Paper P7: Advanced Audit and Assurance - Study text 2016

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Contents

Page

Introduction

Helping you to pass v

Studying P7 vii

The exam paper xiii

Syllabus and study guide xvi

Part A Regulatory environment 1 International regulatory environments for audit and assurance services 3

Part B Professional and ethical considerations 2 Code of ethics and conduct 35

3 Professional liability 69

Part C Practice management 4 Quality control 99

5 Obtaining and accepting professional appointments 113

Part D Audit of historical financial information 6 Planning and risk assessment 137

7 Evidence 185

8 Evaluation and review (I) 221

9 Evaluation and review (II) – matters relating to specific accounting issues 255

10 Evaluation and review (III) – matters relating to specific accounting issues 281

11 Group audits and transnational audits 321

Part E Other assignments 12 Audit-related services and other assurance services 355

13 Prospective financial information (PFI) 385

14 Forensic audits 399

15 Social, environmental and public sector auditing 411

16 Internal audit and outsourcing 441

Part F Reporting 17 Reporting 459

Part G Current issues and developments 18 Current issues 485

List of articles by the examining team 501

Practice question and answer bank 505

Index 587 Review form

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Helping you to pass

BPP Learning Media – Approved Content Provider

As ACCA's Approved Content Provider, BPP Learning Media gives you the opportunity to use study

materials reviewed by the ACCA examination team By incorporating the examination team's comments and suggestions regarding the depth and breadth of syllabus coverage, the BPP Learning Media Study

Text provides excellent, ACCA-approved support for your studies

The PER alert

Before you can qualify as an ACCA member, you not only have to pass all your exams but also fulfil a three

year practical experience requirement (PER) To help you to recognise areas of the syllabus that you

might be able to apply in the workplace to achieve different performance objectives, we have introduced

the 'PER alert' feature You will find this feature throughout the Study Text to remind you that what you are learning to pass your ACCA exams is equally useful to the fulfilment of the PER requirement

Your achievement of the PER should now be recorded in your online My Experience record

Tackling studying

Studying can be a daunting prospect, particularly when you have lots of other commitments The different

features of the Text, the purposes of which are explained fully on the Chapter features page, will help you while studying and improve your chances of exam success

Developing exam awareness

Our Study Texts are completely focused on helping you pass your exam

Our advice on Studying P7 outlines the content of the paper, the necessary skills you are expected to be able to demonstrate and any brought forward knowledge you are expected to have

Exam focus points are included within the chapters to highlight when and how specific topics have been examined, or how they might be examined in the future

Using the Syllabus and Study Guide

You can find the Syllabus and Study Guide on page xvii to xxviii of this Study Text

Testing what you can do

Testing yourself helps you develop the skills you need to pass the exam and also confirms that you can recall what you have learnt

We include Questions – lots of them – both within chapters and in the Practice Question Bank, as well as

Quick Quizzes at the end of each chapter to test your knowledge of the chapter content

Chapter features

Each chapter contains a number of helpful features to guide you through each topic

Topic list

Topic list Syllabus reference Tells you what you will be studying in this chapter

and the relevant section numbers, together with

ACCA syllabus references

Introduction Puts the chapter content in the context of the syllabus as a whole

Exam guide Highlights how examinable the chapter content is likely to be and the ways in which it could be

Examples Demonstrate how to apply key knowledge and techniques

earn you easy marks in exams

Exam focus points

Tell you when and how specific topics have been examined, or how they may be examined in the future

Formula to learn Formulae that are not given in the exam but which

have to be learnt

This is a new feature that gives you a useful indication of syllabus areas that closely relate to performance objectives in your Practical Experience Requirement (PER)

Question Essential practice of techniques covered in the chapter Case Study Real world examples of theories and techniques

Chapter Roundup A full list of the Fast Forwards included in the chapter, providing an easy source of review

Quick Quiz A quick test of your knowledge of the main topics in the chapter

Practice Question Bank Found at the back of the Study Text with more comprehensive chapter questions Cross

referenced for easy navigation

FAST FORWARD

Studying P7

As the name suggests, this paper examines advanced audit and assurance topics Paper P7 is one of the professional level Options papers and as such candidates must consider carefully whether they have the

required competencies

The P7 examination team

The examination team expects you to demonstrate a highly professional approach to all questions – not just presenting information in a professional manner, but also integrating knowledge and understanding

of topics from across the syllabus The examination team is also very keen for students to demonstrate

evidence of wider reading and to demonstrate an understanding of current issues as they affect audit and

assurance At the absolute minimum you should read Student Accountant The examination team often

examines topics that it has written about in Student Accountant

Syllabus update

The P7 syllabus has been updated for the September 2015 sitting onwards The full syllabus and Study

Guide can be found in this Study Text on pages xvii to xxviii

1 What P7 is about

The aim of the syllabus is to analyse, evaluate and conclude on the assurance engagement and other audit and assurance issues in the context of best practice and current developments

The paper builds on the topics covered in Paper F8 Audit and Assurance but as an advanced paper it tests

much more than just your knowledge of ISAs and your ability to list standard audit procedures You must

be able to apply your knowledge to more complex audit and assurance scenarios, identifying and

formulating the work required to meet the objectives of audit and non-audit assignments and to evaluate

the findings and results of work performed Accounting knowledge examined in Paper P2 Corporate

Reporting is also assumed Therefore, candidates studying for P7 should refer to the Accounting

Standards listed under P2

The syllabus is divided into seven main sections:

(a) Regulatory environment

This section introduces the legal and regulatory environment including corporate governance

issues It also examines the topics of money laundering and the consideration of laws and

regulations

(b) Professional and ethical considerations

The details of the various ethical codes should be familiar to you from your earlier studies,

however the importance of this topic should not be underestimated The examination team has

indicated that ethical and professional issues are likely to feature in every sitting This section also

covers fraud and professional liability, both of which are topical issues

(c) Practice management

This part of the syllabus covers quality control, tendering and professional appointments It also

covers advertising, publicity, obtaining professional work and fees

(d) Audit of historical financial information

This is the largest section of the syllabus looking in detail at the procedures involved in a range of audit and assurance assignments The examination team has indicated that evidence gathering is a key part of the syllabus and is likely to feature at each sitting Requirements are likely to focus on

specific assertions, balances or transactions

(e) Other assignments

This section also covers a range of audit-related and assurance services The examination team

has stressed the need for candidates to be able to tackle these types of scenario

(f) Reporting

The detail of audit reports should be familiar to you from your earlier studies At this level you will

be expected to apply this knowledge to more complex scenarios The examination team has also stressed the importance of the relationship between financial reporting and auditing This will be

particularly important when forming an appropriate audit opinion This section of the syllabus also includes reports to management and other reports

(g) Current issues and developments

Current issues and developments includes a wide range of topics including the IAASB clarity project, professional, ethical and corporate governance, information technology, going concern, transnational audits and social and environmental auditing The examination team has indicated that this is likely to be examined at each sitting, and that candidates are expected to have read

around the issues for themselves You will need to be able to discuss current issues topics in the

context of a client scenario

2 Skills you have to demonstrate

2.1 Knowledge and application

Even with exams you've previously taken, you'll remember that passing didn't only mean reproducing

knowledge You also had to apply what you knew At Professional level, the balance is tilted much more

towards application You will need a sound basis of technical knowledge The exams will detect whether you have the necessary knowledge However, you won't pass if you just spend your time acquiring knowledge Developing application skills is vital

2.2 Application skills

 A thorough understanding of the relevant audit, assurance and financial reporting regulations that fall within the syllabus

 The ability to apply knowledge to specific client scenarios

 The ability to have an independent opinion, backed by reasoned argument

 An appreciation of commercial factors which influence practice management

 An appreciation of fast-moving developments in audit and assurance practices The P7 examination team made very similar comments in a number of recent examiner's reports which is

so important that we will quote it here These pitfalls tend not to change from year to year:

'Similar factors as detailed in previous examiner's reports continue to contribute to the unsatisfactory pass rate:

 Failing to answer the specific question requirements

 Not applying knowledge to question scenarios

 Not explaining or developing points in enough detail

 Lack of knowledge on certain syllabus areas

 Illegible handwriting'

'As seen in previous sittings, what makes the difference between a pass and a fail script is usually

the level of application skills which have been demonstrated Candidates who answer the specific question requirement, and tailor their answers to the scenarios provided are likely to do well.'

(Examiner's Report, June 2011)

3 How to pass

3.1 Study the whole syllabus

Study the entire syllabus Although Section B of the paper contains an optional element, the two questions

in Section A are compulsory and could cover a range of topics from across the syllabus Question spotting

at this level is unwise and not recommended

3.2 Focus on themes, not lists

There are quite a number of lists in the Texts This is inevitable because corporate governance guidance quoted as best practice is often in list form Lists are also sometimes the clearest way of presenting

information However, the examination team has stressed that passing the exam is not a matter of learning

and reproducing lists Good answers will have to focus on the details in the scenario and bring out the

underlying themes that relate to the scenario The points in them will have more depth than a series of

single-line bullet points

3.3 Read around

Read the financial press and relevant websites for real life examples – the examination team is specifically

looking for evidence of wider reading

Read Student Accountant (the ACCA's student magazine) regularly – it often contains technical articles

written either by or on the recommendation of the examination team which can be invaluable for future

exams

3.4 Lots of question practice

You can develop application skills by attempting questions in the Exam Question Bank and later on in the

BPP Learning Media Practice & Revision Kit

4 Answering questions

Practise as many questions as you can under timed conditions – this is the best way of developing good exam technique Make use of the Question Bank at the back of this Text BPP's Practice & Revision Kit

contains numerous exam-standard questions (many of them taken from past exam papers) as well as

three mock exams for you to try

Section A questions will be the case study type of question – make sure you relate your answers to the

scenario rather than being generic Answers that are simply regurgitated from Texts are unlikely to score highly

Present your answers in a professional manner – there are between four and six professional marks

available for setting answers out properly and for coherent, well structured arguments and

recommendations You should be aiming to achieve all of these marks

Consider the question requirement carefully so that you answer the actual question set

Answer plans will help you to focus on the requirements of the question and enable you to manage your time effectively

Answer the question that you are most comfortable with first – it will help to settle you down if you feel

you have answered the first question well

4.1 Analysing question requirements

It's particularly important to consider the question requirements carefully to make sure you understand exactly what the question is asking, and whether each question part has to be answered in the context of

the scenario or is more general You also need to be sure that you understand all the tasks that the

question is asking you to perform

Remember that every word will be important If for example you are asked to:

'Explain the importance of identifying all risks that Company X is facing', then you would explain that:

 Taking risks is bound up with strategic decision making

 Some risks may have serious consequences

 Identifying all risks means they can be prioritised and managed efficiently and effectively

You would not identify all the risks that Company X would be facing

4.2 Understanding the question verbs

Verbs that are likely to be frequently used in this exam are listed below, together with their intellectual levels and guidance on their meaning

Intellectual level

1 Define Give the meaning of

1 Identify Recognise or select

1 Describe Give the key features

2 Distinguish Define two different terms, viewpoints or concepts on the

basis of the differences between them

3 Examine Critically review in detail

3 Discuss Examine by using arguments for and against

3 Explore Examine or discuss in a wide-ranging manner

3 Criticise Present the weaknesses of / problems with the actions

taken or viewpoint expressed, supported by evidence

3 Evaluate/critically

evaluate

Determine the value of in the light of the arguments for and against (critically evaluate means weighting the answer towards criticisms / arguments against)

3 Construct the case Present the arguments in favour or against, supported by

evidence

3 Recommend Advise the appropriate actions to pursue in terms the

recipient will understand

A lower level verb such as define will require a more descriptive answer A higher level verb such as evaluate will require a more applied, critical answer The examination team has stressed that higher-

level requirements and verbs will be most significant in this paper, for example critically evaluating a statement and arguing for or against a given idea or position The examination team is looking to set questions that provide evidence of student understanding

Certain verbs have given students particular problems

(a) Identify and explain

Although these verbs are both Level 1, the examination team sees them as requiring different

things You have to go into more depth if you are asked to explain than if you are asked to identify

An explanation means giving more detail about the problem or factor identified, normally meaning

that you have to indicate why it's significant If you were asked to:

(i) Identify the main problem with the same person acting as chief executive and chairman

– you would briefly say excessive power is exercised by one person

(ii) Explain the main problem with the same person acting as chief executive and chairman

– you would say excessive power is exercised by one person and then go on to say it would mean that the same person was running the board and the company As the board is meant

to monitor the chief executive, it can't do this effectively if the chief executive is running the board Also, you may be asked to explain or describe something complex, abstract or philosophical in nature

(b) Evaluate

Evaluate is a verb that the examination team uses frequently Its meaning may be different from the way that you have seen it used in other exams The examination team expects to see arguments for

and against, or pros and cons for what you are asked to evaluate

Thus for example if a question asked you to:

'Evaluate the contribution made by non-executive directors to good corporate governance in companies'

You would not only have to write about the factors that help non-executive directors make a worthwhile contribution (independent viewpoint, experience of other industries) You would also have to discuss the factors that limit or undermine the contribution non-executive directors make (lack of time, putting pressure on board unity)

If the examination team asks you to critically evaluate, you will have to consider both viewpoints However you will concentrate on the view that you are asked to critically evaluate, as the mark scheme will be weighted towards that view

4.3 Content of answers

Well-judged, clear recommendations grounded in the scenario will always score well, as markers for this

paper have a wide remit to reward good answers You need to be selective As we've said, lists of points

memorised from Texts and reproduced without any thought won't score well

The examination team identified lack of application skills as a serious weakness in many student answers What constitutes good application will vary question by question but is likely to include:

 Only including technical knowledge that is relevant to the scenario For example, although the

SPAMSOAP mnemonic can be a useful memory aid, you shouldn't quote it in full just because the question requirements contain the word 'control'

 Only including scenario details that support the points you are making, for example quoting from

the scenario to explain why you're making a particular recommendation

 Tackling the problems highlighted in the scenario and the question requirements

 Explaining why the factors you're discussing are significant

 Taking a top-down strategic approach – remember that at Professional level you're meant to be adopting the viewpoint of a partner or finance director Excessive detail about operations is not important

Important!

5 Gaining professional marks

As P7 is a Professional level paper, four professional level marks will be awarded in a Section A question

These are marks allocated not for the content of an answer, but for the degree of professionalism with which certain parts of the answer are presented

The examination team has stated that some marks may be available for presenting your answer in the form of a letter, presentation, memo, report, briefing notes, management reporting, narrative or press statement You may also be able to obtain marks for the layout, logical flow and presentation of your answer You should also make sure that you provide the points required by the question

Whatever the form of communication requested, you will not gain professional marks if you fail to follow the basics of good communication Keep an eye on your spelling and grammar Also think carefully, am I saying things that are appropriate in a business communication?

6 Brought forward knowledge

The P7 syllabus assumes knowledge brought forward from F8 Audit and Assurance It also assumes knowledge from Paper F7 Financial Reporting and Paper P2 Corporate Reporting It is very important to be

comfortable with your financial reporting studies because such aspects are likely to come up in based questions in Sections A and B of this paper

scenario-The P7 examination team has written a number of articles relevant to the P7 exam and it is highly recommended that you read them A list of these articles can be found after Chapter 18 of this Study Text

Important!

The exam paper

Format of the paper

Number of marks

Section A: Two compulsory questions:

Section B: Choice of two from three questions (20 marks each) 40

100 Time allowed: 3 hours

Guidance

Section A will consist of two compulsory 'case study' style questions These will include detailed

information including, for example, extracts from financial statements and audit working papers The

questions will include a range of requirements covering different syllabus areas

Section B questions will tend to be more focused towards specific topic areas, such as ethical issues and

auditor's reports Short scenarios will be provided as a basis for these questions

Analysis of past papers

The table below provides details of when each element of the syllabus has been examined and the question number and

section in which each element appeared Further details can be found in the Exam Focus Points in the relevant chapters

1 International

regulatory frameworks for audit and assurance services

considerations

2 Codes of ethics for

professional accountants

1(d), 4(b)

4 1(c) 4 1(b),

2(a)

1(a), 3(b)

1(b), 3(b), 4

2(b) 3(a) 2(a),

4(b) 3(b), 4 4(b) 4 4

3 Professional

liability

Practice Management

5 Advertising,

publicity, obtaining professional work and fees

(i) Planning, materiality and assessing the risk of misstatement (ii) Evidence (iii) Evaluation and review

1(a)–(c),

2, 3(a), 5(b)

1, 3, 4 1, 3, 5 1(a), 3,

4(b), 5(b), (c)

1, 2, 3(a)-(b), 5(a)

1(a), 2(b), 3(a)-(b), 5(a)

1(a), 2(a)-(b), 3(a)-(c), 5(a)-(b)

1, 2, 3(b)

1(a), 2(c), 3(a)-(c)

1, 3(b), 5(a)

1, 2(a)-(b),

5

1(a), 1(b), 1(c), 3(a), 3(b)

1(a), 1(b),

3, 5

3(b)

13 Prospective

financial

information

2(a) 2(a) 2(a) 3

Syllabus and Study Guide

© ACCA 2015-2016 All rights reserved

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© ACCA 2015-2016 All rights reserved.

© ACCA 2015-2016 All rights reserved.

Regulatory environment

P A R T A

Topic list Syllabus reference

1 International regulatory frameworks for audit and

environments for audit

and assurance services

Introduction

This chapter covers a wide range of regulations that affect the work of audit

and assurance professionals You need to be aware of the international nature

of the audit and assurance market and the main issues driving the development

of regulatory frameworks

The detailed requirements relating to money laundering are then discussed

You should be prepared to explain the responsibilities of professional

accountants in this area and to outline the procedures that audit firms should

implement

The final section looks at the auditor's responsibilities in respect of laws and

regulations that apply to an audit client This is a topic that could be built in to a

practical case study question

Study guide

Intellectual level

A Regulatory environment A1 International regulatory frameworks for audit and assurance services

(a) Explain the need for laws, regulations, standards and other guidance relating

to audit, assurance and related services 2 (b) Outline and explain the legal and professional framework including:

(i) Public oversight to an audit and assurance practice (ii) The role of audit committees and impact on audit and assurance practice

2

A2 Money laundering

(a) Define 'money laundering' 1 (b) Explain how international efforts seek to combat money laundering 2 (c) Explain the scope of criminal offences of money laundering and how

professional accountants may be protected from criminal and civil liability 2 (d) Explain the need for ethical guidance in this area 2 (e) Describe how accountants meet their obligations to help prevent and detect

money laundering including record keeping and reporting of suspicion to the appropriate regulatory body

2 (f) Explain the importance of customer due diligence (CDD) 2 (g) Recognise potentially suspicious transactions and assess their impact on

(h) Describe, with reasons, the basic elements of an anti money laundering

A3 Laws and regulations

(a) Compare and contrast the respective responsibilities of management and

auditors concerning compliance with laws and regulations in an audit of financial statements

2

(b) Describe the auditor's considerations of compliance with laws and

regulations and plan audit procedures when possible non-compliance is discovered

2 (c) Discuss how and to whom non-compliance should be reported 2 (d) Recognise when withdrawal from an engagement is necessary 2

Exam guide

The technical content of this part of the syllabus is mainly drawn from your earlier studies Questions in this paper are unlikely to ask for simple repetition of this knowledge, but are more likely to require explanation or discussion of the reasons behind the regulations

1 International regulatory frameworks for audit and

Major developments in international regulation of audit and assurance have recently concluded, with reaching effects on ISAs

far-1.1 The need for laws, regulations, standards and other guidance

Corporate scandals, such as Enron and Worldcom in the US, Olympus in Japan and Autonomy in the UK, have brought the audit profession under close scrutiny from investors, businesses, regulators and others Businesses have become more complex and global, and firms of accountants have expanded their range

of services well beyond traditional assurance and tax advice This has led to a great deal of re-examination

of regulatory and standard-setting structures both nationally and internationally in recent years

1.2 The legal and professional framework

One of the competencies you require to fulfil Performance Objective 18 of the PER is the ability to describe the audit regulatory and legal framework You can apply the knowledge you obtain from this section of the Study Text to help you demonstrate this competency

You have studied the regulatory framework in earlier papers The following summaries will provide a quick reminder Note that the UK regulatory framework is given in this International-stream Study Text as an example only

1.2.1 Overview of the UK regulatory framework

The EU Eighth Directive on company law requires that persons carrying out statutory audits must be approved by the authorities of EU member states The authority to give this approval in the UK is delegated

to Recognised Supervisory Bodies (RSBs) An auditor must be a member of an RSB and be eligible under its own rules The ACCA is an RSB

The RSBs are required by the Companies Act to have rules to ensure that persons eligible for appointment

as a company auditor are either:

 Individuals holding an appropriate qualification

 Firms controlled by qualified persons

The Financial Reporting Council

The Financial Reporting Council (FRC) is the UK's independent regulator for corporate reporting and governance Its structure has recently been revised

The FRC now has the following core structure and responsibilities under the overarching FRC Board

 Codes and Standards Committee – responsible for actuarial policy, audit and assurance, corporate governance, and accounting and reporting policy

 Conduct Committee – responsible for audit quality review, corporate reporting review, professional discipline, professional oversight, and supervisory inquiries

 Executive Committee – providing day to day oversight of the work of the FRC

FAST FORWARD

The main changes that concern P7 students are:

 The APB (Auditing Practices Board) is no longer responsible for auditing standards (ISAs) This

is now the direct responsibility of the FRC Board – but the Board is advised by the new 'Codes and Standards Committee', which is in turn advised by the new 'Audit and Assurance Council'

 The ASB (Accounting Standards Board) is no longer responsible for accounting standards Again, this responsibility has now passed to the FRC Board, which is advised by the 'Codes and Standards Committee' and the 'Accounting Council' in turn

The revised role of the FRC Board is:

 To set high standards of corporate governance through the UK Corporate Governance Code

 To set standards for corporate reporting and actuarial practice

 To monitor and enforce accounting and auditing standards

 To oversee regulatory activities of the actuarial profession and professional accountancy bodies

 To operate independent disciplinary arrangements for public interest cases The revised structure is shown by the following diagram

Although this restructure took place some time ago, the FRC is still in the process of 'rebranding' documents and other publications issued by the former APB and other bodies under the old structure You will therefore see references in the Text to APB pronouncements where these still exist and are in force

Point to note

1.2.2 International standard setting

International Standards on Auditing (ISAs) are produced by the International Auditing and Assurance

Standards Board (IAASB), a technical standing committee of the International Federation of Accountants (IFAC) You should also be familiar with the International Ethics Standards Board for Accountants (IESBA),

another body of IFAC and the producer of the Code of Ethics (see Chapter 2)

The IAASB's Preface to International Standards on Quality Control, Auditing, Assurance and Related

Services Pronouncements states that all the IAASB's 'engagement standards' above are 'authoritative

material', which means that they must be followed in an audit that is conducted in accordance with ISAs The IAASB also publishes four kinds of 'non-authoritative material'

 International Auditing Practice Notes (IAPNs) These do not impose additional requirements on

auditors, but provide them with practical assistance

 Practice Notes Relating to Other International Standards, eg in relation to ISREs, ISAEs or ISRSs

 Staff Publications, which are used to help raise awareness of new or emerging issues, and to direct attention to the relevant parts of IAASB pronouncements

 Consultation Papers, which seek to generate discussion with stakeholders

Within each country, local regulations govern, to a greater or lesser degree, the practices followed in the auditing of financial or other information Such regulations may be either of a statutory nature, or in the form of statements issued by the regulatory or professional bodies in the countries concerned

National standards on auditing and related services published in many countries differ in form and

content The IAASB takes account of such documents and differences and, in the light of such knowledge, issues ISAs which are intended for international acceptance

The European Union, for example, has since 2014 required ISAs (as issued by the IAASB) to be adopted at

EU level Member states may impose additional requirements on auditors (such as the FRC, whose ISAs (UK and Ireland) are in some places more stringent than the IAASB's ISAs) but these must not contradict

EU ISAs

IFAC

(International Federation of Accountants)

IAASB

(International Auditing and

Assurance Standards Board)

 Code of Ethics for

Professional Accountants

The IAASB issued A Framework for Audit Quality (February 2014) in this area, which is covered in Chapter

18

1.2.3 The IAASB clarity project

In 2003 the IAASB reviewed the drafting conventions used in its ISAs, with a view to improving the clarity and overall understandability, and therefore the consistent application of its ISAs

The IAASB's Preface to international standards on quality control, auditing, review, other assurance and

related services (2007) established the conventions to be used by the Board in drafting future ISAs In

accordance with this, redrafted ISAs are structured as follows

 Objective. This provides the context in which the requirements of the ISA are met

 Requirements. These are contained in a separate section and expressed using the word 'shall'

 Application and other explanatory material. This is an integral part of the ISA

1.2.4 Current ISAs

No Title

200 Overall Objective of the Independent Auditor, and the Conduct of an Audit in Accordance with International Standards on Auditing

210 Agreeing the Terms of Audit Engagements

220 Quality Control for an Audit of Financial Statements

230 Audit documentation

240 The Auditor's Responsibilities Relating to Fraud in an Audit of Financial Statements

250 Consideration of Laws and Regulations in an Audit of Financial Statements

260 Communication with Those Charged with Governance

265 Communicating Deficiencies in Internal Control to Those Charged with Governance and Management

300 Planning an Audit of Financial Statements

315 Identifying and Assessing the Risks of Material Misstatement through Understanding the Entity and Its Environment (Revised)

320 Materiality in Planning and Performing an Audit

330 The Auditor's Responses to Assessed Risks

402 Audit Considerations Relating to an Entity Using a Service Organization

450 Evaluation of Misstatements Identified during the Audit

No Title

610 Using the Work of Internal Auditors (Revised)

620 Using the Work of an Auditor's Expert

700 Forming an Opinion and Reporting on Financial Statements

705 Modifications to the Opinion in the Independent Auditor's Report

706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor's Report

710 Comparative Information – Corresponding Figures and Comparative Financial Statements

720 The Auditor's Responsibilities Relating to Other Information in Documents Containing Audited Financial Statements

ISQC 1 Quality Controls for Firms that Perform Audits and Reviews of Financial Statements, and Other

Assurance and Related Services Engagements

Notes

1 Students should be aware of the nature and meaning of the audit report and should be able to discuss the contents and wording of the report Students would not be asked to reproduce the audit report in full in an exam question, but they may be requested to prepare explanatory paragraphs for inclusion in the report, particularly in situations leading to a modified report

2 Students are advised that questions will be based on the principles and good practice set out in the ISA

International standards are quoted throughout this Text and you must understand how they are applied in practice Make sure you refer to auditing standards when answering questions

1.3 Public oversight

Public oversight of the audit profession and of standard setting has been a trend in recent regulatory developments internationally

1.3.1 Public oversight internationally

The Public Interest Oversight Board (PIOB) exists to exercise oversight for all of IFAC's 'public interest

activities' including its standard-setting bodies such as the IAASB Its work involves:

 Monitoring the standard-setting boards

 Overseeing the nomination process for membership of these boards

 Co-operation with national oversight authorities The objective of the international PIOB is to increase the confidence of investors and others that the public interest activities of IFAC are properly responsive to the public interest The PIOB is based in Madrid, Spain, where it operates as a non-profit Spanish foundation

1.3.2 Other examples of public oversight

An example of public oversight is the Professional Oversight team of the UK's FRC (formerly the Professional Oversight Board, or POB), which has a number of statutory responsibilities These include:

 Independent oversight of the regulation of statutory auditors by the RSBs (eg ACCA)

 Independent supervision of Auditors General in respect of the exercise of their function as statutory auditors

 The receipt of statutory change of auditor notifications from companies and statutory auditors in

respect of 'major audits'

Exam focus

point

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Case Study

Among other significant scandals in America in recent history was the Enron scandal, when one of the country's biggest companies filed for bankruptcy The scandal also resulted in the disappearance of Arthur

Andersen, one of the then-Big Five accountancy firms who had audited Enron's financial statements The

main reasons why Enron collapsed were over-expansion in energy markets, too much reliance on derivatives trading which eventually went wrong, breaches of federal law, and misleading and dishonest behaviour However, enquiries into the scandal exposed a number of deficiencies in the company's governance:

(a) A lack of transparency in the financial statements, especially in relation to certain investment

vehicles that were kept off balance sheet

(b) The non-executive directors were weak, and there were conflicts of interest

(c) Inadequate scrutiny by the external auditors Arthur Andersen failed to spot or failed to question

dubious accounting treatments Since Andersen's consultancy arm did a lot of work for Enron, there were allegations of conflicts of interest

(d) Information asymmetry where the directors and managers knew more than the investors

(e) Executive compensation methods were meant to align the interests of shareholders and directors, but seemed to encourage the overstatement of short-term profits Particularly in the USA, where the tenure of Chief Executive Officers is fairly short, the temptation is strong to inflate profits in the hope that share options will have been cashed in by the time the problems are discovered

In the US, the response to the breakdown of stock market trust caused by perceived inadequacies in

corporate governance arrangements and the Enron scandal was the Sarbanes-Oxley Act 2002 The Act

applies to all companies that are required to file periodic reports with the Securities and Exchange Commission (SEC)

The Public Company Accounting Oversight Board (PCAOB) is a private sector body in the USA created by

Sarbanes-Oxley Its aim is to oversee the auditors of public companies Its stated purpose is to 'protect the interests of investors and further the public interest in the preparation of informative, fair and independent audit reports' Its powers include setting auditing, quality control, ethics, independence and other standards relating to the preparation of audit reports by issuers It also has the authority to regulate the non-audit services that audit firms can offer

Sarbanes-Oxley has been criticised in some quarters for not being strong enough on certain issues, for

example the selection of external auditors by the audit committee, and at the same time being over-rigid

on others Directors may be less likely to consult lawyers in the first place if they believe that legislation could override lawyer-client privilege

In addition, it has been alleged that a Sarbanes-Oxley compliance industry has sprung up focusing companies' attention on complying with all aspects of the legislation, irrespective of how significant they

may be This has distracted companies from improving information flows to the market and then allowing

the market to make well-informed decisions The Act has also done little to address the temptation provided by generous stock options to inflate profits, other than requiring possible forfeiture if financial statements are subsequently restated

Most significantly, perhaps, there is recent evidence of companies turning away from the US stock

markets and towards other markets, such as London An article in the Financial Times suggested that this

was partly due to companies tiring of the increased compliance costs associated with Sarbanes-Oxley implementation In addition, the nature of the regulatory regime may be an increasingly significant factor

in listing decisions