Audit Exam Ultimate Pass Key

Last summer I successfully passed ACCA exam, P7 “Advanced Audit & Assurance”. While preparing for the exam, I designed succinct and universal “question tackling plan”, which helped to structure my ideas on auditing. In this post I would like to share my knowledge just before coming ACCA examination session.  

I believe it would be useful for all exams related with financial audit. So the candidates for qualifications like CPA or ICAEW are welcomed to utilize it as well. J

The logic is simple: the plan consists of common subjects/questions and points suggested to be addressed.

Question Tackling Plan

1.      Ethics area question

1.1.   Technical competence;

1.2.Objectivity/Independence (possible threats: self-review, familiarity, intimidation, self-interest, advocacy)

1.3.   Professional behavior;

1.4.   Integrity;

1.5.   Confidentiality.

Mnemonic: TOPIC

2.      Professional (audit business) area question

2.1.   Competence;

2.2.   Resources/costs;

2.3.   Reputation;

2.4.   Staff quality;

2.5.   Quality control: Acceptance; Directorship; Supervision; Review; Consulting; Disputes.

3.      Audit Opinion related question

3.1.   Clarity;

3.2.   Details (standards, amounts, scope);

3.3.   Structure (is heading on the right place?) of opinion and its Consistency (starts like “except for” and finishes like adverse opinion);

3.4.   Types of appropriate opinions. This depends on evidences (sufficient, mistake material and pervasive?);

3.5.   Prior year opinion.

4.      Audit Matters (audit evidence/process) question

4.1.   Materiality;

4.2.   Standard breached (IFRS, recognition, valuation criteria etc.);

4.3.   Risks of misstatement;

4.4.   Impact on Audit Opinion;

4.5.   Reliability (source of evidence).

5.      Audit Evidence question

Mnemonics:

Sources of evidence -  DADA3: Document Asset Director (interview/representations) Accounting record 3rd Party

Procedures AE IOU: Analytical (plausibility/predictability)   Enquiry & Confirm (written/verbal)     Inspection (documents/assets)       Observation (assets, process) RecalcUlation (opening balance check)

Elements of evidence:

5.1.   General: budgets/plans, accounting policy;

5.2.   Calculations: rates, models, risks, probabilities, impairment reviews, useful lives, assumptions reasonableness explanation;

5.3.   Disclosure: draft notes;

5.4.   Documents types:

5.4.1.      Bank statements, invoice, bill, dispatch/delivery note;

5.4.2.      Contract, agreement, insurance policy, title deed;

5.4.3.      Claim litigation copy, insurance claim;

5.4.4.      Log books, time-sheets;

5.4.5.      Minutes, orders, policies;

5.4.6.      Correspondence, letters;

5.4.7.      Tax returns;

5.5.   Reconciliations (with tax authority, debtor), confirmations;

5.6.   Record of discussion, interview, talk with employees;

5.7.   Valuation reports, surveys;

5.8.   Breakdowns (check for misclassification), samples.

Golden Rule:

Your answer should be always close to the question scenario: (1) the answer should be relevant; (2) the question text contains hint for answer.

You are welcomed to share your tips for audit exams. Good Luck! J

          Disclaimer:
"This group is not associated with or approved by ACCA and the views expressed on this page do not necessarily reflect the views of ACCA".

New Audit Order: Take 2. Remodeling audit services

The audit profession is very conservative by its nature but to survive any organism must be flexible, open for changes and new trends.

How can we modify meaning of “audit services” terminology? How could it influence audit firms market and multinational companies (MNC)?

New services – more analysis

Let’s be clear about it. Society demands from auditor to give the opinion about financial soundness and performance of listed companies, given that auditors have extensive access to information. Green Paper of  European Commission suggests that ‘forward looking analysis’ of ‘large listed companies’ might be ‘real value added to the stakeholders’.

So auditors are going to move to the business of credit rating agencies and financial/equity analysts. And I would suggest this is very good news! Auditors are extremely fit for this job: auditors have enough expertise, knowledge and analytical skills to provide sound analysis of companies, moreover they know degree of reliability and relevance of each line of financial statements.

Format of product: three-fold report

We have already had reports with two types of opinions: financial statements opinion and effectiveness of internal control (over financial reporting) opinion. Under SEC requirement Companies listed in US need to be audited in accordance with Public Company Accounting Oversight Board (PCAOB) standards (after enacted SOX legislation). See, for instance, extracts from Hershey’s financial statements audit report:

Source: http://www.thehersheycompany.com/investors.aspx?ICID=HCOMP1005        

Obviously, the third part could be added to this report. Brief paragraph about financial viability of company (going concern analysis) which must be accompanied by detailed analysis of company’s previous financial year performance and financial perspectives based on evidences  gathered as at  audit report date. The brief paragraph in the body of report together with detailed analysis should give unambiguous understanding of auditor’s opinion about the company financial and business perspectives.  

How to do – technique

Some words about audit team management. In my opinion, in the above case scenario the audit team should split at least in 2 parts: financial statements audit team and business audit team. The first one would be concerned with internal controls and financial statements. The business audit team would have to spend time on analysis. These split in two roles is necessary to avoid any eye-soaping of members of audit team and would encourage fresh look on business activity and company’s reports by business team.  Definitely, both team must work together and question each other on their findings, inconsistencies and misunderstanding. For example, such procedures like overall analytical review supposed to be carried out in cooperation.

Responsibility of auditor: less regulated more active and open?

Responsibility of auditors is very complicated issue to discuss. There are similar kind of services provided by other companies, but their responsibility is not as much auditors’. What does hold our profession from development? How does responsibility influence on competition?

I suggest responsibility should be limited to quality of services provided. In any case, dissatisfaction by work of auditors whether they failed to predict bankruptcy of Lehman brothers or failed to reveal fraud in Enron is caused by bad quality of audit work; non-compliance with audit standards or weak audit standards itself. If society is not satisfied by quality audit standards then it is time to change them, but there is no use to blame auditors, because they complied with wrong standards.

On the hand we have market, which is supposed to regulate audit business. If shareholders are not satisfied with quality of audit services they hire another auditor and bad reputation would not let providers’ of bad services to succeed.

Some considerations about other industries…

Let us look on credit rating agencies. There are no much regulations about them. They do not have such comprehensive quality standards as accountants do. But it is also quite oligopoly market (Big three:  Standard & Poor's, Moody's Investor Service and Fitch Ratings). The agencies also has faced severe criticism after financial crunch for not being accurate in their assessment of companies’ rating. This reminds me something…

There is another interesting industry which is worth mentioning: the higher education institutions. Suppose, I hired MBA graduated from Yale University with GPA = A+. After we signed one year labour contract it have been appeared that my new hire has had idea neither  about efficient market hypothesis nor net present value analysis. What should I do? Should I sue Yale University for that? Does it mean that there is unsatisfactory education quality control and attesting system at University? Or is there anything wrong with my  recruitment system?

Anyway I think it is time to make Porter’s five force analysis and PESTEL for regulators and audit professionals to assess:

1)      if legal, social and political barriers have been already rather high and suppress competition in industry;

2)      if lowering of those barriers might increase competition level;

3)      if increased completion level might positively impact quality of audit services and provide additional value for society.

There are lots of work to be done and long journey to be made. 

Audit Opinion and Share Prices

How often have you heard (working as auditor) or told (being client) “what is the value in all your audit procedure”?

Actually, there is the value of audited company at the stake! To keep our clients from such comments, we can now offer scientific dispute :)

Nowadays I am busy with preparation of my research proposal in the audit area. I have reviewed and read sufficient number of research articles dedicated to subject of relationship between share price and audit opinion announcement effect.

It is interesting that while working in audit firm I was not aware that there were lots of researches in this area. Of course, my colleagues and I assumed that audit opinions are able to communicate additional valuable information to investors, public, and regulatory authorities, but I could not imagine that topic is rather popular among researchers in economics and statistics.

So, the main questions which researchers ask: “Is there any information content in audit opinion announcement for investors?”; “Do audit opinions really influence share prices?”. The researches in this area started in 1970-s and still are carried out. There are different research methods are applied: event study statistics with models, sociological interviews, modeling situation based on group of investors.

Based on what I have already read I can say that the results are controversial.

Number of studies (pls. see Firth (1978); Dopuch et al (1986); Chen et al. (2000); Menon and Williams (2010)) present sufficient evidence that share prices significantly decrease after announcement of qualified (modified) opinions as oppose to non-modified. Chen et al. (2000) illustrated his research with interesting figure showing distribution of share returns as a result of reaction on clean and modified audit opinion (MAO) in Shanghai Stock Exchange.

No very much need in comment. MAO announcement effect is rather negative and significant on event date.

On the other hand there are number of researches that do not prove hypothesis that investor reaction towards audit opinion is statistically significant. Studies are carried out by Chow and Rice[different results for API and types of qulafications] (1982); Martinez et al (2004); Ogneva and Subramanyam (2007); Al-Thuneibat and Nedal (2008)). Probably figure provided by Al-Thuneibat who tested same idea in Jordan market describes behavior of return in this case.

As seen from the figure above behavior of returns on shares of companies’ which have received qualified audit opinions is rather controversial and does not maintains single pattern.

Conclusion

Finally, I personally think that statistical research depend on quality of data you get and appropriateness of method applied. For example, in event study researches it is important to pick up right date. Moreover, attitude of investors towards audit opinion varies from country to country depending on development of markets, institutes, legal relations and culture. Probably cross country research needed to be carried out based on the unified elaborated methodology by group of scientists. So, I would not be much creative if I say: “further researches to be carried out in this area” ;)

Articles mentioned in post:

Ali A. Al-Thuneibat, Basheer Ahmad Khamees, Nedal A. Al-Fayoumi, (2007) "The effect of qualified auditors' opinions on share prices: evidence from Jordan", Managerial Auditing Journal, Vol. 23 Iss: 1, pp.84 - 101

Chen, C.J.P., Su, X. and Zhao, R. (2000), “An emerging market’s reaction to initial modified audit opinions: evidence from the Shanghai Stock Exchange”, Contemporary Accounting Research, Vol. 17, pp. 429-55.

Chow, C. W., and S, J, Rice. 1982. Qualified audit opinions and share prices — An investigation. Auditing: A Journal of Practice and Theory 1 (Wmter): 35-53.

Dopuch, N., R. Holthausen, and R. Leftwich. 1986. Abnormal stock returns associated with media disclosures of “subject to” qualified audit opinions. Journal of Accounting and Economics 8 _June_: 93–117.

Firth, M, A. (1978). Qualified audit reports: Their impact on investment decisions. Accounting Review 53 (3): 642-50.

Martinez, M., Martinez, A. and Benau, M. (2004), “Reactions of the Spanish capital market to qualified audit reports”, European Accounting Review, Vol. 13, pp. 689-711

Menon, Krishnagopal; Williams, David D (2010). Investor Reaction to Going Concern Audit Reports. Accounting Review, Nov2010, Vol. 85 Issue 6, p2075-2105, 31p

Ogneva, M., and K. R. Subramanyam. 2007. Does the stock market under-react to going concern opinions? The evidence from the U. S. and Australia. Journal of Accounting and Economics 43 _July_: 439–452.