding of the entity
and its environment)

WHY….? Please Learn

1. To identify and assess the risks of material misstatement at the financial statement level
2. To identify and assess the risks of material misstatement at the Assertion level
3. To enable the auditor to design and perform further audit procedures in response to risk at the F/S
level
4. To enable the auditor to design and perform further audit procedures in response to risk at the
assertion level.
5. To exercise audit judgment when setting Planning and performance materiality while making audit
strategy.

WHAT………………………….? Please Learn

This will involve the Auditor taking understanding of the following:

1. the industry in which the entity operates
2. the nature and competence of its management
3. the entity’s internal control system (further discussion in chapter 9)
4. Its current financial performance (Profitability and Ratio Analysis etc.)
5. Reporting requirements and deadlines (As per local laws)
6. Any recent developments. (New Product launched by the audit client etc.)
7. Relevant industry, regulatory and other external factors, including the applicable financial
reporting framework. (___________________________)

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8. The nature of the entity, including its operations, ownership and management structures.
9. The entity’s selection and application of accounting policies, including whether they are
appropriate for its business and consistent with the industry norms.
10. The entity’s objectives and strategies and those related business risks that may result in risks of
material misstatement.
11. The measurement and review of the entity’s financial performance.
(_____________________________________)
When the auditor draws on knowledge, he has gained from previous audits of the audit client, it is
important that he takes into account any significant changes in circumstances and general
economic environment. (auditor must update his previous knowledge)
HOW / Sources of Information...............................
Please Learn
(Procedures to be performed by the External auditor)
1. Inquiry / discussion from management (From Directors, Internal Auditors & other officers within
the Entity)
2. Discussion with last year / previous auditors.
3. Analytical procedures (Comparison from last year….. to be covered in ISA 520)
4. Last year’s Management letter / other reports to management
5. Inspection of S.O.P’s and Internal Control Manuals / procedural manuals
6. Knowledge obtained from last year audit
7. Review of B.O.D minutes / other committee minutes. (e.g. Audit Committee)
8. Discussion within the audit team (Managers & Partners guiding the audit team)
9. Information obtained from other engagements performed at the client
e.g. Agreed Upon Procedures and Accountancy assignments etc.)
10. Reviewing last years working paper file.
11. Review prior years F/S.
12. Trade industry journals / trade magazines / Press releases
13. Client website
14. Annual report of the audit Client
15. Financial statements of competitors.
16. Budgets and management accounts.

2) ASSESSING THE RISK OF MATERIAL MISSTATEMENT (R.O.M.M)

When the auditor has obtained an understanding of the entity, he shall assess the risks of material
misstatement in the financial statements, also identifying significant risks, if any.

The auditor is required to identify and assess the risks of material misstatement at both the financial
statement and at the assertion level. (____________________________)

The financial statement level refers to risks which are pervasive to the financial statements as a whole
and which potentially affects many assertions. (For examples refer H.O # 2)
The risk at the assertion level refers to specific risks in P&L, B/S and presentation and disclosure items
in the notes to the accounts. Risk at this level has 02 types. INHERENT RISK and CONTROL RISK.
(For examples refer H.O # 2)

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Summary Notes by S.K
IMPORTANCE OF RISK ASSESSMENT

SIGNIFICANT RISK
The auditor should look for factors that could be significant in the F/S and to which particular
attention should be given by the audit team.

In addition, the auditor may also be aware that the client company has a poor track record in
collecting trade receivables. This knowledge of the business might make the auditor reach the
conclusion that the audit should give particular attention to the verification of trade receivables.

Significant risks are COMPLEX or UNUSUAL transactions that may indicate fraud, or other
special risks and these require special audit consideration. As part of the risk assessment
procedures, the auditor shall determine whether any of the risks are significant risks in the F/S.
The following factors indicate that a risk might be significant: Please Learn
1) Risk of fraud (ISA 240)
2) Its relationship with recent accounting or other developments
3) The degree of subjectivity in the financial information (E.g. Provision for Lawsuit)
4) It is an unusual transaction in the F/S (eg. Lease accounting)
5) It is a significant transaction with related party (e.g. Transactions with Parent or subsidiary
companies)
6) The complexity of the transaction (eg Calc of Borrowing costs and Deferred Tax)

The auditor will then focus his work more on balances in the financial statement where he considers
there is significant risk of material misstatement. High risk/significant material items will be audited in
detail, and low risk items will receive less attention.
i.e. (More time on High risky & material items and less time on low risky and immaterial items)
3) RESPONDING TO THE ASSESSED RISK OF MATERIAL MISSTATEMENT
The objective in this regard is to gather adequate appropriate audit evidence about assessed risks of
material misstatement, by designing and putting in place appropriate responses to the assessed risks.

 Response at the F/S Level (will be covered in the topic of Fraud- ISA 240
 Response at the Assertion Level ------------------By Performing Test of controls,
Substantive Procedures or a combination of both.

From here we move towards the topics of ………………….T.O.C. s and S.P’s

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ACCA F8 Practice Questions on

ISA 315 (Understanding the entity)

S. No. Question Attempt Marks

ACCA Questions

1 Question 2 (c) ACCA Sept /Dec 2015 5 marks

2 Question 3 (a) ACCA Dec 2012 5 marks

3 Question 45 ACCA South 4 marks

4 Question 50 ACCA Serenity 6 marks

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
ACCA F8 Questions
45 South (4 marks)
ISA 315 Identifying and assessing the risks of material misstatement through understanding the entity
and its environment requires auditors to obtain an understanding of the entity and its environment,
including its internal control.

Required
a) Explain why obtaining an understanding of the entity and its environment is important for the
auditor.
Answer:
a) Importance of understanding the entity and its environment
Understanding the entity and its environment (including the entity's internal control), is important
to the auditor because it allows the auditor to:
 Identify and assess the risks of material misstatement, whether due to fraud or error, at both
the assertion and the financial statement level.
 Assess the reliance that can be placed on internal control
 Design and perform further audit procedures in response to the assessed risks such that
detection and audit risk can be reduced to an acceptable level.
 Establish a frame of reference for exercising audit judgement, for example, when setting audit
materiality.
--------------------------------------------------------------------------------------------------
50 Serenity (6 marks)
(a) ISA 315 Identifying and assessing the risks of material misstatement through understanding the
entity and its environment requires the auditor to perform risk assessment procedures which
include obtaining an understanding of the entity and its environment, including its internal
control.

Required
1) Explain the purpose of risk assessment procedures. (3 marks)
2) Outline the sources of audit evidence the auditor can use as part of risk assessment procedures.
(3 marks)

Answer:
i. Risk assessment procedures are performed at the planning stage of an audit to obtain an
understanding of the entity being audited and to identify any areas of concern which could result
in material misstatements in the financial statements. They allow the auditor to assess the nature,
timing and extent of audit procedures to be performed.

ii. Sources of audit evidence that can be used as part of risk assessment procedures.
 Inquiries of management
 Prior year financial statements
 Current year management accounts and budgets
 Analytical procedures
 Observation and inspection

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Student Notings

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Student Notings

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‘Internal Audit Department’

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Summary Notes by S.K
Internal Audit Department
Definition
“Internal auditing means an appraisal activity established within an entity as a service to the entity. It examines,
evaluates and reports to the management on the adequacy and effectiveness of the systems in place. (By system
we mean any department, any process or any business unit of theorganization / company).
 Finance
 Human Resource
 Marketing
 Procurement
 Treasury department etc.
In short, internal auditors are ensuring compliance / adherence to established company policies (S.O.P) for
various departments and functions. Internal audit is currently going through a significant change and is being
evolved gradually as the business risks for the organizations are constantly changing.
One of the key reasons is because of the importance in Code of Corporate governance as it lays great stress
on establishing an Internal Audit department in the company.
Reporting Line:
Internal Audit Function reports to Audit committee (comprising mostly of Independent Non- Executive
Directors- NEDs) which is part of board of directors (B.O.D)
Within the department. Internal auditors report to the Chief Internal Auditor.

Benefits of Internal Audit Department

1. Improvements in financial controls of the entity
2. Improvements in non-financial controls within the entity
3. Improvements in compliance with key laws and regulations
4. Improvements and suggestions in the economy, efficiency and effectiveness of theoperations of the
company.
5. It enhances the reputation of the entity for sound corporate governance and increases shareholders
confidence.
6. If internal audit department is effective than their work can be relied upon by the externalauditors.

Scope/ Assignments of an internal audit department

1. Performing operational audits of various functions like Human Resource, Procurement dept. etc. and
monitoring internal controls (verifying established Policies and Procedures of the company) ... Also called
review of operational and financial controls.
2. Performing Value for Money Audits which includes the review of the economy, efficiency and
effectiveness of various operations.
3. Regulatory compliance (adhering to applicable laws and regulations like health and safety and
environmental laws)
4. Performing Best Value Audits.
5. Performing special Fraud Investigations.
6. Performing risk management.
7. Other assignments / functions
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Summary Notes by S.K
(Various OTHER functions and assignments can be performed on the instructions of Those Charged with
Governance (Refer summary diagram)
Comparison btw External and Internal auditor OR (External or internalaudit dept.)
There are a number of fundamental differences between the two audit roles. These are summarized in the
following table
External Auditor Internal Auditor
Scope of work To express an opinion on the To examine systems and controls
truth and fairness of the annual and assess risks in order to make
financial statements. recommendations to management
/ TCWG for improvements.
The external auditor will
therefore carry out whatever The internal auditor’s work
work he deems necessary to programme / internal audit
reach that opinion assignments are mostly decided by
head of audit with the oversight of
Audit committee / TCWG.
Qualification to act Set out by law and regulation. No statutory requirements —
This ensures that the external management select a suitably
auditor is independent of the competent person to act as
entity and qualified to act. internal auditor. It is therefore
(in Pakistan only CA can sign possible that the internal auditor
the audit report) may not be as competent as the
external auditor, depending on
management’s recruitment
criteria
Appointed by The shareholders in the The Management. in order to
AGM of the company. ensure as much independence as
possible the internal auditors must
therefore be appointed by audit
committee / TCWG

Duties set out by Statue Scope of internal auditors is

Rights and duties of an external determined with the oversight of
auditor are given by law / statute. audit committee and TCWG.
Eg in Companies Act That document is called
Terms of reference (TOR)
Report to The shareholders via audit Audit committee / TCWG via
report Internal audit report.

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Independence and limitations of the internal auditors
External auditors should be and must be see independent of the company they audit. However internal
auditors cannot achieve the same degree of independence as that achieved of the external auditor. Full-
time internal auditors are employed by the entity who rely on the entity for their job and salary and other
benefits.
Various measures can be taken to try to protect the independence of the internal auditors
Factors to be considered in this respect are:

Reporting lines.
The chief internal auditor may report to the audit committee and not to the finance director or the chief
accountant.

Deciding the scope of internal audit work.

The scope of work carried out by the internal auditors should not be decided by the finance director or line
management responsible for the operations that might be subjected to audit. The scope should be decided
by the chief internal auditor or by the audit committee.
Rotation of internal audit staff.
Internal auditors should not be allowed to become too familiar with the operations that they audit or the
management responsible for them. To reduce this, internal auditors should be rotated regularly, say
every two to three or five years.

Appointment of the chief internal auditor.

The chief internal auditor should not be appointed by a senior executive who may have some self- interest
in wishing to appoint a ‘yes man’ who will not ‘cause trouble’. Instead, the audit committee should be
responsible for appointing a new chief internal auditor and that must also be approved by the board of
directors.

Conflict of Interests /Designing internal controls.

The internal auditors should not be responsible for the design of internal controls / SOPs within the entity.
If they did, they would be required to audit their own work creating self- review threat, which is
unacceptable.
Weaknesses and limitations of an Internal audit Department
1. Not a regulatory department (Not required by law unless Listed co. in Pakistan)
2. No prescribed qualification for working as an Internal auditor.
3. No benchmarks / standardization (I.A dept varies from company to company)
4. Cost of setting up an internal audit dept. can be very high.
5. Independence of internal auditors.( Not Like external auditors who are totallyindependent of the
company)

Value For Money Audits (VFM Audit)

Not-for-profit organizations and the public sector organizations (Govt. sector) are currently under
tremendous pressure to justify each of their actions in terms of economy, efficiency and effectiveness.
Achieving value for money is a symbol of good governance for such organizations.
(E.gs of N.P.O are Selani Welfare Trust and Edhi Foundation — Public Sector Org e.g Government
Colleges and Govt. Hospitals)

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The absence of a profit measure requires an alternative focus in a not-for-profit organization. The
principle of value for money implies that efforts must be made to ensure available funds are spent in the,
provision of services in a way that maximizes the benefit to the user of the services / customers.
The value for money principle focuses on three E’s namely, Economy, Efficiency and Effectiveness in any
activity/ function of the organization.

Economy
Implies the principle of prudence i.e. the least possible cost should be incurred to fulfill any need or say
that resource cost to be kept at minimum or lowest. Attaining the resources/ material at the lowest cost.
(Getting 2 products at Rs 1000 & Rs 950. economy is achieved by purchasing at Rs
950)

Efficiency
Implies the maximization of output input ratio i.e. the output per unit of input should be maximized.
An efficient operation produces maximum output for a given set of input (resources required) or requires
minimum input for a given level of output.

E.g. One Teacher and 150 students & One Teacher and 50 students

Effectiveness
Organization objectives have been achieved.
(E.g. Spending on College, spending on Food Etc.)
Example
Purchasing less expensive raw material (economy) may help maximize the number of units that may be
obtained for a given sum of money (efficiency). This may be at conflict with the desired objective of
high standard of performance for finished goods. (Effectiveness).

IMP
Internal auditors will evaluate these factors for any given business system (function / dept. /
Operation) or product/ service of the company.
V.F.M will be judged by comparison with best systems / products / services and other alternatives
available.

Limitations of Value For Money:

1.

2.

3.

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Fraud Investigations / Special Fraud Assignment

The Primarily Responsibility for establishing & maintaining control in the organization rests with Board of
Directors or say those charged with Governance similarly they are responsible for the prevention and
detection of fraud and error in the organization.
In this respect, internal auditors are responsible for ASSISTING/ HELPING the B.O.D in the
deterrence of fraud/ or prevention and detection of fraud and error, by performing special
investigations and evaluating the adequacy and effectiveness of the internal control system in place.

Remember it’s the directors (TCWG) who are wholly responsible for the prevention and detection of fraud
and error in the company.
When assessing the risk of fraud, internal auditors should determine few factors

 Are Realistic organizational goals and objectives are set by the management…………
 Are their Policies and Procedures to monitor activities and safeguard company assets….

While the internal auditors verify transactions of various operations (called operational audits) they cannot
conduct detailed audit of every transaction (they also work on a sample basis just like external
auditors). Accordingly, the internal auditor CANNOT achieve/ or give an Absolute Assurance that
non-compliance or irregularities do not exist.
(Remember Inherent Limitations are there....and they cannot be eliminated !)

Internal Auditor’s Role in Preventing and detecting Fraud & Error

1. Internal Auditor can conduct investigation of any department/function where there is slightest
risk of fraud. (after consent and approval from management)
2. Internal Auditor assess the adequacy & effectiveness of internal controls of the concerned function/
department.
3. Internal auditors can help directors/ senior management identify areas where fraud risks exists by
regular reviews of various operational functions.
4. Internal auditors can help management to develop controls to mitigate against fraud risks.
5. Internal Auditors must be alert for any fraud risk indicators (E.g. Unauthorized/
unapproved transactions, No supporting documents, purchasing from other than
approved vendors, no timely Bank & stock reconciliations, no signatures obtained on
delivery notes from customers, unexplained prices for new customers, Unauthorized
hiring of key employees in the finance department, abnormal credit terms etc.

Reporting of Fraud
 When an internal auditor suspect’s wrong doing, the appropriate authorities within the
organization should be informed (i.e. Chief Internal Auditor, Audit Committee and C.E.O)
 When the incidence of significant fraud has been established after fraud investigation
(supporting evidence has been gathered), senior management and the board should be notified
immediately.
A written report might be issued at the conclusion of the investigation phase and might be
submitted to legal. counsel (in-house legal dept.) or for any subsequent police investigation, where
relevant.

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Risk Management
1. The I/A dept assists the Audit/Risk committee in identifying the areas of high risk
2. The I/A dept may suggest controls to manage the risks that are identified
3. The I/A dept may conduct regular procedures to determine any changes in the key risks of the
company
4. The I/A dept may conduct regular procedures to ensure that controls created in relation to key risks
identified are operating effectively or not.

Best Value Audit

The best value audit is aimed at improving the effectiveness, efficiency and economy of the various
business functions / operations under review. This can be achieved by reviewing the functions under
review and by recommending improvements.

Internal auditors evaluate the current system and methods/services provided by the companies and then
recommend mgmt. (by recommending new strategies and methodologies) how to achieve best value be it
any department or any product or service of the company)

The most important ingredients of a best value review are explained with the ' 4 Cs'. These four C's are
Challenge, Compare, Consult and Compete.

1. Challenge
Identifies the need of the service and the way it is provided. An entity should discontinue
providing a service if the reason why the service is provided cannot be identified satisfactorily
2. Compare
Compares the attributes of the services provided with those provided by similar organization.
Comparison paves the way for improvements.
3. Consult
Suggests consulting with service users / customers in order to know whether or not the
services provided meet the needs of the consumers.
4. Compete
Encourages fair competition so as to achieve efficient and effective services.
The element of competition enables and paves the way to achieve best value audit.

Outsourcing the Internal Audit Department

Rather than having a permanent internal audit presence some organizations have chosen to outsource
the function (acquiring/purchasing the service from a 3rd party/ External Service Provider) such that
they would ‘buy in’ necessary skills as they needed from an external serviceprovider.
Background behind outsourcing is the fact that often companies CAN’T AFFORD to have certain
departments/ functions on a permanent basis e.g.
Cafeteria, Human Resource, repair Maintenance, Internal audit and Payroll functions etc. (mostly those
functions are outsourced that are NOT CORE departments / functions of the organization)

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Advantages of outsourcing an Internal Audit Department
1. Internal Auditors do not need to be permanently recruited/ hired. (Full time ee’s are not required)
thus resulting in saving of monthly fixed costs.
2. Outsourcer provides specialist services (they are experts for their work)
3. Outsourcer provides immediate services to the company. (hiring time is saved)
4. Outsourcer provides access to new techniques/ methodologies without the need foradditional
investment or in-house development etc.)
5. Less management time is required on permanent internal audit dept. (e.g. Annualappraisals,
training and development
6. Outsourcing service can be acquired for a short period of time.

Disadvantages of outsourcing an Internal Audit Department

1. There is a threat to Independence & Objectivity if the outsourced internal audit service is
provided by the company’s external auditors.
2. Outsourcing may be expensive for the company as service is being acquired from a professional
service company. (Big 4 firms are expensive)
3. The outsourced firm may not be flexible when problems arise, since they do not have a
permanent presence in the company. (Time Constraints are there)
4. Standard of service may not be up to the standards of the company. (difficult to understand the
requirements of the management)
5. There is a risk of lack of knowledge, proper understanding of the organization objectives and its
culture.
6. Loss of development of in-house skills by the company (by not a permanent I.A.D)
7. Company staff may oppose outsourcing if it results in existing staff being made redundant (losing
jobs)
8. There will be lack of loyalty and dedication of external staff for the company.

Assessing the need for an internal Audit department / or say Factors to be

considered before establishing an internal audit department
(IMP)

1. The size and complexity of the business.

2. The number of employees in an organization or changes in the business structure.
3. Are the benefits of having an internal audit department more than the cost of forming an internal
audit department.
4. Changes in key risks that the organization faces.
5. Frequent errors occurring in the exiting accounting and internal control system.
6. An increased number of unexplained or unacceptable events
(e.g. Large number of inventories gone missing, or various frauds being highlighted etc.)

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Internal Audit Report

As there are no formal reporting requirements for internal auditors therefore the report may take any
format.
Internal auditors produce reports for directors and management as a result of various operational audits
and other assignments performed.
performed. These reports are internal to the organization and are unlikely to be shared with third parties
other than the external auditors.
Step 1 - Produce Draft Report
First the internal auditors produce a draft internal audit report which is discussed by the relevantmanagement.
Step 2 - Exit meetings
The people at this meeting are likely to include both operational staff from internal audit dept.
operational staff of the department and managers of the relevant dept. along with the manager of the
internal audit dept.
The objectives of this meeting are to:
 Discuss the findings and associated recommendations
 Provide management with the opportunity to give their views on, and ask for clarification of, the
observations and recommendations allowing any misunderstandings to be resolved.
 Agree on possible solutions to the problems the internal audit assignment has identified.
Step 3 - Final Report
Depending on the organization, the final report may take the form of a written report or a PowerPoint
presentation.

Standard report format would include the following elements:

 TERMS OF REFERENCE
 EXECUTIVE SUMMARY
 BODY OF THE REPORT (more elaborative)
 APPENDIX / ANNEXURES (if required)

Step 4 - Distribution of the final report

The full report should be provided to those people who can take corrective action on the issues raised in
the report. Summary reports should be provided to B.O.D and Audit committee. Communication may
also go to external auditors and others who are affected by, or interested in, the results.

Step 5 - Releasing the Report

If the report is to be released to parties outside the organization, the risks of doing so should be assessed.
Approval to release should be gained from senior management & legal counsel.
Step 6 - Management Response
After the issuance of the final report, management (CEO and Heads of Departments) will be given
the opportunity to provide their formal response to the internal audit report.

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ACCA F8 - Audit & Assurance
Summary Notes by SK

ACCA F8 & CA CAF 8 Practice Questions

on Internal Audit Department

ICAP Questions
S. No. Question Attempt Marks

1 Q.5 b ICAP March 2020 7 marks

2 Q.1 e ICAP Sept 2015 2 marks

ACCA Questions
3 Q.16 c ACCA March / June 2018 5 marks

4 Q.4 b c d ACCA June 2013 10 marks

5 Q. 3 c ACCA Dec 2012 5 marks

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by SK
ICAP CAF 8 - March 2020 (7 marks)
Question 5 b
Malta Limited (ML) has been facing problems in running an effective internal audit department. The
directors of ML has shared with you a brief structure, functioning, roles and responsibilities of the
current internal audit department, which are as follows:

The internal audit department is headed by Hina Akram, a Chartered Accountant. She works in close
coordination with CFO and CEO. She prepares audit plan for each quarter by herself. All the internal
audit findings are first discussed at length with both the CFO and the CEO and are then presented to the
audit committee.

Hina’s internal audit team comprises of three members, Usman, Kashif and Amna. Usman is
responsible for the audit of treasury and payments, Kashif is responsible for the audit of procurement,
payables and production and Amna is responsible for the audit of revenues, receivables and assets, for
the last three years. Hina believes that the continued involvement of her team in the same areas has
helped them to develop expertise in their assigned areas. This also helps her and her team to design
internal controls for the above mentioned areas in an effective manner.

Required:
Identify the deficiencies relating to independence of internal audit department and recommend measures
which should be taken to protect the independence.

Answer 5 b:
Reporting lines: Hina works in close coordination with CFO and CEO and also discusses all of the
findings with them. Therefore it seems that the internal audit department is also reporting to CFO and
CEO which would impair its independence. Hina should be directly reporting to the audit committee
rather than going through CEO and CFO.

Deciding the scope of internal audit work: The scope of work carried out by the internal auditors is
solely decided by Hina without the consultation of the audit committee. The scope of internal audit
work should be decided by the audit committee or the chief internal auditor herself with the approval of
the audit committee.
Rotation of internal audit staff: Internal auditor staff has been auditing the same processes for the last
three years. They would have become too familiar with the operations that they audit or the
management responsible for them. To reduce the familiarity threat, internal auditors should be rotated
regularly.
Designing internal controls: The internal audit department is also involved in designing the internal
controls. However, they should not be responsible for the design of internal controls within the entity. If
they did, they would be required to audit their own work, which creates self-review threat. Senior
management in accounting and finance or line management should have responsibility for the design
and implementation of internal controls, taking advice where appropriate from the external auditors
when control weaknesses are identified during the external audit.
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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by SK
ICAP CAF 8 - September 2015 (2 marks)
Question 1 e
Identify the factors that are considered in determining the independence of internal auditors.

Answer 1 e:
Following factors are considered in determining the independence of internal auditors:
 To whom does the internal auditor reports to
 Who decides the scope of internal audit work
 Frequency of rotation of internal audit staff
 Appointing authority of chief internal auditor
 Conflict of interest i.e. they should not be responsible for designing internal controls

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by SK
Student Notings

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ACCA F8 - Audit & Assurance
Summary Notes by SK
Student Notings

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by SK

‘Internal Control’

( This Topic can be covered either before

or after TOC topic)

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KnS School of Business Studies
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Summary Notes by SK

INTERNAL CONTROL
Definition of Internal Control:

An internal control system includes the policies, processes and other aspects of a company that, taken
together:
….Facilitates its effective and efficient operation by enabling it to respond appropriatelyto significant business, operational,
financial, compliance and other risks to achievingthe company’s objectives. This includes the safeguarding of assets from
inappropriate use or from loss and fraud, and ensuring that liabilities are identified and managed.
….Internal control is the PROCESS designed and affected by those charged with governance, management and
other personnel, to provide reasonable assurance about the achievement of the entity’s objectives with regard to reliability of
financial reporting, effectiveness and efficiency of operations and compliance with applicable laws and regulations
...designed and implemented to address identified business risks that threaten the achievement of any of these
objectives.”

Internal control objectives ……………….

1. The orderly and efficient conduct of the business

2. Adherence to internal policies / S.O.P
3. The safeguarding of assets (Co. Assets)
4. The prevention of fraud and error
5. The accuracy and completeness of the accounting records
6. The timely preparation of reliable financial information

Limitations of an Internal Control: OR Why Internal Controls may be ineffective?

Internal control, no matter how well designed and operated, can provide an entity with only about achieving the
entity objectives. The likelihood of achievement is affected by limitations inherent to internal control, these
include:

1. Human Errors ( .)
2. Human Judgment ( )
3. Collusion between employees ( )
4. Cost/Benefit Feasibility or
5. Management override of controls
6. Incompetent staff / mgmt. ( )

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by SK
Components of internal control: (TCM)

1. The Control Environment

2. h
The Entities Risk Assessment Process
3. e
The Information System
4. Control Activities
5. Monitoring
C of Controls
o
n
1. The Control Environment:
t Please Learn
r
The auditor should obtain an understanding of the control environment. The control environment
o
includes the governance and management functions and the attitudes, awareness and actions of
TCWG concerning l the entity’s internal control and its importance in the entity.

E
The control environment sets the tone of an organization, influencing the control consciousness of its
people. It is the foundation
n for an effective internal control, resulting in overall internal controls in the
organization. v
i
The control environment
r includes the following elements OR say that control environment can be
evaluated by the following factors
o
n
m
Factors for understanding of the control environment are:
e
n
Control Environment
Communicationtand Essential elements which influence the effectiveness of the design,
enforcement2.of integrity
T implementation and monitoring of controls.
and ethical valuesh ( Eg by Mission and Vision statements of Co.in the annual reports
e etc)
Commitment to Management’s consideration of the competence levels for
competence E the particular jobs and how these can be further enhanced.
n (Hiring and training the best resource)
Participation by tthose Attributes of those charged with governance such as:
charged with governance
i  Extent of involvement
t  Appropriateness of actions and interactions with internal and
i external auditors
e (Involvement of CEO in all Internal control enforcement
sessions and seminars etc )
s

R
i
Page 117 of 272 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)
s
k

A
KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by SK
Management’s philosophy  Approach to taking and managing business risks
and operatingstyle  Attitudes and actions towards financial reporting
(selecting prudent acc. Policies )
(Is mgmt. Risk seeker or risk averse?)

Organizational structure The framework, within which an entity’s activities for achieving its
objectives are planned, executed, controlled andreviewed.
(Tall structure or flat structure)

Assignment of authorityand How authority and responsibility for operating activities are assigned and
responsibility how reporting and authorization hierarchies are established.
(there must be proper segregation of duties and proper
delegation to assistants )

Human resource policies Recruitment, orientation, training, evaluation, counseling, promoting

and practices and compensation of ee’s and remedial actions,if any. (HR dept. must
be very strong as it plays a very prominent role in developing quality
staff for the
organization)

Methods to determine Control environment:

 Inquiries from management ( eg From Departmental heads )
 Observing Processes
 Inspection of documents ( SOPs , Written code of conduct etc )

2. The Entities Risk Assessment Process:

In order to design controls that will effectively prevent and detect errors within a system, directors must fully
understand the risks that threaten the system in the first place.

If TCWG do not understand that cash is at high risk of being stolen or being misappropriated, they will not
implement controls such as timely banking, cash reconciliations plus timely bank reconciliations etc.

For financial reporting purposes, the entity's risk assessment process includes how management
identifies business risks relevant to the preparation of F/S in accordance with the entity's applicable FRF. It
estimates their significance, assesses the likelihood of their occurrence, and decides upon actions to
respond to and manage them and the results thereof.

Risks in the F/S can arise or change due to circumstances such as:

 New personnel (New CFO or Director Finance)

 New information systems (Oracle or SAP implemented during the year)
 Rapid growth (Sales Growth by 30 % from Last Year)

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 New technology introduced (new method / new formula)
 New products launched (New Civic Model)
 New accounting pronouncements OR new Laws and Regulations (e.g. new IFRS)

3. The Information System:

The auditor is required to consider the information system (M.I.S) relevant to financial reporting system
operating at the client, and should consider what internal controls are there on the Information system
being operated at the client.
Auditor to obtain to understanding of the below mentioned areas:

 The procedure by which business transactions are processed

 The process for preparing F/S including estimates ( eg Provision forLawsuit)
 Controls on adjustments / recurring and non-recurring entries (Customerclaims etc)
 The processes used in the preparation of the financial statements
 How these transactions and other events relevant to the financial reporting process are ‘captured’ by
the entity

4. Control Activities....... also called

The control activities / procedures are those policies and procedures (more detailed day to dayoperating
procedures) in addition to the control environment which are established to achieve the entities specific/
general objectives.

They are the application of internal controls. Please Learn - IMP

Examples of control activities
Approval and control of documents Transactions should be approved by an authorized person. For
example, overtime hours should be approved by departmental
managers. Budgets should be approved by B.O.D ….

Controls over computerized Includes General AND Application Controls (page 97 onwards)
applications
Maintaining the arithmetical accuracy For example, checking to see if individual invoices have been
of records added up correctly and Calculations done accurately (done via Ms
Excel or any accounting software)

Maintaining and reviewing control Control accounts bring together transactions in individual ledgers.
accounts and trial balances Trial balances bring together unusual transactions for the
organization as a whole. Preparing these can highlight unusual
transactions or account balances.

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Summary Notes by SK
Reconciliations Reconciliations involve comparison of a specific balance in the
accounting records with what another source says the balance
should be, for example, bank reconciliation. Differences
between the two figures should only be reconciling items.
Comparing the results of cash, For example, in physical count of petty cash, the balance shown in
security and inventory counts with the cash book/ petty cash book (G.L) should be the same as the
accounting records amount held. ( Physical Cash)

Comparing internal data with For example, comparing records of goods dispatched ( )
external sources of information to customers with customers’ acknowledgment of goods that
have been received. Or comparing G.R.N with suppliers invoice
Limiting physical access to assets Only authorized personnel should have access to certain assets
and records (particularly valuable or portable ones) e.g. ensuring that the
inventory stores are properly locked and only authorized store
personnel are allowed access.
Performance Reviews Examples Include :
 Comparing actual performance against budget
 Comparing actual performance against forecast
Comparing actual performance against prior period performance
 Variance analysis and other control reporting for mgmnt
Segregation of Duties Segregation of duties means dividing the work to be done
between two or more individuals, so that the work done by one
individual acts as a check and balance on the work of the others.
This reduces the risk of error or fraud.

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Plan B – (CAR-CAPS)

Comparison Controls Comparisons are a very powerful control. Imagine we budgeted to

spend
$ 1m on capital expenditure this year but the actual spend was
$2rn.This could suggest a number of issues:
 perhaps the 'actual' figure is wrong;
 perhaps the budgeting process is inadequate;
 perhaps there was no authorization for the extra $ 1m.
 . perhaps there was no authorisation for the extra $ I m.
Authorisation An appropriate person should approve transactions. For example,
employee expense claims should be approved by a department
manager to ensure no fraudulent expenses are being claimed.
Reconciliations A bank reconciliation can help to pick up errors between postings in the
cash book and the bank statement
Computer Controls Controls over access to computer systems, such as passwords, can help to
prevent unauthorised access to books and records.
Arithmetical Controls Checking to see if balances have been added up correctly or
if number sequences are complete to detect missing transactions.
Physical Controls Physical controls such as CCTV, safes and locks can help to prevent
theftand unauthorised access.
Segregation of Duties Allocating tasks within an accounting system to different employees
reduces the risk of fraud and makes the detection of errors more likely.

Concept of Segregation of Duties

If several individuals are involved in the completion of an overall task, this increases the likelihood that
errors will be detected when they are made. It is more difficult for a person to commit fraud, when
there is proper segregation of duties.

5. Monitoring of Controls:
Monitoring of controls is a process to assess the effectiveness of internal control’s performance over time, it
involves assessing controls, on a timely basis and taking necessary corrective actions modified for any
changes in conditions. Management accomplishes monitoring of controls through either ongoing
activities or separate evaluations.

Companies are monitoring these internal controls by the help of Internal Audit Function
(ISA 610)

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Summary Notes by SK

‘Small Company and its Internal

Control’

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Summary Notes by SK
Small Company and its Internal Control
 General definition of a Small Company
 Features/characteristics of a Small Company.
 Problems of a small Company for an External Auditor

i. Problems of internal control in a small company &

ii.Difficulty to obtain audit evidence and the impact on audit approach in the case of a small
company.

A small entity is an enterprise in which:

 There is concentration of ownership and management with a small number of individuals (often a
single individual or Group of Individuals)
 One or more of the following characteristics are also found:

 Few sources of income and uncomplicated activities (Simple Trading of Few Commodities like Sole
proprietorship)
 Unsophisticated record keeping (Receipts and payments a/c only)
 Limited internal controls
 Straightforward or uncomplicated transactions
 Few lines of business / few products
 Few personnel / employees.

General Features of a Small Company:

 These are mostly managed by a single individual i.e. denominated by a single member e.g. (Naheed
Super Store, Aghas Super store, Arif Habib Investments , Jahangir Siddiqui Group etc.}
 They have weak internal controls. (Can’t afford lot of staff members)
 There is no segregation of duties. (as its not cost feasible)
 There is lack of experienced and qualified staff. (Cannot hire ACCAs and CAs)
 There is lack of evidence as less documentation and records are maintained. (Fewer Books of
accounts)
 There are mostly chances of management override of controls. (as Mgmt. is closely involved
at all times)
 In the audit of small companies, the emphasis of auditor is more towards verification of
financial numbers rather than testing of controls.
 Auditor independence is impaired in the audits of small companies as auditor also performs some
accountancy work for the client as small companies expect external auditors to provide professional
advice and guidance on various matters including accountancy matters.

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Internal control problems in a Small Company
 Most internal controls / SOPs are not practicable for small companies however, important internal
control in a small co. is the close involvement of directors/ owners in day to day controls. This close
involvement may, however, result in management override of controls which may result in some
control weakness.
 Auditors, auditing small companies face problem of insufficient evidence with respect to both Test
of Controls and Substantive procedures i.e. In the case of TOC’s there is little evidence that whether
control is operating effectively or not.
 Small companies should focus on setting good ethical behavior & integrity values to strengthen
internal controls so that external auditor can place reliance on the same during the audit.
 Where managers of small company are not the owners, in this case risk for an external auditor
further increases because of weak control environment.
 Small companies do however, have some primary internal controls like management’s sole authority
on sales, purchases and payments, controls on cash and fixed assets……leading to correct balances
in the balance sheet.
 If these controls can be relied upon, than the extent of substantive procedures on P&L and B/S
might decrease thereby reducing the audit risk to an acceptably low level.

Problems of Internal Controls for small entities

Many control activities that are found in a large company may be inappropriate for a small entity
because they are too costly or impractical to apply.
Segregation of duties is an obvious example of this. It is difficult to segregate duties in a small company
with only a few employees. The same individual has to carry out a variety of different tasks.
Often, control systems in small entities are based on a high level of involvement by the directors or
owners. Authorisations of the owner-manager personally authorising many transactions, might therefore
be a key feature of control systems. The active involvement of an owner-manager might mitigate risks
arising from a lack of segregation of duties.
However, because of active involvement of the owner-manager the attitudes and actions of that person
will be key to the auditor’s risk assessment. There is unlikely to be a written code of conduct so a culture
of integrity and ethical behaviour will be important.
The following problems may arise when internal control systems rely excessively on the involvement of
TOP/senior management.
 There may be a lack of evidence as to how systems are supposed to operate. The auditor will need
to rely more on enquiry than on review / inspection of documentation.
 There may be lack of evidence of controls being actually operated. (How does the auditor know
that the controls exist and are being applied?).
 Management may override internal controls.
 Management may lack the necessary expertise. (Lack of qualification or experience)
 There is unlikely to be any independent person within the management team as there would be
within BOD of a large entity.

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Audit Approach
When auditing a small entity, the auditor needs to understand and evaluate whatever controls are in
operation. It is likely …………. that a lower level of reliance will be placed on controls in a smaller entity,
and that a large sample size of ........................................... substantive testing will therefore be required
to reduce the audit risk to an acceptably low level.
( )

Conclusion

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Summary Notes by SK

‘Documentation of accounting and

internal control system’

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(This topic to be covered after Internal Controls)
Documentation of accounting and internal.control systems of
the AUDIT CLIENT.
The auditors must keep a record of the client's accounting and internal control system which must be
updated each year. This can be documented through the use of narrative notes, flowcharts, questionnaires
or checklists.
There are several techniques for recording the internal control system as follows:

• Narrative notes
• Questionnaires
• Flowcharts
• Checklists

Narrative notes
The purpose of narrative notes is to describe and explain the accounting & internal control system e.g.
Sales and Purchase system.

Narrative notes
Advantages Disadvantages
They are relatively simple to record and can facilitate Describing something in narrative notes can
understanding to all. be a lot more time consuming.

They can be used for any They are awkward

Acc. system due to the method’s flexibility. to update if written manually.
Flowcharts
Flowcharts can take many forms, but in general are graphic illustrations of the physical flow of
information through the accounting system. This can sometimes help the auditor to identify weakness in
controls more easily than by reading narrative notes.

Flowcharts have certain advantages and disadvantages.

Advantages
Can be prepared quickly.
Flow Charts are fairly easy to follow and to review.
They generally ensure that the system is recorded in its entirety i.e. completely.
Disadvantages
They are ONLY most suitable for describing standard systems.
Major amendment is difficult without redrawing.
Time can sometimes be wasted by charting areas that are of no audit significance.

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An example of flowchart is as follows:

Internal Control Questionnaires (ICQs)

In respect of questionnaires, there are 02 types:

 Internal Control Questionnaires (ICQs) are used to ask whether controls exist which meet specific
control objectives.
 Internal Control Evaluation Questionnaires (ICEQs) are used to determine whether there are controls
which prevent or detect specified errors /omissions / Frauds.

They comprise a list of questions designed to determine whether desirable controls are present or not.

Questionnaires are answered by stating a 'YES' or 'NO' and a 'NO' answer indicates a deficiency in the
internal control system.

An example I.C.Q in PURCHASE CYCLE………

Are PURCHASES made from only authorized suppliers?

Are Purchase Orders made and approved?

YES/NO/Comments or Remarks

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Internal Control Evaluation Questionnaires (ICEQs)
The characteristic of ICEQs is that they concentrate on the significant frauds, errors or omissions that
could occur at each phase / step of the appropriate cycle and see if controls are operating or not.

Main Control Qs
Is Sales Invoice made at the time of shipment of GOODS ?......................... e.g. of ICQ
a) Is there segregation of duties when making sales invoices?
b) Are invoices sequentially pre-numbered?
c) Are invoices checked for Quantity? ICEQ
d) Are invoices checked for authorized prices? Advantages and disadvantages of ICQs
and ICEQs

ICQs and ICEQs

Adv. Dis-adv.
They can be drafted vaguely, hence
If drafted thoroughly, they can ensure misunderstood and important controls not
all controls are considered identified
They are quick to prepare They may contain a large number of irrelevant
controls
They are easy to use and control They may not include unusual controls,
which are nevertheless
effective in particular circumstances

Checklists

Checklists may be used instead of questionnaires to evaluate the internal control system. The difference is
that, instead of asking questions, statements are made to ‘mark off’ and tick boxes are used to indicate
where the statement holds true.
For example a checklist may state ‘GOODS are examined on arrival as to quantity and quality’ which
would be ticked (√) if this control does actually occur, or crossed if not. (Simply checking that whether
statement holds true or not!)

(Checklists share many of the same advantages and disadvantages of IQCs and ICEQs.)

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Summary Notes by SK
(*Please cover this, after covering the concept of walkthrough test)Question:

Explain the steps the external auditor should take to confirm the accuracy of flowcharts / documentation
in the working paper file.

Steps to confirm Prior year system notes & Flowcharts and other
documentation of Internal control system

1. Obtain system notes/documentation form last year working paper file and ensure they are complete.
2. Review prior year M.L to identify the recommendation that were made last year as this may result in
changes on the system notes / control documentation for the current year.
3. Obtain system documentation/system flowchart from the management to identify any changes made
in last 12 months.
4. Interview the client staff/ management to determine that either any controls / S.O.P’s have change
during the last year.
5. Perform walk-through tests by tracing a single transaction throughout that system to ensure and verify
that system notes/ documentation is accurate.
6. During the walk-through test, confirms that notes/ documentation reflects the current S.O.P in place.

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ACCA F8 & CA CAF 8 Practice Questions on Internal
Control and I.C Documentation

S. No. Attempt Marks

ACCA Questions
1 Q. 16 b Sept/Dec 2017 5 marks
2 Q. 18 a March/June 2017 4 marks
3 Q. 16 a Sept 2016 6 marks
4 Q. 2 a June 2015 5 marks
5 Q. 3 a Dec 2013 6 marks
6 Documenting Internal Controls (June 2011) 10 marks
7 ICQs and ICEQs 10 marks
ICAP Questions
8 Q. 5 Sept 2017 6 marks
9 Q. 1 c Sept 2016 3 marks
10 Q. 6 a Sept 2014 4 marks

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61 ICQs and ICEQs (10 marks)
ISA 315 Identifying and assessing the risks of material misstatement through understanding the entity and its
environment details the auditor's responsibilities in relation to an entity's system of internal controls.

Required:
a. Explain the auditor's responsibilities in relation to an entity's system of internal controls. (3 marks)
b. Other than internal control questionnaires and internal control evaluation questionnaires state
two methods which an auditor may use to document an entity's internal controls. (1 marks)
c. Explain what is meant by 'internal control questionnaires' and 'internal control evaluation
questionnaires’. For each type of questionnaire, give one example of a question that might be
included in respect of the purchases cycle (6 marks)

Answer 61:

a) The auditor should obtain an understanding of internal controls relevant to the audit. They should:

 Obtain an understanding of the entity and the risks it is exposed to

 Ascertain the nature of the entity's internal control system and assess the Impact of this on the level of
audit risk
 Decide whether the internal control system is sufficient to gather audit evidence through tests of control
with reduced substantive testing or whether full substantive testing is required
 Report any significant deficiencies in internal control to those charged with governance

b) Narrative notes and flow charts.

c) Internal Control Questionnaires (ICQs)

IQCs are used to ask whether controls exist which meet specific control objectives. They comprise a list
of questions designed to determine whether desirable controls are present, and are formulated so that
there is one to cover each of the major transaction cycles.

An ICQ is therefore designed to help evaluate the system as well as to record it. One of the most effective
ways of designing the questionnaire is to phrase the questions so that all the answers can be given as
'YES' or 'NO' and a 'NO’ answer indicates a deficiency in the system.

For example, one question in respect of the purchases cycle might be 'Are purchase invoices matched and
compared to goods received notes before being passed for payment?'

Internal Control Evaluation Questionnaires (ICEQs)

ICEQs have a different focus from ICQs and are concerned with assessing whether specific errors (or
frauds) are possible, rather than establishing whether certain desirable controls are present. This is
achieved by reducing the control criteria for each transaction stream down to a handful of key questions
(or control questions).

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The characteristic of these questions is that they concentrate on the significant errors or omissions that
could occur at each phase of the appropriate cycle if controls are weak (deficient).
For example, one of the questions in the purchases cycle might be ‘Is there reasonable assurance that
goods or services could not receive without a lability being recorded’?
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ICAP CAF 8 Sept 2017 (6 marks)

Question 5
TS Limited is a small software house. Due to the nature of the business no significant human resources are
required except the programmers and system analysts. The Managing Director (MD) oversees all the
operations. Besides the programmers and system analysts there is only one manager, who reports to the MD.

Required:
Describe the key characteristics of such organisations with respect to internal controls and the risk which the
auditor may face in such audits.

Answer 5:
Many of the control activities that are typically found in a large company such as segregation of duties, internal
audit etc. may be inappropriate for a small entity because they are too costly or impractical for such smaller
organizations. Often, control systems in small entities are based on a high level of involvement by the directors
or owners. Following audit risks may arise when control systems rely excessively on the involvement of senior
management:

i. There may be a lack of evidence as to how systems are operating.

ii. There may be lack of evidence of controls.
iii. Management may override controls that are in place.
iv. Management may lack the expertise necessary to control the entity effectively.
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ICAP CAF 8 Sept 2016 (3 marks)
Question 1 c
You are working in IT department of a firm of Chartered Accountants. The partners are concerned about the
confidentiality of client data which is electronically transmitted by firm’s staff from the clients’ offices.

Required:
(c) In the context of control activities explain what is included in ‘Performance reviews’. (3 marks)

Answer 1 c:
Performance reviews – In the context of control activities, performance review includes:
 analyses of actual performance against budget and forecasts;
 analyses of actual performance against prior period performance
 control reporting and variance analysis
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ICAP CAF 8 Sept 2014 (4 marks)
Question 6 a
You are the training manager in a firm of chartered accountants. Prepare brief presentation for newly
inducted trainees, on the following:

a. Control Environment and its elements

Answer 6 a:
Control Environment and its elements

The 'control environment' is often referred to as the general 'attitude' to internal control of management and
employees in the organization.

The elements of control environment include the following:

 Communication and enforcement of integrity and ethical values
 Commitment to competence
 Participation of those charged with governance.
 Management's philosophy and operating style
 Organizational structure
 Assignment of authority and responsibility
 Human resource policies and practices
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Student Notings

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Student Notings

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ISA 610 (Revised) - ‘Using the Work of

Internal Auditors’

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Introduction to ISA 610 (Revised)
Scope of ISA 610 includes: (READ ONLY)
 using the work of the internal audit function in obtaining audit evidence; and
 using internal auditors to provide direct assistance under the direction, supervision and review
of the external auditor.

To determine whether the internal auditor’s work is adequate for his purposes, the external auditor is
required to evaluate the internal audit function and its procedures. A decision can then be taken as to
whether the work of the internal auditors can be used as part of the evidence or not.

The table below summarizes the criteria against which the internal audit function will be assessed.

(GENERAL CRITERIA)
If any of the above factors are lacking than external auditor shall not use the work of the internal audit
function.

Evaluating internal auditors’ work ( PLZ LEARN)

Criteria Comment
Objectivity  What is the status of the internal audit
function within the entity?
 To whom does it report? Does it have
access to those charged with governance?
 Is it free of any conflicting responsibilities
(e.g. any operational responsibilities)?
 Are there any restrictions placed on the
Technical Competence internal audit function / or their scope?

 Are internal auditors members of relevant

professional bodies?
 Do they have adequate technical training
and proficiency?
 Are there established policies for hiring
and training internal auditors?
 Do the internal auditors possess the
required knowledge of financial reporting?
 Is the work of internal audit properly
planned, supervised, reviewed and
documented?
 Does the I.A function have appropriate
quality control procedures, audit manuals,
work programs (list of procedures to be
performed) and other relevant documents?
 Is the work of internal audit properly
planned, supervised, reviewed and

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documented?
 Does the I.A function have appropriate
Systematic anddisciplined approach quality control procedures, audit manuals,
work programs (list of procedures to be
performed) and other relevant documents?

Examples of work of the internal audit function that can be used by the external auditor include:

 Testing of the operating effectiveness of controls;

 Substantive procedures involving limited judgment;
 Observation of inventory counts;
 Tracing transactions through the information system relevant to financial reporting;
 Testing of compliance with regulatory requirements;

Using the work of internal auditors (SPECIFIC CRITERIA)

In addition to the general assessment of the internal audit function, ISA 610 also requires the external
auditor to evaluate each specific piece of work performed by internal audit dept. before it is used as
external audit evidence for the external auditor.

The external auditor is required to evaluate whether: ( PLZ LEARN)

1. the work was properly planned, performed, supervised, reviewed and documented;
2. sufficient, appropriate evidence was obtained to enable auditors to draw reasonable
conclusions;
3. appropriate conclusions were reached, consistent with any reports prepared;
4. any exceptions or unusual matters were properly resolved.
5. making inquiries of appropriate individuals within the internal audit function;
6. observing procedures performed by internal audit;
7. reviewing the internal audit function’s work program and working papers;
8. reperforming a sample of the internal audit function’s procedures

Communication with those charged with governance (TCWG)

ISA 610 requires the external auditor to communicate the planned use of the work of the internal audit
function to those charged with governance for their understanding of the proposed audit approach.

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Using the Direct assistance of Internal Auditors

Direct assistance is defined as the use of internal auditors to perform audit procedures under the direction, supervision
and review of the external auditor.

Considering the use of internal auditors to provide direct assistance

If the external auditor plans to use internal auditors to provide direct assistance on the audit (and is not
prohibited from doing so by law or regulation) they must evaluate the existence and significance of
threats to objectivity and the level of competence of the internal auditors who will be providing such
assistance.

Internal auditors may not provide direct assistance if:

 there are significant threats to the objectivity of the internal auditor; or

 Lacks sufficient competence to perform the proposed work.

And should NOT BE involved in making significant amount of judgment in:

 planning and performing audit procedures; and

 evaluating the audit evidence gathered.

When determining the nature and extent of direct assistance work to be assigned to internal audit, the
external auditor shall consider:
 the amount of judgment involved;
 the assessed risk of material misstatement;
 the existence of threats to the objectivity and level of competence of the internal auditors;

ISA 610 precludes the use of internal audit to perform direct assistance in procedures that:
 involve making significant judgments in the audit;
 relate to higher assessed risks of material misstatement where the judgment required in
performing the relevant audit procedures is more;
 relate to work with which the internal auditors have been involved and which has already been,
or will be, reported to management or
 relate to decisions the external auditor makes regarding the internal audit function and the use
of its work or direct assistance.
The external auditor shall direct, supervise and review the work performed by internal auditors on the
engagement. In doing so:
The direction, supervision and review by the external auditor of the work performed by the internal
auditors must be sufficient in order for the external auditor to be satisfied that the internal auditors have
obtained sufficient appropriate audit evidence to support the conclusions based on that work.

Plz NOTE:
The ultimate responsibility of the external audit is of the external auditor who will be signing the audit
report after the completion of the audit.

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Prior to using internal auditors to provide direct assistance:
The external auditor shall:
 Obtain written agreement from an authorized representative of the entity that the internal
auditors will be allowed to follow the E.A instructions, and that the entity will not intervene in
the work and
 Obtain written agreement to keep all matters confidential as instructed by the E.A and inform
them of any threat to their objectivity.

Documentation by the External Auditor (READ ONLY)

1. The existence and significance of threats to the objectivity of the internal auditors, and the level
of competence of internal auditors.
2. The basis for the decision regarding the nature and extent of the work performed by the internal
auditors;
3. Who reviewed the work performed and the date and extent of that review in accordance with
ISA 230;
4. The written agreements obtained from an authorized representative of the entity (may be CEO,
CFO or Head of Internal audit dept ) and the internal auditors; and
5. The working papers prepared by the internal auditors who provided direct assistance

ISA 610 - Using the work of Internal Auditors

Areas to be Covered in - ISA 610 Action Plan

1 Evaluating Internal Auditors Work (General Criteria) Learn

2 Using the specific work of Internal Auditors (Specific Criteria) Learn
3 Direct assistance of Internal Auditors Read
4 Areas where direct assistance should not be taken by the internal Auditors Learn
5 Documentation by the External Auditors Learn

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CA CAF 8 Practice Questions on ISA 610

S. No. Attempt Marks

1 Q. 9 d Sept 2021 4 marks

2 Q.7 b March 2019 4 marks

3 Q6 March 2016 4 marks

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ICAP CAF 8 Sept 2021 (4 marks)
Question 9d
State any four factors which the external auditor may need to consider while assessing the competence
of the internal audit function

Answer:
i. Are the internal auditors members of relevant professional bodies?
ii. Do they have adequate technical training and proficiency?
iii. Are there established policies for hiring and training internal auditors?
iv. Do the internal auditors possess the required knowledge of financial reporting?
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ICAP CAF 8 March 2019 (4 marks)

Question 7b
State the matters to be documented by the external auditor if he uses the internal auditor for providing
direct assistance on the audit.

Answer:
If the external auditor uses internal auditors to provide direct assistance on the audit, the external
auditor shall include the following in the audit documentation:
 The evaluation of the existence and significance of threats to the objectivity of the internal auditors,
and the level of competence of the internal auditors used to provide direct assistance; The basis for
the decision regarding the nature and extent of the work performed by the internal auditors;
 Who reviewed the work performed and the date and extent of that review in accordance with ISA
230;
 The written agreements obtained from an authorized representative of the entity and the internal
auditors; and
 The working papers prepared by the internal auditors who provided direct assistance on the audit
engagement.
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ICAP CAF 8 March 2016 (4 marks)
Question 6c
Briefly explain how an external auditor would evaluate the adequacy of the work performed by the
internal audit function.

Answer:
In order to evaluate the adequacy of internal audit function, the external auditor should assess
whether:
i. The work was properly planned, performed, supervised, reviewed and documented;
ii. Sufficient, appropriate evidence was obtained to enable internal auditors to draw reasonable
conclusions;
iii. Appropriate conclusions were reached, consistent with any reports prepared;
iv. Any exceptions or unusual matters were properly resolved.
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Student Notings

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Student Notings

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ISA 620 – ‘Using the Work of

an Auditor’s Expert’

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Using the Work of An Auditor’s Expert - ISA 620

Definitions

1. Auditor’s expert – An individual or organization possessing expertise in a field other than

accounting or auditing, whose work in that field is used by the auditor to assist the auditor in
obtaining sufficient appropriate audit evidence.
An auditor’s expert may be either an auditor’s internal expert (who is a partner or staff, including
temporary staff, of the auditor’s firm), or an auditor’s external expert.
2. Management’s expert – An individual or organization possessing expertise in a field other than
accounting or auditing, whose work in that field is used by the entity to assist the entity in
preparing the financial statements.

Examples / areas / situations where experts are used by the auditor (IMP)
1. Valuation of land & buildings, plant & machinery or any specialized stock)
2. Valuation of intangible assets.
3. Estimations of oil & gas reserves.
4. Valuation of environmental liabilities.
5. Interpretation of contracts and various laws.
6. Analysis of complex tax issues.

Factors to consider whether or not to use an expert (whether to use the work of an
expert or not)

1. Whether management has used a management’s expert in preparing the financial statements. The
nature and significance of the matter, including its complexity.
2. The risks of material misstatement in the matter.
3. The expected nature of procedures to respond to identified risks, including the auditor’s knowledge
of and experience with the work of experts in relation to such matters;
4. The availability of alternative sources of audit evidence.

Terms of agreement with the Auditor’s expert (IMP)

1. Nature, scope and objectives of the expert’s work
2. The respective responsibilities of the expert and the external auditor
3. The form of the expert’s report ( )
4. Confidentiality requirements for the expert

Assessing the overall work of an expert ( 04 points)

The auditor shall:
1. Assess the competence, capabilities and objectivity of the expert

Factors to assess the competence, capabilities and objectivity of an

expert… ..... (IMP)
a) Personal experience with previous work of that expert.
b) Discussions with that expert.
c) Discussions with other auditors or others who are familiar with that expert’s work.
d) Knowledge of that expert’s qualifications, membership of a professional body or industry
association, license to practice, or other forms of external recognition.

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e) Published papers or books written by that expert.
f) The audit firm’s quality control policies and procedures

OBJECTIVITY OF AN EXPERT
 The expert must not be in any type of employment with the audit client.
 The external auditor must not be dependent or related in any form on the audit client
e.g. (He has obtained a loan from the client or is a family relative of the audit client.)

2. Obtain an understanding of the expert’s field of expertise to allow the auditor to determine the
scope of his work.
3. Obtain an understanding of the expert’s field of expertise to allow the auditor to evaluate the
adequacy of his work.

4. Evaluate the adequacy of the expert’s work, including the:

a) relevance and reasonableness of the expert’s conclusions
b) consistency of those conclusions with other audit evidence
c) relevance and reasonableness of significant assumptions and methods used
d) relevance, completeness and accuracy of source data.

Note: Generally, the auditor is assessing whether the expert’s work constitutes sufficient and
appropriate audit evidence for the audit.

Procedures to be done if work of expert is not adequate

1. The auditor shall agree with the expert on the extent of further audit procedures to be performed.
2. The auditor shall perform additional audit procedures.
3. Hire another expert

The auditor’s responsibility for the audit opinion

The auditor has sole responsibility for the audit opinion expressed, and that responsibility is not
reduced by the auditor’s use of the work of an auditor’s expert.

Reference to the auditor’s expert in the auditor’s report

The auditor shall not refer to the work of an auditor’s expert in an auditor’s report containing an
unmodified opinion (unless required by law to do so)

If such reference is required by law, the auditor shall indicate in the auditor’s report that the reference
does not reduce the auditor’s responsibility for the auditor’s opinion.

If the auditor makes reference to the work of an auditor’s expert in the auditor’s report because such
reference is relevant to an understanding of a modification and in this case experts name will be
mentioned in the modification para with the approval of the expert. (If consent not given, obtain
legal advice)

Exam Focus Point

1. Separate question can be asked on the above ISA.
2. Can also be examined along with the topic of inventory and fixed assets.(in the question
of Substantive Procedure)
3. Can also be examined along with the topic of Audit Report.

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Using the Work of An Auditor’s Expert - ISA 620

Areas to be Covered in - ISA 620 Action Plan

1 Examples / situations where an auditors expert may be used by the E.A Learn
2 Terms / contents of an agreement with an expert Learn
3 Factors to assess the competence, capability and objectivity of an expert Learn
4 Evaluating the adequacy of an Experts work Learn
5 Reference to the work of an Expert in the auditors report Read

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CA CAF 8 Practice Questions on ISA 620

S. No. Attempt Marks

1 Q. 9 a Sept 2021 3 marks

2 Q.5 a March 2020 6 marks

3 Q.7 c September 2017 2 marks

4 Q.9 March 2016 6 marks

5 Q.4 March 2015 9 marks

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ICAP CAF 8 September 2021 (3 marks)
Question 9a

How would an auditor assess the competency and capabilities of an auditor’s expert?

Answer:
We will assess the competence, capabilities and objectivity of the expert in one or more of the following
ways:
(i) Personal experience with previous work of that expert.
(ii) Discussions with that expert.
(iii) Discussions with other auditors or others who are familiar with that expert’s work.
(iv) Knowledge of that expert’s qualifications, membership of a professional body or industry
association, license to practice, or other forms of external recognition.
(v) Published papers or books written by that expert.

--------------------------------------------------------------------------------------------------

ICAP CAF 8 March 2020 (6 marks)

Question 5a

An audit junior of your firm has inquired about the following matters relating to an audit:
(i) Is there any need to evaluate the adequacy of expert’s work, if the procedures related to competency
and independence of the auditor’s expert have been performed?
(ii) Can an audit firm include a reference to the expert’s work in the audit report so that the audit firm’s
responsibility may be reduced in the areas in which the audit firm does not have expertise?

Required:
Comment on the above queries raised by audit junior in the light of International Standards on
Auditing.

Answer:
Auditor remains fully responsible for the report produced, even if evidence on which it is based was
produced by others. The auditor has sole responsibility for the audit opinion issued and this is not
reduced in any way by his use of an expert.

Therefore, he should not refer in his report to the use of an expert, unless that is required by law or
regulation. Even then, or if the auditor refers to the expert’s work in his report because it is relevant to an
understanding of a modified opinion, then he must make it clear that such a reference does not reduce
his responsibility for that opinion in any way.

The auditor therefore cannot simply accept work performed by experts. That work must be evaluated in
the same way as any other audit evidence is evaluated.

 reasonableness of the expert’s conclusions.

 consistency of those conclusions with other audit evidence
 reasonableness of significant assumptions and methods used.
 relevance, completeness and accuracy of source data.
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ICAP CAF 8 September 2017 (2 marks)
Question 7 c
Identify four examples of situations which may require the engagement of an auditor’s expert.

Answer 7 c:
Following are the situations which may require the engagement of an auditor’s expert:
• legal opinions
• specialist valuation areas, such as property or pension liabilities
• analysis of complex or unusual taxation issues
• specialized inventory counts
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ICAP CAF 8 March 2016 (6 marks)
Question 9
You are the audit manager in a firm of Chartered Accountants. Your firm is often required to
engage an auditor’s expert for reporting on matters relating to the audits.
a. List four key terms of engagement which should be agreed with the expert. (2 marks)
b. Specify the factors which should be considered in evaluating the adequacy of the work
performed by the expert. (4 marks)
Answer 9:
a.
(i) the nature, scope and objectives of the expert’s work
(ii) the respective responsibilities of the expert and the auditor
(iii) the form of the expert’s report
(iv) confidentiality requirements

b. The factors that should be considered in evaluating the adequacy of the expert’s work, include:
 reasonableness of the expert’s conclusions
 consistency of those conclusions with other audit evidence
 reasonableness of significant assumptions and methods used
 relevance, completeness and accuracy of source data.
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ICAP CAF 8 March 2015 (9 marks)
Question 4
Mineral Limited (ML) has incorporated a liability for gratuity payable to its employees on the basis of
actuarial valuation carried out by Professionals Limited (PL). As the audit partner of ML you are not
satisfied with the valuation report prepared by PL, and have decided to appoint Experts Limited (EL)
to carry out the valuation exercise again.

Required:
a. State the matters that you would consider regarding:
i. The competence, capabilities and objectivity of EL. (3 marks)
ii. Evaluation of the adequacy of EL’s work. (3 marks)

b. Briefly discuss the course of action in case you are not satisfied with the work performed by EL.
(3 marks)

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Answer 4:
a.
(i) Matter that should be considered by the auditor in determining the competence, capabilities and
objectivity of EL
 The competence, capabilities and objectivity of an expert may be assessed in one or more of the
following ways:
 Personal experience with previous work of that expert.
 Discussion with that expert.
 Discussion with other auditors or others who are familiar with that expert's work.
 Knowledge of that expert's qualifications, membership of a professional body or industry
association, license to practice, or other forms of external recognition.
 Published papers or books written by that expert.

ii. While evaluating the adequacy of the EL's work, the following would be considered:
 Reasonableness of the EL's conclusions.
 Consistency of such conclusions with other audit evidence.
 Reasonableness of significant assumptions and methods used.
 Relevance, completeness and accuracy of source data.

b. If the auditor decides that the work of the expert is not adequate, he is required to:
 agree additional work with the expert, or
 perform other appropriate additional audit procedures.
 hire another expert

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Student Notings

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Student Notings

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‘Audit Report’
(ISA 700/701/705/706)

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Expected Questions on ‘Audit Report’

1. List & briefly explain the contents of an external audit report as per ISA
700 (Revised).
2. List the contents of an audit report and also explain the reasons for such
para in the audit report/ appropriateness of such statements in the audit
report.
3. Explain the term modified opinion as per ISA 705 /
Briefly explain the types of modifications.
4. Explain the term unmodified opinion and also draft an opinion paragraph
for such an opinion.
5. Briefly list the contents of an auditor’s responsibility para as per ISA 700.
6. Define / briefly explain the term pervasive & explain with examples.
7. Briefly explain the conditions of an E.O.M para & also list the example of
situations under which an E.O.M para can be given by the Auditor.
8. List the contents of an E.O.M para / Features of an E.O.M para.
9. Briefly explain the conditions of an O.M para & also list the example of
situations under which an O.M para can be given by the Auditor.
10. Scenario based question (V. Imp)
________________________________________________________
________________________________________________________
________________________________________________________

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Example of an Unmodified Opinion
INDEPENDENT AUDITOR'S REPORT (As per ISA 700 Revised)
To the Shareholders of Company

Report on the Audit of the Financial Statements ----------------First Heading

Opinion
We have audited the financial statements of ABC Company (the Company), which comprise the
statement of financial position as at December 31, 20X1, and the statement of comprehensive income,
statement of changes in equity and statement of cash flows for the year then ended, and notes to the
financial statements, including a summary of significant accounting policies.

(2nd Para – This is opinion on the F/S)

In our opinion, the accompanying financial statements present fairly, in all material
respects, (or give a true and fair view) of the financial position of the Company as at
December 31, 20X1, and (of) its financial performance and its cash flows for the year then ended in
accordance with international Financial Reporting Standards (IFRS).

Basis for Opinion para (This is standard para)

We conducted our audit in accordance with international Standards on Auditing (ISAs). Our
responsibilities under those standards are further described in the Auditors Responsibilities for the
Audit of the Financial Statements section of our report. We are independent of the Company in
accordance with Code of Ethics for Professional Accountants (IESBA Code) together with the ethical
requirements that are relevant to our audit of the financial statements, and we have fulfilled our other
ethical responsibilities in accordance with these requirements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide
a basis for our opinion.
Key Audit Matters (ISA 701) ------Significant Matters for the current period
Key audit matters are those matters that, in our professional judgment, were of most significance in our
audit of the financial statements of the current period. These matters
were addressed in the context of our audit of the financial statements as a whole, and in forming our
opinion thereon, and we do not provide a separate opinion on these matters.

[Description of each key audit matter in accordance with ISA 701, which applies to audits of the
financial statements of listed entities.]

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Other Information (ISA 720)

Responsibilities of Management and Those Charged with Governance for the

Financial Statements
Management is responsible for the preparation and fair presentation of the financial statements in
accordance with IFRS and for such internal control as management determines is necessary to enable
the preparation of financial statements that are free from material misstatement, whether due to fraud
or error.
(To be covered in ISA 570)
In preparing the financial statements, management is responsible for assessing the Company’s ability
to continue as a going concern, disclosing, as applicable, matters related to going concern and using
the going concern basis of accounting unless management either intends to liquidate the Company or
to cease operations, or has no realistic alternative but to do so.

Those charged with governance are responsible for overseeing the Company’s financial reporting
process.
Auditor’s Responsibilities for the Audit of the Financial Statements (Most
Important para)
Our objectives are to obtain reasonable assurance about whether the financial statements as a whole
are free from material misstatement, whether due to fraud or error, and to issue an auditor’s report
that includes our opinion. Reasonable
assurance is a high level of assurance, but is
not a guarantee that an audit conducted in accordance with ISAs will
always detect a material misstatement when it exists.
Misstatements can arise from fraud or error and are considered material if, individually or in the
aggregate, they could reasonably be expected to influence the economic decisions of users taken on the
basis of these financial statements. (Concept of Materiality- ISA 320)

As part of an audit in accordance with ISAs, we exercise professional judgment and maintain
professional skepticism throughout the audit. We also:

1. Identify and assess the risks of material misstatement of the financial statements, whether due to
fraud or error, design and perform audit procedures responsive to those risks, and obtain audit
evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not
detecting a material misstatement resulting from fraud is higher than for one
resulting from error, as fraud may involve collusion, forgery, intentional omissions,
misrepresentations, or the override of internal control.

2. Obtain an understanding of internal control relevant to the audit in order to design audit
procedures that are appropriate in the circumstances, but NOT for the purpose of expressing
an opinion on the effectiveness of the Company’s internal control.

3. Evaluate the appropriateness of accounting policies used and the reasonableness of accounting
estimates and related disclosures made by management.

(To be covered under ISA 570)

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4. Conclude on the appropriateness of management’s use of the going concern basis of accounting
and, based on the audit evidence obtained, whether a material uncertainty exists related to events
or conditions that may cast significant doubt on the Company’s ability to continue as a going
concern. If we conclude that a material uncertainty exists, we are required to draw attention in our
auditor’s report to the related disclosures in the financial statements or, if such disclosures are
inadequate, to modify our opinion.
Our conclusions are based on the audit evidence obtained up to the date of our auditor’s report.
However, future events or conditions may cause the Company to cease to continue as a going
concern.
5. Evaluate the overall presentation, structure and content of the financial statements, including the
disclosures, and whether the financial statements represent the underlying transactions and events
in a manner that achieves fair presentation.
We communicate with those charged with governance regarding, among other matters, the planned
scope and timing of the audit and significant audit findings, including any significant deficiencies in
internal control that we identify during our audit. (Refers to M.L)
(in the case of Listed company)
We also provide those charged with governance with a statement that we have complied with relevant
ethical requirements regarding independence, and to communicate with them all relationships and
other matters that may reasonably be thought to bear on our independence, and where applicable,
related safeguards.
(in the case of Listed company)
From the matters communicated with those charged with governance, we determine those matters
that were of most significance in the audit of the financial statements of the current period and are
therefore the key audit matters. We describe these matters in our auditor’s report unless law or
regulation precludes public-disclosure about the matter or when, in extremely rare circumstances, we
determine that a matter should not be communicated in our report because the adverse consequences
of doing so would reasonably be expected to outweigh the public interest benefits of such
communication.
Report on Other Legal & Regulatory Requirements ------------------Second Heading
(This para depends upon the local law of the respective country)
[The form and content of this section of the auditor’s report would vary depending on the nature of the
auditor's other reporting responsibilities prescribed by local law or national auditing standards.]
Name of Engagement Partner

Auditors Signature
(The report can be signed in the name of the audit firm OR in the personal name of the sole partner, as
the case may be.)

Auditors Address
Date of Audit Report (D.O.R)
----------------------------------------------------------------------------------------------------------

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Contents Elements of an Audit Report (ISA 700 Revised)
Shortcut to Remember contents of an Audit Report

Explanation

Title of the Report The auditor’s report must have a title that clearly indicates that it is
the report of the independent auditor and distinguishes this from
other reports.
The address will be determined by the law / statue, but is likely to
Addressee be the shareholders or those charged with governance.

Opinion paragraph The opinion paragraph must identify the entity being audited, state
that the financial statements have been audited and also
mentioning that B/S, P&L, SOCE, Cashflows and notes to the
accounts comprise the F/S and also specifies the period covered by
the financial statements.

If the auditor expresses an unmodified opinion on financial, the

opinion shall use the following phrase:
 The financial statements are giving are True and Fair view
of the financial position of the company
The basis for opinion paragraph must state that the audit was
Basis for opinion Para conducted in accordance with ISAs, and refers to the para
mentioning the Auditor’s responsibilities for the audit of the
financial statements’.
The Auditor must also state that they are independent of audited
entity, in accordance with the relevant ethical requirements.

Key audit matters For the audit of listed entities, or where required by law or
(ISA 701) regulation, the auditor should include Key audit matters section.

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This section describes the matters that, in the auditor’s
professional, judgment, are most significant to the audit of the
current period.

Other information For the audit of listed entities or any other entity where the
(ISA 720) auditor has obtained other information, an ‘Other information’
section should be included in the auditor’s report. This section
should include
 A statement that management is responsible for the other
information
 A statement that the auditor’s opinion does not cover the
other information
 A description of auditor’s responsibilities for reading
considering and reporting on other information, and

Responsibilities for the Financial This section describes management’s responsibilities including the
statements following:
(Mgmt. and TCWG)
 The preparation of financial statement in accordance with
the applicable financial reporting framework;
 The implementation of such internal controls.
 The assessment of the entity’s ability to continue as a going
concern, the appropriateness of the going concern basis of
accounting and adequacy of its disclosures in the F/S.

Auditor's responsibilities for the This section describes External Auditors responsibilities including
audit of financial statements the following:
 The auditor’s objectives are to obtain reasonable assurance
that whether the financial statements as a whole are free
from material misstatements
 To issue an auditor’s report that includes the auditor’s
opinion; and
 Explain that misstatements can arise from fraud or
error
 Describe the meaning of materiality
 That the auditor exercises professional judgment and
maintains professional skepticism throughout the audit
 Other responsibilities of an external auditor.

Other reporting responsibilities If the auditor is required by local law to report on any other matter,
this must be done in this additional paragraph.

Name of the engagement partner The name of engagement partner should be mentioned in the Audit
report.
The report must contain the auditor’s signature, which can be the
Auditor’s signature auditor’s own name or the audit firm’s name as the case may be.

Auditors Address The location / city where the auditor practices must be mentioned.

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Date of the report (D.O.R) This is the date where sufficient appropriate audit evidence has
been obtained by the external auditor on which to base the audit
opinion.

Types of Audit Opinions

1. Unmodified Opinion
This opinion is expressed when there is no Material misstatement and there is no inability to
obtain sufficient appropriate audit evidence by the External auditor.

2. Modified Opinion (Covered under ISA 705)

When the audit opinion is not in the original form i.e. other than unmodified opinion.
There are three types of modified opinions.
 Qualified opinion
 Adverse opinion
 Disclaimer of opinion

When auditor MODIFY’s the AUDIT opinion…….

The ISA 705 states that the auditor shall modify the opinion in the auditor’s report when:
 The auditor concludes that, based on the audit evidence obtained, the financial
statements as a whole are not free from material misstatement; or

 The auditor is unable to obtain sufficient appropriate audit evidence to conclude that
the financial statements as a whole are free from material misstatement.

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Modified

Due to insufficient appropriate evidence Due to material misstatement

 Evidence which should be available to the  The appropriateness or application of
auditor is not available, for example: selected accounting policies
 Inadequate accounting records/ records lost  The appropriateness or adequacy of
or destroyed disclosures in the financial statements
 Auditor appointed after the period end
 Management prevents the auditor from
requesting/obtaining audit evidence

Material but Material and Material but Material and

not pervasive pervasive not pervasive pervasive

Qualified opinion Disclaimer of Qualified opinion Adverse opinion

'Except for' opinion 'Except for' 'The FS do not
(Illustration: 3) 'We do not (Illustration: 1) present fairly'
express an ((Illustration: 2)
opinion'
(Illustration: 4)

Modified Opinions:
Qualified Opinion, Adverse
Opinion and a Disclaimer of
Opinion

Illustration 5: E.O.M + OM
Illustration 6: E.O.M + M.O.O

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Concept of Pervasive

A term used to describe the effects or possible effects on the financial statements of misstatements or
undetected misstatements (due to an inability to obtain sufficient appropriate audit evidence). There are
three types of pervasive effect:

a) Those that are not confined to specific elements, accounts or items in the financial statements
b) Those that are confined to specific elements, accounts or items in the financial statements and
represent or could represent a substantial portion of the financial statements
c) Those that relate to disclosures which are fundamental to users' understanding of the financial
statements

1. Are not confined to specific elements, accounts or items of the financial statements;
_______________________________________________________________________________________

_______________________________________________________________________________________
2. If so confined, represent or could represent a substantial proportion of the financial statements; or
(One misstatement is 30% of profit before tax or say that Inventory could not be verified amounting to
45 % of total assets.)

3. In relation to disclosures, are fundamental to users’ understanding of the financial statements.

(A disclosure if not given or not adequate …could seriously mislead the shareholders and stake holders

eg No disclosure in the case of going concern as per ISA 570) ……….will be covered later in ISA 570
------------------------------------------------------------------------------------------------------------------------

PERVASIVENESS……(bohat ala !!!) ….(READ ONLY)

Pervasiveness is a matter that confuses many candidates as; once again, it is a matter that requires
professional judgment. In this case the judgment is whether the matter is isolated to specific components
of the financial statements, or whether the matter pervades many elements of the financial statements,
rendering them unreliable as a whole.

The bottom line is that ….IF the auditor believes that the financial statements may be relied upon in
some part for decision making then the matter is material and not pervasive. If, however, they believe
the financial statements should NOT be relied upon at all for making decisions then the matter is
PERVASIVE.

--------------------------------------------------------------------------------------------------------------------------
(Practical aspects of this concept have been covered under the heading of Audit report kay
cheetay points) very Imp !

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Qualified Opinion:

When there is ……

Material Misstatement = Material but not Pervasive

OR Auditor is Unable to obtain S.A.A.E = Material but not Pervasive

Qualified Opinion
A qualified opinion must be expressed in the auditor's report in the following two situations:

The auditor concludes that misstatements are material, but not pervasive, to the financial statements

Material misstatements could arise in respect of: ( covered separately ahead)

 The appropriateness of selected accounting policies
 The application of selected accounting policies
 The appropriateness or adequacy of disclosures in the financial statements

The auditor cannot obtain sufficient appropriate audit evidence on which to base the opinion but
concludes that the possible effects of undetected misstatements, if any, could be material but not
pervasive.
The auditor's inability to obtain sufficient appropriate audit evidence is also referred to as a limitation on
the scope of the audit and could arise from:
 Circumstances beyond the entity's control (e.g. accounting records destroyed)
 Circumstances relating to the nature or timing of the auditor's work (e.g. the timing of the auditor's
appointment prevents the observation of the physical inventory count)
 Limitations imposed by management (e.g. management prevents the auditor from requesting
external confirmation of specific account balances)

Drafting of Various Opinions

QUALIFIED OPINION
In the case of Material Misstatement (M.M)

Because of TREATMENT

In our opinion, except for the effects of the matter described in the Basis for Qualified Opinion
section of our report, the financial statements give a true and fair view of the financial position of the
Company as at December 31, 20Xl, and (of) its ………….

Because of Disclosure
If disclosure is NOT given than wordings will be:
“In our opinion except for the non-disclosure of the matter described in the basis for qualified
opinion section of our report the accounts are giving a true and fair view….”.
If disclosure is not INADEQUATE

“In our opinion except for the incomplete disclosure of the matter described in the basis for
qualified section of our report the accounts are giving a true and fair view…..”.

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Because of Accounting Policy
Material but not pervasive

“In our opinion except for the affects of the matter described in the Basis for …. Financial statements
give a true and fair view”.
OR
“In our opinion except for the affects of the incorrect accounting policy as described in the Basis for ….
Financial statements give a true and fair view”.

(In this case a basis for qualified opinion paragraph will be inserted immediately after the opinion
paragraph mentioning the reason for qualification)
In the case of Inability to obtain S.A.A.E
In our opinion, except for the Possible effects of the matter described in the Basis for Qualified Opinion
section of our report, the financial statements give a true and fair view of the financial position of the
company as at December 31, 20Xl……………….

Adverse Opinion
When there are Material Misstatements individually or in the aggregate and are both Material
&Pervasive to the financial statements taken as a whole.
An adverse opinion is expressed when the auditor, having obtained sufficient appropriate audit
evidence, concludes that misstatements are both material and pervasive to the financial statements.

Because of TREATMENT
In our opinion, because of the significance of the matter discussed in the Basis for Adverse Opinion
section of our report the financial statements DO NOT GIVE a TRUE and FAIR view of the financial
position of the company as at December 31 20X1, and ………..

Because of DISCLOSURE

If disclosure is NOT given than wordings will be:

“In our opinion because of the omission of the information mentioned in the Basis for……in the
accounts do not give a true and fair view”.

If disclosure is NOT ADEQUATE

“In our opinion because of incomplete disclosure of the information referred / mentioned in the Basis
for ………… accounts do not give a true and fair view”
Because of Accounting Policy
Material but not pervasive - Qualified Opinion

The opinion paragraph will be as follows:

“In our opinion, because of the significance of the matter described in the Basis for …. Financial
statements do not give a true and fair view”.
OR

“In our opinion because of the significance of the incorrect accounting policy as described in the Basis for
…. Financial statements do not give a true and fair view”.

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In this case a basis for adverse opinion paragraph will be inserted immediately after the opinion paragraph
mentioning the reason for modification.

Disclaimer of Opinion
Auditor is Unable to obtain S.A.A.E on which to base the audit opinion AND the matter is Material
AND Pervasive

ISA 705 states that the auditor shall disclaim an opinion when the auditor is unable to obtain sufficient
appropriate audit evidence on which to base the opinion, and the auditor concludes that the possible
effects on the financial statements of undetected misstatements, if any, could be both material and
pervasive.

Example might be where the auditor is unable to attend the inventory count and unable to request
receivable confirmations, and there is no other realistic means of gathering evidence on these two areas.
If these two areas form a significant element of the total assets value, a disclaimer may be appropriate.

We do not express an opinion on the accompanying financial statements of Company. Because

of the significance of the matters described in the basis for Disclaimer of Opinion section of our report,
we have not been able to obtain sufficient appropriate audit evidence provide a basis for an audit
opinion on the financial statements.

EXCEPTION
ISA 705 states that the auditor shall disclaim an opinion when, in extremely rare circumstances
involving multiple uncertainties, the auditor concludes that, notwithstanding having obtained
sufficient appropriate audit evidence regarding each of the individual uncertainties, it is not possible to
form an opinion on the financial statements due to the potential interaction of the uncertainties and
their possible cumulative effect on the financial statements.

IMPORTANT…Changes in the Audit Report in the case of Disclaimer of Opinion

1.

2.

3.

4.

5.

6.

7.

8.

9.

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Examples of Material Misstatement and Inability to Obtain S.A.A.E

IMPORTANT……………Audit Report Infrastructure

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BASIS FOR MODIFICATION PARA…………. Contents!

In case of M.M due to disclosures

There may be an inadequate disclosure OR Non-Disclosure in the F/S.

In the case of inadequate Disclosures

The external auditor to explain in the basis para that inadequacy of disclosure in the F/S

If there is a M.M that relates to non-disclosure the auditor shall:

 Discuss the matter with top mgmt.

 Describe the nature of omitted information in basis for modification para.
 If practically possible, include the omitted disclosure in the basis for modified opinion para
(UNLESS prohibited by law /regulation.)

(READ ONLY)
Disclosing the omitted information in the basis for modification paragraph would not be practicable if:
 The disclosures have not been prepared by management or not readily available to the auditor; or
 The disclosures would be unduly voluminous in relation to the auditor’s report.

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Inability to obtain sufficient appropriate audit evidence
Inability to obtain S.A.A.E (also called Limitation of Scope)

(1) Circumstances BEYOND the control of the entity:

Force majeure events (fire, floods, storms etc.) Eg: Accounting records have been destroyed by Fire
Assets have been taken over / seized by Govt.
Accounting records have been seized by Govt. authorities

(2) Circumstances relating to the NATURE OR TIMING of the Auditor’s work:

Timing: Auditors appointment was such that they could NOT verify the stock
counting or other counting of assets at the B/S date.

Class Example:

Nature: Substantive Procedures cannot be performed because of system automation and the results of
TOCs are not effective. (This is covered after TOC and S.P)

(3) Limitations imposed by management:

(In this case, external auditor is being prevented by management to perform the desired Audit
procedures.
Eg:
Not allowing the dispatch of debtor / creditor confirmation,
Preventing the counting of stock at yearend,
Preventing from meeting with persons whom auditors think appropriate for the
purpose of audit
Not providing the required Purchase Orders and sales invoices etc.

IMP
If alternative/further audit procedures can be performed by the External Auditor, this will NOT
constitute an inability to obtain sufficient appropriate audit evidence.

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Communication with those charged with governance
ISA 705 states that when the auditor expects to modify the opinion in the auditor’s report, the auditor shall
communicate with those charged with governance the circumstances that led to the expected modification and
the proposed wording of the modification.
This enables:
The auditor to give notice to them of the intended modification(s) and the reasons (or circumstances)
for the modification(s); and provide
TCWG an opportunity, where appropriate, to provide the auditor with further information and
explanations in respect of the matter(s) giving rise to the expected modification(s).

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Emphasis of Matter Paragraph (E.O.M) + Other Matter Para (O.M) (ISA 706 Revised)

E.O.M= Matter is FUNDAMENTAL to the

User’s understanding +
The matter has already been presented &
disclosed in the financial statements

Above conditions have to be met simultaneously

Further Conditions:
There is no Material Misstatement &
Inability to obtain sufficient appropriate audit evidence

IMP POINTS TO REM !

1. E.O.M will not be given for a matter that has already been discussed in KAM para.
2. E.O.M will not be given for a matter that has already been discussed in Basis for
Modification para.
3. E.O.M will not be given for a matter that has already been discussed in Other matter
para.
4. E.O.M will not be given for a matter that has already been discussed in Separate Para
Headed “Material Uncertainty Related to Going Concern”

Few circumstances / Examples of E.O.M: ………………… (Please Learn…!)

1. An uncertainty relating to the future outcome of exceptional
litigation or regulatory action.
2. Early application of new IFRS/IAS that has a MATERIAL effect on the financial statements.
3. Major catastrophe that has had or continues to have a significant effect on the entity’s financial
position
4. Any Other case as the external auditor may think appropriate in the
circumstances.
E.O.M required by standard

ISA 560
covered later
ISA 570

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Contents of an E.O.M Paragraph (also called features of an E.O.M para) (Please Learn…!)
1. It highlights a matter affecting the financial statements.
2. It highlights a matter already disclosed in the notes to the financial statements.
3. The Para must clearly refer to the note in the financial statements that more extensively discusses
the matter highlighted.
4. The E.O.M Para is inserted immediately before / after the KAM Para.
(with the Heading of E.O.M)
5. The Para must clearly mention that our opinion is not MODIFIED in respect of this matter.

EXAMPLE of an E.O.M PARA…

EXAM HINT FOR E.O.M

DRFATING OF E.O.M Para in the EXAM

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Other Matter Paragraph
If the auditor considers it necessary to communicate matters not presented or disclosed in the
financial statements that in the auditor’s judgment is RELEVANT to;

I. the user’s understanding of the audit;

II. the auditor’s responsibility or
III. auditor’s report,
The auditor shall do so by adding paragraph in the auditor’s report called “Other Matter Paragraph”
provided such communication is not prohibited by law or regulation.

(It refers to a matter other than those presented or disclosed in the financial statements)

Important Points:

Examples / Circumstances when OTHER MATTER Para is given in the Audit

Report…………
1. If prior period financial statements were NOT audited.
2. If prior period financial statements were audited by a predecessor auditor (date of report +
opinion expressed to be mentioned in the other matter para)

Example of Other Matter para

3. Relevant to Users Understanding of the Audit

In rare circumstances auditor could not withdraw (because of legal requirements) even though the
effect of inability to obtain SAAE (due to management-imposed limitation) was material and
pervasive, auditor may consider to include an OTHER MATTER Para describing the reason for
not withdrawing from the engagement.

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Illustration 1 - Qualified Opinion due to a Material Misstatement of the Financial
Statements
INDENPENDENT AUDITOR 'S REPORT
To the Shareholders of ABC Company
Report on the Audit of the Financial statements

Qualified Opinion
We have audited the financial statements of ABC Company (the Company) which comprise the
statement of financial position as at December 31, 20X1 …………………………………………………

In our opinion, Except for the effects of the matter described in the Basis for Qualified
Opinion section of our report, the financial statements give a true and fair view of the financial position of
the Company as at December 31, 20Xl, and (of) its
……………………………………………………………

Basis for Qualified Opinion

The Company's inventories are carried in the statement of financial position at xxx. Management has
not stated the inventories at the lower of cost and net realizable value but has stated them solely at
cost, which constitutes a departure from IFRSs. The Company's records indicate that, had
management stated the inventories at the lower of cost and net realizable value, an amount of xxx
would have been required to write the inventories down to their net realizable value.
Accordingly, cost of sales would have been increased by xxx, and income tax, net income and
shareholders' equity would have been reduced by xxx, xxx and xx, x respectively.

We conducted our audit in accordance with International Standards on Auditing (ISAs). Our
responsibilities under those standards are further described in the Auditor's Responsibilities for the Audit of
the Financial Statements section of our report. We are independent of the Company in accordance with
the ethical requirements that are relevant to our audit of the financial statements in [jurisdiction], and
we have fulfilled our other ethical responsibilities in accordance with these requirements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for
our qualified opinion.

Other Information

Key Audit Matters (ISA 701)

Key audit matters are those matters that, in our professional judgment, were of most significance in
our audit of the financial statements of the current period. These matters were addressed in the context
of our audit of the financial statements as a whole, and in forming our opinion thereon, and we do not
provide a separate opinion on these matters. In addition to the matter described in the Basis for
Qualified Opinion section we have detern1ined the matters described below to be the key audit
matters to be communicated in our report.
(Rest wordings are the same )

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Illustration 2 — Adverse opinion due to a Material Misstatement of financial
statements

INDEPENDENT AUDITOR' S REPORT

To the Shareholders of ABC Company [or Other Appropriate Addressee]

Report on the Audit of the Consolidated Financial Statements

Adverse Opinion

We have audited the financial statements of ABC Company (the Company) which comprise the
statement of financial position as at December 31, 20X1 and …………………………………………..

In our opinion, Because of the significance of the matter discussed in the Basis for
Adverse Opinion section of our report the financial statements do not give a true and fair view of the
financial position of the company as at December 31, 20Xl and ………………………………….

Basis for Adverse Opinion

As explained in Note X, the company has included houses built for re-sale (including related land) at a
cost of $X as non-current assets and depreciated them at a rate of X%, resulting in depreciation of $X.
Under International Financial Reporting Standards, these should have been included as inventory in the
financial statements and no depreciation should have been provided in respect of these. The carrying
value of the houses represent 90% of the company's total assets and the company's records indicate that
... [explanation of the effect on amounts presented in the financial statements).

We conducted our audit in accordance with International Standards on Auditing (ISAs). Our
responsibilities under those standards….same wordings….

Key Audit Matters

Except for the matter described in the Basis for Adverse Opinion section, we have determined that
there are no other key audit matters to communicate in our report.

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Illustration 3 — Qualified Opinion due to the Auditor's Inability to Obtain
Sufficient Audit Evidence Regarding ________________________________________

INDEPENDENT AUDITOR'S REPORT

To the Shareholders of ABC Company

Report on the Audit of the Financial Statements'

Qualified Opinion

We have audited the ………………………………………………………………………………………..

In our opinion, Except for the possible effects of the matter described in the Basis for
Qualified Opinion section of our report, the financial statements give a true and fair view of the
financial position of the company as at December 31, 20X1, and………………

Basis for Qualified Opinion

With respect to inventory having a carrying amount of $X the audit evidence available to us was limited
because we did not observe the counting of the physical inventory as at 31 December 20X1, since that
date was prior to our appointment as auditor of the company. Owing to the nature of the company's
records, we were unable to obtain sufficient appropriate audit evidence regarding the inventories
quantities by using other audit procedures.

We conducted our audit in accordance with International Standards on Auditing (ISAs). Our
responsibilities under those standards …same

Key Audit Matters

Key audit matters are those matters that, in our professional judgment, were of most significance in
our audit of the consolidated financial statements of the current period. These matters were addressed
in the context of our audit of the consolidated financial statements as a whole, and in forming our
opinion thereon, and we do not provide a separate opinion on these matters. In addition to the matter
described in the Basis for Qualified Opinion section, we have determined the matters described below
to be the key audit matters to be communicated in our report.

[Description of each key audit matter in accordance with ISA 701.]

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Illustration 4 — Disclaimer of Opinion due to the Auditor's Inability to Obtain
Sufficient Appropriate Audit Evidence about Multiple Elements of the Financial
Statements

INDEPENDENT AUDITOR'S REPORT

To the Shareholders of ABC Company

Report on the Audit of the Financial Statements"

Disclaimer of Opinion
We were engaged to audit the financial statements of ABC Company (the Company), which comprise
the statement of financial position as at December 31, 20X1, and the statement of comprehensive
income, statement of changes in equity and statement of cash flows for the year then ended, …….

We do not express an opinion on the accompanying financial statements of the Company.

Because of the significance of the matters described in the Basis for Disclaimer of Opinion
section of our report, we have not been able to obtain sufficient appropriate audit evidence to
provide a basis for an audit opinion on these financial statements.

Basis for Disclaimer of Opinion

We were not appointed as auditors of the Company until after December 31, 20X1 and thus did not
observe the counting of physical inventories at the beginning and end of the year. We were unable to
satisfy ourselves by alternative means concerning the inventory quantities held at December 31, 20X0
and 20X1, which are stated in the statements of financial position at xxx and xxx, respectively. In
addition, the introduction of a new computerized accounts receivable system in September 20X1
resulted in numerous errors in accounts receivable. As of the date of our report, management was still
in the process of rectifying the system deficiencies and correcting the errors. We were unable to
confirm or verify by alternative means accounts receivable included in the statement of financial
position at a total amount of xxx as at December 31, 20X1.
As a result of these matters, we were unable to determine whether any adjustments might have been
found necessary in respect of recorded or unrecorded inventories and accounts receivable, and the
elements making up the statement of comprehensive income, statement of changes in equity and
statement of cash flows.

Responsibilities of Management and Those Charged with Governance for the

Financial Statements
Same wordings…

Auditor's Responsibilities for the Audit of the Financial Statements

Our responsibility is to conduct an audit of the Company's financial statements in accordance with
International Standards on Auditing and to issue an auditor's report. However, because of the matters
described in the Basis for Disclaimer of Opinion section of our report, we were not able to obtain
sufficient appropriate audit evidence to provide a basis for an audit opinion on these financial
statements.
We are independent of the Company in accordance with the ethical requirements that are relevant to
our audit of the financial statements in [jurisdiction], and we have fulfilled our other ethical
responsibilities in accordance with these requirements.

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Example of E.O.M + O.M (ISA 706) and an Unmodified Opinion
Illustration 5

INDEPENDENT AUDITOR'S REPORT

To the Shareholders of ABC Company

Report on the Audit of the Financial Statements"

Opinion

We have auditing the financial statements of ABC company (the Company),…………

In our opinion the financial statements give a true & fair view of the financial position of the
Company as at December 31, 20X1, and …………..

Basis for Opinion

We conducted our audit in accordance with …………………………………………………………..

Emphasis of Matter
We draw attention to Note X of the financial statements, which
describes the effects of a fire in the company's production facilities. Our
opinion is not modified in respect of this matter.
Key Audit Matters
Key audit matters are those matters that, in our professional judgment, were of most
significance in our audit of the financial statements of the current period. These matters were
addressed in the context of our audit of the financial statements as a whole, and in forming our
opinion thereon, and we do not provide a separate opinion on these matters.
(Description of each key audit matter in accordance with ISA 701)

Other Matter

The financial statements of ABC Company for the year ended

December 31, 20X0, and were audited by another auditor who
expressed an modified opinion on those statement on March 31,
20X1.

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Illustration 6

(Example where both Modification plus E.O.M is given in the Audit Report)
INDEPENDENT AUDITOR'S REPORT
To the Shareholders of ABC Company

Report on the Audit of the Financial Statements"

Qualified Opinion

We have audited the financial statements of ABC company (the Company)……………

In our opinion, Except for the effects of the matter described in the Basis for Qualified Opinion
section of our report, the financial statements give a true & fair view of the financial position of the
Company as at December 31, 20X1, and …………………………………………………………………..

Basis for Qualified Opinion

We conducted ……(stnd Para)

Emphasis of Matter - Effects of a Fire

We draw attention to Note X of the financial statements, which describes the

effects of a fire in the Company's production facilities. Our opinion is not
modified in respect of this matter.

Rest contents are same.

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Placement of K.A.M, E.O.M & Other Matter Paragraph as per ISA

As per ISA
1. Report on Financial Statement
(1st Heading)

E.O.M K.A.M
K.A.M E.O.M
(effects of fire lawsuit etc.)
O.M O.M

2. Report in other legal & regulatory requirement. (2nd Heading)

Will be inserted as a Sub-Heading

Other matter

3. In case it pertains to the whole AUDIT report than no sub heading …. rather
there will be a 3rd main heading in the audit report
Other matter

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Audit Report Exam Focused Points

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Audit Report

Exam Focused Points

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Audit Report Exam Focused Points

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Audit Report Exam Focused Points

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DRAFTING OF THE AUDIT REPORT ANSWER
1) Explanation of the Issue / Matter

2) Calculation of Materiality

3) Audit Procedures / Audit Tests

4) Impact on the Audit Report / Audit Opinion

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Exam Focused lecture on Audit Report

(ISA 705, ISA 320 and ISA 450)

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Additional concept……. 

Year Ended Sept 30,20x8

Profit before Tax 131.4 m
Uncorrected misstatements
Your review also includes an assessment of uncorrected misstatements. These have been recorded by
the audit team as follows:

$000
1 Interest payable omitted in error 1,942
2 Additional allowance for receivables required 9,189
3 Error in sales invoice processing resulting in understatement of sales 8,541
4 Write off in respect of faulty goods 2,900

Faulty goods
The adjustment for faulty goods listed as an uncorrected misstatement above relates to an entire batch
of shoes, which was produced on 12 September 20X8. The audit work concluded that the cost of this
inventory exceeded its net realisable value by $2·9m. The directors dispute the audit team’s figures and
believe that the realisable value of the inventory still exceeds its cost.

1. Which of the uncorrected misstatements numbered (1), (2) and (3) by the audit team MUST be
adjusted for if the auditor is to issue an unmodified audit opinion?

A. Misstatements 2 and 3 only

B. Misstatements 1 and 3 only
C. Misstatements 1, 2 and 3
D. Misstatement 2 only

2. All adjustments required by the auditors have been made to the financial statements with the
exception of adjustment (4) relating to the faulty goods.

Which of the following correctly describes the effect of this matter on the auditor’s report?
A. Unmodified opinion with no further disclosure
B. Unmodified opinion with disclosure in an emphasis of matter paragraph
C. Qualified opinion due to material misstatement
D. Qualified opinion due to inability to obtain sufficient appropriate audit evidence

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Recap of ISA 450 with reference to ISA 580
Extract from ISA 450

Written Representations
The auditor shall request a written representation from management and, where appropriate, those
charged with governance whether they believe the effects of uncorrected misstatements are immaterial,
individually and in aggregate, to the financial statements as a whole.

A summary of such items shall be included in or attached to the written representation.

Written Representations
Because the preparation of the financial statements requires management to adjust the financial
statements to correct material misstatements, the auditor is required to request them to provide a
written representation about uncorrected misstatements.

In some circumstances, management and, where appropriate, those charged with governance may not
believe that certain uncorrected misstatements are misstatements.

For that reason, they may want to add to their written representation words such as: "We do not agree
that items ... and ... constitute misstatements because [description of reasons]."

Obtaining this representation does not, however, relieve the auditor of the need to form a conclusion
on the effect of uncorrected misstatements.

When the question of Audit Report mentions Planning Materiality (Variable for determining the
materiality) than the following wordings to be added in the solution / answer:

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Expectations Gap…..IMP
‘Expectations gap‘, is defined as the difference between the apparent public perception (Shareholders
and stakeholders) about the responsibilities of external auditors on one hand and the legal and
professional responsibilities of external auditor on the other hand.( As per ISAs and Companies Act
2017)

The question is ….. how can we make the unmodified auditor's report/ opinion clear and so
transparent and understandable to the users / shareholders ….that this expectation GAP reduces to a
reasonable extent .( it can never be reduced)

What are these Expectation Gaps?

a. Misunderstandings as to the nature of audited financial statements, for example that:
 The statement of financial position provides a fair valuation of the reporting entity. (few items
in the F/S are recorded at cost)
 The amounts in the financial statements are stated precisely i.e they are accurate.
 (there are estimates and judgements involved like provisions and fair value estimates)
 The audited financial statements give a guarantee that the entity concerned will continue to
exist for the foreseeable future.
(Auditors never express a guarantee on the F/S neither they give a guarantee about the company’s
future or its continuity)

b. Misunderstanding as to the type and extent of work undertaken by the External

auditors.
External auditors express an opinion on the financial statements only & not the internal controls of
the audit client plus we only verify material balances during the audit and lastly, the audit is done
on a sample basis (test basis) as per ISA 530.

c. Misunderstanding about the level of assurance provided by External

auditors, for example.
These misunderstandings are:
An unmodified audit opinion means that no frauds have occurred during the audit period.

(The objective of an external audit is to expresses an opinion on the financial statements of the
company and not the prevention and detection of fraud, as it is the responsibility of management &
TCWG. Adding further, an unmodified opinion is not a guarantee that no frauds exist in financial
statements
The auditors provide an absolute level of assurance that the figures in the financial statements are
correct (ignoring the concept of materiality and the limitations of estimates and various assumptions).

Clarification:
External auditor provides reasonable level of assurance which is a high but not an absolute level of
assurance because there are inherent limitations of an audit. For example: 100 % testing is not done as
the external auditor use sampling technique to conduct the audit plus in few cases audit evidence is
persuasive rather than conclusive.

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Lets enjoy some Practice ……………………………………….
Activity 1:
The auditor's report
Check & Co is also the auditor of Research Ltd and is currently finalising the audit of its financial
statements for the year ending 31 December 20X6. Research Ltd designs, develops and produces
medical scanning equipment to be used in hospitals and doctors' surgeries. The financial statements of
Research Ltd show revenue of $98 million, profit before tax of $20 million and net assets of $78 million
for the year ending 31 December 20X6.

During the audit, the team learnt that Research Ltd capitalised $2.5 million of development costs in the
year, relating to a new portable scanning machine for ambulances. However, the audit team also found
evidence that Research Ltd have been unable to sell any of the portable scanning machines since they
are too large to fit in a standard ambulance. Further audit procedures discovered there was no market
for the machines elsewhere.

The directors of Research Ltd have refused to remove the development costs from their statement of
financial position as they believe that ambulances will probably get bigger in the next few years and they
will be able to sell the machines then.

Required
1. Explain why the inclusion of the development costs on Research Ltd's statement of financial
position for the year ending 31 December 20X6 is an issue for the auditors.

2. Provide a calculation to show whether the matter in part (1) is material.

3. Assume management refuses to correct the financial statements for the matter in part (1). What
modification to the auditor's opinion would Check & Co need to make and why?

4. Explain how the modification will impact the structure and form of the auditor's report.

-------------------------------------------------------------------------------------------------------------------
Solution of Activity 1:

The auditor's report

1. Research Ltd have included $2.5 million of development costs on their statement of financial
position which do not meet the criteria of IAS 38 Intangible Assets. IAS 38 includes a number of
criteria which must be satisfied before development costs can be capitalised including commercial
feasibility of the asset for sale. Since the machines are currently too large to fit in the ambulances and
there is no other market, Research Ltd have not met this criteria and the development costs should
not have been capitalised. The $2.5 million should be expensed to the statement of profit and loss.
Otherwise, intangible assets and profits will both be overstated, and expenses will be understated.

2. The development costs are 3.2% of net assets, 2.6% of revenue and 12.5% of profit before tax.
Therefore, they are material to both the statement of financial position and the statement of profit
and loss.

3. If management refuse to remove the development costs from the statement of financial position then
there is a material misstatement and the opinion will need to be modified. Since this misstatement

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only affects one area of the financial statements it is not pervasive. A qualified ('except for) opinion
will be required.

4. The title of the opinion paragraph will be amended to 'Qualified Opinion'. The title of the 'Basis for
Opinion' paragraph which immediately follows the opinion paragraph will need to be amended to
'Basis for Qualified Opinion'. This paragraph states the reason for the qualification and quantifies its
effect on the financial statements. Its positioning will not change due to the qualification.

----------------------------------------------------------------------------------------------------------------------------

Activity 2:
Modified opinions and modified auditor's reports

You are the audit manager of Check & Co and are reviewing the key issues identified in the files of
several audit clients, each of which has a year end of 30 September 20X6.

1) The first audit client is Little Bees Co (LB). The fieldwork stage for this audit has been completed
and the draft financial statements show a profit before tax of $175,000.

LB has valued a certain inventory line at its total cost price of $17,000. These inventory items have
not been sold for a number of years and it is unlikely that they can be sold in the future unless the
price is reduced to $3,000. The finance director is confident that the issue will be resolved and no
write down was made with regards to this balance.

Required:
Which of the following options correctly summarizes the impact on the auditor's report if the issue
remains unresolved?

a) Adverse opinion
b) Disclaimer of opinion
c) Qualified 'except for'
d) Unmodified opinion

2) The second audit client is Hayden Co (Hayden).

On 1 January 20X6, Hayden implemented a new accounting system; this was generally a success,
with the exception of February 20X6 when one month of Hayden's inventory records were lost.
Despite several attempts, the audit team was unable to perform alternative audit procedures to verify
material inventory transactions in February 20X6, although the year-end inventory count went
smoothly.

Required
Which of the following options correctly summarises the impact on the auditor's report of the above
issue?
a) Disclaimer of opinion
b) Qualified 'except for’
c) Unmodified opinion
d) Unmodified opinion with emphasis of matter paragraph

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3) The third audit client is Maker Co (Maker), a listed construction company which specialises in
residential housebuilding. One of Maker's construction workers, Edward Shift, was dismissed in
August 20X6 after turning up for work under the influence of alcohol. In September 20X6, Mr. Shift
began a case against Maker for unfair dismissal.
Required
Which TWO of the following audit procedures should be performed in order to form a conclusion as
to the appropriate accounting treatment of the above claim in the year end year-end financial
statements?
a) Recalculate Mr. Shift's wages and salaries for the year to verify that he was only paid up to the
date of dismissal
b) Review the construction work performed by Mr. Shift in August 20X6 to determine whether
there are any concerns over the quality of his work and whether Maker's health and safety
procedures were followed
c) Review legal correspondence relating to the claim in order to determine Maker's lawyers'
opinion as to the likely outcome of the claim
d) Review the post year end cash book in order to determine whether any payments were made to
Mr. Shift

4) Mr. Shift has sent such a huge amount of paperwork to Maker detailing the extent of his claim along
with supporting medical documentation and character references that the audit team has had to
devote a significant amount of audit attention to this area of the audit. The directors have not made
any reference to the claim in the financial statements and you agree with Maker's lawyers' indication
that it is highly unlikely that Mr. Shift will be successful in his claim.

Required
Based on the above information indicate whether the audit opinion should be modified or
unmodified and the appropriate disclosure which should be made in the auditor's report:
Audit opinion Disclosure in the auditor's report
Audit opinion: Modified
Unmodified
Disclosure in the auditor's report: Emphasis of matter paragraph
Key audit matter paragraph
Material uncertainty related to going concern paragraph
No disclosure required
Other matter paragraph

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Solution of Activity 2:
Modified opinions and modified auditor's reports

1. The correct answer is: Qualified 'except for’

LB has not valued inventory at the lower of cost and net realisable value on a line by line basis,
which is contrary to the accounting standard IAS 2 Inventories.
If it had, then the inventory line would have been written down by $14,000 ($17,000 cost less $3,000
NRV). Inventory is therefore overstated in the statement of financial position.
The misstatement is material as it represents 8% of profit before tax ($14,000/$175,000), so
management should correct this misstatement in the financial statements.
As the Finance Director has refused to amend this misstatement then the auditor's opinion will need
to be modified. As management has not complied with IAS 2 and the misstatement is material but
not pervasive, a qualified opinion 'except for' would be necessary.
The auditor's report would include a qualified opinion section, together with a basis for qualified
opinion section explaining both the material misstatement in relation to the inappropriate valuation
of inventory and quantifying its effect on the financial statements.

2. The correct answer is: Qualified 'except for'

Check & Co has been unable to gather sufficient appropriate audit evidence over the inventory
transactions which occurred in February 20X6, and these are considered to be material.
It has, however, been able to gather sufficient appropriate audit evidence over the year-end inventory
balance and so this issue is considered to be material but not pervasive.
As such a qualified opinion 'except for' would be expressed, and a basis for qualified opinion section
would be included to explain the potential impact of the loss of inventory records.
An emphasis of matter paragraph would not be issued as the issue is not believed to be fundamental
to the financial statements.

3. The correct answers are:

 Review legal correspondence relating to the claim in order to determine Maker's lawyers opinion
as to the likely outcome of the claim.
 Review the post year end cash book in order to determine whether any payments were made to
Mr. Shift
Recalculating Mr. Shiff's wages and salaries for the year to verify that he was only paid up to the
date of dismissal and reviewing the construction work performed by Mr. Shift in August 2016 to
determine whether there are any concerns over the quality of his work and whether Maker's health
and safety procedures were followed are audit procedures relating to wages and salaries and
inventory rather than to the accounting treatment of the claim itself

4. Unmodified audit opinion with a key audit matter paragraph. The directors have not made any
reference to the claim in the financial statements. This seems appropriate as you agree with the
lawyer’s indication that the claim will not be successful Therefore, an unmodified audit opinion
would be issued.

However, Maker is a listed entity and the claim has taken up a significant amount of audit time and
so this would be included within the key audit matters section.

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The issue would not be included as an emphasis of matter (since it has been dealt with as a key
audit matter) and there is no indication that it impacts Maker's ability to continue as a going
concern.
-----------------------------------------------------------------------------------------------------------------

Activity 3:
Homes’r’Us is a large listed construction company based in the north of the country, whose activities
encompass house building and development. Its annual revenue is $550m and profit before tax is $70m.

You are the audit senior involved with the audit of Homes’r’Us for the year ended 31 December 20X7.
The following matters have come to your attention during the review stage of the audit in April 20X8;

1) Customer going into liquidation

One of Homes''Us's major commercial customers has gone into liquidation shortly after the year end.
As at the year end, the customer owed the company $7.5m. (7 marks)

2) Claim for unfair dismissal

One of the company's construction workers, Basil Evans, was dismissed in November 20X7 after
turning up to work under the influence of alcohol. In December 20X7, Mr Evans began a case against
the company for unfair dismissal. Lawyers for the company have advised that it will be highly
unlikely that he will be successful in his claim. (7 marks)
3) In March 20X8 a fire was started by vandals at one of the company's ten storage depots, destroying
$1m worth of building materials. (6 marks)
Required
For each of the three events at Homes'r'Us mentioned above:
(a) Describe the additional audit procedures you will carry out.
(b) State whether the financial statements will need to be amended and explain your reasoning.
(c) Discuss the potential impact on the auditor's report, fully explaining your answers.
(a) Note. The mark allocation is shown against each of the three events

Solution of Activity 3:
a) Customer going into liquidation
Audit Procedures
 Assess the likelihood of recovery of this amount by discussion with the directors of Homes'r Us.
 Confirm the amount of the amount outstanding as at the yearend by inspection of the receivables
ledger and correspondence with the customer.
 Review any correspondence between the company and the customer to assess likelihood of recovery
of any amounts.
 Obtain a written representation point regarding the amount outstanding from the customer from the
directors of Homes’r ‘Us.

Impact on financial statements

The financial statements will need to be amended, as this is an example of an adjusting event after the
reporting period. It provides additional information concerning the recoverability of the debt at the
reporting date.

Revenue, profit and net assets will all be overstated by $7.5m if the accounts are not adjusted. The
amount represents 10.7% of profit before tax and 1.4% of revenue so is clearly material.
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An adjustment is required in the financial statements to reduce the receivables balance and profits.
Effect on auditor's report.
The effect of the matter on the financial statements is clearly material. If the adjustments required are
made, then there would be no effect on the auditor's report.
If the directors refused to make the adjustment required, the audit opinion would be modified on the
basis that the accounts are not free from material misstatement and a qualified 'except for' opinion would
be issued, as the mat material but not pervasive.

b) Claim for unfair dismissal

Audit procedures
 Discuss the case for unfair dismissal with the directors of Homes'r'Us to find out
 background of case, date when claim was lodged and assessment of success.
 Review lawyer's correspondence regarding this case, as it may have an impact for next year's audit.
 Review any press reports in the local or national papers about this claim against the company.
 Review minutes of board meetings regarding this case and any other claim cases against the
company.
 Obtain written representations on this matter from the directors of Homes'r'Us.

Impact on financial statements

A provision for this claim is not required since the requirements for recognising a provision under IAS 37
Provisions, Contingent Liabilities and Contingent Assets are not met. Under IAS 37 (para, 14), a provision
should be recognised when there is a present obligation as a result of a past event, it is probable that a
transfer of economic benefits will be required to settle it and a reliable estimate can be made.
In this case, it appears unlikely that Mr Evans will be successful in his claim and so no provision should
be recognised in the financial statements for the year ended 31 December 20X7.
Disclosure of a contingent liability is also unlikely to be required since the possibility of any transfer in
settlement appears to be remote.
Effect on auditor's report
There would be no effect on the auditor's report as a result of this matter, as no amendment would be
required to the financial statements. An unmodified report on the financial statements could therefore be
issued.)
c) Fire
Audit procedures
 Discuss fire with management of Homes'r'Us to clarify facts of the situation.
 Read minutes of board meetings and any reports submitted by insurers.
 Review insurance documents to confirm that damage cause by the fire is covered.
Impact on financial statements
The fire at the storage depot is a non-adjusting event after the reporting period - it does not relate to
conditions which existed at the year end. It is unlikely that the fire is significant enough to impact on the
going concern of the company. Disclosure of the event surrounding the fire should be made, together with
an estimate of the financial effect.
Effect on auditor's report
Provided that adequate disclosure has been made of the event and its financial impact, there would be no
need to modify the audit opinion as a result of this incident. An emphasis of matter paragraph drawing
attention to this issue is unlikely to be required, unless it is viewed as being fundamental to the users'
understanding.
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Further quick examples for ACCA Students ………………………………

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Class Practice Questions on Audit Report

S. No. Attempt Marks

ACCA

1 Q/s 5 c June 2011 12 marks

2 Q/s 3 June 2015 10 marks

3 Q/s 6 c Sept / Dec 2015 4 marks

4 Q/s 18 d Sept / Dec 2020 5 marks

5 Q/s 18 d Sept / Dec 2017 5 marks

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Student Notings

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Student Notings

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ISA 701 - Key Audit Matters (KAM)

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KEY AUDIT MATTERS (KAM- ISA 701)

Expected Questions on KAM

1. Briefly explain the concept of KAM and list examples of matters that can be included or placed
in KAM para as per ISA 701.
2. Determine the matters to be considered to place a matter as KAM in the audit report.
3. Explain the factors to be considered in determining whether a matter will be placed in KAM
para.
4. Importance / purpose of KAM in the audit report
5. Scenario based question along with the audit report (very imp! )
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Auditor shall communicate key audit matters in the auditor's report for audits of
 Listed entities
 Other than listed entities, if required by law
 Other entities as per auditors professional judgment, including those that may be of significant
public interest.

Purpose and Importance of KAM in the Audit report (IMP)

Communicating key audit matters provides additional information to intended users of the financial
statements to assist them in understanding those matters that, in the auditor's professional judgment,
were of most significance in the audit of the financial statements of the current period.

The purpose of including KAM in the audit report is to help users in understanding the entity and to
provide a basis for users to discuss with management and TCWG about matters related to the entity and
the financial statement i.e. KAM has increased more transparency for the users of the F/S.

KEY Word for KAM

Most significant matters for the CURRENT period that are selected from matters
communicated with TCWG
1. The auditor to perform the following: ( Read Only )
a. Determine the matters which should be described as KAMs
b. Communicate - the KAM to TCWG
c. Communicate - KAM in the Audit Report.
d. Maintain proper documentation as per ISA 230
2. Features of KAM ( Please Learn)
a. Matters that were communicated to Board Audit Committee or other BOD members
b. Matters that required significant attention
c. Matters of most significance in audit. (e.g.: Provision for Law suit)

3. KAM is NOT ………………………(very very important)

 A substitute for disclosures on the financial statements (AFRF)
 A substitute for a modified opinion (ISA 705)
 A substitute for reporting a material uncertainty related to GC (ISA 570)
 A separate opinion on individual matters (ISA 700 – other reporting resp.)
 An implication that matter has not been resolved by the auditor.

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4. Types / Examples of matters reported by different auditors as KAM ( IMP -Please Learn)

1) Property valuation and impairment

2) Goodwill impairment
3) Inventory valuation
4) Revenue recognition
5) Change in accounting policy
6) Claims & litigation
7) Taxation (deferred and current)
8) I.T environment and control deficiencies
9) Management override of controls or Internal control deficiency impacting F/S

5. Why KAM in the Audit REPORT……….. ( IMP - Please Learn)

(Explain how the auditor determines that whether a matter will be placed as KAM or not)

1. High ROMM
2. Significantly subjective or Judgmental issues / amounts
3. Uncertainty of matter
4. Complex issue
5. Areas where an expert is required or any consultation is required
6. Assessed Significant Risks that required significant audit attention/
7. Significant transactions and events affecting the audit
8. Change in audit approach during the audit as a result of an unexpected audit evidence
9. The severity of control deficiency identified.
10. Whether several separate issues interacted, eg if a long-term contract had repercussions
in several areas (revenue recognition, litigation or contingencies)
11. Any misstatements related to the matter, and the nature and materiality of the
misstatements
12. The importance of the matter to intended users' understanding, including materiality

Descriptions of individual Key Audit Matters in the Audit Report - IMP

(Contents of KAM Para)

The description of each key audit matter in the Key Audit Matters section of the auditor's report shall
1) Include a reference to the related disclosure(s), if any, in the financial statements;
2) State that why the matter was considered to be one of most significance in the audit; and
3) Specify how the matter was addressed in the audit
I. A brief overview of procedures performed;
II. An indication of the outcome of the auditor's procedures; or
III. Key observations with respect to the matter,

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Communication with Those Charged with Governance

Communication with those charged with governance enables them to be made aware of the key audit
matters that the auditor intends to communicate in the auditor's report, and provides them with an
opportunity to obtain further clarification where necessary.
The auditor shall communicate with them:
 Those matters the auditor has determined to be the key audit matters; or
 The auditor's determination that there are no key audit matters to communicate in the auditor's
report.

Drafting & Placement of KAM in the Audit report

In the case of Listed company + KAM ( Listed co )
Stnd Para
Key Audit Matters are those matters that, in our professional judgment, were of the significance in
our audit of the financial statements of the current period. These matters were addressed in the
context of our audit of the financial statements as a whole, and in forming our opinion thereon, and
we do not provide a separate opinion on these matters.

[Description of each key audit matter in accordance with ISA 701, which applies to audit of the financial
statements of listed entities….]

In the case of Modification of opinion (Qualified or Adverse opinion) + KAM (Listed

co )

Key Audit Matters

Key Audit Matters are those matters that, in our professional judgment, were of the significance in
our audit of the financial statements of the current period. These matters were addressed in the
context of our audit of the financial statements as a whole, and in forming our opinion thereon, and
we do not provide a separate opinion on these matters……. IN ADDITION to the matter described
in the Basis for Qualified Opinion section we have determined the matters described below to be the
key audit matter to be communicated in our report. (Reference to the modification is given in the
audit report)

(Description of each key audit matter in accordance with ISA 701, which …….)

In the case of Modification of opinion (Qualified or Adverse opinion) + No KAM (

Listed co )
Key Audit Matters

Except for the matter described in the Basis For Adverse Opinion section we have determined that there
are no other key audit matters to communicate in our report.

In the case of Listed company + No KAM (and Unmodified Opinion)

Key Audit Matters

We have determined that there are NO Key audit matters to communicate in our report.

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In the case of Un-Listed company + KAM
(same as Above)

In the case of Un-Listed company + No KAM

No heading of KAM Para is mentioned in the audit report

In the case of Disclaimer of Opinion

No KAM

Drafting of KAM for exam solution

Explanation of the matter

As the matter is most significant for the current period and discussed with B.O.D / A.C during
the Audit and at the same time special audit procedures were performed by the External Auditor
and to resolve the matter / an expert / independent consultant was also hired to perform
procedures to resolve the matter / case.
Therefore as there is no M.M in the F/S or inability to obtain S.A.A.E the matter will be placed
as KAM para in the audit report

Calculation of Materiality / threshold:

In the case of P.B.T

In the case of Revenue
In the case of T.A/T.L

In the case where Planning Materiality is given

Impact on the Audit report

Based on the above explanation as the matter is most significant matter for the current period
therefore the matter will be placed as KAM Paragraph in the auditor report. This para to give an
overview of audit procedures performed, outcome of those procedures, reference to related
disclosure in the F/S and key observations of the auditor with respect to the matter.

KAM para to be placed after Basis for Opinion para and will be placed either before EOM or
after EOM para (if any) as per ISA 706.

Further explanation depending upon the number of marks…………..

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Exam Hints for KAM

Relationship with the auditor's opinion

The basic relationship is this:

Financial statements as a whole

Key audit matters (KAMs) Auditor's opinion

The KAMS are the key matters for the audit of the whole financial statements. They are not separate
auditor's opinions for each little part of the financial statements, but merely further information on the
process that led up to the opinion on the financial statements as a whole.
Likewise, the auditor's opinion refers to the financial statements as a whole: as a whole they might give
a true and fair view, or as a whole they might be true and fair but 'except for one area (and so on).

If the auditor is going to express a modified opinion, then logically the matter giving rise to the
modification is a key audit matter. However, the description of the matter will be given in the 'basis for
modified opinion' paragraph, so it is not included as a KAM in the report. The auditor should include a
reference to the basis for modified opinion paragraph instead.

ISA 701 also makes special mention of going concern problems. Where there is a material uncertainty
in relation to going concern, the matter should not be described as a KAM, but should be discussed in
the 'Material uncertainty in relation to going concern' paragraph' instead.

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Placement of K.A.M, E.O.M & Other Matter Paragraph

As per ISA
2. Report on Financial Statement
(1st Heading)

E.O.M K.A.M
K.A.M E.O.M
(effects of fire lawsuit etc.)
O.M O.M

2. Report in other legal & regulatory requirement. (2nd Heading)

Will be inserted as a Sub-Heading

Other matter

3. In case it pertains to the whole AUDIT report than no sub heading …. rather
there will be a 3rd main heading in the audit report
Other matter

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Difference between E.O.M and K.A.M

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Here is an example of how KAMs could appear in the F/S as per ISA 701:
Key Audit Matters
Key audit matters are those matters that, in our professional judgment, were of most significance in our
audit of the financial statements of the current period. These matters were addressed in the context of
our audit of the financial statements as a whole and in forming our opinion thereon, and we do not
provide a separate opinion on these matters.

Revenue Recognition
The amount of revenue and profit recognized in the year on the sale of [name of product] and
aftermarket contract for services is linked to or separate from the contract for sale of [name of product].
As the commercial arrangements can be complex, significant judgment is applied in selecting the
accounting basis in each case. In our view, revenue recognition is significant to our audit as the Group
might inappropriately account for sales of [name of product] and long-term service agreements as a
single arrangement for accounting purposes and this would usually lead to revenue and profit being
recognized too early because the margin in the long-term service agreement is usually higher than the
margin in the [name of product] sale agreement.

Our audit procedures to address the risk of material misstatement relating to revenue recognition,
which was considered to be a significant risk, included:

 Testing of controls, assisted by our own IT specialists, including, among others, those over:
input of individual advertising campaigns' terms and pricing; comparison of those terms and
pricing data against the related overarching contracts with advertising agencies; and linkage to
viewer data; and
 Detailed analysis of revenue and the timing of its recognition based on expectations derived
from our industry knowledge and external market data, following up variances from our
expectations.

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Student Notings

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Student Notings

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CA CAF 8 Practice Questions on KAM

S. No. Attempt Marks

1 Q/s 7 b March 2022 7 marks

2 Q/s 3 a March 2017 4 marks

3 Q/s 5 f Sept 2016 3 marks

ACCA F8 Practice Questions on KAM

S. No. Attempt Marks

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CA CAF 8 March 2022 (7 marks)
Question 7 b
You are the audit partner in a firm of Chartered Accountants. Following independent matters for the
year ended 31 December 2021 are presently under your consideration:
b. Your firm has been appointed as auditor in place of retiring auditor for Smart Footwear Limited
(SFL), a listed company. SFL owns number of retail outlets across Pakistan and many of them
were acquired on rental basis. During the year, SFL has adopted IFRS 16 ‘Leases’. The audit team
has made significant efforts to review the adjusting entries made in the financial statements to
reconcile the change in accounting policy of operating leases. The matter was discussed in detail in
the audit committee meeting. Your team has included the details about adjustments and impact on
financial statements in the board letter.
Required:
In the above independent situations, discuss the reporting implication(s) including the changes that
needs to be made in the audit report as illustrated in ISA-700.

Answer:
Reporting implication:
The matter of application of IFRS 16 is significant as Smart Footwear operates through number of
rentals outlets. Furthermore, the change in accounting policy and related adjustments have taken
considerable time of audit team to verify. The matter was also discussed and brought to the knowledge
of those charged with governance in the meeting of the audit committee and through board letter.
Considering all these factors, the auditor will add the matter of application of IFRS 16 as key audit
matter in the audit report.

Changes in the standard audit report:

Since the financial statements of previous year were audited by another auditor, the other matter
paragraph will be added in the report which will mention that the financial statements were audited by
another auditor, the type of opinion expressed and the date of that auditor’s report.
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CA CAF 8 March 2017 (4 marks)

Question 3 a
You are the audit partner in a firm of chartered accountants. Some of the audits are in the finalization
stage and presently the following matter is under your consideration:
a) The management of Sohni Limited has changed its revenue recognition policy. As the audit
engagement partner you are satisfied with the accounting and disclosures related to change in
accounting policy. Further, the impact of the change is significant.
Required:
Discuss the possible impact on the audit report and specify the procedures (if any) which you would
undertake in the above situation.

Answer:
Change in accounting policy has to be reported as a key audit matter. For this purpose it is necessary
that it should be discussed with those charged with governance. In the key audit matter section, the
auditor shall:
 include a reference to the related disclosure(s), if any, in the financial statements
 state why the matter was considered to be one of most significance in the audit; and
 specify how the matter was addressed in the audit.
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CA CAF 8 Sept 2016 (3 marks)
Question 5 f

In relation to the audit report on financial statements and the contents thereof (under revised/new
ISAs), discuss the appropriateness or otherwise of the following statement:

‘Key audit matters are determined from the matters communicated with the management of the entity
that required significant auditor’s attention in performing the audit. In making that determination, the
auditor shall take into account the effects on the audit of significant events or transactions that occurred
during the current year and prior period presented.’

Answer:

The statement is not appropriate as the Key Audit Matters are selected from the matters communicated
with those charged with governance and in making those assessments matters pertaining current period
only are considered as opposed to matters pertaining to prior period.

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Student Notings

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Student Notings

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ISA 560 - ‘Subsequent Events’

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Expected Questions on ‘Subsequent Events’ ISA 560
Q1. Explain the objectives of an External Auditor with respect to
ISA 560 / subsequent events?

Q2. Explain the term subsequent events as per ISA 560 and
briefly discuss the events that it deals with?

Q3. Explain the Audit procedures/ Audit Tests that will be

performed by the External Auditor to ensure that events
occurring between the date of F/S (B/S Date) and date of
Audit Report are identified and accounted for?

Q4. Explain the External Auditor’s responsibility with respect to

facts that are known to the Auditor after the date of the Audit
Report but before the date the F/S are issued?

Q5. Explain the External Auditor responsibility with respect to

facts which become known to the Auditor after the F/S have
been issued?

Q6. Scenario based question? (Most Imp!)

 Explain whether the F/S need amendment or not / Evaluate

the need for amendment in the F/S
 List/ Explain the audit procedures the auditor needs to
perform in this regard / Suggest the auditors course of Action
AND
 Discuss the impact on the Audit Report/Audit Opinion
(Should the issue remain unresolved)

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Summary of ISA 560
 ISA 560 provides guidance to auditors in this area. The objectives of the auditor are:
To obtain sufficient appropriate audit evidence about whether events occurring between the date of
the financial statements and the date of the auditor’s report that need adjustment or disclosure in
the financial statements are properly reflected in the financial statements

 To respond appropriately to facts that become known to the auditor after the date of the auditors’
report which may have caused the auditor to amend the auditor’s report if they were known to the
auditor at the date of the report
-------------------------------------------------------------------------------------
Subsequent Events are events occurring between the period-end (B/S Date) and the date of the
auditor’s report and also include facts discovered after the auditor’s report has been issued.
Auditors shall consider the effect of such events on the financial statements and on their audit
opinion.

IAS 10 – Recap..

ISA 10 Events after the reporting period deals with the treatment in the financial statements of events,
both favourable and unfavourable, occurring after the period-end. There are two types of event
defined by IAS 10:
 Those that provide evidence of conditions that existed at the year-end date (adjusting
events)
 Those that are indicative of conditions that arose after the year-end date (non-adjusting
events)

General Procedures / General responsibility

Auditors have a responsibility to review subsequent events before they sign the auditor’s report, and
may have to take action if they become aware of subsequent events between the date they sign the
auditor’s report and the date the financial statements are issued.

Events occurring UP TO the date of the auditor's report

The auditor shall perform procedures designed to obtain sufficient appropriate audit evidence that all events up to the
date of the auditor's report that may require adjustment of, or disclosure in, the financial statements have been identified
and adjusted and disclosed accordingly.
These procedures should be applied to any matters / events examined during the audit which may be sensitive to
change after the B/S date.
Lecture Example:
______________________________________________________________________________________
ISA 560 lists procedures to identify subsequent events which may require adjustment or disclosure. They should be
performed near the auditors' report.

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General audit procedures to test subsequent events

Inquiries of management
 Status of items involving subjective judgment (like provisions involving estimates)
 Status of items accounted for using inconclusive data at the B/S date (based on info at the B/S
date)
Whether there have been any:
 Sales or destruction of assets
 Developments involving risk areas, provisions and contingencies
 Unusual accounting adjustments
 Major events (eg going concern problems)
 Litigations or claims
Other Procedures

 Review management procedures for identifying subsequent events to ensure that such events are
identified
on a timely basis.
 Read minutes of B.O.D /other committee meetings and enquire about unusual items.
 Review latest available interim financial statements. (First quarterly F/S)
 Obtain evidence concerning any litigation/ lawsuit from the company's lawyers.
 Obtain written representation that all events occurring subsequent to the period-end which need
adjustment or disclosure have been adjusted or disclosed. (TO BE COVERED IN ISA 580)

Facts discovered AFTER the date of the auditor’s but BEFORE the financial statements
are issued

The financial statements are the management’s responsibility. They should therefore inform the
auditors of any material subsequent events between the date of the auditor’ report and the date of the
financial statements are issued. The auditor does not have any obligation to perform procedures, or
make enquiries regarding the financial statements, after the date of the report.

However, if the auditor becomes aware of a fact that, had it been known to the auditor at the date of
the auditor’s report, may have caused the auditor to amend the auditor’s report, the auditor shall:

 Discuss the matter with management and those charged with governance.
 Determine whether the financial statements need amendment.
 If amendment is required, inquire how management intends to address the matter in the financial
statements.

If amendment is required to the financial statements and management makes the necessary changes,
the auditor must carry out a number of procedures:

 Undertake any necessary audit procedures on the changes made.

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 Extend audit procedures for identifying subsequent events that may require adjustment of or
disclosure in the financial statements to the date of the new auditor’ report.
 Provide a new auditor’s report on the amended financial statements.
If managements does not amend the financial statements:
 If the auditor’s report has not yet been provided to the entity, the auditor shall modify the opinion
and then provide the auditor’s report.
 If the auditor’s report has already been provided to the entity, the auditor shall notify
management and those charged with governance not to issue the financial statements before the
amendments are made……………………… but if the financial statements are issued anyway, the
auditor shall take action to seek to prevent reliance on the auditor’s report.( Seek legal advice)

Facts discovered AFTER the financial statements have been issued

Auditor have no obligations to perform procedures or make enquiries regarding the financial
statements after they have been issued.
However if the auditor becomes aware of a fact that…………… had it been known to the auditor at
the date of the auditor’s report………….. may have caused the auditor to amend the auditor’s report,
the auditor shall:
 Discuss the matter with management and those charged with governance.
 Determine whether the financial statements need amendment.
 If amendment is required, inquire how management intends to address the matter in the financial
statements.
If management amends the financial statements, the auditor shall carry out any necessary procedures
on the amendment and review the steps taken by management to ensure that anyone in receipt of the
previously issued financial statements is informed.
The auditor shall also issue a new or amended auditor’s report, which will include an explanatory
paragraph known as emphasis of matter paragraph (E.O.M) that refers to a note in the financial
statements that discusses the reason for the amendment. Audit procedures will be extended up to the
date of the new report.
If management does not take the necessary steps to ensure that anyone in receipt of the previously
issued F/S is informed of the situation and does not amend the F/S where necessary, the auditor shall
notify management and those charged with governance that the auditor will seek to prevent future
reliance on the auditor’s report. If management still does not act, the auditor shall take appropriate
action to seek to prevent reliance on the auditor’s report. (Seek legal advice).

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Subsequent Events (ISA 560) - Practical Cases for Scenario
Based Questions (V.IMP)

1. Debtors/Receivables
1a)

B/s Date D.O.R

Dec 31 ,2017

1b) Exception to the above Case

Student Notings

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2. Lawsuit/Court Case filed by the Customer or Supplier

(i) Court Case Filed ……………..BEFORE the B/s Date

ia) Case Pending till the Date of Report…………….

ib) Case Finalized before the Date of Report………..

(ii) Court Case Filed ..................... AFTER the B/s Date

ii a) Case Pending till the Date of Report

ii b) Case Finalized before the Date of Report………..

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3. Out of Court Settlement Case (Extension of 2nd Case)

Matter is resolved mutually between the parties outside the court.

Assumption: _______________

3a) Provision recorded in the F/S at the B/s Date

(Provision recorded at an estimated amount)

3b) Contingent liability disclosed in the F/S at the B/s Date

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4. Damage of Inventory / Stock or Fixed Assets
Due to Natural Disaster after the B/s. Date
(eg: Fire, Flood, Earthquake)

(____________________________________)

4a) 100 % Insurance Coverage……

4b) No Insurance Coverage…..

4b) Partial Insurance Coverage……

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5. Return of Stock / Inventory after the B/S Date…

5a) Sale of stock after the B/S Date that is damaged or obsolete

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KnS School of Business Studies
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Audit Procedures / Audit Tests for the Question of Subsequent Events Cheetah-pun…...!

Lawsuit / court case- Substantive Procedures For Scenario based Q/S’s…..

 Review / Inspect documentation/correspondence of the case / legal action.

 Review customer correspondence to consider the likelihood of any payment (in the case of
receipts)
 Discuss the matter with management and those charged with Governance:
 Whether the amount will be paid or not
 Whether disclosure is required in the F/S or
 An adjustment is required in the F/S
 Obtain lawyer confirmation (Lawyer Report) to obtain their point of view/opinion.
 Discuss the matter with lawyer to confirm their point of view on the matter / issue.
 Review correspondence with the supplier/ vendor to confirm the amount they are willing to
accept. (in the case of out of court settlement)

Debtors / A/c Receivables - Substantive Procedures

 Verify subsequent receipts / post balance sheet receipts from the customers
 Discuss with mgmt. / TCWG why they think an adjustment is not required in the F/S
 Review customer correspondence to assess whether there is any likelihood of payment or not.

Fire/Flood / explosion Substantive Procedures

 Obtain a schedule of damaged P.P.E/Inventory & agree its net book value to the non-current
register to confirm its value of affected assets.
 Verify breakdown of Inventory records & P.P.E records to determine / ascertain the level of the
inventory/ P.P.E at the time of fire / flood.
 Inspect / review any correspondence from insurance company confirming the amount of claim,
likely payments and current status of investigation via surveyor’s report to determine / assess the
extent of any uninsured amounts because it’s the uninsured amount which if material is required
to be disclosed in the financial statements.
 Obtain analysis of Inventory/Assets damaged and compare with Average Inventory/Fixed Assets
in the warehouse/Stores to see the reasonableness of amount claimed by management.
 Discuss with T.C.W.G as to the disclosure of this non-adjusting event in the financial statement.
 Discuss the matter with management & those charged with Governance as to the continuity of
business & validity of going concern assumption.

Inventory – sale after the B/S date

 Obtain schedule showing the inventory and agree to supporting documents that it was produced
prior to B/S date (otherwise it would not require a write down at year end.)
 Verify the calculation of scrap value /NRV & agree the amount/ value to the supporting
documents.

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 Discuss the matter with TCWG as to the treatment of IAS 2 & whether adjustment will be made
or not in the F/S.
 Obtain Management representation with respect to the validity of going concern Assumption.
 Review B.O.D minutes to assess whether this event was the only event / case for defective
inventory (as there might be other events like this)
 Inquire from mgmt. that whether the company has sufficient stock to continue business in the
short term or not.

Other points / Other Procedures

Page 237 of 272 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

KnS School of Business Studies
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ACCA F8 Practice Questions on Subsequent Events

S. No. Attempt Marks

1 Q.5 Dec 2011 20 marks

2 Q.5 b June 2013 12 marks

3 Q.18 d March / June 2019 6 marks

Page 238 of 272 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

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Subsequent Events Exam Focused Points

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Subsequent Events Exam Focused Points

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ISA 570 – ‘Going Concern’

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Expected Questions on Going Concern (ISA 570 – Revised)

1. Define Going Concern assumption?

2. Explain 4 / 5/ 6 potential indicators that company is not a
going concern
3. List and explain the going concern indicators?
4. Differentiate/Explain/Discuss between Management &
External Auditor responsibilities for Going Concern
assumption?
5. Briefly explain the auditor’s responsibility for reporting on
going concern to the directors / TCWG?
6. What are the reporting responsibilities of an external auditor
with respect to Going Concern?
7. Scenario Based Questions? ….IMP
 List and explain the Indicators of Going Concern
 Describe the audit procedures / audit tests to be performed
by the external Auditor to assess that whether the
company is Going Concern or not.
 Explain the impact on the audit report / opinion

(________________________________________________________________)

Page 242 of 272 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

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Going Concern Assumption
Definition

Under the going concern assumption, an entity is viewed as continuing in business for the foreseeable
future. General purpose F/S are prepared on a going concern basis, unless management either intends to
liquidate the entity or to cease operations, or has no realistic alternative but to do so and when Going concern
assumption is valid than assets and liabilities are recorded on the basis that the entity will be able to realize
its assets and discharge its liabilities in the normal course of business.

Responsibilities of Management

Because general purpose F/S are prepared on a going concern basis, the going concern assumption is a
fundamental principle in the preparation of F/S. Therefore managements responsibility for the
presentation and preparation of the F/S also includes responsibility to assess the entity’s ability to
continue as a going concern even if there is no explicit requirement to do so in the framework.

If mgmt. becomes aware of facts that cast doubt upon the entity’s ability to continue as going concern
than Mgmt. must disclose those uncertainties in the F/S.

If mgmt. concludes that G.C assumption is not appropriate than F/S will be prepared on breakup
value basis but this fact must be disclosed in the F/S for the shareholder / users

Period of Assessment…… (Evaluating Management Assessment)

The auditor to inquire and perform procedures to identify events or conditions that may cast
significant doubt on Going concern assumption for a period of twelve months from the balance sheet
date or a longer period if the applicable F.R.F / law or regulation specifies / or conditions require.

(Period beyond 12 months can be inquired by the E.A)

Responsibilities of External Auditor …IMP

The auditor must remain alert throughout the period for conditions that may cast doubt on the entity’s
ability to continue as a going concern. The auditor’s responsibility is to obtain sufficient appropriate
audit evidence about the appropriateness of management’s use of the going concern assumption in the
preparation and presentation of the financial statements for the year and to conclude that whether
there is a material uncertainty about the entity’s ability to continue as a going concern.

The potential effects of inherent limitations on the auditor’s ability to detect material misstatements
are greater for future events or conditions that may cause an entity to cease to continue as a going
concern. The auditor cannot predict such future events or conditions.
Accordingly, the absence of any reference to going concern uncertainty in an auditor’s report
cannot be viewed as a guarantee as to the entity’s ability to continue as a going concern

(In short, Auditor must be alert throughout the audit for doubts on GC ..! + evaluate management’s
assessment of the entity’s ability to continue as a going concern Note: this assessment will be for a
minimum period of 12 months)

Page 243 of 272 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

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Going concern indicators (3 types)
Financial IMP…!
Operating
Others
Mitigating Factors (very Imp when deciding to modify the audit report)

The significance of such events or conditions often can be mitigated by other factors. For example, the
effect of an entity being unable to make its normal debt repayments may be counter-balanced by
management’s plans to maintain adequate cash flows by alternative means, such as by disposing of
assets, or obtaining additional capital.
Audit Procedures When Events or Conditions Are Identified
Specific Audit procedures to be performed as follows: (Please learn these…..!!) (IMP)

1. Obtain company’s cashflow forecast and review the cash inflows and cash outflows and also the
reasonableness of their assumptions and also discuss unfavorable findings with management.
2. Review post year end management accounts to assess if they are in line with cashflow and other
forecasts.
3. Reading the terms of loan agreements and determining whether any have been breached.
4. Discuss with director finance regarding increase in sales or whether new customers have been
obtained. (new sales lead )
5. Review the company’s post year end sales order book to assess and determine if the levels of
trade/sales are likely to increase.
6. Review post year end (subsequent) B.O.D minutes and minutes of other relevant committees to
identify other issues which might indicate other risks of going concern.
7. Inquiring of the entity’s legal counsel regarding the existence of litigation and claims.
(eg Claims from Suppliers and Customers)
8. Enquire from company lawyers with respect to proposed change in any law / legislation which
might make company product obsolete in the near future.
9. Confirming the existence of arrangements to provide financial support from related and third
parties and assessing their financial ability.
10. Evaluating plans to deal with un-fulfilled customer orders. (Orders that are pending yet )
11. Performing audit procedures regarding subsequent events to identify those that affect the entity’s
ability to continue as a going concern.
12. Confirming the existence, terms and conditions of borrowing facilities from Banks. (eg Loan
Agreements or correspondence)
13. Obtaining and reviewing reports of any regulatory actions. (for any penalties being imposed by
regulatory bodies )
14. Assessing the genuineness for any planned disposals of assets. (e.g. Vacant Building or Land to
confirm the mitigating factor )
15. Obtaining written / management representation confirming the B.O.Ds view that company is a
going concern. (to be linked and covered in ISA 580)

OR Obtain Management representation for future plans & their feasibility.

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EXAM FOCUS POINT

1. Theoretical question can be asked for the above procedures.

2. In the case of scenario-based question, above procedures will have to be linked with the given
scenario in the exam.

Going Concern Indicators ……………………………MOST IMP

Events or conditions that may cast doubt about the going concern assumption (potential indicators
that an entity is not a going concern).
 Financial Indicators  Net liability or net current liability position
 Fixed-term borrowings approaching maturity without
prospects of renewal or repayment
 Indications of withdrawal of financial support by
creditors
 Negative operating cash flows (historical or prospective
i.e future Cash flows )
 Adverse key financial ratios or decreased as compared to
last year)
 Substantial operating losses or significant deterioration
in the value of assets used to generate cash flows
 Arrears or discontinuance of dividends
 Inability to pay creditors on due dates
 Inability to comply with terms of loan agreements
__________________________________________
 Change from credit to cash-on-delivery transactions with
suppliers
 Inability to obtain financing for essential new product
development or other essential investments

 Operating Indicators  Management intentions to liquidate or cease operations

 Loss of key management without replacement
___________________________________________
 Loss of a major market, key customers, license, or
principal suppliers (Supplier has ceased trading )
___________________________________________
 Labour difficulties ( eg Trade Union Strikes)
 Shortage of important supplies
__________________________________________
 Emergence of a highly successful competitor
( Eg Pizza Max and 14TH Street for Pizza Hut)
 Other Indicators  Non-compliance with laws and regulations
 Pending legal or regulatory proceedings against the
entity that may, if successful, result in claims that the
entity is unlikely to be able to satisfy
__________________________________________
 Changes in laws/regulations/government policy
expected to adversely affect the entity
_________________________________________
 Uninsured or underinsured catastrophes
Page 245 of 272 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)
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Other Going concern indicators

Audit conclusions & reporting – Going Concern

Scenario Impact on auditor’s report

1. Going concern assumption is appropriate Unmodified opinion PLUS Separate Para
but a material uncertainty exists …which Section headed ‘Material Uncertainty Related
is adequately disclosed to Going Concern’
2. Going concern assumption is appropriate Qualified or adverse opinion (i.e. modified
but a material uncertainty exists …which opinion)
is NOT adequately disclosed in the F/S
3. Use of going concern assumption is Adverse opinion (i.e. modified opinion)
inappropriate in the F/S
4. Management is unwilling to make or Qualified or disclaimer of opinion (i.e. modified
extend its assessment with respect to opinion)
going concern… Because of Lack of S.A.A.E

Case 1: Going concern assumption is appropriate BUT a material uncertainty exists which is
adequately disclosed in the F/S………….

In this situation, the opinion on the financial statements will be unmodified but the auditor's report will
include a separate para headed ‘Material Uncertainty Related to Going Concern’
The report is standard/unmodified, except for this new paragraph, placed immediately after the ‘Basis
for Opinion Para’…

Material Uncertainty Related to Going Concern

We draw attention to Note 6 in the financial statements, which indicates that the Company incurred a
net of loss of ZZZ during the year ended December 31, 2OX1 and, as of that date, the Company's
current liabilities exceeded its total assets by YYY. As stated in Note 6, these events or conditions,
along with other matters as set forth in Note 6, indicate that a material uncertainty exists that may cast
significant doubt on the Company’s ability to continue as a going concern. Our opinion is not modified
in respect of this matter.

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Case 1(a): Going concern assumption is appropriate BUT a material uncertainty Exists which is
NOT adequately disclosed in the F/S….

In this situation, as inadequate disclosure has been made of the material uncertainty, the auditor’s
opinion will be modified - either a qualified or adverse opinion will be issued depending on the
magnitude of the uncertainty.
An extract from the auditor's report where a qualified opinion is issued is provided by the ISA
follows.

Qualified Opinion
In our opinion, except for the incomplete disclosure of the information referred to in
the Basis for Qualified Opinion paragraph, the financial statements present fairly, in all material
respects (or ‘give a true and fair view of’) the financial position of the Company as at December 31,
20X0, and of its financial performance and its cash flows for the year then ended in accordance with
international Financial Reporting Standards (IFRSs).

Basis for Qualified Opinion

The Company's financing arrangements expire and amounts outstanding are payable on 19 March
20X1. The Company has been unable to conclude re-negotiations or obtain replacement-financing.
This situation indicates that a material uncertainty exists that may cast significant doubt on the
Company's ability to continue as a going concern. The financial statements do not fully disclose this
matter.
Case 1(b): Going concern assumption is appropriate but a material uncertainty Exists which is not
adequately disclosed in the F/S….( Impact is Material and Pervasive )
Adverse Opinion

In our opinion, because of the omission of the information mentioned in the Basis for
Adverse Opinion section of our report, the accompanying financial statements do not present fairly
(or do not give a true and fair view of), the financial position of the Company as at
Dec………….
Basis for Adverse Opinion
The Company’s financing arrangements expired and the amount outstanding was payable on
December 31, 20X1. The Company has been unable to conclude re-negotiations or obtain replacement
financing and is considering filing for bankruptcy. This situation indicates that a material uncertainty
exists that may cast significant doubt on the Company's ability to continue as a going concern. The
financial statements do not adequately disclose this fact.
Case 3: Management unwilling to make or extend its assessment
In some circumstances, the auditor may ask management to make or extend its assessment. If
management does not do this, a qualified opinion or a disclaimer of opinion may be
appropriate, because it may not be possible for the auditor to obtain sufficient appropriate audit
evidence regarding the use of the going concern assumption in the preparation of the financial
statements.

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KnS School of Business Studies
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Summary Handouts by SK
Exam Focus point
1. Both theoretical and practical / scenario based question can be asked on the
Audit report with respect to going concern.
2. Please remember audit report cheetay points in the case of impact of going
concern on the audit report.

Communicating to those charged with governance (Responsibility Towards

Directors)
The auditor shall communicate with those charged with governance, events or conditions that may
cast doubt on the entity's ability to continue as a going concern. This will include:

 Whether the events or conditions constitute a material uncertainty

 Whether the use of the going concern assumption is appropriate in the preparation and
presentation of the financial statements
 The adequacy of related disclosures
 Implications on the audit report

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Handouts by SK
Exam Focused Points for ACCA F8 Students

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Handouts by SK
Exam Focused Points for ACCA F8 Students

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Summary Diagram – Going concern impact on the Audit Report

GOING CONCERN- ISA 570

Impact of Going Concern on the Audit Report/Opinion

Going concern Assumption is Management is

valid BUT a material uncertainty Going concern unwilling to make OR
exists. assumption is extend its Assessment
NOT valid for Going concern as
requested by the
auditor.
F/S needs to disclose this F/S should now NOT be
uncertainty in the notes to the prepared on a normal basis
F/S Inability to obtain
If made on normal basis = Adverse S.A.A.E in this respect.
Disclosure Modify opinion (Material & Pervasive) impact
given in the No = the
F/S opinion
If F/S prepared on NRV basis Qualified
than opinion
OR
Yes
Qualified Adverse Disclaimer of
opinion opinion Unmodified Opinion + E.O.M Para Opinion
Unmodified Separate Para in the (Material and Pervasive)
opinion Audit Report
AFTER Basis Para

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Summary Notes by S.K

ACCA F8 Practice Questions on Going Concern

S. No. Attempt Marks

1 Q.5 June 2012 17 marks

2 Q.5 June 2014 20 marks

3 Q.3 Sep/Dec 2015 10 marks

Page 252 of 272 Prepared by M. Sajid Kapadia (ACA, FCCA, APFA)

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
Going Concern Exam Focused Points

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
Going Concern Exam Focused Points

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Summary Notes by S.K
Going Concern Exam Focused Points

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Summary Notes by S.K

‘Non-profit Organizations’ (NPO)

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Expected Questions on N.P.O

1. Briefly list the Internal control features of a Not for Profit organization.

2. From a given scenario identify Inherent Risk, Control Risk & Detection
Risk / or Identify the audit risks for a N.P.O and explain the auditors
response in this regard.

3. Briefly explain the impact on the audit approach in the case of Not for
Profit organization.

4. Briefly discuss why control environment is weak in the case of a Not for
Profit organization.

5. Explain the substantive procedures to verify completeness of income of a

Not for Profit organization / explain the audit test to verify donation/
income of a charity organization.

6. Explain the substantive procedures to verify expenses of a Not for Profit

organization.

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Summary Notes by S.K
AUDIT RISK

Inherent  The complexity and extent of laws and regulations.

Risk (Tax laws for NPOs – varies from country to country)

 The significance of donations & cash receipts

(More cash donations = more risk)

 Difficulties establishing timing of voluntary income.

 Lack of predictable income (you cannot predict future

donations)
 Uncertainty of future income
(as compared to commercial organizations, donations and funds
are very uncertain)

 Expenses
 Risk of completeness of donations

 Risk of incorrect / wrong classification of Funds

Charities established for a Special Purpose

 Restrictions imposed by the objectives and powers given by
charities' governing documents
 Restricted funds (Restricted Funds: Funds that can only be
utilized for particular purpose/charity)
Control  The amount of time committed by directors/trustees to the
risk charity organization.
 The skills and qualification of trustees and of senior staff
members of the N.P.O.
 The regularity of trustee meetings.
 The independence of trustees from other trustees / members (
might be from one family or close friends )
 The division of duties (S.O.D) between management/trustees.
 The degree of involvement/or supervision of the organizations
events and various activities.
 Segregation of duties
 Qualifications and competence of management / finance
department / accountant

Detection Risk
 detection risk (the risk that the auditor will fail to identify any material error or misstatement in
performing the audit – e.g It’s the first year or no proper documentation trail / or no supporting
documents).

Examples of Detection Risk

 First year of Audit
 No reliable accounting system
 Lack of overall documentation

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Summary Notes by S.K
 Integrity of trustees
 Complex accounting system / software

Control Environment (HOW it can be strong)

 There must be proper organization structure

 There must be proper segregation of duties
 All activities must be supervised by trustees of the N.P.O
 Employees &volunteers must have adequate training, competency and must be qualified for
the job
 All hiring must be supervised by responsible officials.
 There must be proper budgetary controls.
 All documents must be approved. (in the case of receipt of donation plus disbursement of
donation)
 There must be significant controls on most risky areas (e.g. Receipt of Cash donations and
issue of donations & grants)

Audit evidence ( READ Only..)

Obtaining audit evidence is the major problem for such organizations and this may have an impact
on the auditor's opinion. Auditors should give special attention to:

 Understatement or incompleteness of the recording of all income including gifts in kind,

cash donations etc.
 Completeness of income can be a particularly problematic area. Areas auditors may verify
include:
 Loss of income through fraud ( theft of cash donations and donations in Kind )
 Recognition of government funding
 Recognition of income from professional fund raisers (N.G.Os) and informal fund
raising groups.
 Overstatement of cash grants or expenses
 Misuse in the application/ utilization of funds
 Misstatement or omission of assets including donated properties and gifts in kind.

Other factors to consider include:

 Income could be a risky area, particularly where money is donated or raised informally.
 There may be a limitation on the scope of the audit if obtaining audit evidence is problem.
(lack of documentation)
 There may be a lack of predictable income or identifiable relationship between expenditure
and income which could make analytical review less appropriate.
 Restricted funds may exist where the organisation is only allowed to use certain funds for
specific purposes. (eg child healthcare only or for orphans only)

Audit Procedures to Verify Income (Donations)

1. Obtain schedule of income / donation / subscription and cast to verify completeness &
accuracy.
2. Compare the various categories of income / donations against prior year & inquire from
management for significant variance.
3. For a sample of donations verify donations from cashbook & bank statement.

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Summary Notes by S.K
4. In case of donations obtained via charity events or similar events perform predictive test /
proof in total test and compare this with actual donations / charity recovered in financial
statement and inquire from management in case of any significant variance.
5. In case of donations received via post, agree sample of donations from donation account &
verify from cashbook & Banks statements.
6. Verify Material donations via correspondence or by dispatching donor confirmation

Internal Controls on RECIEPT SIDE

Cash donations Examples of controls
Collecting boxes and Numerical control over cash collection Boxes.
tins
Satisfactory sealing / locks of cash collection boxes.

Regular collection and recording of proceeds from collecting boxes

(proper reconciliation must be done)

Dual control over counting and recording of proceeds

Postal receipts Unopened mail to be kept secured (it may have cash or Cheques)

Dual control over mail opening (segregation of Duties)

Immediate recording of donations on opening of mail or receipt

Internal Controls on Use of Resources / allocation of Funds

1- Application of funds must be properly controlled
2- Utilization of funds must be supervised independently by trustees.
3- 3All funds must be utilized as per the authority/ terms of the donors.
4- Grant / donation must be utilized as per the objects of the N.P.O.

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Summary Notes by S.K
Extra Handout for N.P.O

Explain how the audit of small Not-for-profit organizations differs from the audit of for-profit
organizations
The duties and responsibilities of the auditors in respect of small not-for-profit organization are same
as those for a larger / profit-making organisation. However, the nature, timing and extent of the audit
procedures vary from entity to entity according to the judgement of the auditor.

Characteristics of small not-for-profit organizations and its impact on audit

The audit of small nor-for-profit entities varies from the audit of for-profit entities due to the special
characteristics of not-for-profit organisation. These characteristics are:

1.Internal control System

The main consideration which differs from a large profit including organisation is the internal control
system. As stated above, in many small not-for-profit entities a formal internal control system is lacking
on account of cost benefit analysis. For an internal control system to be effective, a fundamental rule is
that there should be segregation of duties between two or more persons in such a way that the work of
one person is automatically checked by another. However, in small not-for-profit entities, adequate staff
is not available to implement this rule.

Also, not-for-profit organizations are voluntary organizations and mostly non-professionals are
employed by these organizations. Many times, the trustees and employees are otherwise involved in
different operations. They cannot devote their whole time to the non-profit organizations.

This does not mean that there is no internal control not-for-profit entities. Although a formal internal
control may not exist, the manager may control the operations of the entity effectively. However, due
to the lack of a formal control system, it is difficult for an auditor to obtain audit evidence.

Whereas, in the case of larger entitles, an auditor can rely on the control system and reduce the extent
of audit procedures, in the case of small entities he normally has to extensively perform substantive
audit procedures.

Generally, those working in not-for-profit organizations are volunteers who may not be aware of the
importance of effective internal controls or, due to cost constraints; it is not possible to have effective
controls in this type of organisation

2.Unavailability of sufficient appropriate audit evidence

Many not-for-profit and / or small organizations are less formal. When the volunteers are managing
the entity, less documentation tents to be maintained.
In such a situation, the auditor has to perform more substantive audit procedures and less control
testing as less control exists.

For a matter material to the financial statements, if sufficient appropriate audit evidence is not
available, he may obtain management representation and evaluate its reliability

3.Lack of experts in accounting:

In the case of many charitable institutions, accounts are maintained by a person who has little
knowledge about accounting. For ensuring the finalization and preparation of the financial statements

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is correct they rely on the auditor. In this case, the auditor should ensure that his scope of work is
clearly defined in the letter of engagement.

Principally the auditor should not prepare the basic accounting records including making journal
entries etc. but generally he is asked to help management in preparation of the financial statements.
4.The purpose of a not-for-profit organisation and of an audit.
The primary objective of this kind of organisation is other than making a profit. They serve society as a
whole or a section of the society. They run on the money contributed for the well-being of the society
therefore this money should be used for the society and not for the benefit of those running the
organisation.
This difference in primary objectives makes a difference to the objective of the audit. The audit
objective of profit-making organizations is to express an independent audit opinion on the truth and
fairness of the financial statements. On the other hand, the objective of the audit of not-for profit
organizations is to determine whether the grants, donation, membership fees etc are utilized to meet the
organization's objectives and not misappropriated
Example: In a society by the employees of a company, membership fees are taken to run the society
and a benevolent (charitable)fund is created. According to the constitution, out of this fund, financial
help is provided to the family of the member after his demise. This is the proper utilisation of the fund.

However, this fund is utilised to purchase a flat for a member of management, this will not be proper
utilization of the society's fund since the fund is being used for the benefit of a particular person. This is
misappropriation of the fund.

Where the audit is a statutory requirement the auditor has to express an opinion on the truth and
fairness of the financial statements.

5.Source of money
Not-for--profit organizations, e.g. charitable institutions, schools, hospitals etc. accept donations and
grants to create funds and use that money for charitable purposes.

ln the case of clubs, associations, societies etc. members pay subscriptions and the club uses that money
to provide services to members and to run the club

An auditor has to ensure that the grants, donations etc. are utilised for the purpose for which they are
obtained (to meet the objectives of the organization) and are not misappropriated.

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CA CAF 8 - Practice Questions on N.P.O

S. No. Question Attempt Marks

1 Q.6 (b) ICAP March 2019 5 marks

2 Q.4 (b + c) ACCA Dec 2008 20 marks

ICAP CAF 8 March 2019 (5 marks)

Question 6 (b)
Ameer Welfare Trust (AWT) is engaged in providing education and three daily meals to the
underprivileged citizens of the society. Donation collection kiosks have been established at various
public spots which collect donations predominantly in cash.

The constitution of AWT states that administration costs should not exceed 10% of its income. Due to
this restriction, AWT has employed only one accountant who works on part time basis.

The constitution further requires AWT to maintain separate bank accounts for donations collected for
education and meals. Donors are requested to mention the purpose of donation. Donation received for
a specific purpose cannot be spent for any other purpose.

Required:
Identify the risks which AWT’s auditor would need to consider.

Answer 6 (b):
There is a risk of embezzlement in cash collection and inventory.
 Donation for food are recorded in donation for education account and vice versa.
 Contributions are spent on other than intended purpose.
 There is a risk that the money spent on administration is not recorded as administration cost
and is misclassified.
 Since only one person is responsible for managing the accounts, there is a lack of segregation of
duties and hence risk of fraud and error may arise.
 Since there is no full-time person to look after the accounts, there is a risk that transactions are
not recorded on a timely basis

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
ACCA F8 December 2008 (20 marks)
Question 4 (b + c)
b. Explain the term ‘audit risk’ and the three elements of risk that contribute to total audit risk.
(4 marks)
The Eukare charity was established in 1960. The charity’s aim is to provide support to children from
disadvantaged backgrounds who wish to take part in sports such as tennis, badminton and football.

Eukare has a detailed constitution which explains how the charity’s income can be spent. The
constitution also notes that administration expenditure cannot exceed 10% of income in any year. The
charity’s income is derived wholly from voluntary donations. Sources of donations include:

i. Cash collected by volunteers asking the public for donations in shopping areas,
ii. Cheques sent to the charity’s head office,
iii.Donations from generous individuals. Some of these donations have specific clauses attached to them
indicating that the initial amount donated (capital) cannot be spent and that the income (interest) from
the donation must be spent on specific activities, for example, provision of sports equipment.

The rules regarding the taxation of charities in the country Eukare is based are complicated, with only
certain expenditure being allowable for taxation purposes and donations of capital being treated as
income in some situations.

Required:
b. Identify areas of inherent risk in the Eukare charity and explain the effect of each of these risks on the
audit approach. (12 marks)
c. Explain why the control environment may be weak at the charity Eukare. (4 marks)
(20 marks)
Answer 4 (b + c):
b. Inherent Risk Areas

Detailed constitution
The charity has a detailed constitution which sets out how money may be spent. This increases the
inherent risk of the audit.

The auditors will need to spend time examining and becoming familiar with the constitution and design
their audit procedures with this in mind.

Limit on administration expenditure

The constitution states that administration expenditure cannot exceed 10% of income in any year.
This increases inherent risk as management may be tempted to misstate income or administration
expenditure so this limit is not breached.

Special attention will need to be devoted to income and expenditure to ensure that the 10% limit is not
breached legitimately.

Uncertainty of future income

The charity relies wholly on voluntary donations for its income which means that it cannot be assured of
receiving a minimum level of income from one year to the next. This increases the risk of it not being
able to continue.

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The auditors must bear in mind whether the charity can continue as a going concern when carrying out
their final review procedures. This will involve discussion with management and examination of
budgetary information.

Cash donations:
Some of the donations received will be in the form of cash collected from the public. There is a risk of
misappropriation of cash as a result.

Controls over cash should be examined as this is an area open to misappropriation and theft.

Donations from individuals

Some donations have clauses about how the money can be spent. This again increases inherent risk
because money may be misspent without regard for the conditions in place.

Where donations have been received with clauses attached the auditor will need to do detailed work to
ensure the conditions have not been breached.

Taxation legislation
There are complex rules in place regarding the taxation of charities.

The audit team will need to familiarise itself with the taxation rules for charities to ensure that this area
correctly dealt with.

c) Control environment
The control environment at Eukare may be weak, for a number of reasons.

The staff working at the charity may be volunteers who may not have accounts experience and who may
also not work there full-time. There may also be a high staff turnover because of the nature of the work.

There may be a lack segregation of duties in place due to the number of staff working at the charity. This
mean that trustees may play a role in the day to day running of the charity and there is therefore a risk of
override of any controls that are in place.

The charity may not have an internal audit department in place due to its size or the equivalent of an
audit committee to monitor its effectiveness.

There may also be lack of budgetary information being produced on a timely basis which increases
control risk from the auditor's point of view.

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
Student Notings

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KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Test Question Solution of Audit Risk:
Answer 1:

Risks and responses

Audit risk Auditor's response
Hart Co is a new client for Morph & Co. Morph & Co should ensure it has a suitably
As the audit team is not familiar with the experienced team assigned to the audit and that
accounting policies, transactions and balances of adequate time is allowed for team members to
Hart Co, there will be an increased detection risk on obtain an understanding of the company and the
the audit. risks of material misstatement, including a
detailed team briefing to cover the key areas of
There is also less assurance over opening balances risk.
as Morph & Co did not perform the audit last year.
Increased audit procedures should be performed
over opening balances.
The directors are paid a bonus based on a The audit team should be aware of the increased
percentage of profit before tax for the year. risks of manipulation and should assign more
experienced audit members to significant
There is a risk that the directors will try to overstate estimates and judgmental areas.
the profit, and therefore their bonuses by increasing
the revenue and income recorded and decreasing Also, adequate time should be allocated for team
expenses. This is a particular risk relating to members to obtain an understanding of the
judgmental areas such as provisions and estimates. company and the significant risks of
overstatement of profit, including attendance at
an audit team briefing.
The team needs to maintain professional
scepticism and be alert to the increased risk of
manipulation. Increased testing should be
performed relating to adjusting journal entries.
Customers pay a 25% deposit on signing the The audit team should obtain a copy of the
contract to purchase the playgrounds. contracts with customers and review them to
understand the performance obligations. They
The deposits should not be recognized as revenue should discuss with management the criteria for
immediately and instead should be recognized as determining whether performance obligations
deferred income (contract liabilities) within current have been satisfied and the treatment of deposits
liabilities until the performance obligations, as per received to ensure it is appropriate and consistent
the contracts, have been satisfied. This is likely to be with relevant standards.
at a point in time, when control of the playground is
passed to the customer. During the final audit, the audit team should
undertake increased testing over the cut-off of
There is a risk that revenue is overstated and current revenue and the completeness of deferred income
liabilities understated if the deposits have been (contract liabilities).
recorded within revenue.
The audit team will only attend the WIP counts at The auditor should assess which inventory counts
five of the 16 sites. the team will attend, most likely to be those with
the most material WIP balances or which are
WIP is a material balance and the valuation of WIP assessed as having the greatest risk of
is a judgmental area. misstatement.

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As the audit team is not attending all sites, detection For those inventory counts not attended, the
risk is increased as the team will be unable to audit team will need to obtain and review
directly obtain evidence relating to WIP. documentation relating to the controls
surrounding the counts and will need to review
reports from any experts used to value the WIP,
and any exceptions noted during the count and
discuss with management any issues which arise
during the count.
Hart Co offers its customers a warranty at no extra The audit team should discuss with management
cost, which guarantees the playgrounds will the basis of the provision calculation and compare
function as expected for three years. The provision this to industry averages and the level of post
is calculated as 2% of revenue in the current year year-end claims, if any, made by customers. In
against 6% in the prior year, despite there being no particular, they should discuss the rationale
changes in the construction techniques or the level behind reducing the level of provision this year.
of claims.
The audit team should also compare the prior
Under IAS 37 Provisions, Contingent Liabilities year provision with the actual level of claims in
and Contingent Assets this should be recognized as the year, to assess the reasonableness of the
a warranty provision. Calculating warranty judgements made by management.
provisions requires judgement as it is an uncertain
amount.

There is a risk that the warranty provision could be

understated, leading to understated expenses and
liabilities.
Hart Co has recognized $0.6m of research The audit team should obtain a breakdown of the
expenditure in profit or loss with the remaining research expenditure recognised in profit or loss
$1.2m having been capitalised as development and of the development costs capitalised and
expenditure. review supporting documentation to determine
whether they have been correctly classified. Any
IAS 38 Intangible Assets has strict criteria as to development expenditure should then be agreed
which costs can be capitalised as development as meeting the relevant criteria for
expenditure. There is a risk that the requirements of capitalisation as set out in IAS 38.
the standard have not been applied correctly.
The team should also discuss the accounting
If research costs have been incorrectly classified as treatment with the finance director and ensure it
development expenditure, there is a risk that is in accordance with IAS 38.
intangible assets could be overstated and research
expenses understated.
Hart Co placed an order for $2.4m of machinery, Review the non-current asset register to determine
paying $1m in advance. if the $1m paid in advance has been capitalised.
The machinery was due to be received in July 20XS Discuss the correct accounting treatment with
but will now be delivered post year end. management to confirm that the amount paid in
advance is recognised as a prepayment and if
Only assets which physically exist at the year-end incorrectly recognised review the correcting
should be capitalised as property, plant and Journal entry.
equipment (PPE).
The $1m deposit paid in advance should be
recognised as a prepayment.

If the deposit of $1m paid in advance has been

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Summary Notes by S.K
capitalised within PPE then prepayments are
understated and PPE will be overstated.

Hart Co made a rights issue in the year. This is a The audit team should obtain legal
non-standard transaction and there is increased risk documentation in support of the rights issue to
that the issue has not been recorded correctly. agree the number of shares issued and the rights
price. They should recalculate the split of share
The rights issue has been made at a premium and capital and share premium and agree this to the
therefore requires to be split into its share capital journal entry to record the rights issue.
and share premium elements. The audit team should also agree that disclosures
are adequate and consistent with standards and
There is a risk that the split between share capital legislation.
and share premium has not been accounted for
correctly and that these balances are misstated.
There is also a risk that the rights issue has not been
disclosed in accordance with accounting standards
and local company legislation.

Hart Co's payroll function is outsourced to an Discuss with management any changes to the
external service organisation. extent of records maintained at
Hart Co since the prior year audit and any
A detection risk arises as to whether sufficient and monitoring of controls which has been
appropriate evidence is available at Hart Co to undertaken by management over payroll.
confirm the completeness and accuracy of controls
over the payroll cycle and liabilities at Consideration should be given to contacting the
the year end. auditor of the service organisation, Chaz Co, to
confirm the level of controls in place. A type 1 or
Consideration should be given to the level of type 2 reports could be requested.
controls in place at the service organisation and
whether the data is reliable. If any errors occurred Consider the extent to which sufficient
these could result in the wages and salaries expense appropriate audit evidence can be obtained from
and any accruals being misstated. records held at Hart Co in respect of the wages
and salaries expense and liabilities.

Directors' remuneration disclosures have been made Discuss this matter with management and review
in line with IFRS® Standards but not local the requirements of local legislation to determine
legislation. if the disclosure in the financial statements is
included appropriately.
Where the local legislation is more comprehensive
than IFRS Standards it is likely that the company
must comply with local legislation.

The directors' remuneration disclosure will not be

complete if the additional information is not
disclosed.

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 KnS School of Business Studies
ACCA F8 - Audit & Assurance
Summary Notes by S.K
Test Question Solution of Understanding the Entity:
Answer 2:

a) The auditor should consider the following matters while obtaining understanding of APL and its
environment. This will involve following factors:
 Obtaining the understanding of the tourism industry in which APL operate.
 Inquire specific laws and regulation applicable on tourism industry.
 Understand APL’s operations, the range of services it offers and its dynamics.
 Obtain the ownership structure, management structures and types of current and planned
investments.
 Assess APL’s selection and application of accounting policies, including whether they are
appropriate for its business and consistent with the industry and the applicable financial
reporting framework.
 Obtain understanding of APL’s strategies of managing the tough competition and assess the
business risk which may result in risks of material misstatement.
 Review the APLs financial performance.
b)
S. No. Business risk Audit Risk
(i) Breach of the safety standards may result Liabilities of APL might be understated as a
in litigation against APL. result of non-recognition of the provision in
respect of the litigation.
Due to the increasing competition, any
such incident will also affect APL’s The disclosure regarding contingencies may not
reputation. adequately disclose the effects of the pending
litigation.
(ii) Frequent upgradation of equipment is The frequent upgradation of equipment might
required to prevent accidents. decrease the useful life of the equipment or
might need to be charged off instead of
capitalizing them.
(iii) APL’s competitor has introduced similar If the revenues keep on decreasing, APL’s
products at a low price which has affected equipment may need to be tested for
APL’s revenue. impairment.

(iv) Due to bank loan, APL will now have to In order to meet bank’s covenants, APL may
manage its debt load and all the terms and overstate its revenue or understate its expenses to
conditions of that loan. depict a better picture to its lenders.
(v) There is a risk that a client may cancel its There is a risk that APL may recognize
booking. Dealing with cancellation will commission as revenue
also effect revenue flow of APL.
(vi) It seems that APL may also face cash flow There is a risk that receivable from customers is
challenges as it would have to pay its debt overstated and a provision for doubtful
on time, whereas it would be receiving customers has not been recorded.
money from its customers later on.

There is also a risk that APL may offer

credit to those customers who are not
financially viable and would not be able to
pay on time.

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Summary Notes by S.K
Student Notings

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ACCA F8 - Audit & Assurance
Summary Notes by S.K
Student Notings

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