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Audit book by m asif chapter 17 reliance on others

Auditing – Study Notes

Chapter 17 Reliance on Others

CHAPTER SEVENTEEN
RELIANCE ON OTHERS
LO #

LEARNING OBJCTIVE

PART A – AUDIT OF GROUP FINANCIAL STATEMENTS
LO 1

WHAT IS A GROUP AUDITOR

LO 2

WHAT IS A COMPONENT

LO 3


TYPE OF WORK TO BE PERFORMED ON COMPONENT

LO 4

RESPONSIBILITIES IF WORK OF COMPONENT AUDITOR IS USED

LO 5

IMPACT OF USE OF WORK ON AUDITOR’S RESPONSIBILITIES

PART B – USING THE WORK OF INTERNAL AUDITORS

DEFINITION AND OBJECTIVES OF INTENRAL AUDIT FUNCTION

LO 6

COMPARISON OF INTERNAL AUDITOR WITH EXTERNAL
AUDITOR
AUDITOR’S RESPONSIBILITIES IF AUDITOR USES WORK OF AN
INTERNAL AUDIT

LO 7
LO 8

IMPACT OF USE OF WORK ON AUDITOR’S RESPONSIBILITIES

LO 9

PART C – USING THE WORK OF AN AUDITOR’ S EXPERT
LO 10

AREAS WHERE WORK OF EXPERT CAN BE USED

LO 11

DETERMINE WHETHER TO USE WORK OF AUDITOR’S EXPERT
AUDITOR’S RESPONSIBILITIES IF AUDITOR USES WORK OF AN
EXPERT
EVALUATE THE COMPET ENCE, CAPA BILITIES AND OBJ ECTIVITY
OF EXPERT


EVALUATE APPROPRIATENESS/AD EQUACY OF WORK OF
EXPERT AS AUDIT EVIDENCE

LO 12
LO 13
LO 14
LO 15

CONCLUSION ON ADEQUACY OF WORK OF EXPERT

LO 16

IMPACT OF USE OF WORK ON AUDITOR’S RESPONSIBILITIES

1

REFERENCE
Section 1
(Chapter 13)
Section 1
(Chapter 13)
Section 1
(Chapter 13)
Section 1
(Chapter 13)
Section 1
(Chapter 13)
Section 2
(Chapter 13)
Section 2
(Chapter 13)
Section 2
(Chapter 13)
Section 2
(Chapter 13)
Section 3
(Chapter 13)
Section 3
(Chapter 13)
Section 3
(Chapter 13)
Section 3
(Chapter 13)
Section 3
(Chapter 13)
Section 3
(Chapter 13)
Section 3
(Chapter 13)


Auditing – Study Notes

Chapter 17 Reliance on Others

PART A – AUDIT OF GROUP FINANCIAL STATEMENTS
LO 1: WHAT IS A GROUP AUDITOR:
Group Auditor:
Group auditor is the audit firm responsible for the audit of the group financial
statements. Group auditor will also be the auditor of the parent company.

Problems in a Group Auditor:
 Large number of components.
 Components may be with a different accounting year end.
 Components may be with a different currency.
 Specific adjustments relating to consolidation.

Responsibilities of Group Auditor:
 Perform Acceptance and Continuance Procedures (i.e. whether he will be able to obtain
sufficient appropriate audit evidence on all components).
 Obtain understanding of components (i.e. which is significant and which is not) and
consolidation process
 Establishing overall group audit strategy, including
o Determining materiality levels for components
o Deciding type of work to be performed on component.
 Responsibilities if work of component auditor is used.
o Evaluate the competence, objectivity etc. of component auditor
o Communicate with component auditor.

LO 2: WHAT IS A COMPONENT:

Component:
A component is an entity or business activity, for which group or component
management prepares financial information, that should be included in the
group financial statements (e.g. in case of subsidiaries, branches or
combination of both).
Significant component:
Significant Component is a component identified by the group engagement
team, that is:
1. of individual financial significance to the group, or
2. likely to include significant risk of material misstatement in the group
financial statements (due to its specific nature or circumstances).

LO 3: TYPE OF WORK TO BE PERFORMED ON COMPONENT:
Nature of component
Significant
(on financial basis)
2

Work to be performed
Audit of whole component using component materiality


Auditing – Study Notes

Significant
(on risk basis)
Non-significant

Chapter 17 Reliance on Others
1. audit of whole component using component materiality or
2. audit of one or more account balances or classes of transactions or
3. audit procedures specific to assertions having significant risk.
(Procedure to be performed will depend on effect of risk.)
Analytical procedures at group level.
If evidence cannot be obtained from analytical procedures, additional
procedures (similar to significant components) may be performed on
some of selected components (this selection will change every year).

If a component is subject to an audit by law or regulation or other reason, auditor shall evaluate
whether materiality level is appropriate. If materiality level was low, additional procedures will be
necessary.

LO 4: RESPONSIBILITIES IF WORK OF COMPONENT AUDITOR IS USED:

A component auditor is an auditor who, at the request of the group auditor, performs work on the
financial information of a component.

Obtaining understanding of component auditor:
Group Engagement Team shall obtain understanding of following if it plans to use a component
auditor:
1. Whether component auditor understands and will comply with Independence requirements
(and other ethical requirements)
2. Whether component auditor has Professional Competence (e.g. industry specific
knowledge)
3. Whether component auditor operates in a regulatory environment that actively oversees
auditor
4. Whether group engagement team will be able to be involved in the work of component
auditor to the extent necessary to obtain sufficient appropriate audit evidence
If group engagement team has serious concerns/issues about component auditor from above
evaluation, it will not engage such component auditor. However, if concerns are less than serious,
group engagement team may engage component auditor but it will have to perform additional audit
procedures by getting involved more extensively in the work of component auditor.

Involvement in work of component auditor:
In case of a significant component, group engagement team shall be involved in component’s risk
assessment to identify significant risk. This involvement shall include, at minimum, following:
o Discussing those business activities of component which are significant to the group.
o Discussing susceptibility of component to misstatement due to fraud or error.
o Reviewing component auditor’s documentation of identified significant risks for group
financial statements.
For other components, extent of involvement will depend on understanding of component auditor.

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Auditing – Study Notes

Chapter 17 Reliance on Others

Communication between Group Auditor and Component Auditor:
Letter of Instructions
Memorandum/Report of work performed
(From group auditor to component auditor) (From component auditor to group auditor)
–nature, timing and extent of work to be –List of uncorrected misstatements
performed by component auditor.
–Material weakness in internal controls
–Identified risk of material misstatement
relevant to component auditor.

LO 5: IMPACT OF USE OF WORK ON AUDITOR’S RESPONSIBILITIES:

1. Auditor (i.e. Group Engagement Partner) has sole responsibility to express opinion on
Financial Statements. His responsibility is not reduced if he uses the work of component
auditor.
2. He shall not refer to the work of component auditor in auditor’s report unless it is:
a. Required by Law or Regulation or
b. Necessary to explain nature of modification in auditor’s report
3. If reference of component auditor is made in auditor’s report:
a. Auditor may need the permission of the component auditor before making such a
reference and
b. Auditor shall state that such reference does not reduce auditor’s responsibility for
audit opinion.

PART B – USING THE WORK OF INTERNAL AUDITORS
LO 6: DEFINITION AND OBJECTIVES OF INTENRAL AUDIT FUNCTION:
Internal Audit Function:
Internal Audit Function is a function that performs activities to evaluate and
improve entity’s Governance, Risk Management and Internal Control.

Following are objectives/scope/activities/benefits of internal audit function:
Governance
Activities

Risk Management
Activities
Internal Control
Activities
Special
Investigations
4

Assisting Board of Directors in overseeing:
 strategic direction of the entity and
 obligations related to accountability of the entity.
 Identification of Risks.
 Management of Risks .
 Review of economy, efficiency and effectiveness of operating activities
(called Value for Money audit).
 Review of compliance with laws and regulations.
 Review of financial information (by performing tests of details).
 Monitoring and Evaluation of Internal Control (by performing tests of
controls on design, implementation and operating effectiveness of
internal control).
 Investigations when there is suspected fraud within the entity.


Auditing – Study Notes

Chapter 17 Reliance on Others

Disadvantages of internal audit department include:
 Internal auditors are not independent of entity.
 Higher cost is involved in establishing internal audit department.
 There may be lack of qualification and experience in internal audit department.

LO 7: COMPARISON OF INTERNAL AUDITOR WITH EXTERNAL AUDITOR:
Internal Auditor
Relationship/Independence Employee of entity
Appointment
By BOD/Audit Committee
Qualification
Determined by BOD/Audit Committee
Objective is to evaluate and improve
Scope / Objectives /
entity’s Governance, Risk Management and
Activities
Internal Control.
Scope/Objectives/
BOD/Audit Committee
Activities determined by
Reports To BOD/Audit Committee and his
Reporting
reports are restricted to them.
Format of Report
Any (depending on circumstances)

External Auditor
Independent of entity
By Members
Determined by Law
Objective is to express an opinion on
financial
statements
and
on
additional matters required by law.
Determined by Laws and Regulations

Reports to Members and his report is
publically available.
Determined by Law

Methods to ensure Independence of Internal Auditor:
Internal auditors are not independent of company; however they should be independent of
management. To ensure this:
 they should be reportable to audit committee and not to CFO.
 Scope of work of internal auditor should be decided by audit committee or internal auditor;
and not by management or finance director etc.
 To avoid familiarity threat, Internal auditors should be rotated periodically e.g. after every 3
to 5 years.
 Internal auditor should be appointed by BOD or audit committee; and not by management.
 Internal auditor should not be responsible for design or implementation of control; they
should be responsible for monitoring and evaluation of control.
Areas where work of internal audit function can be used by external auditor:
 Testing of the operating effectiveness of controls;
 Substantive procedures involving limited judgment;
 Observations of inventory counts;
 Tracing transactions through the information system relevant to financial reporting;
 Testing of compliance with regulatory requirements;
 audits or reviews of the financial information of subsidiaries that are not significant
components to the group.

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Auditing – Study Notes

Chapter 17 Reliance on Others

LO 8: AUDITOR’S RESPONSIBILITIES IF AUDITOR US ES WORK OF AN INTERNAL
AUDIT:

If entity has an internal audit function whose activities are relevant to audit, external auditor shall
perform following procedures before using/relying on the work of internal audit function:
1. determine whether the work of the internal audit function can be used by evaluating
competence, objectivity and approach of internal auditor.
2. (if work can be used) evaluate appropriateness/adequacy of internal auditor’s work as
audit evidence.

Evaluating the Internal Audit Function:
Evaluation
Factors to consider while evaluating
– Level of education and professional qualification.
– Training and experience of internal auditors.
Competence
–Specific knowledge and skills relating to entity’s financial statements.
–Whether internal audit function is adequately resourced.
–Compliance with internal auditing standards relating to objectivity
–Hiring/Firing authority of internal auditors should be with TCWG.
Objectivity
–Organizational status (e.g. whether it reports directly to TCWG).
–Free from conflicting responsibilities (e.g. no managerial work).
–Whether internal auditors apply a systematic and disciplined approach.
–Quality of internal auditor’s working papers (covering risk assessments, work
Approach
programs, documentation and reporting).
–Consistency of Conclusions with work performed.
–Quality Control Program for internal auditor.
Evaluating the adequacy of work of Internal Audit Function:
Before using specific work of internal auditor, auditor shall determine adequacy of work by
evaluating whether:
 The work of the function has been properly planned, performed, reviewed and documented.
 Sufficient appropriate evidence has been obtained to draw reasonable conclusions, and
 Conclusions reached are appropriate in the circumstances and reports prepared are
consistent with the conclusions.
For this evaluating, auditor’s procedures may include:
 Reperformance of some of the work
 Review of internal audit function’s work programs and working papers.
 Observation of procedures performed by the internal audit function.
 Inquiries of individuals within the internal audit function.

Exact nature, timing and extent of testing of specific work depend on:
 Scope and assessment of of internal audit function’s work
 Risk of material misstatement.
 Significance of Judgments involved in work.

If auditor determines that the work of internal auditor is not adequate for auditor’s purposes,
auditor may:
− Perform additional audit procedures appropriate to the circumstances or
− Agree with internal auditor on further work to be performed by internal auditor.
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Auditing – Study Notes

Chapter 17 Reliance on Others

LO 9: IMPACT OF USE OF WORK ON AUDITOR’S RESPONSIBILITIES:

1. Auditor (i.e. external auditor) has sole responsibility to express opinion on Financial
Statements. His responsibility is not reduced if he uses the work of internal auditor.
2. He shall not refer to the work of internal auditor in auditor’s report in any circumstances.

Direct Assistance:
Direct assistance is defined as the use of internal auditors to perform audit procedures under the
direction, supervision and review of the external auditor.

ISAs prohibit direct assistance procedures that:
 involve making significant judgements in the audit;
 relate to higher assessed risks of material misstatement;
 relate to work with which the internal auditors have been involved and which has already
been, or will be, reported to management or TCWG by the internal audit function; or
 relate to decisions the external auditor makes regarding the internal audit function and the
use of its work or direct assistance.
Prior to using internal auditors to provide direct assistance, the external auditor shall:
 Obtain written agreement from an authorized representative of the entity that the internal
auditors will be allowed to follow the external auditor’s instructions, and that the entity will
not intervene in the work the internal auditor performs for the external auditor; and
 Obtain written agreement from the internal auditors that they will keep confidential specific
matters as instructed by the external auditor and inform the external auditor of any threat
to their objectivity.
Agreement:
It may be useful for the external auditor to agree the following in advance with internal audit:
 the timing of such work
 the nature of the work performed
 the extent of audit coverage
 materiality and performance materiality
 methods of item selection and sample sizes
 documentation of work performed
 review and reporting procedures.

Documentation:
The external auditor is required to document:
 threats to the objectivity of the internal auditors, and the level of competence of the internal
auditors used to provide direct assistance;
 The basis for the decision regarding the nature and extent of the work performed by the
internal auditors;
 Who reviewed the work performed and the date and extent of that review;
 The written agreements obtained from an authorized representative of the entity and the
internal auditors; and
 The working papers prepared by the internal auditors who provided direct assistance on
the audit engagement.
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Auditing – Study Notes

Chapter 17 Reliance on Others

PART C – USING THE WORK OF AUDITOR’S EXPERT
LO 10: AREAS WHERE WORK OF EXPERT CAN BE USED:

Expert may be required by management/auditor when financial statement involve following:
− Estimation of life and valuation of fixed assets.
− Valuation of specialized inventory.
− Analysis of complex or unusual tax compliance issues
− IT Expertise
− Legal Opinions

LO 11: DETERMINE WHETHER TO USE WORK OF AUDITOR’S EXPERT:

Auditor’s expert:
An individual or organization possessing expertise in a field (other than
accounting or auditing), whose work in that field is used by the auditor to
assist the auditor in obtaining sufficient appropriate audit evidence.

Assessing the need for an expert:
Considerations when deciding whether to use an auditor’s expert may include:
1. Risk of material misstatement of the matter.
2. Subjectivity, significance and complexity of the matter.
3. Availability of alternative sources of evidence

LO 12: AUDITOR’S RESPONSIBILITIES IF AUDITOR USES WORK OF AN EXPERT:
Auditor shall perform following procedures if auditor uses work of an expert:
1) Evaluate the competence, capabilities and objectivity of expert.
2) Obtain an understanding of the field of expert.
3) Evaluate the appropriateness/adequacy of expert’s work as audit evidence.
4) Agree terms with expert i.e.
 Nature and scope of work
 The respective roles and responsibilities
 Communication and Reporting
 Confidentiality requirements

LO 13: EVALUA TE THE COMPETENCE, CAPABILITIES AND OBJE CTIVITY OF EXPERT:

The auditor shall evaluate whether the auditor’s expert has the necessary competence, capabilities
and objectivity.
Competence, capability and objectivity of an expert may be assessed in following ways:
 Personal experience of previous work with expert.
 Discussion with expert.
 Discussion with other professionals who have worked with expert.
 Books or papers published by expert.
 Knowledge of expert’s qualification, membership of professional bodies or other external
recognition, license to practice.
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Auditing – Study Notes

Chapter 17 Reliance on Others

LO 14: E VALUAT E APPROPRIATENESS/A DEQUACY OF WORK OF EXPERT AS AUDIT
EVIDENCE:

For this purpose, auditor shall evaluate:
1. Relevance, completeness, and accuracy of significant source data (if expert’s work involves
use of significant source data)
2. Relevance and reasonableness of significant assumptions and methods (if expert’s work
involves use of significant assumptions and methods)
3. Reasonableness of expert’s findings and conclusions
4. Consistency of these conclusions with other audit evidnece

LO 15: CONCLUSION ON ADEQUACY OF WORK OF EXPERT:

If auditor determines that the work of expert is not adequate for auditor’s purposes, auditor shall:
− Agree with expert on further work to be performed by expert.
− Perform additional audit procedures appropriate to the circumstances
− Consider the necessity to engage another expert.

LO 16: IMPACT OF USE OF WORK OF EXPERT ON AUDITOR’S RESPONSIBILITIES:

1. Auditor has sole responsibility to express opinion on Financial Statements. His
responsibility is not reduced if he uses the work of expert.
2. He shall not refer to the work of expert in auditor’s report unless it is:
a. Required by Law or Regulation or
b. Necessary to explain nature of modification in auditor’s report
3. If reference of expert is made in auditor’s report:
a. Auditor may need the permission of the expert before making such a reference and
b. Auditor shall state that such reference does not reduce auditor’s responsibility for
audit opinion.

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