Audit Planning, Strategy and Execution
9 theoretical questions from ICAI Study Material
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As per SA 540 “Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures”, the auditor shall obtain an understanding of the following in order to provide a basis for the identification and assessment of the risks of material misstatements for accounting estimates: (i) The requirements of the applicable financial reporting framework relevant to the accounting estimates, including related disclosures. (ii) How Management identifies those transactions, events and conditions that may give rise to the need for accounting estimates to be recognised or disclosed, in the financial statements. In obtaining this understanding, the auditor shall make inquiries of management about changes in circumstances that may give rise to new, or the need to revise existing, accounting estimates. (iii) The estimation making process adopted by the management including- (1) The method, including where applicable the model, used in making the accounting estimates. (2) Relevant controls. (3) Whether management has used an expert? (4) The assumption underlying the accounting estimates. (5) Whether there has been or ought to have been a change from the prior period in the methods for making the accounting estimates, and if so, why; and (6) Whether and, if so, how the management has assessed the effect of estimation uncertainty.
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Using the work of an Auditor’s Expert: As per SA 620 “Using the Work of an Auditor’s Expert”, the expertise of an expert may be required in the actuarial calculation of liabilities associated with insurance contracts or employee benefit plans etc., however, the auditor has sole responsibility for the audit opinion expressed, and that responsibility is not reduced by the auditor’s use of the work of an auditor’s expert. The auditor shall evaluate the adequacy of the auditor’s expert’s work for the auditor’s purposes, including the relevance and reasonableness of that expert’s findings or conclusions, and their consistency with other audit evidence as per SA 500. Further, in view of SA 620, if the expert’s work involves use of significant assumptions and methods, then the relevance and reasonableness of those assumptions and methods must be ensured by the auditor and if the expert’s work involves the use of source data that is significant to that expert’s work, the relevance, completeness, and accuracy of that source data in the circumstances must be verified by the auditor. In the instant case, Mr. X, Mr. Y and Mr. Z, jointly appointed as auditors of KRP Ltd., referred their own known Actuaries for valuation of gratuity scheme. Actuaries are an auditor’s expert as per SA 620. Mr. Y’s referred actuary has provided the gratuity valuation report, which later on was found faulty. Further, Mr. Z is not in agreement with this report, therefore, he submitted a separate audit report specifically for such gratuity valuation. In such situation, it was duty of Mr. X, Mr. Y and Mr. Z, before using the gratuity valuation report of Actuary, to ensure the relevance and reasonableness of assumptions and methods used. They were also required to examine the relevance, completeness and accuracy of source data used for such report before expressing their opinion. Mr. X and Mr. Y will be held responsible for gross negligence and using such faulty report without examining the adequacy of expert actuary’s work whereas Mr. Z will not be held liable for the same due to separate opinion expressed by him.
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Development of an overall plan - Overall plan is basically intended to provide direction for audit work programming and includes the determination of timing, manpower development and co-ordination of work with the client, other auditors and other experts. The auditor should consider the following matters in developing his overall plan for the expected scope and conduct of the audit: (i) Terms of his engagement and any statutory responsibilities. (ii) Nature and timing of reports or other communications. (iii) Applicable Legal or Statutory requirements. (iv) Accounting policies adopted by the clients and changes, if any, in those policies. (v) The effects of new accounting and auditing pronouncement on the audit. (vi) Identification of significant audit areas. (vii) Setting of materiality levels for the audit purpose. (viii) Conditions requiring special attention such as the possibility of material error or fraud or involvement of parties in whom directors or persons who are substantial owners of the entity are interested and with whom transactions are likely. (ix) Degree of reliance to be placed on the accounting system and internal control. (x) Possible rotation of emphasis on specific audit areas. (xi) Nature and extent of audit evidence to be obtained. (xii) Work of the internal auditors and the extent of reliance on their work, if any in the audit. (xiii) Involvement of other auditors in the audit of subsidiaries or branches of the client and involvement of experts. (xiv) Allocation of works to be undertaken between joint auditors and the procedures for its control and review. (xv) Establishing and coordinating staffing requirements.
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Formulation of Audit Strategy: While formulating the audit strategy for a company, following factors may be considered - General Factors: Refer Para 2.1. Specific Factors for Online Shopping: The auditor shall also obtain an understanding of the information system including the related business processes due to new venture of online shopping in the following areas: (i) The classes of transactions in the entity’s operations that are significant to the financial statements; (ii) The procedures, within both information technology (IT) and manual systems, by which those transactions are initiated, recorded, processed, corrected as necessary, transferred to the general ledger and reported in the financial statements; (iii) The related accounting records, supporting information and specific accounts in the financial statements that are used to initiate, record, process and report transactions; this includes the correction of incorrect information and how information is transferred to the general ledger. The records may be in either manual or electronic form; (iv) How the information system captures events and conditions, other than transactions, that are significant to the financial statements; (v) Controls surrounding journal entries, including non-standard journal entries used to record non-recurring, unusual transactions or adjustments.
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As per SA 220, Engagement Partner shall form a conclusion on compliance with independence requirements that apply to the audit engagement. In doing so, Engagement Partner shall: • Obtain relevant information from the firm and, where applicable, network firms, to identify and evaluate circumstances and relationships that create threats to independence; • Evaluate information on identified breaches, if any, of the firm’s independence policies and procedures to determine whether they create a threat to independence for the audit engagement; and • Take appropriate action to eliminate such threats or reduce them to an acceptable level by applying safeguards, or, if considered appropriate, to withdraw from the audit engagement, where withdrawal is permitted by law or regulation. The engagement partner shall promptly report to the firm any inability to resolve the matter for appropriate action. Engagement Partner shall take responsibility for reviews being performed in accordance with the firm’s review policies and procedures. As per SA 220, “Quality Control for Audit of Financial Statements”, for audits of financial statements of listed entities, Engagement Quality Control Reviewer (EQCR), on performing an engagement quality control review, shall also consider the engagement team’s evaluation of the firm’s independence in relation to the audit engagement. In the given case, Engagement Partner is not right. The independence assessment documentation should also be given to Engagement Quality Control Reviewer for his review.
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As per SA 210 ‘Agreeing the Terms of Audit Engagements’, the auditor shall agree the terms of the audit engagement with management or those charged with governance, as appropriate. The agreed terms of the audit engagement shall be recorded in an audit engagement letter or other suitable form of written agreement and shall include: (i) The objective and scope of the audit of the financial statements; (ii) The responsibilities of the auditor; (iii) The responsibilities of management; (iv) Identification of the applicable financial reporting framework for the preparation of the financial statements; and (v) Reference to the expected form and content of any reports to be issued by the auditor and a statement that there may be circumstances in which a report may differ from its expected form and content.
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As per SA 540, “Auditing Accounting Estimates, Including Fair Value Accounting Estimates, and Related Disclosures”, the auditor shall review the outcome of accounting estimates included in the prior period financial statements, or, where applicable, their subsequent re- estimation for the purpose of the current period. The nature and extent of the auditor’s review takes account of the nature of the accounting estimates, and whether the information obtained from the review would be relevant to identifying and assessing risks of material misstatement of accounting estimates made in the current period financial statements. The outcome of an accounting estimate will often differ from the accounting estimate recognised in the prior period financial statements. By performing risk assessment procedures to identify and understand the reasons for such differences, the auditor may obtain: • Information regarding the effectiveness of management’s prior period estimation process, from which the auditor can judge the likely effectiveness of management’s current process. • Audit evidence that is pertinent to the re-estimation, in the current period, of prior period accounting estimates. • Audit evidence of matters, such as estimation uncertainty, that may be required to be disclosed in the financial statements. The review of prior period accounting estimates may also assist the auditor, in the current period, in identifying circumstances or conditions that increase the susceptibility of accounting estimates to, or indicate the presence of, possible management bias. The auditor’s professional skepticism assists in identifying such circumstances or conditions and in determining the nature, timing and extent of further audit procedures. However, the review is not intended to call into question the judgments made in the prior periods that were based on information available at that time. In the given case, the management is not correct in refusing the relevant information to the auditor.
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As per SA 620, Using the work of an Auditor’s Expert, the nature, scope and objectives of the auditor’s expert’s work may vary considerably with the circumstances, as may the respective roles and responsibilities of the auditor and the auditor’s expert, and the nature, timing and extent of communication between the auditor and the auditor’s expert. It is therefore required that these matters are agreed between the auditor and the auditor’s expert. In certain situations, the need for a detailed agreement in writing is required like - • The auditor’s expert will have access to sensitive or confidential entity information. • The matter to which the auditor’s expert’s work relates is highly complex. • The auditor has not previously used work performed by that expert. • The greater the extent of the auditor’s expert’s work, and its significance in the context of the audit. In the given case, considering the complexity involved in the valuation and volume of derivatives and also due to the fact that the auditor and auditor’s expert were new to each other, auditor should have signed a formal agreement/ engagement letter with the auditor’s expert in respect of the work assigned to him.
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Audit Programme of Movie Theatre Complex: (i) Peruse the Memorandum of Association and Articles of Association of the entity. (ii) Ensure the object clause permits the entity to engage in this type of business. (iii) In the case of income from sale of tickets: (1) Verify the control system as to how it is ensured that the collections on sale of tickets of various shows are properly and accurately accounted. (2) Verify the system relating to online booking of various shows and the system of realization of money. (3) Check that there is overall system of reconciliation of collections with the number of seats available for different shows in a day. (iv) Verify the internal control system and its effectiveness relating to the income from café, shops, pubs, game zone etc., located within the multiplex. (v) Verify the system of control exercised relating to the income receivable from advertisements exhibited within the premises and inside the hall such as hoarding, banners, slides, short films etc. (vi) Verify the system of collection from the parking areas in respect of the vehicles parked by the customers. (vii) In the case of payment to the distributors verify the system of payment which may be either through out right payment or percentage of collection or a combination of both. Ensure at the time of settlement, any payment of advance made to the distributor is also adjusted against the amount due. (viii) Verify the system of payment of salaries and other benefits to the employees and ensure that statutory requirements are complied with. (ix) Verify the payments effected in respect of the maintenance of the building and ensure the same is in order. (x) Verify the insurance premium paid and ensure it covers the entire assets.