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Learning objectives
n Explain and discuss the objective of an audit, and the structure of the audit profession within which the audit function is operationalised
n Outline the basic approach to audit and its purpose
n Evaluate the extent to which the audit objective can be obtained given embedded limitations of audit
n Describe the objective, nature, scope and authority of the regulatory framework governing the audit of financial statements of corporate entities registered or listed in Europe
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Reading References
¨ Gray Manson and Crawford, 7th Edition, Chapter 1, 2 and 4
¨ ISA 200 ‘Overall objective of the independent auditor and the conduct of an audit’. International Federation of Accountants (IFAC), International Auditing and Assurance Standards Board (IAASB) at: http://www.ifac.org/iaasb/
For reference and further reading:
o IFAC: http://www.ifac.org/
o Financial press coverage relating to audit quality and oversight
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The Audit Objective and the Auditing Profession
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Objective of an Audit
Objective of an audit (International Standard on Auditing 200, para 11)
(a) To obtain reasonable assurance that the financial statements as a whole are free from material misstatement, whether due to fraud of error, thereby enabling the auditor to express an opinion whether the financial statements are prepared, in all material respects, in accordance with an applicable financial reporting framework, and
(b) to report on the financial statements and communicate as required by the ISAs, in accordance with the auditor’s findings.
Fundamentally linked with concept of Audit QualityThe probability that the auditor will both discover a breach in the client’s accounting system and report a breach in the client’s accounting system (DeAngelo, 1981)
Auditors work within a regulatory framework of: standards, compliance and oversight to enable them to achieve this objective
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The basic approach to auditing
Plan the audit Know the client and business environment Review of accounts Identify areas of riskDocument the accounting and information system Perform analysis and audit testing Prepare an audit reporting expressing an opinionDebrief and start planning (all of the above!!)
This is all done within a framework of professional and ethical standards and legislation – national, regional and international, underpinned by a conceptual framework
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Audit postulates
1. Accountability relationship
2. Remoteness and complexity => need for audit
3. Independence and freedom from constraints
4. Subject matter susceptible to verification by evidence
5. Standards for accountability
6. What is audited has clear meaning
7. An economic or social benefit
Green: justifying the audit; Purple: how the auditor should behave; Blue: functional postulates of collecting evidence and reporting
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Guardian v’s commercial functiono Auditors operate at the cusp between the guardian and commerce
function –embedded conflict
o Audit is a statutory requirement for limited liability companies,
o However, the auditor relies on fees from the clients they audit.
o Guardian functiono Skill and competence and judgement to issue an audit opinion based
on evidence to those who will rely on audited financial statements to make economic decisions
o Acting in the public interest
o Commerce function –o Reliance of fees from the client – audit and non-audit fees
o Reliance on repeat business
o Need to sustain a professional working relationship (with shareholders, directors, stakeholders)
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The structure of the Audit Profession
Auditing firms - Big 4; mid-tier; small
Audit Practitioners - trained/experience professionalsUK & Ireland - CIA, ACCA, ICAS, ICAEWItaly – CNDCECAcross the globe – many!
Regulatory framework:Standards – EU Directives, national company legislations; national and International Standards on Auditing, national and andinternational ethical standards
Compliance – audit profession must comply with auditing standards of practice and behavior (and know the accounting framework they are auditing)
Oversight – monitoring audit quality and auditor behavior, for example in the UK by the Financial Reporting Council
Complex, complicated, conflicted, privilaged arena of work!
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POB report (available from FRC* website)
o Key facts and trends about the accountancy profession in the UKo Big4 audit 99% of FTSE100 companies – oligopoly! o Audit firms:
List of the larger registered audit firmsCorporate structure of the firmsDemographic information (students, gender, age, sector…)Fee income from:
AuditNon-audit work to audit clientsNon-audit work to non-audit clients
Analysis of big 4 fee income, 2018:
• PWC – audit (£676m), NAS to audit clients(£351m); NAS to other (£1975)• KPMG – audit (£548m), NAS to audit clients(£221m); NAS to other (£1403)• EY – audit (£442m), NAS to audit clients(£229m); NAS to other (£1677)• Deloitte – audit (£418m), NAS to audit clients(£214m); NAS to other (£2309)• GT – total = £500
• *Financial Reporting Council – the UK regulator of the audit profession
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We are where we are!
After BHS, after Carillion …(major UK corporate collapses in the UK in 2018)
The CMA’s chairman, Andrew Tyrie, said: “Addressing the deep-seated problems in the audit market is now long overdue. Most people will never read an auditor’s opinion on a company’s accounts. But tens of millions of people depend on robust and high-quality audits. If a company’s books aren’t properly examined, people’s jobs, pensions or savings can be at risk.”
…… the importance of serving the public interest!!!
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Approach to Audit
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What is an audit?
n A systematic process to establish whether assertions made by a reporting entity are credible and can be relied on
n Involves the auditor gathering and evaluating evidence – doing and judging and making decisions
n Auditor remains objective and unbiased
n Auditor adheres to established criteria within a regulatory framework
n The auditor reports the results of the audit to users of the audited information.
n There is a gap in expectations between what auditors do and what users expect them to do
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Purpose of a corporate auditn To give an opinion on the financial statements
n Solely to report to shareholders of an incorporated entity (limited liability, for example, public listed companies)
n Corporate audit is an example of an “assurance engagement”
n Other organisations and entities may require an audit, e.g. charities, universities, trade unions; public sector bodies.
n Other types or reporting may be subject to mandatory or voluntary independent assurance – e.g. Sustainability reporting; reports on payments to governments, listing documents.
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Nature and scope of audit (ISA 200)
n the auditor must exercise professional judgment and maintain professional skepticism and at all times be INDEPENDENT:
¨ Assessing entity; planning the audit; obtaining evidence; forming an opinion
n Requires the auditor to be competent, and experienced, and exhibit appropriate values, attitudes and ethics
n Final communications¨ The audit report¨ Other communication and reporting responsibilities
as determined by ISAs, listing rules and any jurisdiction-specific requirements
¨ Reports to regulators as required
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The Audit Opinion
n In the case of most general purpose frameworks, the auditor opinion is on whether the financial statements is expressed as:¨ “are presented fairly, in all material respects”, or¨ “give a true and fair view”
n Look at an audit report for a listed company and see what information it gives you about the scope, purpose and outcome of the audit.
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The audit opinionn The audit opinion is communicated to users of
financial statements in the Audit Report
¨ audit reports give an opinion on information in the financial statements
¨ Financial statement audit does not give an opinion on performance, [though of course, user assessments of performance may be based on the information in the audited financial statements]
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The need for audit - Accountability and audit!
Separation of ownership from control “a structure for understanding the audit process, placing it … in an accountability context”
Principal and agentsn Shareholders - Principaln Directors - act as agents for the shareholder to manage the
property of shareholders (stewardship); they issue account to the shareholders (accountability)
n Auditor – agent of the shareholder; gathers evidence, evaluates, forms an opinion on the stewardship and accountability role of the Directors
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Embedded limitations of an audit
n Not objective; entails judgmentn Not all items are auditedn Limitations inherent in accounting systemn Non-routine transactionsn Time lag for issuance of audit reportn Audit evidence – may give indication of
‘probability’, not certaintyn Structure of profession and concerns with
independence.
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Is audit justified?
Catastrophic corporate collapses – where were the auditors?: Enron, WorldCom, Parmalat, Global Financial Crisis, Carilleon Group!!!
Global Financial Crisis and audit…
n “The fact that the auditing process failed to highlight developing problems in the banking sector does cause us to question exactly how useful audit currently is. We are perturbed that the process results in ‘tunnel vision’, where the big picture that shareholders want to see is lost in a sea of detail and regulatory disclosures” (UK Government report)
n In April 2014, the European Parliament introduced new, stricter regulation of the audit profession and its duties, to increase stakeholder confidence in audit function by enhancing auditor independence and oversight.
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Is an audit useful? UK Parliamentary committees) hold … joint inquiry into Carillion (UK Construction company), which finally collapsed in January 2018 with the firm owing financial creditors well over £1 billion, a further £2bn to suppliers, and carrying an eye-watering £2.3bn pensions liability: just months after being signed off as a going concern by auditors KPMG.
¨ “How did KPMG sign off accounts that had £845 million written off their value four months later?”
(Commons Select Committee, Feb 2018)
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The Regulatory Framework for Auditing
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Remember - The justification for audit¨ Shareholders (and credit providers) providing resources
to directors
¨ Directors entrusted with the resourcesn Information gapn Agency risk
¨ Auditor is an agent for those shareholders – statutory duty
¨ General rule – limited liability companies require an audit
n Small company exemptionsn Never exempt (for example: PIE – unless dormant;
banks; insurance
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How does the auditor meet this roleComplying with the regulatory framework
¨ Starting point = complying with Companies Act 2006 (Part 16)n Broad and detailed statutory framework
n Delegates authority to other bodies for detailed standards and guidance
n Determines who can become an auditor and delegates authority to other bodies to operationalise
Process -¨ ~Standards [of behaviour and practice and education]
n ~~Compliance
¨ ~~~Oversight
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Overview of types of regulationn Legislation – UK law (and EU post-Brexit)
n Delegated authority to FRC¨ Note that FRC is currently in place but will replaced (no date set
yet) by the Auditing, Reporting and Governance Authority in the near future. This new body will be directly accountable to parliament.
n Standards, …standards and more standards¨ National, for example:
n ISA (UK), FRS 101-105, UK Corporate Governance Code, FRC Ethical Standard
¨ International, for examplen ISAs; IFRS/IAS; IFAC Code of Ethics
¨ Public sector, for-profit sector, not-for-profit sector (at national and international level)
n As an auditor, depending on the organisation you are auditing, you will have to know which standards are relevant for you to conduct the audit competently, over and above audit specific standards.
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Institutional nature of regulationThe rights, responsibilities and duties of auditors are regulated by various
means:
n Legal regulation [Coersive] (Company Law and Case Law)
n Professional regulation [Normative]¨ national and international professional standards¨ additional pronouncements¨ professional body membership requirements¨ oversight:
n of firms and oversight of professional bodies and oversight of professional members
n Other regulatory requirements may be legal or professional and including best practice guidance (for example, the Corporate Governance requirements and the Stock Exchange rules, Financial Services Authority, and sector-specific regulatory requirements)
n Voluntary: a reporting entity may adopt voluntary reporting standards and the auditor may be asked to give some level of assurance over such voluntary reporting requirements.
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Who can be an auditor?
EU Directives (CA2006 in the UK) sets out rules, detail of which is delegated to FRC and professional bodies
Only personsn Appropriately qualifiedn Properly supervisedn Awarded registered auditor status
Terminology – statutory auditor/registered auditor
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Statute: RSB and RQB
n Transposed from EU Directives, which: ¨ formalised the delegation to professional bodies ¨ Introduced: [RSB] Recognised Supervisory Body; [RQB]
Recognised Qualifying Body
n Deals with eligibility to be an auditor¨ be member of an RSB and satisfy its rules and be qualified with a
RQB¨ audit practice certificate¨ and includes some older legislation on ineligibility (eg the auditor
may not be an “officer or servant” of a company) ¨ (but note that Ethical Standards say a lot more about this ….
threats to independence!)¨ Certain professional bodies have additional practical experience
requirements
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RSB and RQBMust be appropriately qualified
n RQB – issuing an appropriate professional accounting qualification (ICAS, ICAEW, CAI, ACCA, CIPFA, AIA)¨ Must have suitable standards for entrance, practical experience,
formalised exam structure
Must be properly supervisedn RSB – responsible for supervising the activities of its members (ICAS,
ICAEW, CAI, ACCA,); Requirements: ¨ Systems in place to register audit firms; ¨ to monitor the work of audit firm; ¨ Rules re eligibility to be an auditor; ¨ Systems to deal with complaints; ¨ Procedures to maintain competence; ¨ Disciplinary procedures
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Summary
n There is a clear audit objective to be achieved as stipulated in ISA 200
n This audit objective is achieved within the existing structure of the audit profession, following an approach to audit that is regulated through legislations, standards and oversight
n The audit opinion is the culmination of gathering sufficient appropriate audit evidence, by competent, experience auditors who act independently and apply professional scepticism and judgement throughout the audit
n The audit regulatory framework captures audit practice, auditor behaviour and auditor education.
Thank you J
