essential issues in audit workshop: a practical approach · essential issues in audit workshop: a...

Essential Issues in Audit Workshop: A PracticalApproach

February 2016

Essential Issues in Audit Workshop: A PracticalApproach

February 2016

12/02/2016Uphold Public Interest

AUDITING ACCOUNTING ESTIMATES,INCLUDING FAIR VALUE ACCOUNTINGESTIMATES, AND RELATED DISCLOSURES –ISA 540

USING THE WORK OF INTERNAL AUDITORS– ISA 610

USING THE WORK OF AN AUDITOR'SEXPERT – ISA 620

AUDITING ACCOUNTING ESTIMATES,INCLUDING FAIR VALUE ACCOUNTINGESTIMATES, AND RELATED DISCLOSURES –ISA 540

USING THE WORK OF INTERNAL AUDITORS– ISA 610

USING THE WORK OF AN AUDITOR'SEXPERT – ISA 620

12/02/2016 Uphold Public Interest 2

Auditing Accounting Estimates, Including FairValue Accounting Estimates, and Related

Disclosures

Auditing Accounting Estimates, Including FairValue Accounting Estimates, and Related

Disclosures


To obtain sufficient appropriate audit evidenceabout whether accounting estimates, including fair value

accounting estimates, in the financial statements,whether recognized or disclosed, are reasonable;and related disclosures are adequate,

in the context of the applicable financialreporting framework

To obtain sufficient appropriate audit evidenceabout whether accounting estimates, including fair value

accounting estimates, in the financial statements,whether recognized or disclosed, are reasonable;and related disclosures are adequate,

in the context of the applicable financialreporting framework


Some financial statement itemscannot be measured precisely, butcan only be estimated. Theseitems are accounting estimates.

An accounting estimate is anapproximation of a monetaryamount in the absence of aprecise means of measurement.This term is used for an amountmeasured at fair value where thereis estimation uncertainty, as wellas for other amounts that requireestimation.

Some financial statement itemscannot be measured precisely, butcan only be estimated. Theseitems are accounting estimates.

An accounting estimate is anapproximation of a monetaryamount in the absence of aprecise means of measurement.This term is used for an amountmeasured at fair value where thereis estimation uncertainty, as wellas for other amounts that requireestimation.


Examples of judgmental estimates included infinancial statement items?

Examples of judgmental estimates included infinancial statement items?


Receivables — Uncollectible receivables — Allowance for loan losses — Valuation of long-term

unconditional promises to give

Inventories — Obsolete inventory — Net realizable value of inventories

when future selling prices and futurecosts are involved

— Losses on purchase commitments

Revenues — Airline passenger revenue — Subscription income — Freight and cargo revenue

Contracts — Revenue to be earned — Costs to be incurred — Percent of completion

Leases — Initial direct costs — Executory costs

Financial instruments — Valuation of securities — Probability of high correlation of a

hedge — Sales of securities with puts and calls

Receivables — Uncollectible receivables — Allowance for loan losses — Valuation of long-term

unconditional promises to give

Inventories — Obsolete inventory — Net realizable value of inventories

when future selling prices and futurecosts are involved

— Losses on purchase commitments

Revenues — Airline passenger revenue — Subscription income — Freight and cargo revenue

Contracts — Revenue to be earned — Costs to be incurred — Percent of completion

Leases — Initial direct costs — Executory costs

Financial instruments — Valuation of securities — Probability of high correlation of a

hedge — Sales of securities with puts and calls


Productive facilities, natural resources,and intangibles

— Useful lives and residual values — Depreciation and amortization

methods — Impairment analysis — Recoverability of costs

Accruals — Property and casualty insurance

company loss reserves — Compensation in stock option plans

and deferred plans — Warranty claims — Actuarial assumptions in benefit

costs

Litigation — Probability of loss — Amount of loss

Other — Fair values in nonmonetary

exchanges

Productive facilities, natural resources,and intangibles

— Useful lives and residual values — Depreciation and amortization

methods — Impairment analysis — Recoverability of costs

Accruals — Property and casualty insurance

company loss reserves — Compensation in stock option plans

and deferred plans — Warranty claims — Actuarial assumptions in benefit

costs

Litigation — Probability of loss — Amount of loss

Other — Fair values in nonmonetary

exchanges


Gain an understanding of the data on which they arebased including:- the method and model used in making the accounting

estimate; relevant controls; whether management has used an expert; the assumptions underlying the accounting estimates; whether there has been, or ought to have been, a

change from the prior period in the methods for makingthe accounting estimates, and if so, why; and

whether and, if so, how management has assessed theeffect of estimation uncertainty (the susceptibility of anaccounting estimate and related disclosures to an inherent lack ofprecision in its measurement).

Gain an understanding of the data on which they arebased including:- the method and model used in making the accounting

estimate; relevant controls; whether management has used an expert; the assumptions underlying the accounting estimates; whether there has been, or ought to have been, a

change from the prior period in the methods for makingthe accounting estimates, and if so, why; and

whether and, if so, how management has assessed theeffect of estimation uncertainty (the susceptibility of anaccounting estimate and related disclosures to an inherent lack ofprecision in its measurement).


Evaluating the degree of estimationuncertainty associated with an accountingestimate includes consideration of:- Level of judgment involved Sensitivity to changes in assumptions Extent to which the estimate is based on

observable or unobservable inputs

Evaluating the degree of estimationuncertainty associated with an accountingestimate includes consideration of:- Level of judgment involved Sensitivity to changes in assumptions Extent to which the estimate is based on

observable or unobservable inputs


The auditor should review the judgments anddecisions made by management in makingaccounting estimates to identify whether thereare indicators of possible management bias:- Susceptibility of an estimate to management bias

increases with subjectivity involved Indicators may affect auditor’s conclusion of

whether risk assessment or responses remainappropriate, but do not themselves constitutemisstatements for purposes of concluding onreasonableness of individual estimates

The auditor should review the judgments anddecisions made by management in makingaccounting estimates to identify whether thereare indicators of possible management bias:- Susceptibility of an estimate to management bias

increases with subjectivity involved Indicators may affect auditor’s conclusion of

whether risk assessment or responses remainappropriate, but do not themselves constitutemisstatements for purposes of concluding onreasonableness of individual estimates


Changes in an accounting estimate or method wheremanagement has made a subjective assessment thatthere has been a change in circumstances

Use of an entity’s own assumptions for fair value whenthey are inconsistent with observable marketplaceassumptions

Selection or construction of significant assumptionsthat yield a point estimate favorable to management’sobjectives

Selection of a point estimate that may indicate apattern of optimism or pessimism

Changes in an accounting estimate or method wheremanagement has made a subjective assessment thatthere has been a change in circumstances

Use of an entity’s own assumptions for fair value whenthey are inconsistent with observable marketplaceassumptions

Selection or construction of significant assumptionsthat yield a point estimate favorable to management’sobjectives

Selection of a point estimate that may indicate apattern of optimism or pessimism


In response to assessed risks, considerwhether specialized skills or knowledge inrelation to aspects of the accountingestimate are needed to obtain sufficientappropriate audit evidence Individuals become part of the engagement

team if the matters are accounting- andauditing-related Those with experience in a field other than

accounting or auditing are consideredauditor’s experts (ISA 620)

In response to assessed risks, considerwhether specialized skills or knowledge inrelation to aspects of the accountingestimate are needed to obtain sufficientappropriate audit evidence Individuals become part of the engagement

team if the matters are accounting- andauditing-related Those with experience in a field other than

accounting or auditing are consideredauditor’s experts (ISA 620)


Obtain sufficient appropriate auditevidence about whether disclosuresrelated to accounting estimates are inaccordance with the applicablefinancial reporting framework

For estimates giving rise to significant risks,also evaluate the adequacy of thedisclosure of estimation uncertainty in thecontext of the applicable financialreporting framework

Obtain sufficient appropriate auditevidence about whether disclosuresrelated to accounting estimates are inaccordance with the applicablefinancial reporting framework

For estimates giving rise to significant risks,also evaluate the adequacy of thedisclosure of estimation uncertainty in thecontext of the applicable financialreporting framework


The auditor must obtain written representationsfrom management and those charged withgovernance, saying that they believe significantassumptions used in making their accountingestimates are reasonable.Representations alone do not constitute sufficient

appropriate audit evidence

The auditor must include in the auditdocumentation the basis for the conclusions aboutthe reasonableness of accounting estimates andtheir disclosure that give rise to significant risks; andindicators of possible management bias, if any.

The auditor must obtain written representationsfrom management and those charged withgovernance, saying that they believe significantassumptions used in making their accountingestimates are reasonable.Representations alone do not constitute sufficient

appropriate audit evidence

The auditor must include in the auditdocumentation the basis for the conclusions aboutthe reasonableness of accounting estimates andtheir disclosure that give rise to significant risks; andindicators of possible management bias, if any.


Obtaining an understanding of howmanagement (or owner-manager) identifiesthe need for accounting estimates is oftenrelatively straightforward

The ISA allows for different approaches forresponding to assessed risks depending on thenature of the accounting estimate

In many cases (other than for fair valueestimates), review of events occurring up to thedate of the auditor’s report may be aneffective and efficient approach

Obtaining an understanding of howmanagement (or owner-manager) identifiesthe need for accounting estimates is oftenrelatively straightforward

The ISA allows for different approaches forresponding to assessed risks depending on thenature of the accounting estimate

In many cases (other than for fair valueestimates), review of events occurring up to thedate of the auditor’s report may be aneffective and efficient approach


USING THE WORK OF ANAUDITOR’S EXPERT

USING THE WORK OF ANAUDITOR’S EXPERT


An individual ororganization

Expertise other thanaccounting or auditing


Auditor’sExpert

Internal or external to thefirm

Assists the auditor inobtaining sufficient

appropriate auditevidence

Standard requires overriding question tobe asked: Is an auditor’s expert neededfor the engagement? Risk may increase when other expertise is

needed to prepare the financial statements Engagement partner should be satisfied that

engagement team collectively has appropriatecompetence and capabilities

Keep the situation under review as the auditprogresses − circumstances may change

Standard requires overriding question tobe asked: Is an auditor’s expert neededfor the engagement? Risk may increase when other expertise is

needed to prepare the financial statements Engagement partner should be satisfied that

engagement team collectively has appropriatecompetence and capabilities

Keep the situation under review as the auditprogresses − circumstances may change


Relevant considerations Nature, significance and complexity of the matter Has management used an expert? What are the related risks of material misstatement? What sort of procedures are likely to be necessary?

An auditor’s expert not always needed in everycase In some cases, the auditor, although not an expert,

may have enough understanding of a field to performthe audit without an auditor’s expert

Relevant considerations Nature, significance and complexity of the matter Has management used an expert? What are the related risks of material misstatement? What sort of procedures are likely to be necessary?

An auditor’s expert not always needed in everycase In some cases, the auditor, although not an expert,

may have enough understanding of a field to performthe audit without an auditor’s expert


Relevant considerations include Is the auditor’s expert’s work subject to professional or

industry requirements? Is the expert’s competence relevant to the matter at

hand? Is any accounting or auditing competence expected

in addition to competence in the expert’s particularfield and, if so, does the expert possess thatcompetence?

Do changing circumstances indicate a need toreconsider initial evaluation as the audit progresses?

Various sources of information may be used

Relevant considerations include Is the auditor’s expert’s work subject to professional or

industry requirements? Is the expert’s competence relevant to the matter at

hand? Is any accounting or auditing competence expected

in addition to competence in the expert’s particularfield and, if so, does the expert possess thatcompetence?

Do changing circumstances indicate a need toreconsider initial evaluation as the audit progresses?

Various sources of information may be used12/02/2016 Uphold Public Interest 21

Independence Objectivity required for all auditor’s

experts Use “threats and safeguards” approach

to evaluate objectivity Are threats to objectivity, e.g., familiarity and

self-review, eliminated or reduced to anacceptable level by safeguards?

A number of procedures may beperformed to evaluate objectivity

Independence Objectivity required for all auditor’s

experts Use “threats and safeguards” approach

to evaluate objectivity Are threats to objectivity, e.g., familiarity and

self-review, eliminated or reduced to anacceptable level by safeguards?

A number of procedures may beperformed to evaluate objectivity


Understanding needs to be sufficient todetermine nature, scope and objectives ofthe expert’s work and to evaluate theadequacy of that work for the auditor’spurposes Understand relevant aspects of the expert’s field The auditor does not need to become expert in

the field himself or herself

Sources of information similar to those whenevaluating the expert’s competence,capabilities and objectivity

Understanding needs to be sufficient todetermine nature, scope and objectives ofthe expert’s work and to evaluate theadequacy of that work for the auditor’spurposes Understand relevant aspects of the expert’s field The auditor does not need to become expert in

the field himself or herself

Sources of information similar to those whenevaluating the expert’s competence,capabilities and objectivity


Agreement is always needed Nature, scope and objectives of the expert’s work Respective roles and responsibilities of the auditor and

the expert Communication between the auditor and the expert Need for the expert to observe confidentiality

requirements Level of detail and formality of the agreement Use a “sliding scale” approach

Agreement need not always be formally in writing

Agreement is always needed Nature, scope and objectives of the expert’s work Respective roles and responsibilities of the auditor and

the expert Communication between the auditor and the expert Need for the expert to observe confidentiality

requirements Level of detail and formality of the agreement Use a “sliding scale” approach

Agreement need not always be formally in writing


Evaluate for the auditor’s purposes The expert’s findings or conclusions The expert’s assumptions and methods

(when significant to the expert’s work) The source data used by the expert (when

significant to the expert’s work)

Evaluate for the auditor’s purposes The expert’s findings or conclusions The expert’s assumptions and methods

(when significant to the expert’s work) The source data used by the expert (when

significant to the expert’s work)


No reference to the auditor’s expert inunmodified auditor’s report Unless required by law or regulation (Not in Kenya) If required, indicate that the reference does not

reduce the auditor’s responsibility

If reference is needed in relation to amodification Indicate that the reference does not reduce the

auditor’s responsibility

May need expert’s permission to makereference

No reference to the auditor’s expert inunmodified auditor’s report Unless required by law or regulation (Not in Kenya) If required, indicate that the reference does not

reduce the auditor’s responsibility

If reference is needed in relation to amodification Indicate that the reference does not reduce the

auditor’s responsibility

May need expert’s permission to makereference


ISA 610 (REVISED 2013)USING THE WORK OF INTERNAL AUDITORS


An effective internal audit function cansignificantly strengthen the monitoring ofcontrol.

ISA 610(R) recognises that an external auditoris able to use the work of an internal auditorto assist in an audit engagement and incertain instances, be part of the engagementteam.

Extent of reliance is dependent on evaluationof internal audit function by external auditor.

An effective internal audit function cansignificantly strengthen the monitoring ofcontrol.

ISA 610(R) recognises that an external auditoris able to use the work of an internal auditorto assist in an audit engagement and incertain instances, be part of the engagementteam.

Extent of reliance is dependent on evaluationof internal audit function by external auditor.


Differences are: Objectives Independence

For an external audit, elements areregulated by legislation. For an internal audit, elements are

determined by management.

Differences are: Objectives Independence

For an external audit, elements areregulated by legislation. For an internal audit, elements are

determined by management.


In evaluating internal audit, externalauditors should consider: Organisational status; Scope of internal auditing; Technical competence; and Due professional care.

In evaluating internal audit, externalauditors should consider: Organisational status; Scope of internal auditing; Technical competence; and Due professional care.


The overall responsibility for audit engagementremains with an external auditor.

The external auditor is required to undertakegeneral evaluation as part of review of internalcontrols.

If the external auditor plans to rely on internalaudit, they should carefully review internalauditor’s working papers and procedures toensure testing is sufficient to meet theirrequirements, and that conclusions outlined inworking papers are appropriate.

The overall responsibility for audit engagementremains with an external auditor.

The external auditor is required to undertakegeneral evaluation as part of review of internalcontrols.

If the external auditor plans to rely on internalaudit, they should carefully review internalauditor’s working papers and procedures toensure testing is sufficient to meet theirrequirements, and that conclusions outlined inworking papers are appropriate.


Amendments introduced in 2013 - ISA 610 (Revised2013) with an effective date for audits of financialstatements for periods ending on or after December15, 2014 for the section on - the use of internal auditorsto provide direct assistance.

Review Objectivity and Competence of the internalauditor

Internal Audit Direct Assistancei. may be prohibited by law or regulation from obtaining

direct assistance;ii. evaluate the existence and significance of threats to

objectivity and the level of competence of the internalauditors who will be providing such assistance.

Amendments introduced in 2013 - ISA 610 (Revised2013) with an effective date for audits of financialstatements for periods ending on or after December15, 2014 for the section on - the use of internal auditorsto provide direct assistance.

Review Objectivity and Competence of the internalauditor

Internal Audit Direct Assistancei. may be prohibited by law or regulation from obtaining

direct assistance;ii. evaluate the existence and significance of threats to

objectivity and the level of competence of the internalauditors who will be providing such assistance.


Performance of procedures that:a. involve making significant judgments in the audit

b. relate to higher assessed risks of material misstatementwhere the judgment required in performing therelevant audit procedures or evaluating the auditevidence gathered is more than limited

c. relate to work with which the internal auditor havebeen involved and which has already been, or will be,reported to management or those charged withgovernance by the internal audit function

d. Relate to decisions the external auditor makes inaccordance with this ISA regarding the internal auditfunction and the use of its work or direct assistance

Performance of procedures that:a. involve making significant judgments in the audit

b. relate to higher assessed risks of material misstatementwhere the judgment required in performing therelevant audit procedures or evaluating the auditevidence gathered is more than limited

c. relate to work with which the internal auditor havebeen involved and which has already been, or will be,reported to management or those charged withgovernance by the internal audit function

d. Relate to decisions the external auditor makes inaccordance with this ISA regarding the internal auditfunction and the use of its work or direct assistance


When using the internal auditor to provide directassistance, the external auditor shall:-

a. obtain written agreement from an authorized representative of theentity that the internal auditors will be allowed to follow theexternal auditor’s instructions, and that the entity will not intervenein the work the internal auditor performs for the external auditor

b. obtain written agreement from the IAs that they will keepconfidential specific matters as instructed by the external auditorand inform the external auditor of any threat to their objectivity.

c. direct, supervise and review the work performed by internalauditors {nature, timing and extent of direction, supervision, andreview - checking back to the underlying audit evidence }

When using the internal auditor to provide directassistance, the external auditor shall:-

a. obtain written agreement from an authorized representative of theentity that the internal auditors will be allowed to follow theexternal auditor’s instructions, and that the entity will not intervenein the work the internal auditor performs for the external auditor

b. obtain written agreement from the IAs that they will keepconfidential specific matters as instructed by the external auditorand inform the external auditor of any threat to their objectivity.

c. direct, supervise and review the work performed by internalauditors {nature, timing and extent of direction, supervision, andreview - checking back to the underlying audit evidence }


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