Audit Method: Best practices in Audit Documentation

ISA 230, deal with the auditor’s responsibility to prepare the audit documentation. Audit Documentation is defined in ISA 230 as “The record of audit procedures performed, relevant audit evidence obtained, and conclusions the auditor reached (terms such as “working papers” or “workpapers” are also sometimes used).” The auditor shall prepare audit documentation that is sufficient to enable an experienced auditor, having no previous connection with the audit, to understand

• ·         The nature, timing and extent of the audit procedures performed
• ·         The results of the audit procedures performed
• ·         Significant matters arising during the audit and the conclusions reached thereon

In documenting the nature, timing and extent of audit procedures performed, the auditor shall record:

• ·         The identifying characteristics of the specific items or matters tested;
• ·         Who performed the audit work and the date such work was completed; and
• ·         Who reviewed the audit work performed and the date and extent of such review.

The auditor shall assemble the audit documentation in an audit file and complete the administrative process of assembling the final audit file on a timely basis. After the assembly of the final audit file has been completed, the auditor shall not delete or discard audit documentation of any nature before the end of its retention period.

Audit documentation may be recorded on paper or on electronic or other media. Examples of audit documentation include:

• ·         Audit programs.
• ·         Analyses.
• ·         Issues memoranda.
• ·         Summaries of significant matters.
• ·         Letters of confirmation and representation.
• ·         Checklists.
• ·         Correspondence (including e-mail) concerning significant matters.

However it should be kept in mind that neither auditing standards nor any audit firm policy prohibits the audit team members from including documentation in the file that they believe necessary to support their work.

Practice

Documentation prepared after the audit work has been performed is likely to be less accurate than documentation prepared at the time such work is performed. ISQC 1, requires firms to establish policies and procedures for the timely completion of the assembly of audit files. An appropriate time limit within which to complete the assembly of the final audit file is ordinarily not more than 60 days after the date of the auditor’s report.

Audit Method: Quality Review

ISA 220, deals with quality control for an audit of financial statements. Engagement teams have a responsibility to implement quality control procedures that are applicable to the audit engagement and that are within the context of the firm’s system of quality control. The objective of the auditor is to implement quality control procedures at the engagement level that provide the auditor with reasonable assurance that:

• The audit complies with professional standards and applicable legal and regulatory requirements; and
• The auditor’s report issued is appropriate in the circumstances.

ISQC 1, deals with the firm’s responsibilities to establish and maintain its system of quality control for audit engagements. The system of quality control includes policies and procedures that address each of the following elements:

• Leadership responsibilities for quality within the firm;
• Relevant ethical requirements;
• Acceptance and continuance of client relationships and specific engagements;
• Human resources;
• Engagement performance; and
• Monitoring.

For audits of financial statements of listed entities, and those other audit engagements, if any, for which the firm has determined that an engagement quality control review is required, the engagement partner shall:

• Determine that an engagement quality control reviewer has been appointed;
• Discuss significant matters arising during the audit engagement, including those identified during the engagement quality control review, with the engagement quality control reviewer; and
• Not date the auditor’s report until the completion of the engagement quality control review.

Practice

The engagement partner shall take responsibility for the overall quality on each audit engagement to which that partner is assigned. The engagement partner should ensure that

• Appropriate procedures regarding the acceptance and continuance of client relationships and audit engagements have been followed;
• All ethical requirements are met;
• Independence criterion is met;
• Assignment of team members is appropriate;
• Overall direction, supervision and monitoring of the audit engagement is carried out.

Audit Method: Analytical Procedures

The substantive analytical procedures (SAP) are one of the weakest points in audit program when it is come to execution. The authorities both in USA and UK when conducting review of audit work like to point on inappropriateness of evidence gained from analytical procedures.

Generally, the mistakes made when performing analytical procedures are as follows:

1. Insufficient reliability of data used in analytical procedures. For example, the data of average sales per employee taken from not independent source, a client representative. The information should be checked before used in our calculations.

2. Expectations regarding tendencies are not well elaborated and/or not based on understanding of  client business. For example, very often for PL analytics general expectation is used that sales/expenses are expected to grow same level as prior year or to be on the same level as prior year, which is not correct by default.

3. Analytical procedures might be performed well, but insufficient on it is own. Usually the procedures could be limited to SAP in case test of controls (TOC) are effective. But in real life the situation may be different:

• TOCs are effective but there are some material items within account, that may change picture completely and, hence, need to be tested;
• The account balance has significant risk, which means that SAP is not sufficient on its own and should be accompanied by test of details.
• When TOCs are ineffective, then we might talk only about application of SAP for the areas of audit where test of details were performed as well

My special comment to an audit firm new joiners: please, be aware when you are questioning client regarding changes in the account balance and then document explanations. I am sure you have a good guidance in your firm on how to perform inquiries and SAP. Moreover, there are a lot of instructions in internet on this issue.  Please, do not write comments like this, which might be then published in Thomas Houck book*: “Sales increased because the client sold more goods”. He refers sarcastically about these type of explanation as “stellar analytical explanation”. The focus of analytics should be real business reason of change in figures.

*Thomas P. Cook. Why and How Audits Must Change:  Practical guidance

New Audit Order: Take 1

There would be demand for independent assessment of products made by humanity as long as human beings are not perfect. The Audit Society is a term used by Michael Power to name his book about role of audit in our life. So the major question I would address these days is as follows:

«Can audit of financial  statements accomplish its objectives

effectively and efficiently and still be profitable business with 

active competitive market?»

For productive discussion it would be useful to remind some elements of agency theory in illustration below:

Source: http://maaw.info/ArticleSummaries/ArtSumTiessenWaterhouse83.htm

As  recognized in previous post auditors were given  specific ‘societal mandate’, but stakeholders (principals) of auditors' (agents) activity are not satisfied with the work done.

I have some ideas, which I would like to share.

Addressing Independence Threat

Audit business is not only attesting business in the world. There are lots of firms around evaluate, assess and make opinions. Examples? Here are they:

·        Knowledge tests for students: GRE, GMAT, EITLS, Toefl;

·        Exams for professionals: US CPA exams; ACCA exams;

·        University system assessment of knowledge;

·        Peer reviewed journals: review of scientific articles

·        And so on, there are lots of them!

All of these businesses do similar thing – express opinion about quality/level of something. The key thing in independence here that markers (evaluators) do not know their concrete client (personalities) and clients do not know concrete people who check their  workings. In audit of financial statements it is not an easy to do thing.

However, we can eliminate influence of board of directors decision to switch an auditor on independence of audit firm. How?! I would  propose following model. For example, we are going to pay special attention on audit of global multinational companies (MNC) by audit firms. Given that assets and performance of MNCs are spread across the world it is difficult enough to observe independence of audit firms on local level.

Global (National) Audit Fund (GAF)

GAF could be established by G20/G40 countries to tackle the problem. The function of GAF would be to appoint external auditors for MNCs and pay remuneration to auditors. There would be list of MNCs which activity has national and global impact (addressing partly “too big to fail” issue). Criteria to include MNC in list are not a problem and could be easily established. GAF would be funded through following sources:

·        investor/shareholder tax, which could be withdrawn at the moment of purchase shares or could be part of dividend tax;

·        government budgets (with inevitable increase of MNC and/or individual taxes).

Thus, in our model we would align practice with theory: principals pay agents to act for their benefit. Agents care about their business and prosperity and would do anything to satisfy their customers-principals. MNCs’ financial statements (FS), which audit firm would have to audit under the contract are only subject of an agreement – more precisely it is kind of product produced by other agents (management of company) of principals. To say more allegorical FS are just peace of paper with student’s workings which are needed to be assessed.

Issues to concern about        

I would suggest following problems of model:

·        process of external auditor appointment: inevitable ‘red tape’, threat of corruption;

·        competition on audit market;

·        quality and nature of service rendered by audit firm.

I would be glad and grateful if guys reading my blog would provide their suggestions in comments and participate in discussion.

In the next post I am keen to address the expectation gap issue and nature of services provided by auditor. I suppose it might be partial solution to the problems of model identified above.

References:

Power, M. (1997). The Audit society: rituals of verification. Oxford: Oxford University Press.