Audit Method: Inventory Count

As per the requirements of ISA 501, if inventory is material to the financial statements, the auditor shall obtain sufficient appropriate audit evidence regarding the existence and condition of inventory by: a) attendance at physical inventory counting; b) performing audit procedures over the entity’s final inventory records to determine whether they accurately reflect actual inventory count results.

An Inventory count is carried out by business either: 

• to corroborate information contained in their books and records which is the product of a continuous accounting and control system, or
• to provide an inventory figure for inclusion in financial statement and to use in calculating profit where there is no system of continuous inventory accounting.

 The purposes of the physical inventory observation by auditor are to determine that

 the inventory actually exists,

• the methods of inventory taking are effective in obtaining accurate counts, and
• the inventory is in a usable and salable condition in the normal course of business (e.g., not damaged or obsolete).

It should be remembered that while the auditor will himself carry out test counts and extract certain cut-off information he is primarily there to observe that the client’s procedure are satisfactory. Where the client has an efficient system for inventory records, the physical inventory may be carried out on a continuous basis as opposed to counting everything in one go at the year-end. In the case of a client using the continuous basis, the auditor will still be required to observe a part of this continuous inventory counting.

  

Recommendation

When conducting inventory count at year end special attention needs to be paid by the auditor to apply proper cut off procedures (testing last receiving and shipping transaction), reconciling inventory count to the general ledger, testing high value items, testing inventory in transit, testing the inventory at third party warehouses, testing inventory cost including freight charges and testing for lower of cost or net realizable value/market etc. The working paper should be prepared in such a manner that the information can be easily followed up at the final audit visit. Test counts for example should have been traced to the stock sheets to confirm that they are a proper record of the results of the physical inventory.

Audit Firms: Non-Audit Services

Growth in consultancy among the Big Four is outpacing their traditional tax and audit services, while the firms are also outperforming management consultants. Big Four firms have been steadily rebuilding their consultancy arms through a series of acquisitions in order to compensate for stagnating growth for traditional audit work. The type of non-audit services that audit firms provide ranges widely from audit firm to audit firm. They may include professional advice on transactions (for example, a merger, acquisition or restructuring) as well as tax and broader business advisory services (including performance improvement and information technology). Non-audit services may also include advisory work to assist companies to comply with laws and regulations.

The strict regulations imposed by Sarbanes Oxley Act introduced in USA led to a rash of sales of consultancy divisions by the auditing firms. IBM for instance bought PwC's consulting arm, E&Y Consulting had already sold to Cap Gemini and KPMG did an IPO of KPMG Consulting, which then became BearingPoint. But by the time the Big Four's non-compete clauses expired, typically in three to five years, consulting was back as a high-focus area at the accounting firms.

Soon after the Enron controversy died, the accounting firms realized that regulations could be taken care of if they built a practice that largely consisted of non-audit clients where conflict situations didn't arise; and where there was overlap, they could always avoid selling certain services. And that's what they did. Deloitte recorded a revenue figure of US$ 34.2 billion (2014) with growth for consulting at 10.3 percent. EY advisory grew by 14.4% as compared to assurance growth of 4.5% in 2014. Out of PWC total revenue of US$ 34 billion in 2014 18.8 billion was generated by Tax and Advisory Services. Kpmg total advisory revenues for the year 2014 were up by 10.4% to US$9.09 billion, up from 6.5% in FY13.

That's indeed a high turnaround from 2002 when following Enron's bankruptcy and the dissolution of Arthur Andersen, KPMG and PwC dumped their consulting arms; Ernst & Young had already done so in 2000. The sell-off was a reaction to a toughened up Sarbanes-Oxley Act that restricted the scope of non-audit services that could be offered to audit clients to limit any conflict of interest.

Additional Thoughts

In many countries the codes of corporate governance forbids auditors to provide non-audit services to audit clients if that would present a threat to independence for which no adequate safeguards are available. It is the responsibility of the audit committee being the representative of shareholders to oversee the relationship between the auditor and the company. The audit committee must scrutinize the provision of non-audit services by the audit firms and must have to make sure that the independence and objectivity of the audit firm is not compromised.  

Week-End: The Rope for Young Elephants

As a man was passing by the elephants, he suddenly stopped, confused by the fact that these huge creatures were being held by only a small rope tied to their front leg. No chains, no cages. It was obvious that the elephants could, at any time, break away from their bonds but for some reason, they did not.

He saw a trainer nearby and asked why these animals just stood there and made no attempt to get away. “Well,” trainer said, “when they are very young and much smaller we use the same size rope to tie them and, at that age, it’s enough to hold them. As they grow up, they are conditioned to believe they cannot break away. They believe the rope can still hold them, so they never try to break free.”

The man was amazed. These animals could at any time break free from their bonds but because they believed they couldn’t, they were stuck right where they were. Like the elephants, how many of us go through life hanging onto a belief that we cannot do something, simply because we failed at it once before?

For all the aspiring accountancy career students; “Failure is part of learning; we should never give up the struggle in life.”

Audit News Briefing: 24 September 2015

Audit-is-cool is pleased to accumulate and provide its readers with the news on audit and related topics:

September 21, 2015

Accounting Today

US: PCAOB Strikes Deal with Luxembourg

“This agreement with the Luxembourg audit regulator reflects the strength and depth of our relationships in Europe.” – is the statement of PCAOB Chairman James R. Doty when US accounting and audit regulator, Public Company Accounting Oversight Board has entered into a cooperative arrangement with Luxembourg’s audit regulator, the Commission de Surveillance du Secteur Financier of Luxembourg. This is in relation to the oversight of audit firms subject to the regulatory jurisdictions of both regulators. Please follow link for details: http://www.accountingtoday.com/news/audit-accounting/pcaob-strikes-deal-with-luxembourg-75850-1.html

September 16, 2015

Accounting Today

Global: Demands Increase on Financial Service Internal Auditors

“This latest report in the Common Body of Knowledge series provides a provocative and in-depth look at modern financial services internal auditing,” said Institute of Internal Auditors global chairman Larry Harrington in a statement. “Its analysis provides real insight into some of the most vexing challenges the profession will face as it meets growing demands for services.” This is concerning the financial service industry as pressures for internal auditors are growing quickly around the world. The report examined the challenges facing the profession, identified regulatory requirements, and technology risks or threats involved. Please follow link for details: http://www.accountingtoday.com/news/audit-accounting/demands-increase-on-financial-service-internal-auditors-75803-1.html

September 3, 2015

Computer Business Review

Top 5 IT Security Audit Questions

The CBR Online recently featured in their Cybersecurity/Business segment, the most common audit compliance questions asked by external IT auditors to determine whether a company is able to safeguard its most valuable assets.

They are, as follows:

1. Do you have a documented security policy?
2. Are access privileges in your organisation granted adequately?
3. What methods do you use to protect your data?
4. Do you have a disaster recovery plan?
5. Are your employees familiar with existing security procedures and policies?

Please follow link for details: http://www.cbronline.com/news/cybersecurity/business/top-5-it-security-audit-questions-4661821

Audit Firm: Message from Financial Reporting Council to the Big 4

The Financial Reporting Council is the UK’s independent regulator responsible for promoting high quality corporate governance. It recently issued Audit Quality Inspection Report for the year 2014/15.

The review of the firm’s policies and procedures supporting audit quality is undertaken by the Audit Quality Review team of the Financial Reporting Council (“the FRC”) and it covered aspects of the following areas: 

• Tone at the top and internal communications
• Transparency report
• Independence and ethics
• Performance evaluation and other human resource matters
• Audit methodology, training and guidance
• Client risk assessment and acceptance / continuance
• Consultation and review
• Audit quality monitoring
• Other firm-wide matters

 Some of the key messages given by the FRC to the Big 4 audit firms are as follows: 

• Improve the testing of management reports and other system generated information to obtain assurance on its reliability for audit purposes.
• Improve the testing of controls.
• Ensure that audit planning discussions are held with Audit Committees on a more timely basis to enable their input to be reflected appropriately in the audit plan.
• Ensure audit teams pay more attention to the nature and complexity of entities when determining the scope and extent of group and component audit procedures.
• Improve the audit approach in relation to the testing of journals including the selection of journals based on the characteristics of fraud risk
• Ensure that, when using the firm’s valuation and other specialists, audit teams obtain sufficient appropriate audit evidence to corroborate their conclusions.
• Take action to ensure that partners are notified promptly of new audited entities and dispose of any financial interests held in them on a timely basis.
• Ensure that the firm’s audit reports accurately describe the audit procedures performed to address the identified risks.

Additional Thoughts

The key messages given by the FRC to the audit firms can be used as guidelines by the firms to improve the quality of their audits. Firms should develop more stringent internal quality control review mechanisms to improve audit quality and deliver services to the complete satisfaction of all the stakeholders. 

Audit Method: Written Representations

A written statement by management provided to the auditor to confirm certain matters or to support other audit evidence. Written representations in this context do not include financial statements, the assertions therein, or supporting books and records (ISA-580).

Written representations are audit evidence and are necessary information to arrive at audit conclusions. However on their own they can not be relied upon for audit evidence to support audit conclusions therefore they do not affect the nature and extent of other audit evidence that is to be obtained by the auditor. It should be obtained only from management who has responsibility for preparing and presenting financial statements and is knowledgeable about the relevant matters.

ISA 580 requires the auditor to request management to provide written representations that it has fulfilled certain of its responsibilities. It may therefore be appropriate to make management aware that receipt of such written representations will be expected, together with written representations required by other ISAs and, where necessary, written representations to support other audit evidence relevant to the financial statements or one or more specific assertions in the financial statements.

The following issues may be documented in a written representation letter obtained from the management:

1. Assessment of risk of fraud by management
2. Management’s knowledge of identified or suspected non-compliance with laws and regulations
3. Related parties identification by the management
4. Consideration of all aggregated uncorrected misstatements to be immaterial
5. Assumptions used in making accounting estimates are reasonable
6. Consideration of subsequent events by management
7. Consideration of all possible matters and contingencies in going concern review
8. Any restatement made to correct a material misstatement in prior period financial statements that affect the comparative information.

Recommendation

My recommendation to the audit team would be to gather a list of issues about which it is appropriate to require a written representation. During finalization stage of audit, the audit team should write to the client confirming the issues about which they need a written representation from the management. The client must formally write the representation letter including all the issues pointed out along with other necessary representations, sign it and send it to the auditor. The written representation should be dated as nearly as possible, but not after, the date of audit report. 

Audit News Briefing: 20 September 2015

Audit-is-cool is pleased to accumulate and provide its readers with the news on audit and related topics:

September 10, 2015

Accountancy Live

Government has poor oversight of financial entities it controls - NAO

Due to double increase of up to 54, in the number of supposedly controlled financial institutions since year 2007, The National Audit Office (NAO) criticised the government for failure to effectively oversee the matter. NAO Head Amyas Morse, advised: “Financial institutions are becoming significant elements in the government balance sheet, creating a range of opportunities and risks but no one part of government is taking an overview. The government should adopt a portfolio management approach alongside the traditional departmental oversight model to provide heightened assurance over the portfolio.” Please follow link for details: https://www.accountancylive.com/government-has-poor-oversight-financial-entities-it-controls-nao

September 9, 2015

Corporate Crime Reporter

US: BDO Admits Wrongdoing, To Pay $2.1 Million to Settle Audit Fraud Charges

The US member audit firm of the BDO International network, BDO USA has been fined $2.1m (£1.37m) by US regulator – Securities and Exchange Commission (SEC), for ignoring red flags and issuing ‘false and misleading’ unqualified audit opinions about the financial statements of staffing services company General Employment Enterprises (GEE). Charges were also filed against five firm partners with fraud charges against GEE’s then-chairman of the board and majority shareholder. “Audit firms must train their audit and national office professionals not only to recognize red flags but also to have the resolve to refuse signing off on an audit if there are unresolved material issues. BDO failed to do that here, even though these issues were elevated to the highest levels of its audit practice,” SEC Director Andrew Ceresney explained. Please follow link for details: http://www.corporatecrimereporter.com/news/200/bdo-admits-wrongdoing-to-pay-2-1-million-to-settle-audit-fraud-charges/

September 9, 2015

Accountancy Live

Requirements for accounting skills and tougher independence for bank audit committees

In accordance with the government's implementation of the 2014 EU audit legislation, Financial Conduct Authority (FCA) consultations are being held to aid in the amendment of their existing rules under the Disclosure Rule and Transparency Rule (DTR) Sourcebook. Under new proposals, stricter rules around independence and requirements for technical accounting skills are on the cards for the audit committees of public interest entities (PIEs). The EU audit legislation must be implemented in the UK by 17 June 2016. The deadline for feedback on the FCA consultation is 5 November 2015 and details are available here: http://www.fca.org.uk/news/cp15-28-quarterly-consultation-paper-no-10

Please follow link for details: https://www.accountancylive.com/requirements-accounting-skills-and-tougher-independence-bank-audit-committees

Audit Firms: Audit Market

The large listed audit market is dominated by the Big Four accounting firms; this has led to concerns about the lack of competition and choice in the audit market. With only four possible firms, because of reputation and expertise, to choose from there might be a lack of competition. The high degree of concentration in the audit market became obvious when the Price Waterhouse and Coopers & Lybrand merged in 1998 (Big six to Big five) and the demise of Arthur Andersen in 2002, following its involvement in the Enron Scandal (Big Five to Big Four).

There is a genuine concern about the impact of concentration in the audit market and, in particular, the potential impact of a major firm failure on capital markets. The problem would for sure become very serious significantly if the Big 4 audit firms were to become a Big 3.

The Big Four audit firms audit all but one of the FTSE 100 companies. In the perception of most large listed companies, the Big Four are better placed to offer two key components of the audit product: value-added services on top of the audit itself, and insurance against catastrophes and reputational risk. The Big Four are also perceived to have greater capacity and international coverage to deliver the third key component: the technical audit itself (Oxera, 2006, p.1). Reputation is an important driver of choice, favoring the Big Four, whether this is based on real or perceived differences.

For mid-tier firms there are various entry barriers. They lack the expertise, manpower and funding to compete with the Big Four firms. Big Four firms have

•                a credible reputation with large companies, their investors and other stakeholders.
•      appropriate resources and expertise in place to carry out large company audits,   including relevant sector-specific skills.
•     an effective capability to secure timely and reliable audit opinions on overseas subsidiaries for audits of companies with significant international operations.

Additional Thoughts

Large accounting networks are necessary to perform quality audits of the financial statements of multinational companies. Most stakeholders agree that additional choice in the audit market would be beneficial but should this be left to market forces or should regulatory measures be adopted? Taking away or limiting a company’s ability to choose its best provider would not enhance objectivity, skepticism, or the public interest. Reforms should be made to encourage more natural competition in the audit market such as reforms that govern firms’ access to capital, reform of regulation around auditor liability, reforms to apply ban on restrictive big four clauses in audit proposals. Measures that are designed to artificially limit the scope and outreach of existing large global networks are inappropriate and will likely to limit a company’s choice of auditor, reduce competition and restrict continuous quality improvement.

Audit News Briefing: 10 September 2015

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September 8, 2015

Accounting Web

U.S.: Accounting Salaries Estimated to Rise 4.7% in 2016

The 2016 Salary Guide: Accounting & Finance by Robert Half Management Resources, issued last September 2, revealed that –

In corporate accounting, salary predictions for senior internal audit and internal audit manager, IT audit manager, and general accountant manager positions are expected to exceed the 4.7 percent increase. Increases in starting salaries for corporate accountants are projected to range from 4 percent to 5.2 percent. Please follow link for details: http://www.accountingweb.com/practice/team/accounting-salaries-estimated-to-rise-47-in-2016

September 7, 2015

Accountancy Live

Woolf: paying the price for delusional regulation

Well-acclaimed professional textbook author and Hyperion Insurance Group Board Director, Emile Woolf FCA, shared his expert view on Audit, he said: “The unbridled lack of measured regulation at every level is highlighted by the recent Quindell accounting fiasco which is now under investigation by the Serious Fraud Office which is now taking the lead in the probe into accounting irregularities.” Please follow link for details: https://www.accountancylive.com/woolf-paying-price-delusional-regulation

September 4, 2015

Journal of Accountancy

Rise in US accounting salaries accelerates

Starting salaries for accounting and finance positions in the United States are expected to rise in 2016 between 4.0% and 5.3% over the previous year. This is according to 2016 Salary Guide: Accounting & Finance by the world's premier provider of senior-level financial and business systems professionals, Robert Half Management Resources. According to their Vice President, Dan DeNisco, high-demand skill areas for accountants include:

·         A combination of audit/compliance and IT skills.

·         Senior accountant skills, such as the ability to do reconciliations and monthly closes.

·         Financial analysis skills, such as budgeting and variance analysis.

Please follow link for details: http://www.journalofaccountancy.com/news/2015/sep/accounting-salaries-rise-201512959.html

September 4, 2015

Accountancy Age

KPMG ends PwC's 11-year audit reign at Premier Foods

One of Britain's largest food producers, Premier Foods, has appointed KPMG as auditor for the 2015/16 financial year. Audit committee chairman Ian Krieger said, "We would like to thank PwC for their significant contribution as the company's auditor since the company's stock market listing in 2004 and look forward to working with KPMG going forward." Please follow link for details: http://www.accountancyage.com/aa/news/2424649/kpmg-ends-pwcs-11-year-auditor-reign-at-premier-foods

Week-End: Right Decisions Matter!

I would like to present you a good story about the auditor and making right decisions in life:

"The accounting department dean had worked for the prestigious firm of Arthur Anderson for a number of years. He had been one of their rising stars until he had a tiff with upper management concerning how to report certain transactions for a client. Arthur Anderson management wanted the transactions recorded in a manner which would make the client look good. The Dean however insisted on full disclosure with the transactions being reported clearly and informatively. That wouldn't have been favourable for the client. So rather than compromise his integrity, he resigned from Arthur Anderson and found the job of dean of the accounting department at St. Martins College."  

From the Book: Odyssey of the Auditor Interns

Author: Thomas McGoldrick

Audit News Briefing: 01 September 2015

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September 1, 2015

Accountancy Live

Audit Updates: September 2015

Charity Commission financial probe of Swimming Teachers’ Association

The non-ministerial government department that regulates registered charities recently held a financial investigation at Swimming Teachers’ Association (STA) – to inquire upon the charity’s governance, financial controls and a plan for organisational changes, which posed a potential risk to its assets.

10-year audit tender rules for public interest entities

The UK government recently pronounced thru a written ministerial statement that public interest entities (PIEs) will be required to put their audit out to tender at least every 10 years. Further, the requirement to change auditor was ruled every 20 years. The confirmation statement also emphasized the authority and audit regulation roles of the Financial Reporting Council (FRC) and recognised supervisory bodies such as the Institute of Chartered Accountants in England and Wales (ICAEW).

Audit win: PwC keeps flying with easyJet

 After meetings with each of the top 10 audit firms in the UK, the board of easyJet is set to recommend the reappointment of PricewaterhouseCoopers (PwC) as the company’s auditor for the year ending 30 September 2016 to shareholders at the annual general meeting in February 2016.

Please follow link for details: https://www.accountancylive.com/audit-updates-september-2015

Audit Method: Materiality

The concept of materiality is applied by the auditor both in planning and performing the audit, and in evaluating the effect of identified misstatements on the audit and of uncorrected misstatements, if any, on the financial statements and in forming the opinion in the auditor’s report. Information is material if it is likely to influence financial statements users’ decisions. The major reason for thinking about materiality is to try to fine tune the audit for effectiveness and efficiency.

Planning Materiality: Auditors use planning materiality at the planning stage to determine which financial statement items, account balances and transactions to test and which to not test. It affects the scope of both tests of controls and substantive tests.

Performance Materiality: To plan the audit of various accounts, auditors need to assign part of the planning materiality to each account or class of transactions. If planning materiality is 1million CU(Currency Unit) and procedures for each account or class of transactions are designed to allow a 1million CU misstatement to go undetected, the total misstatement could obviously be more than acceptable. Therefore, auditors use performance materiality (an amount less than materiality for the financial statements as a whole) to make sure that the aggregate of uncorrected and undetected immaterial misstatements does not exceed materiality for the financial statements as a whole.

Computing Materiality: A number of quantitative approaches may be used by the auditor depending on his professional judgment; two common methods employed are discussed here:

Single Variable Approach This approach uses a single financial variable for computing materiality. Depending on qualitative factors, an auditor would select the variable that was judged to be the most appropriate way to compute materiality for a specific client. Examples of possible common single variables are: 5% of pre-tax income, 1/2% of total assets, 1% of equity, 1/2% of total revenues.

Blend or Average Method This method typically takes four or five variables and then either weights each variable according to some proportion or averages them (an equal weighing). Presumably, the blending or averaging process provides an indirect way of considering qualitative factors. An example of the averaging method would be to take the previously listed four single variables and average them (give each of them a 25% weight).

Recommendation

My recommendation to audit seniors will be that consider the amount (quantity) and nature (quality) of misstatements as both are relevant in deciding what is material. Moreover consider the industry in which your audit client falls and then decide on which financial variable is most relevant to the particular industry. For example for retailers revenue or profit after tax would be more suitable, for business concerned with asset growth e.g. property development an asset based benchmark would be a better measure to use, a not for profit organization or a public sector body could use 0.5% to 1% of expenses since they are normally not concerned with revenue generation or profits.