Week-end: Monty Python

Here is a video from old good Monty Python on audit! I liked this joke, sounds all old good British and rather funny J

I wonder what was the audit firm's materiality basis on that engagement with such profit??? J

Audit Method: list of information requests

A list of information requests (LIR) is method to establish common understanding with audit client: what documents need to be prepared in order to progress with audit. The LIR also known in different audit firms as list of outstanding items, client assistance schedule, prepared by client (PBC) list. LIR is one of the project management tools when auditors track if all required information was provided in appropriate quality and on time.

In theory LIR needs to be very specific and at least have following characteristics: detailed description of the request (e.g. it should mention specific account in trial balance), auditor and client employee responsible for request processing, date when information due, format and if applicable prior year example.

I can give following tips on managing LIRs:

1. I advise to use Excel in managing LIRs;
2. The level of details in LIR depends on client: when client is difficult to manage, it might be better to add some more details to be always ready to answer specific questions;
3. The request should be ideally sent 2-3 weeks before start of the engagement, depending on the timing of audit procedures;
4. The auditor must meet and discuss LIR with client representative in charge of the audit after sending the first version of LIR. The protocols of  communication would depend on arrangements with client: e.g. the client might prefer the auditors to work directly with each responsible person in LIR;
5. LIR should be compared with status of audit work at list once a week. I would propose following formula: information received – information processed = unprocessed audit evidence. If there is a lot of unprocessed evidence then it raises questions if audit team have issues with adequate staffing in terms of time and skills of team members.
6.  LIR should be designed in the way to be able to support audit teams in calculating overruns and defend auditors’ position. This could be achieved by updating LIR once a week, calculating number of days/hours from the due date to current date.
7. Regular LIR status calls with client should be organised. All audit team members should participate being ready to provide an update on their section of Audit.

News from Airstrip One: Toxiba case

Toxiba company, one of the biggest in the region of Eurasia, apologised for using fraudulent methods of inflating its profit. The company artificially increased its profits by USD 1.2 bln during preceding 7 years.  The technique of defrauding financial statements was not innovative and referred by Capitalist (magazine in Oceania) as “101”. This usually includes overstating net revenues, booking early revenues and postponing expenses. The company had the auditor R&U, which failed to detected fraud. R&U is multinational company founded in Oceania, having offices in all big cities, including Airstrip One. Our correspondent, Rob, asked for the comments from the audit specialist, Mr Ask, in the city of Airstrip One:

• Rob: What could be done to prevent such cases?
• Mr Task: Well, first of all the corporate culture in Eurasia should change towards being more open and this depends from tone at the top. Second, I think the auditors from R&U should review their fraud detection and cut-off procedures, and then, question themselves, why they were not able to find the intentionally made errors.

Disclaimer: all situations and names is this blog post are not real.

Group and Statutory Audit tailoring

Hi there! Today we are going to talk about combination of two audits (let them be G&S in this blog post): a group and statutory audit. It’s not uncommon to perform them one after in another.

Both auditors and clients want to use synergy of two audits. The value for clients to be serviced by one firm for G&S is saved company’s time/efforts spent for audit and decreased combined price. An  auditor wins by decreasing costs of doing audit and improving realisation rates. However these benefits could be jeopardised by incorrect selection of approach to materiality and scope. There is a necessity to align and methodologically tailor both type of audits. There are number of issues which might differ and impact our samples and scope: materiality, risks (as well as new risks might appear by the time statutory audit starts or whichever is going to be the second), and accounts in scope.

The problem I see here is time lag between these assignments. Sometimes it’s unclear what surprises might appear in statutory accounts after G audit. Primary team instructions and activity also play a big role here.

As in case of multilocation audits I think that methodology should be developed for the purposes of combined (G&S) audit as well.

Restart

  The blog is about to restart.

The Results of Blog Polls

This post reports on the results of polls carried out in my blog from 18^th of January to 15^th of February 2012. The polls closed automatically on 15^th of February and have been seen for all readers of my blog on the right hand side of blog interface.

The rules of polls were published in separate post (see link). Total number of votes (voters) amounted 48 with the option to select three subjects. However, some voters selected less than 3 subjects and total number of votes is 125, not 144 (48x3) as it could have been expected if each of participants selected 3 options. Percentages are calculated by dividing number of votes for given subject by total polls participants, i.e. 48 voters (e.g. 9/48=19% for “6. Audit in entertaining context: books, videos”).

The most wanted subjects to be discussed in this blog are: option 3 – “audit methodology” (66%); option 5- “audit studies, research and other analytics” (54%); option 4 – “audit business, professional & regulation issues” (45%).

   

I would like to thank all my readers and those active people who participated in polls. My further blog posts would reflect your preferences. Actually I have already done that my last articles are related with mentioned subjects: Chinese Companies Need Vigilant Audit; Audit Firms: Financial Performance 2011; Audit Method: Audit Approach.

If you have any additional suggestions how to make blog more interesting you are welcome for comments.

Chinese Companies Need Vigilant Audit

Some of my readers have shown their interest to the assurance services in BRIC in the comments to the last post. And guess what? The recent issue of The Economist contains the article “Accounting in China”, which reflects my concerns about audit of companies from BRIC in general (see link). The beginning of the article is quite appealing:

“CAN you trust Chinese accounts? Many investors fear (and several short-sellers are betting) that the answer is “no”. Sino-Forest, a big forestry firm listed in Toronto, is a case in point. Last year Muddy Waters, a short-seller, accused it of running a Ponzi scheme, which it denies. On January 31st Sino-Forest released the final report of independent investigators into the charge. Insiders crow that the gumshoes found no smoking gun. The gumshoes grumbled that, lacking access to all the evidence, they were “not able to reach definitive conclusions”.

America’s SEC is trying to force the Shanghai office of Deloitte Touche Tohmatsu, a big Western accountancy firm, to hand over papers related to Longtop, a Chinese software firm that was delisted by the New York Stock Exchange last year. Deloitte refuses, saying this would violate Chinese laws on “state secrets”. Deloitte may have a point. If it co-operates, its local staff could be jailed under Chinese law.”

So, this is the question, which had to be raised sooner or later: can be the companies transparent while operating in the conditions of non-transparent political system? There are no big traditions of Chinese government accountability to citizens of China. The market incentives to provide true and fair financial statements are seem to be not enough.

How to deal with this issue?

China need not take all the blame for the failure to provide true financial statements. The problem is common for all emerging markets. It could be said that the reason for that is not necessarily deliberate misrepresentation. Errors might happen due to lack of knowledge, the absence of open communication tradition.

According to the article in The Economist one of the Big4 bosses acknowledged the issue and insisted that “the Big Four have greatly increased their vigilance in China”. To generalize this comment one can state an implicit rule for the audit of financial statements in emerging markets: the financial statement risk for all companies originated from emerging markets should be assessed as "high" at the beginning of audit unless otherwise could be proven. The proof of lower risk assessment could be obtained after one or two years of audit, which would provide evidence about low susceptibility of systems to errors and effective control system.

I agree that this proposal could be viewed as a strict and reactionary one, but I stated it to initiate discussion of what could be done regarding accounts provided by BRIC and other emerging markets. I expect you to share your valuable ideas in the comments, and we might discuss them.

PS Please, do not forget to vote for your top 3 favorite subjects. The polls are going on the right-hand side of the blog. The rules and explanations regarding subject are here.